Bryan Caplan  

Macroeconomic Identity Politics

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I've already faulted Fama for misuse of the macroeconomic identity GDP=C+I+G+NX.  Now TheMoneyIllusion takes the War On Misleading Tautology to a new level:
When I discuss the effect of monetary stimulus on aggregate demand with other economists, I notice that they often want an explanation couched in terms of the major components of GDP.  I find this very frustrating, as this approach does more to conceal than illuminate.  Suppose you were policy czar in a liquidity trap (such as right now), and you were asked to increase nominal GDP by 3-fold (i.e. 200%) in the next five years.  If you were given a choice of only one tool, which would it be-monetary or fiscal policy?  Any economist with an ounce of common sense would take monetary policy.  OK, so how would you explain its effect in terms of the 4 components of GDP?
How indeed?  The post re-analyzes not only the Great Depression, but also the panic of 1920-1, about which it says:
The sharp fall in the base caused the sharpest 12 month deflation in modern American history between 1920-21.  And it also caused the sharpest one year increase in real wages in modern American history between 1920-21.  And real output plummeted.   What does the C+I+G+NX approach add to this story?  Nothing.  Of course investment usually falls more sharply than consumption in a depression, but that would be true almost regardless of what caused the depression.
I hadn't heard of TheMoneyIllusion before, but it looks like it's already got a good stock of quality content.  See for yourself.

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COMMENTS (4 to date)
David R. Henderson writes:

A comment on one of my pet numeracy peeves. This is on the person you quoted, not you. A 3-fold increase in nominal GDP is a 300% increase, not a 200% increase. Increasing nominal GDP to 3 times its current level is a 200% increase.

Scott Sumner writes:

Bryan, Thanks for the mention. I am relatively new to blogging and am gratified that people I respect like yourself, Arnold, and Tyler have read my blog and enjoyed at least parts of it. It so happens that a few years ago I began thinking about the distinction between what I called the "commonsense view" and the "economistic view". Later I discovered that you had already published work in this area. I argued that changes in the plausibility of each view (driven by events) drive changes in what is loosely called "liberalism." I will try to post something on this topic soon. (My current focus is obviously monetary economics. I will also add you to my blogroll soon.

Bill Woolsey writes:

My answer to Sumner's question is that I would expect all of them to increase roughly in proportion.

Dezakin writes:

With all the discussion on Keynesian stimulus, why is there so little focus on monetary solutions like quantitative easing to this liquidity trap? I'm beginning to fear the paranoia of inflation will lead us to repeat Japan's trip into stagnation.

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