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:
(1) M*V=P*Y
People, you can't explain anything about causation WITH AN ACCOUNTING IDENTITY!
10 comments:
Like!
I also note scaling the graph to make things look really bad, just in case we didn't figure it out from the accounting identity.
Lol.
I'm old enough to remember V not having any verifiable effect on GDP. Now, everything seems to hinge on V.
Does anyone ever make the distinction between endo- and exo-?
I hold a number of Canadian dollars, and have made more from those than from interest payments on dollars held in money market accounts. If price tells me what something is worth, why can't I buy Canadian dollars at the price I could five years ago?
Oh, it could be that forced increases in inventories has driven prices down. Cet Par. Or, it could be that the recession and federal borrowing with QE has been able to shift nominal prices without reflecting real prices.
Maybe a cup of coffee should be fifty cents. Can't argue with the Fed. We'll see what the price is after the bubble bursts.
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This is pathetic.
Here's the kicker for ya - STICKINESS. The economy is not perfectly elastic. Never has been, never will be.
Wages, debts and other things are STICKY. A fall in spending causes an increase unemployment and bankruptcies.
This is basic stuff. David Hume understood all this in the 18th century.
Apparently, the sophisticated minds (read - pompous bullshitters)of the 21st century can't quite wrap their minds around this.
That's not to say Italy doesn't have supply-side issues.
But just because you're too ignorant to grasp the reality of what "aggregate demand shortfall" means doesn't mean it doesn't exist.
Try harder, bro.
I was taught in my econ courses that if P and Q move in opposite directions it’s (probably) a shift in the supply curve, while if both move in the same direction it’s (probably) a shift in the demand curve. Doesn’t that apply here?
"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."
Also, at a point in time this is correct, over time it isn't. Hedonic adjustments and the like. Comparing NGDP over time is objective, RGDP and price levels aren't.
Angus, you've done a fine job skewering Christenson. But including all of Market Monetarists in your post is inappropriate.
You are right that XY doesn't cause a fall in X NECESSARILY. But it is entirely seemly that lower than expected prices move us along the supply curve to a lower level of output.
Maybe I'm missing all of the irony in written form. But I think that you may have failed the Turing test here.
It might help to realize that most market monetarists think of NGDP as being the same thing as aggregate demand, and that the Fed determines aggregate demand (NGDP) by shaping expectations of future aggregate demand (NGDP). Then the supply side determines how much of that increase or decrease in aggregate demand (NGDP) gets split between price changes and quantity changes. If prices are sticky and the supply curve is flat then increases in aggregate demand (NGDP) get split more into quantity increases than price increases. If prices are flexible and the supply curve is vertical, then increases in aggregate demand (NGDP) get translated into mostly price increases.
So, when MM's say that RGDP fell because NGDP fell, they are simply saying that RGDP fell because aggregate demand fell and prices are sticky. If RGDP had fallen and NGDP hadn't, then it would be a supply side recession.
I am personally entertained by David Beckworth's idea that the Fed is hitting its inflation target where the evidence consists of looking where the core PCE inflation data is, defining that as the target, and saying therefore the Fed must be on target:
http://macromarketmusings.blogspot.com/2014/08/about-fed-not-trying-hard-enough-to-hit.html
For many market monetarists, the Bayesian prior probability of the model that the central bank has and can achieve its inflation target is P = 1, therefore whatever inflation is measured to be, that must be the target (or measurement error).
Friedman's thermostat.
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