## Saturday, February 20, 2016

### 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 hold 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?

The Arthurian said...

1. Sumner says "people will choose to hold more cash" as if the statement stands on its own. It does. People hold more of their money as cash is the meaning. But Sumner never states this clearly.

2. After being unclear about cash relative to money, Sumner provides a graph showing cash relative to GDP. The graph is unrelated to the discussion. But the irrelevance of the graph is not obvious, because Sumner was not clear on "cash relative to money".

3. Sumner uses the irrelevant graph as evidence of his "hold more cash" claim. No one seems to object to this.

4. Am I the only one who sees that Sumner's argument is flawed?

jim said...

I think your reasoning is sound but as Sumner pointed out he is not interested.

Sumner thinks that for some reason* GDP is the result of how well the Fed controls Currency in circulation. "monetary policy mostly consists of Federal Reserve changes in the currency stock"

* I say some reason because I have yet to figure out what that reason is (or at least how it works). Sumner wrote one article where he claimed that the Fed making \$100 bills (Benjamins) less available was a major cause of the great recession.

http://www.themoneyillusion.com/?p=18300

Jazzbumpa said...

And why wouldn't Sumner be interested? He has an agenda, and your facts don't fit.

I looked at the currency series as fraction of both M2 and MZM. They are weirdly different.

What do you make of it?

https://research.stlouisfed.org/fred2/graph/?g=3wEC

JzB

Jazzbumpa said...

Now i'm really confused, 'cuz M2 and MZM aren't THAT different.

https://research.stlouisfed.org/fred2/graph/?g=3wEI

JzB

The Arthurian said...

Jazz: "And why wouldn't Sumner be interested? He has an agenda, and your facts don't fit."

I can re-state this argument of Sumner's in a way that makes sense to me. And I can find graphs that provide some support for his argument. I would be willing to accept the view that "interest rates influence the desire to hold cash" is at least a part of the whole truth.

What bothers me is that, having become part of the conversation, Sumner now seems to think he can provide bogus evidence for his claims, and no one will challenge his evidence.

What bothers me even more is that apparently he is right. Why are there not 30 people pointing out that in this particular case his evidence is bogus?

I went back and looked thru the comments on Sumner's post. Why are there not 30 people pointing out bogus evidence? Maybe because Sumner tends to bully people who challenge him.

Oilfield Trash said...

Art

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 MI (GDP/ Currency Component of MI).

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.

https://research.stlouisfed.org/fred2/graph/?graph_id=283942&category_id=

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