He also writes:
But what are theses variables and relationships that have such mathematical precision? Consider V, velocity. Velocity is the residual of the measurables nominal income and money. Thus, the derivative of V with respect to i (the interest rate) is really from the derivatives, and their correlations, of nominal income and money. Are either of these stable in any sense (d(PY)/di, dM/di)? No. They have no stable values and suggest they are no better than asserting a mathematical relationship between your body temperature and how much coffee you drank based on thermodynamics: there's a simple effect from the initial impact, but very shortly feedback effects that make the initial physical model worthless.Read the whole thing. Also, check out the comment from Brad Delong and Eric's response.
And so it goes with all these relationships. The economy is a complex, nonlinear, adaptive system where short run effects are often opposite of long run effects. Ultimately, people need to be involved in activities that generate more benefit than they they cost for they to be sustainable, and they must appear attractive to individuals given their other opportunities as they see them. A higher growth rate simply involves having more people near their unknown optimal--unknown because only rudimentary laborers know what the truly best use of their time is at any moment--and stagnation is caused when too many individuals lose their ability or willingness to actively search and make these choices. The more government puts in rules saying we can't drill in the Arctic because of potential effects of exhaust on a nearby village of 100 Eskimos, or that we can't cut hair without a state license, the lower our productivity. Economic freedom results in long term growth and so the key to macro policy is not from some chain rule but rather the wisdom of Smith, Bastiat, von Mises, Hayek, Friedman, Stigler, and the rest who found aggregate prosperity and economic freedom synonymous.
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