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A thread on "nominal anchor".
Which is something central banks & monetary economists talk about, but rarely explain.
(I have no idea where I'm going with this.) 1/
Which is something central banks & monetary economists talk about, but rarely explain.
(I have no idea where I'm going with this.) 1/
Everyone knows that 2 metres is twice as long as 1 metre, but "metre" is just a name.
We need to pin down the length of a metre against something real. Like a metal rod in Paris, (or a distance travelled by light).
That's a "nominal anchor". 2/
We need to pin down the length of a metre against something real. Like a metal rod in Paris, (or a distance travelled by light).
That's a "nominal anchor". 2/
If we measured length in apples, we wouldn't need a "nominal anchor". Because apples are real things, not just a name.
But apples are a bad way of measuring length, because they are all different sizes. 3/
But apples are a bad way of measuring length, because they are all different sizes. 3/
If we measured prices in apples, we wouldn't need a "nominal anchor" either.
But apples are a bad way of measuring prices, just like they're a bad way of measuring length, because they are all different. 4/
But apples are a bad way of measuring prices, just like they're a bad way of measuring length, because they are all different. 4/
We measure prices in dollars. But "dollar", like "metre", is just a name. (Or just numbers on bits of paper, or electronic ledgers.)
We need some sort of "nominal anchor" to pin down the market value of a "dollar" in terms of apples, or something real. 5/
We need some sort of "nominal anchor" to pin down the market value of a "dollar" in terms of apples, or something real. 5/
A digression:
Don Patinkin was great on this. His "Money Interest and Prices" used to be the bible.
But it was flawed (no proper role for money as medium of exchange, so just cooked up a story to stick M/P in U(.)).
So it's been forgotten. 6/
Don Patinkin was great on this. His "Money Interest and Prices" used to be the bible.
But it was flawed (no proper role for money as medium of exchange, so just cooked up a story to stick M/P in U(.)).
So it's been forgotten. 6/
But Patinkin understood the "nominal anchor" question, and what an answer would look like.
His particular answer (which held the stock of Central Bank Money fixed) should be understood as just one example, to illustrate something more general, about different answers. 7/
His particular answer (which held the stock of Central Bank Money fixed) should be understood as just one example, to illustrate something more general, about different answers. 7/
"Money illusion" is when you forget that "dollar" is just a name. Rational people know it's only the *ratios* of things measured in dollars (or metres, or yards) that really matter.
But that creates a paradox.
If *everybody* is rational, there's no nominal anchor. 8/
But that creates a paradox.
If *everybody* is rational, there's no nominal anchor. 8/
If everybody cares only about the *ratios* of things measured in dollars, and acts accordingly, only those ratios get determined, in *any* economic model.
Someone, somewhere, has to have "money Illusion", and act accordingly, to determine the price level, or inflation rate. 9/
Someone, somewhere, has to have "money Illusion", and act accordingly, to determine the price level, or inflation rate. 9/
Central Bankers see it as *their* job to be that someone who has "money illusion", and so creates a "nominal anchor".
It's like providing a public good. It's individually irrational to have money illusion, but we all gain if someone does, so we can use names like "dollar". 10/
It's like providing a public good. It's individually irrational to have money illusion, but we all gain if someone does, so we can use names like "dollar". 10/
There are many different ways central banks could create many different "nominal anchors".
They could peg the price of apples.
Or the price of gold.
Or the CPI basket of consumer goods.
Or make it grow at 2%.
Or peg the stock of dollars.
Or make it grow at 4% (Friedman). 11/
They could peg the price of apples.
Or the price of gold.
Or the CPI basket of consumer goods.
Or make it grow at 2%.
Or peg the stock of dollars.
Or make it grow at 4% (Friedman). 11/
And there are 2 ways can peg the price of gold:
1. Buy & sell gold for dollars at a fixed price.
2. Create & lend more dollars when the price of gold starts to fall; fewer dollars when it starts to rise.
They use 2 for CPI, because it's hard to store CPI baskets. 12/
1. Buy & sell gold for dollars at a fixed price.
2. Create & lend more dollars when the price of gold starts to fall; fewer dollars when it starts to rise.
They use 2 for CPI, because it's hard to store CPI baskets. 12/
Anyway, that's me on "nominal anchor".
And maybe you can also see where us monetarists are coming from. If things are getting longer in metres, we ask how the "metre" is defined. 13/end
And maybe you can also see where us monetarists are coming from. If things are getting longer in metres, we ask how the "metre" is defined. 13/end
BTW: thanks to @JoMicheII and @Britonomist for inspiring me to write this thread. Jo asked whether "nominal anchor" means "numeraire", at the end of an argument about wage-price spirals. Thought it deserved a better answer than the one I gave in reply.
