itfitzme
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- #21
Yeah see I have a pure maths background, so I approaching things with "is this a helpful way to think about something; does it yield any interesting results?" rather than trying to map concepts to some physical representations.
So the equation of exchange is just an identity. We can't get anything useful out of an identity. First off let's write it in terms of growth rates rather than levels, so MV=PY => %M + %V = %P + %Y. We have to add some rules to make it interesting. The first and most obvious being that Y returns to its natural rate in the long run, it's long run growth rate being the trend growth in productivity + trend growth in population. Say about 3%. Next we ask what measure of money we should pick for M. Friedman liked to use M2 because M2 did something cool. I can't find it now, but I recall seeing Friedman showing that the long run demand for money when money is measured as M2 is stable. So the velocity of M2 is stable, hence %V = 0. So the only things left to vary are M and P, which gives you the conclusion that inflation (%P) is everywhere and always a monetary phenomenon.
This turns the "equation of exchange", a useless identity, into "the quantity theory of money". An immediate consequence of which is that inflation = %Y - %M = 3% - %M. So if you want to have zero inflation, you should target M2 growth of 3% (Friedman's K-percent rule). On top of that, if there's a stable relationship between "how much" monetary base gets "turned into" M2, you can achieve stable prices with a constant monetary base rule.
Of course the problem is that over the short run velocity isn't stable (in the same way the exchange rate isn't stable around PPP in the short run), and the economy can be hit by productivity shocks which change the natural rate of ouput. And of course the way MB affects M2 is volatile.
So over the short run the quantity theory of money is useless. The reason you'll see me citing MV=PY all over the place is because people frequently misapply QTM thinking that velocity is constant over the short run. So you get shit like "interest rates rates were low, that means easy money!".
And yet, in things like electrodynamics identities lead to useful deductions. Interestingly, the history of electrical engineering, that was added to by Farady, Henry, Volta, and others, was then picked up by Maxwell who began with identities and deduced that the speed of light is dependent on only the permeability and permittivity of free space. It is an interesting process of taking a bunch of mathematical identities that were tested under the condition that the mathematical representations map into physical quantities. The combination of a few identities combined to show that c=root(e0*u0). Every thing else, relative speed, etc, just canceled out. That result was picked up by Einstein who then leveraged it to produce his theory of special relativity.
Of course, the history of modern physics seems to be an interchange between the theoretical physics, more pure mathematics types, revealing some things and the applied field reveling other. Each often getting the other unstuck. Currently, they are working on the Higgs boson where the the pure math is able to suggest where to look and the particle physicists are now looking.
In MV=PQ, P and q are identifiable quantities. M is a countable quantity and V can, in a simpler system, be identified. But, each are physically different objects. As such, while mathematically it is simply an identity, it shows how these otherwise different observable phenomena are in fact related.
It's similar to voltage and current which are measurable and physically different quantities. The identity, V = RI is simply an identity. But it becomes pretty important when combined with the identities related to other objects that are in the same physical system. V=c*dI/dt, and I=L*dV/dt are also simply identities. But combined in the same physical system, the I becomes a common element of flow and suddenly, the performance of all of the quantities become interdependent.
I am in no disagreement with the idea that the frequency of money is not necessarily constant. I have yet to see any way to deduce or demonstrate even it's upper and lower boundaries.
It will take me a while to absorb your comments. Unfortunately, I am afraid you haven't presented it in a manner that I am going to find easy to recognize. But I'll give it a shot starting with rewriting it in terms of growth rates and following through. It might be helpful if you can show how
MV=PY => %M + %V = %P + %Y
is arrived at.
And I will see if i can find Friedman and his M2.
Being that V and M are not directly measurable, just too many people, it will be nice to see how Friedmen got around this issue.
And M2 is nice in that it doesn't include reserves. It includes the stock of money available to enter the flow, demand deposits and the like. But, it isn't the stock in the flow. For all I know, this is why it is considered that V is not constant. Without either a direct measure of it, a solid deduction based on underlying physical quantities, or some valid deduction based on an alternative and measurable quantity, it remains simply unknown. That becomes a real problem. All I find so far are statements that it isn't constant, without any proof, or s presentation of VM1, which isn't M or V.
And it is a fact to say that V is not infinite nor can it increase without bound. It does rely on physical processes that limit it. One dollar can only go round the loop so fast, even if it is just two people handing the same dollar back and forth between them. It may very well be that the introduction of electronic transactions have substantially increased the rate.
M2 may serve as an indirect measure of M. I am not sure what we mean by M2 is stable. M1 and M2 have increase constantly since 1959. I haven't converted that to real or per capita.
The question remains, how does M2 actually increase. It certainly has, as has M1. But, it does not account for all money in the flow, especially if the flow is dependent on some other source or sink. There is no doubt that the change of M1 and M2 are connected to the change of M. They are sources and sinks for M. And, if in fact, no other method exist for putting debt free money into the flow, there is only one way that these could increase. All physics models are based on capturing all sources or sinks. Otherwise, you have some unknown that may be serving as a buffer that has a performance which is correlated to the level of the flow, but isn't it. So we look at M1 and M2, increasing yet have no defined source for that increase.
Ergo, why I am looking at if from the perspective of
(Mf + dC + dS) V = PQ = GDP(2)
because dS captures the savings, demand, and other checkable deposits as they serve as a source and sink to the flow. dS is the change in M1 and M2. Clearly, if everyone keeps $200 in their savings account, thus elevating the M1 and M2, but is not used for M which accounts for P, then doesn't to do anything. And, unlike simpler processes where the level of the source does have a definable effect on it's rate of change, I don't see we can say the same for savings.
Let's face it, it's just money and transactions, it's just not that complicated. The complicated part is that its based on 7 million businesses, 160 million workers, and twice that in population. That makes it difficult to observe M and V. P and Q we can get by survey or sample.
I am left, there for, to conclude that (Mf + dC + dS) V = PQ = GDP(2), given that V cannot increase unbounded and no mechanism exists to increase Mf, leads to the unmistakable conclusion that dC, credit, remains the only source of money to increase the flow, in the long run.