"Inflation is always and everywhere a monetary phenomenon" was Milton Friedman's slogan. It was revolutionary (or counter-revolutionary) when he said it in 1970, but it's now very widely accepted. After all, we make central banks responsible for keeping inflation on target. We do not make fiscal authorities responsible for targeting inflation (unless they happen to control monetary policy too). And we certainly don't give the Competition Bureau or Industry Canada responsibility for targeting inflation (which would make perfect sense if economists believed, as many did in 1970, that inflation was caused by monopoly power).
But nobody strictly believes the full quote from Milton Friedman. I bet hardly anybody even knows the full quote. "Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output." Nobody believes that last bit is strictly true.
What about my own slogan (though it might easily have been Friedman's): are recessions always and everywhere a monetary phenomena? And if so, in what sense?
Robinson Crusoe doesn't use money. If Robinson Crusoe has a bad harvest, his GDP will drop. It's conceivable he might even work less, if there is less to harvest. But is that a recession?
Well, you could call that a recession if you like. But it is missing one very distinctive feature that we normally associate with recessions.
In a recession, it gets harder to sell stuff, and easier to buy stuff. It takes more effort to find a buyer, if you want to sell goods or labour; and it takes less effort to find a seller, if you want to buy goods or labour. Most economists look at an economy like that and say that goods and labour are in excess supply. In the olden days, we would say there's a "general glut".
It's the excess supply of goods and labour that makes it a recession. The fall in output and employment is merely a typical symptom of that excess supply. Less stuff usually gets sold when there's less demand than supply.
In fact, I can imagine an economy having a recession even while output was rising, even rising faster than normal. An economy could experience a general glut, and at the same time have a massive oil discovery that causes its output to rise. Unlikely maybe, but I can't see why it couldn't happen. Just have the central bank halve the money supply at the same time as oil production skyrockets. That should do it. If the discovery is big enough, the increased oil production and oil exports could be quite enough to offset the decline in the rest of GDP.
Inflation is a rising price of goods in terms of money. Because money, understood as the medium of account, is what we price goods in. I don't see how anyone could sensibly talk about inflation without mentioning money.
A recession is an excess supply of goods in terms of money. Because money, understood as the medium of exchange, is what we buy goods with. I don't see how anyone could sensibly talk about recessions without mentioning money.
We live in a monetary exchange economy. Sure, some parts of the economy are handled by barter, like production within the household, and exchanges with close neighbours. But the barter parts of the economy seem to do OK during a recession. Maybe even expand when the monetary economy falls, so people are forced to rely on their own production of vegetables, or that of their family, friends, and neighbours.
It's the monetary exchange economy that suffers during a recession. It gets harder to sell stuff for money. It gets easier to buy stuff with money. There's an excess supply of other (non-money) goods, and there's its flip-side: there's an excess demand for money.
I don't see how anyone could sensibly talk about inflation without mentioning money. I don't see how anyone could sensibly talk about recessions without mentioning money.
When it comes to inflation, we are (nearly) all monetarists now. At least in accepting the shortened version of Milton Friedman's slogan. But very few (if any) economists would accept the full version of Milton Friedman's slogan. We turn a blind eye to the bit where he adds "… in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output". OK, we say, he was wrong on that bit, but still right nevertheless. We still say that central banks' monetary policy can be given full responsibility for targeting inflation. We recognise that a change in the money supply will change the price level, other things equal. We recognise that a change in some of those other things can also change the price level, holding the money supply constant. That's OK, we say, because it is the job of the central bank to do whatever is necessary by changing the money supply to offset any changes in any of those other things that would otherwise cause inflation to vary from target.
Similarly, if we accept that recessions are always and everywhere a monetary phenomena, that does not mean that changes in the money supply are the only thing that can cause a recession. That's OK, we should say, because it is the job of the central bank to do whatever is necessary by changing the money supply to offset any changes in any of those other things that would otherwise cause a recession.
There ought to be a symmetry here. We are all (quasi-)monetarists when it comes to inflation. We should all be (quasi-)monetarists when it comes to recessions.
Worthwhile Canadian Initiative 
“But is it a recession”
Yes, I think it would be. Scaling this up, if there are many parallel examples to pets.com, of businesses ultimately producing nothing of value, investors are worse off and the aggregate starts to materially weigh on wealth. I’m simply arguing that a recession comes when investments don’t pay off, and if enough investments don’t pay off then people will be worse off, even if they’re immediately put back to work elsewhere. To use a very simple example, if I’m a bad farmer I starve.
Sorry, I’m not following the supply argument (but that’s likely because I don’t understand your definitions). I’m going to re-read your post and the comments.
Interesting question. I am inclined to argue that this is incredibly easy to evade. Imagine a two currency world. I’d simply sell domestic currency, buy foreign currency, sell insurance on the domestic currency, and use the premium to buy insurance on the foreign currency. Change the example to a closed economy and the foreign currency becomes a financial asset, and the result is the same.
I am assuming complete capital markets and other similarly unrealistic properties and am however slightly puzzled whether a recession is even possible in such a world. For isn’t it simply possible to replicate cash balances in such a world? How can there ever be an excess demand for money then?
Oh wait, complete capital markets rely on the non-existence of uncertainty. How else can you have a a contract with a pay-off for each state?
The world where you have to spend dollars instantly is just called a barter economy. It is identical to a standard barter economy in every way except that sometimes goods may be priced in a common unit of account.
Okay, how do you know there is a recession?
Jon: “Okay, how do you know there is a recession?”
Mostly, I read anecdotes from the newspapers 😉
We have very little good direct data on how easy it is to buy and sell stuff. The unemployment rate is usually (I hope) a good proxy for how hard it is to buy or sell labour. Survey data from firms can tell us how big a problem demand is, and how easy it would be for them to buy inputs to meet an increase in demand. Months listings for houses. But yes, mostly I just listen to a load of anecdotes about this.
Sure, if there is no other plausible explanation, a decline in output and employment would be a symptom of a recession. But only a symptom, not the thing itself.
Nick,
OK, but one can write down a model in which this is imposed as a constraint on all the actors, right?
Just imagine a discreet model, in which no one in the private sector is allowed to hold any cash balances at the end of each period.
They can borrow cash from the central bank, and they can lend cash to the central bank (by purchasing government bonds). But at the end of each period, they are only allowed to hold bonds or goods.
The central bank ensures that the interest rate charged to those who borrow cash (from it) is the same as the interest rate charged to those who purchase government bonds.
You are saying that in any model that has this transactional constraint, that demand-style recessions are impossible? Even if we add price rigidity, disequilibrium, coordination failures, expectations failures, downward nominal wage rigidity, etc?
It will never be the case that it is harder to sell (produced) goods rather than to buy them?
But if your answer to the above is “you can have recessions with this transactional constraint”, then there something else going on here other than just a demand for money.
Nick;
“Martin, Jacques: why would a fall in the supply of oil cause an excess supply of everything else, if it didn’t have some monetary impact.”
Production functions are clay-clay. If the price of oil goes up we must reduce production of things-that-use-oil but they themselves are part of some other clay-clay productions that are also reduced. The limited amount of monetary signs goes to the King of Saudi. He doesn’t want the goods we no longer buy but something else ( fighter jets in that historical case) that will be available only with a lag.
It is primarily a lack of AD for the less prized goods. You may want to see it as a glut of other things even though the glut is a result not a cause.
And the monetary angle is through the fact that reduced buyiing power is transmitted through having less money than before. But it is not a “monetary recession”.
In 73, we encountered such a phenomenon for the first time ( there was a samll similar event for the same causes in Europe in 57 after the Suez affair.) We were spoooked, called it a recession and told the public it was though it wasn’t. We then tried to solve it through keynesian means utterly irrelevant to the task and were told that we needed new economics to replace Keynes. We are still suffering the aftereffects.
I agree entirely with Jacques. His point is entirely why I say there is more than one type of recession. I will bang on about that one. You can have a supply recession and a demand recession, we are currently having the latter.
I came to this conclusion about two years ago and I’m glad to see at least one genuine economist agrees with me.
rsj: I like the way you have re-posed the question, within a discrete time model, where we can assume away the impracticalities. And your money turns into a pumpkin at midnight.
There’s something not quite right in your specification however.
1. You have a perfectly elastic money supply function. Start in full equilibrium. Hold prices fixed (by assumption). Now suppose there’s a sunspot, and everybody expects everybody else will withdraw only one half the amount of money from the central bank. The each individual will expect everyone else to spend only one half the normal amount, so expects to get half the income, so only withdraws half the normal amount too, and only spends half as much. Which causes a recession. The model would need the central bank to set M where M=PY/V, where V=1 by assumption, and Y is full employment income.
2. In a world of imperfect competition, all goods will tend to normally be in excess supply. It’s like a permanent ‘recession”. (Remember my old posts on this). Which is why I was careful to say that stuff is harder to sell than normal in a recession (did I remember to say this?).
3. I’m trying to think how I would have prices determined in such a model.
Determinant: “You can have a supply recession and a demand recession, we are currently having the latter.”
Nearly all economists would agree with you and Jacques, though most would say that supply recessions are much rarer historically (though, if monetary policy were perfect, the only recessions left would be supply recessions).
I’m the weird outlier here!
OK. If most economists agree with me, or I agree with most economists then the best thing that can be done for economics discourse and for political discussion of economic policy is for the distinction to be made clear and incorporated into ordinary language.
The use of the word “Recession” without qualifier must be eradicated.
The problem here is one of perspective. A shortage of real materials or services is apparent for all to see and almost everyone can agree that such a shortage exists. But a money shortage looks like a general glut of goods, it’s counter-intuitive to see one and then examine the underlying causes.
What works in a supply recession, innovating, substituting and investing your way out of it does not work at all in a demand recession. Reduced to its most basic, you have to either let prices fall (people without money or trying to acquire it suffer the adjustment) or inject more money into the economy (people with money or those who try to spend it) suffer.
The question is a political one, which group pays the price of monetary adjustment in a demand recession?
Nick,
In this model, the central bank cannot control M like this.
If it purchases a bond for money, the household will turn around and purchase a government bond, supplying money to the private sector, then they can bid up the price of the government bond, at which point the CB, as it is obligated to keep the yield on the government bond equal to the policy rate, will need to sell more bonds into the market.
The net result of this is that the private sector can undo any OMO, unless it really wanted to use that much money during the period. But if it did, it would have withdrawn that much money in the first place!
And yet this model will have well defined prices, so I am urging you to re-consider the notion that the size of the monetary base, rather than the quantity of bonds and the rate of interest, is the key determinant to setting the price level.
Sorry, in the above, I meant: CB purchases a bond –> households have too much money–> households bids up price of the government bond –> CB sells a bond –> households have the right amount of money and the OMO is reversed.
The mandate to keep the yield on bonds at the policy rate means that the quantity of money borrowed from the CB each period is no longer a policy variable.
Yep. Supply side contractions are sort of obvious. The weather, earthquake, war hit, and we can’t produce as much stuff as before. Usually (not always) we can understand what’s happening as the market doing it’s best to play a bad hand it’s been dealt. It’s the demand-side recessions that are harder to understand, where the market just seems to be doing obviously wrong things with an OK hand.
rsj: “And yet this model will have well defined prices, so I am urging you to re-consider the notion that the size of the monetary base, rather than the quantity of bonds and the rate of interest, is the key determinant to setting the price level.”
No it won’t. We’ve known that since Wicksell. Stop trying to lead me down that Neo-Wicksellian garden path! That’s the dead-end the rest of the profession has gotten lost in.
OK, then for the dullards, please explain why prices are not well-defined. Does the economy explode? It’s a very simple constraint to impose on an economy, so what do the inhabitants of our model do the day after the CB introduces dated cash and simultaneously promises to lend and borrow at the policy rate?
Start in equilibrium. Double all prices, double the money supply, leave the interest rate constant, and you are still in equilibrium. It’s all to do with units not really mattering.
http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/05/units.html
You are assuming that prices are determined by the money supply, but they aren’t. The money supply is determined by prices. Now, you may disagree, but you can’t build a case by asserting that it is so.
No I am not. If the central bank pegs the rate of interest, it is neither true that M determines P nor that P determines M. P and M are two linked balls on a flat table. Neither determines the other. Which is why the US is in such a mess.
Or, Nick, to be less combative (“garden path” comment notwithstanding :P), you are assuming that the only possible mechanism to set prices is a hot-potato of outside money.
And I proposed a simple constraint that, in principle, can be imposed on any economy, in which the hot-potato-ing of outside money is impossible. The constraint should not materially alter anything else happening in the economy.
The proper response is not “well, prices are undefined!”, but rather, “the hot potato effect is not operative in this model, and therefore prices are defined by some other mechanism.”
Not every model in which there is a medium of exchange has to be forced onto the procrustean bed of paleo-monetarism, even if the latter is your favorite way of thinking about price-determination.
Points to rsj simply for his last sentence which just sounds sooooo good phonetically, emotionally and intellectually.
Can all the instances of “money supply” in the post be replaced with medium of exchange supply?
Yes, it is important because lots of people have different definitions of “money supply”. The first one I am thinking of is all the people who will say the “money supply” is the monetary base (currency plus central bank reserves).
“There ought to be a symmetry here. We are all (quasi-)monetarists when it comes to inflation. We should all be (quasi-)monetarists when it comes to recessions.”
So does the medium of exchange supply trade relative to the amount of goods/services in the economy (meaning if the amount of goods/services starts rising, does the amount of medium of exchange need to increase to keep it from rising in value relative to the amount of goods/services)?
It seems that Nick’s basic point is currently being supported by the empirical evidence. See:
http://macromarketmusings.blogspot.com/2011/08/other-side-of-households-balance-sheets.html
No, no… after this sequential adjustment, you can have excess demand for something you don’t have the money to pay for. Likewise you can have excess supply of something you don’t have (because you’ve allocated it all to other purposes). So in sequentially suppressing the non-chair related markets, you can force the excess supply of money relative to chairs to spread itself out among the universe of goods, less chairs. But you cannot make the excess supply go away. Nobody will have unallocated money or goods but if someone offered them antique chairs for any given basket of non-chair goods at the prevailing price vector, they would swap. It doesn’t even have to be money.
Observation of effort to locate transaction counterparties is misleading – there is always excess demand for any number of impossible goods. If presented with a genie-containing lamp I would pay vast sums for it. But that doesn’t mean I go out searching for it. The degree of effort also captures the degree of my limited-rational belief of such costly effort actually finding a counterparty, not merely the degree of my unmet demand for it.
The part where RBC is wrong is not where they claim the unemployed take a Great Holiday. That’s not wrong, the unemployed really do. There are 24 hours in a day and unemployment doesn’t change that, so they HAVE to do being something else. The part where they are wrong is where they claim indifference by the unemployed between non-work and work at the prevailing wage. In sequentially visiting each market for “what someone can spend their time doing”, you will observe all of an unemployed worker’s hours being allocated, but that doesn’t change the existence of excess supply of labour. So why doesn’t this apply for a goods market unless people idle money? They don’t idle time!
Quantities are normally sticky, in that they are scarce because it is costly to create more of it. One can create more money though, instead of changing the price of money. Regardless, goats don’t only cause a recession because they affect the demand for money. They cause a recession because their relative price to cows is sticky!
re: the rest. Okay, try this. Mundell-Fleming, small open economy with a fixed exchange rate. The central bank always stands ready to maintain the rate, and the economy is small relative to the rest of the world, so there is never a (non-small) excess demand for media of exchange: one can readily substitute foreign money.
A recession hits (and you can’t really deny that small open economies can have isolated domestic recessions). There is excess supply of domestic goods (or domestic labour to produce domestic goods). There is no domestic excess demand for money; instead there is domestic excess demand for foreign goods. Resolution is achieved by altering the exchange rate so that domestic demand shifts from foreign goods to domestic goods/labour (and, likewise, foreign demand shifts from foreign goods to domestic goods/labour – call centers, maybe). Very textbook M-F.
Would this suffice as a conceptual example of a non-excess-demand-for-money disequilibrium recession?
Hayek sought to prove exactly this: “recessions always and everywhere a monetary phenomena” in his famous 1929/1933 book Monetary Theory and the Trade Cycle.
Hayek in 1929 (etc.) shows that this statement “recessions always and everywhere a monetary phenomena” does NOT imply that “a recession is an excess supply of [all] goods in terms of money”. In fact, showing that “recessions always and everywhere a monetary phenomena” show something different: “recessions are an excess supply of some goods and a deficient supply of other goods, effected by changes in the liquidity of near moneys, leverage, money demand, credit flows, credit availability & changing the relative values of production & consumption goods”.
Let’s put some more bones on that:
“Recessions are a systematic value destroying disequilibrium across all relative prices — including relative prices across time — expressed in an excess supply of some goods and a deficient supply of other goods, effected by changes in the liquidity of near moneys, leverage, money demand, credit flows, credit availability & changing the relative values of production & consumption goods”.
The KEY thing is that the disequilibrium effected by changes in liquidity, credit, money, leverage etc. is an disequilibrium which — once unavoidably exposed — inescapably exposes systematic false valuations .. and thereby the less-economic or non-economic status of many prior goods & inputs.
Wishing these to have economic status or more-economic value status doesn’t — and can’t — make it so. The prior “equilibrium” was a leverage / credit / money / mis-valued disequilibrium which only managed to hide itself & maintain itself because it depended on expectations across time that could not be fulfilled and which were hidden from view by all sorts of massive non-transparencies and knowledge problems.
Think of all the leverage, non-transparencies, knowledge problems, across-time expectations, etc. involved in mortgage backed securities, the housing market, Fannie Mae, credit default swaps, Too Big To Fail moral hazards, the Greenspan Put, etc., etc., etc., etc.
Think of old Palm Pilots or tube televisions or tape deck radios.
It’s really easy to buy such stuff — find a seller. But its really hard to sell such stuff — find a buyer.
Why? Because these things have radically lost their relative economic value in the system of relative prices — or they completely lost their status as economic goods.
Macroeconomists seem incapable of thinking in terms of things that lose their economic value, or even their economic goods status, due to the ending of an unsustainable money/credit/leverage/liquidity generated dis-coordination across all relative prices and production processes and consumption expectations.
Do sort of magic can give these goods back a status dependent on a structure of relative prices existing only in the past which can never return — and wasn’t viable even when it existed.
Think of the subprime / housing market / mortgage backed security / credit default swap structure of 2006 …
Make that:
“NO sort of magic can give these goods back a status dependent on a structure of relative prices existing only in the past which can never return — and wasn’t viable even when it existed.”
“How about we change terminology a little? Recessions have to do with Relative Prices. Depressions have to do with Demand.”
I prefer the term “deflationary recession” (though the ‘deflation’ can be disinflation rather than absolute deflation).
The horde of angry Austrians arrive! Well, Austrian.
Why do rational people not hedge against knowledge problems? 😀
Are people systematically wrong? Is ratex not justifiable here? How would limited-rational overvaluation of future investment (aka, malinvestment into projects that would be unprofitable at the “correct” rate) be consistent with observed comovement of investment and consumption? Or are we combining these with some Galbraithian notion of a bezzle?
Undoubtly you have seen these attacks before!
Determinant:
“The question is a political one, which group pays the price of monetary adjustment in a demand recession?”
When the recession is monetary one group already paid the price for going off trend and one group gained. Going back to trend would merely reverse the positions of both groups and would restore the economy to the point where the economy would have been without the recession.
Does a belief in “inflation is always and everywhere a monetary phenomenon” mean that income doesn’t matter? That is, that changes in money drive behavior independent of income?
Did Milton Friedman believe that a helicopter drop of income (not accompanied by an increase in money) would not be inflationary?
david: I like this: “Observation of effort to locate transaction counterparties is misleading – there is always excess demand for any number of impossible goods. If presented with a genie-containing lamp I would pay vast sums for it. But that doesn’t mean I go out searching for it.”
Did you ever see my old post on how an excess demand for unobtainium must, by Walras’ Law, cause a recession?
http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/12/unobtainium-and-walras-law.html
I accept your point there. I think of it as an (extreme) example of the discouraged worker effect. The unemployed make no effort to find a job, because they know they won’t find one. There’s still an excess supply of labour, but we can’t easily observe it. We could only see it by interviewing the unemployed “would you accept a job at wage W if one were offered you?”, or by an experiment where we offer them a job and see what happens.
So, when I say “effort to sell/buy” what I should be talking about is the marginal amount of effort it would take to make an extra sale/purchase, not the average or total amount of effort actually expended. In the case of unobtainium, or Alladin’s lamp, the marginal amount of effort needed to buy one would be infinite, while the total amount of effort actually expended is zero.
(And this is one reason why it’s so hard to collect useful data on how hard/easy it is to buy/sell stuff. We want the marginal; but we only observe the average, or total.)
That has helped me clarify my thoughts. Thanks.
david again: “No, no… after this sequential adjustment, you can have excess demand for something you don’t have the money to pay for. Likewise you can have excess supply of something you don’t have (because you’ve allocated it all to other purposes)”
Let’s take a concrete example, for greater clarity.
Start in equilibrium. Then everybody decides they want to buy an old (antique) chair, rather than a new (newly-produced) chair. Hold the prices of both chairs fixed. The Paradox of Thrift says that the increased desire to save will cause a recession. And I say that’s false. They can’t buy old chairs, so they keep on buying new chairs. No recession.
I say there’s an effective excess demand for old chairs, and no effective excess supply for new chairs. You say there is an excess supply of new chairs, if I understand you correctly.
I would respond: OK, there is a “notional” excess supply of new chairs (“notional” in the Clower sense of first-best what they would want to buy if there were no quantity-constraints), but no “effective” excess supply of new chairs. It’s the effective demands and supplies that matter for determination of quantities traded. The new chair producers will still be able to sell their chairs as easily as before. They actually sell as many as before. The market for new chairs continues to operate as if there were no excess supply. We would not observe that notional excess supply if we just looked at what was happening in the market for new chairs.
If we look at this economy, and look for queues of buyers and sellers, we will see a queue of buyers at the old chair market, (or at least, people saying they want to buy an old chair but can’t), and no queue of sellers in the new chair market. Everything we see would tell us that Walras’ Law is violated.
(And the Paradox of Thrift is wrong too.)
david again: on your Mudell-Fleming example. OK. I understand you now.
Go back to my “peanut theory of recessions”.
http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/07/the-peanut-theory-of-recessions.html
Assume all prices are fixed/sticky, except for the price of peanuts. So you can always trade peanuts for money. Does that mean there cannot be an excess demand for money? Not in any useful sense of the word. Sure, you can always sell peanuts if you want to hold more money, but that makes no real difference to the economy (assuming peanuts are a small part of the economy). You still get recessions, if the supply of money falls.
Now assume the central bank has a money that is convertible on demand into peanuts at a fixed price. Same as above. If the peanut crop fails, so the equilibrium relative price of peanuts rises, we still get a recession. Why? Because it causes an excess demand for money. Peanuts area tiny part of the economy, so a peanut harvest failure would not cause a recession, if peanuts weren’t tied to money.
Now assume that all peanuts are imported. Mundell-Fleming model with fixed exchange rates. Yes, there is still an excess demand for money. The fact that you can always get more money buy selling more or buying less peanuts does not matter (much).
To add to my 8.02: if there were a barter market where new chairs exchanged for old, then we would observe an excess supply of new chairs. There would be a queue of people carrying new chairs trying to trade them for old. But there is no such market, so we don’t observe it.
Greg: my understanding of Hayek is that his theory is indeed a monetary theory of recessions. As you say.
1. But did Hayek ever say (something like): “you can’t get recessions in a barter economy”; or “OK, maybe you can get recessions in a barter economy, but they would be so totally different from the recessions we observe in a monetary economy that we couldn’t think of them as “recessions” in the same sense”; or “in principle, if a central bank had (un-Hayekian) knowledge, and got monetary policy exactly right, there wouldn’t be recessions”?
(My guess is that Hayek would have said “yes” to most of the above, but I’m not sure.)
2. One of the reasons I never got my head around ABCT is that it did seem to suggest that some goods (some particular sorts of goods) should normally/typically be in excess demand in a recession. Take the old metaphor (from von Mises?) about the builder with a pile of bricks and blueprints for a house, and then the blueprints get accidentally expanded, so he tries to build a house twice the size, runs out of bricks, and ends up with a useless half-built house. Shouldn’t there be an excess demand for bricks in a recession? But, we don’t see that. Why?
Max: “Did Milton Friedman believe that a helicopter drop of income (not accompanied by an increase in money) would not be inflationary?”
Two ways of interpreting your question:
1. Assume that productivity doubles overnight, so each worker can produce twice the output as before. Milton Friedman would say that would be deflationary. The price level would (roughly) halve.
2. The government borrows $100 per year per person, and gives it out as a transfer payment, increasing their disposable income by $100 per year. Fiscal policy. Most economists would say this would cause a rise in aggregate demand and a rise in the price level. (It’s one of those “other things” I mentioned in the post). Milton Friedman was more skeptical about whether it would have an effect.
Nick: I don’t agree that recessions are always and everywhere monetary phenomena. I think they are – especially the biggest of them – coordination failures. Many people think RBC is an abject failure at explaining the Great Depression or the Great Recession. It is. But the disequilibium keynesian-cum-monetarist explanation is not the only alternative to RBC! I think the idea that these are the only two choices leads people to put far too much weight on the liquidity trap – weight it cannot bear.
kevin: I am never quite sure what people mean when they speak of “coordination failure” models of business cycles.
1. I can think of any simple monetarist (or keynesian) model as being, in some sense, a coordination failure model. E.g. suppose there’s a recession caused by an excess demand for money. Take Paul Krugman’s babysitter model for example. If everybody could just get together and agree to spend more, our reduce velocity, or try to reduce their desired stock of money, the recession would end. But they can’t all get together and make such an agreement and enforce it, so it doesn’t end.
2. Then there are coordination failure models to explain why prices are sticky. Even Keynes sort of sketches one in the GT. If everybody cares about his relative price, and doesn’t want to cut it, and nobody wants to move first, prices are stuck. If they could only coordinate to all move at once they would all be better off.
3. Then there are Diamond-type search models, with a thick market strategic complementarity, that if big enough will give multiple equilibria. In the bad equilibrium, sellers make little effort to find buyers, because there are so few buyers, and buyers make little effort to find sellers, because there are so few sellers. (But those models don’t look like recessions as I have described them, because Diamond says it is hard for both sellers and buyers to find trading partners.)
The sort of coordination failure models that Roger Farmer does seem more promising to me. Actually, I think I would categorise them under 2 above.
What sort of thing did you have in mind?
Nick:
“2. One of the reasons I never got my head around ABCT is that it did seem to suggest that some goods (some particular sorts of goods) should normally/typically be in excess demand in a recession. Take the old metaphor (from von Mises?) about the builder with a pile of bricks and blueprints for a house, and then the blueprints get accidentally expanded, so he tries to build a house twice the size, runs out of bricks, and ends up with a useless half-built house. Shouldn’t there be an excess demand for bricks in a recession? But, we don’t see that. Why?”
We do see a whole lot of unfinished buildings/skyscrapers.
There isn’t an excess demand for bricks, because in the recession, ‘the builder’ (which I believe is a metaphor for the economy) finally realizes that he could not afford to finish the project to begin with. Low interest rates, trick ‘the builder’ in believing that there are more funds available than there really are. The project in the recession then cannot be finished and there exists an excess demand for loanable funds.
Co-incidentally, if you’ve ever been to Vienna or any other Old World (Power) Capital, what you will notice is that the capital is rather out-sized for the country. The reason is that most of its more elaborate buildings are generally from its Golden Age (Read: Bubble) when the rulers of said empire expected its growth to continue. It obviously didn’t and as the empire fell to its more manageable proportions, the out-sized capital remained, essentially ossifying for us what previous generations expected to be the future.
Mises and Hayek both were a product of such a declining empire. Amateur psychology tells me it’s understandable that they’d fit the crisis in such a metaphor. It’s not even a bad one, given the prominent role expectations play in it.
Right, but what I’ve been getting at is that is a bad reason because leisure preference manifested in a reservation wage can create the same effect. So we must infer the general glut some other way than looking at the employment level. Moreover, with the employment level down, so is output. So output being low or declining is also not evidence per se.
Sounds like you admit this in your later remark: “Sure, if there is no other plausible explanation, a decline in output and employment would be a symptom of a recession. But only a symptom, not the thing itself.”
So your statement is not a revelation; its a definitional statement, and so this entire thread is sort of pointless.
Now if you want to discuss whether Peter Orszag’s recent essay about declining medicare expenditures is actually evidence of a general glut… well, maybe, maybe.
rsJ (while i think of it):
Wicksell said that there exists some (unobservable, unknown) rate of interest he called the “natural rate”. If the central bank sets the actual rate below that natural rate, the price level (and money supply) will rise without limit. If the central bank sets the actual rate above that natural rate, the price level will fall without limit.
And you ask: what happens if the central bank sets it exactly at the natural rate? I shrug my shoulders and say: P and M are indeterminate. All levels of P and M are an equilibrium
You press, and say: come on, something must determine them!
I say: maybe, but that is not a question I can be bothered to spend much time answering. Because it ain’t going to happen. What happens when a perfectly sharp pinpoint lands exactly on a perfectly sharp knife-edge? What happens when an unstoppable object hits an immovable barrier?
Kocherlakota has an answer. But that’s only because he doesn’t realise it’s a knife-edge. He thinks it’s a deep perfectly sharp groove.
Nick Rowe: “Start in equilibrium. Then everybody decides they want to buy an old (antique) chair, rather than a new (newly-produced) chair. Hold the prices of both chairs fixed. The Paradox of Thrift says that the increased desire to save will cause a recession. And I say that’s false. They can’t buy old chairs, so they keep on buying new chairs. No recession.”
First, let me see if I understand one thing. The increased desire to save is the desire to buy an old chair, right?
Second, isn’t the question of whether the result would be a recession or whether people would continue to buy new chairs (under the assumption of fixed prices) an empirical one?
To put it another way, without an operational definition of desire, how can we make a prediction?
Nick, when Wicksell spoke we had the legal gold price to anchor P when the interest rate was floating at the natural rate. It took fisher for us to understand that Wicksell’s process really explains how the inflation rate acts always to bring the market rate back into equilibrium with the real rate.
Further, Gold convertibility meant that M would always be adjusted to restore P to the legal gold price eventually. That meant deflation from time to time.
Todays gold peg is the inflation target which Avoids the volatility implicit in a price peg.
You of course know all this. So I’m missing why you are focusing on a 120 year old point of ignorance that we’ve moved beyond….