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Here's everything I know about macro:
Inflation is defined as an increase in the general price level.
The price of something is determined by the ratio between the value of a dollar and the value of that thing. (?)
The value of a dollar comes from, er, somewhere? You need dollars to pay taxes? Everyone else wants dollars so you want them to trade them with those suckers who want them? Something about oil?
The government can "dilute" those dollars by printing more, in effect taking value from everyone who holds dollars, or "concentrate" dollars by destroying them?
Fractional reserve banking, de facto, means that when you take a loan the dollars are minted and when you repay a loan the dollars are destroyed. The government can increase the supply of loans by lowering the reserve ratio or their discount rate, and increasing the supply of loans means more loans are taken, which means more dollars are created, so they can "create" dollars by increasing the supply of loans or destroy dollars by decreasing the supply of loans.
The government can also borrow money, but I have no idea about the effects are of government borrowing so I'm going to ignore it
When there's inflation, the profit-maximizing behavior is to raise prices. When there's deflation, the profit-maximizing behavior is to lower prices
People are irrationally unwilling to lower their prices, so deflation leads to people making less profit, which makes them worse off, so the government really wants to prevent deflation and will tolerate some inflation if that's what it takes
Everyone knows the government can't make sure inflation is 0, so instead they try to make inflation be about 2%, so even if they mess up and miss that goal by a little at least it's better than deflation.
That all makes sense so far.
It seems like a problem is that inflation has some "lag". The prices go up at the store before the price of my labor goes up. So for a while, my purchasing power goes down. I suspect that the reason that deflation intuitively sounds like such a good deal is that people assume that the lag will exist there too, so people's purchasing power will go up for a bit.
If the fed came to me and asked "hey, we need to print more dollars and get them out there with as little lag as possible, what should we do?", the first approach that would come to mind would be to print a bunch of money and give it to everyone equally.
But there's an asymmetry: you can give dollars to everyone and most people won't complain, especially if it's for a worthy cause like preventing deflation which would cause a recession. But you can't as easily take the dollars away from everyone equally because some people might not have any for you to take. (You could indebt those people, but that intuitively seems like a pretty bad idea to me.)
So I've been playing with another idea: Make a federal bank account, and when you want to change the supply of money, multiply the balances of everyone's federal bank accounts by some constant. (If they think you're going to multiply their bank accounts by a number less than one, they'll take their money out, but hopefully if you're doing a good job at being a central bank no one will know in advance what you're going to do, because these decisions will be made by a subsidized prediction market and to predict its movements you'd have to violate EMH, and anyone who can violate EMH that has better things to do than take their dollars out of their federal bank account.)
Consider the case where the fed wants to create inflation:
The current way privileges people who take loans. Since people who take big loans tend to have good credit, and people who have good credit tend to be wealthier than average, the current system kind of a transfer to the wealthier than average. Meanwhile, my suggestion would privilege people who keep their cash in the federal bank account. Poor people keep a larger percent of their net worth in cash, so my proposal would be a transfer to the poor.
Consider the case where the fed wants to create deflation:
The current way has the desirable property that poor people (who don't take many loans) are basically unaffected. But it has the undesirable property that the reduction in the supply of money is gradual at some level, because it works by people repaying loans and then not taking new ones. But it's also not gradual at another level, because having the option of taking a loan in the future might make you more spendy in the present (knowing you could get a loan is a kind of asset). Also, EMH says it doesn't matter how gradual it is, because if everyone knows the value of money is going to change tomorrow they're going to act like it's tomorrow's value today. Let's call this one a wash.
I'm mostly just posting this because I think macro is fun to talk about and this thought experiment has been good at getting me thinking about it. Plus I didn't want my first post to be about some degen CW twitter controversy. Anyone have any thoughts?
My understanding of #9 is that a little inflation is desirable for stimulating investment, for giving more leeway for monetary policy, and for favouring spending over saving (-> picking up unused capacity -> more efficient), and yes on the flip side preventing the paradox of thrift, while not drastically reducing the purchasing power of normal people?
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I think you get off to a bad start here. Changes to prices are not necessarily a result of inflation/deflation, but rather a change in the relative availability of Dollars vs Goods. An increase/decrease in the availability of dollars (inflation) affects prices, but so does a lot of other stuff that isn't inflation.
If, for example, there's a drought and the grain harvest is half of what it usually would be (moving the Supply Curve for grain to the left), grain (and thereby bread, beer, beer, and fuel prices) rise, that's not really inflation per se; conversely, if a new process comes about which enables greater production at the same cost, prices will fall without deflation occurring as competitors
By the same token, if we write in a 0 after the numbers on all our accounts so that everyone has ten times as many dollars, prices will rise without any change in the actual cost of producing a bushel of wheat. THIS is inflation.
There really is no such case as regards actual deflation. As you mentioned, it mostly relates to the velocity of money: if my money will be worth more tomorrow, I have incentive to hold it instead of spend or invest it. Shoving it under my mattress incurs zero risk and zero costs, and makes me MORE WEALTHY tomorrow, without having done anything or accepted any risk. (Imagine the whole country does this, and the money supply shrinks as the Fed lowers the money supply--has anybody actually gotten any wealthier, or created any value, by holding cash? Nah.) If someone can make money with no effort and no risk, they're gonna, because that simply doesn't happen in nature. So everybody waits and demand falls even further because nobody is buying. This is a problem. And we haven't even talked about lending or international trade...
It's a truism of life that all things decay, and that you can't get somethin' for nothin'. In a deflationary environment, my money grows by sticking it under a mattress, a zero-risk zero-cost "getting something". If ya don't "work", ya don't "eat"--doesn't matter if you're a bee, a tree, a human, or a dollar.
The current system IS prejudiced, but the prejudice is toward people who pay their debts on time. This correlates to wealthiness, but isn't necessarily causative. Paying small amounts on time gives one preference when borrowing larger amounts, and leveraging larger amounts is how people get wealthy.
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If inflation were zero, it would amount to deflation over time as productivity and population increases. You have to have a little inflation to keep up with growth.
If productivity is increasing, thus making goods and services cost less and making their prices lower, isn't that definitionally not a case of inflation=0?
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What? If price inflation is zero then it's zero. How could it not be zero, when it is zero?
Are you confusing price inflation with changes in the money supply or nominal spending?
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Inflation is defined as an increase in the general price level.
Yes
No. It's determined by demand and supply. Internalizing this fact is as important as internalizing 2+2 to understand math, as is for economics.
It comes from demand and supply in the forex market. In the goods/services market its a proxy for all goods and all services and all labor exchange rate for one another, that can be stored for future use.
Yes.
Depends on the price elasticity of the good.
No. This depends on the good and the market. There are many things that are (were) deflationary.
Deflation isn't bad.
It's bad according to Keynes, and if you have certain goals as the central bank.
Strongly suggest reading any Macroeconomics textbook. Any would work given the fundamentals of macro are so fundamental...
If you want a more "based" theory of Economics, Basic Economics by Thomas Sowell is a must read.
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Basically .... the price of X is the ratio at which the marginal persons are willing to exchange dollars for X.
There is a basic instinct among humans to use collectibles of tokens of "I did this for you, you owe me a favor in return" --- https://nakamotoinstitute.org/shelling-out/. As society evolves, a particular collectible can be a Schelling point for the token a society uses to track exchange of value and this token becomes valued in its own right -- this is "money." If the society has a government, this government might find it convenient to demand taxes in this token, rather than say, bushels of grain. The token becomes embedded in contracts, which means demand for it is stabilized because people will always need this token in order to fulfill a contract and not lose their house or car. A very strong government might force people to use a government created token as the dominant collectible and medium of exchange -- hence fiat currency like the U.S. dollar.
This is only true if the fractional reserve banking is backed by the Federal Reserve and the FDIC. Otherwise every time the bank issued a new loan, everyone else's deposits would become more risky and their expected value would be below par with a straight U.S. dollar.
Back after the 2008 crisis I did a ton of reading on macro, reading original sources from Mises to Keynes, reading original ground-breaking academic papers, reading defenses and critiques...and I basically came to this same conclusion.
The current way of generating inflation -- by subsidizing low interest rates which then stimulates otherwise unprofitable investments and asset bubbles, which then create wealth effect spending -- is both incredibly regressive and continues a cycle of instability.
Renominating bank accounts does have a couple tricky aspects:
The banking system is still very fragmented and archaic, there would need to be major consolidation, legal, and technological upgrades for the government to simply renominate bank accounts at the snap of their fingers. A lot of people might not like this because it would turn into everyone basically holding their bank accounts directly with the government. (Which is de facto what we have now, but a lot of people don't realize this and would object to making it overt and formal).
It is, in a sense, the government overtly stepping in and cancelling a portion of everyone's debts. At least that is what it seems like, if the renomination is done to perfectly balance out deflationary tendencies, it will not in practice be this, but there will be a lot of arguing over it.
It makes it seem like the government is just giving away money. Whereas using interest rate manipulation to stimulate lending doesn't seem like a giveaway.
But the real problem is a deep political problem -- the current way of stimulating the economy allows for backdoor gifts to large numbers of politically powerful people and classes. It was a stunning for me to realize that 1) the current system of stimulating the economy was a massive giveaway to the rich, dwarfing what rich lose through progressive taxation and 2) no liberals/Democrats really seemed to care about this issue, and most powerful liberal/Democrats benefited from it. My conclusion from that, was not "full communism now!", but rather that it is probably just a law of human society that the rich are going to benefit more from the government, even in societies that brag about their history of government benefiting the poor and middle class.
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Does it though?
The value of the dollar comes from our belief that it has value, primarily. Also because people have debts denominated in dollars and need them to pay those debts down, including foreign entities in the offshore dollar market or 'eurodollar system'. The US dollar is the global reserve currency and so USD is always in demand for international trade. Part of the issue we have today is the opacity of offshore dollar markets and the distortion of price signals due to all the international demand for dollars, as observed in the recent volatility in currency markets.
When people say 'print' money, what they really mean is borrow. The confusion -- and apparent ignorance about the effects of government borrowing -- comes from the trends in interest rates over the past 2 decades, namely being so low that interest on debt has been basically negligible. That is just starting to change as more debt gets refinanced at current rates which have risen rapidly this year. If rates stay elevated for some time, the government interest expense is going to be a problem.
Central banks are exploring CBDCs for the reason you describe, more direct control over the money supply. Multiplying balances by a constant is unfair if the value is greater than one, enriching the wealthy exacerbating inequality. If the value is less than one, you are basically implementing a flat wealth tax.
The objection is, can you trust the government with that level of surveillance and control?
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#2 is incorrect. Prices of a thing are a function of supply and demand, not the value of the thing and the value of a dollar. First, things do not have values; they have prices. Eg: Gasoline prices, after all, go up and down even as the value remains constant. Perceived value can affect demand (which is the willingness and ability to buy different amounts of a product at different prices, so it can affect willingness, but really that is just part of utility. Second, the "value of a dollar" doesn't mean much: it is a vernacular term commonly used to refer to prices; saying "the value of the dollar has shrunk since I was a kid" is simply a way of saying that prices have gone up. Changing the supply of money does affect prices, including the price of borrowing money (ie, interest rates), but its effect on consumer prices is really more about its effect on aggregate demand (see #4)
#3 is irrelevant, per above. The price of a dollar relative to other currencies is a function of supply and demand for each currency, which in part is a function of trade imbalances.
#4, since currency is only about 10 percent of the money supply, the government rarely prints money in order to adjust the money supply. Rather. the fed tries to affect inflation by adjusting interest rates, changing bank reserve requirements, and buying and selling bonds. Total demand in an economy consists of 1) consumer demand; 2) business demand; 3) government demand (expenditures - income); and 4) Net foreign demand (exports - imports). When the Fed raises interest rates it charges banks, banks borrow less from the Fed and hence loan less to businesses, thereby reducing business demand. Also, banks charge higher interest on loans (there is a lower supply of money available to lend, so the price of a loan -- the interest rate -- rises). When the Fed buys outstanding bonds, there is more money in the hands of consumers or businesses (whomever held the bonds), so demand rises. To reduce demand, the Fed tries to sell more bonds. Bank reserve requirements are discussed below.
#5: Suppose a bunch of us go to Mars. I am the only one with money ($10,000 in cash). Money supply is now $10,000. I deposit it into your bank and open a business. Since the business is not drug dealing, I pay my suppliers by check, not in cash. So, I open a checking account. You are a bank. You make money by lending it out. Suppose you lend $9000 to Joe to start his business. He does not want cash; rather you open a checking account for Joe, and write "$9,000" in his account ledger. Joe now can write checks up to $9,000, and I can write checks up to $10,000, so the money supply is now $19,000. That is how fractional reserve banking affects the money supply. Changing the reserve requirement or otherwise discouraging or encouraging lending changes how big that part of the money supply is.
#6 - See discussion of bonds above. If govt borrows money to spend it, not much happens: Consumer/business demand drops, but govt demand rises. If govt borrows money and sits on it, then aggregate demand declines.
#8 - The govt wants to avoid deflation because it creates the risk of recession; When there is deflation, rational consumers delay big ticket purchases in hopes of paying less in the future. That reduces demand, leading to layoffs, which leads to more reduced demand and even more deflation, and the process accelerates.
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This isn't really true. It kinda works in reverse. You put $100 in your bank, and the bank has to keep 10% in reserves (though I think right now the US reserve rate is suspended; most countries have no reserve rate). The bank can loan out up to 90% of your deposit. So let's assume they do, they take $90 and loan it to Bill. Bill takes that money and buys a TV from Bob. Bob puts that money in the bank. The bank keeps $9, and can loan out up to $81. And this cycle continues, until there's $1000 out there, all being held in deposit.
Anyways, a bit unrelated. Banks had long lobbied congress to pay interest on the money banks were required to hold in reserves. Congress, either right before, or right at the beginning, of the last financial crisis passed that law. But.. they didn't limit it to required reserves. They allowed any reserves to get interest paid on them.
So the financial crisis rears its head, and what do banks do? They stop loaning out money. The Federal Reserve wants to loosening up the bank's wallet, so the start Quantitative Easing, where they basically buy shit on the open market, with the idea of getting more money into the economy. The hope is that the banks will become flush with cash and loan it out. But banks did something utterly remarkable; they just shoved all that cash into reserves, and started collecting interest on it. So the Federal Reserve did more Quantitative Easing. And banks held that money in reserve. Turns out a couple percent on all this money is far better than the risk of loaning it out during a major recession.
Anyways, that little difference, between giving interest just on required reserves vs all reserves, extended the recovery period and kept interest rates low. And the Fed struggled with Quantitative Tightening (where they sell all the shit back), because every time they'd sell stuff, prices would fall.
So the US could probably (if it already hasn't?) solve a lot of their issues by making one little change to the law, which would make the federal reserve much more effective. Of course you wouldn't want to do that right now (or would you? unleashing trillions held in reserves? lol).
As for your idea, is it much different than just having everyone write a trailing 0 on all their bills and coins? The fear here would be that you undermine long term contracts. If I loan you $100, and expect you to pay back $1/month, and then the next month the government says every dollar is now worth ten, then I've just lost a lot of money. You pay me back $10 (now 'worth' $100) and keep the $90 (which is now $900). Of course the policy change wouldn't be that drastic. But even still, a lot of long term debt is extremely sensitive to a percent of interest. Add a percent to your mortgage of 30 years and that could cost you $20k per $100k you borrow. So if long term lending becomes more risky, less uncertain, banks are going to charge higher rates, or move towards short term lending.
You also create an environment where the average person isn't going to save much money, because the value of $1 now is greater. So people have an incentive to spend, and an incentive to take on debt, and an incentive to hope politicians bail them out.
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Of course that direct access to every bank account's balance would very much help the fed do its job. Maybe you remember that there was talk of the fed having it's own cryptocurrency, where it could see everyone's balance and every transaction that was taking place, this would eliminate the huge measurement error in basically all the metrics that we care about. With a cryptocurrency we could compute local inflation rates in real time, and the fed's interest rate could be continuously set to achieve whatever outcome we want. The only teensy weensy little downside is that you let the government have complete access to all balances and transactions that occur.
Not without building out an insanely complex goods tracking system and tying it to every payment system. Specifically, every good sold would need to be tagged with adequate metadata for the BLS to replicate CPI calculations. Instead of
product category: grocery(as distinguished from "product category: alcohol" necessary to enforce certain rules) you'd need{'type: 'flour', 'quality': 'organic', 'amount_in_oz': 32}.The only major CPI category this could be used to directly track that I can figure out is medicine, but that's because we don't actually track inflation of medical spending, we just track medical spending and treat all increases as inflation. I.e. if open heart surgery used to cost $100k and people bought 1, but now it costs $80k and people buy 2, that's treated as 60% inflation. That means that actual inflation (cost increase of a fixed basket of goods) in the period of 2000-2020 was significantly lower than CPI reports.
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