14 Feb 2011

Twin Spin on Inflation Fears and Monetary Aggregates

Economics, Shameless Self-Promotion 12 Comments

With my crazy traveling I didn’t post last week’s article on “Investors Finally Fear the Inflation Precipice.” Here’s an excerpt:

When Bernanke made his infamous appearance on 60 Minutes, most analysts understandably focused on his absurd claim that he wasn’t printing money. But the thing that most alarmed me was this exchange (starting at about 7:20 in this video):

BERNANKE: There really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation at the appropriate time. …

Q: You have what degree of confidence in your ability to control this?

BERNANKE: A hundred percent.

Now that should be terrifying. Realistically, Bernanke shouldn’t have 100 percent confidence that he can control his toaster. I mean, he might turn the dial up too high, or someone might spill water on it. It could happen.

Then today I have an article explaining why economists use different monetary aggregates (M1, M2, etc.) and how Rothbard/Salerno decided to engage in product differentiation. In all seriousness, I think I give the rationale behind some of the classifications that you wouldn’t get in a standard list of definitions.

12 Responses to “Twin Spin on Inflation Fears and Monetary Aggregates”

  1. Jonathan M. F. Catalán says:

    Have you ever given serious consideration to throwing your own opinion into the fray on what constitutes money, and what a better money aggregate would look like? To me, it seems that we should actually operate with several aggregates in mind. Two of which are: the amount of money in circulation (which is what is “presently” relevant) and the amount of money that is out of circulation (which has a high potential of going into circulation in the future).

    • Captain_Freedom says:

      There are complications with that.

      First is that what is in circulation is in part a function of what is not in circulation, and what is not in circulation in is in part a function of what is in circulation. Most people decide how much money to spend/invest and how much to hold as cash in a simultaneous manner. A high cash to spend/invest ratio does not necessarily imply that price inflation is going to rise in the future, and a low cash to spend/invest ratio does not necessarily imply that price inflation is going to fall in the future.

      Second, since at any given time, the total quantity of money is always sitting in people’s back accounts, which already complicates the idea of “circulation”, it is in addition difficult, if not impossible, to separate cash balances into two parts, i.e. that part which people use for transactions, and that part which is kept as cash. For example, if you “peer” into someone’s back account, you will see a sum of cash. Can you know on the basis of this alone the amount of money they will use for transactions and the amount they are going to hold as cash, for say, the next month?

      Every dollar in existence, in everyone’s bank account, has the “potential of going into circulation”. Perhaps you can explain the way you can go about separating them into two parts?

  2. Bill Woolsey says:

    Salerno’s discusion was dated.

    The things included in the aggregates have changed.

    While I don’t agree with what he does and does not call money, (particularly, I
    think money market mutual funds are media of exchange,) the overnight repurchase
    agreements and eurodollar accounts are gone.

    Also, the development of sweep accounts makes a lot of the approach of 20 years ago

    What the Fed asks the banks to report and reality have become very divergent. And we
    know much less about reality than before.

    • Captain_Freedom says:

      particularly, I think money market mutual funds are media of exchange

      Shares in highly liquid, short term debt securities have dollar prices that can diverge from their par value. Money’s claim is to itself only. If someone wrote checks off their money market mutual funds account, the shares in their account would have to be sold in the market for cash first, before the money implied in the check is transferred and the trade completed. The shares themselves are not generally accepted media of exchange. The shares are credit based claims to future money flows.

      Salerno’s discusion was dated.

      Shostak (2000) provides a more up to date definition that includes sweeps.


  3. Bill Woolsey says:

    If think the Fed can reduce reserves to offset falling demand by banks to hold them and it can do so with no pain to the banks.

    It is almost as if you are thinking it is still 2008 or 2009 and the Fed is lending to banks.

    Or if you are imagining that the banks will have to shrink their balance sheets (like there will be a multiple contraction in the quantity of money and credit.)

    Of coursre, the Fed could fail to reduce the quantity of reserves.

    And if they insist on targeting interest rates, especially keeping them low for an extended period, they will have problems.

    But I think the story we are telling here is growing demand for bank credit. Always good for the banks. And then a shift from reserves by banks to loans, which they can do. (It is just the multiplication that is going to be prevented.) The banks switch from low interest reserves to higher interest loans. They do this because more people want to borrow.

    Also, higher interest rates that dampen an increase the quantity of loans demanded shouldn’t be confused with a decrease in the supply of credit.

    • Stephen says:

      Bill, Bob Murphy had his Mises class on the Fed read your article, “Who Owns The Fed”, which I found to be a nice counter point to conspiracy theories of Fed ownership. Have you read Vijay Boyapati’s artilce on Inflation vs Deflation (http://libertarianpapers.org/articles/2010/lp-2-43.pdf)? I would appreciate your insights on whether the Fed (run by politicians) gives us inflation or the Fed (run by bankers) gives us deflation as a solution to our current financial crisis.

  4. Blackadder says:


    What is it about the “True Money Supply” that makes it more useful than the other aggregates? Is there supposed to be a relationship between changes in the TMS and inflation, or interest rates, or whatever, that isn’t necessarily present for M1, M2 etc.?

    • Captain_Freedom says:

      What is it about the “True Money Supply” that makes it more useful than the other aggregates?

      Mises, and thus Rothbard and Salerno, hold that the fundamental purpose of money is to be a “medium of exchange”. Using this principle, TMS is according to them the closest statistic that represents the total quantity of money, i.e. “medium of exchange”, in the economy.

      As for how “useful” it is, that is subjective and up the individual using it. ZeroHedge for example charted TMS and commodities prices, and they found this:


      • Blackadder says:

        I went and compared changes in the AMS to changes in the CPI since 1959. There does not appear to be much of a connection.

        • Captain_Freedom says:

          CPI is already inherently problematic as it is.

          I wouldn’t be surprised if TMS didn’t correlate with it.

          CPI probably correlates well with political deception.

          • Blackadder says:

            The CPI correlates pretty well with the Shadowstat numbers (the Shadowstat numbers tend to be higher than the CPI, but rise and fall in tandum with it).

  5. Mike Sandifer says:

    Where is your actual evidence for coming high inflation? 30 year Treasury yields are still well-below 5%, for example, and commodity indexes are still well below ’08 pre-late summer levels. I can’t think of one metric that signals anything like above long-term trajectory inflation, or indeed any rate even getting us back there.
    As Sumner might point out, if you generally know better than the markets, then maybe you should at least be wealthy

    I have three serious questions for you:

    1. When will you start providing actual evidence that any of your predictions are supported any way?

    2. How long does the US have to go without serious inflation before you recognize and then admit you’ve been terribly wrong?

    3. Have you thought about what happens to your overarching paradigm if high inflation never appears?