Friday, April 27, 2007

Channeling James Tobin

Mark Thoma (with support from Frederic Mishkin) holds with those who insist that only money can cause inflation – at least if, by inflation, one means a sustained pattern of increases in the price level. I believe that, as a formal matter, the argument is somewhat circular tautological: the conclusion is based on comparative static models in which money is the only stock variable. Fiscal policy is, almost by definition, a one-shot deal in these models, so it cannot produce a sustained pattern of change in anything.

Consider the standard closed-economy IS-LM model, as I learned it in school:

IS curve: Y = C(tY) + I(r) + G
LM curve: M/P = L(r, Y)

Y = national output
C = consumption
I = private investment
G = government spending
t = tax rate
r = interest rate
M = money stock
P = price level

Applying the standard assumption of a vertical long-run Phillips curve, we can take the growth rate of Y as exogenous for our purposes. Without loss of generality, let’s assume Y is constant.

Now, we want to ask, can the growth rate of P (otherwise known as the inflation rate) be positive if M is constant? You can see immediately from the LM curve that, if P were rising and M were constant, either r or Y would have to be changing. Otherwise the left-hand side of the equation would be falling, while the right-hand side would be constant. However, we have assumed that Y is constant, and a look at the IS curve shows that, if r is changing, then one of the other flow variables (Y, G, or t) must also be changing. But, again, we have assumed Y is constant, so unless there is a constantly changing fiscal policy (e.g., the tax rate constantly falling or government spending constantly rising), the equations won’t balance. So without money growth, you would really have to do something bizarre to get sustained inflation.

But suppose we introduce a new stock variable, call it “B” for bonds (government bonds, that is). The stock of government bonds grows as the government accumulates deficits (or falls as it accumulates surpluses). Using the “d” operator to indicate a rate of change, we can describe this process as:

dB = G – tY

For completeness, we can add yet another stock variable, the capital stock (“K”). Without loss of generality, I’m going to ignore depreciation and just say:

dK = I

In principle, private investment depends not directly on the government bond interest rate but on the required return on private capital. Let’s call this required return “s” (for “stock market return” as a mnemonic, although you should understand that it is the general required return on private capital, not just for the stock market).

In the standard IS-LM model, it was assumed that s and r were in some fixed relation, but in a world where government competes with the private sector for capital, the relation between the two returns need not be fixed. Government bonds and private capital have different characteristics – different risks, different degrees of liquidity, and so on. Investors may have a preferred proportion of holdings between the two, and when the relative supply of one asset increases, they will require some compensation for changing their proportions. Call the difference in returns between the two assets “e” (for “equity premium”) and recognize that it will depend on the relative outstanding stocks of government bonds and private capital. That gives us the following model:

Y = C(tY) + I(s) + G
M/P = L(r, Y)
dB = G – tY
dK = I(s)
s = r + e(B, K)

We now have a wedge between money growth and inflation. As the government runs a constant (sufficiently large) deficit, B increases relative to K. Therefore e(B, K) increases, and s falls relative to r. In order for Y to remain constant in the IS curve, s has to be constant in absolute terms, so this means r has to rise. In the LM curve, as r rises, with Y and M constant, P has to rise. Fiscal policy does cause sustained inflation.

Labels: , , , , , , , ,


Blogger Gabriel M said...

This looks like a good argument for calling (some) financial instruments "money". :-)

Fri Apr 27, 05:14:00 PM EDT  
Blogger knzn said...

There’s a basic problem with choosing any single definition of “money” in a “quantity theory” context. The problem is that different forms of money (and quasi-money) are not perfect substitutes. No matter what definition you choose, you’re going to end up having problems. If you choose a narrow definition, the problem is that there are substitutes available. If you choose a broad definition, the problem is that different components of the “money stock” have different demand equations. For example, if you choose to include government bonds in your definition of money, then you might think that open market operations would have no effect on aggregate demand. But of course they do. (OK, that’s not a good example; because of the fractional reserve banking system, open market operations actually change the total stock of money and bonds, but suppose you were to offset the effect of the money multiplier by changing the reserve requirement at the same time. You would still get a net effect, because bank deposits and bonds are not perfect substitutes.)

I would say (and I think most central bankers today would agree) that we should stop worrying about measures of money per se (except perhaps as indicators of potential demand) and just adjust interest rates so as to produce the intended path for the price level, given various models of the economy, economic indicators, feedback from actual prices, and some amount of intuition. If you don’t like active policy, OK, then just use a Taylor rule, or some more sophisticated variant on the Taylor rule (except I think you can do better with active policy).

If one is talking about fiscal policy, I would say that, realistically, any analysis should make monetary policy endogenous, and since bonds and base money are not perfect substitutes, a central bank that targets the price level can and will ultimately offset the inflationary effect of fiscal policy. But then the question becomes, what exactly are they trying to offset? If they think the effects of fiscal policy on the inflation rate are only temporary, they might ignore it. But…never mind, just see the end of my next post.

Sat Apr 28, 05:02:00 PM EDT  
Blogger Karl Smith said...

I am not sure we even have to get this deep. If the government spending is rising faster than taxes then it should be enough in the simple model.

Now of course this can't happen forever but if we had a steady increase in the price level over a period of 5 years I think everyone would call that inflation.

Thu May 03, 06:21:00 PM EDT  
Anonymous Anonymous said...


Thu Apr 02, 09:52:00 AM EDT  
Anonymous Anonymous said...

酒店喝酒,禮服店,酒店小姐,酒店領檯,便服店,鋼琴酒吧,酒店兼職,酒店兼差,酒店打工,伴唱小姐,暑假打工,酒店上班,酒店兼職,ktv酒店,酒店,酒店公關,酒店兼差,酒店上班,酒店打工,禮服酒店,禮服店,酒店小姐,酒店兼差,暑假打工,酒店經紀,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店兼差,暑假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,酒店小姐,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,酒店小姐,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,酒店傳播,酒店經紀人,酒店,酒店,酒店,酒店 ,禮服店 , 酒店小姐,酒店經紀,酒店兼差,暑假打工,招待所,酒店小姐,酒店兼差,寒假打工,酒店上班,暑假打工,酒店公關,酒店兼職,禮服店 , 酒店小姐 ,酒店經紀 ,酒店兼差,暑假打工,酒店,酒店,酒店經紀,酒店領檯 ,禮服店 ,酒店小姐 ,酒店經紀 ,酒店兼差,暑假打工, 酒店上班,禮服店 ,酒店小姐 ,酒店經紀 ,酒店兼差,暑假打工, 酒店上班,禮服店 ,酒店小姐 ,酒店經紀 ,酒店兼差,暑假打工, 酒店上班,酒店經紀

Tue Apr 21, 06:45:00 PM EDT  
Anonymous Anonymous said...

Some new style Puma Speed is in fashion this year. chaussure puma is Puma Shoes in french. Many france like seach “chaussure sport” by the internet when they need buy the Puma shoes or buy the nike max shoes.The information age is really convenient. By the way ,the puma CAT is really good chaussures puma ,don’t forget buy the puma mens shoes and nike air max ltd by the internet when you need them . Do you know Nike Air Shoes is a best Air Shoes .

Spring is coming, and how to choose the polo shirts is the main concern of many people. ralph lauren polo shirts is a classic type and reliable. ed hardy clothing is more in line with the aesthetic ideas of young people, so many young people filled with a variety of ed hardy clothes in their wardrobes. New style ed hardy womens shirt match the new style ed hardy sunglasses , it is a good idea.
Do you think this season is not for ugg boots ? maybe yes .but this season is best time that can buy the cheap ugg boots. Many sellers are selling discounted. Do not miss . Please view my blog and fc2 blog .thank you .

Wed May 20, 03:22:00 AM EDT  
Anonymous Anonymous said...

cheap wow gold buy wow power leveling my wow gold cheapest wow power leveling
replica replica rolex
CHEAP wow power level
BUY power leveling
replica rolex replica
cheap lotro gold
replica rolex
CHEAPEST power leveling
cheap rs gold l

Tue Jun 09, 10:38:00 PM EDT  
Anonymous Anonymous said...

wholesale gemstone jewelry
wholesale crystal jewelry
crystal wholesale
rock crystal

crystal jewelry
wholesale jewelry
jewelry wholesale
cheap jewelry

Sun Sep 27, 10:45:00 PM EDT  
Blogger Adi said...

Oes Tsetnoc one of the ways in which we can learn seo besides Mengembalikan Jati Diri Bangsa. By participating in the Oes Tsetnoc or Mengembalikan Jati Diri Bangsa we can improve our seo skills. To find more information about Oest Tsetnoc please visit my Oes Tsetnoc pages. And to find more information about Mengembalikan Jati Diri Bangsa please visit my Mengembalikan Jati Diri Bangsa pages. Thank you So much.

Sun Nov 22, 01:22:00 AM EST  
Blogger Jimmy Wang said...

I had never see a blog batter than this blog, I like this blog very very much.By the way, do you like my products: solar street lights, street lights, street lighting, street lamps, ball valves, butterfly valves, butterfly valve handles, check valves, sanitary fittings, butterfly valve handles, butterfly valve handles, street light, butterfly valve handles butterfly valve handles, street lamp, solar street light, ball valve, butterfly valve, check valve

Wed Mar 24, 05:26:00 AM EDT  
Anonymous Moncler Outlet Online said...

We are dedicated to delivering the most recent and greatest high quality Louboutin Heels along with other artist at Cheap Ugg Uk.With this broad variety of Christian louboutin Heels and the beautiful Moncler Outlet and Moncler Outlet Online at our Moncler Online Shop. now gets the ladies' favorite. New Best Hair Straightener from our finest locks Straightener on the Chi Hair Straightene anything you have to produce Ugg uk sale that great bohemian style.

Fri Aug 26, 03:02:00 AM EDT  
Blogger Unknown said...


louboutin shoes
michael kors wallets
swarovski outlet
stephen curry shoes
cheap jordans
football shirts
michael kors outlet
pandora charms
lebron james shoes
suicoke sandals

Thu Jun 28, 05:25:00 AM EDT  
Blogger Unknown said...


converse trainers
kate spade outlet online
louboutin shoes
cheap jordan shoes
vibram fivefingers shoes
moncler online
michael kors outlet online
true religion jeans
coach outlet

Sat Jul 28, 02:53:00 AM EDT  
Blogger yanmaneee said...

michael kors outlet
michael kors
nike sneakers for women
fila shoes
michael kors bags
birkin bag
curry 6
michael kors
michael jordan shoes
coach outlet

Mon Jul 15, 03:33:00 AM EDT  
Blogger yanmaneee said...

birkin bag
cheap jordans
kobe basketball shoes
kawhi leonard shoes
jordan shoes
moncler jackets
kd shoes
golden goose
stone island sale
bape outlet

Mon Mar 15, 06:32:00 AM EDT  
Blogger yanmaneee said...

yeezy boost
moncler jackets
cheap jordans
nike off white
kd shoes
kobe 9
off white
birkin bag
air jordans
yeezy supply

Mon Jul 12, 08:40:00 AM EDT  

Post a Comment

<< Home