Monday, January 7, 2013

Another one from Glasner's About page

Anthony Migchels and I are pretty much on the same page. Migchels writes:

all monetary debate should address cost for capital just as much as volume of the money supply.

By "cost for capital" I think Anthony means what I mean by the factor cost of money. There is more to the cost of money than just the rate of interest.

Everybody on television speaks of the interest rate. Not one of them considers the number of dollars on which interest is paid: Not one considers the reliance on credit.

The rate of interest is one thing. The reliance on credit is another. Hold the reliance on credit constant, and the factor cost of money varies with the rate of interest.

Hold the rate of interest constant, and the factor cost of money varies with the reliance on credit. If interest rates don't change but the amount of debt doubles, interest costs will double because of the increased reliance on credit.

Combine the rate of interest and the reliance on credit, and you have a useful measure of the cost of money in our economy -- the measure of a cost that competes with wages and profits.

Anthony also says

One of the key issues is that interest is an important cause of inflation.

He's raising the issue of the cost for capital -- the factor cost of money -- as a driver of cost-push inflation. Exactly right. But then he adds

Higher interest rates lead to more inflation in the long term, after the higher rates have subsided.

"After the higher rates have subsided". It sounds like Anthony Migchels wants to say that the rates going down is what leads to inflation. Not sure what he's thinking here, unless it's that when rates go down the reliance on credit increases even more.

Migchels also points out that "interest is a wealth transfer" which of course it is. And this brings "distributional" issues in to the discussion. Yet even in a world of perfect equality of income and wealth, a long-run increase in the factor cost of money must give rise to a problem that works itself out either as cost-push inflation or sluggish growth and stagnation. Our problem.

Having now disposed of some miscellaneous matters, I come at last to the words that drive me to write this post. Anthony Migchels:

Higher Interest rates temporarily slow the velocity of circulation, making the real money supply smaller.

Forget about the "real money supply". Money is what it is. If prices double, that doesn't mean there's half as much "real" money. Real money is a concept that should be dropped from the lexicon.

But again... Migchels says: Higher Interest rates temporarily slow the velocity of circulation. David Glasner responds:

Increasing interest rates increases, not, as you assert, reduces, the velocity of circulation. That implication of basic monetary theory is well supported empirically...

The purpose of raising interest rates is to fight inflation by reducing the growth of spending by reducing the growth of borrowing. (Whether it works is another matter, but this is the purpose.) So after interest rates go up, the quantity of money should go down (or, should increase less than it otherwise would have). And so spending should go down (or increase less). And then GDP should go down (or increase less).

Velocity is a relation between GDP and the quantity of money. Since an increase of interest rates affects both GDP and money, it is difficult to say what the eventual consequence will be. But then, Glasner did use the word empirically...

Graph #1: Velocity and Interest shown at the Same Scale
The blue line is velocity going way back. The green line is more recent velocity for MZM money, which best shows the thing I want to show here. And the red line is one measure of interest rates. Graph #1 shows some vague and minor similarity between the red line and the other two.

Now look what happens when I show the red line on the right-hand scale:

Graph #2: Velocity and Interest shown at Different Scales
Click Graph for FRED Source Page
Velocity and interest are impressively similar.

1 comment:

The Arthurian said...

The two are so similar that I am left wondering whether perhaps the interest rate is used in whatever calculation they use to determine velocity or (more likely) to determine the quantity of money.