Tuesday, July 16, 2013

The Reach for Real Bills















  1. very intersting and nice post thanks! would just add that reserves are a meaningless measurement to lending so regardless of cash/deposits on hand internally at the banks it will have zero impact on their ability to lend. especially lend aggressively. the fed needs to reignite the shadow banking system at the same time regulators are pushing through bills that are doing the exact opposite. in that sense the fed is just fighting itself.

  2. If there's an excess demand for money, why doesn't the Fed just create more (and inject it into the economy via QE)? Why bother with forward (interest-rate) guidance?

  3. Besides being superfluous, forward interest-rate guidance carries an inherent lack of credibility, since this year's FOMC cannot bind next year's; indeed, it cannot even bind the later temporal stages of *this year's*!

  4. I don't follow your explanation here:

    "But you can convince people to hold less money as long as the interest rate is low enough."

    Lower interest rates, all else equal, cause people to want to hold more money since the opportunity cost of doing so is lower, no? I feel like I must be misinterpreting you.

  5. Philo,

    I will argue in an umpcoming post that forward guidance is actually the more important part and that QE is only there to solve the commitment problem that you mentioned.


    I have edited it slightly to get my true point across. Recall that money also includes deposits, so demand for money can loosely translate to demand for savings as well. The main idea is that recessions are caused by people wanting to hold onto savings. People do this because they expect to be able to use the money tomorrow to spend and want something to deal with the uncertainty in a recession. But if you lower the interest rate, it's less worth it to hold onto the money as savings, and people are more likely to spend it. In particular, if the interest rate were negative and holding onto money was actually costly, then it would be in the incentive of people to spend that cash.

    Another, perhaps more natural, framing of it is a decision between consumption now and consumption later. Lowering the interest rate serves as a signal to consume now, thereby solving the excess supply of goods.

    1. “I will argue in an upcoming post that forward guidance is actually the more important part and that QE is only there to solve the commitment problem that you mentioned.” I am looking forward to that upcoming post!

  6. The reasoning in your economic model looks rather well done, Yichuan Wang.

    However, have you gone back to the primary sources?

    By that, I mean, have you went back to the writings of thinkers who have been described as supporters of the Real Bills Doctrine? These include Adam Smith, John Law, Simon Clement, Charles Bosanquet, Thomas Tooke, and John Fullarton.


    The trouble was not the real bills doctrine, but rather the Fed's misunderstanding of that doctrine. Properly understood, the RBD says that money should be issued in exchange for short term real bills of adequate value, but its historical advocates put far more emphasis on "adequate value", than on the idea that banks should issue money only for "productive uses". For example, RBD advocates often approved of issuing new money in exchange for government bonds or other "solid paper".

    A central bank that follows this more reasonable version of the RBD will automatically issue or absorb money in response to public demand for that money. During busy times, when people need cash, those people will bring "solid paper" to the Fed to exchange for money. During slack times, those same people will withdraw their "solid paper" in exchange for paper dollars. Thus, the Fed would passively issue money when it was needed, and absorb that money when it was not needed. This is a procyclical policy in the sense that it accommodates the public's need for cash during booms and busts, but it is not the cause of those booms and busts.