05 Oct 2011

Starting From Scratch With the Quasi-Monetarists

Economics, Federal Reserve, Inflation 34 Comments

Scott Sumner popped in to leave a comment on my earlier post. To refresh your memory, I was complaining that Scott (and his quasi-monetarist peers) is so sure that tight monetary policy is to blame for our economic woes, that he’s neglecting the host of other massive interventions into the market economy that have occurred in the last 3 years in particular. One of the things I mentioned was the continued extension of unemployment benefits. In his comment Scott said:

“I think the 99 week extended [unemployment insurance] has sign[i]ficantly increased unemployment. But that doesn’t reduce M*V.”

OK, this floored me. (I know, I know, maybe what’s happening here isn’t that Scott is a shocking fellow, but that I just need to get out more and experience the world.)

Let me say it plainly: Some economists (largely centered in the Rothbardian tradition, but perhaps there are others) REJECT the theory that explains years-long recessions on “inadequate demand.” In a healthy, free market economy, if for some reason people decided they wanted to hold 10% more in cash balances, then prices would fall. I’m not saying it would happen instantly, and of course it would screw up people’s plans if they didn’t see it coming. There might be bankruptcies, wealth transfers from debtors to creditors, etc. etc. But I don’t think you would see (the broadest measures of) unemployment shoot up into double digits for years on end, nor would real output collapse for years on end.

In contrast, when I am asked to explain why we’ve been stuck in such a slump for the last 3-4 years, I would go through and list the incredible interventions. (I’m not going to make this list now; I’ll do an article at Mises.org on this.)

Go look at Scott’s comment again. He is agreeing with me that extending unemployment benefits–i.e. paying people to not find a new job–is keeping unemployment high. OK, how are real goods and services produced? Firms hire workers who then process natural resources and capital goods, to create the output.

So, if we can explain why unemployment remains high, that’s a darn good start on explaining why (a) unemployment remains high (which is what most people care about) and (b) why real output isn’t snapping back (which is what economists care about).

As Scott’s comment reveals, he doesn’t think this can be a large part of the story, because it doesn’t explain the trend in MV. But what if the trend in MV is an interesting bit of trivia?

You don’t have to share my extreme views that aggregate demand will largely take care of itself, to at least see that Scott is unwittingly going to the other extreme.

Last point: The reason I pick on Scott so much is because he is such a good representative of the quasi-monetarist position. Let us recall my August 2009 blog post:

Wow. I am totally blown away by Scott Sumner’s blog, The Money Illusion. He is a Chicago PhD who specializes in the gold standard and the Great Depression. I don’t even necessarily agree with his overall views, but WOW his posts are really really good. It’s what I would have expected from nerdy academic economists before I actually saw the real world buffet available for sampling.

34 Responses to “Starting From Scratch With the Quasi-Monetarists”

  1. Silas Barta says:

    Yeah, I was blown away by Sumner’s comment on that post too. There’s a joke in here somewhere…

    Scott Sumner becomes president, and during his term, there’s an apocalypse. He asks for a status report.

    “Sir,” his chief of staff replies, “it’s a disaster: most agricultural land is now fallow. Critical industrial infrustructure has been destroyed, leaving us unable to produce much of anything, nor to ship what we do have. There’s widespread looting in all population centers. People are reduced to bartering for basic necessities … ”

    “Well, there’s your problem,” interjects President Sumner, “Obviously we have an M*V shortage. The first order of business is to get our Mint functional again!”

  2. RG says:

    I would argue that nearly every economist that flies the Austrian banner is a convert from other economic schools of though. There may be the few exceptions of interested children inheriting a parent’s Austrian sensibilities or the young person that stumbles upon it prior to the standard academic indoctination, but the David Friedmans of the world are the rule.

    Abandoning the basis of your career and the respect of your colleagues are extremely difficult vanities to overcome. You might even say they are the top reasons why economists that have been exposed have not adopted the Austrian viewpoint.

    I have only 16 credit hours of state university econ under my belt and it took me over 2 years after first finding it to fully accept the Austrian perspective which now seems so blatanly obvious. I did it in spite of potential ridicule and ostrazation from family and friends – which have occurred, but to a lesser extent than expected. The same conversion for a pHD economist must be orders of magnitude more difficult.

    Many individuals that have gotten caught in the slough of malivestment caused by the most recent bust find themselves in an ironically similar situation. It’s tough for someone to admit that the last X years building a career was a waste and must be abandoned for a different direction.

    I agree that increasing the incentives of unemployment have sustained unemployment (duh), but the affect this latest massive bust had on disjoining professionals from their careers – not just laborers – should not be underestimated when assessing the fall in output.

    If you look at Bob’s gnome analogy, the extension of unemployment benefits would be like finding yourself relocated next to a clean water source with lots of available food. That certainly hinders output because why leave? I believe, in addition, many of the relocated highly skilled people came down with amnesia as well.

    • Bob Roddis says:

      RG: I can understand the Keynesian/Friedmanite unwillingness to accept the sad fact that they are the cause, not the cure, of our misery. However, I’ve always found it strange that our opponents cannot or will not wrap their minds around the simple concepts of ignorant acting man, economic calculation and the pricing process. All I can come up with is that we think it’s essential that average people be allowed to run their own lives which totally negates the possibility of the intellectual overseer of society. The abolition of the possibility of the intellectual as overseer is just as fatal to our opponents’ self esteem as accepting their role as having been the cause of our problems. What we end up with from our opponents is nothing but continuous avoidance, aversion and name-calling.

      Finally, why can’t people understand the concept of economic calculation when people playing an online game have helped determine the structure of an enzyme that could pave the way for anti-AIDS drugs:


      • MamMoTh says:

        This said by the attorney who thinks Cantillon effects result from changes in the stock of money? Hilarious!

        • Bob Roddis says:

          For the record, I don’t believe that I’m having a personal dispute with Mam-mouth. The “insight” of his “analysis” stands on its own merit. Further, he can’t trash talk to save his life. In fact, the quality of this trash talking is below that of his “analysis”.

      • RG says:

        Yeah, I can see the self annointed divinity wrapped up in there as well.

        I could also see that delusion contributing to the unwillingness of a professional to transition to another market.

        The truly sad aspect is that these delusions can only be held in place by violence on their behalf.

  3. DT says:

    Perhaps Murphy didn’t get the memo ( to be expected, I suppose, since Mr. Murphy is not an elite economist). It’s not “Quasi-monetarists” anymore.

    The new title is “Market Monetarists”.

    Please update your systems.

    Thank you.

    • Desolation Jones says:

      You’re not supposed to say the Q-word anymore. It’s politically incorrect. It’s was pejorative label coined by Krugman to put down a certain type of of economist. Only the Market Monetarists are allowed to say the Q-word to each other now.

  4. MamMoTh says:

    Market Monetarists Theory?

  5. Rob says:

    “In a healthy, free market economy, if for some reason people decided they wanted to hold 10% more in cash balances, then prices would fall”

    Other economists (some from a non-Rothbardian but explicitly Austrian perspective) believe that in a healthy free-market economy banks ( driven by the desire to maximize profits) would address this situation by expanding the money-supply to allow stable AD and this would be a more optimal outcome than allowing the general price level to fall

    From this framework one cannot simply ignore the demand for money without an explicit acceptance that the “great recession” could go on for many years. Free Banking is not on the horizon anytime soon so as a “second best” option we have no choice but to take the Market Monetarists seriously.

    • Silas Barta says:

      You can print money easily. You cannot easily print the value that money provides to the holder.

      • Rob says:

        I’m not sure I follow , unless that is a quote from from the Zen book of economics ?

        • Silas Barta says:

          You’re acting like money is just some kind of widget that you can just give away when there’s higher “demand” for it. But no, what people want is the value contained by the money they hold (not the nominal amount) which depends on the amount in circulation. So a free market couldn’t just “print up money” to meet the demand like you’re suggesting.

          Hence my comment.

  6. Rob says:

    Thanks for the clarification.

    In fact the suggestion isn’t to just randomly print up money to meet demand but rather that banks in a free market fractional reserve situation would, when their customers hold increased balances , be able to (safely) use these increased balances to expand the money supply (via loans and other activities). In this way they would stabilize AD and prevent the need for adjustments to the general price level.

    • Silas Barta says:

      No, because the consumers would be relying on being able to arbitrarily withdraw those funds (since they’re intended to satisfy liquidity needs), which means that a business plan could not (reliably) be predicated on loans from such a source — you would have panics and collapses the moment people tried to actually exercise the option to use those funds. Any such production would be built on a foundation of sand.

      And why would any free market financial institution care about aggregate demand, or indeed, any other aggregate number. Contra Scott_Sumner, businessmen don’t actually look at NGDP numbers.

    • RG says:

      In addition, it’s not money they are printing, it is a (false) claim on money. The ruse can hold out for some time – and has for a little over a century – but eventually the false accumulation of savings will reveal itself and destroy anyone trying to redeem their worthless claims.

      • Silas Barta says:

        What is that a response to? Are you talking about what a private free bank would do, or a CB?

        • RG says:

          I addressed FRB in a private law market economy below, but was looking at the role of FRBs and the CB here.

  7. Rob says:

    To address the second bit first: They wouldn’t need to care about AD or NGDP. They would just want to maximize their profits by using the money from account and cash holding to make good investments. The fact that this does also stabilize AD is just (in my opinion) one of those wonders of the free market.

    For the first part it would be up to the banks to get this right. They would not remain in business very long if they loaned long and borrowed short. The would need to hold the right balance of assets that allowed them to stay solvent and liquid at all times (obviously bankers will get smarter in a free banking system than those we have now – no bailouts will be available if they get it wrong)

    • Silas Barta says:

      Rob, a bank *cannot* simultaneously satisfy a consumer’s desire to have fully-liquid holdings *and* invest them in productive enterprises. The supposition in this situation is that people want liquid holdings. That means not having to take a risk that the securities the banks hold won’t sell at par. A bank cannot bridge such a gap without an inflationary CB backstop.

    • RG says:

      Anyone that says increased NGDP is a good thing or that decreased NGDP is a bad thing is spouting non-sequiturs. It’s akin to saying that microphones and loudspeakers have improved music.

      Lending someone money that doesn’t exist is fraud. Fraud can exist in a free market, but it would be difficult to stay in business long if it was at the core of your business strategy.

  8. Rob says:

    In a free banking world customers will have the choice between 100% reserve banks (safe but they will have to pay to store their money) or fractional-reserve (some risk but a share in the rewards via interest on deposits).

    Which option they choose will be down to the survival rate of banks that offer fractional reserve. I see no particular reason why fractional reserve banks are more likely to adopt a suicidal business model than any other type of business so I would predict that they will end up with a bigger market share.

    • Silas Barta says:

      We don’t disagree on that point, Rob. What I dispute is that a free market bank could simultaneously provide a venue for people to keep fully liquid holdings and be able to use that same money for investment (in just the right way to restore optimal AD or whatever), which is what the discussion was about.

      IOW, you were trying to say that somehow free market banks would turn hoarded cash into AD-stabilizing investment. But no: while banks could certainly invest money held with them (should the terms of the storage allow), they could not do it in a way that allows hoarded cash to double as investment cash, as you were claiming.

    • RG says:

      I agree that if a free market would ever develop, then someone would most likely attempt to operate a fractional-reserve bank. I’d like to see the attempt, but I don’t believe it would operate for very long. I think those banks would attract the highest risk investment opportunities and would have to charge obscene rates. Betting on long shots is not a good long term investment strategy. I could imagine some surviving if they had a couple big projects pay off early, but they would most likely have to transition their bank to 100% reserves if they wanted to survive long term.

  9. Rob says:

    Here is a simplistic model of how I see it as working.

    Suppose there is $1000 in existence (all held by individuals in bank accounts or cash) and everyone spends all their money each week in such a way that each $ gets spent once and everyone end up with what they started with.

    Something happens and only $900 starts getting spent even though just as many goods are brought to market. There is now $100 in cash balances in the system.

    If the money supply is fixed then prices will have to fall so that that $900 buys as much as $1000 used to (assuming the sellers still want to sell at the lower price).

    If the extra $100 was in FR banks however that money could be put back into the system. if the banks were confident that the change in the demand for money was long-term they could use it for longer term investments (and in Austrian terms it would be the same as a decrease in time preference).

    If they thought it was shorter term (due for example to a loss in business confidence) they would need to keep it more liquid (say buying safe corporate bonds that they could sell quickly if needed for customer demand) .

    In any case this would lead to spending being close to $1000 again and no need for a such a large general reduction in the price level.

    • RG says:

      Prices did fall, that’s where you got the initial $100.

      • Rob says:

        To clarify: Until prices either fall or the money supply expands then less things would get sold. There would be a surplus on the market

        • RG says:

          Not a supply chain genius here.

          I have a child that doesn’t speak in sentences yet. A couple months ago he would point at the counter and grunt until someone came and gave him what he wanted. In the interim he has developed the ability to climb on a chair and get what he wants for himself – and he didn’t need the money supply to increase to reduce the price of cookies.

          He is infinitely better at economics than you.

          • RG says:

            Sorry, pretty rude.

            I get a little testy when trade is lost in a media of exchange discussion.

    • Richard Moss says:


      In the scenario you gave people hold $100 in cash balance and then spend $900. You say that prices will have to fall so that $900 buys as much as the $1000. Your concern seems to be on relying on prices to fall in order to spend the $900.

      But, if people do decide to increase cash balances by $100, and really do spend the $900 left, then would not have prices adjusted? How else would people come to spend the $900? If they were holding off because prices weren’t adjusting (as you seem to suggest might happen) then the full $900 would have been spent, would it not?

      And, if that is the case, what is the benefit of of banks having the $100 to ‘put back’ into the system?

      • Rob says:

        I posted a clarification above that there was an implicit assumption in my simple model that until prices either fall or the money supply expands then less things would get sold and there would be a surplus on the market.

        I don’t really have a concern as such with prices falling. If FRB turned out to not have a viable business model then price adjustments may be the only way for equilibrium to be restored. I don’t really disagree with what Bob says in his post about the effects of a 10% fall in demand for money and how a truly free economy would respond apart from that
        the free banking model seems to me to offer a more elegant and faster solution.

        In a hampered economy like ours the extent of price stickiness means that the change in demand for money that we are experiencing could lead to a long , drawn out recession. Leaving aside the ability of the fed to deliver it efficiently I believe an adjustment in the supply of mind would provide net benefits in the current situation and I think this needs to be more broadly discussed in a free-market context.


        • Rob says:

          I meant “supply of money” not “supply of mind” in the last sentence 🙂

  10. Silas Barta says:


    If the money supply is fixed then prices will have to fall so that that $900 buys as much as $1000 used to (assuming the sellers still want to sell at the lower price).

    Not necessarily: there is $100 that could splash back onto the demand for goods anytime. The $100 is not gone.

    If the extra $100 was in FR banks however that money could be put back into the system. if the banks were confident that the change in the demand for money was long-term they could use it for longer term investments (and in Austrian terms it would be the same as a decrease in time preference).

    If they thought it was shorter term (due for example to a loss in business confidence) they would need to keep it more liquid (say buying safe corporate bonds that they could sell quickly if needed for customer demand).

    Again, you’re contradicting the terms of the initial thought experiment. If people are hoarding money *to hold as liquid cash, ready to spend on anything at any time*, then that desire cannot be satisfied by a bank that lends it out. While such banks could exist, they would not, in that form, satisfy the desires consumers have in keeping the $100 liquid.

    It doesn’t matter if they made sure to invest in “really safe” stuff: because if everyone is predicating their plans on the existence of $1100, then the bank cannot provide the liquidity that they demand. This is because, if everyone demands their deposits at the same time, the securities won’t be worth enough to be sold for the full value of the balance of the customers’ accounts.

    If consumers wanted the $100 liquid, as the thought experiment presupposes, they would not put their money in places that have these kinds of risks. You continue to posit that people both do and don’t want liquidity.

  11. Rob says:

    You are correct that the $100 “could splash back onto the demand for goods anytime” In the case where the bank assumed that the changes were short term they would simply sell the liquid interest-bearing assets they bought. – I’m not sure why this would create a problem.

    The situation where the bank lends long term is not well served by this simplistic model. In a more realistic economy it is likely that the demand for money stays constant over time and the bank will be able to predict with a degree of accuracy what the turnover of money will be and what reserves it will need to keep to meet its obligations and set up its business plan accordingly

    If the demand for money increases unexpectedly and the bank has greater reserves to lend out then a sensible bank will assume its a short-term change and use the extra money conservatively.

    A bigger problem would be a sudden decrease in the demand for money (customer want to spend their cash balances) which could lead to bank runs. Banks will need to have the right asset mix to deal with this scenario. There is no reason however to believe that banks will not develop business models to deal with unexpected changes in the demand for money in both direction.

    Remember that customers are willingly putting their money into FRB’s – if they do not believe that these banks are offering them the option ” to hold as liquid cash, ready to spend on anything at any time” then they will hold in 100% reserve banks instead.