The great monetary injection debate of 2012

1563, Bruegel the Elder
"Therefore is the name of it called Babel; because the Lord did there confound the language of all the earth"

This post is written for people in 2013 or 2014 who decide to have a debate on the importance (or not) of monetary injection points. This debate already transpired in early December 2012 across multiple blogs. Rather than starting from scratch, here's a bibliography.

The debate kicked off with Scott Sumner's response to this article by Sheldon Richman. From then on, in no particular order, are these posts:

Scott Sumner
It really, really, really doesn’t matter who gets the money first—part 2
You can start talking about Cantillon effects as soon as central banks start buying bananas
A voice of reason from the comment section
If I buy T-bonds, their price rises. If the Fed buys T-bonds, their price (usually) falls

Bob Murphy
Scott Sumner and I Have a Failure to Communicate
Resolution of the Sumner/Richman Showdown
You Might Be Talkin to a Market Monetarist If…
I Have a Deal for JP Koning, Scott Sumner, and Nick Rowe
Clarification on Cantillon Effects
Bill Woolsey Replies on Cantillon Effects
One More on Cantillon for 2012

Nick Rowe
Cantillon effects and non-SUPER-neutrality = does fiscal policy matter?
Defending Hayek against the Austrians

Bill Woolsey
Sumner on Injection Effects
Injection Effects and the Quantity Theory
Selgin on Cantillon Effects

Steve Horwitz
Sumner, Murphy, Richman, and Cantillon Effects

George Selgin
Sumner v. Cantillon

David Glasner
Those Dreaded Cantillon Effects

Daniel Kuehn
On Cantillon Effects
It's the rational expectations, stupid

JP Koning
Richard Cantillon on Cantillon Effects

Gene Callahan
Golden Meteors and Cantillon Effects

Kurt Schuler
Cantillon effects in Africa

If I've missed any other blogs, please post them in the comments section.

What was the final conclusion from all this debate? I haven't the foggiest clue. Unfortunately there's no final arbiter on blog wars. But since this is my blog, I'll go ahead and attach my final thoughts.

I'm only going to respond to the exact comment from Richman that set the debate off:

First, the new money enters the economy at specific points, rather than being distributed evenly through the textbook “helicopter effect.” Second, money is non-neutral. Since Fed-created money reaches particular privileged interests before it filters through the economy, early recipients—banks, securities dealers, government contractors—have the benefit of increased purchasing power before prices rise. Most wage earners and people on fixed incomes, on the other hand, see higher prices before they receive higher nominal incomes or Social Security benefits. Pensioners without cost-of-living adjustments are out of luck.

Say the Fed announces that rather than buying bonds from traders as it normally does, tomorrow it will inject new money by purchasing goods in shops. Upon the injection announcement, savvy traders will quickly bit up financial asset prices to offset the anticipated money injection. Goods prices, on the other hand, do not immediately get updated because shopkeepers don't pay much attention to Fed announcements. So even though shops will be the first to receive the new money tomorrow, shop keepers cannot purchase a larger real quantity of IBM or Google shares—these prices having already adjusted. So the uneven distribution created by new money has little to do with where money is injected. Even if shopkeepers receive the money first, it is the owners of flex-priced assets like IBM shares who will enjoy increased purchasing power—at least until all prices in the economy have adjusted to the new equilibrium.

[Updated with new links]

Richard Cantillon on Cantillon Effects

There's a dustup between market monetarists and Austrians over Cantillon effects. See Nick Rowe, Scott Sumner, Bill Woolsey, and Bob Murphy. What are Cantillon effects? One definition is the effect that a change in the money supply has on the real economy due to where money is injected. Rereading Cantillon, I think its better to define the effect he is writing about as the influence that a change in the money supply has given that people are incapable of anticipating that change.

Cantillon wrote in a world in which huge discoveries of gold in the Americas had steadily increased the price level. We know that if people perfectly anticipate the arrival of new gold, all prices will immediately rise. Cantillon thought somewhat differently. According to him, the initial discovery of gold would go unnoticed by people:

It is also usually the case that the increase or decrease of money in a state is not perceived because it comes into a state from foreign countries by such imperceptible means and proportions that it is impossible to know exactly the quantity which enters or leaves the state.

Il arrive aussi d'ordinaire qu'on ne s'apperçoit pas de l'augmentation ou de la diminution de l'argent effectif dans un Etat, parcequ'il s'écoule chez l'Etranger, ou qu'il est introduit dans l'Etat, par des voies & des proportions si insensibles, qu'il est impossible de savoir au juste la quantité qui entre dans l'Etat, ni celle qui en sort.

In his paper on Richard Cantillon, Michael Bordo echoes this:

In Cantillon’s work, the dynamic path of adjustment of relative prices, output, the interest rate, and specie flows depends on the expectations of agents in the various markets. This emphasis on expectations presages much of modern monetary theory. It is unclear exactly how expectations are formed in his scheme but the frequent examples of agents catching on slowly suggests that they are formed adaptively. Moreover, the repeated examples of people being fooled suggests that the availability and cost of information is an important aspect of Cantillon’s scheme. Such an emphasis antecedes modern macro theories of disequilibrium.

Cantillon then goes on to describe how unanticipated gold inflows would first be spent on food, forcing up food prices and the earnings of farmers. Farmers in turn employ more land, forcing up land prices. While all prices have now adjusted to the change in the money supply, during the adjustment period landowners are relatively disadvantaged since the price of their product is the last to increase.

While we don't have to agree with Cantillon's ordering of effects, it seems uncontroversial to assume that if expectations only adapt slowly, then there will be some sort of distributional effect during the adjustment period to an unanticipated change in the money supply. There can certainly be debate over the size and consistency of this effect. Austrians, for instance, build a business cycle theory out of it. Others consider the effect to be ephemeral.

On the other hand, if rational expectations are assumed from the start, then the location of gold's injection point is moot since everyone perfectly anticipates the repercussions and adjusts. In talking about injection points under rational expectations, it seems to me that market monetarists are having a totally different conversation than Austrians, who are interested in injection points under imperfect expectations. Is this just a debate over the nature of expectations? I see that Bryan Caplan has made the same point.

Inflation as theft

Noah Smith writes a somewhat facile post targeting internet Austrians. They're too easy of a target - and I doubt that thinkers like Mises, Menger, or Hayek would disagree with any of Smith's facts and calculations.

They might disagree with the spirit of his post. His post paints a somewhat benign view of inflation. For instance, he pokes fun at the idea that inflation is akin to stealing by pointing out that a large component of the public (those with large debts) actually benefit from inflation.

The "inflation as stealing" meme is a very old one that predates Austrian thinkers, as I pointed out in my comment:

On a superficial level I agree with you.

On a deeper note, the idea that altering the value of money can be equated to stealing is a very old idea that predates Austrian economics, and in attacking Austrians you're also attacking thinkers like Adam Smith, ARJ Turgot, and Richard Cantillon who wrote along similar lines and were reacting to very real circumstances.

In medieval Europe, the sovereign was often the realm's biggest financial actor, controlled the mint, and by corollary set the definition of what constituted the unit of account. Debts were payable in these units. Prior to paying off its debts, the sovereign had a huge incentive to "cry up" the coin - reduce the amount of gold in the unit of account, thereby reducing the real amount the sovereign owed its creditors. On the other hand, when the sovereign was creditor and expecting payment, they had a huge incentive to "cry down" the coin, thereby increasing the amount of gold in the unit of account and increasing the real value of what they were to receive.

In short, there have been situations in which inflation and deflation "steal" the public's resources (the public being anyone who is not the sovereign). I would be hesitant to apply this to the modern western situation, but in analyzing the economics of modern third world dictatorships, it is important to understand how the dictator - much like a medieval king - might utilize the monetary system to redistribute resources from the public to his/her circle of cronies and thereby maintain a grip on power. I would strongly recommend most people from these sorts of nations to ignore your somewhat facile and euro-centric description of the effects of inflation and other forms of monetary confiscation, but I doubt they need my advice as they are probably more well-versed in the specifics than I.

In short, when the entity that is the largest debtor is also the entity that defines the nation's unit of account, and also controls the balance sheet of the nation's central bank, you have a significant conflict of interest. That doesn't mean that something conflicted will necessarily occur... but you might want to keep the potential for shenanigans in mind. In times past, conflicted sovereigns haven't always been hesitant to use their control over the monetary system to steal from non-sovereigns, and thus the meme "inflation is theft" has survived over the decades.


Here is Adam Smith, who in pointing out why the coin of the realm was below the original standard in weight, ascribed it to:

...the temporary and fraudulent views of the government, who found their interest at times to diminish the coin by adding a greater quantity of alloy, in order to pay off their various debts with a small quantity of silver and gold... in the 1st place, the creditors of the government are cheated of their money; if the coin be one half less they have but one half of the value that was given to the government, though they have in appearance the whole. To screen themselves also it is necessary that all debts in the kingdom should be paid by this money in the same manner as by the old money. So that all the creditors in the kingdom are in this manner defrauded of their just debts.

Two sources which are quite good on the method of augmentation and diminution of the coin of the realm. The first is from this chapter from Richard Cantillon's Essai sur la Nature du Commerce in Général, the second is excellent paper called Chronicle of a Deflation Unforetold by Francois Velde. The latter has another paper with Rolnick that describes the terminology of augmentation and diminution.


Here is a key for understanding the terminology:


Augmentation =  a way for the prince to reduce the real value of his debts owed by reducing the amount of gold in the nation's unit of account. An alternative way of thinking about this, the number of units of account that each coin could "purchase" was augmented.

Diminution =  a way for the prince to increase real income from debtors by increasing the amount of gold in the nation's unit of account

Debasement is a different term - it means to changing the physical constitution of the coin by reducing its gold content. The opposite of debasement is enhancement - adding precious metals to the coinage.