New Monetarists Are Redistributionists

Conservative economists are sometimes stereotyped as being anti-inflation, ‘hard-money‘ Austrians because the Austrians tend to be staunchly conservative.  This is not fair because the Austrian gold-bugs are a very small faction of conservatism compared with the Keynesian conservatives who have had near hegemonic control over official Republican party economic advice.  Unfortunately, both Republican and Democratic politicians ignore their economists whenever it is politically expedient, so the Keynesians (on the right or on the left) have not actually had that much power over economic policy in the Great Recession of 2008.  Another faction of conservative economists is even more ignored by establishment conservatism than the conservative Keynesians: the market monetarists or new monetarists.  They deserve more clout.

These economists have continued to work in the intellectual tradition of the greatest conservative macroeconomist of the 20th century, Milton Friedman.  Friedman is the father of monetarism and his work was so successful that monetarism became part of the standard Keynesian theory.   Brad Delong wrote a history of the two schools and concluded that monetarist policies have dominated Keynesian thought for stabilizing recessions at least since the 1980s.  But Delong is not a self-described monetarist.  He is a Keynesian.  What would a monetarist say?  There aren’t many people who call themselves monetarist anymore and no universities call their perspective monetarist as far as I know.  But there are a few economists who have held on to the monetarist moniker.  One of them that has influenced my thoughts a lot, Nick Rowe, basically agrees with Delong’s perspective:

A Keynesian Rip Van Winkle from the late 1960’s seeing a New Keynesian model would be surprised to see that Friedman’s followers were now calling themselves New Keynesians, and that Friedman had obviously won his war.

Perhaps because the market monetarists are such a small group with no institutional home, they have been ignored by policymakers and the press.  Even the hard-money gold bugs have had more influence in the business press (notably the Wall Street Journal) and in Washington (notably in the Ron-Paul wing of the Republican party).  One reason the market monetarists are marginalized may be that their preferred economic policy seems counter intuitive to the masses and is threatening to the kind of moneyed interests who think lower inflation (a return to the deflationary gold standard even) would help preserve their economic power.

The market monetarists want higher inflation to fight the recession.  Some moneyed interests feel threatened by this (see below) and the masses think that inflation is bad because it is a pain in the butt and workers worry that wages will not keep up with the rise in prices.  But inflation has little impact on real wages which are determined by supply and demand in the labor market, not by the inflation rate.    Higher inflation would help workers more than usual today because the US is in a liquidity trap with zero-short-run interest rates which means that conventional monetary policy is useless for helping unemployed workers.  And inflation has been lower than it usually has been historically, so we have less reason to fear it than in most of history.

The market monetarists think that a recession happens when the supply of loanable funds (savings) is too high relative for the demand for loanable funds (borrowings) and so there is excess savings (hoarding).  They want to lower the real price of loanable funds, the interest rate in order to bring back an equilibrium between the supply of savings and the demand for borrowings.  The real interest rate is the nominal interest rate minus the inflation rate.  The nominal interest rates for the safest loans are already at zero and cannot go below zero, but if we raised inflation, that would reduce real interest rates further.  And that would tend to reduce real interest rates for everyone.  For obvious reasons, this is not popular with lenders (banks) and savers (elderly) who want higher interest rates.   Because savers tend to be wealthier than borrowers (for obvious reasons), higher inflation would redistribute wealth from a relatively wealthy group to a relatively poor group.

This is undoubtedly one reason why the market monetarists are ignored.  They don’t have the support of the wealthier Americans who have have clout to push a political movement.  They have published no books, have no think tanks, dominate no academic journals, and don’t even have any professional association.  In contrast, the Austrian gold bugs have influence at at least 12 think tanks in the US (listed by George Mason University’s library) and there are more abroad.  The market monetarists are a grass-roots group that was “born out of the blogosphere” which is where it largely remains.  See the excellent blogs written by Scott Sumner, Lars Christensen, Nick Rowe, and David Beckworth for more about market monetarism.

Market Monetarist theory has the same ultimate remedy as the Keynesian theory.  The cure for a recession is to get people spending and the only way to do that is Robin Hood redistribution.  We have to redistribute resources from the (relatively wealthy) people and institutions who are hoarding them to the (relatively poor) people who feel greater spending needs and want to spend.   Government fiscal policy can accomplish this by borrowing money from the hoarders and spending it or by giving money as a tax break to citizens who feel greater a need to spend than the hoarders had.   Monetary policy accomplishes the same kind of redistribution by reducing the reward for hoarding money and increasing the incentive for borrowing and spending it.

Conventional monetary policy works by controlling short-term interest rates.  When there is too much hoarding, the central bank lowers the price of lending  to punish the hoarders and encourage the spenders.  And when the central bank feels like the spenders are buying too much and are driving up prices (inflation), the central bank raises interest rates to increase the incentive to save and reduce the incentive for people who want to borrow and spend.  This is a remarkable level of central planning.  Government intervention in the supply of money to change the rental price of money, the interest rate.  This kind of government control over financial markets deeply disturbs many free-market fundamentalists, but it has been central to capitalism in a big way since the gold standard was largely abandoned during the Great Depression and to some extent, it has been part of capitalism ever since the beginning.

The old monetarists focused on conventional monetary policy which controls the nominal interest rate on short-term government bonds.  That has worked fairly well during the last century except when interest rates hit zero.  This is the simplest definition of a liquidity trap and on the following graph, you can see that it happened during the Great Depression and the Great Recession of 2008.

Graph of 3-Month Treasury Bill: Secondary Market Rate

A liquidity trap is a ‘trap’ because the central bank (the Fed) feels trapped.  It cannot use conventional monetary policy to reduce the nominal short-term interest rate below zero.  Since nominal interest rates cannot go below zero, monetarists have focused on ‘unconventional’ monetary policy which has two primary flavors:

1. Reduce long-term and risky interest rates by having the Fed directly lend money in long-term and riskier loanable funds markets.  That would help redistribute income from hoarders to borrowers in loanable funds markets where interest rates are still well above zero.

2. Raise inflation as a way to redistribute resources from people who are hoarding money (relatively wealthy) to people with a propensity to spend it (most of us). An increase in inflation would reduce the real interest rate of all loanable funds markets and reduce the incentive to hold cash.  The market monetarists tend to focus on raising inflation because it has such broad effects across all financial markets, including the desire to hold cash which perhaps the biggest source of hoarding problems during a liquidity trap.   Because short-term interest rates are zero, they are equivalent to keeping cash.  The savers who hoard money in bonds that pay zero percent might as well bury cash in a jar in their yard except that cash in a jar is more likely to get stolen or ruined in a flood than the zero-interest bonds that they hoard.  But the effect on the economy is the same either way.  All money that is hoarded at zero-percent interest rate is effectively taken out of the economy during a liquidity trap.

Of course, not all hoarders are rich even though the median hoarder is a lot richer than the median spender.  The hoarders include most Americans who are retired and it is unfortunate that they should share more of the pain of a recession.  About 14% of Americans are over age 65, and it is unfortunate that their real wealth is threatened by a rise in inflation, but they are not served by high unemployment either.  Ending the recession and lowering unemployment will mean that their future Social Security checks are fully funded and more secure.  And Social Security provides the majority of income for the median American who is eligible for benefits.   Plus, returning to economic growth is the best way to raise real interest rates back up.  A prolonged recession means prolonged low real returns on savings.  It is better for savers to think long run.  They are better off in the long run if they endure a short burst of inflation and get back the higher interest rates that come with the recovery from a recession.

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