As all good
Keynesians, neo and otherwise, learn in Economics 101, there is a tradeoff
between employment and inflation. The
theory is that if you want low inflation, you’ll have to put up with high
unemployment, and if you want low unemployment, you’ll have to accept
inflation.
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| Say's Law of Markets, very simplified. |
As we’ve seen in
the blog postings over the past two days, that whole idea is nonsense — if you
assume the validity of Say’s Law of Markets, which posits that there is always
enough money for production (whether by labor or capital, not just labor),
simply because money derives from production.
Inflation — or deflation — in the classic sense (too many or too few
units of currency chasing the same amount of goods and services) only results
when somebody, usually government, messes around with the money supply and the
value of the currency, cutting it off from production.
Why? Because if you think labor is the only thing
that is productive, while capital is actually doing most of the work, you will
be utterly baffled as to why labor can’t seem to produce enough in a society in
which production is coming out the wazoo (so to speak). The answer?
Those villainous owners of capital and the greedy politicians (usually
the same bunch) must be stealing from the workers! (Of course, if you realize that capital is
also productive, you realize that the answer is that people with only labor don’t
own the capital that is doing most of the producing, and therefore aren’t able
to produce. . . .).
Getting back to
money per se, we’re limiting our
discussion here to “demand-pull” inflation, the kind that results from
manipulating the currency somehow, e.g.,
increasing or decreasing the amount in circulation by issuing or retiring
government debt. The other kind,
“cost-push” inflation is really just the laws of supply and demand acting on
something other than the currency, e.g., when a lot of chickens get sick
and die, the price of eggs shoots up.
What brought this
up was an article in the Wall Street
Journal from last Friday, October 20, 2017, “A Fed for a Growth
Economy.” The bottom line was the demand
that there be economic growth without inflation and low taxes, thereby shifting
out of the current Neo-Keynesian presumed tradeoff between inflation and
employment.
We, too, want
economic growth without inflation — or deflation, for that matter. The problem is that both sides in the debate
are arguing from the same set of flawed assumptions: that manipulating the
money supply in some fashion will bring about the desired results.
It ain’t gonna
happen. Why?
The fact is that
the underlying assumption of both sides in the debate is fundamentally wrong, viz., that manipulating the money supply
by issuing or retiring debt and changing the tax rate will result in
predictable changes in the velocity of money, the price level, and the number
of transactions.
Oh, there will be
changes, all right. The problem is that
you can’t predict them. In mathematical
terms, here’s why. Start with the
Quantity Theory of Money equation,
M x V = P x Q
where M is the quantity of money, V
is the average number of times each unit of currency is spent in a period (the
“velocity” of money), P is the price level, and Q is the number of
transactions.
Any first-year algebra
student can (or should be able to) tell you that if M is the “independent
variable” in the equation (i.e., the
one that gets changed or manipulated and determines the value of all the other
variables), you have absolutely no idea what is going to happen to V, P. or Q
when you have only one equation that gives you relationships between the
variables. Oh, you can hope, all right,
and sometimes what happens is what you wanted to happen, but it is by no means a
sure thing.
Mathematically
speaking, it’s a total crap shoot: you can’t have one independent variable and
three dependent variables in one equation — and only one equation — and hope to
have anything that makes sense. And when
you add the complexities of the real world to pure mathematics, anything goes.
So, what is a
valid assumption on which to develop a sound monetary policy?
Sound practice
requires sound theory. Obviously, then,
the first step in developing a sound monetary policy is to come up with a
workable assumption, or at least one that makes sense.
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| Plato: the particular comes from the general. |
That means
instead of assuming that the velocity of money, the price level, and the number
of transactions depends on the money supply, we should at least examine the alternative. That is, we need to look at the assumption
that the money supply (absent somebody messing with it, like a counterfeiter or
the government) depends on the price level, and the number of transactions, and
see how well it complies with the demands of logic, mathematics, and just plain
common sense.
Thus, instead of
M being the independent variable and V, P, and Q being the dependent variables,
we need to look at the possibility that V, P, and Q are the independent
variables, and M is the dependent variable.
Under this assumption, M changes to reflect changes to V, P, and Q; V,
P, and Q don’t change to reflect changes in M.
Mathematically,
we discover immediately we are on solid ground.
Assuming that V, P, and Q are independent variables, and M the only
dependent variable, makes perfect sense.
Algebraically, having one dependent variable per equation is a
fundamental principle. Since we have
only one equation, the most we should have is one dependent variable. And that is what we have.
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| Aristotle: the general comes from the particular. |
Further, given
Say’s Law of Markets and the definition of money as anything that can be
accepted in settlement of a debt (“all things transferred in commerce”), it is
supremely logical that money — the means by which I exchange what I produce for
what you produce — depends on production; production doesn’t depend on money. Our change in basic assumptions meets the
logic test.
Finally, does our
change meet the demands of plain common sense?
If money isn’t production, but is simply the symbol of production, it
makes sense that you can’t derive the thing from the symbol. You can only derive the symbol from the
thing.
It is a
fundamental principle of Aristotelian-Thomist philosophy (the philosophy of
common sense) that people go from the particular to the general. Production, whether existing or reasonably
expected in the future (a good promise of “production-to-be”), is particular,
while money, the symbol of production, is general. Production doesn’t come from money, money
comes from production.
Yes, the logic
test and the common sense test are in reality simply two similar ways of saying
the same thing, but then logic and common sense are two different terms for the
same thing as well. What’s important
here is that our new assumption makes sense regardless which way we look at it.
Why that is
important is what we’ll start looking at tomorrow.
#30#
