The national account standard:
And the equation of exchange:
As Matt rightly notes that we can combine the two:
Matt uses the notation X for net exports – I use NX. P is assumed to be 1.
This is of course completely correct – both are identities. They do not tell us anything about causality. However, the point I have been making is that when people think of (1) they also tend to think that causality runs from right to left in the equation. However, that is only the case if you ignore (2).
This is of course is also why the fiscal multiplier is zero. Hence, public spending (G) can only increase nominal GDP (PY) if the central bank plays along (and increases MV) or as Matt express it:
“If monetary stimulus increases MV then what you’ll get is more spending across a wide variety of categories. Since in today’s economy some things are scarce (gasoline, apartments in San Francisco) and other things are not (unskilled labor, mall space near Phoenix) that will mean some increase in real output and some increase in prices. Similarly on the fiscal policy side, there’s no such thing as an inflation-adjusted tax cut or appropriation. You’re pulling on nominal levers, so if crowding out doesn’t occur that has to be because the central bank is tolerating an increase in the price level.”
This is of course also why the idea that we could use fiscal stimulus to get us out of the European crisis makes no sense at all unless the ECB plays along. You can not increase PY without increasing MV.
Matt has been calling for fiscal stimulus in the US, but his fun with the identities could indicate that he is changing his mind or as David Wright comments on Matt’s article:
“The contrapositive of an assertion is logically equivilent to the original assertion, and the contrapositive of this statement is “if the central bank is enforcing an inflation target, fiscal policy will be ineffective because of crowding out”. This is precisely the claim that Scott Sumner has been shouting from the rooftops from the last couple of years, but in that same time you have been advocating fiscal stimulus and the fed has been consistently enforcing an inflation target. Have you changed your tune?”
I will leave it to Matt to answer, but I agree with David that it surely looks like Matt is now fully converted from the New Keynesian view to Market Monetarism. Not that it really matters – Matt has long been advocating NGDP level targeting and that is what is really important…
– and unsurprisingly reaches the same conclusion as me (and a bit more).