07 December 2012

It’s A Wonderful Theory

It makes no difference who gets the extra money from the Fed, because the recipient is no wealthier than before (money is swapped for bonds) and hence they have no incentive to spend any more.  Rather the impact occurs in the AGGREGATE.  Total holdings of the base now exceed total base demand at the current price level, and hence aggregate nominal spending rises (if the injection is permanent.) [Emphasis added.]

So, Sumner is essentially asserting that the people who sell bonds to the government for cash are essentially kind-hearted souls who are doing the economy a big ol’ favor by spending a ton of time and energy in an unprofitable activity to help plain ol’ average Americans avoid a liquidity trap.  And who are these blessed, selfless individuals?  Why, these oh-so-helpful people who are engaging in unprofitable activities for the sake of all Americans are none other than bankers!

It is truly amazing how some economists can get so wrapped up in their abstract theories that they cling to the point of absurdity.  Seriously, Sumner’s model is essentially predicated on an implicit assumption that those who engage in trading bonds for cash from The Fed only do so out of the goodness of their hearts.  It ignores the actual motivations of the economic actors involved, and somehow ignores that most people engage in what they determine to be profitable activities (in whatever way they subjectively value profit).  And if Sumner’s theory is predicated on the assumption that bankers do not, when messing around with hundreds of billions of dollars, seek to make a profit, then his theory is probably not all that realistic.

It makes considerably more sense to assume that bankers will swap out their bonds for cash from the central bank because doing so is quite profitable.  The central bank will take the hit because, like all good political agencies, it is corrupt and inefficient, and exists to channel wealth from the middle and lower class into the hands of the wealthy.  Of course, Sumner can’t admit this because committing heresy against the church of the central bank and its high priest Ben Bernanke would miraculously cause Sumner’s head to explode.  And so, he assumes that bankers (again, bankers) engage in economically unprofitable activity because…bankers are nice people, I guess.

And so, you can see that Sumner’s assertion is probably false because there is quite a mismatch between incentives and behaviors.  At least it’s a wonderful theory.

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