Salter argues that having a central bank adjust the quantity of base money to keep nominal GDP on a stable growth path is very different from allowing free banks to operate so that nominal GDP is stabilized. In my view, he exaggerates the differences. Further, I find the way he describes the difference disconcerting.
Salter argues:
The monetary disequilibrium theorists regard NGDP as an emergent phenomenon of the competitive market process as described by Mises (1949), Hayek (1948) and Kirzner (1973). It is not something that exists as an object of choice for any individual or group of individuals. Rather it is the unintended consequence of the decentralized actions of private bankers who, in attempting to maximize profits, offset changes in inside-money velocity with corresponding and opposite changes in the circulation of their privately-issued money. The end result is a state of affairs where nominal income is stabilized, meaning the impacts of changes in the supply and demand of bank-issued money are minimized, approximating the ideal of monetary neutrality.
In contrast, the view held by (some) Market Monetarists treats NGDP as an object of choice—or rather, something that ought to be treated as an object of choice, and one that ought to be acted upon in order to prevent the economy from deviating from its trend growth path. The view is inherently mechanistic: the economy proceeds smoothly along its growth path until it is disturbed by some sort of shock, in which case the monetary authority takes action to stabilize aggregate demand, meaning to stabilize NGDP. The motivation, as before, is an attempt to approximate monetary neutrality as closely as possible.
I think nominal GDP measures the nominal value of the goods and services produced over time. I think this is "an emergent phenomenon of the competitive market process." Firms quote prices and produce output aiming at profit. They make their decisions according to plans to sell products to households and other firms. The firms they plan to sell to plan to sell to households or still other firms. And when the prices times the quantities of all of this competitive market activity during some period of time are added up, it comes to a total. Once care is taken to avoid double-counting, the result is nominal GDP.
The owners of the resources used to produce this output earn matching incomes. Sum up all of those incomes--the services provided times prices of the services, when combined with depreciation, also results in nominal GDP. How much of which resource is used by which firm and how much they are paid, including the profits plus depreciation of various firms, is also "an emergent phenomenon of the competitive market process."
The prices firms set and the quantities they produce very much depend on how much they expect to sell. Market Monetarists argue that the key role of the monetary regime is influencing expectations of what firms expect to be able to sell. This determines how much labor and other resources they will hire and what they will pay for them. The primary determinant of what consumer goods and services firms produce and what they charge is what households find most valuable. And the firms produce products for other firms similarly based upon what these other firms are willing pay, which in the end depends on what households value products.
In my view, the competitive market process is one of creative destruction, with firms constantly introducing new products and new processes that they believe will be more profitable. What the monetary regime does primarily is define the environment under which these products will be sold. Market monetarists believe that expectations of a slowly growing level of nominal GDP is the best environment. No firm can know how much buyers will spend on their product, but what they do know is that if less is spent on their product, more is spent on some other product.
Market Monetarists have come to understand that these expectations are very powerful and that what is most important is that the monetary regime be expected to support them. As long as the quantity of money is expected to be adjusted in a way consistent with slow steady growth in spending on output, then the actual quantity of money can vary substantially. The demand to hold money can passively adjust. However, when expectations change, and the monetary regime is believed to be aimed at some different goal, then disruption can be rapid. If the quantity of money is expected to adjust in ways such that it will persistently deviate from the demand to hold money at some particular level of nominal GDP, then expectations for nominal GDP will change quickly.
Anyway, I think it makes some difference whether the growth path of the quantity of base money is the nominal anchor or the growth path of spending on output is the nominal anchor. With the first, the path of base money is an object of choice and mechanistic, and nominal GDP develops according to changes in the demand for base money. With the second, the growth path of nominal GDP is an object of choice and mechanistic, but the quantity of base money depends on the demand for base money. The demand for base money is part of the competitive market process, but it very much depends on expectations.
Still, the primary practical difference between the two monetary regimes is going to be the expectations generated for nominal GDP. If some particular growth path of base money, combined with the activity of the profit maximizing banks, is expected to generate a similar level of nominal GDP to a central bank adjusting the quantity of base money, the final result will be very much the same. It is expectations of how demand will develop in the future that will have the largest effects on the spending in the present.
In particular, the notion that it is the decisions of particular banks about where they want to lend that determine the pattern of expenditure in the economy and so "nominal GDP" seems backwards. The pattern of credit demands, or more broadly, the demands for finance, and expectations about what particular products will be most profitable, seem much more important.
Further, Market Monetarists have been very critical of efforts by the Federal Reserve to direct credit. Paying interest on reserve balances and allocating its asset portfolio to correct market failures has no connection to the Market Monetarist approach. Most banking activity has been private, profit maximizing activity, and that is just fine with Market Monetarists.
Reserve requirements play no role in the Market Monetarist approach. As far as I know, no Market Monetarist supporst them. On the other hand, Sumner, in particular, is critical of private currency issue. He believes it involves the government giving away its seigniorage income and that competitive issue of currency is likely to be wasteful. (Perhaps banks would give away toasters to people who come make currency withdrawals.)
I favor full privatization of hand-to-hand currency. But, I doubt that in a world of persistent government budget deficits, having part of them financed by the issue of central bank currency really makes much difference to the allocation of resources. Still, I wish Salter would consider such a scenario. Fully-private currency and no reserve requirements. Banks are free to issue monetary liabilities and lend as they choose. But the private monetary liabilities are redeemable in central bank deposits, whose quantity adjusts so that expectations of nominal GDP are kept on a slow, steady growth path.
Salter wrote: “The monetary disequilibrium theorists regard NGDP as an emergent phenomenon of the competitive market process . . . . It is not something that exists as an object of choice for any individual or group of individuals.” NGDP is, indeed, an emergent phenomenon, but that does not prevent it from being an object of choice. Most of the outcomes that we ordinarily regard as “chosen” actually emerge from more basic events and processes.
ReplyDeleteOf course, we might have a system in which no single agent cared about NGDP, or in which no agent had enough influence over NGDP to make it an object of choice (even if he would have wanted to); then NGDP would not be an object of choice. But instead we have the Fed, which might well care about NGDP, over which it does have a lot of influence. NGDP, emergent though it is, might well be an object of choice for the Fed.
Of course, it’s another question whether the Fed, given that it exists, *should* make NGDP an object of its choice. And it’s a still other question whether the Fed should exist at all.
Market Monetarists place emphasis on "guidance." I wonder.
ReplyDeleteIn a Western democracy, what fraction of the population has any faith in any government official? Amidst the clouds of perfidy and PR, we are supposed to exactly divine that central bankers are truthful....
Consider: We continue to hear talk about the Fed's "credibility." This after 30 years of crushing inflation, and bringing us to zero bound. The financial pages and websites are rife with hysterical diatribes about the Fed's fecklessness in regards to fighting inflation. Even "serious" scholars are constantly fretting about inflation. See Cochrane.
If the Fed has limited credibility as an inflation-fighter now, when would it be fully credible? Are we talking centuries?
Market Monetarism is the right course, but sustained QE is the only policy tool that really counts. We may have to wipe out a substantial portion of the national debt to get this economy going. It is an interesting thought, if taboo. I invite Woolsey to examine the prospect closely.
Money talks. Print more money. Tons of it.