The Conservative Case for QE2, Or, Why I Still Will Not Be an Austrian.

Economics Economics Questions
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In The Conservative Case for QE2, David Beckworth provides a quasi-monetarist defense for the second round of quantitative easing.

He states that the purpose of QE2 is “about fixing a spike in the demand for money that has significantly hampered spending.” He elaborates, “Because the monetary base has been increasing so rapidly and there has been very little inflation, it must be the case that demand for the money must be increasing even more. In fact, money demand has been so pronounced that even the previous $1.2 trillion increase in the monetary base was not enough to prevent outright deflation in 2009 or a sustained decline in core inflation (which shows the trend path of inflation) over the past two years. Thus, a significant portion of the money supply is being hoarded and not spent. This is the excess-money-demand problem.”

In essence, the Federal Reserve has failed in the same regard that Milton Friedman blamed it for the Great Depression: “The fact that total current-dollar spending has remained depressed for so long means that the Federal Reserve has failed to do its job and effectively has kept monetary policy too tight.” The solution is produced by the new monetary policy: “QE2, then, is a long-overdue attempt by the Federal Reserve to address the excess-money-demand problem. It will do so in two complementary ways. First, QE2 will increase inflation expectations, which should reduce the demand for money. Knowing that prices will be higher in the future will motivate creditor households, firms, and banks to start spending their money today while prices are lower. Second, QE2 will increase the monetary base, and this should begin to satiate excess money demand. Together, these developments should provide the catalyst needed to get the virtuous spending cycle started.”

And, of course, lowered-interest rates are not necessarily problematic: “Note that lower long-term interest rates are not the key to QE2 working. Yes, long-term interest rates may initially drop as the Federal Reserve buys up long-term Treasury securities to increase the monetary base. But this effect will be fleeting if QE2 is successful. Once the economy starts recovering, interest rates will start increasing. Similarly, QE2 may initially cause the dollar to lose value, but by spurring a recovery QE2 will ultimately put upward pressure on the dollar.”

Bob Murphy responds to Beckworth’s quasi-monetarism with several Austrian challenges.

In turn, Bill Woolsey responds, once again pleading the quasi-monetarist case. David Beckworth, too, responds to Bob Murphy. He summarizes his key points skillfully: “During 2008 there emerged a surge in money demand as the housing fiasco began to unfold. This spike in money demand got even more pronounced in late 2008 with the uncertainty created by the financial crisis. Given that we have a central bank — and this is not an endorsement of the Fed — its job should be to offset and stabilize such money demand shocks. The Fed failed on this count and, as a result, what should have been an ordinary recession got turned into the ‘Great Recession’ of 2007-2009. Yes, this Fed failure — like its failure to raise the federal funds to its natural rate level sooner in the 2002-2004 period — is another indication the Fed is flawed. Nonetheless, we are stuck with this monopoly producer of money and have to work with it. This means the Fed should have done more to prevent the surge in money demand. Because it did not, the Fed effectively tightened monetary policy in 2008. Moreover, despite the large increases in the monetary base to date, money demand remains elevated. From this perspective, then, monetary policy is still relatively tight. QE2 is an attempt — a flawed one as I will discuss later — to address it.”

He adds, “Appreciating the importance of money demand shocks also helps explain why conservative economists like Scott Sumner, Bill Woosley, Josh Hendrickson, and I are sympathetic in spirit (if not in form) to QE2. It would do all hard-money advocates some good to wrestle with the monetary disequilibrium literature and its implication for a commodity standard. It is worth noting that there are prominent Austrians like George Selgin and Steve Horwitz who take the monetary disequilibrium seriously.”

I think the money demand shock, given our monopolized currency, can only be treated through the machinery of the Federal Reserve; given the excess money demand, greater supply is required.

P.S. I fully endorse free banking.

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Of course the problem with this analysis is that it ignores the fact that Bernanke is paying interest on reserves and is therefore intentionally preventing the expansion of the monetary aggregates (in the short run) which, if allowed to expand, would easily satiate the demand for money as money (and then some). Bernanke’s monetary policy is contradictory; it’s simultaneously expansionary and contractionary. This leads me to believe that Bernanke is not at all interested in satiating the elevated demand for money but is rather attempting to elevate asset prices (the wealth effect), especially bond prices (lessen the burden on the federal government), and alleviate deflationary expectations (which no longer exist).

In other words, he’s fighting the deflation boogey-man and trying to inflate another bubble.

Alternative and older measures of consumer price inflation show an inflation rate of around 7%. The CPI-U says that the inflation rate is around 2%. Energy, food, and commodity prices are at, or near, all-time highs (and the core CPI measure entirely ignores them).

Absolutely incorrect. Milton Friedman criticized the FED during the 30s because it allowed something like 9,000 banks to fail in a matter of weeks (failed to perform its function as the lender of last resort–demanded sound collateral in the middle of a financial crisis), which led to a liquidity crisis, a massive credit contraction, and ultimately 30% deflation. Anna Schwartz warns that Bernanke’s actions may potentially yield hyper-inflation somewhere in the future.

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Excellent (and helpful) reply, Esuric.

I’m days away from beginning Man, Economy, and State. I was considering buying Microfoundations and Macroeconomics: An Austrian Perspective by Steven Horwitz after that (when I’m actually finished with Rothbard’s large tome!). Have you read it before? (I believe I’ve asked for recommendations from you on Austrian macroeconomics before, but I misplaced the list.)

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I have and I would recommend it to anyone interested in macro-economics, with some knowledge of the mainstream. I liked the book - especially the summaries on Austrian economics - but must, ultimately, admit that I’m not entirely convinced of the argument. But I’m perfectly willing to attribute it to my lack of understanding.

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No, unfortunately I haven’t.

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StrangeLoop,

How can you have made over a thousand posts here and fallen for that nonsense? Have you not picked up the basics by osmosis hanging around this site?

This whole “money demand shock” problem is about as real as vampires.

You will note that what it really means is that people are not spending money and banks think they will lose money if they lend it to deadbeats and incompetents, and that’s all they see coming into their office. So to turn it into a boogeyman, you have to postulate that spending is what drives the economy, which is of course nonsense. Production is what drives it.

Also, he creates the mythical problem of deflation, which is both factually untrue [we have constant inflation all the time and the CPI is laughably twisted to hide that fact] and not a problem [how can increased purchasing power for all be a problem?].

Finally his solution is to rob every man and woman and child in the USA [and those abroad who have dollars] of their wealth, because that is what QE [=money printing] does.

I have only asserted the flaws in his thesis, not proved them, because I am in a Liberty Student frame of mind. I won’t do your research for you. 1,089 posts. You should know your way around here by now, find the places that support my contentions.

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You don’t believe an excess demand for money is possible?

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Good to have you back, StrangeLoop.

“Excess demand” in terms of what, exactly?

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Not that you’re asking for one, but my recommendation would be for you to tackle Mises’ Human Action right after MES. There is no substitute for Human Action!

Horwtiz’s book is highly recommended. It is a well written and excellent exposition of the Monetary Equilibrium perspective usually associated here with the “free banking” school. It is a also a marvelous example of how when the rigorous deductive method of praxeology is abandoned, proclaimed Austrians become monetarists.

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To build upon my last post, I fail to see how demand for money is really any different from demand for other commodities. In the absence of a price ceiling, is there ever any “excess demand” for a particular commodity? No – as the demand for the commodity rises, ceteris paribus, the price will rise.

Of course, that seems to beg the question: what’s the “price” of money? My answer is that, since all other commodity prices are in terms of money, the “price” of money is therefore in terms of other commodities. Thus, as people’s demand for money increases, ceteris paribus, more commodities will need to be exchanged for it. As a result, prices of commodities will decrease.

However, I think what’s really meant by “excess demand for money” is that people have found themselves holding assets which they thought were (relatively) liquid, but have turned out to be (relatively) illiquid. I fail to see how they’re entitled to any (further) liquidity in such situations.

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Autolykos,

You presented my thoughts more eloquently than I could have.

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You both fully rebuke this extension of Austrian theory?

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To be honest, I’m not familiar with “Yeager’s approach”, nor with how Horwitz reconciles it with that of the Austrians. What I will say is that the ABCT essentially describes putting price controls on interest rates. My comments above weren’t about this, however – they were about demand for money vis-à-vis supply.

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for what its worth, I do. Its like saying just as being poor is bad, so is being rich

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A timely contribution from Horwitz.

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“Excess demand” for anything is not only possible but it’s the state of nature. “Excess demand” is but another name for scarcity.

The magic of fiat money transports us smartly into the post-scarcity universe, where money literally grows on trees and every (“excess!”) demand is easily satiated at the click of a mouse. Lucky us.

Z.

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OK, it’s amateur hour, with me on stage. Let’s go right to the timely contribution from the distinguished Prof. Hurwitz, to whom I am indebted. He has been very good with his time to me, answering emails and the like.

As always, my comments in bold:

It appears as though, reading some of the Austrian blogs and community forums in the last couple of years, that one of the barriers to understanding the monetary disequilibrium view is the phrase “an excess demand for money.”

Oh, yeah. That hit it right on the head. Because how come one never hears of the technical sounding phrase “excess demand” when we talk about apples, or cars, or anything else but money? The usual term used then is “shortage”. I suspect the reason is that someone is trying to slip in an implied “solution” to the problem of “excess demand” for money. Too much demand for money? Fine. Let’s print some, and everyone will be happy.

As David Beckworth found out in posting a response to Bob Murphy over at the Mises Blog, many of the commenters over there deny that the phrase “an excess demand for money” is meaningful or simply don’t understand what it refers to.

Count me in as one of those commenters. Happily, Uncle Wikipedia comes through once again. Let’s see what he says:

Economic shortage is a term describing a disparity between the amount demanded for a product or service and the amount supplied in a market. Specifically, a shortage occurs when there is excess demand; therefore, it is the opposite of a surplus.

Economic shortages are related to price—when the price of an item is “too low,” there will be a shortage. In most cases, a shortage will compel firms to increase the price of a product until it reaches market equilibrium. Sometimes, however, external forces cause more permanent shortages—in other words, there is something preventing prices from rising or otherwise keeping supply and demand unbalanced.

In common use, the term “shortage” may refer to a situation where most people are unable to find a desired good at an affordable price. In the economic use of “shortage”, however, the affordability of a good for the majority of people is not an issue: If people wish to have a certain good but cannot afford to pay the market price, their wish is not counted as part of demand.

And the article goes on and on about this. The question is, why is the price “too low”? What happened to our good friend, the Law of Supply and Demand, which will ensure that prices go up in such a case? Uncle Wikipedia doesn’t spell it out, but reading the whole article makes it clear that shortages happen because of a govt decree, such as an imposition of price controls. It doesn’t happen any other way.

And yet suddenly, when we get to money, this situation supposedly happens “by itself”, with no “price controls”. Not that I am even sure what that really means. What is a price control on money? In order to produce a shortage of money similar to a shortage of apples, it would have to mean that the govt decrees that prices of everything must never sink [= making the price of money “too low”]. Since there is never ever such a govt decree, we have fallacy the first.

Not only that, the usual solution supposedly no longer exists. The price [=purchasing power, as we all know, right?] of money is not going to rise by itself, solving the problem. Why not? Which exposes fallacy the second. That’s why I think the whole concept, applied to money, is a myth.

People who have studied monetary economics seriously understand it, as should anyone who was an economics major.

They used to call this appeal to authority, no? How about tackling the ideas involved?

But the truth is, when people say total silliness about a topic I know something about, which they would have avoided by studying it at an elementary level, I too use that kind of phrasing. So maybe we can excuse Prof. Hurwitz his passion. But let us clearly understand that it is not a logical argument. There has to be a logical argument to support the use of such verbiage, which I fail to see here, for the reasons above.

Simply put, it means that people’s demand to hold real money balances at the current price level is in excess of the supply of such balances. Hence, an excess demand for money.

We have already explained above why this is a mythical situation.

Given the confusion this phrase generates, I would suggest that we adopt Leland Yeager’s way of seeing the issue: it’s a comparison between desired money balances and actual money balances. Assuming, and some consumers of Austrian economics appear to deny this is the case, that the demand to hold money balances is not infinite, i.e., there is a determinant amount of wealth people wish to hold in the form of money, this Yeagerian distinction is sensible.

Wait a minute. Are you saying that if we rename something it’s logical problems will vanish? I am sure that not. So we also have desired amounts of apples in existence and actual amounts of apples in existence, and so on for all goods and services. Now, does this mean “at a given price level”, like before? Then it has the same problems, obviously. Let’s wait and see.

If our actual holdings are greater than our desired holdings, we get rid of the excess by spending on goods, services, and financial assets. This, of course, is how excess supplies of money translate into rising prices: the excess supply of money is spent because it is more than people wish to hold in their balances at the current price level.

When our actual holdings are less than our desired holdings, we will try to acquire additional money balances. The one sure way we have of doing so is to cut back on our spending. (There are other ways, but they are not completely under our control.) The result is downward pressure on prices, which is how deficient supplies of money lead to falling prices (eventually).

Oh, I totally agree. This is just a restatement of the Law of Supply and Demand, applied to money. Fine. However, once again, there is a little trick here. Suddenly the word “deficient” is thrown in. Which has two big big problems.

Just as the phrase “vitamin deficiency” implies that 1. the current state of affairs is bad, and 2. the solution is to take more vitamins, so too the phrase “money deficiency” implies that 1. the current state of affairs is bad, and 2. the solution is to print more money.

But 1. is a huge mistake, because there is nothing wrong with prices going down. On the contrary, we all have increased purchasing power from that. It’s a good thing.

And 2. is a huge mistake, because printing money is not a solution to anything at all. It is merely destruction of purchasing power.

Applied to apples, this kind of thinking says that when there is a shortage of apples, the solution is to cut the existing apples in half and call each half by the name “apple”. That way there are plenty of “apples” for everyone.

Because printing more money is exactly like cutting existing money in half. It destroys the purchasing power of the existing money. I do hope we agree on that. Because the law of supply and demand says so. If we disagree on this, the topic is now “Does printing more money destroy the value of the currency or not?” And the burden of proof lies on thee, Mr Yeager, to show it doesn’t. And you will have to explain the Weimar republic and Zimbabwe and dozens of other examples.

Of course the idea that we hold a portion of our wealth as real cash balances was central to Mises’s monetary theory. This means that the concept of an “excess demand for money” is not nonsensical in Mises’s system.

Non sequitor, sir. Of course people always hold on to some cash. You don’t need a Mises to tell you that. But the concept excess demand for money is nonsensical for the reasons I mentioned above.

But if that phrase causes too much confusion, I would happily substitute “actual money balances are less than desired money balances.”

No let’s keep the old phrase, so that its weakness is more in the open.

I would be curious to know if those who, in their confusion, think the idea of an “excess demand for money” is nonsensical see the quoted phrase above as equally nonsensical, and, if so, why.

I hope I have done that.

To sum up, if whatever phrase you use assumes that the price of money somehow cannot go up, then that is a mythical situation, as explained in the first half.

If the phrase means “a situation where a lot of people start saving their money, causing prices to fall”, well there is nothing “excessive”, or “deficient”, or even “bad” about that. It is a situation that does not call for meddling. In fact, it’s a good thing.

In conclusion, I admit I am but an amateur, certainly compared to the distinguished Mssrs Hurwitz and Yeager. But then again, I’m an amateur compared to Keynes. That doesn’t make Keynes automatically right, right?

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EDIT: what’s here was incorporated into the previous post

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**

Yes, if the demand/supply for a good jumps/plummets, the price for that good will change to accomodate the new circumstances. Certainly, though, you can see the problems when the good is money itself, right? Then, instead of one good changing in price, all goods bought with money must change in price to reflect the new circumstances. That takes time to work itself out and, since money coordinates economic activity, can cause a bunch of discoordination and general economic harm. There can be discoordination due to the sudden surge in demand for a particular good - entrepreneurs’ otherwise sound plans could be ruined because of the unanticipated rise in demand towards this good and thus away from the entrepreneurs’ goods - but it is nothing compared to the problems borne from a radical change in the supply/demand for money itself.

“Excess demand” may not be an appropriate term, just as “market failure” has problems, but we can agree on the point being made, right? In the wake of a hurricane, there can be an “excess demand” for bottled water, can’t there? Demand skyrockets and though suppliers may raise their prices, there may still exist a shortage. Even if there is no literal shortage (each water bottle vendor still has product to sell), we can agree that there is something abnormal, something special, about the demand for bottled water in this situation, right? Similarly, in the wake of bank failures and a financial panic, the demand for holding money can skyrocket and, since you’re dealing with money, it’s not as simple as a small number of vendors adjusting their price for a certain good - everyone must adjust their price.

One can accept all this while still believing the government would only do more harm than good through ‘quantitative easing’ or anything else through a central bank. One can believe this is a very serious problem while believing that the best/least worst solution is indeed to let prices adjust without issuing a single additional unit of money

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Excellent explanation by Dave. Monetarists always complain about the excess demand for money while totally ignoring the logical fallacies involved. But it is not limited to them. Some economists, schools commit the same fallacies in the opposite direction. They are always whining about an excess supply of money whenever anyone engages in printing money. Whatever happened to our old friend the Law of Supply and Demand? Too much money is as much a problem as too many bicycles are. The prices will simply adjust.