Friday, September 6, 2013


Below is a test reply comment to Fed Up and winterspeak in JKH's post on Market Monetarism. My original posted comment is here, but as of this writing it's "awaiting moderation" (I'm sure because there's more than one link in it), but it still let me grab a link to it, so it'll be interesting to see if people can see the original even though it's awaiting moderation.

 Fed Up & winterspeak,
“Tom Brown, does this sound familiar?” — Fed Up
Yes, this sounds very familiar, which is why I posted a link to my post “Nick vs Scott” on this subject above. And Nick’s response above again highlights a difference with Scott. Let’s review: Scott Sumner, in this post explaining the hot potato effect (HPE), used as an extreme example under which the HPE still applied a “cashless economy” (his case 7):

7. Now let’s assume a cashless economy where the MOA is 100% reserves. Still no change; reserves are still a hot potato.
Using Scott’s hypothetical case 7 a basis, I asked Scott and Mark Sadowski the following question:

OK, let’s start with your own example #7 from this post: “7. Now let’s assume a cashless economy where the MOA is 100% reserves.”
You’ve clearly identified the MOA there: reserves. Banking doesn’t matter, so why not assume a single commercial bank? And my other assumptions: no taxes, gov spending, foreign trade, etc.
So if initially the CB buys $X in assets, this gives us an initial $X in reserves, which you’ve identified as MOA.
Since we have an MOA, we will reach a steady state price level, P, right?
Now what if the CB sells 1-epsilon of its assets? The new eventual price level should be:
new steady state price level = P*(epsilon*X/X) = P*epsilon
So as epsilon approaches zero, the new steady state price level should approach zero too??
At which point I added

Scott, of course the reserve requirement = 0% too.
Scott’s response was:

Tom, Yes, as the level of reserves go to zero, so does the price level.
Mark Sadowski agrees with Scott, although he complains about the realism of my (actually Scott’s!) hypothetical cashless society:

Tom Brown,
I agree with Scott. However, any example that doesn’t include currency is excluding what has been the most important part of the monetary base historically. In short it is extremely unrealistic.
This is quite different than what Nick writes above:

If there were just one commercial bank, and if nobody used central bank currency, and if there were no legally required reserves, then that single commercial bank would not need to hold any reserves. That single commercial bank could ignore the central bank. The central bank would disappear.
Nick wrote nearly the same thing when I first presented him with my version of Scott’s hypothetical, however after showing him Scott’s response, he wrote this:

Tom: you really do need to distinguish between the *demand* for reserves going to zero and the *supply* of reserves going to zero. (And *both* supply and demand going to zero.) I read you one way, and Scott read you the other. It’s supply AND demand.
He also later saw my notional chart (animated version here) of my interpretation of what he meant by this and wrote:

Tom: thanks. looks roughly right on a first glance.
though to be fair, the version he saw was slightly different, but not substantially so (embedded in the comments here).

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