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It's true that why the price levels change can make a difference. What I wrote was meant as examples of the type of relations that are there. You're still wron

It's true that why the price levels change can make a difference. What I wrote was meant as examples of the type of relations that are there. You're still wrong or at least extremely misleading in your characterization of how the money supply behaves. First of all, base money is really almost entirely an implementation detail of interbank settlement and decoupled from the real economy.[1] Because of that, the focus on base money is wrong-headed and you should look at broad money instead. Broad money grows and shrinks almost entirely due to commercial bank lending and loan repayment. The central bank has no influence on that. It is technically correct that base money can only be changed by central bank actions, but that is a somewhat misleading statement, because the focus should be on what the chains of causality are. We've had a perfect experiment for that in the last few years due to quantitative easing. There, central banks tried to affect the real economy by being the initial cause of a change in the money supply. Well, they successfully raised the size of base money to totally unprecedented levels, but that had virtually no effect on the broader money levels, let alone on the real economy. All other central bank actions that change the size of base money are actually done as a reaction to demand by commercial banks, which in turn is a consequence of commercial bank lending. Because in any case, central banks haven't even usually targeted the size of the money supply as a matter of policy. The policy has been to target a level of interbank interest rate, and let the size of the base money supply go wherever it needed to in order to accommodate the interest rate. And when central banks tried to target the money supply via quantitative easing, which was only tried when the interest rate was already effectively at 0, the evidence is that it had virtually no effect. There is no causal chain in practice[2] that starts with the central bank deciding to change the size of the money supply and goes into changes in price or output. [1] It's even decoupled from the major financial markets that people are usually interested in. [2] Of course, in theory central banks could just go nuts and start targeting the money supply in crazy ways. But even in that case, they can't just decide to cut or grow the money supply arbitrarily (because they need to find a commercial bank counterparty for what they want to do). And further, due to the decoupling of base money and broader money, the causal chain would go mostly via the effect that the base money changes have on interest rates, which is a very different story from the one that you probably wanted to tell.

nickik 10y ago
I agree that one usually looks at broad money, but this essentially all boils down to claims on base money. It is my hole argument the bank system produces this money, and that a good montary system, including banks, optimally should pruce stability of nominal spending. I think you are wrong about QE, if you look at NGDP you can see that the US went back to a stable growth after a while. Europe and others who did far less, never managed to do that and thus has a way worse recovery. The Fed made a effort to make sure to prevent that money from getting out, paying interest on reserves, explicitly insuring everybody that they will not allow inflation over 2% and they did otherthings besides. If you look at NGDP you see a big drop in 2008/2009 and then stady growth again. What they would have to do was go back to the pre crisis trendline, and they refused to do so explicitly. The Fed targets price level, not interest rates, interest rates are just the policy rate of choice. A inflation target is just a perticular form of demand side target, NGDP is another, superior demand side target. The liquidity trap idea is flawed because if you take the argument to its logical conclusion the Fed could buy all the worlds debt without it impacting the domestic price level. If you look broader then the US you will see that the idea of the liquidity trap has essentially been demolished, multible countries easly expanded on zero rates. Switzerland did it for example. The problem is not that there is a real effect, the prolem is that modern central banker only know how to deal with interest rates based models, and consider everything else 'unconventional'. Most of these things simply are not 'unconventional', the are traditional instruments that central banks have used for 100s of years. I would also say that the interest rate is not the only transition mechanism, and not the one monetarists focus on.
- nhaehnle 10y ago
  Why do you believe that the difference between the developments in the US and Europe is explained by different central bank behavior, when there is also a huge difference in effective fiscal policy behavior that is consistent with the difference in outcome? You're right though that central banks really target inflation. Inflation -> Interest rate -> Market transactions. If you look broader then the US you will see that the idea of the liquidity trap has essentially been demolished, multible countries easly expanded on zero rates. Switzerland did it for example. The talk about a liquidity trap doesn't actually say that growth is impossible at an interest rate of zero. What it does say is that if you're at an interest rate of zero without growth, the usual monetary theory policy prescription of "just decrease the interest rate" doesn't work. I wouldn't say that that's discredited just yet, even though some central banks have started to implement mildly negative interest rates. The proof of the pudding would be if a country implemented significantly negative interest rates, but that would force commercial banks to charge negative interest rates on regular bank accounts, and nobody wants to go there (for good reason IMO - messing with institutions like that is not something you do lightly). I would also say that the interest rate is not the only transition mechanism, and not the one monetarists focus on. Can you explain that? So far, whenever I've talked to people about this issue, they usually don't come up with any alternative transmission mechanisms at all (i.e. it's all hand-waving and fuzziness/buzzwords), or ones that actually misunderstand what's going on (e.g. confusing open market operations, which are asset neutral, with "helicopter drops" that are basically fiscal policy in disguise).

nickik 10y ago

I agree that one usually looks at broad money, but this essentially all boils down to claims on base money. It is my hole argument the bank system produces this money, and that a good montary system, including banks, optimally should pruce stability of nominal spending. I think you are wrong about QE, if you look at NGDP you can see that the US went back to a stable growth after a while. Europe and others who did far less, never managed to do that and thus has a way worse recovery. The Fed made a effort to make sure to prevent that money from getting out, paying interest on reserves, explicitly insuring everybody that they will not allow inflation over 2% and they did otherthings besides. If you look at NGDP you see a big drop in 2008/2009 and then stady growth again. What they would have to do was go back to the pre crisis trendline, and they refused to do so explicitly. The Fed targets price level, not interest rates, interest rates are just the policy rate of choice. A inflation target is just a perticular form of demand side target, NGDP is another, superior demand side target. The liquidity trap idea is flawed because if you take the argument to its logical conclusion the Fed could buy all the worlds debt without it impacting the domestic price level. If you look broader then the US you will see that the idea of the liquidity trap has essentially been demolished, multible countries easly expanded on zero rates. Switzerland did it for example. The problem is not that there is a real effect, the prolem is that modern central banker only know how to deal with interest rates based models, and consider everything else 'unconventional'. Most of these things simply are not 'unconventional', the are traditional instruments that central banks have used for 100s of years. I would also say that the interest rate is not the only transition mechanism, and not the one monetarists focus on.

nhaehnle 10y ago
Why do you believe that the difference between the developments in the US and Europe is explained by different central bank behavior, when there is also a huge difference in effective fiscal policy behavior that is consistent with the difference in outcome? You're right though that central banks really target inflation. Inflation -> Interest rate -> Market transactions. If you look broader then the US you will see that the idea of the liquidity trap has essentially been demolished, multible countries easly expanded on zero rates. Switzerland did it for example. The talk about a liquidity trap doesn't actually say that growth is impossible at an interest rate of zero. What it does say is that if you're at an interest rate of zero without growth, the usual monetary theory policy prescription of "just decrease the interest rate" doesn't work. I wouldn't say that that's discredited just yet, even though some central banks have started to implement mildly negative interest rates. The proof of the pudding would be if a country implemented significantly negative interest rates, but that would force commercial banks to charge negative interest rates on regular bank accounts, and nobody wants to go there (for good reason IMO - messing with institutions like that is not something you do lightly). I would also say that the interest rate is not the only transition mechanism, and not the one monetarists focus on. Can you explain that? So far, whenever I've talked to people about this issue, they usually don't come up with any alternative transmission mechanisms at all (i.e. it's all hand-waving and fuzziness/buzzwords), or ones that actually misunderstand what's going on (e.g. confusing open market operations, which are asset neutral, with "helicopter drops" that are basically fiscal policy in disguise).