Arnold Kling has a good "rant against monetarism", triggered by my saying "My position is that a general glut can *only* be caused by an excess demand for the medium of exchange."
Arnold's response:
"Most economists believe this, or something like it. I used to believe it, or something like it. I think that it is a horrible, horrible, confusion."
(I only wish he were right about the first bit, because I can find very few economists who believe it, and I've been trying hard to get them to believe it.)
Let's start with where I agree with Arnold.
"If you took money out of the picture, the construction worker and the college student would still be unable to solve their problem. When it comes to the failure of wants to coincide, the existence of money is part of the solution, not part of the problem."
Bingo! Yes, absolutely. It is hard to solve the economic calculation problem, of who should produce what, with whom, and how, and who should consume what. And without monetary exchange, solving that problem would be much, much, harder. Monetary exchange is part of the solution, not part of the problem.
With monetary exchange, I can concentrate on deciding what to produce, and on what to consume. I don't have to concentrate also on the chain of barter transactions that might eventually lead me from what I produce to what I consume, which depends on all the other things that all the other people might want to produce and consume. That's why we have a monetary exchange economy.
But it is precisely because money is part of the solution, and a very important part of the solution to a very real problem, that when something goes wrong with money, the solution falls apart. If it really were as easy to solve the economic problem with barter as with monetary exchange, it wouldn't matter if something went wrong with money. We would just resort to barter.
If barter were nearly as easy as money, then an excess demand for the medium of exchange would not cause a recession. People would just switch to barter, and the economy would carry on as normal, with a slight increase in transactions costs.
And I also agree with Arnold here:
"Perhaps my rant should be directed against Walras' Law, which says that excess supply somewhere implies excess demand somewhere else. Who the heck enforces Walras' Law? Nobody. Entrepreneurs are trying to figure out how to make a profit. Their aggregate groping is what discovers a viable pattern of comparative advantage and specialization."
Yep. Walras' Law is false. Yes, I know we learn it in micro, and it seems to drop straight out of the budget constraints, when you add them all up. But it's false, horribly false. And it's false because, as Arnold says, there's nobody to enforce it. More precisely, if there were a centralised Walrasian auctioneer, trading every good for every good in one big market, and not allowing trade to begin until he had found the market-clearing vector of prices, then Walras' Law would be true. But there isn't, so it's false.
That Walras' Law doesn't work in a monetary exchange economy is obvious, once we start to count up how many excess demands and supplies there are. Let there be n goods, including money. Walras' Law says that the sum of the values of the n excess demands must equal zero, for any price vector. Rubbish. In a monetary exchange economy, with n goods including money, there are n-1 markets. And in each market two goods are traded: money; and one of the other goods. So there are n-1 excess demands for the non-money goods, and n-1 excess demands for money. That makes 2(n-1) excess demands in total, not the n excess demands in Walras' Law. And each of those n-1 excess demands for money is chosen to maximise utility subject to the quantity constraints in the other n-2 markets. So they aren't even mutually consistent. If you actually succeeded in buying or selling what you wanted in one market, you would want to do something different in all the other markets.
Setting n=2(n-1), we solve for n=2. Yep. Walras' Law would work fine in a monetary exchange economy with 2 goods, one of which was money. But who the hell would need money if there were only one other good? If there are only 2 goods, apples and bananas, how could we even tell whether apples were used as money, or bananas were used as money? If n=3, and we saw carrots exchange for apples, and carrots exchange for bananas, but we never saw apples exchange for bananas, then we would know that carrots are used as money. But n=3 means n is not equal to 2(n-1). So Walras' Law is nonsense in a monetary exchange economy. It's not even false; it's nonsense.
Forget Walras' Law. What about re-calculation?
The calculation problem doesn't solve itself. It takes people to solve it. The price system helps them solve it. Monetary exchange helps them solve it. But it isn't easy to solve. And it never really does get solved, because there's always the chance another entrepreeur could come along and solve it better. And if technology, resources, and preferences are changing as well, people have to keep re-solving it. That's what I take to be the re-calculation problem.
But that re-calculation is happening all the time. What's it got to do with recessions?
Sure, sometimes a really big real shock comes along, like the rise in oil prices in the 1970's, or a war, and it takes a lot more re-calculation than it normally does. And OK, a financial crisis isn't exactly like a change in the underlying tastes, technology, and resources of Walrasian general equilibrium theory. But you don't have to try hard to convince me that it too would require a re-calculation. And maybe output would fall while we are trying to figure out how to re-solve the economic problem. Maybe even employment would fall too. "Hang on guys, don't commit to doing anything quite yet, while I try and figure out where you should best be working now that everythings changed". I'm sure every central planner or local manager has had to say that at some time or another.
[Added for clarity: this is the point at which I start disagreeing with Arnold.]
But I just can't buy it as a full story of recessions. It's the general glut thing that's missing. Stuff gets easier to buy in a recession, and stuff gets harder to sell. That's an essential part of what makes it a recession. To say that stuff is harder to sell and easier to buy is meaningless outside a monetary exchange economy. In a barter economy, selling stuff is buying stuff. When you are trying to sell you are trying to buy at the very same time. A thing can't be harder or easier than itself.
What makes a recession a recession, and something more than a bad harvest, or a re-calculation, is that most goods, and most labour, gets harder to sell and easier to buy. And I really want to call that an excess demand for money. Because it is money we are selling stuff for, and it is money we are buying stuff with. And if I've also got a theory as well, which says that an excess demand for money will cause a drop in output and employment, and an excess supply of goods and labour, that's just icing on the cake.
This probably won't convince Arnold. But it's why I believe that general gluts — recessions — are always and everywhere a monetary phenomenon.
Worthwhile Canadian Initiative 
Its the recalculation that leads to the excess demand for money. As I understand Arnold, you can avoid the excess demand for money by printing more money, but if the underlying cause is a coordination failure, having extra money doesn’t relieve “the” problem. It just limits the effects of not having enough.
So which is “the” problem? “recession” stands in for a “recession in the growth of real output”, not a general glut of goods. You’ve done a bait-and-switch in this post!
So I don’t think excess demand for money is the theory of everything. Its a theory of a uniform decline in the price-level which is basically a tautological statement.
So again: why is real output slumping? That’s where recalculation deserves some credit, but yes its also true that an excess demand for money can cause real output to slump.
Nick, your argument appears to be that a general glut is equivalent to an excess demand for money. That seems entirely logical, but it says nothing about causation. Does causation appear anywhere in your line of reasoning?
I’m very confused about what a general glut would look like. Could someone describe a situation in which a general glut would exist (involving a small number of goods)? That would be great.
[edited to remove italics around “equivalent to” NR]
Sorry, I failed at html.
Hi, Nick. It is hard to think of a counter-example in human history where there is a glut in a non-monetary economy. But I wonder how you would characterise the honey-bee economy, which produces so much honey that bee keepers are able to harvest the surplus continually without doing any damage to the hive. Might that be an example a glut in a non-monetary economy? In this example, I would say that the glut is simply caused by excessive supply of labour and insufficient demand (within the bee hive) for honey.
Just a thought!
“But I just can’t buy it as a full story of recessions. It’s the general glut thing that’s missing. Stuff gets easier to buy in a recession, and stuff gets harder to sell. That’s an essential part of what makes it a recession. To say that stuff is harder to sell and easier to buy is meaningless outside a monetary exchange economy. In a barter economy, selling stuff is buying stuff. When you are trying to sell you are trying to buy at the very same time. A thing can’t be harder or easier than itself.”
I totally don’t buy this paragraph.
In a barter economy, John writes detective stories and needs a haircut, David is a hairdresser and wants something to read. Recently, David has gone off detective novels and won’t read them. As a result both John and David are underemployed and sitting around, and their consumption has fallen too, and they’re both desperate. If I’m willing to give John a haircut, he’ll write an extra-special detective story for me. And if I’m willing to write David an interesting novel, he’ll give me an extra-special haircut. It’s very easy to “buy” and very hard to “sell,” precisely because a Recalculation is going on. But because there’s a mismatch between production and desire, the barters cannot take place. What no-one knows (not even David) is that he would really enjoy reading horror novels. Once everyone figures that out, and John works out how to write them, the economy is going to be fine.
Nick,
You show why Walrus’ law doesn’t work in a monetary economy.
Kling says it doesn’t necessarily work in a barter economy either:
“If you took money out of the picture, the construction worker and the college student would still be unable to solve their problem.”
Then he says money is only PART of the solution:
“When it comes to the failure of wants to coincide, the existence of money is part of the solution, not part of the problem.”
So he is arguing that money is a necessary but not sufficient part of the solution.
You agree at one point – but then you also seem to argue that money is not only necessary but sufficient – i.e. there is no recalculation scenario that dominates over the effectiveness of money as a solution. Which is it for you?
And:
“More precisely, if there were a centralised Walrasian auctioneer, trading every good for every good in one big market, and not allowing trade to begin until he had found the market-clearing vector of prices, then Walras’ Law would be true.”
But Kling disagrees with that as well – recalculation dominates.
Then:
“That Walras’ Law doesn’t work in a monetary exchange economy is obvious.”
Kling doesn’t disagree with that.
Then:
“The calculation problem doesn’t solve itself. It takes people to solve it. The price system helps them solve it. Monetary exchange helps them solve it.”
Kling doesn’t disagree with that.
“But I just can’t buy it as a full story of recessions. It’s the general glut thing that’s missing.”
Which is it? I’m very confused on where you stand about the relationship between recalculation and money solutions. Are you saying that there is no Kling recalculation story that can’t be resolved with money, or not? If not, you must be agreeing with him.
Someone should tell Kling that house building is now behind the curve. The excess supply of houses should already have been worked off in a normal market. The problem is that households have too much debt because the prices they paid for LAND were too high (including the much greater number who brought existing houses).
And another issue I have with the “it’s just recalculation” crowd is that they need a dynamic explaination of how the recovery starts. Do new industries quietly grow until they take over the economy. Or do existing industries mostly recover?
But I still have a question for Nick here.
Distribution matters. It is not enough to “create more money” on the books of financial institutions. That won’t work. You need to distribute it. All the people who are madly trying to grab money, and trying to grab money to make up for the hole in their balance sheets (i.e. not to buy things but to pay off debts, or accumulate other financial assets). Isn’t this missing from the story. What does the Walrasian auctioneer do with financial assets? It is not enough to just have consumer goods and money, you need financial assets to tell the whole story.
… I can find very few economists who believe it, and I’ve been trying hard to get them to believe it.
Here’s my suggestion: stop trying to make your case by explaining how your view differs from that of Scott Sumner, Arnold Kling etc. No doubt they are good people in their way, but they don’t provide a sufficiently clear statement of their models to enable readers to see just what the issue is. Instead, take something out of a serious textbook as your starting point. Specifically, take Chapter 18 of Mas-Collell, Whinston and Green (especially section 18C). Those authors dot their teas and cross their eyes, as Krugman would say. They provide a clear starting point for discussion.
Jon: at the margin, in a recession, it’s the excess demand for money that limits output. If that excess demand for money were removed, output would rise, until it hits the new limit imposed by recalculation. If that recalculation limit were removed, output would rise, until it hit the new limit imposed by available resources and technology and tastes.
Output and employment fell badly in Germany and Japan in 1946. That wasn’t a recession. That was bombing plus recalculation. (Unless my history is very wrong).
Blikk and Salem: here’s my story. It’s a monetary exchange economy, because there’s no double-coincidence of wants. Start in equilibrium, then cut the stock of money. Everyone stops buying, because each is trying to rebuild his stock of money. Apples producers want bananas but can’t sell their apples and so won’t buy bananas. Banana producers want carrots, but can’t sell their bananas, so won’t buy carrots. Carrot producers want apples, but can’t sell their carrots so won’t buy apples. Each one tries to conserve his money. Barter can’t work (unless all 3 find each other in one place and do a 3-way deal).
Salem: In your story, if it’s a barter economy, there’s an excess supply of detective novels matched by an excess demand for haircuts. It’s not a general glut. Haircuts are in excess demand.
anon: I have edited my post to make it clear exactly where I begin to disagree with Arnold. Right near the end.
reason: Maybe, you think that the excess demand for money is caused by an excess demand for financial assets. Like Brad DeLong’s story.
“But I just can’t buy it as a full story of recessions. It’s the general glut thing that’s missing. Stuff gets easier to buy in a recession, and stuff gets harder to sell. That’s an essential part of what makes it a recession. To say that stuff is harder to sell and easier to buy is meaningless outside a monetary exchange economy. In a barter economy, selling stuff is buying stuff. When you are trying to sell you are trying to buy at the very same time. A thing can’t be harder or easier than itself.”
Naturally you could have a recession in a barter economy, but in that case things are both harder to buy and to sell (say due to increased transaction costs, etc.). Never really thought it before, but a recession with money things really are different.
Thanks for the post!
I think you have a double-barrelled version of the same resistance to your argument so far.
The first is that the recession is caused by an excess demand for safe assets, rather than a excess demand for money (DeLong). It just happens that the demand for safe assets spills over into money.
The second is that the recession is caused by recalculation rather than the excess demand for money (Kling). Money assists with the required recalculation process.
These are similar in that they both view the excess demand for money as a by-product or symptom of the primary cause, rather than the cause itself.
Nick:
Your point that recessions are situations where it is hard to sell and easy to buy is important.
Jon’s claim that no, recession is output falling suggests one source of confusion.
The puzzle is why is it that in a world of scarcity we have a situation where there are unemployed resources? People want goods and services. People want to provide resources to produce them.
If a plaugue wipes out 50 percent of the population, or bombing destroys 25% of the capital stock, and production falls–what is the puzzle?
If people decide they don’t want to work as much and would rather enjoy long weekends or a longer retirement, output falls. What is puzzling?
Pollution is considered such a problem that producing goods and services is greatly restricted. Output falls. This is a puzzle?
We live in a world where everyone has every good they good use. We produce too more of some of them and they have to be hauled to the dump. Output is reduced so that disposal problem doesn’t have to be repeated. What is the puzzle?
But, we live in a world of scarcity. Many people could use additional amounts of many sorts of goods. They have resources that could be used to produced them (and have in the past.) But, now, they are producing less. They are consuming less. But they want to produce more and consume more. That is a puzzle.
Finally, there is a change in tastes, technology, etc. People want more of some things and less of others. The ability to expand the production of the goods people want is limited in the short run (low elasticity of supply.) Production can be expanded more effectively over time as new workers are trained, appropriate capital goods are produced and so on. Elasticity of supply rises over time. But in the contracting industries, it is possible to cut production immediately (though not necessary.) Yes, this is going on all the time, and the economy is in the middle of some elasticities of supply rising, and industries shrinking, and growing and so on.
Still, we can imagine it happening more or less. That creative destruction can be more intense sometimes. And so, these adjustments–people being put out of shrinking industries and the growing industries having caught up yet. Perhaps real output can fall.
But is the notion that structural unemployment and other adjustment costs (like specfic capital being lost and new capital goods slowly constructed) can vary really so special?
The puzzle, again, is when the demands for some things shrink and nothing grows. Or the growth in demand is less than the decrease. Or, most incredibily, the demand for everything falls.
And all of this in a world of scarcity.
What is the answer? Monetary disequilibrium.
“I can find very few economists who believe it, and I’ve been trying hard to get them to believe it.”
But wait … what Kling actually said was “… or something like it.” Perhaps it is true that narrow monetarists, who believe that recessions can only be caused by an excess demand for the medium of exchange as a medium of exchange, constitute a minority of economists. But economists who believe that a general glut can only be caused by an excess demand for the medium of exchange for whatever reason – i.e. “something like it” – are surely the majority, for they include economists who believe that recessions are caused by a general demand to shift consumption into the future, and such time-shifting is only possible in the presence of money.
That is a pretty technical point of difference, and you yourself remarked on how small is the disagreement between you and DeLong (say) in a previous post. As Kevin Donoghue remarked, you have not explained yourself very clearly here.
Nick wrote:
Salem: In your story, if it’s a barter economy, there’s an excess supply of detective novels matched by an excess demand for haircuts. It’s not a general glut. Haircuts are in excess demand.
I think Arnold’s argument is not correctly described by Salem’s story. An equivalent story would be something like:
In a barter economy, John writes detective stories and needs a haircut, David is a hairdresser and wants something to read. Recently, David has gone off detective novels and won’t read them. John’s needs also changed: he wants a modern haircut, one that is fashionable with story writers – but David only does conservative, old-style haircuts.
As a result both John and David are underemployed and sitting around, and their consumption has fallen too, and they’re both desperate.
If I’m willing to give John a modern haircut, he’ll write an extra-special detective story for me. And if I’m willing to write David an interesting novel, he’ll give me an extra-special old-style haircut.
It’s very easy to “buy” and very hard to “sell,” precisely because a Recalculation is going on. But because there’s a mismatch between production and desire, the barters cannot take place.
Once John works out how to write horror stories and David works out how to give a punk style haircut, the barter economy is going to be fine.
The ‘medium of exchange’ is not a necessary prerequisite for a recession, and “general glut” recessions can occur in barter economies just as well. That is what Arnold argues via his “double coincidence of wants” point. So I think Arnold’s criticism of your original statement was justified.
One could argue that it is harder for barter economies to enter recessions: there’s no money and there’s no debt, it needs a significant mismatch of output versus demand in multiple major categories of products for a general glut to occur. In barter economies ‘general gluts’ are probably limited to major changes in external parameters, which dramatically shift the ‘graph of needs/wants’: an ice age, an earthquake, extinction of a key animal, depletion of a key resource (bronze), etc.
In modern economies, the flexibility of money makes it also more flexible for problems to accumulate: bad debt can accumulate and overconsumption of the wrong type of product can occur as well. Once there’s a demand shock caused either by a sudden turn of luck for an over-rated piece of key commodity (like housing), or a sudden debt shock caused by a sudden (and self-accelerating) deleveraging spiral, there’s a general glut. (The world economy may be experience both of these shocks at once currently.)
These types of phenomena probably do not occur in barter economies.
Barter economies have their own special problems though: the cost of trade is very high if the graph of needs/wants is very complex (which it is for a modern society), and seasonal/cyclical fluctuations in demand and supply cannot be buffered at all. (without some sort of medium of exchange.) Barter economies ‘live for the moment’ pretty much and there’s no ‘insurance’ against fluctuations at all.
Nick,
I really don’t agree that in my barter economy there is excess demand for haircuts. The issue is price, in real terms. Let’s examine the real prices.
Suppose that 1 unit of time is worth 1 util to everyone as leisure, and in 1 unit of time everyone produces 1 unit of their goods. John values 1 unit of haircut at 2 utils, and previously David valued 1 unit of detective story at 2 utils. So they were happy to trade, and let’s posit they did so on a 1-1 basis, each accumulating a 1 util consumer surplus. Now, with David’s change in preference, he values 1 unit of detective story at 0.1 utils. So for John, he would have to give up at least 10 units of his time to get 1 unit of haircut, which he is not willing to do, as it would be negative utility (-8 utils). So now David and John both work 1 unit of time less. Economic output is down by 4 units, and “wellbeing” is down by 2 units.
Now look at the market for haircuts. Previously, John was willing to sell 1 unit of haircut for 1 unit of interesting story, gaining 1 unit of surplus. Now, he’s underemployed, and you could drive a better bargain – you could get (say) 1.5 units of haircut for 1 unit of interesting story. John is lowering his barter demands, which means that haircuts are oversupplied, they are in a glut, but he just can’t make a trade. Saying there is excess demand for haircuts has it backwards.
There IS a market with excess demand, the market for “interesting stories,” but this is not a properly formed market because it is poorly specified. We do not know what stories David will find interesting. Indeed, the kind of stories already on the market are overproduced. In fact, the price signals for John suggest he should reduce production, when in fact what he needs to do is reassess his product.
I agree with you 100% that a sudden and massive demand for money would produce a glut. Where I disagree with you is that I think that a large-scale recalculation could also produce a glut. It is an empirical matter what is actually going on.
Salem: it’s not just demand for money that matters to the depth of a glut, but also the distribution of money (debt and assets).
If everyone has an equal amount of money (the distribution is a constant function) then changing demand for money is an invariant to the economy.
But if the money distribution function is very assymetric it’s different. If there’s a significant number of actors with lots of debt, and if a lot of money is concentrated in the hands of a few actors, then a deleveraging shock can create a glut: those who would be willing to consume cannot (they cannot increase their debt), and those who have the resources don’t increase consumption (there’s just a few of them).
There’s an actor level mismatch of ‘want’ and ‘can’.
And that is what may be happening currently: 80%+ of the money equivalents are concentrated in the hands of the top 1% earners plus the top 500 corporations.
That is faced against tens (hundreds …) of millions of consumers, hundreds of thousands of small corporations and small-time producers (workers).
That kind of assymetry cannot end well, because ‘future demand’ is set by those hundreds of millions who actually consume – but they cannot consume. So a deadly spiral of lack of demand, overcapacity and deleveraging gets underway.
In such a scenario increasing the monetary base will help, but if and only if that money ends up in the hands of those willing to consume.
Otherwise it ends like in Japan (the increased supply of money ended at the banks, never got to those who’d be willing to consume) or it ends like the Great Depression (where there was no increase in the supply of money at all, due to the gold standard being upheld up into 1932).
Translation for the US today:
– tax cuts for the rich probably wont help. (they don’t consume the extra money but save most of it – because they are affected by the general psychology and because their marginal willingness to consume is much lower – it gets harder to consume money as you have more of it.)
– payroll tax cut – probably a good call
– QE1: probably a good call, the non-tax-cut components of it
– QE2: probably not so good call [the money may stay stuck at the banks] – but nothing else left for the Fed
Salem wrote:
Now look at the market for haircuts. Previously, John was willing to sell 1 unit of haircut for 1 unit of interesting story, gaining 1 unit of surplus. Now, he’s underemployed, and you could drive a better bargain – you could get (say) 1.5 units of haircut for 1 unit of interesting story. John is lowering his barter demands, which means that haircuts are oversupplied, they are in a glut, but he just can’t make a trade. Saying there is excess demand for haircuts has it backwards.
The thing is, there is excess demand for haircuts, from David – he is just unable to pay for it with his own labor.
I.e. there’s a product quality crisis in the detective story writing industry, which spills over to its main trade partner, the haircut industry.
Thanks Mike. And it’s only by arguing with people who disagree with me that has forced me to think through explicitly just why I find their explanations of recessions so unpersuasive, and focus on the ease of buying, and difficulty of selling.
anon: Yep. I feel like I’m fighting a war on two fronts. One one side, against Keynesians who accept the general glut idea, but aren’t convinced about the role of the excess demand for money. And on the other side, those who don’t really accept the general glut idea.
Kevin: I’m not familiar with that book. If I laid out a formal derivation and then critique of Walras’ Law, and suggested an alternative, “Nick’s Law”, would that work?
Bill: Yep. Arnold says that almost everyone more or less believes the excess demand for money story. Sometimes I think it’s just you and me!
Phil: When I really get into it with Brad DeLong, yes, I find out there isn’t that much difference between us. Brad basically gets it theoretically (though we can still disagree on details of the story in particular cases). But Brad, although everyone thinks he’s a Keynesian, always seems to turn Monetarist when he’s in a foxhole fighting Says’ Law. He starts talking about velocity. But yes, this post is not clear on those issues. It really needs to be read in conjunction with my other post, the response to Brad. But I can’t fight on two fronts at once.
“But Brad, although everyone thinks he’s a Keynesian, always seems to turn Monetarist when he’s in a foxhole fighting Says’ Law. He starts talking about velocity.”
A completely false statement. Just mentioning velocity doesn’t mean he’s turned monetarist.
Nick- Great post. I am still in the DeLong corner on this one. As I see it, a big group of safe assets MBS, for example, were suddenly considered unsafe and became illiquid. They went from being decent substitutes for money to being very poor ones. Consequently, demand for money and other close substitutes went up.
Let me also ask this, for clarification, if money is only a medium of exchange and never a store of value is your contention that general gluts could happen? It seems obvious that it is the desire of people to move demand from time period to time period that make general gluts possible.
White Rabbit –
I did not see your earlier post when I posted mine (teach me to refresh before I post). I disagree that it is necessary for the haircut market to become disconnected for my example to work. I think my example with the real prices shows how this would work (and of course it works just as well with nominal prices). Just one sector becoming disconnected is simulating a fall in AD, because those workers have lost the ability to purchase. And so we have a general glut, but with unemployment concentrated in the sector which became disconnected. To me that’s what the current situation looks like, with the disconnect obviously being in housing/construction.
As I am unpersuaded by your theory that the current situation is caused by a demand for money, I’m not buying your remedies, but I do note that the evidence suggests that tax cuts for the rich are more stimulative than for the middle class, who would just use the money to de-leverage.
As for the notion of whether there is “excess demand” for haircuts, I am not interested in getting into some semantic argument. I simply note that the production of haircuts has fallen, and so has the marginal price. From the point of view of an economist examining the data, it certainly LOOKS like a glut, however you want to categorise the true nature of supply and demand.
Woolsey: The puzzle, again, is when the demands for some things shrink and nothing grows. Or the growth in demand is less than the decrease. Or, most incredibily, the demand for everything falls.
And all of this in a world of scarcity.
What is the answer? Monetary disequilibrium.
Again, we not only live in a world of scarcity in this time period, but lived in one in previous time periods and will continue to live in a world of scarcity in the future. People know this, of course, and so borrow and lend to each other to smooth that out based on uncertain estimates of wants, needs and capacity.
It seems to me, that in this case it should not be terribly surprising that during particular time periods demand for somethings shrink and this is not offset. Problems arise when some people have sold too many of their present claims on resources in the past, while others then find out that their future and present claims are not as valuable as previously thought. The recalcuation is then the recalculation of conflicting claims on present and future resources.
Phil Koop: Unless other safe assets are a perfect substitute for money (and they’re not, as you can’t spend your T-bill at the grocery store) it doesn’t really matter how the excess demand for money arises. The central bank always has the power to eliminate it by increasing the money supply. This is easy and nearly costless to do.
Not every economic fluctuation is due to bad monetary policy, but that’s no reason to tolerate the ones that are.
There was barter beween detective novels and old fashoned haircuts.
There is a change in tastes. The writer doesn’t want old fashioned haircuts. He would like a modern haircut, but no one is providing those. The demand for old fashioned haircuts is zero. They aren’t scarce. The supply of detective novels is also zero. The writer offers none for old fashioned haircuts. How is he desparate? He hates his long hair? Apparently not as much has he hates an old fashioned haircut.
The barber no longer likes to read detective novels. He wants horror novels, but these don’t exist. And so, detective novels aren’t valued. They are no longer scarce. The supply of old fashioned haircuts falls to zero because there is nothing the barber wants to sell them for. Desperate? How? Because he is bored? No, evidently prefers to do nothing than read one more detective novel.
There is no general glut of goods. Both the supply and demand for all goods have fallen to zero. There is no scarcity.
In a money economy, both the barber and the writer could offer their products for sale for money. And they can’t sell. And there is nothing they want to buy.
However, there is nothing they want to buy. Nothing is scarce.
They are willing to sell their current products for money on the speculation that someone might appear. They want to save and in this economy, they do so by accumulating money. But there is no scarcity. Production should drop to zero.
In the real world, we do have scarcity.
“In a monetary exchange economy, with n goods including money, there are n-1 markets.”
How about in the monetary exchange economy we have now, with n goods including medium of exchange, there are n-2 markets because one medium of exchange is currency and the other medium of exchange is demand deposits created from currency denominated debt?
“If barter were nearly as easy as money, then an excess demand for the medium of exchange would not cause a recession. People would just switch to barter, and the economy would carry on as normal, with a slight increase in transactions costs.”
Do barter economies have savings? Do barter economies have retirement?
if i were to hazard a guess, in barter economies one owns “productive assets” or rights to cash flows coming from them, rather than “savings” defined in a nominal sense. if i owned a herd of cows, i could rent them out for health care.
As long as you have at least one a market for non-produced goods (e.g. bond markets), then a disequilibrium in the bond market can cause a general glut of all produced goods. Therefore you don’t need a violation of Walras’ law as long as you have bond markets.
And it’s not hard to come up with barter economy models in which this happens.
In general, you would imagine that the most sensitive part of the system would be the bond markets, since you are relying on people’s predictions of the future, the goods being sold have zero production cost, no one is really sure how much utility these goods will deliver, and yet it is critical that they be accurately priced. Also, these markets tend to have demand increase with price (you buy the asset because you think others will want to buy it, too).
That is a flashing red light, saying — “look here for the cause of recessions!”
Why keep asserting that only a desire to save in the form of the medium of exchange (whatever that means) is so central? Are you saying that barter explanations of general gluts don’t exist, or that they are so fundamentally inapplicable that we should ignore them, in which case, why?
Nick: I’m not familiar with [Mas-Colell, Whinston and Green, Microeconomic Theory]. If I laid out a formal derivation and then critique of Walras’ Law, and suggested an alternative, “Nick’s Law”, would that work?
It’s not the sort of book you become familiar with. It’s much too magisterial to permit familiarity. It sits on my shelf, which sags under its weight, and gazes down at me in a reproachful manner. I would never have bought it but for the fact that a local bookshop went bust, so I got it for €5, which fits the classic definition of a bargain – something you don’t want at a price you can’t resist. Anyway, if you’re in the library you’ll find Section 18C is well worth a look. It works through examples of Cournot competition and a trading-posts model (from a 1997 paper by Shapley and Shubik) to show (this is my summary, not the authors’) that the Walrasian budget set, and hence also Walras’ Law, emerge quite naturally as a special case in models which are also capable of generating nasty, non-Walrasian outcomes.
For me, the moral is that you can get sort-of-Keynesian results (not to be confused with results which Keynes would have endorsed or even dreamt of) from an idealised barter model by introducing a requirement for money. But you can also get them in other ways, for example by allowing for ‘thin’ markets. My conclusion, which is subject to change if and when I learn more, is that ‘Keynesian’ ideas are not fundamentally about money.
Incidentally, the main reason I’ve looked at that particular section of the book is that it mentions the Clower cash-in-advance constraint. I haven’t seen another microeconomics text which ventures that far into macro territory. But maybe some others do? I admit to being out of touch.
Nick: “… when he’s in a foxhole fighting Says’ Law …”
Well, he’s got your back at the moment: he’s just linked, with approbation, to this post.
… a 1997 paper by Shapley and Shubik ….
Whoops! Actually 1977: Trade using a commodity as a means of payment (JPE).
Salem wrote:
As I am unpersuaded by your theory that the current situation is caused by a demand for money, I’m not buying your remedies, but I do note that the evidence suggests that tax cuts for the rich are more stimulative than for the middle class, who would just use the money to de-leverage.
Well, the article you linked to states:
The high-income group increased total spending by 77% of the value of their stimulus checks. The low-income group increased total spending by 128% of the value of their stimulus checks.
That means that it’s almost twice as effective of a stimulus to send checks to low-income groups than to high-income groups.
The middle class might be even less willing to spend that money, but at that point I think the methodology should really be considered: these numbers were based on a $300 Bush-era check sent in 2008 – well before the crisis fully unfolded.
Now we have a fully developed panic and scare, fully developed unemployment, plus we have tax cuts that go well beyond $300. Will a rich family spend 77% of say a $100,000 tax cut? In current sentiment I call that unlikely – and the cited study does not examine that question.
OGT: “Let me also ask this, for clarification, if money is only a medium of exchange and never a store of value is your contention that general gluts could happen? It seems obvious that it is the desire of people to move demand from time period to time period that make general gluts possible.”
That’s a good question, and a hard one.
I’ve argued in the past that stores of value per se don’t cause recessions. An increased demand to save in the form of land, or bonds, or antique furniture, wouldn’t cause an excess supply of newly-produced goods, unless it spilled over into an excess demand for the medium of exchange.
It’s hard to think of a medium of exchange that isn’t, to some extent, also a store of value. In a discrete time model we can perhaps imagine a money that must be spent before the end of the period. I don’t think you could get a general glut in that case. But my mind is not clear on this.
In Arnold’s barter examples, and in the examples that Salem gives, we need to distinguish between: demands and supplies of goods that currently exist; demands and supplies of goods that don’t currently exist. I would work if someone gave me an elixir of youth in exchange. There’s an excess demand for the elixir of youth, and an excess supply of my labour in exchange for that elixir. No general glut.
Jeff wrote:
“Phil Koop: Unless other safe assets are a perfect substitute for money (and they’re not, as you can’t spend your T-bill at the grocery store) it doesn’t really matter how the excess demand for money arises. The central bank always has the power to eliminate it by increasing the money supply. This is easy and nearly costless to do.
Not every economic fluctuation is due to bad monetary policy, but that’s no reason to tolerate the ones that are.”
Actually, T-bills are money, and I will show why. I define “money” to be any instrument denominated in the medium of exchange (dollars) whose value can be ascertained now or in the future with certainty. A T-bill which has zero default risk and negligible interest rate risk due to its short term nature is money. I can sell it at the bank for a clearly-known value, put the proceeds in my chequing account and spend them.
Money is any instrument with a definite Net Present Value in dollars. If it has interest rate risk, default risk or both, it isn’t money. It it bears inflation risk, it isn’t money either. That’s why 5-year GIC’s aren’t money, even though they qualify on all other grounds. Same with Canada Savings Bonds.
T-bills have zero default risk, negligible interest rate risk and negligible inflation risk. They’re money.
The problem with the current recession is that many market participants tried to use high-rated commercial paper, (Asset backed commerical paper and the like) as money, thinking they had negligible default risk when in fact the default risk was anything but negligible.
Nick:
I fully agree – the medium of exchange function comes before the store of value function of money. Stores of value are not useful as money because they are stores of value – they must also possess the ability to be a useful medium of exchange.
The question: “if money is only a medium of exchange and never a store of value is your contention that general gluts could happen? It seems obvious that it is the desire of people to move demand from time period to time period that make general gluts possible.” is not quite nonsense, but misses the point about general gluts nearly entirely. Why would the entire world decide to put off consumption for the future when this additional consumption would actually increase their future wealth?
Or in other words, why would the world as a whole decide to pass up a free lunch? Because that is what the world is doing right now – passing on the only free lunch. Some economists think: there cannot be a free lunch, so there cannot be a general glut. However, by any reasonable intrepretation of the data, there is a free lunch – the question is what to do with it.
I think the point you are trying to make is if the medium of exchange becomes a “too good” store of value, it loses the “medium of exchange” trait. For example, if money made 20% per year in real terms, would anyone want to use it as a medium of exchange? Of course not – it would be too valuable for this use.
In general, we want a medium of exchange that stores value about as well as real world goods. If it is much worse, then we get inflation. If it is far better, then we get deflation. But the real problem comes when there is great uncertainty about the future value of real assets, and the medium of exchange is a good to very good store of value. Then you get a general glut.
I have actually had this argument/discussion many times, and people tend not to understand it very well.
I would also argue that the “ability to extinguish tax liabilities” comes before these two traits, but that it besides the point you are trying to make.
Determinant: I nearly fully agree. T-bills are money. Ask the CME, or really anybody who uses T-Bills on a regular basis. I also have a much larger theory about how these depressionary recessions start. They start when there isn’t enough money to satisfy the trading that needs to be done. People start to use other things as money-like assets. In the late 1990s, you could use stock to buy other real world assets. Once people found out that this wasn’t real money, then the entire scheme collapsed. Then real estate combined with CP became money like.
But it isn’t money, and cannot extinguish tax liabilities. It all comes down to what you can “trade” your “money” for easily. And the one thing about real money – you always, always know you can go give it to the tax collector, and they will accept it in trade. No other asset has that 100% odds of being a negotiable instrument accepted at full value, except real money.
Hello Nick!
“Stuff gets easier to buy in a recession, and stuff gets harder to sell. That’s an essential part of what makes it a recession. To say that stuff is harder to sell and easier to buy is meaningless outside a monetary exchange economy. In a barter economy, selling stuff is buying stuff. When you are trying to sell you are trying to buy at the very same time. A thing can’t be harder or easier than itself.”
What exactly do you mean by easier to buy and harder to sell?
I am thinking, if it’s easy to buy things, surely all the sellers will be happy?
mickslam: “In general, we want a medium of exchange that stores value about as well as real world goods. If it is much worse, then we get inflation. If it is far better, then we get deflation. But the real problem comes when there is great uncertainty about the future value of real assets, and the medium of exchange is a good to very good store of value. Then you get a general glut.”
I think that is a good/interesting way of looking at it.
Take a simple world in which central bank currency is the only medium of exchange. We would normally think of monetary policy as the central bank varying the quantity of currency, while holding the own rate of return on currency fixed (at 0% in nominal terms). But (practical issues aside) there is no reason why we couldn’t think of monetary policy as the central bank varying the rate of interest on currency, while holding the quantity of currency fixed. (My previous post, when I imagined an increased demand for milk, when cows are money, is like an increase in the rate of interest of currency, because even though the cow yields the same quantity of milk, the milk is more valuable).
But the real world has elements of both. Currency doesn’t pay interest, but banks’ reserves at the Bank of Canada do pay interest, at a rate set by the Bank of Canada. And balances in chequing accounts (which are media of exchange) may pay interest (sometimes in the form of the bank not charging you fees if your balance is over $X), but that rate of interest is not under the direct control of the central bank.
And it makes me wonder if there could be some monetary system in which the own rate of interest on money would adjust automatically (rather than needing to be set by the central bank) to eliminate the possibility of excess demands or supplies of money, even while the quantity of medium of exchange adjusted in response to entirely different reasons. I think Bill Woolsey argues that a system of competitive media of exchange could do this. Bill?
Hi James! “What exactly do you mean by easier to buy and harder to sell?”
Ah. That’s something that is hard to define and measure exactly. I mean the same thing as people who talk about there sometimes being a “buyers’ market” (easy to buy, hard to sell), and sometimes a “sellers’ market” (easy to sell, hard to buy). But I don’t know of any exact definition for those words either. And that same distinction seems to correspond, at least crudely, with the economists’ distinction between markets in excess supply (buyer’s market) and excess demand (sellers’ market).
In the housing market, for example, if you are trying to buy a house, there’s a trade-off between: the price you pay; whether you get a house that’s very close to the sort of house you want; and how long it takes you to find it. The longer you are willing to wait/search, the better the price, and the closer to what you were wanting. And the slope of that trade-off depends on whether it’s a buyers’ or sellers’ market. Similarly the seller faces a trade-off between price and expected time to sell.
In a buyers’ market, sellers find it hard to sell, but are really happy when they succeed in selling.
Nick wrote:
I mean the same thing as people who talk about there sometimes being a “buyers’ market” (easy to buy, hard to sell), and sometimes a “sellers’ market” (easy to sell, hard to buy). But I don’t know of any exact definition for those words either.
That’s a concept that pure monetarism does not really cover – and it occurs in real-life all the time.
A transaction needs 3 elements: the meeting of buyer and seller (market), the setting of the right price (price discovery), plus the willingness of both seller and buyer to enter into a transaction (willingness to transact).
There can easily be markets where prices are ‘sticky’ and spreads are high – where, despite demand, prices are not moving because sellers are unwilling to sell below a certain price, for various reasons.
In a stock/auction market this would be equivalent to the trading book being ‘thin’ either upwards (buyer’s market), or thin downwards (seller’s market). The lack of intention to transact results in fewer limit orders being in the books in one direction.
Two things can happen in that situation: either the price collapses (there’s sellers willing to sell at any price – for example because they are panicking), or there’s no sellers willing to hit the lower prices and the price freezes up and the spread increases.
Note that there can be these two starkly different outcomes, from the same initial condition of supply, demand and price.
This is something where mechanics based on price, money, demand and supply alone are not enough – it’s the intent and expectations of individual actors that matters as well.
This is a common phenomenon in markets of non-perishables. With perishable commodities there’s a natural ‘timeout’ for transactions due to the limited life-time of the commodity. For something like houses this timeout can be near infinite – people routinely wait a decade or two before giving up and selling their houses.
(There can also be artificial freeze-ups of markets: when a few actors own most of the goods, and there’s an accounting reason why they don’t want the central ‘price’ to fall – even if they cannot transact. For example banks in the US have a vested interest in not seeing housing prices collapse further. They will keep houses on inventory and not sell them – because mark-to-market accounting keeps them solvent on paper.)
Btw., this phenomenon is probably the best real-life refutation of the hypothesis of rational expectations. (If actors truly ‘knew’ what to expect in the future, on average, they would never need to wait with transactions speculatively …)
“What exactly do you mean by easier to buy and harder to sell?”
Any market, at any moment when there is no actual trade, has an asking price and a bid price, separated by a bid-ask spread.
“Easier to buy and harder to sell” means – more volume willing to sell at the asking price than volume willing to buy at the bid price.
White Rabbit: “That’s a concept that pure monetarism does not really cover – and it occurs in real-life all the time.”
Yep. Or rather, no simple macro model covers at all well. (It’s not just monetarism, which, anyway, really disappeared 25 years ago.) But search models try to come to grips with it. Buyers and seller have to search for each other. Sometimes it’s relatively easier for a buyer to find a seller and relatively harder for a seller to find a buyer, so we call that a buyers’ market. (And in illiquid markets, it’s hard for both buyers and sellers to find each other).
anon: Yep. Though I would say “at or near the asking price”. But that definition only really works for auctions of identical goods. It doesn’t work so well for houses, used cars, or labour.
“One one side, against Keynesians who accept the general glut idea, but aren’t convinced about the role of the excess demand for money.”
???? I think the argument is over the definition of money. I’m sure both Keynes and Krugman (and me) believe that an excess demand for money leads to a general glut.
Isn’t a better way to put this – a general glut arises when some people want to earn now and consume later to a greater extent than all other people are prepared to consume now and earn later (either by borrowing or running down their assets). Money/more or less liquid assets are what facilitates this.
“Isn’t a better way to put this – a general glut arises when some people want to earn now and consume later to a greater extent than all other people are prepared to consume now and earn later (either by borrowing or running down their assets).”
No, that’s not a better way to put it.
You’re just talking about the existence of aggregate savings, on their own savings don’t cause a recession. The recession is caused when some of the savings are not invested. The issue is equally a lack of investment demand as a lack of consumption demand, and empiricaly it’s the investment demand that usually falls short in recessions.
Nick,
Chequing deposits earn exactly zero interest. Insured overnight savings deposits earn token interest only (5-10 basis points), even when rates were at 4.5%. Check page 8 of the BOC’s weekly statistics from July 2007. You really shouldn’t think of any of this stuff as interest bearing at all.
Adam P,
now we are arguing about the definition of “consume”. Sorry, if I wasn’t clear. And yes you are correct about investment usually leading the move to recession. (Read this excellent piece:
http://blog.andyharless.com/2009/11/investment-makes-saving-possible.html
But in that case it is just the corporate sector rather than the household sector that is trying to do the intertemporal shift. I was speaking more generally.)
Nick
Right on cue http://krugman.blogs.nytimes.com/2010/12/15/what-is-money/
reason:
I recall Andy’s post from when it came out, at the time I rather suspected I’d helped write it, see the following comments on this blog from a few days before Andy’s post:
http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/11/accounting-and-economics-and-money.html?cid=6a00d83451688169e20120a6bb020e970b#comment-6a00d83451688169e20120a6bb020e970b
http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/11/accounting-and-economics-and-money.html?cid=6a00d83451688169e20120a6bb1041970b#comment-6a00d83451688169e20120a6bb1041970b
http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/11/accounting-and-economics-and-money.html?cid=6a00d83451688169e2012875bcf4f6970c#comment-6a00d83451688169e2012875bcf4f6970c
http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/11/accounting-and-economics-and-money.html?cid=6a00d83451688169e2012875bd3edc970c#comment-6a00d83451688169e2012875bd3edc970c
@Determinant and Mickslam:
Money is the medium of exchange and it’s price is fixed, by definition, at 1. T-bills are neither. It’s certainly true that when interest rates are low, T-bills are as good a store of value as is money, and due to their short maturity, their prices are close to 1. Both of these characteristics make them a close substitute for money, but they still aren’t money. I say again, money is the medium of exchange. You don’t pay for things with T-bills, you pay with money.
If all short-term government debt is money, then why don’t we experience massive inflation when the government runs a large deficit, and massive deflation when it runs a surplus? You know the answer. We’re accustomed to seeing deficits create inflation in third world countries because they monetize the debt. If they didn’t do that, they, like Japan and the U.S., would see increasing public debt with little or no inflation.
Nick:
Seller’s market and buyer’s market is not a “search” problem – i.e. it’s not a price discovery problem, it is not an information propagation inefficiency problem.
It is an actor intent problem. Even if perfectly informed, sellers might not sell at current market prices (which is generally seen as the current average of last transacted prices) – and wont sell at marginally higher prices either. The bid/ask spread goes up and it goes way beyond the cost of transaction.
Transactions are voluntary, thus ‘intent’, ‘future expectations’ and ‘uncertainty’ enters the picture and those are pretty hard to model.
It is not true that price discovery alone will match up transacting parties. There’s a hard to measure metric of ‘liquidity’, which is often controlled by human behavior, not by price and other market parameters.
And it’s a deeply relevant metric. Part of the horrors in mid/late 2008 were caused by “interbank trust” vanishing, which caused interbank loan liquidity dry up, which caused certain big players getting squeezed. That big scare (magnified by the media as well) helped kick-start the psychology of prioritizing savings and thus started the deleveraging, started the recession and started the deflationary spiral as well.
It’s not a phenomenon that can be explained by monetary mechanisms alone.
Nick, I don’t doubt that excess demand for money is an important problem. I’ve been at the fore of this issue calling for a more expansionary fed policy since the earliest days of the 2008 crisis.
But look, you and wooley seem to be caught on a semantic nail. A recession in output can have other causes and the price level can fall for other reasons. Just because the U3 BLS numbers say their are unemployed people does not mean there are unemployeed resources and therefore a scarcity violation. When you’re trapped in a snow storm and thirsty you don’t eat the snow, when you’re lost at sea and thirsty you don’t drink the water. Either one being the path to death.
So it goes with factors of production during a recalculation. You naively suppose there is slack but really those idle factors arent factors at all. It’s just your cognitive bias of functional fixatedness that assumes they are. If we go through a fad of building houses in the desert, then the fad ends we can hold the houses idle or lower their let rate or liquidate them. If the houses could be valuable later, then letting them on the cheap may incur too much depreciation. So we leave them fallow. Real output today falls and we have unused resources.
Now you tell me that that’s one factor but not all factors.
Is that a practical complaint, no. Is that a fatal complaint, no. Future expectations can idle factors of production today even in a barter economy. So I think this narrows your claim quite a bit.
In an evenly rotating economy a general glut is due go an excess demand for money.