Finally the Moment of Clarity

[Beet]

First of all, this is a debate between two conservative schools of economics, the mainstream monetarist school, represented by the likes of Milton Friedman, and heterodox schools, or alternatively, simple guttral cries expressed in intellectual language. There is nothing Keynesian being discussed here; Keynes himself abhorred monetary policy and thought it was quite useless in overcoming depressions. Just because he understood it, it does not mean his contribution to economics can be understood by it. However, it is true that Keynesian proposals are generally 'stimulative' as opposed to contractionary, and hence it is accurate in that sense.

First though, a point about justice. Behind all the talk of numbers there is always a rightwing tendency to imply a sort of moral superiority on their part, "oh boo hoo, low interest rates / inflation are hurting the savers, the poor grandmothers on fixed income." What this misses is that most of fixed income actually goes towards the rich- the trust fund kids, others who live off their investments, and the like. By definition, a person who lives off fixed income is independently wealthy-- they do not have to work to live. The same is true of saving in general: Ebenezer Scrooge was the ultimate saver. All money saved must eventually be spent. Or else he or she is a hoarder.

Economic leftists have a different conception of justice. Our economic heores are not idlers that live off past capital, but workers who earn current income. Hence inflation that includes income inflation and increases workers' incomes and reduces their debts is good. Hence low interest rates that allow them to borrow at the least cost to themselves is good. It equalizes the difference between the poor and middle class who lack capital, and the banks whose primary asset is their capital. Our economic heroes are not those that take in money to watch numbers accumulate greedily in their savings accounts, but those who see money as a means to an ends and only oil for the engine of the real world.

Oh my, three paragraphs and I haven't even begun to respond to you. But you've essentially constructed a net and asked us to find holes in it.

[Beet]

You do realise that the rich don't fill their swimming pools with money, don't you? Savings are ultimately invested, either directly though stocks/bonds or indirectly when the bank loans out the funds in your account. Slashing interest rates cuts out this source of investment in the economy while creating speculative bubbles fuelled with malinvestment.

Ah, finally, an anti-Keynesian idea. To get away from that amorphous term 'invest', no, not all savings are ultimately deployed (using them to buy stocks or bonds is not deploying them). Actually, the economy can operate at a level below its potential. That is the point of Keynesianism, put in layman's terms.

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Sure, encouraging people to rack up low cost debt is a great idea. It will help them purchase houses they otherwise couldn't afford. I'm sure there won't be any negative side effects to that /sarcasm
[/quote]

That is not what I said- I said low interest rates equalize the relationship between those who do, and those who do not have capital, just as the concept of leverage does. But that does not mean that banks should not be properly regulated with respect to whom they give loans to, or that asset prices bubbles are not a bad thing that can be identified and avoided by policymakers. Those faulty positions are the positions of those rightwingers who believed that neo-liberal economics was the cure to everything, such as Alan Greenspan.

[Beet]

Ok, let me start to actually respond.

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This part I actually agree with. Specifically, the idea that spending is being held back by private sector debt stasis compared to ten years ago, when private sector debt was exploding.

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I agree that part of the problem is that too much liquidity is simply being deposited in the broader financial system (you say 'the Fed' but I would say all sorts of asset purchases as well). However, raising interest rates would only make things worse because it would decrease liquidity in the system, and this would have a net negative effect on aggregate demand. The goal is to increase aggregate demand. The increase in spending from those who live on a fixed income would be overwhelmed by the decrease in spending from businesses, governments, and current income earners.

I guess I agree with Einhorn and yourself more that the effectiveness of monetary policy is limited, but I think the proposed solution (raising interest rates, tightening monetary policy) would only make things worse and not ebtter.

[Beet]

Re: the velocity of money. Yes, a decrease in the velocity of money is cancelling out the inflationary impact of printing, but this decrease itself is harmless if it is only a mathematical artifact of the printing.

Take this simple equation:

Money Supply = Velocity of Money x Base Money

If Base Money increases, and the Money Supply does not increase, then, the Velocity of Money must fall. This is nothing more than a mathematical truism. It says nothing about the real economy. The Fed could print $100 trillion and store it under Ben Bernanke's mattress at midnight tonight, and the velocity of money would plummet to near zero without a single thing being different in the real economy. Not even a single Starbucks' coffee worth of difference.

The real economic concept behind why printing is not increasing the Money Supply is again-- because of the build-up of private sector debt in the years before 2008. The private sector is resistant to more leverage (rightfully so), hence the printing has a minimal effect.

[Beet]

Money Supply = Velocity of Money x Base Money

Somehow I glossed over this one.

The problem here is that this equation does not exist in reality.

Instead the equation is:

Velocity of money = aggregate transactions / broad money supply

Or it's more measurable option: V = PY/M(price level*GDP/money supply) nor does PY/M = Base money either.

Aggregate transactions has nothing to do with base money.

Instead you may be referring to base velocity which is different.

Nice try though.

Well yes, as QE affects base money, then base velocity is what is important. The point is that decreases in base velocity are a mathematical artifact of the increase in base money, and are by themselves harmless.

If you want to use broad money as your measure of money, then QE has no direct effect on broad money (M1, M2, MZM). The effect is transmitted through the money multiplier.

[Beet]

1) Money isn't deposited in asset purchases. It buys an asset from a different person and that person either buys some other asset or deposits the money. Before and after the transaction the same amount of the asset and cash exist.

It's not the transaction that matters, it's the total amount of money in the financial system. The more there is, the more asset prices are bid up. Hence, if X amount of good is produced each period, then a higher quantity of money chasing those goods would result in a higher price each period, so long as the propensity of those with money to buy those assets is the same. Lower (real) interest rates also effectively the amount of money by allowing greater leverage. But the solution is not higher interest rates, but redirecting money to the parts of the economy where it will lead to the most growth in the long run.

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Oh, sure it would. Just look at 2008.

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The FFR's impact has nothing to do with whether the banks utilize Fed money. If the Fed wants to raise interest rates all it has to do is sell Treasuries, which are in high demand. This will lower the banks' liquidity. If that fails (which it wouldn't) they could always raise the required reserve ratio. Removing liquidity from the financial system is the easiest thing in the world. It's the consequences that tend to worry policymakers.

[Beet]

First of all, the velocity of money isn't just some arbitrary item with no meaning like you claim it is.

That is a seriously dumb notion. I mean what do you think, the Nobel Committee just decided to give out the prize to someone who invented a formula where one variable is some arbitrary undefinable value?

The velocity of broad money is very important and significant, yes. As is the velocity of base money, or the liquidity leverage ratio if you prefer. However, a decrease in the velocity of base money as a result of monetary stimulus is a mere mathematical artifact and therefore meaningless. It is, in the words of Keynes, "pushing on a string." The same could be said of broad money. QE has no direct impact on the quantity of transactions. If banks don't want to loan money, or if there is no demand for loans, increasing reserves can't force them to do so. On the other hand, if banks did want to make loans and there was demand for them, then the frequency of transactions would increase even without monetary stimulus.

Basically, the point is that demand for money is what determines the frequency of transactions, as well as the money multiplier, and demand for money is an independnet variable from monetary stimulus. The only argument I've seen you make contrary is to argue that low interest rates benefit debtors at the expense of savers. But the net amount of disposal income is a wash-- for every dollar that an interest-bearing account holder loses, so a loan holder gains, minus the difference that gets taken out by the financial system. Paradoxically, you seem to argue that savers are less likely to spend when their interest rates are lower, but that makes no sense. The lower the interest rate, the less reason for you not to spend. That is monetary policy 101.

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Well yes, that's because of the massive debt overhang from the past 30 years.

Looking over the rest of your post, besides the misinterpretations of what I and/or the Fed believe, I largely agree with them. What you've just explained is the Keynesian critique of monetary policy. But I'm still struggling to where you get from this to the idea that fiscal stimulus is ineffective or that we have 'too much liquidity'. Certainly, the effectiveness of monetary policy is limited, but that is just another reason why fiscal stimulus is warranted.