Tuesday, May 25, 2010

Some Fed Articles on Inflation

Here are three interesting and readable short pieces from the Federal Reserve System. They all deal, in one way or another, with inflation, and they all provide good background for teachers and students alike.

The first is from the Federal Reserve Bank of Cleveland's Economic Trends and is by far the timeliest. By that I mean it really is of the moment and probably needs to be used or read in the near term to have the most value.

The remaining two are courtesy of the Federal Reserve Bank of St. Louis. This one is from their Economic Synopses publication and deals with a practical definition of monetizing the debt. You know, it’s the answer you have to give when students ask "why doesn't the government just print more money and pay off the debt?" In this case, the definition depends upon intent. And the article provides some good historical context.

The next article is a brief essay from the recent issue of Monetary Trends. It asks "Why Do People Dislike Inflation?" And it provides a good answer. If your students sometimes speak like inflation might be a good thing (wages rise, debts are easier to pay off, etc.), this could be helpful.

I look forward to your thoughts on these articles.


Flow5 said...

There isn't anyone at the FED who understands money & central banking. Why should I read a bunch of Keynesian crap?

Flow5 said...

MV doesn't equal PQ. MV = PT.

The transactions concept of money velocity (Vt) has its roots in Irving Fischer’s equation of exchange (PT = MV), where (1) M equals the volume of means-of-payment money; (2) V, the rate of turnover of this money; (3) T, the volume of transactions units; and (4) P, the average price of all transactions units.

The “econometric” people don’t like the equation because it is impossible to calculate P and T. Presumably therefore the equation lacks validity. Actually the equation is a truism – to sell 100 bushels of wheat (T) at $4 a bushel (P) requires the exchange of $400 (M) once (V), or $200 twice, etc.

The real impact of monetary demand on the prices of goods and serves requires the analysis of “monetary flows”, and the only valid velocity figure in calculating monetary flows is Vt.

Income velocity (Vi) is a contrived figure (Vi = Nominal GDP/M). The product of MVI is obviously nominal GDP.

So where does that leave us? In an economic sea without a rudder or an anchor. A rise in nominal GDP can be the result of (1) an increased rate of monetary flows (MVt) (which by definition the Keynesians have excluded from their analysis), (2) an increase in real GDP, (3) an increasing number of housewives selling their labor in the marketplace, etc.

The income velocity approach obviously provides no tool by which we can dissect and explain the inflation process.

To the Keynesians, aggregate demand is nominal GDP, the demand for services (human) and final goods. This concept excludes the common sense conclusion that the inflation process begins at the beginning (with raw material prices and processing costs at all stages of production) and continues through to the end.

Obviously funds used for short selling do not contribute to a rise in prices. The Fed calculates these velocity figures by dividing the aggregate volume of debits of these banks against their demand deposits.

But we do know that to ignore the aggregate effect of money flows on prices is to ignore the inflation process.

And to dismiss the concept of Vt by saying it is meaningless (that people can only spend their income once) is to ignore the fact that Vt is a function of three factors: (1) the number of transactions; (2) the prices of goods and services; (3) the volume of M.

Inflation analysis cannot be limited to the volume of wages and salaries spent. To do so is to overlook the principal "engine" of inflation - which is of course, the volume of credit (new money) created by the Reserve and the commercial banks, plus the expenditure rate (velocity) of these funds.

Also overlooked is the effect of the expenditure of the savings of the non-bank public on prices. The (MVt) figure encompasses the total effect of all these monetary flows (MVt).

This is inviolate and sacrosanct.