From Sunday:
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| Graph #3: The Monetary Base relative to Actual-Price Output |
Graph #3 shows a remarkable decline in the quantity of money from the end of World War II until about 1981. Then a persistent, gradual increase lasting until just after the year 2000. Then a brief decline, followed by the Bernanke spike. That spike, however, does not this time appear to increase the quantity of money to a dangerous and unprecedented level. It only restores the quantity of money to the level it was starting from, at the end of World War II.
We came out of World War II with too much money. The evidence is not in the graph above, but rather in the wartime and post-war inflation we experienced.
A combination of rising prices and anti-inflation policy helped reduce the quantity of money relative to Actual-Price Output.
By 1960 inflation was almost non-existent. Soon, however, it started coming back.
In my view, after 1960 the quantity of money was insufficient. In my view, after 1960 the increasing use of credit was more and more responsible for inflation.
But policymakers continued to reduce the quantity of money until 1981. By that time, we didn't have enough money to have a vibrant economy. And by that time, the cost of credit-use was the major force behind inflation.
So the Sunday graph, at the top of this page... The quantity of money is back up where it was at the end of World War II. At that time, it was enough to cause inflation. So it is probably enough to cause inflation now. But there is more to the story.
Back at the end of WWII we had financial technology that could turn a dollar of base-money into 12 dollars of debt.
Today we have the financial technology that can turn a dollar of base-money into $60 of debt. Five times as much. So there is the chance that inflation can be five times worse now, as compared to the inflation we had in the years after World War II.
To prevent it, we need economic policies that encourage accelerated repayment of debt and policies that limit our exploitation of the financial technology.
13 comments:
Hey, great blog, nice charts! I found it via a link to maxedoutmama on housepricecrash.co.uk.
I like the money base versus size of economy and would like to offer a few thoughts on it.
Firstly, I think that one needs to be careful in defining what money is, since it may not be what we are told it is. Money here in your chart is public debt albeit of zero maturity.
But during the credit growth you discuss postwar, bank debt (deposits) was insured. What is the difference between an insured bank deposit and base money?
Secondly, what is the difference between base money, bank debt/broad money, and non-zero maturity government debt. Not much, I would say.
Thirdly, I don't understand the bit about the cost of using credit to finance growth versus using 'money'. During this epoch 'money' also bore interest, which was stumped up by the taxpayer. Also, more importantly someone must have been the beneficiary of the cost of this credit and would presumably have been spending it back into the economy as consumption or investment. Given that financial sector salaries were not at all insane in the period 1945-1980, one wonders how this cost of credit produced a drag effect, as opposed to a simple effect of wealth distribution.
Anyway, would love to hear your thoughts on the above.
Cheers!
Hi, Liminal. Thanks for writing. Thanks for letting me know how you found me. And thanks for testing me. I need it.
"...one needs to be careful in defining what money is, since it may not be what we are told it is. Money here in your chart is public debt albeit of zero maturity."
Let me begin by being careful about the definition of money. I think we know what money is; I am satisfied to leave it undefined. "Credit" is other people's money, or money that costs interest to use. "Debt" is simply the record of credit in use.
But let's look at it your way. Money on my chart -- base money -- is public debt. But not all public debt, surely. Base money is nearly equal to public debt held by Federal Reserve banks.
When interest must be paid on public debt held by Federal Reserve banks, the government pays and the government receives payment. So the cost of creating base money from public debt, the cost is essentially zero. You know: money from nothing.
That's not exactly true, but it is conceptually true. It is a thinking tool.
"What is the difference between an insured bank deposit and base money?... what is the difference between base money, bank debt/broad money, and non-zero maturity government debt. Not much, I would say."
Base money is essentially interest-free money in the private sector. All other money in the private sector (including money created by deficit spending) bears an interest cost. The difference is cost.
Two scenarios. In one, the monetary balance favors money that does not cost interest. In the other, the balance favors money that does cost interest. Now in the second of these, the interest rate is applied many times. This cost -- the cost of borrowing a dollar multiplied by the number of dollars that are borrowed (relative to the size of the economy, say) -- this is the factor cost of money.
The factor cost of money competes with wages, the factor cost of labor, and with profit, the factor cost of capital.
"I don't understand the bit about the cost of using credit to finance growth versus using 'money'."
Consider a business with sufficient profit to finance its own growth. In contrast, a business that must borrow for everything. (I should point out that it is policy to remove money from circulation and it is policy to encourage the use of credit.)
"Also, more importantly someone must have been the beneficiary of the cost of this credit and would presumably have been spending it back into the economy as consumption or investment."
Yes... But I don't think the money gets spent back into the economy. I think it largely gets lent back into the economy, at interest.
Oh, and this:
"...one wonders how this cost of credit produced a drag effect"
Labor and capital are factors of production. Money is a factor of facilitation. Money is the grease that makes productive factors perform better -- but only up to a point. Too much grease does no good.
Thanks for the replies, which I want to follow up a little.
""Credit" is other people's money, or money that costs interest to use."
Given that base money has paid interest for much of the period shown on that chart (various world CBs have paid interets on reserves since the 190s), one might suppose then that base money is in fact credit. It is money that belongs to the private sector, which I guess is the narrative for why deposits at the central bank might pay interest.
Also, prior to that, if some CB is altering the stock of base money via OMO to create a de-facto non zero interest rate, then that is equivalent to paying interest on reserves anyway since the process of removing money basically equates to taking tax revenue and then shredding it.
"Money on my chart -- base money -- is public debt. But not all public debt, surely."
Sure, non zero maturity public debt is not shown on the chart, yet this debt is performing most of the functions of base money, if not all. It acts as an equivalent (or better) store of value and also facilitates lending via its use in repos etc (if the mainstream banking system is built on base money, then the shadow banking system is built on government debt)
It is not fully equivalent to base money but it is not fully like private sector credit either, which implies it is adding to the money supply if not on a 1:1 basis.
"Base money is nearly equal to public debt held by Federal Reserve banks."
Yes, because this is how base money is created, even before advent of QE. Correct me if I am wrong, but back towards the beginning of your chart the majority of government debt was not held by the federal reserve. My view, clearly, is that base money and government debt/bonds have a more or less equivalent liquidity effect, so your chart is not showing all the money, so to speak.
I'll carry on in the next reply....
"Base money is essentially interest-free money in the private sector. "
I think this is how it **seems** but is not how it is if we strip away the obfuscation of the monetary system.
Leaving aside the fact that most central banks pay interest on reserves, lets look at one that doesn't (like the FED, until recently). Is the base money supply really "free"?
If a CB is removing base money from the supply via OMO, then one way this can happen is if the public is sold a bond in exchange. The bond bears interest, and assuming the government is running a balanced budget then the interest due on the bond must come from taxpayers.
Thus in order to keep a base money supply at a sufficiently scarce level to create a non zero base rate, taxpayers are basically paying interest on the monetary base. This is what ricardian equivalence is about - if a bunch of base money is created, then at some point in future taxpayers would end up paying interest on it, assuming the CB is claiming an inflation target.
The other way to remove base money is for government to run a surplus and then shred the extra tax receipts. This is also equivalent to charging interest on the base money because the taxpayers pay taxes and get nothing (e.g. public services) in exchange.
None of this is positioned as the taxpayer paying interest on base money, but it economically, if not culturally, equivalent.
Interestingly, we have only now reached the point when the existing base money supply is truly interest free, yet this is almost universally claimed to be a huge problem.
1. What is OMO? Seems to be an anti-inflation move by the Fed, but I don't know the language.
2. You refer to the liquidity of "government debt/bonds." Government debt represents money that was borrowed and spent (or spent and borrowed, maybe). Anyway, that stuff was obviously as liquid as money. Not the debt, but the money that was borrowed.
Bonds are the creditors' records of that borrowing. Are you saying the bonds are liquid? Do people use them to buy things? Not much of that going on in my world.
3. My Sunday graph at the top of the post, shows a decline in Mbase/NGDP. I am more than willing to admit that this could only happen if there were "other" monies in use, adding to aggregate demand and affecting prices. These other monies are M1, M2, MZM, M3... and, ultimately, total debt.
This is related to the Keynes footnote about drawing the line between money and debt at any convenient point.
Understood. But the more of this kind of money there is, the less control the Fed has over its duties. And the less is Fed money responsible for inflation.
Also we have more debt as a result.
I have no conclusion here...
1. "What is OMO? "
Sorry. It means open market operations - buying and selling of bonds to alter the base money supply and thus set short rates.
2. "Government debt represents money that was borrowed and spent"
But the debt is guaranteed by a printing press. Does lending money that was printed by a printing press, back to the owner of that press, make any sense? Could that be called debt?
"Are you saying the bonds are liquid? "
Yes. How often does a 25 year treasury change hands? The answer is, a good deal more often than a base money dollar does.
See www.mpls.frb.org/research/sr/sr275.pdfwww.mpls.frb.org/research/sr/sr275.pdf
Also see 'the societal benefits of illiquid bonds' by the same author.
"Do people use them to buy things?"
Banks do, and so do nations, but individuals don't. That said, individuals swap them for base money to but things, just like individuals swap bank debt for base money before they actually buy anything.
3. " But the more of this kind of money there is, the less control the Fed has over its duties. And the less is Fed money responsible for inflation."
Agreed and agreed. But then was the FED ever in control of inflation? Were the (few) low inflationary periods since the war to the credit of the FED or other factors? Even if one credits the fed with them, the record is so mixed it is difficult to make a case that the FED controls inflation.
In any case, I would say a mandate for full employment is not compatible with control of inflation.
Also see
Ack, bad link above. Try this one:
http://www.mpls.frb.org/research/sr/sr275.pdf
Some Blogger glitch this morning, but all the messages are back in place now.
"I would say a mandate for full employment is not compatible with control of inflation."
Okay. I would point out that the mandate was established by Congress, the same people who keep creating more incentives to use credit and accumulate debt. I hold that our economic problems originate more with Congress than with the Fed.
Your questions are often more like philosophy than economics:
1. "Could that be called debt?"
(It IS called debt.)
2. "But then was the FED ever in control of inflation?"
(It is the Fed's JOB.)
I am very mathematical about economics, and not very philosophical about anything.
" I hold that our economic problems originate more with Congress than with the Fed."
That's my view as well.
"I am very mathematical about economics, and not very philosophical about anything."
Fair point - as long as the economics/mathematics in question is not founded or predicated on philosophy!
The above message, posted by Liminal Hack at 4:07 pm on 11 May, survived the Blogger glitch.
Liminal's follow-up message, of 4:29 pm 11 May, did not survive.
Here is the body of that message:
Ack, bad link above. Try this one:
http://www.mpls.frb.org/research/sr/sr275.pdf
[end]
I liked that: Liminal checks his work.
//if Blogger restores the original messages, I will delete this restoration sequence.
My reply to LiminalHack, 12 May, 7:21 AM:
Some Blogger glitch this morning, but all the messages are back in place now.
"I would say a mandate for full employment is not compatible with control of inflation."
Okay. I would point out that the mandate was established by Congress, the same people who keep creating more incentives to use credit and accumulate debt. I hold that our economic problems originate more with Congress than with the Fed.
Your questions are often more like philosophy than economics:
1. "Could that be called debt?"
(It IS called debt.)
2. "But then was the FED ever in control of inflation?"
(It is the Fed's JOB.)
I am very mathematical about economics, and not very philosophical about anything.
LiminalHack's reply, 12 May, 2:31 pm:
" I hold that our economic problems originate more with Congress than with the Fed."
That's my view as well.
"I am very mathematical about economics, and not very philosophical about anything."
Fair point - as long as the economics/mathematics in question is not founded or predicated on philosophy!
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