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What does MV = PY actually mean?

It means V is PY/M.

And that’s all it means.  But the textbook description of MV=PY is sometimes a bit confusing, as it seems to say two conflicting things:

1.  V is the velocity of circulation, the average number of times a dollar is spent per year

2.  MV = PY is an identity.  But this suggests V is defined as PY/M

So which is it?  It turns out that when MV= PY was first created, V was probably something like #1, but today #2 is the accepted definition.

For example, some money is spent on things that are not a part of GDP, such as used goods, or intermediate goods.  So could we fix the definition by calling V the “average number of times a dollar is spent on final goods”?  Unfortunately no, as there are some final goods for which money is not spent.   Suppose that (on average) each dollar was spent 15 times per year on final goods transactions.  And suppose there were a trillion dollars in money in circulation.  Would NGDP be $15 trillion?  No, as NGDP also includes things like implicit rent on owner-occupied housing, for which no money changes hands.

Similarly, saving once had a common sense meaning that was different from investment.  Saving and investment (as defined in earlier eras) were not equal by definition.  But then economists found it useful to define saving as the funds spent on investment.  They became two sides of the same coin, like sales and purchases.

Now it’s not clear if these identities are useful.  I think they are, as (for instance) it’s simpler to model NGDP if it equals M*V, than if it equals M*V*ff, where ff is a fudge factor to account for the fact that there are issues like owner-occupied housing.

Oddly, there is another version of the equation of exchange where the common sense definition is exactly right:

M = k*P*Y

Where k is both:

1.  M/PY

2.  The average share of gross domestic income held as cash balances (globally).

It’s unfortunate that most textbooks rely on the version of the equation of exchange where the common sense definition is not equal to the official definition.

Suppose the government suddenly redefined cars as a capital good (they are currently considered consumer goods.)  Gross investment would immediately soar much higher (although net investment, which really matters, wouldn’t change all that much.)

So would saving still be equal to investment?  Yes, because at the same moment gross saving would also soar in value, as funds spent on cars would now get included into saving.

Many commenters on confused on that point.  They talk about Americans “spending” lots of money on housing during the housing boom, instead of “saving” the money. But according to the official definition, spending on new housing is saving.  Perhaps spending on cars should also be viewed as gross saving.

Even better, why not stop obsessing over the C+I+G+NX = GDP relationship, and just focus on NGDP.  The line between C and I is quite arbitrary, and not all that important for issues like the business cycle.  It’s NGDP that matters.

At one time Keynesians thought saving was really important for the business cycle, but in the New Keynesian era we all realized that it wasn’t, what mattered was monetary policy.  No more paradox of thrift.  Unfortunately some have forgotten that lesson, others have wrongly assumed that everything is different at the zero bound.  It isn’t.

PS.  This is inspired by a recent post by David Glasner.  This paragraph is worth commenting on:

OK, savings are the funds used for investment. Does that mean that savings and investment are identical? Savings are funds accruing (unconsumed income measured in dollars per unit time); investments are real physical assets produced per unit time, so they obviously are not identical physical entities. So it is not self-evident – at least not to me — how the funds for investment can be said to be identical to investment itself.

The “S” and “I” that are used in national income accounting are both measured in dollar terms.  It’s not the number of houses built that matter, but the dollar value of expenditure on those houses.  So there is no “apple and oranges” comparison problem here.  Both saving and investment can be measured in either real or nominal terms. In either case they will always be exactly identical, because they are defined as being identical.  However, just as with MV=PY, I can imagine definitions of saving where S=I is not an identity.

Japan continues to add jobs at an astounding rate, as unemployment falls to the lowest level in decades

That’s right, the Japanese “recession” grinds on.  A few months ago bloggers on the left and right, as well as the mainstream news media, reported that Japan had fallen into a “recession.”  Only TheMoneyIllusion pointed out that this was nonsense, as analysts were confused by Japan’s falling population.  Japan’s trend rate of RGDP growth is currently no higher than zero, and the post-sales tax increase RGDP slump was completely expected.  The Japanese stock market was not fazed, Japanese companies continue to add workers at a rapid rate, and unemployment just fell to 3.4%, the lowest rate since the 1990s.

Japan’s seasonally adjusted unemployment declined to 3.4 percent in December compared to 3.7 percent reported in the same month of 2013 as the number of employed rose 0.6 percent and the number of unemployed decreased 6.7 percent.

The number of employed persons in December 2014 was 63.57 million, an increase of 380 thousand or 0.6% from the previous year.

The number of unemployed persons in December 2014 was 2.1 million, a decrease of 150 thousand or 6.7% from the previous year.

The jobs-to-applicants ratio increased to 1.15 from 1.12 in the previous month, the highest since March of 1992.

The number of new job offers rose 4.7 percent in December from previous month and rose 5.6 percent from the same period a year ago.

To the uninformed, the 0.6% rise in Japanese employment might seem unimpressive.  But the Japanese working age population is falling by 1.5% per year, so this is equivalent to 2.1% employment growth in a stable population country, or 2.4% employment growth in a country with 0.3% growth in the working age population (such as the US.)  Of course our employment only rose by about 2% last year, and yet that was the strongest performance since the late 1990s.  In other words, the Japanese labor market is even hotter than the US labor market in a cyclical sense.  All the claims to the contrary are written by people ignorant of Japanese demographics.

Abenomics has done the two things that it was capable of doing (reducing unemployment and slightly easing the public debt problem) and failed to do the thing many hoped for, but was never realistic given the demographics (create rapid RGDP growth.)

The people that disagreed with me, claiming Japan really was in recession, told me that unemployment is a lagging indicator (it actually is not, at least not significantly.)  OK you guys, go on record and tell me when the delayed rise in Japanese unemployment will occur.  I want a specific date, or at least a specific year.  Will it be 2015?  If not, then when? How about 2016?

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Off topic, there are times that I just want to give up.  From today’s news:

LONDON/SYDNEY (Reuters) – European and Chinese factories slashed prices in January as production flatlined, heightening global deflation risks that point to another wave of central bank stimulus in the coming year.

While the pulse of activity was livelier in other parts of Asia – Japan, India and South Korea – they too shared a common condition of slowing inflation.

Central banks from Switzerland to Turkey via Canada and Singapore have already loosened monetary policy in the past few weeks.


With my new Mercatus job, I think I’ll go back to my practice of doing off-the-wall stuff on Sundays–the day of rest.  I already did one today, here’s another.

While flying back from Hong Kong last September I read the Financial Times.  They have a glossy section discussing objects at their website

Then Mosqueda has commissioned many of the world’s most interesting designers to create pieces for the project. Maarten Baas has taken an old carpenter’s desk ($15,000) and done his famous burning act with it, while Matali Crasset for Nodus has produced strikingly geometric rugs ($5,900). Some of Holland’s top designers (Julius Vermeulen, Swip Stolk and the legendary Wim Crouwel) have brought out special fabrics, which have been used to upholster vintage furniture, such as the Theo Ruth & Swip Stolk chair ($6,300). There is a copper Dutch bicycle ($7,100) in an edition of 10 from Van Heesch Design, a skull sculpture ($6,700) by Nick Ervinck and a Botanica vase ($3,100) by Studio FormaFantasma, plus an amusing Naughty Bavaria pillow by Studio Job for Maharam ($415). Verging more towards art than functional pieces are Esther Janssen’s hand-sewn, leather artworks of natural disasters ($5,900), but alongside these there are also utilitarian pieces such as a steel floor lamp by Tom Dixon ($5,900) and a Piet Hein Eek chair ($7,500), as well as a stunning Camino vase by Alessandro Mendini ($7,100). A contemporary Nendo Deep Sea table for Glas Italia ($9,000), a stylish tray by Tord Boontje ($2,200) and a special Viktor & Rolf doll ($75,000) add to the curiosities.

Each new collection at Chamber will come with a limited-edition perfume. The scent for the gallery’s opening has been created by Julian Bedel of Argentine perfumery Fueguia 1833 and costs $350 for 100ml eau de parfum. Mosqueda asked Bedel, who is famous for taking his inspiration from South America and its culture (for example, a fictional library in one of Jorge Luis Borges’s short stories), to craft a unisex scent based on the experience of being in an old Louis Khan building. It is bottled in a porcelain vessel that was designed by Studio Job.

My first reaction was that if the rich need advice on how to spend their money, then maybe it’s time for a progressive consumption tax.  But of course first reactions aren’t always the best, and so for months I mulled the question of how to address this issue; do I want to mood affiliate with philistine populists or reactionary aesthetes?  Let’s consider a few arguments:

1.  The marginal utility argument.  Surely the rich receive less marginal utility from these objects that the poor would receive from an equivalent amount of money.

2.  On the other hand there are externalities involved.  People like me can get utility browsing the Chelsea gallery where these objects are displayed.  And jobs are created making these objects.

3.  But jobs are a cost.  The opportunity cost of making these objects is fewer objects for the poor. Many fewer, as objects for the poor are mass-produced in southern Chinese factories.  And people browsing that Chelsea gallery will also be fairly affluent; these objects do nothing for the working class and poor.

4.  But these jobs are a labor of love for those who feel called to the arts.  Do we really want to go back to the egalitarian 1950s, when Wallace Stevens had to sell insurance? The super rich support a large class of young artists.  Right now the 21st century equivalent of Venice is being created somewhere, we are just too close to see it.  (Let’s just hope it isn’t Macao.)

5.  Perhaps we could tax mansions and yachts on a sort of aesthetic basis, with much higher property tax rates on faux Versailles palaces in the Hollywood Hills than mid-century modern masterpieces.

6.  Are you kidding!  You expect IRS agents to be able to assess artistic merit?

And so it goes.  So I’m torn between these two arguments.  I suppose in the end it was the perfume that tipped me over the edge.  Now I’m as much a fan of old Louis Kahn buildings and infinite libraries as the next guy, but let’s consider the following hypothetical.  Suppose it cost $350 to create the Louis Kahn perfume and only $250 to create a perfume that will leave you smelling like an old Louis Sullivan building.  What is the marginal utility from that extra architectural cache?

So the philistine in me won out.  But how are we going to get the money to the poor? Matt Yglesias tells us that our next president (Hillary Clinton) plans to run on a platform to help the middle class, not the poor.  (I refuse to believe she has no idealism; rather (like Mitt Romney) she intends to lie her way into office and then tell us what she really believes.)  At the other extreme, after very wisely cutting the Kansas income tax, Governor Brownback had to wreck everything by a plan to raise the cigarette tax from 79 cents to $2.29/pack.  A blow right to the solar plexus of poor and working class Kansans.

The Dems want to subsidize NPR while the GOP doesn’t want to subsidize any radio stations.  Who will subsidize the stations that the poor listen to?

So I’ll keep advocating a progressive consumption tax/wage subsidy to help the poor. But I’m not very optimistic. The rich have their lobbyists and the middle class has their teachers/public employee unions.  No one listens to the poor cigarette smokers.

You might wonder why I am so obsessed with redistributing consumption from the rich to the poor, and so disdainful of those who want to help the middle class.  I suppose it’s partly because I believe the motivations are different, utilitarianism vs. envy.  Why is utilitarianism better? Consider the following from a recent piece in the New York Review of Books:

Aly’s emphasis on emotion (in this case envy) and psychology (concerning the reception of race theory), to say nothing of the topic of anti-Semitism itself, represents a significant departure from his earlier work. Here is a creative scholar who continues to grow in remarkable ways. In Aly’s portrayal the German paradox alluded to above disappears. If the Jews of Germany experienced the greatest success of any Jewish community in Europe in assimilation, social mobility, and the attainment of wealth and preeminence, they did so amid a Gentile population for which the modernization experience was more compressed, intense, and disorienting than in other countries. If envy of Jewish success was the driving motive behind modern anti-Semitism, as Aly argues, then it would be logical rather than paradoxical that the most intense anti-Semitic reaction would also occur in Germany, the land of the greatest and most visible Jewish success. This in my opinion is the most important contribution of Why the Germans? Why the Jews?

PS.  Would you rather smell like this:

Screen Shot 2015-01-25 at 6.38.25 PMOr this:

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My new career

I have spent the past 6 years trying to do two jobs at once, my teaching job at Bentley and lots of blogging/writing/speaking on monetary reform.  I am pleased to announce that from now on I’ll be able to focus on monetary policy. Through a very generous donation of Kenneth Duda (a Silicon Valley entrepreneur who is supportive of market monetarism), the Mercatus Center has created a new program on monetary policy, and appointed me as director.  I’m sure people will have some questions about this, so let me provide a bit more detail.

A few months back I began raising money to set up a NGDP futures market.  At the time, Ken Duda offered to support the project with a large donation.  He also expressed an interest in supporting my NGDP targeting in any way he could. Initially he suggested setting up a foundation to promote monetary reform, and having me direct the foundation.  I thought it might make more sense to work within an institution such as a university or a think tank, where I could get managerial support.  We eventually decided to embed the project within the Mercatus Center.

The Mercatus Center is a bit different from Washington DC think tanks.  It is often regarded as the world’s premier university-based research center with a focus on free market ideas. I was reassured by the fact that Mercatus is attached to George Mason University (my favorite econ program), and that Tyler Cowen is the Chairman of the Board. One nice thing about Mercatus is that they are focused on funding serious academic research, and don’t insist that researchers follow any particular party line.  I’ve done three papers for Mercatus in recent years, but they’ve also funded other researchers with very different views of monetary policy.

Here I might add that at this stage of my life I’m not too worried about a lack of academic freedom. I’ve always been the type to say what I thought, even though my research topics were so unconventional that I often had a hard time getting published, and almost didn’t get tenure. Nonetheless, it’s nice to be in a situation where no one is likely to question my academic independence.  Not only does Mercatus allow me academic freedom, Ken Duda also wants me to follow the implications of my research where ever it leads, even if it leads me away from NGDP targeting.

As you might expect from someone who has donated money to both and Mercatus, Ken Duda is not a strongly partisan or ideological person.  He has told me that he’s basically a pragmatist, who became very frustrated by the condition of the US economy after 2008 and thought that my monetary policy ideas made sense.  He’s been a long time reader of my blog and has commented on numerous occasions.

I actually wouldn’t have had any problem taking a position funded by a much more partisan donor, and/or at a highly ideological think tank.  My policy is to always say what I think and let the chips fall where they may.  But I can’t deny it’s nice to be involved with a donor and research center that encourage academic freedom.

Although I am done teaching, I will actually be a Bentley employee for another 18 months, and after that I hope to maintain my Bentley affiliation through some sort “emeritus” relationship.  I will continue to live in the Boston area, although long term we plan to retire in Southern California. (In a sense I’ll never retire, as I’ll keep promoting NGDP.)  My contract with Mercatus runs through mid-2018.  I won’t discuss the monetary details, other than to say I’ll make roughly as much doing this project over the next 3 and 1/2 years as I would have made teaching at Bentley over the next 2 and 1/2 years.  More work for the money, but that’s fine as I won’t be so stressed trying to do 100 things at once.

I hope to achieve many goals, but the one that might be of greatest interest to MoneyIllusion readers is a book on NGDP targeting and market monetarism, based on this blog.  Mark Sadowski has agreed to work as a research assistant on the project.  I also hope to support academic research that provides more “rigorous” empirical and theoretical support for NGDPLT and related ideas. And I’ll continue to do shorter papers, op eds, speak to academics, business people and policymakers, work on the NGDP futures markets, etc.

And of course I’ll keep blogging here and at Econlog.

I’ve known this was likely to happen for several months, but kept it secret until the funding was in place.  Even my colleagues didn’t know (except my chair.)  It was a bittersweet feeling going down the final stretch last semester after 34 years of teaching.  I always envisioned telling my students it was my last class, but life never plays out as you envision it will.

I’ve started noticing restaurants that offer senior discounts to the over 60 group, a milestone I’ll reach later this year.  But you know what they say, 60 is the new 50.

PS.  I have a new post at Econlog on the zero bound problem.

Update:  Stocks open sharply higher on the news!  :)

The Gabe Newell funded Hypermind NGDP market is up and running

Before discussing the new Hypermind NGDP futures market, let me mention that the donations to iPredict are now coming in.  As I mentioned in earlier, there was a glitch in the process for a few weeks due to the fact that (for tax reasons) donations in the US must go through several layers of bureaucracy.  If you planned to donate and were frustrated a few weeks back, please try again.  All the information including the correct contact address are included in this post.  I plan to complete the donation process in mid-January, and start the program with whatever funding we have received by that time.

Gabe Newell (CEO of Valve) has generously donated $10,000 to Hypermind, and they plan to run 5 markets, 2 of which are now up and running.  The plan is to have 4 quarterly GDP prediction markets, 2014:4, 2015:1, 2015:2, 2015:3, and one annual market; 2014:4 to 2015:4.  The first quarterly market currently trades at 43, which means 4.3% expected (annualized) NGDP growth in Q4.  The annual market began just minutes ago, and is the one I’m most interested in for monetary policy evaluation purposes.  For that reason, the total prize money in the annual market is 4000 euros (about $5000), whereas each quarterly market offers prizes of $1000 euros (about $1250.)

Update:  Actually all five markets are now running.

This is not gambling, as you do not put up your own money.  Thus it is perfectly legal for Americans, but you do need to go through a brief registration process. You can’t get rich doing this, but I’m told the winnings are skewed, with some individuals winning much more than the average.

Here is the way Hypermind describes the payoffs:

Cash rewards are based on a fixed EURO amount and translated in US Dollar according to the current exchange rate.

A contest’s cash reward is split among the participants pro rata of their performance in the contest. For instance, if Jane achieves twice Joe’s performance, then Jane receives a share of the reward that is twice as large as Joe’s. Only the participants who made a profit in the contest can share in the reward. The sharing formula is detailed in Article 7 of the rules.

Your cash earnings are cumulative across contests. You can request a payment at any time in the form of Amazon Gift Certificates. The amount is of your choosing, with a minimum of 20 USD.

So you can win money, but you can’t lose.  And you would be helping to save the world economy by supporting a demonstration project for NGDP futures.  Note that this market is not intended for the general public, but rather for people who are well informed on the issue.  Readers of this blog are some of the most well-informed individuals on NGDP.

PS.  I’d like to thank Emile Servan-Schreiber at Hypermind for helping to create the market.