Monday, July 30, 2012

How does the economy work?


That's really the question, isn't it? How does the economy work?

At The Grumpy Economist, John Cochrane (looks like Anthony DiNozzo) writes a post called Myths and Facts About the Gold Standard. The post is about doing something like the gold standard: targeting the price level.

I don't care. Me and "Grumpy" may be the only two people left in the world who would be happy with price stability. But that's a result, you know, like GDP is a result. When economists forget how the economy works, there gets to be a lot of mistaking goals for policies: We want price stability? Well, let's target price stability! We want a smoothly expanding NGDP? Well, lets target the NGDP level!

No. You guys have to throw away everything you know -- all the nonsense that got us to the crisis you couldn't see coming -- and start with something simple.

Always keep in mind the ratio between inside money and outside money.

"Imagine a government with $15 trillion of debt," Cochrane writes. Yeh, okay. But also imagine $60 trillion of private-sector debt.

Now, imagine $6 trillion instead. The burden is gone.

It is not only government debt that matters. The level of private debt matters even more. And the balance between the two is what matters most. It is the most important thing, and the most neglected.


A gold standard cannot work if it fails to manage the balance between public and private debt -- to manage, and to prevent imbalances from arising.

Price-level targeting cannot work if it fails to prevent imbalances from arising between public and private debt.

NGDP-level targeting cannot work if it fails to prevent imbalances from arising between public and private debt.

Nothing will work, that fails to prevent imbalances from arising between public and private debt -- between internal and external money, if you prefer to say it that way.

How does the economy work? It runs on money.

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