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equations for policy changes

 

If I wanted to do a thought experiment or back of the envelope calculations for how new government spending would influence broad money supply, real GDP and inflation what equations would you recommend?  For instance if I wanted to make rough estimates of changes in the above quantities for spending $100B on previously involuntary unemployed workers to produce (A) $100B worth of infrastructure versus or (B) digging and filling in the same ditch how would I do that?  (hypothetical MMT free lunch scenarios)

Does the (1 / (1 - marginal propensity to consume)) multiplier come into play?  When forecasting inflation do you care about the amount the workers got paid or the market value of the work they did?  Are there simple curves/lines to plug into the IS-MP model?

https://economistsview.typepad.com/economistsview/2011/10/the-new-keynesian-is-lm-and-is-mp-models.html

Or is the answer that I need to read Monetary Economics by Godley and Lavoie =)  Thanks!

Kevin

It seems like the stock flow consistent models (PK-SFC) are quite promising for capturing the full inter-connected nature of economic activity.  The first link is for a slide presentation giving a related overview and the second link is to a paper looking at an SFC model with a high return sector and a low return sector.

https://www.boeckler.de/pdf/v_2015_10_22_godin.pdf

http://www.levyinstitute.org/pubs/wp_733.pdf

I'm trying to read through the paper but I currently don't understand how investing in computers (high investment return) and investing in ditch digging and refilling (low investment return) are differentiated in this watertight accounting approach that SFC uses.  It seems like GDP calculated using income should be used for all accounting identities, and GDP using output (did the investment actually create value?) should be used for inflation calculations.  Any thoughts would be much appreciated.

Building on top of the above they've also done simulations with many small agents (agent based models, AB-SFC):

https://www.siecon.org/sites/siecon.org/files/oldfiles/uploads/2015/10/Caiani.pdf

Kevin

Hi @KEVIN,

This is kind of the holy grail. It's like asking what can I spend money on that will be profitable in the future? 🙂

At the most basic level, real resources are the true constraint. So, the things we produce limit how much money we can create to some degree. The problem is, no one knows what is productive or what will be considered productive in the future. So, it's all kind of a guessing game. And that's what makes inflation such a confounding thing.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

The question I'm trying to get at is not how to predict the most profitable investments (but always happy to hear thoughts), but rather assuming perfect information and hindsight how would you roughly model the results of a new hypothetical government program that spent $100B to produce goods valued at $100B (as judged by the market after the fact), versus a hypothetical program that spent $100B to dig ditches and fill them up again (worthless output, aka helicopter money).  Assuming the $100B was all spent employing people who were previously unemployed does a sizable injection of deficit spending cause the money supply to increase (more bonds and more deposits increase broad money supply), or would the money supply decrease as households reduced private sector debt?  Or does this depend on the spending and debt repayment preferences of households which is hard to predict so there's no obvious answer?

My second post was essentially the same question but just specific to these SFC models that look interesting but which I don't fully understand.  They have a watertight accounting system and take great pains to make sure that the accounts all sum to zero where they should but I don't see how the system retrospectively differentiates between good and bad investments.  A government ditch digging program that produces a product the market finds worthless will have a different impact on GDP and inflation than a government farming program that produces food which the market finds valuable, correct?

I hope that makes some amount of sense.  Thanks!

Kevin

Hi @kevin,

You're really trying to model how inflationary govt spending it. If we dig ditches and pay people to do it that should create inflation since we aren't producing goods to support the new assets. That assumes there's no other multiplier though (the people who get paid to dig could be indirectly funding other investments made by the pvt sector).

So, you see, this all gets very very complex and you have to start making all sorts of assumptions.

 

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

A technical point,  deficit spending does not cause the money supply to increase , the "more deposits" above,  as it moves existing deposits from the  deposit accounts of bond buyers to the deposit accounts of the recipients of government spending.

But rather than the quantity of ,  it is the spending thereof that has effects and as Cullen says there you get into all sorts of assumptions.

Continued -

Considering the "money supply" you could say that for a saver when they consider the amount of "money" that they have in savings, that there is very little difference between a deposit account and a Treasury bond, but then we are back into behavioural assumptions again.

@CULLEN-ROCHE and @DINERO thanks for the replies!

If deficit spending does not increase the money supply the argument is that deficit spending puts money in the hands of people with a greater marginal propensity to consume (MPC) and their consumption leads to increased economic activity (which leads to greater demand for credit which affects inflation?  If anyone was willing to take a rough stab at sketching out a possible scenario I would be very curious.  For concreteness we could assume this would be increased deficit spending for the US economy in 2010 with high unemployment and many households have low savings so their MPC would be high.  On the other hand in 2010 the private sector is attempting to reduce debt so if households use money to reduce debt instead of immediately consume in that case deficit spending may help the private sector get to a healthier debt level more quickly but not have a significant short term effect.

Another question, if foreign investors buy 40% of US debt, and we don't consider foreign deposits to be part of the US broad money supply (or maybe we should?), then in that case would issuing debt increase the money supply?

Thanks again for the responses.

Kevin

Hi @KEVIN,

Right, deficits create a bond and redistribute money from a saver to a spender. But there's also a multiplier effect in the bond creation because the bondholder sold cash and has a higher income generating instrument. So it's more like the govt printed a savings account that the saver can also leverage to some degree.

It's nearly impossible to model how this will all unfold because no one knows how long the virus will last. And that's the kicker when it comes to measuring the deflationary effects. The longer it lasts the more damage it causes and the more defaults you have (defaults destroy money). So we're at a point where we are trying to measure what the govt has created vs what the virus will destroy. I think the stock market is guessing this thing goes away sooner rather than later. But if it flares up badly into the Fall then look out below....

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche