Saturday, May 27, 2017

Money is unimportant

I have a novel theory for why all the discussions of "money" in macroeconomics don't seem to go anywhere. Aside from cases of really high inflation (the only cases with any empirical support of money having a macroeconomic effect), money doesn't matter. It doesn't matter what it is. It doesn't matter what it does. It doesn't matter if it's base money or MZM. It doesn't matter how it's created. It doesn't matter how it's destroyed.

It simply doesn't matter.

Money is a proxy for our human behaviors in the economic sphere. It's like the iron filings conforming to the magnetic fields, or the smoke in a wind tunnel test. It's not doing anything; we're doing things.

Let me back this up with a few aspects of the information transfer model.

First, it is basically a mathematical identity to insert money that mediates transactions into an information equilibrium (definition) condition. If you have A B then A ⇄ M ⇄ B is just a chain rule and use of M/M = 1 away.

Second, most recessions and other shocks involve non-ideal information transfer (definition). It is caused by correlation of agents in state space (if agents were uncorrelated and fully exploring the state space, you'd have ideal information transfer). Money wouldn't correlate in state space without agents (in fact, if we had just mindless sources and sinks of money, macroeconomics would just be thermodynamics). Money in cases of non-ideal information transfer is just an indicator dye along for the ride reeling about with the non-equilibrium dynamics of human behavior.

And finally, what about those high inflation cases? In those cases we have empirical evidence that money is tied to inflation, so how can you say it doesn't matter? Well if we think of money M as a factor of production (along with labor L and other factors) we have 

(1) log P ~ ⟨α − 1⟩ log L + ... + ⟨β − 1⟩ log M

where P is the price level. If money grows at a rate μ, and labor at a rate λ, then we have

(2) π ~ ⟨α − 1⟩ λ + ... + ⟨β − 1⟩ μ

If m is large and π is large [1], we can approximate the equation with just 

(3) π ~ ⟨β − 1⟩ μ

which is basically the quantity theory of money. That's a relatively trivial role for money, however. And empirically, a trivial relationship is what we see for high inflation (over 10%). 

For most modern economies, inflation dynamics are more likely demographic (see here or here) or due to other shocks (e.g. oil). Basically, that means the other terms in Eq. (2) are more important than the money term.

Overall, we have a series of trivial (math identity, quantity theory) or non-causal ("iron filings") relationships between money and macroeconomics. In most of the policy-relevant scenarios (recessions, modern moderate inflation economies), money doesn't really matter [2].


Update 29 May 2017

This is mostly for commenter Shocker below, but I think this post has been generally misinterpreted to mean we don't need money at all. My thesis is that we don't need money to explain modern moderate inflation economies or to implement economic policy. Only in trivial scenarios (e.g. high inflation, or no money at all) does it have an impact. Graphically:

This is to say that for policy relevant scenarios in modern moderate inflation economies, for random macroeconomic variable R and money supply M:

∂R/∂M ≈ 0


[1] If π is small, then we must have a large cancellation.


  1. Of course money matters. It's just that you've got your definitions wrong. See this graph:

    As to why there was no crash, see this graph:

    Money matters above everything else.

    1. Your measure doesn't seem to provide a model of recessions. Recessions sometimes follow falls in CMS (which I gather from searching around your blog is that CMS ~ M1 - PMSAVE), and sometimes don't (or the delay is longer in some cases than others). There are falls in CMS that aren't accompanied by recessions. Does it matter if CMS goes through zero or not? And why?

      This makes CMS no different than any other measure of money as an economic indicator. If you don't have "drop in CMS" if and only if "recession after drop", then at best we can say is that CMS is correlated with RGDP growth. But that's not even true:

      But the biggest problem I have with this is that the measure M1 essentially changes definition with the advent of NOW accounts in 1981 and the reserve requirements on some elements of M2 dropping to zero in the 1990s meaning that money probably started moving out of M1 and into M2:

      M1 is defined in terms of particular social institution that has different instantiations in different countries (and even different instantiations at different times in the same country, e.g. the US as described above); it's not an economic definition like e.g. MZM which is not particular kinds of bank accounts but rather anything that acts as a zero maturity coupon.

  2. You say that money may not matter but Philip comments "Of course money matters." Can you both be right?

    I think "yes".

    Now I am guessing here, but I think you are thinking of money as a measurement; as a scale useful for comparing the size of something. Philip is thinking of money as a physical object; something that can be translated reliably as a proxy object. Philip is thinking that money = object despite the difference in dimensional units (money dimensioned in dollars, object dimensioned in bushels/tons/carets/etc).

    If my guess is correct, both of you are correct in your comments.

    I like using mercantile money as an analog for common money. Mercantile money is commonly known as a "gift certificate". When we consider how a merchant and worker can use a gift certificate (mercantile money), we see the gift certificate playing the role of measurement and physical object at the same time. The choice of character depends upon whether merchant or worker is making the judgement.

    1. If you think "yes" then you misunderstood me. And you're still talking about scale in a way that doesn't make sense. If anything, I'd say the scale of e.g. population growth g sets the scale of inflation π and money growth μ ... i.e.

      μ ~ a g
      π ~ b g

      for some constants a and b.

  3. I think you are assuming the thing you wish to prove here. Money doesn't just mediate transactions, it enables them. It probably does other things too but I'm too tired to bring them to mind right now...
    I'm reminded of Krugman's claim that banks don't matter since all they do is mediate loans. Well yes, if banks did mediate loans they wouldn't matter, but they don't so they do.

    1. No economy can run on the basis of barter.
      Barter-by-proxy commodity money, which is what you postulate here, may be slightly better but is not how real economies operate.
      They operate on the basis of credit. Once a mechanism has been devised to make credit transferable we call it "money".
      It enables deferred payment. It disconnects the quantity of money from the quantity of wealth. It disconnects the issuers of money from the creators of wealth.
      It is simply not credible to suggest that these things have no effect on the operation of an economy.

    2. I am not assuming what I am trying to prove. It's actually based on empirical data: the fact that the quantity theory of money basically describes inflation above about 10%, but below that there is no obvious relationship except a loose correlation:

      I'm definitely not saying that barter will work. I am saying in normal economies with moderate inflation, money is not a good explanation or indicator of economic activity. Additionally, for high inflation, it is a trivial indicator (i.e the quantity theory of money). That means money isn't really important in describing an economy. Sure, it's probably necessary for a modern economy sort of like how air is necessary for human life. However once you have air, air doesn't really dictate how humans behave.

      Maybe a good analogy here is paper for law. While any legal proceeding or law-making activity has a paper trail, that paper trail is more of an indicator of the legal process than a causal factor. If we make more paper, we won't make more laws. In the normal functioning of society, laws are made according to politics and human interactions. In the normal functioning of markets, transactions are made according to human interactions -- not because we printed up more dollar bills.

      In a simple sense, we can say there is a "satisficing" regime where you have some money. There is another regime where there is too much (sustained inflation above 10%). If you're in the satisficing regime, changes in money supply (whatever money supply means) are not leading order contributions to economic models.

    3. I do not disagree that money is not normally the main driver of inflation. I disagree with your somewhat broader claim that "money doesn't matter. It doesn't matter what it is. It doesn't matter what it does. It doesn't matter if it's base money or MZM. It doesn't matter how it's created. It doesn't matter how it's destroyed."
      If you look at other other variables, say employment or asset prices, money clearly matters.

      I know you don't think barter will work, but you appear to have adopted the Austrian/Neoclassical fallacy that money is, or works like, commodity money. If you do that then yes, money is neutral. But that ain't our money.

      Sure, if everyone has enough money then adding a bit more will have little effect on economic activity. Meanwhile, back in reality, handing out freshly minted dollars to people who don't have enough of them will result in some money being spent that wasn't being spent before.

      No money, no transactions.

    4. I do not think money works like commodity money. I think money works by being a source of information entropy and is a manifestation of the scale invariance of economics.

      I am pretty certain "helicopter money" would work in much the same way as fiscal stimulus (e.g. those with lower marginal propensity to consume wouldn't spend it as quickly as those with higher) -- meaning the "moneyness" aspect of it is not the correct focus. That is to say it is "unimportant" that helicopter drops are done with "money" rather than tax credits or government hiring of labor.

      I'm not saying money is useless, just that your macroeconomic theory probably should concentrate on other important things like population growth and intertemporal equilibrium failures ... not unimportant things like money.

      I also think you ignored my satisficing argument. Yes, no money means transactions are harder. But once you have sufficient money, more or less of it is of lower order importance. My view should be visualized by a broad flat equilibrium where perturbations in the money supply don't strongly impact economic variables.

    5. I updated with a graphic above that may help you understand my bold claim a bit better.

    6. You're trying to blind me with science with those links, successfully. I will have to study them this evening.

      I think your bold claim is actually quite modest, you've just wrapped it in an outrageous claim that you now claim not to be claiming at all. Then you claim it again...
      The important things are all affected by the unimportant money. That makes it important. (I don't think moderate inflation is important.)

      And I actually agreed with your satisficing point, except to note that there is also an unsatisficing zone which you didn't mention, but appears in your diagram.

      Oh, and money is tax credits :-)

    7. I am still claiming money is unimportant to understanding the macroeconomics of most countries.

      --Money explains 0% of the business cycle.
      --Money explains 0% of unemployment
      --Money explains 0% of the impact of government policy
      --Money explains 0% of economic growth

      Those are the key questions of macroeconomics, therefore money is unimportant.

    8. "Money is a thing that mediates transactions and has high information entropy"

      As a definition I don't find this very satisfactory. I want to know what money is. Telling me one thing it does and one property it has doesn't really tell me what it is. Most definitions I have seen suffer from the same problem. If it contains the word "thing" it needs more work.

      I think money is transferable credit, denominated in a unit of account. In our fiat system it is transferable tax credit.

      0%? Really? Money doesn't make the world go round even a little bit?

      What would the business cycle look like if money grew on trees? There would be boom every spring and a bust every fall.

      Unemployment is caused ultimately by the need to pay taxes. These days that is done only with money.

      Therefore the government can reduce unemployment by creating enough money for people to pay their taxes.

      And if it creates a little more people can invest it in increasing capacity and so grow the economy.

      If your definition allows you to prove the absurd you need a better definition.

    9. Symbol or token? Object? It doesn't matter what its physical manifestation is (as paper or electrons). It's definition is in terms of mediating transactions with high information entropy (i.e. every dollar is the same as ever other).

      If money is a transferable credit, what does that provide in terms of theory that explains empirical data?

      I still think you are misunderstanding my point. Human societies need oxygen but in general -- as long as there is enough -- oxygen levels don't matter except in extreme situations. They explain why e.g. humans don't live above 10,000 feet. But at lower altitudes, oxygen levels don't matter for understanding how societies are structured or human behavior.

      Regarding your comment about money growing on trees: there is in fact a seasonal component to various measures of the money supply and there aren't recessions every fall.

      Do you have some theory where you can explain measured unemployment rates based on the need to pay taxes? Where is it? How well does it perform with empirical data? My dynamic equilibrium model sees unemployment as constantly falling except for periodic shocks. Do we only need to pay taxes once every 7-8 years or so (the mean time between recessions)? Does the government suddenly supply less money to the economy for a couple of quarters roughly every 7-8 years or so? Why does it do that?

      You can't just assert things about economics and expect anyone to believe you. You need to provide theory that explains empirical data. You need to provide the code for your models. You need to put up explanations of your models.

    10. "Symbol or token? Object? It doesn't matter what its physical manifestation is (as paper or electrons)."

      I agree.

      How would credit-based money and commodity money manifest differently in the behaviour of an economy?
      I would expect commodity money to have a deflationary bias and credit-based money to have an inflationary bias.
      Credit-based money incorporates an element of borrowing from the future which commodity money does not. So I would expect more aggregate demand with the former.
      A bit tricky to test empirically as there are no economies based on commodity money so far as I know.

      "I still think you are misunderstanding my point."

      Not sure why you think that. You are saying that the economy is (usually) sailing happily along the still, quiet waters in the middle of your graph, unperturbed by any waves of money that may pass by.
      I understand that, and I disbelieve it.
      The reality (I believe) is that the economy is usually surfing on waves of money up and down the hill at the left. My intuition is that the knee of your graph should be pushed way over to the right and your "Sea of Tranquility" should be much narrower.

      "there aren't recessions every fall."

      I'm struggling to get consistent results from FRED. When I first clicked your link I saw a distinct 13 month periodicity, which I thought intriguing. But once I started fiddling with it I couldn't get back to it even by clicking your link again. There appears to be a monthly periodicity now.
      Anyway, the fact that there are seasonal variations in money supply such that the Fed makes "seasonally adjusted" figures for many variables rather supports my point I would think. It also makes me wonder if the influence of the money supply is being masked because people use data that has had some of it stripped out.

      "Do you have some theory where you can explain measured unemployment rates based on the need to pay taxes?"

      I am not positing some dynamic relationship between levels of unemployment and tax. I am stating a socio-economic "fact": unemployment only exists at all because taxes are levied. short argument long argument

      "Does the government suddenly supply less money to the economy for a couple of quarters roughly every 7-8 years or so? Why does it do that?"

      Yes, because that is when the president is changing and they think they will gain votes by decreasing the deficit. I think the empirical data gives some, though not conclusive, support to this hypothesis.

  4. This post comes across as a premature declaration of victory, but I am still trying to get comfortable with this framework. So far, it certainly seems it can be right, but it's far from chest to me so far that it is, even after having read many more blog posts here since last having commented.

    I don't think you've slayed the market monetarist dragon yet. You've seemed to indicate market monetarism is untestable, but I don't think that's true. If NGDPLT were adopted, especially by multiple central banks and there were still swelling central bank balance sheets and persistently low interest rates and inflation, I think that would at least partly discredit the framework. The IT framework would gain relatively,

    However, if NGDPLT did boost rates and inflation in several countries near the ZLB, it would obviously be a plus for market monetarism, but how much would the IT framework suffer? The latter admits a change in monetary policy regimes can change k, if I've under stood correctly. Also, if I understand correctly, the IT framework would suffer somewhat, but would not be dead.

    My guess is that the IT framework is correct in at least some respects, given the elegance and fit to data so far, bit macroeconomics in general has a long way to go before more or less permanent, wide adoption of a single framework.

    1. NGDPLT = Nominal Gross Domestic Product Level Targeting
      IT = Inflation Targeting or Information Transfer?
      ZLB = Zero Lower Bound of the interest rate
      k = ?

      Monetary policy is unimportant. Maybe Jason can investigate that proposition.

    2. I did put this forward in "bold claim" form (which is a reference to conversations I have with one of my grad school friends where we'd either put forward "bold claims" or call out each other's statements as "bold claims").

      It's meant more as the beginning of a debate than an end.

      RE: Market Monetarism

      It's never a good sign if the only way you can test a policy is to try it. Given that prediction markets only seem to work as well as polls, there's little theoretical reason to think NGDPLT will function any different than a poll. That may be a more democratic/statistically better move (i.e. away from forecasts being a poll of 10 or so people on the FOMC), but in a sense the future is unknown and rational expectations requires some information theory violating properties of the E_t operators:


      I think IT refers to information transfer here. And k is the IT index.

    3. Jason,

      Yes, there's not much more than a priori reasoning to try NGDPLT, but the cost of doing so is presumably less than trying the possible solutions the IT framework would suggest to limit business cycles, or at least the damage they cause.

      That said, your framework is overall more rigorous than that I've seen from market monetarists, providing a concrete explanation, for example for the disconnect between micro and macro. And the framework is more interesting, looking at information content as an explicit variable. I admit it strains the intuition of a very non-physicist like me, but that's a good thing.

  5. Shocker,

    You are correct and k does refer to the information transfer index.

  6. You write
    "Well if we think of money M as a factor of production (along with labor L and other factors) we have

    (1) log P ~ ⟨α − 1⟩ log L + ... + ⟨β − 1⟩ log M"

    I can get part way to this expression.

    To find a price, a product is dissolved into components and each component assigned a monetary equivalent. The sum of these components becomes the price.

    It would be OK to think of money as automatically a "monetary equivalent. You would not apply a growth rate to money because it is the common conversion element being used.

    "Price" is a monetary equivalent. It follows that a change in price is composed of the sum of changes in monetary equivalents.

    The price of a product can change each year despite no change in the quantities of components. Such a price change would be the result of a different monetary equivalent being assigned to components each year. In this case, the change in price would be entirely due to the changes in monetary equivalent.

    I think I am agreeing with the results of your math while still not understanding why you would present equation 1 as a logarithmic expression.

    1. It is a way to write a Cobb-Douglas production function.


      P = L^⟨α − 1⟩ × M^⟨β − 1⟩


      log P = ⟨α − 1⟩ log L + ⟨β − 1⟩ log M


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