What does it mean? -- "If you lower interest rates, people will choose to hold more cash."

"If you lower interest rates," Scott Sumner says, "people will choose to hold more cash." He provides this graph showing "the demand for currency (as a share of GDP) and T-bill yields":

"Notice that the two variables tend to move inversely," he says. Sumner uses the graph as evidence of his claim that "If you lower interest rates, people will choose to hold more cash."

I have to ask: More cash, compared to what? More cash, compared to the money people have in total, I think. If you lower interest rates, Sumner is saying, people will choose to hold more of their money as cash.

The argument makes sense: People holding cash don't earn interest on it. If interest rates go down there is less incentive to hold money in an interest-bearing form, and more incentive to hold money as cash. If interest rates go up, there's more incentive to hold money in an interest-bearing form and less incentive to hold it as cash. This is his argument.

But Sumner is careful not to say "hold more of our money as cash."


If you wanted to show the relation on a graph, you'd want to show an interest rate. This, Sumner does. And you'd want to show the amount of cash people are holding, compared to money held in total. The ratio would show people's preference for holding money as cash. This, however, Sumner does not do.

Sumner's graph shows cash relative to GDP. The context variable is wrong. The graph does not show cash compared to money in total. The graph does not show what it must show to be relevant evidence.

The lines on Sumner's graph seem to support his statement about holding more cash, because the lines move in the directions they should move if his statement is true. But the blue line does not show the ratio that his statement describes.

Sumner's graph is not relevant evidence.


I pointed out the discrepancy on Sumner's blog:

Scott, why does your graph not show currency relative to *money* ?

You say that when interest rates fall, currency holdings rise. To my mind “currency holdings rise” is the same as “we hold more of our money as cash”. To look at “holding more of our money as cash” the graph would have to show currency relative to M1 or some broader money.

Sumner replied:

I use currency to NGDP, because I’m interested in explaining changes in NGDP, not the broader aggregates.

Of course he's interested in NGDP. The whole focus of his blog is NGDP targeting. That's fine. But it doesn't address the issue.

The ratio of currency to NGDP says nothing about the preference for holding money as currency. The ratio of currency to NGDP is not evidence of the desire to hold money as cash. Sumner's graph is not evidence of his claim. And his response to my comment does not resolve the matter.

Am I looking at this wrong? Or did Sumner try to bullshit me?


// Edit, 11 Jan 2019, changed
"More cash, compared to the money people hold in total, I think" to
"More cash, compared to the money people have in total, I think".
Now that I know what "holding" money means.

MICROBES

From The Money Illusion:

Back in late 2008 and early 2009 most people focused on “the debt crisis” as being “the problem.” But debt is a problem only to the extent that it exceeds one’s ability to repay the loans, which depends on one’s income.

MICROBES, I say.

I say again: MICRO BS. "One's income" is micro. The relation of one's debt to one's income is micro. The sum of all debts relative to the sum of all incomes IS STILL MICRO.

Ours is a MACRO problem.


The fly in Sumner's ointment is the pretense that income can exist without debt. He says debt is only a problem if it is too heavy for your income, but he forgets that in our economy, almost all income comes from somebody using debt. We do not increase income without increasing debt; at the macro level, this is the problem.

Income CAN exist without debt, of course, but only if we change the way we do things. We have to increase the quantity of money relative to output and at the same time decrease the amount of credit generated from every newly printed dollar. But as long as people continue to think money and credit are the same, that will never happen.

Sumner does not call for the necessary change. He says:

A few of us market monetarists argued that you also needed to look at the denominator of the debt/income ratio, not just the numerator.

By looking at the denominator of the debt/income ratio, he means: Look at income. Well yeah, income is too low. Income is GDP, and GDP is too low, so income is too low. If you don't get a headache because this is such basic stuff, well, you should.

GDP growth has been too slow since the mid-1970s. What's that, going on forty years now? GDP growth has been too slow for 40 years, for the most part getting worse all the while. The money illusionist waves his hand and pretends that the whole GDP problem never existed until "late 2008" or something. And with that magical analysis, Sumner declares that the problem is not excessive debt, but insufficient income.

Does it matter? Well, yes: Excessive debt IS THE REASON INCOME HAS BEEN LAGGING for forty years.

The solution that calls for "more income" is likely to be nothing but an inflationary solution. That's because we're not getting growth. If we don't get growth, all we get from an expanding NGDP is more "N". And don't forget, it's debt that hinders growth.

Sumner ignores the numerator. He ignores debt, the hinderer of growth.


Debt relative to income is high. Sumner says we can solve the problem by increasing income via inflation. Did that work, say, in the 1970s?

Graph #1: Debt-to-Income (blue) and Debt-to-CPI (red)

Not really. Here's a close-up through 1980:

Graph #2: Debt-to-Income and Debt-to-CPI (up to 1980)

Maybe it did work for the latter half of the 1960s. Inflation pushed NGDP up, and at the same time inflation reduced the burden of existing debt: Inflation increased Sumner's denominator and decreased his numerator simultaneously. And all it took was a 23% increase in prices in the five years between 1965 and 1970. Meanwhile, total debt increased 44.6%, almost twice the rate that prices went up.

Prices couldn't go up fast enough to keep up with the growth of debt. After 1970, inflation got worse, but Sumner's "debt to income" ratio WENT UP ANYWAY.

As long as debt continues to increase, inflation cannot solve the problem of excessive debt. And debt hinders growth.

Dwell on it.