Fixated on the True Meaning of Money

Charles Kindleberger, my old teacher at M.I.T., used to say that anyone who spends too much time thinking about international money goes mad. He meant that people start obsessing about the international role of the dollar, thinking that it’s the most important thing in the world, when it’s actually fairly trivial.

What he didn’t say, but what seems obvious these days, is that a similar thing happens to people who spend too much time thinking about money in general — specifically about trying to decode money’s true meaning and find the real measure of the money supply. They end up believing that everything in economics hinges on getting that measure right, when, in fact, almost nothing does.

One particular variant of this madness, which I found myself thinking about after reading two recent blog posts by the economists Simon Wren-Lewis and Frances Coppola — neither of whom has, I think, gone mad in this way, but allude to people who have — is the sort of boomerang position that since we can’t clearly define money, and because there isn’t a fixed money multiplier, monetary policy doesn’t matter. That’s as wrong as the simplistic quantity-theory view that “printing money” leads directly to inflation.

It’s true that we’re living in a time of monetary impotence, where central banks that have tried to reflate economies aren’t having much success. But it’s important to note that contractionary monetary policy is working just fine: All the central banks that mistakenly decided that it was time to raise rates succeeded in doing just that, before realizing their error and reversing course.

But what about the fact that vast increases in the monetary base have failed to do much to the economy, and that various broad measures of money haven’t moved? Doesn’t this show that monetary policy doesn’t matter? No, not at all. The irrelevance of the monetary base isn’t a generic issue; it’s something that happens when you’re in a liquidity trap — when interest rates are at the zero lower bound. And this is not hindsight. Way back in 1998, when I analyzed the liquidity trap in Japan, I predicted exactly this disconnect in a research paper: “[P]utting financial intermediation into a liquidity trap framework suggests … that it is quite misleading to look at monetary aggregates under these circumstances: In a liquidity trap, the central bank may well find that it cannot increase broader monetary aggregates, that increments to the monetary base are simply added to reserves and currency holdings, and thus both that such aggregates are no longer valid indicators of the stance of monetary policy and that their failure to rise does not indicate that the essential problem lies in the banking sector.”

You can see, by the way, why I get annoyed both by people who declare that nobody could have predicted the failure of a balance-sheet expansion to cause inflation, and by those who claim that conventional economists like me just don’t understand that money is endogenous.

Guys, I laid it all out 16 years ago.

And as for the idea that the absence of a clear definition of money, plus the fact that most money is created by financial institutions, means that central banks don’t matter, the economist James Tobin dealt with all that more than 50 years ago. Just read the first couple of pages of a paper he wrote in 1963; Mr. Tobin anticipated just about every piece of the current debate.

The point is that if you think something deeply disturbing from an analytical perspective has taken place, if you think that recent events require a fundamental rethinking of monetary theory, you basically weren’t paying attention. If you read Mr. Tobin, if you read what people like the economist Mike Woodford and I had to say about the liquidity trap, you expected to see exactly what we’re seeing.