Friday, July 13, 2012

A Taste of Market Monetarism

"Market Monetarism Blogroll" in the sidebar at Marcus Nunes' Historinhas presents a link to Nick Rowe's What's wrong with New Keynesian macroeconomics -- an MM perspective. Rowe links to Market Monetarism: The Second Monetarist Counter-­revolution, a 36-page PDF by Lars Christensen.

If you've seen the label "market monetarist" and wondered what it means, you might want a peek at that PDF.

This bit of it starts on page 12:
Interest rates are NOT the price of money

A very common fallacy among both economists and laymen is to see interest rates as the price of money. However, Market Monetarists object strongly to this perception. As Scott Sumner spells out in capitals: "INTEREST RATES ARE NOT THE PRICE OF MONEY, THEY ARE THE PRICE OF CREDIT" (Sumner 2011C).

Well, yeah.

On the other hand, the price of money or rather the value of money is defined by what money can buy: goods. Hence, the price of money is the inverse of the price of all other goods -- approximated by the inverse of for example consumer prices.

This is completely in line with the view of traditional monetarists such as Brunner and Meltzer (1997) or Yeager and Greenfield (1986) who strongly stress the difference between money and credit.

Again, yes. Here's how I have it:

The difference between money and credit is that credit is more costly to use. An economy that shifts from a low reliance on credit to a high reliance on credit will find itself with financial costs rising relative to other costs. It will find itself with interest costs rising relative to wages and profits. It will find itself with living standards squeezed, business growth below par, and financial activity as its growth industry.

William Woolsey (2009B), with direct reference to Leland Yeager, spells out the key difference between money and credit.

First, he defines money.

"Money is the medium of exchange. The quantity of money is the amount of money that exists at a point in time. The demand for money is the amount of money that people want to hold at a point in time. To hold money is to not spend it."

Then he defines credit.

"The supply of credit is the amount of funds people want to lend during a period of time. The demand for credit is the amount of funds that people want to borrow during a period of time."

Okay. But the key difference between money and credit is cost.

This cost can be calculated.

Once we distinguish money from credit we want to look at credit in its various phases. For example, what Bill Woolsey calls "the supply of credit" is the same as what I call "credit available". To me, the supply of credit is credit available plus credit-in-use.

The total supply of credit includes both the money available for new lending, and the money already on loan.

There is another difference between my thinking and Woolsey's. See how he sticks the phrase "during a period of time" in there? Twice, he says it. If I had to include time in my definition, I would say "at some moment in time". I see the supply of credit as a stock; Woolsey describes it as a flow. One of us has it wrong.

The first difference is more important. If I decide to borrow a dollar, the demand for credit increases. When I actually borrow a dollar, I put credit to use. Until I repay that debt, the demand for that credit continues to exist. UNTIL I REPAY THE DEBT, THE CREDIT REMAINS IN USE.

The demand for credit is not measured by *new* borrowing alone, but also by the accumulation of existing debt. To ignore credit-in-use is to ignore accumulated debt.

... Woolsey acknowledges that "there are relationships between the supply and demand for money and the supply and demand for credit... But money and credit are not the same thing" and "One of the first rules of monetary economics is to never confuse money and credit."

That's a good rule.

While the Market Monetarists have been calling for quantitative easing to help pull the US out of the Great Recession, they are also critical of the actual implementation of QE under the leadership of Federal Reserve chairman Bernanke. This is because they believe QE in the form implemented by the Federal Reserve focuses excessively on the functioning of the credit markets rather than on expanding the money supply...

That's about right. The Fed is still trying to get people to increase their borrowing, because they still think using credit is always good for growth.

The basic problem is the imbalance between money and credit-in-use or between money and debt, as you can see on my Debt-per-Dollar graph. The focus on increasing credit use rather than on expanding the money supply is exactly the wrong focus.

But the focus on expanding the money supply is also flawed. The problem is not that we have too little money. The problem is that we have too little money relative to accumulated debt. And as you already know, this problem is due more to the growth of private debt than to the suppression of money.

The obvious solution -- the correct solution -- is to reduce private debt.

One more thing: I searched that 36-page PDF for the word debt. Found exactly one occurrence, in footnote 6 on page 3: "While Market Monetarists acknowledge their intellectual debt to Leland Yeager..."

That's the only one.


Nick Rowe said...

Yep. But "credit" and "debt" are really just two sides of the same errrr, coin. So when we're talking about "credit", we're talking about debt too.

The Arthurian said...

I love ya Nick, but more care must be taken with the definitions of those particular words.

"Debt" is the same as "credit-in-use".

Debt is certainly not the same as credit, as Woolsey describes credit: "the amount of funds people want to lend during a period of time". But then, that's what I call "credit available".

NEW USES of credit (Woolsey's "supply of credit", being borrowed and spent) help the economy grow. OLD ACCUMULATIONS of debt are the offsetting hindrance.

For credit use to be conducive to growth, the new use of credit must be large enough to completely offset the drag created by existing debt, and then some.

After two or three generations, it becomes untenable to expand credit-use enough to more than compensate for existing debt.

Please do not say credit and debt are two sides of the same coin.

Tom Hickey said...

The interest rate in countries in which the central bank is the rate setter sets the price of bank reserves, which influences the price of credit through the spread. Reserves at not "credit" but currency, currency being cash currency through which spot transactions are settled and reserves through which demand account draw downs are settled in the interbank system (after netting.

The cb sets (fixes) the price of reserves and reserves are "base money" or HPM, i.e., "money."

The Arthurian said...

Hi Tom. My favorite and most useful book for many years was The Programmer's Problem Solver, a computer-programming book by Robert Jourdain. The author warned that the prose was "dense". It was not always an easy book to understand, but it was always interesting. Your remarks are like that.

I'm trying to figure out why you are focused on reserves. (I didn't think I was talking about reserves.)

Your opening sentence -- "The interest rate ... sets the price of bank reserves, which influences the price of credit ..." -- is mostly in agreement with Sumner's capitalized run-on sentence, except in the next sentence you seem to be saying reserves are a special case. I can see that. And I don't think it contradicts Sumner. Reserves *are* a special case.

Putting your view in my words: Reserves are the medium of exchange of the banking system.

Sound about right?

Tom Hickey said...

I focused on reserves because the interest rate is the cost of borrowing to the banks. It is a price and what is prices is currency. Through interest rate setting ("price-fixing") the cb influences the yield along the curve, and these are the benchmark that banks use to "price" their loans.

Under the present policy, the Fed sets the interest rate by paying IOR, that is sets price and lets quantity float. The cb can do this because it holds a monopoly on reserves and can control price or quantity. The price here is HPM, so it is correct to say that the interest rate is "the price of money."

The price of money affects the cost of borrowing, first for banks at the cb and then to borrowers from the banks as they set the spread wrt their costs, risk assessment, and profit margin.

There is no such "thing" as reserves in a non-convertible system. Reserves are simply accounting entries on the cb's used in interbank settlement. They provide liquidity. They are the means through which the cb guarantees liquidity under LLR by providing automatically for overdrafts (at the penalty rate).

Just wanting to keep the terminology straight.