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David Andolfatto
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Nick, I'm not sure about your calculations, but here is one way to evaluate the impact of a minimum income policy (negative income tax scheme): http://www.sfu.ca/~dandolfa/discount1.pdf It is a theoretical analysis that explicitly takes into account the incentive effects.
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Nick, OK, I think I follow now. I'll have to think about the assumption that the IS curve is unaffected by the interest rate spread. In my OLG model, the object I would identify as an IS curve does depend on the spread. In my model, capital spending is constrained by the need to hold cash reserves. Lowering Rm lowers the opportunity cost of holding reserves and stimulates capital spending. But if IS curve is invariant to the spread as you assume, then OK. I suppose one could use this as a rationale for negative nominal interest rates (central bank deposit rates)?
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Can you display what you mean using IS-LM diagram? Would be helpful for me. Thx. :)
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Nick, "You could get exactly the same rightward shift in the AD curve, holding expected inflation constant, by assuming the nominal interest on holding money drops from 0% to minus 2%." Did you mean "leftward?" Consider standard textbook experiment: tighten monetary policy (by lowering M). Since we usually assume Rm = 0, effect is to raise Rb. This is contractionary, since higher (Rb-Rm) reduces AD (movement along IS curve). But we might alternatively have assumed Rb=0 and let Rm vary. Same experiment (monetary tightening) means a *decline* in Rm. The increase in (Rb-Rm) is again contractionary. Lowering the central bank deposit rate here corresponds to a *tightening* of monetary policy (and is contractionary). Is this what you were trying to say? Incidentally, I have a fully worked out OLG model that links demand (investment demand) to Rb - Rm, see equation (9) here: https://research.stlouisfed.org/publications/review/2015-09-08/a-model-of-u-s-monetary-policy-before-and-after-the-great-recession.pdf
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Nick, I think we can stick to my intertemporal formulation. All we need to do is to assume that the decision-maker, at date 0, goes through thought-experiments concerning what is likely to transpire in the future. (I.e., suppose I get to date t and that no date t goods are available?) We are in the realm of game theory here; not conventional competitive analysis. What's this got to do with money? Well, because once you recognise that people can re-formulate their plans, taking these quantity constraints into account, then the market structure really starts to matter. Hmmm. What do you mean by "reformulate plans?" Are people prohibited from formulating a state-contingent plan? I mean, if I understand the environment, I understand that for a given p, my plan to purchase x may not materialize. If I can anticipate all possible future contingencies, then I come up with a state-contingent plan that maximizes my expected utility, subject to those pesky "effective demand" constraints. Of course, everyone is playing the same game; and they formulate their state-contingent strategies accordingly, taking as given the play of everyone else (standard Nash assumption). And now, to close the model, we need a solution concept. A Nash equilibrium, I guess. Not sure what this has to do with needing money. If people can commit, as I have assumed all along, then claims to their endowments will be acceptable for payment. Let me now move on to your example (sorry, I am thinking on the fly here). You have a three good example. Let us imagine an intertemporal Wicksellian triangle. Good j=1,2,3 represents output at date j. There are three agents, j=1,2,3. Agent j wants to consume good j. But agent j has an endowment of good j-1 (modulo 3). There is a complete lack of double coincidence of wants here. Despite the lack of double coincidence, money is not necessary (this is contrary to Kling's assertion--he obviously does not know monetary theory). In particular, an Arrow-Debreu market with 2 relative prices will do the trick. For that matter, cooperative exchange will do the trick too. Imagine now that agents 2 and 3 lack commitment, but that agent 1 does not. Agent 1 is the person endowed with the asset that pays off in the "long run," date 3. It is natural here to let a claim to this good serve as money, and that agents meet in sequence over time: 1 acquires good 1 from 2 in exchange for money (good 3). Then, 2 acquires good 2 from 3 in exchange for money (good 3). Then agent 3 redeems his money for good 3. This is a monetary economy. Let's see, instead of 3 agents, assume a continnum of 3 types of agents. Then we can speak of a sequence of competitive spot markets. We use good 3 (money) as the numeraire; so price vector is (p1,p2,1). OK, you say to start in a competitive equilibrium. Fine. Now, double both p1 and p2. OK, do that. What happens? Your claim is that in barter (AD market), we'd still get efficient trade in goods 1 and 2 because the price ratio p2/p1 remains unchanged. I am not sure I understand/agree with this statement. The demand for good 1 here depends not only on that relative price, but also agent 1's wealth. And if p1 and p2 double, the purchasing power of agent 1 is diminished (recall, he owns good 3). I think that I'd better stop here. Remember your post: Why Blogging is Hard? It sure is.
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Frances: While debtor households may not be adept at arithmetic, one would expect their creditors to be. If debtors are pushed off the edge, it is the creditors who stand to lose. (Unless they're bailed out, on behalf of the general taxpayer...for the good of society, of course.)
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Nick: I see a crack in the clouds. Let's see if I'm following. Consider a standard choice problem, max U(x) s.t. p(x-e)=0. Suppose there is a unique solution x(p). We add up the demands and solve for p* in the usual way; x(p*)=e. We may without loss interpret x as a vector of time-dated commodities, and p as a set of intertemporal prices. The choice of numeraire is irrelevant. If there are n goods (n dates), then there are n-1 prices. You might want to say n-1 "markets," but that's not quite right. There is a single market; it opens at the beginning of time and clears immediately. As time unfolds, claims are simply redeemed as they come due. There is no need for a medium of exchange, obviously (which I define, btw, as an object that circulates as a means of payment). You want to consider the following thought experiment. Imagine that an agent enters the world thinking that he has to solve the choice problem above. Consider some p that does not clear markets. At the given p, the guy was planning to buy x1(p) at date 1. To support this planned purchase, he has issued claims against his future endowments. But imagine that x1(p) is not available. Then what does the guy do? Your assumption is that he re-optimizes from date 2 onward...subject to the same price vector (?)...and proceeding as if date 1 goods and prices never existed (it is now date 2, after all). The new solution to his choice problem (ignoring x1) is x'(p); which will generally be different that the original solution x(p). So, of course, if we add over all the x(p), x'(p), x''(p), etc...we get nonsense. In particular, Walras' law does not hold. (Not too surprising, since we are no longer describing a Walrasian market structure). Something tells me that I am missing a part of your argument. In particular, I'm not sure where money fits in here. I have assumed that people can keep their promises, so their time-dated claims can be used to purchase whatever they want as time unfolds. The problem arising above appears to have nothing to do with money, per se. Also, I wonder what you assume about peoples' expectations. Do they anticipate these trading difficulties? Sorry for all the questions. Let me know if they are peripheral to the main point you are making.
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Nick: I'm afraid that I'm having a terribly difficult time following your discussion of Walras' law. There are, of course, theorems that prove the validity of Walras' law under a set of maintained assumptions. So when you say that the law is false, you obviously mean that one or more of these maintained assumptions is violated. Evidently, it is the assumption that prices are market-clearing that seems to be the problem. This assumption is, of course, nothing more than part of the standard solution concept that is applied to competitive market settings (centralized markets with price-taking agents). Or, is it more than this? Do you also take issue with the assumed market structure; i.e., the idea that all trade occurs in a centralized market? The way your discussion proceeds leads me to believe that you have in mind some decentralized exchange process. Can you be more precise about the nature of this "monetary economy" that you speak of? Perhaps you have in mind sequential pairwise meetings, as is the case in standard search models? But in those models, prices are determined not by an auctioneer, but by bilateral bargaining. And I'm not even sure that it makes sense to speak of Walras' law in such an environment. (That is, telling us that Walras law is false is a nonsensical statement). Anything you can say to clear my thoughts on this matter would be greatly appreciated. I am enjoying the general discussion.
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I respect what you're saying here. But I still think you are missing my original point to Mark. Re: your last sentence...the primary utility (of models) seems to be in advancing ideological agendas. Can you please provide me an example here? (am genuinely curious). My point was that you do not need a formal model to advance an ideological agenda; and that, indeed, most people who push this stuff typically use informal models to do so. My interpretation is that it is easier to persuade when you are not bound to making assumptions explicit and having your arguments restricted to be logical (i.e., consistent with the collection of implicit assumptions). By the way, it seems to me that the economists I know who work on formal models are much less likely to push ideological agendas. My interpretation of this is that the models they work with make them recognize how little we truly know. It teaches us to tread cautiously when making policy recommendataions. Of course, one rarely, if ever, reads about this in newspapers, so your keen empirical eye is likely to miss it.
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Goldilocks, I think I know where you're coming from, as there was a time when I thought very much like you. I am no longer so self-assured. "...when a simple narrative based on obvious real-world observations is not only sufficient but far superior , at least to an intelligent, unbiased observer." I see. So why is there so much disagreement even among "intelligent" observers? Is it because I am biased and you are not? "Now why would someone try to clutter the debate about the current economic weakness..." I'm trying to "clutter" the debate? All I did was point out a fact and ask people to interpret it in light of their favored hypothesis. I can't help but note that you did not answer the question. Is this because the evidence I highlighted is inconsistent with your "intelligent and unbiased" observations? Is this the criterion you use to classify evidence as "clutter?" "Why dismiss the reliance on asking businesses directly why they're not hiring?" I do not want to "dismiss" this evidence. But I do think it should be interpreted with care. Like Paul Krugman says, "The thing is, no amount of experience meeting a payroll helps you understand issues that are critically affected by the way things add up at a macro level." "You don't need models or a PhD in economics to see this , but it seems that both are required to not see it." You don't even recognize the model(s) you have floating around in your brain. We are, as Keynes once said, the slaves of some defunct economist. I'm not sure why you want to pretend that you are not. I have a preference for formal models, you have a preference for informal models. Another way to express my response to Mark is that we all possess interpretative tools (models) and that I'm not sure why he is only picking on one type of abuser. Regards, DA
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Mark, Your point is well taken. However, what about those who argue for specific actions affecting hundreds of millions of people, based on half-baked economic ideas floating around in their head? We all use models to interpret, predict, and offer advice. Theorists make their assumptions explicit, inviting criticism, which is necessary for constructive debate and scientific progress. Others (self proclaimed non-theorists, who believe that data speaks for itself) like to offer interpretation and advice while keeping their assumptions hidden--sometimes even from themselves. I'm just saying that your criticism applies more broadly than to people like Diamond. It would be helpful for all of us to keep this in mind.
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Mark, Your point is well taken. However, what about those who argue for specific actions affecting hundreds of millions of people, based on half-baked economic ideas floating around in their head? We all use models to interpret, predict, and offer advice. Theorists make their assumptions explicit, inviting criticism, which is necessary for constructive debate and scientific progress. Others (self proclaimed non-theorists, who believe that data speaks for itself) like to offer interpretation and advice while keeping their assumptions hidden, sometimes even from themselves. I'm just saying that your criticism applies more broadly than to people like Diamond. Let's all keep this in mind.
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Nick: You see...the discussion has suddenly turned much more interesting! :) In reply, I do not read Krugman's piece as explaining anything. Perhaps I suffer, as Mark Thoma claims (with some justification) from "Krugman Derangement Syndrome." I can literally make no sense of the guy, except when I interpret what he says from his obvious political agenda. Peter Dorman: I offer you this as an example of some people are trying to interpret depression episodes via the lens of RBC theory: http://www.aeaweb.org/articles.php?doi=10.1257/jel.46.3.669 You also ask: That is, are people working on RBC primarily because there are a lot of publishing opportunities in tweaking the model, because of ideological motives (they want to rehabilitate noninterventionist macro), or because they are motivated to actually provide convincing explanations for economic phenomena? You really need to define what you mean by RBC. I don't think that (political) ideology has very much to do with anything, as it is easy to construct RBC models with a welfare-enhancing role for government. I think that for the most part, people are just trying the best they can to come up with plausible interpretations of important economic events. Darren: Always nice to hear from former students.
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Nick, I'm sorry, but this post just rubs me the wrong way, and in every which way possible! To be fair, you begin with a given supposition: suppose you believe theory X, but are somehow drawn to do work in theory Y. As a young researcher, you somehow already "believe" in theory X. Evidently, there is nothing much left to learn about theory X, but you really want to work on it anyway. And then you hear the siren call of theory Y. You don't "believe" in theory Y. But you work on it anyway, since evidently there is much to explore about the nature of this theory. But this is a rather strange and unfamiliar story, in my view. Who actually "believes" in a theory? When I first started working on RBC theory, I did not "believe" in it. Nor did I "believe" in any of the theories that preceeded or coexisted with it. Theory, in my view, constitutes a body of tentative hypotheses (assumptions) leading to a set of conclusions (predictions) via a mapping of deductive logic. What does it mean to "believe" or "not believe" in such objects? We are supposed to be scientists, not priests. What sort of scientist says to him or herself "I really believe in X, and I don't believe in Y--even though I haven't really explored Y that much." Really? And then you go and associate Y with RBC theory, linking to Krugman's foolish post asserting that "RBC theory is wrong." Krugman is clueless. Nay, beyond clueless...I would say, appallingly ignorant, especially with respect to the body of macroeconomic research produced since 1982. What is "RBC theory" anyway? I suspect that when most people think of "RBC theory," they are thinking of maximizing agents operating in a world of complete markets where the primary impulse mechanism constitutes a random arrival of events that alter the economy's production possibilities frontier (e.g., technology shocks). Is RBC theory, in the narrow way I just defined, "wrong?" What does one mean by "wrong?" Bad assumptions? Bad predictions? Implausible interpretations? Or is the theory "correct" in the sense that it appears to offer a plausible interpretation of the forces behind at least some component of the business cycle (certainly consistent with Schumpeter, and Robertson before him)? Of course, RBC theory has evolved far beyond the narrow characterization I described above. Distortionary taxes, externalities, search frictions, heterogeneous agents, financial market imperfections, etc., etc. etc. Not that Krugman has ever acknowledged this. But the lasting legacy of RBC theory extends, I think, beyond any specific model. RBC theory, more than anything else, represents a methodological approach to understanding or interpreting aggregate phenomena. It is a method that accommodates many different schools of thought. Indeed, I believe that it may even accommodate behavioralists, since any given behavioral rule can be thought of as the solution to a highly constrained problem (e.g., a decision-making unit constrained in information processing). So there you have it, a few Sunday morning thoughts. I realize that your post has more to do with the incentives to do research. But then, if so, there would have been no need for you to take that gratuitous swipe at RBC theory and then link up to a foolish Krugman post.
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Patrick: Twas the rum speaking, not I! :)
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A slow day, Nick? What if I told you that in my view, Y = the incoherent, static, reduced-form macro models of the 1950s and 1960s? I could blog about it, but what would be the point? You have your Y (or is it Krugman's Y?) and I have my Y. And the point of this is? PS. Your link to the Krugman article needs to be fixed.
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David Andolfatto is now following Mark Thoma
Sep 3, 2010
Nick, It would have been helpful if you had defined what you meant by a "looser" monetary policy. In my mind, there are only two practical options: [1] lower the interest rate paid on reserves, [2] increase purchases of longer dated government bonds. It seems clear enough that option [1] would have almost trivial consequences, given that this rate is already close to zero. Given the very low interest rate on even longer dated maturities, it is not even clear that option [2] would have any quantitatively important effects. (If people think it would, I would be interested in hearing what sort of mechanism they have in mind). There is a third option, discussed in an earlier post (which I haven't had the time to read) of purchasing other asset classes. The Fed got away with the MBS purchase program under emergency conditions, but at some political cost (Congressional pressure threatening Fed independence, or even its existence). The Fed does not want to go there again, if at all possible. (And if you think it should, you should be talking about decision-making in Congress, not the Fed). It could be that the majority of Fed policymakers view our fundamental economic problems as stemming from conditions that the Fed cannot control (fiscal policy, structural reallocation, uncertain lending environment that prevents banks from lending, etc.). If this is true, then the best the Fed can do is to try to manage inflation expectations to the best of its ability, promising to act in some manner in the event of deflationary pressure, while at the same time promising not to let inflation get out of control in the event of improved economic conditions (in short, trying to maintain its implicit inflation target of around 2%). Now that I write this, the thought did occur to me that the Fed recently did "loosen" its policy when it announced that it would replace the unexpectedly rapid runoff in its MBS holdings with longer dated government securities, so as to maintain the size of its balance sheet. So again, I guess it depends on how one defines a "loosening" of MP.
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Simon, Wrt your first and second paragraphs, OK. Wrt your third paragraph. I am delighted to report that I am just as surprised by your reply! I don't want to put words in your mouth, but are you suggesting that expectations are easy to observe? How would we know whether expectations are easy to observe or not??? I don't get it. Personally, I have no idea what people are truly expecting...do you? My technique is to observe behavior (e.g., plummeting investment and asset prices) and then try to interpret observed behavior in the context of some economic model embedded in my brain. One (certainly not the only) interpretation is that expectations (over future profitability of investment) have fallen. I can't tell whether we are agreeing or disagreeing here. Please straigten me out here (I ask for some leniency, as I am presently jet lagged). Wrt your fourth paragraph, and in particular, your italicized comment. I agree that desired investment may theoretically contract even in the face of relatively stable profit expectations. I did not mean to suggest that my interpretation is the only plausible one (I simply offered it as an hypthesis worthy of discussion). Debt constraints that bind more tightly is another hypothesis, and one that I have some sympathy for. However, I am led to ask what caused these debt constraints to bind more tightly (or the cost of external finance to increase)? I think it may have had something to do with lower profit expectations, perhaps on the part of the creditors. I also wonder how this interpretation squares with the evidence. My understanding is (I could be wrong) that the business sector is flush with cash. If this is true, then how does one square reduced investment with bullish (is this true?) surveys of professional forecasters? Wrt to your fifth paragraph. Just because recessions have been short in the recent past, does not mean that they should be forecasted to be short in the future. I have in mind here "growth slowdowns." Japan, perhaps? Thanks for bearing with me!
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Simon, Looks like I am about to learn something (again). You appear to hang much on this notion of a "rational forecasting model." Can you please explain what you mean by this? In my mind, I have an image of an econometrician working with some limited set of historical data X, imposing some restriction (e.g., linearity) on this information set, then deriving some forecast (over some variable of interest) by some method (like minimizing SSE). The econometrician then discovers that, based on this estimation procedure (and the limited information at his/her disposal), it would have been "irrational" for business sector participants to forecast an unusually low return to planned capital expenditure. If I have that just about right (I realize that I may have missed the boat entirely), then I'm not sure what to make of it. Expectations are notoriously difficult to observe directly. The actors in the economy almost surely have more information than the econometrician. There is indirect evidence that expectations are tremendously volatile; evidence in the form of asset price movements, for example. The preciptuous drop in capital spending is another (indeed, it is precisely these phenomena that led Keynes, Pigou, and other before them to hypothesize the capricious nature of business sector expectations). I try to put myself in the place of someone, in the depths of the financial crisis, contemplating a planned capital expenditure at that time. I don't think I would have paid much attention to the forecasts generated by your forecasting model. I would have likely thought that it was a terrible time to invest, stemming from what I would have considered a justifiably bearish outlook. Now, trying to distentangle whether my bearish outlook was in fact based on "fundamentals" or whether it might have been the product of some "animal spirit" is an interesting question. But either way, it is easy to see how a depressed economic outlook could lead investors to flock to government bonds, increasing their price, and leading to the "bond bubble" that concerns Nick here. Basically, I am reversing the causality put forth by Nick. Who is right or wrong, I have no idea. But I do think my interpretation is one that should be considered. Does this make any sense?
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Nick, "If Wicksell is wrong, so is the Taylor (Howitt) principle." I think that most of us would agree that there exists an underlying logic to Wicksell's theoretical construct. I am wondering, however, what sort of empirical evidence people use to convince themselves that the phenomenon actually exists (obviously, one cannot simply appeal to the fact that central bankers believe in and use the Howitt-Taylor principle). Anyway, just wondering. Perhaps others can help out here. By the way, great post. I plan to draw on this material the next time I teach macro. (You should really write a book and save us a lot of trouble).
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If you read Howitt (JPE, 1992, Section VI, Figure 2), you'll see the "Taylor principle" in there. As far as I can tell (I may be wrong), this predates Taylor's statement of the result. So perhaps we should call it the "Howitt principle" from now on.
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Simon, Welcome back. Yep, the fireworks have been blazing. It's that trouble-maker Nick at it again! You are right to be confused by the "flight to safety" phrase. In the model I had in my head, it is a simple portfolio substitution that rebalances E[MPK | n] = R, when n falls (a bad news event). See here for details: http://andolfatto.blogspot.com/2010_07_01_archive.html You are right, this is a simple first-order moment story. I could add risk-aversion and higher-ordered moment shifts, but this seemed like plausible first-pass. Your remaining comments question the plausibility of this interpretation. I certainly do not believe that this was the only thing going on. But in any case, let me address your questions: 1) our ability to forecast variations in the private return to capital investment is poor at both short and long horizons. OK, no problem with this. However poor these expectations are, all I need is form them to move around in response to information relating to future fundamentals. 2) given the positive surprises in US productivity growth over the past 2 years, our forecasting models do not make us revise long-term US productivity growth downwards. I don't really trust aggregate measures of TFP (composition bias; the weak have been cleansed, so measured productivity increases). And I trust the predictions of forecasting models even less! Are you really so sure that it was unreasonable to revise long-term US productivity growth downward during the depths of the crisis? 3) We've seen broadly similar falls in nominal and real interest rates in Canada and the US, despite quite different fiscal and productivity performance. I'm not sure why you would use this as evidence against a "news over future capital return" interpretation. Complicated interactions between monetary and fiscal policy can generate all sorts of outcomes. And mix this in with surprise shocks to realized productivity (relative to earlier expectations) and I'm not sure what to expect. (Why do you ask -- are there other interpretations out there consistent with these facts?) How do you think that I should update my prior? It's really up to you to decide that! I do think that this interpretation should be explored in greater depth however (there are people doing this). The classical writers, including Keynes, stressed the importance of expectations in generating fluctuations in investment. Declines in what they called the "marginal efficiency of investment" were responsible for leading agents to substitute in money and bonds. I was just trying to propose this as an alternative to the interpretation offered by Nick.
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Andy, Well, you certainly have an intriguing way of thinking about the issue. I am not completely convinced, but I see where you're coming from. Let me mull it over... Thanks, DA
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Andy, I think you make an excellent point, but then carry it too far. Let me see if I understand your basic point correctly. First, assume a legal tender regime (all debts dischargeable in the legal tender). Second, assume a fixed exchange rate regime (all bank money is legally stipulated to exchange at par with the legal tender). Third, assume that the legal tender is fiat (in the sense of being intrinsically worthless). Then it follows that bank money must be intrinsically worthless. To demonstrate this claim, imagine that I take out a $100K bank loan (banknotes or electronic digits created by the bank and credited to my account) to purchase a $100K home. I transfer my bankmoney to the account of the original homeowner; the latter is now a "depositor." On the surface, it appears that the bank loan is collateralized by the $100K home. But now, imagine that hyperinflation makes fiat worthless. I can discharge my bank loan at zero cost. The depositor discovers that his "deposits" are also worthless -- there is no hard asset backing up his bank money. This argument seems right to me. But does it imply that bank money is intrinsically worthless? I do not think so. You have only described one contingency in which it becomes worthless. Let me now describe another contingency. Imagine that the price-level remains constant over time. Repeat the home purchase scenario described above. Now, imagine that I refuse to go to work to acquire the money credits I need to service my mortgage. Is the depositor screwed in this case? No, the depositor (via the bank) has recourse to my property. The bank liability in this event is evidently NOT intrinsically worthless. If what I just said makes sense, then your statement that "Bank money (along with all other financial assets) has only a derived value, derived from the value of fiat money" goes a little too far. It might be more accurate to say that some of the value is derived from the value of fiat money, but not all its value. Thoughts?
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