Money, Inflation, and the Lack Thereof: A Reply to Alex Rosenberg

By EJ Spode 

Alex Rosenberg laments the current state of economics, worrying both about its failure to secure its basic concepts (notably the concept of money) and its predictive failures. In the end, he asks the following question. 

“The elimination of money as a real causal factor from economics’ description of reality certainly hasn’t improved its predictive power. In fact it’s done the opposite: exposed the theory to disconfirmation by the actual facts about money. Is this what we should expect from a science we can use?” 

There is a lot to unpack here, not least the issue of whether science is supposed to be something we can use , as opposed to being a kind of quest for understanding. And for sure, as the philosopher Cate Elgin has observed, sciences do progressively deepen our understanding even without always yielding truths, much less helpful predictions. 

One of the ways that sciences deepen our understanding is by questioning the basic concepts of a subject matter. Physics has placed the idea of matter under scrutiny, and in the science that I know best, linguistics, there are serious questions about whether there are such things as languages (and whether they are more than a dialect with an army and a navy) and whether there are words, or morphemes or phonemes or whether there is such a thing as tense as traditionally understood and the list goes on. But this questioning of basic concepts isn’t an existential problem for physics or linguistics. These are just two sciences going about their business, questioning their basic concepts as traditionally understood. 

I don’t see why economics should be any different. To be sure there is a traditional understanding of what money is, which is that it is (i) a medium of exchange, (ii) a unit of account, and (iii) a store of value. And there is no question that quite apart from the concept of money all of these criteria can be subjected to critical investigation. Indeed, anyone who has been involved with cryptocurrencies and blockchain technologies has been knee deep in questions about whether Bitcoin and or Ethereum and or stablecoins are money. More to the point, these developments lead one to question whether the concept of money is that useful, looking forward, from a scientific point of view. 

So, what happens if we question the concept of money within scientific theorizing about economic matters? Here, Professor Rosenberg is unclear. Is he saying that that questioning the utility of money has led to predictions about a positive correlation between quantitative easing and inflation, and those predictions have been wrong, and so…so we need to think seriously about the value of economics? Or is he saying that that problematizing basic concepts like money has distracted economics from figuring out how inflation works and so…so we need to think seriously about the value of economics? Neither interpretation makes much sense. 

What seems to have gotten into Professor Rosenberg’s craw is his belief that somehow questioning the ultimate reality of money has let us to a state in which there are numerous predictions about impending inflation, when no such inflation ever arrived. 

“Three times in the last twenty years, the amount of money has rapidly increased in the US (and other developed countries): after the dot com bubble of the late 1990s, in the period following the subprime mortgage crisis of 2007-8, as a result of the 2017 Trump tax cuts. Now via the Biden stimulus it has to happen a fourth time. None of the first three of these events had the predicted inflationary impact on the economy. There hasn’t been even a hint of what, according to the off-shelf theory, should have been a tsunami of price increases.”

 It is really hard to see how or why questioning or even abandoning the concept of money would yield the predictions about inflation that we have witnessed over the past 25 years. Similarly, just because a science can question basic its entities it doesn’t follow that the science can’t carry on with its old school business. Physicists can still tell you why a square peg won’t go through a round hole, but they will use classical physics to do it, not quantum physics. And linguists can still tell you why English is different than German even if they don’t really believe in languages. Concern for foundations does not torpedo the day-to-day business of a science. 

As for all those predictions about impending inflation, it is not like economics has been mute or even unhelpful in explaining what is going on. The predictions derive from the belief that if you increase the monetary supply, you will generate inflation. And packed inside the phrase “ monetary supply” is the word (or at least the concept) “money”. 

Money is also right there in Milton Friedman’s famous equation: M*V=P*T. What that equation says is that the monetary supply times the velocity is equal to the price times transactions. If monetary supply increases, so too should inflation. And that equation (or some version of it) has been driving a lot, if not most, of the predictions about inflation over the past 25 years. So, one might have argued something else here – namely that it is precisely because of our obsession with money and how much of it there is that we have generated our predictions about inflation. 

This leads to the question of the alleged predictive failures of the economics profession, which Rosenberg sums up thus: 

“What gives? The fact that economists have predicted three out of the last zero rounds of inflation doesn’t seem to have much of an effect on the discipline of economics, when it should have undermined economists’ confidence and dismantled their explanations.” 

Again, there is much to unpack here. First of all, not all economists are Milton Friendman/Ronald Reagan/Ayn Rand disciples, so not all of them assume or argue or believe that loosening the monetary supply yields inflation. They don’t buy that equation! Indeed there, is a movement within economics, called Modern Monetary Theory (MMT to the cool kids), that specifically argues that quantitative easing and other forms of so-called “money printing” do not in and of themselves cause inflation. 

If we are being fair, not even old school monetary theorists like Milton Friedman believed that expanding the monetary supply in and of itself gives rise to inflation. There is also the variable of velocity. It is represented as the V in Friedman’s equation. It is not monetary supply itself, but monetary supply  times the velocity that is equal to the price times transactions. In effect, you need to figure in the effects of velocity before you make strong claims (or really any claims) about inflation. 

Let’s illustrate this point with the rounds of quantitative easing that have been taking place since COVID appeared over a year ago. If you read the popular press you will read a lot about the Federals Reserve “printing money” and Twitterspace is full of claims about the Fed “making the money printer go brrrrr.” But in point of fact the Fed doesn’t “print” money. It is more apt to “buy” some assets from investment banks. But in doing that the Fed doesn’t actually give the banks cash money for those assets. What the Fed does is provide a reserve account for the bank, and that reserve account is going to be electronic digits in the bank’s account with the Fed. The bank can’t withdraw that money, except perhaps to buy treasuries from the US Government, which is just to say that the digits will be moved from a reserve account to a treasuries account at the Fed. If the bank “sells” the treasuries the digits go back to the reserve account. But what the bank can do, is use the digits in its reserve account as collateral to write loans. But here is the thing: If the bank doesn’t write any loans there is no monetary velocity and there is no inflationary pressure. 

This is complicated, sure, but it isn’t  that complicated.  If there is no inflation there is no great mystery about why we don’t see inflation at the moment. And this explanation has absolutely nothing to do with economists fretting about the reality of money. Nor is it something that can’t be explain if you are questioning the concept of money itself. It all makes perfect sense within old school models of  monetary theory. Which involves  money and, importantly, its velocity. 

In the previous paragraph I added the disclaimer “if”, when I said, “if there is no inflation.” But here too some caution is in order. While it is true that the Consumer Price Index (CPI) is currently under 2%, and indeed has been around 2% for the past twenty years, there is an argument to be made that CPI isn’t doing a great job of tracking actual inflation. On the one hand it bakes in some theoretical deflationary effects of technological improvements in things like computer memory. Your computer may cost the same as two years ago, but if the memory and processing speed doubles, well you have twice as much computer for the same price, and that “deflationary” effect is baked into the CPI. But more importantly, while the cost of bread and milk may be increasing at 2% per year, other things that might matter a lot to you could be inflating in price much faster than that. Things that you need. Like houses and education. 

Let’s take the case of the cost of college education at Duke University, where Professor Rosenberg has taught since the year 2000. In that period the cost of tuition at Duke has gone from $24,040 in 2000, to $58,198 in 2019. That isn’t a criminal increase in cost, but it is more than 2%. In fact, it is closer to 4.76% per year. At a time when yields on long term bonds have been tiny, that is a brutal rate of inflation, and it would not be insane to say that the easing of monetary supply and quantitative easing is driving it. 

I’m not saying that existing economic models have everything nailed down, for obviously they don’t. There are things we don’t know. For example, it is hard to predict the lending policy of banks, no matter how robust their collateral positions. It is also hard to figure out the ingredients that are woven into monetary velocity in general. Beyond that, a prediction of inflation doesn’t necessarily tell you where the inflation might appear – it could appear in the cost of housing and education, rather than milk and bread. So, there are a lot of variables to keep track of. 

But none of this means that economics is a bust. There are a lot of things in this world that we don’t understand, and in fields where there are lots of variables it can take a long time to dial in predictive models. But we don’t measure the interest or value of a science by its ability to achieve predictive accuracy by the end of the academic term. We would love such predictive accuracy in meteorology, but there are just too many variables for us to ask for that. The fact that your picnic got rained on is not evidence that meteorology is a bust. Similarly, progress in economics is incremental, and our ability to predict and control inflation (and indeed to properly define inflation) is not something that is in the cards for your next end-of-term report to the university provost. 

Most importantly, when economists predict inflation based on quantitative easing and more liberal monetary policy, that prediction has nothing to do with economists questioning primitive concepts like “money.” To the contrary, those predictions stem from classical monetary theory, which is a theory that has no objection to money, or quantifying it, or representing it by a big fat letter M in its fundamental equations. What we have learned is that getting the predictions right will also require us to dial in the value of V. Thoughtful questioning of foundational concepts does not get in the way of that enterprise.

About the Author

EJ Spode is a philosopher primarily interested in philosophy of language, linguistics, epistemology and conceptual issues of virtual worlds.

Alex Rosenberg's Money Problems is here

Don Ross response is here

Diane Coyle's response is here