Velocity Wanted: Inflation, a Matter of Kind

 

Let us recall the IS-LM model, which a certain famous-yet-infamous Nobelist calls “a model of several interacting markets, which will make a lot of sense.” Depending upon what he means with “making a lot of sense,” the model would be right or wrong. Here, we do not mean true or false, because the model can by no means be true: Very much surreal is the presumption therein that the price level (P) remains indefinitely “constant”.   

             Incidentally, “right or wrong” is to an opinion what “true or false” is to a theory. And, the time period is un-defined (T⁰) in association with GDP (Y) on the abscissa or the interest rate (i, r, both, either or neither) on the ordinate of IS-LM.

Rule of Thumb. I bring an umbrella when it feels like rain. If the central bank pump-primes money, GDP is likely to stabilize. Voila, the time is irrelevant (T⁰)!

Conventional Wisdom. The sun rises in the east. As the raven flies off the tree, pears fall down to the earth (烏飛梨落, wūfēi líluò). It’s gonna rain when my knees ache. When the government “digs a ditch and refills it,” the economy’s gonna stabilize, and that “many times over.” Why care about the time dimension (T⁰)?

Tautology. According to GAAP, the AS is always and everywhere identical to the AD. We know that GDP is GDP is GDP is GDP and that “indefinitely” (T⁰).

Wild Guess. My guts tell that when the interest rate declines GDP will get bigger (T⁰).

Hypothesis The interest rate from the money market is upward sloping while that from the product market downward. The former is called the LM curve (T⁰) while the latter the IS curve (T⁰). While macroeconomists feel in peace (T⁰), the economy will definitely be in equilibrium (T⁰) at the cross point of the two curve and that eternally (T⁰).

Theory. In finance, there is such a thing as “efficient market hypothesis.” As a matter of fact, the author, one of the “Chicago boys,” is very humble and too much honest in naming his Nobel-winning theory as “hypothesis.” As he famously quips, after all, “Theories are approximations. Nothing is completely anything.”

             The omnipotent and ubiquitous key to differentiating (in vernacular) an accepted theory from a rejected hypothesis is “truthfulness in kind,” never the “frequency in degree.” For instance, Jack and Jill see one another for several hours per working day while Romeo and Juliet are almost never spotted together. What would you say? What shall macroeconomists propose?

Velocity or Stabilization. In the times of William Shakespeare the velocity of money was alive and well. In the times of macroeconomics, the same is long decimated.

             Nice and popular is macroeconomics. Only regret: Upon money supply (ΔM/ Δt), the velocity of money (V, not for “victory”) does increase, pulling down the Hichsian “constant” k= 1/ V to a degree, conveniently negligible may it be.

             Alas, macroeconomists in Cambridge “unanimously prefer” the degree to the kind. Sir Isaac Newton when in Cambridge might be “intellectually dishonest” claiming that due to the gravity of earth the apple should fall “straight down.” On the wayside, the rest of us do guarantee to macroeconomists that no apple has ever dropped “straight down” in Here as opposed to Eternity. What Newton really means is “approximately so in real,” with the theory itself  intact. 

             Macroeconomists are first to get the kind correct. As another matter of fact, inflation is first to occur upon monetary easing. The nominal interest rate (i) and the real interest rate (r= i- π) when exogenous to IS-IM are never and nowhere equal until post mortem.