Typography

David Glasner finally chimed in on the subject of endogenous money. I pretty much agreed with everything he said on the topic of bank money endogeneity. Basically, the financial system adjusts to a reduced demand  for bank money by destroying that money rather than keeping it in circulation and forcing all prices to adjust. The process by which this occurs is an arbitrage process. This is the classical theory of money that Glasner describes in his book Free Banking and Monetary Reform , and it applies equally to the modern banking system since banks make their deposits convertible into central bank money. David said something interesting: So while I think that bank money is endogenous, I don’t believe that the quantity of base money or currency is endogenous in the sense that the central bank is powerless to control the price level. I was curious about his claims that modern central bank (CB) money is not endogeneous and left some comments on his post trying to drill down on this iss...

Perry Merhling had an interesting quote from Fischer Black: Thus a long term corporate bond could actually be sold to three separate persons. One would supply the money for the bond; one would bear the interest rate risk; and one would bear the risk of default. The last two would not have to put up any capital for the bonds, although they might have to post some sort of collateral In the comments I pointed out that a fourth person can be added to the list - someone who bears the liquidity risk of that corporate bond in the secondary market. This would amount to a liquidity option. Essentially, the bearer of liquidity risk would allow the bond owner to sell that bond at some preset level in the bid-ask spread. For instance, the option could allow the bond owner to immediately sell their entire bond holdings at the upper end of the spread, or at the ask price. Normally, sellers can only sell quickly if they accept a price near the bid price, or lower end of the bid-ask spread. When il...

In his tradition of imagining alternative monetary systems, Nick Rowe asks if there is any fundamental theoretical difference between how monetary policy worked under the gold standard and how monetary policy works today for a modern inflation-targeting central bank. Nick uses a progression-style of reasoning in which he incrementally adds/subtracts elements to the original gold standard system to arrive at a modern inflation-targeting regime, or what he calls the CPI standard. His point, and I agree with it, is that the two standards are not fundamentally different - rather, the same core mechanism underlies each system, with only a few modifications here and there. This runs counter to most people's intuition that the gold standard is a totally different beast from our modern system. Although I criticized some of his points in the comments section, these disagreements stemmed from the fact that what interests me is not so much the evolution of monetary policy, but the evolution ...

Nick Rowe had an interesting post here . He asks how the Bank of Montreal would be different from the Federal Reserve if the Fed decided to peg it's currency to the Canadian dollar. I think the difference would be that BMO has access to Canadian Payments Association's LVTS (Canada's monopoly payments clearinghouse) and LOLR services provided by the Bank of Canada, whereas the Fed would have neither benefit.

Michiel Bijlsma and Jasper Lukkezen have a very good article on the Bruegel blog that deals with the question: why is there no Target2 debate in the US? On a purely technical note, they bring up an interesting point that Interdistrict Settlement imbalances can arise not just from capital outflows from one district to another, but from the daily redistribution of SOMA assets bought on behalf of the other Reserve banks by the New York Fed. I hadn’t previously considered this mechanism and consider it to be a good addition to understanding the debate. More controversially, they maintain that ISA imbalances primarily arise from SOMA redistribution and that regional capital flows contribute fewer imbalances. Perhaps, but that’s an empirical question. Continuing on a purely technical note, Bijlsma and Lukkezen note that when the FRBNY purchases from a counterpart with a depository account at one of the FRBs, this particular FRB then credits the counterpart’s depository account, which incre...

Stephen Williamson suggests here , here , and here that blog readers browse his recent paper, Liquidity, Monetary Policy, and the Financial Crisis: A New Monetarist Approach . Here are some thoughts I had upon reading it. Williamson sets up an imaginary universe in which there are two types of people who live and produce in differing market environments. The various frictions that these two types must bridge in order to purchase each other's production leads to a role for fiat money, and later banks. The first environment is a Walrasian centralized market in which trade is easily executed. The second is a decentralized market. Trade is difficult in the decentralized market because buyers and sellers meet each other in a haphazard and anonymous manner. Those who inhabit the centralized market must trek over to the decentralized market so as to trade for consumption goods. Unfortunately for them, they can't bring the goods they have produced in their centralized market habitat s...