Sound Money

Market Monetarists advocate sound money.   We favor a monetary regime where the quantity of money adjusts with the demand to hold money, resulting in spending on output growing at a slow steady rate.   We believe that such a monetary regime creates the least bad environment for microeconomic coordination.   Yes, that is microeconomic coordination.  It includes creative destruction, inter-temporal coordination and so on.

Unfortunately, too many advocates of the free market blindly accept the wrongheaded framing of the Federal Reserve itself.    Monetary policy is identified with interest rates and lending.    The discussion appears innocent of even the fundamentals of economic analysis.

The fundamental forces that determine the level of interest rates are saving and investment.   If we assume these are constant and that the current interest rate coordinates them, then any "monetary policy" that involves changing interest rates must be distortionary.  

However, saving and investment are not fixed and unchanging.   In particular, worries about the future can easily lead to an increase in the supply of saving and decrease in the demand for investment.   This requires a decrease in the interest rate to bring them back to equilibrium.  

An increase in saving is a decrease in consumption--spending on consumer goods.   A decrease in investment is a decrease in spending on capital goods.   The direct effect of these decreases in spending is reduced sales, production, and employment.   However, the lower interest rate decreases the quantity of saving supplied--it stimulates spending on consumer goods.   And the lower interest rate stimulates spending on capital goods.

How low should interest rates go?   Until saving and investment are equal.   That means that any decrease in investment spending is offset by an increase in consumption spending.  Or any decrease in consumption spending is offset by an increase in investment spending.   It is even possible that investment and consumption spending would remain the same.

It is a travesty that supposed advocates of the free market are complaining that interest rates are too low and so are harming savers.     Yes, it is true that if saving supply rises and investment demand falls, then saving is less attractive.   That is how market prices work.   If the supply of corn rises and the demand falls, then the price of corn falls, and growing corn is less remunerative.

What about "blowing up bubbles?"   When interest rates are lower, the present value of future flows of income is higher.   This tends to raise the fundamental values of financial assets like stocks and also capital goods, including single family homes.    This is one of the ways in which lower interest rates cause a decrease in the quantity of saving supplied and increase in the quantity of investment demanded so that they return to equilibrium.    This is a coordinating adjustment.

Now, it is possible that foolish momentum traders will project past price increases into the future, and pay too much for assets.   It is even possible that clever traders will also buy such assets, planning to sell to a greater fool.   However, this is not a reason to prevent interest rates from coordinating saving and investment.    It is not a reason to keep asset prices from rising despite lower equilibrium interest rates.

To repeat, when saving rises and investment falls, the market process that prevents this from causing a decrease in spending is lower interest rates.   Complaining about lower interest rates in such a circumstance is simply anti-market propaganda.