NOW HERE'S THE INTERESTING QUESTION...:

Monetarism: Dead at Last?: If the economy decides to demand more money, how then does money supply matter? (Thomas E. Nugent, 7/23/07, National Review)

The Journal piece also included this revealing Laffer paraphrase on inflation: “The ‘velocity’ of money is soaring as the world demands more of it (money), [Laffer] says, so there is no inflation threat.” In other words, Laffer is implying that the demand for money is dramatically increasing, even though the Fed deserves high marks for controlling the growth in the money supply as measured by the monetary base.

Now here’s the point. If the economy decides to demand more money, as reflected by the “soaring” demand for it, how then does money supply matter? The Fed’s supposed tinkering with the monetary base as reported in the weekly data from the Federal Reserve Bank of St. Louis is meaningless. In fact, its tinkering has everything to do with maintaining the fed funds target rate and nothing to do with attempts to control the money supply. The “demand side” theory of money creation, or the “quality of money” theory, is in essence liquidity created by the system since the structure demands that liquidity. Effective money supply is determined by money demand, or velocity.

The idea that central-bank increases to the money supply are inflationary is debunked by the modern Japan example. The Bank of Japan (BOJ) lowered its policy interest rate to zero, without regard to controlling interest rates, in order to pump money into the economy. This surge in money supply was enormous, yet inflation in Japan was non-existent. In fact, the problem in Japan was deflation, even though central-bank-induced money supply was exploding.

The reason why the increase in money supply didn’t increase inflation was that money demand also was non-existent. No matter how much money the central bank “printed,” the liquidity wasn’t demanded by the private sector. Wayne Angell accurately described this phenomenon as the money-demand equation, or what Laffer calls the “velocity,” or rate of turnover, of money. (For more on the Japan example, and monetary demand, see my article: “Print More Money, Create Higher Inflation?”)

The primary implication of the extinction of monetarism is that the U.S. Federal Reserve is marginalized by the ability of the markets to function efficiently as reflected by the changing velocity of money.

...as a corollary, isn't it also possible that a booming global economy's demand for secure bonds can also require us to run deficits and maintain the national debt?

Posted by Orrin Judd at July 23, 2007 9:08 AM