The Schwartz

The name Anna Schwartz should ring a bell. She wrote a very great book (which I never read) with Milton Friedman, who was a very great man. Schwartz has some thoughts on the money supply, here. I have just a few remarks.

Schwartz writes:

Why Is the Money Supply Important?

Because money is used in virtually all economic transactions, it has a powerful effect on economic activity. An increase in the supply of money works both through lowering interest rates, which spurs investment, and through putting more money in the hands of consumers, making them feel wealthier, and thus stimulating spending. Business firms respond to increased sales by ordering more raw materials and increasing production. The spread of business activity increases the demand for labor and raises the demand for capital goods. In a buoyant economy, stock market prices rise and firms issue equity and debt. If the money supply continues to expand, prices begin to rise, especially if output growth reaches capacity limits. As the public begins to expect inflation, lenders insist on higher interest rates to offset an expected decline in purchasing power over the life of their loans.

1. The economy is transaction, and money is its vehicle. I am completely happy with first sentence of the excerpt.

2. Schwartz does not really define "economic activity" in that opening sentence, but she relates it to "virtually all economic transactions," which accords with my recent definition of the term. Thumbs up.

3. In the article Schwartz refers to data from June of 2004. So we should presume the article is from that time, or after. And the citation notes a 2008 publication date. The article represents current thinking.

4. Here's the problem then. Schwartz says "An increase in the supply of money" makes people "feel wealthier" and stimulates spending. "Business firms respond to increased sales by... increasing production. The spread of business activity increases the demand for labor and raises the demand for capital goods." Schwartz wants to describe this as "a buoyant economy."

4a. I don't know when there has been an increase in money, except when I read about it. I don't discover it by feeling wealthier. And it doesn't make me feel wealthier when I do find out. The majority of people expressing views on the internet seem to be upset or angered by increases in the supply of money. So Schwartz's whole premise -- that it makes people feel wealthier and stimulates spending -- must be questioned.

4b. If it is true (as has been stated repeatedly) that our money supply has increased, then where is "the spread of business activity"? Where is "the demand for labor"? Where is "the demand for capital goods"? Where is the approach to "capacity limits"? Where is the "buoyant economy"? And why do we have all this debt?

What Schwartz describes is the "demand-pull" version of inflation -- a version we've not seen since the rise of stagflation in the very early 1970s. Her famous book with Milton Friedman was published in 1963. At that time, the economy was buoyant. It is buoyant no more. Her explanation is defunct.

Schwartz writes:

Even if there were no legal reserve requirements for banks, they would still maintain required clearing balances as reserves with the Federal Reserve, whose ability to control the volume of deposits would not be impaired. Banks would continue to keep reserves to enable them to clear debits arising from transactions with other banks, to obtain currency to meet depositors’ demands, and to avoid a deficit as a result of imbalances in clearings.

Mmm. So having reserves should not be something altogether objectionable to banks. The existence of a legal reserve requirement should be perfectly acceptable. Yet is is often viewed by bankers as a "burden" or a "tax."

It should not be objectionable. And if the reserve requirement makes our economy a bit more secure, so much the better. It is possible that the growth of credit (and economic growth itself) may be less because of the legal restraint. But under proper fiat management, that problem can be overcome.

That's all I have, except to say the Schwartz article is worth the read.


Reference:
Anna J. Schwartz. "Money Supply." The Concise Encyclopedia of Economics. 2008. Library of Economics and Liberty. Retrieved October 31, 2009 from the World Wide Web: http://www.econlib.org/library/Enc/MoneySupply.html