Monetary Theory on the Neo-Fisherite Edge

The week before last, Noah Smith wrote a post “The Neo-Fisherite Rebellion” discussing, rather sympathetically I thought, the contrarian school of monetary thought emerging from the Great American Heartland, according to which, notwithstanding everything monetary economists since Henry Thornton have taught, high interest rates are inflationary and low interest rates deflationary. This view of the relationship between interest rates and inflation was advanced (but later retracted) by Narayana Kocherlakota, President of the Minneapolis Fed in a 2010 lecture, and was embraced and expounded with increased steadfastness by Stephen Williamson of Washington University in St. Louis and the St. Louis Fed in at least one working paper and in a series of posts over the past five or six months (e.g. here, here and here). And John Cochrane of the University of Chicago has picked up on the idea as well in two recent blog posts (here and here). Others seem to be joining the upstart school as well.

The new argument seems simple: given the Fisher equation, in which the nominal interest rate equals the real interest rate plus the (expected) rate of inflation, a central bank can meet its inflation target by setting a fixed nominal interest rate target consistent with its inflation target and keeping it there. Once the central bank sets its target, the long-run neutrality of money, implying that the real interest rate is independent of the nominal targets set by the central bank, ensures that inflation expectations must converge on rates consistent with the nominal interest rate target and the independently determined real interest rate (i.e., the real yield curve), so that the actual and expected rates of inflation adjust to ensure that the Fisher equation is satisfied. If the promise of the central bank to maintain a particular nominal rate over time is believed, the promise will induce a rate of inflation consistent with the nominal interest-rate target and the exogenous real rate.

The novelty of this way of thinking about monetary policy is that monetary theorists have generally assumed that the actual adjustment of the price level or inflation rate depends on whether the target interest rate is greater or less than the real rate plus the expected rate. When the target rate is greater than the real rate plus expected inflation, inflation goes down, and when it is less than the real rate plus expected inflation, inflation goes up. In the conventional treatment, the expected rate of inflation is momentarily fixed, and the (expected) real rate variable. In the Neo-Fisherite school, the (expected) real rate is fixed, and the expected inflation rate is variable. (Just as an aside, I would observe that the idea that expectations about the real rate of interest and the inflation rate cannot occur simultaneously in the short run is not derived from the limited cognitive capacity of economic agents; it can only be derived from the limited intellectual capacity of economic theorists.)

The heretical views expressed by Williamson and Cochrane and earlier by Kocherlakota have understandably elicited scorn and derision from conventional monetary theorists, whether Keynesian, New Keynesian, Monetarist or Market Monetarist. (Williamson having appropriated for himself the New Monetarist label, I regrettably could not preserve an appropriate symmetry in my list of labels for monetary theorists.) As a matter of fact, I wrote a post last December challenging Williamson’s reasoning in arguing that QE had caused a decline in inflation, though in his initial foray into uncharted territory, Williamson was actually making a narrower argument than the more general thesis that he has more recently expounded.

Although deep down, I have no great sympathy for Williamson’s argument, the counterarguments I have seen leave me feeling a bit, shall we say, underwhelmed. That’s not to say that I am becoming a convert to New Monetarism, but I am feeling that we have reached a point at which certain underlying gaps in monetary theory can’t be concealed any longer. To explain what I mean by that remark, let me start by reviewing the historical context in which the ruling doctrine governing central-bank operations via adjustments in the central-bank lending rate evolved. The primary (though historically not the first) source of the doctrine is Henry Thornton in his classic volume The Nature and Effects of the Paper Credit of Great Britain.

Even though Thornton focused on the policy of the Bank of England during the Napoleonic Wars, when Bank of England notes, not gold, were legal tender, his discussion was still in the context of a monetary system in which paper money was generally convertible into either gold or silver. Inconvertible banknotes – aka fiat money — were the exception not the rule. Gold and silver were what Nick Rowe would call alpha money. All other moneys were evaluated in terms of gold and silver, not in terms of a general price level (not yet a widely accepted concept). Even though Bank of England notes became an alternative alpha money during the restriction period of inconvertibility, that situation was generally viewed as temporary, the restoration of convertibility being expected after the war. The value of the paper pound was tracked by the sterling price of gold on the Hamburg exchange. Thus, Ricardo’s first published work was entitled The High Price of Bullion, in which he blamed the high sterling price of bullion at Hamburg on an overissue of banknotes by the Bank of England.

But to get back to Thornton, who was far more concerned with the mechanics of monetary policy than Ricardo, his great contribution was to show that the Bank of England could control the amount of lending (and money creation) by adjusting the interest rate charged to borrowers. If banknotes were depreciating relative to gold, the Bank of England could increase the value of their notes by raising the rate of interest charged on loans.

The point is that if you are a central banker and are trying to target the exchange rate of your currency with respect to an alpha currency, you can do so by adjusting the interest rate that you charge borrowers. Raising the interest rate will cause the exchange value of your currency to rise and reducing the interest rate will cause the exchange value to fall. And if you are operating under strict convertibility, so that you are committed to keep the exchange rate between your currency and an alpha currency at a specified par value, raising that interest rate will cause you to accumulate reserves payable in terms of the alpha currency, and reducing that interest rate will cause you to emit reserves payable in terms of the alpha currency.

So the idea that an increase in the central-bank interest rate tends to increase the exchange value of its currency, or, under a fixed-exchange rate regime, an increase in the foreign exchange reserves of the bank, has a history at least two centuries old, though the doctrine has not exactly been free of misunderstanding or confusion in the course of those two centuries. One of those misunderstandings was about the effect of a change in the central-bank interest rate, under a fixed-exchange rate regime. In fact, as long as the central bank is maintaining a fixed exchange rate between its currency and an alpha currency, changes in the central-bank interest rate don’t affect (at least as a first approximation) either the domestic money supply or the domestic price level; all that changes in the central-bank interest rate can accomplish is to change the bank’s holdings of alpha-currency reserves.

It seems to me that this long well-documented historical association between changes in the central-bank interest rates and the exchange value of currencies and the level of private spending is the basis for the widespread theoretical presumption that raising the central-bank interest rate target is deflationary and reducing it is inflationary. However, the old central-bank doctrine of the Bank Rate was conceived in a world in which gold and silver were the alpha moneys, and central banks – even central banks operating with inconvertible currencies – were beta banks, because the value of a central-bank currency was still reckoned, like the value of inconvertible Bank of England notes in the Napoleonic Wars, in terms of gold and silver.

In the Neo-Fisherite world, central banks rarely peg exchange rates against each other, and there is no longer any outside standard of value to which central banks even nominally commit themselves. In a world without the metallic standard of value in which the conventional theory of central banking developed, do the propositions about the effects of central-bank interest-rate setting still obtain? I am not so sure that they do, not with the analytical tools that we normally deploy when thinking about the effects of central-bank policies. Why not? Because, in a Neo-Fisherite world in which all central banks are alpha banks, I am not so sure that we really know what determines the value of this thing called fiat money. And if we don’t really know what determines the value of a fiat money, how can we really be sure that interest-rate policy works the same way in a Neo-Fisherite world that it used to work when the value of money was determined in relation to a metallic standard? (Just to avoid misunderstanding, I am not – repeat NOT — arguing for restoring the gold standard.)

Why do I say that we don’t know what determines the value of fiat money in a Neo-Fisherite world? Well, consider this. Almost three weeks ago I wrote a post in which I suggested that Bitcoins could be a massive bubble. My explanation for why Bitcoins could be a bubble is that they provide no real (i.e., non-monetary) service, so that their value is totally contingent on, and derived from (or so it seems to me, though I admit that my understanding of Bitcoins is partial and imperfect), the expectation of a positive future resale value. However, it seems certain that the resale value of Bitcoins must eventually fall to zero, so that backward induction implies that Bitcoins, inasmuch as they provide no real service, cannot retain a positive value in the present. On this reasoning, any observed value of a Bitcoin seems inexplicable except as an irrational bubble phenomenon.

Most of the comments I received about that post challenged the relevance of the backward-induction argument. The challenges were mainly of two types: a) the end state, when everyone will certainly stop accepting a Bitcoin in exchange, is very, very far into the future and its date is unknown, and b) the backward-induction argument applies equally to every fiat currency, so my own reasoning, according to my critics, implies that the value of every fiat currency is just as much a bubble phenomenon as the value of a Bitcoin.

My response to the first objection is that even if the strict logic of the backward-induction argument is inconclusive, because of the long and uncertain duration of the time elapse between now and the end state, the argument nevertheless suggests that the value of a Bitcoin is potentially very unsteady and vulnerable to sudden collapse. Those are not generally thought to be desirable attributes in a medium of exchange.

My response to the second objection is that fiat currencies are actually quite different from Bitcoins, because fiat currencies are accepted by governments in discharging the tax liabilities due to them. The discharge of a tax liability is a real (i.e. non-monetary) service, creating a distinct non-monetary demand for fiat currencies, thereby ensuring that fiat currencies retain value, even apart from being accepted as a medium of exchange.

That, at any rate, is my view, which I first heard from Earl Thompson (see his unpublished paper, “A Reformulation of Macroeconomic Theory” pp. 23-25 for a derivation of the value of fiat money when tax liability is a fixed proportion of income). Some other pretty good economists have also held that view, like Abba Lerner, P. H. Wicksteed, and Adam Smith. Georg Friedrich Knapp also held that view, and, in his day, he was certainly well known, but I am unable to pass judgment on whether he was or wasn’t a good economist. But I do know that his views about money were famously misrepresented and caricatured by Ludwig von Mises. However, there are other good economists (Hal Varian for one), apparently unaware of, or untroubled by, the backward induction argument, who don’t think that acceptability in discharging tax liability is required to explain the value of fiat money.

Nor do I think that Thompson’s tax-acceptability theory of the value of money can stand entirely on its own, because it implies a kind of saw-tooth time profile of the price level, so that a fiat currency, earning no liquidity premium, would actually be appreciating between peak tax collection dates, and depreciating immediately following those dates, a pattern not obviously consistent with observed price data, though I do recall that Thompson used to claim that there is a lot of evidence that prices fall just before peak tax-collection dates. I don’t think that anyone has ever tried to combine the tax-acceptability theory with the empirical premise that currency (or base money) does in fact provide significant liquidity services. That, it seems to me, would be a worthwhile endeavor for any eager young researcher to undertake.

What does all of this have to do with the Neo-Fisherite Rebellion? Well, if we don’t have a satisfactory theory of the value of fiat money at hand, which is what another very smart economist Fischer Black – who, to my knowledge never mentioned the tax-liability theory — thought, then the only explanation of the value of fiat money is that, like the value of a Bitcoin, it is whatever people expect it to be. And the rate of inflation is equally inexplicable, being just whatever it is expected to be. So in a Neo-Fisherite world, if the central bank announces that it is reducing its interest-rate target, the effect of the announcement depends entirely on what “the market” reads into the announcement. And that is exactly what Fischer Black believed. See his paper “Active and Passive Monetary Policy in a Neoclassical Model.”

I don’t say that Williamson and his Neo-Fisherite colleagues are correct. Nor have they, to my knowledge, related their arguments to Fischer Black’s work. What I do say (indeed this is a problem I raised almost three years ago in one of my first posts on this blog) is that existing monetary theories of the price level are unable to rule out his result, because the behavior of the price level and inflation seems to depend, more than anything else, on expectations. And it is far from clear to me that there are any fundamentals in which these expectations can be grounded. If you impose the rational expectations assumption, which is almost certainly wrong empirically, maybe you can argue that the central bank provides a focal point for expectations to converge on. The problem, of course, is that in the real world, expectations are all over the place, there being no fundamentals to force the convergence of expectations to a stable equilibrium value.

In other words, it’s just a mess, a bloody mess, and I do not like it, not one little bit.


31 Responses to “Monetary Theory on the Neo-Fisherite Edge”

  1. 1 Nick Rowe May 6, 2014 at 8:39 pm

    Hmm. I think it matters a lot whether inflation is inertial. If actual inflation cannot jump, expected inflation will not jump, and real and nominal interest rates will go in the same direction in the short run. I also think it matters a lot how people interpret a change in interest rates (“why did they do that? How should I update my beliefs about the Fed’s beliefs and target?”)

    By the way, how would Irving Fisher react to our calling this the “Neo-Fisherite” theory? Would he be mad at us?


  2. 2 Noah Smith May 6, 2014 at 9:28 pm

    No more than Keynes would be annoyed at the Neo-Keynesians!


  3. 3 Morgan Warstler (@morganwarstler) May 6, 2014 at 9:34 pm

    I think the thing that most deeply annoys you about Bitcoin, is exactly the same thing annoying you about the current economy.

    There is no there, there.

    Ultimately, atomic economy really started when you took out a loan against atoms. Banks are pawn shops. The size of the bank / economy grows and more people drag in atomic stuff and use it as collateral. Even taxes are a claim against your atoms, your assets that can be seized and liquidated.

    Whereas the truly productivity gains we have now are literally non-atomic. Software is eating the world. And sooner than you think, you are going to sit all day in a small space with a VR rig on (electons) and suck down soylent (calories).

    It seems obvious. Greenspan talked of the physical tonnage of GDP shrinking every year,

    Now with 3D printing, Jurvetson is predicting everything will cost $1 per pound, (the designs like music, movies, edu, videogames, and software you’ll give a shop $200 and over the year get 200 lbs worth of whatever the hell you need.

    I’m not an economist, but its pretty clear GI/CYB solves unemployment. Gets us down to zero consumption poverty. Sumner and Farmer and Kimball will all say “let’s do it”

    GI/CYB is really just Uber for Welfare. Software eating the cost of govt.

    That’s $1.7T in public employee compensations and god knows how much atomic stuff, we don’t nee to pay for anymore.

    So maybe the only problem is that MP is fighting the debtless future, where you can’t borrow, bc you don’t have any atomic collateral, and the growing software companies, don’t need debt, bc they sell equity and either die or take over an entire old atomic system like WhatsApp.

    Using MP to solve unemployment via demand, when we could instead build an Open Source app, and be done with it, seems a bit mad, doesn’t it?


  4. 4 polymath May 6, 2014 at 10:52 pm

    I’m enjoying your ongoing engagement with this topic and I find it enlightening to watch. I think you’re on to something key when you say the theory of value of fiat currency is important.

    I’m struck by how quickly you move from the concrete, yet as you say unsatisfactory, tax-acceptability theory of value to a very handwavy pure-expectations theory, which also feels unsatisfactory.

    The tax-acceptability theory is also about expectations, but it limits itself to expectations about how taxes must be paid under threat of jail. This seems so odd to me because, as I mentioned in a comment on your Bitcoin post, there are other non-tax-related coercive powers that enforce payment in dollars (for tax debts e.g.) or more anonymous currencies (for online drug debts e.g.). In Thompson pp23-25 he calculates a value based on tax use because his model admits of taxation as the sole coercive power. We should expect this to be wrong (as it is) to the extent that there are other market-relevant coercive powers.

    I suggest that pure-expectations theory feels unsatisfactory only inasmuch as it makes currency value “inexplicable.” Yet value is inexplicable only if one ignores the specific expectations in money and goods markets. Solvent borrowers must expect to borrow at a satisfactory real interest rate, either through foreign conversion or natively. Holders of the currency must expect to achieve a satisfactory real interest rate. Taxes, central bank operations now, central bank communications about the future, government contracts, government takings, and actions of private market participants (Citibank, Exxon, MtGox, Silk Road) constrain expectations in concrete, explicable ways. Value is jointly determined, and coercive power is part of the determination.

    So yes, Bitcoin has less coercive power behind it, and expectations about it are very volatile, and its value is very volatile. This is compatible with the pure-expectations theory of value. That theory would also imply that expectations would become less volatile if Bitcoin becomes more widely used.

    The neo-Fisher question would be resolved to the extent that we can characterize how the joint determination works. On that front, I simply don’t understand how the neo-Fisherfolk set up the joint determination to avoid the hot potato effect. Please post links to any attempts; if they exist I’ve missed them.

    On the topic of coercion, assuming the neo-Fisherfolk have defined a way that avoids the hot potato effect, I’m pretty sure I can bring it back. Central bank helicopter drops will be available only to sellers in the market who can prove they raised their selling price. Of course that’s not in the neo-Fisher models, so it’s not a critique of their theory on its own terms. But as you point out they need to admit some theory of value, and if their model necessarily relies on a wholly unrealistic one, while more traditional monetarist models don’t, they have a problem.


  5. 5 Lord May 6, 2014 at 11:38 pm

    It is all about expectations, but if it is all about expectations, why do they ever change? Why do surprises occur? Why do things ever differ from what we expect? Is it only a discrepancy between our individual expectations and collective realization?


  6. 6 Nick Edmonds May 7, 2014 at 1:18 am

    The big difference between bitcoin and dollars is the amount of debt denominated in dollars. People accept dollars not just because they hope that someone else will accept them, but because they know that somebody somewhere absolutely must obtain those dollars to discharge their debt.

    The theoretical end price for dollars is only zero if we assume that there is still some outside money left when everything else is gone – which depends on what we assume about government deficits and surpluses. Otherwise, it’s indeterminate. The holder of the last dollar would be prepared to exchange it for anything, the debtor for the last dollar would be prepared to exchange everything he has to obtain it.

    In the meantime, the willingness of people to be either dollar debtors or dollar creditors swamps any concerns about what the end position might be. This comes down to expected returns / costs from owning / owing dollars compared to returns on other assets.


  7. 7 Phil Sage May 7, 2014 at 1:36 am

    “Bitcoins, inasmuch as they provide no real service, cannot retain a positive value in the present”
    BItcoins provide an anonymous digital means of exchange. In a world of overpowerful states that is a very valuable service.
    Fiat currency enables people to settle tax debts. Bitcoin enables people to settle private transactions. How is that intrinsically different. Bitcoin may also emerge as a store of value. It is also an indicator of “coolness”. Bitcoins will retain a positive value unless the state succeeds in reinstating its monopoly hold on currency.


  8. 8 Rob Rawlings May 7, 2014 at 7:21 am

    Suppose that the CB could announced “We are setting an inflation target of 10%. To achieve that we will target an interbank rate of 15% and we will adjust that as needed to hit the target”.

    I believe that if the CB was thought to be serious then it would achieve its goals fairly quickly.

    What if it just set rates to 15% and said nothing , but held them there long-term ? I think the inflation rate would adjust anyway even without expectations (after an initial deep recession). One mechanism (there are certainly others) that would drive this adjustment is that eventually businesses would need to factor high-interest rates into their price models if they wanted to continue to make a profit. This would bootstrap an inflation expectations process (even without the CB) and lead to a new equilibrium with higher interest rates and inflation than before (and the same natural rate).

    So: In my view expectations can help get to the new equilibrium quicker, but even without it higher interest rates will eventually drive higher inflation (and vice versa).


  9. 9 steve from virginia (@econundertow) May 7, 2014 at 9:30 am

    “In a world without the metallic standard of value in which the conventional theory of central banking developed, do the propositions about the effects of central-bank interest-rate setting still obtain?”

    Redeemability relates to the exchange of govt paper for bullion at a fixed (fiat) rate not the fact of the exchange. Exchange and redemption transactions are essentially the same (exchanging paper for bullion or exchanging it for something else.)

    There is no more metallic standard, instead there is the petroleum standard of ‘value’ (should be ‘worth’ not ‘value as money cannot have value and be money): millions of people every day swap their money for gasoline @ gas stations around the world. This — not interest rates — fixes the price of money.

    Add the cost of fuel to the (fuel derived) cost of money (future money, actually because what is spent @ gas stations is borrowed) and the economy that makes use of (wastes) the fuel is underwater: it can no longer afford fuel + credit by way of borrowing: also, there is no real collateral (only the wasting process itself and bankrupt enablers) and all credit is unsecured (including bank liabilities which undoes money managers). The system is functionally insolvent which is why there is a crisis right now and why the banking management cannot do anything to ‘fix’ things.

    Consider Fisher more relevant to deflation (think ‘energy deflation’ = debt deflation) but the rest is Minsky.


  10. 10 David Glasner May 7, 2014 at 10:07 am

    Nick Rowe, By inflation being inertial, do you mean that inflation only tends to change gradually? How would you tell whether gradual changes in inflation reflect gradual changes in the central bank target or some deeper property of the economy? In 1933, there was a pretty sudden burst of inflation when FDR suspended the gold standard. What do you make of that episode? I think Fisher, in attempting to account for Gibson’s Paradox, clearly believed that inflationary expectations are very slow to adjust. That was probably where the idea of adaptive expectations comes from. I think he would be horrified of the company that he was being associated with, but I don’t think he would be mad at us, just Noah.

    Noah, Well just because Keynes has been mistreated, doesn’t give you license to trash Fisher.

    Morgan, Well obviously something is bothering; whether you’ve put your finger on it, I honestly can’t tell.

    polymath, I’m actually not moving from the tax-acceptability theory. As I suggested, it does need more work to make it useful, however. My discussion of the pure expectations theory was intended precisely to show how unsatisfactory it is. What is your take on backward induction?

    Lord, My intuition tells me that it is not all about expectations (though they are very important). But even if I believed that it is all about expectations, I certainly would not believe that all expectations are rational so that not everyone’s expectations will be realized. Aside from that the world is not a closed system; new knowledge is gained, which means that expectations based on old knowledge will almost certainly turn out to be disappointed.

    Nick Edmonds, Good point, which I have wanted to make explicit, but haven’t got around to. Nobody is quoting the price of anything in terms of bitcoins. People are quoting prices in dollars and there is a dollar/bitcoin exchange rate. If bitcoins were a real alternative to dollars, there would be prices of a lot of stuff quoted in bitcoins. Why would anyone contract a debt in terms of some asset unless the expected value of the asset is positive? I see a circularity problem in saying that the value of a dollar is positive because people are contracting debts in terms of dollars. Do you not think that’s a problem?

    Phil, Yes an anonymous means of exchange is valuable, but my point (which I keep seem to keep repeating) is that there’s a problem with assuming a medium of exchange is valuable just because it’s a medium of exchange. Where does the value come from? It starts at zero and it ends at zero. How does it ever get off the ground?

    Rob, In the world you are describing anything seems to be possible. I don’t see why anyone should be confident that any of those possible outcomes will be realized.


  11. 11 Rob Rawlings May 7, 2014 at 10:30 am


    “In the world you are describing anything seems to be possible. I don’t see why anyone should be confident that any of those possible outcomes will be realized.”

    I obviously express myself badly as I was actually trying to make the point that in the long term whatever nominal interest rate the CB targeted the inflation rate would (other things equal) eventually settle at (nominal rate – natural rate).


  12. 12 Tom Brown May 7, 2014 at 11:46 am

    Marcus Nunes, of course, has argued that inflation is not inertial:

    Also, you might check out what Mike Friemuth has to say about fiat money here:

    I first encountered Mike on JP Koning’s site:

    And for a very different view of expectations and the neo-Fisherites, I enjoyed these posts by Jason Smith:

    He has a whole series on expectations too just recently… here’s one of four recent ones:


  13. 13 Nick Edmonds May 7, 2014 at 11:51 am


    No, I don’t think it’s a problem. We know there are people that want to borrow and people that want to lend. They can lend durable assets, or have contracts for delivery of goods, but there will also be borrowers and lenders who are happy to contract in an abstract unit, where they have a reasonable expectation of what it will exchange for at some point in the future. This demand and supply for monetray loans determines a real quantity of dollars that is needed. The job of the monetary authority is then to ensure that the nominal quantity of dollars bears such relationship to the real quantity demanded that a relatively stable price can be maintained. Which in turn is what is needed to ensure that people continue to want to contract in it.

    If all bitcoins had been loaned into existence, you wouldn’t have the problem of a zero end value, because there could never be bitcoins left that nobody else wanted. But that alone wouldn’t give it a stable price.


  14. 14 Max May 7, 2014 at 2:42 pm

    A central bank’s credible commitment to price stability is a sufficient explaination for why dollars, euros, yen, etc. have value.

    What muddies the waters is that fiat money is often defined in a way that makes such a commitment impossible (i.e. if the CB regards its money as a liability, then it’s not “fiat”), coupled with the casual assumption that dollars/euros/yen fit this definition.


  15. 15 Tom Brown May 7, 2014 at 3:23 pm

    “I see a circularity problem in saying that the value of a dollar is positive because people are contracting debts in terms of dollars.”

    Freimuth (see me link above) touches on some of these issues.


  16. 16 Morgan Warstler (@morganwarstler) May 7, 2014 at 4:17 pm

    Fred Wilson is a really strong VC, and on the issue of a tech bubble in start up valuations, he directly pointed to QE and said “that’s why”

    Capital is desperate for a return. No bubble.

    So let’s game this out:

    1. QE
    2. Software start ups valuations up
    3. Incredibly small labor force needed, so run rate is low, and runway is long.
    4. This means the founders get to own a bigger piece of the equity. Capital gets less.
    5. So an entrepreneur has more reason to build software than other atomic startup.

    Does QE mean that power shifts away from capital faster than it would if there was no QE? At the same time, technology is shifting the power away from labor?

    The idea here being that maybe QE hastens the decline of credit, bc it hastens the decline of debt.

    Before What’sApp, telecom players all over the world could point to their sms messaging revenue, now gone, and use it to justify buying costly hardware for sms.

    Now it’s just “data.” – screw you dumb pipe telecom players, screw you banks that would have loans that money to telecom.

    Facebook acquires WA and $19B, founders own a ton of it. Huuzzah! Even more entrepreneurs resolve to find another atomic debt structure and destroy it with equity and very little labor.

    Pretty soon, start up are going to do the same thing to EDU and GOVT debt structures….


  17. 17 Jason May 7, 2014 at 6:14 pm


    Here’s a quasi-microfounded theory that gives the relationship between the price level and the monetary base without expectations and even allows for the possibility of “deflationary monetary expansion” due to the competition between (analogies of) the unit of account function and the medium of exchange function:

    Tom Brown above linked to one of my posts on expectations and the neo-Fisherite stuff (thanks Tom!), but I thought I’d tackle the “bloody mess” more or less head on with a novel (but hopefully not crackpot) theory of money. It reduces to the quantity theory of money in a particular limit, so it’s not completely out of left field. It’s also directly related to matching theory and David Beckworth pointed out some similarities with Narayana Kocherlakota’s paper “Money is Memory”.


  18. 18 JP Koning May 7, 2014 at 7:14 pm

    “However, the old central-bank doctrine of the Bank Rate was conceived in a world in which gold and silver were the alpha moneys, and central banks – even central banks operating with inconvertible currencies – were beta banks, because the value of a central-bank currency was still reckoned, like the value of inconvertible Bank of England notes in the Napoleonic Wars, in terms of gold and silver.”

    David, what do you mean when you say that during the Napoleonic Wars, central-bank currency was still reckoned in terms of gold and silver? Do you mean to say that people anticipated that gold redemption would be re-established at the at the pre-1797 rate, and therefore priced pounds accordingly, perhaps at a slight discount to par?


  19. 19 JKH May 8, 2014 at 9:41 am

    Regarding the specific question, I’m wondering why you would think there is that much difference in principle between maintaining the value of the dollar against gold, and maintaining it against target CPI. The accumulation or disbursement of gold reserves doesn’t necessarily require a change in bank reserves. That can be “sterilized”. If the CB is in danger of running out of gold, it jacks rates. A CPI “peg” is no different in this regard. If the CB is in danger of losing CPI to the upside, it jacks rates. The only difference is that “CPI reserves” don’t appear on a central bank balance sheet. But that’s just a controlling transactional feature in the case of gold, where the central bank is the market maker for the exchange rate, using interest rates to its advantage. Everybody is a market maker in the case of CPI. So CPI is sloppier than gold in that sense. But I think the principle is the same. In fact, the role of interest rates is the same. So if the role of tactical interest rate setting is the same, and if this role contradicts the neo-Fisherite hypothesis in the gold/fixed FX case, it should contradict it in the fiat case as well.


  20. 20 Benjamin Cole May 9, 2014 at 11:56 pm

    Thoughtful blogging.

    Yes, fiat money has value because you can pay taxes with it. That part is simple. And, in the USA, we pay taxes quarterly if not constantly (payroll taxes, property taxes, sales taxes, fees etc.), so I think that issue is settled too. I think David you take an unnecessary diversion when you think about the PV of fiat money in relation to taxes due dates.

    But why a certain amount of inflation in fiat money?

    I think that comes from a mix of excess demand and expectations. If there is excess demand, then supply is allocated by price. But until then, you only get more supply, and perhaps some sort of frictional inflation, around a bottleneck or two.

    Maybe Milton Friedman did have a handle on this.

    As to Williamson’s arguments, explain how Volcker did what Volcker did. I do not recall inflation shooting through the roof when Volcker went to higher interest rates.


  21. 21 Lorenzo from Oz May 13, 2014 at 12:50 am

    I entirely agree that the value of Bitcoins are very weakly anchored, hence the wild gyrations in price. I don’t like the notion of bubbles, since they can only exist through the inability to predict turning points, at which point what are you saying when you say “bubble” other than an asset price is weakly anchored and/or likely to be highly volatile over time?

    The backwards induction argument I give no credence to, since transactions take place in time and if we have no information on which time period an asset is suddenly going to have no value (as, at some period, they all will), then it will not affect current decision making (at least, not in the sense of differentiating one time period from another).

    Tax liability as anchor I take to be only applying to fiat money (i.e. money whose transaction utility is not anchored in production or consumption utility). But even money that does also have production or consumption utility has transaction utility “over the top”, otherwise it will cease to be used as money. So, really, it is transaction utility in general which has to be “anchored”, fiat money is just a special case because that is all it has. (And transaction utility is a real utility as, in a monetised economy, many transactions only take place because of money.)

    Given the vast variety of things that have been used as money–to take examples from A H Quiggin’s “Primitive Money”: shells (especially cowries), beads (whether made of stone, shell, glass or whatever), salt (including stamped salt cakes), cloth (from silk to wadmal, a coarse wool fabric), tool metals (iron, copper, tin, bronze) in various shapes, die cakes, gold dust, weighted gold, teeth, feather coils, strings of coconut discs, carved stone (also a tool material), animal skins, cattle, grain (notably barley and rice), pigs, coconuts, buffaloes, seeds, slaves, silver in lumps or shaped, tea (including in bricks), plaited palm-fibre rings, tobacco, beeswax, camphor, porcelain jars, human heads (only for really important transactions: specifically peace agreements between villages), cocoa beans, balls of rubber, coca leaves, logwood (mahogany); to which we can add rum in the early NSW colony, cigarettes in PoW camps and prisons and tinned mackerel in non-smoking prisons–clearly information feedback about acceptability is central to transaction utility.

    Which begins to look like “it is accepted because it is accepted”. However, anchoring the transaction utility is not the same as anchoring the exchange value (for goods and services). Under hyperinflations, transaction utility (as indicated by the range of transactions money is used for) is much more stable than its exchange value (whether for goods and services or other monies). Not understanding that anchoring transaction utility and anchoring exchange value are not the same thing is part of where MMT goes off the rails.

    Which does not answer your question, but getting the framing right is a necessary step in doing so.

    Also, the neo-Fisherite reasoning seems to go from the Fisher equation to the real world in a very dubious way.

    Oh, and having read Knapp, he is a truly appalling economist. His one catchy sentence as the beginning of the book (“money is a creature of law”) is his sole contribution, and that is wrong. (See above list.)


  22. 22 Lorenzo from Oz May 13, 2014 at 1:01 am

    In commenting on my second post on why I don’t like the backwards induction argument, a friend commented that bitcoins were like trading cards—i.e. a community of people had agreed to use them. There is something in that.


  23. 23 Tom Brown May 13, 2014 at 10:39 am

    Benjamin Cole, check out Jason’s blog above. I have no idea if he’s correct or not, but AFAIK the information transfer model (ITM) way of looking at some of these questions is unique and even suggests some explanations to some vexing questions (at least vexing to me). For example, one of the things that comes up in the ITM perspective is the relative size of the currency in circulation to NGDP. This *may* go some ways towards explaining differences in the US now vs the 1970s. Actually Jason looks at several countries, including Canada and Japan and the US pre-WWII, and post-WWII. According to the ITM, in the 1970s we were closer to where Canada is now in the relative sizes of currency in circulation vs NGDP. Jason’s ITM offers one possible explanation of why Canada can so easily inflation target while the US and Japan seem to struggle a bit now to hit their targets. He doesn’t ignore the concept of expectations, but his model seems to indicate that expectations in general interfere with the efficient transmission of information from demand to supply (er… I hope that’s basically correct)… and that unless expectations are very close to being correct, it’s difficult to beat the “maximally ignorant” case (in which equal probability is assigned to all possible states). His ITM cautions against misusing “expectations” as an economic explanation. The way he puts it “expectations destroy information.” So again, I’m definitely not the one that should be critiquing his work, but I find the list of things that he thinks he can explain to be very intriguing. For example, this is a short post that gives an overview:

    I’m very curious as to what people more knowledgeable than myself think.


  24. 24 Diego Espinosa May 18, 2014 at 8:02 am

    Doesn’t “all about expectations” equal “Keynesian uncertainty”?


  25. 26 Mitch May 19, 2014 at 7:02 am

    Two points:

    First, regarding Bitcoin. Those who think it is anonymous – especially from the government – are in for a rude shock when they learn how Bitcoin actually works. In fact, every transaction is broadcast everywhere, so from an anonymity point of view it’s far worse than bank transactions or cash. It’s true that the wallets don’t have personal data attached to them, but once you figure out who’s the owner of a given wallet (say by determining the shipping address on some orders placed using that wallet), you know everything that wallet purchased, now and in the future.

    Don’t think that the NSA doesn’t already know who owns every Bitcoin wallet.

    Second, regarding the neo-Fisherite position: It’s depressing to see that economists can’t dispense with such a weak argument.

    Let’s forget about the Fed. Suppose *Congress*, by fiat, simply decided at what rate loans were allowed to be made. (And we’ll also suppose that the ban cannot be evaded.) Let’s suppose also that they set the nominal rate R quite high. No one is allowed to lend money except at a high nominal rate of interest.

    Now the relation R = r + i is a tautology, so nothing Congress can do will change it. Now what happens? What happens to economic growth? I am sure we all agree that it declines. But the loans that do get made (and there’s no reason to assume there won’t be some) will carry a high real rate of interest.

    We leave as an exercise to the reader to imagine what happens if Congress sets a low interest rate – either with or without the added benefit of a lender of last resort who lend at that rate.

    There are therefore two obvious fallacies in the NeoFisherite position:

    a) There’s no policy-independent “natural” rate of economic growth. Why should there be?

    b) Even if there is, there need be nothing connecting it to the real rate of return on loans, especially if the government is intervening.


  26. 27 Frank Restly May 28, 2014 at 5:56 pm


    “Let’s forget about the Fed. Suppose Congress, by fiat, simply decided at what rate loans were allowed to be made. (And we’ll also suppose that the ban cannot be evaded.) Let’s suppose also that they set the nominal rate R quite high. No one is allowed to lend money except at a high nominal rate of interest.”

    How does “Congress” accomplish this?

    1. Congress hits its target by dictating the interest rate that it pays on it’s own bonds and private interest rates adjust upward to reflect credit risk?

    2. Congress and the central bank become one entity. Congress hits its target by lending money at an interest rate that it decides upon?

    “Now the relation R = r + i is a tautology, so nothing Congress can do will change it. Now what happens? What happens to economic growth? I am sure we all agree that it declines.”

    No we all do not agree. It would first depend on how Congress achieves it’s interest rate target – do they set the interest rate they borrow at or the interest rate they lend at?

    It would also depend on the tax policy of Congress, productivity, inflation, private liquidity preference, and several other variables.

    Assuming only private borrowers (no government borrowing) – a high nominal interest cost can be offset by a reduction in other costs (labor, materials, taxes, etc.). Volatile interest rates are a different animal altogether. Volatile interest rates will tend to lower economic growth because other costs may not be able to adjust as quickly.

    That was the secret to the Volcker induced recession – push the nominal short term interest rate up faster than other prices (including the nominal long term interest rate) could adjust. It was interest rate volatility that did it, not interest rate level.

    An economy can operate quite well with a constant high nominal interest rate, and even a constant high real interest rate if it is offset by a reduction in other costs.


  27. 28 Mitch May 29, 2014 at 3:42 am

    Frank Resty: The example I was asking you to contemplate was if Congress passed a “usary” law that forbade the making of loans at below a certain rate. I fail to see how the introduction of such a law would result in the reduction of any costs, at least in the short term. (In the long term, if it suppressed economic activity, as it surely will, overall prices could fall. This would in fact result in an increase in the real rate of interest.)


  28. 29 Frank Restly May 29, 2014 at 7:10 am


    “The example I was asking you to contemplate was if Congress passed a usury law that forbade the making of loans at below a certain rate.”

    Okay, my first question is Congress a borrower, a lender, neither, or some combination of both under such a situation?

    “In the long term, if it suppressed economic activity, as it surely will, overall prices could fall.”

    Here is an example of the “long term” comparing nominal interest rates and nominal economic growth in the U. S. What you should notice is that over the “long term” nominal interest rates and nominal economic growth tend to be positively correlated.

    Obviously correlation is not causality, but to blithely say that a higher nominal interest rate (even if dictated by Congress) “surely will” suppress economic activity misses a lot of contrary evidence.

    “I fail to see how the introduction of such a law would result in the reduction of any costs, at least in the short term.”

    I never said it would. I said that private borrowers facing a high cost of servicing debt can do just fine if that cost is offset by lower costs elsewhere.

    And so Congress could set a high minimum interest rate for loans and also make interest re-payment on private loans tax deductible. Oh wait, it already does that (the second part).


  1. 1 Neo-Fisherism | Stephen Hannah Trackback on May 11, 2014 at 10:14 am
  2. 2 The Backing Theory of Money v. the Quantity Theory of Money | Uneasy Money Trackback on June 9, 2014 at 7:30 pm

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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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