You can never reason from a price change without knowing the reason for the price change. 'When he price level increase', how? why?
We know that money demand is non constant. That just has to do with the flow of money. We know that base money is constant unless the central bank act. Thus causation goes from changing V or central bank action to changes in price or output.
It's true that why the price levels change can make a difference. What I wrote was meant as examples of the type of relations that are there.
You're still wrong or at least extremely misleading in your characterization of how the money supply behaves.
First of all, base money is really almost entirely an implementation detail of interbank settlement and decoupled from the real economy.[1] Because of that, the focus on base money is wrong-headed and you should look at broad money instead.
Broad money grows and shrinks almost entirely due to commercial bank lending and loan repayment. The central bank has no influence on that.
It is technically correct that base money can only be changed by central bank actions, but that is a somewhat misleading statement, because the focus should be on what the chains of causality are.
We've had a perfect experiment for that in the last few years due to quantitative easing. There, central banks tried to affect the real economy by being the initial cause of a change in the money supply. Well, they successfully raised the size of base money to totally unprecedented levels, but that had virtually no effect on the broader money levels, let alone on the real economy.
All other central bank actions that change the size of base money are actually done as a reaction to demand by commercial banks, which in turn is a consequence of commercial bank lending.
Because in any case, central banks haven't even usually targeted the size of the money supply as a matter of policy. The policy has been to target a level of interbank interest rate, and let the size of the base money supply go wherever it needed to in order to accommodate the interest rate.
And when central banks tried to target the money supply via quantitative easing, which was only tried when the interest rate was already effectively at 0, the evidence is that it had virtually no effect.
There is no causal chain in practice[2] that starts with the central bank deciding to change the size of the money supply and goes into changes in price or output.
[1] It's even decoupled from the major financial markets that people are usually interested in.
[2] Of course, in theory central banks could just go nuts and start targeting the money supply in crazy ways. But even in that case, they can't just decide to cut or grow the money supply arbitrarily (because they need to find a commercial bank counterparty for what they want to do). And further, due to the decoupling of base money and broader money, the causal chain would go mostly via the effect that the base money changes have on interest rates, which is a very different story from the one that you probably wanted to tell.
I agree that one usually looks at broad money, but this essentially all boils down to claims on base money.
It is my hole argument the bank system produces this money, and that a good montary system, including banks, optimally should pruce stability of nominal spending.
I think you are wrong about QE, if you look at NGDP you can see that the US went back to a stable growth after a while. Europe and others who did far less, never managed to do that and thus has a way worse recovery.
The Fed made a effort to make sure to prevent that money from getting out, paying interest on reserves, explicitly insuring everybody that they will not allow inflation over 2% and they did otherthings besides.
If you look at NGDP you see a big drop in 2008/2009 and then stady growth again. What they would have to do was go back to the pre crisis trendline, and they refused to do so explicitly.
The Fed targets price level, not interest rates, interest rates are just the policy rate of choice. A inflation target is just a perticular form of demand side target, NGDP is another, superior demand side target.
The liquidity trap idea is flawed because if you take the argument to its logical conclusion the Fed could buy all the worlds debt without it impacting the domestic price level.
If you look broader then the US you will see that the idea of the liquidity trap has essentially been demolished, multible countries easly expanded on zero rates. Switzerland did it for example.
The problem is not that there is a real effect, the prolem is that modern central banker only know how to deal with interest rates based models, and consider everything else 'unconventional'. Most of these things simply are not 'unconventional', the are traditional instruments that central banks have used for 100s of years.
I would also say that the interest rate is not the only transition mechanism, and not the one monetarists focus on.
Why do you believe that the difference between the developments in the US and Europe is explained by different central bank behavior, when there is also a huge difference in effective fiscal policy behavior that is consistent with the difference in outcome?
You're right though that central banks really target inflation. Inflation -> Interest rate -> Market transactions.
If you look broader then the US you will see that the idea of the liquidity trap has essentially been demolished, multible countries easly expanded on zero rates. Switzerland did it for example.
The talk about a liquidity trap doesn't actually say that growth is impossible at an interest rate of zero. What it does say is that if you're at an interest rate of zero without growth, the usual monetary theory policy prescription of "just decrease the interest rate" doesn't work. I wouldn't say that that's discredited just yet, even though some central banks have started to implement mildly negative interest rates.
The proof of the pudding would be if a country implemented significantly negative interest rates, but that would force commercial banks to charge negative interest rates on regular bank accounts, and nobody wants to go there (for good reason IMO - messing with institutions like that is not something you do lightly).
I would also say that the interest rate is not the only transition mechanism, and not the one monetarists focus on.
Can you explain that? So far, whenever I've talked to people about this issue, they usually don't come up with any alternative transmission mechanisms at all (i.e. it's all hand-waving and fuzziness/buzzwords), or ones that actually misunderstand what's going on (e.g. confusing open market operations, which are asset neutral, with "helicopter drops" that are basically fiscal policy in disguise).
Since this is a old thread now, I will not spend to much time.
> Why do you believe that the difference between the developments in the US and Europe is explained by different central bank behavior, when there is also a huge difference in effective fiscal policy behavior that is consistent with the difference in outcome?
Because the US had both expansion and contraction in fiscal policy, and growth was not infected. New Keynesian predicted the 'fiscal cliff' in 2013 and monetarist said it would not have any effect.
You can also look at some of the smaller similar economies in Europe that are inside and outside of the Euro. Generally the fiscal policy is not that different, but the countries outside of the Euro generally do better if they had expansionary monetary policy.
I think we're getting into a region of subtlety where we'd have to actually look at data. I have no idea which countries you're referring to specifically, for example.
On the "hot-potato effect", I found this part of the linked article quite funny:
> Notice that so far these changes can be fully explained using the basic principles of microeconomics. There is no need to resort to “transmission mechanisms” such as interest rates. Just S&D.
Well, how does the author think that the "transmission mechanism" of interest rates is supposed to work? By the basic principles of microeconomics, supply and demand! The price of money is the interest rate.
And yes, so far as banks trade financial assets with each other in exchange for reserves, there can be an effect on asset prices. But asset prices are basically an inverse of the interest rate; in particular, when you look at the bond market, long term bond prices are an inverse of long-term interest rates.
Indeed, when you look at quantitative easing, it did have the effect of pushing the long-term interest rate even further down, which is equivalent to pushing asset prices up.
So yes, the transmission mechanism is the interest rate. The article pretends to disagree with that, but it really doesn't. Instead, it just explains it in more detail, but without being aware of the connection. Of course, there's nothing wrong with explaining things in more detail.
There are two points where I believe the article is wrong. The first is a minor point, namely where it says there can be a (direct) effect on output. Since reserves aren't used for transactions in the real economy, that's not possible.
The second is quite a bit more important. The article starts its analogy with a scenario where new gold deposits are discovered, i.e. the increase in gold is a purely exogenous event.
Base money increases are never purely exogenous events. Of course it might start with a central bank policy decision (although more often than not it starts with a commercial bank decision!), but even in that case, the central bank can only increase the level of base money if it finds a willing commercial bank as a counterparty to a trade. So the "hot-potato effect" is necessarily weaker than in the case of newly found gold deposits. The analogy with gold is not ideal and could be misleading your intuition.
You can never reason from a price change without knowing the reason for the price change. 'When he price level increase', how? why?
We know that money demand is non constant. That just has to do with the flow of money. We know that base money is constant unless the central bank act. Thus causation goes from changing V or central bank action to changes in price or output.