(1) Income velocity is a contrived figure (viz., make believe)(2) The distributed lag effects for monetary flows have been mathematical constants for over 100 years
(3) Keynes' "Liquidity Preference Curve" (demand for money), is a False Doctrine
Professor Irving Fisher's transaction's concept of money velocity, or the "equation of exchange", is an algebraic way of stating a truism; that the product of the unit prices, and quantities of goods and services exchanged P*T, is equal, for the same time period, to the product of the volume, and transactions velocity of money M*Vt.
The "transactions" velocity (a statistical stepchild), is the rate of speed at which money is being spent, i.e., real money balances actually exchanging hands. E.g., a dollar bill which turns over 5 times can do the same "work" as one five dollar bill that turns over only once. It is self-evident from the equation that an increase in the volume, and/or velocity of money, will cause a rise in unit prices, if the volume of transactions increases less, and vice versa. Of course, this is just the "unified thread" of algebra, estranged from "general field theory" of macro-economic modeling, where the chorus is: "All analysis is a model" - Ken Arrow.
In contradistinction, the mainstream Keynesian-economic metric variant, income velocity - Vi, a contrived figure, is calculated: by dividing N-gDp for a given period by the average volume of the money stock (M1, M2, & MZM), for the same period (viz., make believe). A decline in the income velocity of money (like during the Great-Recession), is supposed to suggest that the Fed initiate an expansive, or less contractive, monetary policy.
This signal could be right - by sheer accident. I.e., the historical trend of Vt vs. Vi, at various intervals, moved in absolutely divergent paths - giving the income velocity economists false signposts:
See: Sept. 30 1979, correspondence between R. Alton Gilbert (Ph.D., Senior V.P., FRB-STL), and Leland J. Pritchard, then Professor Emeritus, KU (Ph.D., "Chicago School", Economics, 1933, MS Statistics, Syracuse).
Remember that in 1978 all economist's forecasts for inflation were drastically wrong. To put that into perspective (Business Week): there were 27 price forecasts by individuals & 9 by econometric models for the year 1978. The lowest (Gary Schilling, White Weld), the highest, (Freund, NY, Stock Exch) & (Sprinkel, Harris Trust & Sav.).
The range CPI, 4.9 - 6.5 percent. For the Econometric models, low (Wharton, U. of Penn) 5.7%; high, 6.6% U. of Ga.).
For 1978 inflation based upon the CPI figure was 9.018%. Roc's in M*Vt projected 9.0%
The importance of Vt in formulating - or appraising monetary policy, derives from the obvious fact that it is not the volume of money which determines prices & inflation rates, but rather the volume of monetary flows, M*Vt, relative to the volume of goods & services offered in exchange. And the importance of Vt is demonstrated by the historical fact that it has fluctuated 2.5 times as widely as the primary money stock over a corresponding 50 year period.
Leland J. Pritchard (Ph.D., "Chicago school", Economics, and Milton Friedman's classmate in 1933) - writing for Dr. Christopher Thomas' IMTRAC:
"N-gDp is the demand for services (human) & final goods. This concept excludes the common sense conclusion that the inflation process begins at the beginning, with raw material prices & processing costs at all stages of production, & continues through to the end…
….To ignore the aggregate effect of money flows on prices is to ignore the inflation process. To dismiss the concept of Vt by saying it is meaningless (that people can only spend their income once), is to ignore the fact that Vt is a function of three factors:
(1) the number of transactions;
(2) the prices of goods and services;
(3) the volume of M.
…Inflation analysis cannot be limited to the volume of wages and salaries spent. To do so is to overlook the principal "engine" of inflation - which is of course, the volume of credit (new money), created by the Reserve & the commercial banks, plus the expenditure rate (velocity) of these funds. Also, e.g., overlooked is the effect of the expenditure of the savings of the non-bank public on prices (dis-savings). M*Vt's outcome encompasses the total effect of all these monetary flows."
Prior to Sept. 1996, the BOG reported the numeric values for the variables indispensable for solving Fisher's truistic concept money velocity on its G.6 release: "Debit and Demand Deposit Turnover" (back then, it was the BOG's longest running statistical time series).
The significance of bank debits in the G.6's prologue was described as: "Changes in business activity are closely linked with changes in the volume of money payments made by check, of which bank debits provide the best available single indicator."
This aforementioned data was untimely, and un-necessarily, non-conforming: "based upon statistical aggregates where data cannot be compiled accurately or in a manner which conforms to rigid theoretical concepts, in which the entire approach tends to be ex posit and static".
Despite its delimited character, it provided accurate economic projections.
Since demand deposit, DD, turnover was discontinued (via a theoretical and empirical misunderstanding), in Sept. 1996 (when Ed Fry in D.C., was its manager), RRs, required reserves, have to be drawn upon as a surrogate metric, for all money transactions. And don't be logically trapped - by final-product arguments, which assume that the commercial banks, CB's, the volume of financial transactions aren't random, no, historically, speculation's informative and correlated.
Accordingly, Dr. Richard G Anderson, former V.P., Economic Research, FRB-STL remarked on Thursday, 11/16/2006: "This is an interesting idea. Since no one in the Fed tracks reserves"…"Today, with bank reserves largely driven by bank payments (debits or withdrawals), your views on bank debits and legal reserves sound right!"
Per the last publication of the G.6 release, 93% of all demand drafts, bank debits, cleared thru demand deposit classifications (525 demand drafts/mo for Vt, as compared to 7.648/qtr for Vi on 10/1/1996), and 7% thru OCDs, NOW and ATS accounts. The Fed calculated the G.6 figures by dividing the aggregate volume of debits of these banks against their demand deposit accounts.
Yet the 12/23/14 M2-Vi figure printed @ 1.538 x/qtr? - non sequitur! In other words, with this disparity, it is wanton apocrypha to presuppose, with if half of Americans are living paycheck-to-paycheck, that there is, e.g., no minimum monthly number of current bills, and undisposed income? - naught!
So our "means-of-payment" money is designated by transaction based accounts. Whence, "money" is the measure of liquidity, hence, bank debits - the "yardstick" by which the liquidity of all other assets is measured.
See: "New Measures Used to Gauge Money supply" - WSJ 6/28/83 "The experimental measures are designed to resolve some of the confusion by isolating money intended for spending, the money held as savings. The distinction is important because only money that is spent-so-called "true money" - influences prices and inflation."
Our means-of-payment money is extricable linked to legal or RRs. But the politics are wrong (the ABA erroneously considers RRs to be a tax - not a multiplier, contrary to fractional reserve banking). Member CB reserve maintenance, or policy compliance, is based upon transaction type deposit accounts 30 days prior.
Inexorably, and contrary to the provisions of the ABA's "Financial Services Regulatory Relief Act of 2006", the only tool at the disposal of the monetary authority in a free capitalistic system through which the volume of money can be controlled is legal reserves - as Keynes' "liquidity preference curve, demand for money, is palpably a false doctrine. It is an incontrovertible fact, the money supply, and commercial bank credit, can never be managed by any attempt to control the cost of credit, i.e., thru pegging the policy interest rate on governments; or thru "spreads", "floors", "ceilings", "corridors", "brackets", etc.
The BOG cannot adjust its policy rate (or even fine-tune it through a series of modified pegs), so as to counteract the distributed lag effect of money flows (which can be inherently sudden, sharp, and incessantly temporal). Thus the Fed's always "behind the curve".
On October 15, 2014 the U.S. Treasury market had one of its largest swings in yields in a quarter century, larger than on September 15, 2008, when Lehman Brothers filed for bankruptcy - that's no happenstance. Rates-of-change in money flows (all transactions), or the proxy for real-output (which is based on the distributed lag effect of money flows), has fallen by 1/2 since July 2014. The roc in the proxy for inflation has fallen by 2/3 since January 2013 (i.e., QE's a misnomer).
We should have learned the falsity of this assumption in the Dec. 1941-Mar. 1951 period. That was what the Treas. - Fed. Res. Accord of Mar. 1951 was all about. The effect of tying open market policy to a FFR, was to supply additional, excessive, and costless legal reserves to the banking system when loan demand increases.
The sine qua non of monetary management is total current control by a central monetary authority over the volume of legal reserves held by all money creating institutions, and over the reserve ratios applicable to their deposits.
Prima facie evidence that the Reserve banks and the commercial banks have created credit, as with all bank credit creation, is an expansion in the money stock. Prima facie evidence that the money stock, transaction based accounts, has expanded, is given by the roc in legal, RRs - the definitive adjusted monetary base.
But we already knew this: After 7 years of compilation, see article: "Member Bank Reserve Requirements -- Analysis of Committee Proposal"; published -- Feb, 5, 1938.
"In 1931 this committee recommended a radical change in the method of computing reserve requirements, the most important features of which were…"
# (2) "Requirements against debits to deposits"
# (5)"the committee proposed that reserve requirements be based upon the turnover of deposits"
This research paper was DECLASSIFIED after a 45 year hiatus on March 23, 1983. See:
Roc's in RRs may understate money turnover, Vt, for infrequently, up to 2-3 months, but forward-looking RR extrapolations are still unparalleled. And contrary to all statistical analyses, and econometric modeling, roc's in money flows can't be examined in retrospect - regression analysis, et. al. See: "Lies, damned lies, and statistics - a phrase describing the persuasive power of numbers, particularly the use of statistics to bolster weak arguments" - Wikipedia
The "unified theory" is: (1) that the non-banks are the customers of the commercial banks. Thus (2) all demand drafts originating from the NBs clear thru the CBs. (3) Bank reserves are driven by payments (bank debits). And (4) legal reserves are based on transaction type deposit classifications 30 days prior.
Quantitative Easing and Money Growth:
Potential for Higher Inflation?
Daniel L. Thornton (senior economist and V.P., FRB-STL)
"the close relationship between the growth rates of required reserves and total checkable deposits reflects the fact that reserves requirements apply only to checkable deposits"
I.e., RRs = the base for the expansion of new money and credit.
Contrary to monetary theory, and Nobel Laureate Milton Friedman, the distributed lag effects for money flows, have been observable, mathematical constants, for the last 100 years.
M*Vt = P*T; where roc's in RRs = roc's in N-gDp; a proxy for all transactions in the "equation of exchange". I.e., N-gDp is determined by the volume of goods & services coming on the market relative to the actual, transactions, flow of money. Roc's in R-gDp serves as a close proxy to roc's in total physical transactions T, that finance both goods and services. Then roc's in P, represents the price level, or various roc's in a group of prices and indices.
The distributed lag effects for both bank debits and M*Vt are not "long and variable".
The roc in M*Vt (the proxy for real-output) = 10 month delta (courtesy of Montreal, Quebec, Bank Credit Analyst's, "debit/loan ratio".
The roc in M*Vt (the proxy for inflation) = 24 month delta (courtesy of "The Optimum Quantity of Money" - Dr. Milton Friedman.
Note1: their lengths are identical (as the weighted arithmetic average of reserve ratios and reservable liabilities remains constant).
Note2: the roc's were originally derived from the G.6 release. RRs are substituted for bank debits as the proxy for M*Vt, since the G.6's discontinuance.
Manmohan Singh, Peter Stella papers on this are disingenuous. See: "Central Bank Reserve Creation in the Era of Negative Money Multipliers" S& S say that from 1981 to 2006 total credit market assets increase by 744%, while inter-bank demand deposits, IBDDs, owned by the member banks, held at their District Reserve banks, fell by $6.5 billion.
The BOG's reserve figure fell by 61% from 1/1/1994-1/1/2001. The FRB-STL's figure remained unchanged during the same period - all because the CBs ceased to be reserve "e-bound" c. 1995. S & S neglect to point out legal, fractional, reserves ceased to be binding because:
(1) increasing levels of vault cash/larger ATM networks (c. 1959 the CB's liquidity reserves began to count),
(2) retail deposit sweep programs (beginning c. 1994),
(3) fewer applicable deposit classifications (including the yearly expansion of "low-reserve tranche" and "exemption amounts" c. 1982),
(4) lower reserve ratios (c. 1980, between Dec. 1990 & Apr. 1992 the BOG reduced reserve requirements by 1/3),
(5) and, reserve simplification procedures, have combined, to remove most reserve, and reserve ratio, restrictions.
(6) CU, MSB, and S&L correspondent balances are larger than passthru accounts require for clearing payments.
Prior to c. 1995, an individual bank could theoretically create deposits up to an amount approximately equal to its excess reserve position - unused lending & investment capacity. But by mid-1995, legal, fractional, reserves ceased to be "binding" - making the system's expansion coefficient less predictable.
Note1: the BOG's figure differs from the STL FRB's figure. STL's RAM takes other factors into consideration (but there are some huge errors, e.g., Paul Volcker's version of monetarism or its "cover-up", during reconstruction).
Note2: The BOG apparently forgot (oops), to re-index RRs after "Reserve Simplification" was implemented.
The roc's were originally derived from the G.6 release. RRs are currently substituted for bank debits as the proxy for money flows since the G.6 release was discontinued.
The abysmal significance of this discovery (July 1979, then after the G.6 discontinuance is that all boom/busts since the Great-Depression are the Fed's fault, and that Bankrupt U Bernanke caused the Great-Recession, solely by himself (all other factors were immaterial):
As soon as Bernanke was appointed to the Chairman of the Federal Reserve, he initiated, his first "contractionary" money policy for 29 contiguous months (coinciding both with the peak in the Case-Shiller's National Housing Index in the 2nd qtr. of 2006 @ 189.93), or at first, sufficient to wring inflation out of the economy, but persisting until the economy plunged into a depression.
Note: A "contractionary" money policy is defined as one where the roc in monetary flows, our means-of-payment money times its transactions rate of turnover, is less than 2% above the roc in the real output of goods & services. For this entire 2 year period roc's in M*Vt were NEGATIVE - less than zero!
Money market & bank liquidity continued to evaporate despite the FOMC's 7 reductions in the target FFR - which began on 9/18/07. I.e., despite Bear Sterns two hedge funds that collapsed on July 16, 2007, & immediately thereafter filed for bankruptcy protection on July 31, 2007, the FED maintained its "tight" money policy, or credit easing (mix of assets), not quantitative easing (injecting new money & reserves).
The FOMC's "tight" money policy was due to flawed Keynesian dogma - using interest rate manipulation, as a monetary transmission mechanism, rather than by using open market operations of the buying type with non-bank counterparties (pre-1961 operating procedures), to expand legal reserves & the money stock.
Note: BOG's Chairman William McChesney Martin Jr., abandoned the FOMC's net free, or net borrowed, reserve targeting approach in favor of the Federal Funds "bracket racket", or using interest rates as the Fed's transmission mechanism, beginning in c. 1965 (coinciding with the rise in chronic monetary inflation & in anticipated inflation).
On January 10, 2008 Federal Reserve Chairman Ben Bernanke pontificated: "The Federal Reserve is not forecasting a recession". Bernanke subsequently initiated the economy's coup de grâce during July 2008 (his second ultra-contractionary money policy). I.e., in December 2007, the projection in the rate-of-change in monetary flows forecast a -160 percent decline in aggregate monetary purchasing power during the 4th qtr of 2008. Note: the third contractionary policy was the introduction of the payment of interest on excess reserve balances.
I.e., Bernanke failed to initiate an "easy" money policy until Lehman Brothers later filed for bankruptcy protection (& it was one the Federal Reserve Bank of New York's primary dealers in the Treasury Market), on September 15, 2008. The next day AIG's stock dropped 60%.
Note aside: the 2 roc in M*Vt (which the FED can control - i.e., the roc in N-gDp), peaked in the 2nd qtr of 2006 @ 12%. Bernanke let it fall to 8% by the 4th qtr of 2007 (or by 33%). N-gDp fell to 6% in the 3rd qtr of 2008 (another 25%). N-gDp then plummeted to a -2% in the 2nd qtr of 2009 (another - 133%).
By withdrawing liquidity from the financial markets, risk aversion was amplified, haircuts were increased, additional and/or a higher quality of collateral was required, liquidity mis-matches were multiplied, funding sources dried up, long-term illiquid assets went on fire-sale, deposit runs developed, withdrawal restrictions were imposed, forced liquidations lowered asset values, counterparties' credit default risks were magnified-- all of which contributed a general crisis of confidence & frozen financial markets (regulatory malfeasance or circumvention were subordinate factors). I.e., safe-assets were turned into impaired ones.
The naysayers "threw in the towel":
(1) In the Federal Register: "The usefulness of the FR 2573 data in understanding the behavior of the monetary aggregate has diminished in recent years as the distinction between transaction accounts and savings accounts has become increasingly blurred."
(2) And from "The Money Supply" (FRB-NY) "Chairman Greenspan added, "The historical relationships between money and income, and between money and the price level have largely broken down, depriving the aggregates of much of their usefulness as guides to policy".
Money should be defined exclusively in terms of its means-of-payment attributes. The present array of interest-bearing checking accounts has confused the distinction between means-of-payment accounts, and saving-investment accounts, and created a dilemma as to what portion, if any, of these interest-bearing accounts should be considered as savings. This dilemma is resolved when the transactions velocity of demand deposits is taken into account; i.e., deposit classifications are analyzed in terms of monetary flows. Obviously, no money supply figure standing alone is adequate as a "guide post" to monetary policy.
Scientific evidence "is proof, which serves to either support or counter a scientific theory or hypothesis. Such evidence is expected to be empirical evidence and in accordance with scientific method" - Wikipedia
Scientific method is "a method or procedure…consisting in systematic observation, measurement, and experiment, and the formulation, testing, and modification of hypotheses" - Wikipedia
The scientific evidence for the last 100 years is irrefutable. I.e., the trajectory in the roc (proxy for inflation indices), for M*Vt (the scientific method), projected a bottom in the inflation indices in December (signal to buy commodity ETF's and sell bonds), and an upswing beginning in Feb. 2015. Every year, the seasonal factor's map, or scientific proof, is demonstrated by the product of money flows.
The only tool at the disposal of the monetary authority in a free capitalistic system through which the volume of money can be controlled is legal reserves.
The FOMC's monetary policy objectives should be formulated in terms of desired roc's in monetary flows M*Vt relative to roc's in real-gDp - Y. Roc's in N-gDp, P*Y, can serve as a proxy figure for roc's in all transactions P*T. Roc's in real-gDp have to be used, of course, as a policy standard
Lest we are to believe the pundits (those responsible for our condition):
"I know of no model that shows a transmission from bank reserves to inflation" - DONALD KOHN - former Vice Chairman of the Board of Governors of the Federal Reserve System
"Reserves don't even factor into my model, that's not what causes inflation and not how the Fed stimulates the economy. It's a side effect." - LAURENCE MEYER - a Federal Reserve System governor from June 1996 to January 2002