He starts with Mv=Py, where M is money supply, v is velocity of money, P is average price, y is quantity of production.
He then says that increasing M may not increase P, for several reasons.
It may increase y instead. “Take for example y. One need only look out the window to see that it is not currently at the full-employment and therefore maximum level…there is no reason that this [=increase in M] could not lead to the rise in y… as those spending their “excess money balances” actually cause entrepreneurs to raise output to meet the new demand…This is, of course, the goal of the government deficit spending that so many economically-ignorant people are trying to stop right now.”
There may be a corresponding decrease in v. "As one would expect, it [=v] tends to decline in recessions when people do, in fact, want to hold more cash".
He then argues that it is impossible to increase M, ever! He assumes, with Milton Friedman, that increase in M means an increase of the supply of money over the demand for money. [Esuric. I think you agree with that also]. But how can you supply more money unless someone demands it, i.e. is willing to trade it for something. In his own words:
But perhaps the real nail in the coffin of the “money growth==>inflation” view is this: the phenomenon that Milton Friedman identifies as key to the whole process, i.e., the excess of the money supply over money demand, cannot happen in real life. ..How is it that the Federal Reserve increases the money supply? Remember that Friedman used a helicopter–indeed, he had to, for there was no other way to make the example work. This wasn’t just a simplifying device, it was critical, for it allowed the central bank to raise the money supply despite the wishes of the public.
However, that can’t happen in the real world because the actual mechanisms available are Fed purchases of government debt from the public, Fed loans to banks through the discount window, or Fed adjustment of reserve requirements so that the banks can make more loans from the same volume of deposits.
All of these can raise M, but, not a single solitary one of them can occur without the conscious and voluntary cooperation of a private sector agent. You cannot force anyone to sell a Treasury Bill in exchange for new cash; you cannot force a private bank to accept a loan from the Fed; and private banks cannot force their customers to accept loans.
Supplying money is like supplying haircuts: you can’t do it unless a corresponding demand exists.
Would appreciate any comments on any or all of those 3 points.
prices do not equal inflation, his argument that rises in prices can be offset by production doesn’t disprove inflation. There can be serious inflation, i.e. an increase in money accompinied by serious deflation, i.e. a decrease in prices. These events aren’t mutually exclusive.
Velocity will drop as demand for cash is higher.
This point is so stupid, as if credit isn’t over demanded. Lower interest rates create demand, they signal investors to take risks. As if people are going to say no to a glut of money. Was this asshat in a cave during the housing bubble? Does he not see the over consumption from an overabundance of money that was available? He is essentially saying that individuals only take what the want and they take exactly what they need. If this were true, we wouldn’t need a market for anything, no prices needed as people would just take the proper amount from an unlimited supply .
At this point you should already understand the differences between general price inflation on the one hand, and relative price inflation on the other. Increasing the supply of money never necessarily yields the former but must cause the latter (alters relative prices in a disproportionate way). It is true that increasing the supply of money may, and frequently does increase Y/Q, but only because relative price distortions (and artificially lowered interest rates, which go hand-in-hand with monetary injections) yield malinvestments. The creation and accumulation of malinvestment will in fact increase output and reduce unemployment, but only temporarily. It is met with an inevitable correction, i.e. recession.
The rest of the argument is pure nonsense. It’s true that no 1 can force the private sector to buy government bonds, but so what? If Bernanke wanted to, he could write me a check for 10 trillion dollars, which he would create out of thin air (would just credit my bank account). And finally, this person does not understand Milton Friedman, who never claimed that monetary expansion always leads to general price inflation.
Increasing the supply of money never necessarily yields the former
Is that statement contreversial, or do all Austrians agree?
What is the Q in Y/Q?
If Bernanke wanted to, he could write me a check for 10 trillion dollars, which he would create out of thin air (would just credit my bank account).
Yes, he could, indeed. But I don’t see how that addresses Harvey’s point, that it’s never done that way, but always in exchange for something. Which he says means the demand always equals the supply.
What I’m asking is, is his reasoning wrong, and if so what is the flaw?
Possible answers:
The supply of money increasing may cause price inflation even if there is a corresponding increase in demand.
The situations he describes [Fed buying treasuries etc.] are not increases in demand. Demand for money means hoarding it.
Which of those possible answers are right, if any, and why?
The demand for what always equals the supply of what? When the FED engages in open market operations, it purchases financial assets, usually treasury bonds/bills/notes, with money that it creates out of thin air. It’s not the case that you’re exchanging money for money; you’re exchanging a note for money that the FED just created, therefore expanding the supply of money.
Again, Bernanke could write me a check for 10 trillion dollars (created out of thin air) in exchange for my 1998 Volvo. This too would be an exchange, and it would also expand the supply of money by 10 trillion dollars.
This. A higher demand for government bonds (which is not real demand; it’s demand that the FED artificially creates) does not equal a higher demand for money. They are two different things.
How about :“increasing M may, or may not not increase P”, "
If we forget the rest of the fol de rol [i.e his reasoning, because maybe he’s right but for the wrong reasons! ], would you say that you either agree, or disagree, with his claim ? Just curious. Regards, onebornfree
So you posted the article because even though you “know” that the author’s conclusions ["increasing M may not increase P, " ] “must” be “wrong”, you were/are unable to refute his reasoning?
So you posted the article because even though you “know” that the author’s conclusions ["increasing M may not increase P, " ] “must” be “wrong”, you were/are unable to refute his reasoning?
That was [and is] a simple question, asked out of genuine curiosity as to your reason for posting,not an accusation of anything. Why do you choose to see it as accusatory? Regards, onebornfree.
The value of money is determined by both the supply of money and the demand for money. Friedman’s error is in agreeing with the Keynesians that money supply and demand cannot be analyzed in the same way as supply and demand of any other good. The only difference between fiat money and any other good is that the supply of fiat money can be increased without bidding away resources from other sectors of the economy. Hence, the natural interest rate is not necessarily affected by changes in the fiat money supply. This is explained by Hulsmann here.
If it is a simple q asked out of genuine curiosity, here’s the answer.
EDIT: Oops, it’s been a long day. The article is about Milton Freidman’s theory of inflation, which I do not subscribe to in the first place for other reasons. I was curious if the article had detected some basic blunder Freidman had made which I knew nothing about.
I see. I asked because I could not understand why you would reference an article like that [while already being aware of the fact that you have previously disagreed with similar conclusions made by others that “increasing M may not increase P” ].
I guessed that either you were somehow now less sure of your previous position [for whatever reason], or perhaps that you were simply looking for some sort of “feel good” psychological validation of what you already “knew” via another member agreeing that that the author was talking out of his rear end and you were therefor merely engaged in publicly laughing at the authors “ridiculous” conclusions [i.e “hanging him out to dry”]. But I was not sure which, if any, of those two applied, that’s all.
For what its worth, although I disagree with his reasons, personally I agree with the authors’ conclusion [“increasing M may not increase P”] , although as I already hinted, I think that “increasing M may or may not increase P” is a slight improvement.
I also believe that that conclusion [ “increasing M may or may not increase P”] is fully consistent with Austrian monetary theory- at least as far as Von Mises’ “The Theory of Money and Credit” goes.
I don’t have the book in front of me, but isn’t this Irving Fisher’s equation of exchange? If this is the case, then he’s using a formula which I recall Rothbard (perhaps Mises?) identified as a fallacy since it was based on the assumption that an exchange between two goods sets their value as being equal. If all this this is true, then wouldn’t the analysis presented by the economist in this article be flawed at best and completely wrong at worst?
Surely the question is, in the real world, can a person be right in their actual conclusions yet wrong in the reasoning used and reasons given to reach those conclusions?