EC HH Why Money Matters

Some commenters who are sympathetic to MMT seem unfamiliar with the standard view of why money matters. They argue that swapping base money for an equal dollar value of bonds doesn’t matter, because the recipient of the new money is no better off than before. It’s true they are (approximately) no better off, but that’s NOT why economists think money matters. It would be nice if commenters showed they understood the traditional view, and then explained why it’s wrong and MMT is right.

Conventional economists believe that an injection of new base money creates a situation of excess cash balances. Keynesians believe the attempt to get rid of these excess cash balances causes bond prices to rise (i.e. interest rates to fall), and this boosts AD. Monetarists believe that the attempt to get rid of excess cash balances causes the price of a wide range of assets to rise, not just bond prices. Thus the Fed announcements of January 2001 and September 2007 caused only a small decline in short-term interest rates, but a big rise in stock prices. (BTW, long-term rates actually rose both times due to the Fisher effect—a factor ignored by MMTers.)

Monetary stimulus boosts the prices of T-bills, stocks, commodities, real estate and foreign exchange. I.e., it depreciates a currency. During normal times such as the 1990s, the difference between Keynesians and monetarists is just a theoretical curiosity. They both agree that monetary policy drives NGDP; they merely differ in how they see the transmission mechanism.

When rates fall to zero, however, the monetarist model is clearly superior. In March 2009, the Fed announced a QE program and as a result stocks rose and the dollar sharply depreciated against foreign currencies. That’s consistent with the monetarist model and inconsistent with the (extreme) old Keynesian view that monetary injections don’t matter at zero rates. (In fairness, New Keynesians have a more nuanced view.) MMTers seem to think money never matters, even at positive interest rates, although as I pointed out in this post it’s hard to be sure, as their statements are so contradictory.

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William K. 1 month ago Member's comment

I had a college professor who had nothing good to say about the Keynesian theology. Some of the terms sound good and make sense, but the basic premise seems defective.

Of course the proof of any theory lies in how well it correlates with actual events and happenings.

William K. 1 month ago Member's comment

At least one college professor had nothing good to say about the majority of the Keynesian theology. While some of the terms and expressions sound good and make sense,a fair amount of the basic premise does seem rather defective, to put it politely. So the article carries some good insights. And the common means for evaluating theories is how well they agree with what actually happens.

Gary Anderson 1 month ago Contributor's comment

Great article. Asset rise due to MMT money supply rise won't help mainstream labor much. Asset rise seems to have little to do with wage appreciation.

Bill Johnson 1 month ago Member's comment

Agreed.