Total Spending can be called:
•X
•Expenditures
•Aggregate Demand (AD)
•Nominal GDP
They all mean the same thing:
how much was spent in a year.
From CirF we take PRINCIPLE 1:
Total Spending (X) can change only if there is a
change of a monetary variable. There are two
monetary variables:
-- the money supply
-- money demand
X can rise if (a) the money supply is increased or
(b) liquidity demand is reduced.
We can summarize this with the
Credit Market Equation: x = m + v
x = m + v. The Credit Market Equation
x stands for the (rate of change of) total spending.
m stands for the (rate of change of) the money
supply. This is substantially controlled by the
government agency, the Federal Reserve.
The equation says that one way to get more
spending (x) is to increase the money supply (m).
x = m + v. The Credit Market Equation
v stands for the (rate of change of) the velocity of
money. It measures how fast money moves through
the economy.
•The equation shows that another way to get an
increase of spending is to have a higher velocity of
money. (v x)
•Velocity moves opposite liquidity demand: The
more people hold money, the slower it moves.
•That is: The greater is liquidity demand, the less is
the velocity of money
x = m + v. The Credit Market Equation (con’t)
To repeat:
The Credit Market Equation says that the two
ways to get more spending are:
• the Fed can print more money or
• the public can hold less liquidity so as to raise
velocity.
x = m + v. The Credit Market Equation (con’t.)
Factually, x and m are very similar
Quarterly,
since 1960
Quarterly,
since 2000
x = 7.2%
x = 5.0%
m = 7.1%
m = 6.4%
This means that we can roughly say,
over long periods: v = 0 and x = m
Data from FRED
x = m + v. The Credit Market Equation (con’t.)
x = m means that, over long periods, total
spending grows at the same rate as the
money supply.
Apparently, over time, the demand for
liquidity hasn’t changed much.
Over long periods, total spending grows at the
same rate as the money supply.
This suggests that:
•the people who control the money supply
(the Fed) might be important
•we should print lots of money, get lots of
spending, which will create lots of jobs and we
will all be better off.
Just kidding: If it were that easy, everyone
would be rich
Why can’t we print ourselves rich?
Inflation.
•An overall increase in the prices of goods.
•A rise in the “cost of living.”
•A reduction in the value of money
Inflation is defined by some as a sustained
increase in prices. That is, it needs to last a
while before it’s considered inflation.
Is money important? Does money matter to the
economy?
No, in the very short run (a few months), changes of
the money supply may have little effect.
Yes, in the slightly longer run. The quantity of
money seems closely related to total spending which
is important to how the economy behaves.
No, in the long run. Printing more money just causes
higher prices and doesn’t affect any real variables
such as employment and the standard of living.
There is an equation that relates spending, prices and
real changes
x = p + q The Product Market Equation
x = the growth rate of spending
p = the inflation rate
q = real growth rate
q = x – p is the part of spending that didn’t get
turned into inflation. It represents the real
increase of goods and services produced.
x = p + q. The Product Market Equation (con’t.)
Since 1960
Since 2000
x = 7.2
x = 5.0
p = 4.3
So: q = 2.9
p = 2.9
So: q = 2.1
Data from FRED
Start again with PRINCIPLE 1:
Total Spending (X) can change only if there is a
change of a monetary variable.
That means: Without a change of a monetary
variable, if any one sector increases its spending,
then the spending of some other sector(s) must be
decreased. We say that the expanding sector is
“crowding out” the other sector.
Crowding out: The decline in one sector’s
spending that occurs as a result of increased
spending by some other sector. (“I spend more so
you spend less” means that you are being
crowded out. )
Crowding out is shown in the closed model. In
that model any increase in one sector’s spending
results in a decrease in another sector’s spending.
That is, the increasing sector has crowded out the
decreasing sector.
So where does real long run growth come from?
Why is our standard of living higher than it was
100 years ago?
What causes real growth?
PRINCIPLE 2: Long run, real economic
growth is the result of increases in the quantity
and quality of the factors of production.
What causes real Long Run growth?
Increases in the quantity and quality of the
FACTORS of PRODUCTIONS
Land
raw materials
Labor
quality = human capital
Capital
quality = technology
The economy in
the SHORT RUN
The economy in
the LONG RUN
is largely controlled by
the level of spending
which is largely
controlled by the quantity
of money and credit.
is largely controlled by
the quantity and quality of
the factors of production.
Money matters.
The levels of spending
and money are less
important in the long run
because of inflation.
The economy in
the SHORT RUN
The economy in
the LONG RUN
Money matters.
Money doesn’t matter.
v can change as people
v = 0 over time.
hold more or less money.
Changes of m get people Printing money causes
to spend more. This can inflation.
cause inflation and/or real
growth.
Credit Market Equation: x = m + v
Product Market Equation: x = p + q
So: m + v = p + q.
In Long Run v = 0, so m = p + q
q is growth due to changes of the factors of
production, unrelated to m or x.
So m = p + q
Since m = q + p, we might consider a plan for zero
inflation.
What would the plan be?
That’s all for now