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Patrick Newman


Review of Peter Bernholz's book, second edition in the The Quarterly Journal of Austrian Economics, Vol 19, # 2, pgs., 187 -191


Reviewer comments:
Newman writes that in this second edition, the author devoted most attention and change to Chapters 2 and 9, therefor he focuses his review on these. His overall assessment is that the book is valuable and he recommends it to readers. See Bernolz's book


Newman writes that the financial crisis of 2007-08 created much debate by economists over the huge expansion of their balance sheet by the FED would create inflation and depreciation of currency (actually the relative value of the dollar not only it the form of currency). The FED response to the crisis was to expand its own reserves and to increase the reserves that member banks held with the FED. The crisis generated an immediate liquidity crisis in bank reserves, so the principle emergency FED effort was to increase those reserves. This, in turn, was expected to stimulate the economy. But, apparently surprisingly, the inflation measure of the CPI increased only moderately. The GDP expansion during the entire Obama administration was meager.


Newman asks: "Have we entered into a special period where monetary economics is no longer valid, and inflation is no longer a monetary phenomena?" (Of course I wonder if waves of inflation and deflation are caused by monetary phenomena or do they cause monetary phenomena? - See Fischer's The Great Wave)


Newman continues by noting that answering the question is one of Bernholz's purposes for his investigation and book. Bernholz wrote the second edition to bring his research up to date, to include the 'great recession of 2007-08. His main additions in Chapter 2 about that financial crisis. "Why central bank's monetary expansions have not led to present day inflation, and whether or not they will lead to it in the future. Bernholz also added a "new Chapter 9 about how historically, stable monetary regimes (that is, monetary regimes that were constrained and did not lead to significant inflation) were eroded."


Newman then discussed Bernholz's answer in Chapter 2. Why no significant inflation? He cites the increase of the monetary base, MO, (currency in circulation plus member bank reserves) increase of 363.87 percent between Dec. 2007 and April 2014 with little increase in consumer prices. Newman writes that Bernholz provided some illustrative examples of great increases in MO in different countries with small increases in M2.
He writes that Bernholz "concludes that it provides a permanent potential for inflation in the years to come, once banks start to engage in credit expansion". And also, that Bernholz 'argues that the rise in consumer prices was mitigated because velocity during this period fell ) i.e. money demand rose) and most of the new money was not spent on consumer goods, but on goods not included in a cost of living index, such as houses and stocks."
(My own opinion has been that US consumer prices did not increase because consumers are buying on credit from foreign producers - exporting inflation for instance to China.)


Newman remarks that it would have been helpful had Bernholz provided numerical data.
He then provides some data himself. "It would have been nice to know that from the beginning of Dec. 2007 to the beginning of Dec. 2013 .... despite the enormous MO growth of 334.99 Percent (27.76 per annum) M2 growth in the U.S. increased only 47.42 percent (6.68 percent per annum) and the CPI increased even less that that at 10.99 percent (1.75 percent per annum)". And likewise for velocity and the money multiplier and housing and stock prices.


Newman then turns to the real situation that Selgin shows in his book - FLOORED!- Newman writes, "Bernholz should have also mentioned, at least for the United States, the use of the contemporary new policy tool by the Federal Reserve to pay interest on member bank deposits. With this new proviso, banks no longer have as much of an incentive to engage in credit expansion in order to earn interest and to cover the cost of inflation eroding away idle balances."


Newman turns to the new Chapter 9. The topic is two questions: "Why did some stable monetary regimes arise when there was no large inflation beforehand to incentivize their adoption, and under what circumstances did stable monetary regimes become abolished?" He gives us Bernholz's answers: "Bernholz answers the first question with the theory (note theory) that countries enacted stable monetary regimes so they would have an international currency that could be used in foreign trade." He uses ancient Athens and Corinth as examples.
(I disagree - see Sitta von Reden - Money in Classical Antiquity in addition to other reverences listed. Some historians believe that coins - currencies - were introduced to pay mercentary soldiers who needed a way to transport easily funds to pay their way.)


Newman writes that Bernholz "answers the second question by arguing that countries are able to dismantle their stable monetary regimes and engage in inflationary policies when ever there is an'emergency'." In other words people do what they believe they must do. But I do not believe the authorities in question believed they were 'dismantling their stable monetary regime'.Newman continues by refering to Robert Higg's Crisis and Leviathan.


Please note also that in all this discussion of monetary policy - and money - they are focused on credit -NOT currency. Something that 'gold bugs' like Nathan Lewis and others consistently ignore. Currency comprises a very minor component of the real money supply. And while 'gold bugs' are championing fixing the 'value' of the currency to gold, more and more we read that the government should abolish currency itself, and use only credit - that is digital entries in bank accounts.


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