Tuesday, March 11, 2008

What is inflation?

I must admit, I did not understand macroeconomics at all when I studied it in Chicago. I suspect that no-one else really understands it either. For one thing, there seems to be no consensus on what the elasticity of anything is, such as the elasticity of labor supply to wages. Therefore, no one knows what the impact of any policy will be, since that ends up depending on what the supply (or demand) response will be. As for cross-price elasticities, forget it.

I was also told that "money is anything that can extinguish debt". I think this is wrong, because it implies "no debt, no money" which is true in fractional reserve banking, but also does not make much sense. Hmmm, this does not say good things about fractional reserve banking.

I'm also not sure about Bryan Caplan's assertion here that
1. Seigniorage is a trivial fraction of the U.S. federal budget. Contrary to Rothbard's extravagant claims, printing money accounts for only about 1-3% of the federal budget.(pdf). There are some Third World countries where Rothbard's "conspiracy" theory is quite right. But in the First World, the government has much easier - and less unpopular - ways to pay the bills.
Looking at the way the publication from the St Louis Fed he links to calculates "money supply", it's pretty clear that there are instances of money printing that they do not count as seigniorage "officially", but are nonetheless. For example, Fannie Mae is now going to buy $729,750 mortgages. If a green piece of paper, with "$1" written on it, that's backed by the US government counts as money, then shouldn't a white bit of paper, with "$729,750" written on it, that's also backed by the US government, also count as money? I certainly think it should, but the St Louis Fed does not think so as it is not included in its definition of "extended money seigniorage". In fact, I'm not even sure that these brand new $729,750 bills are included in M3. Of course I may be totally wrong -- please email me if you know better.


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