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