(Just a quick one, on a topic I am still highly uncertain and confused about. So be nice.)
I’ve been taught no less than three times that the interest rate is the price of money: once at school, once at college and once again at CFA class. And that doesn’t seem right to me.
First, consider a world without money. I offer you one sheep in exchange for two this time next year. The interest rate is 100%. It expresses the rate at which consumption can be shifted through time.
Second, consider a world where everyone adhered to Polonius’ admonition to neither a borrower nor a lender be. There is still money in this world. It is traded for goods and services. The price of money is the rate at which it is traded for goods and services. That is to say, it is what we normally call ‘the price level’.
So money is not essential to the existence of interest rates, and interest rates are not essential to the existence of money. As the medium of exchange, the price of everything is expressed in terms of money. There is no more a case for the price of future consumption being “the” price of money than the price of kumquats. A price is nothing more and nothing less than the rate at which things are exchanged, and money can be exchanged for anything. Considering this, I find it hard to see why setting an interest rate is the ‘essence’ of monetary policy, because it’s just one price among many. That we do it this way just seems like a historical accident.
This is also by way of saying that while I understand the zero-lower-bound issue under the current monetary system, the reason why it’s an issue at all is because normal monetary operations revolve around exchanging an asset that, under certain circumstances, becomes highly substitutable with money*.
Maybe we should choose a different one.
*This is also the only way I have been able to understand the ‘QE is just an asset swap’ objection, but that could be as much to do with my feeble brain as the quality of explanation on offer
I’m not likely to be back blogging anytime soon. But there was a simpler time before I had a respectable number of readers, and I thought it would be a good idea to collect all my favourite posts in one place, for the sake of posterity, my own future reference and the outside chance that you may find it interesting. I really hope that you enjoy reading as much as I did writing.
The burden of public debt
My four (good) posts on this debate, which raged throughout the econoblogosphere back in January, can be found here, here, here and here. If Paul Krugman or Dean Baker ever again make the claim that it’s a matter of identity that domestically-held public debt can’t be a burden to future generations, I will come out of retirement and remind them of the Epic Defeat they were dealt last time round. There aren’t many things I am sure about in this world, but this is one of them.
Adventures in GDP accounting
Other random musings
Being altruistic towards ourselves (on discounting)
Principle, not principal (on the student loan controversy in the UK)
The Christensen/Williamson/Roth exchange
(I was originally going to flesh this out and try and get this published, but have come to the belief that the blogosphere is intellectually and morally preferable to academic journals for discussing these ideas. Also, this is obviously way easier, and I’ve been sitting on the argument for so long I just want to put it out there and see what people think. So I’ve mostly just copied this from the draft, and put some token links in to make it look like a blog post…)
It has been alleged against the epistemic account of vagueness that the determination of the precise meaning of a vague term appears miraculous, severing the connection between meaning and use. Given the infinite possible precisifications of terms like “thin”, “heap” and “tall”, how on earth is one of those concepts picked out by our ordinary expressions? However, an actual refutation of epistemicism has never been forthcoming, and the epistemicist defence (e.g. Williamson 1994) against the above accusation has been to correctly point out that there isn’t any promising account of how the meaning of non-vague terms is related to use, and that it is unfair to demand that one be provided:
“Every known recipe for extracting meaning from use breaks down even cases where vagueness is irrelevant. The inability of the epistemic view of vagueness to provide a successful recipe is an inability it shares with all its rivals. Nor is there any reason to suppose that such a recipe must exist.” [Williamson 1994 p207 (1996 edition)]
Whilst I agree with Tim Williamson (no relation!) that such a recipe may forever be beyond our grasp, we can still ask whether the epistemic account of vagueness is consistent with the necessary conditions of a true account of meaning determination. It could be the case in the physical sciences that a ‘Theory of Everything’ is necessarily impossible to describe, but this would not prohibit us from making less ambitious but nevertheless true statements about physics and seeing whether they are consistent with other propositions. I submit than the following condition would have to be met in the case of meaning determination
(1) The determination of the meaning of a word/expression/concept* makes reference to the actions/assertions/intentions/beliefs* of the speakers of the language
(1) does not imply that meaning is exclusively determined by use, whatever that may mean, but it is impossible to see how we could explain how words change their meaning without some version of it. The ordinary phenomenon of semantic change provides the most compelling intuitive support for there being a role for the speakers of a language in determining the correct meaning of the words they use. Examples abound of words whose meaning has changed over time, with the most plausible explanation of the change being that the speakers of the language gradually took the word to mean something different. This is completely consistent with a realist account of universals, whereby the word “awful” could have once denoted the same universal as “awesome” does now, with the changing actions/assertions/intentions/beliefs of English-speakers eventually changing the denotation.
But who exactly are the speakers of English? The set of English-speakers is a classic example of a vague set; there are borderline cases in terms of who alive today might count as a member of the set (infants/bilinguals/speakers of dialects), and there are borderline cases going back in time (Was Chaucer a speaker of English? How about Shakespeare? Or Samuel Johnson?). On the epistemicist account, it is either True or False as to whether Chaucer spoke my language, even if we cannot ever know whether he did.
However, “English-speaker” is a word in English and, if (1) is correct, its meaning is partially determined by the actions/assertions/intentions/beliefs of the set of English-speakers. The epistemicist cannot account for how “English-speaker” takes on a precise meaning in English, for it requires that an already precise set of individuals be constituted (the set of English speakers), whose actions/assertions/intentions/beliefs serve as an input into the function that is supposed to determine the contents of the very same set. It would be as if a polity attempted to establish the extent of the franchise on the basis of a democratic vote.
Therefore, unless the epistemicist can account for semantic change without positing a (1)-like principle that leads to the problem of the self-constituting set of language-speakers, the epistemicist explanation of vagueness cannot be correct. But since my claim is actually negative (I’m agnostic as to the precise form (1) must take, it merely seems to me that you *can’t* come up with an account of semantic change that won’t result in the circular feature I have described, although I don’t know how to prove it), I would be very interested if anyone can come up with a plausible substitute for (1) that does not have the problem for epistemicism I have described. I can’t think of one, which makes this argument the closest thing to a refutation of epistemicism that I am aware of, and as such is worthy of further inquiry.
Comments/counter-arguments/reading suggestions are most welcome.
*Delete as appropriate, according to your philosophical sensibilities
Whilst I initially planned to just cut back on the volume of posts, I have decided to take an indefinite break from blogging. If I may beg your attention for a few short minutes, I would like to explain why.
Back in December, before I began my three-week Christmas holiday, I posted a list of books I intended to read over the period. I thought making a public statement about it would mean I would actually do it. Compared to the rate at which I used to read, it should have been a doddle.
As it turned out, I barely managed to read a third of them. Because I spent most of my time thinking about what to write on my blog. To help provide inspiration, and to avoid saying the same things as other people, I more than doubled the number of subscriptions in my Google Reader. I was spending several hours a day just reading other people’s blogs, and thinking about how I could say something interesting and novel in response. And on one or two occasions, I believe I have succeeded.
However, any limited success I may have experienced has come at a profound cost. I find myself no longer as oriented towards truth and understanding, but more on how to go about agreeing or disagreeing with a particular intellectual community – economics bloggers. In my own interactions with my family and friends, I find it increasingly difficult to talk informally on the subjects I write about on my blog, so embedded my thinking has become within the language, conventions and background assumptions of the economics blogosphere.
In short, I find myself a less well-rounded human being than I was, even compared to just three or four months ago. I barely read novels any more (I haven’t touched my Kindle in ages, and I own dozens of books I have paid for but not yet read). My philosophy paper-in-progress – ‘Who are the speakers of English’ – languishes on my hard drive, unedited for weeks. I don’t have the conversations I used to, transitioning effortlessly between history, philosophy, theology, politics, economics, literature and film – and it’s because I’m reading blogs instead.
Here you might say: “Richard, why not just cut down on the blogging, rather than the more drastic step of cutting it out completely“? Quite simply, because it is so addictive. When my pageviews started going up, and people started linking to me and commenting, I just couldn’t stop worrying about all the things I write that I realize are wrong or grossly oversimplified. I always want to take time I don’t have to write something new, explain things better, show where I think I may be right and where I was definitely wrong. Blogging, I fear, is not a good fit for someone of my skeptical and critical temperament.
In an undeserved stroke of fortune, I have had some fantastic commenters somehow find their way over to my humble blog. Thank you all for abiding by the most unusual comments policy on the web, and for putting up with my gibberish. In particular, I would like to single out Lars Christensen, Steve Roth, ‘Max’, Bob Murphy and especially Nick Rowe for their valuable contributions, sometimes sharp criticisms but always kind words.
I have generally eschewed advocacy on this blog, but I would like to tell you that whilst I am a Bleeding Heart Libertarian, a Market Monetarist and a Possibilian (and if you don’t know what any of those terms mean, I would highly recommend you click on the links), above all I strongly believe in academic civility and Bayesian thinking. Over the course of this project I have had to constantly update (and often radically revise) my beliefs, which is so much easier to do when disagreements have been expressed in a civil and respectful manner. I would urge you to take the same attitude in all your endeavours.
Finally, this is an indefinite and not a permanent hiatus, so please do subscribe in case I ever come back.
Thanks so much for reading,
Unfortunately, in between my fun (but demanding) day job and studying for the CFA, I am finding that I just don’t have the time and mental energy to sustain the level of blogging seen here recently. From now on, barring exigent circumstances I will be publishing two items weekly: one proper post, and another with links and some brief thoughts on them. It’s something I have been considering for a while, but the change was prompted by my hasty adventures this week over reserve requirements, which are somewhat symptomatic of my mental overstretch (I will return to the question in future, but I need to put some more serious thought in first). So I’m going to pull back a bit and focus more intently on what I see as my comparative advantage – conceptual/philisophical issues in economics. I hope this will give me time to interact more fully in the comments section and to phrase what I write more carefully. It has been amazing to pull in some fantastic commenters in the last few weeks; you guys are awesome and I really would love it if you stick around (the ‘follow by email’ and RSS feed buttons are on the top right!). I hope this change means I will be at my best with everything I write in future.
To whet your appetite, some things I have bouncing around my head at the moment include:
- Alternatives to the fiduciary theory of the firm (and towards a more general theory, including non-profit orgs)
- Some stuff on the economic concept of ‘capital’ (of which I am not a fan)
- The case for using market forecasts in public policy (esp. monetary)
- The role GDP accounting may be playing in the debate over the existence of ‘liquidity traps’
I may also re-publish (with light edits) some of the best posts I wrote in the period before most of you started tuning in.
Many thanks for reading,
Yesterday, some guy obviously *pretending* to be me wrote some seriously crazy stuff on my blog. He thought that reserve ratios made no difference to the banking system, and basically bought the MMT line that the only thing that matters is bank capital. But here’s a pretty simple reductio: if reserve requirements are 100%, then deposits finance zero lending. Since banks make money by lending, no bank will (voluntarily) pay interest on deposits. 100% reserve requirements completely divorce lending and deposits. Duh.
How could that guy be so wrong? Well, maybe he thought about it this way. Suppose reserve requirements were increased in such a way that there were no longer enough reserves to sustain the current level of deposits in the economy. In order to prevent a likely deflationary contraction (decrease in V), the central bank creates more reserves (increase in M). As long as no one changes their intertemporal consumption preferences or the balance of their portfolios (a whopping great big howler of an assumption), this *appears* to have no effect at all on the economy or the banking system. The Fed can just create more reserves, whilst managing the marginal cost of loanable funds, and everything seems to go along as normal. But this cannot be right, because if reserve ratios increase then deposits ‘fund’ less lending and banks won’t pay as much to compete for them. The central bank makes up the difference. Interest on deposits fall, and ends up being paid to the central bank instead (as I’m assuming for the moment the Fed funds rate stays the same, and this is supported by repo transactions which earn the Fed interest). Of course, this isn’t even remotely close to an equilibrium, as a reduction in the interest rate on deposits will cause depositors to re-balance their portfolios, affecting both AD and the natural rate of interest (and hence the optimal Fed funds rate under the policy regime).
Basically, an increase in the reserve ratio (under a monetary policy regime like in the US) redistributes seigniorage away from depositors and towards the central bank*. Depositors then take some action to mitigate this by re-balancing their portfolios, with the central bank then counteracting any effects of said re-balancing on the policy target. If any of this re-balancing is towards higher consumption, the Fed funds rate will have to increase (reflecting the change in intertemporal consumption preferences, and hence the natural rate of interest). That being said, as the Fed remits any net income to the Treasury, it’s a little more complicated as less taxation/bonds would be required to finance any given level of government spending.
In conclusion, that guy who took over my blog really should have just spent Sunday morning watching the tennis instead. What an idiot**.
*This, I think, is just another way of making Nick Rowe’s point in the comments on the previous post. I’m seriously considering just outsourcing all my beliefs to him, and being done with this whole ‘having opinions of my own’ thing
**In that guy’s defense, this stuff is (in my view) pretty damn hard. It’s unbelievably easy to make silly mistakes – even if you have a Nobel prize. So be nice… if you happen to see him around
Why do we have fractional reserve banking in a fiat currency world? (speculative, blue-sky thinking, tell me why I’m crazy)
UPDATE: I have a new post here, arguing that this post is wrong.
If the coin be locked up in chests, it is the same thing with regard to prices, as if it were annihilated – David Hume
OK guys, you’re going to have to bear with me on this one because I’m in blue-sky thinking mode – so usual caveats on speculative thinking apply double for this one. What would happen if the central bank just said “We’re implementing a 100% reserve ratio, but don’t worry we’re just going to create all those reserves in your account with us at a click of a button”? I can’t see how anything would happen at all. It wouldn’t be inflationary, because it would make no difference to people’s decisions or ability to use their money to chase goods and services – ‘the coin be locked up in chests’. But it would mean there are no bank runs, because ‘the money is always there’.
So, why can’t we just do this? The central bank can control the money supply as before to maintain a certain policy target, the only difference is there are now tons of new reserves sitting in accounts with the central bank that aren’t allowed to ‘go anywhere’ due to the 100% reserve requirement. The new reserves are created by the central bank as needed, and everything just goes on as before. Except that old-fashioned bank runs would not happen.
Am I crazy? What else would happen to the banking sector if we did this? How would it affect the natural rate of interest? This smacks of WAY-too-good-to-be-true, and I thought the most efficient way for me to find out where I’ve gone wrong here is to open myself up to public humiliation for having missed something totally obvious.
FWIW, the way I ended up at this conclusion was wondering as to what would happen if we increased or decreased reserve requirements, which seemed to me to be precisely nothing – as the central bank (if it was doing it’s job) would just offset the deflationary/inflationary effects caused by a massive reduction/increase of supply in the market for excess reserves. So long as the central bank controls the price in that market, then I can’t see why reserve requirements matter at all. Except that less reserves means more bank runs.
This is by way of saying that I can’t think of any objections to the full-reserve position that are not general objections to the marginal cost of funds being the key instrument of monetary policy, which would apply no matter the regulatory reserve requirement ratio.