Asymptosis

Economists’/monetarists’ use of the term Money “Supply” reveals multiple levels of deep confusion.

1. Supply implies a flow. But they’re clearly referring to a “stock” of money: what’s tallied in monetary aggregates.

2. Even if you’re think of a stock of money: Supply is not a quantity, an amount, a numeric measure. It’s a psychological/behavioral concept — willingness to produce and sell — commonly depicted in a curve representing that willingness at different price points. (All economics is behavioral economics.)

But “supply” is necessary to validate the incoherent ideas of the “price of” and “demand for” money — a set of financial instruments like checking deposits whose price never changes (relative to the Unit of Account). That price can’t change — by definition, by construction, and by institutional fiat.

Likewise, the aggregate stock or so-called “supply” of fixed-price instruments, money, changes only very slowly via bank net new lending. (That change in lending is determined by myriad economic behaviors and effects.)

If so-called demand for money can’t change the (P)rice of money (it can’t), or the collective (Q)uantity of money outstanding (it can but not much and very slowly), what exactly are we talking about here in our imagined supply-and-demand diagram toy thought-experiment?

I’m thinking this headline will raise some eyebrows in the MMT community. But it’s not really so radical. It’s just using the word money very carefully, as defined here.

Starting with the big picture: 

You can compare the magnitude of these asset-creation mechanisms here. (Hint: cap gains rule.)

The key concept: “money” here just means a particular type of financial instrument, balance-sheet asset: one whose price is institutionally pegged to the unit of account (The Dollar, eg). The price of a dollar bill or a checking/money-market one-dollar balance is always…one dollar. This class of instruments is what’s tallied up in monetary aggregates.

A key tenet of MMT, loosely stated, is that government deficit spending creates money. And that’s true; it delivers assets ab nihilo onto private-sector balance sheets, and those new assets are checking deposits — “money” as defined here.

But. Government, the US Treasury, is constrained by an archaic rule: it has to “borrow” to cover any spending deficits. So Treasury issues bonds and swaps them for that newly-created checking-account money, reabsorbing and disappearing that money from private sector balance sheets.

If you consolidate Treasury’s deficit spending and bond issuance into one accounting event, Treasury is issuing new bonds onto private-sector balance sheets. It’s not printing “money,” not increasing the aggregate “money stock” of fixed-price instruments.

This was something of an Aha for me: If you look at the three mechanisms of asset-creation in the table above, only one increases the monetary aggregates that include demand deposits (M1, M2, M3, and MZM): bank (net new) lending.

Arguably there might be one more row added to the bottom of this table: so-called “money printing” by the Fed. But as with Treasury bond issuance, that doesn’t actually create new assets. The Fed just issues new “reserves” — bank money that banks exchange among themselves — and swaps them for bonds, just changing TheBanks’ portfolio mix. That leaves private-sector assets and net worth unchanged, and only increases one monetary aggregate measure: the “monetary base” (MB). 

I’ll leave it to my gentle readers to consider what economic effects that reserves-for-bonds swap might have.