Saturday, May 21, 2016

Monetarism's epistemological nightmare

As I mentioned yesterday, I was reading over George Selgin's series on monetary policy. The post on money demand is an epistemological nightmare. Let's see if I get this straight ...
(Somewhat) Shorter Selgin: There's supply and demand for money, but there's no real way to measure the supply for money. That's okay; we still can use the concept of demand for money (which is different from wanting money). Let's assume monetarist economics -- define economic growth as money demand growing slower than the (unmeasurable) money supply and economic, and economic contraction as as money demand growing slower than the (unmeasurable) money supply. Now monetary policy can mitigate that shortage or surplus of (again, unmeasurable) money by "an appropriate change the available number  of dollars of different sorts" (where the meanings of "appropriate", "available number", and "different sorts" are unknown, unmeasurable and undefined, respectively). But also, even though I started off this explanation with demand for money, we're really talking about the demand for purchasing power which involves the demand for money and the prices of goods. And if prices were flexible, then changing the (unmeasurable) supply of money would just lead to changes in prices of goods.
One thing I think is useful about the information equilibrium model is that you can make it clear when someone is trying to pull a fast one with a couple symbols. Selgin's model is two information equilibrium relationships:
  • NGDP ⇄ ?? if prices are sticky, and
  • CPI ⇄ ?? if prices are flexible
Where ?? is the (unmeasurable) "available number of dollars of different sorts". But even the equation of exchange is NGDP = ?? × V??.

Let's look at this crazy passage:
Finally, the fact that an increased demand for money manifests itself in peoples' refraining from spending the stuff, while a decline in the demand for money translates into increased spending, means that one can get a handle on whether an economy has too much, too little, or just enough money without having to decide just what "money" consists of. One need only keep track of overall spending or aggregate demand. Whenever overall spending goes up, that's a sign that the supply of money is growing faster than the demand for it. When it shrinks, it's a sign that demand for money is growing relative to the available supply.
We don't need to decide what money is because we just assume how macroeconomics works. Just trust us. And whatever money is, there's also a counterfactual path of the economy where overall spending grows at some undefined lower rate that tells us what the counterfactual path of undefined money is where the supply and demand for it grow at the same rate.

I think there is no way around it at this point. Monetarism is a degenerative research program. It started with gold, then on to M1, and when that didn't work, M2. Or M3. Or Mn+1.Or maybe velocity changes. 

The massive increase in the monetary base after QE in the US basically de-coupled monetarism from money at all. Selgin tells us it doesn't matter, and in various other places it's been completely replaced by expectations of ... what? ... monetary expansion? M2 expansion? Base expansion? Ah, but people could expect the base expansion could be taken away.

If money enters the market and no one expects it, does it raise prices?

21 comments:

  1. "If money enters the market and no one expects it, does it raise prices?"

    AFAICT, the whole expectations thing comes from Krugman 1998, and CIA models in general in which expected reduction in the money supply (as well as a negative natural interest rate) makes current increases in the money supply irrelevant.

    MM's have hijacked this, arguing two things: 1) the natural rate bit from Krugman 1998 is wrong (no reasons, just assertions) and 2) thus liquidity traps only happen as a result of stupid monetary policy, which can be alleviated if we adopt NGDPLT (there is no exact explanation of how adopting NGDPLT --> a scenario in which the money supply is never expected to grow slower than negative the real natural rate)

    Now pretty much every time a Market Monetarist appeals to expectations, it is not because of some model, but because they are rationalizing the empirical failure of their implicit theory, which, as you have said, is unfalsifiable for this reason.

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    1. I think it dates to a bit earlier than that -- didn't Lucas have a model where anticipated changes in monetary policy had no effect, but unanticipated ones did?

      I think expectations in general are flawed if they are in any way connected to the actual value of macroeconomic aggregates, but that's because I believe in causality and you can't extract information from the future.

      (The last line was a reference to a tree falling in the woods making a sound ...)

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    2. Expectations in economics certainly go a lot further back than market monetarism, but the argument that an expected reversal of monetary stimulus yields it ineffective comes from Krugman.

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  2. From:
    http://www.forbes.com/sites/johntharvey/2011/05/14/money-growth-does-not-cause-inflation/4/#6e38191ef9f8

    “ . . . Again, however, I’m afraid I don’t see a direct answer to my question. I asked what mechanism in the real world the Fed has available to raise money supply above money demand (something that you said above is necessary if inflation is to occur). Money supply can rise if the Fed buys assets or if loans are made from available reserves. To my way of thinking, neither of these can occur without the full and conscious participation of the other side of the transaction. Hence, the supply of money cannot be increased in the absence of demand.
    Yet you say (above) that inflation only occurs when money supply is in excess of money demand. You have defended this with analogies, but not with real-world examples of the underlying process. I am a huge fan of using analogies to get the essential idea across; however, unless these mirror something that is going on in the real world (and in a very real and tangible sense), then recommending policies based on such stories is dangerous to say the least.
    I hope you don’t think I’m being rude, but I think this is a key question and one that I have never found a monetarist able to answer: how is it in the real world that the central bank raises money supply above money demand? Can you please tell me this and in the context of actual Federal reserve policy tools?
    This is not a trivial question. The entire monetarist superstructure rests on it. If the answer is that in reality this cannot happen, then I’m not sure how the rest of the monetarist analysis survives.”

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  3. They are high priests and they are preaching to those wanting to believe in them.

    We are decades from this scourge leaving the earth....... if ever.

    They are impenetrable to reason or logic.

    Sorry for the pessimism this morning but if any of these guys had any scientific integrity they would have abandoned monetarism years ago. Monetarism is the logic of the money hoarders and their apologists.

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    1. I think it goes a bit deeper -- it calls into question the entire foundation of economics. If supply and demand doesn't work for money, then does it work for anything else?

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    2. "I think it goes a bit deeper -- it calls into question the entire foundation of economics. If supply and demand doesn't work for money, then does it work for anything else?"

      " Money supply can rise if the Fed buys assets or if loans are made from available reserves."


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  4. "If supply and demand doesn't work for money, then does it work for anything else?"

    Does that mean the IE is also cactus?

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    1. That is a possibility.

      Already the price level/money relationship is not a pure IE relationship -- it allows for a changing value of k. That changing value of k can be derived from an ensemble of IE markets. So instead of a single IE relationship between money and the price level, we have an ensemble of IE relationships.

      However, there is the possibility that real economies are IT markets, not IE markets -- information transfer (IT) is not ideal information equilibrium (IE). In that case, supply and demand is just a bound for what happens in economics.

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  5. This comment has been removed by the author.

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  6. Well, Jason, suppose your bathtub is overflowing. Would you be able to tell whether too much water was poured into it without knowing just how many gallons of water it holds? Or would you regard any attempt to arrive at such an inference as an "epistemological nightmare"? If the first, then, with just a little effort (more, that is, than you've put into understanding my post), you can understand how it's possible to infer from an increased flow of spending alone, and without having to refer to M1, M2, or whatever, that the quantity of money supplied has grown faster than the quantity demanded.

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    1. " . . . that the quantity of money supplied has grown faster than the quantity demanded."

      "Again, however, I’m afraid I don’t see a direct answer to my question. I asked what mechanism in the real world the Fed has available to raise money supply above money demand (something that you said above is necessary if inflation is to occur). Money supply can rise if the Fed buys assets or if loans are made from available reserves. To my way of thinking, neither of these can occur without the full and conscious participation of the other side of the transaction. Hence, the supply of money cannot be increased in the absence of demand.
      Yet you say (above) that inflation only occurs when money supply is in excess of money demand. You have defended this with analogies, but not with real-world examples of the underlying process. I am a huge fan of using analogies to get the essential idea across; however, unless these mirror something that is going on in the real world (and in a very real and tangible sense), then recommending policies based on such stories is dangerous to say the least.
      . . . but I think this is a key question and one that I have never found a monetarist able to answer: how is it in the real world that the central bank raises money supply above money demand? Can you please tell me this and in the context of actual Federal reserve policy tools?
      This is not a trivial question. The entire monetarist superstructure rests on it. If the answer is that in reality this cannot happen, then I’m not sure how the rest of the monetarist analysis survives.”

      http://www.forbes.com/sites/johntharvey/2011/05/14/money-growth-does-not-cause-inflation/4/#6e38191ef9f8

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    2. If this is the real George Selgin, then thanks for reading!

      Regarding your question about whether the bathtub is overflowing with water, we don't start our argument with saying it doesn't matter what water is. We can't know if something is overflowing with X if we don't know what X is.

      I actually don't have much of a problem with the equation of exchange (I derive it from information theory here).

      It is true that if supply and demand were always in equilibrium you don't need to know what supply is if you know demand because Md = Ms. But if you want to say

      Md = Ms + dm

      if Ms is undefined, we can't know what dm is -- i.e. what monetary expansion would bring Md and Ms back into equilibrium in the next period.

      What is needed is a theory that relates inflation/the price level to money supply and then you can look for what money is empirically. Using that information theory model, you end up with the answer that "M0" (monetary base minus reserves, basically currency) is the best answer -- and does pretty well predicting future inflation.

      My issue is that you can't say monetary policy can impact money but we don't know what money is. It's like saying we can achieve warp speed if we just harness dark energy in physics. We don't know what dark energy is and it is called dark energy only because of some generic properties it has in Einstein's equations (as opposed to dark matter, which we also can't identify, but has the properties of ordinary matter).

      Now if you want to say money is like dark energy (we know some of its properties, but it's not well defined), I'd actually agree! But if you then want to add that we can manipulate "dark energy money", then you're going to need to define it. And there the problem becomes the fact that many definitions of money don't seem to work empirically.

      Basically, you can't have it both ways. Money supply is either not well-defined and you can't manipulate it or it is well defined and you can manipulate it.

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  7. I am dying the death of 1000 misquotes on this site. I never said (to reply to Postkey) that inflation always means to much money. Indeed, I specifically denied this: that's why I refer to the spending criteria, and not the price-level one! Nor did I ever say that "it doesn't matter what money is." I merely said that it isn't necessary for us to agree on any particular measure of it. It is simply not true that you have to insist on a particular definition of the money stock in order to be able to manage money responsibly. That's the whole point of treating the money flow, rather than any and stabilize stock, as the appropriate policy target. One can measure NGDP, for example, without referring to any particular measure of money, or without having to be concerned about the fact that different financial assets can acquire different degrees of "moneyness" over time. Once upon a time, you could easily spend money in a savings account. Now you can do so by swiping a card. No matter: if its stable spending you want, you don't have to know where the money being spent resided before it was handed over for goods to have it. You can "know" MV (or Py) precisely without knowing (or rather, deciding on) any particular definition of M, with its corresponding V. There's no great challenge, "epistemological" or otherwise, involved!

    None of this, by the way, is denying that during and since the crisis the Fed has distinctly failed to keep the flow of spending stable. But that hardly proves that it can't be done, much less that it shouldn't be done. The collapse of the multiplier has to at least some considerable degree been the fed's own doing, as I've written about now in several Alt-M posts.

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    1. Oh dear, '1,000 misquotes'. Such hyperbole?

      " . . . that the quantity of money supplied has grown faster than the quantity demanded."

      " . . . what mechanism in the real world the Fed has available to raise money supply above money demand"?


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    2. George,

      Directly quoting a point and then arguing with the point in such a way that makes it look like you made an untenable argument is not misquoting. It is called "winning the argument", or on the internet "pwning".

      You said:

      "Nor did I ever say that "it doesn't matter what money is." I merely said that it isn't necessary for us to agree on any particular measure of it."

      I made a perfectly logical deduction from your statement about not agreeing on a measure (definition) of money.

      If it isn't necessary to agree on a definition (measure) of money, then the definition of money (i.e what money is) doesn't matter. If money does have observable consequences in the economy, then we'd have to agree on it's definition. If the definition of money doesn't matter, then it doesn't matter what money is.

      Different things may have different degrees of moneyness, but in a country like the US (politically stable), base money should have sufficient moneyness under any definition of moneyness to count as money. However output in the US and UK didn't go up with the increase of base money with QE, so either base money doesn't have moneyness or the theory is wrong.

      If the definition of money fluctuates enough for even base money to fail to have moneyness, then the concept of "money" is useless and you might as well just call it phlogiston. "Money is that which has moneyness" is identical to "combustible materials contain phlogiston".

      It's now not just an epistemological nightmare but an ontological one.

      ...

      Postkey,

      You asked:

      " ... what mechanism in the real world the Fed has available to raise money supply above money demand"?

      I'm not sure why you are asking George Selgin this as he defines economic expansion as the supply of money exceeding the demand for money. If the economy grows, then this mechanism must exist by definition.

      The issue here is not with the specific mechanism of managing the supply and demand for money (that's a few steps down the road), but rather that definition of money -- and how we arrive at knowledge about money -- in the first place.

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  8. O/T: Jason, do you have any thoughts on Noah's theory vs evidence post?:
    http://noahpinionblog.blogspot.com/2016/05/theory-vs-evidence-unemployment.html

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    1. I'd agree with much of what Noah says.

      One thing is that "theory" in economics isn't a framework that organizes a bunch of empirical successes. In physics, the theory is organizing a bunch of empirical successes so that a theoretical argument can potentially be more convincing (say because the empirical data would be hard to gather or extract without noise) than an empirical one.

      An excellent example is the theoretical argument for gravity waves. Physicists were convinced they existed long before LIGO -- partially because they explain energy loss in neutron star binaries. Because general relativity is very good at everything else, the gravity waves had to exist.

      And that's the thing in physics: there's no "versus" there. Theory and evidence go together. Theories organize past evidence and data interpretation. Collected evidence leads to theories. Much like the electric field and magnetic field in light waves, they "generate" each other.

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    2. Another way to put this is that there is no "theory" in economics yet in the same way there is theory in physics. There are no empirical successes organized by any principle. There are lots of toy models (those models with lots of assumptions) ... so Noah's post should really be called "Toy Models vs. Evidence".

      And then the answer becomes obvious ... econ needs to look at evidence and basically ignore any theory focused on a single effect. Econ lacks a theory that organizes a bunch of effects, so theoretical papers that try to do such things (e.g. my paper) are fine. But unless the theory explains many things at this point, it's pretty useless.

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