John Taylor, Post-Modern Monetary Theorist

In the beginning, there was Keynesian economics; then came Post-Keynesian economics.  After Post-Keynesian economics, came Modern Monetary Theory.  And now it seems, John Taylor has discovered Post-Modern Monetary Theory.

What, you may be asking yourself, is Post-Modern Monetary Theory all about? Great question!  In a recent post, Scott Sumner tried to deconstruct Taylor’s position, and found himself unable to determine just what it is that Taylor wants in the way of monetary policy.  How post-modern can you get?

Taylor is annoyed that the Fed is keeping interest rates too low by a policy of forward guidance, i.e., promising to keep short-term interest rates close to zero for an extended period while buying Treasuries to support that policy.

And yet—unlike its actions taken during the panic—the Fed’s policies have been accompanied by disappointing outcomes. While the Fed points to external causes, it ignores the possibility that its own policy has been a factor.

At this point, the alert reader is surely anticipating an explanation of why forward guidance aimed at reducing the entire term structure of interest rates, thereby increasing aggregate demand, has failed to do so, notwithstanding the teachings of both Keynesian and non-Keynesian monetary theory.  Here is Taylor’s answer:

At the very least, the policy creates a great deal of uncertainty. People recognize that the Fed will eventually have to reverse course. When the economy begins to heat up, the Fed will have to sell the assets it has been purchasing to prevent inflation.

Taylor seems to be suggesting that, despite low interest rates, the public is not willing to spend because of increased uncertainty.  But why wasn’t the public spending more in the first place, before all that nasty forward guidance?  Could it possibly have had something to do with business pessimism about demand and household pessimism about employment?  If the problem stems from an underlying state of pessimistic expectations about the future, the question arises whether Taylor considers such pessimism to be an element of, or related to, uncertainty?

I don’t know the answer, but Taylor posits that the public is assuming that the Fed’s policy will have to be reversed at some point. Why? Because the economy will “heat up.” As an economic term, the verb “to heat up” is pretty vague, but it seems to connote, at the very least, increased spending and employment. Which raises a further question: given a state of pessimistic expectations about future demand and employment, does a policy that, by assumption, increases the likelihood of additional spending and employment create uncertainty or diminish it?

It turns out that Taylor has other arguments for the ineffectiveness of forward guidance.  We can safely ignore his two throw-away arguments about on-again off-again asset purchases, and the tendency of other central banks to follow Fed policy.  A more interesting reason is provided when Taylor compares Fed policy to a regulatory price ceiling.

[I]f investors are told by the Fed that the short-term rate is going to be close to zero in the future, then they will bid down the yield on the long-term bond. The forward guidance keeps the long-term rate low and tends to prevent it from rising. Effectively the Fed is imposing an interest-rate ceiling on the longer-term market by saying it will keep the short rate unusually low.

The perverse effect comes when this ceiling is below what would be the equilibrium between borrowers and lenders who normally participate in that market. While borrowers might like a near-zero rate, there is little incentive for lenders to extend credit at that rate.

This is much like the effect of a price ceiling in a rental market where landlords reduce the supply of rental housing. Here lenders supply less credit at the lower rate. The decline in credit availability reduces aggregate demand, which tends to increase unemployment, a classic unintended consequence of the policy.

When economists talk about a price ceiling what they usually mean is that there is some legal prohibition on transactions between willing parties at a price above a specified legal maximum price.  If the prohibition is enforced, as are, for example, rent ceilings in New York City, some people trying to rent apartments will be unable to do so, even though they are willing to pay as much, or more, than others are paying for comparable apartments.  The only rates that the Fed is targeting, directly or indirectly, are those on US Treasuries at various maturities.  All other interest rates in the economy are what they are because, given the overall state of expectations, transactors are voluntarily agreeing to the terms reflected in those rates.  For any given class of financial instruments, everyone willing to purchase or sell those instruments at the going rate is able to do so.  For Professor Taylor to analogize this state of affairs to a price ceiling is not only novel, it  is thoroughly post-modern.


28 Responses to “John Taylor, Post-Modern Monetary Theorist”

  1. 1 Marcus Nunes January 30, 2013 at 2:28 pm

    David, In a post on Krugman (who else) a while ago I put a definition of “post modern” (that´s how he qualified the great recession.
    From a definition: “Postmodernism is a philosophical movement… it holds realities to be plural and relative, and dependent on who the interested parties are and what their interests consist of.”.


  2. 2 nottrampis January 30, 2013 at 2:54 pm

    Then that would be high nunes!


  3. 3 Donald A. Coffin January 30, 2013 at 6:41 pm

    Furthermore, if Taylor were right–that the Fed is artificially holding the interest rate on Treasuries below the equilibrium level–wouldn’t we expect some disequilibrium in that market? Specifically, buyers of such securities, who might expect rates to rise would (perforce) have to expect market prices of T-bonds to *fall,* wouldn’t they? So shouldn’t we observe an excess supply of T-bonds, even given the Fed’s actions?


  4. 4 Roman P. January 30, 2013 at 9:52 pm

    While it is not prudent to dismiss the argument that the high interest rates may increase the aggregate demand from the get-go, Taylor’s argument does not hold water. Near-zero discount rates do not equal zero interest rates on credit in the wider economy! For the banks, the discount rate is just a part of the cost (along with the usual operation costs, marketing, etc). Therefore, for the same profit margin for the banks, higher interest rates that Taylor wants will just be translated into the higher costs of the business borrowing.


  5. 5 catotheelder January 31, 2013 at 4:46 pm

    don’t you understand that everything prices off the risk free asset? taylor is correct and you are either playing dumb, being obtuse or in serious need of a debt capital markets primer.


  6. 6 David Glasner February 1, 2013 at 9:02 am

    Marcus, As a Supreme Court Justice once said about something else, I say about post-modernism, “I can’t, define it, but know it when I see it.”

    nottrampis, Oh dear.

    Donald, Yes, it all depends on expectations, that’s why they call it the expectations theory of interest rates. But there is no sign of disequilibrium (in the narrow microeconomic sense) in the market for Treasuries. For Taylor to suggest otherwise is just inexcusable.

    Roman, Agreed.

    cato, No , I don’t understand that. You are suggesting a fixed relationship between the interest rate that the Fed controls (the overnight rate for bank reserves and now interest paid on bank reserves) and interest rates for everything else. There is no such fixed relationship. If there were the entire yield curve would always have the same slope, at every maturity. How many nanoseconds does it take to realize that the shape of the yield curve changes all the time? So do the risk premia. Crude oil prices are set in terms of Brent crude and WTI. The spread between Brent and WTI used to be $10, now it’s closer to $30. When market conditions change, relationships between market prices change. I would have thought that was the most basic idea there is about any kind of market.


  7. 7 catotheelder February 1, 2013 at 12:04 pm

    ceterus paribus! you know that’s what he and i both assume. stop it.


  8. 8 Tom Brown February 1, 2013 at 3:27 pm

    David Glasner: I’m not terribly familiar with MM ideas, and I’m not an economist, but you seem to be an advocate and I have been reading you and Scott Sumner and Nick Rowe for over a year now… not everything you write, but I try to keep up with what I can understand.

    As I understand it, you (personally) do not believe in the “money multiplier” idea, and I’m fully on board with that. I also think you agree that banks create most money in the economy (“inside money”) through creating loan/deposits and then find reserves as needed (for example to support payments from customer deposit accounts to parties having deposits at other banks, or to meet reserve requirements, etc.). Also you don’t agree with Nick Rowe about the “hot potato effect” correct?

    My favorite example is if Person 1, Person 2, Bank A, and Bank B all start off w/ empty balance sheets and 1 takes a loan from A to buy a car from 2 who holds a $0 deposit account at B, then the Fed will cover A’s overdraft of reserves to B (when the check clears), but then A can immediately borrow those same reserves back from B to repay the Fed. A makes money off the spread between the interest 1 pays it for the loan and the interest it pays B for borrowing reserves. The Fed just created reserves temporarily (1 night), and B makes money from the interest A pays on borrowing the reserves. A nice tidy self contained example. If we add in reserve requirements (move from Canada to the US), then the Fed must permanently create 10% of the car’s price in reserves… and A’s loan to 1 can be used as collateral to secure that borrowing from the Fed. But still this represents just 10% of the inside money created. I’m ignoring capital requirements here obviously.

    I recently had some back and forth with Scott Sumner at his blog regarding his John Taylor article. I wanted to know exactly how “easy” money would be implemented by the Fed to target NGDP (NGDPLT). Another commenter there found some old Sumner quotes that answered my question: The Fed announces what it will do (I knew that), followed by (if it needs to take actions to back that up) buying Treasuries, and Agency Debt, and MBS (a la QE), and moves on to corporate debt and eventually “buys the whole Earth” if necessary.

    I can certainly see how buying the whole Earth would raise NGDP, and I understand that was written by Scott with a bit of hyperbole since he doesn’t think all that would be required, and I understand that his preferred method is for the Fed to instead establish an NGDP futures market (although I think he states that the “buy whatever is required,” though less optimal than a futures market, would still get the job done). Although elsewhere Sumner states that he thinks that the Fed will never have to get to the point where it buys non-traditional financial assets to achieve it’s goals and “thus he opposes it.” … a thought I find strange… but no matter:

    My question to you is where do you come down on this? You agree the money multiplier concept is false and that money is created in the real economy (inside money) mostly by the banks when they extend credit… but where do you come down on what the Fed might actually have to DO (rather than just state) to achieve their NGDP goal (5% growth a year, or whatever). Can you imagine the Fed buying corporate debt or perhaps other non-traditional assets for NGDPLT to be achieved? To me it seems almost a necessity.

    It seems to me that QE has resulted in excess reserves in the banks. This is a fact, no? Those reserves don’t result in inflation necessarily because there’s no money multiplier… loans on bank balance sheets can remain stagnant while reserve balances (and customer deposits) continue to climb… and loans represent money that will be spent in the real economy… on consumer goods or houses or whatnot.

    If the banks invest the excess reserves in higher yielding assets they have to meet capital requirements and their CAMELS rating has to be up to snuff in regulator’s eyes, so there are real limits on what they can do with them in practice. Besides, whatever they do with those excess reserves in the private sector, those reserves just end up in another bank’s reserve account ultimately, correct? (OMOs with the Fed, etc being an exception, but I’m excluding operations with the Fed here).

    So I know I’m speaking as an amateur here, but it seems to me that Fed activity restricted to “traditional” financial assets is severely limited in what it can accomplish. We’ve had it now, and a glut of excess reserves seems to have been the result. Those can be invested in higher yielding (higher than the 0.25% the Fed pays), and that perhaps distorts markets to some extent, but no real inflation to speak of. Your thoughts?

    Also, I’m not positive, but I seem to have detected on Sumner’s and Rowe’s sites, — and certainly Krugman’s — what I’ll call “physical cash mysticism,” meaning I get the impression that all three assign some sort of mystical significance to physical bills and coins. I really REALLY don’ t get that!! I severely doubt that if we went to an all electronic system tomorrow it would have much of an effect. Do you assign some sort of special significance to physical money? Do you know anybody that stores or carries large amounts of physical cash around anymore? Pretty much everybody in my universe uses electronic payments almost exclusively. When I do get a significant bit of cash (which is EXTREMELY rare) I deposit it in the bank immediately. For example, somebody bought an old car of mine and gave me $100 bills… I took those to the ATM and deposited them w/in 10 minutes. That was the first time I’d held that much cash in probably the last 7 years or so. My “hot potato” effect was to transfer those into electronic format ASAP! I think that would be the reaction of most people. But I wonder if Nick Rowe would agree…

    Perhaps I’m misreading them regarding that “cash mysticism” because I can’t tell sometimes if they’re serious or not. Sumner wrote a piece not long ago about the crisis being caused by not enough $100 bills being available for drug dealers, foreigners, … and some other group. I kept reading it to see if he was joking… but I couldn’t tell! I think Krugman is serious about the “specialness” of cash, but I can’t tell about the others.

    Thanks in advance for helping an amateur to sort this stuff out!

    BTW, I love the following site for figuring out what the effects of deficit spending, QE, gov or private borrowing, OMO’s etc are on the macro consolidated balance sheets… really REALLY helps to clear up all kinds of mystical thinking on these subjects (you can set what operation you want to see in the lower left corner, and then “run” it):

    For example, it becomes clear as day that QE, in whatever form, is just a swap of assets (no net new financial assets — and certainly not “money printing” or equity injections in the sense that Peter Schiff or Rick Perry would have you hyperventilate about), whereas government deficit spending (“Government Spends (Consolidated)”) is simply a matter of redistributing deposits from Peter to pay Paul and issuing a bond in the process to Peter. No net change in reserves in the private sector (but private equity does increase).


  9. 9 Tom Brown February 1, 2013 at 3:51 pm

    Also, I guess Sumner has written “no central bank in history has tried to inflate, and failed.”

    Do you agree with that?


  10. 10 David Glasner February 2, 2013 at 7:17 pm

    cato, I’m sorry, but I really don’t know what you and Taylor are assuming, and I don’t see the point of a ceteris paribus assumption in a discussion of the effect of monetary policy on the term structure of interest rates.

    Tom, You covered a lot of ground, but I will try to respond as best I can. You are right that I don’t agree with Nick Rowe that there is a hot potato effect for bank created money. I do agree that currency is a hot potato. Another commenter on this blog and both Scott’s and Nick’s blogs, Mike Sproul, doesn’t think that even currency is a hot potato. Your main question seems to be how the Fed or any central bank can reach its NGDP target. The answer is that by issuing more currency in exchange for bonds held by the public, the Fed can induce more spending on the part of the public because they find that the amount of currency in their pockets is just too great. At low nominal interest rates, this is hard, but not impossible, to do. The Fed just has to keep doing it with sufficient resolve until people decide to spend some of those balances and the public begains to expect the price level to rise. This has nothing to do with the money multiplier, this is just creating an excess supply of currency.

    Another strategy is to work through the foreign exchange market, i.e., starting a currency war. If the Fed announces that it is aiming at a lower value of the dollar in terms of foreign currencies and will engage in FX transactions to achieve that result (e.g., buying euros with dollars) the quantity of dollars will rise and the exchange value of the dollar will fall.

    One reason for all the excess reserves held by banks is that the Fed is paying interest on reserves. Scott and a number of others (including me) have been arguing that this has been a huge mistake on the part of the Fed because it simply creates an unlimited demand by the banks for reserves when the interest on reserves exceeds the rate on Treasuries.
    There is a huge stock of currency outstanding so even though the demand for currency by some people may be falling, in the aggregate it is still huge, so I don’t think that currency is irrelevant for the determination of prices.
    And thanks for the link, I will have a look.

    I am not sure if I agree with Scott’s claim, but it does not seem implausible to me, and I couldn’t name a central bank that did try to inflate and failed. On the other hand, I am not sure how many central banks have deliberately set out to inflate. In most cases, inflation was the result of other factors that forced central banks to accommodate the fiscal needs of governments to which they were answerable.


  11. 11 Benjamin Cole February 2, 2013 at 10:03 pm

    I read Taylor’s piece forward, then backwards and then sideways. It makes no sense. It was like watching a top boxer fight himself.

    This is John taylor, who gushed about Japan’s QE program from 2001-2006?

    I agree with David G.—commercial banks can and do charge what they can charge for loans to businesses or home mortgages. In fact, they are getting great spreads. If you pay 12 percent on your credit card, imagine the bank’s spread.

    Taylor’s piece grows nuttier as you go along—not enough credit? There is a global capital glut! Money is seeking a harbor everywhere. C&I loan volumes are rising nicely and the housing market is coming back.

    BTW, most small commercial loans are made agains assets, and that usually means real estate. If real estate values can inflate, we will see a lot more loan volume….

    I just cannot understand the people who say we must do a Japan, to avoid becoming Zimbabwe. Even John Taylor did not say that in 2006—he raved about the success of Japan’s QE program.

    And uncertainty? You mean, businesses and investors are more certain if the Fed plays the mysterious Sphinx?

    I could write a book about how wrong John Taylor is in this piece. Is he short on bonds? I just do not get it.


  12. 12 Tom Brown February 2, 2013 at 10:51 pm

    David, thanks for your detailed response and for your patience. A few questions about what you wrote:

    “bank created money” … what is your definition of this? bank customer deposit accounts created by extending credit (creating an loan-asset / depost-liability on the bank bank balance sheet through double entry accounting?). Do you refer to this as “inside money” or “endogenous money?”

    “I do agree that currency is a hot potato.”

    What is your definition of currency here? Is it

    1. physical bills and coins in circulation outside of bank vaults?

    2. physical bills and coins in bank vaults plus 1.

    3. bank Fed reserve deposits (required & excess) plus physical bills and coins in bank vaults? [I’ve heard this called “bank reserves”]

    3. M0 or MB as defined here:

    When you write this:

    “The answer is that by issuing more currency in exchange for bonds…”

    Your definition of “currency” here seems to definitely include bank Fed reserve deposits. True? Is it the same definition as you use above?

    In general when you refer to “currency” in your reply, are you always using precisely the same definition each time?

    When you write:

    “The Fed just has to keep doing it with sufficient resolve until people decide to spend some of those balances and the public begains to expect the price level to rise.”

    How do you know that the lack of Treasury bonds won’t just cause investors to seek other “safe” assets with similar qualities? Won’t the private sector be incentivized to provide financial assets which can be substituted for Treasury bonds?

    Good points about the foreign exchange market. I hadn’t thought that through too much, but I had heard a similar argument somewhere… perhaps on Sumner’s site.

    Regarding the interest on reserves (required and excess?), have you seen this online debate regarding the “permanent floor?”:

    Do you have a position in this debate?

    Regarding the link I sent, it’s pretty simple minded but it helps me keep the consolidated balance sheets clear in my mind for all these operations.

    OK, thanks again!


  13. 13 Tom Brown February 2, 2013 at 11:05 pm

    Regarding the “floor” debate, I first read about it here in Cullen Roche’s site:

    But have since read many of the Waldman, Krugman, Rowe, Kaminska, Beckworth, Sumner, Coppola and Fullwiler links Waldman gives above. This is another good set of links at the top of Fullwiler’s first article on this which is convenient for following the debate:


  14. 14 Tom Brown February 2, 2013 at 11:30 pm

    David, the reason I’m so interested in your definition of “currency” is related to my earlier question about whether you assign some special significance to physical paper bills and metal coins. I don’t see why they have any special significance because they are convertible at par value to or from bank deposits. And from the banks’ point of view, since physical money in their vault is defined as reserves just as their electronic Fed reserve deposits are, they again are convertible at par value to their electronic equivalent. In short, if paper and metal money were to be phased out tomorrow, I don’t see why that would have any significant effect on the economy. Do you?


  15. 15 W. Peden February 3, 2013 at 2:08 am

    Tom Brown,

    “Won’t the private sector be incentivized to provide financial assets which can be substituted for Treasury bonds?”

    Incidentally, that is exactly one of the transmission mechanisms that Tim Congdon sets out for QE and it does a good job of explaining the effect of QE (that is not expected to be reversed in its effects later) on asset prices. Financial assets are priced in money and a central bank buying bonds changed the ratio between the two, increasing the price of financial assets.


  16. 16 David Glasner February 3, 2013 at 10:50 am

    Benjamin, Good summary of the problems with Taylor. There actually are some good (or at least plausible) arguments that he could be making. I don’t understand why he is so attracted to the lousy ones.

    Tom, Yes, bank-created money is “inside money” or “endogenous money.”

    Currency is the total stock of currency held by the public including banks. I would talk about the monetary base instead if there were no interest paid on reserves. What is special about currency is that it is non-interest-bearing.

    The problem is not that the pubic holds too many Treasuries. We want to put more currency in the hands of the public to increase spending on goods and services and to raise prices. Some of the excess cash will be diverted to assets similar to Treasuries, but some will be spent on consumer durables and fixed capital assets.

    W. Peden, Good point. But the increase in asset prices is not an automatic and inevitable result of an open market sale. For asset prices to rise, presumably there must be an increase in the expected net cash flows associated with the assets or a decrease in the rate of discount used to evaluate those cash flows.


  17. 17 W. Peden February 3, 2013 at 1:26 pm

    David Glasner,

    That makes sense to me.

    “Some of the excess cash will be diverted to assets similar to Treasuries, but some will be spent on consumer durables and fixed capital assets.”

    That reminds me a lot of Milton Friedman’s version of the Keynesian liquidity preference function, i.e the key point is that money and Treasuries are alternatives, byt so are money and a lot of other things. A model with only Treasuries and money obscures this substituability and was the source of Keynes’s error with the liquidity trap; it was a valid deduction from false premises assumed in the model.


  18. 18 Tom Brown February 3, 2013 at 1:57 pm

    David, thanks again. But your definition of currency as being “non-interest bearing” doesn’t seem to fit with how you used it in this sentence:

    “The answer is that by issuing more currency in exchange for bonds held by the public, the Fed can induce more spending on the part of the public because they find that the amount of currency in their pockets is just too great.”

    in this comment:

    Does it? That “currency” issued “in exchange for bonds held by the public,” (that public being either bank or non-bank) will mostly be in the form of electronic bank Fed reserve deposits earning interest from the Fed, correct? I understand that if a non-bank get’s this “currency” in exchange for bonds, that the non-bank holds this “currency” in the form of a deposit account with the bank, but the bank itself will get reserves transferred to it from the Fed in a 1:1 ratio with the deposit held by the customer.

    So I’m still confused by that… are you using “currency” in this sentence to describe electronic bank Fed deposits as you wish they were (should the Fed change policy and stop paying interest on reserves) or how they actually are right now?

    I’m going to say you probably mean the former (how you wish they were) rather than the latter (how they actually are).

    Given that, then the only non-interest bearing forms of money currently in existence (as it stand right now) are physical paper bills and coins outside of banks (in circulation) and 90% of customer bank demand deposits (since the banks must keep approximately only 10% of demand deposits as required reserves, which also bear interest), True? I’m assuming here (because I don’t know) that the Fed pays the banks interest on their “vault cash” [paper bills and coins] because those are strictly still defined as a component of a bank’s reserves. Is that assumption correct? Those paper bills and coins lose their status as “bank reserves” (and thus stop bearing interest from the Fed) as soon as a bank customer withdraws his deposit in the form of paper bills and coins and walks out the door.

    On a related topic, it seems to me that the only ways in which excess reserves disappear off of the consolidated banks’ balance sheet are:

    1. bank customers withdraw deposits in the form of paper bills and coins.

    2. The Treasury auctions bonds. When the dust settles, this results in less reserves in the Fed accounts of banks regardless of who the ultimately buyer of the bond was… and as I understand it, most Treasury bond sales are “on-sold” to non-banks.

    3. Fed OMOs to raise overnight rates.

    4. Banks make loans to non-banks, thus converting a small fraction (~10%) of the loan amount into required reserve deposits at the Fed.

    1. is almost entirely a wash because CostCo and Wal-Mart collect paper notes and coins and deposit them into their accounts ASAP, thus converting them back into interest bearing excesses bank reserves for the bank. Of course CostCo and Wal-Mart also earn interest from the bank on their deposits, but at a smaller rate. The only leakage here is people stuffing paper notes and coins in their mattresses and losing or destroying the paper notes and coins.

    2. is a wash because the government spends every $ in proceeds from those auctions and thus they return to the banking system as interest bearing excess bank reserves.

    3. Is not really happening right now, right? In fact the opposite is happening, especially with QE operations.

    4. This is currently the only means I see of interest bearing bank excess reserves being diminished. And in this case they just change status from excess to required and thus they still bear interest for the bank from the Fed.

    Do you agree with my characterization here? Is there something I’m missing?


  19. 19 Tom Brown February 3, 2013 at 2:20 pm

    BTW, you can see all four of those circumstances play out on the econviz consolidated balance sheet visualizer tool… except that I don’t think they really show a distinction between excess and required reserves (so I guess you could say those are Canadian balance sheets).

    So I guess you could say what I’m getting at with this is that if the interest on reserves were to drop to zero, I still don’t see those reserves escaping the banking system as a whole. How would they, aside from Fed overnight rate raising OMOs? Because even my item 4. doesn’t change the amount of reserves in total (excess + required). Are you saying that a “hot potato” effect really just changes the rate of movement of these reserves between banks… (in the process of backing payment settlements of non-bank depositors, for example)? Is that’s what’s referred to as “the velocity of money?”


  20. 20 Tom Brown February 3, 2013 at 2:54 pm

    … and are you saying that this velocity would increase if the Fed were persistent enough, thus increasing inflation? Of course the quantity would also increase with the Fed’s persistence… and as long as that quantity had some “velocity” it would also increase inflation.


  21. 21 Tom Brown February 3, 2013 at 3:11 pm

    Oh, and I guess my item 4. implies that bank-created money is entering the economy in a 10:1 ratio with the amount of reserves changing status from excess to required, so of course that is inflationary.


  22. 22 Tom Brown February 4, 2013 at 10:59 am

    5. Taxes: again all spent back to reserves usually.


  23. 23 David Glasner February 5, 2013 at 2:31 pm

    Tom, In principle, I am claiming that the monetary variable that can have a hot potato effect is the monetary base which includes both currency and the holdings of central bank reserves by commercial banks. In the current special case in which the central bank is paying interest on reserves at a higher rate than banks could earn on alternative instruments, e.g., Treasuries, the banks’ demand for reserves is unlimited so that they will hold whatever quantity of reserves is available, eliminating any hot potato effect on reserve balances. However, the hot potato effect still applies to currency in these circumstances. There may be times when I use the term “currency” as a short-hand synonym for the monetary base, but in the present context I mean currency that is held by individuals as well as vault cash held by banks. I may be wrong but I thought that vault cash is non-interest bearing.

    Under current economic conditions, it is true that bank deposits are non-interest bearing, but they are inside money, so I don’t consider deposits in my model of price level determination. The supply of and demand for deposits determines the quantity of deposits in existence and the spread between the borrowing and lending rates of banks. In the current environment, the market clearing deposit rate is stuck at zero, but the market for deposits is still basically clearing.

    I agree that excess reserves would be eliminated if the banks were lending more than they are not to non-banks. At present it makes no sense for the Fed to sell bonds to eliminate excess reserves, but that will start to become an option if inflation expectations rise sufficiently to induce additional spending by the public. The point of eliminating interest on reserves is to induce banks to increase their lending to non-banks. That would increase velocity.


  24. 24 Tom Brown February 5, 2013 at 7:36 pm

    David, thanks. I’m starting to get a clearer picture. I’ve learned a lot over the past few days. I’m indebted to you, Nick Rowe, commenter “dtoh” on Sumner’s site, and Mike sax for engaging w/ me and my many questions. Just in case you’re interested, here’s the other threads I was talking about w/ Rowe, etc.:

    Thread w/ dtoh at Sumner’s site:

    Thread w/ Nick Rowe and Mike Sax at Sax’s site:

    I bring up many of the same issues in those other threads. I especially appreciated dtoh’s alternate (but equivalent, he claims) description of how NGDPLT works which does not require a “hot potato effect.” Instead in his description, paper money in circulation is not a CAUSE of anything… just highly correlated with the true mechanism. This makes me feel a LOT better about the theory. Sumner concedes that dtoh’s description is probably “more marketable.”

    I think I’ve already covered this here, but I don’t know if I got your full response: let me try a slightly different angle (I’ve already asked Nick Rowe and dtoh, BTW):

    If we were to get rid of paper bills and coin money* and go fully electronic, would that have any significant impact on MM theory, the mechanism by which NGDPLT works, or on the economy as a whole?

    Just as a heads up (it’s covered in the links above), both Rowe and dtoh essentially said “No” (with some qualification by both).

    *I spell out “paper bills and coins” to be absolutely clear, because some people like “currency” and others “cash” but sometimes they use those words in different ways as well, which I find confusing…. especially when I’m trying to get t the bottom of whether or not the person ascribes any special significance to this form of money. I realize that even the way I describe it leaves as ambiguous whether or not I’m talking about “vault cash,” which are considered reserves, or that component in circulation with the non-bank private sector, or both. Here I mean both of course.


  25. 25 David Glasner February 10, 2013 at 7:25 am

    Tom, I looked at your exchange with dtoh, but not carefully enough to follow it. I don’t think that I agree with dtoh on the mechanism by which open market purchases raise the price of Treasuries. Ultimately the price of Treasuries depend on expectations of future interest rates, so if the price of Treasuries change you have to explain how expectations have changed. About electronic money, I don’t see any basic difference between electronic money and paper money. It’s easier to pay interest on electronic money, but in principle the analysis does not change merely because the physical characteristics of money change.


  26. 26 Tom Brown February 10, 2013 at 1:37 pm

    David, thanks.


  1. 1 John Taylor, Post-Modern Monetary Theorist | | Trackback on January 31, 2013 at 11:42 am
  2. 2 Don’t Touch the Yield | J. W. Mason Trackback on May 14, 2015 at 9:54 am

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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