"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 
Jon: “Okay, how do you know there is a recession?”
This is anecdotal, but this is the first recession that I have been able to tell just walking down the street. In the depths a few years ago traffic was noticeably sparser (except during rush hours), and stores had empty shelves. Locally, more stores closed after the official end of the recession than during it, but I guess that there was a lag. This summer I have noticed store shelves starting to empty again. I guess that locally we are in a double dip. (Car traffic has not noticeably dropped, however, even with high gas prices.)
Min, I noticed the dip in car traffic too–in 2008. Not so much lately. The traffic reved up earlier in the year and has not receeded again for me, but as I stated to Nick, a mere decline in output and employment does not a recession make IF we use nicks restricted definition of recession.
At my firm revenue growth has been slow, and recently turned lower again. Why is that happening? I think the explanation is different this time around.
2008 was a money problem. This is a supply side problem which is why productivity was rising the first time around and falling this time around.
Nick, the language of “excess demand” can have it’s problems here, but lets stick with that language.
One key place where “excess demand” — the bidding up of prices — comes is at “the top of the boom”. Hayek spends some time on this topic, the “shortage” and competition for resources at the top of the boom. I’ve tracked this a bit in the housing market in the 2005 -2006 period. Labor prices in construction, in particular, spiked in 2006, and then dropped.
You see this also in the hundreds of miles of lumber hauling rail cars now mothballed on closed rail lines around the country — at one time at the top of the boom there was an excess demand for rail cars. Very quickly they became non-economic goods producing only storage costs.
I’ll add more later.
Nick writes,
“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?”
In 1929 Hayek thinks of the “barter economy” as a formal Walsarian / Wieserian equilibrium economy where you really can’t have recessions. Note the date. This is early in the history of modern economic thought. Hayek then asks, what happens when we introduce leverage, banking, credit, money, liquidity and all of the anticipatory coordination problems across time which these bring, particularly in the domains of production goods and inputs to production, and the pricing and trading of these.
Hayek FIRST identities his “knowledge problem” right here — and explicitly points out that other monetary / cycle theorists were falsely assuming that actual real world PRICES-AS-SIGNALS role of prices existed in their formal models, when in fact a formal model actually only lays down the given implications of logically given assumptions, and fails to capture the non-perfect signaling role of prices.
In 1929 Hayek has yet to revise / reject the deductivist ideal of explanation he had inherited from this 2nd cousin Ludwig Wittgenstein & his followers like Carnap.
So he attempted to show you could derive a deductive proof of the necessity of money for the trade cycle.
But his “proof” depends on his knowledge problem — but in fact, empirically, utter magic, Martian intervention, or unimaginable luck could overcome these knowledge problems.
Those is absolutely no empirical plausibility of this, but, formally, the argument is causal / empirical and not formal / deductive.
And note well. If you attempt to capture Hayek’s argument in backward looking & aggregated Cambridge / Ricardian / Marhsallian categories — such as Kaldor did — you can fool yourself into thinking pure unimaginable luck is empirically plausible, and the knowledge / coordination problems at the center of Hayek’s mechanism are “not to worry about”.
Nick writes,
“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.)”
Nick,
All you need is history + the rate of change in prices, to get the current change in prices.
I’m really curious about this aversion to any path-dependent process. So the answer to your question is not that the price level is undefined, but that the rate of change of the price level is constant. If you must (for some odd reason) care about the absolute value of prices, then look at the historical evolution of the system.
So Hayek’s big, history making move comes right here — in the domains of both scientific explanation & economic science.
Hayek was an empiricist who had already rejected Mach & Schumpeter’s empiricism (see The Sensory Order).
But in his 1929 book Hayek see how and where to reject Mises’ apriorism And the deductivism of the positivist / logistic conception of “science” and “explanation” (which really goes back to Aristotle’s equation of “science” with demonstrative knowledge and justification).
The place is in the empirical knowledge problem and the causal explanatory role of price signals and learning.
Now, science begins with problem raising patterns — and complex sciences offer rival causal mechanisms which provide powerful or weak answers explaining how those patterns could possibly have been brought about. Examples: Darwinian biology, geology, economics, global brain theory.
I wrote,
“In 1929 Hayek has yet to revise / reject the deductivist ideal of explanation he had inherited from this 2nd cousin Ludwig Wittgenstein & his followers like Carnap.
So he attempted to show you could derive a deductive proof of the necessity of money for the trade cycle.
But his “proof” depends on his knowledge problem — but in fact, empirically, utter magic, Martian intervention, or unimaginable luck could overcome these knowledge problems.
Those is absolutely no empirical plausibility of this, but, formally, the argument is causal / empirical and not formal / deductive.”
@Nick Rowe
No, that’s not how excess supply relates to recessions. The Paradox of Thrift only occurs where there is a non-internalized externality to saving (for whatever reason – zero lower bound, etc.). Some agents make plans that assume you’re not going to save (at the margin), and then you go and save anyway, and so we have a problem. If you allow those agents to adjust their plans, then there can still be an increased and unmet desire to save (due to incomplete nominal price adjustment) but no involuntary unemployment.
No, I say that there is either excess supply of new chairs and excess demand for old chairs, or no excess supply of new chairs and no excess demand for old chairs, depending on your choice of definition. We can label them notional and effective to keep them consistent…
Suppose there is effective excess demand for old chairs. Then people are holding their money whilst searching for these old chairs and they are correspondingly not spending it on new chairs; thus there is effective excess supply of new chairs. Suppose they now give up and spend their money on the new chairs. Now there is no effective, but only notional excess supply of new chairs. But there is also no effective, but only notional excess demand for old chairs, for if you (1) froze their new plans into place, and then (2) offered old chairs pulled from the ether at the prevailing price vector, nobody would be able to buy them. They would have nothing unfrozen to trade for it. They are quantity-constrained by their budget constraint.
You can unfreeze their plans and allow them to trade back along the price vector to obtain the introduced old chairs, but that just returns us to effective excess supplies of new chairs. You can have it one way, or the other way, but Walras’ Law applies in both.
… no we wouldn’t. If they’ve spent their endowment on new chairs to clear its market, they have nothing to buy old chairs with… except new chairs. If you observe a queue of buyers at the old chair market, it’s the exact same queue which is futilely trying to sell new chairs too.
Greg Ransom, so is Hayek saying that currency denominated debt is most of the problem?
How are those credit default swaps with AIG treating you?
David,
“The horde of angry Austrians arrive! Well, Austrian.
Why do rational people not hedge against knowledge problems? :D”
Is ratex ultimately dependent on TOO BIG TO FAIL and Uncle Sugar? That’s not working out so well either.
These are BAD arguments which show an inability or unwillingness to take knowledge problems seriously — this could be a pathological artifact of grad school economic education and a life lived in math models and not the real world.
To give just a stupid example, take my second favorite example of a circular economy, in which everyone takes out a loan and buys the house of the person on their left for 2x what the previous owner paid for it. Assume the previous owner had 0 equity in the house and held an interest only loan. Say the previous price was $100.
Now, everyone in the economy is $100 wealthier. They have $100 left over after repaying the debt from their old house, they have $200 in debt for buying their new house, and they own a house valued at $200. Their net worth is now $100, whereas before it was 0. The results of these transactions is that their savings increased.
If they do not wish to hang onto all of those savings, then they use some of the $100 to buy goods, and pay down debt with the remainder.
To the degree that they have excess wealth, they drive up prices, until their real wealth is at the level demanded.
No increase in base money was needed — the increase in bonds was enough to cause an increase in prices.
Now perhaps this isn’t a good model of price determination for our economy, but you cannot say that prices are always just a function of the quantity of base money. There are many things that go into price determination.
Hmm.
Alright. Consider the market between money and peanuts. By definition, it clears; there is no effective excess demand for money within this market. There isn’t even notional excess demand for money in this market. At the prevailing price, nobody wants but is unable to trade peanuts for money or money for peanuts.
Consider the market between money and other, non-peanut goods. Given wrong prices, it might not clear. So you look at this and say, behold, excess demand for money (leave aside whether it is notional or effective for the other thread of argument).
But there’s something wrong here, in the way that peanuts are not like foreign currencies. One doesn’t trade domestic money for foreign goods. One trades foreign currencies for foreign goods. There’s no market between money and non-peanut goods, just peanuts and non-peanut goods. i.e., there isn’t a market between domestic money and foreign goods; there is only a market between domestic money and domestic goods, domestic money and foreign money (forced to clear by the bank), and foreign money and foreign goods.
So we should really be considering peanuts and other, non-peanut goods (aka foreign goods). And lo, there is excess demand for peanuts, because that’s what Johnny Foreigner wants for his stuff. If Johnny Foreigner readily swaps peanuts into goods, too, then one arrives at excess demand for foreign goods. QED.
@rsj
I like that example for a non-constant money multiplier… it’s elegant.
Thanks, David
And note that in the example prices do not increase “without bound”. They increase and then stop increasing. So the causality goes from
change in interest rate –> increase in value of fixed asset –> increase in nominal net-worth –> increase in prices of consumption to bring real net worth to level demanded –> prices stabilize at the higher level.
But that is because no one is borrowing to buy capital, they are just borrowing to buy land. But if you borrow to buy productive capital, then there are also other equilibrating mechanisms (e.g. falling MPK) that prevent infinite prices. Anytime your model says that something is infinite, it means that there is something wrong with the model — some omitted constraint, which when included, would hide the singularity.
You don’t need knife edge conditions for an interest rate model of price determination.
I’m a believer in economic censorship 🙂
Jon: “So we must infer the general glut some other way than looking at the employment level.”
You are talking about employment. I was talking about unemployment. If there’s a decline in employment, but no increase in unemployment, my first thought would be that employment fell because labour supply fell.
Min: “First, let me see if I understand one thing. The increased desire to save is the desire to buy an old chair, right?”
Right. (And yes, that does fit the economic definition of an increase in “saving”. But if you want to substitute “land” or “bond” for “old chair”, the argument still works.
“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?”
Yes. But if they try to buy something other than new chairs, i could just repeat my argument, and you still don’t get a recession. Unless they decide to hold money.
Jon: Because we still need to explain to people why you can’t have the central bank peg the nominal rate of interest forever. Like Kocherlakota. OK. I will farm out rsj to you.
rsj said: “No increase in base money was needed — the increase in bonds was enough to cause an increase in prices.”
Was it the bonds or the demand deposits (medium of exchange) that caused the rise in prices?
And, “Now perhaps this isn’t a good model of price determination for our economy, but you cannot say that prices are always just a function of the quantity of base money. There are many things that go into price determination.”
One reason I like to use medium of exchange. True, there are other things that go into price determination.
Greg: thanks for trying to explain that. I basically read that as a “yes”.
david: Suppose there are 3 goods, X,Y, and Z, plus money. So 3 markets. There are 3 ways of defining excess demands/supplies (that I know of):
1. Here’s the Clower/Benassy approach, that I find most plausible:
In market X, people max U subject to any quantity constraints on Y and Z. That gives excess demand/supply for X.
In market Y, people max U subject to any quantity constraints on Z and X. That gives excess demand/supply for Y.
In market Z, people max U subject to any quantity constraints on X and Y. That gives excess demand/supply for Z.
(By “quantity constraints” I mean rations on how much they can buy or sell because they are on the short side of a market in disequilibrium.)
2. The alternative approach (Dreze?) assumes:
In market X, people max U subject to any quantity constraints on X, Y, and Z. That gives the excess demand/supply for X.
Ditto for markets Y and Z.
3. (And the Walrasian “notional” excess demands/supplies ignore quantity constraints entirely).
You want me to pick between 2 (Dreze) and 3. (Walrasian “notional”). I refuse to accept Walras, because it means people ignore quantity constraints, which isn’t rational. I refuse to accept Dreze, because it means that all excess demands and supplies are 0, at any possible price vector. (If you can’t actually buy any, Derze says you don’t demand any. And if you can’t actually sell any, Dreze says you don’t supply any.)
I’m sticking with Clower/Benassy. Even if it does violate Walras’ Law. Even if the excess demands/supplies do seem to be “inconsistent”, because each one comes from a different maximisation problem.
Nick,
“After all, we make central banks responsible for keeping inflation on target.”
And this is what is wrong with economics. Fiscal policy can stabilize the price level, monetary policy works very weakly, especially near zero interest rates, as we all see now.
This paper shows, using sectoral balances consistent model (this annoying MMT again!) that you can control inflation and aggregate demand (so: employment) with fiscal policy, leaving rates constant.
Click to access wp_494.pdf
Ron T. Thanks. But the idea that fiscal policy can shift the AD curve is not something invented by MMTers.
david: on Mundell-Fleming.
Either there is a sequence of markets through which individuals can sell stuff to foreigners to get more domestic money, or there isn’t.
If there is, then I’m just going to argue that it’s just like my “peanuts” model, only more indirect.
If there isn’t, then I’m going to argue that there’s an excess demand for money.
Nick,
During the leverage/false credit/false prices artificial boom there is an excess demand for non-economic goods, e.g. long term production goods like housing & inputs to housing for which there would not be a demand if economic plans were perfectly coordinated across time.
After the unavoidable turn & the inevitable bust, there is an excess supply of non-economic goods.
The key thing is the substitutability of one thing for another — excess demand creates what turn out to be non-economic substitutions one one thing for another, exp. across time and between capital goods and labor.
We could illustrate this with the housing market, once again.
Nick, for Hayek and many of his generation the “barter economic” was the God’s eye view with perfect coordination and perfect knowledge formal construction.
There are NO recessions in the barter economy, because by assumption the construction just is a perfect coordination “economy”.
Make that:
Nick, for Hayek and many of his generation the “barter economy” was the God’s eye view with perfect coordination and perfect knowledge formal construction.
There are NO recessions in the barter economy, because by assumption the construction just is a perfect coordination “economy”.
Nick, Hayek would answer NO to this:
“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””
Why? Because by assumption the barter economy is a perfect coordination formal construction, and you can’t do any better or worse than perfect coordination.
This one is trickier:
“in principle, if a central bank had (un-Hayekian) knowledge, and got monetary policy exactly right, there wouldn’t be recessions”?
You are still allowing everyone else in the system to make mistakes, and monetary policy can only do so much offset or influence the direction of those mistakes.
The “perfect knowledge” Central Bank would be dampening recessions, it could not fully block systematic discoordination.
Greg: if aggregate output declined (simply because of something like bad weather) Hayek would not call that a “recession”, I take it? Not every coordination failure is a recession, but every recession is a coordination failure?
Greg Ransom, and by extension Nick:
Hayek was wrong, or more precisely he didn’t go far enough about money. It is very, very easy to generate a Keynesian demand-deficient depression in a Hayekian model.
First, go see Roger Garrison’s three-graph visual interpretation of Austrian-based macro from his book Time and Money. He has some wonderful slides on the subject. The schematic consists of three graphs: A Hayekian Triangle of Consumption vs. Time, a Production Possibilities Frontier of Consumption vs. Investment and a Loanable Funds Market of Savings vs. Investment.
Now I will give it the following spin.
1) Draw an arc within the Loanable Funds Market graph. The area under this graph is in the units of money, it describes the money supply. We know the money supply is finite and changeable, I describe it as confidence-based money. The intersection of the graph must be within the money supply curve.
2) Assume the economy is in its Growth State. That means the [C,I] point on the PPF graph is on the PPF arc. The “market” “clearing” or “natural” interest rate determined by the particular [S,I] point is within my previously described money supply arc though it need not be on it.
Now in a monetary economy all transactions must pass through the Loanable Funds Market, all goods are traded for money, no barter. This graph is the hoop through which the entire trade of the economy passes.
3) Now, contract that Money Supply, make the arc smaller on the Loanable Funds Market graph. The following will happen.
a) The Loanable Funds Market will settle at a lower [S,I] point. The interest rate may even be negative.
b) The loss of investment will drag the economy, characterized by a [C,I] point away from the PPF arc. An output gap will open up. Hello demand depression.
c) The Hayekian Triangle of C vs. t will contract, in fact it will get “bashed” downward in a haphazard way. Loss of money supply means that not every transaction demanded can clear. The economy has been strangled by the contraction of the money supply.
Now, you’re going to come at me with “this is nonsense, flexible prices mean”. I will reply that price adjustments are not linear, they exhibit both inertia and hysteresis. The inertia means that due to contracts, supply chains, etc means that price adjustments due to a shock will lag due to the storage effect. Hysteresis means the path upward is different (and steeper) than the path downward, simply due to the basic behaviour of maximizing profits and reluctance to realize losses. It’s price stickiness with a more scientific and accurate description.
What I have just demonstrated is how a Hayekian-described economy can settle into a Keynesian Depression with a persistent output gap, unemployment and a glut of Real Goods due to a shortage of money. It’s Hayek’s model but I just admitted the whole of Keynesian economics to it.
Two simple questions for you Nick.
What do you call the hundreds of miles of unused lumber hauling rail cars mothballed across North America?
Do you call them “idle resources” or “non-economic goods” .. and on what basis do you decide this, and what knowledge assumptions are you making in arriving at this determination?
Nick — are you staying in a perfect knowledge / perfect coordination construction, or are you moving to partial equilibrium supply and demand analysis?
Nick writes,
“Greg: if aggregate output declined (simply because of something like bad weather) Hayek would not call that a “recession”, I take it? Not every coordination failure is a recession, but every recession is a coordination failure?”
Note that Hayek invented the notion of dated goods / the intertermporal equilibrium construction in his 1928 paper, which attempted to make sense of equilibrium across time with anticipated changed in production conditions, using the example of changing weather condition for the production of fruit.
You can’t have “unanticipated bad weather” in a God’s eye view / Dictator / perfect knowledge – perfection coordination “barter economy” formal construction. Everything is “given” from a God’s eye point of view in such a construction.
In the sort of “God’s eye view” / Dictator / Perfect Knowledge / perfect coordination construction assumed by Hayek (and others of his generation) there can be no “coordination failure” — you have perfect coordination success by assumption. This is the equilibrium condition assumed when Hayek (and others) used the words “barter economy”.
Is someone seriously quoting the same Hayek who said the government is probably putting something into the water to brainwash us? There’s a reason why Hayek quickly turned away from economic theorizing, because everyone rejected his ideas, and the only people going back to look at his ideas today are those that liked his political views and assume his economic views were as valid.
“The most rapid progress toward a coherent and useful aggregate economic theory will result from the acceptance of the problem statement as advanced by Hayek” — Robert Lucas
Deus-DJ = Paul Krugman? Bozo The Clown? Zippy The Pinhead?
The idea that Hayek turned away from economics is one of the many Hayek Myths I blew up years ago.
Greg: you wrote 10 of the last 13 comments; this is commonly known as spamming.
Please control yourself. Let others get a word in edgewise.
You can read Hayek’s 1929/1933 Monetary Theory and the Trade Cycle here:
Click to access hayekcollection.pdf
or here:
http://mises.org/daily/3121
Stephen — cull the trolls, and it would be 3 less.
Also, Nick seemed to misunderstand and also to have a different conception of a “barter economy” that assumed by those Nick was asking me about. It sometimes takes effort to head off misunderstanding, which can go in any direction.
Two consecutive posts is not what I had in mind by way of controlling yourself. That’s 12 of 16. Stop it.
Um, I pitched an idea directly at Greg Ransom, so if I might beg Stephen’s indulgence, I await a substantive reply from Greg.
Nick, I think this is very close to being a very good post. This part, especially, is great stuff, and is just about one of the most descriptive and concise explications of the current economic problem that I have read:
“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.”
You are great when you are talking about money. There is indeed an excess demand for money, and that is exactly the problem. And in order to fix this problem, we need to increase the amount of money until the point that there is no longer an excess demand for it.
I think where you go off track is when you start talking about the “money supply” and the central bank. The thing that you call the “money supply” is not the money supply. In other words, you have the wrong money supply.
It’s as though your car has stopped working. You then correctly determine that your battery has stopped working, and determine that you need to replace your battery. But then when you pop open the hood, you point to the radiator, and you say “Ah, there’s the battery.” You then replace the radiator, which is actually the battery.
But the car doesn’t work. The thing that you call the “battery” is not the battery. In other words, you have the wrong battery.
The sort of “money” that the Central Bank can create (via influencing the private banking system) is bank credit money. Bank credit money is not the sort of money for which there is an excess demand. The reason why there is not excess demand for bank credit money is because it comes with a string attached. The string is the flip side of bank credit money, or the liability – also known as “private debt.”
So, what is the sort of money for which there is excess demand?
Actual money. The sort that does not have the string of private debt attached. Note that one can use actual money to pay down bank credit money, effectively converting the bank credit money into actual money.
And that’s what a balance sheet recession is all about.
Back to the car now. When you identify the correct battery, the solution becomes obvious. Everything suddenly falls in place. You become a Modern Battery Theorist (one of those MBTers). But before you can do that, you have to identify the correct battery.
@Nick Rowe
Alright. Take Clowerian effective excess demands/supplies. In each market, an excess demand for the product is mirrored by an excess supply of money (and vice versa). After computing all the good markets, sum the excess supplies/demands for money in each market to arrive at the excess supply/demand of money. Sum of excess demands must hence equal sum of excess supplies: Walras’ Law holds. QED.
If you observe a queue of unmet-excess-demand people queuing for something, they’re also people who must be trying unsuccessfully to sell something to exchange for whatever they’re queuing for.
I’d change some of Mattay’s terminology at 10:39 p.m. However, that is a big step in the right direction.
Just to be clear and for Mattay, are you saying too much private debt is the problem?
There is a sequence of markets. It goes through the one market between domestic money and foreign money. The central bank sets prices here and forces this market to clear by issuing or destroying domestic money at will.
So it’s not like your “peanuts” model. Your peanuts have to be traded back to money in order to buy other goods. Here money has to be traded to ‘peanuts’ in order to buy foreign goods. If someone unearthed a pirate’s chest full of domestic money, it wouldn’t resolve the problem because (1) people would immediately trade it for foreign money, and then (2) the central bank destroys the domestic money, and (3) there is no macroeconomic impact because the additional foreign money in the world economy would be small.
This might help: http://dl.dropbox.com/u/27783795/images/peanuts.png
In Fig. 2, people don’t really want peanuts. They want media of exchange. In Fig. 3, people don’t really want media of exchange. They want foreign goods. It would as if one took the peanut model and, instead of imposing a monetary shock, imposed a peanut craze. It would look very much like a monetary shock. But it wouldn’t be.
david: “Alright. Take Clowerian effective excess demands/supplies. In each market, an excess demand for the product is mirrored by an excess supply of money (and vice versa). After computing all the good markets, sum the excess supplies/demands for money in each market to arrive at the excess supply/demand of money. Sum of excess demands must hence equal sum of excess supplies: Walras’ Law holds. QED.”
Yes! That is the same conclusion I came to, in this post:
http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/04/walras-law-vs-monetary-disequilibrium-theory.html
But as I argue in that post, that version of Walras’ Law is true, but useless. Here’s a short bit:
“Let a be the excess supply of apples, and let A be the excess demand for money in the apple market. Let b be bananas, and c be carrots. If a=A, and b=B, and c=C, then whoopee! a+b+c=A+B+C. But that tells us nothing about the relation between a,b,and c. On the other hand, a+b=C would be useful, but unfortunately it’s also false.
Walras’ Law is either useful or true. Pick one.”
In other words, if there is a market in which apples trade for money (or anything else), then it is trivially true that the excess demand for apples in that market must equal the excess supply of money in that same market. That’s what we mean by a “market”. And we can add up those n market equations if we like, but it doesn’t tell us anything new. It gives us absolutely no restrictions on economic behaviour across markets. The original version of Walras’ Law was supposed to tell us what was happening to the nth good, or the nth market, if we knew what was happening to all the other n-1 goods, or n-1 markets. This one tells us nothing about the nth market that we didn’t already know.
(One of these days I am going to have to try to get my head around what it means to talk about “the sum of the n excess demands for money” too.)
david: neat picture! It did help. I’m still thinking about it. Wondering if it’s like my example where cows are money, and all the goats go dry, so we get a recession. Dunno.
Mattay: Thanks! (It’s nice to read someone say something nice about this post, especially an MMTer!)
OK, let me try to get my head around what you are saying, translating it into my language:
A recession is caused by an excess demand for money. But there’s “outside” money (a liability of the government/central bank, or gold in the olden days) and “inside” money, which is a liability of the private sector. And the stock of inside money can’t expand unless someone is willing to take on that liability. And, in a recession, maybe they aren’t willing.
Which makes me think of banks. And agreeing that if banks go bad, and contract, then the supply of inside money could contract (or not expand to meet an increased demand for money). Which could indeed cause a recession.
Not sure if we are on the same page or not.
Greg: “Two simple questions for you Nick.
What do you call the hundreds of miles of unused lumber hauling rail cars mothballed across North America?
Do you call them “idle resources” or “non-economic goods” .. and on what basis do you decide this, and what knowledge assumptions are you making in arriving at this determination?”
You call those simple! If I really knew the answers to those questions, I should become central planner (as of course you would agree).
There’s an old English country saying: “If you see one rook it’s a crow; if you see a lot of crows they are rooks.” It’s a bit the same with idle resources. You can’t tell from looking at each individual one. But if you see a lot of them, in a wide variety across the economy, you figure there must be something going on in all markets. And what do all markets have in common? Well, money is one of the two goods traded in all markets. (And if you see the non-monetary economy doing fine, that just confirms your suspicions.)
Why isn’t the rest of Friedman’s quote on money correct? Is it because he’s not accounting for the demand for money?
Mattay
That was beautiful. I’m definitely copying that and putting it in my folder I keep of great comments I find around the web.
Why would we have an INCREASED demand for something we already have too much of…… bank debt? Its clear to MMTers that private debt is the problem but since most of the Sumners and the Rowes and even the Krugmans think private debt cant be a problem because it is a zero sum game (yes on person has large debt but that means another has large surplus). What there is a demand for is money we dont have to pay back with interest, heck even with no interest, to some banker.
The other problem with the above described wrong view of private debt, is that in fact everyone is in debt, even the rich. The poor owe money to the rich and the rich owe money to each other, so to speak. I’ll bet if you took the net worth of the(private) US economy it would be negative. Even many of the mega rich, if they had to liquidate and pay off all their accumulated debts tomorrow they couldnt. One reason is the cash on hand is not larger than the debt they owe AND the assets they hold are falling in value by the month. BUT, here’s the deal……. SO WHAT!!! We can keep this monopoly game going by simply keeping enough debt free money circulating so people will be willing to spend it. People will continue to pay their loans and banks wont have to fail.
Its ONLY frikken money. WE invented the stuff, we can do with it whatever we wish.
Gizzard said: “Its clear to MMTers that private debt is the problem but since most of the Sumners and the Rowes and even the Krugmans think private debt cant be a problem because it is a zero sum game (yes on person has large debt but that means another has large surplus).”
But can private debt increase the amount of medium of exchange?
And, “Even many of the mega rich, if they had to liquidate and pay off all their accumulated debts tomorrow they couldnt.”
What about Apple, Microsoft, and others?
“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.”
being an American, perhaps Friedman forgot about trade – Canadians know all to well that recessions can be brought on by a decline in foreign demand for goods, or for price changes in those goods relative to other imported goods – such as when the price of oil declines.
@Too Much Fed
Private debt certainly IS a medium of exchange in and of itself. The debt buys something and then must be paid back later out of income.
Good question about Apple and Microsoft. I dont know and I’m too lazy and suspicious of any internet data I might be able collect to “do the numbers” myself. My suspicion is that they are overleveraged as I define it above. The overall level of their cash balances and the value of their assets is less then their debt. But again……. SO WHAT? They are not being asked to pay off their debts all at once right now. Just like no insurance company is being asked to pay off every life insurance policy holder in full today, so examining whether or not they could is specious (which incidentally is the fallacy being espoused by those talking about the longterm obligations of SS and medicare fall for…. but thats another discussion)