The real money supply is shrinking…

Now we are backing commercial paper, in an attempt to keep private intermediated liabilities going. Here is one reason why:

The Great Depression and the Friedman-Schwartz hypothesis

Abstract:

The authors evaluate the Friedman-Schwartz hypothesis–that a more accommodative monetary policy could have greatly reduced the severity of the Great Depression. To do this, they first estimate a dynamic, general equilibrium model using data from the 1920s and 1930s. Although the model includes eight shocks, the story it tells about the Great Depression turns out to be a simple and familiar one. The contraction phase was primarily a consequence of a shock that induced a shift away from privately intermediated liabilities, such as demand deposits and liabilities that resemble equity, and towards currency. The slowness of the recovery from the Depression was due to a shock that increased the market power of workers. The authors identify a monetary base rule that responds only to the money demand shocks in the model.

This is what we need to deal with. The current ‘bailout’ may well lead to worse regulation and institutions in the future as we over-react and that makes me more nervous.

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