01
Jan
2016
My Inflation Bet: The Gift That Keeps on Taking
Don’t worry kids, I didn’t make another bet. Rather, this was the original wager that David R. Henderson then tweaked (including making the time horizon shorter). I am mailing the check to Bryan this month.
If you want to hear my thoughts on what went wrong, here is my indignant reaction to Krugman and DeLong, and here is my calm contribution in a Reason symposium on people who made faulty warnings about consumer price inflation.
Your semantic quibbling is disingenuous and cowardly; this was not “one bet.” These were two distinct bets. You could have won one but not the other. (In fact, after you lost the Henderson bet, you were still saying you’d win the Caplan belt.)
He never said that it was one bet. That’s just what you read. He said this was the original bet, and that David Henderson tweaked it (when making his own bet). Even so, why this would be such a point of rancor is anyone’s guess.
In the “what went wrong” part I was expecting you to mention interest on reserves.
Me too.
He did mention it in his contribution to the Reason symposium;
But the U.S. economy has stayed in this holding pattern, where people expect low consumer price inflation and so commercial banks keep their excess reserves earning 25 basis points parked at the Fed rather than make new loans. Thus the process I described above has been thwarted; the quantity of money held by the public right now is much lower than it would be, if the banks decided they would rather make loans and earn a higher interest rate than the 25 basis points currently paid by the Fed
Classic making a mountain out of a molehill. Japan didn’t have IoR. Neither did the U.S. in the 1930s. They still had massive excess reserve pileups.
Different times, different circumstances responsible for the increase in reserves.
IOR is not a sole cause, but it is a cause.
.25% can’t make that much of a difference. You, Murphy, and Sumner, are all allied against me on this subject. That should worry you.
I only just noticed this, but the interest rate paid on reserves went up from 0.25% on 2015-12-16 up to 0.50% on 2015-12-17 at the same time the target discount rate went up.
Thus, the income stream coming into the banking industry just doubled.
Which brings up an interesting question about tight money and loose money. If Yellen just doubled the size of free-money inflow to the banks, one would think more money would be available now? Who knows where that money ends up…
“.25% can’t make that much of a difference.”
It makes a huge difference if the alternative is investment in negative NPV projects.
The Fed knew it would be a huge factor that incentivized banks to NOT lend in the same proportional ratio to reserves as they historically have. The whole point of IOR was for the Fed to print bajillions of dollars which bails out the banks, but to also avoid runaway price inflation.
The fact that others agree with me against you has absolutely no bearing whatsoever on what I think, thank you very much. I put zero weight on the popularity of an idea as a factor in me accepting it as true. Absolutely zero.
E. Harding, the point is to keep the IOER above the market rate.
Does everybody here agree that if the banks really prefer not to lend the money and get 0.25% interest, this means that the natural (wicksellian) interest rate is below 0.25% right now?
If so, should the Austrian theory not explain how the Fed rate was once below the natural interest rate, but is now _above_ it?
The higher rate is restricted to banks, only.
(Aside: I submit that Austrians don’t really believe in the wicksellian natural interest rate.
(Rather, since interest rates derive from individual time preferences, the “natural rate” is really billions of individual natural rates.
(So, Fed manipulation of interest rates distorts many natural rates.)
True, but now that the floor has been raised from zero- the Fed can effectively pay interest to everyone else with idle cash via the reverse repo program, and that rate is between .25 and .50%.
I still wonder whether or not IOR was ever necessary in order to, for example, keep inflation from running away. The non-bank entities were the ones still participating in the Fed Funds market, and that rate was near zero for almost seven years. Why would the banks have done differently with their excess reserves absent IOR? I just don’t buy it as anything other than a direct subsidy to the banks- nothing more.
“Aside: I submit that Austrians don’t really believe in the wicksellian natural interest rate.”
But they say the Fed kept interest rates too low. Too low compared to what?
“But they say the Fed kept interest rates too low. Too low compared to what?”
Excellent question. I always enjoy answering this one.
The Fed sets interest rates too low compared to what would have naturally resulted from consumer time preferences.
The idea is that. since consumers in their attempt to satisfy their prefereces are what give all goods and services their value, the misrepresentation of that value (say, through printing money) will necessarily mislead producers to produce what is inconsistent with consumer preferences..
(Because people work for what they already value; That is, value causes people to labor, rather than labor giving something its value. See Carl Menger’s Theory of Imputation [video, time stamped].)
As a producer, you only want to be producing that which consumers want to spend their scarce resources on.
The best way of knowing what products to produce, then, is to allow consumer preferences to be freely expressed (free market), so that consumers’ voluntary spending becomes the producers’ nominal upper bound of income (how much can be made, nominally, off of voluntary transactions).
Knowing how much you can make, nominally, you can then determine whether or not your costs will be low enough for you to make the amount of profit you want.
(Since consumers set all values, producers will make the same amount of money per unit of a good no matter what their costs are.
(So, producers can only make a profit when the amount that consumers will spend is of greater value to the producer than his opportunities foregone (his costs.)
Since interest rates result from consumer preferences for present goods at the expense of future goods, interest can be understood as the price of present goods in terms of future goods.
If you misrepresent the interest rates that naturally obtain from consumer time preference, this will necessarily cause investment in projects that will not be in sufficient demand to sustain profitability.
The only real way to “manipulate” consumers into buying what you want them to, is to forcibly prevent them from satisfying any higher-ranked preferences they have.
But since the definition of “wealth” is subjective to the individual, to do so is an act of wealth destruction.
“The Fed sets interest rates too low compared to what would have naturally resulted from consumer time preferences.”
that is called the natural (or wicksellian) interest rate, right? but previously you had denied the existence of the natural interest rate…
“that is called the natural (or wicksellian) interest rate, right?”
No. The wicksellian rate is a single rate.
Austrians – consistency demands, I would say – believe in many natural rates because interest rates reveal a time preference, and only individuals prefer things.
So, there are as many natural interest rates as there are people.
Hayek referred to a single rate in arguing that the Fed set the rate too low, but I think he was attempting to answer his opponents on their own terms, and mistakenly granted the minor premise (of that particular objection) that there was a single rate that was being distorted.
Can’t I use your same reasoning to conclude that there is no single “price of gold”, or “price of sugar”? Why are we allowed to talk about “the price of sugar” but not about “the price of loans”?
“Can’t I use your same reasoning to conclude that there is no single “price of gold”, or “price of sugar”?”
Yes, precisely right.
Depending on the opportunity costs of the specific sellers and buyers involved, the price can vary quite a bit.
Take the Hurricane Sandy gas prices that stations could charge because of the crisis. It wasn’t that high, elsewhere.
Which is why, if government hadn’t violated people’s rights, those who could buy cheaper gas could deliver it at a lower cost than was previously being offered, yet higher than what they bought it for.
As Bob Murphy noted on YouTube, there wouldn’t have been any lines for gas had people’s right to price gouge not been violated.
(Consider that if the government forces you to sell at a price that’s lower than you like, you’ll take your gas off the market, and now your gas might as well be priced at a million dollars.)
You can see a steep upward slope in aggregate mortgage debt from about 2000 to 2007, then it peaks and resets as many families walked away from their mortgages, and other households did their best to pay it back and/or renegotiate while rates are low.
https://research.stlouisfed.org/fred2/graph/?g=31vS
If fractional reserve banking can cause money multiplication and expanding bank balance sheets, then the reverse process must work.just the same way. Financial transactions are all fully linear, nothing is irreversible. Austrians often tend to overlook debt-deflation, but it is fully supported by the theory.
Tel, what do you mean by saying they are “fully linear”? (As opposed to, say, “linear”? Are there no non-linear financial transactions?) How does that connect to reversibility?
Have you ever wondered why it is easier to stir milk into a coffee, than it is to stir the milk back out again?
https://youtu.be/p08_KlTKP50
In a linear universe, you can stir the milk back out just as easily as it went in. All actions are reversible. Linearity is boring, but then accounting is supposed to be boring. The only operations you have available are addition and multiplication. If accounting can get us into debt, then it can also get us back out of debt… guaranteed!
In a non-linear universe you can have turbulence, chaos, entropy and other things… resulting in the arrow of time, and actions that cannot be reversed.
“Linearity is boring, but then accounting is supposed to be boring.”
Because efficiency, damnit!
#SpreadsheetBrutalism
😀
(OT)
Wow, is Robert Wenzel way off:
Confusion about Fractional Reserve Banking
http://www.economicpolicyjournal.com/2016/01/confusion-about-fractional-reserve.html
“The initiative, promoted by the Swiss Sovereign Money movement, calls for private banks to hold 100 percent reserves against their deposits.
“Some see this as an important battle against fiat currency. I would argue it is not such and is simply misdirection that will accomplish nothing good.
“How far has this confusion spread? I suspect very far. When discussing another topic with an Austrian fellow traveler, he responded to me in an email:
“”I did not say anything about the central bank. I don’t think that the [Austrian Business Cycle] theory requires a central bank, it requires fractional reserve banks.”
“But is fractional reserve banking really the key to money distortions that result in misdirected funds into the capital sector? I think not. …”
“… Take fractional reserve banking away and central banks can still pump funds into the commercial bank sector all day long.
“Note what the Swiss Sovereign Money movement says:
“”Banks won’t be able to create money for themselves any more, they’ll only be able to lend money that they have from savers or other banks.”
“But what prevents a central bank from being one of these “savers”? That is, why can’t a central bank buy term paper from banks, the funds of which the banks could then lend out since it isn’t part of demand deposits (where 100% reserves would be required)?”
Buy term paper with what?
[Stolen wealth cannot be malinvested. You won’t be able to invest as much, but you can still engage in economic calculation because you know how much wealth you have and your costs.]
Of course the business cycle requires fractional reserves, because the business cycle is caused by producers getting price signals that aren’t coming from consumers, causing them to malinvest their resources.
Now, you need, in effect, a central bank, in order to maintain and expand fractional reserves, because the market would make bank runs, limiting the amount and duration of malinvestments that could be made.
Tom Woods has already dealt with this issue:
Economic Cycles Before the Fed | Thomas E Woods, Jr.
[www]http://www.youtube.com/watch?v=TxcjT8T3EGU
Monetary Lessons from America’s Past | Thomas E. Woods, Jr
[www]https://www.youtube.com/watch?v=91OIBnrjzLU
You didn’t read his post closely enough. He wasn’t saying fractional reserve banking doesn’t cause monetary inflation that will set in motion the business cycle. His point was there are many other ways for the central bank to inflate the money supply, so banning just one of the ways is useless.
Read the whole blog post. He wasn’t saying fractional reserve banking isn’t a cause of the boom-bust cycle. He was saying it is only one method by which the Fed inflates the money supply. Getting rid of just one of many methods the Fed can use to inflate the money supply is useless. That’s what he was saying.
Mr. Wenzel said “Take fractional reserve banking away and central banks can still pump funds into the commercial bank sector all day long.” “End the Fed”
What I don’t understand is how does a central bank pump money all day long absent frac reserve banking? Wont a central bank ever run out of money?
What’s a bummer is enough new money has been created since the financial crisis for inflation to hit double digits as Murphy warned fairly easily even without more Excess Reserves being loaned out. D’oh!!!
History seems to show depreciation of the exchange rate of a currency to be the beginning of high consumer price movements.
I imagine it’s difficult to factor in the exchange rate of the USD in an inflation bet when it’s the reserve currency ?
Isn’t most of QE contained within the financial system with relatively little leakage into the real economy, and most inflation also contained within the financial system, e.g. stock prices, etc.?
Instead of CPI they need the Ferrari price index.
First I am not aware what was said in the original bet, so forgive me if this doesn’t characterize the situation.
But in general, Austrians can be plain dumb on predicting inflation, and do not adhere to their OWN THEORY. They are looking at the situation as if increasing M1 leads to inflation and not the real supply (closer to M2). M2 has only increased modestly, and some of it has gone overseas because of balance of payments deficits. Meanwhile the stock prices have been restored to the unsustainable levels.
All in all the Fed’s huge money expansion simply counteracted the decreasing bank credit. I think Murphy and many Austrians learned a lesson here. Unfortunately, the integrity of the whole Austrian school is now questioned because such a careless mistake. For the record heavy inflation might still occur if the balance of payment deficits find their way to America, in such case the Fed is completely powerless. This might happen if the confidence in USA and the government debt becomes questioned.
First I am not aware what was said in the original bet, so forgive me if this doesn’t characterize the situation.
But in general, Austrians can be plain dumb on predicting inflation, and do not adhere to their OWN THEORY. They are looking at the situation as if increasing M1 leads to inflation and not the real supply (closer to M2). M2 has only increased modestly, and some of it has gone overseas because of balance of payments deficits. Meanwhile the stock prices have been restored to the unsustainable levels. Claiming this is because of 0.25% pay on reserves is preposterous.
All in all the Fed’s huge money expansion simply counteracted the decreasing bank credit. I think Murphy and many Austrians learned a lesson here. Unfortunately, the integrity of the whole Austrian school is now questioned because such a careless mistake. For the record heavy inflation might still occur if the balance of payment deficits find their way to America, in such case the Fed is completely powerless. This might happen if the confidence in USA and the government debt becomes questioned.
Seems like you are saying there would have been huge deflation absent Fed intervention.
Indeed…
So the Fed really did create massive inflation, it just happened to be offset by natural deflation.
Serious question: Assuming the consumer base whom purchases the products contained within the CPI, have no extra money in their budget, how can prices increase?