Monday, October 5, 2009

Traps and multipliers

Tyler Cowen has a post where he says that it is inconsistent to hold both that there is a liquidity trap and that the fiscal multiplier is large. He says that if the government spends more on cement - say- when we are in a liquidity trap, the cement supplier will simply add the proceeds to his money hoards and that's the end of the matter. I find this puzzling, to say the least. The liquidity trap doesn't mean that you have an unlimited demand for money balances. It means that you regard money and bonds - due to the zero interest rate- as perfect substitutes. So monetary policy, which substitutes money for bonds in private sector balance sheets, can't work. In normal times, this substitution can't happen without a fall in the interest rate, which would then be stimulative. In a liquidity trap, giving the cement supplier, or anybody else, money in exchange for bonds doesn't change anything; but giving the cement maker money to produce cement increases her income, and thus, to some extent her spending, and thus someone else's income and yadda yadda. Am I missing something basic here?

30 comments:

Anonymous said...

"giving the cement maker money to produce cement increases her income, and thus, to some extent her spending, and thus someone else's income and yadda yadda. Am I missing something basic here?"

Yes. You have just given someone some worthless electronic digits in exchange for a real good - which means they have exchanged something for nothing.

It is an unfinished transaction, even though, formally, a recognizable exchange has taken place that seems fair and completed. The fact is otherwise, however: an industrial product has been produced, but there is no real product with which it can be exchanged.

The only basis for this transaction not to collapse is that (1) another real product is produced at some later time to maintain equal exchange, or, (2) another such ficticious transaction take place where the money now possessed by the cement maker is then exchanged for nothing - to pay taxes, for instance.

IN the latter case, the cement maker has been flim-flammed out of her product, but that is simply her fault.

"Seller beware"

The great problem economics keeps running into is the belief that printing money and using it to purchase real goods has no consequences.

Starving Economist said...

I believe you are missing something.

The primary reason that monetary policy is stuck in liquidity trap is not simply that the interest rate is zero, it is the deflationary expectations of the public.

If the fed could make a credible commitment to inflation, then money and bonds would no longer be substitutes and monetary policy would be effective.

However, the problem in a liquidity trap is that no one believes the Fed will stick to an inflationary strategy, so they hoard their cash in expectation of future price level declines.

As a result, it shouldn't matter if the money comes from the central bank out of a helicopter or out of some budgetary expenditures for cement. People will still hold on to new found cash balances because of their deflationary expectations.

rosserjb@jmu.edu said...

Regarding the cement case, the problem with Tyler's comment is that much of the money spent on the cement will go to the workers there as wages, and they will spend it, or much of it. The idea that money spent on cement will simply sit at the cement firms is totally ridiculous.

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Starving Economist said...

Barkley Rosser,

I don't see how that changes Tyler's argument. If they money is passed on to workers, they simply add a good portion of it to their cash balances.

Will they spend some? Sure. Tyler is not saying the multiplier is zero. But will they spend any where close to all of it (implying big multipliers)? I wouldn't think so. At least not if you take the liquidity trap seriously.

Miracle Max said...

Workers with cash balances? What planet are you from?

Starving Economist said...

Max,

Last I checked, as a worker, I can save my money in a variety of ways. I can buy bonds, stocks, and *gasp* I can even keep it as cash!

What planet are you from, where workers do not face a portfolio decision?

Anonymous said...

Apparently, you are all from the planet where government can just imagine money into existence and exchange it for real goods without consequences...

Government spent money has a history - it came into existence at some point and it goes into circulation in some fashion. Unless you trace the money from its beginning, you will run into unintended consequences.

TheTrucker said...

I am looking back to the first comment about paying for cement with worthless bucks and thus there has been an "incomplete transaction" and there is demanded something of real value be produced to "sanctify" this exchange. The blatant real life circumstance is that the value of everyones money has been reduced but the cement providers have gotten a lions share of the minimally depressed currency. And by devaluing the money you convince people that it is not a real good idea to stuff it in their mattress.

On the "spiritual" side of the "sanctification" we _WILL_ see something produced because there will now be a DEMAND for something that did not exist until we blasted the money into the bottom of the economy as opposed to giving it to a @#$^&#% bank. The "cement" was quite worthless in the dead economy until the government caused it to be demanded.

Anonymous said...

Trucker said: "The blatant real life circumstance is that the value of everyones money has been reduced but the cement providers have gotten a lions share of the minimally depressed currency. And by devaluing the money you convince people that it is not a real good idea to stuff it in their mattress."

This look at the situation completely backwards, trucker.

What has actually happened is that the cement provider has given up her real good for something of no value at all. By exchanging her product for dollars she has reduced the value her product to zero without knowing it.

This action completely escapes the notice of the economist, who imagines that value is an arbitrary phenomenon that can seen simply as the nominal face value of the currency, rather than something which exists independent of this face value.

Hence, economics does not find it important to investigate what is really taking place in this simple transaction. The economist will never ask, for instance, why does the devaluation of real goods (printing money) increase economic activity during a depression?

Marxian economics offers an explanation for this fact: devaluation of the existing stock of capital lowers the rate of accumulation, and allows the economy to recover.

And, what also lower the rate of accumulation? --Reducing hours of work.

So we have a choice: we can work for nothing, or we can work less.

kevin quinn said...

Starving:

The problem in a liquidity trap is that the Wicksellian natural(real) rate is below the negative of expected inflation. (This is consistent with positive expected inflation - if the natural rate is negative and bigger in absolute value than expected inflation.) One way to get out of the trap is to increase expected inflation, as you say. Another way - and this is the point of fiscal policy in a liquidity trap - is to increase the natural rate. Suppose expected inflation is -3 and the real rate is 2. Fiscal policy that increases the natural rate to something above 3 ends the liquidity trap.

Martin Langeland said...

Is not the prime function of markets to establish values of goods? How can money be valueless if it is accepted in exchange for a good or service? How does money gain value when saved if it has no value? It is Humpty Dumpty's dictum: "Words (or Money) mean what I (we) choose them to mean. When I say glory, I mean a good knock down, drag 'em out, fight."
--ml

Anonymous said...

"How can money be valueless if it is accepted in exchange for a good or service?"

To ask this is to ask: How can something without value be exchanged for a thing which contains value? The fact is, any given transaction may or not reflect the actual value contained in the goods exchanged - this much had already been established centuries ago, and the fact that you ask the question is stunning.

Paper currency is not money, it is a token of money - as fiat, the token has replaced this money by law and purports to stand in its place. Thus, every fiat rests on the effective monopoly of ownership of money commodities, law, and price manipulation to discourage the monetary use of the money commodity.

The other way to understand this is that the product of the cement producer has no market price - which is to say, the cement maker cannot find a market for her good. Although she has produced the cement using only the costs that, on average, are incurred on the production of the product, she has, nevertheless, produced more cement than is required by society.

Her hard work is without any value at all, and if she did not exchanged it for an equally valueless piece of paper, she would receive nothing for it at all.

So, both from the circulation side of the market and the production side of the capital, no value exists. The recognition of this is found in the devaluation of her capital in this exchange to zero.

This devaluation of capital is one of the means capital uses to reduce the accumulation of surplus value, and re-establish, forcibly, the necessary equilibrium of its process.

Starving Economist said...

Kevin,

My point was that the primary reason monetary policy is stuck in a liquidity trap is because of deflationary expectations that lead people to hoard the money printed by the central bank.

Tyler Cowen's point is that it is this same desire to hoard money that will reduce the multiplier and weaken the effectiveness of fiscal policy.

I think all of this is entirely consistant with your post. If you truly believe we are in a liquidity trap, then its highly doubtful there is anything the government can do to resolve the problem (monetarily or fiscally).

--SE

Miracle Max said...

If I was starving I would not be keeping any damn cash balances.

-- "The workers spend what they get, and capitalists get what they spend." (Kalecki, maybe)

PQuincy said...

It makes little sense to pay close attention to a post by an anonymous who claims "where the money now possessed by the cement maker is then exchanged for nothing - to pay taxes, for instance."

Anyone who thinks that paying taxes is for "nothing" should go live in Somalia.

PQuincy said...

Starving Economist says: "Last I checked, as a worker, I can save my money in a variety of ways. I can buy bonds, stocks, and *gasp* I can even keep it as cash!"

Evidently, Starving Economist is not a starving economist at all!

PQuincy said...

This thread has apparently brought out the monetary fundamentalists in force, though they all prefer to post as "Anonymous."

E.g.: "Paper currency is not money, it is a token of money - as fiat, the token has replaced this money..."

And tell me, Little Monkey, what was that money that was replaced?

It was a token of value, Teacher, replaced by fiat...

...and it's all fiats from then on downwards. Frankly, metaphysical realism about 'money' strikes me as an awfully problematic approach, since it leads to the claim, also above, that "it came into existence at some point and it goes into circulation in some fashion. Unless you trace the money from its beginning, you will run into unintended consequences."

This is of course true at one level, but begs an unanswerable question: HOW con money "come into existence" in some fashion, or perhaps another fashion? The argument when and where value is attributed to a particular exemplar of a medium of exchange is itself another problem of infinite regress. Did the gold become 'valuable' when God gently poured it into those Sierra veins? When the river washed it out? When Johan Suter shouted Eureka and opened a store? When the news hit New York City? When it was delivered to a bank and replaced with gold coins? When those coins were exchanged for paper bills?

Anonymous said...

PQ: "HOW con money "come into existence" in some fashion, or perhaps another fashion?"

Money comes into existence when, as in any other commodity, it is pulled from the earth and its impurities removed, then fashioned into coin. It can enter circulation as (1) printed token; (2) borrowed savings; and (3) at the point where it is first removed from the earth. As currency, it can appear in its own form, as a token of this form, and as inconvertible fiat replacing this form.

Each of these differences have their own consequences for consideration. It is important to not make the economist's mistake of assuming the existence of the can opener: If Washington prints a trillion dollars and hands it to the banks, this has different consequences than digging up an ungodly amount of gold and giving it to the banks.

PQ: "what was that money that was replaced? It was a token of value, Teacher, replaced by fiat..."

Money is itself not the token of value - it is value. It is this value because, (1) like all other real goods it contains a definite amount of socially necessary labor AND (2) Its use is to measure the value in other commodities.

PQ: "Anyone who thinks that paying taxes is for "nothing" should go live in Somalia."

Yes. The old timers used to tell us to go to Russia if we were dissatisfied with the way things are run here.

Barkley Rosser said...

starving,

The liquidity trap is not about people having near zero marginal propensities to consume. It is about people not wishing to borrow money to do anything with it. The LQ is essentially a monetary policy phenomenon running through the banks. Banks get money, offer it out to potential borrowers (the most significant of whom are not individuals, and especially not cement workers or their cohort), but firms who might use the funds for making capital investments. But, they see no good capital investments to make, so they do not borrow, and the money just piles up in the banks as excess reserves. This can go on, even if the workers have .9 mpc's and spend most of what they get. An LQ is not at all inconsistent with multipliers exceeding one, indeed doing so by a substantial margin (and I made these points over on MR, with nobody successfully counterarguing against my point).

Anonymous,

Are you the same one who thinks no Nobel should be given for ten years?

I do not know and do not care what crank theory of money you are pushing, but as far as I am concerned, the value of money is what it can buy. As long as people are willing to accept something because they think others will accept it, then it is money and will have the value of what it can buy. Nothing in your argument indicates how it is that when the cement producer takes this money, somehow suddenly nobody else will accept it (including the workers at the cement company who are expecting to be paid in something, bet they'll take it). Your argument falls down before it can even walk anywhere.

Anonymous said...

"Are you the same one who thinks no Nobel should be given for ten years?"

Yes. And this is why:

"as far as I am concerned, the value of money is what it can buy."

Have you ever tested this assumption? What consequences are there for the economy if, in fact, the value of money is not simply what it can buy.

How can you prove otherwise: that value is something independent of what it can buy.

If a trillion fiat dollars is injected into the banks, how would this be different from injecting a 100 billion ounces of gold into the bank?

Do you know? You use this thing every day in your life. Its existence is the basis of all your professional assumptions, but you have not even considered it itself.

Anonymous said...

"suddenly nobody else will accept it (including the workers at the cement company who are expecting to be paid in something, bet they'll take it). Your argument falls down before it can even walk anywhere."

Rosser, the negative consequences of fiat result not from its rejection by economic actors, but from its acceptance. It is akin to ingesting polluted water to quench one's thirst.

Barkley Rosser said...

A.,

Oh, you are one of the pathetic gold bugs.

We are dealing with a definition, not an empirical hypothesis. So, the issue is to accept (or not) the definition, and then test whether or not something is money based on it. I challenge you to take some of your precious gold and try to buy a week's worth of groceries at the nearest supermarket with it. Bet you will not be able to; but they will be perfectly happy to take your "without value" paper money.

Of course, if you define money as being gold, well....

TheTrucker said...

Money is what the king's men will take instead of your chickens or your life.
And since no one wants to lose his chickens or his life, money has value:

Soft Currency Economics

"The concept of fiat money can be illuminated by a simple model: Assume a world of a parent and several children. One day the parent announces that the children may earn business cards by completing various household chores. At this point the children won't care a bit about accumulating their parent's business cards because the cards are virtually worthless. But when the parent also announces that any child who wants to eat and live in the house must pay the parent, say, 200 business cards each month, the cards are instantly given value and chores begin to get done. Value has been given to the business cards by requiring them to be used to fulfill a tax obligation. Taxes function to create the demand for federal expenditures of fiat money, not to raise revenue per se. In fact, a tax will create a demand for at LEAST that amount of federal spending. A balanced budget is, from inception, the MINIMUM that can be spent, without a continuous deflation. The children will likely desire to earn a few more cards than they need for the immediate tax bill, so the parent can expect to run a deficit as a matter of course."

I have accepted this definition of fiat money and will find it hard to put down. There was a time when gold coins were indeed money. But what made them money as opposed to a bartering tool was taxation and the King's men.

"Those are my opinions and YOU can't have em" -- Bart Sympson.

Starving Economist said...

Barkley Rosser,

The reason you did not find a suitable counter argument is probably because you are defining a "liquidity trap" different than everyone else.

If you check out Paul Krugman's note "Thinking about the Liquidity Trap" you would see that it is possible to have a liquidity trap situation even in a model that totally ignores investment spending (see the Mana and Money section).
http://web.mit.edu/krugman/www/trioshrt.html

Why? Because we essentially have a case of what Krugman called "self-fulfilling pessimism". People expect deflation, they hoard their cash, which leads to realized deflation and a recession.

Anonymous said...

"We are dealing with a definition, not an empirical hypothesis ... I challenge you to take some of your precious gold and try to buy a week's worth of groceries at the nearest supermarket with it."

Rosser,

That is the definition of currency, not money...

I suggest suspending the Nobel prize - not simply for ten years - but, until all economists have the common sense to know the difference between the two.

Eric said...

Perhaps the original offense is two Keynesian ideas gaining general circulation at once. What I have read of Cowen suggests he isn't going to like that.

Rather than a "if monetary policy won't work fiscal policy won't work" argument, I would think the more relevant point (brought up here by Quinn/Rosser)is - during a liquidity trap, which is more effective, MP or FP?

PQuincy said...

Anonymous (again) says: "Money comes into existence when, as in any other commodity, it is pulled from the earth and its impurities removed, then fashioned into coin."

This curious conflation of mining and government action strikes me as fundamentally confused.

"pulled from the earth and its impurities removed" describes the human activities of mining and refining. These take place in many ways, and have nothing do to, per se, with 'money'.

"fashioned into coin" -- ah, there's the rub. You, I, and our neighbors, whether or not we partake of the mining industry, cannot do this. Mining companies cannot do it. Only a soverign can "fashion [something] into coin". Moreover, that fashioning has absolutely nothing to do with mining. Sovereign entities can fashion paper into coin, they can fashion various alloys into coin (convenient for durability, compared to paper, but otherwise no different), or nowadays, they mostly fashion electrons into coin.

Naturally, doing so -- more or less, wisely or foolishly -- has consequences, since 'coin' (i.e., soverign-guaranteed stores of abstract value) has large consequences for economic activity, the action of markets, etc. Small sovereigns can fashion coin that no one wants (cf. Gresham's law, as applicable to electrons as to coins). Larger sovereigns' 'coin' is likely to retain value, but people may disagree about, arbitrage, manipulate, or speculate on that value.

Why any of this has anything to with extracting things from the ground leaves me mystified, however.

Anonymous said...

PQ,

Here: http://www.marxists.org/archive/marx/works/1867-c1/ch03.htm

There will be a test later.

Have you ever wondered how economics could have monetary theory, when it never had a theory of money?

Go figure...

Anonymous said...

Time's up.

Answer: Because economist are so concerned about how the banker's gratuity ends up in their account, that they never wonder how their professional skills comes to be measured by it in the first place.