# Two residuals multiplied become an illusion

You are a Monetarist.

You think Y=C+I+G+NX is just an identity, it doesn’t tell you much.

You believe fiscal policy is ineffective.

You believe the Keynesian multiplier is Zero.

You believe in the Sumner Critique.

Hence, the multiplier is nothing more than an ILLUSION, the shadow of Central Bank incompetence.

You are a Keynesian.

You believe fiscal policy is effective.

You believe monetary policy is effective (except in the Zero Lower Bound).

Monetary Policy is conducted through variations in the Monetary Base (which may affect interest rates).

You think M=mB is just an identity, it doesn’t tell you much.

Hence, the Money Multiplier is just a RESIDUAL.

You think MV=PY is just an identity, it doesn’t tell you much.

Therefore, the Money Velocity is just a RESIDUAL.

Let’s all be friends again?

Imagine two things:

You have a lot of unemployed resources in the economy, so an expansionary policy will only move Y (P is fixed).

You shall use a Helicopter Money. A Money Financed Deficit. Monetization. Whatever you want to call it.

Basically the Government spends newly-printed (or newly electronically  created) Monetary Base.

What will happen???

Hyperinflation!!! Zimbabwe! Weimar!

Nope.

Let’s build an example.

So, we have have dG= 1000 and dMB =1000.

The increase in Government Spending somehow (magic?) increases Output (Y) in 3000.

So… the Keynesian multiplier (dY/dG) of the increased spending would be 3.

Shall we continue? Of course.

We  know mBV=PY. We know P is constant (assumption), we know the Monetary Base increased 1000, and Real Output increased 3000 (multiplier effect).

So..By definition, we must have that the effect of the Money multiplier and Money velocity should lead to an increase in Output of 3000, given the increase of 1000 in the Monetary Base.

Basically the expansionary effect will be the result of the Money multiplier and the Money velocity, which must “multiply” the increase in Monetary Base by….3.

Some caveats:

1. We can’t (in this model) disentangle which (V or m) “multiplies” the Monetary Base into Real Output, we must assume it’s a combination of both the indicators
2. The Keynesian multiplier is about a flow, (an increase in GDP), the Money multiplier and velocity are about a Stock (the Money stock), so in this example both the multiplier and velocity represent variations of the Base (flow)

But in the end of the day, we can say this:

(Using flows, using deficit monetization and assuming fixed prices)

The Keynesian Multiplier is equal to the Money Velocity times the Money Multiplier

Or as I said in the tittle

Two residuals multiplied become an illusion

# Are you a Socialist or a Communist??

Or do you just want to see the world burn?

(This post builds on ad absurdum arguments, if you are not able think “theoretically”, this one is not for you)

Imagine the mother of all crisis!

This is not the Great Recession! This is not the Japan Crash! Not even the Great Depression!!!

All people stop consuming in large scale, all companies stop investing! Unemployment reach maximum peaks! Why? Oh..forget why.. Let’s call it…the animal spirits, a decrease in confidence, whatever…that’s not the point.

Well.

At least we have a Central Bank, some will shout!

At least we have a Fiscal Authority, others will scream!

Let’s start with the first ones: What would the Central Bank do? It would start buying Short Term Treasury Securities (or define a short term interest rate), but then suddenly the interest rate reaches the Zero Lower Bound (or another bound..) and they decide to buy longer term bonds, until the interest rate reaches zero too! Then it will go to corporate bonds! Stocks! Houses? What else??

The Central Bank just bought everything…and still no resurgence in private spending to acceptable levels.

Did the Central just buy everything? And the Central Bank is part of the Government, right? So if the Government owns all the assets in an Economy…

Those who shouted for Monetary Policy ended up as Communists! (Friedman would not be happy about this – neither would Sumner)

What about the ones who called for the Fiscal Authority?

Well…Let’s say, first of all, the Ministry of Finance cuts taxes all the way to zero… Still..no resurgence in private spending to acceptable levels.

What else? Well..Government Spending it is!

The Government will just Deficit Spending all the way to prosperity, choosing the sector in which to spend/invest as it would seem fit. It would choose the direction of the economy!!

What? Those who shout for Fiscal Policy ended up as Socialists! (I guess both Keynes and Krugman wouldn’t mind…)

So..in the end,  are we all just Socialists or Communists?

No..You could just shout (as Mises): “YOU’RE ALL A BUNCH OF SOCIALISTS” and watch the world burn.

P.S: I know, I know.. I maybe distorted a little the meaning of socialism and communism, but if the great Nick Rowe can (but much better), so can I, right? (Wrong)

# Scott Sumner, semantics and bias

Scott Sumner is referred by some as “the economist that saved the economy”.

He is kind of an hero to me, because he rose from the blogosphere and became one of the most influential economists nowadys.

In a recent entry in his blog, he refutes Old Keynesianism based on Japan.

I don’t think he is completely right, and maybe his “libertarian” bias is leading him to the kind of semantics error that he so hard tries to fight (regarding monetary policy).

Let me explain.

(My apologies in advance if you don´t agree with what I think you believe, Scott)

A macroeconomic policy is the set of policies that are taken by the Government (and/or Central Bank) to achieve some macroeconomic targets (employment, inflation, NGDP,…).

Scott thinks the best target is Nominal Gross Domestic Product (or some proxy). I agree.

Scott thinks monetary policy is the best policy to achieve that target. I agree, most of the times.

Scott thinks that although fiscal policy may have some macroeconomic effects, it is highly ineffective and subject to various kinds of political incentives, that should reduce its use to bare minimum. It should reduce its use to microeconomics purposes and not to stabilization. I do agree, most of the times.

So, Scott doesn’t think of fiscal policy as a macroeconomic policy. But Keynesians do.

And when he tries to play the “Keynesian game” and tries to refute them, he falls to same type of fallacy Keynesians fall in terms of monetary policy.

“it’s one of the most expansionary fiscal policies in all of history coinciding with the worst performance of aggregate demand ever observed in a major economy”

If you replace “fiscal” with “monetary”, Scott would roll over his eyes (probably).

As Scott would deem monetary policy in Japan since the 1990s highly contractionary (by the bad performance of the economy), despite low interest rates, it’s legitimate that Keynesians see fiscal policy as highly contractionary, despite high fiscal deficits. Just ask Richard Koo.

Maybe fiscal policy is Japan is being highly ineffective, but maybe because it’s not being applied the right way.

Maybe Quantitative Easing (the first round) in Japan was highly ineffective, but maybe because it’s not being applied the right way.

I guess this is all for today. But I will publish more on this topic during the week.

A simple IS/LM type of model but regarding fiscal policy.