Sumner, Murphy, Richman, and Cantillon Effects

Steven Horwitz

I have been both busy and traveling the last few days and haven't been able to read all of the controversy set off by a Sheldon Richman column on Austrians and inflation, including the back and forth between Scott Sumner and Bob Murphy.  However, I have read some of it and I think folks have focused too much on the question of the wealth effects of who gets the money first as opposed to the fact that  money takes a particular path means that money affects prices differentially. 

What I mean by that is that, yes, a bond dealer who sells to the Fed is just swapping one asset for another (which is also true of anyone who spends money of course), but that particular exchange leads to some banks having additional reserves, which translates into loans (well, normally anyway), which translate into borrowers spending.  Those borrowers spend on some goods and not others.  Yes, all of these are just swaps of assets, but the imporant point here is not the change in wealth but the impact on relative prices. 

Whatever the existence or non-existence of wealth transfers from the injection of new money, it does afffect the array of relative prices, which means it affects the investment decisions of entrepeneurs, which means it affects the capital structure.  Given the heterogeneity and specificity of capital, the capital structure cannot be costlessly refit each time a new injection of money occurs, nor when the injection stops and underlying demand and supply reassert themselves.  These represent real wealth lost due to the injection/relative price effects of inflation.

Even if we take Bill Woolsey's point that people base price changes on anticipated changes in spending and not actual changes, in an Austrian world there's no reason to believe those expectations will all be identical.  Because the money goes to specific places at specific times, people will still react to the changes in the prices of their inputs, say, in different ways, and those different reactions will have real effects on the capital structure and therefore other real variables.

More systemically, these relative price effects increase the epistemic burden on market actors as prices become less reliable signals of underlying consumer preferences and opportunity costs, thanks to the temporary pushes and pulls from the injection of excess supplies of money.  People are simply more likely to guess wrong about what a price movement means, and are thereby more likely to make irreversible (at least to some degree) decisions with respect to investments in human and physical capital.

The Austrian understanding of injection effects cannot be separated from its understanding of the price system and capital theory.  It doesn't matter so much WHO gets the money first.  What matters is that SOMEONE does and that the dispersion across the price system is not even.  THAT matters because it ripples through the capital structure with real, not just nominal, effects.  The Austrian theory of the business cycle is one kind of systematic real effect, but there can be others.

Again, I haven't read all of this debate, so perhaps Scott and others have addressed this point.

You can read more about all of this in my paper on "The Costs of Inflation Revisited" or my book.

Comments

[Nicolas Cachanosky]

Indeed, with no such clarity, that was the point I was trying to make:

http://puntodevistaeconomico.wordpress.com/2012/12/03/does-it-make-any-difference-how-money-is-injected-into-the-market-sumner-and-the-cantillon-effect/

http://puntodevistaeconomico.wordpress.com/2012/12/04/scot-sumner-and-cantillon-effectspart-2/

[Sheldon Richman]

The reason I brought up the change in wealth at all, and not just the change in relative prices, is that my article was about plutocracy and not the economics of inflation and the business cycle.

[John Hall]

Steve, I feel like what you just said was much clearer than everything Bill and Scott have been saying.

[Nick Rowe]

Steve: Here is my little contribution: http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/12/cantillon-effects-and-non-super-neutrality.html

How much money is created is monetary policy. What the government decides to buy with that new money is fiscal policy, and it can be offset, if the government chooses, by regular fiscal policy.

The revenue from printing money is about 1% of regular tax revenues. It's peanuts.

1. Would helicopter money have big "Austrian" effects?

2. Would an open market purchase of bonds have very different effects?

3. Would a bond-financed tax cut have big effects?

The answers to those three questions cannot be independent of each other. Because:

Helicopter money = open market purchase of bonds + a bond-financed tax cut.

[Daniel Kuehn]

Exactly Steve - I was making just this point earlier on in the debate: http://www.factsandotherstubbornthings.blogspot.com/2012/12/on-cantillon-effects.html

I don't think it's as big of an issue as you do, but I do think the discussion was missing a lot of the point.

[Xerographica]

There are 3,290,000 Google search results for "the customer is king" but only 64 results for "the taxpayer is king". Is that a problem?

If you're tired of having a "plutocracy"...then why not advocate for taxpayer sovereignty?
http://en.wikipedia.org/wiki/Tax_choice

Speaking of which...have you folks heard of civic crowdfunding?

http://pragmatarianism.blogspot.com/2012/11/civic-crowdfunding.html

Is the movement worth a post or two? Only time will tell...but you might as well hedge your bets.

[rob]

I got the impression that Sumner was not talking about the kind of money creation that would generate high levels of inflation but more like the kind that would be needed to hit an NGDP target when demand for money has increased.

Would the comments in your post apply to that kind of regime ? Its clear that many of the Austrians who commented on Sumner's blog felt that any kind of monetary policy would be highly discretionary whether or not it was aimed at stabilizing the value of money.

[Jerry O'Driscoll]

Steve,

Very well stated. Your emphasis on relative prices is central to any analysis of Cantillon effects.

For me, your strongest point is that monetary shocks render prices less reliable signals. Whatever minimal degree of expectational uncertainty exists, a policy of shocking markets with money increases uncertainty.

I read Sheldon's piece, which is excellent. I haven't read all the commentary.

[Joshua Wojnilower]

Steve,

Very well said. The other side may argue that the decisions after the Fed swaps Treasuries for reserves are fiscal policy, but I think it's hard to divorce changes in borrowing from the Fed's actions.

Since you clearly state that monetary injections can have real effects, at least in the short-run, I was wondering, what is your view on long-run monetary non-neutrality?

[Bill Woolsey]

Steve:

When I read your post (and some of your and others writing in this vein,) I found it just too abstract.

This morning I read a post by Glasner:

http://uneasymoney.com/2012/12/06/those-dreaded-cantillon-effects/

As usual, I don't agree with everything David said, but he also makes the point about having some kind of effect and creating a recognizable pattern.

I think that excess supplies of credit money push the market rate below the natural rate, and this impacts the demands for various goods diferentially based on their interest elasticities of demand. How shifts in demand impact relative prices depends on price elasticities of supply and demand. I don't think that the shift in demand, shift in relative prices (assuming perfectly inelastic supply in the short run?,) shirt in relative profitabilities, shift in production, is realitic or helps communicate the process. Aside from perfectly inelastic supplies in the long run, the differential impact on demands is going to impact the allocation of resources and the composition of output. Now, to what degree entrepreneurs will expect this pattern of demand to persist and so motivate them to commission many specific capital goods is another question.

I think you need to be careful when making the abstract argument that doesn't involve excess supplies of money pushing the market rate below the natural rate, but rather money must enter someplace, to make sure you are not making elementary errors on an intuitive basis.

Those particular people getting the new money with the big pictures of Ben Franklin don't benefit more than people who sell their products for "old" money. It is the impact on pattern of demand that counts, not which sellers get which money.

And, as I have emphasized, the counterfeiter obtains nearly all of his gain even if prices immediately adjust to their new equilibrium pattern. The gains of couterfeiters or the seignorage of the government have little to do with the excess supply of money. They can persist.

If the government decides to use money creation to fund more tanks, it can do this forever. If the government uses special currency with a big picture of Ben Franklin to buy the tanks, it makes no difference. If they only used tax revenue to buy the Tanks, and used the new currency to pay postal workers the same salary they have been making for years, the result is the same. Also, the tank manufacturers probably do benefit from the spending program--entreprenerial profit, quasi-rents, and maybe some pure rents for someone. But they would get that same benefit if the tanks were funded by an income tax surcharge or explicit borrowing.

If the tank buying program were maintained forever, then commissioning specific tank manufacturing equipment would be sensible (which is how the quasi-rents disappear, right?) But how is this malinvestment?

And, of course, when the tank manufacturing program is discontinued, we should expect some structural unemployment and some abandoned specific capital goods. The old tank plant building might sit vacant forever.

I think it is important to distinguish between the equilibrium phenomenon--the public finances of money creation (or the gain from criminal counterfeiting) and the disequilibrium phenomenon.

[Bill Woolsey]

Sheldon:

I think you should be careful about how you characterize monetary policy as being an element of crony capitalism.

It seems to me that the huge increace in lending by the Fed to commercial banks and other finanical institutions in 2008 and 2009 was pretty questionable. It has mostly been paid back. With TARP and the guarantee of Fanny and Freddy, that is just a drop in the bucket.

Still, the big bailout was to people making short term loans to financial institutions--people holding shadow bank money. I don't think characterizing these people as "getting new money first before it loses value" is at all useful. I have never had a sweep account or held overnight commercial paper or a repurchase agreement, but I do hold FDIC insured bank deposits. The big effect of the bailouts was to protect all short term creditors in the same way. And, of course, the managers of the financial institutions didn't go through reorganization. They just have to face their current stockholders who took heavy losses rather than new owners.

I would suggest rethinking all of the prejudices from years past that come from too easily accepting Rothbardian propaganda. The primary security dealers that sell T-bills to the Fed are not at all similar to counterfeiters printing money and spending it on goods and services.

[Mario Rizzo]

On the wealth point: It is true that in the sense of current market estimation of value, if A gets a loan from B, then B has a debt with a present value of X and A has an asset with a present value of X. No wealth transfer.

However, (1) relative prices will be affected; (2) obviously B thinks he will gain more than the present value of the debt. He *thinks* he is wealthier. (And I should add the naive observer thinks that the society is wealthier.)

The problem is that the credit expansion screws up price signals and expectations. The truth will out: We are all poorer.

[Jerry O'Driscoll]

Jeff Hummel's piece in the Independent Review on the Fed as central planner already raised the issue of crony capitalism. I do not understand why Sheldon's article has caused such a stir. Even high Fed officials have raised the issue, albeit with more circumspection.

In the paper that Tom Cargill and I just presented at the Cato monetary conference, we also raise the issue of cronyism in monetary policy. For those attending the AEA meetings in San Diego in January, you can hear us present the argument again.

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