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Sumner v. Cantillon

(For Don.)

After trying a couple months back to defend the Austrian-School thesis that excessively rapid monetary expansion might give rise to what I termed "Intermediate Spending Booms," I promised myself that I'd keep out of the recent, related exchange between Scott Sumner and Sheldon Richman (among others) concerning so-called "Cantillon" effects. My inclination was, I daresay, only natural: after seeing commentators misrepresent my humble suggestion that a Fed policy involving a negative FFR target might perhaps have contributed just a wee bit to the subprime boom as (1) the simian proposition that that boom was entirely the Fed's fault and (2) the no-less absurd claim that the post-2008 collapse of nominal spending itself did no harm, I decided that this time I'd resist supplying raw material for more such libels by (for once) keeping my opinions to myself. (NB: Scott himself wasn't among the libelers.)

A couple nights ago, though, my good buddy Don Boudreaux wrote me asking, in effect, whether in denying Cantillon effects Scott had perhaps fallen off his rocker, and I promised to review the exchanges in question and to then give him my answer. And now, having done that, I just can't help sharing my conclusions. So much for resolutions.

The specific claim to which Scott objects is Sheldon's assertion that Fed open-market operations benefit those directly involved in them more than others because “early recipients—banks, securities dealers, government contractors—have the benefit of increased purchasing power before prices rise.” On its face that assertion appears, to me at least, as incontestable as the claim that, if I choose to do my Christmas shopping at Macy's rather than at Bloomingdale's, Macy's gains more from my display of Christmas spirit than Bloomingdale's does.

Nor can I see why it should matter whether the spending in question involves newly created money. Were I a counterfeiter whose products are perfectly indistinguishable from the real things, Macy's would still profit more from my spending than Bloomie's, provided it succeeds in fobbing the notes off just as easily as I do. The suppliers that Macy deals with are likely to profit as well, as may others who experience an increased nominal demand for their goods at stages of the "circular flow" not far removed from the fake notes' point-of-entry. Eventually, though, the notes will have worked their influence on prices generally, so that increased revenues, rather than going hand-in-hand with enhanced profits, merely compensate their recipients for a heightened cost either of living or of doing business.

How, then, does Scott attempt to refute Sheldon's argument? He does so mainly by resorting to two counterarguments, to wit: that Sheldon wrongly assumes that the Fed gives away new money instead of selling it, and that he confuses the effects of monetary policy strictly understood with those of what is properly regarded as fiscal policy.

"Richman seems to be assuming," Scott observes,"that OMOs are gifts of purchasing power from the Fed to the recipients.” Because the Fed actually sells new base money, Scott claims, initial buyers gain no more from it than anyone else, because they must part with other assets that are worth as much as the money they receive.

Much as I'm tempted to observe that the distinction between selling money and giving it away can get pretty darn blurry in practice (QE1, anyone?), it seems to me that Scott's position is unsound even putting that observation aside, for unless I'm missing something Scott here appears to neglect the basic truth that voluntary economic exchange is not a zero but a positive sum game. From that it follows that Primary Dealers, for instance, gain (or at least expect to gain) from their dealings with the New York Fed's Open Market desk no less than Macy's expects to gain from my doing my shopping there rather than somewhere else. They gain, moreover, even assuming that competitive bidding enforces a "zero-profit" condition, for that doesn't mean that such bidding rules out normal profits. And if anyone doubts that this is so, they would presumably have to insist that Primary Dealers, for starters, attach no particular importance to their status, and might indeed prefer to forgo it and let others go through the bother of selling stuff to the Fed since they would gain no less from its OMOs by waiting for new money to trickle its way toward them, and would do so notwithstanding the risk that the same money might in the meantime have raised the prices of their inputs.

But of course Primary Dealers do prefer dealing directly with the Fed to waiting along with everyone else for their share of enhanced Aggregate Demand. In suggesting that they shoudn't Scott appears (to invoke the terminology of Roman law) to overlook the crucial distinction between lucrum emergens and damnum cessans. Fed insiders alone experience the former, whereas the latter is the paltry reward typically granted by the Fed to hoi polloi.* (The reward is, of course, greater when the initial equilibrium involves a shortage of money–but Scott never claims that his arguments refer only to monetary expansions undertaken during a state of deflationary recession.)**

As for Scott's second counterargument, it seems to me to amount to nothing more than wordplay. Monetary expansion, Scott insists, is really "fiscal expansion" when it can be understood to involve an element of government largesse. Even a Friedman-style helicopter drop, according to this view, is really a form of fiscal rather than strictly monetary stimulus; monetary expansion in the strict sense of the term must take the form of conventional open-market purchases.

I've never had much use for a definition of "fiscal" policy that would have us believe that there's nothing "fiscal" about the Fed supporting the market for U.S. government securities. But in this case I fear the problem is more serious even than usual, for Scott comes perilously close to defining as "fiscal" any monetary operation that might have distribution effects of the kind Sheldon (and Cantillon) insist upon. Semantics aside, the real question isn't whether "pure" monetary expansions involve distribution effects, but whether most real-world monetary expansions have such effects, however pure or impure those monetary expansions may be.

As I conclude these remarks I already anticipate someone declaring in reply to them that I apparently believe that Cantillon effects are the only effects of monetary policy, or that Sheldon Richman is a better monetary economist than Scott Sumner, or that water flows uphill. For whoever does so, may the lamb of God stir his hoof through the roof of heaven, and kick you in the arse.

*Upon further reflection I concede that my emphasis on Primary Dealers is misleading, for when the assets that the Fed purchases are being actively traded in an organized market–as is the case with U.S. government securities, though it wasn't with MBSs back in 2008–all holders of such securities, and not merely those who deal directly with the Fed, gain from the Fed's purchases of them and their consequent appreciation. Here the analogy with shopping at Macy's also proves deficient, because an increase in demand for shirts at Macy's doesn't serve to immediately bid up the value of shirts everywhere. But the increase in the relative price of government securities, and corresponding reduction in their yield, ceteris paribus, is nonetheless a Cantillon effect, stemming from the initial injection of new money into a particular market; indeed, it is the most important sort of Cantillon effect in modern monetary arrangements, and one the existence of which is presupposed whenever the Fed employs an intermediate interest-rate target. (Note added on 12/9 at 8:45PM.)

**Upon still further reflection I conclude that most important determinant of whether or not Cantillon effects arise is not, as Scott maintains, whether or not the Fed gives money away, but precisely whether the economy is or isn't suffering from a deficiency of aggregate demand, with P > P,* when monetary expansion takes place. (Added 12/10 and 11:10AM.)