Monetary Theory Prof. Dr. Gerhard Illing M. Sc. Course Winter Term 2014/2015 Motivating Slides Part 0 © Prof. Illing Winter 2014/15 Part 0 1 What is money? © Prof. Illing Winter 2014/15 Part 0 2 Yap “Land of the Stone Money” © Prof. Illing Winter 2014/15 Part 0 3 Bundesbank Reallocation Gold-reserves 31.12.2012 31.12.2020 Frankfurt am Main 31 % 50 % New York 45 % 37 % London 13 % 13 % Paris 11 % 0 % © Prof. Illing Winter 2014/15 Part 0 4 Bundesbank Reallocation Gold-reserves 31.12.2012 31.12.2020 Frankfurt am Main 31 % 50 % New York 45 % 37 % London 13 % 13 % Paris 11 % 0 % © Prof. Illing Winter 2014/15 Part 0 5 Paper Money – Germany 1923 © Prof. Illing Winter 2014/15 Part 0 6 Goethe, Faust II, Erster Akt Zitiert von Jens Weidmann, Papiergeld – Staatsfinanzierung – Inflation. Traf Goethe ein Kernproblem der Geldpolitik?, 18.9.2012 Mephisto, als Narr verkleidet, spricht zum von Geldnöten geplagten Kaiser: „Wo fehlt’s nicht irgendwo auf dieser Welt? Dem dies, dem das, hier aber fehlt das Geld.“ Der Kaiser „Ich habe satt das ewige Wie und Wenn; Es fehlt an Geld, nun gut, so schaff’ es denn.“ Mephisto „ Ein solch Papier, an Gold und Perlen statt, Ist so bequem, man weiß doch, was man hat; Man braucht nicht erst zu markten, noch zu tauschen, Kann sich nach Lust in Lieb’ und Wein berauschen.“ © Prof. Illing Winter 2014/15 Part 0 7 Electronic Money – Bitcoin? © Prof. Illing Winter 2014/15 Part 0 8 Why does money matter? Core of micro-economic theory (Arrow Debreu framework): Complete set of state contingent contracts Only relative prices affect supply and demand; Changes in the value of the monetary unit (level of wages and prices in terms of some monetary unit) shouldn’t have any effect on the real economy. No role / no need for money Irrelevance of design for monetary policy? Role for money/ liquidity: Requires incomplete contracts; trading frictions © Prof. Illing Winter 2014/15 Part 0 9 Why does money matter? Martin Feldstein (NBER), EMU and International Conflict, 1997 For many Europeans, reaching back to Jean Monnet and his contemporaries immediately after World War II, a political union of European nations is conceived of as a way of reducing the risk of another intra-European war among the individual nation-states. But the attempt to manage a monetary union and the subsequent development of a political union are more likely to have the opposite effect. Instead of increasing intra-European harmony and global peace, the shift to EMU and the political integration that would follow it would be more likely to lead to increased conflicts within Europe and between Europe and the United Stat Although it is impossible to know for certain whether these conflicts would lead to war, it is too real a possibility to ignore in weighing the potential effects of EMU and the European political integration that would follow. © Prof. Illing Winter 2014/15 Part 0 10 Why does money matter? Empirical Evidence for non-neutrality of money VAR Analysis: Christiano, Eichenbaum, Evans, 1999 © Prof. Illing Winter 2014/15 Part 0 11 Why does money matter? Empirical Evidence for non-neutrality of money 0.1 0.08 0.06 0.04 0.02 0 -0.02 -0.04 -0.06 -0.08 -0.1 -0.12 1956 1961 1966 1971 1976 1981 1986 1991 1996 DM to $ nominal to month before DM to $ real to month before Mussa-Puzzle: Strong increase in short run volatility of real exchange rate (monthly change; DM zu $) after the break down of Bretton Woods Systems (1971) © Prof. Illing Winter 2014/15 Part 0 12 Why does money matter? Empirical Evidence for non-neutrality of money: The Great Depression © Prof. Illing Winter 2014/15 Part 0 13 Does money really matter? Great Depression: Real or nominal shock? Structural Break or temporary depression? Real GDP US (ln) 10 9.5 link 9 8.5 8 7.5 7 6.5 6 1929 1934 1939 1944 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009 Real GDP US (ln) Linear ( Real GDP US (ln)) © Prof. Illing Winter 2014/15 Part 0 14 The Great Depression? Ben Bernanke, On Milton Friedman's Ninetieth Birthday November 2002 Fed “I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.” Mervyn King, Bank of England, Interview with Daily Telegraph March 2011. “We prevented a Great Depression,” © Prof. Illing Winter 2014/15 Part 0 15 Why does money matter? Empirical Evidence for non-neutrality of money iMFdirect March 4, 2014 Euro Area — “Deflation” Versus “Lowflation” Actual distribution of nominal wage changes, US 2011; Data: Current Population Survey (CPS); Mary Daly, Bart Hobijn, and Brian Lucking, San Francisco Fed Economic Letter April 2, 2012 Why Has Wage Growth Stayed Strong during recessions? © Prof. Illing Winter 2014/15 Part 0 16 Why does money matter? Empirical Evidence for non-neutrality of money: US Wage changes Mary Daly, Bart Hobijn, and Brian Lucking, San Francisco Fed Economic Letter April 2, 2012 Why Has Wage Growth Stayed Strong during recessions? © Prof. Illing Winter 2014/15 Part 0 17 link Deflationary Spirals; Negative interest rates The Economist, Depreciating currencies; The money-go-round IN 1933, in the depths of the Depression, Irving Fisher, America's most prominent economist, wrote a pamphlet on “Stamp Scrip”. This was a type of alternative currency popular in America and elsewhere at the time that was periodically taxed with a stamp so that it would be spent, not hoarded. Based on the theories of Silvio Gesell, a German “quasi-economist”, one such currency, the wära, was used to revitalise Schwanenkirchen, a Bavarian coalmining village, in 1931. “No one who received wära wished to hold [them], the workers, store-keepers, wholesalers and manufacturers all strove to get rid of them as quickly as possible, for any person who held [them] was obliged to pay the tax. So wära kept on circulating, a large part of [them] returning to the coal mine, where [they] provided work, profits and better conditions for the entire community,” Fisher wrote approvingly. © Prof. Illing Winter 2014/15 Part 0 18 Silvio Gesell Schwundgeld - Chiemgauer The Economist March 2009 Still, stamp scrip lingers on, including the Chiemgauer, named for the region of Bavaria where it still circulates, according to The Economist: In the town of Traunstein, the chiemgauer can be spent on newspapers and food and some people are paid in it.Spent it must be, because it loses value every quarter. The notes have an expiry date after which they need to be renewed with a sticker costing 2% of their value. Back in 1999 Marvin Goodfriend, then at the Federal Reserve Bank of Richmond and now at Carnegie Mellon University, also proposed ways of imposing negative interest rates—make banks pay a fee on reserves left on deposit at the Fed, and equip all currency with a magnetic strip so that when it was deposited, some of its value was automatically deducted depending on how long it had been in circulation. So there are a lot of creative ways of dealing with deflation. The challenge is getting society to go along with them. Having the currency in their wallets lose value for doing nothing will feel to Americans like the ultimate in unfair taxes. © Prof. Illing Winter 2014/15 Part 0 19 Silvio Gesell Schwundgeld - Chiemgauer © Prof. Illing Winter 2014/15 Part 0 20 Silvio Gesell Schwundgeld FT Alphaville 15 August 2011 An admittedly simplified way to described the latter scheme is that the monetary authority issues money that, by design, loses its value over time, thereby encouraging spending. The basic idea was advocated in the late nineteenth century by economist (and anarchist) Silvio Gessel, who believed economic downturns were aggravated by wealthy individuals hoarding cash. Interestingly, this strategy already has been tried on a small scale in parts of the Eurozone. For example, a community currency called the chiemgauer was introduced in Bavaria, Germany, in 2003, with the intention of promoting local commerce. The chiemgauer is designed to lose 2% of its value every quarter. It has to be “topped up” every three months by purchasing a coupon. According to a July 13, 2010 program on National Public Radio (NPR), this “microcurrency” is now accepted by “more than 600 regional businesses — from drugstores to architects…The chiemgauer is not backed by federal or local governments, though some banks are offering loans and checking accounts in the currency.” It is estimated that the chiemgauer circulates three times more rapidly than the euro. Retail chains in the US have experimented along these lines, too. Several drugstore chains reward customers’ purchases of selected items with “money” coupons good for the next purchase at the same store and, critically, good only for a specified period of time. Anyone who has gotten one of these will appreciate the temptation to go back to the store promptly, and buy something © Prof. Illing Winter 2014/15 Part 0 21 Chiemgauer The Guardian, Friday 23 September 2011 23.02 BST Local currencies the German way: the chiemgauer The chiemgauer, a school currency project in southern Germany, is the envy of other currency schemes as shoppers opt for local cash to spend in local shops Unlike conventional currencies, the chiemgauer is only valid for three months, ensuring it is spent rather than saved. Paper Chiemgauer: 8 %/ depreciation per year. youtube Electronic Chiemgauer: 30 days no depreciation. Then daily depreciation(0,022 % per day).