Trouble with the equation of exchange.

[DSGE]

...such as? That's ridiculous. There are good reasons why demand for certain goods and services should fall. There's no reason to prevent aggregate demand from falling. But there is a good reason to not let it fall.

Sorry but I don't think there is a constant of "NGDP". The number at which it should always be for maximal wellbeing given. How do you know you have the right constantat X anyway?

It's a nominal variable. It doesn't matter which constant you target. You just have to pick a target and not deviate from it. It's real variables we care about. If 1 dollar buys one can of coke and 100 yen buys one can of coke, who gives a shit? We don't care about the number, we care about how much coke we buy. The point of picking an NGDP target and not deviating from it is that we no longer have to worry about nominal variables fucking over the real economy.

Maybe the best economic outcomes come if it's the money that is constant. Or maybe not. I am saying that you are assuming.

Well I'm not assuming, I have reasons for choosing an NGDP target over a monetary aggregate target or a price level target or an inflation rate target. That's a different conversation, but I gave one reason above. Demand side recessions happen because of frictions preventing nominal variables adjusting downward. If we stop those nominal variables having to adjust downward we stop having to care about the frictions which make nominals affect reals.

So with this in mind are you saying NGDP should be constant or only increase.

Both are acceptable. The important thing is announcing the trajectory for NGDP and not deviating from it (up or down).

Either way, we are just blocking the discussion here. Let's move it somewhere else.

I don't think we are. A discussion about which variable the central bank should target is for another thread, but the idea that all demand side recessions are the central bank's fault is relevant because the equation of exchange can help us see that NGDP is entirely determined by monetary policy.

 

[Norman]

It's a nominal variable. It doesn't matter which constant you target. You just have to pick a target and not deviate from it. It's real variables we care about. If 1 dollar buys one can of coke and 100 yen buys one can of coke, who gives a shit? We don't care about the number, we care about how much coke we buy. The point of picking an NGDP target and not deviating from it is that we no longer have to worry about nominal variables fucking over the real economy.

So you would rather impose a mandate of constant NGDP (Or constantly growing NGDP) than employment and stable currency? Or maybe combination?


Anyway I disagree you with that it's the NGDP that "F*cks" the economy. I think that shrinking NGDP is an effect and not a cause. For example if meteorites fall on earth the NGDP will shrink (or change curse) and that's a good thing.

Well I'm not assuming, I have reasons for choosing an NGDP target over a monetary aggregate target or a price level target or an inflation rate target. That's a different conversation, but I gave one reason above. Demand side recessions happen because of frictions preventing nominal variables adjusting downward. If we stop those nominal variables having to adjust downward we stop having to care about the frictions which make nominals affect reals.

Again I disagree. I think demand side recessions happen because people no longer want to consume certain goods. That means a lot of people need to get fired etc. That is what triggers the shrinking NGDP and while there are some good arguments for monetary stimulus I don't think boosting some number to it's "magical constant" value is very good reason.

I don't think we are. A discussion about which variable the central bank should target is for another thread, but the idea that all demand side recessions are the central bank's fault is relevant because the equation of exchange can help us see that NGDP is entirely determined by monetary policy.

Well I will stop replying now because I think we are no longer discussing the equation. I do like to participate in "NGDP and economy" discussion though.

 

[DSGE]

So you would rather impose a mandate of constant NGDP (Or constantly growing NGDP) than employment and stable currency? Or maybe combination?

An NGDP target is a maximum employment and stable prices target. Remember NGDP is the price level, P, multiplied by real output, Y. It services both at the same time. If you want no inflation on average, you pick a 3% NGDP target (since trend growth of Y is 3%). If you pick a constant NGDP target, you'll get about 3% deflation per year.

If Y and P both fall, money it too tight, so the target will force the central bank to ease. If Y and P are both too high, money is too loose, so the target will force the central bank to tighten. If Y falls and P rises, or P falls, and Y rises, those are supply side factors changing that the central bank shouldn't react to with demand management. An NGDP target will prevent them from reacting to supply shocks (the same isn't true of a price level or inflation target).

Anyway I disagree you with that it's the NGDP that "F*cks" the economy. I think that shrinking NGDP is an effect and not a cause. For example if meteorites fall on earth the NGDP will shrink (or change curse) and that's a good thing.

No, RGDP will fall. There's no reason for NGDP to fall. This is why this conversation is relevant to this thread. NGDP is MV. It's entirely controlled by the central bank. Real factors need not affect NGDP, and monetary policy should not be reacting to real factors.

Again I disagree. I think demand side recessions happen because people no longer want to consume certain goods. That means a lot of people need to get fired etc.

Well that's not a demand side recession. That's a reallocation of resources throughout the economy. RGDP will fall, and we shouldn't try to prevent that or offset it with monetary stimulus. But there's no reason NGDP would fall.

Well I will stop replying now because I think we are no longer discussing the equation. I do like to participate in "NGDP and economy" discussion though.

Okay. I'll get around to creating a "What should the Fed target?" thread soon.

 

[itfitzme]

Not only do you have to live in the real world, you have to live in all of it. Ignoring one part of the real world leads to conclusions that are not real.

If your looking for real GDP, all you do is

MV/CPI=Σpq/CPI=NGDP/CPI=R_GDP.

Σpq = p1q1+p2q2+p3q3 and those are real goods.

Uhm. No you don't. When you insert the CPI there you start living in real world, but that completely changes the equation and renders it meaningless.

CPI can change while M and V are both stable so you can not at that point predict anything anymore.

It's always interesting when people take the positions of "If it doesn't produce what I am looking for, then it is useless for everyone", "If I don't understand it, then nobody does", or "If I don't know it, then it is unknowable."

And, I don't think anyone anywhere suggested it serves as a predictor of inflation. But, as you bring it up, if M and V are fixed, it does put some limits on inflation. Inflation is, of course, measured by the change in the CPI.

If you want to predict inflation, you might want to start with what the Fed is targeting. Bernanke took his position as Fed Chairman on Feb, 1 2006. Assuming that the first month was to make the decisions to affect inflation in the following month, then I would go with the CPI since March-2006. Of course, we had that bugger of a recession that made for some tremendous instabilities, so we will want to look at the "stable" period in order to predict performance going forward. We can use the instability, but that's just going to increase the spread.

The recession was December 2007 to June 2009. That kind of limits the data to March '06 to December '07 and July 2009 to October 2011. (I didn't feel like downloading new data) So, just for shits and grins, we will drop just the October 2008 through December 2008 as outliers. A 3% yearly rate is .247% a month and a 2% yearly rate is .165%.

The Fed performance over Bernanke's term has been an average of 0.27% with a standard deviation of 0.35% per month. Assuming the target was 3%, then the Fed managed to get to 0.023% above the target.

So assuming all else being the same, if they are targeting 2% a year, or .165% a month, I predict they will get to an average of 0.188% monthly or 2.28% yearly. Of course, random fluctuations were at that one standard deviation of 0.35% per month which is a swing of three times that some 1% of the time. So, while it will average about .188% monthly, it will swing by +/- 0.35% 60 percent of the time and by as much as +/- 1.049% every so often. The calculations might be a bit of a cheat as there is that whole (1+r)^n-1 thing that has to be done when dealing with year vs month in percentage changes to money. But it's close enough.

See how I did that?

That's good enough for Vegas odds.

If you have a better way, the world would like to know.

But lets just look at one point. By money supply, I am using Hume's definition, the money that is used for the purchases of the goods.

CPI is Σpq = p1q1+p2q2+p3q3 based on some standard basket of goods. NGDP, which is fixed by MV is Σpq for everything. The CPI can actually stay constant with one price going up if another goes down.

If, in fact, the makeup of output, population, standard of living, income, and everything else were absolutely fixed, then inflation would simply not happen, period. If population were to continue to increase with a fixed money supply and standard of living, all other things being equal, we would have deflation simply because the increase in output is necessary to maintain the standard of living and all that M is divided out among all that output. As such, prices go down.

If the CPI were to increase, being a subset of the NGDP, then the only way for it to do so with a stable money supply and all other things being equal would be for some other prices in the NGDP, not part of the CPI, to decrease.

MV=PQ isn't, though, a predictor of inflation. It sets some constraints on what all the markets can do. Assuming M and V are constant, then all prices are simply a percentage of the money supply.

If you don't believe that, then ask Mitt Romney why he says that "Bernanke has over inflated the currency"? Or, why the "gold standard" guy is ticked off with the government "printing money"? What they are also saying is that if the government didn't print money (increase the money supply, M) then there wouldn't be price inflation. Their conclusions are based on this simple little MV=PQ.

The reason I would use the performance of the Fed to predict inflation rather than MV=PQ is the same reason I predict the temperature of my home using the setting on the thermostat. On the other hand, you can bet your sweet patooty that the Fed targets inflation based, in part, on MV=PQ. I don't work there and they tend to be a bit secretive, so I dont' know exactly what they use.

Someone else came up with the home heater analogy. The CPI target is the thermostat setting. The CPI is actual temperature of the house. The central heater, and the warm air coming out of it, is the change in the money supply that the Fed accomplishes though monetary policy. And the temperature outside the house, that determines how much heat gets lost and how often the heater goes on and off, is the factors that affect the CPI and GDP that the Fed is busy trying to offset.

So, if it's good enough for the Fed, to manage inflation, then it's good enough for me in understanding how and why they manage it.

That said, it is completely unclear what you possibly mean by "renders it meaningless." As I recall, your original statement was that it was useless, even without the CPI. So I take it to mean that adding the CPI makes it doubly useless. That, of course, is a useless statement.

In fact, while MV=PQ is already useful. It gets even more potential use by dividing through by CPI. You get, R_GDP = (M/CPI)*V=Σ[(p/CPI)*q]. We like that because we recognize that the value of the dollar changes with respect to what it can purchase. An increase in M may actually not keep up with inflation or even population. By dividing M by CPI, we get something that is comparable from year to year. By dividing by population as well, we get something that is representative of the real value per person. If we expect our standard of living to remain the same while cost of living is targeted at 2%, then the money supply better increase by enough to represent a constant real dollar value. So dividing by CPI and POP, we get something that we might even consider to be more useful. And, um no, it doesn't completely change it, it changes it in a controlled and recognizable way.

See what I mean?

 

[itfitzme]

Also this is incorrect because according to the equation it is also possible that when price of a product halves you buy 2x more of it. If you "halve" the price of potato from 2 per 2 dollar to 53243 per 1 dollar nothing happens if people buy 2 times more of those 1 dollar transactions. See what I did there? Nominal tinkering gets us nowhere when measuring REAL inflation.

Then again, as I thought about it, going back to Hume and his observations, what he said was, in fact, there were two effects that occurred when more money was introduced into a country. One effect was that prices increased and the other was that output increased.

What bugged the h out of me when studying physics was, at first, that I couldn't for the life of me build my own relationships. After a while, I understood that what the greats did was to focus on those factors that had the most effect and treat the rest as noise, or fiction. They kept simplifying the problem until they had something that was manageable. If you take Newton's equations for motion, you can predict where a projectile will land based on them. So you build this spring loaded mechanism to launch a steel ball, set a target out where you think it will land, and fire away. The ball never hits dead center of the target. Sometimes it is a little to the left, sometimes it's a bit long, other times it's short, etc. Over thirty trials, the average is right where you expect it to be. And given that your launching the thing some thirty feet with a one inch steel ball, that's not bad. Of course, if you decided to use the same contraption with a bowling ball, it would be way off. It would have to be recalibrate because the weight of the bowling ball is so extreme that it adds pounds of friction that swamp the effect. You do better with a bigger spring. If you want to launch a pumpkin 3/4 of a mile, you need something a bit bigger. And, as Newton's equations of motion don't account for wind, you might want to factor that it. This doesn't invalidate Newtons laws of mechanics. Newton's laws have been tested in a vacuum. Amazingly, though he didn't have a vacuum, they are dead nuts on. The laws of mechanics, like micro and macro economic laws, are based on "all other things being equal" and "within a realistic range". If we had a perfect spring that functioned under all possible conditions of compression, that could be compressed from 0 lbs force to infinite lbs force under no length of travel then it could handle everything from a ball bearing to a bowling ball with perfect accuracy and precision. But that's just silly.

If you could control everything, then yes indeed, MV=PQ says, and supply and demand says, that given a price elasticity of 1 and a supply elasticity of one, if you dropped the price in half from 1lb for 2 dollars to 1lb for 1 dollars by shifting the supply, then people would spend there last two dollars on two pounds of potatoes. But a non normal example of 53243 per 1 dollar to demonstrate that MV=PQ or even supply and demand doesn't produce a "normal" result makes little sense. You put non-normal in, you get non-normal out. P1Q1 is the micro-economic equilibrium point. And how that point finds its new equilibrium point due to shift in supply and demand as well as changes in the quantity supplied and demanded is constrained by both the micro-economic factors that effect the supply and demand curves as well as the macro-economic effect of the money supply.

Just as well, you can't, by any stretch of the imagination, predict the macro economic general increase in prices using micro-economics supply and demand. I order to do that, you have to combine all those micro-economic supply and demand markets together into one big equation and when you do, what you get is a very complex version of MV=PQ. You also end up with a model that even the IPCC climate modeling computers couldn't handle. Trust me I did it, to a point, and then realized that all I did was reinvent the wheel. Hume, Mills, and Keynes had already gone through the trouble. So I managed to spend a week of evenings only to end up with what I would have gotten by reading Wikipedia. Then again, I ended up with a much better appreciation of what I was looking at, that prices are not just a function of their individual markets but, though the chain of supply and demand, as things are all interconnected, it all finds a final balance within the constraint of the money supply.

What I have gotten, as someone else has pressed me to get, is that MV=PQ has kind of mutated from Hume's initial presentation, to something that real economists with limited real data can manage to accommodate. Now, apparently, there is Hume's model where M is the money that is what is actually spent of the goods at price p to something that uses what the Feds can measure, the monetary base, M1, M2 etc and includes all the "in between" forces in V. That works for them.

But, what Hume's definition tells us, within realistic range of prices and quantities, is that the upward pressure on the price of gasoline at the pump puts a downward pressure on the price of DVDs at Blockbuster. After all, when it comes right down to it, responsible Susy homemaker uses her balanced budget, in the form of M=PQ where M is all the money she can spend and PQ are the prices and quantities of stuff she has to buy, her husband need to fill up that Ford Pickup and she her SUV with $50 worth of gas, and after coupon clipping and buying groceries, what is left over from M determines if she's going to buy 4 for $20 or just settle with one romance movie for $10 and let her kids watch the Toy Story a second time. And, if Blockbuster were to have an amazing sale of 53243 DVDs for $10, she would have her kids and hubby down there on Saturday loading up her SUV and his Ford Pickup with everything that they could carry. And that would be deflation, if the CPI includes DVDs in the standard basket of goods.

All that said, if you read Hume's examples, he suggests that the first thing that an increase in the money supply does is cause output to increase to supply pend up demand. That is because the signal that there is more money doesn't happen until after demand increases. After demand has increased and excess supply has begun to be used up, then prices may start to increase as either suppliers recognize that they can or they increase production which has increasing marginal cost.

This is an interesting point because it does say something about whether the increase in M will result in inflation or increased output. If output is already at a maximum and there is no excess supply, then it will show up in inflation. If output is below it's maximum, like unemployment is high, then it will result in increased output.

So actually, now that I've gotten here, I realize that, given other information, MV=PQ does add to the ability to predict inflation. But, as the Fed uses it and targets inflation, the better predictor is the Fed target. This is, after all, what the Fed does, predict inflation. The second best prediction is what month it is because the price of gas goes up on Memorial Day, something like 80% of the time. Some things are predictably seasonal.

 

[Norman]

Then again, as I thought about it, going back to Hume and his observations, what he said was, in fact, there were two effects that occurred when more money was introduced into a country. One effect was that prices increased and the other was that output increased.

This again is wrong. Output doesn't increase by printing money (well it may or may not, but this equation can not be used to predict that). It can decrease, increase or do whatever it wants. If meteorites hit earth it will decrease no matter what you do with the money stock.

This is an interesting point because it does say something about whether the increase in M will result in inflation or increased output. If output is already at a maximum and there is no excess supply, then it will show up in inflation. If output is below it's maximum, like unemployment is high, then it will result in increased output.

And this is why I hate the equation. People try to use it to analyze what it isn't supposed to do. The equation is useless at predicting what will happen when you print more money (besides the obvious). The equation should only be used to calculate velocity of money or money stock if you know the other variables.

For example if you print bunch of money but bury it underground. All that happens is velocity decreases. If you use fish as currency and fish is also large part of economy the increase of M could also mean increase of Y.

Besides that there is the general problem of GDP with the equation. Things that are not transacted with money do not show up.

Here is also something interesting about the equation worth discussing about:

The V in the equation must only apply to newly produced goods right? Since by selling used good back and forth you don't increase the price or real GDP. This means that the P in the equation only means prices of newly produced goods.

If there was a hundred trillion dollar net worth, but 1 dollar of GDP. Let's just say that in this case doubling the money supply would actually "lead" someone to produce that 1 extra dollar of gdp. However since the used market is much bigger in this economy the real price level on the streets would actually double or so...


On the other hand an economy with same GDP every year, but growing net worth would also be expected to have declining prices (more goods same amount of money) even on the equation but ever decreasing velocity of money and NGDP. Your opinion on this?

 

[editec]

Dude, what is the point of all this? 90% of the folks on the board have no idea what you are talking about and the 10% who do think you are full of BS

The point of this is that two people here are attempting to arrive at a better understanding of the macroeconomy through a process known as having an intellectual discussion.

Note that while they often disagree, they do so without being DISAGREEABLE?

This is how GROWNUPS discuss issues, BM.

This thread is an exploration by two intellectually honest guys trying to determine how to figure out the relationship between money supply and macroeconomic outcomes.

Those of us, like myself, not well versed in macroeconomic theory, CAN follow it, if we're willing to read their posts thoroughly.

I've been cooling my jets not asking either of them questions because these to guys are doing such a great job of testing their own arguments and each other's arguments logically.

Basically they're asking themselves how our economy matches the monetary supply to the needs of the economy at the moment.

First of all, they question how do we measure the monetary supply (and its velocity within the economy at any given time) and how does (or how should) that economy alter the money supply to continue to best serve the economy?

What I especially like about their style is both of them are coming at this discussion admitting that they don't have the answers.

They both know they are SEEKING the answers.

This kind of humility is quite typical in great SOCIAL SCIENCE discussions.

The target of this KIND of discussion is to find the TRUTH, not win the debate.

 

[editec]

So you would rather impose a mandate of constant NGDP (Or constantly growing NGDP) than employment and stable currency? Or maybe combination?

An NGDP target is a maximum employment and stable prices target. Remember NGDP is the price level, P, multiplied by real output, Y. It services both at the same time. If you want no inflation on average, you pick a 3% NGDP target (since trend growth of Y is 3%). If you pick a constant NGDP target, you'll get about 3% deflation per year.

Doesn't the above presume that the players in the market are autonotoms who are not reacting to the actions of the central bank and changing market conditions?

I think it does. I also think we here who are following this discussion all know that is not true.

If Y and P both fall, money it too tight, so the target will force the central bank to ease. If Y and P are both too high, money is too loose, so the target will force the central bank to tighten

Will it really FORCE the central bank to do that?

I don't think so. (this is why the issue of the TARGET of the central bank cannot be dismissed in this discussion)

Doesn't that theory preume that the central bank is truly a neutral player in the economy?

Do any of us here really believe that the central bank is truly a neutral player?

. If Y and P are both too high, money is too loose, so the target will force the central bank to tighten. If Y falls and P rises, or P falls, and Y rises, those are supply side factors changing that the central bank shouldn't react to with demand management. An NGDP target will prevent them from reacting to supply shocks (the same isn't true of a price level or inflation target).

Anyway I disagree you with that it's the NGDP that "F*cks" the economy. I think that shrinking NGDP is an effect and not a cause. For example if meteorites fall on earth the NGDP will shrink (or change curse) and that's a good thing.

No, RGDP will fall. There's no reason for NGDP to fall. This is why this conversation is relevant to this thread. NGDP is MV. It's entirely controlled by the central bank. Real factors need not affect NGDP, and monetary policy should not be reacting to real factors.

Again I disagree. I think demand side recessions happen because people no longer want to consume certain goods. That means a lot of people need to get fired etc.

WHY would people suddenly "no longer want to consume certain goods"?

Well that's not a demand side recession. That's a reallocation of resources throughout the economy. RGDP will fall, and we shouldn't try to prevent that or offset it with monetary stimulus. But there's no reason NGDP would fall.

Well I will stop replying now because I think we are no longer discussing the equation. I do like to participate in "NGDP and economy" discussion though.

Me too.

In fact that is the HEART of the issue, isn't it? What is the POINT of the central bank? That question cannot be answered until we ask ourselves the only GERMANE issue in economics.

Is the point of economic policies to have a thriving economy (as defined as "increasing GDP") or is the point of economic policies to serve the needs of the nation which it is making policies about?


And the heart of that question is really this question...who DECIDES what the "needs of the nation" really are?

The central BANKSTERS??!!

Okay. I'll get around to creating a "What should the Fed target?" thread soon.

I'll be contributing to THAT discussion, I suspect.

 

[Wedn]

This has been a perfect thread combining all the right elements- intellect, seriousness, wit, tom-foolery, and quirks. Bravo.

 

[itfitzme]

This again is wrong. Output doesn't increase by printing money (well it may or may not, but this equation can not be used to predict that). It can decrease, increase or do whatever it wants. If meteorites hit earth it will decrease no matter what you do with the money stock.

This is an interesting point because it does say something about whether the increase in M will result in inflation or increased output. If output is already at a maximum and there is no excess supply, then it will show up in inflation. If output is below it's maximum, like unemployment is high, then it will result in increased output.

And this is why I hate the equation. People try to use it to analyze what it isn't supposed to do. The equation is useless at predicting what will happen when you print more money (besides the obvious). The equation should only be used to calculate velocity of money or money stock if you know the other variables.

For example if you print bunch of money but bury it underground. All that happens is velocity decreases. If you use fish as currency and fish is also large part of economy the increase of M could also mean increase of V.

Besides that there is the general problem of GDP with the equation. Things that are not transacted with money do not show up.

Here is also something interesting about the equation worth discussing about:

The V in the equation must only apply to newly produced goods right? Since by selling used good back and forth you don't increase the price or real GDP. This means that the P in the equation only means prices of newly produced goods.

If there was a hundred trillion dollar net worth, but 1 dollar of GDP. Let's just say that in this case doubling the money supply would actually "lead" someone to produce that 1 extra dollar of gdp. However since the used market is much bigger in this economy the real price level on the streets would actually double or so...

On the other hand an economy with same GDP every year, but growing net worth would also be expected to have declining prices (more goods same amount of money) even on the equation but ever decreasing velocity of money and NGDP. Your opinion on this?

Except you've completely ignored 99% of what I said, created ridiculous straw man arguments, and actually restated what I already said as if they were somehow proving something.

I repeatedly defined it as THE MONEY USED IN THE EXCHANGE FOR GOODS. I even found Hume's original essay where he defines it as THE MONEY USED IN THE EXCHANGE FOR GOODS. I quoted Hume where he says the money held in some vault or corn set aside for seeds doesn't come into account because it isn't used in the exchange. You follow with, "if you print bunch of money but bury it underground" like somehow you’ve made some great revelation.

We don't use fish as a currency. Nowhere, as presented, do the definitions suggest the equation of exchange is meant for a system that uses fish as both a form of currency and a commodity. If you’re going to do that, they your going to have to separate the period of time that it is used as currency from the period of time that it is used as food. We don't have a barter economy, housewives do work that isn't included in the GDP, the kids get an allowance for doing chores, and on and on.

If I say automobiles need four wheels to function, it is meaningless to say that motorcycles are motor vehicles like an automobile and they use only two wheels. When the cook says, "We need a pound of chicken to make the soup," it makes no sense to say, "Your wrong because beef stew doesn't have chicken in it."

And, if I say, "ceteris paribus", it makes no sense to respond, but V can change. And, as created, the V in the equation has nothing to do with the goods. It applies to the physical money as it is used more than once in the exchanges.

I don't know, dude, how does GDP account for the value added portion of recycled and refurbished equipment without counting the intermediate value added twice?

Your "disagreeing" with me, is not because what I'm saying is incorrect, it's because you’re talking about something else and then arguing with yourself about it.

 

[itfitzme]

The point of this is that two people here are attempting to arrive at a better understanding of the macroeconomy through a process known as having an intellectual discussion. Note that while they often disagree, they do so without being DISAGREEABLE? ...This thread is an exploration by two intellectually honest guys trying to determine how to figure out the relationship between money supply and macroeconomic outcomes. Those of us, like myself, not well versed in macroeconomic theory, CAN follow it, if we're willing to read their posts thoroughly. First of all, they question how do we measure the monetary supply (and its velocity within the economy at any given time) and how does (or how should) that economy alter the money supply to continue to best serve the economy? What I especially like about their style is both of them are coming at this discussion admitting that they don't have the answers. They both know they are SEEKING the answers. This kind of humility is quite typical in great SOCIAL SCIENCE discussions. The target of this KIND of discussion is to find the TRUTH, not win the debate.

Here is what I've learned so far.

Actually, the pure math guy, the applied economics guy, and the applied math guy haven't disagreed in the least. There can be no disagreement because any appearance of disagreement is inevitably due to looking at different things or based on preference. Preference is just preference.

Oh, sure, the pure math guy says something like, "You don't map variables to objects, you look for interesting things you can do with the math." But then, we understand he has this wealth of doing the "look for interesting things", so it's more like his personal preference.

And sure, the "applied economics guys says something like, "but you can use any money supply you choose and then you have this liquidity trap thing". But then, we understand that, in practice, the monetary base is what the Fed measures so it makes sense, from an applied position, to use that.

I know that there are interesting things that can be done with the math that also has utility. I know that it is true that the V_Mb = GDP/Mb has utility.

What the pure math guy and the applied econ guy have given me is a better understanding of how Friedman approached it and how the applied science of economics approaches it to come up with something that either the business guy or the Federal Reserve guy can use.

As more of an applied math guy, I know that it is true that you can map variables to objects and that it has utility. I also know that a lot can be gleaned from economics without needing to go to calculus. Algebra and trig is enough. I also know that most people intelligent enough to read are intelligent enough to understand the stuff. Any problems they have experienced had to do with how the studies went or a matter of being use to it. It's just a second language. All I am after is some basic insight that can be gleaned from a comprehensive view of the basics.

From an applied math standpoint, we can go downtown, observe people and what they do, and construct a model that is a viable representation of how the economy functions. Of course, we've been downtown and actually been the "people" that we just need to think about it. What we end up with is M=PQ. In fact, if M is the money we are spending at the store and PQ are the groceries, then it's pretty obvious that if we had more M then we can buy more PQ.

And when we think about the entire economy, we recognize that it's just more of the same multiplied a couple of hundred million times. So we can create a flow diagram like

I haven't invented anything here. It's just a flow diagram and another version of the same economic flow diagram found all over the place. I've boiled it down to the basics, the things that are significant.

And because anything worth saying in the first place, is worth repeating, let me explain. The money flows in a closed loop. Ignoring the financial services thing, all the money goes around in a closed loop so wherever you cut into the flow, it's the same. Total wages equals total purchases. What is spent on consumption has to equal income. I can't take home stuff from the store that I didn't pay for and I can't pay for stuff with money I don't have.

So, by definition, GDP is the total of the prices times the quantities of all the goods that are purchased at the final use level. That is GDP = PQ. And obviously, it is equal to the total amount of money in the flow with one caveat. Someone was clever enough to notice that the dollars often go around that loop more than once in accounting for P.

So, M_flow*V_flow= PQ = GDP.

If we go back to Hume, we see that he said, M_flow = PQ. He wasn't so formal about it, but that's what he said.

Over the history of economics, it went from Hume, to Mills, to Fisher, to god knows who else, to Keynes, to god knows who else.

Somewhere along the way, the velocity of money was added. A good thing to because that isn't so obvious. Then Keynes adapted it to Money Demand and changed the V to a 1/k.

And, because we can't measure M_flow, someone came up with using the monetary base, and it became Mb * V = PQ. Except, then V isn't V_flow, it's partly V_flow and partly the "liquidity trap" or whatever it is that is keeping Mb from getting into M_flow.

All this history is a bit beside the point, because M_flow*V_flow = PQ = GDP is absolutely correct. And because P is using the money from M_flow, just more than once, as measured by V_flow, then a few simple things can be concluded. And, they are the same things that Hume was nice enough to write down in the first place in his essay "On Money".

One thing to note is that, without other information, MV=PQ doesn't say anything about causality, just what must happen together. Assuming V is constant, if M goes up, P and/or Q go up. This was Hume's observation. Whenever a country or region had more money introduced into it, the standard of living increased. And, often enough, prices also went up. In "On Money" he spells out what happens to make the different. He also points out that, in every region where the supply of money was depleted, the standard of living fell. Hume must have traveled a lot.

Of course, it is interesting to notice that in those days, people actually had to carry a purse with gold coins around. Now, we never need to even go to the bank. Our paycheck just gets electronically deposited and we use a debit card for purchases. It should be apparent that the velocity of money has been increased due to that. Though it is actually frequency, the number of times around a circle. If it goes faster along the edge of the circle, it's going around the circle faster.

Oh, if you want to, you can stick the government and taxes in there. But, effectively, the government is just another company, that we all subscribe to, with a different pricing scheme that depends on the "board of directors" that we appoint during the election process. Splitting it out doesn't add any new information. If you think it does, by all means, split it out and make things more complicated. I don't like things any more complicated than necessary. Things should be only so complicated as they need to be, and no more.

Now, I haven't touched on that savings and credit thing. Those are sinks and sources for M_flow. As far as I can tell, that is all the sources and sinks. Obviously, money goes into saving and comes back out later, even with a little bit more money. And that little bit more money doesn't just materialize out of thin air. It got there because someone else took out credit, then put that back in again, with a little bit more money.

And now, were discussing how this think changes over time.

And, you might want to stick China in there, but functionally, it's just another big company in the flow. Money flows into it and they put it into the bank, then the other company called the government, borrows on credit from them and puts the money into the flow. And, every so often, one of those big companies, like Dubai, actually do buy, or try to buy, something.

You might want to have the intermediate companies have savings and credit. This doesn't add any new information.

The savings and credit balance. They have to unless the Fed does something to change the amount of money.

Still none of this changes Hume's fundamentals that M_flow * V_flow = PQ or the BEA PQ = GDP. And it points out that, if GDP, CPI, or population are to go up, then M_flow has to go up if V_flow doesn't change. It must go up, just like your income must go up with your expenses because the bank isn't going to let you carry a negative balance. Well, for that matter, that is why it must go up. Because all those households don't get to use any more money than they have. That is how our accounting system works. That is how the banks do accounting. That is how the economy does accounting.

None of this says anything about how prices and quantities find that equilibrium point in the market. It's not suppose to. But it does say that if M and V stay the same, and one PQ goes up, then other PQs go down.

It's not meant to predict inflation. It's not suppose to. But it does say that, if there is inflation, then M_flow has to go up or the quantity of something must come down, assuming V_flow doesn't change.

And, as far as I know, the only way M_Flow does go up, is if the Fed "prints" money and sticks in it that financial institution thing. As far as I know, they don't stick in any savings account for free. They stick it in the reserves account of banks where it becomes a source of credit. In order for it to get to M_flow, someone borrows it. But that means, they pay it back later.

You can make that financial services all more complicated by detailing every fractional reserve and private bank, but it doesn't add any new information.

But, by all means, if anyone can tell me how M_flow increases without the requirement of credit, I'm dying to know. There is no magic here, no complicated annuity expressions. CDSs, derivatives, straddles and swaps, MBS, stock, T-bills, whatever, is just moving back and forth between savings and credit accounts. An IPO moves money from one guys savings to a companies savings in trade for a contract of repayment and dividends. That is great. But it's just another, out of a savings and into the flow. Sure, some company makes a business loan which increases their savings that then pays for intermediate capital equipment that then creates a new product stream for Q. But, that loan gets paid back and it doens't permanently increase M_flow.

All it takes, is one little connection from that block labeled "Fed" to that block labeled "savings". Just one little line will fix it.

 

[Norman]

And, as far as I know, the only way M_Flow does go up, is if the Fed "prints" money and sticks in it that financial institution thing. As far as I know, they don't stick in any savings account for free. They stick it in the reserves account of banks where it becomes a source of credit. In order for it to get to M_flow, someone borrows it. But that means, they pay it back later.

There are some more ways theoretically.

If the GDP is 0, money flow will be 0 too, even if it changes hands. The equation only considers newly produced goods and their price level. And that the real world application is not perfect meaning the sides can be way off anyway. This is in fact one reason why I don't believe the NGDP target could work. Well it could work, but there could possibly be problems.


As far as the math goes. I think maths dont work very well in economics when it comes to policy making. That is because I consider economics a behavioral science. Humans are way better at predicting behavior via other means than mathematical modeling currently. And of course as we are part of the system so complete predicting is impossible - if you know something happens, you will act differently.

 

[itfitzme]

And, as far as I know, the only way M_Flow does go up, is if the Fed "prints" money and sticks in it that financial institution thing. As far as I know, they don't stick in any savings account for free. They stick it in the reserves account of banks where it becomes a source of credit. In order for it to get to M_flow, someone borrows it. But that means, they pay it back later.

There are some more ways theoretically.

Don't care about "some ways theoretically", care about any specific way, really.

--------------------------------------------------

As far as the math goes. I think maths don't work very well in economics when it comes to policy making. That is because I consider economics a behavioral science. Humans are way better at predicting behavior via other means than mathematical modeling currently. And of course as we are part of the system so complete predicting is impossible - if you know something happens, you will act differently.

It's not that you "consider economics a behavioral science", it is a behavioral science. It's a social science. It is the study of how people allocate scarce resources. And the thing that Hume recognized is that, just as money facilitates that process of allocating resources, it also affects it in very specific ways. When the money supply goes up, production and prices follow. If excess supply exists, output goes up first. Just as well, when the money supply goes down, prices and production follow.

Every time someone says something like, "The gov't printing more money causes inflation" they are presenting 'the math' and making a prediction. They are saying that MV=PQ means that an increase in M causes an increase in P. But, because they aren't using a good model, the miss that it can also increase output.

Every time you press on the gas peddle of your car, you are making a mathematical prediction of how the car will perform. You press a little, the car goes a little faster.

Every time you slow down at the site of a highway patrol officer, you are predicting human behavior. If you don't slow down, you predict he will pull you over and give you a ticket. That you don't use the language,

#_tickets = the intersection of (#_times_speeding and #_times_seen_by_highway_patrol

changes nothing, it's still a "math" model.

The whole friggin brain is a biological, statistical, mathematical modeling machine.

Heck, even kids with siblings use a math model.

My_annoying_brother = I_get_ticked_off.

If My_annoying_brother > 0 then #_of_wacks_on_his_head > 0

and the prediction is that

If #_of_wacks_on_his_head > 0 then My_annoying_brother <= 0.

The model is usually wrong because the correct one is

#_of_wacks_on_his_head = How_Loud_My_annoying_brother_Yells > 0

and his prediction is

How_Loud_I_Yell = #_of_wacks_Mom_gives_my_mean_brother.

My dog uses a mathematical model when I give him a dog treat when I go out of town for the day.

If My_owner's_presence =0 then #_treats_I_eat = 0

and then, when I get home he uses

My_owner's_presence > 0 then #_treats_I_eat > 0

Math is just a shorter, accurate, and more precise way of saying many things that can take paragraphs to express with words. And that "Humans are way better at predicting" the effect of a reduction in the money supply doesn't do anyone else any good if I can't express it. There is no other way except some form of, however informal, "mathematical modeling".

At the simplest level it is "level of danger = number of angry or hungry bears" or "if it is Valentines Day and the number of flowers or boxes of candy equal zero then the level of anger expressed by the wife or girlfriend will be more than zero".

"if you know something happens, you will act differently" is a prediction of human behavior. You are predicting that the perception of future events affect their decision and future behavior. So, more easily, if people have less money, they spend less money. And that is a pretty simple, accurate and precise prediction of human behavior.

Saying "I don't believe the NGDP target could work. Well it could work, but there could possibly be problems" is simply fuzzy math. NGDP is a number that measures nominal prices and quantities. That the "maths" don't work well for you is no different then that speaking Latin doesn't work well for you. That you "believe" doesn't mean anything. Comments are full of beliefs, like "fiat money is the cause of business cycles" that prove false when we look at the numbers, the math.

You seem to be of the mindset that, unless something can be accomplished with perfection of the thing your looking for, then if cannot be accomplished at all. "MV=PQ doesn't predict the price of donuts at your local donut store therefore it can't predict anything at anytime", seems to be the mindset. "Complete predicting" is possible in many cases and accurate predicting is possible in even more cases. There are plenty of unstated, bad models. But that is a reflection of the person, not the process. There are plenty car accidents due to speeding, but that is a reflection of the driver, not the car.

--------------------------------------------------

If the GDP is 0, money flow will be 0 too, even if it changes hands. The equation only considers newly produced goods and their price level. And that the real world application is not perfect meaning the sides can be way off anyway. This is in fact one reason why I don't believe the NGDP target could work. Well it could work, but there could possibly be problems.

The GDP counts all value added activity in the monetary economy, including used and refurbished products. That someone lends $10 to someone else in exchange for "good will" is meaningless as a) it doesn't happen to a significant amount b) it doesn't add product value c) the amount and occurrence is just as affected by the money supply as value added production. If you want to include "good will" as a product and use NGDP + P * Quantity_of_good_will, by all means do, but it doesn't add any information. If the money supply falls, then so will the price and production of "good will".

NGDP counts both relative price and production increases. RGDP measures just relative production change.

The equation of exchange considers everything of significance for looking at the aggregate behavior of the economy. It does because it captures everything at the GDP level. You might like looking at how the GDP is calculated and how it captures all the the economic activity attached to prices except black market activity. All intermediate goods and prices are captured as value added in the final product and price.

These are good.

Introduction to Gross Domestic Product

http://www.bea.gov/national/pdf/nipa_primer.pdf

The table on page three shows how intermediate products are handled. That is the thing that I find most informative.

We don't need to precisely predict that the price of apples will go from exactly $1 a pound to $2 a pound to accurately predict that bad weather that reduces the supply of apples will go up. Just as well, we don't need to precisely predict what the price of everything will be to accurately predict that a reduction in the money supply will cause prices and output to go down. Before you can make precise predictions, you have to be able to make accurate predictions. I can predict, with accuracy, that the price of gasoline will go up on Labor Day and back down on Memorial day without predicting the precise price. I can accurately predict that, in playing roulette at Las Vegas, I will eventually lose the $100 I came with.

There is little need for concern for the specific macro economics of human behavior in this overview. Whatever it is, it is constrained by how much money there is. I can accurately predict that Susy housewife will not purchase any more groceries than she has money to spend. Human behavior affects the equilibrium point of PQ in the micro markets. Whatever they are, they are what they are and final production and prices are captured by GDP.

The number one predictor of human behavior is past behavior. I predict, accurately, my house-mate's behavior all the time. I predict that every 20 days, when her Vicodin supply is renewed, she will clean the kitchen. I predict aggregate behavior on forums all the time. I predicted that, on first posting to this forum, someone would express territorial behavior and reply with some second person pronoun followed by a personal and negative criticism. It's guaranteed.

Marketers predict human behavior all the time. They accurately predict that if they run an advertisement. It is inconsequential that they cannot predict the precise increase in sales to the last penny. And human behavior doesn't change until impacted by some external force. Human behavior is not random. Any lack of ability to predict it is a lack of information. And, just because one person cannot predict human behavior doesn't mean no one can predict it.

Hume made observation that allow accurate prediction of human behavior. When the supply of money within a region or country was depleted, output fell. This, and other predictions of the economy based on the money supply are achievable.

Aggregate behavior is easier to predict than individual behavior. All of micro economics is the prediction of aggregate human behavior. Price elasticity is a study and formalization of human behavior with a specific product. Tobacco is highly inelastic. The prediction is that an increase in price for cigarettes has little or no effect on the consumption.

Never the less, we don't need to predict human behavior here, we need to predict the forces that effect human behavior. Supply affects human behavior. Prices affect human behavior. Supply and prices are affected by the money supply. The money supply is affected by the availability of credit. The availability of credit is affected by the Federal Reserve Bank.

Before we can attempt to predict the aggregate behavior, we have to understand the environment that affects that behavior. The money supply is big part of that environment.

That a sever decrease in the money supply doesn't precisely predict how much of the economy will switch to bartering is secondary to the fact that a severe decrease in the money supply will accurately predict an increase in bartering and food stamps.

But the fact of the matter is that M_flow * V_flow = P * Q does accurately predict that if V_flow is constant and the Fed causes M_flow to increase then prices and output will increase. It does because M_flow is the physical thing that is used in the purchase of products at its given price.

It also accurately predicts that, given no other source for M_flow, there will be no economic recovery except by a constant addition of aggregate credit. It also accurately predicts that, at some point, the debt burden of constantly increasing debt credit will result in a recession. It doesn't say precisely when or how that will happen. To do that requires other information.

It is little different than saying that the location that a mortar shell is dependent of the muzzle velocity, the weight of the mortar, the force of gravity, the angle of trajectory, wind, and the air resistance. And air resistance can be neglected because it's an explosive round so "close enough" works just fine. The impact point is independent of the behavior of the enemy, how marines are eating at the time that the mortar is launched, or if there are enemy troops in the vicinity of the target.

And, the same level of accuracy and precision works in economics. In fact, all of the social science of economics is presented with the "maths". Supply and demand is presented with the maths. Demand curves typically have a negative slope while supply curves have a positive slope. Some demand curves are very elastic while others are inelastic. Those are the "maths".

Businesses use the "maths" all the time to predict the future with some accuracy. When they count the amount of product sold and see that it has gone up consistently, or they count the number of orders they cannot fill, the predict that increasing production (a number) will increase total sales (another number).

The "maths" can and do "work very well in economics" including policy making. After all, Mitt Romney is using "the maths" when he says, "Bernanke has over inflated the currency' and it is his obvious intent to use "the maths" to effect policy.

In fact, "the maths" is all that there is. When bankruptcies were on a rise in 2004, this was followed by a tightening of bankruptcy laws. The "maths" was a count of the number of bankruptcies and the change in those numbers. The predictions was that those numbers would go down. The beginning of legislation begins with a whole bunch of equalities, stated in words, about what words will be equal to. Just because they say "means" rather than "equals" or "=" doesn't change that it is "the maths".

 

[DSGE]

Okay, so there are basically two reasons I think it's better to think of M as some stock of "money" rather than the "stock in the flow". One practical and one theoretical.

So we don't actually directly measure velocity, since it's not feasible. What we need to do is observe our money stock, then if a dollar gets used in an exchange, we tag it and start counting the number of transactions it's used in. Then we sum them up, and we divide by the number of dollars that we've tagged.

Example 1:
If there are 5 dollar notes in the economy, 3 of them get used in exchange, dollar1 gets used once, dollar2 gets used twice, and dollar3 gets used three times. The "stock in the flow" is $3. Velocity is (1+2+3)/3 = 2. Of the money being used in transactions, each dollar will be used 2 times on average. Nominal spending is MV = 3*2=$6.

Now conditioning on a dollar being used in an exchange once before it starts being counted, despite the fact that it may have been Hume's original intention, is an extra step not required. It's exactly as easy mechanically, but intuitively simpler, to just count money that doesn't enter the flow and say it gets used 0 times in an exchange.

Example 2:
Same set up as before. Except now rather than M being $3, M is the whole $5. We count velocity exactly the same as before. D1 gets used once, D2 twice, D3 thrice, and D4 and 5 zero times. So velocity is (1+2+3+0+0+)/5 = 1.2. Of all the 5 dollars in the money stock, each gets used 1.2 times on average. Nominal spending is MV = 5*1.2 = $6.

So both methods result in exactly the same nominal spending. But one requires a pesky restriction, one does not. Either way, directly measuring V like this isn't feasible. In reality what happens is that we take NGDP, which is directly measurable, and divide it by a money stock. Now which money stock is measurable? The one that includes reserves and dollars not being spent, or the one that requires you to restrict measurement to dollars that are "in the flow"? Obviously the former. Both result in the same answer, but the former is the practical way to go.


The theoretical reason relates to how we use the equation of exchange. Obviousy if V is just NGDP/M in theory, that's tautological and completely useless. We need to construct theories of monetary velocity - like, maybe it's constant or a stable function of something? - in order to get use out of the EoE. Velocity is just the inverse of money demand. Money demand is "for a given money balance, how much of it do we want to hold?", and velocity is "for a given money balance, how much of it do we want to shed?". When we form ideas about the demand for money, we don't condition upon "given that a dollar gets used in a transaction, then what's the demand for money?". The entire point is that given some stock of money, any stock, how much of it are we going to hold; or how much of it are we going to not spend. Keynes had the liquidity preference theory of money demand; it's a function of output and the interest rate. Friedman had his money demand function which was a function of a bunch of relative rates of return on various assets. The point being, it's actually counter-productive to talk about the demand for money "in the flow". Since velocity is the inverse, why would we talk about the velocity of money "in the flow"?

 

[itfitzme]

Okay, so there are basically two reasons I think it's better to think of M as some stock of "money" rather than the "stock in the flow". One practical and one theoretical...

This is very good. I appreciate you work here, especially in showing that, either way, you get the same N_GDP. And, as you point out, both ways are equally valid. If, what we have is M2, then it is more practical to use that.

Though, my question never was whether one is as or more functional as the other. That was, as threads usually go, a distraction from my purpose.

My reason for using M_flow is simply that I like to boil things down to the essential elements. Whether we use one form or the other, the conclusion of the money supply being necessary to increase output just as being potentially causal of price inflation is the same.

I find M_flow more direct because it is obvious, without having to show that M2 is essentially the same, that M_flow is the prices. The money supply and the prices are simply different ways of measuring the same thing. One counts the money direction while the other uses the same more than once. Still, when it comes down to it, if there isn't more of the first, then we can't have more of the second. And, I suspect that I am not the only one that finds is more direct. People are funny that way.

That we can measure the same thing in different manners, finding a third factor that connects the two, is the essential underpinning of our ability to find connections in our natural world. Mass can be measured on way, acceleration can be measured another way. And when we do, we find a third factor called force that connects the two.

In this case, we can measure prices and quantities. We know that, if we could, we could measure M_flow. We can use the same method of measure, counting, to measure M2. And, by deduction are able to show that, while V is different for each, N_GDP remains the same.

And, you are saying, contrary to some others, that either way is just as valid.

I respectfully disagree that "it's actually counter-productive to talk about the demand for money "in the flow"."

I had a specific purpose for choosing it over M2. You couldn't know, a prior, if it is or isn't productive without knowing a priori, what my purpose is.

 

[DSGE]

I had a specific purpose for choosing it over M2. You couldn't know, a prior, if it is or isn't productive without knowing a priori, what my purpose is.

Fair enough.

 

[Norman]

And, as far as I know, the only way M_Flow does go up, is if the Fed "prints" money and sticks in it that financial institution thing. As far as I know, they don't stick in any savings account for free. They stick it in the reserves account of banks where it becomes a source of credit. In order for it to get to M_flow, someone borrows it. But that means, they pay it back later.

There are some more ways theoretically.

Don't care about "some ways theoretically", care about any specific way, really.

I did give an example there.

Every time someone says something like, "The gov't printing more money causes inflation" they are presenting 'the math' and making a prediction. They are saying that MV=PQ means that an increase in M causes an increase in P. But, because they aren't using a good model, the miss that it can also increase output.

IMO you can entirely forget that equation. It's just simpler to state

1) If you increase the supply of money prices increase to level higher than otherwise.
2) If you increase the demand for money prices decrease.

This is much simpler than the equation. And also gives you actual cause effect relationships.

Besides that it's clearly untrue that inflation will always increase economic output. With enough inflation people will abandon the currency its value will fall to 0 (infinite prices and no velocity). You can think what happens to that equation then.

Besides that the final conclusion of this kind of statement is that if every guy would be employed to print money GDP would raise. That is clearly untrue.

Every time you press on the gas peddle of your car, you are making a mathematical prediction of how the car will perform. You press a little, the car goes a little faster.

Every time you slow down at the site of a highway patrol officer, you are predicting human behavior. If you don't slow down, you predict he will pull you over and give you a ticket. That you don't use the language,

I absolutely do not mean that as mathematical modeling. By this logic *EVERYTHING* is mathematical modeling so it makes my statement meaningless. By mathematical modeling I mean mathematical models that are built to predict the economy.

Saying "I don't believe the NGDP target could work. Well it could work, but there could possibly be problems" is simply fuzzy math. NGDP is a number that measures nominal prices and quantities. That the "maths" don't work well for you is no different then that speaking Latin doesn't work well for you. That you "believe" doesn't mean anything. Comments are full of beliefs, like "fiat money is the cause of business cycles" that prove false when we look at the numbers, the math.

You playing religion card on me? I clearly stated the reason why I think there could be problems. But this needs to be further investigated, true.

The GDP counts all value added activity in the monetary economy, including used and refurbished products. That someone lends $10 to someone else in exchange for "good will" is meaningless as a) it doesn't happen to a significant amount b) it doesn't add product value c) the amount and occurrence is just as affected by the money supply as value added production. If you want to include "good will" as a product and use NGDP + P * Quantity_of_good_will, by all means do, but it doesn't add any information. If the money supply falls, then so will the price and production of "good will".

It's not just good will products. It's all the existing prior products, and all the consumption / net worth not being accounted. Like I said in economy with a very low GDP/net worth ratio the equation "fails" to work.

Used products are not value added products. The equation does not consider net worth or destruction thereof. Selling and buying used products between me and my cousin shows as 0 on the equation. Yet the price of those sales can be affected by M which is not captured.

Also there of course exists many problems calculating the real gdp. But as you said it doesn't need to be perfect. I am just pointing out the flaws.

 

[itfitzme]

It's just simpler to state

And it's oversimplified. It only tells half of the story, leading to oversimplified and limited understanding.

There are multiple methods for achieving understanding.

1) Personal anecdotes.
2) The anecdotes of other people with more experience.
3) Examining the complete set of data.
4) Repeating the statements of people that are chosen as an authority.
5) Breaking things down to their essential elements reaching conclusions through deduction.

1) If you increase the supply of money prices increase to level higher than otherwise.

Not always. When there is a excess of production capacity then an increase in the money supply, all other things being equal, will lead to an increase in output.

And, it is exactly the same thing as saying if M(2) > M(1)

2) If you increase the demand for money prices decrease.

I have no idea what this is suppose to mean. An increase in demand is exactly an increase in actual use. It does not mean an increase in the desire for more money. An increase in the desire for more money is excess demand. (It does annoy me that economics uses terms in a way that is so much different that colloquial usage. It means having to be careful.)

For example, lower interest rates may cause an increase in the demand, actual use of, money because the lower interest rates satisfy the potential demand. People want to borrow the money but the rate is too high. Excess demand is unsatisfied potential demand, the fact that there is the desire for product that is not satisfied.

If the demand for money is increased, more money is in the system, the prices may increase or output may increase, depending on other factors.

Perhaps you mean that if a proprietor wants to increase profit, they may lower prices in order to increase sales. On the other hand, if an individual wishes to increase their income, they may take a part time job. And, if there is excess demand for money, on the financial side of things which isn't in my whole discussion, then a decrease in interest rates may increase demand.

Besides that it's clearly untrue that inflation will always increase economic output. .

At no time did I say that "inflation will always increase economic output". I said that an increase in the money supply can result in an increase in prices and/or an increase in output.

Inflation is an increase in prices. Inflation is not an increase in output.

With enough inflation people will abandon the currency its value will fall to 0 (infinite prices and no velocity). You can think what happens to that equation then.

If people abandon currency, then they are moving to some other economic system, like bartering. No where does an examination of how a monetary economy function make any claim as to what happens in a bartering based economy.

Besides that the final conclusion of this kind of statement is that if every guy would be employed to print money GDP would raise. That is clearly untrue.

Obviously not. If everyone was busy printing money then there would be no one making cars and other goods. If no one is making product, then GDP is zero because there are not product to purchase with all the money being printed.

By mathematical modeling I mean mathematical models that are built to predict the economy.

I am making is as clear as possible that even a statement like "If you increase the supply of money prices increase to level higher than otherwise" is no less a mathematical model than anything else. We can write "1 + 1 = 2" or we can write "If I have one apple and then someone gives me another apple then my apple stock increases."

In saying "If you increase the supply of money prices increase to level higher than otherwise" your making a mathematical model that says that if M(time_2) > M(time_1) then p(time_2) > p(time2). This relationship is included in M=PQ. Except M=PQ also included that output can increase as a result of an increase in the money supply.

And in general, if even non economic statements of cause and effect are a form of mathematical modeling regardless of them being presented in words, then by extension so are economic statements of cause and effect that are put in words.

And so, yes, it does make your statement meaningless. That was the point. Your statement is meaningless. Mathematical models are not less useful or informative then statements in English. They are simply another form of language. Statement makes no more sense then saying that stating it in English is "better" then stating it in Spanish.

The GDP counts all value added activity in the monetary economy, including used and refurbished products. That someone lends $10 to someone else in exchange for "good will" is meaningless as a) it doesn't happen to a significant amount b) it doesn't add product value c) the amount and occurrence is just as affected by the money supply as value added production. If you want to include "good will" as a product and use NGDP + P * Quantity_of_good_will, by all means do, but it doesn't add any information. If the money supply falls, then so will the price and production of "good will".

It's not just good will products. It's all the existing prior products, and all the consumption / net worth not being accounted. Like I said in economy with a very low GDP/net worth ratio the equation "fails" to work.

Net worth has nothing to do with it. This is, in fact, the very reason for my sticking to Hume's original definition and not using the definition that includes reserves and savings as there are additional factors that come into play like the "liquidity trap". Like you said, "if you print bunch of money but bury it underground", that million dollars wouldn't effect anything.

This is the reason I set up the context of what I mean before hand, so that the conversation doesn't spiral off into things that I have intentionally isolated as not part of the context. I even went through all the trouble to make a diagram. The only intent of Hume and the very basic nature of a monetary economy is that both prices and output are dependent upon the amount of money that is being used for the process of exchanges. And while "if you print bunch of money but bury it underground" you net worth will be high, it doesn't effect GDP.

Used products are not value added products. The equation does not consider net worth or destruction thereof. Selling and buying used products between me and my cousin shows as 0 on the equation. Yet the price of those sales can be affected by M which is not captured.

The resale of used products does add value for a host of reasons. I went back to the BEA publication of GDP to see what they had to say. It is basically that they do not include the original value added to the product when it is sold new, because this is included in the GDP when the product is sold new. What they include is the value added by the reseller of the used product. As I know the basic definition of how GDP is calculated, I don't really need to go back and check every single product as I am assured that the BEA knows what they are doing.

And, the exchange of some stuff between you and someone else has no effect on prices and output as a function of M. It may very will be that Bob doesn't need to buy a television because his friend Tim gave him the old one. This may be a factor in the demand for televisions, but it does nothing to the affect that the money supply has on the prices and output of products. All it means is that Tim doesn't need to purchase a TV.

Another way to look at it is if the price is zero and quantity is 1, then it may be added to GDP as zero.

The work that housewives do around the house doesn't get included in GDP. Volunteer work may not be included in GDP. There are a bunch of things that aren't included. Illegal drug deals aren't included. People making trades on Craiglist aren't included. Babies provide all sorts of satisfaction to grandparents and aunts alike. I have wondered whether two for one sales are included or if the BEA only includes them at the list price.

And, as a result, in fact, if the money supply becomes too restrictive because incomes have fallen, then other parts of the economy that are not part of the monetary economy may and often to increase in activity. Since the recession occurred, bartering did go up. Websites that connect individuals have become more popular.

None of this changes the fact that changes in the money supply can result in either an change in prices, an change in output, or both.

Also there of course exists many problems calculating the real gdp. But as you said it doesn't need to be perfect. I am just pointing out the flaws.

Well, no your not "just pointing out the flaws."

Your repeating the same statements that only account for an increase in prices as a result of an increase in the money supply, while pointing out the "flaws" to make the point that any reasoning which concluded that output can increase as well as prices is inherently flawed and therefore, only your "reasoning" is functional so the only conclusion is that only prices increase.

Just as well, your also sticking in conclusions that are, in fact, completely false. And, your creating straw man arguments, such as claiming that I said, "always", or applying the equation to things that it clearly doesn't apply to, then arguing that it doesn't work for them.

You playing religion card on me? I clearly stated the reason why I think there could be problems. But this needs to be further investigated, true.

Here is where you distinguish yourself from someone trying to have a serious conversation from someone desperately trying to use any form of maladjusted logic and reasoning in order to reject anything that doesn't support their limited belief system.

Obviously, the word "belief" does not have anything to do with religion except that people that are religious also have beliefs.

I am reminded of the woman that called tech support because her computer wasn't working. The tech says, "So, do you see the little icon that looks like a computer?" She replied, "I am Catholic and we don't pray to icons." I give the benefit that she is just patently insane.

On the other hand, I cannot extend you the same generosity. Whether by learned behavior or design, you demonstrate that your only intent is to simply "win" your argument.

I may be wrong and, if in fact, you are actually insane then I apologize. But the net effect is the same in being a complete waste of time.

 

[Widdekind]

Hume's model where M is the money that is what is actually spent on the goods at price P ... Hume said... M_flow = PQ...

if M and V stay the same, and one PQ goes up, then other PQs go down... Hume's definition tells us, within realistic range of prices and quantities, is that the upward pressure on the price of gasoline at the pump puts a downward pressure on the price of DVDs at Blockbuster...

Hume... suggests that the first thing that an increase in the money supply does is cause output to increase to supply pend up demand... After demand has increased and excess supply has begun to be used up, then prices may start to increase...

increase in M will result in inflation or increased output. If output is already at a maximum and there is no excess supply, then it will show up in inflation. If output is below it's maximum, like unemployment is high, then it will result in increased output...

MV=PQ... Assuming V is constant, if M goes up, P and/or Q go up. This was Hume's observation. Whenever a country or region had more money introduced into it, the standard of living increased. And, often enough, prices also went up. In "On Money" he spells out what happens to make the different. He also points out that, in every region where the supply of money was depleted, the standard of living fell. Hume must have traveled a lot... in those days, people actually had to carry a purse with gold coins around.

Hume's fundamentals that M_flow * V_flow = PQ ... = GDP

i understand:

MV = PQ = GDP
[M] = $
[V] = 1/yr.
[P] = $/widget
[Q] = widget/yr.
[GDP] = $/yr.​

regarding repeated discussions of "money in flow", i understand, that simplistically ("toy model"):

Money = [Money in flow] + [Money in savings]
MV = [Mf V] + [Ms 0]
.....= Mf V​

if the "demand to hold Money" increases, then some [Money in flow] is de-circulated, into [Money in savings]; if all new Money is swiftly saved, then a "liquidity trap" exists. Money held as reserves (e.g. by China) is de-circulated; that money is "decelerated", becomes "frozen", "static", "idle". Fractional-Reserve policies allow banks to "accelerate" such money, making it "liquid", "dynamic", "in motion":

s = "Savings" rate
s* = 1-s

f = "Fractional-Reserve" rate
f* = 1-f

Money = [Money in flow] + [Money in savings]
M = Mf + Ms
.....= [s* M] + [s M]
---> [(sf)* M] + [sf M]​

where i have tried to simplistically suggest, that FRs reduce the amount of "idle" (V=0) Money, by the FR factor f = 0.1-0.2, thus putting most Savings back into "motion" (V>0). Money in "savings" is a "hidden term" in the equation of exchange:

GDP = PQ = MV = [Mf V] + [Ms 0]​

seeking Profits, banks have learned, via centuries of experience, to minimize [Money in savings] (Ms), since "idle" money "collecting dust" is economically non-existing, i.e. "worthless".

imagine an isolated economy (no foreign trade), with no Government; assume banks are required to retain no reserves:

C+I+G + NX = GDP = PQ = MV = [Mf V] + [Ms 0] = [(sf)* M V] + [sf M 0]
G = 0
NX = 0
f = 0

C+I = PQ = s*MV​

naively, the rate of "savings" [$/yr.] = sMV; with no FR requirement, all "savings" are farmed back out, re-loaned as "investments":

S = sMV
S = I

C+I = s*MV
C+sMV = s*MV

C = (s*-s)MV = (1-2s)MV​

somehow, "savings", "investment", "Money supply", and "Fractional-Reserves" inter-relate; somehow "savings" becomes the "Supply of loans", which when contrasted with the "Demand for loans", determines the interest-rate. Naively, increasing interest-rates imply increasing "Demand for loans", i.e. increasing "Demand for credit", i.e. increasing "Demand for Money supply", i.e. suggest the existence of untapped excess supply (per Hume):

Mf ---> Mf + c
Ms ---> Ms - c ("hoards tapped")
-or-
c printed ("Fed increases Money Base")​

the equation of exchange describes economic money flows [$/yr.]; "savings" describes economic money stocks [$].

the only way M_Flow does go up, is if the Fed "prints" money and sticks in it that financial institution thing... they don't stick in any savings account for free. They stick it in the reserves account of banks where it becomes a source of credit. In order for it to get to M_flow, someone borrows it. But that means, they pay it back later.

the Fed makes "open market purchases" of outstanding Government debt, so "paying off" those bonds, thereby injecting Money into the economy ?

 

[Widdekind]

Velocity of M1 Money Stock (M1V) - FRED - St. Louis Fed

USD are employed, to "lubricate" economic transactions, about half-a-dozen times per year:

US MB ~= $2T
US GDP ~= $15T/yr.
V ~= GDP/MB ~= 8/yr.​