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Pete:

For what it is worth, Sumner (rather than Cowen) actually advocates a stable growth path of nominal GDP. Specifically, he adovcates that nominal expenditure remain on a 5% growth path. For sumner, what this implies regarding CPI inflation is secondary. On the other hand, because the difference between inflation indexed bonds and other bonds suggest a market expecation of inflation, and Sumner interprets it as suggesting that nominal income will not be on the desirable 5% growth path, I guess it should not be a surprise the Cowen interprets this as advocating inflation. Further, Sumner has stated from time to time that a 5% growth path for nominal income suggests a 2% inflation rate, and that he considers that a good thing because nominal wages are sticky in a downwards direction.

Still, Sumner advocates more rapid growth in nominal income, and and specifically, more inflation.

Right on!

What we now have are the Keynesian Austrians. In fact, Mario Rizzo even said as much, that if that made him, and Hayek, Keynesians, so be it. They even tried to drag Mises in on it, in their discussions at ThinkMarkets. I defended the real Mises, and real Austrian economics as long as I could, but they finally won the argument, by the time honored method of banishing the dissenter. Misesians like that must have Mises spinning in his grave. Thanks for upholding the real tradition.

Pete,

I should preface this by saying that I largely agree with the points that you raise here. However, I think that it might be good to frame the discussion in terms of an analysis that we are both familiar and comfortable with and then explain why I don't think monetary policy is as loose as you think.

In A Monetary History of the United States, Friedman and Schwartz (henceforth F&S) blame the Federal Reserve for failing to provide the base money necessary to prevent the collapse of broader money aggregates. As you well know, what they are essentially arguing is that the money multiplier is falling (the currency-deposit and reserve-deposit ratios were rising). In my mind, it should be the Federal Reserve's goal to maintain monetary equilibrium -- consistent with the work of Steve Horwitz, George Selgin, and Hayek himself. However, I think that looking at the monetary base or the interest rate is not sufficient to judge whether the Federal Reserve is achieving its goal. The reason that we have seen what you believe to be "loose" policy is because of a drastic decline in the money multiplier (just as described by F&S).

I recently wrote a post on my own site, in which I showed the the money multiplier has declined from 1.6 at the start of the recession to .97 approximately one month ago. This implies that the monetary base would have to grow by over 70% just to keep M1 constant. The link is here:

http://everydayecon.wordpress.com/2009/07/03/inflation-is-a-monetary-phenomenon-but-this-isnt-inflation/

Now, of course, I share your concern for inflation. I have discussed this with Steve Horwitz in the past and he emphasized that the problem occurs when this begins to unwind. Can the Fed pull the money out in time? He significantly doubts that they can. I have my doubts as well. However, I am not willing to allow the money supply to contract in the interim in the fear that we might conduct bad policy in the future as I believe that F&S have provided an excellent account of what happens when the Fed fails to act. There is a distinct difference between deflation caused by an excess demand for money and that caused by productivity growth (as Selgin has articulated).

I realize that there are a subset of Austrians who believe that we do nothing in response to a change in the demand for base money. I do not wish to re-hash that argument here. However, I would point out that the decline in the money multiplier itself has been caused by Fed policy more than an exogenous change in preferences. It was largely following Bernanke's testimony to Congress in September that the money multiplier started to collapse and, more specifically, after the Fed started paying interest on excess reserves in October. Look at the historic data on excess reserves and note the sharp increase after Oct. 2008:

http://everydayecon.wordpress.com/2009/07/14/graph-of-the-day/

Josh,

What you are expressing is the Keynesian bias for spending over saving, with but one minor difference. Whereas the pure Keynesians favor a direct, “fiscal” approach, with the “government” doing the spending, you Keynesian Austrians favor an indirect, “monetary” approach, with the “government” merely pumping up the money supply, in order to stimulate private spending. But spending, public or private, is not what is needed. Capital has been squandered on unproductive enterprises, and trying to keep them afloat is wasteful and futile. What is needed is not more “spending” on them but more saving and investment in new and more productive enterprises.

What is needed is to halt all intervention and let the market find its own way back.

"In my mind, it should be the Federal Reserve's goal to maintain monetary equilibrium -- consistent with the work of Steve Horwitz, George Selgin, and Hayek himself." - Josh

Interesting ...

Some Austrians believe the Federal Reserve should emulate what a free market would do in its absence, that is, calibrate the supply of money to changes in the demand for money. Of course, there is not a chance this will ever happen, because the Federal Reserve would cease to have any purpose. It would be like enforcing a price control that tries to match the price that would emerge in a free market, when the whole point of a price control is to prevent the free market price from emerging!

There are also some other important differences between inflation created by a central bank and inflation created by free banking. In a free banking system, banks that make bad bets and fail don't receive money from the Federal Reserve. New money is created by healthy banks, and therefore reinforces successful business practices. To emulate a free banking system, the Federal Reserve doesn't just need to get the supply of money right, but also direct it to the right businesses, sectors, and people. This is also why free banking inflation would not reinflate bubbles, because it is directed elsewhere.

DG Lesvic,

I am merely advocating the position articulated by Hayek. I am merely arguing that we offset changes in money demand with changes in the money supply.

To argue that we should do nothing in response to an excess demand for money requires: (1) that prices are perfectly flexible, and (2) that there is no transmission mechanism through which changes in the money supply have real effects. Multiple deposit destruction (where banks accumulate excess reserves), is contractionary in that it reduces bank lending. What's more, I think that Steve Horwitz has articulated on this very blog in the past why an excess demand for money is harmful and, as I said in my previous comment, I do not wish to re-hash this argument. It has divided Austrians for some time and I do not think that I would contribute anything new to the debate nor do I think that either one of us will be convinced that we are wrong.

Finally, I would argue that we are not seeing an increase in saving behavior. The money multiplier is falling because the central bank is paying banks to hold excess reserves. To what extent does this imply that savings is increasing?

Lee Kelly,

I am not defending the Federal Reserve system, I am merely operating within the social constructs and institutions that exist today.

Peter (& Josh),

You make great points. I agree with both of you. A little inflation would probably be a good sign, but not if it was forced prematurely. I'm worried about the day the Fed starts raising rates and the traders come crashing in to inflate the market.

DgLestivic

"They even tried to drag Mises in on it, in their discussions at ThinkMarkets. I defended the real Mises, and real Austrian economics as long as I could, but they finally won the argument, by the time honored method of banishing the dissenter. Misesians like that must have Mises spinning in his grave. Thanks for upholding the real tradition."

Dear friend, I am afraid you profoundly misunderstood the basic thrust of the people on this blog, if you believe that they cherish a different approach to Mises or Hayek than those on Think Market. At the contrary. Approaches are very, very similar.

Josh,
Hayek himself was not in the same column with Selgin and Horwitz in this regard, because Hayek was a "liquidationist" who believed that problem with Great Depression was not "monetary disequilibrium" and deflation, but credit inflation. He thought Depression was so severe because liquidation and recession were delayed by inflationary monetary policy for too long, and not because deflation was allowed. For Hayek, stabilization policy (avoiding deflation) either during the boom or during the bust is wrong policy. Liquidation/recession is both for Mises and Hayek and Rothbard healthy recovery from inflationary boom, if necessary with temporary decrease of general price level.

For Selgin and Horwitz that's not so simple. According to them, if recession is followed by deflation, they advocate monetary stimulus, little bit more inflation to avoid "over-correction" (just like Cowen). Technically, they describe condition for such a policy as unanticipated increase in demand for money (caused by "hoarding" of cash building"), that should be offset by increasing volume of bank credit. As Horwitz put this, people should be allowed to keep as much cash as they want "at the current price level". That clearly indicates that his monetary ideal, at least for recession, is stabilization. So, Selgin's and Horwitz's approach to recessions is much more similar to monetarist and Keynesian, than to orthodox Austrian one. Selgin himself concedes this in his book by saying that his approach should be acceptable for Keynesians if they don't consider liquidity preference as serious practical problem. Basically, if they believe that you can to jump start economy by pumping money in it (many Kaynesians don't believe that since assume that both people and banks would continue to hoard cash instead to spend out of irrational fear and uncertainty), they are in the same column with free banking theory, at least in terms of how to cure recession.

Nikolaj writes: "Hayek himself was not in the same column with Selgin and Horwitz in this regard, because Hayek was a 'liquidationist'..."

This is simply not true. I will refer you to Larry White's recent work:

http://economics.sbs.ohio-state.edu/jmcb/jmcb/07056/07056.pdf

Josh,
Hayek was "liquidationist" whether you or White like it or not. In attempt to portray him as some kind of closet monetarist White, Selgin, Horwitz and others often cite following paragraph from Prices and production which superficially supports stabilization of MV as a policy prescription:

"But I think that what I have already said on this point will be sufficient to justify the conclusion that changes in the demand for money caused by changes in the proportion between the total flow of goods to that part of it which is effected by money, or, as we may tentatively call that proportion, of the co-efficient of money transactions, should be justified by changes in the volume of money if money is to remain neutral towards the price system and the structure of production"

But, they conveniently forget to cite the very next paragraph in the same chapter, from which we clearly see that Hayek saw MV stabilization just as theoretical possibility that never can be realized in practice:

"...in order to eliminate all monetary influences on the formation of prices and the structure of production, it would not be sufficient merely quantitatively to adapt the supply of money to these changes in demand, it would be necessary also to see that it came into the hands of those who actually require it, i.e., to that part of the system where that change in business organization or the habits of payment had taken place. It is conceivable that this could be managed in the case of an increase of demand. It is clear that it would be still more difficult in the case of a reduction. But quite apart from this particular difficulty which, from the point of view of pure theory, may not prove insuperable, it should be clear that only to satisfy the legitimate demand for money in this sense, and otherwise to leave the amount of the circulation unchanged, can never be a practical maxim of currency policy".

So, in order to avoid deflation and at the same time to keep money neutral towards prices and production it is by no means enough to "stabilize MV" as free bankers naively believe. You must adjust money supply both quantitatively and qualitatively, i.e. give it to those whose demand for it increased. Hayek clearly sees this task as impossible.

Listen to him:

"In theory it is at least possible that, during the acute stage of the crisis when the capitalistic structure of production tends to shrink more than will ultimately prove necessary, an expansion of producers’ credits might have a wholesome effect. But this could only be the case if the quantity were so regulated as exactly to compensate for the initial, excessive rise of the relative prices of consumers’ goods, and if arrangements could be made to withdraw the additional credits as these prices fall and the proportion between the supply of consumers’goods and the supply of intermediate products adapts itself to the proportion between the demand for these goods. And even these credits would do more harm than good if they made roundabout processes seem profitable which, even after the acute crisis had subsided, could not be kept up without the help of additional credits. Frankly, I do not see how the banks can ever be in a position to keep credit within these limits."

It seems like direct attack on White, Selgin and Horowitz and utter rejection of their idea of fine-tuning the credit supply to match the increase in demand for money.

In the preface for second edition of Prices and Production Hayek writes that aggregates and averages such as M or V cannot be used as a part of theoretical chain of argument whatsoever! Nothing to say about their "stabilization" as an analytical device.

So, Hayek was "liquidationist", and for a good reason.

Nik,

You wrote,

"you profoundly misunderstood the basic thrust of the people on this blog, if you believe that they cherish a different approach to Mises or Hayek than those on Think Market. At the contrary. Approaches are very, very similar."

If, by "people on this blog," you mean Peter Boettke, his approach seems to me to be completely at odds with that of Mario Rizzo and his friends at ThinkMarkets. And Boettle doesn't try to win his arguments by banishing his critics.

According to my interpretations, Rizzo was in favor of monetary tinkering and Boettke completely opposed to it. Boettke follows the thinking of Mises, that the recession is not a malady but a curative process, purging the system of bad investments, and should be allowed to run its course, to complete the cleansing, and enable the market to make a clean start.

What's wrong with that?

Nikolaj:

We can do this til we're blue in the face, but...

Hayek IS on "our" side in theory. There are other places White cites as well. Instead of just dismissing that paper, read it. Write a response, Submit it for publication somewhere. And he is *correct* that central banks in practice cannot maintain MV perfectly. I AGREE WITH THAT and have said so here and elsewhere.

The question is this: is it better for the central bank to try to target nominal GDP (PY) and thereby mimic what free banks would do, or is it better for central banks to not worry about changes in V? That is a judgment call. It is not a question of being "truly" Austrian.

Both Mises and Hayek argue in places that matching money supply to money demand is the ideal. Selgin, White, and I argue that a free banking system would achieve this best. We also argue that central banks should try to achieve that the best they can. We might be wrong about the latter. But in the world of the second best, we have to accept second best solutions.

The real solution is free banking, which *would* get the result that both Mises and Hayek have defended.

If you'd stop throwing epithets around (same goes for Lesvic) like "Keynesian" etc and actually read the literature and make arguments, this all might go better.

Lesvic:

You say that what is needed is not more spending, but rather more saving and investment.

Well, investment is spending by firms on capital goods.

If households want to spend less on consumer goods and firms want to spend more on capital goods, that is just fine by me, but that doesn't involve less spending. It is a change in the composition of spending. It is a change in the allocation of spending and the utilization of reousrces.

My view is that such reallocations are much likely to occur in a smooth fashion if total spending is maintained--less nominal consumption spending and more nominal investment spending.

If nominal spending does fall and prices and wages drop enough to maintain full employment, then real spending will not fall. It remains possible, of course, that real spending on consumer goods might fall and real spending on capital goods might rise.

The notion that this would be the effect of a secondary depression is doubtful. The Pigou effect suggests an expansion of real consumption and reduction of real saving. And the impact on real interest rates by undershooting the long run price level and generating expected inflation is almost by definition not smooth.

I don't deny that increased real balances might be used to buy capital goods, but the notion that this is a smooth and obvious process is a mistake.

Are you confusing what needs to happen with what a plausible market process will cause to happen?

Kelly:

You say that central bank policy is like price controls, and the entire point is to manipulate some price. Please explain exactly what you mean. I think there are plenty of macroeconomists, including many with positions at the Fed, who are seeking to avoid monetary disequilibrium. There has been a lot of work by neo-Keynesians that is neo-Wickellian. The Fed is supposed to be adjusting the target interest rates to the natural interest rate. And, of course, money supply rules, were never about _trying_ to manipulate the allocation of resources. And, frankly, I don't see how inflation targetting could possibly be described as trying to impact real interest rates and the allocation of resources either.

The Austrian critique of those policies is that the central bank will get it wrong and that it will distort the allocation of resources unintentionally.

Now, there was a time when there were all sorts of monetary cranks who believed that with the right kind of monetary instutions--ones that created more money--real interest rates could be permanently reduced, maybe even to zero, and the distribution of income between labor and capital could be justly shifted towards labor and away from capital. Keynes even said crazed things along those lines sometimes.

But which monetary economists are proposing that today?

Lesvic:

You say that there is no need for more spending, but rather more saving and investment. But investment is spending by firms on capital goods. So an increase in some sort of spending is needed.

A return of nominal expenditure to pre-depression levels is consistent with a decrease in consumption spending and an increase in investment spending.

And, for the economy to recover, real expenditure must increase to pre-depression levels. And, for saving and investment to increase, then real investment expenditures must increase.

The actual process by which a deflation of prices and nominal incomes results in an expansion in real expenditure seems unlikely to involve an increase in saving and investment. The more likely scenario, is the pigou effect, which is an increase in real consumption.

Dg Lesvic,

Mr Boettke's primary field of research in Austrian economics is not monetary economics, but methodology, application to transition economics and so on. But, Steve Horwitz is primarily macroeconomist, interested in Austrian credit cycle theory, and his position is,a s far as I can tell, very similar to Rizzo's.

Situation is little bit more complicated with the people at AE than you described it. Of course, Horwitz certainly would agree with the basic Austrian proposition that recession is a part of process of recovery. And also with the proposition that general decline in price level is consistent with free market as far as it is driven by increased productivity. But, at the same time, he is convinced that deflation caused by money hoarding or "increased demand" should be fought by means of monetary policy, i.e. credit expansion (even in central bank regime). I wrote in previous comments something about that. That is free banking position which other significant proponents, apart from Horwitz, are Selgin, White or Garrison, which combines Austrian with Keynesian arguments in monetary theory. Preventing deflation, theory that price and wage rigidities justify expansionary monetary policy during recession, the idea that during recession prices should be stabilized - all that are typical Keynesian or monetarist arguments. Their interpretation of Great Depression is basically monetarist-Friedmanite - Fed didn't inflate enough to prevent dangerous deflation (unlike Hayek and Mises who believed attempts to delay recession through large credit infusions were responsible for particular severity of Great Depression). Central argument of increased demand for money as justification for monetary expansion is at odds with basic framework of Austrian business cycle theory.

I don't want to say they are Keynesians, but only that they use very significant Keynesian arguments in their monetary theory, and that it's unjustified to sharply distinguish them from Rizzo. I am certain Horwitz and Boettke would agree with me on that point.

This is not an issue of deflation vs inflation, it is an issue of nominal GDP, as Bill Woolsey has said. The point is that current money supply is not sufficient to accommodate money demand. This is equivalent to a drop in the money supply, leading to lower expectations of future NGDP growth. I'm not sure what this has to do with inflation, as stable nominal spending (MV) will not lead to any inflation (in terms of the price level), as Selgin has pointed out. It will also not effect long-term interest rates, which are arguably more important when considering investment than short term rates.

By meeting money demand, an increase in the money supply will lead to an increase in expectations of future NGDP which will boost prices in industries not affected by stickiness. This will cause unused resources to flow into those sectors and therefore boost output and nominal spending today. This is why Sumner advocates an increase in the supply of money now, not because he is deathly afraid of all forms of deflation. In fact, he has said that in an ideal world a mild deflation due to productivity growth might be better than mild inflation.

I also don't see what this has to do with Keynes.

Jake,

There's no such thing as an insufficient supply of money. Since the given supply is infinitely divisible, any samount of it will be sufficient for all of its needs.

You wish to boost spending, output, and prices. But that is just more of the same old poison that sickened us in the first place. What we need is not more sickness but the cure, a halt to the misdirection and squandering of precious resources, and saving and investment in new, useful, and sustainable lines of production.

And, by the way, this is what it has to do with Keynes. What you and the Keynesian Austrians have been expressing was the Keynesian bias for spending over saving.

Let's talk about what I do and do not believe, shall we?

Nikolaj writes:

"Preventing deflation, "

I do wish to prevent deflations caused by excess demands for money, not by the revaluation of asset prices or by productivity increases.

"theory that price and wage rigidities justify expansionary monetary policy during recession"

Maybe, maybe not. Depends. Is the recession causing an excess demand for money? If so, yes. If not, no.

"the idea that during recession prices should be stabilized - all that are typical Keynesian or monetarist arguments."

I do NOT think prices should be stabilized during a recession. At least not as phrased. I believe excess demands for money should be offset with increases in the nominal supply. Recessions might be characterized by that problem, but they might not. Price stabilization is NOT, repeat NOT, the goal of MET or free banking. Price drops alone are not a reason to expand the money supply. How many damn times do I have to say this? (Including again here today at FEE!)

"Their interpretation of Great Depression is basically monetarist-Friedmanite - Fed didn't inflate enough to prevent dangerous deflation (unlike Hayek and Mises who believed attempts to delay recession through large credit infusions were responsible for particular severity of Great Depression)."

Why is this an "or"? My view of the Great Depression is this:

1. Inflation in the 20s caused a boom and bust
2. Fed errors allowed a deflation in the early 30s that magnified the depth of the bust
3. Hoover and FDR interventions prevented necessary readjustment and recovery, lengthening the bust.

I think the Austrians and the monetarists both have a piece of the story. Why must we choose?

"Central argument of increased demand for money as justification for monetary expansion is at odds with basic framework of Austrian business cycle theory."

No it is not. I've argued otherwise in print, as have others. Show me your argument to the contrary then we'll talk. Reply to my extensive written work. Get it published somewhere. Otherwise, you're just complaining. Send me a paper explicitly responding to my work. I'll be happy to read and comment on it. But stop misrepresenting it please.

And as for DGL: believing that cutting the money supply in half would do no damage to the economy makes you not a Keynesian but a general equilibrium theorist who believes that prices can instantaneously and perfectly adjust to a smaller flow of spending. Such an approach is at odds with Austrian economics.

Folks, Mises and Hayek BOTH accepted significant parts of the monetary equilibrium theory approach I've advocated. You can disagree with it (but please report on it accurately), but to dismiss it as "not Austrian" is exactly what's wrong with too many Austrians today: you're too busy circling the wagons to even understand what Mises and Hayek had to say.

I think Sumner might actually agree with many of these criticisms. Myself and others have belabored the "structure of capital" point in his comments section. Sumner has admitted that malinvestment caused damage to the economy, but his main focus was on the secondary depression caused by unexpected concretionary policy. Market estimates of inflation dropped significantly in the fall of last year.

Sumner advocates using futures markets rather than discretionary central banking. This may not be as good as free banking, but it is a significant improvement over technocrats centrally fixing interest rates. Rule based policy can be an effective constraint on abuse by policymakers.

Sumner views monetary policy as a substitute for fiscal policy. When monetary policy screws up, the government uses that as an excuse to expand its power and size. If there had been a smaller downturn, we might not have been stuck with a stimulus package.

Dear Nikolaj,

I don't view Mario Rizzo as a monetary theorist, but instead as a microeconomists who has consistently emphasized on his blog the importance of allowing relative price adjustments to guide the reallocation of resources during the correction phase of the cycle. If fiscal policy and/or monetary policy is distorting this free adjustment of relative prices, Rizzo has repeatedly stressed, then we are further disrupting the economy not allowing it to fix itself.

So I don't think Mario has made a deep commitment to a particular monetary theory. He does seem to suggest at times that perhaps the issues are harder than a more orthodox Austrian response might imply.

As you say, I am not a monetary economist. But I do defer to White, Selgin, Horwitz and Garrison on these issues. I see their work as fully consistent with Mises and Hayek, and even the basic thrust of the writings of my teacher Hans Sennholz. Inflation is distortionary and leads to the misallocation of resources. But for the very reason that inflation is distortionary (money works its way through the system through relative price effects), I think we have to admit that deflation can also be distortionary if induced by a change in the demand or supply of money not offset by a response in the demand or supply of money. This is, I would argue, classic Mises in The Theory of Money and Credit, and it is classic Hayek as well.

However, I am a strong advocate for a declining price level in times of productivity increases. I think much of the distortions we saw in the 1990s and 2000s were a consequence of significant monetary expansion to try to keep prices when falling, when their falling would have been appropriate due to the productivity gains we achieved through increased technology and increased trading opportunities.

I don't fear deflation in the same way that many other economists do, but I do worry about inflation. To me inflation is never good, but deflation can come in the form of both good deflation and bad deflation. Bad deflations can cause adjustment problems. But you don't fix it by inflation, you fix it by abolishing the Fed and letting competitive monetary issuance self-regulate the supply and demand for money. In the absence of the abolition of the Fed, I would not (and have not) advocated inflation for both economic and public choice reasons (see the post you are commenting on). In this sense, I would rather the Fed's hands be tied and deal with the economic consequences of adjustment difficulties to deflation. Why? Because I believe (a) we should not so empower the Fed as if it was going to engage in policy decision making divorced from politics, (b) that political influence will lead to bad policy, and (c) in this sense the cure will be worse than the disease.

Mises supposedly once remarked that inflating and then deflating would be like running over a man with your car, and then realizing what you have done deciding to back up your car over him again in the hope of undoing your original damage.

So I am taking the position that the link between deflation and depression is very small; that our current crisis is not one of confidence, but bad decision making; the we did not experience a credit crunch, but an insolvency issue compounded by a regime uncertainty issue; and that the cycle of deficits, debt and debasement will threaten the financial health and perhaps even survival of the US economy. We have to stop fueling this cycle of irresponsibility --- we have to cut off the lifeblood of this cycle --- easy credit, and put some checks on the spending behavior of governments.

I am not sure your description of my policy stance matches with what I have consistently written on this subject since last September. No bailout, no monetary activism, let the market adjust, and all attempts to stop market correction only turn a correction into a crisis. I think I have been pretty clear.

Somehow I managed to miss quite a bit of the commentary here, directed to me. Rather than try to catch up with all of it, I would just like to clarify one thing. Prof Horwitz objected to my tossing the epithet "Keynesian Austrians" around. But Prof Rizzo himself had said that if his position, and Hayek's, made them Keynesians, so be it. So I was saying no more about him than he said about himself.

And, suppose he hadn't. Would I be any more at fault? If the shoe fit, why shouldn't Rizzo wear it. And, if it didn't, why not show me up?
Why just shut me up?

Sorry, but here's one more thing I can't let pass.

Prof Horwitz wrote,

"And as for DGL: believing that cutting the money supply in half would do no damage to the economy makes you not a Keynesian but a general equilibrium theorist who believes that prices can instantaneously and perfectly adjust to a smaller flow of spending. Such an approach is at odds with Austrian economics."

If I ever said such things, I was certainly wrong. Prof Horwitz and I are in perfect agreement that there would be damage and that the market would have been better off had no such thing occurred.

Here's where we disagree.

#1 He said that there would a smaller flow of spending.

Why wouldn't there be the same flow, but at lower prices?

#2 If I understand him correctly, he is saying that we should try to lead the market back to where it was or where we think it ought to be.

I believe that we should let the market find its own way to wherever it needs to be, that there i nothing Austrian economists could do to lead the market that would be any better than what Keynesians could do to lead the market, that Austrian leadershiip no less than Keynesian leadership is just more of the same poison that sickened us in the first place, and that we need is not more of the same old poison but the only cure, to let the market run its course, and find its own way, without any leadership or interference by foolish Keynesians or wise Austrians.


Pete said:
"Inflation is distortionary and leads to the misallocation of resources."

I once thought I understood this claim but now I'm not so sure. Is the problem the decrease in short term interest rates due to price stickiness or just the new money itself? I can't see how a decrease in the short term rate would lead to that large of a mis-allocation. If the money injection is expected to be permanent, the rate will only decrease as long as prices have not fully adjusted. Long term rates are not affected as they will automatically incorporate inflation expectations.

I just don't buy the claim that this decrease in rates tricks investors. A 2-3% drop in short term rates seems negligible to me, especially when we consider inflation expectations and long term rates are rising.

I've also never heard a good response to Sumner's view on the causality of this particular crisis. Most Austrians seem to assume that the causality ran from housing crisis to financial crisis to recession. But Sumner provides compelling evidence that nominal spending was only marginally affected by the housing collapse.

And to DGL: if we are trying to stabilize MV then of course there can be a shortage of money.

DGL said:

"He said that there would a smaller flow of spending.

Why wouldn't there be the same flow, but at lower prices?"

Because prices and wages are sticky. That's the point, wages and commodity prices don't adjust downward fast enough and so you get unemployment instead of lower wages.

Jake,

The, or at least "an" Austrian view is: inflation led to housing bubble, collapse of housing bubble led to the collapse of other instruments, all of this required the reallocation of resources away from housing and finance toward other areas. That reallocation, or attempts at it, constitute the recession. The recession is not necessarily a collapse in nominal spending per se, but rather the imperfect attempt at reallocating resources in the wake of discovering the errors of the boom.

See: http://www.mercatus.org/PublicationDetails.aspx?id=27494

Prof Boettke wrote,

"deflation can also be distortionary if induced by a change in the demand or supply of money not offset by a response in the demand or supply of money."

Let me try to make sense of that:

Case #1, a change in the demand for money not offset by a response in the supply of money.

That might come about through greater production, more goods and services, falling prices, and greater demand, in terms of goods and services, for money.

How is that distortionary?

Or, if not through more production of goods and services, through the loss of money, as in fire or shipwrecks. Again, how is that distortionary?

Some people lost their money. Others who depended on them lost out on their money, too.

But losses are not distortionary, they're facts of life. Trying to wish them away is distortionary.

Case #2, a change in the supply of money not offset by a response in the demand for money.

If more gold is discovered, how could the marginal demand for it not fall. Or, if some of it was lost, again, through a shipwreck, how could the marginal demand not rise?

The proper distinction is not between good and bad deflation but the market and interference with it. Interference, whether inflationary or deflationary is distortionary, and that is what should be emphasized, the interference, not the goodness or badness of "deflation."

For, as Prof Boettke stated, however the deflation came about, through healthy market forces or unhealthy political forces, it is a fact that only the market itself can deal with.

Jake,

I don't know what you mean by MV.

And, whoever is trying to stabilize anything, it isn't "we." You, perhaps, but not I. Constant change is a fact of life, and "stability" a fool's errand.

We must understand that "inflation" and "deflation" are merely symptoms of the disease, interference with the market, and that it is the disease and not the symptoms that must be treated, the interference, and not the "inflation" or "deflation."

And the only way to treat the real malady, the interference, is to put a complete halt to it.

Jake,

You also wrote,

"prices and wages are sticky. That's the point, wages and commodity prices don't adjust downward fast enough and so you get unemployment instead of lower wages."

That's like saying that starvation is sticky, that it's hard to get people to want to eat again.

Not in my house.

Jake,

If prices are "sticky," as you said, it is because of political restraints upon them, such as minimum wage laws. Granted that inflation would be an antidote for that problem, but wouldn't a completely free market be an even better one?

Professor Horwitz,

I'm actually pretty familiar with the Austrian view. I attended last year's Mises University, I've heard all the FEE lectures and I regularly attend Professor Rizzo's colloquium at NYU. However, as I learn more about other lines of thought, certain things in the Austrian story don't make sense to me anymore.

For example, in your paper, you say that investors prefer long-term production processes because they are more productive. OK. But I still can't see how minor fluctuations in the short term rate of interest can make investors more interested in long term projects. As Tyler Cowen has put it, if your expected returns are 40-45%, a 2% drop in short term interests rates isn't going to make a huge difference in your investment descisions.

Also, I'm confused as to how investors are fooled if inflation expectations show that the drop in rates will only be temporary. In other words, everyone knows that the rate drop can't persist because the drop only occurs due to the stickiness of prices and wages. Once they adjust, the rate will return to the natural level. I've looked hard but I can't find a good Austrian response to that criticism.

I'll admit that on the margin, the drop in rates can lead to mal-investment, but i don't think the margin is very large and if anything, the effect only contributes to existing bubbles; it doesn't create them.

DGL:
The answer to all your questions comes down to sticky wages and prices. That isn't Keynesian theory, it's an empirical fact. Standard, non-Keynesian theory says that if spending drops dramatically, nominal GDP growth expectations will drop leading to drops in NGDP today because wages can't fall fast enough. This leads to unemployment and a recession. Keynes has nothing to do with it. In fact, much of modern theory was developed in direct response to Keynesian theory.

Unions and minimum wage laws are certainly a factor. No one denies that. But even without those restrictions wages and prices would be sticky, for two reasons.

First, empirically, workers don't understand the difference between nominal and real wages very well and so unemployment results instead of reduced wages. Sure some wages adjust but the vast majority don't, or at least not fast enough to prevent unemployment. This occurred well before large labor restrictions were put in place.

Second, problems of information. The problem might not even be that wages and prices don't adjust, but that they don't adjust the right way because employers don't have access to the information they need. In a situation where there is mass uncertainty, such as in a recession, market signals tend to be weaker, thus contributing to the problem.

I'm all for markets, and government surely contributes to the problems of a recession, but it
just doesn't seem correct to attribute all of the problems to regulation. Besides, I don't see why you're pushing so hard against this. Austrians should be the first to tell you that market participants don't always behave optimally.

Jake,

Cowen's argument requires very restrictive assumptions about expectations and the monetary transmission mechanism. There are a wide spectrum of economists, whether they be Austrian, monetarist, or those who believe in a "credit channel" of monetary policy. These advocates of the credit channel believe that imperfect information between borrowers and lenders create financial market frictions that increase the cost of external borrowing and therefore amplify changes in the interest rate. Austrians emphasize the particular nature through which monetary policy is conducted in producing changes in the structure of production. Finally, the monetarists argue that monetary policy affects real money balances, asset prices, and net worth thereby translating to significant real effects.

A close examination of the changes on the real side of the economy suggest that those who favor a broader monetary transmission mechanism than the interest rate channel are correct.

DGL,

Prices might be sticky due to political factors, but this is hardly the sole reason. I would suggest consulting Leland Yeager's excellent paper, "The Significance of Monetary Disequilibrium". Here is an excerpt:

"It is illegitimate to suppose that people somehow just know about monetary disequilibrium, know what pressures it is tending to exert for corrective adjustments in prices and wages generally, and promptly use this knowledge that the system is working to convey. Businessmen do not have a quick and easy shortcut to the results of the market process.

[...]

Even if an especially perceptive businessman did correctly diagnose a monetary disequilibrium and recognize what adjustments were required, what reason would he have to move first? By promptly cutting the price of his own product or service, he would be cutting its relative price, unless other people cut their prices and wages in at least the same proportion. How could he count on deep enough cuts in the prices of his inputs to spare him losses or increased losses at a reduced price of his own product? The same questions still apply even if monetary conditions and the required adjustments are widely understood."

What Jake says above about sticky prices is right on! Yes, gov't makes matters worse, but market processes, as every Austrian should know, are imperfect and take real, historical time. They are discovery processes.

A challenge for the doubters: if you really think prices can "just adjust" downward, why not upward? Why worry about inflation? Won't prices just smoothly and quickly find their new, higher values? Isn't the Austrian story of inflation and the cycle really one about the inability of prices to adjust smoothly and quickly to higher nominal values in the face of an excess supply of money? If so, why have a different theory when prices have to fall?

Can someone please give me an example of 'bad deflation'? I mean an actual result. Also, can't we agree that the idea of price stickiness or wage stickiness is discredited? Ask any salesman what there wages are now compared to three years ago and you'll find that most make far less, even if in the same job. Where's this reluctance to accept smaller nominal wages? They accept smaller real wages, not just nominal wages. Same with just about any worker in the U.S. facing a layoff. Nearly all will take a wage cut and still to keep their job. That's what's happening all over corporate America right now, so this wage stickiness nonsense needs to end. It's simply not true.

Greg,

Thank you for some common sense, at last.

I'll take a stab at that, Steven. Prices can natually adjust downward because the correlate to productivity gains, meaning as efficiencies take place in production, products can be sold for less at the same or even greater profit. Competition should bring this about.

But the upward prices you're suggesting, as I read it, are inflationary and are caused by monetary manipulation. They do not have anything to do with the natural supply and demand for a given product at all, but are a distortion of the means of exchange for the products. And that brings about a whole slew of other problems. If those price increases were simply caused by supply and demand, then Austrians wouldn't have a problem with it at all.

And prices can adjust upward. If you have a house in a really sought-after location, then you could expect a price increase as long as demand for those houses was greater than the supply.

Quick disclaimer: I just found out that most of the participants on this board are real live economists, and 'Austrians' to boot. Sort of blew me away. So take my posts are merely the opinions of a laymen who has in interest in economics in general (and Austrian economics in particular) and nothing more. I don't pretend to be an academic or expert (one could either or both, I suppose) in economics.

That out of the way, I'm curious about the postion of Steven and his challenge to doubters. Does the Austrian method accept the ideas of price stickiness and wage stickiness in general? I can understand when there are artificial means to keep prices and wages 'stuck,' say, trade unions and price controls on products. But outside of that, what stickiness? My only guess would be wages, and that stickiness would be based on the psychology of the worker. Making less, even in nominal terms, would be resisted on purely pychological grounds, and he/she might rather have nominal wage gains while having real wage decreases when inflation is factored in. I get that.

But isn't the wage stickiness really prevalent when the worker has, or believes he/she has, alternatives? If that worker, faced with a wage cut can (or at least believe she/he can)simply replace that job with another making the same (or perhaps marginally more) wage at a different firm, then there would be real reluctance to accept a wage decrease in nominal or real terms. But remove the possiblity of landing a different job or the belief that it's even possible to find an alternate job, and doesn't the problem of wage stickiness evaporate? Even unions agree to cutbacks and wage concessions, and in non-union corporate America, we see wage cuts all the time. How many of you would resign rather than take a pay cut at this moment in time?

Or is the argument that the wage cuts would have to be so drastic to achieve equilibrium (Austrians wouldn't use that concept, would they?), that wage stickiness would occur? The example being that if wages were allowed to fall to $0.10 per hour, that pesky problem of unemployment would disapear, but wage stickiness prevents this. Is that it?

As to price stickiness. Which prices? Consumer goods? Capital goods? Does it matter? Where is the price stickiness for things like computers or electronics that we expect to get cheaper each year?

I thought price stickiness was some type of Keynesian double speak in order to justify his the math in his theory. Is this an Austrian concept too?

You posed the problem, Steven. So what's the answer?

Think of it this way: If you own a restaurant and you get 100 customers a day spending an average of 25 dollars and then one day only 50 customers show up and spend the same average, will you automatically cut all of your prices in half? I doubt it. The point is the market process takes time. You, as a restaurant owner, don't know if this demand decrease is only temporary or if it will last for a while. Also, as Steve has said, you might not be so quick to cut prices because the price of your inputs hasn't decreased yet. You may cut savings in the short run instead of prices.

For wages, most people think they can do better than the average person. This means that they might rather be unemployed temporarily in order to look for another job that pays their original wage because they think it won't be very difficult.

I'm not saying that prices don't adjust downward; I'm saying that it takes time and the process itself can lead to some bad results. Keynes did not invent this idea, it has been around for a long time.

Greg:

You are confusing "stuck" wages with "sticky" wages.

If prices (including wages) adjust like the prices of stocks on the NY stock exchange, then an excess demand for money might result in lower prices and wages without any impact on output or employment.

If, instead, prices (including wages) are sticky, then real expenditures, real output, and real employment all drop. Then, as prices (and wages) drop, real expenditures, real output, and real employment expand again.

That decrease and then increase in output and employment _is_ the problem.

Unfortunately, Keynes and some Keynesians today cast about for arguments as to why the lower wages and prices will not allow for a recovery of output and employment. And, of course, if prices (or wages) never decrease, then obviously, decreases in prices and wages won't lead to recovery.

But, for monetary disequilibrium theorists, those are really red herrings. It is the fluctuation in output and employment that is the problem. It decreases and then increases. The decrease is a waste.

The notion that all prices and wages should be set like exchange traded stocks is unrealistic. Avoiding the output and employment fluctuation by having prices (and wages) perfectly flexible in unrealistic.

And so, monetary institutions that avoid excess demands for money are desirable. And that means avoiding decreases in the quantity of money if the demand for money isn't decreasing. And increases in the quantity of money when the demand for money does increase.

Greg,

Bill W. and Jake have answered the sticky prices question for the most part. I'd just add that your invoking productivity driven price declines is a different issue. That's the "good" kind deflation and it works because individual entrepreneurs can reduce prices because THEY have innovated in ways that enable them to do so. Excess demands for money require economy-wide adjustments simultaneously, and it's not in the interest of any one producer to initiate that process.

George Selgin nicely differentiates the good and bad kinds of deflation here: http://www.amconmag.com/article/2009/feb/09/00014/

Let me be clear: monetary policy should NOT be used to offset the good kind of deflation (productivity induced ones), but should be for the bad ones: monetary deflations.

As for the inflation challenge: the point is the one that Bill and Jake have made. Austrians do not think prices are perfectly flexible, either up or down.

Greg,

Stick to your guns. You're right.

Jake,

If individuals are slow to adjust their prices downward, so what? That's their problem. Why is it mine? And how does abandoning the free market for the sake of monetary tinkering solve anyone's problem?

Bill,

You spoke of an "excess" demand for money.

What is that, but your own value judgment, that you know what's good for another person better than he does? If he wishes to hold a certain amount of money, who are you to say that it is too much?

If wages are "sticky," and employment drops, it is voluntary. The worker has chosen unemployment for himself. Why is that my problem? Why must I abandon the free market in order to counteract his own decision for himself?

Why is a decrease in output necessarily a "waste." If the output is for what isn't wanted, that is the waste. When resources have been misallocated, what the market needs is not the continuation but discontinuation of the misallocation, a halt to the current line of output, and saving and investment in a new and sustainable line of output.

Prof Horwitz,

First, let me thank you for your great work througout this current crisis. Yours has been one of the few voices of sanity in this country, and I, for one, would have been lost without the leadership of the few people like yourself who knew what was really happening.

But, respectfully, I disagree with you on this matter.

You wrote,

"Excess demands for money require economy-wide adjustments simultaneously, and it's not in the interest of any one producer to initiate that process."

What is an excess demand for money?

If someone wishes to hold a certain amount of money, who am I to tell him that it is too much?

Why must I agree to the abandonment of the free market in order to pry his money lose from him?

Why is it better that he spend than save?

What it really comes down to is that you are a closet Keynesian. You would call yourself a macro-economist, wouldn't you? What is that but a Keynesian? You share the Keynesian view of a disconnect between the economy of the individual and of the nation, don't you, and the Keynesian bias for spending over saving? What more would it take to make you a Keynesian Austrian?


If I wish to hold a certain amount of money, who are you to tell me it is too much?

DGL: I'm not going to repeat our debates of the past. No one is telling you that you have an excess demand for money. An economy can be in a situation in which people's actual money balances are less than what they desire to hold *by their own preferences.* In such a situation either the price level must fall or the nominal money supply must rise.

The very fact that you think an "excess demand for money" means you are "holding too much" belies your ignorance here. An excess demand for money means your actual money balances are LESS than what you desire. That is right out of Mises's cash-balance approach to the demand for money. If you can't understand that, it's back to Theory of Money and Credit with you.

Your ignorance about the basic concepts of supply and demand is where you and I started back when and I can see not much has changed in the interim.

Finally: I appreciate your kind words about my work on the crisis. I must ask, though, how you reconcile my clear apostasy that you identify with my work on the crisis. If I'm such a Keynesian (and I don't think you really know what that means), why are you trusting me on the crisis? Alternatively, if you trust me on the crisis, why not consider that I might be right about this too?

Prof Horwitz,

You wrote,

"An excess demand for money means your actual money balances are LESS than what you desire."

In other words, any time anyone wants more money, the "government" should print it for him?

And that's out of Mises? I'd like to see the quote on that.

As to trusting you, I don't trust anyone. I trust my reason. A great deal of what you said about this crisis made sense to me. But what you're saying about "a little inflation" does not.

As for my "ignorance of basic concepts of supply and demand," we had that argument before, and I hope you're not going to waste any more time on the most utter nonsense I have ever seen in economics.

And, as to which of us doesn't understand what Keynes was about, that is debatable.

But, in general, you're doing a great job, and are one of the few economics teachers in the country I would send my kids to.

Read again: when, *for the economy as a whole*, the actual supply of money is less than that which people wish to hold, the banking system should supply more.

Mises defines inflation as an excess supply of money and deflation as a deficient supply. He says both are to be avoided, which implies that the money supply should be expanded to meet that deficient supply. I don't have my TTOMAC handy to find the page cite.

The comments here no longer have anything to do with Pete's initial post and so in an effort to resolve the issues I raised earlier, I have created a post of my own on my new blog. I hope it's not against blog etiquette to attempt to restart the initial discussion there.

http://consequentialist.wordpress.com/

BTW, I'm a long time reader of this blog, but first time commenter.

Prof Horwitz,

From Human Action, 3rd Rev.

"The services which money renders can be neither improved nor repaired by changing the supply of money…The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do.” P 421

“It is possible by means of an increase in the quantity of money to delay or to interrupt this process of adjustment. It is impossible either to make it superfluous or less painful for those concerned.” P 431

I bought a copy of Theory of Money and Credit a long, long time ago, and couldn't get very far into it. Human Action was another matter. I've worn out two copies of that.

Theory of Money and Credit came much earlier. Perhaps Mises changed his mind. All I know is what I see in his much more mature and considered work, Human Action. That's the Mises I know, and that, apparently, you don't.

I recommend it.

Prof Horwitz,

You wrote,

"Read again: when, 'for the economy as a whole', the actual supply of money is less than that which people wish to hold, the banking system should supply more."

But what is "the economy as a whole?"

It's all the individuals in it. So it still comes down to this: when anyone, or everyone, wants more money, the "government should print it for them."

Why?

It's not that complicated. The Fed has an artificial monopoly on money creation. There is evidence that if that monopoly didn't exist, private currency issuers would increase the supply of money in response to an increase in demand. The very existence of the Fed, then, can be seen as an intervention. The policy recommendation that Professor Horwitz and others are making is for the Fed to emulate what the market would have done in the absence of a central bank. That actually seems like less of an intervention to me.

Jake,

Whatever "evidence" you have of an increase in the supply of money in a free, competitive market, there could be no such increase other than that of bullion itself. For the demand for paper money, wharehouse receipts for bullion, depends upon its integrity, and it is precisely the need to maintain it that keeps the private, competing issuers of it from inflating and degrading it.

So the only way to emulate them is by not inflating the money supply.

Increasing the supply of money is not like increasing the supply of apples. When you increase the supply of apples, you decrease the demand for them at the margin. But when you increase the supply of money, when your competitors are not doing the same, you don't just reduce your demand at the margin, but lose it altogether.

And the previous comment indicates why my continuing to have this discussion with you is pointless. You don't even understand supply and demand.

In the words of that well-known economist Inigo Montoya: "You keep using those words. I don't think they mean what you think they mean."

Steve,

I cited passages that prove Hayek thought MV stabilization was only theoretical possibility that by definition cannot be realized in practice; that stabilizing MV cannot be "maxim of practical policy" and that banks never can keep credit within these limits". That is something very different from how you interpreted those passages, that whole operation of MV stabilization cannot be carried out "perfectly". You misrepresented Hayek's argument, i.e. severely downplayed incompatibility between his views expressed in those paragraphs and your own views.

As for why stabilization of prices during recession is at odds with basic framework of Austrian credit cycle theory, Hayek himself explained that even in the paragraphs I cited: distortive effects of credit inflation will be exerted in deflation-preventing money infusions as well. Distortions of productive structure will take place when banks try to stimulate economy during recession, in the exactly same way as distortions occur initial inflation during the boom. In de Sotto's book you have very detailed explanation of that phenomenon (pp 675-705). Detrimental effect of credit expansion on relative prices doesn't cease to operate only because general price level is falling, or velocity of circulation decreasing. Those are macroeconomic fictional magnitudes that have nothing to do with real causal operation of individual factors that bring about changes in relative prices. Assumption that credit expansion during deflationary contraction doesn't have distortive effect on relative prices equal to those during the boom is very naive.

I don't understand for what reason you always try to eat the cake to to have it at the same time. On one hand, I am wrong that Hayek was liquidationist and that contrary to your interpretation he believed that severity of Great Depression had nothing to do with deflation, but, on the contrary, with misguided attempts to avoid it. On the other hand, you say that Friedman was right that deflation was very important reason for that severity (Friedman who castigated Hayek and Robbins for not understanding that). “Both Austrians and monetarist” are to some extent right, as you said, - Austrians that depression was initiated by credit expansion, monetarists that its severity was due to failure of Fed to prevent deflationary contraction by additional credit expansion. So you now concede that Austrians didn't believe that deflation was mistake, i.e. Hayek was not "on your side" in this matter, but Friedman was. That was exactly what I have said. You have Austrian theory of the boom, and monetarist-Keynesian theory of the bust (Selgin openly confessed that, so I don't see much reason to debate this point).

Nik,

You wrote,

"distortive effects of credit inflation will be exerted in deflation-preventing money infusions as well. Distortions of productive structure will take place when banks try to stimulate economy during recession, in the exactly same way as distortions occur initial inflation during the boom...Detrimental effect of credit expansion on relative prices doesn't cease to operate only because general price level is falling, or velocity of circulation decreasing."

That's it exactly.

Guess what guys, we're talking economics here, not party politics. Stop putting everything in terms of the various labels for different groups like Keynesian or Monetarist. Different people can be right about different things. There doesn't have to some sort of grand theory for everything, despite what Mises thought. Also, Hayek wasn't very consistent so trying to figure out what he really, really meant is a fool's errand.

This discussion is obviously going nowhere let's just end it.

Jake,

Welcome to this blog. :)

Jake,

You wrote,

"This discussion is obviously going nowhere let's just end it."

Translation: your side lost.

And that comment only goes to prove Jake's point.

Some of us are here to learn, and not for our "team" to "win" or "lose." When the "discussion" turns into teams winning and losing, it's long past time when people are actually listening and trying to learn. I, for one, am not especially interested in talking to those who are here to ensure their team wins.

Maybe you'll like it better if I put it this way:

the free market won.

I haven't read much of Mises yet. Still getting through Rothbard. What I thought I did read in one article, I think it was The Case Against the Fed or Repudiate the Debt, was a passage about money if gold was to be used as the currency. And it stated something to this effect: as long as there were enough currency to meet the demands of commerce, then no more would need be created. Since it is merely a means of exchange and nothing else, demand for it would really be demand for goods it could be exchanged for, right? What exactly is 'demand for money' if money is merely a means of exchange? I don't follow.

And didn't Rothbard in an article about free banking say something to the effect that even if an increase of the supply of money was desirable, that the danger of allowing a bank to increase that supply, with all the inherent dangers of trusting a bank with such powers, outweighs any advantages and should not attempted. I thought he mentioned that it would be nearly impossible to know exactly how much to increase it as well.

Did Rothbard agree with Mises in this area? This concept boggles the mind and seems so out of step with these guys.

Greg,

I don't know how old you are, but you are a great student and already a damned good economist. I'm 77 years old and have been into economics for most of those years, and am still not too sure of myself in this area. Prof Horwitz said one of my statements above demonstrated ignorance of supply and demand theory. He may be right. And, what does this mean, the demand for money? Great question.

As Prof Horwitz stated, there is too much emphasis on winning and losing. Yours is clearly on learning. Stay with it. Economios needs you, desperately.

And, Greg, another thing, about my quarrels with Prof Horwitz. I quarrel with everybody. Rothbard and his partner, Rockwell, threw me out of Mises University. I never knew Mises personally, and am just as well satisfied, as I know I would have had trouble with that old SOB, one to another. I wouldn't want to run into Horwitz in a dark alley. He is a throwback to those old Murder Inc mob bosses, but one of the few economists today who is more than one in name only. Would you call Krugman or Summers economists? I wouldn't. But Horwitz, imperfect, like anybody, is the real thing, an economist, and one of the few today. So, God bless you, professor, we love you.

And, Greg, another thing, about my quarrels with Prof Horwitz. I quarrel with everybody. Rothbard and his partner, Rockwell, threw me out of Mises University. I never knew Mises personally, and am just as well satisfied, as I know I would have had trouble with that old SOB, one to another. I wouldn't want to run into Horwitz in a dark alley. He is a throwback to those old Murder Inc mob bosses, but one of the few economists today who is more than one in name only. Would you call Krugman or Summers economists? I wouldn't. But Horwitz, imperfect, like anybody, is the real thing, an economist, and one of the few today. So, God bless you, professor, we love you.

I lost my earlier reply, so I'll try again but in brief detail. I did see the link about the 'good' and 'bad' type of deflation. Okay, I see what he is talking about. I actually don't recall what the point of it was anymore. Was the suggestion that a little inflation would ease the burdens of this harmful deflation? If that's the idea, then I hope the 'intervener' is smarter than the free market and the intervention doesn't have unintended consequences that may outweigh its benefit. If so, maybe we should have this 'intervener' permanently intervene on our behalf?

Anyway, the notion of demand of money is something that boggles my mind. I haven't gotten around to reading much Mises. I'm still plowing through Rothbard.

Is this 'demand for Money' linked to Mises preference for free banks? Wasn't Rothbard is disagreement with the idea since any good that could possibly come out of it would be negated by the possible dangers of allowing money manipulation by the bank, and by the fact that no agency intervening could possibly know the exact to increase the money supply? I thought I read something about it in one of Rothbard's articles, but I could be wrong.

So a suitable definition of 'excess demand for money' might be: that your actual money balances are LESS than what you desire and therefore the money supply, to which Mises recomends increasing the money supply. Is that it?


But does this square with Rothbard's view, as he states in The Case for 100% Gold:

These economists have not fully absorbed the great monetary lesson of classical economics: that the supply of money essentially does not matter. Money performs its function by being a medium of exchange; any change in its supply, therefore, will simply adjust itself in the purchasing power of the money unit, that is, in the amount of other goods that money will be able to buy. An increase in the supply of money means merely that more units of money are doing the social work of exchange and therefore that the purchasing power of each unit will decline. Because of this adjustment, money, in contrast to all other useful commodities employed in production or consumption, does not confer a social benefit when its supply increases. The only reason that increased gold mining is useful, in fact, is that the large supply of gold will satisfy more of the non--monetary uses of the gold commodity.

So what would Mises' demand for money be? A demand for goods that the medium of exchange (money) could aquire? Or is it some irrational demand for more phsysical dollars or gold or whatever constitutes money? Doesn't Rothbard's first few sentances conflict with the idea of 'excess demand for money' and render it pointless? Why would it be wise for the government to increase the supply of money if, as Rothbard points out, would do nothing but decrease purchasing power.

I admit I haven't gotten to Mises yet, but this concept he puts forth (as you defined) is difficult to square in my mind. I'm having a hard time making sense of it.

[excuse any typos. It's late and I'm tired]

Will try a third time to post if this one is successful.

DG, here's something that would scare the hell out of me had I pursued an advanced degree in economics. It is quite possible, and for some people absolutely certain, that nearly everything learn about economics will be wrong. You can literally be wrong about the subject that you are an expert on. And I mean Nobel prize winners. If there are, say, three conflicting theories (or however many we say there are), then those who are not right will be wrong. Imagine studying economics all your life to find out you don't know shit about the subject. We all hope we are right, but if Austrian school is right, then Keynes and the Monetarists must be wrong. I wonder how many other fields of study where you can become an expert and literally get it all wrong.

razerfish said:
"Anyway, the notion of demand of money is something that boggles my mind. I haven't gotten around to reading much Mises. I'm still plowing through Rothbard."

Two things. One, money isn't just a medium of exchange; its also a store of value. Talking about an increase in the demand for money is equivalent to talking about an increase in people's desired level of savings. The problem occurs when total savings can't increase because prices are sticky.

Second, most (all?) of the economists on this site will tell you not to take Rothbard too seriously. This isn't a Rothbard fan club; he totally misunderstood most of the arguments levied against his case.

Razerfish:

Mises is one of the 20th century economists most responsible for our understanding of the demand for money with his "cash balance" approach to money demand.

And as Jake said, Rothbard is a wonderful and important Austrian economist, but his work on money and banking is, IMO, not as good.

Keep reading, esp. Mises.

Let me clarify one thing: I do disagree with Jake in saying that we shouldn't take Rothbard seriously. We should take him very seriously, both because he was right about a lot and because when he was wrong, we need to make sure we understand him well and clarify what his mistakes were.

Greg,

Wow! I don't think you need any help. You nailed it. Anyways, from my experience, no matter how much you read, and I think you're reading the best, with Rothbard, and then, hopefully, Mises, they'll all leave questions that you'll have to think through for yourself.

It seems to me though that you may have allowed the Keynesian Austrians to mislead you about Mises. They tell us what he said in some earlier book of his, that I tried to read, but couldn't. All I know is what he said in his much later and greatest work, his magnum opus, Human Action, and, in that, he is right there with you and me on the monetary issue.

One warning about Rothbard. He talks against symbolic and geometric economics, but turns right around and uses it. So you have to separate his wheat from his chaff, and there's plenty of both.

For me, Mises was tough going at first, but I sensed that there was something there, so stayed with it, and was ultimatley rewarded for the effort. For me he is the indispensable guide. But there are others who have no use for him and still do magnificent work, like our friends at Cafe Hayek, Roberts and Boudreaux, instinctively great economists, without really knowing why. But they can only go so far that way. Ultimately their ignorance of Mises is going to catch up with them. You need Mises to go all the way to victory.

razerfish,

You're just going to have to let reason be your guide.


Anyone, like our friend DGL, who purports to pronounce on Mises and banking theory while admitting to not having read The Theory of Money and Credit should not be taken seriously on the subject.

And yeah, Richard, "store of value" was a bad choice. Money is a medium of exchange.

And while I'm at it, some politeness to other commenters is appreciated. Continued violations will lead to banning.

Prof Horwitz,

You wrote,

"Anyone, like our friend DGL, who purports to pronounce on Mises and banking theory while admitting to not having read The Theory of Money and Credit should not be taken seriously on the subject."

Should the Mises of Human Action be taken seriously, or only the Mises of Money and Credit?

You wrote,

"And while I'm at it, some politeness to other commenters is appreciated. Continued violations will lead to banning."

Don't worry about that, fellows. It's only directed at me, and won't be enforced against anyone else.


to be banned almost everywhere in the economics community. Banned in Economicsland.

The answer DG is "both."

And my comment was directed at Mr. Cheese not you.

Prof Horwitz,

We must certainly appreciate your providing this forum for us, and trying to maintain essential standards. But, speaking for myself, I can only say that I don't find a bit of badinage a problem. In fact, I enjoy.

Over at Cafe Hayek, they have a big problem, that I haven't seen here, with goddawful bores who routinely overtake every topic and choke off intelligent discussion like some sort of intellectual crabgrass. That's the real problem, and I don't see that here. So, why not count your blessings, and not get too uptight about innocent trifles.

And don't you remember all the vituperation directed at me, that never bothered you, and, as you know, never bothered me, and that, in fact, I loved, as I love your continuing ad hominem attacks upon me, in lieu of any upon my logic.

I apologize. I shouldn't have spoken for other people on Rothbard. I was tired when I made that last comment. What I meant to say was exactly what Steve said. Rothbard's work on money and banking is weak but we should still try and learn from it. I'm just frustrated that so many Austrians seem to think that Rothbard and Mises were the last true economists and that all of economics is contained with their work. Economics is a rich and varied subject and I think opening up to other points of view is an enriching experience.

That said, I'm confused by the response to my use of the term "store of value." What's wrong with that term and why can't money be both a medium of exchange and a store of value?

Jake (the snake?, sorry, Prof Horwitz, but I just coudn't resist that)

I don't know about Rothbard, but Mises would have been the last one to say that his was the last word on any subject. He has no greater admirer than I. To me, he was number 1, and whoever was second was a distant second. But I still think he missed the boat on the biggest issue of economics, redistribution, and one of the biggest, competition and monopoly.

I do vaguely recall some criticism of the store of value concept, but not exactly what it was.

Interesting question. Bit I really think that Greg above said all that needed to be said about it.

Anyways, right or wrong, you're doing good work here, so keep it up.

Jake,

I don't think there is anything wrong with saying that money is a good "store of value," though it depends significantly upon when and how long the money is held for.

From 1900 to 2000, the U.S. Dollar would not have been a good store of value, but from 1999 to 2000 it done quite well. When people save by holding money, they are speculating that when they come to spend it, its purchasing power will have increased or remained constant. Thanks to central banks like the Federal Reserve, U.S. Dollars usually lose purchasing power, but over short time periods it is of little significance. There are many worse stores of value, such as fruit and vegetables or computer hardware.

There are other benefits to U.S. Dollars over alternatives like gold and silver. The U.S. Government demands that taxes be paid its own currency, thus producing a constant demand for U.S. Dollars. Since everyone knows that others will always be willing to trade for U.S. Dollars to pay taxes, many will be held speculatively as a "store of value."

Perhaps "store of purchasing power" is a better phrase than "store of value." Perhaps I am using these terms in an irregular way; I am just trying to make the best sense of it I can.

Jake,

Let me add to the above comment to clarify something. You said: "what's wrong with that term and why can't money be both a medium of exchange and a store of value?"

It seems to me that a good only becomes a "medium of exchange," because it is speculated to be a good "store of value," i.e. store of purchasing power. Nominal "money" (e.g. Zimbabwean Dollars) ceases to be a medium of exchange under severe inflation, because people no longer consider it a good store of value, that is, they do not expect it to trade at the same value from one day to the next.

My only point was that money is normally defined, at least by Austrians, as a "generally accepted medium of exchange." Its role in facilitating exchange is its fundamental function.

Ok. I take both your points, Lee and Steve.

When I referred to Greg's work above, I should also have mentioned Nik's.

With both of them, two stars were born.

And joining Lee Kelly, not always right, but always one of the best.

These are the two postings that most stand out in my mind, and I think best summarize this issue.

From Greg,

"Also, can't we agree that the idea of price stickiness or wage stickiness is discredited? Ask any salesman what there wages are now compared to three years ago and you'll find that most make far less, even if in the same job. Where's this reluctance to accept smaller nominal wages? They accept smaller real wages, not just nominal wages. Same with just about any worker in the U.S. facing a layoff. Nearly all will take a wage cut and still to keep their job. That's what's happening all over corporate America right now, so this wage stickiness nonsense needs to end. It's simply not true."


From Nikolaj,

“distortive effects of credit inflation will be exerted in deflation-preventing money infusions as well. Distortions of productive structure will take place when banks try to stimulate economy during recession, in the exactly same way as distortions occur initial inflation during the boom...Detrimental effect of credit expansion on relative prices doesn't cease to operate only because general price level is falling, or velocity of circulation decreasing."

Greg and Nikolaj, our two new stars of economics.

And kudos to the rest of you, too. There were two different groups with two different points of view, but one agenda, a serious discussion.

You don't always find that on the internet. All too often there is one side with a different agenda, to smother serious discussion.

FYI, Greg and Razerfish are the same person. I didn't see my posts showing so I figured I had to sign up to make a post. And I just chose that name.

I'll have to check out Mises. I was under the impression that Rothbard and Mises were sympatico with each other on pretty much everything, so reading one would be like reading the other. I'll get around to Mises, same with Hayek (I finished a third of one of his books) adn other articles posted from other authors.

I also read parts of other books I'll get around to reading that I think are pretty interesting. History of Coinage and The History of Banking (I think that's the name). Both were written over a hundred years ago but you can see that we've had these same problems (banks cozy with the government, government wanting to inflate) since our country began. Nothing has changed. I recommend both.

If prices are sticky, are some stickier than others? My hypothesis was that the more heavily bought and sold items would be less sticky, but I'm just guessing. Perhaps I'm wrong. Austrians say that capital goods will have greater price decreases relative to consumer goods. Does this mean that capital goods are less sticky? I think it stands to reason that consumer goods are less sticky because they are more heavily traded, and therefore, more efficiently price. The bid and ask spread is far closer than, say, the market for heavily farm machinery and therefore, more efficiently priced. So big, incremental price decreases are just a natural consequence? And isn't it possible that you could get a sizable decrease in a 'sticky' product, but would its descent in price would just be much smoother?
I'm just thinking out loud here, so I might be a mile off the mark.

Anyway, I'll just accept that prices are sticky, and perhaps some are stickier than others, and deflation will cause a distortion, and these effects will be inefficient and harmful. Is that a fair description of the original position? And the prescription is a little inflation, i.e. a soft landing. Right? Does this presuppose that this inflation will gently buffer the prices that are deflating too quickly and stay out of the prices for items that do not deflate too quickly (or inefficiently as I think the post described)? Will it make efficient the process you declared to be inefficient?

Is it possible that inflation, even if it were intended to soften this bad deflation, would have unintended consequences even it were applied perfectly? Isn't the net effect that you robbed one group to reward another? And aren't you basically rewarding those who are first to receive and spend these dollars over those that get them last or not at all? And since the banks are not only the creators of inflation but the first to be able to receive and spend these inflated dollars, aren’t you rewarding them above all others? I'm skeptical that the antidote of inflation would be worth its price. If deflation is a distortion and causes inefficiencies in prices, doesn't inflation also do the same thing? Assuming the prescription is perfectly efficient and works just as planned, haven’t you just created one problem to solve another? Did you just hurt one group to help another? And that's assuming the injection of inflation works perfectly. What if it doesn't quite have the planned effect?

Maybe the deflation period is drastic and inefficient but is still more efficient than any other alternative?

Or maybe I've confused the basic premises and concepts and any reasoning is now just compounding error on top of error. I think that quite possible too.

my apologies for the grammar mistakes in my earlier post. I didn't edit properly. I wish I could edit it now but I see the option on this board.

razerfish or Greg,

I think you do better as Greg.

You better go back to that persona.

Reread my two excerpts right above from Greg and Nikolaj. I really think they say it all.

My advice is to forget about Hayek and get right to Human Action by Mises and Man, Economy, and State by Rothbard. With Mises, there are basically two subjects, economics itself and epistemology, the definition of it and how to think about it. Those parts you'll have to read twice. And don't dwell on any one part. Just keep moving along and try to get the big picture without getting bogged down, especially with Rothbard, who is a mixture of gems and trash. Just follow your instincts. And remember that economics is a simple science, and, if it isn't simple, it isn't economics. No matter how complex a chain of reasoning, each of the links is simple, can be explained in simple terms, and if not worth the bother of explaining, not worth that of trying to understand it. Almost everything that passes for economics today, especially Nobel Prize winning economics, is just erudition in the air, without any visible points of departure from solid ground. If you can't see the links to solid ground, there are none, just hot air. It is the author's obligation to make himself clear, not yours to decipher his mysteries. Don't bother with crypto economics. Any economist who really has something to say will find the means of saying it clearly.


When Rothbard talks about angles and tangents, just pass over that. When anybody talks about supply and demand curves, just pass over that.

There is no geometry in real economics. Just verbal logic. Nothing else. All the rest is just professor speak.

"Even I don't know what they're talking about, when I go from one classroom to another."

What I was told by the chairman of the Department of Economics at UCLA many years ago.

He should have fired every one of those professors on the spot.

And notice that whatever our quarrels with Prof Horwitz, he talks our language, and, right or wrong, at least makes some sense.

And they don't make 'em like that much any more.

I would guess that no more than 1 or 2% of the economics professors today are like that, both talking our language and talking sense.

We're none of us perfect, but he's pretty damn good.

Actually, what that chairman at UCLA said was,

"when I go from one classroom and one specialty to another."

Greg:

Oddly enough, I don't think anyone on this thread has been agreeing with Cowen that "a little bit of inflation is desirable."

Most of the argument has been about whether an increase in the nominal quantity of money to match an increase in the demand to hold money is desirable. The opposite view is that it is better for the purchasing power of money to rise (deflation) so that the real quantity of money rises to meet the demand.

Sumner favors a 5% growth path of nominal income (which is pretty much the same as total spending in the economy.) The trend growth rate of real production in the economy is about 3%. And so, that implies a 2% inflation rate--that is, rate of increase in the price level. Nominal income is way below that 5% growth path. Sumner advocates whatever increases in the quantity of base money needed to get the expected value of nominal GDP back on the growth path one year from now.

Since that growth path of nominal GDP implies a 2% inflation rate, when he looks at the difference between inflation adjusted bonds and ordinary bonds, and sees what appears to be an expected inflation rate of less than 2%, he takes that to mean that nominal GDP is not expected to be on the 5% growth path and so insists that too little base money is being created.

Cowen summarized this as there being too little inflation. That is, the money supply should grow more quickly so that inflation would be a bit higher. And he suggested that is a good idea.

Sumner has a Chicago Ph.D.. He is a moderate libertarian with somewhat unorthodox monetary views. I have known him since the early nineties, and I understand his perspective as being broadly in the monetary disequilibrium camp. I have found his unusual perspective congenial because he shares with those few of us influenced by the "Greenfield/Yeager" payments system, a focus on the centrality of the medium of account.

Cowen is a Harvard Ph.D. (right?,) but who was an orthodox Austrian as a teenager. I still remember meeting him when he was a high school student at some libertarian think tank conference (probably Cato, but maybe IHS.) His ability to parrot the Rothbardian plumbline was impressive (and a bit irritating.) He has gone far. He went from being one of the smartest orthodox Rothbardians to being one of the smartest moderately libertarian eclective free market economists.

Like Sumner, I favor targeting the growth path of nominal GDP. (Well, total sales of final goods, which is about the same.) But I favor a 3% growth path. With the growth rate of real output trending at 3%, that is zero inflation on average. Inflation when productivity growth is less than average and deflation when it is more than average. (On the other hand, moving to that regime involves disinflation, which is painful at any time. Last fall, I thought it was the wrong time for disinflation and so agreed with Sumner. Today, I would be happy getting back to a 3% growth path.)

While I strongly favor increasing the quantity of money enough to get back to 3% growth path of nominal GDP, and I recognize that this could result in inflation (rising prices,) I don't consider the _inflation_ a good thing.

Horwitz has adopted the productivity norm. I had always taken that to mean that nominal income should be fixed, but I now understand that the proposal is for nominal income to increase with total factor supply. The 3% growth trend in real output growth combines increases in factor supply (the labor force, for example,) combined with increases in productivity. Nominal income should rise to reflect the increases in factor supply while prices should fall to reflect the increase in factor productivity. (Right?)

Anyway, nominal income today is less than it was a year ago. It dropped a lot during the six months between October 2008 and March 2009. From all three perspectives (Sumner's, mine, and Horwitz's) this was a bad thing.

However, I think all of us agree that the reason the decrease in nominal income is a bad thing is closely related to the theory that it must have been caused by an imbalance between the quantity of money and the demand to hold money. I think we all agree that if prices and wages fall enough, the real quantity of money, the real volumne of expenditures, real output, and employment can all recover with nominal income remaining at this low level. But that it would have been better if the nominal quantity of money had risen enough so that nominal income didn't fall, so that this deflation would have been unnecessary.

I think Horwitz, however, has mixed feelings about raising nominal income back up to where it was. I know I have mixed feelings about getting it back up to its past growth path. What should have happened is that the quantity of money should have increased to meet the demand so that nominal income didn't fall. Now that it has already fallen, what should happen?

And this relates to your comment about "some inflation being good." In reality, there hasn't been much price deflation. But, suppose there were. Is it better to raise prices back up to where they were? The quantity of money should have risen to meet the increase in money demand before nominal income or prices fell. But after the fact, is it better to reverse? Or is it just too late? Generally, I am more confortable with reversing changes in nominal income than prices, but if it isn't done promptly, at some point, it is just better to start again from where you are.

One final note. What is behind much of the heat in the discussion here is "free banking" vs. "100% reserve banking." Horwitz believe that if banks are free to adjust the amount of redeemable money they issue, then the quantity of money will adjust to meet the demand for money so that increases in the demand for money do not cause falling nominal income or deflation. I am not sure exactly why this will have the unintended consequence for nominal income consistent with the productivity norm.

In my view, one of the critics has been making a lot of really bad arguments--sort of obstinate refusals to understand what the demand for money means. Another critic has been making arguments that increases in the quantity of money always create malinvestments, regardless of what is happening to the demand for money. I disagree, but not inconsistent with basic monetary economics.

As for Rothbard, I don't agree with his bottom line policy view--no increase in the nominal quantity of money, beyond the increase in the quantity of gold, can ever possibly have any good consequence. That view, however, has nothing to do with failure to understand the meaning of the demand for money or the possibility of an excess demand for money. Rothbard undestood it. Mises played a key role in developing it. Too bad some of their more dogmatic followers can't understand it.

What Bill said. I will just note that the productivity norm idea does implies that a good banking system is one that ensures that M moves opposite to changes in V, which has the consequence of effectively "targeting" nominal income. So as factor productivity and output rise, prices should fall.

How fortunate we are to have these socialists running our lives for us.

Prof Horwitz doesn't like epithets.

Well I don't like having someone try to run my life for me and force their policies on me. If you want to live in a monetary commune, you may do so, with my blessing, and call it anything you want, for it's none of my business. But when you try to force it on me, I'll damn well tell you what I think of it. It's communism.


D.G.,

Your last comment betrays just how poorly you comprehend the position you are trying to argue against.

In short, in a free market for money and banking, issuers of money (primarily banks) *should* be free to create as much, or as little, money as they like. Since such banknotes would be liabilities, those who create too much money, (that is, go into too much debt!), will go out of business.

But you are saying that banks should not be able to go into more debt (i.e. create more money), even though they may be able to afford it. Why might they be able to afford more debt? Well, why might an individual be able to afford more debt? If creditors are calling in debt less frequently, then more debt can be taken while risk remains constant. In the case of new banknotes, any price-inflation created would be offset by the price-deflationary effects of greater bank deposits, i.e. savings.

There is an difference between increasing the money supply and increasing prices. It is possible to do the former while not doing the latter (though the composition of prices will change as spending shifts from consumer to investment goods).

The value of maintaining spending in this very specific instance, is that savings will are enabled to fund new investments. A massive increase in the demand for money without immediate prices adjustments, will temporarily put a significant portion of the increased savings to waste, since until prices fall there will be a glut of "idle resources".

I don't think any of this should happen by decree of some government. I am merely describing what I think would happen in a truly free market fro money and banking. I haven't read Rothbard on this issue, but from what I understand, he got this one very wrong.

Kelly,

You wrote,

"But you are saying that banks should not be able to go into more debt (i.e. create more money)"

This not the first time you have attributed that opinion to me, nor the first time I have tried to tell you that it was not my opinion.

This is my opinion, and I hope you'll get it straight this time, once and for all.

Let all different banking strategies compete on the free market, and to the winner go the spoils.

Tyler Cowen this morning asks, what is progressivism?

My answer:

"What is progressivism?

What is so complicated about it?

You either live and let live in the free market or herd others into your collective. And a collective by any other name is still a collective, a collectivist a collectivist, a liberal a fascist, and a moderate merely those who would only murder half the Jews in the world.

By the way, Greg, could you understand those last statements of Horwitz and Woolsey?

Of course not, and that's why you know they were wrong.

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