Thursday, December 06, 2012

Yes, It Matters Who Receives Newly Created Money

In several posts Scott Sumner has taken the somewhat odd position that who receives newly created money is irrelevant for the distributional effects of money creation.

His argument essentially boils down to asserting that when the central bank purchases bonds the recipient switches bonds for money and is no richer because of that because his holdings of bonds is reduced by the same amount as his holdings of money is increased. This argument is wrong headed for two reasons. First of all, when the central bank purchases bonds bond prices will of course go up, increasing their net wealth.

Furthermore, because lower bond yields will all other things being equal raise other asset prices, including stock prices, it will also increase the wealth of those who hold such asset while reducing the purchasing power of those who don't have such assets

Secondly, the key thing isn't what happens when the monetary base is first expanded, the key thing is what happens when money supply in the fractional reserve banking system expands,

When credit is expanded, perhaps because of central bank policy, the people getting the loans will use the money somehow (considering how you have to pay interest, you don't get a loan just for fun), maybe to buy Internet stocks like in the late 1990s, or maybe to buy houses as in 2001-06. It should be obvious that this increases the wealth of those who currently hold such assets.

And yes, it matters which kind of assets are bought by the people receiving these loans, or if they simply use them for consumption. In the 1990s stock prices rose faster than in 2001-06 because the borrowers bought stocks to a higher extent, while in 2001-06  house prices rose faster than in the 1990s. By contrast in the 1970s when the new money was used for consumption, it resulted in higher consumer price inflation. Exactly how the the structure of those price changes will be depends on which individuals get more the newly created money and how they decide to use those money.