How do the French control the size of the Sun? How does the Fed control the size of the US economy? More importantly, how are those two questions related?
[I'm still thinking about this, but have decided to post it anyway.]
There is a metal rod in Paris that defines the length of the metre. (Actually, Wikipedia tells me that isn't true now, and was never exactly true, but never mind, because it makes a good metaphor). I think you could call that a "stipulative" definition of the metre. "See the length of that metal rod over there? That's a metre."
Suppose the French wanted to double the size of the Sun. They hacksaw the rod in two, throw one half away, et voila! The diameter of the Sun, measured in metres, is now doubled.
Someone who asked how a hacksaw in Paris could reach all the way to the Sun, and who enquired about the causal chain connecting the two, would be making something like a Category Mistake. The only causal chain worth enquiring about is the one between the rod in Paris and scientists' minds. Would scientists accept the new definition of the metre? The causal chain isn't physical; it's, um, metaphysical? It's perhaps a question of the Sociology of Knowledge.
You might say that the French control only the nominal size of the Sun, measured in metres, and not the real size of the Sun. And what the French have really done is halved the real size of the metre, not doubled the real size of the Sun. OK.
If you accept the analogy, you would say the Fed controls the definition of the US Dollar just as the French (in my story) control the definition of the metre. And you would say that the Fed controls only the nominal size of the US economy, not the real size of the US economy. The Fed, for example, controls nominal GDP but not real GDP. The Fed can double GDP measured in dollars by halving the real value of the dollar.
Some economists do believe something very close to that. But most of us believe that when the Fed changes the nominal size of the US economy it will also affect the real size of the US economy too, at least in the short run. And what is puzzling, for us, is not that the Fed can change the nominal size of the US economy; the puzzle is that doing so can affect the real size of the US economy too, at least in the short run. And we think it's got something to do with sticky prices and expectations. When the Fed changes the definition of the dollar, it takes time for that new definition to spread out across people's minds, and so changing the definition will have real effects in the interim. If lumber was sold in old metres, while architects worked in new metres, the French hacksaw might cause real effects in the housing market too.
If you will forgive the anachronism (the Fed wasn't around in David Hume's day), both Hume and Patinkin agree that the Fed controls the nominal size of the US economy in the long run, and can affect the real size of the US economy in the short run. But I think there's a big difference between the two.
I think that Hume would basically accept my metre analogy, and Patinkin wouldn't.
Hume's own analogy, between money and a system of counting, is similar to my metre analogy.
"It was a shrewd observation of ANACHARSIS the SCYTHIAN, who had never seen money in his own country, that gold and silver seemed to him of no use to the GREEKS, but to assist them in numeration and arithmetic. It is indeed evident, that money is nothing but the representation of labour and commodities, and serves only as a method of rating or estimating them. Where coin is in greater plenty; as a greater quantity of it is required to represent the same quantity of goods; it can have no effect, either good or bad, taking a nation within itself; any more than it would make an alteration on a merchant's books, if, instead of the ARABIAN method of notation, which requires few characters, he should make use of the ROMAN, which requires a great many. Nay, the greater quantity of money, like the ROMAN characters, is rather inconvenient, and requires greater trouble both to keep and transport it."
Hume discusses the causal chain between the quantity of money and the level of prices only in the context of discussing why a change in the quantity of money can have real effects in the short run.
"To account, then, for this phenomenon, we must consider, that though the high price of commodities be a necessary consequence of the encrease of gold and silver, yet it follows not immediately upon that encrease; but some time is required before the money circulates through the whole state, and makes its effect be felt on all ranks of people. At first, no alteration is perceived; by degrees the price rises, first of one commodity, then of another; till the whole at last reaches a just proportion with the new quantity of specie which is in the kingdom. In my opinion, it is only in this interval or intermediate situation, between the acquisition of money and rise of prices, that the encreasing quantity of gold and silver is favourable to industry. When any quantity of money is imported into a nation, it is not at first dispersed into many hands; but is confined to the coffers of a few persons, who immediately seek to employ it to advantage. Here are a set of manufacturers or merchants, we shall suppose, who have received returns of gold and silver for goods which they sent to CADIZ. They are thereby enabled to employ more workmen than formerly, who never dream of demanding higher wages, but are glad of employment from such good paymasters. If workmen become scarce, the manufacturer gives higher wages, but at first requires an encrease of labour; and this is willingly submitted to by the artisan, who can now eat and drink better, to compensate his additional toil and fatigue. He carries his money to market, where he, finds every thing at the same price as formerly, but returns with greater quantity and of better kinds, for the use of his family. The farmer and gardener, finding, that all their commodities are taken off, apply themselves with alacrity to the raising more; and at the same time can afford to take better and more cloths from their tradesmen, whose price is the same as formerly, and their industry only whetted by so much new gain. It is easy to trace the money in its progress through the whole commonwealth; where we shall find, that it must first quicken the diligence of every individual, before it encrease the price of labour."
To Hume, it is self-evident that the French control the nominal size of the Sun. What needs explaining is how the French can influence the real size of the Sun.
Don Patinkin's "Money Interest and Prices" is the opposite. The whole point is to explain how the French control the nominal size of the Sun. He deliberately rigs his example (by assuming flexible prices, that new money is distributed to individuals in proportion to their existing holdings of money, etc.) so that there will be no real effects. Starting in one equilibrium, a doubling of each individual's stock of money creates an excess supply of money, and by the logic of Walras' Law, that means an equal excess demand for non-money goods at the previous equilibrium price vector. And that excess supply of money/excess demand for non-money goods is what causes the price level to rise.
Patinkin thought that a reduced form equation like MV=PY or M=kPY wasn't good enought to explain why a doubling of the supply of money caused a doubling of the price level. And just to make sure people got the point, he repeated it in the form of a "stability experiment", by asking what would happen if all prices hypothetically halved, while holding the nominal stock of money (and everything else) constant. He said it would create an excess supply of money/excess demand for non-money goods which would cause all prices to double back up again, to the original equilibrium.
Money Interest and Prices was a book of its time. At that time (the 1950s and 1960s), there was no expectations-augmented Phillips Curve. Prices rose because of an excess demand for goods. So Patinkin explained why an increase in the supply of money would create an excess demand for goods.
There are many specific criticisms one can make of Patinkin's theory. To my mind the most important comes from Clower's observations that: money is not really needed as a medium of exchange in Patinkin's Walrasian economy; if we ask what would happen at a disequilibrium price vector we must allow that agents will be quantity-constrained; and if we put these two observations together we realise that Walras' Law makes no sense in a monetary exchange economy. But there's a more general criticism I want to make here.
There is more than one way to define the metre. You can define it relative to a metal rod in Paris, relative to the circumference of the Earth, relative to the wavelength of krypton-86, or relative to the distance light travels in one second, etc. Similarly, there is more than one way to define a value for the dollar. You can define it relative to gold, or relative to silver, or relative to the CPI basket of goods (which is roughly what modern central banks do now). Or you can define it by fixing the quantity of dollars, which is what Patinkin assumed.
Once you have grasped the idea that the French can double the nominal size of the Sun by cutting the metre rod in half, and redefining the metre, it doesn't matter how the metre is defined, and who defines it. You can translate the same basic idea into the new dictionary. Similarly, once you have grasped David Hume's idea, it doesn't matter how the dollar is defined, and who defines it. You can translate the same basic idea into the new dictionary.
If the dollar is defined by fixing the quantity of dollars, then doubling the quantity of dollars halves the value of each dollar in terms of all goods, which means the prices of all goods double. If instead the dollar is defined by fixing the price of gold, then doubling the price of gold halves the value of each dollar, doubles the quantity of dollars, and doubles all prices. And so on. The Quantity Theory of Money does not need to take the quantity of money as the exogenous variable and the prices of all other goods as the endogenous variables. The same idea is equally valid if the price of gold, or some basket of goods, is the exogenous variable. The Quantity Theory of Money is a theory about units. It says the units don't matter, at least in the long run.
If Patinkin had written a third edition of Money Interest and Prices, in which the dollar price of gold was the exogenous variable, it would be a complete re-write. How would a doubling of the price of gold in terms of dollars cause all other prices to double and the stock of money to double too? That's quite a different question. And inflation targeting, or NGDP level-path targeting, would be complete re-writes again.
All of which makes me wonder: did Patinkin really fill a massive gap in monetary theory by explaining how a change in the quantity of money causes a change in the price level? Or, at the other extreme, is the magisterial Money Interest and Prices just one big Category Mistake?
Patinkin (or the reader) might object that I am confusing money as the medium of exchange with money as the medium of account. Changing the length of the metre is like changing the value of the unit of account, which is a question more like the Sociology of Knowledge, where we ask who decides what units will mean, and how those meanings get propagated into the population. But that still leaves open the question of the value of the good which serves as medium of exchange in terms of other goods, which was Patinkin's question. Patinkin was very careful to make that distinction; Hume didn't.
But I don't think I'm making that mistake here.
The Quantity Theory of Money would not work if we used cows as money. Patinkin could not put M/P in the utility function if M stood for "Cows", because a doubling of the number of cows plus a doubling of all prices in terms of cows would not leave us indifferent. We would be drinking more milk, for one thing.
If we used gold bars as money I could define the physical quantity of money independently of its value in terms of the medium of account. Because I can measure the quantity of gold in kilograms, as well as in dollars. A 2 kilogram bar of gold will be worth twice a 1 kilogram bar of gold, because it's got twice as much gold. A $20 bill isn't worth twice a $10 bill because it's got twice as much paper. It's only worth twice as much because the central bank will exchange them two for one.
The history of money is like the story of the Cheshire Cat, which slowly disappears leaving only its smile. The usefulness of a unit of a good that is used purely as a medium of exchange (and not to produce milk as a byproduct) depends only on its exchange value. Except for the slight difficulties in counting the notes, and fitting them all in our pockets, there is no economic difference between multiplying the number of notes tenfold and adding a zero to each of the existing notes.
David Hume's idea works for a (pure) medium of exchange, even if it isn't the medium of account.
Worthwhile Canadian Initiative 
In the simple model, there are n equations and n unknowns, and a single solution. But that’s when one of the equations represents the central bank’s behaviour, and that equation is not HD0 in nominal variables (i.e. the central bank fixes some nominal anchor).
If we change that model slightly, by making the CB’s behavioural equation HD0 in nominal variables (for example the CB tries to target a particular rate of interest, or tries to target “full employment”) then we still have n equations and n unknowns, but that “counting equations and unknowns” condition is necessary but not sufficient for a solution (maths guys can explain why better than me).
I would say the reverse — that you get homogeneous equations only with a walrassian process. If you change that assumption slightly, you no longer get homogeneous relations. We live in a world without Walrassian processes and yet we have prices.
Without meta-time bargaining, say firms need to hire workers prior to selling the output that the workers create, you get nominal contracts, in which case the equations are not homogenous. The lack of definition of the price level is a knife edge case that is due solely the Walrassian assumption, and is not an inherent economic feature.
Moreover, you do not have a convergence result that says if transactions occur in real time then the economy converges to the Walrassian equlibrium as the speed of transactions goes up. There is no analogue to Shapley-Folkman-Ross’s approximation of u-shaped cost curves with a convexified economy.
So why assume that long run economic behavior is independent of money? If you have an approximation theorem, you would be justified in making that assumption, but you don’t. There could be many explanations of why economies tend to rebound after they contract, e.g.
* technological growth is really all that matters in the long run, provided that there are halfway decent institutions to exploit technological change. Long run, all that matters is knowledge, and we could be in a socialist or a capitalist system, or some completely different system (resources allocated by lottery or birth), and it wouldn’t make a difference at all for long run growth.
* the U.S. experience is a fluke, not shared by the rest of the world. There are no guarantees that long run growth is pre-determined for anyone.
* Our democracy is such that policy changes — e.g. government — ensures that long run growth is at a certain level, as we vote the bums out and make necessary changes (a la redistribution by F.D.R) when markets get too crazy. Nations with less responsive governments let markets run amock and are not able to rebound sufficiently after contractions, or, like Argentina may never recover from a decline.
There are many arguments to make here, and my favorite would not be the knife edge argument about homogeneity. I would much rather believe in thinks that are true in the generic sense — e.g. deform the functions slightly, and see what you get. The generic solution is much more likely to be applicable to our economy than the solution in which everything is scale invariant.
Hume was NOT puzzled. Hume understood and explained the Cantillon Effect — only failing to understand how changing stocks of money and shadow monies also shift the time structure of production, expanding and contracting output across time.
But Hume understood well that its about limited knowledge and the non-sustainable stretching of the net of prices. “Sticky prices and expectations” are just a sliver and shadow of these more fundamental empirical elements.
“And what is puzzling, for us, is not that the Fed can change the nominal size of the US economy; the puzzle is that doing so can affect the real size of the US economy too, at least in the short run. And we think it’s got something to do with sticky prices and expectations.”
Nick, Phil: About multiple equilibria and QTM I am with Nick on this one. Plus the reason we are doing this is that money is an “institution” that is important for coordination of economic activity. And since institutions “evolve” – sometimes getting worse (and as evolutionary biologists know, the probability of things getting worse is proportional to the level of optimization or to the level of how “good” things are) and we need to prevent this detoriation.
There was one story in Bowles Microeconomic book that put me on board. It was story of two villages in India that faced this problem: the wealth of villages depends on the harvest, which greatly depends on farmers planting their seed on time. However farmers also face dangers, one of the most important is flocks of birds that can eat all their freshly planted seed. So the coordination problem is that while collectively, everyone benefits from early planting, individually, farmers have incentives to postpone planting seeds just after other farmers do it so that they minimize the risk of their harvest being eaten by birds. It is given that sooner or later every farmer plants seeds as payoff of actually having something to eat next year is obviously greater than the risk of losing their harvest. So generally there are two equilibria: either everybody plants early or everybody plants late. One village developed a social technology called “festival” and every farmer knew that this is the time to plant. If someone did not plant, he risked becoming social pariah with very serious consequences. Other village did not develop anything like that and farmers decided the right time to plant on their own. It is not hard to predict what village was richer long-term and which one was poorer.
And this is it. If it is mayor of the village who decides when the festival starts, people of concrete steppes could immediately throw their objections – does mayor have enough power to personally punish somebody who does not participate? What are exactly the levers, how is his decision carried out? Some may focus on specifics, maybe Mayor uses village bell to announce the festival. People of concrete steppes could then object “So what if the bell gets stolen or if it is damaged? Then surely festival policy will be rendered ineffective because crucial point in the causal process of transmission mechanism is missing”. Is this absurd? So is the current debate about crisis. And the sad thing about this is that if Mayor gets convinced by these people that he is powerless and that everyone is doomed then we really can witness dissolution of the institutional fabric that holds the society together.
Anyways, intellectually I am confident that Market Monetarism already won. It is the only macro school of thought that incorporates the best of what is now known in Macro an Micro economics. They learned from Keynesians that demand is important. They learned from Friedman that money is what is important for demand and they learned from Lucas that managing the demand is not the game of chess but poker. But unlike him they know that the rules of the game are very important and that they have real impact.
Nick, just dropping this here in your latest post (another great one, btw), would love to hear your thoughts on this:
““While the Fed hates being held hostage by market expectations, we doubt it will be prepared to disappoint global investors this week,” Lou Crandall, chief economist at Wrightson ICAP, wrote in a note to clients on Monday.”
Since the Fed at least to some extent creates those expectations…
Greg: Just to be clear, I interpret Hume as saying “The short run non-neutrality is a puzzle, and here is my resolution of that puzzle..[the passage I quoted]”
I agree with you and Kevin Andrew above that Hume’s story sounds like the Cantillon story. But I also agree with Ritwik above that it sounds like a sticky wage/price/expectations story too. I will leave that one to the historians of thought, as to what Hume really meant. Personally, I don’t think Hume is really explicit enough for us to be able to say for sure.
Kevin: Richard Cantillon wrote before David Hume.
JV: I keep getting Bowles and Gintis muddled (I first came across them in a joint paper they did on the Labour Theory of Value). At least one of them (probably both) is a great thinker, and your story confirms this (it sounds very Elinor Ostromy too). This is the very best sort of work in Institutional Economics. And yes, it is exactly that sort of institutional economics that needs to be applied to our understanding of monetary institutions too. Money, and monetary policy, have to be understood as social institutions — a shared set of mutually-reinforcing expectations and rules of behaviour — and not just the pulling of levers.
Funnily enough, on a personal note, this was exactly my original agenda when I set out to write my PhD thesis. I failed, of course, because I was laughably over-ambitious for my abilities. You might say I’m still trying, though. And still failing!
Nick: thanks for your patient explanation, it is much appreciated.
I see that David Glasner has put up a post espousing the common-sense view of money neutrality (and that you have replied to him.) So there are more varieties of market monetarist under heaven than were dreamt of in my philosophy.
Suitable apologies to you all.
J.V.Dubois: I like your comment, but I would never have disagreed with it in the first place. So I suspect we do not really understand each other.
FrankDeliquo: “Worse, if they decided to continually revise the definition [of the metre NR], the unit would no longer be useable and would be abandoned in favour of one that was not continually being changed.”
Yes, and I think that’s true for money too. Except it is easier to define the metre in a good way than it is to define money in a good way, because a lot of relative lengths in physics stay constant over time, whereas relative prices of almost everything in economics are always changing. But what surprises me is how long people will stick to a particular money, both as medium of exchange and medium of account, even in the face of very bad monetary policy. You have to really screw up before the Greeks start switching to “barter” and the Zimbabweans abandon the Zim dollar altogether.
“The fundamental mistake you are making is to do with the nature of definition. Words are not defined by authorities, or even dictionaries. They are defined by their usage.”
Wittgenstein. And in some sense that’s true for money too. People choose what money to use, and what prices to exchange that money at. So what gives central banks their power? “Asymmetric redeemability” is my answer. If all other monies (such as those issued by commercial banks) are redeemable at fixed exchange rates into central bank money, and it is the responsibility of the issuer, and not the central bank, to ensure they are redeemable, (why this should be so is another question), then the central bank is the one that is free to decide what all the other monies will mean. If everyone else decides they must translate their words into my words at par, then ultimately it is my usage of words that defines what words will mean. I get to play the role of Humpty Dumpty, and everyone else follows my usage.
Ritwik: That’s a lovely piece by Perry Mehrling on Don Patinkin (pdf). He (Patinkin) taught us at Western for 6 weeks, but he wasn’t an easy person for a student to get to know.
rsj: “I would say the reverse — that you get homogeneous equations only with a walrassian process. If you change that assumption slightly, you no longer get homogeneous relations. We live in a world without Walrassian processes and yet we have prices.”
Actually, I sort of agree.
Understanding the short-run non-neutrality of money can be understood as trying to understand which of those equations is non-HD0 in some sense, and moving away from a Walrasian model is (probably) the best way to do this. Taking your example, where a price must be set, based on expectations of future demand and supply, before agents know what monetary actions the central bank will take. (That’s the standard New Keynesian story). The equation is still HDO if we include those lagged expectations and previously set prices but since those variables are pre-determined, the equation is no longer HD0 in current period nominal variables.
The equation is still HDO if we include those lagged expectations and previously set prices but since those variables are pre-determined, the equation is no longer HD0 in current period nominal variables.
I don’t see how you can say that, as we have no idea what the equations are. Has there ever been a solution to a monetary exchange economy that does not assume meta-time tatonnment? If so, I would be interested to find out. I.e. remember the “circle economy” in which I buy some goods from the person on my left, and repay some debt I owe the person on my right. The solutions are not homogeneous in any sense. If many people are sequentially making expenditure decisions, where one person’s expenditure defines the other person’s revenues, then why should such a distributed system be solved by polynominal equations at all, let alone homogeneous polynominal equations that are all of the same degree. Without complete markets in which we can make all decisions in meta-time simultaneously, we are stuck with contingent plans in which we don’t even know what national income will be until everyone has made their expenditure choices.
Nick: “”Asymmetric redeemability” is my answer.”
So under NGDP futures convertibility there is no asymmetric redeemability. Central banks would have no power, and their role would be confined to keeping the metal rod in the safe.
123: I am free to choose. But once I have made my choice, and decided to stick by it, I am no longer free to choose. Central banks exercise their power by choosing NGDP futures convertibility, or gold convertibility, or the k% rule with no convertibility, or whatever. Conditional on how they choose to exercise their power, they have no power. They spent it, in exercising it.
rsj: “I don’t see how you can say that, as we have no idea what the equations are.”
That’s the beauty of Hume’s insight (and Milton Friedman made essentially the same argument in saying there’s a natural rate of unemployment). Regardless of what the equations are that determine the structure of the economy, those equations should be invariant to the monetary unit. Real scientists use roughly the same “trick” in their search for dimensionless constants, as far as I understand it. Starting from that fundamental insight of monetary neutrality, we then work backwards and ask ourselves “Hmmm, now, under what circumstances might a change in the units, that happens in historical time, matter?”
It’s a bit like the Modigliani Miller Theorem. Nobody believes MMT, including MM themselves. But it’s a very good starting point from which to ask ourselves: “Hmmm, now, why might the debt/equity ratio matter, despite MMT?” Discussions of debt/equity ratios that are not informed by MMT (you still see them occasionally) just come across as hopelessly garbled, and “not even wrong”. A lot of “heterodox” macro reads exactly the same way to me.
Oh, and in answer to your earlier question: MMT does not apply to OMO because money is useful as a medium of exchange, so money and bonds would not be perfect substitutes. It’s not just the distribution of returns on your money/bonds portfolio that matters.
rsj: my old post on “Units”. Wikipedia on “Dimensional Analysis”
Nick, so basically central banks preserve their power by not making a choice. By not making a choice, they increase the M0/NGDP ratio, they earn monopoly profits, they grow the value of their franchise. They are earning excess profits by destabilizing the macroeconomy – we need a new James Bond movie with the central bank as a villain.
Starting from that fundamental insight of monetary neutrality, we then work backwards and ask ourselves
OK, so this is an axiom rather than a conclusion. Previously the argument was “the equations are homogenoeus and so money doesn’t matter”. Now, it is “we know money can’t matter so the equations must be homogeneous”.
MMT does not apply to OMO because money is useful as a medium of exchange, so money and bonds would not be perfect substitutes. I
But again, the role of the central bank, as this institution was designed and currently functions — is to erase that distinction. If you have a bond — or anything that the CB deems as appropriate collateral, but government bonds certainly are — they you can instantly convert that bond into money at pre-defined rates of exchange.
The whole raison d’etre of the central bank is to guarantee that a select group of oligopolies known as banks have the monopoly of creating money for the non-financial sector. Inflation fighting is far, far down on the list of priorities next to ensuring that the payments system is functioning.
That is why you are getting so much push back when you pull out the quantity type arguments.
That’s not how things are designed to work and that’s not why the banks got together and forced the creation of a government reserve bank in the first place.
Looking at the behavior of central banks today, they will never take the power to create money out of the hands of the private sector, and they will never do anything to endanger that private monopoly or to encroach on it. Even if, within the context of an a-historical and institutionally-unaware model they could. Central banks restrict themselves to setting interest rates and let the private sector banking system create as much deposits as it can given those rates. They are even very hesitant about things like basic bank regulation, let alone squeezing the banks out of the money supply business.
‘Nature doesn’t care whether we measure her in ponds or kilograms.’
Is that an axiom of physics, or a conclusion, or an empirical regularity? I can imagine a world where it’s false, where Greek Gods rule the physical universe, and care about all sorts of things, like the units men use.
If it’s an axiom at the level of the individual unit, it could be a conclusion at the level of the economy as a whole.
If we used cows as money, the axiom would be false. I “know” that from casual empiricism. Cows give milk, people like drinking milk, cows eat grass, grass is scarce. Cow money is non-neutral.
“If you have a bond — or anything that the CB deems as appropriate collateral, but government bonds certainly are — they you can instantly convert that bond into money at pre-defined rates of exchange.”
Nope. I currently hold $200 in notes in my pocket, earning 0% nominal, while the overnight rate target is 1%. If I could instantly and costlessly convert back and forth between money and bonds I would do so, just before I paid at the supermarket checkout or got my salary.
People hold inventories: of medium of exchange, and of groceries, and of other things. Precisely because life is very inconvenient if you try to hold zero inventories.
Nope. I currently hold $200 in notes in my pocket, earning 0% nominal, while the overnight rate target is 1%. If I could instantly and costlessly convert back and forth between money and bonds I would do so, just before I paid at the supermarket checkout or got my salary.
You can’t. You are not supposed to. The overnight rate doesn’t apply to you at all, as you cannot borrow or lend overnight.
You are in the non-financial sector, and money to you is primarily bank deposits, on which you are earning close to zero if not exactly zero. It is because you cannot costlessly and instantly convert that the banks earn seignorage income on those deposits. Which means that they are more than able to create as many deposits for you as you want to hold. Money to you is just an IOU from the bank.
Hence the privileged position that I was referring to earlier. They have access to the payment system, to automatic CB overdraft facilities, and to lending facilities. They also access netting and after-the-fact settlement. For you, when you pay, you settle. Banks pay to the non-financial sector and settle among themselves ex-post.
Therefore you have a demand for deposits far in excess of the banking system’s demand for reserves.
As far as the private sector as a whole is concerned, the only difference between bonds and deposits is interest rates and interest rate risk. But that arbitrage is a privilege of the oligopoly, and it is not your privilege. As far as you are concerned, you can have as much money as you want, given your total wealth. All you need to do is sell your interest bearing bonds to the banking system and accept their non-interest bearing IOUs in exchange.
They can always accomodate you, so there is never any excess demand for money on the part of the non-financial system.
The financial system can never have an excess demand for reserves as the CB makes sure that this market always clears.
Fair enough.
Nick wrote:
“I agree with you and Kevin Andrew above that Hume’s story sounds like the Cantillon story. But I also agree with Ritwik above that it sounds like a sticky wage/price/expectations story too. I will leave that one to the historians of thought, as to what Hume really meant. Personally, I don’t think Hume is really explicit enough for us to be able to say for sure.”
It’s a consequence of that fact that multiplying by 1 doesn’t change anything.
e.g. 1 mile = 1609.344 meters, and 1 hr = 3600s. Therefore, 1609.344 meters/1 mile = 1, and 1 hr / 3600s = 1. Now, given e.g. 5 miles/hr we convert: 5 miles/hr * 1609.344 meters/mile * 1/3600s = 2.2352 m/s
Patrick: suppose, just suppose, that the Universe were ruled by an Olde English Imperialist god, who didn’t like the metric system? And metrification made him angry, and he created thunderstorms in response? Or a slightly confused French God, who suffered from metre illusion, thought a metre was a metre, and who halved the size of the Sun when the French hacksawed the metre in half? There’s nothing logically impossible about that theory of the Universe.
I think it took the ancient Greeks to figure out that the Universe wasn’t like this. We take it for granted, but I don’t think it was always thus.
rsj: “The financial system can never have an excess demand for reserves as the CB makes sure that this market always clears.”
My old post the peanut theory of recessions
rsj,
And I don’t care whether you believe in MM or not, but am interested in why MM seems to be applied against fiscal interventions (Ricardian equivalence is a form of MM) but is not applied against CB quantity interventions.
See:
Neil Wallace (1979), “A Modigliani-Miller Theorem for Open Market Operations”
Click to access sr44.pdf
vimothy: yep. The fiscal theory of the price level guys also assume MM.
Vimothy,
You rock. Thanks!
No worries. If you have access to JSTOR, I found a version with readable mathematical notation here: http://www.jstor.org/stable/1802777
Nick: I dunno.. I think I’m probably just missing the point, but what the heck … all the intelligent people have already made their contributions, so the peanut gallery might as well have a go now.
I’m trying to think of ways even an Angry Metric System Hating God could pull off what you describe, and I suspect that analogies between physical systems and economic systems just don’t hold-up that well.
To shrink the size of the sun by half by compressing it would cause a much increased rate of nuclear fusion and blow the star apart or perhaps collapse it into a black-hole. If the star did achieve some kind of new equilibrium, the Earth would certainly be outside the habitable zone. In any case,life on earth would end shortly after the start was shrunk.
The only other think I can think of would be for Angry God to have a velocity in all directions relative to the inertia frame of the sun. If Angry God’s relative velocity in all directions at once (this is the part requiring Godlike powers) was just right, the Lorentz contraction would make the sun appear half as big. Of course, it wouldn’t affect humans at all, but the Angry God could appease himself by making the start appear smaller.
But I suspect I’m being too literal. Or perhaps God is an RBC macro-economist(there’s a scary thought).
Ugh. Somehow “star” came out as “start” above. Sorry.
Patrick: Oh man, but you are just so embedded in all this neoclassical scientific “units don’t matter” worldview. Nah, the Sun is just a shining metal disk in the sky. Thor should be able to trim it down, no problem. After all, he sank those ships the other day with that thunderstorm. And he does put the Sun to sleep every night anyway, so cutting it in half shouldn’t be any harder.
In any case, the so-called “external world”, just like the so-called ‘economy”, doesn’t exist outside of our thinking about it. It’s all a figment of our imaginations. So it stands to reason that if we think in smaller units, the Sun we think of will be smaller too!
I’m sporadically near the Internet, but here was a quick proof of non walras.
Remember I thought barter had n choose 2 markets, but that was 2-way trades, you later did a post explaining everything gets switched for everything. It’s like having ratios or fractions with many different numbers, for numerators or denominators. Like using the rational numbers to approx the real numbers. Anyway you were right, 2^n markets exist, if the auctioneer, can take any basket, and switch them around. Or in other words the power set of a set is the possible trades. If there is an infinite number of goods the power set is uncomputable as it is in 1 to 1 correspondence with the real numbers. Using cantor’s diagonalization argument, show it is uncountably infinite.
But I guess this is well known, with the computable general equilibrium models. I tried looking up some constructivist economics, like vela velupillai’s but not sure if it is worth it. Lots of mathematicians aren’t that strict.