The utility of money

Rowe, Beckworth, and Kling are in a blogosphere discussion about money, and its role. Is there a money illusion? Somewhere Jim Hamilton posted a study that determined about 20% of our inflation is monetary, the rest is due to the relative volatility of separate goods. I interpret that to mean that 20% of the efficiency of our economy is due to the efficiency of money.

What makes money useful are the financial analysts, bankers, and investors, real people; just like any other business. These people work along the bankers yield curve, assigned to estimate inventory levels at particular terms. The central bank can deflate of inflate this group of people; making the supply chain for money shorter or larger. When the central banker makes a large enough change in short term rates, the banker people in total will shrink or expand the term points along which they operate, like any other good with its inventory managers. Bankers and investor employment will have sudden changes to such a regime change. I call it a regime change if the number term points on the yield curve change.

When I look at Beckworth's VAR charts, what interests me is the short term effects, how long does the economy take to adapt to a central bank policy change. What I find is that the two sigma boundaries diverge after about six to ten months, which I take as the time required for investors and bankers to adapt to the new inflation/deflation scheme.

In QM Theory, deflation or inflation of any supply chain will of necessity overshoot, because supply chain changes occur in integer jumps. Also, the banker's yield curve, though the fastest adapter, cannot do its job well if it adapts too soon, it is a follower. The VAR system is not quite enough to tell us if the central banker has moved us closer to an equilibrium or away, because of the follower problem. The deflation/inflation scenario has already occurred by the time the central banker reacts. The central banker rarely errors, except in the timing, he is always late.

The research needs to decompose the economy into five or so major sectors, and run what really is a Kalman filter, a simultaneous VAR on the major components of GDP, including the financial system. A more difficult task, but the paper referenced by Hamilton (which I am not searching for) did exactly this. The paper first decomposed GDP into sectors, then ran the VAR separately for each component.