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Horwitz, what are the articles that you think that best articulate the modern austrian monetary theory? I mean, the "core" articles of modern austrian monetary theory.

Even though your question was directed to Steve, I would say read his and Garrison's books.

Rafael,

I am not Horwitz, but I might ask your question slightly differently. What do I think represents the best work in contemporary monetary theory?

I started my career teaching money and banking, but haven't taught it in years (since 1990).

But I would divide the list into (a) professional scientific discussions, and (b) popular presentations of the importance of money in a modern economy.

(A) Mises's Theory of Money and Credit and Hayek's writings from the 1920s and 1930s, and then 1970s would be the start on my list. In the 1950s and 1960s, I guess I would lean toward Leland Yeager and W. H. Hutt, and then Clower and Leijonhufvud. Among post 1970s monetary theory, I would list O'Driscoll, White, Selgin, Dowd, and Horwitz.

(B) In terms of popular presentations of the centrality of money in a modern economy and the consequences of bad monetary policy I would list Milton Friedman, Capitalism and Freedom, Free to Choose and Monetary Mischief; Hayek's chapter on monetary policy in The Constitution of Liberty and the essasy in Tiger By the Tail. Rothbard's What Has Government Done to Our Money would be on the list, as would Sennholz's Age of Inflation and Money and Freedom.

Reading through our blog and also the discussion at the Mises Blog and I have to say that I find Selgin's response from this morning to be the one I most relate to. But I was also struck by something very strange with the Austrian community --- why do people employ professional/technical jargon ladden conversations with people who are NOT professionals, rather than limit their professional/technical jargon ladden discussions to their interactions with peers, and instead when talking to non-professionals focus instead on the problems of inflation and bad monetary policy? You have laymen in this discussion raising questions to Selgin about fine points in monetary theory which they are not qualified to discuss.

On the other hand, there would be a good discussion that would be worth looking at IF the main characters decided to discuss in a serious way these issues outside the purview of the mass of "everyone thinks there is their own economist" and instead confined to the debate among professional economists.

When you go to an NBA game, I don't think people in the stands come dressed ready to play and at timeout they go down to the court to tell LeBron James how he should dribble the ball, or better yet suggests to LeBron that he should play in his place. That would be absurd, right? Well that is what is going on when "anonymous" tries to tell George Selgin about monetary history, law, and economics. As Selgin says, it is exhausting to get attacked by bad history, bad law, and bad economics. If by "Austrian economics" one means accepting these arguments that are bad history, bad law and bad economics, then I would prefer to not be labeled an Austrian economist. I would like to be seen on the side rejecting so-called "Austrian" economics. But while I would rejct "Austrian" economics, I would wholeheartedly accept the label Misesian-Hayekian economist. My reading of Mises and Hayek on monetary issues fits with the White-Selgin-Horwitz position.

Pete

I made a major sin of omission in leaving out Roger Garrison. In fact, I think his original article "Time and Money" from the Journal of Macroeconomics, as well as his original piece on intertemporal coordination from HOPE were two of the most important pieces written by somebody in the Austrian tradition in the 1980s.

Dr. Boettke,

I want to personally thank you for posting on this blog despite your reservations. For us amateurs whose main motivation is the fear of remaining ignorant, professional economists such as yourself who are willing to "bear with us" through embarrasingly ill-informed comments are doing the Lord's work of providing education. No, we have no business trying to take on a scholar in monetary theory like Selgin or Horwitz, but sadly, that is how many people learn. When an individual is willing ask the dumb question and be put in his place, or verbalize a foolish notion in the effort of working out a misunderstanding in their own brain, they have in fact humbled themselves enough to learn something. This is the process where fairly tales and mythologies are replaced with a sharpened intellect.

I personally love going to a party or gathering where someone is facinated that I study tectonics and geophysics. I will inevitabally have to wade through some uniformed person lecturing me why the moon phase causes earthquakes in California, but in the final analysis, if I can ask them a question which gets them to explore further, I can dispell the ignorance and contribute to education. That is what you are doing here. This blog is the endeavor of a 21st Century public intellectual, not mearly hashing out complex theory with your peers, but letting the public in on a little bit of the economic way of thinking. Technical discussions of the fine points of the theory is what professional conferences, journals, personal e-mail and telephones are for.

Thanks for info, Mario and Peter. I will look forward to study all this material.

If I were in charge of an academic department, I would simply drop the term "Austrian Economics" from all titles (courses, journals, field options etc). I'd replace it with either "Hayekian Studies" or "Misesian Studies".

Cult-like behavior has always been one of the main complaints about Mises-Hayek admirers. Since Hayek was the more tolerant and flexible of the two, I'd go with "Hayekian Studies".

The number of libertarians, Ron Paul supporters, and conspiracy fruitcake nutties who are using the term "Austrian Economics" is simply too large compared to the number of serious legit academics and grad students who want to focus on this material. The non-academia crowd has won control of the name. I'd switch to "Hayekian Studies".

You can use the term "market process theory" instead. It contrasts well with the terms "general equilibrium theory" and "game theory".

Thanks for posting the paper. I'll read it.

I read your paper "In Defense of Fiduciary Media", which I mostly agree with.

Rafael is right --- market process theory captures most of the main ideas, but it does tend to not pay enough attention to money and capital. New Institutionalism captures other aspects that are evident in Mises (property rights) and Hayek (spontaneous order and the difference between law and legislation, and the focus on norms), but it underemphasizes entrepreneurship and money and capital.

Moreover, Nick the term Austrian economics is identified with the sort of ideas you are talking about mainly on the internet, not necessarily among professional economists. See the Russell Hardin book I referenced today, he has an entire chapter where he talks about the Austrian school of economics and the Austrian approach to social and political theory in particular where he means Hayekian approach.

Finally, there are methodological issues that are important and unique to the Austrian school --- but which are not considered off the rails (e.g., look at my entry in the Handbook of Economic Methodology, and I am currently writing an entry for a Sage volume on 21st century economic methodology).

So the search for an acceptable alternative label continues.

But let me be clear about something since my friends at the LvMI has suggested that I often engage in false advertising about GMU --- GMU is NOT a PURE Austrian graduate program. It is a conventional graduate program in economics, which has intelectual space both in terms of course work and dissertation level work for specialization in Austrian economics. But let me also be clear, this specialization in Austrian economics is for the purpose of talking to other more mainstream economists in specific fields of inquiry.

The goal is never to talk to ourselves, but to develop the insights of Menger, Mises, Hayek, Kirzner, etc. in a way that addresses the professional debates that are on-going in the top journals and in the top publishers. For example, Acemoglu and Robinson's work on colonial origins, or the discussions on "institutions rule" in development economics, etc. I encourage publication in periodicals such as the RAE, QJAE and Advances in Austrian Economics, but I also think success should be judged by how far an individual can take the ideas they are developing from Mises/Hayek (for example) into more mainstream journals (in fields and in general journals). For example, a piece on the methodology of the Austrian school should be developed in a way that it can be published in the journal of economic methodology, or even in Economics and Philosophy. In other words, we want to be talking with the Dan Hausman's of the world, not with each other. If we are writing on the history of economic thought, say Mises, we want to be getting our work published in HOPE and talking with the great scholars of the Viena period Robert Leonard, not necessarily just Richard Ebeling (however great Richard is). And so on and so on wit respect to development, money, industrial organization, political economy, international trade, etc.

This is a different way to think about professional engagement and the development of Austrian economics.

Bottom line: Ron Paul has absolutely NOTHING to do with professional Austrian ECONOMICS. We can be happy that his political campaign highlights free market economics at a time when many other politicians are running toward statism as fast as they can. But that is not a position related to scholarship, but to my position as a private citizen who has political ideas and interests.

Economics is not about politics and ideology, it is a science of human action and social cooperation. Just as Adam Smith should not be tainted by Thatcher and Milton Friedman should not be tainted by Ronald Reagan, neither should Mises be tainted by American firsters of the 1940s or Ron Paul of the 2000s.

Personally, I did not vote for Ron Paul in 2008, nor did I join any pettion for him. But I do think he has been very sensible in his position against the bailout and the direction that both Republicans and Democrats are taking the country. He is a very useful voice in the contemporary debates. He is NOT my prefered voice, but he is an important one. To me I'd like to see someone who had Paul's ideas on economics with Obama's presence and ability to captivate the imaginations of both intellectuals and the young. But in general, I put no faith whatsoever in politics and politicians.

Getting exhausted by fighting bad law, bad history and bad economics? Hmmm... Why did you omit methodology this time? It is possible to be either a fractional-reserve free banker or a methodological individualist, but certainly not both at the same time... Note also that there are some serious inconsistencies between the views held by the various authors listed...

Ludwig,

Not sure you are right here, the law of reflux as developed by White certainly is consistent with methodological individualism rightly understood. In fact, rational choice within a specified institutional context that provides a "filter" which induces equilibrating tendencies is the hallmark of "invisible hand" economics. In this instance the filter process is described by White as the law of reflux to discipline overissuance.

What am I missing?

Also what do you see as the biggest inconsistencies between White, Selgin, and Horwitz? Do they recognize the inconsistencies between their positions?

As I said, I haven't thought as hard about monetary theory as others so I genuinely defer to the judgement of White, Selgin and Horwitz -- who when I did think about these issues I found to have the most persuasive arguments on monetary economics, and Garrison on macroeconomics. To be honest, Selgin has always impressed me as first-rate economic thinker in general so I always wished he would branch out beyond money and banking and address general economic theory as well. But George follows his passion for monetary theory, history of ideas in monetary economics, and monetary economic history. His latest effort is simply a phenomenal piece of scholarship.

"Economics is not about politics and ideology, it is a science of human action and social cooperation."

And only public intellectuals are fit to talk about human action and social cooperation. We definitely wouldn't want,

"people who are NOT professionals"

to discuss these matters.

My advice is to stay off public blogs if one can't handle debating with laymen or find it beneath their intellectual prowess.

The proper place for Professional Economists are ivory towers, the blogs belong to the people. And when you guys step outside your ivory towers, you're like the NBA fan expecting to enter the arena and play for the home team.

A chorus of angels accompanied by rays of sunshine will not follow your excellence where ever it may go. I think what you are experiencing is tinnitus, which can also distort visual acuity. Or perhaps you just ate some bad chicken.

Peter Boettke has absolutely NOTHING to do with pro or college basketball. Nonetheless, I understand Boettke is passionate about the game of basketball and coaches AAU ball after hours however for his own personal reasons. Does everyone realize what the first “A” stands for in AAU? Is he a real coach? Does he have any professional qualifications to be a real coach? Has he ever played or coached competitive ball at the college or pro level? Has he ever taken a kinesiology class? Has he ever published in the coaching journals or phys. ed. literature? Has he ever even been a graduate assistant at a D1 program or worked on the staff of a real professional coach? Has he paid his dues to gain access into a professional coaching association? Does he attend professional coaching conferences? Or might one speculate that a “real” professional coach might possibly mistake him for a delusional out-of-shape over-the-hill dad who is playing make-believe that he is a real coach and living vicariously through his kid? Please do not take this personally. This is just to make a point!

Now suppose coach K decided to start a basketball coaches blog called the “The John Wooden Coaches”. Wouldn’t it be fun for amateur coaches and players to write in and gain a better understanding of the game, and have coach K patiently explain the finer points to the game or point to literature which might help educate? Suppose one day that coach K was discoursing on the pick and roll. Boettke (using an alias where he would not lose face if he was pummled by the master) wrote in and explained that his old AAU coach taught it a different way. Coach K then berated Boettke harshly and chided him to stay off his blog! He had no time for amateurs who coach junior high and high school AAU ball. What if he advised Boettke that he was not competent to correctly comprehend the pick and roll the way “real” coaches teach it. Boettke had not paid his dues to be a "real" coach. What if coach K said he was even considering changing the name of his sport from basketball to “roundball” because so many idiots were coaching the game, and he did not want his own professional reputation or the game that he loved to be tarnished by their incompetence.

If such a thing really happened, I would think coach K was an arrogant jerk.

PS. As I said above, I appreciate you taking your valuable time to help educate so many of us amateurs. I just wish that that I did not feel like such an ingnoramous in the process.

It´s actually much more elementary than that. You probably haven´t thought about how free banking functions in practice. The demand for money, or the increased demand for money, is always the demand or increased demand for money of someone, of specific individuals, say A, B and C (= methodological individualism). Now for a methodological individualist it is certainly confusing to be confronted with the claim that the banks accommodate the increased demand for money of A, B and C, by putting money in the hands of a different individuals, say x, y and z. I already made that point in a previous thread and Steve then thought it had "merit". Steve then also agreed with my point that under free banking an increased demand for money manifests itself indirectly, via positive clearings for the issuing bank. I then pointed out that what is actually signaled by positive clearings is an increased _and satisfied_ demand for money. Somewhere in the economy some individuals have satisfied their increased demand to hold by changing their spending patterns.
The case for free banking would have been relatively uncomplicated, straightforward and simple if the free bankers had simply made an argument of the kind: credit expansion by the banks is OK, as long as there is no monopoly.
But by trying to change the meanings of familiar Austrian concepts, they have made that case much more problematic than it otherwise would have been.

For the curious, Hutt's paper "The Yield From Money Held" can be found here.

http://www.terry.uga.edu/~selgin/ECON8610/documents/Hutt.pdf

K Sralla and Dixie,

You don't read every blog do you? Don't read this one. It is perfectly acceptable for you to simply not come here and tell your friends to not come here.

Fred and Steve are more comfortable with public intellectual discussions so you should check out their posts, I am an academic elitist --- perhaps even a snob. You should probably ignore me.

To K Sralla -- I am not John Wooden of economics, never said I was. BTW, I am actually a HS coach as well as an AAU coach, and have been coaching since the 1970s at various levels and attended numerous clinics and even worked clinics and camps (so your example is not quite right, perhaps you should have checked up on that -- if you email me at pboettke@cox.net or pboettke@gmu.edu we can talk even more about my background in that arena). To push your example, if John Wooden was before me I would never presume to talk Xs and Os, but instead just listen to him and try to learn as much as I could from the master of his field. The delusion would set in, when I would presume that I could have something to teach John Wooden rather than the other way around.

Remember what I said in this context, I was astonished that "anonymous" (or individuals who make up names --- both acts of an intellectual coward in my book) would actually take on someone as accomplished as George Selgin, or the critical comments I read on some blog posts about other top thinkers in economics such as Israel Kirzner, when the commentators has no understanding of the issues involved. This is a practice of blogs that I find waste of intellectual resources --- intellectual cowards boldly declaring their arrogance as if it was an informed opinion. Questions are not asked, nor does learning take place.

I think there is plenty of room for healthy debate on economic policy and general points that non-professionals can discuss. But the issues in this recent thread where technical points of economnic theory, of which many of the participants simply lacked the background. So as Selgin concluded bad history combined with bad law combined with bad economics get repeated over and over.

Shouldn't we all want to see bad history, bad law and bad economics stopped?! Why don't we stop and listen to someone like George Selgin --- I am pretty sure his track record as a scholar of monetary economics establishes him as an authority on these issues.

In some fundamental sense, all I have ever asked for on this blog is for (a) comments to be posted by named participants, (b) that people be civil, (c) that we understand the different levels of expertise.

If this is not what you want from a blog, then don't read this blog. It is ok if you don't visit us and instead stick to your own list of blogs that better meet your demands.

K Sralla,

Asking dumb questions is never a problem either in the classroom or on blogs. And sometimes even the "best" professors give dumb answers and they should be called out for being lazy.

But what I am objecting to is not examples of genuine attempts at learning, but the lecturing of someone like George Selgin on fine points of monetary theory, and when he straightens out the readers they insist instead that he is a deviant or worse.

It is the arrogance of those without the background to to tell Selgin (or White, or Horwitz) that he doesn't know what he is talking about when they are internationally recognized for their work in this field.

I can understand why Greg Mankiw disabled comments on his blog, and why Pete Leeson often does as well.

I want to invite dialogue -- sometimes among everyone, other times mainly among peers. But there are costs.

Pete,
I´m not sure whether you are insinuating anything in my direction but in intellectual matters, the only criterion for belonging to any elite, academic or otherwise, is the capacity "to get things right". But you are certainly right that this blog amply illustrates the fact that not all bloggers belong to any elite. This by itself may be a sufficient reason for some individuals to prefer staying anonymous, rather than any "cowardness".
I don´t know for sure whether any of you has any "background" or "track record" to speak out about good and/or bad law, but as far as I am concerned, even before I obtained my Ph.D. in Economics (besides several degrees in other academic disciplines), I had practiced with some of the best lawyers here on the Continent, and after the fact I can recognize that this fact also adds to my expertise in these matters. Even the ivory tower theorist should never forget that banking, money etc. remain eminently practical disciplines.

LVDH,

Suppose I'm the manager of a bank that issues credit money.

I go to my head of loans and I ask him "What will our monthly revenue from loans be in the next few months". He does some accounts and tells me.

I then go to the folks who change money for specie. I ask them how much of that is happening.

I can now judge how much credit money I can issue. However, I may choose instead to use part of that capital to deal in long term bonds. I can then go to the long term bond market and ask if anyone wants these at a price I can profit from. I then issue long term bonds if that is more profitable than issuing money.

This means that if there is a demand to hold money then the bank will respond by issuing more. It will respond this way because it will see a fall in the demand for long term bonds.

However, as you point out it will not necessarily place that new money into the hands of those demanding it. That does happen directly when the bank makes a loan to someone who holds money. It doesn't happen directly though when I the bank manager use one of my notes to pay for my car to be repaired.

The question is though: is this really troublesome?

Does one particular market see more demand and then that has a knock-on effect elsewhere? Is there are Cantillon effect? I can't see one.

A bank that sells and buys bonds engages in financial intermediation; this activity has no incidence on the quantity of money and thus generates no injection effect in my opinion. However Walter Block et al. have written a paper for the Journal of Business Ethics - which I haven´t read yet - in which they contest this conclusion in the hypothesis of a maturity mismatch. This paper has been criticized by others. This idea - of a maturity mismatch creating trouble - is also present in some of the post-Keynesian literature.

Lvdh,

In this instance, my comment was directed at you. However, I still don't see the point about anonymous postings in intellectual affairs. I just don't get it at all.

On your last comment -- isn't this the issue of endogenous money supply?

Finally, I always thought one of Selgin's strongest arguments for competitive money supply was that the decentralized market actors (banks in this instance) would be better able to match money supply and demand than any monopoly provider could. Is that argument captured in your earlier comment about competitive versus monopolistic provider? If so, then didn't Selgin (and White) already make the argument you are making?

BTW, I am still not quite sure about your point about methodological individualism. When economists say markets have a tendency to clear because errors will be detected and corrected, they do not assert that it will be the same individuals that detect and correct errors, only that individuals within the economic system will do so. That claim about the entrepreneurial discovery process is not a violation of methodological individualism.

Ludvig I don't see what the discussion about maturity mismatch has to do with your post above.

You say above: "Now for a methodological individualist it is certainly confusing to be confronted with the claim that the banks accommodate the increased demand for money of A, B and C, by putting money in the hands of a different individuals, say x, y and z"

But, when an individual wants more money they go to the bank for a loan. The bank loans them the money. The bank *does* accommodate increased money demand of person A by satisfying it.

It is only when the bank uses its own notes to pay its own bills - such as interest payments. In that case the demand may be satisfied indirectly. What is the problem here though?

Peter Boettke....

Certainly there is some silliness and ignorance by some posters in the various discussions here and on the mises site. However, most of the discussion is really quite good.

Most of the discussion centres on the first principles, the basis for which further work is done. I don't think there is much of a problem with amateurs discussing this. It isn't particularly difficult.

Pete,
If that is the comment you have to direct at me the arrogant piece of sh´t is you not me. -:) The fact that, contrary to many academics, I have done some work in the real world, also in law and finance, gives me a different perspective on some of these issues, and although I have never been particularly infatuated with that, I do consider it as an advantage.
I never said no argument can be made for free banking, nor did I say that George is not a good economist.
I did say that in my opinion he did not make the most effective argument for free banking and part of that has to do with semantics.
There is not only flagrant error on the one hand and apodictic truth on the other; there is also the grey zone in between concerning issues where individuals can legitimately have a different opinion. Semantics probably belongs in that grey zone.


Current, you wrote:
"But, when an individual wants more money they go to the bank for a loan. The bank loans them the money. The bank *does* accommodate increased money demand of person A by satisfying it."

No, no, this is not what the free bankers have in mind when they prone the fact that under free banking the money supply is "demand-elastic". This latter fact has a very specific technical sense in their construction. What they mean is that, in terms of the quantity equation, a change in V will be offset by a change in M, so as to keep MV constant. This is the hypothesis I had in mind. They are not simply talking about making loans etc. Macroeconomically this may be OK; perhaps FRFB would function that way. But microeconomically this cannot be the last word about the issue.

Lvdh,

Sorry, the NOT in my first sentence was omitted.

So my comment rather than easing the situation let to problems.

I apologize.

Pete

LVDH - now I see what you mean.

It is a long stretch from what I'm talking about to a definitive statement about how the variables of the money quantity equation will behave.

I don't fully understand how free bankers handle this so I won't comment on it.

Pete wrote: "BTW, I am still not quite sure about your point about methodological individualism. When economists say markets have a tendency to clear because errors will be detected and corrected, they do not assert that it will be the same individuals that detect and correct errors, only that individuals within the economic system will do so. That claim about the entrepreneurial discovery process is not a violation of methodological individualism."

I see what you mean. I would say there is divergence from methodological individualism as soon as the macroeconomist analyses the behavior of the system using a conceptual structure different from the one implicit in the perception of the actual participants.

For instance, free bankers maintain that the simple fact of increasing money holdings is an act of supplying (lending) money to the bank whose liabilities are held. This is the macroeconomist´s interpretation. I would say it still depends, among others, upon what the legal system says about this, and of course also upon the perception of the participants.
Also I doubt there is an inevitable, automatic connection between an increase of the demand to hold bank money and the bank´s subsequent increasing its circulation. The bank takes an autonomous decision when it increases its circulation. That it is desirable for the system to implement a productivity norm is again something in the eye of the macroeconomist, not something in the eye of the actual participants. The argument is based on the hypothesized maximizing behavior of the banks, and it is remarkable that Austrians who reject this kind of reasoning in other contexts, accept it here.
It has also been contested that an increase in the demand to hold bank money actually lowers the market rate of interest below the natural rate etc.

Sorry, I meant "increases the market rate of interest"...

Sorry, I meant "increases the market rate of interest"...

Ludwig,

Why is it so hard to conceive of the productivity norm as an emergent outcome of the profit-seeking behavior of banks under free banking? The productivity norm does not need to be "implemented" (your word). Rather the gradual reduction in prices is an emergent outcome of the ability of free banking to quickly correct deviations from monetary equilibrium.

It seems to me this IS methodological individualism as Mises, Hayek, and others understood it. Am I missing something?

It is true that if one is providing guidance to a *central bank*, one might encourage them to "implement" a nominal GDP target as a way to approach the productivity norm, but that "implementation" is an artifact of central banking, not an inherent element of the norm.

As regards the interest rate it would seem that according to the free bankers an increase in the demand for money actually lowers the natural rate. But the net effect is the same. The subsequent expansion is thought to eliminate again the gap between natural and market rate.
Is that OK?

As regards the PN it is as such not hard to conceive (economics is really easy). The question is whether it would indeed accomplish what it is thought to accomplish.

There are several problems:

(1) The banks cannot "quickly correct deviations from monetary equilibrium" in a neutral manner. If changes in money demand are non-neutral, then the "offsetting" actions of the banks are necessarily non-neutral too.

(2) The PN is thought to prevent depressions such as occurred historically under central banking. However in historical depressions the problem was not a change in V, but a simultaneous change in M and V, with the change in M probably the determining causal factor. (I would follow the Monetarists here.) So some category mistake seems to be taking place here. In order to make the argument tight one would have to look for possible scenarios under free banking characterized by a change in M, such as the possibility of a redemption run. This may be an improbable scenario but it means the argument is not tight.

I am planning a paper about this topic, in which I will examine this problem starting from Hayek and the Dutch Monetarists. I will keep you posted.

For what it is worth, to be a "free banker" is to take a policy position. It involves applying general free market principles to money and banking. Methological individualism is a way of understanding human action. It is impossible for there to be an inconsistency between methodological indvidualism and being a "free banker."

Now, it could be that "free bankers" claim that free banking doesn't create injection effects and that this claim can be shown to be false if a more careful methodological individualism is used.

I am skeptical about injection effects causing any problem, so that the people accumulating money by spending less are different from the people receiving new money and spending more is not a problem. In my view, if you think about any number of money independent saving and investmnet decisions, similar "injection" effects occur.

I suppose I need to read this paper about maturity mismatch. I have thought about the matter a good bit, and I guess I shouldn't be too surprising that Block takes the anti-market logic that is 100% reserve banking another step further to see problems with other financial transactions.

P.S. Current, no... the demand for money is a demand to hold money. Borrowers generally borrow in order to spend. The "demand for money" as used by just about everyone other than monetary economists is a demand for credit or loanable funds. Monetary economists use the term, "demand for money" to refer to the amount of money people want to hold rather than spend.

Pete,
I agree with Current that the comments and discussions on this blog are generally informative and interesting. Sorry for the misunderstanding, if any.

Current -- about maturity mismatch: the average term to maturity of the (non-equity) items on the liabilities side of the banks´ balance sheet is shorter than the average term to maturity of the items on the assets side. Stated as a truism, banks have liquid liabilities and illiquid assets, or they borrow short and lend long.

Ludvig, I understand that aspect of bank finances. What I don't understand is why you are bringing it up. How does it relate to your points about MV=PQ?

Bill Woolsey: "For what it is worth, to be a "free banker" is to take a policy position. It involves applying general free market principles to money and banking. Methological individualism is a way of understanding human action. It is impossible for there to be an inconsistency between methodological indvidualism and being a "free banker." "

If the argument is that money markets are like other markets then you are right. However, that isn't exactly the argument that Selgin and White use. The argument is much more complicated.

Bill Woolsey: "Current, no... the demand for money is a demand to hold money. Borrowers generally borrow in order to spend. The "demand for money" as used by just about everyone other than monetary economists is a demand for credit or loanable funds. Monetary economists use the term, "demand for money" to refer to the amount of money people want to hold rather than spend."

I see what you mean.

If a person takes out a loan there are two possibilities. That person may demand money in order to hold it or to spend it, or a mixture of both. Subsequent to that if more people who receive the money later decide to hang onto it there will be positive clearings.

Current:
I didn´t bring it up in connection with MV=PQ but in connection with injection effects.
The liquid liabilities-illiquid assets aspect is of course also part of the problem 100 per cent reserves advocates identify with respect to fractional-reserve free banking. Try to visualize the balance sheet, OK? Now 100 per cent reserve advocates have always maintained that it is sufficient to impose 100 percent reserves, so as to exclude ex nihilo money creation by the fractional reserve free banks. Some authors now apparently want to go further by also excluding any maturity mismatch in cases where there is no money creation.
See the following papers, both in the Journal of Business Ethics:

- Barnett, W. and W. Block (2008) "Time Deposits, dimensions and fraud,"

- Bagus, P. and D. Howden (2008 or9) "The Legitimacy of Loan Maturity Mismatching: A Risky, but not Fraudulent Undertaking".

I don´t believe the argument of the free bankers is that complicated, there is quite some mystification about it, and they never answer criticisms, so one sometimes wonders whether they really understand it quite well themselves.

Woolsey wrote: "I am skeptical about injection effects causing any problem, so that the people accumulating money by spending less are different from the people receiving new money and spending more is not a problem. In my view, if you think about any number of money independent saving and investmnet decisions, similar "injection" effects occur."

But my point was precisely that the fact of "people accumulating money by spending less" poses no problem. I am not saying this occurrence is neutral in its effects; I am saying there is nothing to be "offset" or "neutralized".

It is the free bankers who believe that such an occurrence is to be "neutralized", "offset" etc. by a monetary expansion.

If one says that the money supply under free banking is "demand-elastic" this is also misleading, since this somehow presupposes there is a pre-existing demand that must be satisfied by providing additional supply. There is no demand to be satisfied; the market participants who refrained from spending have satisfied their own demand for money.

The point of drawing attention to the fact that the people spending less are different from the market participants receiving new money, was intended (1) to highlight the fact that even if we assume, for the sake of the argument, that anything is to be "offset", this cannot be done in a neutral way and (2) the whole theoretical contruction serves as a "rationalization" of the simple practice of what Austrian economists describe as credit expansion. In fact there is no rational economic link between the bank seeing its reserve position improve and its subsequently raising its circulation. It can now afford additional credit expansion and this is what it does.


Someone else pointed me to P. Bagus' "Deflation: When Austrians become Interventionists". I'll read these things when I get around to it.

These discussions have certainly lengthened my "to read" list. Are your papers available in English?

LVDH:

Is credit creation a bad that needs to be rationalized?

It seems to me that the secondary effects of an increase in money demand matched by an increase in money supply is exactly the same as an increase in the demand for bonds matched by an increase in the supply of bonds.

Smith goes out to east less and accumulates banknotes. Some bank issues new banknotes and lends them to ATT.

The second order effects are that the restaurant Smith patronizes has less revenue and less banknotes. When ATT purchases fiber optic cable, the manufacurer has more revenue and more banknotes.

Now, suppose instead that Smith goes out to eat less and uses the proceeds to buy corporate bonds from ATT.

The seconary effect is that the restaurant where Smith usually goes has less revenue and less banknotes. ATT purchases fiber optic cable from the Manufacturer who now has more revenue and more banknotes.

Now, the puzzle is how does Smith's failure to spend banknotes and accumulate them because he wants to hold them provide a signal to the bank to issue the proper amount of banknotes and lend them to ATT.

I think interbank clearings work more or less perfectly in limiting each bank to its share of money demand. Selgin, of course, argues that an excess demand for bank notes will result in lower nominal expenditure, a lower variance of gross clearings, a lower optimal demand for reserves, excess reserves, and so increased lending. That, of course, is the challenging part of the argument. (Not in terms of understanding how it is supposed to work, but how well it works in practice.)

As for "injection effects" I don't think anyone is claiming that an increase in the quantity of banknotes that matches an increase in the demand to hold them will have the same impact on the allocation of resources as each person shorted by lower spending cutting spending in turn until prices and wages fall enough so that the real supply of banknotes increases to meet the supply, and someone or other responds to the increase in their real holdings of banknotes by spending them on something or other.

You wrote: "It seems to me that the secondary effects of an increase in money demand matched by an increase in money supply is exactly the same as an increase in the demand for bonds matched by an increase in the supply of bonds."

It is indeed on this point that Selgin and his followers differ in opinion from their critics.

According to the critics, the act (of some market participant) of increasing his/her demand to hold money does not, in and of itself, justify the act of "lending money into existence".

Besides the fact that in the particular institutional context at hand the law apparently allows the banks to generate all the credit expansion they can get away with, THERE IS SIMPLY NO LOGICAL OR RATIONAL CONNECTION BETWEEN THE TWO ACTS.

In the second scenario there is such a logical or rational connection: Smith, in managing his own property, has changed his priorities.

Moreover according to the critics, the scenario involving the ex nihilo creation of money, will always generate both redistributive and discoordinating effects. The particular injection effect can also be detailed more specifically: market interest rates are bid down. So the willingness on the part of ATT to accept additional credit by issuing bonds, is induced by the initiative of the bank, and as such it is not related to Smith´s original act of reducing spending.

Perhaps the free bankers are under the spell of Keynes´ dictum that unless an act of saving can be counted upon to end up as an act of investment etc... Is it conceivable that HHH had it right after all?

In any case, as it seems to me, messing with the quantity of money is not something to be taken lightly.


"in the particular institutional context at hand the law apparently allows the banks to generate all the credit expansion they can get away with"

"Smith, in managing his own property, has changed his priorities."

I sense some question begging.

Yes, this is of course obviously true. Both positions start from "first princples" that to the other side of the debate will (and must) appear as "question-begging". I cannot see how it could ever be otherwise. But philosophically, the criterion is ultimately one of conceptual and theoretical coherence: How do particular concepts and theses fit into the entire system of economic knowledge? One can think of the Mises-Rothbard-Hoppe position what one wants - dogmatic, simplistic, impractical, politically naïve, unfashionable etc. -- probably all true to some extent - it is a coherent system.
Selgin´s construction is undoubtedly sophisticated - impressive, really! - but I doubt it will ever be recognized as a viable alternative to Mises, Rothbard etc. precisely for this reason.
And then, the "I am fighting bad economics, bad law and bad history" thesis is also a bit naïve.

Bill Woolsey wrote: "It seems to me that the secondary effects of an increase in money demand matched by an increase in money supply is exactly the same as an increase in the demand for bonds matched by an increase in the supply of bonds."

I can see the point here. The other side of the debate considers the ex nihilo creation of purchasing power of paramount importance when assessing the relative merits of money supply systems. This may probably be related either to their interpretation of Say´s Law, or to underlying ethical considerations.

Bill,

Note that you should carry the thought experiment further into third-, fourth-order effects etc. The day after Smith can change his mind again and spend his accumulated money balance. The logic of the theory says that the banks must now contract credit again.

The production of fiber optic cable, however, is a stage of production in a composite production process that takes time to complete, and that requires an extended forthcoming flow of credit for its completion. Roundabout, time-consuming production processes require commensurate savings commitments sufficient to complete them. Decisions about spending or not spending can be reversed daily or even continually...

Do you sense the problem I am getting at or do you see no problem at all?

Current, you wrote: "Ludwig, I understand that aspect of bank finances. What I don't understand is why you are bringing it up. How does it relate to your points about MV=PQ?"

After reading my previous post it should be clear how the maturity mismatch problem can be related to MV=PQ. In particular it should now be clear why the productivity norm (=stabilizing MV) does not yet mean macroeconomic stability. OK?

We can now also answer more exactly Steve Horwitz´ question why it is so difficult to conceive of the productivity norm as an emergent outcome of the maximizing behavior of the banks under free banking. The point is that even if this would be true - namely that free banking would tend to lead to the "implementation" (so to speak) of the productivity norm - it is not correct that this would indeed also guarantee macroeconomic stability.
In a nutshell this can now be explained as follows, and it has everything to do with the maturity mismatch problem and fractional-reserve banking.
Concentrate on the left-hand side in MV=PQ.
Fluctuations in V reflect mainly decisions about changes in spending patterns (decisions to spend or not to spend by market participants holding bank-issued money). Via a transmission mechanism involving the interbank clearing process, this leads to offsetting changes in M (supposedly so as to keep MV constant) via changes in the lending patterns by banks (the granting of loans by banks). These loans will often serve to buy investment goods in the context of composite (roundabout) production processes that require time to be completed, and that require an extended forthcoming flow of credit. They cannot easily be reversed without causing substantive economic losses. The spending decisions to the contrary can easily be reversed (daily or even continually) and they affect the behavior of the quantity of money in opposite direction, that is, in case of a diminution of spending, the quantity of money is expanded, and in case of an incease of spending, it is contracted.
Free banking would thus actually worsen the erratic, volatile behavior of the quantity of money which is so conducive to crises and macroeconomic instability.

I think I see your point Ludvig, I'll read your papers when I get around to it.

Ludwig's description of the short-term nature of changes in money demand and the challenge of matching that to longer-term investment decisions is accurate in principle.

Three points:

1. In practice, velocity tends to be fairly stable, certainly in the absence of bad policy anyway. We see secular changes, yes, but those are in a long enough run not to be the problem he points to above. Except in extraordinary times, short-run changes in velocity/MD are not so volatile to be a big problem in the way he's noting.

2. The challenge of maturity matching is one that bankers must face as entrepreneurs. If they over-react to temporary changes in money demand, the loans they make will eventually go bad, so they have reason to be careful. It's interesting that someone with Austrian sympathies would seem to forget the role that entrepreneurial judgment and experience might play here. Banks are not black boxes - they are run by people with deep contextual knowledge and strong incentives that would lead them not to over-react to short-run changes without a damn good reason.

3. No one has ever argued free banking will be perfect. It doesn't find monetary equilibrium and stay there forever. The argument is that this set of institutions will better correct errors and minimize systemic disturbances. It's a comparative institutions argument. Someone is going to have to show me how another set of monetary institutions would do the job better.

Imperfections of free banking are not ipso facto cases for alternatives anymore than market failure is an ipso facto case for government intervention.

Ludwig Van den Hauwe has made many provocative statements in the course of his interesting contributions to this discussion. I want to comment on eight of them. I apologize for the length of this entry, but I’m a latecomer to this discussion.

1) LVDH’s statements about the inconsistency of free banking theory with methodological individualism reflect an idiosyncratic view of MI. He writes: “I would say there is divergence from methodological individualism as soon as the macroeconomist analyses the behavior of the system using a conceptual structure different from the one implicit in the perception of the actual participants.” On its face at least, this statement seems to deny that monetary theory consistent with MI can go beyond the individual-choice level of analysis to discuss overall patterns at the market-wide or economy-wide level of analysis that are not apparent to market participants. In the standard view, MI means that the economist must begin at the individual level, but not that he must also stop there. (Indeed, only by providing an overall viewpoint does the economist have much to contribute!) MI thus does not limit the economist to seeing things only as market participants see them. Recommending reading: Leland Yeager, “Individual and Overall Viewpoints in Monetary Theory,” reprinted in the Yeager collection The Fluttering Veil, edited by George Selgin.

If I am misreading LVdH’s statement, if some patterns at the market level of analysis can be “implicit in the perception of the actual participants,” it remains to be explained why the patterns proposed by free-banking theory do not meet this test.

2) LVDH: “Now for a methodological individualist it is certainly confusing to be confronted with the claim that the banks accommodate the increased demand for money of A, B and C, by putting money in the hands of a different individuals, say x, y and z. … [W]hat is actually signaled by positive clearings is an increased _and satisfied_ demand for money. Somewhere in the economy some individuals have satisfied their increased demand to hold by changing their spending patterns.”

Suppose that A, B, and C increase their demand to hold banknotes, and satisfy their increased demands by selling goods to x, y, and z in exchange for banknotes that A, B, and C subsequently hold in their wallets. The demands of A, B, and C are now satisfied, but the story of market adjustment is not yet done. Under the ceteris paribus assumption, individuals x, y, and z have not reduced the average quantities of banknotes that they wish to hold on an ongoing basis, but their purchases have reduced their present inventories. They thus now have unsatisfied demands, and wish to rebuild their banknote inventories. (This is the “shock absorber” view of money-holding.) To restore market equilibrium either the overall nominal quantity of banknotes need to rise, or the price level needs to fall, to match the real quantity of banknotes held to the higher real quantity now demanded. The accommodation in question takes place at the market level.

Here’s an analogy. Individuals A, B, and C increase their demands to own automobiles. Automobile dealers x, y, and z satisfy them by selling cars out of inventory. But if the dealers’ desired inventories haven’t changed, new cars need to be produced (or the price of cars needs to rise) to restore market equilibrium. This despite the fact that the new cars need not be sold to A, B, and C.

3) LVDH: “Also I doubt there is an inevitable, automatic connection between an increase of the demand to hold bank money and the bank´s subsequent increasing its circulation. The bank takes an autonomous decision when it increases its circulation.”

The theory of profit-maximizing reserve-holding, as spelled out by Selgin among others, establishes an “automatic” connection. LVDH apparently rejects this theory, writing: “The argument is based on the hypothesized maximizing behavior of the banks, and it is remarkable that Austrians who reject this kind of reasoning in other contexts, accept it here.” Who are the Austrians who reject this kind of reasoning in other contexts but accept it here? Selgin and I do not generally reject reasoning based on maximizing behavior in other contexts, though of course Kirzner’s theory of entrepreneurship tells us that maximizing isn’t alone sufficient for explaining economic processes.

4) LVDH: “As regards the interest rate it would seem that according to the free bankers an increase in the demand for money actually lowers the natural rate. … The subsequent expansion is thought to eliminate again the gap between natural and market rate.”

Yes, if we are more precise. An increase in the demand to hold bank-issued money (notes or deposits), if it comes at the expense of consumption, corresponds to an increase in the supply of loanable funds that lowers the natural rate. This should be uncontroversial with respect to an increased willingness to save via time deposits.

5) LVDH: “I don´t believe the argument of the free bankers is that complicated, there is quite some mystification about it, and they never answer criticisms, so one sometimes wonders whether they really understand it quite well themselves.”

Surely “they never answer criticisms” is not to be taken literally. As LVDH knows, George Selgin, Steve Horwitz, and I, plus others, have been answer criticisms by the dozen over at the Mises blog. Perhaps LVDH means that we have not answered certain of his criticisms sufficiently to satisfy him.

Any “mystification” of our views is unintentional. Clarity and simplicity of explanation are not always attained even though aimed at.

6) LVDH: “According to the critics, the act (of some market participant) of increasing his/her demand to hold money does not, in and of itself, justify the act of ‘lending money into existence’.”

Justify in a normative sense? If so, why is additional normative justification needed for bank expansion when it coerces no-one? Or does this mean justify in the sense of making it economically profitable? That justification is explained by the theory of profit-maximizing reserve-holding already mentioned.

LVDH continues: “Besides the fact that in the particular institutional context at hand the law apparently allows the banks to generate all the credit expansion they can get away with, THERE IS SIMPLY NO LOGICAL OR RATIONAL CONNECTION BETWEEN THE TWO ACTS.”

Under the common law financial firms can indeed intermediate as far as they “can get away with,” i.e. in whatever volumes they can manage while fulfilling their contracts. But there is in fact a logical and rational connection between the two acts, again as provided by the theory of reserve-holding.

7) LVDH: “One can think of the Mises-Rothbard-Hoppe position what one wants - dogmatic, simplistic, impractical, politically naïve, unfashionable etc. -- probably all true to some extent - it is a coherent system."

I wouldn't call it a Mises-Rothbard-Hoppe position. Mises supported free banking and fractional reserves. The Rothbard-Hoppe position opposes fractional-reserve free banking. A monetary system that voluntarily uses only gold coins and gold-coin warehouse accounts is unquestionably coherent in the sense that its self-regulation is easily understood. What is not so coherent are arguments claiming that money-users are better served by such a system than by a system making use of fiduciary media even if they prefer the latter, and that they should be forcibly prevented from using fiduciary media.

8) LVDH: “Fluctuations in V reflect mainly decisions about changes in spending patterns (decisions to spend or not to spend by market participants holding bank-issued money). Via a transmission mechanism involving the interbank clearing process, this leads to offsetting changes in M (supposedly so as to keep MV constant) via changes in the lending patterns by banks (the granting of loans by banks).”

I would say, via expansion of bank liabilities per dollar of reserves.

LVDH continues: “The spending decisions … can easily be reversed (daily or even continually) and they affect the behavior of the quantity of money in opposite direction, that is, in case of a diminution of spending, the quantity of money is expanded, and in case of an incease of spending, it is contracted.

Free banking would thus actually worsen the erratic, volatile behavior of the quantity of money which is so conducive to crises and macroeconomic instability.”

On the view that what matters for crises and macroeconomic instability is the behavior of MV and not of M alone, stabilizing MV through variations in M dampens and does not worsen macroeconomic problems. M variation is not “erratic” insofar as it serves to offset V variation.

LDVG:

Because the second order effects are the same, so are the third, fourth and so on.

I understand exactly the problem you are getting at. What I can't understand is how you think this has anything to do with money creation per se.

People can always change their mind about saving. What happens if they decide to save less? We need consumer goods now. But if resources are tied up in long term investment projects, there will be losses.

The notion that individuals must commit for the period of time it will take to finance the project is a mistake. For example, suppose that some project will take 10 years to mature. I can save one year. Then another person can save the next year. Then another person the next year, up until 10 years. I give up consumer goods this year and the resources are used for the project. The next year, someone else gives up the consumer goods and that frees up resources to continue the project, and so on.

The notion that we can only do the project if one individual will wait 10 years is..wrong.

In reality, we can arrange matters in ways that different people take the risk that saving will decrease, just as the risk can be shifted regarding whether or not the project will actually produce something of enough value to cover its opportunity cost.

For example, maybe the firm sells a 10 year bond to fund the activity. The saver who buys the bond doesn't have to wait 10 years. But if he changes his mind and doesn't want to wait 10 years, (or never planned on that anyway,) and there is no one else who wants to buy it, then the loss is suffered by that saver who bought the bond. He can only sell it at a loss.

But if ATT funds the 10 year project with 1 year loans, then it is ATT that takes the loss out of its capital. IF it has to pay higher interest rates to complete the poject, then it makes less profit. If this is loss and greater than its captial and it fails, then part of the loss goes to the savers who bought the bonds.

If it is a bank that buys 10 year bonds and sells 1 year CDs then it is the bank's capital that is at risk. If the savers change their minds, then the bank takes the loss. But if it is so bad that the bank runs out of capital, then the savers take the loss too.

There is nothing different about using banknotes to fund the bank.

Saving can change. Someone takes a loss. Financial contracts shift the risk.

It is not whether each project be funded by a saver that is committed to waiting until that specific project is complete--it is whether or not there are sufficient savings by everyone to free up enough resources to complete this and the other projects. Because this is the future, there is no certainty that this will occur. There is risk. And the only question is who bears the risk.

Block appears to have made the connection that these arguments that fractional reserve banking creates malinvestment to the notion that any maturity mismatch in finance creates malinvestment. If there is no distinction to be made, then this approaches Keynes' notion that investors should not be able to sell their stock. Yes.. it would make things more stable.


Bill,

OK, in your previous thought experiment there was only one "saver" so it appeared as if I was making the argument that the one saver has to be willing to wait until the project is completed.

But in fact I was not making that argument. If there are many "savers", we can still imagine that _in the aggregate_ there is no sufficient aggregate willingness to forgo consumption for a sufficiently long period.

Imagine that in a closed economy with a large number of savers, we construct a consolidated balance sheet of all the financial intermediaries. Then it may well appear that this consolidated aggregate balance sheet presents a maturity mismatch in the sense that the average term to maturity of assets is longer than the average term to maturity of liabilities. So in the aggregate there is malinvestment going on in this economy. I don´t directly remember any empirical research along these lines but it is quite conceivable that in the aggregate banks (or, more generally, financial intermediaries) borrow short and lend long. In fact I am almost sure that this is actually the case.

And note that you are yourself describing the beginning of a business cycle scenario:

"For example, maybe the firm sells a 10 year bond to fund the activity. The saver who buys the bond doesn't have to wait 10 years. But if he changes his mind and doesn't want to wait 10 years, (or never planned on that anyway,) and there is no one else who wants to buy it, then the loss is suffered by that saver who bought the bond. He can only sell it at a loss."

So I would say that, in general, your account confirms my point.

Bill,

In your previous thought experiment there was only one "saver" so it seemed as if I was making the point that this "saver" must be willing to wait sufficiently long. However, I was not making that argument.

In an extended thought experiment with many savers we can imagine that we construct a consolidated, aggregate balance sheet of all banks (financial intermediaries) and that that consolidated balance sheet presents a maturity mismatch, which means that _in the aggregate_ there is malinvestment going on in this economy, that is, in the aggegate, the collective willingness to postpone consumption for a sufficiently long time is absent. This appears from the fact that in the consolidated balance sheet the average term to maturity of assets is longer than the average term to maturity of liabilities.

Actually I guess that this situation by and large corresponds to reality since the "liquid liabilities-illiquid assets" phenomenon is rather widespread.

Moreover note that you are yourself providing what is essentially (part of) a business cycle scenario where you write:

"For example, maybe the firm sells a 10 year bond to fund the activity. The saver who buys the bond doesn't have to wait 10 years. But if he changes his mind and doesn't want to wait 10 years, (or never planned on that anyway,) and there is no one else who wants to buy it, then the loss is suffered by that saver who bought the bond. He can only sell it at a loss."

So I would say that, in general, your remarks confim my point.

I think you misunderstand the Austrian point about malinvestment and the cycle if you think Bill's argument helps you.

If I buy a ten year bond and then decide to sell it after two, but can't find a buyer right away and can only sell at a dramatically reduced price, the loss is indeed mine. But such scenarios are inherent in the uncertainty of the future and the exercise of entrepreneurship in any action in the face of such uncertainty. Consider the opposite scenario where lots of buyers want the bond and bid up the price. Is that now malinvestment as well?

And if so, why would we expect, *if not due to monetary disequilibrium caused by a central bank*, for those errors to happen systematically in any direction? Maturity mismatch itself isn't the problem. Systematic mismatches between saving and investment are, but those must be caused by bad interest rate signals, in turn caused by monetary disequilibria.

Am I wrong in thinking that your view suggests that any movement in bond prices over the course of a bond's lifetime constitutes evidence of "malinvestment?"

I was not saying that any movement in bond prices signals malinvestment, but, conversely, that malinvestment adversely affects bond prices. "Malinvestment" was part of the antecedent, not of the consequent in my argument.
My argument is independent of Bill´s remarks. The thought experiment with the consolidated balance sheet was already described in my Ph.D. thesis (Paris 2005). I merely meant to say that his remarks have no force against my argument.

Larry,

Thanks for your remarks. I will not respond point for point. Only this:

- Mises was indeed a fractional-reserve free banker but I believe he would not have agreed with all of Selgin´s claims.

- I remain convinced that stabilizing MV is not equivalent to stabilizing the economy, for the reasons explained. Note that M also means _credit_, a change in M means the injection or withdrawal of money _in the form of credit to business_. Such decisions must be related to savings decisions, not (or not merely) to spending decisions. But I am sensitive to the point that the argument has only force when considered in the aggregate.

- I never expect anyone in particular to comment on my views. However, anyone is welcome and free to do so. Sincerely,

Steve wrote: "In practice, velocity tends to be fairly stable, certainly in the absence of bad policy anyway. We see secular changes, yes, but those are in a long enough run not to be the problem he points to above. Except in extraordinary times, short-run changes in velocity/MD are not so volatile to be a big problem in the way he's noting."

This is correct historically. Still it is a historical point, not a strictly theoretical one. FRFB is not _proof_ against such scenarios even if these may be, in the light of historical experience, somewhat improbable. Note also that free bankers themselves are fond of describing such thought experiments, "Suppose a general increase in the demand for inside money is taking place etc."

But I agree that such historical considerations should not be excluded. Economics is not geometry after all and it should perhaps not be subjected to the rigorous standards of a geometrical, deductive argument...

But note that if historically it is changes in M rather than changes in V that have been most important in causing monetary disequilibria, this perhaps also provides a good argument in favour of 100 per cent reserve banking since here changes in M would be still more limited than under FRFB. Also the possibility of a contraction due to a redemption run would be inexistent.

Steve wrote: "And if so, why would we expect, *if not due to monetary disequilibrium caused by a central bank*, for those errors to happen systematically in any direction? Maturity mismatch itself isn't the problem. Systematic mismatches between saving and investment are, but those must be caused by bad interest rate signals, in turn caused by monetary disequilibria."

The profit motive impels banks to borrow short and lend long, but this may seem to beg the question.

It would be difficult to maintain in my opinion that the Austrian theory has _nothing_ at all to do with maturity mismatch, or that even if aggregate balance sheets may tell us something about maturity mismatch they thereby do not/cannot tell us anything about (the time profile of) saving and investment. I believe macroeconomists just don´t look enough at balance sheets... In fact one cannot be a good macroeconomist if one is not a good financial analyst to start with...

It would of course also depend upon other factors such as the liability/equity ratios in balance sheets. (These would indeed probably be lower under free banking.)

Further not everybody agrees that non-spending can be defined as saving, since as such it does not alter the consumption/investment ratio (time preferences), nor that increases in holding money will lower the natural interest rate. Clearly your position hinges crucially upon the latter assumption.

Steve wrote: "And if so, why would we expect, *if not due to monetary disequilibrium caused by a central bank*, for those errors to happen systematically in any direction? Maturity mismatch itself isn't the problem. Systematic mismatches between saving and investment are, but those must be caused by bad interest rate signals, in turn caused by monetary disequilibria."

The profit motive impels banks to borrow short and lend long, but this may seem to beg the question.

It would be difficult to maintain in my opinion that the Austrian theory has _nothing_ at all to do with maturity mismatch, or that even if aggregate balance sheets may tell us something about maturity mismatch they thereby do not/cannot tell us anything about (the time profile of) saving and investment. I believe macroeconomists just don´t look enough at balance sheets... In fact one cannot be a good macroeconomist if one is not a good financial analyst to start with...

It would of course also depend upon other factors such as the liability/equity ratios in balance sheets. (These would indeed probably be lower under free banking.)

Further not everybody agrees that non-spending can be defined as saving, since as such it does not alter the consumption/investment ratio (time preferences), nor that increases in holding money will lower the natural interest rate. Clearly your position hinges crucially upon the latter assumption.

Bill

I possibly misread your exemple yesterday night, or else Steve misread my comment. I certainly did not intend to say that every and any maturity mismatch is problematic, although some economists do believe so. Steve is also right that under a decentralized system there are in general less reasons to expect systematic errors in a particular direction.

Actually in my opinion the decrease in spending (increase in money demand) need not and will not create any problem at all. The subsequent expansion may do so.

In general I believe Mises´ position was a reasonable one. Fractional reserves, 100 per cent reserves, it doesn´t make that much of a difference.

As a last remark - after that I must go back to work - I still add that unfortunately it is not always clear, when individuals make claims about the working charcteristics of free banking, whether these claims refer to the _logical (im)possibility_ of certain scenarios, or merely to their _more or less (im)probable character_. All of my tentative suggestions above refer merely to _the logical possibility_ of certain scenarios; I was not claiming that they would also be normal, ususal or highly probable. I hope this clarifies.

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