This comment from Oilfield Trash is the most interesting thing I've read in a long time.
So Scott is saying that Currency Component of MI/GDP is the demand for currency. But that calculation is the inverse of the Velocity of Currency Component of M1 (GDP/ Currency Component of M1).
OT's comment appears below one of my continuing mundane criticisms of Scott Sumner's bogus evidence.
OT continues:
I do not think Scott would argue that the Demand for Currency is the inverse of its Velocity. Although he might.
But more important to me is as the Fed creates more monetary base, short-term interest rates fall in a fairly smooth way.
Having hit zero interest rates some $1.5 trillion ago, further increases in the monetary base have simply pushed us further and further to the left, and velocity has simply declined in direct proportion to base money.
Currently further monetary easing (more base) will do nothing but cause velocity to decline, which gives everyone the idea that monetary policy is too tight.
Of course if you use NIRP the theory is that it removes the constraint of the lower bound and you can pump more base in without causing a drop in velocity. But then again cash hording is an issue and the troubles it brings.
I wonder when demand for 1000 franc notes exceed the supply will it become exchangeable above it par value, which means all other notes are deflating. HMMM something to think about.
http://www.zerohedge.com/news/2016-02-22/safes-sell-out-japan-1000-franc-note-demand-soars-nirp-triggers-cash-hoarding
But more important to me is as the Fed creates more monetary base, short-term interest rates fall in a fairly smooth way.
Having hit zero interest rates some $1.5 trillion ago, further increases in the monetary base have simply pushed us further and further to the left, and velocity has simply declined in direct proportion to base money.
Currently further monetary easing (more base) will do nothing but cause velocity to decline, which gives everyone the idea that monetary policy is too tight.
Of course if you use NIRP the theory is that it removes the constraint of the lower bound and you can pump more base in without causing a drop in velocity. But then again cash hording is an issue and the troubles it brings.
I wonder when demand for 1000 franc notes exceed the supply will it become exchangeable above it par value, which means all other notes are deflating. HMMM something to think about.
http://www.zerohedge.com/news/2016-02-22/safes-sell-out-japan-1000-franc-note-demand-soars-nirp-triggers-cash-hoarding
The zerohedge link brings good perspective to the issue. OT's remarks coupled with the ZH article make a very good analysis of very bad policy.
Where OT says
Currently further monetary easing (more base) will do nothing but cause velocity to decline, which gives everyone the idea that monetary policy is too tight.
I'm thinking: Increasing the base reduces the GDP/Base ratio (i.e. velocity) because GDP increases more slowly than base. And when people (Scott Sumner, for example) see GDP failing to increase, they conclude money is tight.
This is a really good analysis.
6 comments:
Art,
It's been a while since I've commented. I think I was trying to articulate the nexus between the base and velocity quite some time ago. I asked what is the nexus between the two? Well, it appears that as the base is increased, velocity decreases. Right? Without positive velocity, no real growth.
Hi Nanute.
"I think I was trying to articulate the nexus between the base and velocity quite some time ago."
Yeah, 2011 in fact:
http://newarthurianeconomics.blogspot.com/2011/10/dear-ben.html?showComment=1318249409758#c5586062427814797433
OT's graph shows interest on the vertical scale, base velocity on the horizontal. The two seem to increase or decrease together, confirming Sumner's view.
The relation between base and velocity looks quite different. (Note that base is the denominator for "base velocity".) This graph shows base velocity (vertical scale) versus change in base money (horizontal)
https://research.stlouisfed.org/fred2/graph/?g=3zc3
Everything is over at the left (small increases in base money) while velocity increases from about 6 to about 22. That corresponds to the years before about 1981 on this graph from Sumner:
https://2.bp.blogspot.com/-Wyfreon7_ZE/Vs3nB13hGyI/AAAAAAAAPrg/kMscMXm6paw/s1600/Sumner%2BScreen-Shot-2016-01-03-at-2.16.24-PM.png
After 1981 base velocity as base money increments get bigger. Corresponds to the start of downslope on the Sumner graph.
Here's a close-up with the last year 2008 way over to the right.
https://research.stlouisfed.org/fred2/graph/?g=3zcA
At the left in the years before 2008 you can see base velocity stalled between 15.0 and 17.5, with base increments unusually large compared to what came before.
Base velocity remained stalled in 2008, the far-right dot is in like with that cluster that ends at 2007.
What it means??
I'd guess that base velocity increasing up to 1981 was a problem. In 1981 something broke. Sumner is all giddy about base velocity following interest rates. I think the thing he's giddy about is a problem.
fix that:
After 1981 base velocity falls as base money increments get bigger.
Art
Thanks for the kind words. I you remember some time ago I told you that if you want to understand monetary policy correctly you have to think like this.
P*Q=M*V
Whatever relationship interest rates have to subsequent economic growth is already contained in prior changes in GDP, unemployment and inflation. Interest rate changes are largely the results of prior measures of economic activity, not the causes of future economic activity.
You can’t increase inflation by creating more money if velocity falls proportionately which has a tendency to strengthen rather than reduce deflationary pressures.
Growth arises primarily from a) the channeling of scarce saving to productive investment that b) generates useful goods and services that c) can be purchased because the income paid to factors of production can – in a circular flow – be used to pay for that output. But no one going to do this in a negative real interest rate economy.
The best way to think about real interest rates is to think about the economic context that produces them.
Depressed real interest rates are symptomatic of a dearth of productive investment opportunities. When central banks respond by attempting to drive those real interest rates even lower to “stimulate” interest-sensitive spending such as housing or debt-financed real investment, they really only lower the bar to invite unproductive investment and speculative carry trades.
High real interest rates generally reflect strong demand for borrowing, driven by investment opportunities that are seen as productive enough to justify borrowing at those rates. They also encourage savings that can be directed to those productive investments. As a result, higher real rates are generally associated with more efficient investment and faster economic growth.
One other thing all of this is coming from my notes, and due to the fact I am lousy at making sure I keep all the footnotes as to where my notes come from I am sure I owe someone some level of attribution. But for Blogging I guess it has to do.
Oilfield Trash, I don't know what you were reading, but I like it.
Thanks, Art. I can't believe it was that long ago! I'm just gonna say this: If the money ain't circulatin', the economy ain't percolatin'
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