Does money boost real output?

Here is one sentence to ponder:

The significance attributed to money in influencing output has fluctuated greatly as various aspects of VAR modeling have advanced.

It is instructive to read the first few paragraphs of that paper (and here), to get a sense of how murky the issues are.  And that is looking at non-liquidity trap periods.  If you want a more recent defense of the relevance of money, try this paper.  Here is a more skeptical view.  Either way, I defy you to come away convinced.

The evidence is much stronger that deflationary shocks are bad; see this Christina Romer and David Romer paper.

We do have theoretical grounds for believing that monetary expansions will be potent when there are lots of unemployed resources and when the demand for money has recently spiked up.  But if we're relying on theory, theory doesn't tell us much about expected employment effects because we're back to Arnold Kling's point:

Pretty much everything in AS/AD is riding on the hypothesis that labor supply is highly elastic at the nominal wage and labor demand is reasonably elastic at the real wage.

This is another way of understanding why the Fed is afraid to inflate some more.  The gain is uncertain, but the bureaucratic cost of coming out for higher inflation is pretty much for sure.  

Mark Thoma's views on the asymmetry of monetary policy, across periods of falling and rising income, can be found here.

Overall, it is easier to break things than to put them back together again.


This is something that lurks at the back of my mind whenever I'm reading Scott Sumner.

If the Fed decides to buy another trillion of assets, does that make capacity utilization go up?

It is very important that you understand that this is NOT what makes nominal variables have real effects. It is a sad comment on the state of economics education that both you and Kling believe this is what makes macro models tick. I stopped listening to Kling on macro when it became clear that he did not understand this well. I will no longer be listening to you on macro topics.

The real microfoundations of macroeconomics are in the demand for money: when people hold less money than they want to, they spend less in order to accumulate more money, but this in turn deprives someone else of money balances (without a change in the supply of money). It is very important to understand that this is a different idea than the idea of a non-equilibrium quantity at a non-equilibrium price. If you do not understand this then your thinking on macro issues will inevitably be confused, and you have zero business commenting on macro topics.

Master of None, Just to be clear, I am not one of those monetarists who argues that you should expect to find a correlation between current movements in M, however defined, and future movements in AD. Indeed if you did find this sort of correlation, it would suggest extraordinary incompetence on the part of the Fed. If they are inflation targeting, there should be no correlation between M and P. And yet M would still be causing P.

These studies don't seem to incorporate recent advances in monetary theory, such as the Woodford model where current movements of AD are caused by changes in the future expected path of monetary policy. It's almost impossible to pick that up with Granger causality.

"This is another way of understanding why the Fed is afraid to inflate some more." Inflate *some more*? Didn't work so well the first time, since the rate of inflation is decreasing to 0. If they were really expecting to inflate using QE1, then the result would be a pretty devastating argument against QE2.

"great depression 2 didn't happen."

Sure it did. We're in it.

Does money boost real output?

Put it this way. Say you have a natural-gas furnace. The furnace has a maximum roaring heat production and you can't get it past that without rebuilding the furnace. And it doesn't have to run at its maximum.

Obviously, if you want to run the furnace hotter you should give it more gas. And if you want it to run cooler, give it less gas. It's the amount of gas that decides how hot the furnace burns, not anything else.

So we ask the question -- can a thermostat make the furnace run hotter or cooler?

And the obvious wrong answer is no. Only real things like gas affect the furnace temperature. All the thermostat does is send a tiny trickle of electricity, a mere signal, homeopathic in its intensity. A truly insignificant amount of power.

OK, that's wrong. But no matter how high you set the thermostat, once the furnace is running full out that thermostat won't get it any hotter.

Perhaps this analogy breaks down. No matter where you set the thermostat it will not persuade the furnace to rebuild itself so it can run hotter than its current maximum.

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