A New Monetary Theory

Although it would probably still be descriptive, I wonder if the exchange equation would be relevant under a market system where M is controlled by the invisible hand rather than a single human decision maker.

Thanks for the article--a good read.

then increasing the money supply can maintain price stability and prevent deflation

Provided the agency controlling the money supply is able to anticipate growth and will manage the money supply accordingly.

However, we are talking about a money supply managed by political forces.

I refer you to this article on Milton Friedman's latter thoughts on the possibility of effective monetary management by political agency.

Some seem to be confusing inflation with increasing the money supply. If a growing economy is not matched by increased reuse (velocity) of the existing money supply, then increasing the money supply can maintain price stability and prevent deflation. It doesn't seem appropriate in that case to refer to it as an "inflationary policy".

A million $1 notes may be sufficient for an economy of 100 people, but obviously the money supply would have to grow to accommodate 250 million people.

From Mystery of banking by Murray N. Rothbard...

The crisis of 1839 ushered in four years of massive monetary
and price deflation. Many unsound banks were finally eliminated,
the number of banks declining during these years by 23 percent.
The money supply fell from $240 million at the beginning of
1839 to $158 million in 1843, a seemingly cataclysmic drop of 34
percent, or 8.5 percent per annum. Wholesale prices fell even further,
from 125 in February 1839 to 67 in March 1843, a tremendous
drop of 42 percent, or 10.5 percent per year. The collapse
of money and prices after 1839 also brought the swollen state
government debts into jeopardy.
State government debt had totaled a modest $26.5 million in
1830. By 1835 it had reached $66.5 million, and by 1839 it had
escalated to $170 million. It was now clear that many states were
in danger of default on the debt. At this point, the Whigs, taking
a leaf from their Federalist forebears, called for the federal government
to issue $200 million worth of bonds in order to assume
all the state debt.
The American people, however, strongly opposed federal aid,
including even the citizens of the states in difficulty. The British
noted in wonder that the average American seemed far more concerned
about the status of his personal debts than about the debts
of his state. To the worried question, Suppose foreign capitalists
did not lend any further to the states? the Floridian replied, “Well
who cares if they don’t. We are now as a community heels over
head in debt and can scarcely pay the interest.”6

The implication was clear: The disappearance of foreign

credit to the states would be a good thing; it would have the


healthy effect of cutting off their further wasteful spending, as


well as avoiding the imposition of a crippling tax burden to pay


for the interest and principal. There was in this astute response an


awareness by the public that they and their governments were


separate and sometimes even hostile entities rather than all part


of one and the same organism.


The advent of the Jacksonian Polk administration in 1845 put


an end to the agitation for Federal assumption of the debt, and by


1847, four western and southern states had repudiated all or part


of their debts, while six other states had defaulted from three to


six years before resuming payment.7


Evidently, the 1839–43 contraction and deflation was a


healthy event for the economy, since it liquidated unsound investments,


debts, and banks, including the pernicious Bank of the


United States. But didn’t the massive deflation have catastrophic


effects—on production, trade, and employment—as we have generally


been led to believe? Oddly enough, no. It is true that real


investment fell by 23 percent during the four years of deflation,


but, in contrast, real consumption increased by 21 percent and


real GNP by 16 percent during this period. It seems that only the


initial months of the contraction worked a hardship. And most of


the deflation period was an era of economic growth.8

That's why an inflationary policy isn't a blunt tool which we can use to extricate ourselves from any situation.

The problem is that when politicians have access to that power, they will use it to maintain their power, thus monetary policy is not used wisely, but rather is used constantly such that corrections are pushed back until the situation becomes inexorable.

And who's to say when reluctance to invest/lend is irrational?

Perhaps all that is needed is to get politicians out of the way and a little time so things can be sorted out.

Promotion of fear is the politicians main tool for acquiring power.

Sam Grove:

Correct! That's why an inflationary policy isn't a blunt tool which we can use to extricate ourselves from any situation. Having said that, I think it generally makes sense to have an inflationary policy in a liquidity trap, since in such a case banks and people would be irrationally afraid of lending. One thing that economics hasn't really considered, though, seems to be the method of inflating the monetary base. There's an argument to be made that traditional methods just give more money to the banks instead of directly stimulating investment. It's all very complex, and I don't pretend to know much about this - I'm just saying that an inflationary policy is the textbook prescription for a liquidity trap, and the orthodox reason why is the irrational fear of investment/lending.

Monetary inflation and deflation is always a matter of government/central bank policy.

Deflation due to increasing productivity is a positive, or would be, if it didn't lead to people clamoring for government to do something about it.

Inflation and deflation in modest amounts are fine. The problem occurs when they're large, or changing. Consider that computer prices have been deflating for twenty years now. Nobody is going to argue that the PC industry is non-functional, are they??

Oh well at least people here aren't taking the opposite take and saying "deflation is therefore good". Robinson Crusoe can't make food appear on his plate by plucking leaves off trees and 'inflate' his way to food and more than taking the same leaves and burning them 'deflates' his way to food. :\

I think that what is absurd (or supposedly absurd) about this film is that it makes a sort of broken window argument about the effects of inflation.

That being said, yes, the money supply shrank out of all proportion with production, leading to the Great Depression. I don't think Friedman would have said "inflation is the answer!" so much as he would have said "the deflation should never have happened in the first place!"

-Russ

What in this video do you think Milton Friedman would disagree with? (the video said "3 million will be inserted into the economy," I'm guessing that is fiscal and not monetary in practice, which MF would not like, but the video doesn't specify). But everything else is pretty straight forward macro. I'm kind of surprised they knew it all back then.

Ask most high school students (even most people) if there was inflation in the great depression, and they will say "yes." Why? Because they know the great depression was bad and they know inflation is bad, and they assume that the two must be one in the same.

Of course, we know that is not true. If FDR had a goal of modest price inflation, he was not able to achieve it:

Year Inflation Rate




1929 0.00


1930 -2.51


1931 -8.80


1932 -10.31


1933 -5.12


1934 3.32


1935 2.54


1936 0.95


1937 3.61


1938 -1.88


1939 -1.42


1940 1.01

From 1933 to 1940, CPI rose about a third of a percent on an annual basis. In 1940, prices were 2.7% higher than 1933. In a well functioning modern economy, prices would be about 17% higher.

Would really like to hear further comment on this. Cheers,

Charlie

One of the previous comments said it best, it really is almost straight from an undergrad textbook.

That being said, though, I can see where they're coming from, just not with the same understandings.

An inflation in the money supply is fine, as long as it matches the demand for money. That shouldn't necessarily result in higher prices, though.

The ideas in the MGM movie and in FDR's 1938 fireside chat were _extremely_ popular, and go back to the writings of William Foster and Waddill Catchings.

The ideas of Foster and Catchings turn out to be an early version of Keynes, and there is some good chance that Keynes took some of his thinking after reading Hayek's debunking of Foster and Catchings in his 1929 essay, "The Paradox of Savings".

Read about Foster and Catchings here:

http://mises.org/story/2804

Is this any more idiotic that the thinking behind the "secular stagnation" of the original American Keynesian, Alvin Hansen?

Note well that such economic idiocy was standard fair among the citizens and academic economists who readily embraced "Keynesian economics" -- perhaps explaining much of the phenomena.

FDR said:

"Over-speculation in and over-production of practically every article or instrument used by man .... millions of people, to be sure, had been put to work, but the products of their hands had exceeded the purchasing power of their pocketbooks."

Crusoe rides his imaginary horse into the sunset

Yeah, for now. But just wait until he starts crapping out all that porcelian shards from the gormet dishes he ate.

that inflation can be a way to get the economy moving again

You have to ask why the economy has stalled.

If it is a result of resource mis-allocation due to previous stimulation (inflation), then further inflation will bring yet another stall.

I think the point that is often missed is that this argument about inflation only applies in unique situations. No serious thinker can honestly believe that the more inflation you have the better things will turn out. Rather, it's when circumstances are right - for instance, in a liquidity trap - that inflation can be a way to get the economy moving again.

Robinson Crusoe gets marooned on an desolate island. he finds a dining table set out with gourmet dishes and starts eating. Island's economy gets stimulated. He leaves a magic IOU ( money ) as a tip on the table. Ponzi Multiplier effect of the IOU sends the economy soaring into the sky.

4 hours later Crusoe comes to the table, eats another set of gourmet dishes and leaves another IOU on the table. IOU's ponzi multiplier effect sends the economy into a tizzy.

Next day Crusoe comes to the table eats a gourmet breakfast and leaves another IOU as tip on the table. Now the ponzi effect send the economy soaring into the orbit.

So on and so forth.

Crusoe rides his imaginary horse into the sunset

The end.

Funny, there are lots of economic models built around the Robinson Crusoe economy or so called representative agent economies. Unsuprisingly, it is hard to make Robinson Crusoe hold money.

Funny, there are lots of economic models built around the Robinson Crusoe economy or so called representative agent economies. Unsuprisingly, it is hard to make Robinson Crusoe hold money.

Robinson Crusoe gets marooned on an desolate island. All he has to do is to find the dining table set out with gourmet dishes and start eating, that will stimulate the island's economy.

Bankster Madoffs run inflationary ponzi schemes of credit that is destined to fail at some point, and when it does, Fed comes in and rewards the Madoffs at the cost of all their victims. Sure, Fed, and its apologists all agree that it is a fair and balanced scheme.

Thank you Fed, Krugman, Mankiw

So we don't have to work, only spend, to become better off?

That seems to be the thrust of spending economics.

So we don't have to work, only spend, to become better off?

That seems to be the thrust of spending economics.

Maybe the video is dumb I'll watch it when I get home. But using inflation to get out of a liquidity trap (or deflationary trap) is mainstream economics. I mean, Paul Krugman and Greg Mankiw agree on it. The intersection of policy ideas they agree on are quite likely to be good ideas.

Here is a brief primer from the Dallas Fed on the topic:

Dallas Fed

Krugman Blog

Mankiw Blog

If you think that video is bizarre, check out Roosevelt's fire side chat from April of 1938: Roosevelt's Economic Explanation

In this fireside chat, Roosevelt is trying to explain why after 5 years of his administration, unemployment is still near 20%. He begins by giving his explanation for the cause of the Great Depression.

"Over-speculation in and over-production of practically every article or instrument used by man .... millions of people, to be sure, had been put to work, but the products of their hands had exceeded the purchasing power of their pocketbooks...Under the inexorable law of supply and demand, supplies so overran demand (which would pay)that production was compelled to stop. Unemployment and closed factories resulted. Hence the tragic years from 1929 to 1933."

He then admits that total national income, at $68 billion, is still below the 1929 level of $81 billion.

Now, get this: here is Roosevelt's explanation for why income has not returned to the level of 1929:

"Again production had (outran)outrun the ability to buy.....There were many reasons for this over-production....Production in many important lines of goods outran the ability of the public to purchase them, as I have said."

So there it is again, that nasty ol' overproduction problem. Roosevelt then explains what he asked Congress to do to correct the problem:

“I asked for ….. additional money for the Works Progress Administration; additional funds for the Farm Security Administration; additional allotments for the National Youth Administration, and more money for the Civilian Conservation Corps….. to make definite additions to the purchasing power of the Nation by providing new work over and above the continuing of the old work…. enable the United States Housing Authority to undertake the immediate construction of about three hundred million dollars worth of additional slum clearance projects……to renew a public works program by starting as quickly as possible about one billion dollars worth of needed permanent public improvements in our states, and their counties and cities. ….to add one hundred million dollars to the estimate for Federal aid highways in excess of the amount that I recommended in January…. to add thirty-seven million dollars over and above the former estimate of sixty-three million for flood control and reclamation…. to add twenty-five million dollars additional for Federal buildings in various parts of the country.

More spending on public works! That should do the trick! Never mind that it hasn’t worked so far, we’ll try more of it!

It didn’t work for Hoover, it didn’t work for Roosevelt -- and yet Obama is determined to try it once again.

A question occurred to me this morning as I was pondering yet another teeth-gnashing letter from a supplier explaining their new higher price points for next year. For many years, my industry (signage) was stable & complacent, with little change from year to year in prices & comparisons between manufacturers. With the shock inflation of the past few years, the manufacturers have been reacting in many ways: absorbing a lot of costs, raising prices, etc. There has been a lot of upheaval with some manufacturers radically reviewing their processes, holding prices as steady as possible, and making a grab for market share.

In practice, the end result, it seems to me, is that a period of shock inflation has triggered true productivity gains well in excess of what would have come along from the previous, complacent scenario.


Is productivity as a result of inflation a recognized outcome? Have I found a future dissertation topic, or is this something everyone else already knew?

I guess Zimbabwe must have a thriving economy since the movie clearly shows how inflation boosts an economy.

Monetary inflation isn't bad if you are experiencing massive monetary deflation.

Fed monetary policy pre-1933 was too contractionary to allow for the real economy to function. Going off the gold standard and devaluing the dollar turned around the depression.

On the other hand, non-monetary efforts to raise wages and prices despite the contractionary monetary situation were worse than useless, they raised unemployment. This kind of thing extended the slow growth in the post-1933 period.

Well, if the Fed. had printed money in the early 30s to prevent the fall in the money supply, would it not have been better than what did happen?

Sadly, it seems that most undergraduate macro text still give the same arguments as in the video.

Good find on this one.

wow... that's some really special economics logic.