Money hoarding — an explanation of today’s low inflation

25 March, 2015 at 14:58 | Posted in Economics | 10 Comments

Based on the [quantity theory of money equation MV = PQ] holding the money velocity constant, if the money supply (M) increases at a faster rate than real economic output (Q), the price level (P) must increase to make up the difference. According to this view, inflation in the U.S. should have been about 31 percent per year between 2008 and 2013, when the money supply grew at an average pace of 33 percent per year and output grew at an average pace just below 2 percent. Why, then, has inflation remained persistently low (below 2 percent) during this period? …

During the first and second quarters of 2014, the velocity of the monetary base2 was at 4.4, its slowest pace on record. This means that every dollar in the monetary base was spent only 4.4 times in the economy during the past year, down from 17.2 just prior to the recession. This implies that the unprecedented monetary base increase driven by the Fed’s large money injections through its large-scale asset purchase programs has failed to cause at least a one-for-one proportional increase in nominal GDP. Thus, it is precisely the sharp decline in velocity that has offset the sharp increase in money supply, leading to the almost no change in nominal GDP (either P or Q).

5267109005_ac183b2699So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? The answer lies in the private sector’s dramatic increase in their willingness to hoard money instead of spend it. Such an unprecedented increase in money demand has slowed down the velocity of Money …

And why then would people suddenly decide to hoard money instead of spend it? A possible answer lies in the combination of two issues:
•A glooming economy after the financial crisis
•The dramatic decrease in interest rates that has forced investors to readjust their portfolios toward liquid money and away from interest-bearing assets such as government bonds.

Yi Wen & Maria Arias (St. Louis Fed)

Anyone still believing in Say’s Law? Just wondering …

10 Comments »

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  1. Clarifying.

  2. “You can lead a horse to water, but you can’t make him drink.”

    Corollary: The central bank cannot force banks to lend or the private sector to borrow in order to invest or consume — even with a negative policy rate.

    That should signal the death of monetarism.

    Fiscal policy that adjusts to variable non-government saving desire rules.

    That is the death knell of “expansionary” fiscal austerity and the confidence fairy.

  3. Perhaps you should read what modern economists have to say more often? Who knows, you might learn something.

    http://www.voxeu.org/article/time-spend-new-insights-multiplier-effect

    • Maybe — but pre-1936 ideas is not exactly my definition of “modern” economics …

      • Well, three years ago I pointed out the same facts as you do, and consider novel, now. It seems as if it depends on who’s mouth it comes from whether or not it is original.

        Anyhow, I still believe in Say’s law. And not a single person has been able to explain to me how you can deny its workings and not fall for the lump of labor fallacy. Do immigrants steal “our jobs”? No, because of Say’s law. Does technology steal jobs? No because of Say’s law.

      • “Do immigrants steal “our jobs”? No, because of Say’s law. Does technology steal jobs? No because of Say’s law.”
        Hmm … Makes me think of Schiller’s dictum — “Mit der Dummheit kämpfen Götter selbst vergebens” …

      • I suppose you’re the God in that passage …

  4. Those two Fed authors, Wen and Arias, claim that the failure of the increased monetary base to spark inflation was caused by the “private sector’s dramatic increase in their willingness to hoard money instead of spend it.” That’s debatable, at least in the following sense.

    The main reason for the rise in the amount of base money was the purchase by the state of state debt (using freshly printed base money) and base money and government debt are little different in nature, as pointed out by Martin Wolf in the Financial Times recently. An offer by the Fed to give everyone two $50 bills in exchange for their $100 bills would have about the same negligible effect.

    I.e. to the extent that government debt and money are the same thing, there has been NO INCREASE in the stock of money.

    Re Lars’s question “Anyone still believe in Say’s law?”, my answer is “Yes, me”. At least, I think Say’s law works in simple barter economies. As to more sophisticated money based economies, it clearly doesn’t work so well there. However, the fact is that in the 1800s, in the days before governments DELIBERATELY tried to counter recessions, economies DID RECOVER from recessions. I put that down to a mixture of Say’s law and the Pigou effect.

  5. Confounding the Quantity Theory and Say’s Law
    Comment on ‘Money hoarding — an explanation of today’s low inflation’
    .
    The core problem of economics is that the representative economist never managed to keep political and theoretical economics properly apart. The mixture is toxic indeed. This thread is a fine specimen of the resulting all round confusion.
    .
    Let us untangle the mess by starting with Pontus’s confession. “Anyhow, I still believe in Say’s law.” Many economists have not understood until this day that science has nothing to do with belief but with knowledge. What can be shown in a formal rigorous way is that Say’s Law does not imply full employment but is compatible with any level of employment (2015c).
    .
    What the believers in Say’s Law persistently overlook is the role of the profit mechanism. More general, both the Walrasian and Keynesian profit theory is false (2015b).
    .
    The correct version of Say’s Law implies that the quantity of money is not a determinant of the market clearing price (2015c, eq. (4)) and (2015a, eq. (7)).
    .
    The most urgent task of Constructive Heterodoxy is to rethink pivotal concepts like market, Say’s Law, money, profit, etcetera. The reconstruction of the theoretical superstructure from scratch is an absolute methodological necessity.
    .
    At the moment both Orthodoxy and traditional Heterodoxy is defended by confused confusers, i.e. proto-scientific believers.
    .
    Egmont Kakarot-Handtke
    .
    References
    Kakarot-Handtke, E. (2015a). Essentials of Constructive Heterodoxy: Money,
    Credit, Interest. SSRN Working Paper Series, 2569663: 1–17. URL http://papers.
    ssrn.com/sol3/papers.cfm?abstract_id=2569663.
    Kakarot-Handtke, E. (2015b). Essentials of Constructive Heterodoxy: Profit. SSRN
    Working Paper Series, 2575110: 1–18. URL http://papers.ssrn.com/sol3/papers.
    cfm?abstract_id=2575110.
    Kakarot-Handtke, E. (2015c). Essentials of Constructive Heterodoxy: Say’s Law.
    SSRN Working Paper Series, 2556434: 1–10. URL http://papers.ssrn.com/sol3/
    papers.cfm?abstract_id=2556434.
    .
    For cross-references and direct links see
    http://axecorg.blogspot.de/2015/02/essentials-cross-references.html

  6. “And why then would people suddenly decide to hoard money instead of spend it? A possible answer lies in the combination of two issues:
    •A glooming economy after the financial crisis
    •The dramatic decrease in interest rates that has forced investors to readjust their portfolios toward liquid money and away from interest-bearing assets such as government bonds.”
    And here’s another possible answer from a non-economist. Poorer people are, of necessity, inclined to spend their money. More wealthy people have the luxury of being able to hoard money, and will do more hoarding when return on investment is low because consumers lack spending power. To what extent is a low money velocity the result of income inequality?


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