But as with all philosophies there appear to be assumptions, and practitioners of the philosophy often struggle to see them. Now this might be because the pupil (ie me) doesn't understand something, or it may be that the evidence hasn't been made clear. Hopefully it is not a logical leap of faith. This series is to get answers to questions I have yet to get resolved to my satisfaction.
My first unanswered question is one that gets to the meat of inflation.
From Money neutrality – another ideological contrivance by the conservatives which includes a good demolition of the Quantity Theory of Money.
The overwhelming evidence is that the macroeconomy quantity adjusts rather than price adjusts to nominal aggregate demand fluctuations when there is excess capacity. Otherwise firms risk losing market share.
So, when the economy is in a state of low capacity utilisation with significant stocks of idle productive resources (of all types) then it is highly unlikely that the firm will respond to a positive demand impulse by putting up prices (above the level that they were before the downturn began). They might stop offering fire sale prices but that is not what we are talking about here.
This should discourage you from automatically linking growth in the monetary base and inflation. There is no link.
So the first unanswered question is:
What 'overwhelming evidence' shows that the economy does indeed demand adjust in preference to price adjusting?
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9 comments:
Neil, it is my anecdotal experience that most prices are not negotiable in stores, and stores are not appreciably cutting prices except through sales and promotions.
Instead, companies are apparently cutting back production to prevent inventory accumulation due to lagging demand, with the result that an output gap has developed, unemployment has risen, incomes have been reduced in aggregate, and demand crimped in aggregate also.
It seems to me that if price adjusted to demand smoothly, as would be expected in a truly free marketplace where price is discovered through negotiation, then velocity would not decrease, inventories would not build up, no output gap would emerge, and unemployment would not rise. Rather, the price of labor would fall in line with lower market prices. But price does not adjust smoothly across the board, so quantity must, ergo output gap and unemployment.
Anyway, that is the way it looks to me. Since CPI is not indicating deflation and measurable output gap and unemployment are historically high, the data seems to back up this anecdotal view.
Am I missing something you are seeing?
My general gut feeling is that there is a demand adjustment on the way down and a price adjustment on the way back.
In other words after the shock of a recession (and destruction of capacity) there is a reluctance to believe market signals in case they are false and that is compounded by some sort of 'propensity to invest' which varies depending on the economy. (The British being much more reticent than the Americans for example).
The British CPI and unemployment figures have behaved differently to the American ones. CPI is upwards tilted and unemployment hasn't gone as high as it has in previous recessions.
I was hoping that somebody had done (and published) an analysis of the accounts to show what happens overall at macro-level, and how that holds across the different currency areas. Hard evidence to back up the anecdotal.
I think the "overwhelming evidence" is that in recessions, you get high unemployment, and flat prices.
Standard macro cannot understand why wages do not fall, and the labor market clears. The attribute this to "sticky price" but I think it is because of nominal nature of debt
Neil,
Well, quite.
But I believe I can paraphrase and answer your question in a single word: stagflation.
I don't think you can, because that is a different kind of inflation to do with a supply side shock and the failure of the economy to distribute that shock effectively.
!?!?!
Explain.
I think its for you to explain.
Colour me confused. How can I explain your argument before you've even made it? Or should I explain that too?
Stagflation is solved by ensuring that the real cost impact is absorbed by the economic actors.
"The preferred approach is to use employment buffer stocks in conjunction with fiscal policy adjustments to allow the available real income to be rendered compatible with the existing claims."
http://bilbo.economicoutlook.net/blog/?p=13035
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