I confess this is a bit of a "Gotcha!". But it's a bit more than that as well. It illustrates the difficulty that people (even economists) have in "seeing" money.
Brad DeLong flatters me (but he's right that this is right up my street), then sends me to David Levine. Here's the "money quote" (sorry).
"I want to think here of a complete economy peopled by real people who produce and consume things. Let's say four of them: a phone guy who makes phones, a burger flipper, a hairdresser and a tattoo artist. Let's say that the burger flipper only wants a phone, the hairdresser only wants a burger, the tattoo artist only wants a haircut and the phone guy only wants a tattoo – around the circle in effect. We'll suppose that each can produce one phone, burger, haircut or tattoo and that each values the unit of what they want to buy more than the unit of what they can sell. That is, the hairdresser happily cuts hair if he can get a burger and so forth. What happens is clear enough: the phone guy produces a phone, trades it to the tattoo artist in exchange for a tattoo, who trades the phone to the hairdresser in exchange for a haircut, who trades it to burger flipper in exchange for a burger. All are employed, all get what they want – everyone is happy.
Now suppose that the phone guy suddenly decides he doesn't like tattoos enough to be bothered building a phone. Now the circle is broken and this is a complete catastrophe. Everyone is unemployed. Demand is insufficient. There isn't enough consumption – none at all in fact. And notice how this works: one person – the stupid phone guy who is causing the problem by not wanting to buy a tattoo – is "voluntarily unemployed" – he is lazy and doesn't want to work. The other three are "involuntarily unemployed" each one is willing to work in exchange for pay. The burger flipper would like to work making burgers if he can get a phone, the hairdresser would like cut hair if he could get a burger and the tattoo artist would like to work if he could get a haircut and yet all are unemployed." (bold added).
Notice the bit I bolded. Notice how the tattoo artist accepts the phone in exchange for a tattoo, not because he wants a phone, because he plans to use the phone to buy a haircut from the hairdresser, who doesn't want a phone either, but plans to use the phone to buy a burger.
In this model economy, phones are used as the medium of exchange. And they need to use a medium of exchange because there's a Wicksellian triangle (or quadrilateral in this case) with no double-coincidence of wants, so direct barter won't work.
Now if this were my story, I would translate the metaphor by saying that phones are money, so the phone guy who makes phones is the central bank which makes money. And the stupid phone guy who creates the whole mess by not making enough phones is the stupid central bank which creates the whole mess by not making enough money. It's a very monetarist story.
But that's not where David Levine goes with his story.
"Is the basis of Keynesianism that we should assume that the government has a phone to give away? Well maybe not. Maybe the government should follow Keynes advice and print some money (or bury it) and give it to the phone guy. Then the phone guy can buy a tattoo, and the tattoo guy can buy a haircut and the haircutter can buy a burger, and the burger flipper – ooops…he can't buy a phone because there are no phones."
No. The phone guy is the government (or rather, the government-owned central bank). The phone is money. And so the phone guy/central bank does have phones/money to give away (or sell).
And the neat thing about money is that it can circulate round and round the Wicksellian circle forever, with nobody every stopping to ask "Hey, do I really want this intrinsically worthless bit of paper?", because each person knows that the next person will accept it in turn. And because using money reduces transactions costs, people will hold money temporarily even if the real rate of return on holding money is negative (as long as it is not negative to a Zimbabwean extent). And if Mr Ponzi could have produced an asset so liquid that people would want to hold it even at negative real interest rates, then Mr Ponzi's business plan would have been perfectly sustainable forever. People would pay Mr Ponzi for the privilege of holding his IOU's.
There are no free lunches in standard competitive equilibrium theory. But standard competitive equilibrium theory ignores transactions costs. And the only way the real world can get anywhere near the zero transactions cost world of standard competitive equilibrium theory is if people use money to help reduce those transactions costs. Because n-person barter is (usually) very very costly for n > 2. And if the central bank can produce money for free (they usually make a profit from producing money, even after paying for paper and ink), and if producing more money reduces those transactions costs (because barter is very costly), then there is a free lunch. And our job as economists (I think this is an Arthur Laffer saying) is to find those free lunches and make sure they are eaten.
David Levine's model/story is a very Monetarist model/story. (OK, a Keynesian model/story too, if by "Keynesian" we mean theoretically correct Keynesians who recognise the central importance of the medium of exchange.) But he misses seeing the point of his own model/story because he misses seeing that phones are money in his story.
[From one of my old posts:
The unemployed hairdresser wants her nails done. The unemployed manicurist wants a massage. The unemployed masseuse wants a haircut. If a 3-way barter deal were easy to arrange, they would do it, and would not be unemployed. There is a mutually advantageous exchange that is not happening. Keynesian unemployment assumes a short-run equilibrium with haircuts, massages, and manicures lying on the sidewalk going to waste. Why don't they pick them up? It's not that the unemployed don't know where to buy what they want to buy.
If barter were easy, this couldn't happen. All three would agree to the mutually-improving 3-way barter deal. Even sticky prices couldn't stop this happening. If all three women have set their prices 10% too high, their relative prices are still exactly right for the barter deal. Each sells her overpriced services in exchange for the other's overpriced services.
But barter is not easy. There is no double coincidence of wants here, and it is costly to find all three people in the Wicksellian triangle to do the barter exchange. So people use money.
The unemployed hairdresser is more than willing to give up her labour in exchange for a manicure, at the set prices, but is not willing to give up her money in exchange for a manicure. Same for the other two unemployed women. That's why they are unemployed. They won't spend their money.
Keynesian unemployment makes sense in a monetary exchange economy, where money is what Hahn calls "essential" for trade. It makes no sense whatsoever in a barter economy, or where money is inessential.
Keynesian unemployment is an excess demand for the medium of exchange. It's a coordination failure, because if all three spent the $20 to buy what they wanted, all three would find her purse is a widow's cruse. The $20 reappears as soon as it is spent. But the widow's cruse fails unless all three increase spending at once. And, in Nash Equilibrium, none of the three wants to do that. She prefers the $20 in her purse.]
Worthwhile Canadian Initiative 
This was interesting: “one of my old posts where I lay out the argument.”
Make sure you read comments too if you find it confusing like I did.
“Keynesian unemployment is an excess demand for the medium of exchange”
I’m impressed
sometimes people have something to barter (rather sell) for the medium of exchange, sometimes they only have their labor to exchange, sometimes they are so disabled or elderly that they dont have anything to exchange
but either way, sounds good to me
bacon: there are commodity moneys too. If we use cows as money, some people might still want to eat a cow, or want it for the milk.
But in today’s world, we don’t use commodity money. So if David Levine’s story is a parable about the real world, the “phone” is just a bit of paper.
Jussi: thanks. I think that was one of my better posts.
djb: yep. But if some people are too disabled to work and earn income, it’s not a problem of insufficient money or AD in the economy. There would be a problem even in a barter economy. We need taxes and transfer payments to fix that problem.
Nick: the phone is clearly not money when B receives it, and it is limited in its “moneyness” depending on whe gets the phone first between H and T. Giving money to B in this scenario actually destroys H and T’s demand for money without employing them- this has serious implications for monetarism (especially with regard to paying IOR to raise rates in the future).
“The unemployed hairdresser is more than willing to give up her labour in exchange for a manicure, at the set prices, but is not willing to give up her money in exchange for a manicure. Same for the other two unemployed women. That’s why they are unemployed. They won’t spend their money.
Keynesian unemployment makes sense in a monetary exchange economy, where money is what Hahn calls “essential” for trade. It makes no sense whatsoever in a barter economy, or where money is inessential.
Keynesian unemployment is an excess demand for the medium of exchange. It’s a coordination failure, because if all three spent the $20 to buy what they wanted, all three would find her purse is a widow’s cruse. The $20 reappears as soon as it is spent. But the widow’s cruse fails unless all three increase spending at once. And, in Nash Equilibrium, none of the three wants to do that. She prefers the $20 in her purse.]”
Let’s say there is $20 total in this economy with $0 being saved.
Now the hairdresser decides to save $20. The saving causes the recession?
Jonathan said: “Is that really equivalent to an excess demand for money? It sounds quite different to me. Sure, it’s an excess demand for financial assets, or equivalently insufficient demand for current goods, but what does this have to do with money as a medium of exchange? You need money as a zero-interest store of value (to get the ZLB), but that’s it.”
What if “money” gets redirected from NGDP of goods/services to “NGDP” of financial assets/saving vehicles?
rsj said: “Or can an excess demand for bank deposits also create recessions?”
I’m going to say yes here because “bank deposits” are both MOA and MOE.
Jonathan said: “Also, how does it fit in with the modern credit/payment system, where “money” is very different than just pieces of paper that circulates? (Okay, that last question is a bit unfair because I don’t think anyone has a good handle on how to properly model money. But the current reality does seem a particular challenge to more “monetarist” positions).”
I’m going to say “bank deposits” and currency are both MOA and MOE. The commercial banks do not allow their “bank deposits” to rise in value. The central bank and deposit insurance do no allow the “bank deposits” to fall in value. The “bank deposits” stay fixed in value to currency. It just happens to be fixed 1 to 1.
“As Scott Sumner keeps on repeating, nominal interest rates (or bond prices) are not a good measure of the tightness or ease of monetary policy.”
I don’t agree with that. Let’s assume pre 2008 in the USA. “Monetary policy” used market interest rates and the fed funds interest rate thru the commercial banks. I am pretty sure the true commercial banks can’t hold stocks and commodities. Market interest rates and the fed funds interest rate were attempts to control the amount of bonds issued and repaid. The amount of bonds issued and repaid affected mostly demand deposits in circulation, MOA and MOE (money).
I’ve ignored levered hedge funds here. I’ve ignored “friend” borrowing or as Steve Keen has recently said peer to peer borrowing (Some entity saves and another entity borrows that saving 1 to 1).
It’s commodity money, not fiat money. Big difference. Levine added an addendum which you may want to read. Clearly he “knows” what money is in his own model.
na: thanks. I have now read the addendum.
Let’s run with it. The phone guy really is a producer of phones, and not the central bank.
Compare David’s parable to a world where we use gold as money, and there’s a supply of new gold from the mines, but also an industrial demand for gold for dentistry. What happens if the gold miners stop mining gold. So the money supply drops. What happens next depends on whether prices are sticky or flexible:
If prices are sticky, there’s a standard recession, due to an excess demand for money. That’s the trouble with a gold standard. The solution is to have the central bank produce paper gold, buy assets to get the paper gold into circulation. And if the supply of gold increases again in future (or if the demand for gold drops) it can buy back the paper money.
If prices are perfectly flexible (as David assumes in his addendum) prices drop until the real stock of money is restored to its original level. There is no recession.
***The reason David gets a recession is that he assumes the money supply drops to zero. There are no phones at all. *** Yep, that will do it. You can’t have monetary exchange if there is zero money.
I see Steve Williamson has joined in. OK. I’m just heading off for the weekend. So this will have to wait till I come back. But yes, if gold producers stop producing gold, that is indeed a problem for people who want gold to fix their teeth, or for airbag switches. But it doesn’t have to cause a recession, by disappearing the money supply.
I find David’s addendum flawed for another reason, where he posits two different scenarios:
In Levine’s model, after the phone maker’s desire for leisure increases , then the optimum situation becomes the situation where no goods are produced and any actions by the government will make things worse.
Move from an economy based on phones being the commodity money to one where there is fiat money. What happens if the authorities target NGDP? By increasing the money supply they can probably keep economic activity going and NGDP on its target path. But it can only do this by fooling the phone maker into thinking he can sell his phone for more real goods than he actually can. Targeting NGDP actually moves the economy out of equilibrium.
Levine has identified a situation (changing relative demand for leisure over work by some people in the economy) where targeting NGDP is sub-optimal.
NGDP targets in the sense we mean here are not possible in Levine’s model, since he’s assuming essentially fixed prices (especially relative prices). Without a meaningful price level, NGDP targets are RGDP targets, which are themselves not possible as a long-term goal of monetary policy.
Richard H. Serlin: “And why do you think {Levin} could be saying these things?”
Well, I finally had a look at Levin’s post, and it seems to me that he intends his toy economy to be a counter-example of Keynesianism, specifically the idea that the gov’t can cure general involuntary unemployment by injecting (gov’t) money into the economy. It is important for his argument that phones are not considered money, even if they are the medium of exchange. Otherwise the gov’t could give the tattoist a phone in each cycle and keep the economy going. (But how does the gov’t get or produce the phones?)
Levin makes it clear that he does not consider his toy economy to be anything like a real economy. He is using it to make a logical argument.
However, does he have Keynesianism right? Does it apply to his toy economy? I don’t think so, because the toy economy lacks gov’t money to start with. The diagnosis of John Stuart Mill does not apply, and, I guess, neither does Keynes’s policy.
It seems to me that Levine makes another couple of slips in the quoted material. (Sorry, it’s Levine, not Levin.)
Levin: “What happens is clear enough: the phone guy produces a phone, trades it to the tattoo artist in exchange for a tattoo, who trades the phone to the hairdresser in exchange for a haircut, who trades it to burger flipper in exchange for a burger.”
Beg pardon, but that that happens is not at all clear. In fact, we have a nice classroom experiment here, where you can use tokens to represent the different goods and services. For instance, the hairdresser can write “Haircut” on a slip of paper and hand it to the customer. My guess is that each player will succeed, but not in the manner Levine posits. I also guess that if you have longer chains, you will reach a limit to the length of the chain beyond which there is no solution in a reasonable length of time.
Levin: When no phone is produced, “Everyone is unemployed. Demand is insufficient.”
That is correct, but it gives the impression that the problem is one of demand. Yes, the demand for tattoos is insufficient, but so is the supply of phones. Supply is also insufficient.
Note also that Levine indulges in some rather strange moralizing.
Levine: “And notice how this works: one person – the stupid phone guy who is causing the problem by not wanting to buy a tattoo – is “voluntarily unemployed” – he is lazy and doesn’t want to work.”
The phone guy is stupid? He is also lazy? Where is that coming from?
I read this post and some other unobtainium posts, and I must confess I don’t understand the “unobtainium” controversy over Walras’s law.
Walras’s law says that if there is an excess demand for unobtainium, there must be an excess supply of other goods. This is true when agents reveal their notional demands, since they wish to sell other goods and purchase unobtainium at any price vector that includes a finite price of unobtainium.
You say that well the agents are smart, realize that unobtainium has no supply, and hence do not demand unobtainium and instead plan to purchase other goods with their production. But if this is the case, then there is no excess demand for unobtainium: the demand (zero) equals the supply (also zero); and hence there is no reason to expect excess supply in the other goods.
The other argument, that in the presence of money, there is not one price vector for n goods that agents see, but rather n 2-price vectors (for each good vs money), and this can result in an excess supply (or excess demand) of all n goods, makes sense. In this context, though, I don’t understand the distinction that some people draw between a medium of account and a medium of exchange. It seems to me that anything that is to have value as a medium of exchange, must also have value as a medium of account (or be instantly convertible into the medium of account, which amounts to the same thing). If you had scrip that only had value as a medium of exchange, but could not be “stored”, it would be useless in solving the coincidence of wants problem, since you would only accept scrip in return for a haircut if you simultaneously had arranged to exchange that scrip for a manicure, and the manicurist would only accept the scrip if she had simultaneously arranged to exchange that scrip for a massage, and the masseuse would only accept that scrip if she had simultaneously arranged to exchange it for a haircut. The scrip adds no value whatsoever over a pure barter economy in this case.
Nive: Suppose I want to buy 100 apples, but I am rationed and know I can only buy 60 apples. I might buy 40 pears instead, but if you asked me if I wanted to buy 40 extra apples I would still say yes. If we say it your way, then all excess demands (and supplies) are always zero, as soon as people realise they cannot buy (or sell) as much as they want to buy (or sell).
Nick, I think my point is that you’re defining excess demand in one way for the apples, but excess supply in a different way for pears.
i.e. if I were to ask you, “at these prices, would you want to buy apples and sell pears”, you would say yes to both those questions. If I asked you, “at these prices, knowing that you cannot buy more than 60 apples, would you want to buy more apples and sell pears”, you would answer no to both questions.
To put it another way, once you’ve hit your constraint, apples are no longer meaningfully part of the market. This is entirely clear in the case of unobtainium — if you are accounting for the fact that it is in zero supply, there is no meaningful sense in which there is an unobtainium market — everything is the same as it would be if there were no such good.
We observe a line of unemployed workers looking for jobs. We do not observe a line of unemployed workers at the car dealer telling them about the cars they would want to buy if they could get a job.
Nick Rowe: “We observe a line of unemployed workers looking for jobs. We do not observe a line of unemployed workers at the car dealer telling them about the cars they would want to buy if they could get a job.”
So you are saying that there may be a desire for cars by the unemployed, but not a demand for cars?
Min: Using the normal terminology, there is a “notional” demand for cars but not an “effective” (or “constrained”) demand for cars. Clower is the man on this.
http://en.wikipedia.org/wiki/Effective_demand is not bad.
Thanks, Nick! 🙂
Nick, I don’t understand your comment about jobs and cars.
My point is that you are comparing an unconstrained excess demand for apples with a constrained lack of excess supply of pears, which makes no sense.
You have to pick one or the other for all the goods. Either say that because you say you would trade pears for apples if given the chance, there is both excess supply of pears and excess demand for apples; or say given the constraint, you are not trying to buy apples, nor are you trying to sell pears.
You can’t have it both ways, saying you want to buy apples, but you don’t want to sell pears because you recognize the apple constraint.
Remember that this is still a barter economy — you cannot say you want to buy apples without specifying what you want to sell in exchange. If given the constraint all other markets were clearing, your statement that you want to trade pears for apples, is equally a statement of excess demand for apples and excess supply of pears.