We need to talk about money and nominal growth

Scott Sumner’s recent post on the alleged irrelevance of monetary policy channels seems aimed to alienate anyone who has taken the time to notice what’s been going on with the economy, banking and monetary policy for the last few years.

Sumner says there’s “no need to talk about ‘channels’” because concerns over propensities to spend, borrow, or lend can be shown to be false by three statements about the world. What are the statements?

1. Counterparties don’t matter.  The Fed buys assets from counterparty X, who almost always immediately cashes the check and the new base money disperses through the economy almost precisely as it would if the Fed had bought assets from counterparty Y, or counterparty Z.

That’s just not right. When the Fed buys a bond, it buys it from a primary dealer. The primary dealer, in turn, either had it in inventory or, more likely, bought it from one of its customers.

Customers buy and sell bonds continuously, whether or not the Fed is buying. The banks have multiple teams of guys whose job it is to facilitate customers doing this. The selling and buying is based on price and other considerations (like portfolio rebalancing or consumption plans). The folks selling bonds do whatever they were going to do with the proceeds—reinvest, pay for their kids college, buy a swimming pool—regards of whether it was the Fed buying or not.

The customer didn’t get a check to cash when he sold his bond. Instead, the balance in his deposit account with the dealer showed an increased. That’s a minor quibble but it is important since I think the concept of “cashes the check” leads to confusion.

This deposit growth doesn’t disperse anywhere. It sits as a deposit until the customer does something else with it, in which case it just becomes a deposit in another account. How would it disperse? Remember, Scott is arguing that “propensity to spend” doesn’t matter. But it is only through spending that the deposit disperses.

2.  The propensity to spend doesn’t matter for the same reason.  Once counterparties get rid of the new base money, the impact on NGDP depends on the public’s propensity to hoard money, and any change in the incentive to hoard. In the long run money is neutral and NGDP changes in proportion to the change in M, depends on the ‘M’ regardless of whether the person receiving the money has a marginal propensity to consume of 90% or 10%.  Either way they’ll almost always “get rid of” the new money, either by spending it or saving it.  Saving is not hoarding, it’s spending on financial assets.

That last sentence is correct.  When the Fed buys a Treasury or a government-backed mortgage-bond from someone who was using it as a savings/investment vehicle, the former bond holder is left with a deposit in a savings account and that deposit is a financial asset.

Why is the counterparty going to “get rid of the new base money?” She is going to do whatever she was going to do with the proceeds of the bond sale. Perhaps spend it on consumer goods, perhaps purchase a different financial assets.

She traded her bond for “base money,” which is to say an increase in his deposit account. I suppose you can say that she’s “spending it on financial assets” since she has “purchased” a deposit at a bank.

But how is this getting rid of anything? It’s just accepting what was on offer in exchange for the bond.

3. The lending channel doesn’t matter.  In the long run all nominal prices rise in proportion to the change in M.In the short run sticky wages and prices cause the new money to have non-neutral effects.  Those non-neutral effects reflect wage and price stickiness, not “channels” of spending.

Why would nominal prices rise because savings are now held in dollar denominated bank deposits instead of dollar denominated government bonds?  What’s changed that could cause a change in NGDP?

Sumner’s obviously a smart and thoughtful guy. But he’s never explained to my satisfaction why we should expect great macro-economic effects from this “new money.” Treasuries are future claims on money, acquired in exchange for current money. So what has happened when “base money” is expanded through QE, is that the central bank has transformed future claims into present claims.

What has changed isn’t really a change in quantity. What’s changed is the yield, maturity and liquidity characteristics of the public’s holding of financial assets. Perhaps those differences are enough to trigger a nominal rise in prices but I suspect that’s getting things backward. It’s not the change of the mix of financial assets (fewer bonds, more deposits) in portfolios that activates behavior likely to push up prices or nominal growth; it’s the change in behavior and plans that leads to changes in portfolios.

“ If I had the choice I would never be in default servicing again. I’d tell anyone who took out a mortgage, if you’re 60 days late, we’re selling the mortgage and we don’t want to do any business with you again. ”

Jamie Dimon, J.P. Morgan Chase Investor Day 2014

The Weird and Costly Stigma of the Discount Window

In my piece for Heard on the Street today, I criticize banks for willingly overpaying for things just to keep up appearances.

Before the crisis, banks often overpaid to buy back shares. During the crisis, they overpaid to borrow money from the Fed’s Term Auction Facility. And now the danger is that they’ll overpay when making buybacks again.

The column is focused on buybacks but I think it’s worth reflecting for a moment just how weird it is that banks insisted on overpaying to borrow money from the Fed even as their balance sheets were under immense pressure. 

The discovery of overpayment comes from the paper linked to in this blogpost at Liberty Street Economics. Fed economists found that in the depths of the financial crisis banks willingly overpaid for loans from the Fed, bidding for loans from the Fed’s Term Auction Facility at a substantial premium over what it would have cost them to borrow from the Fed’s discount window.  .

“In summary, our results show that banks could have lowered their interest expenses substantially during the financial crisis of 2007 and 2008 by borrowing from the DW instead of from the TAF or from the financial markets,” the Fed’s Olivier Armantier explains.

Why on earth would banks willingly pay the higher rate?

My non-serious response is that the banks borrowed at higher rates than necessary in order to set an example for their customers.

"Stop choosing the cheapest loan! Be like us wealthy bankers and choose the more expensive loan! It’s, uhm, prestigious!" 

The Fed’s economists say the “stigma” attached to borrowing from the discount window is to blame. But there is something a bit mysterious about this stigma. Discount window borrowing is confidential and it has been more than a decade since the Fed changed the rules so that even perfectly healthy banks can come to the window. There’s no logical or structural reason anyone should associate borrowing from the discount window with financial weakness. 

If anything’s going to be stigmatized by bankers,shouldn’t it be the choice to borrow more expensively?

Stimulate the Beast

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Paul Krugman has finally gotten around to answering a question I’ve been asking for a long time. Unfortunately—and weirdly—his answer is rooted in a mistaken Republican theory of politics.


The question is this: Why Krugman hasn’t pushed for fiscal stimulus in the form of tax cuts? Krugman’s done a lot of excellent work beating back the deficit scolds. He obviously believes that the economy would perform better if we ran a bigger fiscal deficit but he’s always stopped short of supporting the only politically viable path to deficit expansion: tax cuts.


As both Cullen Roche and I pointed out back in 2011, Republicans would be willing to accept higher deficits if they are the result of tax cuts rather than spending increases. They might even be willing to accept spending increases in exchange for tax cuts. In fact, that kind of “grand bargain” is what Republicans have agreed to a number of times in the not so distant past.

Both Cullen and I were hopeful that Krugman would actually be able to change the terms of the budget debate by supporting tax cuts. But he never did.

Over at the New Republic, Ryan Cooper recently revived this argument:


So if the center, especially including President Obama, can be persuaded to drop their deficit obsession (and again, it’s hardly possible to overstate how badly this debate has been lost), we could trade tax cuts for some austerity relief, like re-extending unemployment benefits and food stamps. And, it’s important to note, both spending increases and tax cuts count as austerity relief. Tax cuts, especially on the rich, aren’t very good stimulus, but they still put money into people’s pockets.


But the main point is to shift ground for negotiation. This strategy of “tax cuts for more spending” has been suggested many times in the past few years and gone nowhere. But before that, it had been the basis for many successful bipartisan deals, including expanding Medicaid in the 1980s and the CHIP program in the 1990s.

Krugman’s response explains why he never came around to supporting tax cuts:

I don’t buy it, basically because I believe you need to play the political economy long game. Starve the beast is still out there as a strategy; conservatives still push tax cuts in part because they expect, probably rightly, that this will tilt the balance toward cuts in the safety net the next time the deficit becomes a big issue. Don’t you think federal spending would be significantly higher now if the Bush tax cuts had never been passed?

Krugman’s right that a lot of conservatives still believe in the “starve the beast” strategy. But he’s wrong when he says that it’s “probably right.” It’s probably wrong.

As I explained a couple of years ago, the history of taxes and spending suggests that government is a beast that doesn’t starve.

Falling revenues are typically accompanied by rising spending; while rising revenues are accompanied by falling spending. In other words, the “beast” of government spending doesn’t require a meal of taxes to grow. It thrives, in fact, on a starvation diet. Government is a hunger artist.

This point was made back in 2004 in a Brookings Institute paper by Peter Orszag and William Gale.

“The ‘starve the beast’ strategy may simply not work as a political equilibrium. We have in mind that policy-makers jointly go through periods of fiscal restraint and fiscal largesse, and the restraint or largesse occurs simultaneously on both the tax and spending sides. That is, periods of fiscal largesse tend to generate declines in taxes and increases in spending (as shares of gross domestic product). Periods of fiscal discipline tend to provide declines in spending and increases in taxes.”

The Cato Institute’s William Niskanen pointed out that the starve-the-beast theory was wrong in a paper published in 2002. I can’t find a link to that paper at the moment, but Niskanen described his findings in this 2004 Cato report:

In a professional paper published in 2002, I presented evidence that the relative level of federal spending over the period 1981 through 2000 was coincident with the relative level of the federal tax burden in the opposite direction; in other words, there was a strong negative relation between the relative level of federal spending and tax revenues. Controlling for the unemployment rate, federal spending increased by about one-half percent of GDP for each one percentage point decline in the relative level of federal tax revenues.

In 2006, both Jonathan Rauch and Jonathan Chait wrote about Niskanen’s findings (although Chait’s article has vanished from the internet) and set off a pretty big debate. National Review responded here, Greg Mankiw here, Mark Thoma here, Brad DeLong here, and Ramesh Ponnuru here.

While Niskanen’s idea was pretty controversial when it was first put forth, it appears to have withstood the test of time. Last year, it received a revival of sorts when it was positively cited by Bruce Bartlett in the New York Times and Andrew Ferguson in the Weekly Standard.

I assume Krugman is aware of the Niskanen and Orszag papers, although I haven’t been able to find any direct evidence he’s read them. If he has, it would be great for him to explain why he isn’t persuaded by them. 

There’s a lot at stake here. If the “starve the beast” theory is wrong, there’s no reason why Democrats and progressives shouldn’t join Republicans and conservatives in crafting a tax-cut based stimulus package. And it’s truly weird to imagine that what might be preventing the progressives from pushing for a job-creating stimulus package is a myth created by Republicans.

Marigny, New Orleans .

Marigny, New Orleans .

Decisions, decisions. Begin hobo life now? Or wait another day?

Decisions, decisions. Begin hobo life now? Or wait another day?

Cafe du Monde injury. #nola #yolo

Cafe du Monde injury. #nola #yolo

These are called beignets but in NYC we know them as zeppoles.

These are called beignets but in NYC we know them as zeppoles.

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