[Winstonm]

blackshoe, on 2011-June-11, 08:49, said:

You can supply all the mud pies you like. Nobody's going to eat them.

I agree, which is the reason IMO either Say's Law is misunderstood or it is wrong.
Overbuidling McMansions did not create a sustainable demand for McMansions.

That misutilization of resources to overbuild compared to demand is the basis of the Austrian concept of malinvestment, which is quite a good description of what occured during the housing boom and bust, but the Austrian monetay policies are pretty arcane and not nearly so well thought out IMO.

[PassedOut]

Winstonm, on 2011-June-11, 09:59, said:

IMO your analogies fail as global warming and evolution are backed by evidence. Velocity is a mathematical expression. Rejecting the former two is not the same as understanding that a mathematical equation cannot be a cause of an event.

It seems rather odd to me to attempt to express economics (human activity) in only mathematical terms - when the preponderance of human activity is much more emotionally or psychologically based.

I'm not following you here. When I use the term "velocity" I mean a descriptive measurement of how often money is spent over a period of time. Of course the descriptive measurement itself does not cause the spending.

But the variations in real-life spending described by changes in velocity do affect the economy: a higher velocity means more goods and services purchased during a specific period than does a lower velocity. Government policies intended to stimulate the economy that produce a higher velocity of circulation do a better job than do policies that produce lower velocities. There is a great deal of evidence to support that position, as there is for evolution and for global warming.

[Winstonm]

Back on the concept of velocity, I do think that the description given by the Austrians makes a lot of sense (or it may be that I simply grasp the written word better than deciphering formulas and equations).

Anyway, the Austrian argument goes something like this: Suppose we start with a single $10 bill U.S. Art is an artist, Bill is a baker, and Fred is a farmer, and they are our economic actors.

Art creates a painting which he sells for $10.
Bill the baker has made 10 loaves of bread.
Art is hungry so he buys the 10 loaves of bred and gives Bill the $10.
Bill needs to bake more bread, so he buys 10 bushels of wheat from Fred for $10.

According to established thought, the initial $10 financed $30 in economic acticity, so the velocity was 3x.

The Austrian school argument is that the money simply provided a medium of exchange, it facillitated economic activity, but the financing was the work done by each person. They further point out that the speed at which the money changes hands has no bearing on price - price is always determined by what one actor is willing to pay and another is willing to accept.

To me this makes more sense than the mathematical formula - and it explains to me why central bank activity of increasing money supply to offset lowered velocity does not work.

But then, what the heck do I know about anything.

[Winstonm]

PassedOut, on 2011-June-11, 10:38, said:

I'm not following you here. When I use the term "velocity" I mean a descriptive measurement of how often money is spent over a period of time. Of course the descriptive measurement itself does not cause the spending.

But the variations in real-life spending described by changes in velocity do affect the economy: a higher velocity means more goods and services purchased during a specific period than does a lower velocity. Government policies intended to stimulate the economy that produce a higher velocity of circulation do a better job than do policies that produce lower velocities. There is a great deal of evidence to support that position, as there is for evolution and for global warming.

Thank you for letting me clarify.

I am questioning the importance of velocity. Certainly velocity describes activity to a degree, but when velocity is placed into a mathematical equation, the equation works but reality fails - and it fails because velocity is not a causation agent.

This is why it is important IMO to understand that low velocity cannot be resolved by monetary policy, which is what the mathematical formula says should happen.

The reason for this IMO is better answered by the Austrians as velocity is based on each individual's decision on whether to spend or delay spending - supply of money is irrelevant to that decision.

So, that is my position - the substitution of velocity into the equation explains what is happening, but the formula does not work as a model that can affect real-world occurences by changes made to the formula, i.e., velocity is descriptive only.

I hope this makes more sense.

[PassedOut]

Winstonm, on 2011-June-11, 10:47, said:

Art creates a painting which he sells for $10.

Art sells fewer paintings (and has a bloated inventory) when people have little money to spend. That also affects Bill and Fred adversely.

Changes made to the formula do not affect the economy, I certainly agree, but changes that affect the actual spending patterns measured by velocity do affect the economy.

[kenberg]

I'm impressed, well, sort of. We are in desperate need of people in policy making positions who know what they are doing. But my thinking is that I won't try to explain Semi-Simple Lie Groups to them and they should not feel the need to explain economic theory to me. They need to convince me that they understand it, not make me understand it.

Let's look at some simple facts.

The economy was in good shape when Bush took office. It was a disaster looking to be a total disaster when he left.

There was a budget surplus when Clinton left office. Taxes were higher but I had no trouble paying them and leading a good life. Taxes were lower when Bush left office and the debt was skyrocketing. True, this continues.

Why on Earth should we think that Republicans know how to handle the economy? Not raising the debt ceiling is like announcing that we are going to be really responsible about money and to demonstrate our responsibility we are going to stop paying our bills. This is their solution?

I am more than willing to listen to arguments about why we should spend less money and especially why we need to get a handle on rising health costs. I would probably agree with many of the proposals. I have lived my life without debt, I avoid debt like the plague, I hate that the nation is in such debt. But a bunch of idiots who ran the economy into the ground and now suggest that we lower taxes further and not pay our bills are not the folks I want to trust with getting us out of this fix.


As to velocity of money, yeah, it moves away from me way to fast.

[Winstonm]

PassedOut, on 2011-June-11, 11:00, said:

Art sells fewer paintings (and has a bloated inventory) when people have little money to spend. That also affects Bill and Fred adversely.

Changes made to the formula do not affect the economy, I certainly agree, but changes that affect the actual spending patterns measured by velocity do affect the economy.

I agree - as a measurement, i.e., a description of what has occured velocity is a valuable tool; however, it is important IMO to keep in mind that velocity is not a "thing" and therefore cannot influence real world behavior as it does the economic mathematical equation when the number representing velocity changes.

When velocity slows the mathematical equation is kept in balance by increasing money supply; but increasing money supply does not equate to real-world activities that match the equation; that is where a problem lies IMO.

In other words, it appears to me to be a terrific example of the difference between reality and an abstraction that attempts to describe reality - too often I am afraid we confuse the two as equal when they are not, and therefore decisions based on the abstract may not be best in reality.

[hrothgar]

Back in the weird old days, I occasionally had to teach Econ 102 (Macro)

I always hated teaching this class (I far preferred teaching Micro or Probability and Statistics)

Issues like "Velocity" and the Equation of Exchange are a classic example why I hated dealing with this subject.

"Velocity" is almost meaningless.

It's an accounting convention to make sure that the equation "MV = PT" balances.

People care alot about "T" (the total value of all the transactions in the economy)
People also get excited about "M" - especially the extent to which jiggering "M" will cause "T" to move up or down.
And, of course, people always care about inflation.

I never once saw any serious discussion about "velocity".
Unless you're dealing with hyper inflation, its always assumed to be a fixed parameter.
I don't recall ever seeing any serious policy discussion that involved velocity.

For that matter, I haven't ever seen serious policy discussion that involved "Austrian Economics" which has long been a marginalized side show, largely isolated to George Mason University.

[Winstonm]

Quote

Velocity" is almost meaningless.
It's an accounting convention to make sure that the equation "MV = PT" balances.

Again you say elegantly in a handful of words what it took me volumes to say and I did not explain it nearly so well.

[y66]

Quote from Andrew Leonard via Krugman's blog:

Quote

The best deficit-reducing strategy is a growing economy that generates increased tax revenues.

Surely, no one disagrees with this.

[Winstonm]

y66, on 2011-June-12, 07:21, said:

Quote from Andrew Leonard via Krugman's blog:


Surely, no one disagrees with this.

I don't think anyone would disagree, but at the same time there are caveats that apply. For example, the current U.S. debt is so great that it is folly to hope that economic growth alone could eliminate it.

[y66]

Winstonm, on 2011-June-12, 10:06, said:

I don't think anyone would disagree, but at the same time there are caveats that apply. For example, the current U.S. debt is so great that it is folly to hope that economic growth alone could eliminate it.

Nobody thinks economic growth alone will eliminate the budget deficit anytime soon.

[y66]

Is U.S. business abandoning the middle class? Good story by Chrystia Freeland.

[Winstonm]

y66, on 2011-June-12, 11:12, said:

Nobody thinks economic growth alone will eliminate the budget deficit anytime soon.

My contention has always been that there is a distinct difference between the tautological balancing of the equation MV=PT and real world economic activity.

The same holds true for the Laffer Curve - when we are talking about 95% taxation rates being lowered to 30% there is benefit, but when rates are lowered from 35% to 30%, the same benefit not only does not hold but reverses.

In both instances, what I think has happened is that a kernal of truth has been extrapolated into a bumper-sticker ideology that is more dogma than doggone right.

[phil_20686]

cherdano, on 2011-June-11, 08:29, said:

I think we agree pretty much. However, unless I misunderstood s.th. very basic, what you describe as "printing money" would be described as the following two things in the US:
1. The federal government runs a deficit.
2. The federal reserve does "quantitative easing", i.e. basically printing money and using it to buy government debt.

I am just pointing this out since what you suggest (printing money to keep the inflation at 3%) seems to be the considered an irresponsible lunatic leftist position in the current public debate in the US.

There are two distinct phases to this. A government can run a deficit, which converts idle private savings into current investments. This is because in order to run a deficit there must be someone who is prepared to buy your bonds. If the economy was booming people would have many profitable investment opportunities and there would not be as great a demand for bonds. You could probably get around this via higher interest rates, but then you would in a sense be robbing peter to pay Paul, as you would necessarily be dampening investment somewhere. (One can see this in the Japenese economy, where the public's desire to buy "safe" Japanese bonds keeps their bond yields low despite a decade of ballooning public debt). At a time like this, with private companies unsure whether to invest there is probably a gain to running a moderate-large deficit. Thus, a deficit is essentially funded by lowering private investment.

Anyway, I got sidetracked, my point is that a deficit does not inherently affect the money supply at all. QE may or may not be funded by government debt, or may be funded by creating money. In the former case it is not inflationary, in the latter is is inflationary, but has some interesting caveats. Say the asset purchased is a mortgage, then as it gets paid off the bank accumulates money, which is is a slow deflationary pressure, as it is slowly decreasing the supply of "narrow money" as people are paying cash to the fed. Its not at all clear what the Fed plans to do with this money. Originally QE was seen as short term solution with the fed planing to sell the assets back to the market at some point. Its now looking like it might have to hold on to the m for a while. It could use the savings to purchase more assets, but normally the activities of a central bank are constrained in this regards. Moreover, if it sells them at a profit the entire escapade will be deflationary as it will be taking back more money than it originally injected. If it sells them at a loss the tax payer will take a hit.

Of course, by printing money it is taking this money from savers, on the grounds that good have value, and that value is only denominated in dollars, so changing the value of a dollar has an inherent effect on the value of goods. Saved dollars do not have inherent value so get degraded by inflation. The total value of this devaluation of savings is the value of the newly printed dollars in the Feds account.

It seems like one of the major problems in the US economy is a failure to invest. One could attempt to see to this shortfall via ever larger deficits to transfer money from private investors into public investments, but it seems like not only is this not really working, but it is also storing up trouble for the future, in the sense that as the debt gets paid back it will put pressure on companies to invest during the boom, which will lead to a real danger of overheating in the economy. Alternatively, by raising inflation one can attempt to force private companies to invest on their own, as holding on to capital becomes ever more expensive.

Inflation will also reduce the indebtedness of private consumers, which might to a little to alleviate suppressed consumer spending.

[phil_20686]

PassedOut, on 2011-June-09, 14:36, said:

Many retired people here no longer receive wages, but live on income that is fixed, such as an annuity or a set pension. Inflation reduces the buying power of these folks.

Yes, but Technology and GDP growth tend to increase it buy making things cheaper. In reality 3-4% inflation will not reduce their buying power as PPP generally increases by more than this. Further, you can always correct for this through state pension schemes if it becomes an issue.

[phil_20686]

On the velocity Issue:

I had always assumed that it was mostly a book-keeping device to make the units fit, but now that I have been thinking about it I think it does show something. Suppose that we lived in a barter economy, now the money supply is precisely those good which are traded, so M = PT, and V=1 trivially. In a monetised economy the velocity accounts for the difference between the money that is involved in doing trades, and the total money supply. Suppose that of the total money supply K is used in trades and M-K is not, by the same argument given above K=PT trivially (the money used in trades = the value of those trades by definition), and hence V = K/M: I.e. the fraction of money that is used for transactions.

This would suggest that V=1 is a limiting case, that if all money were used in transactions the velocity of money is asymptomatically one. Velocities greater than one are measured because in the equation of exchange one tends to look only the velocity of "narrow money" which is only a fraction of "total money". Of course, the implicit assumption above is that we have chosen a time frame small enough that repeat trades are impossible. With this restriction, it is clear that V=1 is a limiting case. IF no player can trade more than once in the time step, the most trades that can happen is if all players trade.

The concept of repeat trades in a barter economy is interesting in its own right, either two people keep making the same trade (i.e. the trade creates no value) or more likely A trades with B, and then recognises that he can trade what he bought from A for even more from C. Now, evidently, one can have a velocity greater than one. Here the velocity is measure in the complexity of the economy. The fact that C wants what A has but A does not want what C has and therefore they have to trade through intermediates. Is it clear then that higher velocity is a good thing? I would say a tentative yes, as it indicates that all players in the exchange brought something of value. A lower velocity would occur if no one wanted the others goods.


Thus low velocity can suggest lots of things. A greater fraction of income devoted to savings. A general reduction of debt. A change in the relative proportions of the money supplies. A change in prices. Or real growth. Or it can indicate that no one wants to buy the goods that are being created. In a complex economy every finished product represents a large number of trades, so velocity represents some hard to unpick group of factors, including consumer spending, overall complexity of the economy, and the effect of various monetary policies, but as to whether it has a direct impact on anything in particular, I would say probably not. Its more a general indicator of the health of the economy.

[PassedOut]

phil_20686, on 2011-June-13, 10:45, said:

It seems like one of the major problems in the US economy is a failure to invest. One could attempt to see to this shortfall via ever larger deficits to transfer money from private investors into public investments, but it seems like not only is this not really working, but it is also storing up trouble for the future, in the sense that as the debt gets paid back it will put pressure on companies to invest during the boom, which will lead to a real danger of overheating in the economy. Alternatively, by raising inflation one can attempt to force private companies to invest on their own, as holding on to capital becomes ever more expensive.

Inflation will also reduce the indebtedness of private consumers, which might to a little to alleviate suppressed consumer spending.

Yes, the low levels of investment now are hurting the US economy. Lawrence Summers discussed this yesterday in the Washington Post: How to avoid a lost decade

Quote

After bubbles burst there is no pent-up desire to invest. Instead there is a glut of capital caused by overinvestment during the period of confidence — vacant houses, malls without tenants and factories without customers. Meanwhile, consumers discover that they have less wealth than they expected, less collateral to borrow against and are under more pressure than they expected from their creditors. Pressure on private spending is enhanced by structural changes. The publishing industry provides a vivid example. As local bookstores have given way to megastores, megastores have given way to Internet retailers and Internet retailers have given way to ebooks, two things have happened. The economy’s productive potential has increased and its ability to generate demand has been compromised as resources have been transferred from middle-class retail and wholesale workers with a high propensity to spend up the scale to those with a much lower propensity to spend.

I agree that inflation (a very modest level of it) would help to solve that particular problem. With a graduated income tax, mild inflation also helps to bring down the federal deficit via bracket creep.

However, I see inflation having more of a negative impact on retirees than you seem to. I can remember a time (admittedly the inflation rate was more than 3% then) when elderly home owners were forced to sell homes owned free and clear because they could no longer afford to pay their property taxes. You can point out that they made substantial paper profits by selling, but the reality is that they had no desire to move and found the whole business very disruptive.

[phil_20686]

Further to my previous post here are some intersting graphs:

% Changes in Money Supply

(sorry apparently .svg files are not supported so you will have to go to the source.)



Bearing in mind that M2 is much bigger than the other measures of money supply we might expect to find that large changes in M2 are reflected in the large velocity changes. further, since M2 is probably not really used in trading as much as other forms we might expect that whenthe % change in M2 is larger than other measures of money, the velocity should fall, when it is smaller than the other measures we might expect velocity to grow.

Between 1960 and 1984 (ish) the change in M2 lwas larger than other forms of money and the veolcity fell throught this time. Sharp peaks appear in 1961, 71. Both of these show up as sharp drops in the money velocity. The next big divergence is the period 90-94 when M2 grew much more slowly than M0&M1, and this was associate with a large growth in the money velocity. What does this tell us? Well, large changes in the money supply do show up in the money velocity. Moreover, this supports the fractional analysis as a strong component, as increasing M0 (currency) with respect to the total supply M2 does seem to increase velocity, as predicted. However, there are many other features on the velocity graph that must be due to other factors, as they do not seem to correspond to any apparent trends in the money supply.

Basically I have come to the conclusion that velocity might be related to the health of the economy, or it might not. Helpful, I know.

[phil_20686]

PassedOut, on 2011-June-13, 12:02, said:

However, I see inflation having more of a negative impact on retirees than you seem to. I can remember a time (admittedly the inflation rate was more than 3% then) when elderly home owners were forced to sell homes owned free and clear because they could no longer afford to pay their property taxes. You can point out that they made substantial paper profits by selling, but the reality is that they had no desire to move and found the whole business very disruptive.

Well I am from the Uk, and here inflation has only been below 3% for 12 years in the last 50, and we seem to be doing ok .

You can count them if you like: My link

In the US inflation has been a bit lower, but your long term average inflation over the last century is above 3%, so it doesnt seem like a terrible imposition on pensioners to have to put up with business as normal

(The US inflation rate was below 3% 22 years in the last 50 you can count them here).