This is a post about the hangup I had in class today. This is not an authoritative post, nor necessarily an explanation of how I think government should run but instead a brief musing on a way the real world and economics COULD interact- please point out flaws in my reasoning.

We were talking about money. At this point i’m not sure where my interpretation divorce from the “official story” so bear with me.  What happens when you expand the money supply. The basic idea was that  money supply goes up, the created money temporarily having an artificial high “value” until the effects of its creation filter down, raising the price level. I don’t think that’s the end of the story however. The specific mental example I was working with was the fed try to stimulate the economy. In the model above as the fed pumps money into the economy the the effects balance out in the long run and cause no real growth in GDP. But I don’t think that’s what actually happens and I don’t think its just a long/short run dichotomy issue.  You might consider the primary actor in this situation the fed, but in reality it isn’t. Far more important then the fed are the banks, the actors that are extracting rents from being the feds money balloons. So the fed cuts interest rates and tries to get more and more money to the banks. There’s a problem for the banks here however. There’s no guarantee the increased quantity of money they’re getting from the fed is going to offset the loss from decreasing interest rates. Sure they have to play ball, if they don’t some other bank will instead. But as an institution they more keenly feel the loss caused by lower then expected interest rates then any other single actor.  So whats a profit maximizing agent to do?

My idea is that, despite what we pretend in econ class, investment is not magically laid out in some gentle spectrum of profitability, with new investments being undertaken as the interest rates fall low enough to make their ROI worthwhile. Instead its more or less laid out as a scatter graph that models the spread between risk and potential profitability. And the axis containing risk fails to have any labels. So when a change in macro economic policy causes the bank to seek new investment its going to want to seek new investment at its old rate of return, not whatever new interest rate that the market will end up balancing to at some point in the future. This incentive to maintain profits forces or at least encourages the bank to make more risky investments, at least insofar as the bank can properly evaluate risk. That’s as far as I’ve really taken the story, i’m not sure how you’d use this as a predictive test because it assumes as a tenant that banks/people are bad at evaluating risk, it works as a means of justifying state policy because if the wise people over at the fed are correct in their ascertainment that the economy is being under invested, ie not performing to potential, capital infusions to risky ventures like, say startups, should help jump start the economy because those start ups will be more able to suck up “wasted productivity” like unemployed workers then ossified companies. Capisce?

A secondary unrelated musing. We were talking about money as both a “real” and “financial” item. Real in the sense that it performs an inherently useful function, as a medium of exchange, and financial in the sense that it can earn income.  State manipulation of the money supply doesn’t affect the “real” value of money as a medium of exchange. Me being able to buy a cup of coffee for 2 bucks instead of 3 chicken eggs, lowers the costs of trade for everyone in society and the same is true if it instead costs 10 bucks.  This only breaks down during hyperinflation at which point money uses all “real” value because its no longer serves as an effective medium of exchange because I no longer trust in my ability to exchange it for something of value. Money as a vector for earning income can fluctuate in completely separation for its first value. I’m curious about money as a financial tool because frankly its not used much as such. If we hold money to be strictly bills its is seldom if ever worth it to hold onto as an “investment” or creator of income, meaning that we seldom experience deflation and so you can never buy more coffee or eggs with the same amount of paper money. So we come the long way around to the fairly obvious conclusion that the higher the liquidity of a financial implement the lower the roi, or in the terms of the discussion we’ve just been having money’s “real” value as a medium of exchange is detrimentally correlated with its viability as a “financial” asset. I feel like there should be something more to that story but I can’t quite pin it down.

P.S.- In my copious free time, I study Japanese. I find this site but both fascinating and incredibly intimidating, I wonder why there are no English equivalents that I know of.