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In his part 5, Kling writes

This aggregate supply mechanism assumes that wages stay fixed while prices move.

so, yes, he is invoking a model where prices are flexible. Thus adjustment of real money balances is indeed taken for granted; the only nominal rigidity here is wages.

Were Kling simply summarizing one common type of model, this would be fine. But Kling says that he is introducing "the way economists use supply and demand", and I daresay that mainstream macro has moved a little beyond simply assuming rigid nominal wages and flexible prices for several decades now (since, atop Lucas Critique problems, real wages have proven to be non-countercyclical). Also, mainstream macro does consider general adjustment problems, in the context of sunspot equilibria and self-sustaining high and low output equilibria - these are often considered "Keynesian" because of the implied role for the state in nudging the economy toward the desirable equilibrium or otherwise lubricating adjustment. The unique element of PSST is in emphasizing the Austrian real calculative aspect.

Is that what Kling meant? I'm not so sure. I see his point as addressing the Philips Curve Keynesian. The one who saw the rate of equilibrium employment as a suitable target of a nominal instrument. In this sense, Kling seems quite lucid and correct. The market clearing quantity of labor is regulated by adjustments in the aggregate 'real wage'.

But Nick, isn't your argument here basically saying that all of the real wage, real interest rates and the supply of real balances have to be at the right level to equate AS and AD at their full output levels?

Nick wrote:

"Monetary disequilibrium theorists will disagree with those Keynesians. [...] It's the real stock of money M/P that must adjust to equilibrate AD and AS."

Yes in a sense, but it's the stock of money of workers that clears the labour market in this (still simplified) example.

And what is the money that workers have? In this simplified model it's predominantly the wages they get ...

Not the money banks are holding. Not the money corporations are holding. Not the money people have set aside for retirement or education.

[Note that even in not so simple models most of the input of money that workers get is via wages. Bonds and other investment sources is mostly the privilege of the rich - or, even if a worker owns some bonds or other instruments, it's set aside for 'future retirement' or 'college fund' purposes.]

That is why Keynesians simply call it 'wages' (and not 'the sum of money workers get as wages') and concentrate on real wages as the fundamental clearing dynamic - not on some money aggregate (which is way too coarse and opaque as a control mechanism).

You are right that in modern economies pretty much everything is accounted in money - thus many things can be expressed in monetary terms as well - most real actions in the real economy have a monetary transaction behind them, somewhere, somehow.

That does not mean that it's money aggregate disequilibrium itself that is the root of the dynamic and that it is money through which the market clears: it's the source and target of money transactions and the often subjective intention and context behind those transactions that moves and clears market(s).

[ continued as a reply to Nick. ]

For those disambiguated combinations of sources and targets of money we have convenient shortcuts: wages, prices of goods, bonds, exchange rates, trade balances, etc., and we measure them and see their relationships - without trying to couple them to the 'space of money' in a rigid way.

This does not mean that money is 'ignored' in Keynesian views: there are many important phenomena that are directly caused by behavior of various monetary bases - too much money printed, or too little money printed.

Money is just not the primary driving factor, because it's too opaque and because it does not explain important phenomena. A good economic theory utilizes fundamental driving forces that capture all important aspects of reality that the theory wants to model.

And note that even going to the very fine-grained view of money transactions (which goes way beyond what could still be called a theory based on supply/demand of money aggregates) does not cover everything: there are psychological states of connected groups of people that very much cause disequilibrium of markets, and those states can be persistent and can not be explained via money at all:

- 'Fear': market panics can be 90% psychological, still have long-lasting effects in the real economy.

- 'Zeitgeist' effects: for example, given the historic context, many people are now concentrated on deleveraging and are thus (unknowingly) driving debt deflation. The 'desire for savings' has become decoupled from any economic parameter that can be described with money: it is the still persisting fear of people from the end-of-world experience in 2008 (Do you still remember what you did on the day of the Lehman bankruptcy? I do!) that is still setting the mood - an irrational feeling further strengthened by unemployment.

- 'Bubbles of optimism': there are periods of time, when people, despite any economic parameter telling them to do so, feel irrationally optimistic about an asset. For example if due to a statistical fluke housing prices only happened to have risen in a country for 10 years or longer, then the likelihood of people taking 'house prices can only go up' and start thinking of real estate as some sort of storage of permanent value - easily driving the bubble for another decade.

These are all important, long-lasting human effects that can be measured via metrics of demand and supply, but which can not be explained via monetary disequilibrium at any granularity - let alone via disequilibrium of money aggregates (which is what monetarists concentrate on).

So why use an economic theory that beyond being too coarse is also totally blind to such very important phenomena? Why not use a theory that is fine-grained enough to explain the real world and can also measure and model irrational states of economies?

Hey, you forgot the EXCHANGE RATE!!!!! Why do economists insist on forgetting the external sector.

The US has a very low national savings rate, excessive savings are not the problem, the persistant large current account deficit is what drains purchasing power out of the country. This really is some sort of massive elephant in the room here.


what do you make of 'demand side' stories, such as told here at Stumbling and Mumbling, in which increasing the real wage at the cost of the mark-up would be helpful?


am I right in thinking then, that one of the ways a decline in W/P "clears" the labour market is that it reduces labour supply; in addition to firms being more willing to hire cheap workers, at a lower wage workers want to supply less labour.

is that really how (many) economists think? "what we need now is for W/P to fall, and our problems will be solved because the labour market will clear?" Because that doesn't seem like a very happy outcome to me - we have millions who cannot find work and are miserable, and the solution is to make work sufficiently less attractive that some of them, I don't know, go down to the bottom of the garden and eat worms, or 'reduce their labour supply' at least, until we can say the market has cleared. That seems like more misery to me, not less.

Here comses a mess.
With a multiple equllibria model, are all the equlilibria Pareto efficient? or is that true by definition, but is there a universal pareto efficiency, including alternate universes. I guess it would be a utilitarian trade off to get to the calculable optimal. sort of lkke the daylight savings hump. I;m looking at amodel to solve a value function in an RBC, you just guess and then iterate. towars the quilibrium. What i'm thinking is, what if every asynchronous participant in the price system, is just throuwing their best guess in, we are always in equilibrium heaing to equilibrium, and i just lost my point. The individuals best guesses will be wrong, so we will be out of euilibrium, but the price system as/ad, will ensure that what exists is equilibrium. still no point.

i mean if as=ad, then we are always pareto effecient.
the world is just, just not from an individuals perspective.

david: well noted. I agree.

Jon: I'm not sure either. But the statement that it's W/P which equilibrates the market for output is not, in general, right.

Adam P.: "But Nick, isn't your argument here basically saying that all of the real wage, real interest rates and the supply of real balances have to be at the right level to equate AS and AD at their full output levels?"

I would agree with that statement (generally), but it's not what I am saying here. Suppose e.g. that monopoly labour unions set W/P too high. Then employment will be too low, and output too low too. But that doesn't prevent AS=AD (the output market clearing).

You would (I am almost certain) agree with that. But you might disagree if I said that the same is true if r is set too high. I would say that if r is set too high then Y will (usually) be at the wrong level, but you can still get AS=AD if M/P adjusts. And I would *try* to resolve our (hypothetical) disagreement on this point by saying it depends *why* r is set too high. If it's set too high because the central bank is setting it too high, then we can't disentangle r being too high and M/P being too low. Which is why I talked about "pro-usury laws" instead.

White rabbit: "Yes in a sense, but it's the stock of money of workers that clears the labour market in this (still simplified) example.

And what is the money that workers have? In this simplified model it's predominantly the wages they get ... Not the money banks are holding. Not the money corporations are holding. Not the money people have set aside for retirement or education."

You are losing me at this point. Wages are a flow, and the stock of money is a stock. And there is nothing special about the flow of money income that is paid for labour; all flows of money income matter. And the money banks are holding is what most people and firms most of the time use as a medium of exchange (aside from currency), and the "money" people have set aside for retirement or education is mostly not money but stocks and bonds.

reason: yep. If I remember the exchange rate this will get even more complicated. But it will depend on why the exchange rate is set too high. If the real exchange rate is set too high it depends on how it is set too high. If it's a law, like minimum wage or pro-usury laws, there will be excess demand for forex, but the output market can still clear. If the central bank sets it too high, we cannot disentangle a high real exchange rate from a low M/P.

On the theme of Monetary disequilibrium .... if you think there is an excess demand for money and so people will be trying to sell more of everything than they buy of everything, what difference does it make if the reason you think this excess demand for money has arisen is a desire to deleverage, repay debts, call in loans, accumulate buffer savings etc.? [*]

You write: "It's the real stock of money M/P that must adjust to equilibrate AD and AS" ... at first I missed the word 'real' and was thinking that an increase in nominal money could ease deleveraging when debt is written as a nominal contract. But that left me thinking what would happen in world with real denominated debts, hit by a sudden desire to deleverage and everybody trying to sell more than they buy. Now I've read you more carefully, I'm left wondering how an increase in the real stock of money is achieved. What policy levers do you have in mind? I found myself thinking that output growth would do it, but you can't cure a lack of growth by prescribing growth.

[*] perhaps caused by a shock to expectations or realization of past errors.

Luis enrique: if you transfer wealth (or income) from those who have a high demand for money to those who have low demand, you might reduce the overall demand for money so it equals supply. But a much surer route would be to increase the supply of money. (Or reduce the overall demand by taxing money, via inflation).

Chris Dillow is thinking on different lines, because he's thinking keynesianism. So if you transfer income from those who have a high desire to save to those who have a low desire to save you can compensate for a real interest rate that is set too high.

"am I right in thinking then, that one of the ways a decline in W/P "clears" the labour market is that it reduces labour supply; in addition to firms being more willing to hire cheap workers, at a lower wage workers want to supply less labour."

You are exactly right in thinking that. If M/P is stuck too low, then AD will be less than AS, so firms can't sell output, so will reduce their (constrained) demand for labour. A fall in W/P will clear the labour market, but at a too low level of employment.

"is that really how (many) economists think? "what we need now is for W/P to fall, and our problems will be solved because the labour market will clear?" "

Some economists think like that because: either they think that M/P is right, and it's W/P that's wrong; or because they are confused, and don't understand the above. Yes. it's an unhappy outcome. But it doesn't create more misery, it just redistributes misery. (Actually, it will very slightly reduce total misery, but only because it ensures that those who get the fixed number of jobs are the ones most desperate to get them.)

edeast: "With a multiple equllibria model, are all the equlilibria Pareto efficient?"

Generally no. Generally some will be better than others. And it may be that none are efficient. There are some exceptions, like whether we drive on the right or left.

AS=AD is (usually) a necessary condition for efficiency, but certainly not sufficient. Lots of other things can go wrong, both at the micro and the macro level.


thanks very much, that's a great help.

[of course as Chris says: "It’s possible that capitalists might reduce investment in response to higher costs rather than increase it in response to higher expected demand"]


If I understood you correctly that you think that increasing M will increase W. If so then I still disagree with you: in Japan M was increased dramatically but W/P got worse. Also in the US M was increased dramatically as well, still unemployment is high.

If you say that "if money to workers is increased then that clears the labour market" then that's a truism - it's practically equivalent to increasing wages.

The keynesian point is that changes in the money supply do not automatically 'flow' into all categories of money. Money can stay stuck at banks. It can stay stuck in corp accounts. It can stay stuck in rich people's accounts. If you want to change demand you need to give money so that it increases (real) wages.

At that point we might as well call that regulatory process "increasing wages" (increasing W/P), and stop calling it "increasing the monetary base" (M/P), right?

I.e. go for the control parameter that most directly describes and impacts the clearing mechanism - not some substitute that is correlated and may or may not have such an effect.

Do we still disagree? :-)

White Rabbit: we are on such a totally different wavelength that we cannot even be said to disagree. For example, what you call real wages is totally different to what I call real wages. I am talking about a relative price: apples per worker-year. You are talking about real wage income: total value of monetary wages measured in number of apples paid to all workers per year. We are not even using the same units.

Let N be employment (workersxhours per year). Let W be the wage ($ per hour). Let P be the price of apples ($ per apple).

The real wage means W/P. That's what Arnold and me mean. When you hear "real wage" you think we are talking about NW/P.

Simpler version, assuming all employed workers work the same fixed number of hours, so all changes in employment are changes in the number of workers employed: W/P is wage income per employed worker per unit of time. NW/P is wage income *for all employed workers* per unit of time.

Nick, Here's my take:

1. Money supply and demand equilibrium determines the position of the AD curve, and explain its shifts.
2. When it shifts, the price level moves to equilibrate AD and SRAS.
3. In the long run W/P adjust to equilibrate AD and LRAS./

You can get a more new Keynesian version (sticky prices) if you abandon the price level and RGDP, and use NGDP on the vertical axis and hours worked on the horizontal axis. The LRAS is a vertical line at the natural rate of hours. The AD curve is a horizontal line, reflecting changes in the supply and demand for money, (actually the supply of money and the Cambridge k). And the SRAS is upward sloping as usual. No need to worry about short run price rigidity, as NGDP is not rigid in the short run. Real wages still adjust to provide equilibrium, but are now defined as nominal wages divided by NGDP/person. This sort of model may have been what Keynes had in mind in the Treatise (income inflation (more wages) vs profit inflation (more NGDP for a given wage rate.))


Great post. My take on Kling, like usual, was more negative. Kling still doesn't get anything about monetary disequilibrium?


You need to be more explicit. Try this: I believe that goods prices are so flexible that we can treat them as perfectly flexible. Money wages, on the other hand, are sticky. They only adjust very gradually.

Put that together, and the only reason why prices in general, including both product and reasource prices, don't adjust enough to keep the real quantity of money equal to the demand to hold it, is that one very important resource price, wages, doesn't adjust, and so an important element of costs are slow to adjust, so product prices don't adjust enough.

I think there is a certain realism to this, but it misses the fundamental nature of the problem.


Note that there are other prices beyond wages that are inflexible/sticky: the price levels set in long-term contracts (often set by monopolies).

Inflexibility comes from how willing or able an entity is to (efficiently) change prices.

Wage reduction is not hard just due to unwillingness, but because it is the smallest economic actor that has to adjust: the individual family. On that level it's highly inefficient to adjust "prices": every family has to adjust the balance of bills, mortgage payments and a dozen small details - all manually. It's inefficient, they are not used to doing it, there's no technology to do it - so they will 'resist' - on an entirely rational basis.

The larger an economic actor is, the easier it is for that actor to "change the price level": for a large corporation there's a highly automated process for letting resource price changes trickle down, etc. etc. The "largest" economic actor, the individual country will generally adjust its "price level" in a fully automated manner: via the floating foreign exchange rate.

In that sense it is all too natural to expect price flexibility from those actors who can do it most efficiently (large entities) - versus actors who cannot do it efficiently (workers).

Scott: I agree with Bill here. If you assume P is perfectly flexible, then M/P can adjust to clear the output market, but then if W is sticky, you can't have both W/P and M/P adjust unless the central bank adjusts M to get the right M/W.

On your second point, if the central bank targets NGDP, then the AD curve is horizontal in {NGDP,N} space. And the LRAS is vertical. And if W is sticky, the SRAS slopes up. But if P is sticky, there's a SRAD curve too, and it's downward-sloping. (I think; not used to thinking in that space).

Bill: thanks! I'm gearing up to do a follow-up, focussing more on those who assert that r is what equilibrates AD and AS. The Pro Usury People's Party takes power.

Nick, now I'm confused about how you are defining money.

The non-financial sector holds currency, bank deposits, and other assets which you may or may not call money. Let's just focus on currency and deposits.

Banks hold all sorts of junk, of which a small portion is vault cash and reserves. But the non-financial sector does not care what banks *hold*, it cares what banks *owe* -- it cares about the liability side of bank balance sheets, not the asset side. Primarily deposits which are liabilites of banks is what is money to the non-financial sector, as currency is fairly constant.

The money market rates adjust so that banks are indifferent as to holding money or not holding money. The only exception to that is when rates are zero, in which case banks have too much money and can't get rid of it, even if they lend it out at zero rates.

Therefore the central bank cannot increase or decrease the quantity of "money" that the non-financial sector holds. What it can do, is adjust the money market rates to whatever level it wants. By doing this, reserves will be a little lower or a little higher. Therefore the central bank adjusts what banks hold, which is not money to the non-financial sector.

Let me repeat, as far as the non-financial sector is concerned, the central bank is not increasing or decreasing the money supply. It is only changing the money market rates. In some cases, the reduced money market rates can affect the economy by encouraging or discouraging more lending and borrowing, which *might*, in some other cases, result in more or less deposit creation. But all of those side-effects are indirect, and they all operate *solely* through the channel of interest rates, and *never* through any "quantity" channel.

Now I wonder, are you aware of all this and disagree? Do you believe that what banks *hold* is money to the non-financial sector?

RSJ: I was too quick to talk about what the banks "hold". I meant the liability side, not the asset side.

I disagree with the rest of what you say. You express the "modern" view that the stock of money is demand-determined. It's the majority "horizontalist" Neo-Wicksellian/New Keynesian view that every central banker believes and every good NK prof teaches. Which is why they sh*t themselves and gave up when nominal interest rates hit 0%. I disagree with it. Yeager showed what's wrong with it. So did Laidler. But I'm not going there here and now. Bill may have the energy to take you up on it. I don't.


The general argument I made about money aggregates not being directly coupled to wages does not depend on the normalization of prices and income - so we can use your units to make those arguments.

What I said was a variant of what RSJ claimed: how can you claim that "real stock of money M/P that must adjust to equilibrate AD and AS" if M/P very clearly has no necessary causal relationship with wage income?

Yes, for certain configurations of AD/AS curves the central bank can influence, as a side-effect, wages and thus AD, via the monetary base and thus via M/P. In many other cases - as RSJ has pointed it out as well, it cannot.

Hence the "natural way" to talk about controlling AD is not M/P but W/P.

The policy implications are very clear and material: instead of trying to target M/P, W/P has to be targeted.

For example, Japan's efforts to drastically increase the monetary base between 1999 and 2003 to get the Japanese economy out of deflation were unsuccessful, and I submit that it was largely because the central bank did not control W/P directly.

Do you accept this as a strong supporting argument for the notion that Arnold Kling expressed, that the right "parameter space" to think about is W/P and not M/P?

Things look quite a bit different if we begin from the premise that Keynes was a crank. I don't mean that in any pejorative sense -- quite the contrary. Keynes proudly affirmed his 'crank' status: "I range myself with the heretics" (who he described as "the descendants of a long line of heretics who, overwhelmed but never extinguished, have survived as isolated groups of cranks").

The consequences of starting from a 'crank' position are not at all the same as "adding financial assets to the mix" of an essentially barter economy. In Keynes's view, the "self-adjusting school" has no theory of the rate of interest. They just assume an automatically adjusting rate. So, besides adding financial assets to the mix, Keynes would add a monetary authority that will adjust rates to compensate for the inevitable discrepancy between factor incomes and factor shares of output.

But that is not all. There are three ways to skin this cat, not just one. Adjusting the interest rate is one of them, but only providing there is "further capital construction worth doing." How would we know? "When the rate of interest has fallen to a very low figure and has remained there sufficiently long to show that there is no further capital construction worth doing even at that low rate, then I should agree that the facts point to the necessity of drastic social changes directed towards increasing consumption."

So that's two out of the three potential applications of Keynes's intellectual theorem: 1. encourage investment by lowering interest rates; 2. facilitate increased consumption through "drastic social changes", which is to say income redistribution. What is number three?

"The full employment policy by means of investment," Keynes explained in a letter to T.S. Eliot, "is only one particular application of an intellectual theorem. You can produce the result just as well by consuming more or working less."

Keynes was a crank.

White Rabbit, Sumner argues that Japanese monetary authorities are (successfully) targeting a zero inflation rate. The "theory that the stock of money is demand-determined" has been quite comprehensively disproven by Dr. Gideon Gono, Governor of the Reserve Bank of Zimbabwe, who was awarded the Ig Nobel Prize in Mathematics[1] for his work in monetary policy.

[1] We can only assume that Gono was a front-runner for the Prize in Economics as well; nevertheless, that Prize was awarded "the directors, executives, and auditors of four Icelandic banks" instead.


See this Krugman article countering Scott Sumner's arguments about Japan.

Krugman writes:

[Sumner] guesses right: that’s not at all the view of those who have been following Japanese monetary policy since the 1990s, and have even talked to BOJ people now and then. I’m sorry to say that the fact is that Japan is in a deflationary trap. You can argue that the BOJ should have done more — and I would. But persistent deflation isn’t a target, it’s what has happened because conventional monetary policy has lost traction and the BOJ isn’t willing to be more adventurous.

Nick, I wasn't articulating a theory of what determines the level of deposits -- e.g. demand determined or not.

I'm not even sure what that theory would be unless additional information was provided, as the suppliers of deposits are banks, and the demand for deposits is from non-banks -- creditors of the banks. Obviously a combination of many factors will determine how much of bank liabilities are offered as deposits to customers and how much of their liabilities must be financed with other forms of debt or equity. Many things go into that determination.

I was just pointing out a hole in your theory by describing how things work. The central bank doesn't increase or decrease the number of deposits, not directly anyways.

It increases or decreases bank reserves -- what banks hold, as you pointed out. That's why Bernanke said several times, in congressional testimony as well as in his public engagements, that the Fed is not "printing money" with QE, or even increasing the amount of deposits or currency, it is merely increasing reserves held by the banking system.

This isn't a theory, it's just a description of how things work.

From there, you need some theory describing how change on the asset side of bank balance sheets corresponds to a change in the liabilites.

The old standby being the reserve multiplier theory, which has been disproven by many.

But if you can't rely on this reserve multiplier, then what *are* you relying on?

That's the hole.

You care about money held by non-banks, i.e. deposits, so that the non-bank sector meets whatever M/P is in its utility function. You don't care about M/P for banks, since they don't have utility.

So what mechanism bridges the gap, allowing non-bank M/P to go up when the central bank increases bank reserves?

This is an open question, and I'm wondering if you have an answer to plug the hole.

Does the linked "theory/model" fit your expectations.


Select "More Decisions", scroll down, try a temporary change in the money supply of say -10%, starting in year 4 for 1 year. Hit Simulate and see if the output makes sense. Try -50%.

Nick, More and more I think there is no AS/Ad model, that everyone has their own model. Each of us seems to be speaking a different language.

1. I wasn't assuming prices are completely flexible.
2. I wasn't assuming the Fed targets NGDP, I was simply defining AD as NGDP. You could have NGDP be a random walk, as under a gold standard.

I don't understand your argument about M/P and W/P adjusting. If you assume P is completely flexible (which I don't), then M/P adjusts by P immediately moving to the new equilibrium (but not the natural rate of output, as W is slow to adjust.) In contrast, W/P adjusts by W adjusting with a long lag, again to bring output to the natural rate. What is the problem?

Maybe I've been teaching AS/AD the wrong way. I assumed that when AD shifted, the price level immediately moved to where the new AD intersects SRAS. Is that wrong? If it is, then what is the SRAS curve supposed to show us? And then in the long run I assume that the price level rises even more, as SRAS shifts left. None of this assumes all prices are flexible.

White Rabbit, You should try to dig up The Economist's comment on the debate between Krugman and I on Japan. I think it was Ryan Avent who commented that the evidence Krugman presented actually proved my point, not his.

Scott: "Nick, More and more I think there is no AS/Ad model, that everyone has their own model. Each of us seems to be speaking a different language."

I'm beginning to think that too! I clearly haven't been understanding your use of it very well.

Part of the problem is that the SRAS curve is not always an SRAS curve! We call it a "supply" curve, but it isn't. Put it another way: there's an SRAS curve which tells us how much output firms want to sell, and there's an SRAS* curve which tells us which point on the AD curve we will be at.

With perfectly flexible prices, the two SRAS curves will be the same. If W is fixed, and P is fixed, SRAS will be upward-sloping, but SRAS* will be horizontal, until it hits SRAS, and then it stops dead, and ends at that point.

(And the AD curve isn't a demand curve either, for that matter.)

White Rabbit: when Arnold talks about W/P equilibrating AD and AS, he is definitely not talking about any wage income mechanism. He is talking about equilibrating the marginal product of labour and the marginal rate of substitution of consumption and leisure. He is talking relative prices, you are talking about a subset of the flow of income. You are giving a very Kaleckian interpretation of Arnold. Which is about the farthest thing possible from Arnold's perspective.

RSJ: When I say: "But I'm not going there here and now. Bill may have the energy to take you up on it. I don't.", and you reply with 03:12, it's a bit of a troll.


The way I read RSJ's reply was that he responded to your short reply (which, despite being brief, was showing that you still misunderstood RSJ's concerns on a fundamental level) and very clearly and politely articulated the hole/gap he is seeing in your theory.

The one he articulated is an open question, and I am too wondering if you have an answer to plug the hole. (The new article about the Keynesian Cross does not address it AFAICS.)


White rabbit: about a year or two back I had several long arguments with a bunch of MMTers and accountants about whether money is demand-determined or supply-determined. It was not very productive. This post is not about that. It's about how we interpret AD and AS. If I say I don't want to argue about that here, and then RSJ makes comments about "holes" in my theory, and about "This isn't a theory, it's just a description of how things work." and "The old standby being the reserve multiplier theory, which has been disproven by many." trying to provoke an argument, so I either have to let his assertions go unchallenged or join in the argument I want to avoid, that is a troll. I'm not very pissed off, but I am a little.

Scott Sumner:

Did you mean this Ryan Avent article, as a reply to Krugman's points about Japan's liquidity trap?

The gist of it appears to be this paragraph:

I am increasingly convinced that it is the commitment of a central bank to continue stimulating that is important, rather than the room that central banker has to cut rates. The determined central banker doesn't blink at 0%, he or she simply switches policy tools. And if this is right, then perpetuation of zero lower bound idea simply provides cover to central bankers who aren't willing to continue easing. That's a decision which should be justified on policy grounds, not chalked up to some imagined constraint.

Krugman never replied to this article and I kind of suspect why, as the article does not address Krugman's key arguments:

1) that Japan is in a liquidity trap

2) that the BOJ, after a massive intervention that almost doubled the monetary base, chickened out from more quantitative easing, after 5 years of not being able to climb out of the liquidity trap.

3) a substantial portion of the excess QE liquidity still appears to be present and stuck in Japanese commercial banks. A rate hike and "back to normalcy" is farther than ever.

Your argument seems to be: "do not chicken out, try harder, you still have plenty of options!" but if the massive effort the BOJ has done was not enough, if you see the kind of utter, mad criticism Bernanke gets for a comparatively much smaller QE effort, can you blame central bankers for saying that "quantitative easing is hard, getting out of the liquidity trap is hard"?

You should also consider that central bankers, for most cases, are 'cautious' people who do not desire the risks and policy implications of unconventional QE at all. In that position being cautious is a virtue not a vice. They like to cut rates and increase rates, and the moment they have to print trillions of dollars the idea makes them deeply uncomfortable. Witness the very visible division within the FOMC!

So your suggestion that the BOJ exiting unconventional QE was a "choice" and that they "liked the results" (I hope I do not misrepresent your point) is akin to a climber giving up half up the highest mountain he has ever climbed, 'out of free choice'. Your argument appears to be: you can make it to the summit, keep climbing, and use different tools!

Well, easier said than done!

You should also note that Krugman, being one of the earliest economists who realized that Japan's deflation is a dangerous condition, actually talked to BOJ officials several times during these years, so he is not merely speculating about their mind-set when he says that they were unhappy about and frustrated with the situation.

To counter him on that point you'd have to 1) claim that Krugman misunderstood (or misrepresented) the BOJ mindset 2) quote BOJ officials contradicting Krugman's points, claiming that deflation and a strong Jen is actually good and they like the end result and want more of it.

Please subtract the default Japanese cultural preference for over-optimism about characterising outcomes :-)

Oh God. This is wandering way off-topic again.

Scott gets to reply to that if he wants. But no more on this from WR.

White rabbit: Here's Avent:

Back in the present, Mr Krugman draws this conclusion:

"In the face of deflation, central bankers are remarkably creative at finding reasons to tighten. That doesn’t mean that they actually prefer deflation."

And...I'm genuinely mystified. The only thing I can think of that would square this circle is if Mr Krugman and I are using different definitions of the word "prefer". As best I can tell, he has conclusively shown that Mr Sumner is right, and Japan hasn't been in a deflationary trap. It just needs to fire all of its central bankers.

QED (That's me, not Avent)

Here's the link:


This can't be right. When demands change, relative demands change, and relative prices change, and relative supplies change.

I.e. people will be trying to sell more of some things, and less of others.

And they will be trying to buy more of some things and less of some other things.

As a result, the demand for output does not equate to a demand for labor -- among many other non-identities.

Nick writes:

"people will be trying to sell more of everything than they buy of everything."

When Nick Rowe writes that we can take M/P for granted in the long run, but just not in the short run, I am reminded of prisoner's dilemma games with a finite (but long) time horizon, vs. games with an uncertain timeline. Cooperative equilibrium unravels because I know that 5,000 years from now, you will defect, but if you throw in a 2% chance the earth ends every morning, then I can cooperate.

Instead of doing backward propagation, just flip it and do forward propagation of short term solutions. At any given time, I believe that inflation is imminent... Just not tomorrow. And tomorrow, I believe it's imminent, etc.

But that would never happen, right?

Which is why we have near-zero short term rates, disinflation, and a still-steep yield curve. Because on any given day, everyone is certain that we'll have hyperinflation eventually, just not tomorrow.

I wrote my comment at 3 am preparing a presentation for a computer modelling class. Thanks for answering it. It should be read in a stoner type voice. It was something profound and fuddled, neurons very slow. I was trying to come to terms with walrasian general equilibrium theory. Thinking we could never be out of equilibrium by definition, of as=ad. You cover it pretty well here. And now in you recent post you mention clower again. Boy do I regret rubber-necking here a few years ago. And the presentation was a glorious disaster. Surveyed general equilibrium macro models, from walras to dsge. Knew I was screwed when I displayed a graph of Ad with three As curves. But it was a lot of fun. The paper was implementing a rbc model on the CUDA framework.

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