It is a cliche (among economists) to say that expectations matter. It is even more of a cliche to say that expectations matter for asset prices. But how much do expectations matter? I'm going to do a quick and dirty back of the envelope calculation to show that expectations matter a lot. And that the lower are interest rates, the more expectations matter.
Then I'm going to remind people that money is an asset. Then I'm going to remind people that recessions are always and everywhere a monetary phenomenon, and that recessions are an excess demand for money. So expectations of future monetary policy matter a lot for recessions. Especially when interest rates are low.
Take an infinitely-lived bond that pays a coupon of $1 per year. If the market rate of interest is 5% per year, the market price of that bond will be $20. Suppose the current annual coupon payment is lost, due to an accident that people expect will never be repeated. The value of the bond drops to $19. Only 5% of the value of the bond depends on what happens this year. The remaining 95% of the value of the bond depends on what is expected to happen in future years. (The proportion would rise to over 99% if coupons were paid monthly and we were talking about future months.)
Take the same bond, but now assume the market rate of interest is 1% per year. The market price of the bond will be $100. The loss of the current year's coupon, if expectations of future coupons are unaffected, will drop the price of the bond to $99. Now 99% of the value of the bond depends on expectations of future years.
Expectations matter a lot for the demand for long-lived assets, and hence for the price of long-lived assets. The lower the rate of interest, the more expectations matter. What happens this year doesn't matter very much at all (unless it affects expectations of future years), and it matters even less as the rate of interest gets lower.
Money is an asset. It's also a very long-lived asset (unless inflation is high). The demand for money, and the equilibrium price of money, depend, like all assets, much more on what is expected to happen in future years than on what happens this year. That is even more true when interest rates are very low. Interest rates are very low now.
Recessions are always and everywhere a monetary (medium of exchange) phenomenon. Recessions are an excess demand for money (the medium of exchange). The demand for money is the demand for an asset. Since the demand for money, like the demand for all assets, depends very much on expectations, especially when interest rates are low, recessions depend very much on expectations too, especially when interest rates are low.
This is for Chris Dillow, who says "@ Nick – you've raised one of my beefs with NGDP targets – that relying upon expectations to do work is to rely upon a weak lever." (with a big HT to Left Outside who also has a good example to show how monetary expectations matter). (And it's also for the people of the concrete steppes).
Worthwhile Canadian Initiative 
Mark: Here’s the intuition behind Warren Mosler’s Jobs Guarantee policy:
It’s a supply-side policy.
Remember that the natural rate of employment/unemployment is not invariant with respect to things like real minimum wages, real unemployment insurance benefits, etc. It is also not invariant with respect to real things things like the duration of unemployment benefits. It is also not invariant with respect to real things like whether you insist that people collecting unemployment insurance “work” at (say) finding a job, or digging ditches, and so whether you call them “employed” or “unemployed”. So suppose you held nominal minimum wages or nominal unemployment insurance benefits fixed. Then you use monetary and/or fiscal policy to increase AD and increase the price level. Real minimum wages and real unemployment insurance benefits will fall. The natural rate of unemployment will fall (regardless of whether you call those collecting unemployment insurance “employed” or “unemployed”).
Here’s the easiest way conceptually to get to WM’s JG plan:
1. Make everyone who is not otherwise employed eligible for UI.
2. Make those collecting UI do some sort of work so they count as “employed”.
3. Fix nominal UI benefits forever.
If you use monetary and/or fiscal policy to increase AD and increase the price level, real UI benefits will fall and fewer will want to apply for UI jobs. You can use AD policies to control the number of people collecting UI.
You now announce you have “full employment” since everyone who wants a job can get one. But the real wages you can earn in the jobs you can get (UI) might be very low.
There is no magic here. And it is irrelevant to the question of whether monetary or fiscal policy “works” to control AD.
But that doesn’t mean it’s obviously a bad policy. Because:
1. Workfare is not an obviously stupid policy. There used to be a lot of talk about it in the US in the 1970’s, IIRC. Practical difficulties, but not obviously stupid.
2. It has a neat form of automatic stabiliser/monetary target. Conceptually, it’s identical to an economy on the gold standard in which the unemployed can go panning for gold with a fixed MPL, and thus the money supply increases more quickly if more people cannot find other jobs and go panning for gold. Now just replace the gold with paper money, with government-owned paper gold mines.
Communication with the MMT guys would be a lot easier if they made a clear distinction between real and nominal variables. They don’t like talking about the supply side (SRAS/SRPC/whatever), because they live in a demand-side world.
Oh, and the fixed nominal UI benefit becomes the nominal anchor for the system, replacing the inflation target or NGDP target, or whatever.
Mark, when you assume at the first step that the IS curve shifts but the LM curve stays where it is, aren’t you assuming a fixed supply of money?
Because it is a DIRECTER way of doing what we actually want to do (give the unemployed jobs)
not necessarily, y’all are not addressing the issue of temporary vs permanent fiscal stimulus. We decide to build a road this year, then we are done (whatever your favorite project is. a) why would the workers do anything but save as much as they can knowing they will be unemployed next year b)whyt would someone with a factory expand it knowing that the stimulus will end (maybe he does not even hire people to build stuff, just uses overtime, because he knows its temporary stimulus).
Dan Kervick,
“It seems strange to regard these highly contingent institutional and political arrangements, and the policy fancies of the neoliberal era, as though they are some kind of hard-wired economic laws.”
It’s just “reality-based” economics. If we want to dwell on considerably different institutional arrangements, then we can as if the broad money supply was straightforwardly and reliably exogenous e.g. with 100% reserve banking + interest/charges on reserves.
I’m not sure why attention to institutional arrangements should be a virtue when done by one’s own side and a vice when done by the other side.
Mark, when you start with a rightward shift in the IS curve without a change in the position of the LM curve, you are assuming a fixed supply of money right? That is, you are rejecting the idea that government spending might itself inject money into the economy, or at least be responsible for an endogenous increase in money at the prevailing interest rate as the additional demand raises production -> demand for borrowing -> deposits?
Also, why couldn’t someone tell a reverse story form the one you have told to prove the inefficacy of monetary policy? That is, the central bank increases the supply of money, leading to an outward shift of the LM curve, leading to a drop of interest rates, leading to a decreased demand for the domestic currency, leading to a drop in the value of the domestic currency in foreign exchange markets, leading to an increase in exports, leading to an increase in employment, leading to a drop in government spending, leading to a leftward shift in the IS curve, leading to the same level of output we started with?
Or to be even closer to your original story, you could imagine that as exports increase and money re-enters the country, the central bank begins to decrease the money supply, shifting the LM curve back to the left and leaving us eventually with the same output we had when we started.
I hate thinking in terms of these curves, frankly, because they have an attractive visual simplicity that makes people start thinking in terms of animated powerpoints where various actions allegedly produce automatic effects in terms of mtions of or along these curves, instead of actual people and institutions. Anyway, my understanding was that people stopped using the LM curve setup once it became clear that central banks these days mainly target an interest rate, not a monetary aggregate.
Dan: “I hate thinking in terms of these curves, frankly, because they have an attractive visual simplicity that makes people start thinking in terms of animated powerpoints where various actions allegedly produce automatic effects in terms of mtions of or along these curves, instead of actual people and institutions.”
I liked that! Did you see Frances’ recent post, where she deliberately used exactly that visual trick?
“Anyway, my understanding was that people stopped using the LM curve setup once it became clear that central banks these days mainly target an interest rate, not a monetary aggregate.”
Some people did do that, but I think it’s a mistake. There is nothing in the LM curve that says that the money supply part of the Ms=Md equation has to read: “Ms=some fixed constant”. We can very easily replace it with “Ms=some function of whatever you like”. I can’t think why macroeconomists don’t always think this way. I can remember seeing ISLM models with Ms=F(i) as an undergraduate. Here is my own use of the ISLM model to teach inflation targeting, where the central bank does not target a monetary aggregate. There is nothing difficult about generalising the ISLM model in this way at all. I can’t even think why we consider it a generalisation. The quantity of money demanded depends on stuff in the ISLM model, so why can’t the quantity of money supplied depend on stuff too?
W. Peden: Yep. And if we do want to talk about “reality-based” macroeconomics, which fully incorporates into Modern Monetary Theory what modern central banks actually do nowadays, then modern central banks target inflation, not nominal interest rates (except in the very very short run). Hence my old post, linked in my previous comment is about what modern central banks really do.
Somewhat off-topic but, have you considered teaching ISLM with G and T as functions of Y?
Or do you prefer that G and T be exogenous since you think that fiscal policy should mostly target a whole host of micro concerns?
dwb
“not necessarily, y’all are not addressing the issue of temporary vs permanent fiscal stimulus. We decide to build a road this year, then we are done (whatever your favorite project is. a) why would the workers do anything but save as much as they can knowing they will be unemployed next year b)whyt would someone with a factory expand it knowing that the stimulus will end (maybe he does not even hire people to build stuff, just uses overtime, because he knows its temporary stimulus). ”
I’m inclined to think you use temporary fiscal stimulus when and only when you have a temporary problem. And whatever happens to someone in a temporary job – surely they will spend more than if they are in no job at all.
(P.S. But I’m not a employer of last resort guy. I’m actually a national dividend (basic income) guy. And that income is persistant and reliable. I reckon that combined with progressive taxation would be a really big automatic stabilizer. Plus if things are really bad, you should invest in new infrastructure while the getting is cheap.)
primed: it is very common to teach ISLM with T as a function of Y. T=tY is a simple way to do it. G is normally held fixed. I can’t ever remember a government spending function.
But your question raises a deeper question. I started to write a blog post on this once, but gave up. Is fiscal policy really exogenous? I we treat expenditure by households and firms as determined endogenously by income and interest rates, why shouldn’t we do the same thing with expenditure by governments? You could answer “Because we want to see what would happen if G increased”, but a public choice theorist would respond “Sure, but that’s not very useful or realistic, is it, because governments in the real world don’t always act the way macroeconomists want them to act”.
Nick Rowe,
I expected you to say that fiscal policy is not fully exogenous because the budget deficit at any moment in time is determined endogenously by the market economy as well as by budgets i.e. deficits are determined by revenues and expenditures, both of which are not fully under the control of the fiscal authorities.
Actually, now I think about it, deficits are also determined in part by the rate of inflation, assuming tax brackets aren’t inflation-linked or if spending targets are set in real terms.
reason,
“If capital inflows completely offset fiscal policy, and capitalists know that, then the capital inflows won’t happen.”
Yes, more or less, but this is not contradictory. Given how instantaneous the adjustment is, the change in exchange rates will occur instead, avoiding the intermediate step. Incidentally this relates to the the “twin deficit problem.” In the case of the United States, it is easily observed that the budget and current account deficits moved in sync from about 1981 until the early 1990s undermining any potential fiscal stimulus.
@reason
why would someone spend more from a “temporary fiscal stimulus” job than UI, knowing the job ends in 12 months?
what if we eliminated UI, replaced it with workfare?
seems to me a good chunk of the stimulative properties stem from some probability its permanent, the rest from a bet the CB wont hike rates sooner.
Nick, I was just wondering if you were willing to endogenize the government’s reaction function (and therefore obtain an IS of any desired shape) just as you endogenized the Fed’s reaction function (and therefore obtained an LM of any desired shape). I think I see your point though – monetary policy is, at least in theory, a technocratic decision while fiscal policy, as a public choice theorist would say, depends on the government’s and the electorate’s incentives.
W. Peden, I agree that fiscal policy is not exogenous and was merely wondering about how to teach a simple model (such as IS-LM) for an intro macro course.
primedprimate,
I see now.
primed: “Nick, I was just wondering if you were willing to endogenize the government’s reaction function (and therefore obtain an IS of any desired shape) just as you endogenized the [edit: Bank of Canada’s not the Fed’s. NR!] reaction function (and therefore obtained an LM of any desired shape).”
Hmmm. Good question.
Hmmm. here’s one weird but interesting answer: Suppose the monetary and fiscal authorities were targeting exactly the same thing. Then the IS and LM curves would lie on top of each other. The model would be overdetermined in some dimensions and underdetermined in others. That tells us something important.
Nick, following your logic, since money does not pay any coupon its value is zero. Why do people have an excess demand something that has a value of zero? Or does it have value of zero?
and I also do not understand about which expectations you are talking about? Expectations of what? Interest rates or value of assets? The two are not the same and are pretty much a universe apart. It does not follow that if interest rates increase then the value will drop. The value can increase in line with interest rates. There is no contradiction here.
Sergei: my car does not pay a coupon either. And its value is not zero. People are willing to hold money, despite the fact that other financial assets pay a higher rate of return, because it is useful to do the shopping. Just like my car.
Expectations of anything that might affect the future demand and/or supply of an asset.
Right, so people demand money in order to spend? And not as an asset. Isn’t another word for this process “income”? So people demand income, not money. Money is not income. Both are a universe apart.
“Expectations of anything that might affect the future demand and/or supply of an asset.”
But you keep on referring to monetary reasons of depressions. Why is then that you admit that expectations of anything can influence expectations? I am really confused. Especially with regards to your whole story which mostly revolves around discounted cash-flows with the rest implying some interest rates.
@Dan,
You wrote:
“Mark, when you start with a rightward shift in the IS curve without a change in the position of the LM curve, you are assuming a fixed supply of money right? That is, you are rejecting the idea that government spending might itself inject money into the economy, or at least be responsible for an endogenous increase in money at the prevailing interest rate as the additional demand raises production -> demand for borrowing -> deposits?”
Yes, I reject the idea that commercial banks create money endogenously. So does almost everybody (economist) I know.
And:
“Also, why couldn’t someone tell a reverse story form the one you have told to prove the inefficacy of monetary policy? That is, the central bank increases the supply of money, leading to an outward shift of the LM curve, leading to a drop of interest rates, leading to a decreased demand for the domestic currency, leading to a drop in the value of the domestic currency in foreign exchange markets, leading to an increase in exports, leading to an increase in employment, leading to a drop in government spending, leading to a leftward shift in the IS curve, leading to the same level of output we started with?”
Why would government spending drop? Government spending is usually assumed to be endogenous in the IS/LM model.
And:
“Or to be even closer to your original story, you could imagine that as exports increase and money re-enters the country, the central bank begins to decrease the money supply, shifting the LM curve back to the left and leaving us eventually with the same output we had when we started.”
No, presumably they are targeting that particular LM curve. It’s not clear to me that they would have to change the money supply in order to maintain that target but even if they did it wouldn’t matter.
“I hate thinking in terms of these curves, frankly, because they have an attractive visual simplicity that makes people start thinking in terms of animated powerpoints where various actions allegedly produce automatic effects in terms of motions of or along these curves, instead of actual people and institutions. Anyway, my understanding was that people stopped using the LM curve setup once it became clear that central banks these days mainly target an interest rate, not a monetary aggregate.”
The LM curve shows the combinations of interest rates and levels of real income for which the money market is in equilibrium. As such, the LM function is the set of equilibrium points between the liquidity preference or Demand for Money function and the Money Supply function (as determined by banks and central banks). (In fact saying that a leftward shift in the LM curve is equivalent to an increase in the money supply is somewhat of an oversimplification, but it is perfectly acceptable for our purposes.) So actually the LM curve is ideally suited for thinking about monetary policy in terms of interest rates and not aggregates. (Probably one reason why Scott Sumner hates it so much.) If anything it became even more central to economics instruction during the Great Moderation and the age of the Taylor Rule.
@Nick,
Thanks for the explanation of Warren Mosler’s Jobs Guarantee policy. Although somewhat clearer, it still seems extremely arcane (almost like a dead language) to me.
“…a leftward shift in the LM curve…”
should read
“…a rightward shift in the LM curve…”
Yes, I reject the idea that commercial banks create money endogenously. So does almost everybody (economist) I know.
Then I think you need to expand your horizons Mark. I can understand disagreeing with the idea. But there really is a fairly large group of researchers, and not all of them in the Post-Keynesian camp, who have defended the endogenous of money.
There is quite probably a semantic thingy here. “Endogeneity of money” means different things to different people.
For example, I believe that money is endogenous (in one sense) under inflation targeting (and a lot of other monetary regimes, except a Friedmanite k% rule). And so does every economist I know.
But I am also a very extreme believer that money is exogenous (in another sense). And I know very few people who agree with me on this.
It’s supply determined, rather than demand-determined (few economists believe this). But the quantity supplied depends on almost everything, under inflation targeting (all economists believe this).
It’s Nick the heterodox!
Sergei: “Right, so people demand money in order to spend? And not as an asset. Isn’t another word for this process “income”? So people demand income, not money. Money is not income. Both are a universe apart.”
No, no, no, no!
Here’s an analogy. Think of a used car dealer. He both buys and sells a flow of cars. At any given time he has a stock of cars on his lot. That’s his inventory, or buffer stock. His inventory of cars fluctuates up and down around some average level as he buys and sells cars. We can talk about his “desired average level of inventory”. If his actual inventory gets higher than that desired amount, he will slow down buying of cars and/or speed up selling of cars. The opposite if the actual inventory gets lower than that desired amount.
People also hold an inventory of money. When economists talk about “the demand for money” we mean the desired average stock of money inventory. We are not talking about desired income, or desired spending, which are both flows.
Ok Nick I see. But I still have troubles re-building your story.
You say “Money is an asset. It’s also a very long-lived asset”. And it obviously pays no coupon. Therefore its value has to be zero since there are no cash-flows to discount. It does not matter what expectations are or will be. Because money is long-lived and does not pay cash-flows its value is always zero. I.e. the value of stock of money is zero. Why do people demand something which has a value of zero?
Then you say: “because it is useful to do the shopping.”
But doing shopping is a flow. This flow (expenditure=doing shopping) must be balanced either by another flow (income) or by changes in the stock (wealth). Since on the macro-level doing shopping does not change the stock (income=spending) then we are in the domain of flows. Assuming people overall want to hold a larger stock they still need a flow and that is income. They need income and desire income! Without income (flow) you can not increase any stock!
Unless you define wealth purely in terms of money. Do you?
Another way to describe your view on economy is in terms of accounting cash-flow statement. Is it correct?
Sergei: “Unless you define wealth purely in terms of money. Do you?”
Certainly not!
“Another way to describe your view on economy is in terms of accounting cash-flow statement. Is it correct?”
Bu**er accounting!
Think back to the used car salesman. He has an inventory of cars. That inventory has both costs and benefits to him. The costs of having a larger inventory are the foregone interest of keeping part of his wealth sitting on the lot (plus depreciation etc.). The benefits are that he can make higher returns because he is more likely to have a car closer to what the buyer wants, so can sell for higher prices.
In principle he could keep exactly the same average flows in and out of cars, while carrying a smaller average inventory. But it would be less profitable (or convenient) for him to do so.
In principle I could keep the same average flows in and out of money, while carrying a smaller average inventory. But it would be less profitable (or convenient) for me to do so.
The used car dealer demands an inventory stock of cars. I demand an inventory stock of money.
I also demand a stock of cars to drive. There is no such parallel with money.
Nick, I have re-read your car salesman analogy several times but still do not get how it answers my problem:
Assuming people overall want to hold a larger stock they still need a flow and that is income. They need income and desire income! Without income (flow) you can not increase any stock!
What happens between a car dealer and a car buyer does not matter for the macro stock of money. Since you confirmed that wealth is NOT just money and you do not describe economy in terms of cash-flow statement, then I do not understand where in your story the inflow of money comes in which is required to increase the stock.
I can understand your story if you describe economy in terms of cash-flow statement. That is what the idea of stock of money generally implies. People spend cash and increasing the volume of cash maybe will induce more spending. But then wealth should also be defined in terms of money.
So either:
1. stock of money is defined as wealth and cash-flow statement result drives shopping trends
2. stock of money is just an asset, i.e. part of wealth, and there is generally no conclusion between stock of money and spending trends
Or?
Whenever I sell something, money flows into my inventory. Whenever I buy something, money flows out of my inventory. If I wanted to, I could try to perfectly synchronise my flows in and flows out, and so I wouldn’t need to hold any inventory. But it is costly for me to sychronise my flows in and flows out. So I demand an inventory of money. Add up every individual’s demand to hold an inventory of money to get the total (stock) demand for money. Compare that to the total stock supply of money. (In the long run) that demand and supply determine the price of money (the reciprocal of the price level). But in the short run, when prices are sticky, the demand and supply of money determine real income instead.
Sergei: I wrote my 9.03 before seeing your 9.00. But does it answer your question?
Yes. As I understand you describe functioning of economy in cash-flow statement kind of way.
I disagree. There is a reason why there are 3 types of accounting statements with cash-flow statement being somewhat important only in special types of situation (like insolvency). Other two accounting statements are much more important to economic behavior than the cash-flow statement. It might be that on the macro level the cash-flow statement becomes extremely important but I do not understand how. At the very least an idea of financial solvency is not applicable to the macro-economy.
Sergei: “It might be that on the macro level the cash-flow statement becomes extremely important but I do not understand how.”
It’s really simple. Start at “full employment” (however you want to define it). Then suppose desired V falls, so people want to hold a larger inventory of money given their income Y and prices P. Suppose P cannot adjust instantly (sticky prices). Suppose the central bank and the commercial banks do not expand M in proportion to the fall in desired V. Then people stop spending their money as quickly, so Y falls, because Y=MV/P. We get a recession. Really simple. Really important.
Look, you are obviously smart, and have obviously been investing a lot of time and thought into reading some high-powered Post keynesian stuff. But despite (or because of) all that reading, you have massive blind spots, because you haven’t learned even the basics of the first year textbook stuff, like what economists mean by “the demand for money”.
Nick, no, it is not simple.
Firstly, I do not understand that little thing called velocity. Apparently it is velocity of money and so should have a dimension of [$/t] (sorry my physics background). So MV has a dimension of [$2/t] that is money squared divided by time. Are you sure that that is what you get out of PY part? Because you do not get it there. In physics the rule number 1 says that in all equations dimensions should match. If they do not match, then you have garbage. Very simple. So velocity in reality should be called frequency and only then dimensions will be equal. Simple? If mean different things no wonder people do not understand each other.
Secondly, I do not like all those “suppose” becoming “look it’s really simple”. If it was really so simple you would not need so many supposes? So probability of 1 suppose conditional on probability of another suppose conditional on probability of one more suppose and then one more suppose will pretty much give you ZERO in the end unless you are talking almost certainties. But if you talk almost certainties why do you need so many supposes?
And finally, one can describe a recession in other words but more or less using the same equation. Say, V drops because some people stop spending (that is pretty much the definition of dropping V, right) because either they do not have income or equivalently because lots of income in the economy (Y) is gobbled up by some big guys who do not want to spend it. The problem is that that income is something that is exogenous to the MV=PY equation. And no central bank can control the flows of income in the economy. You need fiscal policy for that. So fiscal policy kicks in, redistributes income from big guys to smaller ones and V gets fixed and things get going again. That is a much more simple story. And note that I did not mention any “suppose” at all. For me it sounds like an action plan ready for implementation starting now.
As I said above I understand your point. But I disagree. Because I do not see how “on the macro level the cash-flow statement becomes extremely important”. People need income to spend ongoods*. Income often, but not necessarily, comes in the form of money. But income is NOT money. And money is NOT income. P&L statement describes your income but the result (bottom line) of P&L is integrated into the liability side of the balance sheet under equity (net worth). The asset, corresponding to that liability, can come from the cash-flow statement in the form of cash. But not necessary. Very simple.
This story is simple for me. One directly follows from the other and there is no need for “suppose”. That is why I do not see how “on the macro level the cash-flow statement becomes extremely important”. It can but it also might not be.
I do not think those are blind spots. They do not make sense on many dimensions (such of which I tried to outlined from my physics background) and there are simpler explanations for the same phenomenon.
Recessions are always and everywhere a redistribution of income phenomenon! 🙂
Sergei: “Apparently it is velocity of money and so should have a dimension of [$/t] (sorry my physics background). So MV has a dimension of [$2/t] that is money squared divided by time.”
Stop! V has the dimensions 1/time. It’s how many times per year the average note changes hands. M has the dimensions $, so MV is $/time. P has the dimensions (e.g.) $/kg, and Y (or T) has the dimensions kg/time (I’m using kg of apples as an example), so PY has the dimension $/time too.
For example, if I like to hold an average inventory of money equal to one month’s nominal income, and we measure time in years, then my personal desired V is (1/12)years.
(I agree that units are very important. We can sometimes learn a lot just by thinking about units. Did you read my old post on units?) You might find it fun and interesting (even though I know I am behind real scientists in thinking about units).
“Say, V drops because some people stop spending (that is pretty much the definition of dropping V, right) because either they do not have income or equivalently because lots of income in the economy (Y) is gobbled up by some big guys who do not want to spend it. The problem is that that income is something that is exogenous to the MV=PY equation.”
Stop! Y is income. The identity MV=PY says nothing about what is exogenous or endogenous. And when I built my toy model in the comment above, and wrote down (damn! it’s on the other post) Y=MV/P I assumed that M,P, and V were exogenous, and that Y was endogenous.
And why should V depend on income, or the distribution of income? (It might, or it might not). If everyone wants to hold one month’s nominal income in money, then V is independent of income and the distribution of income. V=1/12. And why should fiscal policy change desired V? (It might or might not).
Nick, sure V has a dimension of 1/t. Well, it SHOULD have it and nothing else. But a thing that has a dimension of 1/t is called frequency. Like in “so many times per unit of time” 🙂 But then velocity can not be velocity and frequency at the same time. Velocity and frequency are different things, right? Or my English is so bad? I have just rechecked in the dictionary. They ARE different 🙂 Anyways it is not about linguistics.
Sorry, on re-reading my “(Y)” is confusing. I regret I have put it in there. What I meant is that out of all Y you do not know whose part of Y is not spent back into economy and thus causes V to slow down. Because the part which is spent back tries to keep V constant. And the part which is not spent is exogenous to the MV=PY. It is not there and you can not analyse it or “fix” it. As the share of unspent income diverts from zero (ignoring debt here) and approaches 1 then V approaches 0. In the limit when no income is spent it does not matter how much you increase M you will get zero because anything times zero equals zero. You also can not get M to infinity because that implies no private economy and no problem to solve
Finally, I do not need V to depend on income or its distribution. That is unnecessarily complex for the problem at hand. All I say is that you can fix “the income not spent” which causes V to slow down. How? You ensure it is spent by redistributing it from those who do not spend to those who will spend. Details are important here and very interesting but lets ignore them. You do not need to change “V”. The problem is not in V but elsewhere. So you need to change that “somewhere” in order to “fix” V.
In theory you can run the whole economy on 1 dollar stock of money. And even have inflation. I do not see a problem. Just make sure that your fiscal re-distribution of unspent 1 dollar gets closer and closer to real-time. Can you imagine such a system? Just curious. Not asking whether it makes sense or not, good or bad. Just whether you can imagine. Can you?
If yes, then that is the reason why I like my story more. Your story might be nicer. But you do not need to study string theory in physics only because it is mathematically nice and cool and noone else can understand it. However nice it is it nevertheless does not help us to understand this world. It is super nice but utterly useless.
Sergei: economists are not very good at naming things. What we call “Velocity” is really what a tachometer measures, not what a speedometer measures!
“Just whether you can imagine. Can you?”
Basically yes. Silvo Gessel had a very similar idea in the 1930’s. Money would self-destruct after (say) 30 days (unless you paid to make it valid again, which is like paying negative interest on currency). That increases V. I think Gessel was (in principle) right. (But it’s got nothing to do with rich or poor).
Speedometers measure speed, not velocity :).
curiouseconomist: I think that’s a good example. But I was just literally 5 minutes ago reading your excellent long comment on Chris Dillow’s blog. And I think the evidence you marshal there is more important. And I was wondering who you were, and then returned here to find your comment!
Thanks.
And I was just wondering whether it would be possible to repeat what you did there, only using NGDP forecasts instead of RGDP forecasts, and comparing countries? If there are RGDP forecasts and inflation forecasts, it should be possible to construct NGDP forecasts. Then repeat what you did in your comment, to argue it should have been quite possible for central banks to have loosened monetary policy to prevent forecasted NGDP falling like that?
Maybe when I have more time, but that’s too much work for me at the moment. Sorry.
Nick: “Hume sounds a lot closer to Scott Sumner than to MMT.”
Perhaps only b/c he was writing in the 19th century? Take convertible vs fiat currencies into account, and how new units of each come about (in a closed economy), and Hume could be speaking for either school, I think.
Mark Sadowski, “Let me explain why in the context of the basic IS/LM model.”
There you guys go again… 🙂
My MMT friends assure me that (1) some stock-flow consistent models, as well as various operational aspects of the real world, badly undermine IS-LM assumptions and conclusions and that (2) Hicks disavowed the whole mess later in his career.
There was also Nick’s attempt here, some time ago, to capture MMT in an IS-LM framework, which Warren Mosler dropped in to comment on. If memory serves, it was pretty indeterminate what sloped where.
Godley and Lavoie’s book Monetary Economics was just released, finally. Might be a better place to start searching for common theoretical ground and better models. The old ones are so last century. 😉