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 
Exactly what I thought when I read Brad’s post (before I read this)–the cell-phone-theory of recessions…
If you have to dig phones to get them into circulation, you’re into a gold standard-bitcoin-euro model. So gold-bitcoin-euro are not money. (musing of an humble IO guy.)
Donald: yep!
Jacques-Rene: if we used gold as money, and if the price of gold was equal to the marginal cost of mining gold, then yes it’s not obvious there’s a free lunch. But then the unemployed would immediately head off panning for gold.
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.
This is false. To see why, consider the following case. All households consume burgers. Every household specializes in production, supplying either beef or buns. The utility function is inflexible: every burger must consist of one portion of meat and one bun. Any surplus bread or meat goes in the the garbage. It is obvious that if the butchers believe that the bakers have small appetites, or that they are too lazy to do much baking, then they will respond by producing less meat. The bakers will behave similarly. GDP is determined by the gloomier industry. Keynesian unemployment is the result.
This is Keynes’s “magneto trouble” in the simplest possible setting. It is not fundamentally a monetary problem. Of course any half-decent monetary system will resolve such a problem, in such a simple economy. If the producers specialize in the manufacture of consumption goods and capital goods things get more tricky, because time plays a bigger role. But once again, although the solution may be a better monetary setup, that’s not the heart of the problem. The heart of the problem is coordination.
It’s odd that you mention Frank Hahn; as you surely recall, he’s on my side of this issue.
Kevin: what you say is theoretically possible. And we sometimes observe something like that in micro. No boys go to the disco because there aren’t any girls; no girls go to the disco because there aren’t any boys. No hi-tech firms because there are no hi-tech workers; no hi-tech workers because there are no hi-tech firms.
But business cycles don’t look like that. In recessions it’s harder than normal to find buyers of illiquid goods (like labour). But it’s easier than normal to find sellers of illiquid goods. It is money that is hard to buy, and easy to sell.
@Kevin:
if we used gold as money, and if the price of gold was equal to the marginal cost of mining gold, then yes it’s not obvious there’s a free lunch. But then the unemployed would immediately head off panning for gold.
This was the old Austrian argument that Keynes mocked when he suggested that if this would work in a gold standard economy, then why can’t the government insert pound notes in bottles and bury them in garbage dumps. Then people would be employed digging for money as well. But if that was OK, wouldn’t it be better to employ people to build railroads?
Then everyone misinterpreted this to mean the Keynes was advocating to pay people to dig holes in the ground, when he was pointing out that this is what the gold bugs were advocating as a depression cure.
Nick, I know you’ve explained this before, but there’s something I still don’t quite understand.
Doesn’t excess demand for money imply excess supply of bonds? Which would imply high interest rates? How is it that yields on, say, BBB corporate bonds (not “safe assets” and not terribly liquid either) have been so low since the start of 2010? People seem awfully eager to part with money to own them.
Doesn’t this cut in favor of Kevin Donoghue’s argument?
I know some of these stories relate to money, but I’m not sure why this one does. It seems the exchange value of the phone here depends critically on the fact that the burger guy values the phone for its own sake.
In fact, as far as I can tell, once the phone guy decides he’s out, there are no possible trades that are Pareto efficient, regardless of any co-ordination issues (unlike your own example).
Nick: the unemployed may pan for gold at low cost (untrue given the troble of getting to the Yukon but still). Bitcoin mining is not not for the ordinary unemployed and is costly. But gold and bitcoin are (bad pun alert) bit player.
But there is no way you can mine euro. At least as long as The Amazing Merkel and Her Ordoliberal Circus play at Brussels-Frankfurt auditorium. Tickets are limited and payable only in Golden Delicious apples. Available from Wolfgand Schaüble after he has spread the orchard with Agent Orange.
(God, how I enjoy mixing my metaphors with bad sarcasm.)
Sorry for offtopic
Nick, fund manager John Hussman has published an interesting critique of the monetary thermostat. See the chapter “Fed policy, Granger causality, and the intensity-matching fallacy” at this link:
http://hussmanfunds.com/wmc/wmc150316.htm
I had a twitter debate with him last week, and used some of your blog posts to,defend the monetary policy.
rsj: suppose we take the money=gold literally. Would there be an externality, so it would be efficient for the government to subsidise gold mining?
MR: If you expect that money will be tight not just today, but in the future too, it is quite understandable that the price of bonds would rise. Expected inflation will be low; desired saving will be high (bad times ahead); and desired investment will be low (why buy new capital goods to produce more goods you won’t be able to sell?). Plus, any fall in the natural rate of interest (for reasons unrelated to tight money, like an exogenous increase in saving) would spill over to increase the demand for money, as well as raise the price of bonds.
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.
The bond market is just one of many markets in which money is traded. If the price of (say) peanuts is perfectly flexible, we would never observe an excess supply of peanuts, no matter how much of excess demand for money there was.
Nick E: If the phone guy decides he’s got enough tattoos, and so stops producing phones, the burger guy will stop wanting to work to sell burgers, because there are no phones to buy, and so on. The economy will look like Cuba circa 1994, where many people didn’t want to work because there was nothing to buy (for pesos) in the stores, and there was nothing they wanted to buy because they weren’t working. It was an excess demand for goods and labour, and an excess supply of money. That looks very different from capitalist economies in a recession. Jobs were easy to get, but what could you spend your wages on?
Vaidas: try hitting him with this paper: http://econpapers.repec.org/paper/ottwpaper/0201e.htm
Jacques Rene: “But there is no way you can mine euro.”
True. Which is why we are forced to rely on central banks mining the right amount on our behalf.
Apparently burgers have a freshness to them that make them unsuitable to form a burger standard, and no one had thought of IOUs yet.
Nick,
yes, absolutely. But it would be even better to pay people to build railroads rather then pay them to dig holes. It would also be much better because when one digs a hole, it’s not clear how much gold one will find, but we can pay a regular wage to build the railroad.
Here, I am ignoring for the moment the important disagreement that it is financial assets, rather than money per se, that people want, and that therefore having the government exchange bonds for money doesn’t really do a lot to give people more of what they want. But I don’t want to be accused of splittism.
“Very smart”, “highly esteemed”…. if this intellectual bromance goes any further…
Nick,
How does your story of recessions as excess demand for money square with the “standard” interpretation of Keynes? In a NK model with a ZLB, the problem is that the real interest rate is too high, and can’t fall because of the ZLB, and nominal rigidities mean that expected inflation doesn’t magically rise to lower the real interest rate.
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.
Jonathan: an excess demand for a store of value won’t create a recession. It needs to be an excess demand for the medium of exchange. Keynes himself was a bit fuzzy on this, in fact wrong. Gessell got it right. Here is one of my old posts where I lay out the argument.
So Nick, you believe that recessions are impossible in a pure credit economy? The way to end recessions is to ban cash and now we can go on blindly believing that deposits create loans?
Or can an excess demand for bank deposits also create recessions? What if the bank offers to pay interest on the deposit? What if the deposit is really a money market fund? How about a fund based on equities?
Nick,
Ah, interesting. I will take a look at that piece.
Is this just your view, or do others hold it? It seems inconsistent with what people like Woodford and Krugman say about money in Keynesian models.
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).
rsj: is “credit” used as a medium of exchange in a “pure credit economy”?
If we use cows as a medium of exchange, an excess demand for cows (due to a sudden fashion for drinking milk) will cause a recession.
“Credit” is just an obfuscating name for IOUs. There are lots of different sorts of IOUs. In some economies, some of those IOUs are used as media of exchange, and others are not.
Jonathan: “Is this just your view, or do others hold it? It seems inconsistent with what people like Woodford and Krugman say about money in Keynesian models.”
It’s a minority view, but I don’t think I’m the only one that holds it. Leland Yeager held a similar view. Bill Woolsey too. It is inconsistent with Woodford, who IMHO is wrong. Paul Krugman is harder for me to interpret. Sometimes I think he agrees with me, and sometimes I think he disagrees.
I think Woodford doesn’t understand his own model. Here is my explication of Woodford’s model.
Nick,
Suppose we have N commodities. And the market structure is such that each commodity can only be bought with a special type of script — a “commodity credit” assigned to that commodity. Thus there are N different commodity credits. And there is a credit market where you can exchange any single commodity credit for any other according to some floating exchange rate.
Now, this market does not have a medium of exchange, right? But it can have a recession if there is an excess demand to save in one of the several commodity credits.
^^script should be scrip. It’s a funny word.
rsj: No. Forget the scrips. You are talking about a Walrasian economy where any of the n goods can be traded for any of the n-1 other goods. If you can find a willing seller.
Suppose everyone wants to hold more land. for some reason the price of land does not rise to eliminate the excess demand for land. So what. You can’t buy land, because you can’t find a willing seller. So the desire to save in the form of land is frustrated. We can continue to trade all the n-1 other goods for each other.
“Credit” just obfuscates.
I have been through this so many times on this blog.
First, credit doesn’t obfuscate because the CB doesn’t control it. It’s a crucial point when debating the best policy approach. Because bonds are just as good as money, an operation purchasing a bond for money by the CB doesn’t really help. However, an operation supplying more bonds (e.g. deficit spending) without decreasing the amount of currency does help. It really is about excess savings demands.
“Suppose everyone wants to hold more land. for some reason the price of land does not rise to eliminate the excess demand for land. So what. You can’t buy land, because you can’t find a willing seller.”
Well, that’s what happens in a recession — you can’t find a buyer because the price of goods doesn’t fall enough, or if you prefer, the price of money doesn’t rise enough. It doesn’t rise enough because of the zero bound.
@Vaidas Urba:
Hussman also commits one cardinal sin in his market comment: in his “fed plus other stuff versus growth” chart, he plots the assumed Fed regresion against real output, over multi-decade timescales.
As any regular reader of this blog will know, the Fed cannot target a real variable; monetary policy can only control a (single) nominal variable.
That’s not a strict prohibition for two reasons, but neither of them helps Hussman’s case:
* The first exception is one of price stickiness. To the extent that prices are slow to adjust, the Fed can drive real output in the very short run. However, we’d expect that to show up in quarter-to-quarter fluctuations rather than year-to-year or decade-to-decade fluctuations.
* The second exception is of stability. If the Fed does its job perfectly and controls nominal output (notwithstanding ngdp non-targeting, etc), then we can reasonably expect a slightly higher long-term real growth rate from a more stable nominal economy. That probably wouldn’t show up in Hussman’s plot, and it certainly wouldn’t look like a first-order effect caused by Fed actions.
An extra half-critique is that Hussman has wholly accepted the “monetary policy is as loose as it can effectively be at 0% interest” argument. It’s only a half-critique because the opinion is rather common.
I get the sense that Hussman knows his stuff when it comes to supply-side economics, but he doesn’t fully grasp the monetary/demand connection. Reading his market comment and then this blog I can fully appreciate how:
^^^ I am wrong about land. I am wrong about the zero bound per se. It’s not the same thing as a financial claim. Sorry! I got all heated up.
I think what is getting lost here is the notion that my spending is your income and vice versa. But it is not true that my saving is your investment. I.e. suppose I hold money, as Nick points out. That is not necessarily anyone’s investment. But by the same token, if I buy a bond, then that does not need to be anyone’s investment either. For example, I can be buying a bond from a short seller — they sell a bond they don’t have, because they believe that I am overpaying for the bond and in a future period, the bond will be worth less. The short seller then keeps the cash against the (negative) bond position. No investment arises from this.
Similarly, if I repay a loan to a bank, then the bank merely marks down my balance with them and also marks down its asset. No investment arises from this either. In the above cases, you need a paper claim. I.e. you cannot short sell a real good, or mark down a real good. Land doesn’t work.
My disagreement is not that holding cash can’t be a form of savings that does not result in investment but rather that acquisitions of paper claims are the more general thing to consider. And here we want “liquid” paper claims in the sense that they can be shorted easily, so this also means short dated bonds, or risk free bonds. Basically things “close to money”, where the closeness need not be that they are mediums of exchange but that they have relatively stable value with respect to money and can be shorted or marked down.
One such example would be if the CB hikes rates and causes a recession. We agree, I hope, that in this case we are not at the zero bound and yet there is a recession. Well, if someone wants to save and tries to bid down the yield of bonds below what the CB sets, a short seller will arbitrage this and create a new bond and sell it to the saver, if the saver tries to buy a bond for less yield than the rate set by the CB. We agree, I hope, that this is the mechanism by which the overnight rate propagates to other rates. The income saved by the bond buyer just disappears. It does not cause any investment to occur. All of the above requires sticky prices, of course.
So (IIRC) Keynes’ more general argument, in the sticky price setting and assuming that households save by purchasing paper claims, was that when savings demands exceed investment demand at the going rate, then income adjusts downwards so that the at the lower income, savings is equal to investment. It’s assumed that as income drops, savings demands fall.
This seems to me a very nice and coherent story that encompasses the “excess savings of currency” as a special case. But the advantage of the more general case is that the impotence of the CB is clear at the zero bound.
Is there anything intelligent/useful in Levine’s post?
And why do you think he could be saying these things?
Example: Casey Mulligan, tenure at Chicago, but read some of the things he writes. There, it’s so obviously stupid, I think it has to be either: (1) He’s willing to go to great lengths to lie/mislead for his libertarian ideology, (2) He’s really detached from reality, but good at math, and an extreme workaholic from childhood, and that got him tenure at Chicago, (3) He really wants to prop up the value of the models that got/get him so much money, position, and prestige by making ridiculously over-literal interpretations, (4) To a large extent the guy’s crazy. Or, some combination of the four.
But if you’re not too unwilling to be honest on record, what do you think is going on with Levine’s reasoning for saying this. You appear to think he’s at least largely wrong. Why then is a guy who could get tenure at UWSL saying these wrong things, that Krugman, et. al imply are obviously wrong?
“That looks very different from capitalist economies in a recession.”
Yes. And when I actually read the Levine article (after I posted my comment here), I realised that his very purpose was to describe a situation which was not a monetary problem. To which my immediate response was: “Well fine, but that’s not the problem that Keynesian policies are intended to address”.
The phones are Gesellian money. They self-destruct in each cycle. 🙂
rsj: “But by the same token, if I buy a bond, then that does not need to be anyone’s investment either.”
If there is an excess demand for bonds, will you actually be able to buy a bond? Nobody wants to sell.
There are two ways to get more money (medium of exchange): buy more money; sell less money. If you can’t buy more money, because money is in excess demand, you can still sell less money (buy less other stuff). It doesn’t work with bonds, or anything else, because there is not a steady flow of bonds both into and out of our pockets. But it works with money, because if we can’t increase the flow in we can (as individuals) still decrease the flow out. But when everyone reduces the flow out, we get a recession.
Richard: everybody gets stuff wrong. Nobody understands money properly. Because money is weird. I have seen Paul Krugman get money wrong too. I expect I do too, but it’s harder to see your own mistakes.
I don’t know, this seems like more than just getting money wrong.
How do you explain some of the amazing things Casey Mulligan says? He got tenure at Chicago.
How do you explain some of the incredibly literal interpretations to reality of models you see from professors with tenure at top universities? (Krugman calls this considering the model “The Truth”.)
These aren’t just trivial questions. Because if we could understand this better, we could perhaps prevent a great deal of harm and confusion.
Richard: I don’t know. (And I haven’t read much of Casey Mulligan.) But this is not a right/left thing. Think about some of the daft things Marxists say. Then think of some of the even dafter things post-modernists say. (I’m beginning to suspect that pomo is really just performance art.) Or it may just be that we can’t see our own daftnesses, if everyone around us is daft in the same way.
Nick,
“If there is an excess demand for bonds, will you actually be able to buy a bond? Nobody wants to sell.”
That is impossible in the bond markets, which always clear. I will write “IOU” on a piece of paper and sell it to you. No one can run out of IOUs like they run out of apples. In fact, just offer to buy a bond for a little more than the expected time path of future short rates, and you will be overwhelmed with arbitrageurs willing to create a new IOU just for you.
“There are two ways to get more money (medium of exchange): buy more money; sell less money.”
No, you can create more money on demand. Just borrow it from the bank, which will create it for you. This is just like the bond.
I don’t think it’s helpful to assume that financial operations, whether the acquisition or disposition of financial assets be assumed to move in some lockstep with real operations of consumption or investment. That would be as erroneous as assuming a fixed velocity of money, or some fixed reserve multiplier.
Under the gold/wheat/peanut/IOU standard there can never be a shortage of money. You can always get more money by selling gold/wheat/peanuts/IOUs to the bank. Recessions are caused by the price of gold/wheat/peanuts/IOUs being set too low.
Marxists have no power whatsoever in economics academia, or the Democratic party, so it’s not relevant. These freshwater economists with the ridiculous over-literal interpretations of models to reality have great power to control economics academia, and in the Republican party. It’s nowhere near equivalent on the other side.
Plus, there’s much more of an effort by the Saltwater/Democratic side to try to understand the reasoning and theory of the other side, and see if it can be useful, than vice-versa. There’s an attitude of pragmatism.
Your second story has all participants already holding money. They have a problem in that each would rather hold than spend, with the result that all are unemployed.
“Keynesian unemployment is an excess demand for the medium of exchange. It’s a coordination failure,…………….”
I am thinking that there must also be a lack-of-confidence factor here as well. Perhaps it is a ‘fear’ factor. Perhaps it is a ‘momentum’ factor. The common element would be the condition (or ‘attitude’) change between “confident expectation that $20 spent today will be replaced by $20 to be received tomorrow” and “apprehension of irreplaceable loss of the $20 I already have, perhaps due to inflation.”
Can government restore confidence with QE programs? The results of examples are not very favorable.
Me personally, I spend most of my five minutes per week of free time on one of the main models the freshwater cite for many of their claims, Wallace ’81. After a couple of years I think I really have it nailed (life’s achievement post, for me, forthcoming), and behind the opaque wall of math I see very much unmet requirements and assumptions such that its irrelevance proposition can very far from hold in the real world.
Richard: “Marxists have no power whatsoever in economics academia, or the Democratic party, so it’s not relevant.”
That is a very economics-centric, and also very US-centric, view of the world. Look outside the economics department in academia. And I’m not exactly sure what “cultural Marxism” is, and whether it really is Marxism, but I read enough US stuff to know there’s some weird stuff that gets believed in the Democratic party too, and that they are not very willing to look at the other side of some issues. Or even tolerant enough to let the other side speak. Many Democrats look to me like Blank Slate Creationists, for example. They are certainly not pragmatists. (Canada is no better.)
Nick, would it be correct in your view to say that tight money (or, excess demand for the medium of exchange) exerts upward pressure on prices of bonds and downward pressure on the prices of everything else?
I need to re-read this post of yours: http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/05/islm-money-interest-rates-and-luck.html
MR: tight money exerts downward pressure on the prices of most things. (But it might exert upward pressure on some goods, like inferior goods for example, the demand for which rises in a recession). With the price of nominal bonds (promises to pay future money), there are two effects: tight money today pushes the price of bonds down, and expected tight money tomorrow pushes the price of bonds up. Net effect can go either way.
Nick (in reply to Kevin):
“But business cycles don’t look like that.”
Seems to me they do: firms don’t hire because nobody’s buying; households don’t buy because nobody’s hiring. It’s convenient for the individual firms and households that they have other assets (money &c) to hold when they choose not to hire and buy. It’s also convenient for policymakers that they can juice the recovery by making those assets plentiful and hence relatively unattractive at the margin. But it’s not clear to me that the underlying problem is about money and wouldn’t also occur in a barter economy.
Andy: think about Cuba 199X. M/P was too high (and prices were fixed). Firms can’t hire because nobody’s selling labour. Nobody’s selling labour because nobody’s selling goods. Nobody’s selling goods because they can’t hire the labour to produce those goods.
It’s the exact mirror image of capitalist recessions. (And when I taught macro there I spent a lot of time talking about the Repressed Inflation region, where there is excess demand for both labour and goods.)
Richard H. Serlin: “Plus, there’s much more of an effort by the Saltwater/Democratic side to try to understand the reasoning and theory of the other side, and see if it can be useful, than vice-versa.”
Well, it seems to me that there is much more of an effort on the Republican side to try to understand the theory of the other side, because of the Inner Lawyer effect. You can see that clearly in opposition to climate science among conservatives, where opposition increases with education level. The educated opponent studies the reasoning of the other side intensely in order to come up with counter-arguments. OTOH, Palinesque rhetoric is easy for Democrats to dismiss.
@Roger Sparks:
Roger: I missed seeing your comment. But Majro gave a good answer.
“Under the gold/wheat/peanut/IOU standard there can never be a shortage of money. ”
OK, that is one way of looking at things. But, it’s always about nominal IOUs, as that is what firms use to determine when to invest and what households use for smoothing their consumption or purchasing durables. If you decide to target the current price of peanuts, then you end up making the interest rate tied to the transformation of peanuts, which is going to make economic management difficult. E.g. if there is a productivity shock that improves the peanut-own-rate via a shift to the MPP, then that corresponds to an interest rate hike and the economy goes into a recession. So since you are going to be responding to changing savings and investment demands anyways, you might as well use the interest rate directly as your target.
In the gold standard era, for example, the primary tool of maintaining the peg was interest rate policy, not quantity shifts in the buying and selling of gold. When nations wanted to attract more gold inflows, they raised rates.
Phones aren’t money in this case because the Burger guy wants the phone for its function as a phone- all people in the example are unemployed under either condition because they all get what they want and stop working, or can’t get what they want and stop working. This matters because when you replace phone guy with a CB the CB has no idea who to give the phone to. In the example each of the tattoo, burger and hairdresser (T, B, H) each have identical demand for a phone, but giving the phone to B leaves T and H unemployed. If the CB held an auction somehow B would also be the highest bidder since he wouldn’t incur the transaction costs that T and H do, as the phone is his end good. What looks like money in the early stages of exchange, looks like not money once it hits B’s hands.
We can stretch this example a little further. If the CB produces 1 phone and gives it to B the demand for money has been met just as much as if they had given it to T. With B’s desire for a phone met H no longer wants one, so T no longer wants one. As far as the CB knows they have produced exactly the right amount of money and all UE is voluntary.
We have seen real world examples of this recently. When banks hold cash as reserves for the sake of meeting requirements or as collateral then money stops flowing away from these institutions. Again, due to transaction costs, the banks that want the money the most are the ones that plan on doing nothing with it. Satisfying the liquidity demands of these institutions doesn’t add cash to circulation but “converts” it (for lack of a better term) into a phone in B’s hands. It is no longer a medium of exchange, but a good in its own right.