Pete Boettke Fulfills My Prophecy
UPDATE: Be sure to read the Sumner/Murphy exchange in the comments. Folks, I may have to put the Google ads back up. This is easily a $19.95 value, yours free if you act now. –RPM
Sometimes I feel like the Barack Obama of econoblogging. I understand all sides in a dispute; I am the aloof Olympian overseer.
Case in point: Paul Krugman was upset at economists who use MV=PY not simply as a tautology, but as a causal economic theory. (I’ve criticized Keynesians who do the same with Y=C+I+G+NX.) Krugman is at his best when he goes off on economists who think that exchange rates don’t affect the trade deficit, because “it’s determined by capital flows.” Anyway, in our current case, Krugman says:
Here’s my problem. Underlying the focus on nominal demand or GDP is some notion that there’s a quantity equation:
MV = PY
where M is the money supply, V the velocity of money, P the price level, Y real GDP. And of course this always holds true, by definition. But the temptation is to take it as a causal relationship — to say that real GDP fell because nominal GDP fell, and that this in turn was caused by either a fall in M or a fall in V; and furthermore that any such decline is a failure of monetary policy, because the central bank should have either prevented the fall in M or increased M enough to offset the fall in V.
Referring to the above, our good friend Scott Sumner said:
The second sentence has to be one of the weirdest things I have ever read by a famous economist. I have no idea the point he is trying to make. It is essentially saying that underlying the statement that A*B is important is the implication that A*B = M*(A*B/M). Okay . . .
OK hang in there folks. I know you want to know when Boettke enters the fray. Patience my friends.
OK so even though in general I loved Scott’s post, I chastised him for saying Krugman was speaking nonsense, when Krugman made a perfectly good point. Here’s what I said:
Scott says that he doesn’t even understand what Krugman is talking about in the beginning, when I for one certainly “got” Krugman’s take on people using MV=PY inappropriately. Not only did I get it, I was nodding my head in agreement.
Then Scott in the comments to my above said:
Thanks Bob, BTW, Krugman seems to have a problem with David using MV=PY inappropriately, but if you read David’s post he never even mention’s MV=PY once. It’s all a figment of Krugman’s imagination. I understand that Krugman doesn’t like MV=PY, but how does that relate to talking about nominal GDP?
OK so then I said in response to that:
Well right, but Krugman is saying that a lot of people go from “We need to boost real GDP!” to “We need to boost NGDP!” to “We need to boost M to offset the fall in V!”
He’s not attacking a straw man, since I think a bunch of Austrians say exactly this.
OK enter Boettke. In commenting on Krugman vs. Sumner, Pete says:
Paul Krugman provides his take on the Beckworth graph showing the collapse of nominal spending and relates it to his 1998 work on Japan. The upshot, monetary policy will not produce the desired effect in our current situation. Scott Sumner responds and continues to push his position that monetary policy has been too restrictive.
I have discussed this issue with Steve and Larry and I keep getting hung up on this idea that monetary policy has been too restrictive. I get the point about if V collapses faster than money supply is expanded, you get Sumner’s position. On the other hand, I don’t get it at a very basic level.
Whoa! Danger danger Will Robinson! Not only did Boettke utter the exact theory that Krugman was attacking–Pete attributed it to Sumner!! And then in the comments to Pete’s post, Scott says:
Peter, Thanks for the link. If we take a public choice view then blah blah blah.
1. Blah.
2. Or blah.
In other words blah blah blah.
(Note I have slightly edited the above.) Scott didn’t devote even a single sentence to saying, “Actually Pete, I’m not sure that you’ve correctly interpreted my theory, since when Krugman said what you just said, I told my readers I didn’t even understand the words comin’ outta his mouth. So please rephrase it in a way that a famous economist would talk, because what you’ve typed above is just plain weird.”
OK the above smarty pants version was written for the 100 or so die-hard econogeeks who spend at least 10% of their lives reading MarginalRevolution et al. Shame on you.
Now for the casual reader, a summary:
(1) I am making fun of Scott Sumner, not Pete Boettke. Krugman’s post was perfectly comprehensible, and moreover he wasn’t attacking a strawman–many economists would boil down Sumner’s own view into the very one that Krugman was attacking.
(2) Krugman’s argument is that it is wrong to view V (“velocity of circulation” or the speed with which an average dollar turns over and thus pushes up prices) as independently determined, so that if prices are falling the Fed can just pump up the money supply to keep the total value of output (measured in dollars) from falling. Krugman’s point is that in a liquidity trap, if the Fed doubles the money supply, then velocity will simply get cut in half. So the Fed can push and push and push, and it won’t prop up aggregate demand (measured in nominal dollars).
(3) I’m not saying I agree with Krugman, I’m just saying it is an interesting thing to consider. The standard explanation for what happened in the early 1930s–an explanation shared by Scott Sumner, Ben Bernanke, (the later) Friedrich Hayek, and many modern Austrians–is that the Fed stupidly allowed the money stock to collapse, which pulled down “MV” and thus pulled down “PY.” Since prices couldn’t fall quickly enough (for various reasons some of which were the fault of Herbert Hoover and unions), that meant real output (Y) had to fall. Now if in, say, 2005 we wanted to test this idea, we might say, “Shucks it’s too bad we couldn’t re-run history. If the Friedman explanation were right, a massive spike in the monetary base would’ve nipped things in the bud. But too bad we’ll never be able to really test it; I bet the Fed would never have the courage to really put the pedal to the medal and increase the monetary base a ludicrous amount and keep M1 from falling in the midst of a huge financial panic. But if the Fed did do that–and then the economy quickly bounced back–that would be proof that Friedman was right. Of course, if the economy continued to flounder, and we ended up with the second Great Depression, then propping up M clearly wasn’t the solution…”
(4) To drive home the point: Scott Sumner can appreciate how annoying it is that Krugman will continue to cling to his doctrine that big fiscal deficits are the way to fix depressions, even as unemployment breaks 10% while the government runs a $1.4 trillion deficit. Yet Scott has no problem looking at what Bernanke has done with the monetary base and saying, “Obviously it’s not enough, because we’re still stuck in a recession.” Again, this doesn’t prove Scott is wrong, but surely he can see the eerie similarity.
