I do wonder about the size of the Fed's balance sheet, and how much IOER should be paid.
There are practical realities, such as the Congress will never balance the budget.
Some nations build central bank balance sheets, and seem to prosper, such as Japan and more recently Indonesia.
Japan taxpayers owe money to themselves, as the Bank of Japan owns half of JGBs outstanding. Yields on 10-year JGBs are well below 10-year US Treasuries.
I suspect the Fed should build a larger balance sheet, to avoid over-leveraged US taxpayers.
Another oddity is that central banks followed the establishment of fractional banks. So, central banks glommed onto the existing fractional banking system to make monetary policy. With some help from Rube Goldberg.
But regulated fractional banks look likely to become a shrinking part of the financial landscape in coming years.
AI version:
"Yes, stablecoins have the potential to significantly reduce deposits in commercial banks, with estimations indicating that up to $6 trillion in U.S. bank deposits could migrate to stablecoins under certain regulatory outcomes. Bank of America CEO Brian Moynihan and other industry leaders have warned that if stablecoins are allowed to offer competitive yields (interest) to holders, they could drain 30% to 35% of total U.S. commercial bank deposits."
QE strikes me as the better option, to avoid over-leveraging of taxpayers and to prevent a suffocation of the economy.
But there is substantial definition of V: the amount of money transaccions in a period. Otherwise there is nothing to “understand”. I would say that velocity from the perspective of a bank is “payments/deposits”.
Long time readers know that I find debates over semantics to be stupid and tiresome, but I agree that people define velocity in different ways. I will say that my definition is the one that is almost always used when people publish data on velocity over time, for instance at a data site like FRED:
I don’t think this is semantic. Velocity is first an economic concept, then a ratio. In fact between central bank money and NGDP there are two multipliers: the banking system makes deposits out of high powered money (the bank multiplier) and then the public makes transactions by using deposits to make payments (the proper velocity).
The majority of payments become NGDP: when you buy things produced in US in the same year), but people using money to buy foreing goods or used cars are not making NGDP, while my understanding is that their transactions are part of money velocity.
Hmm, you say it's not semantic, and then disagree about the definition in the link I provided. Saying I'm using the wrong definition is exactly what the term "semantic" means.
This is a waste of time.
Here's what FRED says:
"Velocity is a ratio of nominal GDP to a measure of the money supply (M1 or M2). It can be thought of as the rate of turnover in the money supply--that is, the number of times one dollar is used to purchase final goods and services included in GDP."
But that is the problem! What about dollars not used to buy/sell goods that are GDP?
The fact that you have two sides (money transactions) and GDP (value creation) is what makes the concept useful. There is a complex dynamics on bank multipliers and velocity.
The concept of the “velocity of circulation” of money was used in the XVIII century monetary debates, far before GDP. Petty and Hume were prolífic users, before GDP was even considered, and the concept in its classic aception was used by Allais, perhaps contributing to add confusion to the field.
In fact, the first thing I did when I had my first bank statement in Excel was to compute my own “money velocity”, that being young and overpaid was obviouly too high…
All fair - in my macro courses in the mid-80s, my profs insisted that sustained budget deficits should increase aggregate demand but may crowd out investment. We did not talk much about whether it might crowd out consumption, presumably because the increase in G was not offset by taxes which might have reduced consumption. A lot obviously depends on what central banks are doing at the same time.
Oh, yes, they do! Will take more time to digest, but just the first two already put in sharp focus things that were fuzzy for me before:
> Real shocks do not cause big jumps in unemployment. Period, end of story. Even I’m surprised by this fact, but it is evidently true.
Accompanied with two extremely convincing graphs (and I guess COVID is a good example of a magnitude of a real shock that does cause a jump).
> But imagine a kingdom where for some strange reason people made contracts to supply 100 “units of wheat” 12 months in the future, where units were left unspecified.
And the reason for stickiness of prices is immediately clear!
Thank you very much for the pointer (and for writing those articles in the first place, obviously!)
I'm curious, you keep returning to the theme that "reasoning from a quantity change" is bad. Is there some underlying principle here that is applicable past just economics? Or is the rationale fundamentally about these intersections-of-opposite-sloping-curves that seem to mostly happen in economics where you can interpret anything two ways.
It depends how broadly you define "economics". Does it include sociology? How about never reason from a prison population change? You might have more people in prison because you've become tougher on crime, or because you've become less tough, causing the crime rate to soar.
The exogenous/endogenous distinction seems appropriate here.
What would be the closest to those three chapters in our actual world? I skimmed through the Midas Paradox and the Money Illusion, and while some ideas intuitively made sense to me (NGDP driving business cycle, markets for financial assets as indicators of monetary policy), I must confess that many specifics went over my head (how we _actually_ measure NGDP? How close our measurement is to reality?), and I also failed to get a coherent big picture of how things work. (My level of knowledge is roughly https://www.core-econ.org/project/core-the-economy/)
Fantastic summary, Professor Sumner. Have you ever considered writing a very short economics book for high-school students? (Speaking as a parent of one!)
i suppose increase/decrease in money supply equals same increase/decrease in nominal spending. So, central bank determines level of nominal spending/ngdp.
That I spent too much time studying fiscal levers for macroeconomic policy and not enough attention to the monetary side? I think it's easier for lay undergraduates (and my university econ went no further than intermediate micro and macro) to understand how changes in C, G, S and T affect growth and trade; monetary policy is more abstract.
However, the assumption that demand for the non-currency component of the monetary base is low and stable becomes false the moment you refuse to bailout an institution that is too big too fail.
When you talk about how your approach involves simplifying, one thing that comes to mind is that above you say monetary policy determines NGDP. I feel like we've had at least one back and forth about how monetary policy controls expected NGDP, but it doesn't necessarily control realized NGDP. Maybe you could argue that they do under an NGDP level targeting framework. But then it becomes a question of like "what does this really mean". So simplifying, for me, sometimes open up more questions than answers.
Part of the difficulty is that your approach is spelled out in hundreds of blog posts, tens of papers, and a few books. Most of your posts, at least, are using your framework to analyze something that is happening in the world or critiquing how others are thinking about what is happening. That's very helpful, but even when you describe parts of your approach in more detail I'm not aware of a single place where it's all together, especially not in a way where you can regularly point to it and say this is where my approach/framework is collected.
I understand part of the hesitation. 1. it's a lot of work, and 2. a lot of what you do is more verbal than mathematical. That gives you some freedom in explaining things that something like a simple NK model modified such that the central bank follows an NGDP level targeting framework (which I think Beckworth or others have done). But it also is harder to say "this is exactly what I mean".
It's sort of like when fans of free will criticize determinism by pointing out that some things are random due to quantum mechanics. Yes, but is random the same as free will?
Yes, you are only controlling the expected NGDP, but that still leaves no room for fiscal, trade, financial, etc., to influence NGDP in a systematic fashion.
Aggregate Demand equals [consumption plus investment plus government spending] equals Gross Domestic Product equals [money supply times velocity of money] equals price times output?
Seriously, items joined/separated by an equals sign should indeed actually be equal - no mention of savings. Also, what student can explain the relevance of GDP to real life?
Seems right to me, NGDP should be targeted.
I do wonder about the size of the Fed's balance sheet, and how much IOER should be paid.
There are practical realities, such as the Congress will never balance the budget.
Some nations build central bank balance sheets, and seem to prosper, such as Japan and more recently Indonesia.
Japan taxpayers owe money to themselves, as the Bank of Japan owns half of JGBs outstanding. Yields on 10-year JGBs are well below 10-year US Treasuries.
I suspect the Fed should build a larger balance sheet, to avoid over-leveraged US taxpayers.
Another oddity is that central banks followed the establishment of fractional banks. So, central banks glommed onto the existing fractional banking system to make monetary policy. With some help from Rube Goldberg.
But regulated fractional banks look likely to become a shrinking part of the financial landscape in coming years.
AI version:
"Yes, stablecoins have the potential to significantly reduce deposits in commercial banks, with estimations indicating that up to $6 trillion in U.S. bank deposits could migrate to stablecoins under certain regulatory outcomes. Bank of America CEO Brian Moynihan and other industry leaders have warned that if stablecoins are allowed to offer competitive yields (interest) to holders, they could drain 30% to 35% of total U.S. commercial bank deposits."
QE strikes me as the better option, to avoid over-leveraging of taxpayers and to prevent a suffocation of the economy.
Plus, wipe out all property zoning.
"Monetary policy and NGDP have almost no effect on long run economic growth."
Doesn't the Fed have the ability to constrict real output through too-tight monetary policy? For years on end?
Are you defining "the long run" as long enough that prices would adjust downward and real output would resume growing?
"Are you defining "the long run" as long enough that prices would adjust downward and real output would resume growing?"
Yes.
They do not understand it, because it is false.
Not all monetary transaccions are part of GDP. People buying/selling a house produced 10 years ago are part of MV, but not of GDP, nor PY.
The versions used in textbooks are generally identities, in which case it cannot possible be false. Thus textbooks define V as:
V = P*Y/M
But there is substantial definition of V: the amount of money transaccions in a period. Otherwise there is nothing to “understand”. I would say that velocity from the perspective of a bank is “payments/deposits”.
Long time readers know that I find debates over semantics to be stupid and tiresome, but I agree that people define velocity in different ways. I will say that my definition is the one that is almost always used when people publish data on velocity over time, for instance at a data site like FRED:
https://fred.stlouisfed.org/categories/32242
I don’t think this is semantic. Velocity is first an economic concept, then a ratio. In fact between central bank money and NGDP there are two multipliers: the banking system makes deposits out of high powered money (the bank multiplier) and then the public makes transactions by using deposits to make payments (the proper velocity).
The majority of payments become NGDP: when you buy things produced in US in the same year), but people using money to buy foreing goods or used cars are not making NGDP, while my understanding is that their transactions are part of money velocity.
Hmm, you say it's not semantic, and then disagree about the definition in the link I provided. Saying I'm using the wrong definition is exactly what the term "semantic" means.
This is a waste of time.
Here's what FRED says:
"Velocity is a ratio of nominal GDP to a measure of the money supply (M1 or M2). It can be thought of as the rate of turnover in the money supply--that is, the number of times one dollar is used to purchase final goods and services included in GDP."
But that is the problem! What about dollars not used to buy/sell goods that are GDP?
The fact that you have two sides (money transactions) and GDP (value creation) is what makes the concept useful. There is a complex dynamics on bank multipliers and velocity.
The concept of the “velocity of circulation” of money was used in the XVIII century monetary debates, far before GDP. Petty and Hume were prolífic users, before GDP was even considered, and the concept in its classic aception was used by Allais, perhaps contributing to add confusion to the field.
In fact, the first thing I did when I had my first bank statement in Excel was to compute my own “money velocity”, that being young and overpaid was obviouly too high…
Yes, just as the term "gay" meant one thing in the 1890s and something very different in the 1990s. Meanings change over time.
Maybe the reason NGDP targeting never gets a shot is because some people benefit from booms and busts.
I doubt that. It's pretty clear to me that the Fed regrets its mistakes.
Y = C + I - (G + T) Production minus State Depredation
All fair - in my macro courses in the mid-80s, my profs insisted that sustained budget deficits should increase aggregate demand but may crowd out investment. We did not talk much about whether it might crowd out consumption, presumably because the increase in G was not offset by taxes which might have reduced consumption. A lot obviously depends on what central banks are doing at the same time.
Oh, yes, they do! Will take more time to digest, but just the first two already put in sharp focus things that were fuzzy for me before:
> Real shocks do not cause big jumps in unemployment. Period, end of story. Even I’m surprised by this fact, but it is evidently true.
Accompanied with two extremely convincing graphs (and I guess COVID is a good example of a magnitude of a real shock that does cause a jump).
> But imagine a kingdom where for some strange reason people made contracts to supply 100 “units of wheat” 12 months in the future, where units were left unspecified.
And the reason for stickiness of prices is immediately clear!
Thank you very much for the pointer (and for writing those articles in the first place, obviously!)
Thanks, glad you liked it.
I'm curious, you keep returning to the theme that "reasoning from a quantity change" is bad. Is there some underlying principle here that is applicable past just economics? Or is the rationale fundamentally about these intersections-of-opposite-sloping-curves that seem to mostly happen in economics where you can interpret anything two ways.
It depends how broadly you define "economics". Does it include sociology? How about never reason from a prison population change? You might have more people in prison because you've become tougher on crime, or because you've become less tough, causing the crime rate to soar.
The exogenous/endogenous distinction seems appropriate here.
> In a perfect world […] 3 chapters on macro
What would be the closest to those three chapters in our actual world? I skimmed through the Midas Paradox and the Money Illusion, and while some ideas intuitively made sense to me (NGDP driving business cycle, markets for financial assets as indicators of monetary policy), I must confess that many specifics went over my head (how we _actually_ measure NGDP? How close our measurement is to reality?), and I also failed to get a coherent big picture of how things work. (My level of knowledge is roughly https://www.core-econ.org/project/core-the-economy/)
Perhaps these posts would help?
https://www.themoneyillusion.com/short-intro-course-on-money/
Fantastic summary, Professor Sumner. Have you ever considered writing a very short economics book for high-school students? (Speaking as a parent of one!)
Unfortunately, I'm retired from writing books. The one's I wrote previously did not do well.
i suppose increase/decrease in money supply equals same increase/decrease in nominal spending. So, central bank determines level of nominal spending/ngdp.
They are only equal when velocity is constant. But velocity usually changes over time and the supply of money needs to offset those changes.
I understood your elegant equation immediately.
But I always thought I was 1 in a million like my Ma always insisted
All my commenters are special. :)
That I spent too much time studying fiscal levers for macroeconomic policy and not enough attention to the monetary side? I think it's easier for lay undergraduates (and my university econ went no further than intermediate micro and macro) to understand how changes in C, G, S and T affect growth and trade; monetary policy is more abstract.
I'd say it's easier for a lay person to THINK they understand AD = C + I + G.
But does more G make AD go up, or does it make C + I go down?
According to the outline of your macroeconomics course it would depend on the monetary policy and specifically the change in nominal income
Correction:
According to your fundamental equation, cetirus paribus, C and or I will go down
I enjoyed the podcast.
However, the assumption that demand for the non-currency component of the monetary base is low and stable becomes false the moment you refuse to bailout an institution that is too big too fail.
That's possible, it depends on the situation. In any case, that scenario is not likely to occur under NGDP level targeting.
When you talk about how your approach involves simplifying, one thing that comes to mind is that above you say monetary policy determines NGDP. I feel like we've had at least one back and forth about how monetary policy controls expected NGDP, but it doesn't necessarily control realized NGDP. Maybe you could argue that they do under an NGDP level targeting framework. But then it becomes a question of like "what does this really mean". So simplifying, for me, sometimes open up more questions than answers.
Part of the difficulty is that your approach is spelled out in hundreds of blog posts, tens of papers, and a few books. Most of your posts, at least, are using your framework to analyze something that is happening in the world or critiquing how others are thinking about what is happening. That's very helpful, but even when you describe parts of your approach in more detail I'm not aware of a single place where it's all together, especially not in a way where you can regularly point to it and say this is where my approach/framework is collected.
I understand part of the hesitation. 1. it's a lot of work, and 2. a lot of what you do is more verbal than mathematical. That gives you some freedom in explaining things that something like a simple NK model modified such that the central bank follows an NGDP level targeting framework (which I think Beckworth or others have done). But it also is harder to say "this is exactly what I mean".
It's sort of like when fans of free will criticize determinism by pointing out that some things are random due to quantum mechanics. Yes, but is random the same as free will?
Yes, you are only controlling the expected NGDP, but that still leaves no room for fiscal, trade, financial, etc., to influence NGDP in a systematic fashion.
As a fan of free will I endorse Bohmian mechanics, but also substance dualism
Aggregate Demand equals [consumption plus investment plus government spending] equals Gross Domestic Product equals [money supply times velocity of money] equals price times output?
Yes, that's the equation. But what does it imply?
Seriously, items joined/separated by an equals sign should indeed actually be equal - no mention of savings. Also, what student can explain the relevance of GDP to real life?