If we lived in a world of barter exchange, or in a world where people could use barter exchange at minimal cost, Keynesian macroeconomics would make no sense whatsoever.
That is not, of course, a criticism of Keynesian macroeconomics. We do live in a world where people use monetary exchange, not barter. And people (usually) use monetary exchange because barter is (usually) very costly.
But do Keynesians understand this?
Milton Friedman understood this. Monetarism, rather obviously, would make no sense whatsoever in a non-monetary economy. As Milton Friedman (almost) said, recessions are always and everywhere a monetary phenomenon. He (and Anna Schwartz) wrote a very large book arguing that the Depression was a monetary phenomenon.
If you drew a line, and put Real Business Cycle theory at one end of the spectrum, who would be a natural candidate to put at the other end of the spectrum? I can't think of a better candidate than Milton Friedman. At one end of the line you have people who say that money plays no role in the business cycle. And at the other end you have Milton Friedman. Keynesians are somewhere in between.
So it seems counter-intuitive for Brad DeLong to blame Milton Friedman for the rise of Real Business Cycle theory. The two are polar opposites.
You could argue that the research program called RBC theory, or Classical Macroeconomics (a strange name for something that only started in the 1980's), is an example of the Ricardian Vice. RBC theory is what happens when you insist on modelling everything formally. But who should we blame for the Ricardian Vice? Ricardo, obviously. But if we are looking for more recent culprits, you could argue that, say, James Tobin, an excellent Keynesian economist, is at least as guilty as Milton Friedman.
IIRC, one of the complaints that the Keynesians like James Tobin had against Friedman was that Friedman didn't write down his macroeconomic model in equations so they could see precisely where Friedman's Monetarism differed from their Keynesianism. "OK Milton, we've written down our model, now let's see yours! Stop waving your hands and talking!"
Friedman wouldn't, or couldn't, so Robert Lucas did it for him. And Monetarists can argue whether Lucas' model captured the essence of Friedman correctly just as Keynesians can argue whether John Hicks' ISLM model captured the essence of Keynes correctly. But Lucas set new standards for macro model-building just as Hicks had set new standards for macro model-building a generation earlier.
It makes about as much sense to blame Friedman for the consequences of the Ricardian Vice as it does to blame Keynes. Both gave the model-builders something to model, but they themselves were more talkers. Personally, I blame Tobin for Lucas, and everything that followed. Well, maybe that's a bit unfair.
Actually, you could argue (as I did here) that New Keynesian models capture the essence of Friedman about as well as the old New Classical models of Lucas. Friedman never said that all nominal prices and wages adjusted instantly. Permanent Income Hypothesis: check. Vertical Long Run Phillips curve and non-vertical Short Run Phillips curve: check. Central bank responsible for keeping inflation at the right level: check. Fiscal policy rarely mentioned: check. A Keynesian Rip Van Winkle from the late 1960's seeing a New Keynesian model would be surprised to see that Friedman's followers were now calling themselves New Keynesians, and that Friedman had obviously won his war.
The only thing missing is the k% rule for monetary policy. It gets replaced by the Taylor Rule. But the k% rule was never central to Friedman's vision. He abandoned it later, when he saw it wouldn't work very well. And it was only ever a rule of thumb anyway; something he thought might work reasonably well and better than actual historical policy.
OK, if you want to blame someone for the emphasis on monetary policy and the de-emphasis on fiscal policy, then Milton Friedman is guilty as charged. Though New Keynesian macroeconomists were willing accomplices. "But Milton Friedman made me do it; he made me forget about fiscal policy" doesn't really cut it as a defence.
And it's here I want to return to my opening theme. Do Keynesians really understand their own models? Do they understand the central role of money and monetary exchange in generating recessions? If so, why the emphasis on fiscal policy?
Take a Keynesian model. Any Keynesian model. Start in long run equilibrium. Now hit it with the sort of shock that would cause a recession. Aggregate Demand falls, which causes output and employment to fall. Unemployment increases. OK, what's really going on here?
The unemployed hairdresser wants her nails done. The unemployed manicurist wants a massage. The unemployed masseuse wants a haircut. If a 3-way barter deal were easy to arrange, they would do it, and would not be unemployed. There is a mutually advantageous exchange that is not happening. Keynesian unemployment assumes a short-run equilibrium with haircuts, massages, and manicures lying on the sidewalk going to waste. Why don't they pick them up? It's not that the unemployed don't know where to buy what they want to buy.
If barter were easy, this couldn't happen. All three would agree to the mutually-improving 3-way barter deal. Even sticky prices couldn't stop this happening. If all three women have set their prices 10% too high, their relative prices are still exactly right for the barter deal. Each sells her overpriced services in exchange for the other's overpriced services.
But barter is not easy. There is no double coincidence of wants here, and it is costly to find all three people in the Wicksellian triangle to do the barter exchange. So people use money.
The unemployed hairdresser is more than willing to give up her labour in exchange for a manicure, at the set prices, but is not willing to give up her money in exchange for a manicure. Same for the other two unemployed women. That's why they are unemployed. They won't spend their money.
Keynesian unemployment makes sense in a monetary exchange economy, where money is what Hahn calls "essential" for trade. It makes no sense whatsoever in a barter economy, or where money is inessential.
Keynesian unemployment is an excess demand for the medium of exchange. It's a coordination failure, because if all three spent the $20 to buy what they wanted, all three would find her purse is a widow's cruse. The $20 reappears as soon as it is spent. But the widow's cruse fails unless all three increase spending at once. And, in Nash Equilibrium, none of the three wants to do that. She prefers the $20 in her purse.
We buy newly-produced goods with money. A Keynesian recession is an excess supply of newly-produced goods, and a deficiency of Aggregate Demand. In a monetary exchange economy, a deficiency of Aggregate Demand, and an excess supply of goods, is an excess demand for money. Money is what we demand goods with.
[Update: as Yeager noted, there are two ways to get more money. The first is to sell more stuff; the second is to buy less stuff. And nobody can ever stop an individual from getting more money by buying less stuff. That's what makes money unique. That's what makes an excess demand for money qualitatively different from an excess demand for any other type of savings.]
Keynesian unemployment only makes sense as a monetary phenomenon. What's fiscal policy got to do with it? Fiscal policy is supposed to be about micro stuff, like providing the goods that the government is better at providing. Fiscal policy can't do that micro stuff properly if it's being asked to also do the job that monetary policy is supposed to be doing.
OK. There is a legitimate Keynesian defence. If a doctor can't fix a broken leg, he might recommend a wheelchair as a second best fix until the leg heals itself. He might argue that it will help the leg heal quicklier. OK. But he should admit that it's a second best, and be looking for a first best, and encouraging others to seek a first best. He shouldn't be selling wheelchairs.
The trouble with Keynesians is that they aren't radical enough. They need to look at their own models and see the root of the problem, and recommend policies to get at the root of the problem. The root of all Keynesian recessions is monetary.
Just like Milton Friedman said.
[Afterthought: None of us ever really understands our own models. It's one thing to write down some equations and solve them; it's another thing to really understand what's going on. And there's always an implicit assumption, hidden implication, or new interpretation waiting to be discovered. It's an occupational hazard of model-building. It comes with the territory. It's why theory is challenging.]
Worthwhile Canadian Initiative 
Is the criticism of Keynes here really that he took for granted the presence of something (model) that nearly every other model also includes? If so, I fail to see how the criticism is effective in any way.
Was Friedman really arguing for a moneyless system, or was he comparing monetary systems to non-monetary systems in such a way that it revealed imminent truth about the former? If not, I’m a bit confused about the point here.
An excellent post: a Keynesian recession is a return to barter. Even if a recession is caused by the real rate being below the natural rate, the real rate is above the natural rate in a recession.
Nothing intelligent to add. Didn’t know what IIRC meant so looked it up on urbandictionary.com:
IIRC – If I Recall Correctly. Especially common to be used when trying to cover up a vague guess, or when you are truly befuddled and trying to recall a fact of some sort.
IIRC in hypertext markup language an tag constitutes a hyperlink. IIRC, his dad is 7’5 or some ridiculous amount of the sort.
Steve, can you edit out that accidental hyperlink that I cut and pasted in? Thanks!
Nick,
This is nit-picking, but barter also requires a double-coincidence of timing. This was something illustrated in Clower and Howitt’s reconsideration of the Baumol-Tobin model. We often take timing for granted the timing of transactions, but timing is a choice variable. Organized monetary exchange largely eliminates this problem because of the creation of firms.
Frances: i think I edited it out properly. BTW, you can edit it yourself, I think, even though it’s on my post.
Gotta go test my students. Baksun, as Owl said.
The MOST natural candidate is FRIEDRICH HAYEK.
“If you drew a line, and put Real Business Cycle theory at one end of the spectrum, who would be a natural candidate to put at the other end of the spectrum?”
Dean: I wasn’t thinking of this post as a criticism of Keynes. Though Keynes did say some things that suggest he might not have fully understood the role that money plays in his model (not that he wrote down a formal model).
I’m arguing with Brad DeLong about Milton Friedman. (But my sense is that Brad is a Keynesian who most understands the importance of monetary exchange in macroeconomics.)
I’m arguing with Paul Krugman about macroeconomists not understanding their own models and about why fiscal policy was sidelined.
I’m arguing with any Keynesian, New or Old, who downplays the role of monetary exchange and/or monetary policy.
And I’m using this as a vehicle to repeat some things I’ve said before, and to bring them all together.
Martin: in a Keynesian or Monetarist recession, there are very strong incentives for people to return to barter. And there is a return to non-monetary economic systems (the unemployed growing their own veggies or swapping stuff) in a recession. But barter is too costly for this incentive to be enough to fix the recession.
Josh: if we think of dated goods, then a double coincidence of timing is part of what we should mean by the double coincidence of wants. But yes, your point is correct.
Greg: I would put him up the same end of that spectrum as Friedman, in this dimension. Not sure which one would win the “no enemies to the left of me” contest here.
You forgot one thing.
Most Keynesians ARE Keynesians because they believed it gave them a blanket justification for any and every type of government fiscal action.
This is what makes their heart go pitter-pat.
So they come up will all sorts of ad hoc additions to show why money doesn’t work (liquidity traps, etc.) and why any kind of spending does work (pyramid building, earthquakes, wars).
Look at what the New Neoclassical Synthesis guys say. They say the RBC model is the perfect formal model, but it doesn’t seem to fit the data — so they go ad hoc to make it fit. They could have gone in all sorts of directions. But they didn’t. They went directly back to Keynes, adding ad hoc Keynesian epicycles to the RBC to make it “fit” the data. And now, once again, they see that what they’ve constructed still doesn’t fit, so they are now adding yet new epicycles upon the old epicycles (see Blanchard’s “nevermind” summing up at the IMF conference). Why Keynes, because Keynes fits their “pitter-patter” priors.
Nick writes,
“Keynesian unemployment only makes sense as a monetary phenomenon. What’s fiscal policy got to do with it? Fiscal policy is supposed to be about micro stuff, like providing the goods that the government is better at providing. Fiscal policy can’t do that micro stuff properly if it’s being asked to also do the job that monetary policy is supposed to be doing.”
“there are two ways to get more money …”
Hmm. Isn’t it possible to borrow money? You seem to be assuming (i) that credit is not “money” and (ii) that the “money” supply cannot grow to meet the needs of the economy. If the money supply is elastic (e.g. we have a fractional reserve banking system with excess reserves), all you need to do is borrow money.
In short, you seem to me to be assuming away the fundamental question of Keynesian economics that you are approaching: Why does the money supply fail to grow to meet the needs of the economy?
Hayek, 1929/1933, shows why the existence of money, banking, and credit allows money to be a “loose joint” in the economy, allowing for monetary disequilibrium — and the trade cycle.
Hayek 1929/1933 is arguing against a host of economists who denied the claim that the existence of money was the essential common factor and ultimate cause in the business cycle.
What is missing from Keynes and the New Keynesian of the New Neoclassical Synthesis is exactly what Blanchard and others have now acknowledge: no linkage with the world of finance, credit and banking — the very STARTING POINT of Hayek’s foundational work on the monetary bedrock of systematic, economy wide economic discoordination.
Hayek wins. Hayek links money as a loose joint directly up to the world of credit, finance, and production investment (primitive, yes, but still Hayek’s keystone).
Friedman is working in Keynes’ labor-based framework (see Garrison’s Time and Money) and Fisher’s “crude”, micro-foundationless quantity theory.
Crude Fisherian quantity theory doesn’t get you to the real world of money, banking and credit, interrelated with production investment, etc.
In other words Fisher = failure to genuinely incorporate money.
Nick writes,
“Greg: I would put him up the same end of that spectrum as Friedman, in this dimension. Not sure which one would win the “no enemies to the left of me” contest here.”
Garrison on Friedman as a Keynesian:
http://www.auburn.edu/~garriro/fm2friedman.htm
Hayek vs Friedman on money and the quantity theory from Garrison:
Click to access hayek%20and%20friedman.pdf
The discussion begins a few pages in. A lot more could be said on the particulars, and an lot less on “methodology” (how I hate that term), but it’s a foot in the door on the topic.
Haven’t Blanchard and the rest have effectively admitted that New Keynesian models are FAIL when it comes to genuinely incorporating finance, money, credit — and the relation of all these to production investment, interest rates, and the rest?
Isn’t this just what they mean when they admit that they are FAIL when it comes to finance and “asset bubbles” and the rest?
I think I agree with your analysis, but in defense of Brad that wasn’t exactly why he blamed Friedman.
I’m not sure if I exactly understand why he blamed Friedman. It was something about over-simplifying things which, when monetarism receded, prevented people from having a coherent answer. I’m not sure I know what he was getting at (I’m not sure if he knows!), but his point wasn’t that Friedman and RBC agreed on the role of money in the economy.
Greg –
I got a lot out of Garrison’s book, but the whole idea of Keynesianism as being “labor based” that Garrison promoted was dumb. Keynes’s was a money and capital based economics. As Garrison himself noted, employment was largely an after-thought for Keynes. He just said employment moves with output (well, this is Garrison’s take and I suppose it’s fair enough as far as it goes). How do you claim labor was an afterthought for Keynes and then turn around and claim that his theory was “labor-based”???
“Afterthought: None of us ever really understands our own models.”
Aha! A preemptive strike, I see. Nice try, but that won’t stop me from wondering out loud whether monetarists understand their models. In the classic version of your hairdresser-manicurist-masseuse story, the rich German tourist slaps his bill on the counter and everyone runs around paying each other with it before he can notice that it’s missing. In other words, there are no lags. But what if there were lags? Then not only the amount of money, but its distribution might matter.
But wait … we have a name for redistributing money: “fiscal policy.”
The unemployed hairdresser wants her nails done. The unemployed manicurist wants a massage. The unemployed masseuse wants a haircut. If a 3-way barter deal were easy to arrange, they would do it, and would not be unemployed.
It’s worth reflecting on how they might do this 3-way barter deal, given that it’s obviously impractical for all three services to be delivered simultaneously. The most plausible arrangement is for the consumer in each case to write an IOU along the lines: “I owe Bloggs $10 for services rendered.” Once all three have obtained the services they require they have also obtained the wherewithal to pay for them.
But since it’s easy to see why that solution might not work, that line of thinking suggests to me that it is lack of trust in the IOU clearing system which is the fundamental problem, not a shortage of the medium of exchange. A recession is always and everywhere a brownie-points problem.
You could argue that ANY understanding of money, credit, finance, leverage, and banking involves heterogeneous, incommensurable and rival understandings of expectationally interrelated and marginally evaluated phenomena of any and all kinds — i.e. as a matter of LOGIC the real world of money and credit lies outside of a God’s Eye View formal construct made up of logical or mathematical givens.
In other words, you could “argue” (i.e. prove) that any formal construct — whether GE, or Macro, or GE/Macro combined — leaves out genuine money, credit, leverage, finance, and banking as a inherent formal matter of logic.
This fact is what is motivating Frydman’s book on genuine uncertainty, Taleb’s books on black swans and finance, Woodford’s conference on heterogeneous expectations, Branchard’s conference on the failure of the mainstream macro consensus, etc.
Nick writes,
“You could argue that the research program called RBC theory, or Classical Macroeconomics (a strange name for something that only started in the 1980’s), is an example of the Ricardian Vice. RBC theory is what happens when you insist on modelling everything formally.”
csissoko: when I borrow money I give the lender an IOU. A bond is an IOU. I have sold a bond. But I can’t sell a bond unless the buyer agrees. In general, I can’t get more money by selling more stuff unless the buyer agrees to buy more stuff from me. Yet I can always get more money by buying less stuff. I don’t need anyone’s agreement to do that.
“In short, you seem to me to be assuming away the fundamental question of Keynesian economics that you are approaching: Why does the money supply fail to grow to meet the needs of the economy?”
I don’t want to assume that away. I think that is the fundamental question of Keynesian economics.
Daniel: I’m not exactly sure why Brad blamed Milton either. Of course, we are working off a power point, not the whole presentation. So perhaps I did go a bit shotgunny here, trying to cover all bases?
Phil: in that lovely story about the tourist, there are no lags, and only one big 5(?)-party exchange that needs doing. So a one-time temporary monetary injection is all that’s needed to do the job. If my three women will want their hair, nails and backs done repeatedly, and if they don’t all want it done at the same time, the money will need to stay in the system permanently (unless something else changes). But that’s the usual Monetarist story.
Kevin: “But since it’s easy to see why that solution might not work, that line of thinking suggests to me that it is lack of trust in the IOU clearing system which is the fundamental problem, not a shortage of the medium of exchange. A recession is always and everywhere a brownie-points problem.”
I would say that a central clearing house for IOUs, so all 3 women’s IOUs get cancelled, is a monetary system. It lets those IOUs function as money in the same way that chequing accounts function as money when banks have a central clearing house to cancel offsetting cheques.
csissoko and Nick Rowe, is the price of bonds (i.e. the interest rate) flexible? If it is, there is no reason for the market to fail: the interest rate on money (i.e. convenience/liquidity yield) can rise to clear the excess demand. Similarly for any other goods with flexible prices: their price will fall, but there will be no glut. Perhaps, rather than talking about excess demand for money, we should be talking about a glut of some goods and services (e.g. labor) which have exceptionally rigid prices.
I would say that a central clearing house for IOUs, so all 3 women’s IOUs get cancelled, is a monetary system.
That’s eminently reasonable, but surely it’s an awkward line to take if your aim is to defend Milton Friedman from the Keynesians? Is there a definition of the money supply which includes manicurists IOUs?
Daniel, we can go elsewhere — beyond labor assumptions — for this.
Friedman talks of working and thinking within in the overarching Keynesian architecture, and of assuming the basics of that frame. And of course, Friedman’s best “scientific work” was on the consumption function (Friedman’s characterization).
Daniel writes,
“I got a lot out of Garrison’s book, but the whole idea of Keynesianism as being “labor based” that Garrison promoted was dumb.”
Once you have people collecting and trading claims into the future for highly reliable and widely wanted goods you’ve got money. The first money was the recording and taxing and trading of claims to cattle, recorded on stone tablets (the beginning of writing as well).
Once you have that heterogeneous, rival, and non-commensurable understandings about the present and enter the picture — big time. You enter the world of genuine uncertainty, potential systematic disequilibrium across time, etc.
You also have sudden scope for securitized and traded assets of changing liquidity — hole ranges of different kinds of monies, near monies, and shadow monies.
See Sweeney and Lantz on the whole issue of the role of shadow monies in the business cycle:
http://hayekcenter.org/?p=2954
Make that:
“Once you have that, then heterogeneous, rival, and non-commensurable understandings of the present and future enter the picture — big time.”
Greg –
I’m not challenging the idea that Friedman worked within an essentially Keynesian framework (his own claim that we’re all Keynesians now was a methdological/framing claim after all). I’m challenging Garrison’s point that Keynesianism is not fundamentally a capital and money based economics. Keynes’s treatment of employment is largely incidental to his analysis of the marginal efficiency of capital and its relation with the interest rate.
That’s fine. It worked fine for him and it left stuff for other people to work on more later. I just think Garrison mischaracterized it in his preoccupation with claiming that nobody but the Austrians ever thinks of capital. It’s simply not true.
Nick Rowe,
Thanks for clearing that up. In that case I thought it was a bit of a stretch – the notion that failing to focus on one aspect of a model implies a “lack of understanding.” Nonetheless, I don’t disagree with your points – I would only argue that the magnitude of some effects is often not tested, and therefore correspondent theories – sound in principle – are often applied overzealously.
In much the same way, the relative magnitude of effect (as determined by tests and models available) of Monetary v Keynesian theories may shed some light on the conflict you’re talking about.
I’m fine with criticisms of Garrison. I have my own. I didn’t reference Garrison specifically to endorse Garrison — much less everything he’s ever thought or written.
Daniel wrote,
“I’m challenging Garrison’s point that Keynesianism is not fundamentally a capital and money based economics.”
Note well, however.
This is essentially contested territory.
One charge is that Keynes has a backward looking measure of capital. Another is that he explicitly fails to understand or incorporate the basic valuational logic of production — no one extends the length of production without the promise of greater future value. (Then there is the essentially contested issue of legitimate and illegitimate domains of aggregation).
And, am I mistaking in recalling that Keynes measures capital in terms of labor?
Money is used to settle transactions. Is (central bank) money absolutely required in order to settle transactions? Clearly not. For instance, banks can and do settle a lot of transactions using their own money. So why so much talk about monetary policy? It provides only one type of money. This type is more common than others but it is definitely not the only type out there.
However, what people need in order to buy goods and services is income. And monetary policy can not provide income.
Nick – on my reading of Krugman, I understand him to be saying that QE is not credible because of political constraints. While I have a lot of sympathy for that view, a monetarist could counter by saying that political constraints also rule out fiscal intervention. Maybe both perspectives are right, depending on what the relevant time frame is. Perhaps with Mark Thoma, one ought to argue for both fiscal intervention (for immediate impact) and accommodative monetary policy (for sustained impact). Do you disagree?
The great lesson of the debate between Hayek and Lerner, Mises and Neurath over collectivist economic planning and socialist calculation was just this — the can’t have an extended economic order without money and property rights, and you can’t capture of signaling role of relative prices in the economy in a pure logical / math equilibrium construct.
Hayek was actually aware of this problem of mistaking a math construct for the signaling role of profits and losses and changing relative prices as early as his 1929 book on the monetary foundations of business cycles.
The whole point of Hayek’s justly famous “The Use of Knowledge in Society” paper and his earlier “Economics and Knowledge” pager just was to indicate the explanatory and causal limitations of math constructs — their inability to causally explain this causal coordination process involving production goods and money.
Hayek’s 1929 book explains how Hayek’s landmark 1945 paper is directly relevant to thinking about money and monetary theory.
NR: But I can’t sell a bond unless the buyer agrees. In general, I can’t get more money by selling more stuff unless the buyer agrees to buy more stuff from me.
I think that what we agree on is “It’s a coordination failure.” But I think that the way that you’re using the word money is confusing, because the coordination failure you’re referring to is a problem in the system of allocating credit that we’re used to relying on. The whole point of a checking or a credit card system is that the buyer usually agrees to accept the IOU and does NOT commit to buy more stuff from you, but just to buy more stuff from somebody.
Basically in my view it’s because the economy is used to operating with a functional credit allocation system that it’s possible to have a “collapse in aggregate demand” == failure of the money supply to meet the needs of the economy. In other words, it’s precisely because we’re adapted to a world where buyers usually accept some kind of a “bond” (or check) that we’re used to an environment where the money supply grows endogenously with the economy and where we can even begin to have these problems.
Anon: is the price of bonds (i.e. the interest rate) flexible? If it is, there is no reason for the market to fail: the interest rate on money (i.e. convenience/liquidity yield) can rise to clear the excess demand. Similarly for any other goods with flexible prices: their price will fall, but there will be no glut. Perhaps, rather than talking about excess demand for money, we should be talking about a glut of some goods and services (e.g. labor) which have exceptionally rigid prices.
Because credit markets are so utterly non-homogenous, I think it’s dangerous to talk about “an interest rate” clearing them. While there are contexts in which “aggregate demand” and “sticky prices” may be useful, I think that understanding the underlying problem as one of a coordination failure which impedes the functioning of the price adjustment mechanism is more useful. The whole point, in my view, is that this this is a situation where there are many different prices for credit/money faced by many different participants in the economy and they aren’t responding to the same signals. So, to understand what’s going on, you have to dig into the nuts and bolts of the credit system.
Friedman’s and Hayek’s original thinking have as much relation to what passes as monetarism as the Sermon on the Mount has with the Spanish Inquisition. Every marketer knows that, once you have launched a product,it no longer belongs to you but to the customers. Avon never planned that Skin-So-Soft would turn into a mosquito repellent for burly moose hunters…and just remember what happenned to poor Brian in the Monty Python movie…
http://www.imdb.com/title/tt0079470/
IIRC, in the early 80’s, I read a paper by Michael Parkin ( all apologies to Michael if I’m wrong and please correct) where he listed 9 types of monetarism, all mutually contradictory, few of which Uncle Milty would recognize even as a distant relative).
Hayek was perfectly aware that recessions exist and that the cause was monetary. From his 1929 book to his public letter in The Times (the real one, London)
http://online.wsj.com/article/SB10001424052748704738404575347300609199056.html
But he was frightened of efficient state power becoming addictive. The results that effective economic policies had on Hitler’s popularity later convinced him of his preconceived view rightness. He was willing to make the sacrifice of counter-cyclycal policies as the cost of his view of freedom. And if he needed absurd antiquated arguments to make a point with an ignorant public, so be it.
Keynes had no concern for labor and workers. He said that ” we should take care of our workers aas we take care of our dogs” and to critics that he was a socialit, replied that he would not adopt an ideology that mud above fishes. But he saw that his class might meet the guillotine and didn’t like the look of it.
csissoko: when I borrow money I give the lender an IOU. A bond is an IOU. I have sold a bond. But I can’t sell a bond unless the buyer agrees. In general, I can’t get more money by selling more stuff unless the buyer agrees to buy more stuff from me. Yet I can always get more money by buying less stuff. I don’t need anyone’s agreement to do that.
“In short, you seem to me to be assuming away the fundamental question of Keynesian economics that you are approaching: Why does the money supply fail to grow to meet the needs of the economy?”
Nick
I don’t want to assume that away. I think that is the fundamental question of Keynesian economics.
And that’s why Keynes wrote approvingly of Major Douglas Social Credit…They would have both so loved the solution to the Capitol Hill Baby-sitting Coop recession…
Widow’s cruse, gotta love that phrase. I read a Tobin paper a few weeks ago on banks that used the term, I assume that’s the one you’re referencing. (Commercial Banks as Creators of Credit, ’63)
Nick, I’ve been absent for a while, but as I’ve been reading Leland Yeager in the interim, I feel as if I haven’t stopped reading your blog posts! I see a lot of similarities between Rowe and Yeager.
Cheers, JP
Before we keep invoking Keynes, it is worthwhile remembering:
“If you put two economists in a room, you get two opinions, unless one of them is Lord Keynes, in which case you get three opinions.” – Winston Churchill.
“The trouble with Keynesians is that they aren’t radical enough. They need to look at their own models and see the root of the problem, and recommend policies to get at the root of the problem. The root of all Keynesian recessions is monetary.”
And at the zero lower bound, monetary policy has to get creative, right? It needs to operate by exchanging zero maturity debt for longer term, less liquid assets than normal. It doesn’t get much less liquid and long term than infrastructure or research programs. So why aren’t more economists calling for completely coordinated monetary and fiscal policy? The conclusion that flows from this analysis would seem to be advocating congress to pass a stimulus package that allows the Treasury to finance the expenditure with zero maturity debt – brand new money.
It would appear that there are even greater political constraints on helicopter money than on either unconventional monetary policy or on fiscal stimulus. Seems like it’s the one sure way to end a problem of insufficient demand for newly produced goods/excess demand for money. Just satisfy the excess demand for money and get on with life!. It’s the one thing that hasn’t even been contemplated (at least not as far as I am aware).
What would it take, I wonder…. Putting aside the fact the US in particular seems to have a real need for some big infrastructure upgrades that ought to be done regardless, a one time shot of $10000 per employed American would be a little over $1.3 trillion. Isn’t that about what Romer said the size of the fiscal stimulus should be? So why not just print a trillion and hand it out?
Nick,
Can you recommend any books or papers that explain the history of post WWII macro. I would like to learn more.
Joe
“However, what people need in order to buy goods and services is income. And monetary policy can not provide income.”
Agreed. People can demand nominal income without desiring to increase their stock of money. I think money is important, but more as a flow than as a stock.
Say everyone owes $100 to the neighbor on their left, and has a $100 bond obligation from the neighbor on their right.
Every day, they sell $2 of goods to the neighbor on their right, and buy $2 of goods from the neighbor on their left.
Preferences are as follows:
0. Make money
Sell as much as you can!
1. liquidity:
They each maintain a steady state cash balance of $2 — which is exactly what they want. That allows them to sell first and then buy, or buy first and then sell, but over a complete cycle they want to have $2 to buy again.
2. Balance sheet:
They also want to make sure that they own at least as many bonds as they owe.
3. Consumption
Only when all of the above conditions are met are they willing to buy goods with the remainder.
If one person tries to sell $2 worth of goods, but only buys $1 of goods, using the other dollar to repay a portion of his debt, then he is still getting $2 from the right, and sending $2 to his left.
But the person on his left has $99 of bonds, instead of $100, which is what he wants. His cash balance is now $4, which is $2 too much, but his income has been cut in half.
The demand is to increase his income, not his cash.
He reduces his own debt by $1, to meet #2) and buys only $1 of goods. The situation propagates, each time supplying the person on the left with $2 cash, but only $1 of income.
When you get back to the original person, he will have his bond holdings decreased back to $99 as well.
If his target debt level was $80, then there will be 19 more circles of de-leveraging.
During that period, demand for all goods will be cut in half, even though no one wanted to increase their money holdings.
And interest rates don’t need to fall at all, since people de-leverage by repaying their existing debt without trying to buy more bonds.
If the central bank decides to fix this problem by buying $1 of everyone’s bonds for cash, this is undone by #2) As all the new money circulates to repay liabilities in order to undo the reduction in interest bearing assets caused by the open market operation — Ricardian equivalence in reverse 🙂
The balance sheet constraint is binding, so only an increase in income will help, not an increase in money.
On the other hand, if the government were to buy $1 of goods and finance this by selling $1 of bonds, then this would arrest the problem entirely.
Here, Ricardian Equivalence is a feature, not a bug, as without the government action, households would not succeed in increasing their bond-holdings, but the fiscal action allows them to succeed.
Did you know about the emergence of “clubes de trueque” (barter exchanges) in Argentina during the 2000/2001 crisis? At some point they claimed to have something like 10 million regulars (out of a population of less than 40 million) changing goods and services on a weekly basis. The post-2002 economic recovery killed them (plus some mismanagement in the emission of their own privately-issued currency. Yes, they grew so much that at some point they realized they could use their own money rather than the official peso).
anon: “..is the price of bonds (i.e. the interest rate) flexible?”
Have a look at my old post: http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/02/money.html
Kevin: “That’s eminently reasonable, but surely it’s an awkward line to take if your aim is to defend Milton Friedman from the Keynesians? Is there a definition of the money supply which includes manicurists IOUs?”
Well, Friedman wasn’t right on everything. And the idea that they was a well-defined measure of money with a stable demand and supply function is where he was least right. That’s the main reason why there are quasi-monetarists rather than monetarists nowadays. And why it has become harder to distinguish monetarists who recognise that point from Keynesians who recognise the point I am making in this post. Strangely though, you can still see the old lines on the map, like a palimpest(?).
Sergei: “For instance, banks can and do settle a lot of transactions using their own money. So why so much talk about monetary policy? It provides only one type of money.”
Agreed. But what gives central banks different, and creates their power over the whole monetary system is: they are not trying to maximise profits; all the other banks promise to redeem their money into central bank money at par. It’s like the central bank is the US under the old Bretton Woods system, where all the other countries pegged to the US$, but the US didn’t peg to them. It meant the US could do what it wanted, and all the other countries had to adjust to the US.
“However, what people need in order to buy goods and services is income. And monetary policy can not provide income.”
A stock of money does not create a flow of income for an individual. If one widow spends from her purse, the money runs out. But if all widows try to spend down what’s in her purse, her purse turns into a magic cruse, that refills itself as fast as she spends it. What leaves my pocket enters your pocket.
Some British Keyensians never got this point. “OK, the government prints an extra $100 for each of us. We spend that $100. Then what?” Eatwell and Robinson, from memory. The $100 reappears in my pocket, when someone else buys something from me. So we all spend it again. And income rises until we stop trying to spend away the excess.
Jacques: I’ve read that paper too, but my memory is even hazier on who wrote it. And it called each definition “M1, M2, M3, etc.”? I would have guessed Harry Johnson, but I could easily be wrong, or muddled. Anyone remember?
JP: I think Keynes first used the Old Testament widow’s cruse metaphor in economics somewhere. Maybe the Treatise? That’s where I first heard it, when Don Patinkin taught us some history of monetary thought. I didn’t know Tobin had used it.
I read Yeager as a grad student, just as part of my random readings aside from classes. And started re=reading him a couple of years back. He’s not easy to understand. I think he has had a big influence on me, but maybe subliminally. And I can’t tell what I have got from Yeager and what I have got from David Laidler.
Test and Patrick: a temporary deficit financed by a permanent increase in the money supply would be the textbook response. The new money could either finance infrastructure, or else just be mailed out, like in Australia. I have grappled with this in old posts, but have never got my head around how exactly to implement it. Would it in fact be permanent, or perceived as such? How can we make it so? It’s the credibility/communication of monetary policy problem, reappearing in another guise.
Joe: “Can you recommend any books or papers that explain the history of post WWII macro. I would like to learn more.”
My mind draws a complete blank. Sorry. Does anyone else have a good suggestion for Joe? I am useless at this.
RSJ: If I understand your example correctly, what you are saying is that the stock demand for money depends not just on income (the flow of expenditure on goods and services) but also on the flow of expenditures on bonds (deleveraging). So when people decide to increase their flows of expenditures on bonds, that increases the demand for money, creates an excess demand for money, that causes income to drop. Another way to describe it would be that Velocity must include income transactions plus financial transactions. Interesting. Presumably though you would get the same effect on increased demand for money whether people were leveraging up or down.
Pablo: that is very interesting. It’s exactly what my approach says should happen. When there’s a recession due to excess demand for money, people should try to resort to barter, or to new monetary systems where they create their own money, if the costs are not too high.
If the Treasury were to issue new money to finance the expenditure, the central bank wouldn’t have enough interest bearing assets to counter the effect, would it? It could pay interest on reserves in an attempt to maintain its stingy inflation target once a substantial recovery is underway, but it doesn’t have a good way to permanently neutralize the fiscal-monetary injection with its current toolkit, especially if that injection is on a scale sufficient to deal with our unemployment problem. At least, I don’t think it does.
It’s politically unfeasible – although apparently, “zomg we’re broke – quick, cut taxes and NPR” isn’t – but wouldn’t it be nice?
Joe: “Can you recommend any books or papers that explain the history of post WWII macro. I would like to learn more.”
Snowdon and Vane, A Macroeconomics Reader, covers quite a lot of ground.
Pablo, thanks. That stuff is gold. Just found this too: http://lanic.utexas.edu/project/etext/llilas/claspo/dissertations/Shea.pdf
What is money?
in 1996, after the Saguenay deluge abd flood, the road to Sept-Îles was cut off and as modern business work in the just-in-time mode, within 2 days the stores were out of food. Prices went up in money terms, then barter appeared and obviously within a few days someone wolud offer his 10 year daughter in exchange for milk ( civilisation is a thin veneer.)
Classical case of hyperinflation where the problem is not that the economy is illiquid but that it becomes infinitely liquid as everything becomes part of the money supply.
And by the way , that’s why hyperinflation is easier to fight than simple inflation. Just restore the supply of goods. in our case, the matan to Baie-Comeau was diverted to us with only food- carrying trucks allowed in board ( no market solution here) and nobody was forced to sell his children.