Bizarre Monetary Theory, Once Again
By Arnold Kling
it is not difficult to see that a large shift in the composition of demand would result in larger shifts in resource utilization, higher structural unemployment, and slower growth in the productive capacity of the economy.
For monetary disequilibrium theorists, this would be described as a higher natural unemployment rate, along with slower growth in potential income.
Woolsey is trying to take the Recalculation story and rework it into the MV= PY framework. While the economy is Recalculating, potential GDP goes down. Accordingly, if the monetary authority maintains a high MV, we will get inflation and not more real output.
I think that is a pretty fair description of what happened in the 1970’s. But right now, I am saying that the Fed cannot raise MV. It raises M and V goes down. If the Fed really worked at it for a long period of time, I am sure that they could bring back inflation, like in the 1970’s. However, I do not think that they can cure the Recalculation problem by raising nominal expenditure. If anything, I think more inflation would make the Recalculation problem even harder for the economy to solve.
I should say that there are a lot of policies that are making Recalculation harder. Cash for Clunkers made it hard to figure out the true underlying demand for new cars. All the foreclosure mitigation policies have made it harder to figure out who really can afford the houses they are inhabiting and who can’t.
Maybe I’m wrong to keep pushing this Recalculation thing. But if it happens to be right, then all sorts of conventional macroeconomic wisdom is not helpful right now.