I’m sure that this is hardly entertaining, but I just had one of those moments when a big idea crystallizes in my mind, like finding the missing link that fits all the miscellaneous theoretical pieces of evidence together. It’s a point that I at least thought understood well, but in sort of an ambiguous way when thinking about the nature of the monetary crisis of 2008.

It’s all about MV=PY. Negative supply shock starts a slowdown. At the same time, growth of the base has slowed to a crawl, turning the slowdown into a recession. The demand for money rises while the base stays flat and unemployment starts to rise. And it goes on for a few months this way until the banks start feeling the pinch from double whammy foisted on consumers from the negative supply shock and lower income expectations from the base remaining flat. The Fed then sterilizes additional bank lending, sucking up liquidity from general markets and transferring it to the banks, selling assets (while everyone else is selling them too) until there is almost nothing left of the balance sheet to sell… and so on….

And another way to think about it is with the AS/AD model…

But to the point, this, from the latest Scott Sumner post on China’s transition to consumption, is my crystallizing link:

When investment declines in a well functioning economy, you should see a move along the PPF toward more consumption. When both C and I decline at the same time, and you move inside the PPF, then you have major problems. Think about the US in 1929-33 or 2008-09.

When falling investment is offset by rising consumption, however, employment tends to be stable. Think about how the US created jobs in the January 2006 to April 2008 period, despite residential construction falling in half…

And when I read this, the scenario about MV=PV I mentioned above and the entire idea of inflation targeting became even more revolting than it seemed before because of what happens to prices when falling investment is offset by consumption and the consequences thereof in an IT regime.

IT is just flat out evil, and not just in the sense that it is built on sacrificing working people for the so-called ‘greater good,’ but it also counteracts a natural rebalancing process within the economy as if this kind of transition can never happen, trading natural healing for heartache and ruin in more ways than just economic. Our politics now is a total disaster as a result of multitudes of angry people – think Donald Trump.

Really, the thought of inflation targeting and everything it means should be enough to piss off the pope – if he understood it…

Advertisements