Monday, December 3, 2012

Are Theories of Modern Money and Heterogeneous Capital Compatible?

The other night, a counterpart in my PhD program claimed that Post-Keynesian economists generally deny any truth behind the Austrian views on heterogeneous capital. While others are free to correct to this statement, I suggested that while modern money approaches often don’t discuss capital as a central theme, the two theories need not be contradictory. Ryan Murphy’s argument that It does matter how new money is injected, but that’s probably bad terminology, offers a chance to briefly discuss my thinking on the subject (my emphasis):
The idea that it matters how new money is injected relates to the way in which money “hits” the markets. For the “traditional” story to apply, the price of time -the interest rate- needs to move before other prices move. If it “hits” consumption goods (or some other vector of goods) first, the traditional ABCT story doesn’t apply, though something similar in substance might.
The simplest way to think about this is with Hayekian triangles. It’s a fairly simple question: can monetary policy disrupt the shape of the triangle in the way Garrison described via interest rates? I don’t see why this would be controversial. Some industries (and economic decisions generally) are more sensitive to interest rate changes than others. If you were at monetary equilibrium and you print money in such a way that causes interest rates to fall, then more resources get drawn into those industries than elsewhere. That is almost true by definition. If you assume heterogeneous interest rate sensitivity and that monetary policy can affect interest rates, then you get heterogeneous real effects.
Ryan’s post is a reaction to one by Scott Sumner arguing that it makes very little difference how new money is injected into the economy. The second paragraph above presents an Austrian explanation that seems readily apparent through recent experience. A decade ago, expectations that short-term interest rates would remain relatively low for quite some time helped bring down long-term interest rates. The housing sector, particularly sensitive to long-term rates, saw increasing growth and speculation. More resources were drawn to the sector than elsewhere, fueling a spectacular bubble. When the bubble burst, the economy experienced a real shock to growth.

These effects from monetary policy are only one part of the story. Looking back at Ryan’s first paragraph above, a modern money perspective (is this better than saying Post-Keynesian?) may provide the “something similar in substance”. This view argues that fiscal policy is partially responsible for injecting money into the economy (“inside” money from private banks being the main source). Depending on the distribution, prices in certain industries may adjust before changes in interest rates. These industries will likely attract more resources temporarily due to changes in expected future demand. When the government reduces or stops supporting those industries, revealing the temporary nature of the demand, prices will tend to fall. In this light, fiscal policy that alters the money supply also creates real effects due to the misallocation of capital.

Starting from either approach, it seems clear that money is non-neutral. Given this agreement, I see no reason why modern money and heterogeneous capital perspectives need be incompatible. Hopefully others can shed some further light on this debate.

(Note: Two bloggers that often combine an Austrian and modern money approach (from whom I’ve learned a great deal) are Edward Harrison of Credit Writedowns and John Carney at CNBC’s NetNet.)

Related posts:
The Fallacy of Monetary Neutrality
Fighting for Endogenous Money on Two Fronts
Hayekian Limits of Knowledge in a Post-Keynesian World

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