Selgin and Eagle should be best friends

David Eagle has a comment on Integral’s piece on Evan Koeing. Here is some of the comment:

“This is my first comment, Integral’s review states that Koenig “notes that since nominal debts are paid out of nominal income, any adverse shock to income will lead to financial disruption, not just shocks to the price level.” This drew my attention for reasons I will state in a moment so I looked at what Koenig wrote on p. 1, which is “Households and firms obligated to make fixed nominal payments are exposed to financial stress whenever nominal income flows deteriorate relative to expectations extant when the obligations were accepted, independent of whether the deterioration is due to lower-than-expected inflation or to lower-than-expected real income growth.” Both of these statements seem to indicate that the financial distress from an aggregate-supply shock is due to the income being in nominal form. I disagree; the financial distress related to aggregate-supply shocks will occur on average to people regardless whether their income is in real terms or nominal terms. The reason is because real aggregate supply is basically also real income. If real aggregate supply falls so must real income and so must average real income, by the same proportion. Hence what happens to a household’s income on average is the same whether the income is in real or nominal terms. Now we look at two households A and B where B is making a nominal payment to A. Also, assume that these households are average in the sense that both of their real incomes not including this nominal payment change proportionately to real aggregate supply as they do in Koenig’s model. Under successful price-level or inflation targeting, the real value of that nominal payment will be unchanged. Hence household B will be squeezed between his declining real income and the constant real payment he must make to A. On the other hand, while A is only exposed to her own real income declining, not the real value of the payment she is receiving from B. Therefore, under price-level or inflation targeting, the payer of the nominal payments absorbs more of the aggregate-supply risk than does the receiver.”

Note especially the bold part. Here is George Selgin in “Less than Zero” (page 41-42):

“… if the price level is kept constant in the face of unexpected improvements in productivity, readily adjusted money incomes, including profits, dividends,and some wage /payments, will increase; and recipients of these flexible money payments will benefit from the improvements in real output. Creditors, however, will not be allowed to reap any gains from the same improvements, as debtors’ real interest payments will not increase despite a general improvement in real earnings. Although an unchanged price level does fulfil creditors’ price-level expectations, creditors may still regret having engaged in fixed nominal contracts, rightly sensing that they have missed out on their share of an all-around advance of real earnings, which share they might have been able to insist upon had they (and debtors also) known about the improvement in productivity in advance.

Now imagine instead that the price level is allowed to fall in response to improvements in productivity. Creditors will automatically enjoy a share of the improvements, while debtors will have no reason to complain: although the real value of the debtors’ obligations does rise, so does their real income, while the nominal payments burden borne by debtors is unchanged. Debtors can, in other words, afford to pay higher real rates of interest; they might therefore, for all we know, have been quite happy to agree to the’ same fixed nominal interest rate had both they and creditors been equipped with perfect foresight. Therefore the debtors’ only possible cause for regretting the (unexpected) drop in prices is their missed opportunity to benefit from an alternative (zero inflation) that would in this case have given them an artificial advantage over creditors.” 

It seems to me that David and George more or less have the same model in their heads…what do you think?

Leave a comment


  1. Bill Woolsey

     /  January 6, 2012

    When I read Eagle’s guest post, I immediately thought of Selgin’s Less Than Zero.

  2. Benjamin Cole

     /  January 6, 2012

    OT but fun.

    Lars, you created there excellent “Market Monetarist” handle for our movement.

    I propose we unfairly but diligently and resolutely lump other monetarists into a camp we dub the “Theo-Monetarists.”

    People have been braying about inflation so much they have not recognized the true modern threat to the USA and Europeans economies and that is Japan-itis.

    What you have now is “Theo-monetarism.”

    Theo-monetarism, as practiced, is resulting in recessionary deflations, and a Japan-like economy.

    Japan has an extremely strong yen. Japan has had 15 percent deflation in the last 20 years. Japan’s manufacturing output has fallen 20 percent in that time period, while stock and equity markets cratered by 80 percent. Banks have never recovered as their real estate loans are ever getting worse. (Loans are made in nominal yen).

    You call that Theo-Monetarism. A faith that tight money works, despite abundant empirical evidence to the contrary.

    We make the battle between Market Monetarists vs. Theo-Monetarists.

    That’s a battle we can win.

    • I am a great football (soccer) fan. You need a rerefee. Without the rerefee everything will be a chaos. I think that in a perfect world the central bank and the state(s) should and would act as rerefees. Ensuring fair play. Markets, the teams and the players and the owners, will never be able to do that without the rerefee(s). I come to back my earlier issue. I think that the Market Monetarists and Keynesians boil down into what I would like to see: a clear and understandable rerefee that is aiming for 5% (less inflation than in 7% aim) NGDP growth. The means may be monetary policy, the fiscal policy, voodoo, dice-tossing, or whatever. The idea that the authorities will play the game for that 5% growth in any possible and imaginable way would be enough for me and my colleagues.By the way, one of the most successful export firms in my field of business was mainly owned by the local government. Now the government owns only 48% of that company. They are one of our competitors and still bloody successful..

    • nickikt

       /  May 24, 2012

      Under Selgins system you would have inflation in a japan like economy. When output falles inflation happens.

  1. St. Louis Fed’s Bullard comes out in support of NGDP targeting | The Market Monetarist

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