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the ultimate goldbug

So I’m a little late to this whole Game of Thrones thing, but I’m making up for it, having watched every episode in the last month as well as reading A Game of Thrones and making my way through A Clash Of Kings (my goal is to catch up with the show by the end of the season and read all the books by summer’s end). And since Matt Yglesias has been econblogging from GoT I figured I might as well get on that wagon while it’s still bandy. Also, it involves ragging on the "hyperinflation in America is imminnent!" set and while that’s like shooting fish in a barrel, sometimes shooting fish in a barrel is fun!*
Something that always puzzled me re: predictions of looming hyperinflation is where the predictors think the supply constraint is. Even if you accept certain assumptions about "money printing" that I would quibble with, it’s not an increase in the money supply that leads to inflation per se it’s growth in the money supply that oustripts growth in real goods and services. Assuming "velocity" is constant (whatever that means) to assume that mo money = mo debasement means you have to assume that level of goods and services is constant. If you magic a $20 bill out of nothing and hand it to me I might decide to give it to an unemployed person or stuff it in my mattress or buy something with an extremely elastic supply schedule like a nice haircut. But I might also buy gasoline! To assume that "all this new money" will lead to hyperinflation you have to believe that the economy is producing as much as it can produce or that there is some real constraint on the economy.
Here’s a great example – in A Clash of Kings, when Tyrion Lannister is scoping out King’s Landing (which has seen an enormous influx of refugees since war erupted) he makes this observation:

"The markets were crowded with ragged men selling their household goods for any price they could get…and conspicuously empty of farmers selling food. What little produce he did see was three times as costly as it had been a year ago."

This, of course, implies annualized inflation in King’s Landing of 200%. That’s hyperinflation! But the reason for it is not an influx of money (say, the Lannisters minting more gold to pay off the Iron Throne’s sovereign debt) but severe supply shortages – the war is both reducing the productive capacity and capital wealth of the Seven Kingdoms as well as massively disrupting transportation networks. This is firstly a nice example of the principles behinf Paul Krugman’s work on economic geography but secondly goes to show that hyperinflation a) doesn’t necessarily require an increase in the money supply just as an increase in the money supply doesn’t necessarily engender inflation and b) that hyperinflation is usually a symptom of underlying dysfunction and catastrophe. Certainly there are supply contraints in the modern American economy but given that commodity prices are falling and lots of people aren’t working while putting everyone back to work through monetary expansion would cause some inflation it wouldn’t evaporate all dollar-denominated wealth and it certainly wouldn’t do that while there are vast amounts of underutilized resources in the economy.
*Actually, as of late I’ve been more in to shooting fish in mid-air with a bazooka.

A simple problem – let’s say the central bank has a 2% inflation ceiling. Ergo, if it records inflation expectations as over 2%, it will take action to lower those expectations, usually raising interest rates as a way of draining the money supply, which also has the effect of decreasing total economic activity. Additionally, everyone knows this, so when some activities or events occur that would ceteris paribus increase inflation expectations markets presume the central bank will act to quash inflation and therefore adjust their overall expectations of economic activity. This will probably manifest itself as a reluctance to invest.

Let’s say unemployment is 10%, inflation is 1%, and real GDP growth is 1%. Let’s further say that the central bank is willing to tolerate an unlimited amount of RGDP growth but refuses to budget on its inflation ceiling. Let’s further say that any activation of idle labor will necessitate some inflation due to short-to-medium-run supply inelasticities. And let’s say everyone knows all of this.

Let’s say some large positive exogenous shock causes a boom in labor demand in some sector or another. This model would predict a largely zero-sum net gain in employment or economic growth, as the increase in activity in that sector will be offset by a decline elsewhere. The only net increase would be that commensurate with accommodating short-to-medium run supply inelasticities – that is, there can be some net gain every period, but only enough that it doesn’t push up prices very much.

Consequently, the Committee anticipates that the unemployment rate will decline only slowly toward levels that it judges to be consistent with its dual mandate.

Tyler Cowen poses this question:

Why is there still inflation in Greece?

He thinks this puzzle is hard, but it is in fact easy. Let’s model this more simply:

There are three countries in the world, Productoland, Moderatia, and Dysfunctiony. In this model there are a few rules:

· All money is gold.

· All goods and money can be teleported and traded freely across national borders.

· There is a universal legal prohibition from a resident of any country from relocating to any other country for non-leisure purposes.

· Wages are sticky.

· The equation of exchange accurately describes these economies.

In the initial state all three economies are performing well, even though “fundamentals” (mainly institutions) are much stronger in Productoland and significantly stronger in Moderatia. However, after some unexpected shock (say, a surprising report about the economic state of Dysfunctiony), there is a “panic” about the economy of Dysfunctiony. Very rapidly money, ie gold, begins to flee Dysfunctiony.

What would we expect to see happen? Primarily, we would expect to see a substantial negative shock to AD in Dysfunctiony. Wages are sticky; and more importantly, the law of one price means that prices of all goods (since there are zero transaction costs in this model) must remain equal in all three nations. Therefore, the decrease in MV would result in a reduction in QP; but because both Plabor and Pgoods are sticky, we would expect to see most of the commensurate decline occur in Q. We would expect to see some slowdown in Productoland and Moderatia, since presumably the market for imports in Dysfunctiony is slower, and overall global NGDP would probably fall, but if labor markets remained relatively tight in Productoland and Moderatia, we may in fact see the increase in MV in those countries (due to the influx of gold, ie money) lead to an increase in P, since Q is probably nearing its upper-bound; and an increase in P in those countries would of course result in a further increase in P in Dysfunctiony to the extent it affected teleportable goods. This would of course result in a further commensurate decline in Q, which would cause MV to further flee.

Basically, if transaction costs and barriers to trade are low, we should expect to see consumer prices move in unison within a currency union, and we should expect monetary shocks to result in severe real declines in output but continued price stability. This, I believe, sufficiently explains why Greece saw massive unemployment even as prices continued along the ECB’s chosen path, for the same reason Nevada saw unemployment increase from 4.2% to 14% over the course of the Great Recession even as there is no evidence that consumer prices diverged wildly in Nevada from other parts of the United States.

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