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So don't ask where the demand will come from. It comes from itself. And from an excess supply of money.

Indeed it's recursive and there's either boom (self-strengthening growth) or bust (self-strengthening contraction) - neither process is self-stabilizing.

And this really comes from money: it's either too valuable (causing contraction) or too cheap (causing growth). The magic equilibrium value is not stable either because it's an unstable saddle point, not a stable minimum/maximum.

But I'm not sure a barter economy would be off much better: lets assume that barter price discovery is cheap and automatic (a big if) and that there's no money, only relative value of goods.

Inevitably, in a large, complex economy there would be 'super goods' - ones which are physically so important, so central, so widespread that they'd act as money substitutes. Oil, iron and maybe even perishables that can be stored long enough, such as sugar - but also perhaps some services like transportation or software.

These 'super goods' would take over the role of money, and if they become too valuable or too cheap, compared to other goods, they would contract or grow economies. Producers of these goods would in essence become central bankers of the world - but with no electability and no responsibility. These goods would become imperfect money equivalents.

I think the boom/bust cycles of medieval societies was often driven by supply/demand fluctuations of such 'super goods'. Eventually 'gold' gradually took over the role of 'super goods' and its inflexible supply was just as bad when it came to stability of economic cycles. It was also a massive source of inequality: existing, inherited stocks of gold were disproportionately 'rewarded' by being worth more and more of the real economy, as economies and populations grew both in numbers and in interconnections/sophistication.

So are you sure that barter is a better model that is more recession-proof? I think, applied to big economies, that it's the opposite.

Money is in an abstract sense all goods mixed together - so it's a 'super good' as well, a generic "buffer" of goods, but instead of monopoly producers it's controlled by central bankers (and fiscal authorities) who determine whether to tighten or ease (conventionally or non-conventionally).

Does this make sense? :-)

"It is money, and only money, that makes Say's Law false."
True. Funnily, no money doesn't make Say true but merely a tautology (an accounting identity). The reverse of some truths are not necessarily false and conversely.

"Macroeconomics is ultimately about closed systems. (Sorry guys, but open-economy macroeconomics, and especially small open economy macroeconomics, isn't really macroeconomics.)"
For argument's sake, maybe. But it's definitely not micro. Especially if you leave in the witches's brew, money.
Your point is almost as interesting (in the chinese curse sense) as postings from the Institut Économique de Montréal in Le Journal de Montréal insisting that there are no and never was any recession or that there is no fiscal problems in Texas because of their right-to-work law(their deficit is almost $ 25 billions).
But it's a good wake-the-students-at-8am poke.
Do you consider it macro if there is no wage employment, only self-employment? Is wage-stickiness just complicating your notion of macro or is it a determining factor?

Or maybe should we use the Great Recession as an opportunity to create a third branch, as we created the second during the Great Depression?

Anyway, "very nearly" doesn't cut it.If the bullet "Very nearly misses you" but is in your brain, you are not "very nearly " alive, As soon as you introduce money, Say disappear totaly. In the same way that departing from full-employment of a resource drops its shadow price to zero. No intermediate stage. (Unless you introduce stickiness and the fun really begins).

I don't want to press you on the research program you announced this afternoon but in small open non-macro economies, can the poors use public parks?

It seems to me that you are jumping back and forth between ex-post and ex-ante when talking about aggregate demand and aggregate supply.

Here is what I mean:

Suppose our economy contains two goods: grapes and grape-juice. Grapes are both consumed and they are also intermediate inputs, depending on the intention (and identity) of the buyer.

Let's say that the market structure looks like this: Grapes are sold in the morning. Some of the buyers are grape juice vendors, who spend the day converting the grapes into grape juice, which they sell in the evening.

Workers buy grapes to eat during the day (before they go to work) and they buy grape juice to drink on the way home from work. The grape vendors need to hire labor the day before to pick grapes (so that they have their inventory to sell in the morning), and the grape juice vendors hire labor the same day they buy their intermediate inputs. Both vendors need some estimate of what demand for their product will be.

Labor is hired in the morning and paid at the end of every day.

All goods, as well as labor, are sold via an auction each day (grapes and labor being sold in the morning, and grape juice being sold in the evening).

The exception is money. Anyone can borrow money from the central bank in the morning, and repay (or roll-over) the debt the next morning. As much money is created as borrowers want, but they must all pay the policy rate. The central bank is free to increase or decrease this rate any morning. Anyone with excess money can deposit it in the central bank and also receive the policy rate.

OK, for each individual auction, we can talk about supply and demand curves, and we can also talk about the demand curve for borrowing and lending, but each of these curves will be a function of the other curves. The demand curve in the morning grape auction will be a function of the supply curve in the evening auction, etc.

Given this market structure -- e.g. no "meta-time Walrassian auctioneer" -- how do you dis-entangle that and define a demand curve for final output, or a supply curve for final output? In the morning, the demand curves are for grapes, and you don't know whether a grape is final output or not.

Given this economy -- which is a monetary economy in which no one has a cash-in-advance constraint -- an expectations failure can cause a recession, and excessively high interest rates can also cause a recession, and excessive borrowing from the central bank can also cause a recession. All these things can cause a recession, and none of them have anything to do with an excess demand for money.

"If, in aggregate, we wish to hold more money than we currently hold, we will plan to spend less than our income."

But, Nick, I don't think it is a matter of wishing to hold more (or less) money.

Money is created through credit. Debt must be paid back with interest. The only way principal + interest can be paid back is through the creation of more money through credit. Thus the circulation of commodities is driven not only by demand for the commodities themselves but also (and at times mainly) by demand for money to retire debt. Banks are rather stringent about accepting payment in kind.

There is no conceivable reason to expect the demand for commodities and the 'desire' for money to be perfectly synchronized at all times. On the contrary, there is every reason on earth to expect them to vary at different rates -- one of them being governed by human appetites and the other ruled by an exponential function.

Didn't any of those "older Keynesians" -- Maynard, perhaps -- point that out somewhere?

Or, I suppose one could substitute "animal spirits" for human appetites...

Actually Nick you are somewhere between Say, Marx, Keynes and apologia. Why did Keynes think capitalism tended toward an underemployment equilibrium? Why did he think the state needed to step in to move the economy to a full employment equilibrium? And why did he say that then and only then you could have your beloved Say back?

Nick’s last sentence says that demand comes from, amongst other things, an excess supply of money.

Amazing! The average lottery winner has worked that out. How come academic economists need 50 trillion incomprehensible words to come to the same conclusion? Are academics more interested in keeping themselves employed than in solving economic problems? :)

So if part of demand comes from "an excess of money", have you pretty much written a Rule that the money supply must always grow? Because if you did, it might be helpful to write it down for central bankers everywhere; give them one less section on the dartboard when they're coming up with policy.

Good post whith which I agree in a 98%. I disagree with the sentence:
"Macroeconomics is ultimately about closed systems. (Sorry guys, but open-economy macroeconomics, and especially small open economy macroeconomics, isn't really macroeconomics.)"
Really? I suppose that a huge increase of a commodity (f.i., oil) that come from the rest of the world, and destabilizes the external sector and internal relative prices, has to be imbodied in the macro model, Because the condition to MP has changed a lot.

Very good. You left off an important factor. Distribution of money. If the money is being hoarded by people with no unmet demand and there is no transfer mechanism to people who do have unmet demand, demand will not increase if the increase in money goes to those with zero unmet demand (infinite appetite for money).

Unemployment makes the transfer more difficult, because those with the most unmet demand are typically the unemployed. Fixing demand requires transferring money from the wealthy hoarders (either through tax and spend or by printing more) into goods and services for those with the most unmet demand. Our wealthy elites have been fighting a class war against more equal distribution (and winning) for decades. Our wealthy elites are successfully fighting a major wealth transfer in order to increase demand. Therefore our economy suffers.

“Macroeconomics is ultimately about closed systems... there is no outside.”

Excellent, Nick – there is no outside.

Accounting is also about closed systems.

Double entry ensures closure - there is no outside.

Getting closer!

I like the answer to "where does the demand come from?" In particular, there is no need to create an excess supply of money equal to the nominal value of the output gap.

However, most of your argument seems to be that we need to just create an infintesimally small excess supply of money, then growing real and nominal income will generate growing real and nominal demand.


But I would think of this as velocity. An small excess supply of money creates a multiple impact on demand and output and that multiple is called velocity. Those who receive the money spend it too.

So, the change in the nominal output gap divided by what velocity will be determines the size of the change in the quantity of money needed.

If the demand for money was independent of income, then changes in income would not lead to excess demands or supplies of money at a given quantity of money.

If, on the other hand, lower demand for goods results in lower income (perhaps heading down to zero,) and this lowers the demand to hold money, then a given quantity of money leads to an excess demand for money. This reverses the process.

Similarly, if we imagine some increase in expediture that would head the demand for products and income up to potential income, then the demand for money rises. If the quantity of money doesn't change, there is an excess demand for money which brings the process to a halt.

Getting the quantity of money at the level the demand for money would be if nominal income were on target is the key. (Well, you can say that if the price level is on target and real income is equal to capacity, an the market interest rate is equal to the natural interest rate, if you like.)

However, even with all of these caveates, your post does emphasize an important truth. The newly employed workers will be using the income they earn to buy the products they produce.


That interest must be paid on loans provides next to no contraint on the operation of a monetary order where money is created by lending. Fundamentally, you are ignoring the person who receives the interest. But really, you are worrying about puzzles that are generated if you tried to wind up the monetary order.

A credit money system is consistent with a contant quantity of money, a shrinking quantity of money, or a growing quantity of money. There is no relationship between the interest rate and what happens to the quantity of money. Only if you wind the system up, then the quantity of money can't fall more than (1-r) in a period. So, if the interest rate were 5% per year, then a more than 95% decrease in the quantity of money would result in there being too little money for debtors to pay creditors. Of course, unless there were some alternative monetary system being insituted, that inability for debtors to pay the interest on the loans that matched the money would be the least of our problems. With an alternative monetary order being instituted, that money can be used to pay off any debts involved in winding down the old system.

You do realize that this theory about interest requiring new money or else forcing debtors to default is a fascist theory that blames everything on the money lenders. And usually, the focus is on money lenders of a particular ethnic background.

Think instead about the system operating continuously rather than winding up. Be mindful that interest is received by someone. All loans are not made at once for the same period so every loan doesn't have to be paid off at the same instant. Also, keep in mind that most money bears interest. Put all that together and you will start to see why no one (including Keynes) worries about inside money having to grow to cover interest on the loans matching the money.

Bill: you have got it. I just wanted to remain silent on how the demand for money and the supply of money would be changing in response to the increased income created by the initial excess supply of money. A lot of things will be changing as income increases, and I don't want us to restrict attention to the income elasticity of the demand for money. It's even possible, for example, that the demand for money will fall as confidence returns in a recovery.

Sandwichman is closer to being a lefty. But the origins of that theory (that the supply of money must grow at the rate of interest) are interesting to me. I have heard it before. In the Canadian context, I wonder if I should associate it with Major Douglas and Social Credit? Those creditiste monetary theories still circulate in Canada. They make a fetish of fractional reserve banking and the banking system multiplier. They forget that competition in banking forces the gap between the deposit and the loan rate down to cover the costs. And that monopoly banks, just like any monopoly, will earn supernormal profits.

White rabbit: I agree that there are a lot of "big ifs" in assuming a barter economy. The biggest if is assuming exchange would be as easy in a barter as in a monetary exchange economy. Obviously it wouldn't, which is why we use money. I see barter as a thought-experiment, and thought-experiments don't need to be realistic. But, given that (Massive) caveat, then yes, barter would immediately resolve the problem of a recession caused by a deficiency of aggregate demand. All the people with unsold goods would just get together and start swapping, making all better off. The emergence of those "super goods" you talk about would only create a problem if they became media of exchange. But they wouldn't if there were no transactions costs in my hypothetical barter economy. And if they did, it wouldn't be a barter economy any more.

Jacques: tautologies (sometimes) are nevertheless useful of course. Especially when people forget them!

"Do you consider it macro if there is no wage employment, only self-employment? Is wage-stickiness just complicating your notion of macro or is it a determining factor?"

My preferred (simple) macro model has only self-employment. Workers are firms. The "yeoman farmer" model. *Real* wage stickiness is a complication factor. I like to assume W=P, so nominal wage stickiness and nominal price stickiness are the same thing.

When the bullet misses, and inch is as good as a mile. But if we say that Say's bullet misses *only because of money*, it does (or should) force is to focus our attention on money. It's an excess demand for money that causes recessions; not an excess demand for "savings" (e.g. to hold more bonds). That's the big difference between my approach and most Keynesians.

The Rideau Canal beckons. Back later.

"So if part of demand comes from "an excess of money", have you pretty much written a Rule that the money supply must always grow? Because if you did, it might be helpful to write it down for central bankers everywhere; give them one less section on the dartboard when they're coming up with policy."

Problem is Central Banks cant increase the money supply except by increasing private debt. What we need is debt free money to actually pay down our existing debts not a ponzi like extension of our current debts. Debt free money is a fiscal operation.


A lot of your conclusions are starting to sound more and more like something Mitchell and Mosler would say.

Just sayin'


“It's an excess demand for money that causes recessions; not an excess demand for "savings" (e.g. to hold more bonds). That's the big difference between my approach and most Keynesians.”

Assume there is an excess demand for “saving” (or “savings” I guess; I’m not sure that stock/flow differentiation is that important to the point here).

So if we assume such an excess demand for saving, then whoever has that excess demand starts out with money. He/she either holds onto that money as the desired end form of savings, or exchanges it for some other savings asset, such as a bond, representing a different, more “refined” form of savings.

In such an exchange, the seller of the more refined savings asset receives money, and holds onto it, or perhaps exchanges it again for yet another form of savings. In all such exchanges, it is assumed that the excess demand for savings remains – i.e. there is no consequent leakage into new demand for goods and services – since that would just contradict my starting assumption that there is an excess demand for savings.

Now assume the “reverse” – i.e. that there is an excess demand for money. So long as money is exchanged for other asset forms of savings, and not exchanged for goods and services, the macro situation of an excess demand for money remains – which is the starting assumption.

Bottom line is that money as a specific form of the excess demand for savings gets transferred around in the exchange between the various forms of savings - and vice versa – assuming either an excess demand for savings or an excess demand for money as your starting point.

That just means that an excess demand for savings and an excess demand for money are really the same thing.

One question might be whether “excess demand for money” is itself a tradable asset – within the larger universe of the “excess demand for savings”. And it is – as discussed above. The micro excess demand just gets traded around, preserving the macro assumption of excess demand for money – since excess demand for money is itself defined relative to there not being leakage into demand for goods and services, rather than there not being “leakage” into swaps for other forms of savings – since that of course isn’t leakage at all in the context of the consistent definition of excess demand for either money or savings relative to the demand for goods and services.

Another point is that perhaps “excess demand for money” has its own velocity in the context of its use in trade within the universe of “excess demand for savings”. But the assumption of either one implies the other - which means that they are essentially the same thing, characterized only (but interestingly, I think) by velocity in terms of one relative to the other.

Bill Woolsey,

There is some truth to what you say about fractional reserve banking being an obsession of monetary cranks and about the "real" (which is to say abstract) irrelevance of the money supply to repaying interest -- as long as prices and wages self-adjust to the new level, which of course they don't. You may be interested in a BBC radio address by Keynes from 1934 in which he took his stand alongside those "isolated groups of cranks," which presumably, given the context, included Major Douglas. I've republished that address at ecological headstand. One of Keynes's guiding heresies, it seems to me, was that people don't just care about "real" wages; they care about nominal wages (green cheese). And that's not because they're irrational, their preferences are made in a context in which they have to take into consideration the preferences of other people, who are also taking into consideration other people's choices, etc. (the beauty contest).

Keynes differentiated himself from "the cranks" in that where they saw only one way out of the dilemma, he discerned THREE, with the exact mix of those "three ingredients of a cure" being "a matter of taste and experience".


By the way, Bill, objections to usury preceded fascism by thousands of years -- unless you want to call Deuteronomy a proto-fascist tract.

Pop Quiz

"There is no relationship between the interest rate and what happens to the quantity of money." -- Bill Woolsey


I see barter as a thought-experiment, and thought-experiments don't need to be realistic.

Agreed, but they do need to be coherent in some sense. The plot of The Terminator turns on a thought-experiment of sorts: a cyborg travels back in time in order to kill the mother of the man who will destroy the cyborgs if she lives long enough to get pregnant. It’s a very entertaining scenario, but I’m doubtful as to whether the success of such a mission is even logically possible. Are you really sure that your barter economy is logically possible? It seems to be set in a world where economics has nothing much to study. Problems of resource allocation are terminated prior to conception.

But if we say that Say's bullet misses *only because of money*, it does (or should) force is to focus our attention on money. It's an excess demand for money that causes recessions; not an excess demand for "savings" (e.g. to hold more bonds). That's the big difference between my approach and most Keynesians.

Say fired a blank, not a bullet. It made a lot of noise and the echoes still haven’t died away, but it wasn’t solid enough to puncture anything. Depending on how you interpret it, Say’s Law is either false or vacuous. To my mind, the real difference between you and most Keynesians is something like this (I'm resorting to parody of course, but I don't mean to be rude, I'm just trying to be highlight the essentials):

NR: Barter is impractical, that’s why we have money. Serious macromodels must incorporate money.
MK: Barter is impractical, that’s why prices are sticky. Serious macromodels must assume sticky prices.

Neither argument is entirely compelling, since there are countless features of the real world which don’t exist in an idealised barter economy of the textbook variety. We can’t incorporate all those features.

JKH writes:

He/she either holds onto that money as the desired end form of savings, or exchanges it for some other savings asset, such as a bond, representing a different, more “refined” form of savings.

This is just wrong. Savings in this context means only the accumulation of money balances. Investment is not "refined savings"; its spending. Getting this point and this distinction is very significant to realizing that half of what is said on this topic is wrong.

For instance, you often hear that the wealthy "save" more of their income, so fiscal stimulus should go to the poor. Wrong, wrong, wrong. It could just as well be that wealthy people INVEST more of their income, so giving more money to the wealthy lowers real-rates, and conversely, the poor are more likely to accumulate cash balances because their future income stream is less certain. Its whoever accumulates less cash balances that has the larger multiplier not whoever invests less.

"thought-experiments don't need to be realistic"

Except of course when those "thought-experiments" start to project their own pseudo-reality, as a Bush administration aide explained to New York Times reporter, Ron Susskind in 2004:

The aide said that guys like me were "in what we call the reality-based community," which he defined as people who "believe that solutions emerge from your judicious study of discernible reality." ... "That's not the way the world really works anymore," he continued. "We're an empire now, and when we act, we create our own reality. And while you're studying that reality—judiciously, as you will—we'll act again, creating other new realities, which you can study too, and that's how things will sort out. We're history's actors…and you, all of you, will be left to just study what we do."

Much of contemporary economics consists of "thought-experiments" which have metastasized into certainties about the way the world works. Some of these certainties-qua-thought-experiments then become the arbiters of what further thought-experiments can be admitted, even as thought-experiments! Or as Nietzsche remarked,

"What, then, is truth? A mobile army of metaphors, metonyms, and anthropomorphisms —- in short, a sum of human relations which have been enhanced, transposed, and embellished poetically and rhetorically, and which after long use seem firm, canonical, and obligatory to a people: truths are illusions about which one has forgotten that this is what they are; metaphors
which are worn out and without sensuous power; coins which have lost their pictures and now matter only as metal, no longer as coins."

Ah, a lovely skate on the Canal!

RSJ: You lost me a little in your comment there. Let me make two points, that may or may not engage you:

1. There is a demand for ice cream, and a demand for sardines, but no demand for sardine ice cream. I wouldn't call that a failure of aggregate demand for final output. To my mind, an AD failure is when people want stuff, and want to produce and sell their own stuff to get the income to buy that stuff, and would buy that stuff if they could sell their own stuff and earn income. Yes, there are lots of other coordination failures as well. Arnold Kling's PSST stuff is about those other types of coordination failures.

2. We need to distinguish between the rate of interest *on* money (that you earn for holding money) and the rate of interest on bonds (that you earn for lending, not holding, money). The Bank of Canada for example promises a real rate of interest of minus 2% for holding currency. An increase in the rate of interest on holding money would increase the demand for money, and would reduce AD and cause a recession (or reduce inflation).

Nick, Good post. You seem to be going further and further down the MOE line, a hypothesis that you seemed to advance more tentatively before. In any case, I, for one, have never been convinced entirely, though I am not sure what policy implications that might have.

As I have written before my conception of money's roll in recession still stems primarily from its roll as a store of value. It is in people's attempt to adjust their permanent income that the paradox of thrift arises.

I have been trying to think of a Rowe-esque model to think this through. If we assume there is an economy with three goods, apples, pears, and wheat, where all three are bartered but wheat is the only store of value. My conjecture would be that if the permanent income of society lowered the estimate of wheat production after a few bad years then there would be a recession, even though pears and apples could still be freely exchanged for each other. (My assumption is that no more wheat can be produced by moving land or labor into wheat production).

Travis: There's why Keynes said what he said, and why I think what I think. Not always the same, though in many ways I am a Keynesian.

Ralph Musgrave: "Nick’s last sentence says that demand comes from, amongst other things, an excess supply of money.

Amazing! The average lottery winner has worked that out. How come academic economists need 50 trillion incomprehensible words to come to the same conclusion? Are academics more interested in keeping themselves employed than in solving economic problems? :)"

Oh dear. A lottery is a transfer of wealth that causes a change in the pattern of consumption demand. That is totally different from an aggregate excess supply of the medium of exchange. Most of those 50 trillion words were used up arguing back and forth over issues like this.

The Unbeliever: I wish there were a simple rule for the growth rate of the money supply that would prevent macro problems. If there is, I don't know what it is.

Luis: thanks! I admit my tongue was a little in cheek when I wrote that bit about open economy macro. There's an element of truth in it though. For example, the AD curve in a small open economy under fixed exchange rates slopes down for exactly the same reason that the demand curve for apples slopes down. If there's a fall in the price of Canadian goods relative to foreign goods, there's a substitution effect causing demand to switch away from foreign goods towards Canadian goods.

jonny: I think there may be something to what you say. But it isn't always right. If the extra money goes to those who already have their desired stock, they will now have an excess supply, and will spend it or lend it. And ultimately that excess supply get's spent on the goods and labour in excess supply.

JKH: Say's Law can be understood as an accounting identity. But that's not quite how I'm using it here. (This applies to RSJ's comment as well). The version of Say's Law I'm talking about here is that aggregate ex ante demand equals ex post realised sales. In aggregate, we *plan* to spend all of our realised income on goods. (But we don't, because we might choose to hoard or dishoard money.)

Gizzard: I do have some commonalities with the MMT guys, and some big differences. I've tried to explore them in the past, but not too successfully.

The MMT guys: never understood the truth and beauty of the money supply multiplier; they are weak on the difference between income and substitution effects; they are fuzzy on Phillips Curves; they believe in the State Theory of Money, rather than seeing that money is a social construction of reality ;).

OK, I said good post then criticized it, now I am going to launch a minor provocative attack on "Thought Experiment Economics" or "Blackboard Economics"

From an interview with Ronald Coase: Interviewer: You mentioned many times that you do not like the term, "Coasean economics", and prefer to call it simply the "right economics" or "good economics". What separates the good from bad, the right from wrong?

RC: The bad or wrong economics is what I called the "blackboard economics". It does not study the real world economy. Instead, its efforts are on an imaginary world that exists only in the mind of economists, for example, the zero-transaction cost world.

Ideas and imaginations are terribly important in economic research or any pursuit of science. But the subject of study has to be real.

So, what is the empirical evidence that it is MOE and not SOV? Most 'savings' in the US has been through shrinking credit and default not expanding demand deposits. Bank reserves do not strike me as MOE, they have to be converted to currency before purchases are made, though perhaps you disagree.


JKH: Jon said what I would want to have said.

Kevin: that's more of a caricature than a parody. I like caricatures. And your caricature of me there is fairly accurate. I would just replace the word "money" with "monetary exchange" to make it more precise.

I think prices are sticky. But it is not obvious to me whether prices would be more or less sticky in a barter than in a monetary exchange economy. But (in my view):

1. the *consequences* of sticky prices are *very* different in a barter than in a monetary exchange economy.

2. If prices were perfectly flexible, a monetary exchange economy would function almost the same way as a hypothetical barter economy with low transactions costs.

Many/most economists agree with 2 but disagree with 1.

OGT: Thanks!

I am very much a MOE guy.

In your "Rowe-esque" economy, if wheat is the only store of value, in a barter economy, then an excess demand for wheat (savings) will not stop people trading apples and pears optimally. But if wheat is also the medium of exchange, as well as being the only store of value, then an excess demand for wheat, even if motivated by an excess desire to save, will cause apple and pear sales to fall.

This goes back to my post a couple of months ago, "If cows were money". An excess demand for milk (caused by all the goats going dry) would cause a recession. It's not that people want to hold more money qua money. But if they want milk, and money just happens to yield milk, then an excess demand for milk causes an excess demand for money.

For "milk" substitute "store of value".

OGT @3.27: If we lived in a world where cows were money, it would be very hard to distinguish empirically between an excess demand for milk causing a recession, and an excess demand for the medium of exchange causing a recession. People would even find it hard to distinguish between the two conceptually.

So far, all I have been able to come up with is thought-experiments. Like the Pro-Usury party. And anecdotal evidence that barter increases during a recession.

Nick, I'm interested in your points one and two above. I think I agree with both, but I'm not sure how you conceive of the first. In my view, a barter economy has a near infinite number of media of account, and hence units of account. Thus shocks will be highly uncorrelated across markets, and there will be nothing like the systematic effects that occur when there is a change in the real value of money in an economy where all prices and wages are sticky in money terms. I.e., no major demand-side business cycles. Am I on the right track?

Remember that recessions are the best time to start a new business. Immagine the new entrepreneur making the rounds of his friends and relatives to borrow seed money, and asking friends who he knows are unemployed or underemplyed in spite of being very talented, to come join him.

If you define the slide down into recession as a time when a lot of active resources become idle, and a recovery as when those idle resources become active again, than you see it has a lot to do with emotions and expectations.

When you are suspicious and fear the future, you hold onto your assets, avoid risk and withdraw them from activity.

When you are hopeful (or what is just as likely, a bit desperate for income), you are more willing to take risks and bring those resources into activity again. By resources, I mean your savings, your time, your energy, your hard work and your emotional involvement.

New demand comes from the willingness to expose your resources to risk.


What about those who claim that money is created ex nihilo by banks? What if there's no need to save in order to invest, once all the financing can be provided by credit, not savings?

"Forced savings", as you may call it (business investment will be financed anyway, although there will be inflation).

Scott: the easiest thought-experiment would be where there is one medium of account, but every good is used as a medium of exchange. Start in equilibrium. If that MOA good suffers a shock, the market for the MOA will not clear. But all other markets (except maybe close substitutes or complements to the MOA) can still function normally).

Nick, thanks for the reply. I was hoping to draw you out into a mathy model or empirical test with my last post mainly because I find your posts very interesting and provocative, but not quite satisfying. (Perhaps due to my conception of recessions as fundamentally being about inter-temporal demand shifts).

I see what you mean on the apple/pear/wheat economy. I would try it again with capital and wheat debt, but I think these kinds of thought experiments are out of my wheelhouse.

Back to the original post, the observation about the "short side determines the quantity traded" is a very good way to term the issue. This is related, I assume, to NK slack but is a more intuitive way to put it and keeps macro from seemingly a discipline to only break out in 'liquidity traps.'


I'm shocked you would agree with Jon, given I made no reference whatsoever to investment, but I'll leave it at that.

All the talk about cows and barter vs a separate, distinct money commodity... it seems to me the intrinsic utility of money matters enough to mess up these simplified models.

IOW, it matters if you can literally consume a unit of "money" or not. A cow can convert from money to steaks with the proper application of knives and fire; once consumed for dinner, the total money supply is permanently reduced. Same goes for gold and silver (with different transformation processes). US dollars are designed to be functionally useless--they don't even make good kindling.

A person who holds cow dollars has the option of consuming the money supply without engaging in trade and generating demand. A holder of US dollars MUST engage in commerce if he wants to consume.

So when we talk about a consumer who prefers to "hold money", and claim changes in that preference drive demand, the type of money partially dictates what drives that preference. And I would argue, in a fiat paper money system, worthless money (or computer bits) is designed to encourage worthless consumption.

There are multiple ways to talk about recovery. We can have recovery of GDP without a recovery of the labor market.

The lack of demand that is the most pressing current problem is the lack of demand for labor. Thus we have high unemployment. The lower rungs of the economy with the highest demand for labor to produce goods and services have been cleaned out in the latest recession. People were over leveraged on houses and credit cards. Now they are poor risks for borrowing; credit channels are closed at the same time that income channels have been closed by high unemployment and underemployment.

The wealthy who have high demand for assets that don't utilize enough domestic labor continue to receive income and take money away from those who have unmet demands that would utilize domestic labor. Monetary policy that puts more money in the hands of the wealthy bankers is not finding its way to increase the demand for domestic labor because many of the borrowers are poor credit risks and the risk premium is too high. High risk premium is why monetary policy is stuck at the zero bound with no traction.

Lack of good investments with low risk premiums has increased demand for liquid assets that in turn keep interest rates low. Demand for labor will only increase when those who have an unmet demand that can be filled by domestic labor have the money to spend. BigG has plenty of unmet demand that could be met by domestic labor and BigG is uniquely positioned to capture return on investment from hiring that labor. Without wealth transfer to those at the bottom of the economy through BigG job creation or transfer payments, the demand for domestic labor will be depressed.

Obama cheerleading business to hire more domestic labor will not help. If business cannot capture return on investment in domestic labor, business will not hire domestic labor. Business is in business to make money, not solve social problems. Social problems are the job of BigG, or at least they used to be.

Wait just a minute.

It isn't that the money has to grow to cover the interest on the debt in a continuously operating system. People aren't borrowing money just for the sake of paying it back with interest. They're borrowing on the expectation of gain.


1. in a credit/money system, revenues from transactions for goods and services must continuously grow at a rate sufficient to service the debt,

2. there is no inherent identity between the rate of growth in demand for commodities and the compounding rate of interest; THEREFORE:

3. continuous growth of credit becomes necessary to keep ahead of discrepancies that arise between the rate of growth of final demand for goods (which is fickle) and the funds required to service debt.

4. to NOT continuously expand credit would be to risk choking off final demand and thus precipitate default on outstanding debt.

How does this translate to either "winding up the monetary order" or assuming "the supply of money must grow at the rate of interest"? My original post was perhaps misleading because I presented the conclusion first before the reasons for it. I suppose that was because I was responding to Nick's characterization of the desire for money as a "wish" (as if it was optional) and I wanted to make the point that it was a compulsion.

A decline in the rate of increase of the demand for goods and services doesn't necessarily have to originate in a wish to hold more money:

Put very briefly, the point is something like this. Any individual, if be finds himself with a certain income, will, according to his habits, his tastes and his motives towards prudence, spend a portion of it on consumption and the rest he will save. If his income increases, he will almost certainly consume more than before, but it is highly probable that he will also save more. That is to say, he will not increase his consumption by the full amount of the increase in his income. Thus if a given national income is less equally divided, or if the national income increases so that individual incomes are greater than before, the gap between total incomes and the total expenditure on consumption is likely to widen. But incomes can be generated only by producing goods for consumption or by producing goods for use as capital. Thus the gap between total incomes and expenditure on consumption cannot be greater than the amount of new capital that it is thought worth while to produce. Consequently, our habit of withholding from consumption an increasing sum as our incomes increase means that it is impossible for our incomes to increase unless either we change our habits so as to consume more or the business world calculates that it is worth while to produce more capital goods. For, failing both these alternatives, the increased employment and output, by which alone increased incomes can be generated, will prove unprofitable and will not persist.

The Unbeliever, money is a liability of the central bank, so you can in fact consume money, by returning it to the banking system in exchange for government bonds. This is not "commerce", because that money disappears--it does not stay in the system unless the central bank creates it anew. So we do need to explain why people would hold money in preference to other assets, but that's not different in principle from the cows-and-steaks case.

JKH writes to Nick:

I'm shocked you would agree with Jon, given I made no reference whatsoever to investment, but I'll leave it at that.

Last time I checked "buying bonds" wasn't limited to the secondary market, so at best your remarks were rather imprecise.

As for Nick's agreement with my remark;
I'm sure Nick would have been nicer than I was.

Jon and Nick,

I wrote:

“In all such exchanges, it is assumed that the excess demand for savings remains – i.e. there is no consequent leakage into new demand for goods and services – since that would just contradict my starting assumption that there is an excess demand for savings.”

Meaning - there is no investment scenario considered in my analysis. Goods and services include investment goods, and the purchase of any goods and services are excluded by assumption.

“He/she either holds onto that money as the desired end form of savings, or exchanges it for some other savings asset, such as a bond, representing a different, more “refined” form of savings.”

Meaning – another “savings asset” refers to what is included the entirety of the analysis, which by assumption as above is a use of funds other than for newly produced goods and services, which means using funds to acquire a financial asset or an existing real asset (not newly produced) – like a bond, or a stock, or a mutual fund, or an existing house, or ...

With those meanings, which are not mysterious at all when one actually reads what I wrote, it is obvious that Jon’s comments are utter nonsense.

And BTW, bonds are not investment in any normal definition of terms normally used in economics, and it doesn’t matter whether the bonds are bought in the secondary market or new issue. Bonds are separate entities from real investment and bond transactions are separate transactions from goods and services transactions. Connected sometimes, but separate.


If you choose not to be interested or invested in a particular comment, I can certainly understand that. But when you choose to outsource your thoughts to offensive, ignorant rubbish spewed by some haughty surrogate commenter, I’ll respond as if it’s your own. The better alternative would have been either to ignore my comment, or read it more closely before responding yourself.

JKH: I was pressed for time. I will give your comment a closer read. I thought what Jon said was correct. Whether it was correct as a response to your comment I will reconsider. But it wasn't "ignorant rubbish".

JKH: By the standard economic definition, "desired saving" is anything you plan to do with your income except spend it on consumer goods. For an individual, "desired saving" can mean desired: investment; purchase of bonds, or holding an increased stock of money. Suppose it's desired purchase of bonds. If there is an aggregate increased desire to save in the form of bonds, it simply won't be possible for each individual to carry out his wish to buy more bonds. Nobody wants to sell. So the desire to save in the form of bonds gets frustrated, and *must* rebound as a desire to save in the form of investment or money instead.

If there is an excess supply of goods, a rebound into desired investment is possible. Firms are willing to sell more investment goods. And it's always possible for an individual to get more money by buying less goods, even if it's not necessarily possible in aggregate.

Maybe I have misunderstood your comment (this stuff is not easy). But on giving it a second go, I end up back in the same place. If there is an aggregate excess desire to save, it must end up in Investment or an excess demand for money.


What you've just said doesn't conflict in a major way with my comment. It’s orthogonal to it – given that you can assume away the obvious stuff about the relationship between goods and services, investment, and saving.

I acknowledged in my comment that it all starts with money as the generic form of saving – that’s the medium of exchange that is used to delineate the initial setting for not spending on consumer goods and services.

But the fact is that some of those who participate in the excess demand for saving actually don’t want money as the final form of their saving, and trade that initial money away to others who are willing to exchange non-money forms of saving such as bonds, stocks, existing houses, etc. for money.

Money is a form of saving – that isn’t negated by the fact that the supply of bonds may be fixed. These are two separate ideas.

Given the potential for the exchange of money and non-money forms of saving, the excess demand for money and the excess demand for saving become the same thing.

So I agree with most of what you’ve said, but it misses my point.

Regarding that other comment, ignorance is contextual, as is rubbish.

Nick, You've said:

"Scott: the easiest thought-experiment would be where there is one medium of account, but every good is used as a medium of exchange. Start in equilibrium. If that MOA good suffers a shock, the market for the MOA will not clear. But all other markets (except maybe close substitutes or complements to the MOA) can still function normally)."

I don't agree. Say gold is the medium of account. If the real value of gold doubles, and wages are sticky in gold terms, you get mass unemployment, regardless of whether product markets clear.

In an earlier thread Nick said he thinks I understand his view (and Frank Hahn's also, but that's another story). Let me put that to the test; here, I predict, is the substance of Nick's reply to Scott:

We start in equilibrium, so if the real value of gold doubles, that means that the real wage W/P is still at the market-clearing level. Wages are sticky? In a barter economy, that's no problem. Brewers pay their employees in beer, bakers pay them in bread. The employees trade beer for bread. Impractical? Sure. Barter is impractical, that’s why we have money. Serious macromodels must incorporate monetary exchange.

So, is your concern then that the desire to hold money balances can be served by holding other nominal securities. i.e., that base money is not special, what matters is an excess demand for money broadly construed to include all securities?

Nick is discussing an economy in a state where the goods markets are not clearing. People want money not goods. You propose that they also want nominal securities generally. Okay, being a creative person, I offer to manufacture some asset backed securities--using the goods that aren't being sold as the collateral behind the security. In exchange, I get base money now; I promise to pay you more base money later, but then you only have recourse to the pile of goods I just "sold" you if I don't.

It should be immediately clear that there is a contradiction here.

So my original point stands, its an accumulation of money balances not securities that is at issue. I do take the Austrian position though that there can be money substitutes that do act as medium of exchange, and therefore base money is a little too narrow. For instance, trade credit works by passing around endorsed checks which are treated as money. So there is some latitude here but the device in question must be accepted as a medium of exchange--it must be a money substitute.

"By the standard economic definition, "desired saving" is anything you plan to do with your income except spend it on consumer goods."

But that is a partial equilibrium definition, because there does not exist an exogenous income that you can decide to spend or consume; the income is itself determined by investment and consumption decisions, as well as by the state of the economy (e.g. pre-existing production contracts, pre-existing debt service agreements, interest rates, etc.)

At best, you can say *If* I have an income of Y and the interest rate is r, and the economy is in a certain state, then households will desire to save S_d(Y,r), and firms will desire to invest I_d(Y,r), and then you solve for Y and the actual levels of S and I. Ex-post, they will be equal, but because for a given rate of interest, Y adjusts to make them equal.

We can ask, what is the relevant problem during recessions?

Is the problem that *Y* falls too much, causing less than potential output, or is the problem idle resources and unsold goods for any given level of output?

We do not see increasing unemployment and general gluts that are not accompanied by declines in Y. And more importantly, that are not accompanied by declines in the growth rate of credit.

I argue that the decline in Y is the *cause* of the glut, because production has a certain structure.

For example, if the interest rate is too high, then firms will produce less and utilize fewer factors of production.

In that case, the only way the labor markets will clear is if the real wage declines up until the involuntary employment arising from the sticky wage is the same as the voluntary unemployment arising from the flexible wage. So the realization of the decline in Y will be unemployment, and the structure of the economy will determine whether it is voluntary or involuntary. If you assume that wages adjust *instantaneously*, then you will see only voluntary unemployment.

Similarly, as output declines, this can be realized either as unwanted inventory accumulation or a decline in the capital stock, depending on how quickly each firm can adjust. In both cases, you have some combination of unsold consumption goods and unsold capital goods. If you assume the adjustment occurs *instantaneously*, then the capital and consumption goods would have never been produced in the first place, so do you not see a general glut of goods.

None of this requires money. An excess demand for money only makes in a partial equilibrium context -- in a micro context in which income is given, and then you decide what to do with the income.

An excess demand for money is a necessary explanation for general gluts only if you assume that goods are produced instantaneously, that labor contracts are re-negotiated every second. if you do not assume that, then a decline in Y is sufficient explanation for a general glut.

Moreover the relevant problem is not money, but credit. Capital goods are purchased with credit -- with newly created money, which, when spent, adds to the income of others. Investment is not saving, it is a source of income. Savings is a use of income. There is no "investment/consumption" trade off.

When people are de-leveraging, then by definition they are not going to purchase houses or land, or any capital good, because they do not want to borrow. Therefore there are fewer investments and lower income. As income declines you get a general glut of goods and labor as long as the production system is not instantaneous or stateless.

Kevin: exactly! You pass the test. You can predict exactly what I would say.

"Okay, being a creative person, I offer to manufacture some asset backed securities--using the goods that aren't being sold as the collateral behind the security. In exchange, I get base money now; I promise to pay you more base money later, but then you only have recourse to the pile of goods I just "sold" you if I don't."

No one would make this loan. First, the value of collateral is its resale value, so that means only short term loans can be secured by inventories of consumption goods, and the value of the loan will be less than the expected resale value of the collateral.

Longer term loans would beed to be collateralized by capital goods, but again the re-sale value of the capital goods needs to be more than the loan amount. The residual is your equity in the real asset that you have purchased with the loan, and you generally need skin in the game, and cannot acquire capital goods for free without supplying any capital yourself.

RSJ writes: No one would make this loan.

Precisely. The excess demand for money cannot be met by producing more securities except in the narrow case where those securities are money substitutes and can be used in place of base money (because they are secure claims on money).

An asset backed security will have this precise property when the goods markets would clear. Ergo, there is no excess demand for asset backed securities generally.

And if you cannot make it work with asset backed securities, I find it difficult to believe you can make it work without collateral.

So by exclusion, we're left not with savings generally but savings particularly as the unmet demand to accumulate money balances as the problem.


My most simple model would be that, at the margin, an excess demand for money corresponds to a deficient demand for consumer goods, resulting in an unwanted accumulation of inventory of consumer goods, which is classified as investment.

Making the further simplifying assumption that inventory is financed in the first place by bank loans, and that bank loans are offset by deposits, this means that an excess demand for money shows up as deposits held by households. These deposits are banking liabilities, offset by the inventory financing that is the banking asset. Excess demand for this money means that velocity of this money has hit zero, at the margin under discussion. That zero velocity is operationalized as a holdback of money balances by households due to their excess demand for money.

So far, this story should be consistent with Nick’s story, even though I’m framing it in an ex post sort of way, as the sort of behaviour that must be observed logically in connection with an actual excess demand for money.

The next step is to recognize that this excess demand for money has resulted in an increase in household equity relative to the counterfactual where the market for goods and services would have cleared and households purchase goods that they consume immediately. (This counterfactual position accords with the assumption that consumer goods once purchased are not classified as investments on the balance sheets of households. And that is consistent with the fact that there is an effective equity drain from household balance sheets associated with a counterfactual purchase of consumer goods.) This comparative increase in household equity due to the excess demand for money is deployed as an asset in the deposits that correspond to the collapse in monetary velocity due to the increased demand for money.

This comparative increase in household equity (again compared to the counterfactual of a cleared market) corresponds to an increase in saving. That’s what saving is – an increase in equity. It’s not the money or the bonds or the house or the investment or any of the assets that offset the equity – it’s the equity itself, which is the right hand entry on the balance sheet.

So the increase in the demand for money has been associated with a comparative increase in equity and saving, and in this case a comparative increase in money holdings of households.

Given such a base case position for this example, it is easy enough to consider all sorts of micro permutations whereby those households who initially hold the excess money choose to swap their money for other assets – assets that are not part of the flow of new goods and services – these include financial assets such as bonds, stocks, mutual funds, or “old” real assets such as existing houses. None of these swaps affects the macro configuration of the assumed excess demand for money or the corresponding excess saving that has accumulated. I see nothing special about bonds or the supply of bonds in this context.

Bottom line is that of course the forces in play must involve an excess demand for money, because money is the medium of exchange. But they must also involve an excess demand for saving, because that is inherent in the required behaviour of the accounting identities that are consistent with the granular detail of the particular asset in play – which is money as the medium of exchange. So my conclusion is that it is nonsensical to attempt to divorce the excess demand for money from the excess demand for saving. The former is driven by the fact that money is the medium of exchange and the latter is driven by the fact that accounting identities must behave in such a way to accommodate the assumption of an excess demand for money. The two characteristics are inextricably linked in the description of this type of recession dynamic. It is a matter of recognizing that money is the medium of exchange, and that saving is the accounting requisite that accommodates the assumed money behaviour. If money is the medium of exchange, then one implies the other and vice versa – excess demand for money and excess demand for saving.


You've lost me. The walrassian framework of excess demands assumes that endowments are fixed.

It is a partial equilibrium assumption.

But endowments are not fixed.

Endowments change in real time, because the economy is producing, consuming, and investing in real time.

In that case, it is not true that the sum of demands must equal zero. That is only true in the special case of instantaneous production, or in an economy without production.

Why can't we just agree to switch to a barter economy without production and all get along?

LOL, yeah we need to shift out of time and into meta-time.

I really think that the relevant distinction between monetary economies and barter economies is one of time. To buy something for money is not to exchange a real good for another real good, but to exchange a real good for a paper claim, with the assumption that *later* you can exchange your paper claim for another good. And equivalent to that is the ability to buy something without an endowment (e.g. borrow) and then *later* repay (when your endowment increases).

But as soon as production requires time, then it will be funded by selling some form of paper claim. Whether those paper claims pay interest or not doesn't matter. Now you have individuals transacting across time, but the economy as a whole cannot, and this can lead to the savings/investment miscoordination.

The only true barter economy is one in which no one attempts to transact across time (i.e. sell now and buy later, or buy now and repay later), which means no production, no storage technology, and Say is right in that those wanting to sell must also want to buy at the same time.

But as soon as they have the option to sell now and buy just a few moments later, or buy now and then sell a few moments later, then you are in a monetary economy again, in which, at any point in time, the demand to sell does not need to equate to a demand to buy.

It's a real shame that people get their intuition from statics, and then view dynamics as an advanced concept.

"The only way principal + interest can be paid back is through the creation of more money through credit."

I'm surprised at you here. This is not true. Not when you consider time and the money is relent as it is paid back. Steve Keen addressed this.

P.S. There are implications about the velocity of circulation here and the rate of growth - but in general what you say is not true. It is confusing a stock and a flow.


Why do you ctiticize MMT for adhering to the state theory of money. Its obvious that the state theory is a fact. The US$ was a creation of "the state" as was the canadian dollar, the euro, the yen, the deutsche mark. In fact I'll venture to say that in virtually every stable modern economy it is the states money that is being used. The economies with multiple competing currencies are not places that most of us want to live and do business. Knowing this to be true it follows then that the state is not constrained by tax revenue for its spending decisions, only by its politics. A stable state with a stable state currency is the best place to live and do business.

A social construction of reality........... that sounds an awful lot like a state.

reason: "The only way principal + interest can be paid back is through the creation of more money through credit."

I'm surprised at you here. This is not true. Not when you consider time and the money is relent as it is paid back.

No, you're quite right there I made an unnecessarily absolutist statement. I would suspect, though, that you'll find rare episodes historically in which a contraction of credit hasn't been followed by a rash of defaults.

But, as I've tried to point out before, my overstatement was not the main point I was trying to make. And it's disconcerting to see folks gloating about an infelicity but not addressing the issue I raised (or the quote from JMK).

That point I was trying to make is that debt service and final demand for goods and services are not inherently proportional. If they happened to be proportional or if demand was expanding faster than debt service costs for a period of time, there would be no need -- during that period, anyway -- for credit to expand. There comes a time, though...

Gizzard: most states have nationalised money. But monetary exchange can and did evolve without the state. And a particular choice of which good to use as money can evolve without the state.

The state is a social construction of reality. We make it, by believing in it. It does not exist apart from our belief in it. The state is made out of the same stuff as money. The state is not ontologically prior to money.

In defence of Sandwichman: the demand for money will presumably depend not just on GDP, but also on transactions in intermediate goods, and also on the flows of loans and repayments of loans, and interest payments on loans. All (monetary) transactions will create a demand for the medium of exchange. But a debt that is just accumulating at the rate of interest, without a flow of interest actually being paid, will presumably not create a demand for money.

Nick, I don't get it. If gold is the MOA, then wages are set in gold terms. If wages are sticky, that means they are sticky in gold terms. Otherwise gold is not the medium of account. If the real value of gold doubles, and gold wages are sticky, then real wages double and you get mass unemployment. What am I missing?

If you argue wages are paid in beer, and the wage in beer is sticky, then you have violated the assumption that gold in the MOA. You can't have it both ways.

Scott: Assume W the price of labour in terms of gold is sticky, and P the price of beer in terms of gold is equally sticky. If the real value of gold doubles, then W needs to halve but won't, and P needs to halve but won't, but W/P doesn't need to change at all. So if wages are paid in beer the labour market can function normally. MRS=W/P=MPL. (except in the market for gold miners).

Nick, If gold is the MOA, then it's nominal price is fixed. If its nominal price is fixed, then its real price can only double if the price level falls in half. If you are claiming that goods prices are fixed in terms of gold, then you are claiming that the real price of gold cannot change.

So it seems to me that your actual assertion here is that the real price of gold cannot change if it is the medium of account, not that it could change, but it wouldn't matter.

This is exactly my problem with the (Keynesian) model. We know that some prices are fixed and some are flexible. That means that in the real world the real value of gold can rise (even if it is medium of account), and cause unemployment.

Yes, one could envision a model where all prices were fixed, but it would have no real world applicability.

It also seem to me that your model assumes that monetary shocks cannot cause changes in real wages, because wages and prices are equally sticky. But we know that's false. Monetary shocks do affect real wages.

Scott: a thought-experiment:

Start in equilibrium. Barter economy. Hold all prices fixed in terms of gold. Then the demand for gold increases (or the supply of gold falls). All prices need to fall, but none do. But W/P doesn't need to change, and the market for beer/labour still clears, MRS=W/P=MPL, even if the markets for beer/gold and labour/gold don't clear.

Now the same experiment with a monetary exchange economy. There is no beer/labour market. There's a beer/MOE market, a labour/MOE market, and a gold/MOE market. If all 3 prices (W, P, and Pm) are fixed in terms of gold, then only the gold/MOE market fails to clear. But if Pm falls to clear the gold market, it will cause the beer and labour markets to fail to clear, output and employment to fall, even though W/P is still at the correct level. If P falls to clear the beer market, then W/P must rise to equal MPL at the suboptimal level of employment. So it looks like the real wage is too high.


I tried creating a picture-book version of your argument. I don’t know if it helps, but it was fun fooling around with Paint.

Kevin: that's beautiful!


Just because monetary exchange evolved in many places without the state is NOT a point against MMT. The fact is virtually ALL modern economies use state money, whether historically this has always been true is completely irrelevant. MMT describes the realities of a state money system, the ONE WE ACTUALLY HAVE. Why spend time talking about money systems which we do not use. The problems we are having are not arising from the fact we have a state money system, they are arising from the fact that we have a state money system and too many economists want to act like we have something else.

We have a system which can never run out of "money", so why do we create a financial system that continually acts like we are? Its beyond ignorant and bordering on criminal.

Nick, Hope I'm not beating a dead horse, but I'm not sure what you are assuming. If you say gold is the MOA, and ipso facto we assume that the nominal price of gold is fixed, and we assume that the real value of gold doubles, and we assume all nominal goods prices (in terms of gold) are fixed, then we have a logical contradiction. I must be missing something obvious, because it seems like the way you set up the problem, gold is called the medium of account, but (de facto) it's not the medium of account.

If we are going to discuss whether changes in the real value of the medium of account are important, then we MUST talk about that situation in terms of a model with flexible prices. That's because if prices don't change, it is impossible for the real value medium of account to change.

The only possible exception would be if you wanted to make a queuing cost argument. The nominal price of goods doesn't change, so people try to get the more valuable gold by standing in long lines trying to sell goods for gold. It seems to me that would lead to a recession, even under barter.

Nick, Thanks for pointing out (February 05, 2011 at 03:19 PM) that a lottery win is simply a transfer between different people and has (at least arguably) no macroeconomic implications. I was well aware of that. I thought that point was so obvious that it did not need spelling out.

Thus my basic point still stands. Which is that when someone wins a lottery, their spending rises. Thus if the bank balance of everyone in the country is boosted, then spending in the aggregate will rise (assuming there are no capacity constraints, or put another way, assuming unemployment is above NAIRU).

And I suppose I shall have to point out that I am well aware of the dangers of extrapolating from micro to macro, but in this case as far as I can see it works. Indeed, the idea that boosting everyone’s bank balance boosts employment is central to Modern Monetary Theory.

Which is why if economists and others simply learn a bit about differential equations and statistical mechanics, none of this would be anything but crystal clear because the entire discourse of explaining things in terms of Say or Clower is popped out as simply multiple behaviors of a single solution family.

Basically you are doing what is simple in math by describing the math in many paragraphs of words. It's no different from explaining multiplication by exhaustively reciting all the individual numbers in a multiplication table. Strictly correct, sometimes gets the right answers, is error-prone and just a bit bizarre when you know there's an easier way.

Do I actually imagine math will ever become part of the standard discourse. Not any time soon. The old guard always has to die off before any disruptive improvement can ever be adopted. Probably not in my lifetime.

Yes, I know various financial "rocket scientist" know all this, but consider that they went into finance rather then their own profession - they probably were NOT all that technically.

JG: nearly all economists do learn an awful lot about differential equations and statistical mechanics. (Far more than I have learned, let alone remembered). And they normally do talk about stuff like this in math, rather than words. Math is very much the standard discourse in economics. That's what we teach the students. This post is the exception.

But doing it in math is absolutely no guarantee of getting it right. There are loads of mathematical macro models that totally miss these points. If anything, doing it in math seems to make it easier to miss these points. They can't see whether they are modelling a Walrasian or a monetary exchange economy.

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