I liked this part, even though I don't think AD is always the key factor:
Some people seem to infer from this that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a larger belt. In the United States to-day your belt is plenty big enough for your belly. It is a most misleading thing to stress the quantity of money, which is only a limiting factor, rather than the volume of expenditure, which is the operative factor.
That's Keynes, writing to Roosevelt. The letter is interesting throughout, how about this part:
I put in the second place [as a priority] the maintenance of cheap and abundant credit
and in particular the reduction of the long-term rates of interest. The
turn of the tide in great Britain is largely attributable to the
reduction in the long-term rate of interest which ensued on the success
of the conversion of the War Loan. This was deliberately engineered by
means of the open-market policy of the Bank of England. I see no reason
why you should not reduce the rate of interest on your long-term
Government Bonds to 2½ per cent or less with favourable repercussions
on the whole bond market, if only the Federal Reserve System would
replace its present holdings of short-dated Treasury issues by
purchasing long-dated issues in exchange. Such a policy might become
effective in the course of a few months, and I attach great importance
to it.
That's exactly what the Fed has been stressing and what Robert Lucas has advocated as well.
Why replace short term Treasuries with long term securties?
Why not buy both?
I had a similar question regarding Lucas. If T-bill rates hit zero, rather than thinking–these rare not the same as base money anyway–why not go ahead and buy them all up? And then go on to buy the longer term securities that Lucas suggested.
Where zero interest treasuries are good substitutes for the monetary base for some purposes, and so replacing them with base money might not have much effect, they are not the same. One does have to sell T-bills before making payments. There is some slight risk of capital loss on short treasuries.
Of course, if the Fed insists on paying interest on reserves at a rate higher than short term treasuries, buying them might be counterproductive. But that is a problem with the Fed’s policy of paying interest on reserves.
Fighting fear and greed through money manipulation is like trying to reason with children while loosening your belt.
How’s that?
Thank you for introducing me to this very informative read.
So, increasing the supply of money can’t work, but artificially lowering the rate of interest can… that does not seem a little bit contradictory to you?
What was the duration of the “long bond” in 1933?
Woolsey’s right that Keynes’ proposal (later called operation
twist) makes no sense as it wouldn’t increase the money supply at
all. (But Lucas’s idea is different, he favors purchases of L-T
bonds in addition to S-T bonds.) By the way, there is another
problem with the previous part of Keynes’ letter. He is making
the “liquidity trap” argument against a more expnasionary monetary
policy, at a time when the argument couldn’t have been less
appropriate. Prices rose rapidly between 1933-34, but because of
a huge devaluation in the dollar, not money creation. By late
1933, Keynes thought the dollar devaluation had gone way too far,
and was calling for a more contractionary monetary policy in the
U.S. (Which is why he opposed further increases in the money
supply in his letter.) But it’s not clear why Keynes used an
anti-quantity theory argument for an exchange rate policy.
Perhaps Keynes was confused because because both FDR’s dollar
depreciation policy and the QTM were associated with Irving Fisher
Or perhaps Keynes was implicitly criticizing Fisher’s disciple
George Warren, who sold the program to FDR with a simplistic
tautological model that seemed reminiscent of the QTM, or at least
how Keynesians perceive the QTM. In any case, simplistic
or not, and contrary to Keynes’ assertion, the program boosted AD
extremely rapidly in 1933. Unfortunately FDR’s NIRA program
reduced AS almost as fast as AD rose, so the Depression dragged on
even as nominal GDP rose rapidly.
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