September 25, 2009
Links for 2009-09-25
Tim Duy worries that some FOMC members are overestimating the inflation risk.
Arnold Kling proposes a mackerel theory of value.
The discussion at Cato of monetary policy continues.
Posted by James Hamilton at September 25, 2009 07:26 AMdigg this | reddit
To Arnold Kling's comments on Hummel. I am always amused when someone takes the equation MV=PT or Py or whatever, and attempts to prove anything. As Kling states this is an identity. As an equation it has no meaning unless you can actually define the components and right from the start no one has any idea what M is. We have M0, M1, M2, M3, .... but none of these Ms have any meaning unless they totally define the money supply and they do not.
So that means that V is also an unknown.
What of P? Can you tell me the price of a hamburger plus an hour of digging ditches plus a haircut in terms of a vacation to Las Vegas? Oh, you need to know how long a vacation and where I will stay? How about how much I will eat? Admit it, P is an imaginary number.
So what about the number of transactions? Can't we know that? What transactions, a car wash, a plate of ribs?
Oh, but if we know three of the four we can determine the fourth. Come on! You can't even define one of the four with any accuracy much determine any kind of reasonable value.
Then to say that nominal GDP is equal to MV is absurd. How do you define nominal GDP? Will anyone put their life on the line and say that nominal GDP captures all of PT?
The whole argument is foolish.
Posted by: DickF at September 25, 2009 07:59 AM
And here is what I think Kling has done:
"Isn't the notion that PV is on its own path and that manipulating M forces V to respond ignoring a lot?
Great Recalculation? Sure, call it whatever you want. The thing is, part of whatever you call it was a perturbation in the financial sector. It may be that policy induced changes in M force offsetting responses in V when the economy is running along as it normally does. However, having a large number of financial links come unlinked at the same time is, in this equation, represented by V falling. That is not a response to M. If V falls because we have done a bunch of silly things in the financial sector, then the Fed can aim at keeping MV stable by increasing M.
Now, as I understand these things, M is not so likely to respond automatically to changes in V. Whatever may have happened independently on the PY side of the equation, any drop in V greater than required to accommodate the independent drop in PY would lead to a further drop in PY, unless there is a policy decision to increase M.
In short, what I think I see here is an effort to ignore the largest bout of financial turmoil in decades, just waving PY around and pretending the collapse of financial intermediation was a reflection of that, instead of an independent source of influence in the economy. Policy makers shoved M up because V was down. V did not fall because policy makers shoved M up."
Posted by: kharris at September 25, 2009 08:02 AM
The closest thing we have to money velocity are transaction rates along the supply chain for essential consumer goods. For any given supply chain length, the transaction rates will adjust such that transactions are minimized. Regardless of total output, the lot size of each transaction for a given supply chain length will adjust to keep transaction rates constant and minimized
It is the snap back theorem, the permanent income hypothesis rolled up. Changing the lot sizes to get back to minimum transaction rates with a technology determined supply chain is called achieving economies of scale.
Deflation is the reduction of the supply chain length, inflation the increase in supply chain length. Deflation will always over corrects, resulting in larger, more stable inventories at each step. The opposite happens in inflation, less inventory at each step and greater inventory volatility.
Recalculation results when some essential good wants a shorter supply chain but others chains do not have technology to shorten, so the bankers yield curve suffers supply chain interference.
Because the economy seeks coherence on the yield curve, the economy would prefer all supply chains equalize, including number of terms on the bankers yield curve.
That is what we suffer. The oil supply chain is short, the consumer supply chain is still long. A rise in consumer demand transmits faster up the oil chain than the consumer chain. By the time suppliers respond to consumer demand they are already restricted by oil scarcity.
Posted by: Mattyoung at September 25, 2009 09:26 AM
I thought that even monetarists conceded that looking at Ms is inadequate for policy decisions, and that is why the Fed targets (with much reservations on my part about whether they get these things right) inflation and the "potential" of the economy, which is comprised of things like employment and output gap.
For one thing, we stopped trying to count M3, which is the only measure broad enough that may have captured financial assets like stocks, bonds, commodities and mackerel, er, I mean housing. And we know how easy it is to flip these things back to money and vica versa. Case in point is M2 went to something like 15 trillion at the beginning of the year. Some people thought the Fed did it. I think collapsing world markets did it. Then some stock analysts have warned of flat M2 growth post green shoots. Since the US stock market went up around 3 trillion during this period, I think it was stock people that did it.
Here are some wiki articles which discuss it, but it looks quite hopeless trying to assign which are the dependant variables, which are the dependant ones, and where does the data come?
Posted by: Cedric Regula at September 25, 2009 10:02 AM
Is Kling's posting a variation of the posting you did on Sept 16 discussing Sumner?
Posted by: Rob at September 25, 2009 01:39 PM
JDH: you've spoken about retraining and other built in frictions involved in adapting to a new economy - would you say Arnold's "great recalculation" is similar to your view?
Posted by: Robert Bell at September 25, 2009 04:48 PM
Rob: That's how I read it, though I thought Arnold's version was more entertaining than mine.
Robert Bell: I think the ideas have many things in common. Though one thing that can happen in my model is that people just wait for their sector or specialty to come back.
Posted by: JDH at September 25, 2009 06:56 PM
What a great debate!!!
You and Professor Hummel are definitely more rational than Professors Sumner and Selgin. Selgin and Sumner seem to rely more on wishful thinking than economic analysis.
I believe that Professor Hummel does make one huge mistake. He writes:
Even then, as Sumner astutely emphasizes, Bernanke accompanied this inflationary step with the deliberately deflationary step of paying interest on bank reserves. Henderson observes in a recent post how this stands in marked contrast to what Alan Greenspan did when faced with a mere whiff of panic in anticipation of Y2K and after 9/11. In both instances, Greenspan flooded the system with liquidity and then, when any financial uneasiness calmed, rapidly pulled the money back out, a policy far more consistent with the implications of Freidmanís research. I thus am persuaded that financial failures under Bernanke would have been far less serious if the Fed had simply started expanding the base well before September, and had done so without any direct bailouts that exacerbated moral hazard.
Greenspan did flood the economy with liquidity in anticipation of Y2K. The result was serious and almost immediate inflationary pressures. Then in around April 2000 drastically pulled liquidity out of the economy and created the recession that plagued the end of the Clinton administration and dogged the first part of the Bush administration lasting until the supply side tax cuts in 2002.
Had Bernanke not sterilized his injections of liquidity we would currently be in the midst of a huge stagflation near the 1970s level. Bernanke understood that his actions would cause inflation but because he is Keynesian he attempted to stimulate consumption through the banks while sterilizing his injections into the banks. What he has left us with is the Sword of Damocles dangling over our heads in the form of potential hyperinflation with a FED balance sheet filled with questionable paper.
But that said, In my opinion Professor Hummel is the only one who really seems to understand the unknowable nature of the business cycle and the futility of hubristic attempts by government to control it.
Here is his conclusion.
Ö Given that the financial sector, from which business cycles apparently emanate, is one of the most heavily regulated within the U.S. today and, in fact, has never been fully deregulated, ever, we should instead be looking at deregulation and privatization, rather than better fine tuning. Sumner has, I believe, made a major contribution to the debate over the recent recession. Yet with all his close attention to the work of Milton Friedman and his sympathy for free markets, I am puzzled that he has said little (as far as I know) about Friedmanís conclusion that private currency issued under the Aldrich-Vreeland Act headed off a panic in 1914 and would have done a far better job than the Federal Reserve during the Great Depression. Nor am I aware of his addressing the arguments of Selgin and Lawrence H. White that free banking would spontaneously stabilize MV through the automatic operation of the clearing system. In the final analysis, only abolition of the Fed, elimination of government fiat money, and complete deregulation of banks and other financial institutions offer any long-term hope of bringing better macroeconomic stability.
Posted by: DickF at September 27, 2009 09:51 AM
Back to MV=PT.
First assuming that MT is equal to Py as nominal GDP seems to totally miss the importance of the identity in the equation and substitutes a flawed concept for a correcly theoretical identity.
But that said, why is it that modern economists constantly analyze the left side of the equation but seem to totally ignore the right side? I had a friend tell me that it is because the left side is the government side and the right side is the free market side. Interesting take.
Posted by: DickF at September 27, 2009 10:17 AM
Of course I meant "First Assuming that PT is equal to Py."
Posted by: DickF at September 28, 2009 05:14 AM
Hummel's recent response "Taxing Banks for Holding Reserves" is outstanding. Pointing out the fact that the FED is stepping outside of its role with monetary policy is very important. I have heard that the Congress will get jealous if the FED continues in that direction but I am not sure. More and more the Congress just meddles while dumping the important decisions off on unelected bureaucrats.
Posted by: DickF at September 29, 2009 01:42 PM