Market Monetarists: A Few Questions About a Simple Example

Initial Setup: A cashless society with a central bank (CB) and a set of commercial banks. Assume the long term neutrality of "money" is true. Define "money" as that thing which the long term neutrality applies to. I think it's fair to call that thing "medium of account" (MOA).

Before CB takes over banking:

CB has $R reserve liabilities
banks have $D deposit liabilities
Quantity of MOA = $R

After CB takes over banking:

CB has $0 reserve liabilities
CB has $D deposit liabilities
Quantity of MOA = $D

Change in quantity of MOA = $(D-R)
Change in quantity of MOA as a fraction of the original quantity: (D-R)/R

If the average price level, P, was at equilibrium then normally when the quantity of MOA changes by a factor of F, then prices will change in the long term to be F*P, all else being equal. That's the long term neutrality of money. But the above might not be a "normal" quantity change in MOA, so P might not change to P*D/R in the long term.

I think Nick Rowe, Mark A. Sadowski, and Scott Sumner would agree with how I've calculated the quantity of MOA here, but I'm not certain. David Glasner might as well. Nick Rowe would probably say that this has no effect on long term prices, regardless of the value of D-R, because demand for reserves is substituted for demand for deposits or vice versa: thus supply and demand move together nullifying the effects of the change in MOA quantity.


Based on Mark being "somewhat mystified" by Nick's original explanation hinting at this fuller explanation, I don't know if he'd agree.

http://www.themoneyillusion.com/?p=26213#comment-320452   (there's a whole threat here worth reading)

It's not clear what Scott Sumner thinks about Nick's explanation (see thread above).

My question to Nick or David at this point:
Is there some other non-MOA good, other than bank deposits, which can participate in this substitution effect which moves demand in a 1:1 relationship to supply (to a 1st order approximation anyway, according to Nick), thus eliminating pressure on long term prices despite a change in the quantity of MOA?

My questions to Mark or Scott at this point:
Do you agree that the quantity of MOA changed?
Does this change have an effect on long term prices?
If no effect on long term prices, why not?

Update: 3/3/2014: Mark makes it clear what he found "somewhat mystifying" about Nick's post and it wasn't what I assumed it was above. Also from Nick's other comments there, it seems that Nick is probably on the same page with Mark and Scott.

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