Somehow, this discussion reminds me of Dani Rodrik's conception of economics as a cluster of models that are compatible with many different results, and which of them we choose to explain reality depends on the assumptions that we think are at play. I think it's at that point that we can actually talk about "theories" which are falsifiable, etc. (similar to what you say about supply and demand), but I would not call a model a theory by itself. Anyway, great piece!
Hi Brian - I don't understand why checking a theory against output data - i.e what is actually happening - is "not the most ideal test of the theory". Is, then, the most ideal test of a theory its prediction ability?
Isn't the natural way to apply supply and demand to inflation to look at supply and demand for money, which is at one side of all purchase transactions? Looking at reasons a particular price went up doesn't explain inflation. If the price of eggs goes up that may mean that people are spending more money on eggs so have less to spend on bread so the price of bread goes down.
That's right. It's an awkward framing on my part. I wanted to get to talking about inflation, so I introduce it too soon. One complication of adding all the industry stories into a macro story of inflation is that you need to make sure everything adds up. That's tough to do. You example could perfectly well be true.
Put the argument in terms of the demand for cash balances. That avoids the confusion due to the fact that when one person spends a dollar someone else gets it — money, unlike eggs, doesn't get consumed. If demand for real cash balances stays the same and the amount of money increases prices increase, as everyone tries to spend down his cash balance. If the demand for cash balances goes down with money supply fixed, the same thing happens. That makes it a simple demand and supply story.
The sort of stuff you are talking about only comes in if it changes the demand for real cash balances.
Professor Friedman, not being trained in macro or monetary theory at all, this whole thing is beyond my comprehension. In simple terms, though, is it your view that the inflation we experienced in the past couple of years was due to a rise in the supply of money caused by stimulus measures in 2020 and 2021? I kept seeing all sorts of explanations for inflation from supply chain issues to corporate greed (whatever that is).
Yes, plus lots of complications. The puzzle was why there wasn't more inflation given the amount of money creation. I think the solution is that the Fed, by offering interest on reserves, was in effect printing money and then borrowing it back.
But macro isn't my field either, so I haven't followed things in detail and might be wrong. The general pattern is that you get inflation from increasing the money supply, but the details get complicated in a modern society with a range of moneys and money substitutes.
Somehow, this discussion reminds me of Dani Rodrik's conception of economics as a cluster of models that are compatible with many different results, and which of them we choose to explain reality depends on the assumptions that we think are at play. I think it's at that point that we can actually talk about "theories" which are falsifiable, etc. (similar to what you say about supply and demand), but I would not call a model a theory by itself. Anyway, great piece!
Hi Brian - I don't understand why checking a theory against output data - i.e what is actually happening - is "not the most ideal test of the theory". Is, then, the most ideal test of a theory its prediction ability?
I merely meant that I already have a sense of what is happening to output data, so it's not a clean test. I should have been clearer.
Thanks
Isn't the natural way to apply supply and demand to inflation to look at supply and demand for money, which is at one side of all purchase transactions? Looking at reasons a particular price went up doesn't explain inflation. If the price of eggs goes up that may mean that people are spending more money on eggs so have less to spend on bread so the price of bread goes down.
That's right. It's an awkward framing on my part. I wanted to get to talking about inflation, so I introduce it too soon. One complication of adding all the industry stories into a macro story of inflation is that you need to make sure everything adds up. That's tough to do. You example could perfectly well be true.
Put the argument in terms of the demand for cash balances. That avoids the confusion due to the fact that when one person spends a dollar someone else gets it — money, unlike eggs, doesn't get consumed. If demand for real cash balances stays the same and the amount of money increases prices increase, as everyone tries to spend down his cash balance. If the demand for cash balances goes down with money supply fixed, the same thing happens. That makes it a simple demand and supply story.
The sort of stuff you are talking about only comes in if it changes the demand for real cash balances.
Professor Friedman, not being trained in macro or monetary theory at all, this whole thing is beyond my comprehension. In simple terms, though, is it your view that the inflation we experienced in the past couple of years was due to a rise in the supply of money caused by stimulus measures in 2020 and 2021? I kept seeing all sorts of explanations for inflation from supply chain issues to corporate greed (whatever that is).
Yes, plus lots of complications. The puzzle was why there wasn't more inflation given the amount of money creation. I think the solution is that the Fed, by offering interest on reserves, was in effect printing money and then borrowing it back.
But macro isn't my field either, so I haven't followed things in detail and might be wrong. The general pattern is that you get inflation from increasing the money supply, but the details get complicated in a modern society with a range of moneys and money substitutes.