Tuesday, February 25, 2014

Looking to Hayek on Rethinking Macro

In Prices and Production Hayek writes,
Firstly, that money acts upon prices and production only if the general price level changes, and therefore, that prices and production are always unaffected by money - that they are at their ‘natural’ level, - if the price level remains stable. (7)
Macroeconomic aggregates do not act upon one another. Equations that describe macroeconomic activity provide this illusion. I.e., if the money stock increase by x%, GDP will grow by y%. Trends like these might exist in macroeconomic data, but this by no means suggests a fundamental relationship. An increase in the money stock, for example, acts directly on prices of particular goods. Consider simple, endogenous changes in the money stock that might occur in a boom without a central bank. Say that new credit is created in response to an increase in demand for loanable funds. The new money will be used to by particular goods whose prices will rise due to an increase in investment. This will translate to an increase in the price level over time, but there is no force acting directly on the price level. Most economists understand this, but our models suggest that the macro-aggregates do act upon one another, so this is worth explicitly stating.

2 comments:

  1. "An increase in the money stock, for example, acts directly on prices of particular goods."

    Wouldn't it be even more accurate to say an increase in the money stock is a change in circumstances that causes *people* to act?

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  2. It depends on what we want to model. Credit emerges from the interaction between the borrower and the lender. How would the absence of a particular lender impact a particular borrower or vice versa? Maybe a lot - the borrower dies on the way to find a different lender. Maybe not much at all - the borrower finds the lender and acts as he would have otherwise. We can only know by observation. How will similar absences affect prices? Marginally.

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