I somehow failed to actually post this post earlier. Consider this to be a prequel to Silas against spending 2:

Notable internet guy Silas Barta thinks  calls for stabilizing spending (via the central bank) are ridiculous (link). I have looked for a good explanation of the fundamentals of monetary economics, but I haven’t found something I really like and can point people to. Sumner’s blog used to discuss such fundamental issues more often, but lately he focuses on the politics of monetary policy. I usually tell people skeptical of increased spending to read Sumner’s old blog posts, but that’s quite a bit of work, so it is not a very satisfying answer.

Anyway, in a recent comment, he makes a decent attempt at explaining the most important way that monetary disequilibrium affects economic activity (link)

When the Fed increases the money supply permanently, expected future NGDP will rise due to the “hot potato” concept. People don’t want to sit on a lot of cash forever. But then the fallacy of composition comes into play, what is true for the individual is not true for the group. As individuals we think we can get rid of excess cash holdings, and in a sense we can. But the group cannot, as the money is just passed from one person to another. So it the individual level the attempt to get rid of excess cash seems unimportant, we just swap if for some other good, service or asset. But as the group level if we are all trying to get rid of extra cash, it drives up AD and NGDP.

To summarize:

1. A permanent increase in money tends to raise future expected NGDP due to the “hot potato” process.

2. Higher future expected NGDP means more business confidence, higher current asset prices and more current investment.

The exact opposite occurs if there is an increase in money demand, not supply. Now people try to accumulate more money. This is what happened in late 2008. Even though the Fed did supply more, it was all demanded, and then some, partly because of fear, partly because of interest on reserves.

Both processes seem mysterious because they are based on expectations. The public and investors is looking at a complicated picture, and trying to forecast NGDP growth when we don’t even know exactly what the Fed’s future plans are.

An excess supply of money causes spending to rise and a deficient supply of money causes spending to fall. The hot potato concept is also called ‘monetary disequilibrium’, ‘excess cash balance mechanism’ and probably a bunch of other things.

So if you add more money to the economy when spending starts to fall then you will counteract monetary disequilibrium; this is why Sumner advocates stabilizing some measure of nominal spending. You can also think of stabilizing nominal spending as stabilizing the fraction of total (traded) output that a dollar will get you as opposed to stabilizing the quantity of output that a dollar will get you.

I agree that macroeconomists do a generally poor job of communicating their core theory of monetary economics. I haven’t seen such theory presented in my textbooks and I don’t see many macroeconomists emphasize it, but Sumner and Kling argue that up until about 3 years ago this was basically the macroeconomic consensus, and no one seems to dispute this. Until I started reading Sumner, I was, like Silas, very skeptical of macroeconomics, but Sumner changed my mind.

To respond to one specific question Silas asked: “But I don’t see how it’s responsive to my point that any method of increasing the money supply involves, in effect, bankrolling projects that couldn’t get private funding (or public support), and therefore will, on average, just compound the pain of any existing inefficiency.” I guess I don’t have a very satisfying answer to this except to say that just because a project cannot get funding does not mean that it doesn’t make real sense; for example if people don’t fund it because of how it will affect their money holdings.

I doubt that this will convince Silas that monetary disequilibrium is important, but I do hope this will convince him that it’s not ridiculous.