Sunday, March 22, 2015

Free Radical — C+I+G+NX is a Stupid Way of Teaching Aggregate Demand

C, I, G, and NX are not the fundamental forces driving aggregate demand, they are just categories that you can divide it into. The fundamental force driving aggregate demand is the willingness to spend money on goods. It doesn’t matter if those goods are consumption or investment. The only thing that matters is how much money there is and how willing people are to hold that money instead of spending it on something. If you can grasp this concept, you get aggregate demand. If not, you don’t. If something affects AD, it must affect one or both of these. If you can see how it does that, you get it. If not, you are probably confused.
"how much money there is" sounds like a lump fallacy in an endogenous system?
Now, this is all consistent with the model of aggregate demand taught in introductory macro, it’s just a better way of teaching it, in my opinion. When you get to intermediate, I have a similar set of gripes. So I am coming up with a better way of doing IS/LM. Coming soon.
The actual problem is imputing causality to accounting identities. They are (boundary) conditions rather than causes. They hold if all books balance across the system, which is assumed.

He has the causality right on spending and saving. But there is no (fixed) amount of "money," but rather the flexible use of credit depending on conditions and expectations.

Most introductory macro textbooks are just wrong on monetary economics, and the problem is not chiefly with the accounting identities but rather direction of causation and how an endogenous monetary system operates. As far as the conventional intro texts go, "you can't get there from here."

Someone tell Free Radical to take a look at the draft of Bill and Randy's forthcoming MMT-based macro text.

Real-World Economics Review Blog
C+I+G+NX is a Stupid Way of Teaching Aggregate Demand
Free Radical

3 comments:

NeilW said...

The problem is concentrating on the stock, not the flow.

And counting coins rather than transactions.

That is why splitting Turnover into 'Money' and 'Velocity' fails.

Transaction volume is really a function of deals done. Money is just a way of shifting the credit burdens around so that everybody feels sufficiently comfortable to engage in another round of transactions.

JW Mason said...

I agree.

The fundamental point is that spending decisions determine output. It may or may not be useful to classify spending into C, I, G and NX. I'm not as convinced as this person that it isn't, but he's certainly right that it is an arbitrary convention, not a general law.

You and Neil are also right that it is wrong to think of the choice in terms of spending or holding "money" -- a decision to increase current spending can involve a variety of balance-sheet adjustments, not just a reduction in holdings of one special asset.

Unknown said...

Hello, Tom Hickey
I think this problem is concerning on Aggregate Demand.
Thanks for sharing interesting post.
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