Scott Sumner and Bill Mitchell on the Money Multiplier

         This post of his back in April is a great example of why I say Sumner is a king of concern trolling and sophism-truly his is Milton Friedman 2.0. So does he believe in the money multiplier as his post asks? What do you think based on what he says?

       "What a mind-bogglingly empty question! The money multiplier equals the ratio of the money supply (however defined) and the monetary base. It’s simply a ratio, there’s nothing to believe or disbelieve. It’s like asking if someone believes in the ratio of men to women. Or whether MV=PY."

        http://www.themoneyillusion.com/?p=13852

        Ah, the old arguing from an accounting identity argument. We got into this back in December when he claimed that "saving" means "spending on capital goods" and justified this by pointing out S=I. I mean you can't argue with an accounting identity can you? Surely you can't argue that S doesn't equal I...

         "So let’s start over. Do you believe the money multiplier is stable? Most economists would answer; “It depends.” Or how about; “Do you believe the money multiplier is useful?” Now we are beginning to get somewhere. For instance, do economists believe that an increase in the monetary base will cause the money supply to rise by an amount equal to the change in the base times the multiplier? It turns out that the answer is; “No in the short run, but yes in the long run.”

       "What we actually need to do is start with the concept called “the neutrality of money,” which underlies almost all of macroeconomics, and has done so for hundreds of years. This says that an increase in the monetary base will not affect any real aggregates, and hence all nominal aggregates will rise in proportion. This suggests there are “multipliers” for every conceivable nominal aggregate, from nominal spending on toasters, to nominal spending on Brazilian waxes, to NGDP. The “multiplier” for NGDP has a special name; “base velocity.” But it actually has nothing to do with the velocity of money (the vast majority of money expenditures are not for final goods and services), and should be called the “NGDP multiplier.”

       "So according to the neutrality of money, a 10% rise in the base will increase all nominal aggregates by 10% in the long run. Since M1 and M2 are nominal aggregates, they are affected just like nominal toaster expenditures and nominal Brazilian wax expenditures. (I keep mentioning the latter in a pathetic attempt to show that I am a hip 56 year old keeping up with new industries that didn’t exist when I was 20 years old.)"

      "Of course wages and prices are sticky in the short run, so a 10% rise in the base does not have a proportional effect on most nominal aggregates in the short run. The neutrality of money (and the money multiplier) are long run propositions. However some economists believe the money multiplier is relatively stable when interest rates are positive, even in the short run. This is because the multiplier has two behavioral components; the reserve ratio and the currency/deposit ratio. Many economists think that during normal times (when interest rates are positive), banks hold very little in the way of excess reserves. Hence the reserve ratio is stable, and equal to the required reserve ratio. They also believe the currency/deposit ratio is relatively stable in the short run."

       "This leads to the question of whether the money multiplier is useful. I don’t think it is, but let me try to explain why others disagree. They think a 10% rise in the base (when interest rates are positive) will result in a roughly 10% rise in M2, even in the short run. I have doubts, but I’m willing to accept that claim. Then they claim that changes in M2 have an important causal impact on NGDP—M2 is an important part of the monetary transmission mechanism. That’s the part I reject. I think future expected NGDP, plus asset prices, are the key transmission mechanisms. And future expected NGDP is driven by future expected changes in the supply and demand for base money. I don’t see anything special about M2."

        Ok, so we'll argue about the money multiplier using an argument that is just as debatable-the neutrality of money which many deny in fact is reality even in the long run. Interestingly even Sumner's Market Monetarist buddy, David Glasner, argues that there are permanent effects on monetary shocks, not just short term.

        However, what's real impressive is what do you get from all this about Sumner's actual position on the money multiplier? It might seem that he discounts it-or "denies it" but this is clearly not true:

        "This leads to the question of whether the money multiplier is useful. I don’t think it is, but let me try to explain why others disagree. They think a 10% rise in the base (when interest rates are positive) will result in a roughly 10% rise in M2, even in the short run. I have doubts, but I’m willing to accept that claim. Then they claim that changes in M2 have an important causal impact on NGDP—M2 is an important part of the monetary transmission mechanism. That’s the part I reject. I think future expected NGDP, plus asset prices, are the key transmission mechanisms. And future expected NGDP is driven by future expected changes in the supply and demand for base money. I don’t see anything special about M2."



         The idea is that if you place $100 in a bank deposit then if there's a 10 percent reserve requirement they can only lend out $90. Then of the remaining $90 they can only lend out $81, and so forth until they reach zero. Meanwhile the money supply is growing by the amount of deposits minus reserves. So you add $100 to $90 to $81, etc.

         However, as Mitchell argues this is not how it really works:

          "Well that is not at all like the real world. It is a stylised text-book model which isn’t even close to how things actually operate. The way banks actually operate is to seek to attract credit-worthy customers to which they can loan funds to and thereby make profit. What constitutes credit-worthiness varies over the business cycle and so lending standards become more lax at boom times as banks chase market share."

          "These loans are made independent of their reserve positions. Depending on the way the central bank accounts for commercial bank reserves, the latter will then seek funds to ensure they have the required reserves in the relevant accounting period. They can borrow from each other in the interbank market but if the system overall is short of reserves these “horizontal” transactions will not add the required reserves. In these cases, the bank will sell bonds back to the central bank or borrow outright through the device called the “discount window”. There is typically a penalty for using this source of funds."

           http://bilbo.economicoutlook.net/blog/?p=6617

           What would Sumner say to this? Well we know what he would say-that this is all too much about the tangible details of the deposit process, that this is too "hydraulic" too "literal minded."

            "I recently did a post trying to figure out whether there are any non-quantity theoretic models of the price level. It led to one of the most intense debates I’ve ever seen in my comment section, and even other bloggers chimed in with posts. But no one came forth with a non-quantity theoretic model of the price level. It is very important that any monetary theory be able to explain why prices aren’t 100 times higher, or 100 times lower. Thus I’m more inclined than ever to think the QTM is the best starting point for monetary theory (although obviously it’s not literally true that M and NGDP grow at the same percentage rates.)"

       "I wasn’t able to fully grasp how MMTers (“modern monetary theorists”) think about monetary economics (despite a good-faith attempt), but a few things I read shed a bit of light on the subject. My theory is that they focus too much on the visible, the concrete, the accounting, the institutions, and not enough on the core of monetary economics, which I see as the “hot potato phenomenon.” This is the idea that the central bank controls the total quantity of money, but each individual controls their own personal “money supply.” So if the Fed injects more money into the economy, something has to give to equate money supply and demand. Initially there is too much money in circulation, and people pass the excess balances to one another like a hot potato. This process drives up NGDP, until the public is willing to hold the new quantity of money."

        http://www.themoneyillusion.com/?p=10178

        Interestingly in a reponse Scott Fullwiler argued that MMT  actually is a Quantity Theory of Money model though they define things like M and V a lot more precisely than in most who use the equation of exchange. This is the MMT version of MV=PY:

        M*V = P*Q

      "Where M is net financial assets of the non-government sector and V is the desired leveraging of the non-government sector (V could also be seen as the inverse of the desire to save of the nongovernmental sector); P is the price level and Q is the output."

 

       http://diaryofarepublicanhater.blogspot.com/2012/07/fictional-reserve-barking-on-monetary.html