Mainstream economics — peddling fake knowledge

26 May, 2018 at 11:09 | Posted in Economics | 9 Comments

Based on the [quantity theory of money equation MV = PQ] holding the money velocity constant, if the money supply (M) increases at a faster rate than real economic output (Q), the price level (P) must increase to make up the difference. According to this view, inflation in the U.S. should have been about 31 percent per year between 2008 and 2013, when the money supply grew at an average pace of 33 percent per year and output grew at an average pace just below 2 percent. Why, then, has inflation remained persistently low (below 2 percent) during this period? …

During the first and second quarters of 2014, the velocity of the monetary base2 was at 4.4, its slowest pace on record. This means that every dollar in the monetary base was spent only 4.4 times in the economy during the past year, down from 17.2 just prior to the recession. This implies that the unprecedented monetary base increase driven by the Fed’s large money injections through its large-scale asset purchase programs has failed to cause at least a one-for-one proportional increase in nominal GDP. Thus, it is precisely the sharp decline in velocity that has offset the sharp increase in money supply, leading to the almost no change in nominal GDP (either P or Q).

5267109005_ac183b2699So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? The answer lies in the private sector’s dramatic increase in their willingness to hoard money instead of spend it. Such an unprecedented increase in money demand has slowed down the velocity of Money …

And why then would people suddenly decide to hoard money instead of spend it? A possible answer lies in the combination of two issues:
•A glooming economy after the financial crisis
•The dramatic decrease in interest rates that has forced investors to readjust their portfolios toward liquid money and away from interest-bearing assets such as government bonds.

Yi Wen & Maria Arias (St. Louis Fed)

Anyone still believing in Say’s Law? Just wondering …


  1. “Anyone still believing in Say’s law?” The fact is that prior to the days when budget deficits were used to get us out of recessions, e.g. in the 1800s, the fact is that economies did eventually recover from recessions. That raises a question: why? My guess is that Say’s law had something to do with it. But if anyone thinks Say’s law had nothing to do with it and that there is another explanation, I’m always open to suggestions.

    • “. . . in the 1800s, the fact is that economies did eventually recover from recessions”
      Did they? In what sense?
      Says’ law is opposed to the phenomena of general gluts and money hoarding, both of which are historically documented, contradicting Say. That an episode of general glut or money hoarding may end, given that economic actors have incentives to escape is not any reason to believe any effective mechanism exists in the absence of deliberate fiscal, monetary and trade policy to bring an economy to a full employment equilibrium. If full employment or even real wage growth amidst rampant productivity growth occurred at all in the 19th century, it tended to be transitory.
      The Long Depression that afflicted Britain after 1870 or the two great depressions, 1873-79 and 1893-7, that dragged down U.S. wages during the massive productivity growth of the gathering Second Industrial Revolution, suggest that any “recovery” was an accident and an ephemera.

  2. “The dramatic decrease in interest rates that has forced investors to readjust their portfolios toward liquid money and away from interest-bearing assets such as government bonds.”
    This possible answer gives away your assumptions that acctually confirms the mainstream ideology. That ideology is that business investments is what drives economy not the spending in general.
    BUsiness investment is only a secondary driver that follows spending by wage earners who provide demand. Only then will business invest and procyclically increase demand in general.
    It is also obvious that the level of interest rates does not affect investment decisions which makes your explanation even weirder placing the blame on interest rate as if it affected where the money is invested. Your explanation assumes that it is interest rates that decides investment decisions. That is obviously wrong since then there would be no cases of accelerating inflation with high IR nor low inflation with low IR if that was the case. Investments are obviously decided by something else then IR.
    That “else” is spending by wage earners or majority of population’s spending power. And only then the investment will be procyclical and add to allready growing demand from population’s wage growth.
    The real explanation for no inflation is stagnation in wage growth.
    The real inflation driver is wage growth, working population growth or state spending if on sufficient levels.

    Hence the explanation provided by Syll is reinforcing Say’s Law since it is using it’s assumptions about business investments.
    Although Say’s Law is incorrect i still can find it usefull if it is refrased in monetary terms.
    It would work as following “Monetary supply provides it’s own demand and also the monetary demand provides it’s own monetary supply” with such law we can find it that it correspond with “wage growth (monetary supply) is demand growth and also growing demand is growing the supply (investment into production and wage growth itself).
    There is the explanation for inflation.
    Financial part / credit creation is just acceleration of underliyng causes that drives economy. Wage growth is what allows for more credit creation and such credit helps the causes of the wage growth to increase. Credit is only procyclical in both ways but it can also extend the duration of a trend.
    This all explain for accelerating inflation and low inflation no matter money supply.
    It is the wage growth.

  3. Since we can make our own money every time we use a debit card, there is no way that this formula is applicable to our present-day economic system. It comes from a time when the gold standard still applied and is like a pet pterodactyl.

  4. Last night I went to the movies, paying $16.00 for a senior-discount ticket — no evidence of inflation, there, I guess.( /sarcasm) Just outside the lobby, someone had set up a kiosk promoting residential real estate sales, with pictures of homes for sale. All of the sales pitches argued that these houses, at the listed prices, were opportunities to make money, NOT attractive places to live. One particularly unattractive house in a barren yard caught my eye: just short of 1100 square feet (100 square meters) in the dubious and remote eastern suburb of West Covina — the seller was asking more than $450,000!

    For the technically minded, housing costs are theoretically included in the U.S. CPI, the most popular measure of “headline” inflation, and given a seemingly large weight — 22% of the market basket last time I looked into it more than a decade ago — but the statistical procedure followed severely dampens volatility compared to other components so that “weight” has little effect on movements of the summary index figure representing changes in the general price level. And, there are real questions about where the survey procedures constructing housing costs are at all representative of actual household expenses. In Los Angeles, average single-family unit rent would consume more than 50% of the median household’s income. And, there is a massive, highly visible problem of homelessness.

    So, yes, of course, economists at the Fed would focus on the “unobservable mathematical fudge factor of Velocity”. Makes perfect sense.

  5. “the private sector’s dramatic increase in their willingness to hoard money instead of spend it”
    Even if you believe in the unobservable mathematical fudge factor of Velocity of Money, the psychological nature of bankers’ spending decisions is unavoidable. If bankers capriciously decided to hoard money in Federal Reserve accounts, perversely incentivized by the Fed paying them interest on their excess reserves, licking their psychological wounds after their mental crisis in 2008, then prices themselves depend ultimately on the psychology of bankers.
    I go further in rejecting the quantity theory outright, since Velocity is unobserved and since transaction data from the BIS did not show a decline in the years where money velocity was supposed to have dropped so dramatically. Prices are dependent on whimsical psychology, and supply is adjusted accordingly after the psychological or political decisions have been made. Oil prices for example are going up now not because of some new scarcity in oil, but because OPEC has made a political decision to throttle production. The psychological decision comes first, then, perhaps, some very loose supply-and-demand type of mechanism sets in. OPEC could decide tomorrow to increase supply and drive oil prices down. The only thing that constrains OPEC is its own psychological stance …

  6. The velocity of money is a function of interest rates. The measure of money used in the graph is my own.

  7. “So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP?”

    Because the largest part of the moneysupply-expansion (in the world) comes from investing(consumtion of) in residential housing. Pricelevel-increases can be seen in assets, not cpi´s.

    Of cource the Quantative Theory of Money is still a flawed one.

    • “Pricelevel-increases can be seen in assets, not cpi´s.”
      The private financial sector knows how to increase its incomes faster than even asset prices rise, I contend. Inflating housing prices are affordable to financiers and their investors because they create money faster than housing or asset prices rise. The private sector has redefined inflation as wealth creation, and gains purchasing power by digitally printing their incomes so that they outstrip the rising prices of whatever they may want to buy …

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