Tuesday, September 10, 2013

Business cycles, units of account and the meaning of constant

This is a short one; there are three marginally related points made in the past few posts I'd like to expand on:

  • I don't think I've ever made this point explicitly clear: the information transfer framework does not describe "the business cycle" i.e. changes in aggregate demand. It allows you to describe the detector (price) given the information source and destination. So the output of the model calculations are the prices in the markets Price:Demand→Supply. In the examples in the blog, we are talking about the price level (or inflation rate) given the monetary base and the level of aggregate demand (using NGDP as a proxy). Or in another in another case in the IS/LM model the market r:NGDP→MB allows you to calculate the interest rate given the base and AD. One of the successes is that the price level doesn't have to respond to a major increase in the base (and may even shrink in the case of Japan), but again that is calculating the price given the inputs. The causes of the business cycle would involve a model for aggregate demand. Once you have that however, you can use the information transfer model to determine the other variables.
  • I don't know if the unit of account effect (i.e. information transfer index dependence on the base) should or should not be included in the interest rate calculations. It would make sense to me historically that the success of interest rate theories (say, Keynesianism) in describing the macroeconomy would occur first in a world without the unit of account effect because interest rates are not impacted by it (or less impacted by it). The post WWII world was consistent with a monetarist view that ignores the unit of account effect, but pure monetarism does not work during the depression or our current recession. The historical sequence of the relative apparent correctness of the theories at the time would be consistent with not knowing about the unit of account effect until the information transfer model was developed: Keynesian during the depression, monetarist during the 60s and 70s, then Keynesian during the current recession. Milton Friedman's apparent success was that he used a different measure of the money supply (M2) to claim monetarism could describe the depression. [I think I may want to devote an entire post to this point later.]
  • In this post and others I refer to floating information sources and constant information sources (or destinations). By constant, I don't mean in time, but relative to itself. Temporal changes in a constant supply change the supply explicitly and the demand responds to changes in the supply.Temporal changes in a floating supply change the supply explicitly and the supply and demand both respond to changes in the supply. In pure mathematical terms, constant means the source or destination Q is constant with respect to dQ (its behavior with respect to dt is not specified).

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