The Marginal Revolution Podcast

Episode: The New Monetary Economics
Date: December 3, 2024
Hosts: Alex Tabarrok (A), Tyler Cowen (B)

Episode Overview

This episode explores the school of thought known as "the new monetary economics," pioneered in the 1980s by figures such as Fischer Black and Eugene Fama. Alex and Tyler revisit the radical claims of this movement, its challenge to conventional monetarism and Keynesianism, and examine how its ideas unexpectedly foreshadow today’s financial landscape with digital assets, shadow banking, and crypto. The discussion spans historical debates, contemporary monetary policy, asset liquidity, and the emerging role of crypto in the global economy.

Key Discussion Points & Insights

1. Origins and Claims of the New Monetary Economics

• Foundation: Emerged in the 1980s, primarily from finance scholars like Fischer Black and Eugene Fama.
• Radical Premise: The Federal Reserve (Fed) has little control over the money supply, the price level, or even the economy in many conditions.
• Controversial Reception:
  • Both Keynesians and monetarists at the time dismissed these claims as "crazy" ([01:51]).
  • Their perspective: in a world where financial assets (not cash) dominate, monetary policy’s power sharply diminishes.

2. Envisioning a Cashless Economy

• Scenario: Imagine an economy where bank accounts hold only T-bills, bonds, or crypto — not cash — and transactions involve transferring these assets.
• Implications:
  • "There's no role for monetary policy. Why? No money, only financial assets." – Alex ([03:53]).
  • Resembles trends in Sweden, China, and advanced economies, where even beggars accept mobile payments ([03:37]).

3. Does the Fed Still Matter?

• Distinction Between Black and Fama:
  • Black: Money doesn’t matter.
  • Fama (and Scott Sumner): Currency retains a unique power in price formation.
• Liquidity as a Network of Options:
  • "You own stocks of wealth... The liquidity of your stocks of wealth matters, but it's not represented by any single number." – Tyler ([06:25]).
• Empirical Evidence:
  • Pre-1960s: Money supply and nominal income were correlated (per Milton Friedman).
  • Post-1980s: That correlation broke down; the 2008 crisis showed increased bank reserves didn’t create inflation ([08:58]).

4. Defining (or Failing to Define) Money Supply Today

• Difficulties in Measurement:
  • Tyler mentions "liquidity-weighted money supply" (Divisia indices) but concludes: "Ultimately Black's radical view that it’s a set of embedded options... has been shown to be correct." ([09:07]).
• Complexity of Modern Assets:
  • Most assets now offer varying degrees of liquidity and can serve as near-substitutes for money ([09:44]).
  • The notion of "money supply" is no longer precise or actionable policy-wise.

5. Transformation in Monetary Policy Mechanics

• Shift Since 2008:
  • Banks now hold reserves (on which they earn interest) well beyond any required level.
  • "Monetary policy is fiscal policy... Reserves are just like a little Fed mini T-bill." – Tyler ([13:26]).
  • Only about 20% of lending is done through regulated banks; shadow banking and other forms of intermediation are dominant in credit creation ([14:22]).

6. Monetary Models: Right in Context, But Not Universally Valid

• Zimbabwe vs. US/Developed World:
  • Old monetarist models (print more currency, get hyperinflation) still apply to cash-heavy developing countries but are obsolete for advanced, financialized economies ([16:09]).

7. Media of Exchange, Account, and Store of Value in the Modern Era

• Multiple Media Proliferate:
  • Digital payments, stablecoins, and alternative monies outperform cash in many contexts.
  • "The new monetary economics predicted money can change... multiple monies are possible." – Tyler ([23:02]).
• Marketability is Plural:
  • Bitcoin, stablecoins, and programmable assets each offer unique forms of liquidity and functionality.

8. Price System Flexibility and Multiple Media of Account

• As global actors (especially multinationals) handle multiple media of account, price stickiness becomes a choice; businesses pick which stickiness suits them best ([25:24]).

9. Modigliani-Miller Theorem & Monetary Policy

• Point Applied to Money:
  • The labels ("debt," "equity," "money") don’t matter — real assets do.
  • "What matters is not how payment streams are divided, but the productive capital underneath." – Alex ([26:11], [30:36]).
• Implication:
  • The Fed, at best, nudges expectations/confidence, doesn’t directly move the real economy or price level in a world of financial asset swaps ([30:48]).

10. Expectations, Causal Evidence, and Fed Mythologizing

• Public and even academic belief in the Fed’s omnipotence persists ("Fed should run the economy hot," Twitter economics), but causal evidence is weak ([18:48], [19:08]).
• "The Fed is more the follower than the leader. Bernanke himself has said this." – Alex ([20:29]).

Notable Quotes & Memorable Moments

| Timestamp | Quote | Speaker | |-----------|-------|---------| | 01:51 | "Both the Keynesians and the monetarists ... thought that Fischer Black and Fama were kind of crazy ... but when I reviewed the new monetary economics ... the world they described looks much more like our world today." | Alex | | 03:53 | "The Fed ... could sell T bills or buy T bills, but so what? ... swapping assets doesn't change the real structure of the economy." | Alex | | 06:25 | "You own stocks of wealth... The liquidity of your stocks of wealth matters, but it's not represented by any single number." | Tyler | | 09:07 | "I know what the different numbers say ... but ultimately Black's more radical willingness to just say it's a set of embedded options ... that's been shown to be correct." | Tyler | | 13:26 | "Monetary policy is fiscal policy. It's like the Fed has the right to issue ... a little Fed mini T-bill. ... It's just a very different, very strange world." | Tyler | | 23:02 | "I want to claim vindication for the new monetary economics here because it predicted money can change, it can actually change pretty rapidly. You can have multiple monies or new monies." | Tyler | | 30:36 | "The real assets is what counts, not how those payment streams are divvied up. So what role is there for monetary policy in a Modigliani Miller world?" | Alex | | 32:08 | "To think that whether the height of Jerome Powell and whether he uses exactly the right phrases, that this is going to determine ... the inflation rate over the next year or two. I just can't believe that." | Alex | | 38:14 | "So you had Zimbabwe, but instead of Zimbabwe happening over the price of months or years, you literally within a week you had a massive increase in the supply of Luna ... and that killed the Terra stablecoin, which in turn led to Sam Bankman Friedman ending up in jail." | Alex | | 41:24 | "Pegs are not good and commodities are hard to peg too. Maybe there's some possibility of creating a crypto backed stablecoin where ... the fixed supply is cryptographically enforced." | Alex | | 42:39 | "A future I'm bullish on is the notion that the dollar will spread further ... and this will be combined with crypto. Crypto will give you outs from the dollar system ... US dollar plus crypto as a combined monetary system with multiple monies." | Tyler | | 45:56 | "So the first, the first conscious AI, the first AGI, the first one will be intent on making a lot of money." | Alex |

Timestamps for Significant Segments

• [00:02–03:53] – Defining "new monetary economics"; why it was seen as radical.
• [03:53–06:25] – Thought experiment: No cash, only financial assets; the diminished role of monetary policy.
• [06:25–09:44] – Distinctions between Black & Fama, liquidity as options, the demise of stable money-inflation links.
• [11:50–16:09] – 2008 crisis, reserves, shadow banking, shrinking importance of banks.
• [18:49–21:33] – Twitter economics, Fed's supposed omnipotence, weak empirical support for Fed control.
• [23:02–25:08] – Rise of alternative monies and marketability; practical examples in crypto/finance.
• [26:11–30:48] – Modigliani-Miller in a monetary context; what matters is "real assets," not money labels.
• [32:08–33:39] – Stablecoins: what they've revealed about modern money and programmability.
• [34:09–38:14] – Terra/Luna collapse: theory meets reality of algorithmic stablecoins.
• [42:39–44:10] – The future: crypto plus global currencies, agentic AI as money users.
• [46:04–48:03] – Conclusion & summary; relevance of new monetary economics in today's world.

Takeaways

• The "crazy" ideas of Fischer Black and peers are increasingly relevant in a world dominated by digital assets, shadow banking, and crypto.
• The old frameworks (monetarist/Keynesian) don’t fit modern financial reality; "money supply" is a fuzzy and shifting concept.
• Monetary policy’s true power may be far more limited (and indirect) than commonly believed.
• Crypto, stablecoins, and digital assets reflect and vindicate much of the new monetary economics — especially as AI becomes a crucial actor in global finance.
• “Pegs” (to commodities or real assets) are treacherous; financial innovation flourishes instead at the asset and programmability layer.

Recommended Reading:

• Tyler Cowen & Randy Kroszner, Explorations in the New Monetary Economics
• Foundational papers by Fischer Black, Eugene Fama
• Discussions of Modigliani-Miller in corporate finance and macro identity

Hosts’ Final Words:

"Even though it looked crazy back then, more and more, the world that those guys described, a world in which people trade financial assets, not money... is the world which we’re living in." — Alex [46:54]

"A deeply weird book in the way that young people should write deeply weird books." — Tyler [47:41]

[End of Summary]