Or else there are two Scott Sumners. Here’s Nick Rowe:
Not many people know this, but there were actually two James Tobins.
The first James Tobin (pdf) said that there cannot be an excess supply of money, because if anyone did have an excess supply of money he would immediately run to the bank to get rid of it.
The second James Tobin said that people hold positive average stocks of money for the same reason anyone holds positive average stocks of any inventory: because it is too costly to keep running back and forth to the bank to get rid of inventory immediately and then get it back the moment before you need it again.
Nick is forcing me to do something I thought I’d never do—defending Tobin. That’s because I also hold both views, and see no contradiction. Here’s what I believe:
1. At any given set of prices there can be an excess supply of money. That’s why there is a hot potato effect and that’s why adding more base money raises the price level.
2. However, in the short run asset prices adjust to prevent an excess supply of money. The higher asset prices make people willing to hold larger cash balances whenever the monetary base increases. Thus the money market remains in equilibrium. That’s really what Tobin is assuming when he talks about the ability to go to the bank. The banker is a person standing ready to buy base money (on demand) from the public, and supply financial assets like CDs in exchange. However very little base money actually stays in the banking system during normal times, so it’s actually asset markets more broadly that adjust to the monetary inflow.
So here’s what’s going on. The public determines how much cash they want to hold, and adjusts how often they go to ATM machines to restock. Tobin’s second point refers to the fact that the opportunity cost of holding cash affects the Cambridge k, or ratio of cash to income. Higher rates lead to a lower k ratio. But these adjustments occur almost instantly, as people restock every week or so. You make a mental note; “start going to the ATM every six days instead of every seven.” Done. Almost instantly. The lags (or “monetary disequilibrium”) before the first adjustment is less than a week, and of no macro significance. Here’s what is significant; the broader level of wages and prices take a long time to adjust. So in a sense there is macro disequilibrium, but it’s labor market disequilibrium, not money market disequilibrium. (It would be monetary disequilibrium at original asset prices.)
Now here’s where I part company with Keynesians who might have been with me so far. Although short term interest rates are one of those “asset prices” that cause the money market to achieve near instantaneous equilibrium, even as the goods and labor markets are in disequilibrium, they actually have very little role in moving NGDP and prices to the level necessary to restore long run macro equilibrium (and to move interest rates back to their original level.) In my view 60% of the heavy lifting is done by what Keynes called “confidence” and I call “expectations of NGDP growth” and Ford Motors economic forecasters call “expected nominal incomes in 2014 available to buy Ford cars.” Another 35% of the transmission is done by asset markets like stocks, forex, commodities, real estate prices, junk bond yield spreads, etc. And maybe 5% by risk-free short term rates. At most.
That’s why I call interest rates an “epiphenomenon.” I hope Nick and I can at least agree on that point.
PS. Recall that the hot potato effect is the only explanation for the long run change in NGDP. If expectations of higher NGDP growth do 60% of the heavy lifting, then the HPE provides 60% of the transmission mechanism even though the instantaneous adjustment of interest rates prevents any instantaneous HPE. That’s what Keynesians can’t get through their heads; how (expectations of) the HPE can even work at zero rates.