Fallacy of Composition: Shocks vs Stickiness

 

Macroeconomists are fond of referring to “outside shocks.”

             The rest of us would agree that oil shocks, a pandemic, a volcanic eruption, an outbreak of a major war and the like are exogenous to the macro-economy. However, we are not quite sure about a “major breakdown of the financial system” (to Ben Bernanke) or the so-called “monetary shock” (ubiquitous in macroeconomics).

             In modern times, as opposed to the Mercantilism era, money is generally endogenous; more specifically, “money supply” is the business of “the financial system”; or, it’s the matter of monetary base + credit policy!

             Truthfully, the financial system is endogenous of the nation; but it is by conception exogenous to the womb of economics. A lining in the cloud: Macroeconomics is by creation a mixture of two different species: Finance and Economics. Granted, how far outside of macroeconomics is the “monetary shock” from?

 

Exogenous Shocks. Now, imagine a unanimously-callable “outside shock” to the economy; for instance, a major financial breakdown.

             The rest of us are by now well aware that with the “money supply” fixed (M*) the velocity of money decreases out of blue (V ↓). Which, afterwards, is first to happen, a nosedive in the aggregate demand or a decrease in the price level? Of course, it’s the price level (P↓). Again, “un-spending” is incomparably easier for us than “depressing” the economy (Y↓) is.

             If the IS-LM with the ever-sticky price level (P*) is any guide, on the contrary, there would surely be a sudden drop in the aggregate demand (AD ↓). A follow-up: How soon will the aggregate supply (AS) follow suit? Sure, it will be sooner than later primarily because wages are sticker than prices are sticky; then, we are destined to observe before our eyes, AS ↓↓, “a double shock” as it were.

             Uh, are we not having “ineffective aggregate supply,” then? Well, Alvin Hansen and Larry Summers among other celebs would make the opposite call: “ineffective aggregate demand,” secularly or otherwise.

             On the sidewalk, we don’t forget to remember: M∙V≡ P∙Y. When in Cambridge with both M* and P*, as the V dropped so must Y do, no question allowed. On the flipside, the AD is precisely as effective as the AS, if not more; or precisely as “ineffective,” if not less.

 

Now, a Quick Review:

             The Price. In each and every accounting period, where there is demand there is supply and vice versa. The magic is of course in flexible and variable prices. Wayside, what economists call “the price” is no more than a fictitious price which might have been cleared the market. Such a price, sometimes called “the equilibrium price,” is only for the purpose of ex-post accounting.

             The Price Level. The macro-economy is an aggregation of commercial activities all across the nation. As such, the price level is supposed if anything to be an aggregation of all the prices across the nation. If so, there in each and all accounting periods can be no more “two price levels (P’s)” than “two gross national products (Y’s),” real or nominal as well as on the supply side or on the demand side.

             The GAP (generally-accepted principles) of economics: At the moment of closing the books, there always and everywhere are only one price and only one quantity traded respectively. Closing the books rightly, we can go back home and take a sound sleep.

             After a Full Circle. There are no such things as AS and AD but a single Y. And, the price level (P) must always be sticky for the purpose of it conception.

             Please best regard “the law of one price”!

 

 

Getting out of Fallacy. Please do not, with a stick or stickiness, tease or annoy the price or the price level. Shhhhh, they are resting in peace, ex post facto and that perennially as well as “secularly.”

 

Declaration of Freedom. Exogenous to the market paradigm, the “equilibrium models” partial or general, and the “price fixing public or private: All prices are always free to vary everywhere across the nation.

             In the hinterland, everything ex post or each organism post mortem rests in peaceful equilibrium. Please do not call the RIP “stagnation,” either.