So I'm reviewing Robert Lucas's "Prize lecture" for my "No man is an island" post, and I come again upon this:
Figure 1, taken from McCandless and Weber (1995), plots 30 year (1960-1990) average annual inflation rates against average annual growth rates of M2 over the same 30 year period, for a total of 110 countries. One can see that the points lie roughly on the 45-degree line, as predicted by the quantity theory. The simple correlation between inflation and money growth is .95. The monetary aggregate used in constructing Figure 1 is M2, but nothing important depends on this choice.
The monetary aggregate used is M2, but nothing important depends on this choice.
Nothing could be further from the truth. Everything depends upon the money. In this case, everything depends upon the money used in the calculation.
Lucas reports a high value of .95 for the correlation between inflation and M2 growth. What he does not report is that in 1960, 45% of M2 was in the spending stream but in 1990 only 25% of it was in the spending stream.
Doesn't that throw a monkey wrench into the simple correlation?
Lucas ignores altogether the fairly significant notion that it is not the existence of money that causes prices to rise, but spending. And he ignores the fact that the 75% of M2 that was not in the spending stream in 1990 would have had no inflationary effect.
Lucas does not factor-in the distortion of the numbers caused by the significant drop in the circulating portion of M2, nor the effect this distortion should have had on the correlation. Nor does he consider that this effect is absent. He just takes the point-nine-five and runs with it.
This reminds me of something Milton Friedman said. From my 12 pages:
In Capitalism and Freedom, Friedman calls for "a legislated rule" designed to achieve "a specified rate of growth" of the money supply. But “the precise definition of money" established in this rule, he says, "makes far less difference" than just having the rule would make. For Friedman, any money is good enough.
Friedman wanted to carefully manage the quantity of money, but he didn't care what money was managed, what monetary aggregate. It didn't concern him at all.
But if it is spending that causes inflation, then spending-money is the money to watch. Not the money in savings.