At The Money Illusion a long and interesting discussion is still taking place around a post by Scott Sumner on monetary effects after a monetary injection of money into the market. Sumner takes on a quote by Sheldon Richman where he says that the Austrian school has (1) distinctively paid attention to the fact that money enters into the market through specific parts and not “as it falls from an helicopter” and (2) that money is non-neutral. Sumner argues that the non-neutrality of money is one of the most studied topics in monetary economics and that it is unimportant how money gets into the market. In the comment section (which I also recommend to read) David Henderson asks “Scott, Just so I can make sure what you’re saying: are you denying Cantillon effects?” Scott’s answer: “Yes.” I think there’s some true in Sumner comment, but also some shortcomings that overlook the presence of Cantillon Effects.
Sumner offers the following 4 examples of how money can be injected in the economy:
- Newly injected base money is used to buy T-bonds from banks.
- Newly injected base money is used to buy T-bonds from non-bank securities dealers.
- Newly injected base money is used to buy T-bonds from individuals at a special auction excluding bond dealers.
- Newly inject base money is used to pay the salaries of government workers, and as a result less money is borrowed by the Treasury. The Treasury then creates and donates a T-bond to the Fed.
Since in all cases money has a direct and fast effect on T-bonds, it is indifferent how money is injected in to the economy. If directly to banks, to individuals or through the government. In all cases T-bonds and interest rates are affected first.
There are three things I want to mention.
First, it may be true that these 4 points are an accurate description of how changes in money supply happen in contemporary United States. It may also be true that an increment in money supply is done by buying financial assets at market prices rather than being a free gift of purchasing power. But none of these facts go against the presence of the Cantillon Effects.
Some ones, and not others, see their cash balances increased when the Fed decides to expand money supply. Those some ones are the ones spending the new cash first. Even if we accept this (as Sumner seems to do in the comments sections), there still are Cantillon Effects that can produce long-term non-neutral effects (short discussion here). What would be required for the Cantillon Effects to be absent?
Homogeneous and correct expected inflation is one of the requirements. If all agents know that inflation will be 3%, then they know now much prices will rise. This is a necessary but not a sufficient condition. If I’m an entrepreneur it doesn’t help my business to increase the prices 3% today if my clients still don’t have the extra 3% of money that’s in the economy. To avoid Cantillon Effects the money helicopter is needed in addition to the correct homogeneous inflation expectations. In other words, to argue against Cantillon Effects we need to assume the helicopter. We can indeed imagine a world scenario with such characteristics, but is not one that loyally expresses the problem of monetary policy and changes in money supply.
Second, what would a charitable interpretation (and what I think Sumner is trying to say) of Sumner’s post be? It is not that there are no effects but, that given the institutional and market framework, anyway money is injected into the economy produces the same effects. It is different, however, to say that there are no Cantillon Effects than to say that all money supply produces the same Cantillon Effects. Nonetheless, even if all 4 cases come to produce the same affect on the price of T Bonds, it still has a bearing in the market how the second step of money expansion takes place. It is not the same to call on Richman because one considers he made an analytic mistake than to call on Richman due to a different assessment on the empirical extent of the Cantillon Effects. All 4 cases can present the same first-step Cantillon Effect, but the second and following changes do differ from case to case.
Finally, an academic critique of Austrian theory should be based on academic work, not on media or blog posts. Not that this is what Sumner is trying to do on his post (maybe, maybe not). But it did bring back to my mind the too common rejection of all Austrian economics based on bad economic blogging and conveniently overlooking the academic output and contributions of the last hundred years.