Roger E. A. Farmer

Roger Farmer's Economic Window. Professor of Economics, Warwick University and Distinguished Professor of Economics UCLA.

[Roger E. A. Farmer @farmerrf]

No, the NK model is neither elegant nor useful.

The IS/LM model was useful — but incomplete — because its core equations summarize observable empirical relationships between aggregates. The attempt to graft a forward looking ‘Phillips curve’ onto the model was an unmitigated disaster. @jasonfurman @FrancoisGeerolf @monacelt

1. The Euler equation is an elegant description of the first order condition of a representative agent with perfect foresight. That agent does not exist. A much better foundation for understanding how consumption moves over time was Friedman’s permanent income hypothesis. And since the work of Truman Bewley, we have a firm foundation for that equation that is grounded in borrowing constraints and incomplete markets in a heterogeneous agent model.

2. The NK Phillips curve does not characterize any observable empirical regularity. It never has. The original Phillips curve, a connection between wage inflation and unemployment in UK data, disappeared soon after Phillips published his eponymous article. The reason it takes a semester to teach the NK Phillips curve is that it requires a set of ugly non refutable theoretical contortions that only a mother could love.

3. The NK model has no unemployment. People voluntarily change their labor supply behavior in response to ‘shocks’, the consequences of which are correctly forecast. That assumption does not fit with what we know about labor markets. I blogged about that here

https://t.co/glutnAz7eM

4. The NK model assumes that employment (not unemployment) fluctuates around a stationary ‘natural rate of unemployment’. I wrote about that here

https://t.co/T9ygaMv4SB

Fed economists spend countless hours attempting to estimate this ‘natural rate’. This is a Sisyphean task since the unemployment rate in data is essentially a random walk.

The correct strategy at this point is to abandon much of the rational expectations revolution and to reconstruct macroeconomics beginning with what we knew circa 1960. This, I believe, is already beginning. There is a large body of theorists working on Bewley models and that group has concluded that rational expectations was a misstep. See, for example, the recent working paper by @ben_moll

https://t.co/7rRFtj8lqj

I am not as convinced as Ben, that our models must be nonlinear with global solution methods since, if Ben’s approach is successful, even linearized models in aggregates will likely display very different properties from either NK or classical RBC economies. But dropping the full implications of rational expectations is a promising way forward.

[Jason Furman @jasonfurman]

I don’t like the word “science” for this sort of thing.

But this is a very useful way to understand the world, consider some of the most important macroeconomic policy debates, and a flexible framework that you can build on to add different nuances and complexities.

[Roger E. A. Farmer @farmerrf]

@Jon_Hartley_ @StanfordEcon @I_Am_NickBloom @DuffieDarrell @JohnHCochrane @HannoLustig @HooverInst Congratulations @jon_Hartley

[Phil Magness @PhilWMagness]

This is utter nonsense. Zucman's mentor Piketty manipulated the UK data to show rising wealth inequality, when it has been flat for decades.

Data duplicity is a clear and recurring pattern for these two Frenchmen.

[Roger E. A. Farmer @farmerrf]

I agree with this assessment from @DrJStrategy: To paraphrase Greenspan

“I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I said.”

Central bankers are acting in a world of uncertainty not of risk ; a distinction made by Frank Knight. Economic models are models of risk.

Basing policy on models that attribute an unwarranted degree of confidence to decisions is hubris and likely to lead to bad outcomes.

Central bankers would do well to follow Wittgenstein’s advice:

“Whereof one cannot speak, thereof one must be silent.”

[James E. Thorne @DrJStrategy]

Stanley Fischer Would Applaud This

Warsh can’t scrap the dot plots and forward guidance fast enough. In a world where Stanley Fischer prized humility about models and genuine data dependence, the current regime looks like the opposite: an illusion of precision that locks policy into yesterday’s forecast and invites the Street to trade “the path” rather than the data. The dots convert a committee’s uncertainty into a pseudo‑promise, then punish any attempt to change course as a credibility problem rather than a sign of learning.

Worse, the communications revolution has metastasized into a noise factory. There is no plausible world in which a dozen regional presidents and assorted governors doing a daily speaking tour improves policy or price discovery. It fragments the reaction function, encourages grandstanding, and turns every luncheon remark into a tradable headline. A central bank is not a content platform; it is, as Fischer would insist, a steward of stability, not a streaming service for half‑formed views.

If Warsh is serious about restoring the Fed’s authority, the fix is straightforward: scrap the dots, radically curtail forward guidance, and shut down most of the
speechmaking. Let the institution speak mainly through its decisions and a small number of tightly disciplined communications. Fewer words, clearer incentives, more genuine uncertainty, forcing markets back to the hard work of inference rather than quote‑mining Fedspeak.

[Rafael R. Guthmann @GuthmannR]

I have worked with @BrianCAlbrecht on questions closely related to the issues of stability analysis that @IvanWerning and Lorenzoni have been wrestling with recently.

Some of our papers related to this topic:

https://t.co/GvYaKlvr7D

https://t.co/LWaIbSPGyi

https://t.co/wKbKmLi52B

And some of my observations regarding this topic in general:

1. A perfectly competitive general equilibrium describes a situation where agents know everything they need to know and where the price system enables agents to execute all trades to reach a Pareto efficient allocation.

2. This mechanism of trade through the competitive price system is also very minimalistic in the sense that agents use a minimal amount of information.

3. This competitive general equilibrium can be understood as a steady-state of a learning process operating in a reasonably "fixed" or stable environment, which features imperfectly competitive markets that become more competitive as information "percolates" over the interested parties and profit margins tend to be reduced over time.

4. Macroeconomic issues such as inflation and business cycles that generate fluctuations in unemployment and output are intimately related to this concept of "agents learning towards general equilibrium."

5. That is, if the agents in the economy are very "flexible" and "smart," the resulting reaction of the economic system to unanticipated exogenous shocks will result in quick adjustment and therefore low levels of output and unemployment fluctuations.

6. Random/directed search theory is intimately related to these issues. Hence, why the new monetarist economists such as @1954swilliamson and Randy Wright are tackling money and macro topics using search, and why we have labor search literature to explain why unemployment occurs in "equilibrium." Although I think most of lacks an explicit approach to learning and "convergence process to GE over time," which I tried to bridge in my job market paper (https://t.co/GvYaKlvr7D).

Overall, I think that this "convergence to GE studies" field is enormous and ultimately the field in economics that has an intimate relationship to the evolution of economic theory over the last 80 years, and that there is still a lot (perhaps most) of stuff to be done.

[Roger E. A. Farmer @farmerrf]

Great thread from @drmtgr

[Lönnrot @drmtgr]

Another interesting thing, since RF raises the issue of inventories, is in fact how one should think of production functions if seriously considering disequilibrium problems.
I think the issue is that the common "language" we use to frame things in econ is at heart a language

[Lönnrot @drmtgr]

@QuetzaIc0atl @farmerrf @hidetomitanaka @guido_lorenzoni @IvanWerning Il faut se frayer son chemin, c'est un pari mais moi je suis globalement très content de ma situation

[Roger E. A. Farmer @farmerrf]

Great post from @MZunigaP about the founder of the UCLA school ht @BrianCAlbrecht

[Mario Zúñiga @MZunigaP]

‘Uncertainty, Evolution, and Economic Theory,’ by Armen Alchian
https://t.co/YDN2BMYdsq (via @TOTMBLog).

[Roger E. A. Farmer @farmerrf]

A great comment from @hidetomitanaka on the magisterial paper by @guido_lorenzoni and @IvanWerning and one I endorse. I hope their work leads others to return to questions that predate the rational expectations revolution.

My number one question is: How does an economy function when trades take place outside of a Walrasian equilibrium? I do not think that Calvo pricing is a satisfactory answer to that question because it is, in essence, an alternative equilibrium concept — as opposed to a disequilibrium trading mechanism.

A satisfactory resolution would contain, IMO, several elements.

1. Expectations matter and they do not always coincide with outcomes, even probabilistically.

2. The set of traders changes over time as a consequence of birth and death and some traders, in all markets, are more sophisticated than others.

3. The world is not fully ergodic over the lifetime of a typical agent: see our definition here, in work with J. P. Bouchaud, of quasi-non ergodicity: https://t.co/txeI9cjwid

4. Point 4 implies that people will not generally be able to learn in finite time. The economy will NEVER attain an equilibrium in the Walrasian sense — or in the Lorenzoni-Werning sense which adds price setters.

5. Inventories act as a buffer against imperfect price discovery: they do not appear as an important element in our theories. They should! This, I believe, is one of the points of @hidetomitanaka’s point about early vs late Hicks.

None of these points should be taken as a negative assessment of the LW paper which is a tour de force and which I highly recommend.

[田中秀臣 @hidetomitanaka]

As a researcher in the history of economic thought, I found your paper to be exceptionally intellectually stimulating, and I sincerely congratulate you on its publication.

Unfortunately, due to a prior commitment, I was unable to attend the presentation in Japan. However, I have heard highly enthusiastic feedback from those who did attend.

I am also deeply grateful that you have paid such careful attention to, and generously acknowledged, the contributions of Japanese economists to the theory of equilibrium stability.

If I may, I would like to offer a few brief comments from the perspective of a historian of economic thought.

Your paper is a remarkable achievement in the tradition of general equilibrium theory. By embedding tâtonnement into a forward-looking dynamic environment with price-setting firms, you provide a compelling rehabilitation of stability analysis and, in many respects, a rehabilitation of Hicks's insights in Value and Capital (1939).

However, I wonder whether the paper may be recovering only one Hicks—the young Hicks of Value and Capital—while leaving aside the very different Hicks of his later work.

In Value and Capital (1939), Hicks treated prices primarily as adjustment variables within an interdependent market system. From that perspective, your result that forward-looking price setting restores the relevance of Hicksian stability conditions is both elegant and important.

Yet in his later writings, especially A Market Theory of Money (1989), Hicks increasingly moved away from the Walrasian conception of price adjustment. He argued that many actual markets operate not through continuous price adjustment but through relatively stable prices that function as commitments between buyers and sellers.

In this later Hicksian perspective, a price is not merely a signal of scarcity. It is also a promise. Frequent price changes may undermine confidence, customer relationships, and perceptions of quality. Price stability is therefore not simply a friction delaying adjustment; it is itself part of the institutional structure that makes markets possible.

My concern here is not simply the familiar disequilibrium tradition associated with Clower and Leijonhufvud. In those approaches, quantity adjustment typically emerges because price adjustment is incomplete, delayed, or otherwise impeded. The underlying benchmark nevertheless remains a price-adjustment economy.

The later Hicks appears to suggest something more radical. Relatively fixed prices may themselves constitute a normal institutional feature of organized markets rather than a temporary imperfection. In such markets, prices are not merely adjustment variables waiting to respond to excess demand; they are commitments that sustain confidence, reputation, and ongoing relationships between market participants.

If this is correct, then inventories, delivery lags, customer relations, and other non-price mechanisms are not simply second-best substitutes for missing price adjustments. They are part of the primary adjustment process itself. The question is therefore not how an economy converges when prices adjust imperfectly, but whether many real-world markets should be understood as operating through a fundamentally different logic of coordination.

This raises a question about the meaning of “general” in general equilibrium theory.

Your model incorporates sticky prices, but the underlying role of prices remains fundamentally Walrasian. Prices are still the primary adjustment variables; stickiness only affects the timing of adjustment. The economy ultimately remains a price-adjustment system. This is true even when prices are sticky in the Calvo sense.

By contrast, the later Hicks seems to suggest that many real-world markets may be better understood as operating under relatively fixed prices, with much of the adjustment occurring through quantities and other non-price mechanisms. Inventories, delivery schedules, customer relationships, reputation, and other institutional arrangements absorb shocks that Walrasian models assign to prices.

If this interpretation is correct, then the issue is not merely whether prices are flexible or sticky. The deeper issue concerns the social ontology of prices themselves.

In the Walrasian tradition, prices are primarily signals.

In the later Hicksian tradition, prices are also commitments.

The distinction matters because a commitment-based pricing system may generate stability through mechanisms fundamentally different from those analyzed in tâtonnement models, however sophisticated.

Therefore, while your paper may successfully restore stability theory within a Walrasian framework, one may still ask whether the later Hicks's fixprice economy represents a different class of market order altogether—one whose stability cannot be reduced to price dynamics alone.

From this perspective, the issue is not whether a Walrasian price-adjustment economy can be made stable. Your paper shows that it can. The question is whether such an economy exhausts the relevant notion of generality in the analysis of market coordination.

In that sense, the question is not whether Hicks is back, but which Hicks has returned.

[Roger E. A. Farmer @farmerrf]

@WilliamJLuther @dandolfa @DavidBeckworth @bryan_caplan 🙏

[Roger E. A. Farmer @farmerrf]

@WilliamJLuther @dandolfa @DavidBeckworth @bryan_caplan This is a good time to retweet this link https://t.co/H1mKCkSVmL to @evononomicsmag

[Roger E. A. Farmer @farmerrf]

@WilliamJLuther @dandolfa @DavidBeckworth @bryan_caplan This is a good time to retweet this link https://t.co/H1mKCkSVmL to @evononomicsmag

[Roger E. A. Farmer @farmerrf]

.@LuizaJarovsky “So I was grading people on their ability to use ChatGPT.”

There is no point in resisting the use of AI in the process of creation of intellectual ideas. We must instead, teach our students how to use it effectively.

Here is the assignment I gave my second year PhD class:

Your assignment for the course is to write a research paper using AI. The paper should be a minimum of 15 pages and a maximum of 30 pages including bibliography. Appendixes (if needed) can be additional.  The paper must be formatted for submission to a journal.
At each step of the production of the paper, keep a diary on a word processor of your choice. Document which AI you use at each step and importantly: what prompts you gave it. Typical steps would include:

1Choice of a topic. Is my idea a good one? Has it been done before?
2Literature Review. Check for hallucinations. READ the main papers yourself. Do NOT rely on the AI. Which AI did you use.
3Structure of the paper. Make an outline. Discuss it with one or more Ais. Document your prompts and the AI response.
4Draft the paper. Go back and forth suggesting possible improvements.
5Discuss possible journals that the paper could be submitted to. How should your paper be refined to hit a particular journal?
6When the paper is complete: Send it to a different AI and ask for referee reports. How can the paper be improved in light of the reports? Take up the suggestions.


You will NOT be graded on the quality of the paper. You WILL be graded on the quality of the diary and how well you responded to and interacted with the AI.

[Luiza Jarovsky, PhD @LuizaJarovsky]

🚨 University professors have been saying AI is completely destroying learning and that we'll soon have an AI-powered, semi-illiterate workforce. Here's a glimpse into the educational apocalypse:

"Sarah, a freshman at Wilfrid Laurier University in Ontario, said she first used ChatGPT to cheat during the spring semester of her final year of high school. (...) After getting acquainted with the chatbot, Sarah used it for all her classes: Indigenous studies, law, English, and a “hippie farming class” called Green Industries. “My grades were amazing,” she said. “It changed my life.” Sarah continued to use AI when she started college this past fall. Why wouldn’t she? Rarely did she sit in class and not see other students’ laptops open to ChatGPT. Toward the end of the semester, she began to think she might be dependent on the website. She already considered herself addicted to TikTok, Instagram, Snapchat, and Reddit, where she writes under the username maybeimnotsmart. “I spend so much time on TikTok,” she said. “Hours and hours, until my eyes start hurting, which makes it hard to plan and do my schoolwork. With ChatGPT, I can write an essay in two hours that normally takes 12.”

-

"By November, Williams estimated that at least half of his students were using AI to write their papers. Attempts at accountability were pointless. Williams had no faith in AI detectors, and the professor teaching the class instructed him not to fail individual papers, even the clearly AI-smoothed ones. “Every time I brought it up with the professor, I got the sense he was underestimating the power of ChatGPT, and the departmental stance was, ‘Well, it’s a slippery slope, and we can’t really prove they’re using AI,’” Williams said. “I was told to grade based on what the essay would’ve gotten if it were a ‘true attempt at a paper.’ So I was grading people on their ability to use ChatGPT.”

-

AI in education is a serious topic, and many schools and universities are blindly jumping into the "AI-first" wave without considering short and long-term consequences.

It would be great to hear more from teachers and educators to understand potential solutions.

This might be a great opportunity for rethinking the education system and how students are assessed.

-

👉 Link to the full article below.

👉 To learn more about AI's legal and ethical challenges, join my newsletter's 94,700+ subscribers (link below).

[Roger E. A. Farmer @farmerrf]

There is enough material here for a five volume treatise. @JesusFerna7026 and @ferarteaga display an astounding breadth of knowledge on the ideas and influence of Marx that encompasses his economics, sociology, politics and philosophy all wrapped up in the biographies of antagonists on both sides of the many debates they clarify. Apparently Max Weber is next. I hope they follow through.

[Jesús Fernández-Villaverde @JesusFerna7026]

Since I have posted so much on Marx vs. Weber, modernity, and development over the last few weeks, I have posted an updated slide deck of my lectures on Karl Marx and the Marxian Tradition (together with @ferarteaga) here:

https://t.co/TOGm7jXMKG

This is a long deck: 437 slides in the last compilation! (It also takes a few seconds to upload.) If I were to teach it carefully, with plenty of class discussion, I would require a whole semester. Even then, some topics (e.g., the Frankfurt School) receive only a cursory treatment because I focus more on economics and political economy, broadly construed. I hope to extend the discussion of those someday.

However, I cover topics rarely seen in these courses, such as Hans-Georg Backhaus and the Neue Marx-Lektüre, because most of the work is not translated into English and must be read in the original German.

I don’t have an equivalent slide deck on Max Weber, as I haven’t lectured on him. Hopefully, one day I will.

Comments and feedback are very welcome.

[Roger E. A. Farmer @farmerrf]

This, from @DrJStrategy is well worth reading. Thoughtful analysis of how US policy is reshaping the world order.

[James E. Thorne @DrJStrategy]

Food for thought.

The New Great Game has arrived, and the terrain has shifted from 19th-century mountain passes to 21st-century sea lanes, energy chokepoints, data centers, and payment rails.

As I argue in my recent National Review essay on the Hormuz crisis, what is ending is Pax Americana, the era when U.S. power provided a subsidized security umbrella while others free-rode on the system it maintained. What is emerging in its place is a sharper contest of systems that forces capital back into productive use, restores economic sovereignty, and redefines peace on terms closer to the post–Cold War dividend than to managed decline. This article develops that argument in full, and it is available to read with no paywall.

[Roger E. A. Farmer @farmerrf]

I found JP a pleasure to work with. @JpBouchaud has a justifiable difficulty in accepting bad assumptions that economists take for granted: perhaps because he has made money as a HF manager by exploiting flaws in those assumptions. Here is an ungated link to our 2023 JPE piece. https://t.co/txeI9ciYsF

[𝔐𝔽𝓩 @mean_field_zane]

The thing I find sorta frustrating about JP Bouchaud is that he’s capable of making some pretty sizeable contributions to academic finance and introducing new perspectives, but despite being such an obviously sharp guy, he’s let reflexive NNT-style “seems-true” anti-economics criticisms to make him utterly hostile to other economists who have very valid critiques of his work, so he’s completely limited his own impact. The abrasiveness and arrogance means that a serious contribution is less likely to come into being because of a lack of openness and collaboration. He seems to do this because so many out there love the anti-orthodoxy commentary; it’s a cheap win to sound smart because ivory towers aren’t allowed to hit back, and also because he’s so used to being completely listened to as a rich HF manager that pushback from economists seems to instantly drive him to hostility. The urge to make himself into an outsider firebrand may feel good to indulge, but he really should try and work with other economists so we can all get at the truth better.

[Roger E. A. Farmer @farmerrf]

This analysis from @izakaminska of the purpose of the swap lines extended to the UAE by the US is well worth reading: and, IMO, basically correct. Well worth reading.

[Izabella Kaminska @izakaminska]

A note on the increasingly frustrating dollar swap line confusion.

While the ESF definitely has a shady history in which it doubles up as black ops financing arm of the US Treasury, when it comes to the UAE situation, it's simple dollar liquidity mechanics that are the issue in this case.

To understand this you need to go back to your Zoltan Pozsar 101, about how shadow dollar liquidity actually flows through the system. This explains entirely what's going on at the moment.

Adam Tooze would have you think otherwise and brings up the ESF's shadowy history as a source of slush funds to add intrigue to the situation. (While it's not untrue, it's besides the point). And now Brad Setser is speculating there may be "something radically new about the US providing dollar credit to a country that itself has pledged to invest in the US" and that this "looks like the US government is financing a off balance investment fund outside Congressional scrutiny, with the Emirates getting the upside ..."

But I'm pretty sure that this is not the case. It's an entirely obvious and transparent situation.

First of all, the original WSJ story that flagged the UAE situation talked about swap lines not ESF-funded Argentina-style swaps. These are entirely different arrangements. For one, the ESF is a Treasury-powered vehicle and usually operates via finite credit facilities. It is also usually arranged between respective sovereign Treasuries.

A swap line, however, is Fed-initiated and potentially limitless. It is an arrangement between fellow central banks.

Now, if you speak to central bankers in the know, they will tell you that despite the central banking framing, it's not entirely the case that the Treasury has no influence on the initiation or not of a swap line. But this doesn't change the mechanical structure, which sits outside of the Treasury system — and imposes on it only in so much as central bank profits or losses ever do. The WSJ may have got the nomenclature wrong, but I doubt it.

As to why the UAE, despite having pledged to invest in the US, needs dollars? I'd argue it's because the original investment is mostly an expression of allegiance, and a signal that the UAE trusts the US to defend its property rights more so than any other superpower and is prepared to fund its military-industrial reconstitution... since the protection of its property rights also hangs in the balance.

If the UAE decides to fund these investments with USTs, this mostly constitutes a transfer of that economic value from the Treasury to the private sector. There needn't be a liquidity event associated with the transfer if it's mediated, as it has been, at the US Government level and extended via a co-investment with the US into newly forged equity investments.

The UAE leg, in that sense, becomes a promise to expire its outstanding claim over the US Treasury in exchange for x shareholding (49% one would presume) in the newly forged company. Think of it more like an asset swap, wherein its debt-based assets are swapped into equity assets underpinned by USG co-investments.

The actual liquidity to start the venture up would likely come exclusively from the US side, with the funding essentially already raised by way of the defense industrial allocations in the BBB. In that scenario, the investments act more like a quid pro quo with an ally, to ensure the US can raise the money it needs via formal channels, without fear that its bond markets do a Liz Truss.

But it's very unlikely that the UAE plans to fund these American investments entirely with UST reserve assets. Much more likely, it plans to deploy its trillion-dollar sovereign wealth fund chest, as well its future oil revenue, to meet most of the $1.4 trillion investment it has promised over 10 years.

In that case, what the UAE would really be doing is merely bouncing back dollar liquidity that's already coming its way from existing USD-denominated assets straight back into American investments. The only difference is that on this occasion, it has agreed to transfer some level of influence over how those investments will be steered. This makes sense if the true purpose of the arrangement is to help reindustrialise the US, as the USG sees fit, so that it can better provide regional security and defy industrial decoupling with China.

Why does it make sense for the UAE? Since some 50% of its SWF is already invested in the US, if America loses in a war with China or Iran, so does the UAE. It needs a strong and autonomous America with trusted supply chains to defend it.

In some respects, this is an echo of how China funded its own industrialization. In 1979 under Deng Xiaoping’s broader “Reform and Opening-Up,” China brought in its Equity Joint Venture Law, creating the main channel through which foreign capital first entered China’s industrial economy.

The main difference here is that in China's case, the co-investments were with Western private sector companies or multinationals. In America's case it is wooing capital from fellow sovereigns, with whom it can establish related defense agreements. Statecraft 101.

Why dollar swap lines then? Well, if a good chunk of UAE dollar liquidity is drawn from oil sales, this is self-evidently currently under pressure. And while the UAE probably has many other sources of dollar income, it's what happens at the margin that matters. Under a peg system even a small marginal fluctuation in flows can put pressure on the system. All the more so, if foreign residents are moving money out of the UAE because of regional volatility.

A country like the UAE, in such circumstances, faces the same problem as a distressed bank. It finds itself technically dollar-asset rich, but simultaneously dollar-liquidity poor.

The options it has on the table in that case are either to abandon its peg temporarilly, liquidate its assets at potentially firesale prices compounding the problem (definitely suboptimal), borrow from the market, or seek the one thing it doesn't have under a pegged system: Access to a dollar lender of last resort.

With the UAE likely to become a formal ally, extending lender of last resort facilities to help it manage local dollar liquidity issues, seems the obvious way to go for the US. In a sense it becomes the first official member of what Robert McCauley sees as the emergence of a new dollar swap-line diplomacy club. [Which could, in my mind, be the makings of a new type of IMF system.]

For a country that already operates under a soft form of dollarization, it's not too great a leap.

References below:

[Stéphane Surprenant @S_Surprenant]

Let me clatify this problem for everyone.

MV = PY is an identity. It simply states that you need enough money to cover all transactions. The theory is about how you think money M, velocity V, prices P, and output Y interact.

The intuition behind monetarism is often conveyed to undergraduates by saying that if you hold V and Y constant, then changes in M will be reflected in changes in P. That is the simplest way to say that printing money causes inflation. The problem is that this isn't the actual theory and it glances over important nuances.

For starters, in the theory behind all of this, 1/V is money demand and that thing varies over time. The grown-up version of V is constant is V is covariance stationary meaning that it fluctuates around a stable mean. That is precisely what people debated in the 80s and 90s, and more recently in the 2010s using a different way to measure money in the US (specifically, the latter research used Divisia indexes).

One reason this matters is that if money demand and money supply both increase, M rises and V falls, so there need not be a rise in prices. Intuitively, people have to use the money to bid up prices. Nothing happens if everyone sits on it.

The other reason this is important is the nature of the signal you get from variations in M to predict variations in P. What theory gives you is a long-run relationship between M, P, and Y: if V fluctuates around a stable mean, then M, P, and Y have to "grow together" and, if they break apart too much, they get pulled back in. The technical term is that M, P, and Y share a stochastic trend -- they are cointegrated. So, what the theory buys you is what we call an "error correction" mechanism that keeps everything together over long periods of time. It's not nothing. To first order and with some assumptions, it says that 2% inflation and 2% real GDP growth requires 4% money growth over the long-run. But it's not clear that it's a great signal to forecast inflation -- other things besides monetary policy moves stuff in that equation.

Now, back to policy. Monetary policy in Canada only engaged in quantitative easing during the pandemic. Otherwise, the Bank of Canada usually works by setting a short term interest rate, not by targetting changes in the money supply. So, it's hard to measure those things just for Canada, but one can try.

To do it, you have to ask yourself what happened between March 2020 and the peak of inflation in June 2022 (healine CPI peaked there year-over-year). Can you really attribute all or even most of this to unconventional monetary policy? Because there were massive fiscal expansions in both Canada and the US, lockdowns and subsequent easing of punlic health policy, disruptions in shipping, energy and commodity markets, and the Canadian labor market was extraordinarily tight for a while... Where does any of this figure in your analysis?

I am working on a project specifically on that inflation episode for the US and Canada using a model estimated before the pandemic (partly to see if "old" explanations are enough). I don't explicitly treat unconventonal monetary policy like QE and FG, but it would probably show up as demand shocks in my model. And I also have some policy counterfactuals to think about the cost of moving to hike rates earlier when inflation started rising. I'll be sharing preliminary results in two weeks at the SCSE conference in Quebec City. Feel free to follow my work and take a look later this year when we have a full working paper ready.

[Roger E. A. Farmer @farmerrf]

Congratulations @ChrisPhelanEcon! All the best with your new position.

[UMN Economics @UMN_Econ]

https://t.co/XIq7oaNAyc Congratulations to @ChrisPhelanEcon on his nomination to be Chairman of the Council of Economic Advisers! He continues Minnesota's proud tradition—from Nobel laureate Leo Hurwicz to Walter Heller, CEA Chair under Kennedy/Johnson.

[Roger E. A. Farmer @farmerrf]

💯

[alberto bisin @albertobisin]

Could not agree more.

[Roger E. A. Farmer @farmerrf]

Congratulations @ludwigstraub !!!

[AEA Information @AEAInformation]

Congratulations to Ludwig Straub (@ludwigstraub) of @Harvard, winner of the 2026 John Bates Clark Medal! https://t.co/LmaCMo0HXS

[Konstantin Kisin @KonstantinKisin]

@christopherrufo @micsolana As a huge fan of this platform, I can't help noticing that the noise to signal ratio here has deteriorated. Monetisation has created an incentive structure that is conducive to neither authentic discussion nor quality content.