Monday, August 13, 2012

Example of how MPE would generate inflation

Beware the false dichotomy here: Keynesian economics vs Austrian School is a false dichotomy. Keynesians say that money supply (M) doesn't matter but only velocity (V). Austrian economics like Maudlin say that inflation is all about money supply (M) and not velocity (V). This article is misleading by saying Milton Friedman supported money supply (M) over Velocity (V) "Friedman concluded that “inflation is always and everywhere a monetary phenomenon.” And that has been that ever since." Friedman was not an Austrian economist. Friedman's monetarist equation: dM/dt + dV/dt = dP/dt + dQ/dt accounts for both Money Supply (M) and Velocity (V).

The truth is that both Velocity and Money Supply play a role in inflation and economic growth. Anyone who argues one vs the other is just playing into the historic false dichotomy set up my the Keynesians vs the Austrians.

Velocity can very independent of money supply or production. This is why the economists track consumer confidence. Some of what this writer is saying is because we live in a "just in time" economy. But the reality is that people spend more if they have more. However, on rhe other hand we could easily produce more than we could consume. Just consider the problem of too much commercial real estate in Atlanta. This also is why the US government pays farmers on occasion to not harvest their crop.

The following is an example of how MPE would lead to inflation and fails to account for velocity of circulation. If you don't like my numbers, feel free to substitute numbers you like

Imagine a city with 1000 families. Each family makes $75,000/yr, $6250/mo.
All 1000 families bring in a total town imcome of $75,000,000/yr
Each family lives in a house that cost $250,000.
Each family has a fee-based 30-yr loan and pay $700/mo, $8400/yr
This means the economy retires at least $8,400,000/yr
This means builder will need to build and sell at least 34 houses/yr to replace the retired money
34 new home loans will cover the annual salary of 112 workers/yr
The velocity of currency $75,000,000/$8,400,000 = 9
Local Builders can build at least 1000 houses in 30 year

Repaying at rate of depreciation on $250,000 house is $208/mo, $2500/yr.
1000 families would retire $2,500,000/yr
Builders could replace this retired money building 10 new houses/yr
10 houses/yr will cover the salary of 33 employees/yr
Velocity begins at 30.

However, since only $2,500,000/yr is retired. Town builders are likely to build more than 10 houses/yr. Therefore, the excess money will circulate in the economy until retired. Let's say that builders build 20 houses/yr. this means that an extra $2,500,000 more is added to the money supply each year than is retired. After 50 years, the economy will be circulating $125,000,000. This is 1.667 times over the salary of all 1000 families/yr. however, only $2,500,000 is retired each year. And if builders build 30+ houses, that means even more new money is injected into the system and this doesn't even take into account velocity that $1 dollar can do the work of at least $3, if not more.

The problem with MPE is not that the money created is akways backed by the value of a depreciating house. The problem is that money is not retired fast enough from circulation and therefore new money will continue to build up in the economy year after year causing inflation. After several years, there will be too much money chasing too few things for sale.

No comments: