Velocity Wanted: Sticky Prices yet Flexible Price Level

 

Some macroeconomists differentiate themselves with the name “new Keynesian” from other macroeconomists. Most typically they imagine the so-called “sticky price model of AS-AD” for the medium run, which must fall between the short and long runs.

Their Sophistic Way. The model is often described with the following equation:

P= s∙EP+ (1– s)∙[P+ a∙(Y– Y*)],

where EP is the expected price level (“sticky prices”),

“s” the fraction of firms stuck to EP,

Y* the natural level of output, and

“a” a positive coefficient.

Procrustean Bed. See We Told You So: P= [a∙(1– s)/ s]Y + [EP– a∙(1– s)∙Y*/s]. The AS curve is upward sloping!

             Wonderful, but for reminding us of the super “classical” Greek mythology: Tailor, and that Swift, the customer’s feet to the bed!

A Greek Equation. To emulate Eugene Fama, a Chicago boy, “No similarity is completely similar.” The SPM (for sticky price model) and the PB (for Procrustean Bed) are not entirely but merely 99% similar to one another in being Greek to the rest of us.

             Ninety nine percent of us couldn’t understand the coefficient “a,” similar to the first letter of Greek alphabet, in the equation. First, we never know what substance its metric dollar∙year/ pound has. Watch out: the pound is not ₤ but lb. Second, we wouldn’t even think about taking the “a” as an exponent of a “variable” or a “coefficient” in a logarithmic equation “of convenience”; for instance, the second 2 in 2² (two squared) or the coefficient in a∙(log Y –log Y*) goes “everywhere” metric free “except for in” Cambridge macroeconomics (borrowed from Robert Solow in Here from Cambridge).

A Can of Worms. New Keynesian or otherwise, the equation is a can of worms (in addition to being Greek). First of all, the “macro-economy” has never ever been “natural” but always “human” since before the time of humans began. Much like the human body, the economy cannot be in “equilibrium” or at “the natural level” until post mortem (T⁰).

             According to what we have been hearing for life so far (T^-1), the selected some will “eventually” (T⁰) be resting in peace (T⁰). The un-selected, on the other hand, might “secularly” remain  (T⁰)  as “Anonymous Dustin Coffin,” a relative of Charles Albert Coffin or not.

             Second of all, expectation is one performance is another. The war-room scenario is one each battle is another. As to the fraction “s” which is stuck to EP, the chances of survival wouldn’t be so good in the real economy.

             You will hear the shout of implosion when the *s* begin to fall. 

             Thirdly, every price level is ex post facto. The place in the sun of the “expected price level” shall be in “Oxymoronica” (borrowed from a book title), existent or otherwise.

             Fourthly, the rest of us have a Maginot line (in the battle, real or virtual): There is no way to conceive, much less to scale, the so-called “fraction s.” To tell the minimum, new Keynesians “legitimately” utilize the fraction of “real quantities” for the sake of conveniently fracturing “nominal values.” No wonder, the “real variable” in macroeconomics is by conception fictitious, before all the other misnomers else.

             Are all the “real variables” as in macroeconomics not in name only, or “nominal”?  

             Are you game? 

 

                                  Charles Albert Coffin

Built GE, acquiring Thomas Edison’s firms