I've got three targets in this post: economists who say that recessions are caused by real wages being too high; economists who say that recessions are caused by real interest rates being too high; and economists who say that recessions can't be caused by an excess demand for money, because we can always go to the bond market/ATM and get some more. That's a lot of economists. Most economists, in fact.

Assume a monetary exchange economy. You can't buy or sell anything except by giving or accepting money in return. Every single market is a money market — where one of the other goods is traded for money. Money is both medium of exchange and medium of account, because all prices are measured in money. People hold stocks of money. When an individual buys something his stock of money falls, and the seller's stock of money rises.

Start in full equilibrium. Every single market has demand equals supply. Now assume all prices are fixed. Every single price for every single good, including all inputs like labour, and all asset like bonds, is fixed. Now halve the stock supply of money. (Or double the stock demand, it doesn't matter). Every individual: tries (and fails) to sell more goods; tries (and succeeds) to buy less goods; because he is trying (and failing) to increase his stock of money. The result is a recession. Absolutely standard monetary disequilibrium story.

Now, let's add one tiny twist to that monetary disequilibrium story. Let's make one tiny exception to the assumption that all prices are fixed. Assume the price of peanuts is perfectly flexible. So the market for peanuts always clears. It's only a tiny twist, and a tiny exception, because by assumption peanuts are a tiny and unimportant part of the economy. If some disease destroyed all the peanuts, or some new method of peanut farming doubled the supply of peanuts, nothing much else would change. Peanuts are, well, peanuts, in the big macroeconomic scheme of things. By assumption.

What happens to the price of peanuts when the money supply halves, and all other prices stay fixed? I don't know. It depends. You might think it would halve, because the halving of the stock of money should mean that the equilibrium price level halves. But a moment's reflection is enough to say that that answer is very probably wrong. The recession had a purely nominal cause, by assumption, but the recession itself is a real event. Real income is lower, and there's excess supply in other markets, so people cannot sell stuff, like labour. That real shock would change the demand and supply for peanuts as a function of the relative price of peanuts. If peanuts were a luxury good, their demand would fall now that people are poorer. If peanuts were an inferior good, that people would only eat when they are unemployed and desperate, their demand would rise. Then there's the supply side of the peanut market as well. The fixed prices of all the inputs needed to produce peanuts may prevent the nominal price of peanuts halving. Alternatively, a flood of unemployed workers growing peanuts in their backyards to earn money, because you can always sell peanuts, might cause the price of peanuts to more than halve.

The price of peanuts will almost certainly change. My guess is that it will probably fall. But I don't know that for certain. It will depend on a lot of things. It might depend on how deep the recession is, and how long it is expected to last. Or I could even assume that all prices adjust slowly, but that the price of peanuts adjusts more quickly or more slowly than the prices of all the other goods. But it doesn't matter. Because peanuts don't matter. By assumption.

We know that the recession in this economy is caused by an excess demand for money, and that the fall (or rise) in the price of peanuts is an almost irrelevant side-effect that we can safely ignore. We know this because we built the model economy and we assumed that peanuts are almost irrelevant. But the people living in the economy do not know this. What they see is a fall (or rise) in the price of peanuts, accompanied by a recession.

Someone living in that economy, who didn't understand monetary economics, would be very tempted to say that the fall in the price of peanuts is what caused the recession. Microeconomic theorists would be very tempted to say that the recession is caused by real/relative prices being wrong. The price of peanuts is too low relative to other goods, or the price of other goods is too high relative to peanuts. That's why the peanut market clears but other goods are in excess supply. And if a monetary disequilibrium theorist suggested that the recession was caused by an excess demand for money, he would be met with the objection that people could always get more money by selling peanuts. Which is true, but irrelevant.

Now let's add a second tiny twist to the story. Assume that the central bank conducts monetary policy by buying and selling peanuts. In fact, every month it sets a new target price for peanuts, at which it will buy and sell unlimited amounts of peanuts. But further assume that the stock of central bank money is tiny relative to the stock of peanuts, so even though the bank's peanut market operations have a significant effect on the supply of money, they have only a tiny effect on the supply and demand for peanuts.

Now all the macroeconomists join the microeconomists, and the common people, in focusing on the price of peanuts. "The price of peanuts is set by the central bank, not by production and consumption of peanuts". "The price of money is the inverse of the price of peanuts". "Monetary policy is the price of peanuts, rather than the stock of money, which is endogenous and demand-determined". "There cannot be an excess demand for money, because the central bank is willing to sell an unlimited amount of money". "There is a natural equilibrium (real) price of peanuts, and if the bank sets the price of peanuts below that natural price, there will be a recession and deflation".

All these things the macroeconomists are saying are true. But they are also all irrelevant. Because, by assumption, peanuts are a tiny irrelevant part of the economy, and almost exactly the same things would happen if the central bank did not implement monetary policy in the peanut market, and if the price of peanuts were fixed like all the other goods. Plus, since the recession will affect the demand and supply of peanuts in many unknown ways, the partial equilibrium relative price of peanuts may either rise or fall in a recession, and so you can't even use the price of peanuts as an indicator of the tightness or looseness of monetary policy.

"The recession was caused by an increased demand for peanuts and a consequent rise in the natural equilibrium real price of peanuts, which the bank failed to match by increasing the actual price of peanuts sufficiently". "Perhaps the government should step in and start growing peanuts to reduce the natural price of peanuts, since monetary policy isn't working". This would be the diagnosis and one suggested cure.

Now, it is true, peanuts are a tiny and almost irrelevant part of this economy by assumption. In the real economy, bonds aren't. But so what. And central banks are a tiny part of the bond market.