Late in the afternoon, I often walk up to the top of a ridge just a half-mile northwest of my house. From the top I look out over a broad valley, to a range of hills just above Laguna Beach. On a clear day, you can see the crimson sun gradually sink below the distant hills, as the lights of the Irvine Spectrum begin to twinkle far below:
On a recent trip it occurred to me that there’s a different way of “modeling” this scene. Perhaps I’m not seeing the sun set below the hills. Maybe I should view the sun as stationary. Perhaps what’s really happening is that those distinct hills are rising, as deep forces push up trillions of tons of rock, higher and higher.
It turns out that I’m not the first person to have had this vision; a Polish astronomer named Copernicus had the same insight in 1514. Both “sunset” and “earthrise” are valid ways of describing the scene I observed, but the latter model has proved more fruitful, allowing us to build machines that put men on the moon.
There are also two ways of thinking about the cycles in nominal GDP. One approach is to view the dollar as a stable measuring stick, and look for the reasons why various types of spending rise and fall in dollar terms. Why do government spending, retail sales, exports, housing construction and business investment move up and down? What about health care and education? If we can explain each type of spending, then we ought to be able to explain the aggregate.
A second approach no longer views the dollar as a stable measuring stick. Thus in mid-2008, the dollar could buy roughly 1/14.835 trillionth of a year’s worth of NGDP. By the spring of 2009, the dollar’s value had risen, and it could buy a share of NGDP that was 3.3% larger than in the summer of 2008. (I.e., NGDP had fallen by 3.3%.)
Most economists believe the former approach is a more useful way of thinking about cycles in nominal spending, but I believe the latter approach is more useful. Is there any way to figure out who is right?
Recall that cycles in RGDP and NGDP are highly correlated in the US. So if we could stabilize NGDP, then it seems possible that RGDP would also be more stable. The conventional approach suggests that NGDP cycles just happen; due to “shocks”, and that (at best) policy can then promote a faster recovery from recession. My approach suggests that unstable monetary policy actually causes the cycles.
If I’m right, then an improvement in monetary policy should make cycles less frequent. In a recent post I pointed out that there were 8 recessions between November 1945 and November 1982, and 3 since. I argued that this was due to improvements in monetary policy after the Great Inflation. I also argued that improvements in monetary policy after the Great Recession should lead to a further reduction in cycles—perhaps one recession in the next 37 years. Time will tell.
Did I cheat by trying to link my heterodox theory to the great Copernicus? After all, crackpots often try to associate their ideas with great figures, to lend them an air of respectability. Is there any reason to believe that Copernicus would share my market monetarist way of thinking?
Perhaps there is. Just three years after developing the heliocentric model of the Solar System, Copernicus invented the Quantity Theory of Money. Here’s Murray Rothbard:
In the course of his discussion, Copernicus also became the first person to set forth clearly the “quantity theory of money,” the theory that prices vary directly with the supply of money in the society. He did so 30 years before Azpilcueta Navarrus, and without the stimulus of an inflationary influx of specie from the New World to stimulate his thinking on the subject. Copernicus was still being a theorist par excellence. The causal chain began with debasement, which raised the quantity of the money supply, which in turn raised prices. The supply of money, he pointed out, is the major determinant of prices. “We in our sluggishness,” he maintained, “do not realize that the dearness of everything is the result of the cheapness of money. For prices increase and decrease according to the condition of the money.”
Five hundred years later, there is still a lot of “sluggishness” in the world.
Market monetarism is much more than the Quantity Theory, but that’s the key insight that underlies the MM model. Explaining inflation isn’t about explain lots of individual prices (or God help us the “Phillips Curve”), it’s about explaining the value of money. Just as Copernicus saw that it’s not the Sun that moves, it’s the Earth, he saw that it’s not that the value of things in general change, it’s the value of money that changes.
To summarize:
Sunrise = Expenditure approach to NGDP
Earthrise = Monetarist approach to NGDP
READER COMMENTS
Warren Platts
Dec 21 2019 at 5:09pm
Hi Scott, it certainly is a good thing if recessions happen less and less frequently. But there is a big ceteris paribus caveat that must be attached. As someone commented on your last post, the increasing infrequency of recessions seems to be correlated with anemic overall average growth. If we had a choice, we’d be better off under a regime of 3.5% average growth even with recessions every 4 or 5 years versus a regime with one recession every 37 years, but with <2% growth.
Also, that last recession was a doozy. Could that be the start of a new pattern. Less often recessions, but much more severe ones when they do hit?
Granted, correlation does not equal causation. How growth rates could be causally related to frequency of recessions, I have no idea. Maybe if there are fast growth rates, it is much more likely that the economy will become "overheated" thus precipitating a contraction that prunes the excess capacity; conversely, if growth is anemic, the economy never gets a chance to get "overheated" in the first place.
Phil H
Dec 22 2019 at 8:24am
This is… more subtle than I realised! I just wrote out a whole post complaining that the analogy doesn’t hold, because neither the value of the dollar nor the GDP are actually still, but when I got to the end, I saw that I was totally mistaken. Neither the earth nor the sun are still, and they don’t need to be for the flip of perspective to be effective.
Thanks, that was a good experience to think through the logic.
Benoit Essiambre
Dec 22 2019 at 9:41am
beautiful
Keenan
Dec 22 2019 at 10:19am
This is a great post Scott. Insightful and correct grouping of diff types of thinking… and then a great analogy to boot
Bob Murphy
Dec 22 2019 at 10:34am
I’m with you so far, Scott, but to extend the analogy: What would be the equivalent Copernicus view to the notion that “In 2009 the Fed had the tightest monetary policy since the Hoover Administration”? Would it be something like, “If scientists could somehow make the earth rotate faster than it ever had in its history, but everybody kept their eyes shut, then it would be the longest day ever”?
Scott Sumner
Dec 22 2019 at 12:25pm
You should ask Ben Bernanke. As I recall it was based on his criterion that money was the tightest since the Great Depression.
Michael Rulle
Dec 22 2019 at 10:44am
I wonder if our educational framework toward specialization prevents polymaths like Copernicus to exist? Are there broad based intellectuals like Copernicus (and others) around today? I don’t know. Specialization, I think, is good—but there must be room for the more general thinker.
The reason I accept your views is due to your persuasiveness (as well as implicit support from historical studies by MF and others–including you). However, this does not explain the difficulty—assuming theory is correct—of proper execution by the various Central banks. This always gets me to stare at “after the fact” interpretations—-(you were realtime in ’07-’08—but BB only changed his mind after the fact).
Your market based insights (or your insights on market based insights!) does give me greater comfort. Well, you have made a prediction—however, as I have mentioned before—nothing prevents the next set of central bankers to revert to the Phillips Curve and the like—so your faith in “Fed progress” is interesting.
I still wonder where seemingly implausible Fiscal policies fit in to the big picture. I wonder if Copernicus had thoughts on that.
Jon Murphy
Dec 22 2019 at 11:00am
Specialization allowed Copernicus to specialize in natural sciences (or philosophy as it was broadly known). Specialization does not prevent polymaths from arising; it encourages and fosters their rising.
john hare
Dec 22 2019 at 6:07pm
Unfortunately, the rise of credentialism makes it a bit more difficult for some of them to call attention to their work if in fields other than that they are recognized for. Playing around with some systems engineering made me somewhat aware of this. Often people in one field have solved the problems that people in other fields are fighting.
Jon Murphy
Dec 22 2019 at 11:10am
Great post. I only recently discovered Copernicus’ article. It’s always interesting to me to see how long humans have been considering many ideas. In many ways, there is nothing new under the sun. Heck, there are even hints at comparative advantage in Cicero!
Garrett
Dec 22 2019 at 3:28pm
I recall in old posts you’ve credited Hume as the father of Monetary Economics. Turns out he was scooped by 200 years!
Scott Sumner
Dec 23 2019 at 12:00pm
There’s always someone earlier, but Hume’s work was far more significant, and still underlies much of what is taught in Macro 101.
Lorenzo from Oz
Dec 22 2019 at 8:21pm
To slightly correct Murray Rothbard’s monetary history, the C15th had seen a “bullion drought” or “great bullion famine” of 1457-1464 as the silver mines of Central Europe reached their limit under the current technology. But then the technology changed (the liquation method of separating copper and silver was developed), and there was a fivefold increase in European silver production.
Copernicus (1473-1543) was raised in a period when the bullion famine was a living memory and lived during a period that saw a dramatic surge in silver production and then in access to gold.
The Roman economy went into crisis when its silver mines began to give out (with a slave economy failing to develop new technology). The debasement of the coinage that followed saw massive rises in monetary prices. But given that silver was the medium of account, I have wondered whether that is a case of inflation in the (monetary) medium of exchange but deflation in the medium of account. Certainly, the evidence on trade (which dropped dramatically) is much more compatible with a deflationary story.
Scott Sumner
Dec 23 2019 at 12:02pm
I’d guess that Rome’s monetary problems were partly a result of governance failures in other areas, and thus not really a cause of its decline. But I’m certainly no expert on that period.
Lorenzo from Oz
Dec 26 2019 at 7:13pm
Rome was actually the only major Eurasian imperial state to survive “the crisis of the Third Century”. The Han dynasty collapsed in 220, the Parthian Empire was overthrown by the Sassanids in 224, the Kushan Empire declines markedly after the end of the reign of Vasudeva I (c.190-c.230), the Deccan Satavahanas state collapses in the early C3rd.
My take is the collapse of Roman silver mining destabilised the entire Han-Roman trading system, and the loss of the crucial “cream” of revenue from trade then destabilises the existing imperial states (adapting David Friedman’s theory of state size and taxation). Rome survived because it still controlled the entire Mediterranean littoral, given enough trade income ballast to make it through (though it was a close run thing).
The Western Empire did not fall until the third quarter of the C5th, so there was a “lot of ruin” still left in the Empire after Diocletian (r. 284-305) restabilised it.
But I look at the inflationary surge as the lack of silver led to massive inflation (hence Diocletian’s infamous edict on prices) combined with the shrinkage in economic activity and think that the silver deflation was more important than the monetary inflation.
Han dynasty economy was dependent on Roman silver production, the Ming and Qing dynasty economy were dependent on Spanish American silver production (the collapse of the Spanish empire in the 1820s did bad things to the Qing economy) and more recently the Chinese macro-economy has been reliant on selling goods in exchange for printed pictures of dead US presidents. History may not repeat, but it can rhyme pretty strongly.
Todd Ramsey
Dec 23 2019 at 9:31am
Brilliant. Thank you.
Elegant parallel to Copernicus. Amazing that he deduced a relationship between money and prices. Thanks for bringing it to light.
Scott Sumner
Dec 23 2019 at 12:01pm
Thanks.
Comments are closed.