Learning From Models

1. Learning From Models Chapter 12

2. Irving Fisher • The economic laws and government responsibilities which govern the value of money formed the most important economic question in America in the 1890s • Elections of 1892 and 1896 • Farmers crucified on a cross of gold • PPM: the purchasing power of money

3. Prices • The value of money is the reciprocal of the general level of prices • Quantity theory of money • Double the money and you will double the prices • Fisher did not see this as a policy rule • PPM explored the process and show under what conditions QTM held

4. Irving Fisher: Model Builder • Inventor • Visible card file index • The Equation of Exchange • Three illustrations

5. The Arithmetic ‘Illustration’ • The amount of money in the economy is much less than the total value of goods exchanged, each bit of money exchanges many times in the year. • The ‘velocity’ of money’s circulation • Each person has their own transactions velocity. The communal velocity is an average

6. One Simplifying Assumption • Exclude non cash transactions and foreign trade • Shows that if the amount of money changes, but velocity and quantities do not change, then prices must change • Change in velocity and quantities also affect prices • Three factors determine price levels

7. The Mechanical-balance ‘illustration’

8. The Algebraic ‘illustration’ • Formulas on page 361 • An algebraic statement is usually a good safeguard against loose reasoning • Self-evident

9. The World in the Model • Fisher has led the reader from the world of his/her individual money-good exchange into an aggregate, hence to a general world • We are led into believing in the world in the model because of familiar features • Trading Places • Mechanical balance • Exchange is a physical oscillation? p364

10. There is no constraint that says the balance must rest at equity • What makes the money-exchange balance even out? • Monetary induced cycles and disturbance are included in the model

11. The Connecting Reservoirs Model • Oft-used metaphor in economics • Sees money or goods as flows of water such that their prices are automatically equalized between two places • The effects of different arrangements of the parts

12. Model Design (First) • General design features • Designed system set up as a laboratory experiment • Some features allow intervention and control • Others do not

13. Model Design (Second) • Hybrid model • Part hydraulics • Part economics

14. The Model at Work • Three-fold variations • An increase in production corresponds to an increase in the number of pipes • An increase in consumption corresponds to a decrease in the number of pipes • Closure of an interconnecting pipe by a valve • Goal: to understand what determines the purchasing power of money

15. Rearranging the Model • Fisher extended the model to explore how different institutional arrangements would affect the purchasing power of money • Added an extra element to the model • An additional separate reservoir of is added which is then connected to the currency reservoir • Page 378

16. Bimetallism • Two metals circulate as legal tender together • One cheap, the other dear • Cheap money will drive out dear money • It all depends on the ratio • We may believe that the model is a ‘good representation’ or not

17. What Does the Model Represent? • The bullion flasks represent containers in which the stocks of gold and silver available in the world are stored for usage • There is nothing like this in the real world • Fort Knox is the closest thing I can think of • There is no way to measure such stocks

18. Conclusions • We learn from models in two ways • In building them • In using them