In Which I Respond to Niccolo
Recently, Niccolo was talking about some issues he has with the Austrians, specifically regarding money. He says that he doesn’t believe that the economy can be tied to an inflexible standard, and that he believes that fractional banking is a fine form for banks to take.
A much more effective method for increasing the money supply, I think, would be to have a free market for currencies not connected to the government. This allows for both competitive stability in currency and elasticity between supply and demand for money.
Isn’t this what the price mechanism does? In a free market, all goods and services are (in a roundabout manner) valued in terms of one another; some goods just happen to be more liquid than others. A free-market “fractional reserve requirement” is, however, a fiction.
In a free market, commodities serve as money, or paper notes or digital representations of a commodity. The question needs to be reframed: Is your “money” redeemable? If it is not redeemable, then it’s no different than fiat paper. If it is redeemable, then fractional reserve banking is impossible, as de facto debasement of the currency in question: the moment a reserve is established as a fraction of receipts outstanding, the money is no longer redeemable.
I think it is the mistaken belief that money supply growth leads to growth in the economy overall.
but I also do not believe that an inflexible standard of money will lead to anything less than retarded growth
It is tough to say this with certainty. The Nineteenth century saw a tremendous amount of growth with most of the world on some form of a classical commodity standard. It is true that the 20th century saw growth several orders of magnitude larger, but the case could be made, (although not in this forum) that such a pace was and is unsustainable. I’ll leave that topic for another time and place.
Although in a free market, where money is an economic good in its own right, the money supply should tend to grow at some non-zero rate, it is not imperative for the money supply to grow at all. Moreover, I’m not convinced that increasing the money supply meaningfully “encourages” a greater degree of productivity in the overall economy, and since productivity and a subsequent abundance of material goods and services is the true indication of wealth, it hasn’t been shown how monetary expansion causes wealth, either.
January 12th, 2009 at 9:36 am
David,
I brought this same topic up at the Mises blog the day that I wrote the entry. Something along the lines of - prices will adjust accordingly - also came up.
Here was my reply,
“It seems then that you have to rely on the prices for goods. Which, I guess, is OK, but seeing that prices are sticky, I don’t understand why you would want to prolong corrections like that when the alternative is much easier and less painful.
Moreover, that would make prices for goods a hell of a lot more volatile, which isn’t the best thing for economic stability.”
By the way, someone said something about gas prices as an example of elastic prices, but they’re only partially correct. Gas prices, like most prices, are extremely fluid upwards, but are much more difficult to adjust downwards.
January 12th, 2009 at 1:46 pm
The notion of price stickiness seems to be most often mentioned with regards to wage labor, in other areas, I’m not sure it lives up to the hype.
Clearly, we saw gasoline prices fall 50% over the course of a month, here in Michigan. (I saw the same trend on two separate trips to Los Angeles, too) It just so happens that most of the world’s oil comes from the least politically stable areas on the planet. It’s an outlier.
As for volatility, isn’t it true that the price of any good tends to be more fluid especially upwards? For instance, if an early frost hits Florida, the price of oranges may skyrocket or oranges may become unavailable. The sticky-downward phenomenon is at least as much a function of demand as it is of supply. If groves are left with fewer oranges, it stands to reason that they still try to recoup their costs, but assuming demand hasn’t changed, the fewer, remaining oranges will be sold at a higher price, to those who value them more.
Which forum did you post to, I’d have to see it to understand what you mean by “corrections” in context, in particular, how the augmentation of the money supply can alleviate the pains caused by improper forecasting, erroneous judgments & failure to meet consumer demands - without causing problems of its own.
January 13th, 2009 at 11:12 am
David,
The existence of price stickiness is fairly well established empirically. Taxis, for example, don’t change their prices every second, though demand is always shifting.
Though it is true that the continuum of price stickiness depends upon the specific industry, prices and wages are still sticky - especially downwards.
Gasoline prices, I think, should actually have been lower than they were. One shouldn’t mistake a specific move for the correct move. Yes, sometimes prices do change, but it’s the speed at which they shift that counts.
The alleviation of pains through monetary policy is a widely accepted idea throughout economics - Austrian economics too.
Read VI here explaining Hayek’s views.
http://www.auburn.edu/~garriro/e4hayek.htm
The later version of Mises did not technically disagree with Hayek on this, either, he merely thought that mining for metals could keep pace with economic activity. I think Mises was wrong about that for structural issues that go into the market for mining itself.
January 23rd, 2009 at 6:14 pm
“The existence of price stickiness is fairly well established empirically. Taxis, for example, don’t change their prices every second, though demand is always shifting.”
Depends on how you define “stickiness” I suppose. In fairness, I think this is a lousy example. Maybe I’m mistaken, but I generally understand “stickiness” to be a pejorative term, reflecting irrational unwillingness to accept a lower price. I don’t mean to suggest that stickiness doesn’t exist, however.