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It does matter how new money is injected, but that’s probably bad terminology

Scott Sumner, criticizing Sheldon Richman, writes,

The second assertion is odd, as the non-neutrality of money is probably the single most heavily researched question in all of macroeconomics.  So I am not quite sure why Richman considers it “overlooked.”

The other point is mostly inaccurate.  Consider the following four monetary policy injections, where fiscal policy is held constant in each case.

1.  Newly injected base money is used to buy T-bonds from banks.

2.  Newly injected base money is used to buy T-bonds from non-bank securities dealers.

3.  Newly injected base money is used to buy T-bonds from individuals at a special auction excluding bond dealers.

4.  Newly inject base money is used to pay the salaries of government workers, and as a result less money is borrowed by the Treasury.  The Treasury then creates and donates a T-bond to the Fed.

In all four cases the increase in the amount of base money is identical.  In all four cases within about one week the increase in currency held by the public and bank reserves is virtually identical.  In all four cases the impact on debt held by the public is identical.  Thus the impact on interest rates is virtually identical in each case.  In all four cases the impact on the purchasing power of various groups in society is virtually identical.  Bonds are purchased at market prices.  It simply doesn’t matter how the money is injected, if we assume a pure monetary policy with no change in fiscal policy.  Of course a “helicopter drop” is also a fiscal expansion, and hence would produce slightly different results.

I don’t know if this is what the Austrians actually believe, but Richman seems to be assuming that OMOs are gifts of purchasing power from the Fed to the recipients.  That is not true, the newly injected cash is sold at market prices, in exchange for Treasury debt.

Richman’s attack on Wall Street has strongly Rothbardian undertones that I don’t agree with. They color his presentation of the theory as happened with, well, Rothbard.

The idea that it matters how new money is injected relates to the way in which money “hits” the markets. For the “traditional” story to apply, the price of time -the interest rate- needs to move before other prices move. If it “hits” consumption goods (or some other vector of goods) first, the traditional ABCT story doesn’t apply, though something similar in substance might.

The simplest way to think about this is with Hayekian triangles. It’s a fairly simple question: can monetary policy disrupt the shape of the triangle in the way Garrison described via interest rates? I don’t see why this would be controversial. Some industries (and economic decisions generally) are more sensitive to interest rate changes than others. If you were at monetary equilibrium and you print money in such a way that causes interest rates to fall, then more resources get drawn into those industries than elsewhere. That is almost true by definition. If you assume heterogeneous interest rate sensitivity and that monetary policy can affect interest rates, then you get heterogeneous real effects.

A colleague of mine, Nicolas Cachanosky, is now working on seeing these effects in the data. It is a massive pain in the ass to get the data today for this. If that’s the case, I doubt that literature Sumner refers to is relevant for this particular flavor of “non-neutrality.” If it is, please let me know so I can pass the information along.

2 responses to “It does matter how new money is injected, but that’s probably bad terminology

  1. Joshua Wojnilower December 3, 2012 at 3:12 pm

    Nice response to Sumner. I provided a link to your post with further commentary on a modern money approach here:

    These effects from monetary policy are only one part of the story. Looking back at Ryan’s first paragraph above, a modern money perspective (is this better than saying Post-Keynesian?) may provide the “something similar in substance”. This view argues that fiscal policy is partially responsible for injecting money into the economy (“inside” money from private banks being the main source). Depending on the distribution, prices in certain industries may adjust before changes in interest rates. These industries will likely attract more resources temporarily due to changes in expected future demand. When the government reduces or stops supporting those industries, revealing the temporary nature of the demand, prices will tend to fall. In this light, fiscal policy that alters the money supply also creates real effects due to the misallocation of capital.

  2. Pingback: Advocates of Reason: 5 December 2012 | Economic Thought

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