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# Classical Model

Discussion in 'Economics' started by spice101, Sep 28, 2011.

1. ### spice101

Consider the following version of a Classical Model.
n^d(w,r) = n^s(w) (1)
n = n^d(w) (2)
y = f(k, n) (3)
y = c(r, y - t) + I(r, y - t) + g (4)
M/P = L(i, y) (5)

What are the effects on this model economy of an unanticipated increase in the nominal money supply?

2. ### Ed Breen

You would think that if you seriously wanted responses you would have identified your model variables better.

In the real world, an increase of nominal money supply will only increase bank lending and the general price index when private credit is expanding. When private credit is contractring an increase in nominal money supply will have no transmission effect to influence lending or the price index and will only manifest in an increase in excess reserves.

Is that in the model?

3. ### jueco2005

anticipated or unanticipated inflation is created.

4. ### Ed Breen

"anticipated or unanticipated inflation is created." What does that mean? Where is the evidence? How do you model those concepts in metrics?

You have to come to grip with what inflation is and how it is caused. If you want to say that inflation is always a monetary event and that the incease in base money always causes a general price increase, then you have to measure that price increase. The quantity theory of money that is accpeted by Keynesians, Monetarists, Supply Siders and Austrians alike, holds that an increase in the base money supply will always result in a general inflation of prices of all goods and services in time depending on thier price elasticity.

The most important feature of the current macro economy since the Financial Crises of 2008 has been a grand experiment testing the real world application of the Quantity Theory. The Fed has increased base money on its balance sheet from around 200B to 2,200B over the course of two and half years. During that time that base money has increased so dramatically, the price index measures, the CPI and the PCE Cores, have decreased, while there has been volatile price increase in some commodities that may not be sustainable, there was no increase in collateral asset prices, notabley housing, and wages have continued to decline.

What you have is a grand experiment that appears to disprove the Quantity Theory of Money. Base money was increased, asset values continued to decrease, general price levels declined accept for a few necessities and strategic commodities. The policy reason for the increase in the base money supply was to increase asset prices. That did not happen.

The reason it did not happen is that leverage is the driver of asset price increase and the owners of assets are deleveraging and converting assets to cash and cash equivalents. They are not investing in the creation of new assets or the maintenance of the existing aggregate asset base.

It turns out that there is no transmission mechanism to transfer increase in base money supply to bank lending or general price increase where private credit is contracting. This all reveals that the price change driver is expanding private credit and increasing leverage ratios; which are demand driven and not modulated by money supply or interest rate modulation alone. You can't make the dynamic of private credit expansion work where there is no demand to invest and asset owners continue to divest and repay debt as a strategy less risky than investing in the future. Neither interest rate reductions nor increased bank liquidity can of itself overcome a fiscal context that discourages investment in the future.

So, what the hell is aticipated and unanticipated inflation? If there is no effect in general prices then what difference does it make? Does it really happen if it can't be measured?

5. ### Martinghoul

Is this a homework problem or smth?

6. ### jueco2005

I am not sure I can help you. You would need to read a few books i guess.

Inflation as Milton Friedman said is everywhere and every time a monetary phenomenon. It happens only when money is created by the entity having the power to do so; in this case the Fed.

What you are talking about is the end result. Fed inflation leads to bubble. Mostly Asset bubbles not just price increases in the so called CPI. You also seem to be lost about last decade inflation. Check your numbers again.

It takes time for newly created money to fully move in the economy. It is harder today because newly created money is fueled as debt. And the debt market has been saturated by the housing bubble and the economy is creating few productive enterprises capable of absorbing any credit at all. THAT'S WHY BANKS HAVE SO MUCH CASH NOW.

7. ### Ed Breen

Jueco2005,

I simply asked you to explain your cryptic comment; you don't need to respond with a smug insult that has no basis. Why do you suggest I need to read more books? Is there a specific book you want to recommend. My experience is that cryptic smug comments that hint at some treasure nuget of special knowledge, are really just signs of intellectual insecurity. Why don't you simply explain what you are thinking clearly? Don't you want to communicate?

You like most people, don't bother to pay attention to Friedman's full quote, as it was stated in his 1970 Wincott Memorial Lecture, titled, "The Counter Revolution in Monetary Theory.' (You can get it in book form from Amazon). The full quote is as follows: "Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output." It appears that his version of when it happens is different from yours.

I would suggest that the way to conform Freidman's assetion to the reality of today is to understand that, in a fiat currency world, money is actually credit. James Grant, in his classic book "Money of the Mind" goes so far as to suggest that money has become the 'expectation of credit' (You can get his book from Amazon too). If you consider that the supply of money is actually the supply and flow of credit then you can make useful present sense of Friedman's insight, as I have suggested in my post above. The policy problem is that the fed does not have the power to actully make private actors borrow money and expand the supply of credit; the private actors have to want to themselves. The Fed has been trying to do that by increasing the base money supply in the belief that it will automatically incease bank lending. Now we know it doesn't work that way. All thier money creation lies in thier own accounts as required and excess reserves.

I don't know why you are talking about the last decade and asset bubbles created prior to 2008...I only mentioned the years 2008 to present. What facts did I get wrong?

I sort of agree with your last paragraph but I think your thought about it is muddled. Clearly the Banks are awash in money becuase the Fed created so much and there was no demand for loans. You don't make the leap to explain why there is no demand for loans, why the economy is not producing expanding enterprise to absorb debt. Of course the explanation for that was the whole point of my first post and the problem is that what the Fed is doing can't make that happen and so can't get asset prices to rise. All it can do with its various tortured QE is to discredit the Fed and bankrupt the country.

8. ### jueco2005

Sorry my friend no insults were intended. But few people know what inflation really is.I suggest Milton "Freedom to Chooseâ âCapitalism and Freedomâ âThe theory of Money and Creditâ From Mises (Austrian Economicsâ

He unlike the Austrian did not address fully the issue of money, credit and banking. He did favor the creation of money to provide stable prices in the economy. However, his work is good enough and provides enough evidence that inflation is created by printing money. He also blamed the Fed for being resposible for the great depression.

Credit money arises when fractional reserve lending is performed. That's why we have central bankers, to be the insurance of this baking practice.

What you are referring too is very interesting. In my opinion the Fed has been trying to do business as usual but they face a DEBT TRAP. Although the Fed has been loading banks with huge reserves, they find little incentive to lend and who to lend it too. The bubble has not busted yet. Only when it fully burst we are gonna start getting back up. Few individuals and business can afford to take on more debt. Business as usual has been saturated and the Fedâs ability to increase lending has considerable diminished.

In case you have not noticed this business model failed. The whole baking industry collapsed. Thatâs why they were bailed out. Still the casino derivatives markets continues unregulated and virtually no one knows what the hell is going on over there. No one talks about derivates anymore.

2008 to present is very unrealistic. Try a decade instead. 3 years is too little to talk about inflation.

I think i explained this above.

1- Bubble still bursting.
2-Everyone is buried on debt. Canât' get more.
4-decades of deindustrialization, wars, monopoly creations, and impoverishment for the whole country were hidden during bubble years.

9. ### jueco2005

This is what I think about money. Maybe you agree on some.

Fractional Reserve Lending is immoral and should be outlaw. Then no central bank would be needed.

Currency or money is to be determined in the market place. BACKED BY SOMETHING OF VALUE. Such as gold, silver, oil, gas, the list is endless.

Paper money is a confiscation, a theft, a hidden tax.

Inflation is printing money not backed by anything.

Increases in prices are just that. NOT inflation. but could be caused by it.

10. ### Ed Breen

Jeuco, thanks for you comments. It does appear that you have read a few books and you know quite a lot. Your explanations are much better than your quips. I agree with much of what you assert. I am well versed in the Austrians, currently reading Schumpeter (Who is not an Austrian) and I am well versed in the Keynesian-Monetarists, the Monetarists and I know most of the important supply siders, the real ones, not the politicians. I understand inflation real well. I get it in three dimensions. That is why I can tell we are not having it now.

I have explained enough of what I think above and we are talking past each other, so I'm not going to explain anymore unless you ask me a question.

#10     Sep 30, 2011
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