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Grasping Reality with Both Hands The Semi-Daily Journal of Economist J. Bradford DeLong: Fair, Balanced, RealityBased, and Even-Handed Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; delong@econ.berkeley.edu.

Economics 210a Weblog Archives DeLong Hot on Google DeLong Hot on Google Blogsearch September 30, 2010

What Is This "Demand for Money" of Which You Speak?

If our big macroeconomic problem of deficient demand for currentlyproduced goods and services were the result of a deficient supply of liquid cash money--the stuff you keep in your pockets and use for clearing and functions as a medium of exchange--then the prices of all alternatives to money would be very low: people would be trying to dump their holdings of other assets to build up their stocks of liquid cash money, and only very low prices of and very high expected rates of return on those alternatives could check that desire. Thus we would expect a downturn caused by a shortage of liquid cash money to be accompanied by very high interest rates on, say, government bonds--which share the safety characteristics of money and serve also as savings vehicles to carry purchasing power forward into the future, but which are not liquid cash media of exchange.

Nevertheless, David Beckworth writes: Macro and Other Market Musings: Martin Wolf, the Paradox of Thrift, and the Excess Demand for Money: Martin Wolf concludes more borrowing may be just what the economy currently needs.... [His] paradox of thrift idea is really nothing

http://delong.typepad.com/sdj/2010/09/what-is-this-demand-for-money-of-which-you-speak.html

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more than another way of saying there is a monetary disequilibrium created by an excess demand for money. And, of course, an excess demand for money is best solved by increasing the quantity of money. The painful alternative is to let the excess money demand lead to a decline in total current dollar spending and deflation until money demand equals money supply... the paradox of thrift requires the Fed to be asleep on the job.

Let me explain why the Paradox of Thrift is really just an excess demand for money problem.... [I]ndividual households can save... by cutting back on consumer spending and hoarding money... by spending income on stocks, bonds, or real estate and... by paying down debt.... [I]ncreas[ing] their holdings of money by cutting back on expenditures... will create an excess demand for it and a painful adjustment process will occur. If, on the other hand, the Fed adjusts the money supply to match the increased money demand then the painful adjustment is avoided.... In the latter two cases where assets are bought and debt is paid down the money is passed on to the seller of the assets or to the creditor. Here, the only way to generate the painful adjustment is for the seller or creditor--or any other party down the money exchange line--to hoard the money. If the creditor or seller does not hoard the money then it continues to support spending and price stability. All is well. Increased austerity, then, only becomes an economy-wide problem when it leads to an excess demand for money.... The fundamental proposition of monetary theory is that an individual household can adjust its money stock to the amount demanded, but the economy as a whole cannot...

The hole in David's argument is, I think, where he says "the Fed adjusts the money supply" without saying how. Suppose that we have a situation--like we have today-where people are trying to cut back on their expenditure on currently-produced goods and services in order to build up their stocks of safe assets: places where they can park their wealth and be confident it will not melt away when their back is turned. They switch spending away from currently-produced goods and services and try to build up their stocks of safe assets--extremely senior and well-collateralized private bonds, government securities, and liquid cash money. Now suppose that the Federal Reserve increases the money supply by buying government securities for cash. It has altered the supply of money, yes. But it interest rates are already very low on short-term government paper--if the value of money comes not from its liquidity but from its safety--then households and businesses will still feel themselves short of safe assets and still cut back on their spending on currently-produced goods and services and the expansion of the money supply will have no effect on anything. The rise in the money stock will be offset by a fall in velocity. The transactions-fueling balances of the economy will not change because the extra money created by the Federal Reserve will be sopped up by an additional precautionary demand for money induced by the fall in the stock of the other safe assets that households and businesses wanted to hold.

So, yes, Beckworth is right in saying that there is an excess demand for money. But he is wrong in saying that the Federal Reserve can resolve it easily by merely "adjust[ing] the money supply. The problem is that--when the underlying problem is that the fullemployment planned demand for safe assets is greater than the supply--each increase in the money supply created by open-market operations is offset by an equal increase in money demand as people who used to hold government bonds as their safe assets find that they have been taken away and increase their demand for liquid cash money to hold as a safe asset instead.

Increasing the money supply can help--but only if the Federal Reserve does it without http://delong.typepad.com/sdj/2010/09/what-is-this-demand-for-money-of-which-you-speak.html

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its policies keeping the supply of safe assets constant. Print up some extra cash and have the government spend it. Drop extra cash from helicopters. Have the government spend and. by borrowing to finance it, create additional safe assets in the form of additional government debt. Guarantee private bonds and make them safe. Conduct open market operations not in short-term safe Treasuries but in other, risky assets and so have your open market operations not hold the economy's stock of safe assets constant but increase it instead.

These are all ways of increasing the money supply or of decreasing the effective demand for money by shifting some of the precautionary demand for money-not-asliquid-but-as-safe-asset over to newly-created other safe assets.

These are all ways that ought to work, the Lord willing and the creek don't rise.

But to say that the problem is an excess demand for money is, I think, misleading, for it suggests that the standard way of increasing the money stock--open market operations that swap liquid cash for other assets while holding the total stock of safe assets in the economy constant--will also work. And by this point I think we have a bunch of evidence that it does not.

And to describe these other policy moves--printing up some extra cash and having the government spend it; dropping extra cash from helicopters; having the government spend and. by borrowing to finance it, create additional safe assets in the form of additional government debt; guaranteeing private bonds and making them safe; conducting open market operations not in short-term safe Treasuries but in other, risky assets and so having your open market operations not hold the economy's stock of safe assets constant but increase it instead--as "monetary policy" seems likely to me to add to the general confusion. When the excess demand for liquid cash money is itself the result of a spillover from a more fundamental excess of (planned) savings over investment or of (planned) safe asset holdings over supply, standard open market operations that are designed to hold the stock of safe assets and the stock of savings vehicles constant are unlikely to work. And when Federal Reserve monetary expansions do work, it is likely to be because they not only increased the supply of money but more important increased the supply of safe assets or increased the supply of savings vehicles.

The point, I think, is that liquid cash money is not only a medium of exchange but it is also a store of value--a savings vehicle--and a hedge--a place of safety that you hold in your portfolio to satisfy your precautionary demand, and so the transactions demand for money is only part of the whole. But because other assets are stores of value and hedges a well, to focus exclusively on the supply and demand for money is to miss much of the action in times like these.

I am still frustrated that all of this seems so clear to me and is to opaque to so many other smart people. Personally, I blame Olivier Blanchard for making us spend three weeks on Lloyd Metzler's "Wealth, Saving, and the Rate of Interest" in my first year of graduate school...

UPDATE: Nick Rowe comments on David Beckworth: Yes! There is no paradox of thrift. There is a paradox of hoarding the medium of exchange. That's because there are two ways to buy more money: sell more other things; buy less other things. One of those two options is always open to the individual, but not to everyone.

http://delong.typepad.com/sdj/2010/09/what-is-this-demand-for-money-of-which-you-speak.html

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The only case where Say's Law is wrong is when there is an excess demand (or supply) of money, the medium of exchange.

Could I make Nick Rowe happy by saying that there is too a "paradox of thrift," in this sense: When there is an excess of (planned) savings over investment, savers will be unable to find enough bonds to satisfy their demand and will park the excess demand in liquid cash money instead, which they will hoard. They will thus diminish the supply of money available to meet the transactions demand for money and that imbalance creates the excess demand that breaks Say's Law. Thus even though the problem as an excess demand for money, standard open-market operations will not resolve it: they will increase the money supply, yes, but by diminishing the supply of other savings vehicles they will also increase the amount of the money stock not available for transactions purposes because it is being held as a savings (or a safety) vehicle ?

Does that make anything clear, or just deepen the darkness?

Brad DeLong on September 30, 2010 at 10:01 AM in Economics, Economics: Federal Reserve | Permalink Favorite

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Comments Joe Gagnon said...

Hi Brad, Good column. I agree with the substance of your analysis. But to continue a terminological debate we had about 6 months ago, I would like to propose defining monetary policy as printing money to buy assets and fiscal policy as selling assets to buy goods or make transfers. Thus, helicopter drops are just monetary + fiscal policy.

Away from the zero bound, monetary policy can stick to buying safe short-term assets because money yields zero and all other assets have a positive yield. At the zero bound, as you note, for monetary policy to have any effect it must buy other types of assets that do not have zero yield. But in both regimes the way monetary policy works is by pushing down the rates of return on financial assets. That is quite distinct from fiscal policy which works by increasing demand directly, albeit at the expense of higher rates

http://delong.typepad.com/sdj/2010/09/what-is-this-demand-for-money-of-which-you-speak.html

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of return on financial assets. And of course, helicopter drops increase demand directly without increasing rates of return on financial assets.

Reply September 30, 2010 at 12:54 PM Bob Athay said... > Does that make anything clear, or just deepen the darkness? *I* think so, but I've been following your blog on a daily basis for some time now.

With enough repetition, even quantum mechanics starts to become intuitive. No kidding. So does underwater acoustics, combinatorial optimization, integrated circuit manufacturing and a bunch of other things that are a lot more arcane than anything you've posted here. So far, so good...

By the way, how's your book coming?

Reply September 30, 2010 at 12:55 PM GS said...

Great column. But is that an endorsement of Metzler's work or not?

Reply September 30, 2010 at 01:47 PM Bernard Yomtov said...

"Does that make anything clear, or just deepen the darkness?"

I go for (a).

Reply September 30, 2010 at 02:10 PM jcb said...

Deepens the darkness for me, I'm afraid.

Most families are consuming less and trying to pay off debt. How does that translate into any incentive to "hoard money" or search for safe assets? You are talking mostly about the relatively few wealthy individuals and institutions that have no place to park money in excess of their own consumption. I suspect that the recent increased rate of savings largely pertains to them -- and that they formerly spent the money they now hoard as safe assets, in part, by inflating the bubble that has recently burst (a practice formerly know as "investing").

Your whole discussion seems to monetarize the meaning fiscal policy. So, more money is circulated; so, more safe assets are created. So what? It's the distribution that counts, and the demand that is created. Otherwise, these policy prescriptions seem simply to shift greater quantities of liquid and safe assets into different accounts in different banks.

Your fallback position seems to accept the impossibility of more direct deficit spending to produce jobs and effective demand (instead of classes of "assets"). So, it's trickledown investment economics all over. Wasn't that TARP? Have I missed something?

Reply September 30, 2010 at 02:17 PM Too Much Fed said...

"They will thus diminish the supply of money available to meet the transactions demand for money and that imbalance creates the excess demand that breaks Say's Law." If "money" is currency or the demand deposits created from debt, is one solution to create more currency or create more debt?

Since the fed believes that most if not all shocks are aggregate demand, do they choose

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to lower interest rate(s) to create more demand deposits from more debt?

If there is an aggregate supply shock, should the fed price inflate with currency?

Reply September 30, 2010 at 02:19 PM Min said...

"If our big macroeconomic problem of deficient demand for currently-produced goods and services were the result of a deficient supply of liquid cash money--the stuff you keep in your pockets and use for clearing and functions as a medium of exchange-then the prices of all alternatives to money would be very low: people would be trying to dump their holdings of other assets to build up their stocks of liquid cash money, and only very low prices of and very high expected rates of return on those alternatives could check that desire."

But what if the people who do not have enough liquid cash also do not have other assets to dump for money? The recession officially ended over a year ago, yet unemployment continues to be high and poverty is growing. Does that not indicate a two-tier or multi-tier economy? The people towards the top are not generating enough demand by themselves, but not from their own lack of liquidity. The need for cash is elsewhere, at the bottom. If more people were employed and out of poverty, they would spend money, if only because they need to.

Reply September 30, 2010 at 02:41 PM Nick Rowe said...

There's not much difference between us.

"When there is an excess of (planned) savings over investment, savers will be unable to find enough bonds to satisfy their demand and will park the excess demand in liquid cash money instead, which they will hoard. They will thus diminish the supply of money available to meet the transactions demand for money and that imbalance creates the excess demand that breaks Say's Law." I basically agree with that. I would just say it a little differently. The *proximate* cause of a violation of Say's Law is always an excess demand for the medium of exchange. An excess demand for any other non-newly produced good, like bonds, land (Keynes was wrong when arguing with Gessell), or antique furniture, cannot cause a general glut, *unless* it spillsover into an excess demand for the medium of exchange (which it may do).

"Thus even though the problem as an excess demand for money, standard openmarket operations will not resolve it: they will increase the money supply, yes, but by diminishing the supply of other savings vehicles they will also increase the amount of the money stock not available for transactions purposes because it is being held as a savings (or a safety) vehicle" In "normal" times, an increased supply of money, no matter how it's brought about, will solve the problem, by eliminating the excess demand for money. But right now, in this particular recession, you may very well be right, in that a purely *temporary* Open Market Operation in money and Tbills will have little or no effect, for the very reasons you describe. But I would just describe it differently, by saying that a reduction in the supply of Tbills may cause an increase in the demand for money. Which is one of the reasons I would want some more radical monetary policy, so that the demand for money would actually fall when the Fed increased the supply.

(As an aside, I'm also worried that Tbills may actually have become money, in the literal sense of being used as a medium of exchange, but I'm still trying to get my head http://delong.typepad.com/sdj/2010/09/what-is-this-demand-for-money-of-which-you-speak.html

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fully around that.)

We just have to remember: recessions are always and everywhere a monetary (medium of exchange) phenomenon!

Reply September 30, 2010 at 02:48 PM David Beckworth said...

Brad, Those are fair points and I agree that something beyond a standard OMO is needed to alleviate this excess money demand. I should have been more explicit on this point in my original post. Thanks for being so civil in applying the famed Brad DeLong Smackdown on me!

Reply September 30, 2010 at 03:00 PM Brad DeLong said in reply to Nick Rowe...

Re: Nick Rowe: I would just describe it differently, by saying that a reduction in the supply of Tbills may cause an increase in the demand for money. Which is one of the reasons I would want some more radical monetary policy, so that the demand for money would actually fall when the Fed increased the supply...

And I would then say that a whole bunch of things--having the government spend and. by borrowing to finance it, creating additional safe assets in the form of additional government debt; guaranteeing private bonds and making them safe assets; etc.--that dont look like monetary policy also reduce demand for money right now, and so are much more effective in circumstances like this (and standard OMO much less) than Milton Friedmans standard strictures on the relative power of fiscal and monetary policy would suggest...

Reply September 30, 2010 at 03:44 PM Lord said...

I tend to distinguish these as excess demand as cause, due to fear for example, and excess demand as result, say of insufficient investment alternatives. The result is the same but the solution may not be due to the difficulty of addressing it.

Reply September 30, 2010 at 05:33 PM Ellen1910 said...

"I'm also worried that Tbills may actually have become money . . . ." Nick Rowe Everything has "become money," fool -- well, maybe not old Dutch masters. What do think credit default, interest rate, and currency swaps are there for, eh?

Reply September 30, 2010 at 05:58 PM TravisA said...

Brad, Do you consider 10 year or 30 year US govt bonds 'safe assets' in this situation? I really find it hard to believe that the desire to hold safe assets would remain constant if the Fed announced that it is going to buy $5 trillion of US govt debt.

It's really not that hard to cause inflation. There doesn't have to be any helicopter drops, govt spending, or purchase of risky assets. Just let the Fed set a public price level target and keep buying US govt bonds until the target is achieved. I am not sure why you and Krugman think that it is so complicated...

Reply September 30, 2010 at 06:09 PM Mr. E said in reply to David Beckworth...

He knows you are one of the good guys and amenable to reasonable back and forth. http://delong.typepad.com/sdj/2010/09/what-is-this-demand-for-money-of-which-you-speak.html

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I read your stuff all the time so maybe have a more detailed understanding of your entire idea that Brad does. Lets note for the record that you believe that all of the things Brad mentioned would be effective and that you've mentioned them as beneficial in other posts.

Reply September 30, 2010 at 08:18 PM Mr. E said in reply to Brad DeLong...

RE: spending and creating safe assets. Govt spending don't look like monetary policy because it is fiscal policy. This is one way to create more money - government spending Re: all the other ways you mentioned to create money. They are also fiscal policy. Just because they may be undertaken by the fed doesn't change the essential difference between these actions and traditional fed actions.

Traditional fed actions only impacts the relative price of various levels of liquidity.

During normal times, changing that price matters.

During times where short term interest rates are near zero, these actions have little impact when applied to the short end of the curve because the relative differen ce in both liquidity and the price of that liqidity is small.

But each of the other actions you named are fiscal policy.

1. Giving money away without getting anything in return (helicopter drop) 2. overpaying for assets (insuring non-government debt, presumably at no cost) 3. Buying other risky assets and issuing debt (straight fiscal policy) 4. Spending money without borrowing (even writing this! Bravo! Bravo!)

So lets just call it all fiscal policy, no matter who does it, because it all involves spending and not exchanging money for term money.

Now, to your point on "Store of Value". You need to be pounding the table that we should strive to make money a moderately poor store of value compared to other assets right now. You are, but in such a "professorly" way that Andrea Mitchell might not understand you the first time.

Why? 1. It seems quite clear to me that the unit of account and medium of exchange functions create the store of value property. Note we use paper and magnetic fields to represent money now - things without value - so the "value" part must result from the other properties of money. This is common to nearly everything - value results from other properties.

But unit of account and medium of exchange are what scoreboards do and trading does.

If "store of value" means "I can trade this for something valuable in the future" - and I think that it does - then why should the idea of a trading pit with a scoreboard attached be a better store of value than a physical car or factory?

We need to lower the price of money in assets, it is too dear. Until this is done, our economy will remain broken.

Reply September 30, 2010 at 09:16 PM Ralph Musgrave said...

DeLong claims in his first sentence that people short of cash will sell the nearest equivalent, e.g. bonds. The flaw here is that the large majority of those who are short of

http://delong.typepad.com/sdj/2010/09/what-is-this-demand-for-money-of-which-you-speak.html

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cash just don’t have bonds to sell. To illustrate, about 99% of U.K. national debt is in the hands of institutions, not individuals. And even to the extent that government bonds ARE in the hands of individuals, I guess these will mostly be high net worth individuals: not the sort of people who will cut their spending because of a mere credit crunch.

That is much the point made by JCB above, but I thought I’d put it in my words.

Reply October 01, 2010 at 02:55 AM StatsGuy said...

1) Yes to Joe Gagnon's observations. I have yet to read something he's written that I disagree with. Note that the real foes here, the pop-Austrians, no longer distinguish between Keynesians and Monetarists, or QE and printing physical currency.

2) I do wish the academic debate would move beyond the purely domestic policy questions and focus more on the questions that are driving the markets - which are international. What happens, for instance, when there is an exogenous fixed long term increase in demand for finite supply commodities/resources due to population/standard of living growth in developing countries? In such an environment, it seems that it's quite possible for pure QE (with long term but not permanent injections of money/credit) to generate inflation via commodity-driven carry trades even in a Keynesian model - it's simply not the kind of inflation we all want, nor does it necessarily support investment in value added economic activity. It does, however, create strong incentives to spend effort to redeploy commodities as economic stores of value.

Reply October 01, 2010 at 08:14 AM AuOso said...

So, who has some helicopters? We need to do something NOW. Reply October 01, 2010 at 02:28 PM Frank Moraes said...

I had to read this column a few times before I understood it. Part of this was due to my general lack of intelligence. Part of this was due to the material, which _was_ challenging--even, I suspect, for someone really smart. And part of this was due to your use of dashes.

I too am a lover of the dash; I use it all the time. And you are to be complimented for standing firm against the forces that would put spaces before and after the lovelies: the _New York Times_ comes to mind. However, I think maybe you're over-doing the dashes; commas are nice sometimes, too. This isn't a complaint--just something to consider.

Also, as much as I love the engine-caboose construct of "--," the properly typeset mdash has a poetry that makes my heart sing. You are thinking and writing and the double-hyphen just comes naturally. I understand. But is it really _that_ hard to type "& mdash;"? (Without the space.) Again, just a thought.

I hope you take these suggestions in the filial way in which they were intended--one (lesser) dash lover to another (greater).

PS: Comments don't allow _me_ to format my dashes as I would like.

Reply October 01, 2010 at 08:12 PM Don the libertarian Democrat said...

"Thus, helicopter drops are just monetary + fiscal policy." http://delong.typepad.com/sdj/2010/09/what-is-this-demand-for-money-of-which-you-speak.html

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That's called The Chicago Plan of 1933.

Reply October 01, 2010 at 09:14 PM The Money Demand blog said...

Short response: after Lehman the relative price of very safe but less liquid assets such as TIPS has crashed.

Long response here: http://themoneydemand.blogspot.com/2010/10/brad-delongand-flight-to-safety.html Reply October 02, 2010 at 07:03 AM Comment below or sign in with TypePad

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Me:

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