Tuesday, August 31, 2021

Primer: Quantity Theory Of Money — Brian Romanchuk

Note: This is an unedited excerpt from my inflation primer manuscript.

Even if we put aside the atypical argument that an increase in the money supply is how to define inflation, there is a widespread belief that increasing the money supply causes inflation (as normally defined). These beliefs can be traced back to what is termed the Quantity Theory of Money, which has a long history in economic thinking.

I am extremely allergic to the Quantity Theory of Money. That said, my plan within this book is to stay away from theoretical controversies, and so will attempt to offer as neutral as possible description without inflicting too much pain on myself.
Although I refer to this as The Quantity Theory of Money, there are a few variants, with a long history. My impression is that the most reputable version of the theory is the “equation of exchange” variant. As I discuss below, this variant is not obviously wrong, rather it has the problem that it says very little in practice. As for the other variants, I mainly see various phrasings in popular discussion that have obvious defects, which are not tied to modern economic theory (at best, some garbled version of some dubious assertions made in mainstream Economics 101 textbooks).
Bond Economics
Primer: Quantity Theory Of Money
Brian Romanchuk


Ralph Musgrave said...

So if the Fed printed and handed out $100k worth of $100 bills to every household in the US, there's some doubt as to whether that would cause excess inflation????

Ahmed Fares said...

Steve Randy Waldman (interfluitity.com) has a good take on this. He responds to this commenter's question:

...it is not clear to me that it is well understood why inflation sometimes can be seen in consumer goods and sometimes is manifested in "asset price inflation". Do you have any ideas on this mechanism? I know some people deny there is such a thing as "asset price inflation". Do you have a theoretical basis for your ideas in this area?

Steve's answer:

I have a very simple answer to this question: Follow the money. Whether an economy generates asset price inflation or consumer price inflation depends on the details of to whom cash flows. In particular, cash flows to the relatively wealthy lead to asset price inflation, while cash-flows to the relatively poor lead to consumer price inflation.

Why? In Keynesian terms, poorer people have a higher marginal propensity to consume. The relatively poor include people who are cash-flow constrained — that is they cannot purchase what they wish to purchase for lack of green, so their marginal dollar gets immediately applied to the shopping list. Also, poorer people may be different, there may be a correlation between poverty and disorganization, lack of impulse control, inability to defer gratification etc. Think of Greg Mankiw's Spenders/Savers model.

Link to article: Asset inflation, price inflation, and the great moderation

Ahmed Fares said...

Correction: Steve's site is interfluidity.com, not "interfluitity.com".

Matt Franko said...

“ if the Fed printed and handed out $100k worth of $100 bills to every household”

So ther are 110m households in the US… Then the Fed would fall under its legal requirement to maintain a 7B equity/residual so it can’t happen…will never happen…

Why talk about it?

Art degree?

Matt Franko said...

“If we handed out 1 dollar for every monkey that flew out of Joe Bidens ass,..,”

Same thing…