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The Conservative Case for QE2, Or, Why I Still Will Not Be an Austrian.

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The Conservative Case for QE2, Or, Why I Still Will Not Be an Austrian.

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Lagrange multiplier posted on Wed, Jan 19 2011 5:11 PM

In The Conservative Case for QE2, David Beckworth provides a quasi-monetarist defense for the second round of quantitative easing.

He states that the purpose of QE2 is "about fixing a spike in the demand for money that has significantly hampered spending." He elaborates, "Because the monetary base has been increasing so rapidly and there has been very little inflation, it must be the case that demand for the money must be increasing even more. In fact, money demand has been so pronounced that even the previous $1.2 trillion increase in the monetary base was not enough to prevent outright deflation in 2009 or a sustained decline in core inflation (which shows the trend path of inflation) over the past two years. Thus, a significant portion of the money supply is being hoarded and not spent. This is the excess-money-demand problem."

In essence, the Federal Reserve has failed in the same regard that Milton Friedman blamed it for the Great Depression: "The fact that total current-dollar spending has remained depressed for so long means that the Federal Reserve has failed to do its job and effectively has kept monetary policy too tight." The solution is produced by the new monetary policy: "QE2, then, is a long-overdue attempt by the Federal Reserve to address the excess-money-demand problem. It will do so in two complementary ways. First, QE2 will increase inflation expectations, which should reduce the demand for money. Knowing that prices will be higher in the future will motivate creditor households, firms, and banks to start spending their money today while prices are lower. Second, QE2 will increase the monetary base, and this should begin to satiate excess money demand. Together, these developments should provide the catalyst needed to get the virtuous spending cycle started."

And, of course, lowered-interest rates are not necessarily problematic: "Note that lower long-term interest rates are not the key to QE2 working. Yes, long-term interest rates may initially drop as the Federal Reserve buys up long-term Treasury securities to increase the monetary base. But this effect will be fleeting if QE2 is successful. Once the economy starts recovering, interest rates will start increasing. Similarly, QE2 may initially cause the dollar to lose value, but by spurring a recovery QE2 will ultimately put upward pressure on the dollar."

Bob Murphy responds to Beckworth's quasi-monetarism with several Austrian challenges.

In turn, Bill Woolsey responds, once again pleading the quasi-monetarist case.  David Beckworth, too, responds to Bob Murphy. He summarizes his key points skillfully: "During 2008 there emerged a surge in money demand as the housing fiasco began to unfold. This spike in money demand got even more pronounced in late 2008 with the uncertainty created by the financial crisis. Given that we have a central bank — and this is not an endorsement of the Fed — its job should be to offset and stabilize such money demand shocks. The Fed failed on this count and, as a result, what should have been an ordinary recession got turned into the 'Great Recession' of 2007-2009. Yes, this Fed failure — like its failure to raise the federal funds to its natural rate level sooner in the 2002-2004 period — is another indication the Fed is flawed. Nonetheless, we are stuck with this monopoly producer of money and have to work with it. This means the Fed should have done more to prevent the surge in money demand. Because it did not, the Fed effectively tightened monetary policy in 2008. Moreover, despite the large increases in the monetary base to date, money demand remains elevated. From this perspective, then, monetary policy is still relatively tight. QE2 is an attempt — a flawed one as I will discuss later — to address it."

He adds, "Appreciating the importance of money demand shocks also helps explain why conservative economists like Scott Sumner, Bill Woosley, Josh Hendrickson, and I are sympathetic in spirit (if not in form) to QE2. It would do all hard-money advocates some good to wrestle with the monetary disequilibrium literature and its implication for a commodity standard. It is worth noting that there are prominent Austrians like George Selgin and Steve Horwitz who take the monetary disequilibrium seriously."

I think the money demand shock, given our monopolized currency, can only be treated through the machinery of the Federal Reserve; given the excess money demand, greater supply is required.

P.S. I fully endorse free banking.

"I'm not a fan of Murray Rothbard." -- David D. Friedman

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Autolykos replied on Fri, Jan 21 2011 9:44 PM

DD5:
same page.

Wait, which page is that? You didn't actually answer my question, so I'm still not sure what you mean by "money supply in circulation".

DD5:
No.  it could mean an increase in another commodity.

I do see your point. Then again, a lower price for a product means that people aren't willing to pay as much money for it, which means they prefer to keep more of their money vis-a-vis that product... right?

DD5:
MET - Monetary Equilibrium Theory.

Ah, thanks.

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Smiling Dave replied on Fri, Jan 21 2011 11:46 PM

EDIT: double post

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Smiling Dave replied on Fri, Jan 21 2011 11:47 PM

Since you are so rude, I do not consider you worthy of further reply.

Perhaps someone else will come forward. I find interaction with you distasteful.

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Zachary Plaxco replied on Sat, Jan 22 2011 4:11 AM

You must be joking.  Your reply to Esuric was rather rude and uncompromising, and now that he thorougly discredited your position you refuse to reply because he is "rude."  You implied he has a lack of common sense, and that he has no understanding of Austrian economics...

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Smiling Dave replied on Sat, Jan 22 2011 6:37 AM

Uncompromising yes. If someone says 2+2=5, am I to compromise on 4 and a half?

Rude in reply to his previous rudeness. But it gets tiresome to deal with after a while.

Someones position has been thoroughly discredited, but it's not mine.

All he did was acknowledge that what Mises called a meteor that wiped out the town, he's willing to admit is a pebble.

TY for your input.

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Esuric replied on Sat, Jan 22 2011 7:52 AM

Autolykos:
To build upon my last post, I fail to see how demand for money is really any different from demand for other commodities. In the absence of a price ceiling, is there ever any "excess demand" for a particular commodity? No -- as the demand for the commodity rises, ceteris paribus, the price will rise.

It's far more complicated than this and I don't fully understand it myself. But before I get into my explanation I think it's important to go over Mises' typology of economic goods. Mises breaks it down into three distinct categories; first, there are the consumer goods, then there are the producer goods, and finally there are "media of exchange," i.e., money. This third and final category is a good and class in itself. The natural rate of interest is determined solely by the ratio of demand between consumer goods (consumption) and producer goods (saving), but is not affected by alterations in monetary conditions.

Okay, so let's imagine a simple two good economy where individuals can choose between either x1 or x2. In period t1, the total supply of x1 equals 20 and the total supply of x2 equals 20 as well. As the demand, and therefore price of x1 rises (say by 50%), the demand (and therefore price) of x2 must necessarily fall (by 50%). But the process doesn't end here. The alteration in the relative structure of prices will cause capital to "flow" from sector x2 towards sector x1 so that the supply of x1 in period t2 will equal 30, and the supply of x2 in period t2 will equal 10 (equalizing profits across both industries). Prices guide production. In the aggregate, though, there is no change in total output; the only thing that has changed is the direction of investment, and the composition total consumer goods produced.

Now let's include another good into our simple economy, call it x3, and it will represent money. What happens when the demand for x3 rises? Individuals will limit their consumption and increase sales in order to satiate their demand for money. The demand, and therefore price, of either good x1 and x2 must fall; in fact, the demand and price of both x1 and x2 may, and probably will fall until the price of money adjusts (when the price of x1 and x2 fall enough). But now the marginal producers in industries x1 and x2 will no longer be profitable and this will yield disinvestment.

Now let's consider what actually happens when the demand for money rises. Individuals, as I've mentioned, will cut consumption and they will withdraw money from the bank, from their savings. They will also sell off their securities (bonds and stocks) for liquidity. This will lower (a) the total supply of loanable funds and (b) the demand for securities, which forces financial intermediaries to charge higher rates of return in order to increase QD. In other words, the market rate(s) of interest will rise, but the natural rate of interest will remain unaltered (because the only thing that has changed is monetary conditions). I'm assuming that the demand for consumer goods (consumption) and the demand for producer goods (savings) fall in a proportionate manner for the sake of simplicity. It could very well be the case that they change unevenly which would alter the natural rate of interest.

My model, though, assumes an economy consisting of a single phase of production. With such an assumption, an elevated rate of savings would produce a similar type of effect except for the fact that interest rates would fall, saving the profitability of a few marginal producers. But when we lax this assumption, and consider an economy consisting of multiple phases of production, than an elevated savings rate actually increases total profit in the aggregate (the stock of profits, so to speak) and total output.

Let's now consider the effects of saving in an economy consisting of multiple phases of production:

The demand for producer goods will rise relative to the demand for consumer goods. People will place their savings in commercial banks and there will be higher demand for securities, which will reduce the market rate(s) of interest. But because the ratio of exchange between consumer and producer goods has changed in favor of the latter, the natural rate of interest will fall as well. There will be a further division of labor and capital across the entire economy; in other words, labor will be spread more thinly as the structure of production expands, which lowers marginal costs (firms, at the margin, employ less laborers). The price of other inputs will fall at each successive stage, further reducing marginal costs, and finally the interest rate will fall, also reducing marginal costs.

Arbitrage will restore a single rate of profit (interest) amongst the various stages of production, but in the aggregate total profits should rise (as the economy produces more). Additionally, the total supply of producer goods (capital) will increase relative to the total supply of consumer goods (I'm merely saying that the structure of production is expanding) which will increase the marginal productivity of labor and therefore real wages. There is no actual deflation here because the price of producer goods is rising at the expense of consumer goods (but consumer price indices will record general price deflation because they only measure the prices of final goods and services).

This is not the case when there's an elevated demand for money, even in an economy consisting of multiple phases of production. A higher demand for money, again even in an economy consisting of multiple phases of production, will elevate the market rate of interest above the natural rate, constricting general economic activity. This will yield a condition which resembles inadequate effective demand until prices adjust (which will take time and the adjustments will be uneven).

I believe this is why MET support "keeping MV stable," i.e., satiating the demand for money as money when it rises. And you can basically find this argument in Hayek's Prices and Production. In other words, Warlas' law, and a crude version of Say's law, only holds when there is monetary equilibrium (savings will not equal investment when there's monetary disequilibrium).

"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."

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Smiling Dave replied on Sat, Jan 22 2011 9:59 AM

But now the marginal producers in industries x1 and x2 will no longer be profitable and this will yield disinvestment.

The old "looking at only half the picture" fallacy. Not only will prices of x1 andx2 fall, so will the cost of producing them. In fact, since the price has gone down, more people will buy both x1 and x2, increasing the real profits of both firms.

This is not the case when there's an elevated demand for money, even in an economy consisting of multiple phases of production. A higher demand for money, again even in an economy consisting of multiple phases of production, will elevate the market rate of interest above the natural rate, constricting general economic activity.

The old "they'll hide it under the mattress" fallacy. When people get their hands on the cash they want, where do you think they will put it? Right in the bank, where else? Historically this has always been the case, I understand.

I believe this is why MET support "keeping MV stable," i.e., satiating the demand for money as money when it rises.

The old "attributing noble motives to statists" fallacy. It's all an elaborate rationalization for Obama to print money to buy Michelle a new dress.

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z1235 replied on Sat, Jan 22 2011 11:51 AM

Esuric:
As the demand, and therefore price of x1 rises (say by 50%), the demand (and therefore price) of x2 must necessarily fall (by 50%).

Perhaps I'm missing something but what is the unit of "price" above when money (x3) has not yet entered the picture?

Z.

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Zachary Plaxco replied on Sun, Jan 23 2011 2:27 AM

The old "attributing noble motives to statists" fallacy. It's all an elaborate rationalization for Obama to print money to buy Michelle a new dress.

 

Monetary disequilibrium theorists did not support the Federal Reserve's policy.  The old strawman fallacy.

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Smiling Dave replied on Sun, Jan 23 2011 2:38 AM

Zachary Plaxco:

The old "attributing noble motives to statists" fallacy. It's all an elaborate rationalization for Obama to print money to buy Michelle a new dress.

Monetary disequilibrium theorists did not support the Federal Reserve's policy.  The old strawman fallacy.

You have pulled the old straw man fallacy, Zach. Who said they support "the Fed's policy"?  They support printing money. Read the OP, read Esuric's cheerleading for "fighting deflation" which he claims"distorts" something or other.

By definition, a Monetary DE guy is all about printing money. Who is going to get that money? You? Esuric? Nope, it goes to Obama and his buddies.

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Esuric replied on Sun, Jan 23 2011 10:03 AM

By definition, a Monetary DE guy is all about printing money. Who is going to get that money? You? Esuric? Nope, it goes to Obama and his buddies.

MET's don't support the government printing money. They oppose central banks, i.e., monetary central planning, and favor a free-banking system (a free market in banking). The Rothbardians, on the other hand, demand extreme banking regulations.

"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."

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AdrianHealey replied on Sun, Jan 23 2011 10:39 AM

Smiling Dave:

Zachary Plaxco:

The old "attributing noble motives to statists" fallacy. It's all an elaborate rationalization for Obama to print money to buy Michelle a new dress.

Monetary disequilibrium theorists did not support the Federal Reserve's policy.  The old strawman fallacy.

You have pulled the old straw man fallacy, Zach. Who said they support "the Fed's policy"?  They support printing money. Read the OP, read Esuric's cheerleading for "fighting deflation" which he claims"distorts" something or other.

By definition, a Monetary DE guy is all about printing money. Who is going to get that money? You? Esuric? Nope, it goes to Obama and his buddies.

It does to the people who have a higher demand for money. And no, it's not 'all' about printing money. Straw-man fallacy. 

I wasn't a defender of MET, by the way. But Esuric's post actually made some sense. Will read it again soon. 

The state is not the enemy. The idea of the state is. 

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z1235 replied on Sun, Jan 23 2011 10:55 AM

AdrianHealey:
It does to the people who have a higher demand for money.

Wouldn't scarcity imply that this would be all people? Who doesn't demand more money than they presently have?

Z.

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DD5 replied on Sun, Jan 23 2011 11:15 AM

Esuric:
and a crude version of Say's law, only holds when there is monetary equilibrium

You can make this claim for any type of disturbance from general static equilibrium, or the ERE.

 The  market doesn't work any longer.  For Keynes it was changes in aggregate demand, and for MET it's changes in aggregate demand for money.  

 

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AdrianHealey replied on Sun, Jan 23 2011 11:21 AM

z1235:

AdrianHealey:
It does to the people who have a higher demand for money.

Wouldn't scarcity imply that this would be all people? Who doesn't demand more money than they presently have?

Z.

Good question. 

The state is not the enemy. The idea of the state is. 

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