Wednesday, September 10, 2014

John Cochrane nails it

There are economists who know statistics and stability. Chris Sims, Roger Farmer and John Cochrane are a few examples, there are many more. So the Keynesian idea that some magical expectation operatorss us in the head and we undergo personality change is horse manure, frankly.

Grumpy Economist:
The Friedman Optimal Quantity and Financial Stability Milton Friedman long ago wrote a very nice article, showing that the optimum state of monetary affairs is a zero short-term rate, with slow deflation giving rise to a small positive short-term real interest rate. Friedman explained the optimal quantity in terms of "shoe-leather" costs of inflation. Interest rates are above zero, people go to the bank more often and hold less cash, to avoid lost interest. This is a socially unproductive activity. Bob Lucas once added up the area under the money demand curve to get a sense of this social cost, and came up with about 1% of GDP. Not bad, but not earth-shattering.
Simple really. Keynesians contend that having a Fed that always acts as the short term monopoly lender causes NGDP growth, the total money circulating increases relative to reak growth. Yet a steady state analysis tells us that the Fed, in doing so, actually causes deflation because the Fed is earning unencumbered money with each interest payment it receives.

How did Keynes miss such an obvious problem of connecting two dots on a flat paper? I dunno, I suspect he intended to be fraudulent from the start.

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