Macroeconomic Identity Politics
By Bryan Caplan
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.
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