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And You Thought You Were Done with My Criticisms, Didn't You?

Posted By George Selgin On September 24, 2012 @ 4:30 pm In Uncategorized | No Comments

In reply to Larry White's recent post, my former student David Beckworth has rushed to the defense of QE3 [1], prompting me to offer the following remarks, originally posted to his site, on some of the points he makes:

"there have been a series of negative money demand shocks."

I find this language unhelpful: a "negative" demand shock ought, strictly speaking, to mean that demand for the affected thing goes down, not up. So, the "shocks" must have called for less rather than more easing. But that evidently isn't what is meant here. "Negative" apparently has not its usual sense but that of "unwanted" or "undesirable."

"Institutional investors also need assets that facilitate transactions, but the assets in M2 are inadequate for them given the size and scope of their transactions. Consequently institutional investors have found ways to make assets like treasuries, commercial paper, repos, GSEs and other safe assets serve as their money"

This begs the question, for if it is these assets, rather than those found in narrower aggregates, for which there is excess demand, it is not in the Fed's power to increase their abundance. On the contrary: when it swaps FR liabilities for any of these very assets, it presumably reduces the supply of precisely those things that institutional investors supposedly have to have for their transacting! To help them, the Fed should have been doing "reverse" QE!

"household portfolios are still inordinately weighted toward liquid assets. Take a look at the figure below. It comes from the flow of funds data and show households' total deposit assets and treasuries as a percent of total household assets. There is a sudden jump in this series in 2008 that has yet to return to pre-crisis levels, a sure sign of elevated money demand."

An awkward claim, since the date [sic] suggest a slowdown in demand for time deposits during precisely the period--2007-209--when the "shortage" of money was presumably most acute, as evidenced by shrinking NGDP.

"interest rates are low because of ongoing economic weakness that has decreased the demand for credit. Excess money demand is at the heart of this slump. If money demand were not elevated and the public expected higher nominal incomes these interest rate would be rising. The fact they haven't speaks volumes to the ongoing demand for safe assets or money."

The argument here begs the question. Yes, credit demand is low; and that's because the economy is in a slump. But it doesn't follow that the slump is due to a lack of spending, as opposed to having structural or "real" causes. There is no guarantee that higher spending will lead to higher real rates, rather than simply raising nominal rates by boosting inflation expectations.

"It is hard to believe we have been in this slump since mid-2008. That is a long stretch and one would think enough time for money demand shocks to work themselves out. But the U.S. economy has been subject to a spate of money demand shocks and the Fed has consistently failed to fully respond to them."

The shock of 2008-9 is evident enough in the NGDP and other spending series. But the "shocks" after that do not show up in the one place that should matter most, especially to proponents of NGDP targeting. Instead all concede that NGDP has recovered its pre-2008 level and approximate growth rate; the question is whether it needs to grow faster to "catch up" to its former trend. That claim, in turn, depends heavily in how one constructs the "correct" trend, and especially on the extent to which one is prepared to allow "boom" period NGDP growth (e.g. from the dot.com and subprime bubbles) to inform estimates of "normal" trend growth. Draw the trend at 5% or more, as you and Scott prefer to do, and NGDP is "behind" where it "ought" to be. Draw it for 4.5% or less, and "catching up" looks like just the thing for blowing yet another bubble.

Ah, just like the good old days, David! And, no less than back then, I expect you will not be short of rejoinders and retorts!

Postscript (added 9/24 at 5:41): All these appeals to different measures of the money stock as offering evidence as to the extent to which money is in short supply or has been exposed to demand shocks really are, or should be, considered quite beside the point in the MM and other nominal spending targeting frameworks. After all, nominal spending targeting makes sense precisely to the extent that fluctuations in nominal spending serve as a good indicator of money shortages or surpluses. So who cares what M2 or M3 or m$ or other still fancier M measures are of have been up to? If spending has remained stable, the presumption is that the economy has been getting all the liquidity or exchange media it needs, and that it is therefore not tending to ride up or down a short-run Philips curve. It is precisely because NGDP targeting and similar schemes dispense with the need to track particular monetary aggregates, or worry about the stability of demand for them, while still sticking to a nominal target, that they constitute an alternative and appealing alternative to conventional "monetarist" rules.

So, when it comes to demonstrating that money is or has been in short supply, a consistent Market Monetarist has no reason to appeal to the behavior of any measure of M. What matters is whether a plausible case can be made that spending is too low, or has been growing too slowly. That of course leads to thorny questions concerning the choice of an ideal growth rate and, what amounts in the short run to the same question, the fitting of a trend to past data with the aim of finding the once that would have been most conducive to the avoidance of booth booms and busts. This latter task, it seems to me, is not quite as simple a matter as some MM's have made it out to be.


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[1] rushed to the defense of QE3: http://macromarketmusings.blogspot.com/2012/09/is-there-really-excess-money-demand.html

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