Money Matters No More?
Although there are deep and abiding differences between Chicago school monetarists and Austrian monetary theorists, there has always been strong agreement among them on one thing: the central importance of the money supply in explaining the purchasing power of money or "price level" in the economy.
This does not appear to be the case any longer. [Full Article]
Comments (14)
A few comments regarding the implications of Mr. Gavin's position, which evidently de-emphasizes the importance of the money supply as a policy consideration. The main reason why Mr. Gavin and the policy branch of monetarism can support this faulty analysis is due to the increasing worldwide demand for the U.S. dollar, which is largely the result of the dollar's position as the worldwide reserve currency. Foreign central banks, in particular those in Asia, continue to accumulate dollar balances, thus enabling the U.S. to avoid most of the inflationary effects of its loose monetary policy. If and when foreign central banks decide to reduce their dollar balances, i.e. reduce their demand for the dollar, inflation in the U.S. will increase significantly. Furthermore, as some Austrian School economists have previously explained, there is no theoretical need to increase the quantity of money to offset increases in the demand for it. Mr. Gavin's analysis adopts the incorrect position that a goal of monetary policy should be stable prices. As Professor Salerno and other Austrian School economists have recently emphasized, price declines that are caused by productivity increases or increases in the demand for money are not de-stabilizing. Attempts to stabilize money's purchasing power by injecting increased quantities of money into the banking system lowers the market rate of interest, and it is this artificial lowering of the rate of interest that is the root cause of the business cycle. Unfortunately, monetarists and the large majority of the economics profession continue to wrongly believe that the rate of interest can be manipulated by central banks with no adverse effects on economic activity.
Published: June 29, 2004 9:46 AM
Being an armchair pseudo-layman-economics enthusiast (in other words, I get the basics), I just want to clarify what this article is about. Basically they're saying that the quantity of money doesn't matter, than it doesn't affect prices? And the Austrians are saying that supply and demand are what matter, and that a greater supply will result in a lower dollar value? Do I have this close to right?
If that's the case, then the St. Louis Fed is saying that supply and demand are no longer valid?
Graciously yours,
Jeff
Published: June 29, 2004 9:51 AM
Thanks to Mr. Sperduto and to anyone else who can elucidate at all.
I am 62 years old, and some of my earliest memories are of my father's warnings that economic catastrophe was imminent. He was good at explaining economic effects so that they were accessible to childrens' imaginations. Among other ideas, he related that if the government confiscated 50% of every person's pay, the money would then be worth only half as much, and the person would then be willing to work only half as hard. ( I am not sure this can be entirely true. Many slaves worked hard, and for no pay at all).
Anyway, it is hard for me not to notice that the economy has not collapsed so far. Catastrophes have befallen individuals, but the contretemps the economy has suffered as a whole have apparently all proved tolerable to date during my lifetime and in the USA. I begin to feel like someone born into one of those 19th-century cults whose membership expected the second coming of Jesus and the end of the world during their own lifetimes.
I see why the Chicago school has tried to re-think their position.
It seems to me that there is a possibility for an individual to profit from an enterprise he may start but that the economy as a whole does not experience profit. Whatever new advantage is brought to mankind by any individual, the government tries to quantify and predict its amount, and that is the amount that the government tries to tax away from it in inflation: typically two or three percent a year.
A new computer may seem to be a convenience for an individual, but he must pay extra taxes in an amount to accord with the amount of convenince he has gained.
Perhaps it may be (as I think Mr. Speduto may be suggesting) that just as soon as the foreigners now buying dollars discover that they are the last possible participants in a Ponzi scheme, a collapse will come.
If it doesn't, then I don't think Austrian economics can explain what is happening.
Mary Diane Dolan
Published: June 29, 2004 10:46 AM
Mary Dolan observes: "Anyway, it is hard for me not to notice that the economy has not collapsed so far. Catastrophes have befallen individuals, but the contretemps the economy has suffered as a whole have apparently all proved tolerable to date during my lifetime and in the USA."
Austrian economics predicted what one would think are two of the most significant economic events in the twentieth century: the Great Depression, and the collapse of the Sovient Union. It also predicted the stagflation of the '70s and a myriad other 'minor' economic disasters. One would hope that this kind of track record would give weight to its prescriptions regardless of the fact that the parasite hasn't (yet) killed its host.
Published: June 29, 2004 11:39 AM
There is no problem issuing more paper receipts
for wealth as more wealth is created. The rot sets in when the government is put in charge.
And I think we all know why.
Published: June 29, 2004 11:51 AM
In response to Mary Dolan:
Austrian economics, in itself, does not predict economic phenomena, in my opinion. That's not its purpose. It's purpose is to explain observed economic phenomena, and describe the necessary consequences of economic policies. It doesn't provide any basis for a prediction of when these things will happen. Now, of course, some individual Austrians try to, but, if they are honest, they will admit that their predictions (regarding timing) are uncertain. What is certain, however, is the results.
The Great Depression had to follow the '20s. All the necessary logical conditions for a bust were present, so it had to come eventually. The Soviet Union had to collapse (that or severely reform), though we couldn't say when.
Likewise, the Bretton Woods system had to fall apart. And it did in 1971 when Nixon closed the gold window, and the stagflation of the 1970s followed.
Is economic collapse necessary right now? Well, it depends on what you mean by economic collapse. If you mean that the economy totally falls apart and we have to resort to subsistence farming and barter, I'd say no. If, however, you mean that there need to be a decent number of bankruptcies and liquidations, I'd say we just went through that in the recent recession. Of course, there may be some left that needs to happen (the housing bubble is something we hear about somewhat).
But, you bring to mind an important point. We, as economists need to be very careful and very clear. If you make a false statement, you can ruin the reputation of your school of thought.
So, what then do I have to say about the coming economic crisis? Simply, it can be averted. The market can handle a lot of stress as long as those that feed on it (read: government) don't take too much. Will the system be weaker than otherwise? Of course. But, that doesn't mean it will necessarily collapse. Will our system of fiat money lead to more inflation than otherwise? Yes, but that doesn't mean hyperinflation is inevitable.
Sure, these aren't emotionally stirring doomsday scenarios. But, if they're accurate, so what? I can still say that we would be more prosperous with less government confiscation of resources (through inflation and taxation). I can still say that we would be more prosperous if we were on the gold standard.
So, even without making concrete predictions as to when or how economic crisis will occur, I can devise good policy.
And isn't that really the point?
Published: June 29, 2004 1:33 PM
My thanks to Lucas Engelhardt for elaborating on the point I was too impatient to make clearly.
However: "But, you bring to mind an important point. We, as economists need to be very careful and very clear. If you make a false statement, you can ruin the reputation of your school of thought."
I wish this were truer than it seem to be in my more cynical moods...
Published: June 29, 2004 2:18 PM
Actually, Thant Tessman, I think you have a point... The rule about care and clarity only applies to Austrians. If you're neoclassical or Keynesian, you can be wrong with reckless abandon. (Paul Krugman, perhaps.) The problem with being out of the mainstream is that we have to make sure that we're always right. Of course, who minds that?
Published: June 29, 2004 2:55 PM
Lucas, that's a given for any minority standpoint. In many cases, there's no practical need to argue against fallacies because they simply have no presented basis. The need for refutation arises from the tendency of many to try to use backwards logic; that is proposing a conclusion, then presuming it correct until proven false. Rather than observational data being treated as axiomatic and conclusions provisional, conclusions are considered axiomatic and observational data provisional. Knowledge is a provisionally accepted convention.
Published: June 29, 2004 8:49 PM
As for Monetary Trends, it seems to be trying to condition people with the notion that the Fed is essentially GOD and that value and meaning are merely results of it's policy decisions.
Published: June 29, 2004 8:55 PM
Of course of the several illegitimate uses of money often spoken of one is usually quite ignored, the enslavement of an entire populace by a debt-money system.
There is a basic axiom on money that is either unknown by monetarists or ignored in favor of the many schemes used to enrich the few at the expense of the many. It goes like this:
"As universal prosperity is dependent upon the ability of Money to flow (its "velocity"), nothing may be done to money that would in any way impede that flow."
This would include things like using commodities for money (gold, silver), adding bankers' gimmicks like interest to money, or in giving money additional uses beyond its sole legitimate use as a "medium of exchange."
Money needs to be "created" into circulation by a system's wealth producers, never "borrowed" or "spent" into circulation by its bankers or consumers. It needs nothing backing it but the integrity of its issuers (in a second-rate democracy there can be no integrity).
That is the rule, though it cannot be applied in this time and place. Money issuance is government's most sovereign prerogative, yet in honest form is as unobtainable as is the only workable FORM of self-government, a Republic.
Had we a Republic, one of the very few prerogatives granted to the upper levels of government would be money issuance, a completely worthless medium of exchange, which being worthless would never be hoarded but would be quickly spent for something that one coveted for its intrinsic value. This velocity is what produces UNIVERSAL prosperity. Lack of velocity is what creates wealthy and impoverished classes of people, plus the struggling middle class that actually produces the wealth, and unfortunately, their ranks are constantly diminishing.
Published: June 29, 2004 11:38 PM
Bob Taft,
What you say is nonsense. No matter how many times my coworker and I hand a piece of money back and forth, we aren't any more prosperous unless some real goods or services are exchanged.
Now, it's true that if money is incapable of "flowing" (I assume you mean, changing hands), then the economy doesn't work. The problem is, money is defined (at least in the Austrian tradition) as the common medium of exchange, and therefore MUST flow by definition. A medium of exchange that can't change hands is a contradiction.
As for the alleged benefits of a worthless money that people immediately spend to get something of "intrinsic value" (another fallacious concept), that has happened several times in history. It happened once in Germany in this last century... They call it hyperinflation. And, unlike your claim, hyperinflation actually leads to economic meltdown, dissolution of the monetary system, and a return to primitive barter until a new, VALUABLE money can be established. Unlike what you claim, "hoarding" money (or what may be more appropriately called "maintaining cash balances") is absolutely logically necessary, as someone must always own each moneything in existence. Not to mention that, from a personal standpoint, it's just silly to spend your money the minute you get it. Think about it. Do you take your paycheck and immediately spend it on a good that is "intrinsically valuable"?
I'm also uncertain as to how your Republic would result in this great economic utopia that you claim. If, in fact, a hyperinflation will result from this Republic, as you claim it will, I want no part of it.
Published: June 30, 2004 9:02 AM
Lucas,
Excellent point regarding the term "hoarding." As you mention, because all money must be in someone's cash balance at each moment in time, all money is always "hoarded." As typically used, hoarding is an unscientific term utilized by those who believe other individuals are not "spending" their money fast enough. In this case, a more accurate description would be that it is someone's opinion that someone else's demand for money is too high. As a related point, if I recall correctly, Keynes and other other economists make the mistake of confusing or conflating the demand for money with savings.
Published: June 30, 2004 11:57 AM
Mr Gavin appears to be saying the unthinkable - that so much money has been created, it is, in point of fact, worhtless. The only difference between the US Dollar and Continentals, Greenbacks, or Confederate Dollars is that the point of worthlessness has been reached extremely slowly, so that "not one person in a thousand" is aware of it. Worst part of that thinking is that he seems to think that is a good thing.
Published: July 1, 2004 6:29 AM