In recent discussions with David Beckworth about a
recent post of his, I've become confused as to what the Market Monetarist (MMist) position really is on some key issues. Commentator "Jared" brought David's post to my attention when he
commented about it at pragcap. Since then, the discussion has moved from David's site to pragcap and back again (
under a different post).
Jared's latest on this has been very clarifying.
Basically the discussion has boiled down to the following: David talks about leaving the interest on reserves (IOR) rate at 0.25% as the rate on short term Treasury debt rises, as a way to increase inflation and nominal GDP (NGDP) and all the things that MMist love. He claims this can be done while committing to a permanent increase in the stock of "base money" meaning that the Fed keeps the stock of excess reserves (ERs) above zero (and doesn't let them decrease). In fact not only CAN it be done, he claims that's the way to do it. Or at least I thought that's what he was claiming until his
latest comment. He also brings up cash, but I think Jared effectively dismissed that pretty quickly. Plus David responded to me with one of his previous posts (wherein he claims he did a better job of explaining himself) where he explicitly considers the case of a "
Cashless Society." Actually, when pressed, I've found that all the MMist I regularly read claim that cash isn't really important. That includes Nick Rowe, David Glasner, Scott Sumner, and now David Beckworth. Even some
hyperinflationists have told me that cash isn't important, even though their arguments seemed to imply that it was. (I'll try to provide a few more links here when I get the chance: I think I saved links to all the occurrences where MMist told me cash wasn't important). Although one
hyperinflationist ("bart") took a slightly different tact when he explained that my argument was "made null" by not taking into account "rehypothecation" and "collateralization" (presumably of the ER). He lost me there.
Meanwhile, the discussion with David has now gotten into the realm of the common MMist claim that the endogeneity of inside money really only holds over a short term (six week) basis between Fed meetings (or BoC in
Nick Rowe's case). Rowe also touched on that
here, and so has
Scott Sumner and
David Glasner. So have I for that matter, though I was less endorsing the view than
explaining it. Jared admits some difficulty with this concept, but ultimately
concludes that inside money is ALWAYS endogenous. I don't know if I can follow him there yet. I'm still undecided. However, I'd love to get back to the original issue: how can short term rates rise above the IOR rate when ER > 0? And if they can't, then what's the point of increasing the "base money" stock through central bank (CB) asset purchases (i.e.
Quantitative Easing (QE))? Would it have to do with the rest of the yield curve? Is it just for
psychological purposes?
Also, I suppose we could go the Japanese route and veer off into "non-traditional" asset purchases by the CB, but then is that really still "monetary policy" or have we entered the realm of "fiscal policy?" I think I know where each side comes down on that question, but it seems a little beside the point, since folks like Sumner have said that it's highly unlikely that these kinds of asset purchases would ever be necessary, while Glasner laid out a specific scheme where the kinds of assets purchased didn't really matter. I don't doubt that if the Fed starting buying non-traditional assets (Cullen Roche often mentions "bags of dirt") they could definitely raise the inflation rate. (I know... I owe you more links).
By all means, read Jared's argument(s). They are very good. I perhaps have muddled the issue by building on Beckworth's cashless society concept to conceptually simplify my argument. My assumptions are:
1. No cash (paper reserve notes or coins)
2. No reserve requirements (reserve requirement = 0%)
3. Only a single commercial bank (or just think of all commercial banks aggregated together)
In such a system "base money" = electronic Fed deposits at the bank (i.e. reserves, or excess reserves, since none are required). Since reserves can only go
three places there's limited items our one commercial bank can buy with them. Essentially it boils down to Tsy debt from Tsy auctions. If the Fed were selling (which it's not... according to David's earlier comments, it's committed to keeping stocks of base money elevated: i.e. ER > 0) they could buy Tsy debt or mortgage backed securities (MBS) from them too (in which case the base money would be destroyed). Now when the bank spends on Tsy debt (or when private sector entities pay taxes) the reserves sent to the Treasury General Account (TGA: Treasury's Fed deposit, from which it can spend) end up in the bank again when
Treasury spends into the real economy. So our bank can spend base money on Tsy debt at Tsy auctions, but that base money will end up right back on the bank's balance sheet shortly thereafter. It's only a temporary way to get rid of it. That is, unless Tsy runs a surplus (which they're not).
Everything else that the bank buys it does so by crediting the bank deposits of entities in the private sector. This includes any goods or services the bank uses (electric bill, office supplies, etc), employee salaries, shareholder dividends, interest to depositors, Tsy debt held in the private sector, or any other financial assets (bonds, stocks, etc.), or new loans (you can view new loans as the bank buying loan agreements from the borrowers). Crediting bank deposits means creating inside money ex-nihilo.
I think it's pretty clear that in such a world, whenever short term Tsy debt comes up for auction, and the amount that's being auctioned is less than the stock of ER, that the bank(s) will bid the price up and thus the yield down to the IOR rate. If there's any differential, the banks won't hesitate to buy it all. If I'm wrong about that, what am I missing? Could it be that expectations of higher rates are so strong that the bank is not willing to risk a decline in principal even on very short term debt? Could that be possible?
Now perhaps my simplifying assumptions go to far. If so, which ones, and why? I'm asking for help here in understanding. My simplifying assumptions are not essential (Jared does an excellent job arguing this same position w/o resorting to them). I only made them in an attempt to make the problem more clear w/o significantly affecting the macro picture. But perhaps they are not justified. Either case, I think it would be instructive (to me anyway) to know exactly where I've gone wrong here and why, if indeed I have.
Getting back to Beckworth's position, I thought that
Jared clearly summed up the dilemma of deciphering exactly where David stands, by pointing this out:
"...
our discussion began with this
quote from Friedman, ““Oh well, we’ve got the interest rate down to
zero; what more can we do?” It’s very simple. They can buy long-term
government securities, and they can keep buying them and providing
high-powered money until the high powered money starts getting the
economy in an expansion.” This certainly sounds like a causal (and
temporal) story running from CB asset purchases (injections of
high-power money) to economic expansion. But it seems as if you’re now
saying that the central bank does not really need to conduct asset
purchases to increase the monetary base, it just needs to credibly
commit to a permanent increase in the monetary base, which could FOLLOW
the inside money creation. Is your view different from Friedman’s"
Update: Jared and JP Koning chime in on the thread. I especially liked this from Jared:
"If we cut through the jargon, by "different degree of policy
accommodation to changes in demand for bank reserves," you mean the Fed
will raise or lower the rate at which it provides reserves to private
banks, right?"
Update 2: Sumner makes an amazing statement:
"In a sensible system the base money is endogenous. You set the NGDP
target, and the public tells you how much base money they want to hold.
I’m all for that."
