Revealing my ignorance

Over at the Marginal Revolution, Tyler Cowen asks….

The question is, when inflation comes, why doesn’t the expectation of that inflation lead to proportional increases in nominal interest rates, thus keeping the real rate constant?

In the comment section on his post I said…

I am going to reveal my ignorance here, but it would seem to me that the answer is obvious if you assume that inflation occurs because of excessive increases in money supply.

The banks are the first beneficiary of new money creation. This new money has the same value as the older sound money (for lack of better word. This enables them to lower real interest rates because they no longer have to pay as high a price for money. In my little ignorant hillbilly mind, I have always thought of this effect as being akin to seigniorage.

Maybe there are good empirical reasons for discounting this theory. If so, I await my education.

Mr. Cowen responded by saying….

Apeman makes a good point, when the church bells in Puebla woke me up at 5 a.m. I realized: “I forget to mention the loanable funds channel!” Sadly the computer was in Yana’s room at the time. I added it to the list.

Hurray for me and all that, but I am still confused. Why is that “Loanable funds channel” is not considered the logical answer? It seems to me that it ought to be pretty easy to prove/disprove one way or another. After all, if the Loanable Funds Channel theory is in anyway correct, you would expect to see some kind of lead/lag effect. Obviously I am not the first person to suggest such a idea, so why can’t anyone figure out a way to test the idea?

One Response to “Revealing my ignorance”

  1. […] _uacct = “UA-1202685-1”; urchinTracker(); Map of the Ethereal Land The Ethereal Voice Front Page – Politics – Money – Knowledge – Art – Food – Fun Masthead About Revealing my ignorance By Ape Man | December 24, 2007 – 7:58 pm Posted in Category: Front Page, Money Over at the Marginal Revolution, Tyler Cowen asks…. The question is, when inflation comes, why doesn’t the expectation of that inflation lead to proportional increases in nominal interest rates, thus keeping the real rate constant? In the comment section on his post I said… I am going to reveal my ignorance here, but it would seem to me Click Here to continue reading. […]

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