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Free Banking and the Dollar

I've been getting some flak lately from hard-core free market types for occasionally saying some nice things about NGDP targeting, and especially for suggesting, in the course of a recent Cato forum contribution, that we might improve upon the present U.S. arrangement by replacing the FOMC with a tamper-proof Bitcoin-type protocol that automatically adjusts the output of base dollars so as to maintain a steady NGDP (or, better, Domestic Final Demand) growth rate. Call the dollar thus reformed the "Bitdollar."

My Bitdollar proposal, my hard-core critics maintain, places me firmly in the ranks of apologists for state "manipulation" of the money supply. Consequently I am, by their reckoning, a turncoat in the fight for monetary freedom, and (since I still have the brass gall to post on a site called "") a hypocrite to boot.

What have I to say in response to such charges? Considering their sources, I'm tempted to settle for a Bronx cheer. But as some others may wonder if there isn't some merit in their accusations, I think I'd better indulge my critics by entering a plea of "Not Guilty."

My defense? It is simply this: that while I'm all for monetary freedom and competition, I'm also for reforming the U.S. dollar, which for me means freeing it from control by discretionary central bankers. Like it or not, the dollar is presently the standard money, not just of several hundred million U.S. inhabitants, but of many millions of inhabitants of other countries. What's more, these millions, unlike holders of U.S. securities, hold fiat dollars under some degree of duress, because a combination of network externalities and legal restrictions makes it almost impossible for them–my hard-core critics included–to survive without equipping themselves with dollar-denominated exchange media, or because they live in places where the dollar seems rock-solid compared to anything local authorities have to offer.

Consider, then, some other purportedly free-market strategies for monetary reform, and the alternative fates to which each would consign the world's hapless dollar holders. There is, first, the inevitable catastrophe strategy, according to which, in the wake of a long-forestalled but nonetheless inevitable hyperinflation, a state of monetary freedom (gold version, usually) emerges Phoenix-like from the dollar's ashes. Then there's the level playing field strategy, which supposes that mere elimination of legal tender laws and other government-erected impediments to free choice in currency would provoke a spontaneous switch from dollars to other currencies, leaving to the Fed the choice of either shedding assets to preserve the dollar's value, or letting it become worthless. Next there's the back to gold strategy, in which the Fed (or some replacement agency) is compelled to turn present "IOU nothings" back into redeemable claims to gold. Finally, there's the frozen Fed strategy, which equates any change in the stock of base dollars with monetary interventionism, and therefore treats a frozen base as the closest fiat-money equivalent to monetary laissez-faire.

Unless you happen to live in a bomb-proof shelter equipped with a lifetime supply of canned goods, the catastrophe strategy will, I trust, strike you as undesirable both because you might be among the people wiped-out by the anticipated hyperinflation, and also because that hyperinflation could be a long-time coming. A long delay is also likely to be in store for those banking on the level-playing field strategy, which downplays, I think severely, the likelihood that the dollar will stay in the saddle so long as catastrophe doesn't strike. As for a return to gold payments, I've explained elsewhere why I doubt such a return could be sustained, assuming it might be achieved at all.

That leaves the frozen Fed strategy. For this alternative I admit to having considerable sympathy: I can hardly do otherwise, having proposed the idea myself in my first book (see chapter 11). Besides, unlike the other plans this one could preserve the dollar network whilst safeguarding dollar holders from the Fed's machinations. But in what sense is this strategy any less of a cop-out than my now favorite plan for replacing the present Federal Reserve dollar with an NGDP- (or Domestic Final Demand) stabilizing Bitdollar? If a tamper-proof Bitdollar is a form of monetary central planning, then so is a frozen Fed dollar. The difference between the schemes is, not that one involves a planned base money stock and the other doesn't, but that one involves a fixed base money stock and the other doesn't.

But, you may ask, isn't a fixed stock of base money more consistent with laissez-faire than a stock that grows at some constant rate while also adjusting, albeit automatically, in response to changes in the real demand for base money? No, it isn't. Consider the classical gold standard, or any commodity-money regime for that matter. Such a regime involves, not a constant monetary base, but one that tends to expand along with growth in the real demand for base dollars. Thus the long-run price-level stability that was one of the gold standard's most noteworthy achievements. Whatever else it might be doing, a discretionary Fed that insisted upon keeping the monetary base constant would not be emulating a gold standard. Instead, it would be pursuing a policy that might well lead to disturbances as serious, if not considerably more serious, than those that could be justly attributed to the historical gold standard or (for that matter) than those that might arise today under a discretion-based regime that yielded low and steady inflation. In any event the belief that a central bank is "doing nothing" when it chooses to maintain a constant monetary base (or constant stock of any monetary aggregate) is my personal choice for top honors (and, take my word for it, the competition is stiff) in the "crudest free market monetary fallacy" contest.

Free banking would, to be sure, go a long way toward reducing the risk of money shortages, and consequent downturns, in a frozen-base regime, both because it would allow changes in the relative demand for currency to be accommodated through greater emissions of private banknotes (or their digital counterparts) without need for more base money, and because changes in the free-banking base-money multiplier would tend (for reasons also given in The Theory of Free Banking) to automatically compensate for changes in the velocity of money. But these tendencies would still not suffice to avoid some risk of unwanted deflation–which is to say, deflation that's not just a reflection of productivity gains.* In particular, they would not allow for monetary expansion to accommodate growth in the supply of factors of production, and of labor especially. An automatic and tamper-proof regime providing for a constant spending growth rate would come closer to avoiding both monetary excess and monetary shortages. And that's why I favor such a regime, now that Bitcoin has suggested a means for implementing it.

It would be unnecessary for me to say, where it not for certain contrary animadversions, that, far from being a monetary freedom apostate, I remain as committed to free banking, and to monetary freedom in the more general sense, as ever. I still pine for truly unregulated banking, minus all the regulatory red-tape but also minus government safety nets and the prospect of Fed (or Treasury) bailouts. I still oppose all artificial restraints upon free trade in currency. I still would rather have private mints coining and private firms issuing our small change, for goodness sake! But I also want to see the dollar made safe and sound, and the sooner the better; and I can think of no better way of making it so than by replacing the present discretion-based version with one that provides for an automatically-determined supply of dollars–an automatic mechanism not unlike the one that characterized the gold standard, though one both more conducive to short-run stability and less dependent upon untrustworthy promises.

*I can hear certain self-styled Austrian economists grumbling to themselves, "but there's nothing wrong with any sort of deflation!" Here is another good candidate for the previously-mentioned contest. Like it or not, in today's world, many prices, and wage rates especially, are notoriously "sticky" downwards, which means that a plunge in general spending is bound to result in otherwise avoidable unemployment. True, Murray Rothbard says otherwise in the theoretical part of America's Great Depression. But then he spends the rest of the book explaining how Hoover changed everything with his silly high-wages doctrine. Whether or not price stickiness originated with Hoover, it certainly didn't end with him!

  • Walker Todd

    Generally agree with George's observations here, but I have a soft spot in my heart for "classic Fed" (1920s), with an eventual required gold reserve of 35 percent of liabilities other than capital and an additional 5 percent of Federal Reserve notes outstanding. It was fractional reserve, but it was constrained by a fairly high gold reserve, which in turn limits the Fed's capacity to bail out its larger crony financial institutions. And I think free banking works, but only in sole proprietorship or partnership banking versions, not corporate versions. Corporate banks are the serpents in the free banking Garden of Eden. Especially when they are very big (today's bigger bank holding companies control assets approaching 15 pct. of GDP). And if you're going to allow corporate banking, then I want Chicago Plan 100 percent reserves and separation of the payments system from the lending and investing functions. On the monetary base, a previous post of mine (Oct. 29, I think) noted that the Fed has created enough monetary base to support GDP at 4 times the pre-crisis level, so there is no need to add anything to the Fed's balance sheet for a generation or so. — Walker Todd

  • SpontaneousOrder

    Dr. Selgin –

    Let me take advantage of your gratuitous dialogue with the interested public you offer on this site and ask to enlighten me; and please take me serious and go easy on me – I am a "free market RADICAL"; HARD-CORE baby – and because I am genuinely interested and trying to understand. AND, those glasses of yours on your Cato profile pic are outstanding! You are mightily more handsome than your brother – I don't know what you are talking about when you claim otherwise.

    1. Why would not a society of "free prices" (Professor Boettke uses that phrase a lot – I think it sounds apropos with this blog theme) not adjust to the "demand" and "supply" for money given any fixed money unit quantity infinitely more wisely than an elastic money governed by an algorithm? Consider A: any algorithm self-imposed on a government has historically always been abandoned and so will never actually be effective anyway – think here of the farce of the "debt-ceiling"; B: any so-called algorithm would be outdated in short order after the continuous discovery of newer and better knowledge – we are reminded here of the meat packing regulators that for almost 8 decades used the "Poke-and-sniff" method with the effect of actually spreading the disease made more likely until the USDA finally updated caved.
    Bureaucracy moves slower than an oil-tanker, the market is far more dynamic. Would not the market in a arena of free-prices act like a "super-algorithm", constantly updating itself in real-time?

    2. I agree that deflation is a serious menace in the correct sense of that term. A rogue central bank can decided to contract the money supply with intent to cause real and damaging distortions – is not the case of the Bank Wars and Nicholas Biddle an example of this?
    " He called in loans, tightened credit, and otherwise reduced the bank's financial exposure.… To compliment his fiscal tightening, Biddle went ahead with his bribery, offering lucrative positions to Jackson loyalists if they would abandon the president and join the bank.…

    The attack on the money supply had an immediate effect, starting in the nation's financial capital.… The financial panic spread from New York across the country. Banks collapsed in Washington and Philadelphia while a Boston paper described conditions there as "absolutely frightful." But Biddle maintained his choke hold on the money supply."
    From H.W. Brands, 2005, Andrew Jackson: His Life and Times

    But again, as Professor Boettke and Chris Coyne emphasizes

    "…the focus on deflation leads to an inflation-biased policy which neglects the cost of inflation and the logic of democratic politics…" Public Choice Theory and other insights into incentives inform us "The democratic bias is to concentrate the benefits of public policy on well organized and well-informed voters in the short run, and disperse the costs of public policy on the ill-organized and uninformed masses in the long run. The least informed and organized interest group at any point of time is future generations. Hence, the natural proclivity for the ruling regime is to run deficits that result in accumulated public debt, which is paid off with debasement."

    So, focusing on deflation will only lead to the unintended consequence of a reactionary body-politic favoring inflationary schema. Again, this goes back to comments from other posts highlighting that NGDP or any other rule is inefficient to consider if the institutional structure is not reformed first – as Adam Martin in discussion with Ben Powell you can not expect intended results from foreign aid if institutions like private property are not enabled. In that case you just end up with empowered dictators.

    3. In your defense, I would caution that it is as a rule never so wise to quickly dismiss the great Murray Rothbard. In his memorandum "What is to be done?" he states

    "Our objective is, of course, to advance our principles to spread libertarian individualist thought…among the people and to spread its policies in the political arena. This is our objective, which must never be lost sight of…bearing this objective in mind, we should work on the “lower levels” of thought and action toward a “Fabian” advance of libertarian objectives. In this way, the hardcore man, the “militant” libertarian, works to advance not only the total system, but all steps *toward* that system. In this way,we achieve “unity of theory and practice,” we spurn the pitfalls of base opportunism, while making ourselves much more effective than our brothers, the sectarians."

    The opportunist in contrast loses sight of the end-goal. It is clear the end-goal is free-banking and the ideal abandonment of central bank monopoly. If NGDP targeting is a "step toward that system," you would find Rothbard kinder to you and your associates than perhaps others at CATO would be to him. Nonetheless, I am not convinced of the efficacy yet of rules-based initiatives at the expense of focusing on institutional reform.

    Still those glasses are sharp!

    • George Selgin

      I'm glad you like my glasses, SO. I must send the manufacturer a thank-you note.

      Concerning deflation, I daresay you may search high and low and never find anyone more two-sided than I am when it comes to expressing concerns about deflation and inflation. As proof I offer you the simple fact that, having gone out on a limb to defend productivity-driven deflation back when the idea that deflation could ever be "good" had all but been forgotten (this was in the late 80s), I am used to being accused of being, not overly, but insufficiently concerned about deflation's potential harmfulness.

      • SpontaneousOrder

        You misunderstand me. However, I will accept the fee.

        I am well aware of your insights on this issue and was actually defending, with you, that insight when I was sighting examples of central-bank induced deflation above. I further continued, citing professor Boettke, to apply rational choice theory to the fate of government to over-emphasize any deflation, productivity-driven or not, with the consequence of reactionary inflationary policy that is biased to overcompensate. In other words, yes we know you understand this, which is exactly why we know that central-banks do not understand this – deflation, its own cause in creating it, and why no government will ever allow it happen. Governments use deflation – however ridiculously defined – to only add further inflationary policy so why would giving them more intellectual fuel for fire do any good?

        That was 2.

        You completely ignored 1 which is more important: Why would free-prices, amongst a multitude of market participants dynamically responding to localized knowledge, adjusting to a fixed money quantity be less desirable than an algorithm developed by one or a group of individuals with limited means, held static amongst a bureaucratic status quo?

        But now I am repeating myself. So, if you, or anyone else, wishes not to answer the question, which is always fair (after all this is time consuming and quite frankly sometimes time-wasting considering the unbounded lack of mathematical understanding here, which is not any more nor any less representative of economists elsewhere, but I haven't begun to attack along those lines, I've taken them implicitly giving the benefit of the doubt, for example GDP, MV=PT, and others doesn't mean what economists think they mean, MV=PT particularly is mathematically inconsistent and invalidates the distributive axiom of algebra – unless you assume the only good in the universe is a single infinitely homogenized one across all time and space, etc..etc.. which is why economists are glorified MBAs hired as propagandists (you excepted of course) and macroeconomics is the biggest fraud there ever did live, whose history comes about from on-record socialists who had penis-envy for the natural scientists, like Wassily Leontief and his utterly most egregious laughably embarrassing attempt at reductionism but more embarrassing for receiving a nobel prize for it – which goes to show how much worth the nobel prize is, which isn't even the nobel prize its the Sveriges Riksbank prize, but I digress!!!!!!!!!!!!!!!!!!!!)

        then I will have to assume there isn't a satisfactory one and move on.

        Which manufacturer was it then?

        • George Selgin

          My apologies for having overlooked your point #1, SO.

          The fact is that our theories of why prices and wages should be "sticky," and more so downwards than upwards, are on the whole far less satisfactory than the evidence concerning the fact of their being so. For it is notorious that cyclical movements in nominal and real NGDP are highly correlated, even though this need not be the case and would not be were prices in fact perfectly flexible.

          As for the why of it, there are oodles of theories, some more compelling than others; and I do not doubt that it takes a number of them to fully account for the observed reality. They range from the simple observation that some nominal prices are very difficult to change, and for that reason are changed only relatively infrequently–the minimum wage and major league baseball players' salaries come to mind here–to more elaborate ones, such as that pointing to a "public good" aspect in downward p changes, whereby the gains from any seller's price cut, when P is above equilibrium, are one largely external to the seller him- or herself.

          The literature is vast so I can't pretend to survey it here. Many surveys are available, however. Here is one from the Bank of England.

          • SpontaneousOrder

            So, we need central banks and their fake models because of "sticky prices" ?

            But I thought we need free-banking because unhampered operation of this market would be more efficient ?

            This is incoherent.

          • George Selgin

            No, SO. You are now getting sloppy in your arguments. First, my argument is a defense, not of central banking, but of a monetary regime that allows for some growth in the money stock. I have instanced both the gold standard and my "bitdollar" idea, neither of which requires a central bank.

            As for "free banking," your suggestion that it alone can handle the problem of the dollar is mistaken. Free banking is a banking regime, not a base money regime. Give U.S. banks today perfect freedom, and they will still go on, for the most part, intermediating dollars and treating Federal Reserve base dollars as their ultimate reserve and settlement medium. The rate of inflation and deflation will then remain a matter of how the stock of base dollars behaves.

            Yes, free banking makes for greater monetary order, other things equal, than unfree banking. But it isn't a panacea. And it cannot make up for a mismanaged supply of basic money.

            It's all well and good to suggest that, had there never been any state interference with banks and money, unhampered market forces may have given rise to a stable monetary system. But that belief tells us nothing about what we can or should do now, that is, given the reality we face in which our basic money consists of bits of paper that can continue to have value only so long as their nominal quantity is artificially limited–that is, limited by something other than their marginal production cost. Call it bad; call it tragic. But one can't just assume away this unpleasant fact, any more than one can open a can by assuming a can opener. Nor can one assume away the reality of downward price rigidities, no matter how much one may dislike it, or the various attempts to formally account for it. Click your heels together and repeat "There's no place like an unhampered marketplace" all you like: it will not get you there.

            So, what can one do? What ought one to do? I say, make the best of this bad lot, by wrestling the dollar from the clutches of central bankers, and placing it on the firmer ground of automatic control. A monetary rule would help. A computer algorithm would be better still. A tamper-resistant algorithm best of all.

            Like the critics to which this post responds, you dislike such suggestions. You regard them, correctly, as a departure from the ideal of having government out of the money picture altogether; and you conclude from this that, because they are espoused by someone no less inclined than you are to find that government-free picture attractive, that fellow must be talking gibberish. But there you are quite mistaken. The difference between us isn't that I contradict myself and you don't. The difference is that I am more concerned with getting from bad to better than with merely flaunting my cherished but presently unrealizable ideals.

          • nomorecranks

            It seems odd to me that unions, and we can take sports players because sports is a fascist enterprise wildy subsidized by taxpayers, cause "price rigidities" and then this is then taken as an excuse by very people who created this problem – the government – for more market-interference by the government. Unions are just a protected class by those with guns – the state – forcing other people to comply with special privileges. It doesn't seem like its "economic science" to then create a whole "area of speciality" and "vast literature" or complicated DSGE or whatever models to justify whatever it is they want to do – engineer business cycles and consolidate their own power. Isn't it just a matter of repealing laws that expropriate individuals property rights? It seems to me the solution to "sticky prices" is stop allowing the state to abrogate contracts, individual bargaining, and violating property i.e less science then it is a matter of arresting criminal behavior (wrapped in x-national flag of course).

            Is that not the whole Keynesian edifice? I mean read Barry Eichengreens article on Project Syndicate he sums up Keynesian in one page:

            I'll summarize his summary in one sentence: "the proles are too stupid to accept lower wages so we will trick them by creating inflation and this will lower real wages and allow productivity slack to finally get moving again"

            This is what passes for "science' ? Sounds more like grubering.

            But then again we all know it pays more to gruber and suckle taxpayer money off State in tenureship and consulting fees and federal reserve appointments then to seek the truth.

            After all – how do you think Nouriel Roubini affords all his sex, drugs, and club escapades? Certainly not by writing Austrian Economics articles LOL


          • BillWoolsey

            If both prices and wages are equally sticky, then lower spending on output results in lower output and employment with only modest changes in prices and money wages. Real wages are unchanged. An expansion of the quantity of money that promptly reverses the decrease in spending on output raises output and employment with only modest increases in prices and wages and no impact on real wages.

            The workers are too stupid to lower their wages and so we will fool them by inflation? Not at all.

            If prices are very flexible and wages are sticky, then a decrease in spending on output results in prices falling more than wages. Real wages rises, and profit maximizing employment and output decrease. If spending on output rises again, the decrease in the price level is reversed and real wages return to their initial level.

            The workers are too stupid to lower their wages and so we will fool them by inflation? Well, it is a bit closer to the mark here, but even so, it is that workers had a surprise increase in real wages, and while they have no interest in lowering their nominal wages to return their real wages to the initial level, neither does a return of the price level to its initial level cause them to insist in raising the nominal wages to keep the freak increase in real wages.

            In my view, most of the arguments for "stickiness" depend on prices and wages being on some kind of "normal" trajectory and there is alot of inertia to adjusting them away from that usual trajectory. If there were no such normal trajectory and the market clearing level of wages and prices were fluctuating wildly, I doubt whether there would be much stickiness.

            By the way, my view is also that many prices are quite flexible and others are more or less sticky. Few wages are flexible and most are sticky. Nominal debts are very sticky.

        • George Selgin

          There's a difference, perhaps somewhat subtle, between a regime that merely avoids the need for downward wage rate adjustments and one that tries to "fool" people by making wage rates generally increase. As I said, downward rigidities have many causes; many of these have nothing to do with money illusion. And it isn't just "fascist" ball players (or union members, or whatever group you chose to affix the label to) that suffer when there's a collapse in spending involving a substantial decline in the average equilibrium P's and w's. In fact, the average firm suffers losses, for its revenues are bound to fall short of its past outlays. In other words, even without the nominal rigidities, except in the sense that past contracts cannot be re-written ex post, the average fellow is worse off. Why, other things equal, prefer a monetary regime that makes this sort of thing likely to one that doesn't. (Note that "other things equal": it won't due to assume that the less deflatioonary regime is also "better" in some independent respect.)

          • nomorecranks

            any industry that has massive government subsidies and protected monopolies and privileged legal exemptions and protections (stadiums, taxes, television bargaining, non-profit designations etc..the crony crapitalism of the nfl, nba, mlb, etc..all of this is readily searchable in 5 seconds)is fascist by the definition of merger of corporate and state powers so if one doesn't like the term thats but fine but the basic matter of the reality is one I am not making up just to defend myself there:


            I don't know about P's and w's and things, you are the expert i suppose, but I know there are a lot of X=Y's out there in a lot of so-called "models" that when applied to the real world are terrible ideas – like yellens 19 labor indications chart and the feds dot-plots and whatever other sudoku charts and tic-tac-toe charts they scribble on as the height of innovative 21st century central-planning is not very impressive.

            and what you describe

            "he average firm suffers losses, for its revenues are bound to fall short of its past outlays. In other words, even without the nominal rigidities, except in the sense that past contracts cannot be re-written ex post, the average fellow is worse off. Why, other things equal, prefer a monetary regime that makes this sort of thing likely to one that doesn'"

            etc etc…isn't that the free market? weed out unprofitable competition ? I guess im not convinced how a free-market wouldn't handle "price-rigidity" problems (assuming this concept is true) better than soduko equations. I get the "this is the situation we are in so make it the best because utopia isn't coming anytime soon" argument but I just don't get P's and w's.

            Sounds like another econo "math-trick" voodoo style to me.

            After all then who is to say that R isn't greater than G?? LOL

            R is > than G!!! bring on the new soviet folks! R>G!

          • George Selgin

            For crying out loud, nomorecranks, remember the context: some are saying that a fixed money stock is just dandy. I am saying no, a growing one is better, because less likely to cause avoidable unemployment. There's zero basis for claiming that a constant money stock is more "free market." Zero. Get it? There's no way to have such a money supply that doesn't involve (drum-roll)….heavy GOVERNMENT INTERVENTION. Gold won't achieve it. Nor silver. Nor free banking. So stop playing "more free market than thou" with me, and calling me a commie and all that sorta crap, because the question whether it's better to have a regime that makes substantial (demand-driven) deflation likely or one that doesn't is not the same as the question whether free markets are better than un-free ones.

  • Rob Rawlings


    What are the reasons you prefer Domestic Final Demand over NGDP as a target ?

    • damag0r

      I'm curious to learn more about this Domestic Final Demand thing myself.

    • BillWoolsey

      George can give his own reasons, but…

      In my view, it seems desirable to target final demand rather than nominal GDP because of unplanned inventory investment. If spending on output is "too high," to the degree that added demand is met by running down inventory, then inventory investment is negative, and dampens the increase in nominal GDP. IF spending on output is too low, then to the degree that firms build up inventories, then that is inventory demand, and so the decrease in nominal GDP is dampened. Final demand does not include ant inventory investment.

      Unfortunately, changes is inventory expenditure is where most raw commodities are included as well as partially finished goods. If spending on output should change too much I can easily imagine that it is the demand for these sorts of goods that will be impacted immediately. If they aren't included in the targeted measure, then they won't directly count.

      I also have been persuaded that the reversal of unplanned inventory investment in the future is a good thing on the whole.

      Keeping production stable and consistent with the underlying scarcity of resources is the goal.

      Nominal GDP also measures how much is spent on U.S. produced goods and services rather than how much people in the U.S. spend. Final purchases is spending by U.S. residents.

      The difference is the treatment of imports and exports. In my view, an increase in demand for imports can and should be cleared up by a reduction in the exchange rate.

      The implication of that view is that when foreigners peg to the dollar, then with nominal GDP targeting for the U.S., the foreigners can import inflation or deflation. My view is if they don't want to do that, then they shouldn't peg to the dollar.

      That wouldn't be true if spending by U.S. residents was targeted, but it also means that changes in U.S. international competitiveness would need to be cleared up by changes in U.S. nominal incomes. In other words, if foreign cars become more popular, we need lower wages in the U.S. to bring balance to trade.

      If we target nominal GDP, there is no need for nominal incomes earned in the U.S. to change in aggregate, but those pegging to the U.S. dollar would need to have higher nominal incomes and demand for their output. IF they want spending on their output to be stabilized, then they would need to allow their currencies to appreciate relative to the dollar.

  • Andrew_FL

    I must third the questions about Domestic Final Demand, but not why it instead of NGDP: rather, it is the "final" part I would question. In one of the footnotes of Prices and Production, in which Hayek more explicitly makes clear his stable MV norm, he refers to "the amount of money payments"-that is, as I understand it, all money payments, rather than payments exclusively for final goods. What, if anything, in your view, is wrong with this? Is it redundant? Is it that we lack good measures of the total volume of money transactions? Or is there something economically important about the distinction between these kinds of transactions?

    I get why one wants to measure final goods for a welfare measure like Q. I'm not quite getting the logic of favoring PQ versus what I guess is more like Fisher's PT for a target for *monetary* stability.

    • BillWoolsey

      Scarcity is a fundamental principle of economics. If the demand for consumer goods rises, then to produce more consumer goods it takes more resources. And those resources must come from the production of something else–like capital goods. The demand for consumer goods "should" rise and the demand for capital goods "should" fall.

      Instead of capital and consumer goods, I can say apples and oranges. Or grinders or drill presses.

      Shares of stock are not scarce in the same way. If stock prices rise, should the demand for consumer goods and capital goods both fall?

      Even more oddly, suppose the price of stocks rise, but there is no trading. Does the absence of T, mean that this is irrelevant? If so, that means that if there is greater divergence of expectations, so that there is more volume on the stock market, PT rises. Does this require a decrease in the demand for goods and services?

      For these reasons, stabilizing "PT" is a bad idea.

      Now, the reason why it might seem like a good idea is that if there is an excess supply of money, we can easily imagine that the excess money is spent on something other than current output and while nominal GDP is not changed immediately, PT rises. This signals that an error was made and that the quantity of money needs to fall so that it matches the demand to hold money.

      Unfortunately, the demand for financial assets could rise for reasons other than an excess supply of money. . In that case, it is undesirable for the quantity of money to fall. Higher prices of stock, much less extra stock transactions, in no way requires a reduction in the production of goods and services. Signalling that such a reduction is needed by having the demand for those goods and services fall is the wrong signal.

      Further, suppose that an excess supply of money solely leads to an increase in the demand for financial assets (or nonreproduceble assets of any sort)? How much problem does that cause? Malinvestment is about changes in the demand for produced capital goods. Well, that is output.

      As I explained above, a reason to use NGDP rather than final sales (or purchases) is that intermediate goods are counted in inventories.

      Market Monetarists have thought a good bit about these things. However, the consensus is that the "ideal" measure of spending is almost certainly not any of the actual measures we have. I think the biggest problem with NGDP is indirect business taxes.

      • Andrew_FL

        Thanks, a very detailed, helpful reply. Makes sense to me.

  • Yes, what you say is true. But it is just so hard to get motivated to think and advocate for a better form of central planning.

    Especially since whether one succeeds in returning to a centrally planned gold regime, or moves to a centrally planned automatic NGDP-targeting regime, it is still immersed in the same incentives of any centrally-planned regime, so will inevitably migrate into the same politically-driven arbitrary lawless reactionary system we have today (and I think the worse this system can be is probably yet to come).

    Maybe it is better to replace heroin with methadone, even knowing the return to heroin is inevitable. But it seems so much more worth while thinking about how to end addiction.

    Likewise, ending central planning appears to be the only lasting solution. So even if it is pie-in-the-sky, nothing else really seems worthwhile.

  • Paul Marks

    I am a reformist, I always have been. A bad tempered reformist – but a reformist.

    Sadly no major country is engaging in real reform (indeed the monetary and fiscal policies of most countries are insane). So collapse it is going to be.

  • I'm on the record here advocating the level playing field strategy, so there's no sense in denying it. I expect states to eliminate legal tender laws and other government-erected impediments to free choice soon after the freeze hell over strategy, but I advocate the freest possible currency competition anyway. I don't expect an instantaneous flight from FRNs, but choice seems to benefit most people more than the absence of choice. Of course, Selgin's Bitdollar would be among the choices if he wanted to offer it, but I don't understand how he'd target nominal GDP by issuing currency, and I don't even know what "domestic final demand" means.

  • There are also some economists (e.g. me) that think that both the function of a medium of exchange and the unit of account are emergent phenomena and thus there is no need for central planning. The usual austrian and public school criticism of central planning appllies (e.g. economic calculation problem, concentrated benefits/dispersed costs, principal-agent problem).

    Primarily however it is important to recognise that the issue with monetary reform is not about money per se, but about property rights. A reform needs to provide a mechanism for enforcing the property rights. It nees to define who owns what and make sure contracts are executed. What needs to be reformed is the statist legal system. A cryptocurrency does provide an alternative mechanism for enforcing property rights, so issuing bitdollars would face opposition from the lawmakers, courts and the police, as it would diminish their power.

    Also, since fiat (both base money and money substitutes) is typically debt with something backing it, a move towards a cryptocurrency does not necessarily involve a hyperinflation of fiat, merely a decrease in liquidity of fiat and the redemption thereof. If central banks wished so, they could still redeem the holders of fiat by transferring the ownership of the assets backing fiat to them. This would nicely transfer the function of the money supply into a cryptocurrency while minimising the loss of wealth by fiat holders. If that doesn't happen, blame the state for bullshitting the society rather than cryptocurrencies.

  • driver 8

    Dr. Selgin,

    For you crimes against free banking, the Austrian beatings will continue unabated, probably well past death. The idea of trying to reform our current reality must never be mentioned publicly if you wish to remain in their good graces.

    Anyway, welcome to the club.

    Best regards,
    Milton Friedman

  • gusgutoski

    Hi George. Robert Sams makes the interesting observation that the role of fractional reserve banking in a bitdollar world might naturally be greatly diminished relative to our current world, primarily because most consumers want the convenience of electronic money and the only way to get that in the current world is to hold an account at a fractional reserve bank. What do you think of this idea?

    While I'm here please permit me a naive non-expert question: you seem to suggest in this post that deflation is only a problem because humans have an irrational tendency toward stickiness. Is that to imply that if humans were not irrational in this way then there'd be nothing wrong with deflation? I've always been told that deflation is bad because it artificially slows down the economy by causing people to put off purchases longer than they otherwise would in a world of stable prices. Would you please set me straight?

    If I may be so bold, perhaps a new post is the proper place to answer these questions since nobody reads new comments on old posts. Thank you.

    • George Selgin

      There would still be room for frb in a bitcoin world, to the extent that banks can offer interest and other services such as will make their IOUs seem attractive relative to bitcoin. So long as theirs interest to be earned on bank loans and investments, banks will find clever ways too attract the funds needed to finance them. The extent of FR banking might be a somewhat smaller, but it certainly wouldn't be insubstantial.

      I don't believe that price "stickiness" is the only factor making deflation undesirable to the extent that it isn't productivity-driven. In fact, so long as a general decline in demand can't be planned on in advance, it is undesirable, for the simple reason that it means that the "average" firm can't recover historic costs–which means economic waste. This would be true regardless of whether prices were free to adjust or not.

      Stickiness itself is, in any event, not evidence of "irrationality." It may simply reflect the transactions costs involved in adjusting prices, especially when they are based on longer-term contracts. Since such contracts are themselves often economically desirable, a monetary system that permits them to be engaged in without regret is itself a good thing.

      • What you describe is not FRB. It's merely a maturity transformation. FRB (from monetary perspective) would only emerge if people treated these balances as perfect substitutes to Bitcoin. Only then would this maturity transformation have an effect on the money supply.

        Now, admittedly, that may happen, but I argue that it is less likely than with gold or fiat money. This is because Bitcoin itself provides the features that users expect from money: electronic transfer, accounting data, dispute resolution mechanisms etc. Bitcoin reserves have also better auditability than gold reserves, and several of the service providers that hold Bitcoins on behalf of their users started providing third-party audits, or even better, cryptographic audits, which allow everyone can verify the reserves for themselves. Of those reports that have been published, they tend to have more than 100% reserves.

        When the "gold standard Austrians" argued that FRB also involves confusion about property rights, I didn't agree with them. And one of your other posts shows examples of FRB instruments which also challenge such a position. But when I tell non-experts that their bank deposits do not belong to them, they are surprised. This is even true for many students of economics. With Bitcoin, this problem doesn't exist either, as a Bitcoin is always distinguishable from a Bitcoin-denominated financial instrument: it's not compatible with it on protocol level and they will not interoperate with other software and hardware.