Thursday, June 12, 2008

Macro makes no sense

One area of economics that U Chicago shed no light on for me was macroeconomics, and monetary policy, which is ironic since it's the home of Milton Friedman who founded Monetarism. I don't think Megan understands it all that well either in this post
1. It would involve a massive, massive credit contraction. Hello, Great Depression.

2. Actually matching pool credit to particular loans would be a much more expensive business than the current banking system.

3. The expansion of credit has historically enabled a lot of things we like, such as homeownership and entrepreneurship.

4. How many people want to pay the bank to hold onto their money?

5. A smaller credit system will not ultimately prevent inflation/deflation. Without interest bearing accounts, savings become a wasting asset.

6. To the extent that it does prevent inflation, this is not necessarily a good thing--a little inflation greases the labor market, mitigating the effects of demand shocks.

1. It sure would. That said, the US$ has lost over 90% of its value in just three generations, and if that's a feature of the system, how great is that system?

2. Matching pool credit would be more expensive than maturity mismatched accounting as you would switch to, essentially, a multiple year cash accounting system. Other costs would be lower though -- no more FDIC. Other costs would be much lower, remember the US taxpayer is on the hook for almost $1T (yes, T) shoring up bad housing loans and the shadow banking system via recent Treasury and FNMA intervention.

3. Entrepreneurship would go on unimpeded. Remember, VC funding (a key driver of entrepreneurship) *is* maturity matched. Speculation would be less well supported though, and that is a feature, not a bug.

4. Suppose money did not lose value such that it became near worthless in three generations? Suppose you were hiring someone to protect gold? If we lived in a world of mild deflation (zero currency dilution + technological improvement) then paying a modest fee to have our cash stashed someplace safe would be fine.

5. You are correct that a smaller credit system will not, in and of itself, impact inflation/deflation. Monetary dilution (or concentration) is what drives inflation/deflation. Credit is part of this, and a bank's ability to extend credit (print money) via brittle maturity mismatched instruments is certainly dilutive. But there is also the government's dilutive ability to run the presses, and that element is quite independent of whether maturity mismatching is allowed or not.

6. The standard line is that some inflation makes it easier to cut wages, which has beneficial impacts on the labor market. I used to believe this also, and I still think it has some truth. I also think that, in an environment of mild deflation, over time people would make their peace with nominal wage cuts in the face of demand shocks.

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