Arnold Kling has a good "rant against monetarism", triggered by my saying "My position is that a general glut can *only* be caused by an excess demand for the medium of exchange."
"Most economists believe this, or something like it. I used to believe it, or something like it. I think that it is a horrible, horrible, confusion."
(I only wish he were right about the first bit, because I can find very few economists who believe it, and I've been trying hard to get them to believe it.)
Let's start with where I agree with Arnold.
"If you took money out of the picture, the construction worker and the college student would still be unable to solve their problem. When it comes to the failure of wants to coincide, the existence of money is part of the solution, not part of the problem."
Bingo! Yes, absolutely. It is hard to solve the economic calculation problem, of who should produce what, with whom, and how, and who should consume what. And without monetary exchange, solving that problem would be much, much, harder. Monetary exchange is part of the solution, not part of the problem.
With monetary exchange, I can concentrate on deciding what to produce, and on what to consume. I don't have to concentrate also on the chain of barter transactions that might eventually lead me from what I produce to what I consume, which depends on all the other things that all the other people might want to produce and consume. That's why we have a monetary exchange economy.
But it is precisely because money is part of the solution, and a very important part of the solution to a very real problem, that when something goes wrong with money, the solution falls apart. If it really were as easy to solve the economic problem with barter as with monetary exchange, it wouldn't matter if something went wrong with money. We would just resort to barter.
If barter were nearly as easy as money, then an excess demand for the medium of exchange would not cause a recession. People would just switch to barter, and the economy would carry on as normal, with a slight increase in transactions costs.
And I also agree with Arnold here:
"Perhaps my rant should be directed against Walras' Law, which says that excess supply somewhere implies excess demand somewhere else. Who the heck enforces Walras' Law? Nobody. Entrepreneurs are trying to figure out how to make a profit. Their aggregate groping is what discovers a viable pattern of comparative advantage and specialization."
Yep. Walras' Law is false. Yes, I know we learn it in micro, and it seems to drop straight out of the budget constraints, when you add them all up. But it's false, horribly false. And it's false because, as Arnold says, there's nobody to enforce it. More precisely, if there were a centralised Walrasian auctioneer, trading every good for every good in one big market, and not allowing trade to begin until he had found the market-clearing vector of prices, then Walras' Law would be true. But there isn't, so it's false.
That Walras' Law doesn't work in a monetary exchange economy is obvious, once we start to count up how many excess demands and supplies there are. Let there be n goods, including money. Walras' Law says that the sum of the values of the n excess demands must equal zero, for any price vector. Rubbish. In a monetary exchange economy, with n goods including money, there are n-1 markets. And in each market two goods are traded: money; and one of the other goods. So there are n-1 excess demands for the non-money goods, and n-1 excess demands for money. That makes 2(n-1) excess demands in total, not the n excess demands in Walras' Law. And each of those n-1 excess demands for money is chosen to maximise utility subject to the quantity constraints in the other n-2 markets. So they aren't even mutually consistent. If you actually succeeded in buying or selling what you wanted in one market, you would want to do something different in all the other markets.
Setting n=2(n-1), we solve for n=2. Yep. Walras' Law would work fine in a monetary exchange economy with 2 goods, one of which was money. But who the hell would need money if there were only one other good? If there are only 2 goods, apples and bananas, how could we even tell whether apples were used as money, or bananas were used as money? If n=3, and we saw carrots exchange for apples, and carrots exchange for bananas, but we never saw apples exchange for bananas, then we would know that carrots are used as money. But n=3 means n is not equal to 2(n-1). So Walras' Law is nonsense in a monetary exchange economy. It's not even false; it's nonsense.
Forget Walras' Law. What about re-calculation?
The calculation problem doesn't solve itself. It takes people to solve it. The price system helps them solve it. Monetary exchange helps them solve it. But it isn't easy to solve. And it never really does get solved, because there's always the chance another entrepreeur could come along and solve it better. And if technology, resources, and preferences are changing as well, people have to keep re-solving it. That's what I take to be the re-calculation problem.
But that re-calculation is happening all the time. What's it got to do with recessions?
Sure, sometimes a really big real shock comes along, like the rise in oil prices in the 1970's, or a war, and it takes a lot more re-calculation than it normally does. And OK, a financial crisis isn't exactly like a change in the underlying tastes, technology, and resources of Walrasian general equilibrium theory. But you don't have to try hard to convince me that it too would require a re-calculation. And maybe output would fall while we are trying to figure out how to re-solve the economic problem. Maybe even employment would fall too. "Hang on guys, don't commit to doing anything quite yet, while I try and figure out where you should best be working now that everythings changed". I'm sure every central planner or local manager has had to say that at some time or another.
[Added for clarity: this is the point at which I start disagreeing with Arnold.]
But I just can't buy it as a full story of recessions. It's the general glut thing that's missing. Stuff gets easier to buy in a recession, and stuff gets harder to sell. That's an essential part of what makes it a recession. To say that stuff is harder to sell and easier to buy is meaningless outside a monetary exchange economy. In a barter economy, selling stuff is buying stuff. When you are trying to sell you are trying to buy at the very same time. A thing can't be harder or easier than itself.
What makes a recession a recession, and something more than a bad harvest, or a re-calculation, is that most goods, and most labour, gets harder to sell and easier to buy. And I really want to call that an excess demand for money. Because it is money we are selling stuff for, and it is money we are buying stuff with. And if I've also got a theory as well, which says that an excess demand for money will cause a drop in output and employment, and an excess supply of goods and labour, that's just icing on the cake.
This probably won't convince Arnold. But it's why I believe that general gluts -- recessions -- are always and everywhere a monetary phenomenon.