Steven Williamson replies again. He says things like:

I don't know what "aggregate demand" is.

I'll let him figure that out on his own, so let me deal with another part of his reply. He says this graph shows why we should fear inflation:

Presumably Mark would characterize the current state of the economy as "depressed." And, the fact is that reserves are leaving banks in the form of currency as we can see in this chart.

Note in particular that reserves have recently been leaving banks at a more rapid rate. It's possible that we would get more inflation even without QE2.

Ah, I see, the surge in 2008 is why we are having such a problem with inflation today! Oh wait.

It would be nice if he would take logs so that the "surge" is not misrepresented visually. And it would also be nice if he presented the entire series so we can see if there is, in fact, a surge relative to the historical average:



I'll let you decide if there has been a sudden surge in the growth rate of currency. It does appear to be a bit higher relative to the bubble years, but not relative to the entire history.

But what does an increase in currency holdings tell us anyway? People sitting on cash is no different than banks sitting on excess reserves. Are they spending the money right away or holding it for long periods of time? It matters.

In any case, the charts above show currency in circulation. But Wiliamson says that "Inflation is everywhere and always a monetary phenomenon." So what has been happening to (the log of) M2 (the monetarists' favorite measure of money -- he does call himself a New Monetarist after all)? Not much:

There was a little bit of a surge (remember all that inflation when it happened?), but M2 appears to be mostly back to trend. Maybe a second round of QE can change that?

And what do we know from other evidence on this question? Let me turn it over to Williamson's bestest buddy in the whole world, Paul Krugman (the monetary base is the sum of currency in circulation plus bank reserves):

Here’s a chart of growth rates of the monetary base and of M2, Friedman’s preferred monetary aggregate:



Bank of Japan Bank of Japan

So, after 2000 the Bank of Japan engineered a huge increase in the monetary base; this was the original quantitative easing. And it didn’t even translate into a surge in the money supply!

And we are all aware of the severe problems Japan has faced with inflation as a result of its quantitative easing policy.

Just for completeness, here is the same graph with the growth in currency in circulation shown just underneath it for comparison (taken from the Bank of Japan web site):





Currency in Circulation - Bank of Japan

Japan had surges in currency too, but they did not translate into an outbreak of inflation.

Finally, I found this to be an interesting argument that the presence of excess reserves has nothing to do with the lack of demand for bank loans:

If the opportunities are there, the banks will lend.

Well, yes, but that begs the question of whether the opportunities are, in fact, there. I also like the contention that calling Bernanke a "wuss" is not "disparaging Bernanke's character." Yes, saying Bernanke is lying to himself or the rest of us when he claims, as he has repeatedly over the last week, that he will not let inflation get out of control is not a comment of his character, but whatever.

Despite Williamson's wishes to the contrary, there's no evidence here that inflation is just around the corner, or even down the street.

Update: Williamson replies yet again. I have interspersed my own comments [in brackets to keep them separate]:

Thoma - Last Comment: Thoma is back again with this. Replies as follows: Ah, I see, the surge in 2008 is why we are having such a problem with inflation today! He's talking about the surge in currency in circulation in 2008. Yes, exactly. This is why I'm not an old-fashioned quantity theorist. What has to be going on here is a large increase in the world demand for US currency during the financial crisis. All the more reason to be worried about inflation, as the crisis-driven demand goes away.

[The Fed has no way to remove currency or bank reserves from the system once the crisis is over and the economy starts recovering? This relies on the idea that the Fed won't be aggressive in fighting inflation, which in turn relies upon Williamson's contention about Bernanke's character. More on this below.]

what has been happening to (the log of) M2 (the monetarists' favorite measure of money -- he does call himself a New Monetarist after all)? No, New Monetarists don't care about broader monetary aggregates. Neil Wallace taught us that.

[So his preferred monetary aggregate for predicting inflation is currency in circulation? I find that a bit strange. If it's not his preferred monetary aggregate, then what is it and why didn't he present that as evidence instead of the graph on currency in circulation? Perhaps because it doesn't make the case he wanted to make?]

I also like the contention that calling Bernanke a "wuss" is not "disparaging Bernanke's character." This seems a bit strange. I'm not sure how Mark comes by all this respect for authority. In this context, I think it's healthy to be skeptical about what these central bankers are telling us. They have a penchant for secrecy, and I don't think we should take everything they say at face value, or necessarily trust them. We've given them an important job, and I think they are taking some big risks. If they screw up, we'll all suffer for it.

[It's possible to question authority without using the word "wuss" or turning it into a character issue, so his reply misses the mark. But this has nothing to do with questioning authority -- I have no problem with that -- and it's not about the particular words that are used. He's trying to turn this into a complaint about language when the underlying issue is that Williamson used a supposed character defect to justify his claim that we should be worried about inflation. He chose to hang his hat largely on Bernanke's character rather than try to make the case with economics, but seems unwilling to own up to this (even above, his main argument is that Bernanke and other Fed officials could be intentionally lying to us so we shouldn't trust them). I am not a big fan of Bernanke for reasons that precede his tenure at the Fed, and we should be skeptical and ask questions, but I think I would at least admit it when I attacked his character as a means of buttressing relatively weak economic arguments and to justify my arguments about inflation. Maybe he's right about Bernanke's character, maybe not, but as I said before nobody should mistake what Williamson is doing for economics. It's just as easy to use the character issue to argue that Bernanke will tighten too soon rather than too late, and debating Bernanke's inner soul gets us nowhere.]

[I'll end by simply noting that while I was pleased to see his first post today acknowledge the inconsistency in his original argument that I pointed out, he still hasn't answered one of the questions I asked, how inflation occurs in a recession when the unemployment rate is 10%. This was something he said we should be very worried about but how, exactly, does this occur? He said this was his last comment, so I guess we'll never know.]