I'm pretty sure Mungo was trolling me this morning with his retweets, but it worked anyway.
So let's take a look at the wonder that is market monetarism and its incredible abuse of graphs and accounting identities.
Our data come from Italy and here are the graphs in question:
OK, so the first graph is the path of Nominal income (PY) relative to trend. The second is the path of real income (Y) and the third is the path of prices (P). Nothing objectionable about the graphs in themselves.
You can see NGDP has fallen a lot (relative to trend), mostly due to lower real GDP. Since we are dealing with accounting here, we really only need two of these graphs. the third one is implied by the other two.
But people, what just sets my teeth on edge and puts a bee in my bonnet is the idea that, and I quote:
The message from the graphs above is clear – the Italian economy is suffering from a massive demand short-fall due to overly tight monetary conditions (a collapse in nominal GDP).
Nominal GDP IS nothing more than the product of prices and output. To say that a fall in nominal GDP relative to trend "caused" the fall in the path of prices and output relative to trend is just gibberish.
Try it in the abstract without the sacred labels. "The fall in XY caused the fall in X and the fall in Y".
Ummm, maybe the fall in Y caused the fall in X and as a result XY also fell?? Or the fall in X? Or some third factor caused both X and Y to fall and as an unavoidable consequence of arithmetic, XY also fell?
Labeling PY as "Monetary conditions" and then saying Y fell because PY fell and blaming that on monetary conditions is not an economic theory. It's not even an un-economic theory.
Here's another example of the twisted logic of market monetarism:
One can obviously imagine that the Italian output gap can be closed without monetary easing from the ECB. That would, however, necessitate a sharp drop in the Italian price level (basically 14% relative to the pre-crisis trend – the difference between the NGDP gap and the price gap).
Thats a doozy.
Output is 14% too low so prices need to fall by 14%, doing this will leave NGDP unchanged and the output gap will be eliminated.
The basic problem comes from here:
It is no secret that I believe that we can understand most of what is going on in any economy by looking at the equation of exchange:
People, you can't explain anything about causation WITH AN ACCOUNTING IDENTITY!