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Cullen Roche has a new post that makes the following inaccurate claim:

The system we reside in today is not one designed around central bank reserves and cash. In fact, central bank reserves and cash are playing an increasingly less important role in the economy as time goes on. Reserve requirements are no longer necessary in well managed banking systems, cash is becoming a less common form of money and the importance of inside money (bank money or deposits) has become increasingly evident to the economy as the credit crisis proved.

In fact, both cash held by the public and bank reserves are a larger share of GDP than in 1929. For reserves, that’s partly because of the crisis. But currency as a share of GDP was higher in 2007 than 1929, so it’s not just about liquidity traps. As the role of cash has increased, bank deposits have become steadily less important with both DDs and TDs shrinking as a share of GDP.

Update 9/14/13: Mark Sadowski showed that my bank deposits statement isn’t accurate. There is a long term downward trend in bank deposits as a share of GDP, but recently there has been a sharp uptick, presumably due to the zero interest rates on alternative assets such as T-bills.

Roche contends that economists put too much emphasis on the base. But he overlooks the fact that the base provides a nominal anchor, a numeraire, without which it’s impossible to model the price level or NGDP. And that would still be true even if the base were just 0.00001% of GDP, which it might be in a future all electronic money regime.

While I’m nitpicking other bloggers, let me comment on this post by Ryan Avent:

And he [Tyler Cowen] asks why high-growth countries seem to have high rates of inflation. Looking at the chart we see that low-inflation economies are developed, for the most part, while high-inflation economies fall into the emerging-market category. That dovetails nicely with what we’d expect based on the Balassa-Samuelson theory. It points out that rich countries have higher price levels than poor ones. Productivity in the tradable sector sets wage rates across the economy; wages rise with productivity, and since producers of traded goods hire workers from the national labour pool producers of non-traded goods and services must raise their wages to compete for workers. Non-traded goods and services are therefore very expensive in rich countries and cheap in poor ones. That implies that an economy experiencing rapid productivity growth in its tradable sector””because it is catching up to the rich world, say””will have a high rate of inflation relative to rich economies. Put simply, convergence of its price level with the price level in more developed countries necessitates a higher rate of inflation.

This is false; it necessitates a rising real exchange rate. But that can be achieved either through higher inflation or higher nominal exchange rates. Germany and Japan chose to raise their nominal exchange rates when they were growing faster than the US.

PS. Yes, lots of US currency is held out of the country, but that has no bearing on my argument. It’s all about the medium of account, not the MOE.

HT: lxdr1f7, Saturos

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This entry was posted on September 13th, 2013 and is filed under Monetary Theory. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.



