Not to give away the conclusion, but the answer is ‘no’. Nonetheless, the title is provocative. (Perhaps, that is why Brad DeLong uses these types of headlines).
In all seriousness, I would like to address a recent criticism of David Beckworth. Those who have been reading the blog for the past couple of years will recognize that much of what has been written has been aimed at outlining a particular framework and addressing what that framework implies. At times, this has been done for the analysis of fiscal stimulus and at other times for monetary policy. Regardless, my goal in writing serious posts on this blog for the last couple of years has been in trying to engage readers in a serious discussion about particular topics. Specifically, I have tried to outline my preferred framework for analysis and challenge those who disagree to explain why. Unfortunately, this hasn’t been as successful as I had hoped. The lack of success is not because others have refuted particular ideas, but rather the fact that those who have engaged in the debate have often merely attacked straw man representations of the framework espoused herein — especially with regards to monetary policy.
Having said all of this, the subject of this post is something that was written by Robert Murphy regarding views espoused by David Beckworth regarding monetary policy and, in particular, quantitative easing.
Murphy begins by labeling Beckworth’s views as “monetarist Keynesianism.” I would call this an oxymoron, but it seems far beyond such a simple description. The term seems to refer to the use of “Keynesianism” by certain economists of the Austrian persuasion as synonymous with “interventionism”, but I digress. I would hope that we can dispense with labels as they are often, as this example illustrates, misused and distract from the substance of the conversation.
Now, on to the substance. David wrote an article for the National Review Online attempting to justify quantitative easing. Why does the economy need quantitative easing? David Beckworth explains in the article:
[QE2] is about fixing a spike in the demand for money that has significantly hampered spending.
He then goes on to detail the behavior of aggregate nominal spending in the U.S. economy and demonstrate how it has fell short of its long-run trend and that it can be explained by tight monetary policy (excess money demand). Robert Murphy then replies:
And there you have it, clear as a bell. Paul Krugman couldn’t have said it any better. According to Beckworth, the problem with our economy is that people aren’t spending enough.
This simple idea is very powerful; it permeates our financial press when they wring their hands and wonder if “the consumer” will buy enough Tinkertoys this holiday season “to pull the economy out of recession.” But of course, if spending were really the trick to having a growing economy, then the world would have eliminated poverty long ago. No, it’s production that is the real obstacle; consumption can take care of itself.
This critique sounds harmless enough, but it misses the point. David’s argument is not predicated on the belief that more and more nominal spending will generate prosperity and eliminate poverty. Rather, David’s point is that falling nominal spending reflects excess money demand and therefore implies that monetary policy is too tight. This view is based on the concept of monetary disequilibrium. Although I have detailed this concept on a number of occasions, it seems important to resurrect this framework again; not only to demonstrate the underlying framework for David’s argument, but also to show that this view is consistent with the Austrian business cycle theory.
The concept of monetary equilibrium is rather simple. Monetary equilibrium is defined as the case in which desired money balances are equal to actual money balances. Let’s begin in equilibrium and then describe monetary disequilibrium.
Recall the equation of exchange:
MV = PY
where M is money, V is velocity, P is the price level, and Y is real output.
The two major sources of monetary disequilibrium are changes in the money supply (M) and changes in the demand for money (V). If M or V decline it is because of a decline in the money supply or an increase in money demand, respectively. This results in an excess demand for money — desired money balances are
below above the actual supply. Ceteris paribus a reduction in M or V will result in a reduction in PY, or nominal spending. Since prices are not infinitely flexible, this also implies that at least part of the reduction in nominal spending will be a reduction in real GDP. Thus, it is not that David Beckworth thinks that evermore nominal spending would create prosperity, eliminate poverty, cure cancer, and turn Bob Murphy into a monetarist, but rather that the reduction in nominal spending reflects an excess money demand problem.
How can excess money demand be eliminated?
Excess money demand is reflected in a reduction in M and/or V. In a world with a central bank, monetary policy can eliminate excess money demand by reversing the reduction in M or offsetting the reduction in V. In either case, the central bank is increasing the money supply so that actual money balances increase to equal desired money balances. This is the point that David Beckworth is making.
An alternative way of thinking about monetary equilibrium is to use the interest rate rather than the money supply as a guidepost. If we define the interest rate that reflects the underlying preferences and real factors of the economy as the natural rate of interest and the interest rate that actually exists in everyday activity the market rate of interest, we can then define monetary equilibrium as the case in which the natural rate of interest is equal to the market rate.
So why is the equivalency important? Allow me to quote, at length, a wise monetary economist that I know:
The monetary equilibrium tradition is largely a European one. Much of the work on the doctrine prior to Keynes was in the hands of Swedish, British, and Austrian economists. Arguably, the whole approach begins in Sweden with the work of Wicksell, an in particular his development of the concepts of the natural and market rates of interest.
Wicksell saw himself as rescuing the Quantity Theory from what he saw as overly simplistic treatments that ignored the process by which monetary changes manifested themselves both in the price level and in real effects…
Wicksell’s work had a clear Austrian connection in its reliance on Bohm-Bawerk’s theory of capital in developing the concept of the nature rate of interest.
Hayek’s relationship with monetary equilibrium theory was also somewhat ambiguous. In some of his early writings, he defended a constant supply of money and appeared to agree with Mises’ claim that the creation of fiduciary media would disequilibrate the real capital market. On the other hand, as Selgin (1988a: 57) points out, there are numerous passages in Hayek where is recognizes that the nominal money supply should adjust to changes in the demand to hold money balances…in the second edition of Prices and Production, as we shall discuss later on, Hayek clearly call for changes in the money supply that offset movements in velocity so as to stabilize the left side of the equation of exchange. He was skeptical of the ability of any banking institution to actually accomplish this task, but he does indicate that this is desirable norm. Even as late as his 1978 book The Denationalisation of Money, he argued that:
A stable price level…demands..that the quantity of money (or rather the aggregate value of all the most liquid assets) be kept such that people will no reduce or increase their outlay for the purpose of adapting their balances to their altered liquidity preferences.
In other words, Hayek is arguing that in response to change in the demand for money (liquidity preferences), the monetary authority ought to adjust the supply of money so as to head off a scramble to obtain, or rush to get rid of, money balances.
That lengthy quote is taken from Microfoundations and Macroeconomics: An Austrian Perspective by Steven Horwitz (p. 75 -79). Thus, it is curious that Murphy would write:
As I mentioned in the introduction, this is why intellectually consistent conservatives are defecting to the Austrian camp. They can’t listen to their favorite AM radio hosts or TV pundits blast away at the stupidity of Keynesian deficit spending, and then turn right around and champion Bernanke’s attempt to stimulate aggregate demand.
What David Beckworth is arguing is that we must maintain monetary equilibrium, which is precisely what Hayek suggested was the optimal type of monetary policy not only in Prices and Production, which articulates in great detail the Austrian business cycle theory, but also in his work nearly a half-century later.
So what precisely is the Austrian critique? Murphy seems to be suggesting that any increase in the money supply generates inflation and distorts the capital structure. That view might fly with a certain band of Austrians, but it is not consistent with Hayek’s articulation of the Austrian business cycle theory and it is not even consistent with a free banking system in the absence of a central bank. Under a free banking system, banknotes would be redeemable in terms of a particular commodity. It follows that banks would routinely vary their level of reserves in accordance with the demand for money.
My objective in discussing this issue is merely to point out that David’s argument is not that more nominal spending is always better. Rather, it is the concept of monetary equilibrium that is at the center of David’s claim that quantitative easing is necessary. Accordingly, rapid declines in nominal spending reflect a deviation of desired money balances from actual money balances and, as a result, require monetary expansion to correct. In addition, this concept is not only at the core of David’s argument, but also at the core of the Austrian theory of the business cycle as articulated by Hayek and others.
Thus, Robert Murphy is free to support (or oppose) whatever policy he desires. The astute reader will note that I have not advocated a particular policy in the post. I have not done so because the purpose of the post, as with so many since the recession began, is to explicitly outline a framework rather than a caricature thereof. If one is to advocate the Austrian position and argue that David is wrong, the argument must take seriously the concept of monetary equilibrium and recognize that this concept was also at the core of Hayek’s thinking. Such an advocate would therefore have to explain why Hayek’s policy prescription was not consistent with the business cycle theory that he contributed so much to developing; or, alternatively, that we are not currently in a state of monetary disequilibrium.