Marginal Revolution University
Published on 14 Nov 2017Meet the monetarists! This business cycle theory emphasizes the effect of the money supply and the central bank on the economy. Formulated by Nobel Laureate Milton Friedman, it’s a “goldilocks” theory that argues for a steady rate of fairly low inflation to keep the economy on track.
May 24, 2019
Game of Theories: The Monetarists
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May 23, 2019
Game of Theories: The Keynesians
Marginal Revolution University
Published on 7 Nov 2017When the economy is going through a recession, what should be done to ease the pain? And why do recessions happen in the first place? We’ll take a look at one of four major economic theories to find possible answers – and show why no theory provides a silver bullet.
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April 8, 2019
QotD: Why does US healthcare cost so much?
This is a hotly debated question in health care policy. Here’s my rough stab at it: the 1970s inflation interacted particularly badly with two pre-existing policy choices: the tax deduction for employer-sponsored health insurance, and Medicare.
Start with employer-sponsored health insurance, which is, as everyone knows, tax advantaged relative to salary, because your employer can deduct it as an expense, but you don’t have to show it as income on your taxes.
This was an incredibly dumb decision, but in the defense of the folks who made it in the 1940s, at the time, health insurance wasn’t very expensive, because the health care system couldn’t do all that much (and the female labor that ran hospitals was cheap due to discrimination, or in the case of nuns, basically free).
Come the 1970s, inflation started causing a problem called “bracket creep”. Back then tax brackets weren’t indexed for inflation, so as inflation went up, folks got pushed into higher and higher tax brackets, even though the buying power of their salary had stayed the same, or [had] gone down. This was great for the government (and is a big reason our deficits were not disastrous in the 1970s), but it was terrible for people, and led to the tax revolts that helped put Reagan in office.
But I digress. The point is that bracket creep made non-taxed benefits much more attractive relative to salary, so insurance started getting more generous. That process has continued for decades. Insurance used to be “major medical” that covered big ticket items like hospital stays. Now we expect it to cover the cost of going to the doctor for the sniffles. Well, if you insulate people from those costs, they will incur more of them.
Effectively, this raises demand for health care services. But the US system, decentralized and litigation-happy, is very bad at controlling the supply side. End result: high costs.
The other thing that happened is Medicare. The original legislation called for reimbursing services at “reasonable and customary rates”. This was a gold mine for doctors and hospitals. In New York, for example, doctors used to be forced to do charity care as the price of their admitting privileges at prestigious city hospitals. Once Medicare came into the picture, there was no need for that! Or to economize on beds; you could always find someone to fill them. Eventually, Medicare tried to crack down (http://reason.com/archives/2011/12/13/medicare-whac-a-mole), but by then, it was damned hard to cut physician and hospital incomes, in part because they had made decisions based on their — like building new hospitals with all private rooms — that couldn’t be undone. Our cost base is permanently higher, and politically, we have shown no will to slash provider incomes. So even though our growth rate is about average for the OECD, we’re growing from a much higher level.
Megan McArdle, “Ask Me Anything”, Reddit, 2017-04-10.
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March 16, 2019
MMT – Magic Money Theory
Antony Davies and James R. Harrigan explain just why so many progressives are so excited about MMT:
Modern Monetary Theory, or MMT, is all the rage in the halls of Congress lately.
To hear the Progressive left tell it, MMT is not unlike a goose that keeps laying golden eggs. All we have to do is pick up all the free money. This is music to politicians’ ears, but Fed Chairman Jerome Powell is singing a decidedly different tune. Said Powell recently on MMT, “The idea that deficits don’t matter for countries that can borrow in their own currency … is just wrong.”
MMT advocates see this as outdated thinking. We can, they claim, spend as much as we want on whatever we want, unencumbered by trivialities like how much we have. But MMT is a bait-and-switch wrapped in a sleight-of-hand. It focuses on debt and dollars rather than resources and products. Debt and dollars are merely tools we use to transfer ownership of resources and products. It’s the resources and products that matter. Shuffling debt and dollars merely changes the ownership of resources and products. It doesn’t create more.
[…]
So here’s the sleight of hand. MMT advocates say that we won’t experience inflation because the U.S. dollar is a reserve currency — foreigners hold lots of U.S. dollars. First, increasing the money supply, other things constant, does create inflation. But when a reserve currency inflates, the pain gets spread around the world instead of being concentrated within one country. In short, MMT advocates believe our government should print money and let foreigners bear some of the inflation pain. Second, there’s no law that says that the U.S. dollar must be a reserve currency. The British Pound was one, but as its value declined, foreigners stopped holding it. Foreigners will stop holding U.S. dollars too as their value declines.
And here’s the bait-and-switch. MMTers say that if inflation does become a problem, the government can simply raise tax rates to soak up excess dollars. In short, the government would print money with one hand, buying whatever it wants and causing inflation. It would then tax with the other, thereby removing dollars from the economy and counteracting the inflation. In the end, all that’s happened is that the government has replaced goods and services that people want with goods and services politicians want.
After a bout of MMT, we might have the same GDP and zero inflation, but what constitutes that GDP would have changed dramatically. Instead of having more cars and houses, we might have more tanks and border walls.
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March 5, 2019
Changes in Velocity
Marginal Revolution University
Published on 16 May 2017What happens when aggregate demand shifts because of a change in the velocity of money? You’ll recall from earlier videos that an increase or decrease in velocity means that money is changing hands at a faster or slower rate.
Changes in velocity are temporary, but they can still cause business fluctuations. For instance, say that consumption growth slows as consumers become pessimistic about the economy.
In fact, we saw this play out in 2008, when workers and consumers became afraid that they might lose their jobs during the Great Recession. This fear drove them to cut back on their spending in the short run. But, since changes in velocity are temporary, this fear receded as time passed and the economy began to recover.
Dive into this video to learn more about what causes shifts in the aggregate demand curve.
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January 20, 2019
The Short-Run Aggregate Supply Curve
Marginal Revolution University
Published on 9 May 2017In this video, we explore how rapid shocks to the aggregate demand curve can cause business fluctuations.
As the government increases the money supply, aggregate demand also increases. A baker, for example, may see greater demand for her baked goods, resulting in her hiring more workers. In this sense, real output increases along with money supply.
But what happens when the baker and her workers begin to spend this extra money? Prices begin to rise. The baker will also increase the price of her baked goods to match the price increases elsewhere in the economy. As prices increase, workers demand higher wages to be able to afford goods at a higher price.
In this example, the increase in money supply initially increased nominal and real wages for the baker and her employees, but as prices begin to rise, real wages begin to fall, and workers can afford less. Overtime, the demand for the baker’s goods will fall to pre-spending levels.
The takeaway? An increase in spending can increase output and growth in the short run, but not in the long run. To model this scenario, this video will show you how to draw a short-run aggregate supply curve. Let’s get started!
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November 23, 2018
The Aggregate Demand Curve
Marginal Revolution University
Published on 18 Apr 2017This wk: Put your quantity theory of money knowledge to use in understanding the aggregate demand curve.
Next wk: Use your knowledge of the AD curve to dig into the long-run aggregate supply curve.
The aggregate demand-aggregate supply model, or AD-AS model, can help us understand business fluctuations. In this video, we’ll focus on the aggregate demand curve.
The aggregate demand curve shows us all of the possible combinations of inflation and real growth that are consistent with a specified rate of spending growth. The dynamic quantity theory of money (M + v = P + Y), which we covered in a previous video, can help us understand this concept.
We’ll walk you through an example by plotting inflation on the y-axis and real growth on the x-axis — helping us draw an aggregate demand curve!
Next week, we’ll combine our new knowledge on the AD curve with the long-run aggregate supply curve. Stay tuned!
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November 10, 2018
Hitler’s Beer Hall Disaster I BETWEEN 2 WARS I 1923 Part 1 of 2
TimeGhost History
Published on 10 Nov 2018When Germany spirals into hyperinflation and the French occupy the Ruhr, Adolf Hitler and Erich Ludendorff make a grab for power.
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Hosted by: Indy Neidell
Written and directed by: Spartacus Olsson
Writing and Research Contributed by: Rune V. Hartvig
Produced by: Astrid Deinhard
Executive Producers: Bodo Rittenauer, Astrid Deinhard, Indy Neidell, Spartacus OlssonArchive by Screenocean/Reuter https://www.screenocean.com
A TimeGhost chronological documentary produced by OnLion Entertainment GmbH
And from the comments:
We jump ahead briefly to 1923 as this week is the anniversary of the Hitlerputsch and the Georg Elser Bomb in 1939. We will return to part 4 of 1920 in shortly. Many thanks to Rune V. Hartvig for contributing to the writing of this episode.
READ BEFORE YOU COMMENT: This episode was recorded before we had our studio, therefore our the sound is not great. Also READ OUR RULES:
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October 28, 2018
QotD: Revolutionary price controls and the plight of Washington’s army at Valley Forge
By the end of 1775, Congress had already increased the nation’s money supply by 50 percent in less than a year, and state paper issues had already begun in New England. The Congressional Continental bills followed what was to become a sequence all too familiar in the western world: runaway inflation. As paper money issues flooded the market, the dilution of the value of each dollar caused prices in terms of paper money to increase; since this included the prices of gold, silver, and foreign currencies, the value of the paper money declined in comparison to them. As usual, rather than acknowledge the inevitability of this sequence, the partisans of inflationary policies urged further accelerated paper issues to overcome the higher prices and searched for scapegoats to blame for the price rise and depreciation. The favorite scapegoats were merchants and speculators who persisted in doing the only thing they ever do on the market: they followed the push and pull of supply and demand. In another familiar attempt to deal with the problems of inflationary intervention, they outlawed the depreciation of paper, or the rise of prices.
[…]
State and local governments presumed to know what market prices of the various commodities should be, and laid down price regulations for them. Wage rates, transportation rates, and prices of domestic and imported goods were fixed by local authorities. Refusing to accept paper, accepting them for less than par, charging higher prices than allowed, were made criminal acts, and high penalties were set: they included fines, public exposure, confiscation of goods, tarring and feathering, and banishment from the locality. Merchants were prohibited from speculating, and thereby from bringing the needed scarce goods to the public. Enforcement was imposed by zealots in local and nearby committees, in a despotic version of the revolutionary tradition of government by local committees.
Price controls made matters far worse for everyone, especially the hapless Continental Army, since farmers were thereby doubly penalized: they were forced to sell supplies to the army at prices far below the market and they had to accept increasingly worthless Continentals in payment. Hence, they understandably sold their wares elsewhere; in many cases, they went “on strike” against the whole crazy-quilt system by retiring from the market altogether and raising only enough food to feed themselves and their own families. Others reverted to simple barter.
Murray N. Rothbard, Conceived In Liberty, Volume IV, 1979.
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October 21, 2018
This is why Keynesianism doesn’t work in practice – the politicians flub the hard part
Tim Worstall explains the fatal flaw in Keynes’ economic theory … not so much in the theory part, but in the practical application by flesh-and-blood human beings:
We’re told that government borrowing is falling, the deficit closing. This therefore means that it’s possible to relax austerity, to start spending more upon sweeties for the voters. This being exactly and precisely why Keynesianism as a practical matter doesn’t work. For politicians will follow the fun bit and not the difficult part. Thus as an overall theory it simply is, to use a governmental phrase, no longer operative.
[…]
Think of what that basic Keynesian idea is. When the economy’s in the doldrums we should blow out the deficit in order to increase demand and thus boost the economy. But when we’re running at the resource limit then any such attempts will just turn up as inflation. So, we should stop doing that. Also, as Keynes himself pointed out, when the Sun shines is the time to repair the roof. Perhaps pay down some of that national debt so that the next time we need to blow that deficit out we’ve got space to do so.
Do note that this basic set up is also entirely consistent with modern monetary theory. When the economy is running at its limits then we should be taxing more of that created money back to prevent inflation. That is, running a smaller budget deficit, possibly even a surplus.
So, what happens to kill either theory in reality? Well, here we are. Unemployment at its lowest since the early 1970s. Employment to population ratio at its highest since then. And what are people talking about? Blowing out the deficit again to buy sweeties for voters. That is, the political imperatives just don’t militate in favour of anyone using these theories as they’re supposed to work.
In the meantime, of course, we’ve effectively changed the meaning of the word “austerity“:
Austerity is a political-economic term referring to policies that aim to reduce government budget deficits through spending cuts, tax increases, or a combination of both. Austerity measures are used by governments that find it difficult to pay their debts. The measures are meant to reduce the budget deficit by bringing government revenues closer to expenditures, which is assumed to make the payment of debt easier. Austerity measures also demonstrate a government’s fiscal discipline to creditors and credit rating agencies.
To a modern politician — or political activist — “austerity” now means something more like “only spending a bit more this year than you did last year”. British commentators have been accusing the government’s “austerity” measures for all kinds of negative effects, yet there have been no large scale austerity measures brought in.
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October 13, 2018
Why Governments Create Inflation
Marginal Revolution University
Published on 14 Feb 2017Inflation can carry with it quite a few costs. But some governments, like Zimbabwe under President Robert Mugabe in the early 2000s, will go out of their to way to create inflation. Why?
Well, in the Zimbabwe example, the government printed the money and used it to buy goods and services. The ensuing hyperinflation acted as a tax that transferred wealth from the citizens to the government.
However, this is a fairly uncommon reason. Inflation doesn’t make for a good tax and it’s a last resort for desperate governments that are otherwise unable to raise funds.
There are other benefits to inflation that would make governments want to create it. In the short run, inflation can actually boost economic output. However, as we’ve previously covered, an increase in the money supply leads to an equal increase in prices in the long run.
If there’s a recession, governments might create inflation to spur productivity and ease the economic downturn. However, this type of inflationary boosting can be abused. Long-term boosting causes people to simply expect and prepare for it.
Reducing inflation is also costly. If the process is reversed and the growth in the money supply decreases, we get disinflation. Unemployment will likely increase in the short run and an economy can go through a recession. But in the long run, prices will adjust as well.
Inflation can be a neat trick for governments to boost productivity in an economy. But it can easily get out of hand and has even been likened to a drug. Once you start, you need more and more. And stopping is awfully painful as the economy shrinks.
This concludes our section on Inflation and the Quantity Theory of Money. Up next in Principles of Macroeconomics, we’ll be digging into Business Fluctuations.
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October 2, 2018
Costs of Inflation: Financial Intermediation Failure
Marginal Revolution University
Published on 7 Feb 2017In the previous video, we learned that inflation can add noise to price signals resulting in some costly mistakes from price confusion and money illusion. Now, we’ll look at how it can interfere with long-term contracting with financial intermediaries.
Let’s say you want to take out a big loan, such as a mortgage on a house. The financial intermediary (in this case, a commercial bank) is going to charge you an interest rate as their profit for loaning you the money. In this situation, inflation has the potential to work against you or it can work against the bank.
If the bank charges you a nominal interest rate (i.e., the interest rate on paper before taking inflation into account) of 5% and inflation climbs unexpectedly to 10% for the year, the real interest rate (nominal minus inflation) falls to -5%. The bank actually loses money. However, if inflation has been higher and banks are charging 15% for mortgages and inflation rates fall unexpectedly to 3%, you’re stuck paying a real interest rate of 12%!
The above scenarios are similar to what actually happened in the United States in the 1960s and 1970s. Inflation was low in the 60s. But then in 70s, inflation rates climbed up unexpectedly. People that purchased a home in the 60s lucked out with low interest rates on their mortgages coupled with higher inflation, and many were able to pay off the loans more quickly than expected. But anyone that purchased a higher interest rate mortgage in the 70s only saw inflation fall back down. It was good for the banks and a costly choice for the homeowners. They were saddled with a high-interest mortgage while lower inflation meant a lower increase in wages.
It’s not that the people buying homes in the 1960s were smarter than those in the 70s. As we’ve noted in previous videos, inflation can be very difficult to predict. When banks expect that inflation might be 10% in the coming years, they will generally adjust their nominal interest rates in order to achieve the desired real interest rate. This relationship between real and nominal interest rates and inflation is known as the Fisher effect, after economist Irving Fisher.
We can see the Fisher effect in the data for nominal interest rates on U.S. mortgages from the 1960s through today. As inflation rates rise, nominal interest rates try to keep up. And as the inflation rates fall, nominal interest rates trail behind.
Now, if inflation rates are both high and volatile, lending and borrowing gets scary for both sides. Long-term contracts like mortgages become more costly for everyone with much higher risk, so it happens less. This is damaging for an economy. Coordinating saving and investment is an important function of the market. If high and volatile inflation is making that inefficient and less common, total wealth declines.
Up next, we’ll explore why governments create inflation in the first place.
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September 6, 2018
Costs of Inflation: Price Confusion and Money Illusion
Marginal Revolution University
Published on 2 Feb 2017The inflation rate can be somewhat volatile and unpredictable. For example, let’s take the period between 1964 and 1983 in the U.S. The inflation rate jumped around from 1.3% in 1964 to 5.9% in 1970, and all the way up to 14% in in 1980, before dipping back down to 3% in 1983. These dramatic changes, though still fairly mild in the realm of inflation, caught people off-guard.
Peru’s inflation rates in the late 1980s through the early 1990s were on even more of a rollercoaster. Clocking in at 77% in 1986, its inflation rate was already quite high. But by 1990, it had jumped to 7,500%, only to fall to 73% a mere two years later.
High and volatile inflation rates can wreak havoc on the price system where prices act as signals. If the price of oil rises, it signals scarcity of that product and allows consumers to search for alternatives. But with high and volatile inflation, there’s noise interfering with this price signal. Is oil really more scarce? Or are prices simply rising? This leads to price confusion – people are unsure of what to do and the price system is less effective at coordinating market activity.
Money illusion is another problem associated with inflation. You’ve likely experienced this yourself. Think of something that you’ve noticed has gotten more expensive over the course of your lifetime, such as a ticket to the movies. Is it really that going out the movies has become a pricier activity, or is it the result of inflation? It’s difficult for us to make all of the calculations to accurately compare rising costs. This is known as “money illusion” – or when we mistake a change in the nominal price with a change in the real price.
Inflation, especially when it’s high and volatile, can result in some costly problems for everyone. Next up, we’ll look at how it redistributes wealth and can break down financial intermediation.
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August 20, 2018
Causes of Inflation
Marginal Revolution University
Published on 24 Jan 2017In the last video, we learned the quantity theory of money and its corresponding identity equation: M x V = P x Y
For a quick refresher:
•M is the money supply.
•V is the velocity of money.
•P is the price level.
•And Y is the real GDP.
In this video, we’re rewriting the equation slightly to divide both sides by Y and explore the causes behind inflation. What we discover is that a change in P has three possible causes – changes in M, V, or Y.
You probably know that prices can change a lot, even over a short period of time.
Y, or real GDP, tends to change rather slowly. Even a seemingly small jump or fall in Y, such as 10% in a year, would signal astonishing economic growth or a great depression. Y probably isn’t our usual culprit for inflation.
V, or the velocity of money, also tends to be rather stable for an economy. The average dollar in the United States has a velocity of about 7. That may fall or rise slightly, but not enough to influence prices.
That leaves us with M. Changes in the money supply are the driving factor behind inflation. Put simply, when more money chases the same amount of goods and services, prices must rise.
Can we put this theory to the test? Let’s look at some real-world examples and see if the quantity theory of money holds up.
In Peru in 1990, hyperinflation came into full swing. If we track the growth rate of the money supply to the growth rate of prices, we can see that they align almost perfectly on a graph with both clocking in around 6,000% that year.
If we plot the growth rates of the money supply along with the growth rates of prices for a many countries over a long stretch of time, we can see the same relationship.
We’ll wrap-up the causes of inflation with three principles to keep in mind as we continue exploring this topic:
•Money is neutral in the long run: a doubling of the money supply will eventually mean a doubling of the price level.
•“Inflation is always and everywhere a monetary phenomena.” – Milton Friedman
•Central banks have significant control over a nation’s money supply and inflation rate.
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July 20, 2018
Fiat currency and the impact of cryptocurrencies
At Catallaxy Files, Sinclair Davidson explains some of the advantages and disadvantages of both fiat (government-issued) and private currency:
As George Selgin, Larry White and others have shown, many historical societies had systems of private money — free banking — where the institution of money was provided by the market.
But for the most part, private monies have been displaced by fiat currencies, and live on as a historical curiosity.
We can explain this with an ‘institutional possibility frontier’; a framework developed first by Harvard economist Andrei Shleifer and his various co-authors. Shleifer and colleagues array social institutions according to how they trade-off the risks of disorder (that is, private fraud and theft) against the risk of dictatorship (that is, government expropriation, oppression, etc.) along the frontier.
As the graph shows, for money these risks are counterfeiting (disorder) and unexpected inflation (dictatorship). The free banking era taught us that private currencies are vulnerable to counterfeiting, but due to competitive market pressure, minimise the risk of inflation.
By contrast, fiat currencies are less susceptible to counterfeiting. Governments are a trusted third party that aggressively prosecutes currency fraud. The tradeoff though is that governments get the power of inflating the currency.
The fact that fiat currencies seem to be widely preferred in the world isn’t only because of fiat currency laws. It’s that citizens seem to be relatively happy with this tradeoff. They would prefer to take the risk of inflation over the risk of counterfeiting.
One reason why this might be the case is because they can both diversify and hedge against the likelihood of inflation by holding assets such as gold, or foreign currency.
The dictatorship costs of fiat currency are apparently not as high as ‘hard money’ theorists imagine.
Introducing cryptocurrencies
Cryptocurrencies significantly change this dynamic.
Cryptocurrencies are a form of private money that substantially, if not entirely, eliminate the risk of counterfeiting. Blockchains underpin cryptocurrency tokens as a secure, decentralised digital asset.
They’re not just an asset to diversify away from inflationary fiat currency, or a hedge to protect against unwanted dictatorship. Cryptocurrencies are a (near — and increasing) substitute for fiat currency.
This means that the disorder costs of private money drop dramatically.
In fact, the counterfeiting risk for mature cryptocurrencies like Bitcoin is currently less than fiat currency. Fiat currency can still be counterfeited. A stable and secure blockchain eliminates the risk of counterfeiting entirely.
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