Wednesday, February 10, 2016

Velocity or inequality?

I'm pretty sure a lot of the disagreement between people, when it comes to economic discussions, arises because we are talking about different economies. I generally talk about the one that produces GDP. And I generally see financial activity as a parasite on the economy like heartworms on a dog.

Many people, like Scott Sumner, I think, generally talk about the financial economy: I talk about the medium of exchange. Sumner talks about the medium of account.

The trouble with Scott's view is that finance is a parasite. The productive economy is the host. The parasite cannot live without the host. Left unchecked, the parasite kills the host.

Scott Sumner:
Interest rates are the opportunity cost of holding cash. If you lower interest rates, people will choose to hold more cash.

What people are those?

Sumner says velocity follows the interest rate because when the interest rate goes down, people hang on to more of their cash. And when the interest rate goes up, well, I guess when the interest rate goes up they switch out of cash and into forms of money that pay interest.

For that to be true, you have to be looking at people who have money they can choose to hang on to. I'm not among those people. Most people are not those people. Most people struggle to get by, clip coupons, get extra miles out of worn tires, and have little or no savings.

It's an inequality thing. A few people have most of the money. Most of us have little. Who are the people that hold on to their cash when interest rates go down? The ones who can afford it.


Greg said...

Hey Art

Im not sure I even like the distinction of medium of account vs medium of exchange, at least as it seems to be used by most people like Sumner. Best I can tell, when Sumner talks about medium of account he just means non currency.

Everything on a bank balance sheet is a medium of account and the $ sign is just the numeraire we use in this country. Some entries on banks balance sheets are convertible to cash, in fact all are, its just that some require a few more operations to do so. They all are mediums of exchange as well..... at different levels. Banks exchange (buy and sell) bonds with each other in order to finance certain things and corporations exchange bonds with each other (via banks) on order to finance things. All those bonds are traded for a price its just that some bonds have a more reliable price than others, govt bonds have the most reliable price (hence a lower interest rate). I think using medium of account and medium of exchange as if they are completely separate properties is confusing.

The Arthurian said...

Hi Greg. When I think of "medium of exchange" I think of going to the store and buying something,paying for it. When I think of "medium of account" I think of a nursery rhyme:
The King was in his Counting House, Counting out his Money...

Income is medium of exchange stuff.
Wealth is medium of account stuff.
I think that's a useful distinction.