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

[DD5]

@Esuric

But a higher demand for money is not a higher demand for savings. First, because it does not alter the natural rate of interest (if we hold the ceteris paribus condition), and because it actually reduces the total supply of real loanable funds, as individuals withdraw cash from banks, and liquidate their assets (lower demand for securities means higher interest rates in order to stimulate the QD for them). Additionally, and as I’ve mentioned, individuals will increase sales and limit consumption. So what we get, therefore, is a condition where aggregate demand falls dramatically, and interest rates rise dramatically (a lower supply of lonable funds), so that the structure of production contracts across the board, constricting total economic activity.

If aggregate demand falls dramatically, so do prices. And if prices drop, so does demand for your “loanable funds”, and the interest rate need not rise above the “natural rate”.

Now, obviously nothing happens instantly. But pointing this out and labeling it a problem is a non-sequitur. If things were to happen instantly, then there would be no entrepreneurship and no market process. The changes you describe in your example, such as lower aggregate demand, is what will induce entrepreneurs to bid the interest rate down to compensate for a lower nominal reservoir of savings that also resulted from the increase in cash holdings, as per your example. And it is their entrepreneurial action that will adjust the interest rate and eventually all other prices. Not the other way around, i.e, prices adjust and then action is taken. This is what your theory implies - that entrepreneurs are unable to calculate until monetary equilibrium is reached. This is totally incompatible with Austrian price theory.

The important point to understand here is that the changes in economic activity, such as voluntary increase in demand for money, is by definition, aligned with changes in consumer preferences, so that signals are guiding entrepreneurs in the right direction. It is nonsense to say that there is a problem of “above” or “below” some natural rate, like in the case of monetary inflation (or deflation). The latter are temporary changes in demand brought about by force and not by consumer change in preferences. Like some kind of a concealed subsidy, they do not reflect any permanent changes in consumer preferences. It is only the latter [temporary coercive activity] that guides entrepreneurs astray.

[filc]

Potentially relevant.

http://consultingbyrpm.com/blog/2011/01/i-demand-answers-from-the-aggregate-demanders.html

[Esuric]

@Danny Sanchez

People holding any cash balances whatsoever are always seeking “security”, in that they are always dealing with some degree of uncertainty, and determining the height of their cash balances with reference to that degree of uncertainty.

Yes, but during periods of extreme uncertainty, such as financial and economic catastrophe’s, individual’s tend to demand the most liquid commodity (money) for safety. Do you deny this?

Danny, it seems like you’re trying to conflate the demand for money with the demand for wealth in order to invalidate the concept with a crude version of Say’s law (the only way to consume more is to produce more). But the desire to hold money is not the desire to consume. In fact, when you consume, you’re expressing a diminished demand for money. The term “purchasing power,” in economics, refers solely to the value of money. Thus when you claim that it’s impossible for the whole economy to increase it’s purchasing power, you’re saying that the value of money cannot rise, or, in other words, that deflation is impossible (unless you’re using the term “purchasing power” in a different sense).

@Autolykos

It’s actually a continuum fallacy or a “fallacy of the beard”.

According to Wiki, the continuum fallacy is when “one erroneously rejects a vague claim simply because it is not as precise as one would like it to be. Vagueness alone does not necessarily imply invalidity.”

When did I do this?

@DD5

It is implied in Mises’ theory of the trade cycle that it is only government tampering with interest rates that causes the cycle.

Absolutely ridiculous and simply incorrect. The ABCT is meant to explain all cycles, even those that occurred in monetary systems that did not posses central banks and where the government did not tamper with interest rates. The ABCT can explain this recession as well as the 1890 recession in free banking Australia. Hayek specifically said that recessions are unavoidable precisely because inter-temporal disequilibrium is unavoidable.

Again, rather than dealing with my actual argument, you’re trying to dismiss it by creating this absurd endogenous/exogenous distinction (and you’re treating FRB as an exogenous variable, for some strange reason). It simply doesn’t exist.

@DD5

The multiplier factor is not an inherent feature of free banking!

Except that there’s no proof for this assertion at all.

1. Fractional reserve banking emerged naturally through free market activity
2. You’re going to have to prove that all individual’s would rather pay “storage fees” rather than earn interest and have their cash available on demand
3. The only time that a 100% reserve ratio was employed was during the 13th century in the Middle East due to religious decree (it was forced).

These are the facts.

@DD5

If aggregate demand falls dramatically, so do prices. And if prices drop, so does demand for your “loanable funds”, and the interest rate need not rise above the “natural rate”.

I don’t understand what you’re trying to say here. A lower demand for securities means higher market interest rates, not lower market interest rates. There’s an inverse relationship between the demand for securities and the market interest rate. But what’s the relationship between the general price level of consumer goods and market interest rates? There isn’t one; market interest rates can rise when prices fall, and they can fall when prices fall.

[Smiling_Dave]

@Autolykos

It’s actually a continuum fallacy or a “fallacy of the beard”.

According to Wiki, the continuum fallacy is when “one erroneously rejects a vague claim simply because it is not as precise as one would like it to be. Vagueness alone does not necessarily imply invalidity.”

When did I do this?

You did use the fallacy of the covered wagon. It’s explained in an earlier post, together with the instance you used it [on another thread].

[DD5]

@Esuric

@DD5

The multiplier factor is not an inherent feature of free banking!

Except that there’s no proof for this assertion at all.

I’m referring to the multiplier factor,which is an inherent part of government intervention, i.e., central banking and such.

It is not part of the free market, even if fractional reserve banking existed. See Mises in Human Action. Or even George Selgin’s “The Theory of Free Banking…”

@Esuric

1. Fractional reserve banking emerged naturally through free market activity

2. You’re going to have to prove that all individual’s would rather pay “storage fees” rather than earn interest and have their cash available on demand

3. The only time that a 100% reserve ratio was employed was during the 13th century in the Middle East due to religious decree (it was forced).

Wrong debate. Not relevant to anything.

@Esuric

I don’t understand what you’re trying to say here. A lower demand for securities means higher market interest rates, not lower market interest rates.

ceteris paribus, that would be correct. However, that is not the only condition of the problem at hand, which you had provided. There is a lower demand for goods also:

@Esuric

But what’s the relationship between the general price level of consumer goods and market interest rates? There isn’t one;

There isn’t one? How can there not be one if even you acknowledge that eventually, the market rate of interest would adjust? So even you have to acknowledge that there is a connection, or you must argue that the rate of interest will be above the “natural” rate forever!

For one thing, the fall in monetary demand for consumers goods has an immediate effect on the level of real wages. The decline in prices of final consumer goods will be followed by a rise in the real wages of workers employed in all stages of production. This exerts downward pressure on demand for savings, and interest rate. There is also a fall in prices expected in producers goods, which will also exert downward pressure on interest rate. All of this will offset the fall in nominal savings. In short, entrepreneurial action will adjust relative prices, which will further guide entrepreneurial action in the right direction.

What is amazing is that In your models, only the interest rate adjusts too quickly, but nothing else. How can this be? Entrepreneurs are a bunch of idiots, actually they might as well not even exist in your models, for they speculate on nothing according to you. Only the bank adjusts its interest rate automatically, but also, with no entrepreneurial foresight.

@Esuric

you’re trying to dismiss it by creating this absurd endogenous/exogenous distinction

What is absurd is the claim that a disequilibrium, and no further explanation, is a problem always and everywhere. Even more absurd is that it is a problem for entrepreneurs, since let’s not forget that ABCT is about entrepreneurs going astray, and entrepreneurs themselves only exist on account of such disequilibrium.

@Esuric

But what’s the relationship between the general price level of consumer goods and market interest rates? There isn’t one;

[Lilburne]

@Esuric

@Danny Sanchez

People holding any cash balances whatsoever are always seeking “security”, in that they are always dealing with some degree of uncertainty, and determining the height of their cash balances with reference to that degree of uncertainty.

Yes, but during periods of extreme uncertainty, such as financial and economic catastrophe’s, individual’s tend to demand the most liquid commodity (money) for safety. Do you deny this?

No. But, during those periods, the way people are dealing with the extreme uncertainty is by increasing their facility to exchange. So what I’m saying is that that is only quantitatively, and not qualitatively, different from any other period, because people always increase or decrease their facility to exchange according to the present degree of uncertainty. So, the two components of the demand for money that you posit are really one and the same component.

@Esuric

Danny, it seems like you’re trying to conflate the demand for money with the demand for wealth

I am not doing any such thing. When I’m talking about an increase in an individual’s demand for money, I’m not talking about an increase in his demand for wealth; I’m talking about his desire to, as Mises says in what I quoted before, effect “a change from one way of using wealth to another”.

@Esuric

Thus when you claim that it’s impossible for the whole economy to increase it’s purchasing power, you’re saying that the value of money cannot rise, or, in other words, that deflation is impossible (unless you’re using the term “purchasing power” in a different sense).

The purchasing power of the monetary unit, across the whole economy, can rise, but only to the extent that either (a) more goods are produced, or (b) there are fewer monetary units. As I’ve already said, if (a) occurs, that means there are more “commodities-that-can-be-purchased”, so the total purchasing power to go around can go up. But if (b) occurs, there is deflation, but there is not more purchasing power for the whole economy. This is because, while the purchasing power of the monetary unit has gone up, the number of those monetary units has gone down. It is simply logically impossible for there to be more total purchasing power in the economy as a whole unless there are more goods in the market as a whole to be purchased. How can everybody purchase more goods, if there aren’t more goods to be purchased? And again, the purchasing power of the monetary unit is not the same thing as the purchasing power present in the whole economy.

[Smiling_Dave]

The purchasing power of the monetary unit, across the whole economy, can rise, but only to the extent that either (a) more goods are produced, or (b) there are fewer monetary units. As I’ve already said, if (a) occurs, that means there are more “commodities-that-can-be-purchased”, so the total purchasing power to go around can go up. But if (b) occurs, there is deflation, but there is not more purchasing power for the whole economy. This is because, while the purchasing power of the monetary unit has gone up, the number of those monetary units has gone down. It is simply logically impossible for there to be more total purchasing power in the economy as a whole unless there are more goods in the market as a whole to be purchased. How can everybody purchase more goods, if there aren’t more goods to be purchased? And again, the purchasing power of the monetary unit is not the same thing as the purchasing power present in the whole economy.

Well said, and obvious AFTER you say it.

The above also refutes Esuric’s q, “If deflation is so great, why can’t the govt just burn up dollar bills and we all get richer”?

IF the govt did that, we would be neither richer nor poorer. But if it prints more money, it makes some people richer [=the printers and their pals] at the expense of others [=everyone with paper money in his wallet or bank account or future paycheck].

In any case, in the real world, deflation rarely happens because of (b). It’s always because of (a). And anyone who wants to “solve our problem” of being wealthier by printing money, good luck to him.

[Esuric]

@DD5

I’m referring to the multiplier factor,which is an inherent part of government intervention, i.e., central banking and such.

It is not part of the free market, even if fractional reserve banking existed. See Mises in Human Action. Or even George Selgin’s “The Theory of Free Banking…”

Oh okay, I understand what you’re saying and it’s a very good point. In fact, I’ve been struggling with this very same issue myself, and I think it’s because I’m only familiar with how this monetary system operates. For example, a lower demand for money constitutes a higher velocity which allows banks to increase the supply of money in the broader sense, and this yields general price inflation, but I’m not sure how a lower demand for money elevates prices in different monetary systems. Conversely, a higher demand for money, in our current monetary system, means a contraction in velocity, which reduces the total supply of money in the broader sense, and yields general price deflation.

I’m not really a free banker, and I’ve said this on multiple occasions. I’ve never actually read Selgin or White’s work on this issue (I’ve only read a couple of articles), and I find it fairly problematic in many respects. These are the issues I have with free-banking:

1. The supply of money actually contracts when the demand for money rises (Selgin and White can probably explain why this isn’t a problem for their theory).
2. I don’t see how the expansion of fiduciary media can be funneled in such a way that it only satiates the demand for money (as opposed to the demand for money as capital).
3. I don’t understand how changes in the demand for money effects prices in different monetary systems (if a lower demand for money magically yields general price inflation in other systems, then we cannot say that inflation is solely a function of monetary growth, but this is, of course, absurd).

But I believe that my explanation regarding the effects of a particular type of inter-temporal disequilibrium (market rate elevated above the natural rate), caused by monetary disequilibrium, is still logically sound (it’s merely a deduction from the Mises-Hayek-Wicksell business cycle framework).

@Danny Sanchez

The purchasing power of the monetary unit, across the whole economy, can rise, but only to the extent that either (a) more goods are produced, or (b) there are fewer monetary units. As I’ve already said, if (a) occurs, that means there are more “commodities-that-can-be-purchased”, so the total purchasing power to go around can go up. But if (b) occurs, there is deflation, but there is not more purchasing power for the whole economy. This is because, while the purchasing power of the monetary unit has gone up, the number of those monetary units has gone down. It is simply logically impossible for there to be more total purchasing power in the economy as a whole unless there are more goods in the market as a whole to be purchased. How can everybody purchase more goods, if there aren’t more goods to be purchased? And again, the purchasing power of the monetary unit is not the same thing as the purchasing power present in the whole economy.

This is correct. I don’t really know how to respond to this because I’m failing to grasp the implications. But I still don’t think it’s accurate to equate the demand for liquidity with the “demand for purchasing power.”

[Lilburne]

@Esuric

This is correct. I don’t really know how to respond to this because I’m failing to grasp the implications. But I still don’t think it’s accurate to equate the demand for liquidity with the “demand for purchasing power.”

Well, the purchasing power of money is, again, just another way of saying the facility to exchange with a medium. And just like the “secondary function” of desiring security is really part of the one true function of money (facilitating exchange via a medium), liquidity is also not really a separate function of money in terms of explaining its demand either.

What makes a good a useful medium for the facilitation of exchange is its liquidity (or “saleability” in Menger’s terminology, and “marketability” in Mises’). Saleability/marketability/liquidity is the promptness with which a good can be exchanged anywhere in the market at an exchange-ratio near to the best exchange ratio attainable at all (see Menger’s essay on the origin of money).

From the very beginning of a good acquiring any usefulness for indirect exchange at all (even before it becomes the general medium of exchange), it does so by virtue of its saleability/marketability/liquidity. And every step of the way toward the good becoming the general medium of exchange is supported by its ever increasing saleability/marketability/liquidity as it becomes more and more commonly used. (See what I write in my guide to TMC chapter 1 about the “upward spiral of marketability” responsible for a medium of exchange becoming money.)

Since the saleability/marketability/liquidity of a good is what gives it its purchasing power, the demand for saleability/marketability/liquidity is at bottom the demand for purchasing power. You cannot create more total purchasing power on the market as a whole with a change in the number of monetary units, and so you cannot create more total saleability/marketability/liquidity on the market as a whole with a change in the number of monetary units.

[Lilburne]

Please re-read the post above. Just fleshed it out a bit more. Thanks.

[Autolykos]

@Danny Sanchez

And again, the purchasing power of the monetary unit is not the same thing as the purchasing power present in the whole economy.

I’m confused by this sentence. At the beginning of the paragraph, you referred to “the purchasing power of the monetary unit, across the whole economy”. However, the sentence quoted above seems to imply that the referenced concept isn’t actually valid. Can you please clarify here?

Also, did you happen to miss my earlier post?

[Catalan]

Don’t have a lot of time now, but I’ll answer some of these issues;

The supply of money actually contracts when the demand for money rises (Selgin and White can probably explain why this isn’t a problem for their theory).

Well, that’s actually a premise behind their theory. The idea is for banks to issue more liabilities through fiduciary media when the volume of returning liabilities (returning notes) falls.

I don’t see how the expansion of fiduciary media can be funneled in such a way that it only satiates the demand for money (as opposed to the demand for money as capital).

It’s not. The idea that an increase in fiduciary media can avoid a fall in the prices of industries affected by an increase in the demand for money is false, and I’m not sure why economists like Selgin and Horwitz continue to advocate fiduciary expansion on these grounds. To me, free banking simply maximizes savings, and even then it’s been shown that in a stable, healthy economy the demand for money doesn’t really fluctuate all that much.

I don’t understand how changes in the demand for money effects prices in different monetary systems…

It temporarily decreases the amount of money in circulation.

[nirgrahamUK]

@Autolykos

I’m confused by this sentence. At the beginning of the paragraph, you referred to “the purchasing power of the monetary unit, across the whole economy”. However, the sentence quoted above seems to imply that the referenced concept isn’t actually valid. Can you please clarify here?

You must differentiate between what can be purchased by the lump of all the money tokens (i.e. they can purchase all the goods for sale) and what can be purchased by any one token.

This is kind of difficult to talk about without stepping away from methodological individualism and so on but the mental heuristic is that the purchasing power of the class of all money tokens is affected by the real goods in the market place, and and not the number of tokens in the collection. Whereas the purchasing power of each money token individually is determined on one side by the real goods available and on the other by the number of ‘competitor’ money tokens which are its brothers in the collection.

[filc]

Jonathan,

If you get any more time it would be outstanding if you could add some more commentary here. The last several pages of this thread have been excellent.