Tuesday, September 12, 2017

The butterfly non-effect

The butterfly effect is a concept that states "small causes can have larger effects".

Macro events (in big economies) don't have micro causes

Scott Sumner has a tendency to say things clearly. For example:

I see the business cycle as being (in Fisher's words) a "dance of the dollar". Unstable monetary policy shows up as unstable NGDP. Since wages are sticky, employment tends to move with NGDP in the short run, and unemployment is countercyclical. Recessions occur when a sharp decline in NGDP growth leads to a rise in unemployment ...

In other words:

Monetary Policy --> NGDP Growth --> Employment Growth --> Recession

There's no place for butterflies there.

Like Sumner, I see monetary policy as causal. We differ because, for me, monetary policy should include not only money but also credit; and the credit-to-money ratio is of the utmost importance. But we agree that monetary policy is causal.

I also agree with Sumner (or, say Okun) on the relation of GDP growth and employment growth; and certainly recession may follow from changes in GDP and employment.

But where Sumner has NGDP Growth, I would instead put Spending Growth:

Monetary Policy --> Spending Growth --> Employment Growth --> Recession

I would have a second arrow coming out of Spending Growth, pointing to NGDP Growth on a different line. Other things would be pointing to NGDP Growth as well. Butterflies included.

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