Speedy stimulation

(Continued from yesterday, and referring to the MV=PQ equation)

Presumably most people care most about increasing Q (how much useful stuff people end up producing — the more the better) and keeping P roughly constant (if prices increase a lot, you can’t buy anything unless you’ve got lots of savings; if prices decrease a lot, you can’t get any money to pay back any borrowings you made, and if you can’t predict future prices you’ll have to forego pleasures now just in case necessities cost a lot tomorrow). M doesn’t really matter much in its own right by contrast, and V effectively just measures how long people keep money around before giving it to someone else.

There’s presumably a limit to how large Q can be — 20,000 years ago no matter how much money was around, how quickly it changed hands, or how much/little people charged for things, Q wouldn’t be a high enough value to include a dozen iPhones. That limit has to be set both by both how many people are around who want things from other people, are willing to do things for other people, and what they’re actually capable of doing. But if there’s any significant unemployment, or even any useful new technology that hasn’t been widely distributed, Q probably isn’t maxed out. Which in turn is to say that people could be doing more for each other, but aren’t because they don’t have cash to pay for it.

And in turn, ways to fix that are to find ways to give these groups of people enough money to get started — so that Alice has enough money to buy something from Bob, who then can buy something from Carol, who can buy something from Dave, who can buy something from Alice, rinse and repeat. That might require giving Alice a chunk of money up front (eg a $900 stimulus payment), or Alice getting a short term loan that she can pay back when Dave pays her, or there being a way for all those transactions to require less money up front — eg, each of them paying a $900 total bill in $100 installments.

Of course, except for when Alice gets a free cheque, the above assumes that she has some immediate expectation of future work, either to pay back the loan, or to pay off each upcoming installment. And that expectation will only be there if Dave expects to have money to spend, which will only happen if Dave expects work, and so on. And each step in that will have a slight discount — if Alice is 100% confident of being able to pay Bob, Bob may be only 80% confident of getting paid, since he might justifiably worry that Alice’s confidence is misplaced. But the same discount leaves Carol with only 64% confidence of getting paid, and Dave at 51%, which means Alice should only have been 41% confident. So either someone in that chain needs to be irrationally overconfident, or the only stable solution is that everyone thinks there’s 0% chance of paying the bills and no one buys anything. That seems to me to be the best argument for stupid ideas like paying people to dig holes then fill them back up — it means Alice can decide that even if there aren’t good enough odds that Dave (or someone like him) will pay her, she can always get a lame government job to pay for what she buys from Bob.

It seems to me that something like the MV=PQ formula probably applies on personal level as well as a societal level — if you want to increase your supply of whatever you value (which is Q, at least in so far as anyone can help you with it for money), you either need to hope it magically becomes cheaper (P decreases, not so unlikely if you’re into tech), that you get more money (M increases), or you don’t let what money you have sit around as much (V increases). If you’re already living hand-to-mouth and don’t have any savings, you probably can’t do much about V — if you want more stuff, you just have to work harder or hope something magic happens. But finding ways to make your money move more quickly around the economy (and find its way back to you) probably is a good way to do things. I’m not really sure what that implies though: certainly it means not having your savings on call; probably it means finding alternative ways to let money come back to you (if it can only come back via your boss, guess who gets first pickings of whatever friends it brought back with it); and maybe it implies something about who you give it to or what you spend it on.

Of course, the other aspect of that equation is that it only really says things about instantaneous changes — money could change hands very slowly (which is roughly the same as saying people have more savings), but if that’s compensated by a lot of money in circulation, it doesn’t necessarily imply any difference in prices or GDP compared to today. But when you’re already at some point, in the immediate future the variables tend to be constrained to change at different rates: usually M won’t change very quickly (making money appear or disappear is relatively difficult and heavily regulated), V is heavily dependent on and constrained by public sentiment, and P has a tendency to be a smooth exponential, either with a low or zero exponent if you’re lucky, or a high exponent in hyperinflation.

So, if you get a sudden large drop in the supply of money for trade (which can happen if banks suddenly all significantly reduce their lending), then either the public has to respond quickly by spending their money faster, or you get a resulting drop in production, which is to say, a recession, until either the monetary supply can re-expand, or the central bank fails in its mission to ensure a stable inflation rate, and prices head downwards — ie wages drop, house prices drop, food and petrol prices drop, etc.

Further, if people spotted the signs of a recession/price deflation as a sign the economy was in trouble and they might decide to save more, spend less, or otherwise lower V, and that’s exactly as bad as decreasing the money supply was in the first place. And then there’s a good chance that the attempts to increase the money supply — low interest rates, bank bailouts and guarantees, government spending — will lead people to expect the potential for sudden price increases, which may in turn cause them to save more, just in case.

In so far as that’s an accurate description of the global financial crisis to date (which it may or may not be), it implies the only way to avoid a recession is to avoid the banks not lending in the first place (the only other options are consumer sentiment exactly counterbalancing it, or significant deflation, neither of which are really plausible). In a “functioning” market, banks shouldn’t all suddenly act the same way, without it being in the obvious interests of their customers. That is, the only reason for no one to lend is that no one wants to borrow, which in turn means either everyone already has the money they need saved and are now confident in spending it (V goes up, M goes down correspondingly), or everyone’s decided they do want to take a holiday, work less, and buy less.

But if that’s not the case, then while it’s reasonable for a few banks to stop lending for one reason or another, others (either pre-existing or new) should have picked up the slack and the profits that went with it.

Perhaps that’s the real conclusion: some countries’ banking sectors were full of banks that were too heavily invested in bad bets and not open to new players, while others were luckier. As far as I can see, that means the solution is to either ensure that at least some of your existing banks aren’t making bad bets, or make it possible for new banks to appear fairly quickly when existing banks fail.

Leave a Reply