## Saturday, January 15, 2011

### "...a lack of clearness..."

In a post titled Real vs Nominal, Winterspeak writes:

Lots of activity in recent comments about the distinction between "real" vs "nominal". Here's my take:

Short version: "Real" equals atoms and/or sweat. "Nominal" equals a number in a spreadsheet.

Longer version: Real pertains to real goods and services produced by an economy... Nominal equals a number in a spreadsheet...

An inflation adjusted nominal term is not "real", because it is still a number in a spreadsheet...

At an economy wide level, if nominal incomes increase faster than real production, there is a risk of inflation (unless that extra income is "saved" and becomes, essentially, dead money).

If nominal income increases faster than real output, there is risk of inflation. Sure, I buy that. It's the old "demand-pull" story that, although still true, no longer applies to our economy. But that's not at issue here. I'm trying to get at something simpler.

I highlighted the relevant passage, and commented:

Looking at:
At an economy wide level, if nominal incomes increase faster than real production, there is a risk of inflation...

How can we know whether nominal incomes are rising faster than real production? We would have to measure real production and somehow convert it into numbers in a spreadsheet.

Winter says An inflation adjusted nominal term is not "real", because it is still a number in a spreadsheet... To me this means: You cannot compare nominal income to real output, because real output won't go into the spreadsheet.

Neil quoted my question, and offered an answer.

"How can we know whether nominal incomes are rising faster than real production"

By monitoring inflation.

I understand the principle, and I accept it. That's not at issue. I am pointing out that, as Winterspeak says, "real" output cannot be converted into numbers. So it cannot be used in a calculation to determine whether nominal income is increasing faster than real output.

Winterspeak sets up an equation:

inflation is proportional to income over output

I'm just pointing out that we don't have the numbers, so we can't do the math.

Neil assumes the equation is correct, and says that the answer -- inflation -- is evidence of what the numbers must be. I also assume the equation is correct. But I don't assume it applies to our situation, and I don't assume there is no other cause of inflation.

Given the assumptions I do not make, it becomes necessary to either measure real output or set the equation aside.

Winterspeak says that if income grows faster than output, the result is inflation. Neil says you can tell from the result whether income is growing faster than output. To me this is circular reasoning.

I summarized our exchange and brought it forward a step:

Q: How can we know whether nominal incomes are rising faster than real production?

A: By monitoring inflation.

Q: Circular. Moreover, this approach does not account for the growth of credit-use in place of income.

Wow! I raise doubt about the logic underlying the inflation equation, and immediately offer evidence showing that other factors are involved and that the equation is incomplete.

Unfortunately, it was my last comment that was incomplete. I didn't write Circular reasoning. I just wrote "Circular." And then Winterspeak said to me:

Good point -- horizontal OR vertical money expansion in excess of real production can generate inflation (but the vertical growth of course can also be absorbed as desired savings).

Nevertheless, the circularity you criticize is a feature, not a bug. The desire for the non-govt sector to save changes. It is the exogenous variable.

"Vertical money expansion" is when the Federal Reserve increases the money supply, if I have it right, and "horizontal money expansion" is when private banks and borrowers increase the quantity of credit in use. So Winterspeak's first paragraph there is a reply to mine beginning "Moreover, this approach." That leaves us with my single word "Circular" and Winter's response to it.

"The circularity you criticize is a feature, not a bug," Winterspeak says. I'm not sure what he is talking about there. I think it is about "circular flow of income" or something. It is surely not a defense of circular reasoning.

So anyhow, I guess I blew the whole thing. It was so clear to me that the defense of the inflation equation is a circular argument, that I wouldn't spend two words on it. I didn't say "Circular argument." I just said "Circular," and nobody understood. I blew it.

So much for my New Years Resolution to be more explicit.

The title of this post is a phrase from Maynard, from the Preface of the General Theory. This note is your clue as to who I am quoting tomorrow...

Greg said...

Actually Art I saw your comment (Winter has had some great posts lately, he's on a roll) and I KNEW you meant circular logic or reasoning.

I took pause with winters response as well but I decided that he in fact was criticizing the system. That the feature of using inflation adjusted and real interchangeably and then NOT accounting for credit use as IN FACT the largest source of inflation, was a convenient way for banksters to have their cake and eat it too. Get everyone in debt, let the bust act a s a deflationary force and then be able to blame all vertical money creation as the inflationary boogeyman for all to fear (except the vertical 'reserves' needed to stabilize the banks).

So maybe he was saying that poor or biased inflation accounting was a feature not a bug.

The Arthurian said...

Thanks, Greg, that makes me feel better.

I know Winter's a smart guy, and most of the comments he gets seem at a far more technically-competent level than I can manage. I tend to let things go and keep quiet a lot.

...and generate my own posts in response! :)

Greg said...

Well I'm glad I'm not the only one who feels technically challenged by some of the responses. I think you dont give yourself enough credit though, cuz its clear from following your work the last few months that your grasp of these issues is quite deep. You may struggle (as I certainly do) with some of the technical terms and how different people seem to mean different things by them but they have nothing on you in terms of keeping a consistent, coherent AND explanatory model in your mind.

Thats one of the things I really appreciate about Winterspeak and ALL the MMT authors. They are very clear and consistent about what they mean by an asset, a financial asset, real goods, credit, etc etc.

And its funny to hear their detracors say things like "Well thats just accounting"........ DUH!!! Without accounting we wouldnt know how much of what was where and who had it. Without proper accounting their IS no financial "system". Its the accounting that makes it a system.

The Arthurian said...

Careful Greg... I have a volatile ego! But "consistent, coherent and explanatory" is absolutely the best praise I ever got. Thanks.

I do think the problem is "not in the superstructure" (as Keynes said) but in the foundation of economic thinking. The errors I try to point out are all extremely basic. So then when all these technologically-proficient guys read my comments, they probably figure I'm just a dope (though Winterspeak has offered a few warm words...). Still, I try to undermine the proficient with simple yet undeniable challenges.

Meanwhile, I try to learn what I can from others, as you do.

AND THE JETS ARE STILL IN IT

Greg said...

Can they really beat the Colts, Patriots and Steelers on consecutive weeks on the road?

Your talking about the only teams from the AFC that have been SuperBowl Champs for about 9 years. Pats have three, Steelers two and Colts one. It would be quite a trifecta.

While I dont care too much ( I do like the 4 Buckeyes on the Jets), I'd have to, if forced to, bet on the Steelers.

Cowherd gave me the best reason to bet on the Steelers last week.

The Arthurian said...

Game day!