Sunday, January 30, 2011

A Picture Is Worth a Thousand Words

Why should the Fed aim to stabilize total current dollar spending?  This figure makes it very clear why: changes in nominal spending get translated largely into changes in real economic activity.  Its impact on the price level is far less. 

Of course, in an environment where inflation expectations get unanchored, like the 1965-1979 period, nominal spending shocks will have a greater impact on the price level and less influence on real economic activity.   And, over the long-run the trend growth rate of the real economy is determined by real factors.  But for business cycle considerations, it is hard to argue with a monetary policy goal of stabilizing nominal spending when looking at this figure.

Update:  Check out Marcus Nunes who makes an even stronger case using the above figure.  He also looks at the 1965-1979 period referenced above.   Finally, Marcus provides a nice Beckworth smackdown regarding my use of nominal spending trends.


  1. David
    I "poooled" your post and Scott´s and did 3 pictures = 3000 words?

  2. Things I've been looking at have convinced me that the period of about 1950 to 1980 were different from anything before or since.

    What do you mean by "inflation expectations get unanchored." Can you recommend where or how I can do some homework on this topic?


  3. Marcus,

    Great post. I just did an update mentioning it and your other post. Keep up the good work.

  4. Jazzbumpa,

    When inflation expectations are anchored--i.e.the public believes the Fed will keep inflation stable over long-run--then it is much easier to conduct monetary policy. For example, if the Fed decides to ease monetary policy the public will not get worked up over inflation. Inflation expectations will not rise and the Fed can easily keep nominal interest rates low. If, on the other hand, the Fed has little or no inflation fighting credibility then monetary easing will most likely lead to higher inflation expectations. This will tend to push up nominal interest rates and offset any stimulative effect from monetary easing.

    Here is one of many articles on this time period:

  5. David:
    Here's an excerpt from Bill Vickrey's fallacy #4 from the 15Fatal Fallacies of Financial Fundamentalism:
    The main difficulty with inflation, indeed, is not with the effects of inflation itself, but the unemployment produced by inappropriate attempts to control the inflation. Actually, unanticipated acceleration of inflation can reduce the real deficit relative to the nominal deficit by reducing the real value of the outstanding long-term debt. If a policy of limiting the nominal budget deficit is persisted in, this is likely to result in continued excessive unemployment due to reduction in effective demand. The answer is not to decrease the nominal deficit to check inflation by increased unemployment, but rather to increase the nominal deficit to maintain the real deficit, controlling inflation, if necessary, by direct means that do not involve increased unemployment.
    Is he wrong?

  6. David
    Krugman´s post "blaming Gold" for the 1893-97 "depression" led me to check-out the Monetary Disequilibrium approach. This is what transpired:

  7. David
    More of the usual, a different take: