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"Inflation - a subjective ideological explanation" discussion between classical and keynesian definitions

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dvictr Posted: Sat, Dec 15 2007 4:46 AM


if you graduated college anytime before the year 2000 you will clearly remember that the textbooks on intermediate macroeconomic analysis introduced the keynesian models side-by-side with the classical interpretation... possibly even a chapter was devoted to a discussion between the debate between both economic theories... well it may suprise you that the debate is over... the most widely used textbooks for this intermediate course have completely abandoned the discussion... now including "only the best of all ideas"....according to the author! but most importantly are leaving a generation of college students without a real introduction of the classical theory of ecomomics...

in many ways the debate is ideological.. keynes belived that markets were unable to smoothly find equilibrium..mises belived that in a free-market the forces of supply and demand would force convergence. with world trade tarrifs, subsidies, the geo-political situation the world market is anything but free... but as a libertarian mises viewed the state of a free market not only in principle but an obtainable future goal. the keynesian theory is based on the fact that the world is not a free market and people are ignorant and that governments must interfere with financial transactions. the fed is based on a congressional mandate to keep unemployement low... a basis that during the great depression seemed an essential duty of the government but at this point in an industrial economy is unessesary. the keynesian theory is based on observations from causes of the great depression which were later proven to be incorrect by the monetarists. but the function of focusing and artificially fixing employment continued to created a system of banking which contradicts the monetarist goal of increasing the real value a currency in a time of rising world industrialisation.

the definition of inflation is subjectively debated because of the idea of a "real balance effect" which keynes excluded from his model and has major ramifications to the effects of artificially lowering interest rates including the ones that the fed has direct control of..go to a library of a major research university and there are hundreds and hundreds of books interpreting the classical model also called the dynamic model and the keynes is-lm model graduate programs on economics do not teach the is-lm model but because of its simplity is used to teach income identities to begining students.

to summarize two points.. the classical model assumes the elasticity of money liquidity prefrence makes the the LM curve inheritently inelastic very steep. this is a major difference in both thoeries.. and at this point in time cannot be empirically disproven one way or another in a "long run".. the IS curve in the classical model is very elastic.... in the keynesian model these curves have opposite elasticities.

another major discrepency is the effect of a shift in the LM curve. when the money supply is increased aka shifting the LM curve to the right ... the IS curve does not shift... in the keynesian model!!!an assumption ben bernanke defended in his testimony to the congressional committe of financial services. .. in the classical model which is no longer included in the most widely distributed macroeconomic texts...the IS curve ALSO shifts to the right, from an increase in the money supply. the keynesian model treats the LM curve as exogenoues to IS... the classical theory includes the idea of a "real money balance" an economic effect that the value of someones wealth falls when the money supply is increased because prices go up and the value of someones purchasing power goes down. this fundamental theory is ommitted in newer macro texts... an outrage because the implications are necessary to understand the actions of the federal reserve

the notion that wages and price expectations adjust in the medium run does not change the fact someone that has a depreciating liquid asset "cash" ...the purchasing power in the world market has been reduced two fold.. domestic inflation... and international appreciation of standard commodities. metals, energy etc. in relation to a depreciating fiat currency. this notion is in a sense ideological because some people want you to belive that only nominal values are relevant if you are a wage earner and a domestic consumer you buy your goods in the domestic market so only imports go up.. but when exports are cheap in the world market they have the effect af raising the wholesale price which results in higher prices domestically for consumers... and the CPI is not adjusted to take this into account this is very important because if it was the inflation figures would be much higher

basically the dow jones index will inevitably be priced at 100,000 points but what is 100,000 points in relation to the price of gold/oil yuan/ euro? obviously if you are an active international trader you can move into the highest yielding bonds and stay ahead of the inflation but the national account deficit ballons and the average consumer and the poor which have no savings is the big loser in terms of real world purchasing power...

I know the value of nothing, and the price of everything
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ozzy43 replied on Sat, Dec 15 2007 11:33 AM

May wanna think about reposting in the 'economics questions' forum... 

None are more hopelessly enslaved than those who falsely believe they are free. - Goethe

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