Home > Main > Monetary Policy Sucks because it relies on Real Estate: Long Live MMT!

Monetary Policy Sucks because it relies on Real Estate: Long Live MMT!

July 29, 2011

Oddly, this was inspired by vimothy….

“Isn’t the problem with the idea that doubling the base would automatically double the price level what Nick Rowe calls the short-side rule? If reserves are scarce, then bank lending or the supply of broad money (or whatever) is limited by reserves. If reserves are not scarce, then bank lending is limited by something else, like finding credit worthy-borrowers.

I do not see why the number of credit worthy borrowers demanding credit would automatically double, simply because the Fed doubled the base. It strikes me that the two things should be mostly independent.”

That’s one of the major MMT points.  The constraint is nearly always “creditworthy borrowers at this interest rate”, not lending capability.  This is one of the operational constraints MMTers talk about all the time.

What matters is finding someone both willing and able to borrow enough money to get the economy moving or slowing.

When banks need more reserves, they go to the federal reserve and borrow them.  The aren’t reserve constrained.

During most times, the willing criteria isn’t a problem, it’s the able criteria.  So lowering rates makes investments more attractive even to bankers, because the ability to pay gets higher as the interest rate gets lower.   Therefore, lowering interest rates makes bankers lower their standards for “able to borrow”.

But overall, this monetary mechanism is really indirect. It is rube goldberg method of economic stimulus.

Why does monetary policy work in the real world?  Because it makes people buy more or less real estate.  That’s what it does.  The interest rate markets serve one master – real estate.

Real estate is the 800 pound gorilla of interest rates markets.  Corporate lending is 1/2 of the size of the mortgage markets in a typical year.

That’s the problem with monetary policy.  And that’s what I don’t see Scott Sumner address even for a second in all his talking about the power of monetary policy.  Monetary policy depends on transmitting demand to the broader economy through stimulating or contracting real estate markets.

And real estate markets might be uniquely bad place in our economy, because of the reasons I lay out below.

Everything else is secondary when considering monetary policy.

And this is the problem with monetary policy.  What monetary policy does is set the only place we can push on the economy to “residential real estate and some business borrowing”.  That’s it.

The theoretical models about interest rate determination matter because the real estate markets are so large relative to the economy.  That’s how the theoretical monetary models work – how the must work – in the real world.

Of course, real estate markets can easily be fuddled and may depend upon many factors other than the amount of base money, or the interest rates.

It’s a huge problem.  Even when the real estate markets are functioning properly, there are vast, gigantic, huge problems with the stimulus transmission mechanism:

  • real estate transactions are costly –
  • real estate transacations are bulky – they are huge relative to incomes
  • real estate transactions take lots of time
  • real estate transactions are extremely geographically dependent
  • real estate transactions aren’t easily reversible

Monetary policy forces us to push on what is the slowest moving, bulkiest, costly, and yet geographically limited area of the economy as our stimulus policy tool!

Ok some snark: I wonder why monetary policy takes 12-18 months to see impact?  Why in the world would this be the case?  I can’t figure it out – must be magic or incomplete markets or a breakdown of the EMH.

Then, corporate borrowing isn’t enough on its own, but it can be hugely subtractive or additive to the amount of simulus.

Corporate borrowing isnt’ enough on its own to be able to do much on its own, but its a bitch when it fights against the real estate cycle.  It’s probably worse when it’s in sync with the real estate cycle, because all of a sudden, changes in monetary policy have unexpected results.

You can see the trap for monetary policy – the transmission process takes a year, then you keep pushing on it, then corporate lending kicks in, and exacerbates the entire process.

So we have a stimulus transmission mechanism thats:

  • Very slow
  • very uncertain
  • Very stupid

Why in the hell are we using this?  We’re trying to fly a jet plane with the broken controls of a cruise ship with monetary policy.

What MMT does is set the push place of stimulus policy  to “anything/anywhere we want”.    Mostly this would be to “domestic spending through more money directly to people.”

It isnt’ that MMTers dont’ think monetary policy doesn’t work, but rather that the transmission mechanisms for monetary policy to the real world economy is convoluted and sucks, and we can’t tell what the real world impact might be.

And that transmission mechanism sucks because we cannot observe so many things about it, its becomes a guessing game. Lowering rates or adding base money might increase the price level, or it might not – we need to wait months for people to decide to buy a house or something.

The price level determination is much more direct from the fiscal side.  Once you establish base demand for the medium of exchange through taxation, the government can set price levels for anything it wants by paying a higher or lower price for something.

It sets base demand for the medium of exchange by taxation.  It sets the store of value level through what it pays to the private market.

This is the core MMT insight – if you want to control the price level, it’s much easier to do it directly through financial purchases rather than through monetary easing. 

Kocherlakota went through the fiscal theory of the price level and said “It’s a religious argument”.    But it isn’t, because taxes drive a base level of demand for the medium of exchange.  Once people demand to use this medium of exchange, it’s not religious at all.

Because we control the base demand for the currency through taxation, we can then choose to inflate any segment of the economy we choose with some decent amount of discretion by just buying more stuff in that segment.

Of course, this is terrifying responsibility.  It’s absolute madness to assume that the spending would always be wise. It’s absolute madness to assume there won’t be misspent funds.  It’s absolute madness to assume there will not be inflation.

But the alternative is “so many men no one needs”, sitting on their ass, while roads go un-repaired, and kids go hungry.   We need to grow up and take responsibility for our actions.

jeeze.  it’ ain’t that hard.   This is gets to one of the problems with economics – it does not rely enough on the real world.   Talking about things need to refer back to something real, concrete, and that acutally happens – otherwise it’s worse than useless.

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  1. beowulf
    July 29, 2011 at 3:22 pm

    Michael Hudson’s made the point that banks want property taxes as low as possible so they can expand the share of income they can take in mortgage payments (and other monthly credit streams).

    So flip the script, just as the govt now funds student loans directly, it could offer to fund every new mortgage or refi at some low number (HAMP apparently offered 2% fixed loans over 40 years on refis). If that won’t reflate property values as Ag Demand picks up, we might as well turn over whole counties to Indian reservations. So what’s the catch? A federal property tax, since its an income tax system, you’d start including in AGI the imputed rental value of your property (Hudson would say it should be on land only and should replace earned income in the bargain).

    So Uncle Sam would be like a printer company selling you the printer cheap, and then making you pay for the regular refills. Oh wait, there’s not much room in that business model for banks… however we could tie the tax rate to TC’s floating payroll tax formula. Or would that make the economy counter-cyclical to itself? :o)

    • TC
      July 29, 2011 at 7:11 pm

      Yep. This is another reason that monetary policy is horrible – it makes people into debt slaves.

      The only way monetary policy gets translated into actual demand is through people borrowing money. Borrowing money forces claims on future cash flows. Why in the world would we want to use this as our primary form of economic stimulus?

    • TC
      July 29, 2011 at 9:41 pm

      Beo- I was thinking about this all day and your sentence seals it. I am working on a post right now

      Monetary policy is immoral compared to fiscal policy

      It promotes debt slavery
      It works very slowly
      it ignores the lowest 30% of earners
      It’s anti-democratic
      It’s difficult to manage
      It must – must – end in a massive real estate bust – which destroys the primary store of value for the lower 80% of the popuation.

      Note that these are in additon to:

      Difficult to observe effectiveness
      Uses real estate lending as a transmission mechanism
      Indirect instead of direct action

      I don’t know why people would choose such a mechanism unless they were anti-democratic or ignorant.

      • August 4, 2011 at 10:53 pm

        TC: “I don’t know why people would choose such a mechanism unless they were anti-democratic or ignorant.”

        They’re bondholders.

    • Clonal Antibody
      July 30, 2011 at 4:23 pm

      To highlight this point, we just have to ask ourselves, “Was there a real estate market where there have been no real estate bubbles, and hence no real estate crashes?” Are there such creatures anywhere in the world? Are there any in the US?

      It seems that the answer to all these questions is “Yes!” This then leads to a corollary question – are there any commonalities in these markets? Again, the answer is yes.

      All of these places have what is known as land value taxation

      Further, Pittsburgh has had a land value tax since 1906

      San Diego median income 64,273 median house 569,900 ratio 8.9
      Pittsburgh median income 30,278 median house 74,000 ratio 2.44

      From Pittsburgh, Pennsylvania

      Pittsburgh is consistently ranked high in livability surveys. In 2007, Pittsburgh was named “America’s Most Livable City” by Places Rated Almanac, and “America’s Best City for Relocating Families” in 2008 by Worldwide ERC, a relocation services industry trade group
      Livability rankings typically consider factors such as cost of living, crime, and cultural opportunities. Pittsburgh has a low cost of living compared to other cities in the northeastern U.S. The average price for a 3- to 4-bedroom, 2-bath family home in Pittsburgh is $162,000, which is well below the national average of $264,540, as of October 2004, according to the Federal Housing Finance Board.

  2. July 29, 2011 at 11:38 pm

    You’ve missed one.

    It causes the government to pay people who have money to hoard it and not to spend it.

    Whereas with fiscal policy you either confiscate hoards or ignore them because they are inert.

    So monetary policy is really just a form of government spending with poor distribution characteristics.

    In particular it would appear that it subsides imports with government funds, as foreign hoards receive government money in the form of interest as well.

    And if your monetary system doesn’t (or can’t) expand financial assets to offset that import leakage, that means you are draining your domestic production system in favour of foreign exporters.

    Which appears to fit with the evidence of net importing nations.

  3. Sergei
    July 30, 2011 at 3:35 am

    Clipped to evernote 🙂

  4. July 30, 2011 at 10:28 am

    Also clipped to evernote! That is an amazing post. Thank you… (very slightly edited by TC)

    • TC
      July 30, 2011 at 12:56 pm

      I’m a huge evernote fan. I use it constantly, every day.

  1. July 30, 2011 at 9:41 am
  2. November 7, 2011 at 11:39 am
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