Christopher Pang
Literally every shit goes into the GDP
As you listen to economic news on television the next time, do pay more attention to the things that are said and the forecasts that were made. Are some of these statements facts or just myths?
1. GDP growth is seen as an indicator of the health of the economy. Deficit spending is necessary to overcome recessions.
GDP itself is an aggregation of spending. Spending itself is not a sign of health, in particular deficit spending. Do you look at your ballooning credit card bill monthly and say, “Honey, we are doing better this month than last month?” There is a serious calculation problem with aggregation. Destructive activities such as war, natural disasters, demolitions and man made disasters, including the oil spill from British Petroleum are all contributing to the GDP. Cost of cleaning up the shores and the ligation costs by the parties involved are not creating any economic value. Transactional costs that attempt to protect your assets from governments are also included into GDP, e.g. tax planning to reduce tax burden and investment advisory to protect against inflation.
Politicians who determine their salaries based on GDP growth/figures is akin to a student setting his own exam paper and grading it himself because government spending is a contributor to the GDP in the form of Y = C + I + G + nX. The common misguided thinking is that government spending(G) is the solution to the slack that private sector has created with their reduced investing(I)/spending(C). These folks fail to realize government spending has to be financed, either through tax collections or additional Treasury sales. If the Federal Reserve buys these treasuries, it has to increase the money supply to buy them. Rising prices is an effect of the dilution of purchasing power caused by the increase of money supply. Taxpayers are poorer as a result of taxation but everyone else, except the government, is poorer as a result of inflation. The health of an economy should be reflected by rising standards of everyone in terms of both improvements in life or/and purchasing power and not a politically manipulated GDP figure.
2. Is demand of money infinite? Due to this infinite demand, we cannot use gold as money as there is not enough gold in this world for everyone to use as money.
Common misguided economic thinking will portray demand as infinite because of the argument that everyone seeks more money for himself. Central banks use this as an excuse to conjure up new money by saying money is being hoarded by savers. The most important distinction one has to make is between wealth and money. The collective demand for wealth is infinite, which suggests everyone try to improve his/her wealth consistently over time with every action. However, money is just one form of wealth. There are other substitutes for wealth, inclusive of property, cars, assets and antiques etc.
There is always enough gold. Price of gold adjusts according to supply and demand of gold versus others goods. Gold “circulates” just like our paper money changes hands. It can be used repeatedly with less wear and tear than paper money. If people start storing gold in a bank or hoard it under their pillows, it reduces the gold supply in the market and increases the value of the gold in circulation. Money is a commodity that is being used as an exchange for another good/service. The supply and demand determines the value of the commodity, just like another other good/service. Lowering prices in terms of weight of gold is not deflation. It is a sign of rising standards of living.
Another possible situation is the bimetallism standard where silver and gold could both be used as money concurrently, just like in ancient china where teals of gold and silver were used. There will then be prices in terms of gold and silver, with silver floating freely against gold in a ratio determined by market.
The infinite demand for money is only a psychological effect caused by rising prices. As prices consistent rise over time, the demand for more money to cope with rising costs of living increases. We do not need more money if prices are declining over time, a reflection of higher productivity and larger economies of scale. In order to earn more money we have to sacrifice our time for other things in our lives, leisure, family and friends. Would it not be better if there were declining prices and you have more time for everything else you enjoy other than work?
3. Quantity Theory of Money (MV = PQ) suggests that monetarists can target a specific inflation rate of 2-3% by keeping money supply within a acceptable bandwidth. For the near term, most monetarists agree that an increase in money supply can offer a stimulus in kicking start a staggering economy.
This theory has a list of assumptions that will only hold in this perfect state of economy in Irving Fisher’s mind. The most heavily criticized assumption has to be velocity(V) is assumed to be constant. Robert Gabriel Mugabe probably read Irving Fisher’s theory before he printed trillions of Zimbabwean dollars, creating millions of billionaires in his country. This is probably the only time u will see inflation being announced with percentages in “sextillion”, which represents 10,000,000,000,000,000,000,000. Velocity is neither constant nor stable. Velocity should be a function of price volatility and confidence in the sovereignty of the currency as it reacts to central banks’ policies and prices movements. The more the central bank devalues the currency, the quicker the citizens will spend the currency.
Further assumptions like full employment and economy in equilibrium are also made. This seems to be a perfect world that exists only in monetarists’ theories. The world we know today is never in equilibrium. The economy is made up of billions of people seeking what is best for himself/herself. The economy is constantly evolving and adapting to new changes, regulations, competition and innovation. Change is a constant and not a variable; the only thing that varies is the degree of change.
Economic Myths to be continued…
Hi the problem of the gold standard is that it fixes the amount of fiat currencies to a certain amount of gold. To solve this problem, gold should be set free. Physical gold(not paper gold) should be used as the monetary asset(store of value) and allowed to float. The fiat currencies can then be allowed to retain as the medium of exchange. In this case printing of money will only debase the medium of exchange but not the store of value and makes printing become counterproductive as the outflow of gold assets will occur as people perceive the debasement of the medium of exchange. Silver can also be the medium of exchange but because of its huge industrial uses are less attractive as the medium of exchange.
In this freegold world, the current gold price will be revalued upwards to encompass the world GDP plus assets. As the paper assets become all destroyed in a firestorm in the coming decade, the increase of the value of gold can re capitalize those central banks that have huge amount of gold as their assets such as the European countries. We can see that the gold assets in the ECB balance sheet is always marked to market. The next logical step for the ECB is to mark the gold price to physical gold( decided by either all physical gold dealers or maybe the BIS) and not to the paper gold of the LBMA
@jamesneo
I do not think fixing is the problem. The root of the problem is the ill discipline of the central bankers consistently accommodate the politicians in their fiscal spending by monetary expansion. Supposed gold is fixed at the previous level of 35 USD to an ounce of gold, and politicians and central bankers start to debase the value of the currency of the dollar, gold will start to move out of the reserves from central banks when people redeem it for 35USD. This would then keep them in check. The underlying problem is the ill discipline and not with gold standard. They will no longer have enough reserves to back the money they issued and the currency will face a run based on the fixed exchange rate.
When paper assets get destroyed in the firestorm, is the majority of the people who suffer losses. Such a freegold world which you suggests looks like a wealth transfer program from citizens to central banks. And what is the next step after paper assets get destroyed? If going to physical gold/silver is the next logical step after paper money gets destroyed, then my question is why not earlier/now before people start losing value of every dollar they owned?
The reason it is not implemented is that they do not want to be accused of causing this wealth transfer process in the first place.
Some of the designers of the Euro recognized the problems of the fiat money and fractional reserve system of the IMFS and they knew that all paper assets will fail eventually due to the ill discipline of all politicans. Thus when they design the Euro, they list gold as the reserve asset and they specially mark it to market knowing that the gold will recapitalize them if their paper assets fail.
This freegold world is thus a natural consequence and will only be implemented after the collapse of the paper assets after people try all kinds of reform to the current monetary system which will fail(2008 to 201?). Any reforms now will not work when one recognize the size of the problem( when the derivatives themselves are leveraged up to 40-100 times the world GDP) and the extent of corruption of the private bankers and idiotic behavior of the politicians in US and Europe. Only when the ordinary people recognize themselves the folly of fiat money and recoginize the value of physical gold assets as a reliable store of value , will the ordinary people themselves demand this new monetary system.
This process will be disastrous to people that do not prepare for it but it is my belief that this is what will occur as all our paper assets fail. Many rich people have been preparing for such a eventuality and i wish that the singapore government will also do so by diversifying our foreign assets to partial gold. China, russia and india knew the value of gold and is preparing accordingly.
Please read this website for further understanding of this freegold, i am only just a tiny poor observer starting to prepare for this eventuality.
http://fofoa.blogspot.com/
@jamesneo,
I was just reading this article this morning. The whole world has been entangled in a web of debt. Singapore owns huge reserves (that is what our government say). I am not exactly sure how we account for it, is it the total assets of MAS, GIC and Temasek Less all the liabilities which they owed us in CPF? The only thing I am sure is that our percentage of gold in terms of total reserves is one of the lowest in the world for a central bank. Refer to http://en.wikipedia.org/wiki/Gold_reserve
Refer to this http://www.mas.gov.sg/about_us/annual_reports/annual20092010/fs_05.html
Currently we hold about 226m of foreign assets out of total assets of 285m. Gold constitutes only 2.5% of our reserves. Having paper money backed by another valueless paper money is the name of the game after gold standard was taken off. I am not sure what is the composition of the 226m worth of foreign assets. An intelligent guess would be in USD and EUR, which would be disastrous when everything implodes.
You might want to consider reading dollarcollapse.com if you weren’t direct to fofoa from there. There are a whole range of good articles from there. I am just a puny blogger trying to educate more people to the right path.
About ministerial pay:
I BELIEVE THE FLWG PAY STRUCTURE STILL APPLIES AS OF TODAY –
AsiaOne (11 Apr 2007): For ministers and senior permanent secretaries, 47% of salary is performance-linked comprising:
(a) 20% GDP Bonus – if GDP is 10% or more, max of 8 months (for 2010, this is what they will get)
(b) 27% Perf Bonus – max of 7 months (dependent on ministerial performance as assessed by PM; Exceptions are the President, the Prime Minister, and the judiciary and statutory appointment holders who receive a fixed service bonus of 7 months)
So it is not just the quantum of ministerial pay. It is the structure of such ministerial pay that is at the root of the ills, the policy mis-steps, the super business-friendliness, the progressive corporatism.
For the crème-de-la-crème in the Administrative Service, the performance-linked component is 36% (not 47%).
Also, there is no time bar for such senior public sector employees to be invited to the Board of Directors or to be offered job prospects in the private sector immediately after resigning or retiring from the public sector.
It is reminiscent of the Wall Street amorality (not just immorality)!
It is equally reminiscent of the toggling between Wall Street and Capitol Hill and vice versa that undermines the essential Chinese Wall between private and public sector that serves a vital purpose to preempt contamination (moral corruption) and NOT facilitate pollination (incest).
The Pariah, http://www.singaporeenbloc.blogspot.com
Hi Mr Pang, it should be in billions not millions. I did not know our liabilities are so high. The net asset is only 35 billions. These are hardly enough for any crisis management since a country like Ireland with a GDP of US172 billion(2009 CIA estimate) need a US115billion bailout from the ECB. If our GDP of 251 billion become in dire situation, who will bailout us. The useless IMF will prescribe austerity which will not work then. Any austerity should be done earlier way before any need for bailout to minimize the problem of austerity leading to reduced taxes.
Would we have to sell our assets in Temasek and GIC for penny for a dollars? The worse thing is we do not have any knowledge of the assets or liabilities of our Temasek and GIC. What if our net assets are similar to that for MAS with most of them in US denomination. There is a need for greater transparency in our Temasek and GIC.
I pray that there will not be a housing bust in 2013-2015 which might coincide with the date when the world ‘s paper assets might take a great beating. It would be disastrous. Thanks for showing me our net assets. In the past i forgot to subtract our liabilities to see our net assets.
Let me point out a few of the misconceptions in this essay:
“If the Federal Reserve buys these treasuries, it has to increase the money supply to buy them. Rising prices is an effect of the dilution of purchasing power caused by the increase of money supply.”
There are two problems with the above assertion:
1. Historically, there is no significant correlation between inflation and base money supply in the US.
2. There is also no positive correlation between the amount of US government spending as a percentage of GDP and inflation. In fact, it is the other way round. When inflation goes up, US government spending tends to go down.
“We do not need more money if prices are declining over time, a reflection of higher productivity and larger economies of scale.”
Okay… so you assert that price declines are a reflection of higher productivity. Really? REALLY? Show me some data.
“Is demand of money infinite? Due to this infinite demand, we cannot use gold as money as there is not enough gold in this world for everyone to use as money.”
Demand for money is not infinite. If you hold money, then you are not spending it on things like food, housing, etc.
“Robert Gabriel Mugabe probably read Irving Fisher’s theory before he printed trillions of Zimbabwean dollars, creating millions of billionaires in his country.”
You’re confusing seigneurage with money creation. These are distinct concepts.
“These are hardly enough for any crisis management since a country like Ireland with a GDP of US172 billion(2009 CIA estimate) need a US115billion bailout from the ECB. If our GDP of 251 billion become in dire situation, who will bailout us?”
Oh, what happened to Ireland is not likely to happen to Singapore because the SGD is semi-freely floated. Ireland needs a bailout because it can neither devalue its currency (and hence make its economy more competitive) nor increase its own monetary base. In a country with a floating currency, you get instant wage adjustments with currency devaluation, making exports competitive.
@Fox
1. Historically, there is no significant correlation between inflation and base money supply in the US.
2. There is also no positive correlation between the amount of US government spending as a percentage of GDP and inflation. In fact, it is the other way round. When inflation goes up, US government spending tends to go down.
Every change in the quantity of money always has effects on relative prices, but not every change in relative prices is due to inflation. It is extremely hard to demonstrate a clear example because we do not live in a two dimension world. In most economists, they hold ceteris paribus and start playing around with their model. Clearly the loss in value of the dollar over 95% and gold price at 1380 today instead of the 35 previously is a clear indication of the loss of the purchasing power over the 90 years Fed has been around.
Ireland needs a bailout
Ireland do not need a bailout. In fact, is the banks of those politically stronger influenced countries that want Ireland to bail their banks out as most of these debt the Irish banks are owed to their own local banks. If the financial sector in Ireland does go bankrupt, no doubt the short term pain would be severe for both the Irish financial sector and the EU banks involved. That is how capitalism works. Reward and punishment. Bailout only feeds crony capitalism. Such a system creates moral hazards and drives reckless behaviour over and over again.
Look at the difference between Ireland and Iceland. You may want to suggest it is devaluation that got Iceland back on track. What got Iceland back on track is not devaluation but rather austerity and willingness to punish the reckless financial sector.
In a country with a floating currency, you get instant wage adjustments with currency devaluation, making exports competitive.
This is a very typical mainstream logic for exports. Supposed greenbacks are the only currency used in this world, what would then be the criteria for determining what to be exported? It would be based on comparative advantage of your labour. That is how trade works, based on specialization, not what each person does best, but what each person does best relative to others in terms of resources used. If this logic applies, why do we have to devalue our currency and punish the rest of the industries that otherwise might be more productive than this unproductive industry? By devaluation, you have made all imports cost more for every consumer. Not everyone is a worker but everyone consumes to a certain extent. “The consumers are merciless. They never buy in order to benefit a less efficient producer and to protect him against the consequences of his failure to manage better. They want to be served as well as possible. And the working of the capitalist system forces the entrepreneur to obey the orders issued by the consumers.” – Mises
Okay… so you assert that price declines are a reflection of higher productivity. Really? REALLY? Show me some data.
The trend of the Industrial Revolution in the West was falling prices, which spread an increased standard of living to every person; falling costs, which maintained general profitability of business; and stable monetary wage rates—which reflected steadily increasing real wages in terms of purchasing power. This is a process to be hailed and welcomed rather than to be stamped out.
The computer industry itself provides the best illustration. Prices have plummeted even as sales have soared. Computer makers and retailers have profited handsomely. And this is not a unique case. The same has happened to appliances, which have gone down in price dramatically over the years even as sales have risen higher and higher. Why? Because the companies have gotten better and better at doing what they do, and have thereby been able to make profits even in the face of continual price declines.
http://mises.org/freemarket_detail.aspx?control=451
“Every change in the quantity of money always has effects on relative prices, but not every change in relative prices is due to inflation. It is extremely hard to demonstrate a clear example because we do not live in a two dimension world. In most economists, they hold ceteris paribus and start playing around with their model. Clearly the loss in value of the dollar over 95% and gold price at 1380 today instead of the 35 previously is a clear indication of the loss of the purchasing power over the 90 years Fed has been around.”
I’m asking your for time series data on inflation and money supply. It’s very simple. Just take the quarterly M1 data and the CPI in the US over the last 10 or 20 years, compute their cross-correlation and tell me what the correlation coefficient is. You can do this on Excel.
Of course, there is relatively small rise in the CPI every other year but changes in the CPI are not correlated at all to the base money supply in the US historically. That is because the total money supply is much greater than the M1. Money is constantly created and destroyed by commercial banks when they issue loans, take in savings, give lines of credit, repay interbank loans, etc.
“The trend of the Industrial Revolution in the West was falling prices, which spread an increased standard of living to every person; falling costs, which maintained general profitability of business; and stable monetary wage rates—which reflected steadily increasing real wages in terms of purchasing power. This is a process to be hailed and welcomed rather than to be stamped out.”
First of all, you can have increases in real wages AND price increases.
Secondly, there is no real connection between wage growth and labour productivity for many reasons.
Of course, the proof of the pudding is in the eating. Dig up labour productivity growth rates and the CPI in Singapore and then compute the cross-correlation. Please show us all what that coefficient is to back up your claim that labour productivity is anti-correlated with price levels.
“That is how trade works, based on specialization, not what each person does best, but what each person does best relative to others in terms of resources used. If this logic applies, why do we have to devalue our currency and punish the rest of the industries that otherwise might be more productive than this unproductive industry?”
Simple. The ‘more productive’ industries are not producing enough for export. Why should country A make it easy for workers in the ‘more productive’ industry of country B to buy goods from country A if country B is not producing enough for country A to buy at the prevailing exchange rate?
Currency revaluation helps to overcome the viscosity of sticky wages and price levels. As a result of currency devaluation, export industry firms make more than their non-export industry counterparts and production factors can then shift from the non-export to the export industries. You can’t do that fast enough with wage changes alone.
Read this on why CPI is a flawed measurement of your so called inflation. http://www.shadowstats.com/article/consumer_price_index
Extracted from that article “The Boskin/Greenspan argument was that when steak got too expensive, the consumer would substitute hamburger for the steak, and that the inflation measure should reflect the costs tied to buying hamburger versus steak, instead of steak versus steak. Of course, replacing hamburger for steak in the calculations would reduce the inflation rate, but it represented the rate of inflation in terms of maintaining a declining standard of living. Cost of living was being replaced by the cost of survival. The old system told you how much you had to increase your income in order to keep buying steak. The new system promised you hamburger, and then dog food, perhaps, after that.”
And I never understood aggregation of a basket of goods. I do not rent, I do not buy clothes every week, I do not spend that certain % of my money on food. The way everything is aggregated is just ridiculous. This analogy is most apt in this instance “You do not listen to the weather forecast not to bring an umbrella when it is raining outside your window.” You trust what you see and now what the government tells you.
We will all end up eating dog food one day (thou dog food is getting more expensive than human food)
Of course, the proof of the pudding is in the eating. Dig up labour productivity growth rates and the CPI in Singapore and then compute the cross-correlation. Please show us all what that coefficient is to back up your claim that labour productivity is anti-correlated with price levels.
As I said, CPI itself is having flawed inputs with flawed methodology. The next thing is how productivity is measured. Advances in technology over the years are improving rapidly, resulting in hedonics expert recognizing these advances on productivity computation. Supposed a computer has 10 times the power of the model it replaced, the productivity factor of the manufacturer is increased by factor of 10 and the employee that assembled that computer has improved output by 10 times.
When this logic is carried down to consumer, it looks even more ridiculous. Does it mean I can type on 10 excel spreadsheets at one go? or type 10 times faster? I still type at the same rate. (extracted from Crash Proof and http://mises.org/freemarket_detail.aspx?control=561) No doubt you are right that you can be made more productive if you diminish the wages of the workers through debasement of the currency. The difference is that the consumers will suffer because of that. Ultimately there are more consumers than producers or workers. The question I have is why should consumers take the rap for what is the producers’ problem? If you cannot force your wages lower (sticky wages theory), then you close down your business. Why make everyone else pay more with devalued dollars just because some industry workers needs a job?
Therefore on this basis of garbage inputs creating garbage results, I do not think any correlation studies would mean anything even if you find the results to my advantage or to yours. Its just a meaningless number.
Okay. So you believe that the US BLS’s CPI is flawed, distorted, manipulated, etc. Fine. Use the one from Singapore (or Australia or Canada), compute the cross-correlation between the CPI and the corresponding M1 money supply and tell us what that coefficient is. Come on, man up. The data is there for you to prove what your assertions.
Hi Christopher,
I’m beginning to think that you’re effectively proposing a theory which cannot be empirically verified since you have questioned all statistical data which could potentially show the opposite. Is there any statistical proof of your theory?
Otherwise couldn’t an observer simply invent a theory and when mismatch with reality manifests itself, simply question the reliability of the data? The Austrian school of thought is out of mainstream for a good reason. In a highly indebted country, the worst thing to be experienced is deflation because deflation increases the real cost of paying down debt. Why is Japan still mired in a nearly 2 decade old economic stagnation? Based on your theory, what should Japan have done to get itself out of the doldrums?
You don’t have to use the CPI to measure price levels. You can always try the Producer Price Index (PPI) and calculate its cross-correlation with M1. Maybe you’ll have better luck.
The relationship between M1 and price levels has been studied extensively in economics. It is pretty well-documented that the correlation is weak or insignificant in countries like Taiwan, Singapore, Malaysia, US, Australia, Canada, etc. It is 2010 and it is amazing that we still have people arguing about this.
@ defennder
I think you misunderstood the cause of Japan’s problem. The problem is that prices went up too high with easy credit.
Again the solution is seen as the problem to you guys. Deflation is the necessary correction to the excesses distorted by the credit expansion in the first place. Because deflation never had the chance to take its full flight, there is no way to do such study.
Economics is not a science like Physics, where u can do the same experiment 200 times and test for results because the experiment is only adjusting the variables and holding the rest constant. The same policy implemented in Japan could work differently in USA and vice versa, because of the demographics/culture, working population segmentation, level of indebtedness, savings rate etc.
“In a highly indebted country, the worst thing to be experienced is deflation because deflation increases the real cost of paying down debt.” No doubt. Similarly, the worst thing to experience in a country of high savings is inflation, because inflation reduces their purchasing power of whatever they have saved over time for their future/retirement. So why is there a stance against savings and favouring indebtedness?
Based on not my theory but what would have been recommended by any Austrian Economist, would be to 1.reduce the size of government spending. Capital is not unlimited, it has to be created from savings and not printed through a printing press. Government spending crowds out private sector. 2.reduce taxes 3.stop propping up prices and companies. 4. remove the zero interest rate policy and let market determine the interest. It will probably bankrupt the government given the amount of debt they owed after that reckless spending to try to prop up the economy back then.
Central banks are no different from counterfeiters except one is legal and one is illegal. Central banks called it quantitative easing while counterfeiters called it counterfeiting. At least the illegal ones are more honest about the process.
@Christopher Pang,
“Economics is not a science like Physics, where u can do the same experiment 200 times and test for results because the experiment is only adjusting the variables and holding the rest constant.”
Which is why you have things like econometrics and statistics so that you don’t have to ‘hold the rest constant’ and yet are able to test possible relationships between variables. Average over enough data points and you should be able to find meaning cross-correlations. As I have suggested, take the PPI data from Australia for example and compute cross-correlation with the changes in the PPI with changes in M1. If that data is too noisy, you can repeat the exercise with Singapore, Malaysia, HK and Canada to average out the ‘noise’ from exogenous variables.
I’m still waiting for evidence that increase in the base money supply (M1) correlates with changes in price levels (Consumer PI, Producer PI or Retail PI).
This is a sub-30 minute exercise: 10 minutes to find (thank goodness for Google) and download the appropriate, publicly available data (usually in the form of .CSV files) from the Reserve Bank of Australia, MAS, UK Exchequer, etc; 10 minutes max to copy and paste the data into an MS Excel spreadsheet; 10 minutes max to use the statistical functions in Excel to compute the cross-correlations (this only involves clicking a few buttons).
There is nothing to prove to you on that. Inflation is not a evenly distribution of rising prices. It takes time for effects of money supply to flow through the entire economy such that it affects people’s demand for money and subjective valuations of goods against demand for money.
The increase in money supply does not make everyone better off. The people who received the money earlier than the latter will be better off because they benefit from buying at the lower price levels before the adjustments of the bidding of the prices up to another level.
If everyone gets double their cash balances overnight, society is no better off than before, since real resources, labor, capital, goods, natural resources, productivity, have not changed at all. Society did not gain overall, but the early spenders benefited at the expense of the late spenders (savers, pensioners who save now to spend later). The profligate gained at the expense of the cautious and thrifty, which is always why governments wants inflation because they are the biggest debtor of all.
refer to page 46-48 of http://mises.org/books/mysteryofbanking.pdf
Chapter 3
“Money is uniquely different. For money is never used up, in consumption or production, despite the fact that it is indispensable to the production and exchange of goods. Money is simply transferred from one person’s assets to another.
Unlike consumer or capital goods, we cannot say that the more money in circulation the better. In fact, since money only performs an exchange function, we can assert with the Ricardians and with Ludwig von Mises that any supply of money will be equally optimal with any other. In short, it doesn’t matter what the money
supply may be; every M will be just as good as any other for performing its cash balance exchange function.”
This means M is being determined by market forces, not by a central planner like Fed or MAS.
So, when we take Malaysian M3 data, why can we find a significant correlation between it and price levels (CPI and PPI)?
Why don’t you just admit that M1 is not really correlated with price levels? Most central banks cannot control money suppply; they can only influence it in a limited fashion. It is the commercial banks that determine the amount of money in supply.
@Christopher Pang
I brought up Japan because ever since the 1989 crash the Japanese economy has experienced either deflation or zero inflation. You can check their CPI data on that from 1990 till now. Prices have actually fallen since 1990, if I am not mistaken. If deflation is the way to go, why hasn’t Japan recovered yet? Why isn’t their economy flourishing? Why was its economy overtaken by China as the second largest in the world? It’s all good to quote from out-of-mainstream Austrian theory and their texts, but when you look at the real world, can you find a single successful example of a country which has experienced deflation and return to rapid economic growth? I wager you will not be able to. Austrian theory is all bunk, for a good reason.
Sorry my bad there were some years since 1989 where y-o-y increase was positive, but when you look at the general price level since 1989, prices are still lower:
http://www.tradingeconomics.com/japan/gdp-deflator-imf-data.html
And yet Japan’s still not booming. So much for Austrian economics.
@defender, the falling in prices was despite all the inflation(monetary expansion) Japan was creating. The government was still crowding out the private sector with their massive government spending and stimulus plans when everyone else was cutting their spending. If prices did and were allowed to fall to the level naturally by the markets, it will reach a point where demand would pick up again.
Again when you talk about deflation in this example, you are only looking at 2 things, stock market and property. If you look at the things that really do matter to people, they are rising in prices throughout the period. Don’t you find it ironic that when prices rise for stocks and property, people do not call it inflation but immediately cry deflation when prices start falling for this asset class?
Like I said, the way they measure price rises is deceiving at times on a whole level. CPI is a measurement of an average price level and central banks target a 2-3% inflation rate. I quote an Austrian in his seminar which he said this “It is like saying one of your hands is on fire while the other is in a bucket of ice. On average you are ok.”
The problem with inflation targeting is that the effects are not evenly distributed. Things that matter to you might rise more than things that does not matter. Are you going to believe that 2-3% price level increases has been happening over the last 10 years? I would not think so. The effects of monetary expansion does not take place immediately. It has to do with expectations of inflation and adjustments towards demand for money that lags behind monetary expansion. It does not mean there is no causation between the 2, but just the correlation is difficult to prove through statistical methods.
“The government was still crowding out the private sector with their massive government spending and stimulus plans when everyone else was cutting their spending.”
Huh? How can there be crowding out by the government if the the private sector was cutting its spending??? If there was crowding out, price levels would have risen because the supply of labour/land/raw materials to the private sector would have fallen. Unemployment in Japan rose after the 1989 crash and kept rising until 2003.
See http://www.tradingeconomics.com/Economics/Unemployment-Rate.aspx?Symbol=JPY
@fox you are still getting the point. Price levels are not rising because they have rose so high it is unsustainable. The only reason why it is on such a slow decline is because of this government spending. Yes there is no correlation to prove that. The way i would describe is like u put a thermometer in a cup of ice that is on a stove, it will still be showing lower temperatures until the point all the ice are melted. The ice is just like the faith in the currency. Once its all gone, that’s when the real heat starts to show.
Would you know if the government stops spending, the private sector might take up the excess resources? The fact is you would not know. When private sector cut back on spending/investment, it is because it is not profitable to do so. That would result in a falling demand for the resources. The extra resources that is idle would then be falling to a price level that private sector would find it profitable to take them up again. Crowding out does not necessarily suggests that both have to be spending at the same time and one out bids the other. It could be the exact situation I mention.
Unemployment is rising PROBABLY because deflation was not severe enough to get the required demand. Krugman consistently says that the stimulus was not big enough to get the unemployment down. I argued the deflation is not severe enough to get the unemployment down.
Inflation and money supply growth are two separate things. They’re not the same. Austrians often conflate the two because they incorrectly believe all (or much) inflation is due to increases in the money supply.
http://www.clevelandfed.org/research/Commentary/1997/1015.pdf
You can see that in mainstream economics, monetary inflation is not the same as price inflation. Most people mean the latter when they use the word “inflation”. As for crowding out, it only happens when the economy is operating at potential output. No one would argue that Japan was operating at its potential during the 1990s. As for government spending, the Japanese did attempt fiscal austerity in response to critics in 1996. Did the economy boom after that? No, in fact the opposite happened and economy tanked as a result:
http://mediamatters.org/research/200812220005
Fiscal policy worked when tried in Japan. It only worsened because the government gave into skeptics’ demands and ended up killing the recovery as a result.
No, when I use the term inflation/deflation I’m referring to the price level as measured by the CPI not the money supply. That’s the modern mainstream definition of the term. Stock prices are not reflected in the CPI. Housing prices are likewise not reflected in the CPI in most countries including Singapore and the US. You can see this difference perfectly illustrated in the 1987 Black Monday stock market crash. Stock prices fell dramatically, but there was no effect at all on the CPI or the economy. Secondly with regards to housing prices, because of how the CPI incorporates housing into its index, contrary to what you claim, there are people who care about whether the price index accurately reflects the cost of living associated with that component. See this post I wrote earlier:
http://furrybrowndog.wordpress.com/2010/08/09/housing-inflation-in-singapores-cpi/
There are problems with the way certain components are measured. That’s because while there’s consensus on how inflation is defined and no I don’t mean in Austrian terms, there’s less of a consensus of how to measure it. Secondly not all central banks have an inflation target. The Fed has an implicit 2% target but its recent action this past two years has demonstrated that it’ll act only when core inflation dips below 1%. The Bank of England has an explicit 2% target, while the Bank of Japan has an implicit 0% target. If you’re concerned that a single number cannot adequately capture the increases in cost of living, please bear in mind that the CPI itself can be analysed in terms of all its constituent indices such as grocery prices. Reason why inflation seems understated is because the reported figure is often the core inflation rate, which strips out volatile components such as food and fuel. It makes sense to strip these 2 out because often their prices are independent of Fed actions and are due more to demand and supply rather than any Fed action. Krugman explains this very well here:
http://krugman.blogs.nytimes.com/2010/11/09/inflation-delusions-2/
One of the reasons why inflation targeting is done is because it gives businesses some comfort of knowing more or less what next year’s inflation rate would be like so they can plan accordingly. Under the gold standard, you do get lower inflation but the standard deviation is much higher. Businesses favour inflation certainty over one which fluctuates wildly around 0% or -1%. You should read up some books on how the American and European economies fared prior to and during the Great Depression. Being on the gold standard meant that the central banks had to do daft things like raising interest rates in the middle of slump just to slow the outflow of gold from the economy. If you were a business owner who has plans for expansion funded by a credit line, a sudden rate hike would very unwelcome. If you ask people would they prefer a low stable inflation rate compared to one which fluctuates wildly about 0% or less, I think most would prefer the former. It’s a necessary evil unless someone has a better solution.
“The extra resources that is idle would then be falling to a price level that private sector would find it profitable to take them up again.”
That’s just stupid. When wage levels fall, unemployment goes up. Are you telling us that the unemployment was not high enough for the economy to recover? How come your model of the ideal Japanese economy has to involve a lot of idle land and labour before the private sector can pick up the slack?
You are arguing from the perspective of an economy which is already at potential output. This is not the case for the US or much of Europe now. In the US, there are five unemployed persons to every job vacancy, which means that if every job vacancy is somehow miraculously filled 80% of the unemployment problem would still be there. The entire argument about crowding out works only when you have limited resources and when there is demand for it but right now there’s only slack. I hope you recognise that deflation is self-reinforcing, falling prices only make consumers hold back purchases in anticipation of further price declines; there isn’t any magical level prices would have to fall back to before firms and businesses suddenly decide to invest and hire. Inflation on the other hand, is what makes it unprofitable to sit on cash. Expectations of future inflation would make businesses and consumers do something with idle cash instead of just sitting on them. This is something Greg Mankiw pointed out in an op-ed last year. Raising inflation expectations sharply might be a way of jolting the moribund economy.
@ fox: That’s not stupid. It’s just stupid to you. You are still trying to misrepresent my argument. I was saying deflation was not severe enough to create that necessary demand to get employment back, and not unemployment is not high enough to get a economic recovery. Unemployment is an effect of whatever is happening in the economy, not the cause of it. Prices of asset classes like investments rise, giving people an illusion of wealth, also why you hear analysts and news reader talking about the amount of wealth being wiped out. If prices are so high that it is unaffordable to everyone, it has to fall in order to get the demand, the genuine demand will then get people back employed at the appropriate wage levels based on the new price levels. It is same with investments, electronics, or any other consumer product that you see.
If everything has fallen in price, would wage rate still remain that high? People would not demand so high a wage rate anymore, and wages would come down. Does that mean unemployment would persist? It might if there are laws prohibiting people from rendering their services below a minimum wage. All this is better explained in this paragraph below.
Myth #7: Deflation creates unemployment (http://mises.org/daily/1254)
Unemployment of a factor of production comes about only in two cases: A) if the owner of the factor is not willing to rent it out at the price offered to him, or B) if the law prevents him from doing so. It is therefore not true that declining wage rates bring about unemployment by any sort of inner necessity. People are not just unemployed. They choose not to work for an employer under the (pecuniary and non-pecuniary) conditions offered to them. Now it is clear that no sane person will accept to work for somebody else if the wage rate does not allow him to survive anyway. But this is not the case in a deflation. Remember that here all prices fall, and thus the decline of wage rates is compensated by a parallel decline of the prices for consumers’ goods. It is true that there might not be in all cases an exact parallel between wage rates and the prices of consumers’ goods, but any deviations will be temporary only and can easily be bridged for some time with the assistance of family, friends, and charitable institutions.
Involuntary unemployment might arise in a deflation only if the latter is combined with minimum wage laws, which prevent the worker from offering his services at lower rates. But clearly this unemployment does not result from deflation, but from the minimum-wage laws, which infringe on the freedom of association.
@defender: Falling prices only make consumers hold back purchases in anticipation of further price declines; there isn’t any magical level prices would have to fall back to before firms and businesses suddenly decide to invest and hire.
This itself is a myth. Refer to myth 1:
Myth #1: You cannot earn a living and make profits when the price level falls
Most of our analysis will deal with deflation in the sense of a shrinking money supply. This case is most interesting from a political point of view, because few economists and laymen are ready to concede any benefits to deflation in this sense. But before we turn to this case, let us briefly examine the character of deflation in a somewhat different connotation, namely, in the sense of a decrease of the general price level. This type of deflation draws much less criticism than the other type, but it might be useful to deal with it first as a warm-up for out subsequent discussion.
Thus, is it true that one cannot earn a living and make profits when the price level falls? The answer is in the negative. Successful business does not at all depend on the level of prices, but on price spreads or, more precisely, on spreads between selling receipts and cost expenditure. But such spreads can exist and do exist at any level of prices, and they can exist and do exist even when there is a secular decline of prices. The essential reason is that entrepreneurs can anticipate declining prices, just as they can anticipate increasing prices. If they anticipate a future decline of their selling proceeds, they will bid down present prices of factors of production, thus assuring profitable production and paid employment for everyone willing to work. This is exactly what happened in the few periods of modern history in which deflation was not prevented through inflationist counter-measures.
For example, both the U.S. and Germany enjoyed very solid growth rates at the end of the 19th century, when the price level fell in both countries during more than two decades. In that period, money wage rates remained by and large stable, but incomes effectively increased in real terms because the same amount of money could buy ever more consumers’ goods. So beneficial was this deflationary period for the broad masses that it came to the first great crisis of socialist theory, which had predicted the exact opposite outcome of unbridled capitalism. Eduard Bernstein and other revisionists appeared and made the case for a modified socialism. Today we are in dire need of some revisionism too – deflation revisionism that is.
“For example, both the U.S. and Germany enjoyed very solid growth rates at the end of the 19th century, when the price level fell in both countries during more than two decades.”
Where does your data for falling prices at the end of the 19th century in the US and Germany come from? The Federal Reserve Bank only started to measure CPI and other price indices in the US after it was formed in 1913.
Hi Christopher, I’m somewhat disappointed you didn’t reply to most of my rebuttals in my earlier comment. Nevertheless, I’ve taken some time and space to devote an entire post critiquing the Austrian rebuttal to the myth that falling prices are a bad thing here:
http://furrybrowndog.wordpress.com/2011/01/06/austrian-economics-and-the-fallacy-of-deflation/
In other words, I think you’ll have to do a lot better than simply copy and paste content from Austrian blogs. You can start by addressing my last few comments.
@ defennder: Will reply you in the next article. Will illustrate it step by step. I am tied down with some family stuff, needs to be present at my grandma’s funeral for next few days.
Reading the comment board,
Scholasticism at its best.