Scott Sumner continues to argue that most economists don't have a clue, here and here. I think for the most part this is just more of his frustration with interest rate targeting. The Fed cut its target for the Federal Funds rate over the last year, so money must be loose, right?
Nick Rowe uses simple IS-LM analyis to show how an expansive monetary policy could raise real and nominal interest rates, a point that Scott regularly makes. He then argues that interest rate targeting is a social construction. The theme is that interest rates do not effectively indicate the stance of monetary policy.
I don't use the terms "tight money" or "loose money" very often, but I know what they mean to me.
It's simple. An excess supply, or surplus, of money exists when the quantity of money is greater than the demand to hold money. I suppose I might call that "loose money."
An excess demand, or shortage, of money exists when the quantity of money is less than the demand to hold money. I suppose I might call that "tight money. "
Changed interest rates, nominal or real, play no part in my definition of "loose" or "tight" money. Perhaps loose or tight money will impact nominal or real interests, but the changes in interest rates don't define whether money is loose or tight.
What about changes in some measure of the quantity of money?
An excess supply of money could result from an increase in the quantity of money combined with an unchanged demand to hold money. But it could also result from an unchanged quantity of money and a reduced demand to hold money. Further, it is possible that an excess supply of money could occur when the demand for money is rising. It simply requires that the quantity of money rise by more than the demand to hold money. And finally, an excess supply of money could occur if the quantity of money falls less than the demand to hold money.
The same is true of an excess demand for money. A decrease in the quantity of money, given the demand to hold money, would result in an excess demand for money. However, an increase in the demand for money, with an unchanged quantity of money has the same consequence. If the quantity of money rises, but the amount of money people choose to hold rises by more, an excess demand for money results. Finally, if the quantity of money falls by more than the demand to hold money, there is an excess demand for money.
So, there is no necessary relationship between a change in the quantity of money and whether money is "loose" or "tight." That simple relationship only holds ceteris paribus, that is, if the amount of money people choose to hold is unchanged.
Yes, it is simple. So far.The problem is that an excess supply or demand for money can result in changes in interest rates, real income, and the price level, all of which impact the demand to hold money.
And that makes things complicated.
"Loose money" is when the quantity of money is greater than what the demand for money would be if interest rates, real income, and the price level are all where they should be.
"Tight money" is when the quantity of money is less than what the demand for money would be if interest rates, real income, and the price level are all where they should be.
And where should interest rates, real income, and the price level be? In my view, there are fundamental supply-side factors that determine where interest rates and real income should be
And the price level? Where the price level "should be" is arbitrary. It depends on the monetary regime.
Perhaps the price level should be consistent with a fixed nominal price for gold. Perhaps the price level should be held constant. My view is that the price level "should" be at a level consistent with slow, steady growth in nominal expenditure.
Watch for further posts on the relationship between "tight" and "loose" money, interest rates, real income, and the price level.
I basically agree, but if you have a NGDP target in mind, then isn't tight money a situation where the money supply grows less than 3% faster that the "Cambridge k?"
ReplyDeleteSo if V falls by 4%, then k rises by 4%, and M needs to rise by 7% to hit your 3% NGDP target. Isn't that the same point you are making, with one fewer variables?
Here’s something (among many) that continues to allude my understanding: what constrains (or should constrain) the money supply’s ability to expand to fulfill money demand? I understand the idea that a money supply constrained by some physical property like a commodity + fractal banking. But what about our current central banking regime? If the Fed expands the money supply to meet the demand, doesn’t that keep the interest rates from rising by shifting both curves right? This seems to be an arbitrary choice, rather than a market signal of resource allocation.
ReplyDeleteWhat’s the natural market forces behind this? I get lost trying to understand the connection between this macro monetary world and the land of microeconomic choices and forces. Resource allocation seems to be missing from these kinds of discussions (or, more likely, my understanding of these discussions).
Any help is appreciated.
Scott:
ReplyDeleteI favor targeting a 3% growth path for nominal expenditure.
If nominal expenditure is on target, then if k (understood as the ratio of nominal money demand to nominal income) is rising 4%, then the quantity of money needs to be rising by 7%. (leaving aside complications regarding inventories.)
However, if nominal expenditure is not on target, then it is not correct. The growth rates would involve a return to the growth path.
I think it is important that we fully internalize thinking in terms of growth paths rather than growth rates.
As for replacing interest rates, real income, the price level, and the target for nominal income with "k" and the target for nominal income, I think it is a simplification, but perhaps an oversimplification.
Ms = kY* is pretty simple. I am sure it has some uses. But there is a whole lot being packed into that k.
Papola,
ReplyDeleteI am not sure which curves you mean.
I think that you have in mind the supply and demand for credit.
The demand for money is how much money people want to hold. It is not how much money people want to borrow. As a rule, people borrow money to spend it rather than hold it.
The quantity of money is the amount of money that exists. It isn't how much money people want to lend. While an increase in the quantity of money usually involves an increase in the supply of loans, most lending doen't involve an increase in the quantity of money. For example, the lending involving in holding 10-year corporate bonds.
Generally, interest rates should change to reflect changes in the supply or demand for credit. They should not change to refect changes in the quantity of money or the demand to hold money.
I will write a post on this when I get a chance.
So if I understand this correctly, the monetary equilibrium you’re talking in supply/demand for money is about money being held and that’s a different market/situation than the market for loanable funds which determines interest rates. Is that right?
ReplyDeleteHere’s what I don’t understand, though. Is this demand for money strictly the demand for physical cash?
Example: Everything else is constant. I get my paycheck and decide to save half of it, I most likely put that money in my checking/savings account. Does that contribute to the demand for money or the supply of loanable funds? Both?
This is where demand for money and supply of loanable funds is confused in my understand (among many other things I’m sure). I’m coming at this from an amateur Austrian perspective with an interest in real understanding, not attacking fractional reserves as “immoral” or other strident positions.
Thanks so much.
Is the demand for money strictly the demand for physical cash?
ReplyDeleteI define money as the medium of exchange. It includes currency (what you call, "physical cash," and checkable deposits.
The demand for money then, is the demand for both currency and checkable deposits.
You save half of your pay and put it into your saving/checkable deposit. Does that involve an increase in the demand for money or an incease in the supply of loanable funds, or both?
I think the best answer is "both," but it depends on the monetary regime. I think it should result in an increase in the supply of loans matching the increase in the additional money you choose to hold.
By the way, saving is the difference between income and consumption. People can save by accumulationg all sorts of assets--stock, for example. They can also save by paying down debts.
I don’t know exactly about tight or lose money, but one thing I am pretty sure about and that is about been careful. If we are not careful enough then we can never make it far. I am always very careful in how I work and due to OctaFX broker that I work with, I am getting support with their lovely rebate program where I am able to earn 15 dollars profits per lot size trade and this includes the losing trade too, so it’s all pretty good.
ReplyDelete