Tuesday, October 27, 2009

Previously on the New Arthurian Blog...

Last time, we looked at a typical "money supply relative to output" graph. Then I drew the graph again with the deflator inverted. Inverting the deflator flipped the blue line. The line moved with the deflator. I said this shows that the deflator -- the "correction" to output -- is the reason the typical graph mimics the CPI so closely.

People say it is the relation between money and output that mimics the CPI. But when I inverted the deflator, the blue line inverted. In other words, the line shows what the deflator is doing. Not what "money relative to output" is doing. Money and output play an insignificant role in the graph, despite what people say.

What would happen if we left the deflator alone, and flipped money and output?

This is the typical graph:

This is the graph with money and output flipped:

Flipping money and output makes little difference. If anything, the second graph is closer to the CPI than the first. One could argue that output (relative to the quantity of money) is a better inflation indicator than the quantity of money (relative to output).

I wouldn't make that argument. My argument is simply that the the graph does not show the trend of the money-and-output numbers. The graph shows the trend of the GDP Deflator. The graph closely mimics the CPI because, like the CPI, the Deflator is a record of price movements.

You can access the Google Docs spreadsheet used to create these graphs.

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