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Tuesday, December 14, 2010

Excess Demand for Money

I've been thinking about this debate (also here).  First, I should point out that I'm somewhat sympathetic to the Austrian idea of mis-allocation (or re-calculation as these guys put it) in business cycles.  I think they overdo their hypothesis, but that discussion is for a different time, because also overdone is the idea that recessions are largely monetary (or due mostly to an excess demand for money).  I don't buy that as the whole story either.

For one thing, the mainstream concept of 'money' has to me always been a rather dubious and near-pointless definition in an age where credit is king.  To be more succinct, we don't have a demand for money problem, we have a demand for credit problem.  It's not that people are demanding too much money relative to production, they are demanding too little credit.  We need only look at the Fed's stats to see this. 
Interest rates didn't rise because people started demanding more money - that's always been an incorrect causal relationship with mainstream theory.  Interest rate spreads started rising due to the financial crisis and uncertainties therein of future profits and sustainability.  Those increasing spreads together with the uncertainty etc. meant that people were demanding lesser and lesser loans on credit.   Demand for money is nothing more than a by-product and a symptom of the need for 'flight to safety.'  Obviously, in a major financial crisis, it makes sense to flock to the dollar and to 'money'.

And, when I say "...too little credit..." I don't want to imply that that is a bad thing.  From a certain perspective, and certainly from an Austrian one, it is necessary for credit to drop in order for this resetting to happen.  In other words, it is the very fact that we had too much credit (an over-indulgence) that was a significant cause of the problem in the first place so it is only natural that the economy tighten credit now to shore up balance sheets, payoff past debts, etc.

Until economists leave their nice conventional notions of 'money demand' behind, we will never really get down to the real causes and fixes for these types of issues.

10 comments:

Nathan Tankus said...

I feel like i'm missing something. all it seems you've done in this post is show why there is excess demand for money, not prove that it doesn't exist. sure too much bank money has been created over the past 5 decades; i agree. that doesn't disprove the excess demand for money idea or that policy can meet that "excess" demand.

Garth said...

my point wasn't/isn't to prove it doesn't exist - but to point out that it is a symptom of the problem and not in an of itself a cause of the problem. IE, money is not the problem and therefore it is not the solution either in the long-run. Pumping more money into the equation to meet the excess demand is not a solid solution as the fact that excess reserves are now ridiculously high plainly shows.

Garth said...

I should also say that my second point was that this "problem" may not be a problem in the first place but may be a necessary condition (as I think Arnold Kling was trying to point out) for the economy reset from the excesses of the past.

Nathan Tankus said...

You know that, for now, I accept chartalists arguments.Because of this I will attempt to avoid discussion of this longstanding argument and focus on new issues brought up by your posts. on the excess reserve point however, I will point you to post-keynesian arguments that the level of reserves have no effect on loan generation and thus can't be a critique of fiscal policy. On essentially austrian point, i would like to question the logic. it is indisputable that recessions often curtail the amount of loan generation in the economy and "simplify" balance sheets (minsky's term). traditional fiscal stabilizers have stabilized the economy at the cost of preserving webs of complicated debt instruments. However, does this mean that this system is worse then the pro-cyclical one? i don't think so. webs of debt collapsed quickly during long lasting recessions and depressions but developed even faster during booms. the post war period seems to have generated much more successful policy outcomes then the pro cyclical period. simple "keynesian" prime-pumping in the absence of credit constraining regulation (private or public) will of course become highly inflationary or make the next bust even more painful. i don't think, however, that this means we should just throw up our hands, declare recessions necessary and go home. Full employment is certainly possible and the difficulty of constraining financial innovation and large jumps is a climbable obstacle.

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