Saturday, July 23, 2011

What determines the price level

The price level is determined by aggregate demand. If there already is enough existing demand for all supply, then the more demand, the higher the price level.

Demand is determined by income, and access to credit. The greater the income, the greater the demand (unless one is uncle Scrooge).

Access to credit (assuming banks are prudent lenders avoiding NINJA loans) is determined by expected future level of income.

So the next question is where does income come from? It comes from other people’s spending. Other people’s spending is determined by their own income and access to credit.

So the real question to ask is how does income keep on generating itself? Aggregate confidence in the stability of markets, in the currency, in the belief that income will continue. What makes this confidence possible? The paradigm that answers this best is the true economic paradigm. You be the judge.

Commented at The Money Illusion. And here's me previously on why monetary policy won't work to stimulate demand this time, also here.

Update: Nick Rowe gives the monetarist explanation for the price level, Eric Tymoigne reiterates the MMT view.

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