Leave a Comment, Larry
By Arnold Kling
In an interview, Larry Summers says,
The classic concern with respect to imbalances is that a situation develops where people are both trying to take money out of a country’s banks and trying to sell its currency. And the central bank can’t both add liquidity to help the banking system and the economy and reduce liquidity to maintain currency stability.
This was a new one on me.
I understand that if you raise the growth rate of the money supply, the currency depreciates. And I can see where banks that are suffering from a run might need reserves, and if the central bank adds reserves then this increases the money supply. But…
When people withdraw money from banks, isn’t that contractionary for the money supply? In the money and banking unit of freshman econ, if the public switches out of demand deposits and into currency, then banks have to cut back on lending, and the money supply goes down.
So I’m having a hard time worrying about the monetary expansionary effects of adding reserves, when what those reserves are doing is offsetting the contractionary effect of people pulling money out of banks.
Maybe the concern is what to do about the additional reserves once the bank panic stops and people are putting their money back into banks. But at that point, can’t the central bank sop up the extra, or just raise reserve requirements?
Larry, if you’re reading this, leave a comment and clarify. (This is sort of like the story Tom Wolfe tells in The Electric Kool-Aid Acid Test of Ken Kesey and the Merry Pranksters putting up a sign saying, “Welcome to the Beatles” in the hallucinatory hope that the Beatles would show up.)
Thanks to Greg Mankiw for the pointer.
The entire interview is recommended. Summers gives a number of rationales for having wise heads manage global economic problems. My views differ from his, but his views are well worth reading.