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.