The trick to getting an optimal outcome from a decentralized system to have things arranged such that each actor receives the net benefit, positive or negative, of his actions, the benefit summed over everyone affected. A competitive market system does this, although not perfectly.
This is off-topic, but I see that Vietnam has offered zero tariffs on U.S. goods if the Trump Administration will hold off on the new tariffs on Vietnam. It won't be sufficient for the Trump people, because they want an equal balance of trade in goods. But couldn't Vietnam simply use the cash from its sales to the U.S. to buy, say, platinum from U.S. producers and then use the platinum to buy the autos it really wants from China, thereby achieving the balance?
Forget platinum, an entreprenuer should just sell NFTs to Vietnam for USD, with the promise to buy them back for the same amount in USD. The Vietnamese can buy goods from Country C with the NFTs if the promise is trustworthy.
You might be thinking, doesn't that increase the US current account deficit with Country C, which increases their rate of Trump tariffs? Not necessarily, because the entrepreneur can classify his re-purchase of the NFT as a financial investment, which only decreases the US capital account surplus.
1) All your analysis shows is that the optimal nominal interest rate is zero in the same sense that the optimal sales tax on coffee is zero --- you are minimizing deadweight loss in the money market (or the coffee market).
2) But in a system where the government must raise some amount of tax revenue, the optimal sales tax on coffee is probably not zero, because any reduction in the coffee tax requires an increase in some other tax. So in that sense you have not proved that the optimal nominal interest rate is zero. We might want the government earning more revenue through inflation so that it can lower taxes on other things.
3) There is, however, this: Even if we take it as given that the government needs to raise some revenue through taxes, and therefore the optimal sales tax on coffee is non-zero, it remains the case that the optimal tax on capital income is zero (for Chamley/Judd reasons). [Note: We know from the work of Werning and others that there are important mathematical gaps in the Chamley/Judd analysis. It seems to me that these gaps are unimportant in the sense that the fundamental intuition underlying the Chamley/Judd papers remains clear.] So at least *some* taxes should be zero, and perhaps the implicit tax on holding money is one of these taxes. That, however, remains to be argued.
4) So the question now is: Is money more like coffee or more like capital income from the point of view of optimal taxation analysis? I'd very much like to see a clear answer to this.
I would argue that a money with a fixed supply does not grow in value over time, but rather the value of goods in the market in general goes down over time. This might seem an insignificant distinction, but it is an important one i think. If action A has a negative externality of $10 and action B has a negative externality of $5, you would not say that action B has a positive externality relative to A and therefore subsidize it. Instead the answer would be to tax B but less than A. Similarly, this is why
> It follows that individuals will hold the optimal stock of money, the stock that maximizes economic efficiency, only if the nominal interest rate is close to zero.
It sounds like what you're saying is that because the cost (or benefit) to society of whatever cash balance you hold is approximately zero, that any incentive or disincentive to hold cash will distort the market into a less efficient mode. But certainly if there are good business opportunities out in the market that are accessible to a particular person, that incentivizes them to save less and invest more (in those good opportunities). The interest rate, if set by the market, is merely an abstracted and aggregated way to access the opportunities in the market. So I don't believe I follow your logic. I do agree with its conclusion, but for different reasons.
I believe the optimal quantity of money is any quantity as long as that quantity is static. Any monetary inflation distorts the market to over-incentivize spending that money (and disincentivize saving). The opposite is true for monetary deflation. With a money that is inflating, there are business opportunities that destroy value that are nevertheless profitable to undertake. At a 2% rate of inflation, if your business only loses 1% of its real value per year, that ends up being a nominal return of just a bit over 1%/year and people with no better opportunities in the market will take that opportunity and destroy value in order to better preserve their wealth. The inverse is true with monetary deflation, some businesses that create value but not more than the rate of deflation won't be undertaken and that also represents a loss.
So the optimal quantity of money is the quantity at which all businesses that create value can profitably operate and business that destroy value cannot. That quantity is any static quantity.
There is a common misunderstanding about how money works (I don't expect you, David, to have this misunderstanding, but I assume many of your readers might). The misunderstanding is the idea that more money invested (in the stock market, in bonds, in equity investments, etc instead of being "hoarded" under your mattress) means more activity and production in the market. This isn't the case. There is a particular amount of resources (human and otherwise) available in the market at any given time and they will all be employed in the best use their owners can figure out (tho that use might be to sit around and do nothing). If twice the money is invested this year than last year, it doesn't mean there are twice as many workers and twice as much steel and twice as much energy. What it means is that prices will go up because there is more money floating around. This is why we shouldn't be incentivizing people to put their money in the stock market or to buy bonds or whatever. The fact that fiat money *should* inflate is simply a convenient narrative for the banks and governments.
If your money supply remains static, the natural action of the economy will reduce prices over time which makes the money look like its gaining value. But in reality its value remains constant while the value of products in the economy goes down over time. Many people wonder: wouldn't this disincentivize people from engaging in valuable businesses? If price levels are decreasing by 3%/year, who would invest in a business that expects a 2%/year return on investment? The answer is people wouldn't, and they shouldn't. Investing money in a below average business opportunity (the average being the average rate of economic growth, that 3%), is a value destroying enterprise.
I came up with a simple example to illustrate this: Imaging a universe with $100k and 100 banana farmers. A banana farmer can produce 1000 bananas per year and expect to be paid $1/banana. But competition and innovation is resulting in a 2% decrease in banana production costs. If the money supply isn't changing, that will mean bananas will cost 2% less next year. $100 will buy 102 bananas instead of 100. So if someone has an opportunity to spend $100 to create 101 bananas, wouldn't that be good for the economy? Something is being produced instead of not.
In actuality, that $100 doesn't spring new production into action, it *reallocates* production in the economy. That $100 will employ 1 banana farmer in this venture to create 101 bananas, while the other banana farmers doing their old thing will produce 102 bananas. So despite the fact that the investment produces something, it is a negative for the economy because its worse than the counterfactual.
Suppose that a country that runs a Current Account surplus with the US wishes to bring this to a swift end. It commits to sterilize any net flows if Dollars into its private sector by buying these and using them to swap to non-Dollar assets for its foreign exchange reserves. Given we now have a nearly zero flow of Dollars, would this immediately end the CA surplus?
Of course, only the surplus runner can do this without echaisiing their reserves and thus be credible.
A deflationary standard or interest-bearing money with stable prices both allow one to accrue real value whilst just sitting on money, not investing it or otherwise assisting the productive capacity of the economy.
The nominal risk-free rate should be zero, and nominal should equal real instead, with all new money created coming in through profits, and all money destroyed going by way of losses.
This is off-topic, but I see that Vietnam has offered zero tariffs on U.S. goods if the Trump Administration will hold off on the new tariffs on Vietnam. It won't be sufficient for the Trump people, because they want an equal balance of trade in goods. But couldn't Vietnam simply use the cash from its sales to the U.S. to buy, say, platinum from U.S. producers and then use the platinum to buy the autos it really wants from China, thereby achieving the balance?
Forget platinum, an entreprenuer should just sell NFTs to Vietnam for USD, with the promise to buy them back for the same amount in USD. The Vietnamese can buy goods from Country C with the NFTs if the promise is trustworthy.
You might be thinking, doesn't that increase the US current account deficit with Country C, which increases their rate of Trump tariffs? Not necessarily, because the entrepreneur can classify his re-purchase of the NFT as a financial investment, which only decreases the US capital account surplus.
1) All your analysis shows is that the optimal nominal interest rate is zero in the same sense that the optimal sales tax on coffee is zero --- you are minimizing deadweight loss in the money market (or the coffee market).
2) But in a system where the government must raise some amount of tax revenue, the optimal sales tax on coffee is probably not zero, because any reduction in the coffee tax requires an increase in some other tax. So in that sense you have not proved that the optimal nominal interest rate is zero. We might want the government earning more revenue through inflation so that it can lower taxes on other things.
3) There is, however, this: Even if we take it as given that the government needs to raise some revenue through taxes, and therefore the optimal sales tax on coffee is non-zero, it remains the case that the optimal tax on capital income is zero (for Chamley/Judd reasons). [Note: We know from the work of Werning and others that there are important mathematical gaps in the Chamley/Judd analysis. It seems to me that these gaps are unimportant in the sense that the fundamental intuition underlying the Chamley/Judd papers remains clear.] So at least *some* taxes should be zero, and perhaps the implicit tax on holding money is one of these taxes. That, however, remains to be argued.
4) So the question now is: Is money more like coffee or more like capital income from the point of view of optimal taxation analysis? I'd very much like to see a clear answer to this.
There are taxes that don't cause dead weight losses: pigouvian and land value taxes: https://governology.substack.com/p/land-value-tax
I don't follow your argument for why the optimal nominal interest rate is zero.
After "More On Money", I thought your next post might be entitled, "Common Cents Money".
I would argue that a money with a fixed supply does not grow in value over time, but rather the value of goods in the market in general goes down over time. This might seem an insignificant distinction, but it is an important one i think. If action A has a negative externality of $10 and action B has a negative externality of $5, you would not say that action B has a positive externality relative to A and therefore subsidize it. Instead the answer would be to tax B but less than A. Similarly, this is why
> It follows that individuals will hold the optimal stock of money, the stock that maximizes economic efficiency, only if the nominal interest rate is close to zero.
It sounds like what you're saying is that because the cost (or benefit) to society of whatever cash balance you hold is approximately zero, that any incentive or disincentive to hold cash will distort the market into a less efficient mode. But certainly if there are good business opportunities out in the market that are accessible to a particular person, that incentivizes them to save less and invest more (in those good opportunities). The interest rate, if set by the market, is merely an abstracted and aggregated way to access the opportunities in the market. So I don't believe I follow your logic. I do agree with its conclusion, but for different reasons.
I believe the optimal quantity of money is any quantity as long as that quantity is static. Any monetary inflation distorts the market to over-incentivize spending that money (and disincentivize saving). The opposite is true for monetary deflation. With a money that is inflating, there are business opportunities that destroy value that are nevertheless profitable to undertake. At a 2% rate of inflation, if your business only loses 1% of its real value per year, that ends up being a nominal return of just a bit over 1%/year and people with no better opportunities in the market will take that opportunity and destroy value in order to better preserve their wealth. The inverse is true with monetary deflation, some businesses that create value but not more than the rate of deflation won't be undertaken and that also represents a loss.
So the optimal quantity of money is the quantity at which all businesses that create value can profitably operate and business that destroy value cannot. That quantity is any static quantity.
There is a common misunderstanding about how money works (I don't expect you, David, to have this misunderstanding, but I assume many of your readers might). The misunderstanding is the idea that more money invested (in the stock market, in bonds, in equity investments, etc instead of being "hoarded" under your mattress) means more activity and production in the market. This isn't the case. There is a particular amount of resources (human and otherwise) available in the market at any given time and they will all be employed in the best use their owners can figure out (tho that use might be to sit around and do nothing). If twice the money is invested this year than last year, it doesn't mean there are twice as many workers and twice as much steel and twice as much energy. What it means is that prices will go up because there is more money floating around. This is why we shouldn't be incentivizing people to put their money in the stock market or to buy bonds or whatever. The fact that fiat money *should* inflate is simply a convenient narrative for the banks and governments.
If your money supply remains static, the natural action of the economy will reduce prices over time which makes the money look like its gaining value. But in reality its value remains constant while the value of products in the economy goes down over time. Many people wonder: wouldn't this disincentivize people from engaging in valuable businesses? If price levels are decreasing by 3%/year, who would invest in a business that expects a 2%/year return on investment? The answer is people wouldn't, and they shouldn't. Investing money in a below average business opportunity (the average being the average rate of economic growth, that 3%), is a value destroying enterprise.
I came up with a simple example to illustrate this: Imaging a universe with $100k and 100 banana farmers. A banana farmer can produce 1000 bananas per year and expect to be paid $1/banana. But competition and innovation is resulting in a 2% decrease in banana production costs. If the money supply isn't changing, that will mean bananas will cost 2% less next year. $100 will buy 102 bananas instead of 100. So if someone has an opportunity to spend $100 to create 101 bananas, wouldn't that be good for the economy? Something is being produced instead of not.
In actuality, that $100 doesn't spring new production into action, it *reallocates* production in the economy. That $100 will employ 1 banana farmer in this venture to create 101 bananas, while the other banana farmers doing their old thing will produce 102 bananas. So despite the fact that the investment produces something, it is a negative for the economy because its worse than the counterfactual.
An off-topic but topical question.
Suppose that a country that runs a Current Account surplus with the US wishes to bring this to a swift end. It commits to sterilize any net flows if Dollars into its private sector by buying these and using them to swap to non-Dollar assets for its foreign exchange reserves. Given we now have a nearly zero flow of Dollars, would this immediately end the CA surplus?
Of course, only the surplus runner can do this without echaisiing their reserves and thus be credible.
A deflationary standard or interest-bearing money with stable prices both allow one to accrue real value whilst just sitting on money, not investing it or otherwise assisting the productive capacity of the economy.
The nominal risk-free rate should be zero, and nominal should equal real instead, with all new money created coming in through profits, and all money destroyed going by way of losses.