In our previous discussion of Cantillon effects, I came across this post from Nick Rowe regarding the Hot Potato effect. This is good timing as we just had a recent debate over NGDPT again and what if anything is it
s Transmission Mechanism. Sumner and friends say it's the Hot Potato Effect.
http://diaryofarepublicanhater.blogspot.com/2013/08/then-how-do-you-explain-zimbabwe.html
Some argue whether or not this is a true TM. In any case, in this post by Nick I just came across, he argues that Keynesians-whether Old or New-don't get the HPE through their very faulty assmptions of people's knowledge:
"There is no monetary hot potato in standard Keynesian and New Keynesian models. That is because those models make wildly implausible assumptions about people's knowledge. They assume people have perfect knowledge about how much money everybody else is borrowing from the banking system, and how much they are planning to spend from what they borrow."
http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/10/wicksell-and-the-hot-potato.html
In the question of Cantillon effects Nick argued there are none as no matter who you give the money to it will end up in the bank. This piece of his can be read as what happens next.
"Let's consider an extremely simple monetary exchange economy. There are no commercial banks. A central bank chooses a rate of interest at which individuals can either borrow money from the central bank or lend money to the central bank, as they wish. A Wicksellian central bank with a horizontal LM curve. Most economists say that the stock of money is demand-determined under that assumption. I think they are wrong. There can be an excess supply of the stock of money. There can be a hot potato. The Law of Reflux, which says an excess supply of money must flow back to the central bank, is invalid, even in this case."
Of course, endogenous money proponents would argue that all the increase in money would do would be to increase bank reserves and they would surely not be surprised that in Nick's simple model there are no comerical banks.
"Market monetarists often attempt to bypass such discussions of banking by appealing to a ‘hot potato’ phenomenon, where an increase in the stock of money causes people to trade until a certain level of NGDP is realised. Yet this method of debate only deals with the opposing argument by assuming away banking and therefore their objections. As long as we acknowledge that we live in a world with banks, the hot potato idea is wrong. This was most comprehensively discussed by Scott Fulwiller, who pointed out that attempts to increase the quantity of money in circulation will simply end up increasing bank reserves."
http://www.pieria.co.uk/articles/examining_the_case_for_ngdp_targeting
Nick explains that in Keynesian models people are never suprised to have more money than they expected-thanks to an increase in money:
" People borrow money for two reasons:
s Transmission Mechanism. Sumner and friends say it's the Hot Potato Effect.
http://diaryofarepublicanhater.blogspot.com/2013/08/then-how-do-you-explain-zimbabwe.html
Some argue whether or not this is a true TM. In any case, in this post by Nick I just came across, he argues that Keynesians-whether Old or New-don't get the HPE through their very faulty assmptions of people's knowledge:
"There is no monetary hot potato in standard Keynesian and New Keynesian models. That is because those models make wildly implausible assumptions about people's knowledge. They assume people have perfect knowledge about how much money everybody else is borrowing from the banking system, and how much they are planning to spend from what they borrow."
http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/10/wicksell-and-the-hot-potato.html
In the question of Cantillon effects Nick argued there are none as no matter who you give the money to it will end up in the bank. This piece of his can be read as what happens next.
"Let's consider an extremely simple monetary exchange economy. There are no commercial banks. A central bank chooses a rate of interest at which individuals can either borrow money from the central bank or lend money to the central bank, as they wish. A Wicksellian central bank with a horizontal LM curve. Most economists say that the stock of money is demand-determined under that assumption. I think they are wrong. There can be an excess supply of the stock of money. There can be a hot potato. The Law of Reflux, which says an excess supply of money must flow back to the central bank, is invalid, even in this case."
Of course, endogenous money proponents would argue that all the increase in money would do would be to increase bank reserves and they would surely not be surprised that in Nick's simple model there are no comerical banks.
"Market monetarists often attempt to bypass such discussions of banking by appealing to a ‘hot potato’ phenomenon, where an increase in the stock of money causes people to trade until a certain level of NGDP is realised. Yet this method of debate only deals with the opposing argument by assuming away banking and therefore their objections. As long as we acknowledge that we live in a world with banks, the hot potato idea is wrong. This was most comprehensively discussed by Scott Fulwiller, who pointed out that attempts to increase the quantity of money in circulation will simply end up increasing bank reserves."
http://www.pieria.co.uk/articles/examining_the_case_for_ngdp_targeting
Nick explains that in Keynesian models people are never suprised to have more money than they expected-thanks to an increase in money:
" People borrow money for two reasons:
1. Because their planned expenditures of money exceed their expected receipts of money. They "borrow to spend".
2. Because their desired stock of money exceeds their current stock of money. They "borrow to hold".
"Any money that people in aggregate borrow for the first reason, "borrowing to spend", will create a permanent hot potato that falsifies their expectations. Any money that people in aggregate borrow for the second reason, "borrowing to hold", will not create a hot potato, and will not falsify their expectations."
"Standard Keynesian and New Keynesian models do not allow what I have just described above to happen. They assume an equilibrium in which aggregate planned expenditure is always equal to aggregate expected income for the current period. If the central bank cuts the rate of interest, both planned expenditure and expected income rise by the same amount. In aggregate, people never borrow money to spend. They only borrow money because they want to hold more money. In those Keynesian models, people are never surprised in aggregate to find themselves holding more money than they desire to hold. There is no hot potato in keynesian models"
"Does the standard Keynesian assumption of continuous equilibrium between aggregate planned expenditure and aggregate expected receipts make sense? Is what I have just described a rational expectations equilibrium? It might be. Even if every individual is fully rational, he does not know that a cut in the interest rate from 5% to 4% will lead to aggregate planned spending in excess of expected receipts, and falsify his expectation. For all he knows, the central bank might have cut the interest rate because everyone else planned to spend less, and the central bank was adjusting the actual interest rate down to match the lower natural rate of interest. For all he knows, aggregate planned spending might equal aggregate planned receipts at 4%."
"The standard Keynesian and New Keynesian model assumes that aggregate planned expenditure always equals aggregate expected receipts. People in aggregate never borrow money to spend. They only ever borrow money to hold. It therefore makes totally implausible assumptions about individual agents' knowledge. It assumes a rational expectations equilibrium in which each individual knows the current plans and expectations of all agents. It is that wildly implausible assumption that ensures there is no monetary hot potato in standard Keynesian and New Keynesian models."
When he's talking about Keynesians he must mean those of the Neoclassical synthesis if he claims they don't believe in the HPE because they adhere to RE. Obviously the school that talks about endogenous money quoted above doesn't believe in in full RE or anything like it.
"Update: basically, in Keynesian terms, the hot potato story is a story about the process by which the economy moves from one ISLM equilibrium to another. It is a story of "false trading" (or "false borrowing" in this case) -- because people's expectations and plans do not adjust instantly to the new Hicksian temporary equilibrium where those plans and expectations are mutually consistent, so they make trades they would not make in equilibrium. And when false trading happens, and stocks change as a result, there is always the chance that the economy may move to a different equilibrium, or even away from equilibrium. People may not always succeed in learning the new equilibrium. And their learning may itself change that equilibrium."
"(I think this is related to what the interwar pre-General Theory monetary economists were on about. Robertson, Hayek, etc.)"
I'm a bit confused I admit. I guess I feel a certain sense of whiplash from the idea that the Keynesians are wrong because they believe too much in RE. In the 60s and 70s the anti Keynesian counterrevolution argued that Keynesians made the mistkae of thinking that ecoomic agents could be fooled forever-they didn't take into account that people had rational expectations. So this post by Nick seems like we've come full circle.
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