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I wonder if you're dismissing Mason a little too quickly. To me, many characteristics of a "hard to sell" world could still show up with barter. Divide the world into 2 sectors, things that are flexible and cheap to store (mostly commodities), and things that are inflexible and difficult to store (services, but also finished goods to varying degrees). A futures curve for the former will tend to be well-behaved (in particular, contango is constrained by storage arb), while the latter can be sharply contangoed, or "hard to sell", in the short run. The good equilibrium involves lots of inter-sector trade, while in the bad equilibrium, the first sector likely accumulates inventory and the second must search for intra-sector trade or for ways to migrate.

I'll try to develop this thought further later, it seems very incomplete.

Krugman: “an overall shortfall of demand, in which people just don’t want to buy enough goods to maintain full employment, can only happen in a monetary economy; it’s correct to say that what’s happening in such a situation is that people are trying to hoard money instead (which is the moral of the story of the baby-sitting coop).”

Keynes:

It may be that in certain historic environments the possession of land has been characterised by a high liquidity-premium in the minds of owners of wealth; and since land resembles money in that its elasticities of production and substitution may be very low [1], it is conceivable that there have been occasions in history in which the desire to hold land has played the same role in keeping up the rate of interest at too high a level which money has played in recent times. It is difficult to trace this influence quantitatively owing to the absence of a forward price for land in terms of itself which is strictly comparable with the rate of interest on a money debt. We have, however, something which has, at times, been closely analogous, in the shape of high rates of interest on mortgages.
[1] The attribute of "liquidity" is by no means independent of the presence of these two characteristics. For it is unlikely that an asset, of which the supply can be easily increased or the desire for which can be easily diverted by a change in relative price, will possess the attribute of "liquidity" in the minds of owners of wealth. Money itself rapidly loses the attribute of "liquidity" if its future supply is expected to undergo sharp changes.

Nick, you seem to be saying that Krugman is repudiating Keynes. Maybe so, but I think we need a “wonkish” post from him addressing that specific point. It is noticeable that he usually traces his ideas to Hicks rather than Keynes.

The $ 1,000 is definitely a stock demand.

The $ 30,000 is definitely not a stock demand.

What is your objective in trying to reconcile the two?

Hey, thanks for the discussion!

I should be clear, the point I was trying to challenge wasn't that recessions always, in practice, involve excess demand for money, but that they logically must involve excess demand for money. I was trying to describe a situation without money, where we nonetheless can speak of output as being demand-constrained, in the sense that a change in desired expenditure would lead to a corresponding change in output. Is this model descriptive of something that happens in the real world? Maybe, maybe not. But I hope we can at least agree that the fact that aggregate demand is holding actual output below potential, does not imply that there is excess demand for money as a matter of logic.

As for the real world, I would be willing to agree that in recessions, there is always -- even definitionally -- an excess demand for money, or in your terms, it's harder to sell (or borrow against) goods for money, and easier to turn money into goods. But only if we drop the implicit assumption that the only states of the economy are recessions, and output at/near potential, and allow for extended periods of growth in which output is nonetheless demand-constrained. I think it is definitely true that there is excess money demand in recessions proper, or during the transition from a higher-output equilibrium to a lower-output one. I'm not sure it's true once the new equilibrium is established, and a new set of expectations is in place.

I *think* part of the difference here is that for you (and I think for Krugman, and definitely for DeLong) the barter foundation on which the money and aggregate-demand upper stories are built, is firmly Walrasian. People have secure, true expectations about the (unique) path of lifetime income that their endowments will provide, and the corresponding optimal consumption path. So in any period in which consumption departs from that path, you need a monetary explanation. On the other hand, if that's not the case -- either because people are myopic, or because there is no lifetime income path out there to be known, independent of the current state of demand -- then it's more natural to think in terms of a positive feedback loop where current income determines current expenditure, and current (or recent) expenditure determines current income. In which case you can imagine stable equilibria at many different levels of activity, without any markets failing to clear.

That's the intuition I was trying to get at with the barter babysitting co-op example. Of course it would need a lot more work before it's a story you can tell about the real world.

To my mind the crucial question is whether the Keynesian worry about money relates to (1) the fact that money is the medium of exchange, or (2) liquidity preference, which just happens to show up as demand for money, the most liquid of assets. My take on the following paragraph is that Krugman doesn’t think we should spend much time on such questions:

My broader take on this is that the quasi-monetarists are trying too hard to find a deep essence when what’s really needed is just a model. Let’s tell a story about what economic players do, and see what it says about policy options. That’s all it takes.

Which is fine; he’s not interested. But some of us are. For me, it’s still an open question and an interesting one.

fmb: you might be onto something there. But my hunch is that if you developed it further, and added transactions costs as well as storage costs into your model, in the final analysis of the equilibrium to that model your "flexible" commodities might end up being indistinguishable, functionally, from "money". The "inflexible" goods would almost always be bought and sold for your "flexible" goods (with just a few "barter" trades on the side where the double-coincidence of wants just happens to line up right). In other words, you are doing monetary economics with deep microfoundations of money, while I am just assuming (shallowly) that people have to use monetary exchange.

Kevin: that quote from Keynes is where he is arguing against Gessell, right?

"Nick, you seem to be saying that Krugman is repudiating Keynes."

I agree with Gessell against Keynes (on that point). I think Paul Krugman is also agreeing with Gessell against Keynes. Unless land becomes used as a medium of exchange, an excess demand for land cannot cause a recession, unless it causes an excess demand for the medium of exchange. All my wonkish posts about antique furniture (substitute "land" if you like) are arguing for Gessell against Keynes. Yep, I would like to see a wonkish post from Paul Krugman on the same subject. Dunno how his readers on the NYT would react.

Of course, I might have misunderstood PK. Or maybe, like most of us, he doesn't have hard and fast fixed views, and sometimes sees ducks and other times sees rabbits.

(Funny that Gessell was a totally out-of-the-mainstream nut, right?, unlike Keynes.)

"What about the excess demand for money (the medium of exchange)?"

What if there is more than one type of medium of exchange?

JW: Yep, I got what you were trying to do, and it was the right thing to do. But I should perhaps have been a bit clearer in my post about what you were claiming for your model, so it's good you clarified it here.

I've gotta disagree a bit on this point though:

"I was trying to describe a situation without money, where we nonetheless can speak of output as being demand-constrained, in the sense that a change in desired expenditure would lead to a corresponding change in output."

Trouble is, in a barter economy, an increase in desired expenditure (AD) *is* an increase in desired sales (AS) at the very same time. We can only distinguish the two on a monetary economy because we don't (normally) think of "buying" or "selling" money. In your model, because output is sold for output, output in a recession is both demand-constrained and supply-constrained at the same time.

I can imagine a world like yours in which supply dries up because demand dries up, and vice versa, and there is no unique path like in the Walrasian world, because of the difficulty of finding trading partners. And I see this happening across space, and across commodities at the micro level. But it doesn't look like recessions.

Funny thing is, Menger's story of why we use a unique good as money is very much like your story of positive feedback and thick-market externalities. We accept this good because everyone else accepts this good. We buy money because it is easy to sell it again.

"We observe an excess (constrained) demand or supply of apples in the apple market. But money doesn't have a market of its own. Every market is a market for money. We have to look at all markets to observe the excess (constrained) demand for money."

What about the retirement market?

And, "The excess constrained demand for money will be bigger, probably much bigger, than the excess notional demand for money that was the original cause of the recession. In the labour market, we observe an unemployed worker laid off from a $30,000 per year job. He wants his job back. He wants to sell $30,000 of labour per year but can't. He has an excess supply of labour of $30,000, and an excess flow demand for money of $30,000 too. But if he got his old job back, he wouldn't keep all of that $30,000 in money. He would want to spend (say) $29,000 on other goods, and keep only $1,000 in money. And in the second year, having rebuilt his stock of money to his desired level, he might spend all $30,000 on other goods."

What if this person was able to retire with a pension of $30,000 per year?

JKH: "The $ 1,000 is definitely a stock demand. The $ 30,000 is definitely not a stock demand. What is your objective in trying to reconcile the two?"

The $1,000 is definitely a stock demand but also, by assumption, a flow demand per year. I assumed he is planning to rebuild his stock at the rate of $1,000 per year, which means he will get to his target stock in 12 months. (I could easily have assumed 6 or 24 months.) And the $30,000 is a flow demand that lasts for as long as the recession lasts. I'm not trying to reconcile the two. I'm trying to do the exact opposite. I'm trying to show that a small flow excess notional demand for money ($1,000 per year, or $2,000 per year if it's 6 months, or $500 per year if it's 24 months) could be compatible with a much larger and longer-lasting flow excess constrained demand for money. Because he's not trying to get a job just to put more money in his pocket. He's planning to spend most of it.

Kevin: "Which is fine; he’s not interested. But some of us are. For me, it’s still an open question and an interesting one."

Me too. And I can't think it's totally separate from the policy question. But I see his point. He's writing in the NYT, there's a recession on, he's a policy guy rather than a philosopher.

"Which I think demonstrates that Paul Krugman has a lot of "authority"."

The role of authority in terms of what is believed and not believed is worth a blog post of its own....

I think you can have a Keynesian coordination failure recession in a model without money. When George-Marios Angeletos was presenting his paper http://www.econ.umn.edu/macro/papers/2011_Angeletos-LaO.pdf at the Minnesota Macro Workshop in July, Bob Lucas pointed out that this is exactly what's going on in their model (which has no monetary exchange).

I had thought a bit about this and wondered if recessions should be viewed that previous accounting didn't adequately capture future assets and liabilities? We see in hindsight that GDP growth gets ahead of itself and companies and households improperly book future liabilities. When those liabilities come along, boom, GDP falls and a "recession" -- a few consecutive quarters of falling GDP -- happens.

"And that an excess of desired saving cannot create a recession unless it creates an excess demand for the medium of exchange."

What about buying the highest yielding asset that won't go down in value and won't be defaulted on? Is that considered medium of exchange? For example, I buy an FDIC-insured CD yielding 1% for 6 months.

Frances: yes, but do I have the necessary authority to write such a post credibly? I don't think so.

Joe: Yep. I would describe JW's model as just such a coordination failure model. But:

1. All models of inefficient recessions are, in a sense, "coordination failure" models.
2. Whether they are "Keynesian" models seems to me to be stretching things a bit.
3. There is something that seems very fishy to me about that paper you linked. Either the preferences and technology are somehow very special, so the results are extremely "fragile", or there's something wrong with the derivation, or there's some extra twist in the intuition that is not spelled out in the paper. Those results just seem wrong to me, but it would take me some time to try to figure out exactly where and how, or what it is I'm missing. But I wouldn't trust those results at all. Something is very wrong with that paper. My Spidey sense is ringing alarm bells.

jesse: optimism and pessimism probably do have a lot to do with the business cycle. But how to get from that to a fluctuation in excess demand for money, and excess supply of output, is the next step.

I think it's reasonable to call a model-generated recession Keynesian if it can occur in the absence of any shocks to "fundamentals" like technology, preferences, endowments, etc. A recession generated by an aggregate shock to expectations that makes people more likely to believe a bad equilibrium will occur is a Keynesian recession in its most basic form in my mind.

But yeah, the model is a little funny. Without the one-to-one island-matching construction it doesn't seem like any of the results would work out.

Joe: OK. The "animal spirits" sense of Keynesian. That's reasonable.

It's more than that one-to-one island matching. Something's seriously wrong there. But I would have to wade through thickets of math to try to figure out what exactly. My hunch is there should be a unique, efficient, rational expectations equilibrium in that model. Labour supply slopes up. VMP of labour slopes down. I think. So even if they all start out pessimistic, they ought to be pleasantly surprised when the two islands get matched, and expectations should converge to the REE as they learn. Unless it's because they only live 2 periods so can't learn?

I see what you mean now. I can't figure out why there's no learning either.

Analytically, it's hard to dispute Nick's points here. But something still doesn't feel right to me. One reason, is the aggregate demand shortfall=excess demand for money view, invites responses like this. If you don't have a story about how demand constraints can produce a stable low-output equilibrium, then at some point the mere persistence of high unemployment becomes evidence that it's a supply-side problem. Or in other words, in terms of the previous post, we've done an awful lot of 7, 8 and 9 over the past couple years, with limited effect. So if you think that doing 1 would be effective -- and I do! --, you need to be able to argue that it's somehow different.


I get the focus on money, but what if it's not money, but wealth. Money is one type of claim on resources and production, but so are property rights. I really like your examples of constrained demand, but I thought you were going the opposite way, to discuss the constrained demand for goods and services, rather than the constrained demand for money.

What if a large component of the issue really is, simply, that so many claims are tied up in the hands of a few, and, to the extent that they demand to exchange their claims, the majority of the claims they exchange flow right back to the hands of the few. Once this situation obtains, how are claims channeled to those who have no claims (or, even worse, owe claims they do not even have).

To use your language, the prices of goods and services are set not by notional demand, but by constrained demand. If the amount of money available to those who demand a good or service increases, then the constrained demand for that good or service increases, and thus the price of that good or service can increase (assuming steady supply, etc.). However, if the amount of money available to those whose demand for that good or service was previously unconstrained, then demand for that good or service does not increase.

That is, it would seem to follow that increasing the stock of money only increases aggregate demand for non-money goods and services (primarily) to the extent that it goes to those whose demand for non-money goods and services was constrained by a lack of money.

Thus, the answer to the question how do you increase constrained aggregate demand seems trivially simple: give money to those whose demand is constrained by lack of money. Obviously, however, politically this is a nightmare, which is why you see technocratic proposals such as Steve Waldman's to utilize sovereign equity to mitigate "the tyranny of zero". Alternatively, you can let millions languish doing nothing productive while millions of others would love to have the benefit of the goods and services they could have produced and provided.

(Well, OK, mostly 9 rather than 8 or 7. And really more 10 -- buying the liabilities of the institutions that are financing the investment projects. But the same logic applies.)

The chief problem I still have is visualizing in my head how a Keynesian recession is really a monetary recession. I just can't see how all that stuff about IS/LM, liquidity preference, savings > investment, actual interest rate > natural natural rate, etc. is really just describing a monetary recession. Even after all your valiant attempts, I can't see how Monetarist and Keynesian recessions are just two different correct ways of looking at the same thing. After several years, this is the last area of macro that I keep banging my head against the wall about.

For example, doesn't the theory of liquidity preference assume that the money market is always in equilibrium? Won't interest rates dropping make savings equal to investment? How can money demand be determined by both interest rates AND NGDP/Wealth at the SAME time?

In fact, concerning the income accounts, Consumption, Savings, and Investment are all really metaphysically the act of purchasing some asset in some marketplace. Yet, no one ever actually defines precisely what those three entail, especially savings. They are simply "spoken of," without being given a precise definition of which categories of assets fall under which terms and markets.

For example, is the quantity/horizontal axis of the loanable funds market the same thing as capital goods purchased, or is it something different? If it is the same, then all savings automatically becomes purchased capital goods by firms and thus savings must always equal investment... but if they are different, then obviously savings does not always equal investment. But if THAT is the case, then the model requires a separate "capital goods" market in addition to the loanable funds market.

Sorry for rambling.

Nick: I'm with you for garden-variety recessions, but with JW for the Greats - Depressions or Recessions. Years and Years of depressed activity will surely undo any stickiness in prices or the rate of inflation. Here I agree with Tyler Cowen and Casey Mulligan ( a sentence I never thought I would write!). But the Keynesians and Monetarists are absolutely right - contra RBCers - that a Depression is a great tragedy of wasted potential - not a long coffee break (was it Blinder or Tobin or someone else altogether who used this phrase to describe the RBC explanation of the Great Depression?) It is because they must see the silliness of sticky price explanations of a Depression, as opposed to a recession, but reject, rightly, the supply-side, Panglossian RBC account, that Keynesians are forced to put so much weight on the idea of a Liquidity Trap. I don't think it can bear that weight (although I used to think so). So that's why I think we need to take seriously the multiple real equilibria stories. I think some of what Farmer is doing - to the extent that I can understand it - is interesting. But I was struck recently re-reading Diamond's Wicksell Lectures on Search Theory by something he says in passing. After presenting his famous coconut model, he says that a more realistic source of strategic complementarities might be the credit market, because a lender's willingness to lend might well be increasing in the number of others who lend.

JW: To my mind, the persistence of unemployment and low output invites the question: why don't wages and prices fall? That's the question that worries me. Because if they did fall, and this didn't cure the problem, we could always argue that the AD curve is near-vertical in {P,Y} space. Or even slopes the wrong way due to Fisherian debt-deflation effects. Or say that falling P and W lead to expected future deflation which shifts the AD curve left. But they don't fall, they only rise a bit more slowly, or stop rising. So I have to fall back on some sort of absolute wage and price stickiness assumption. Or say that (somehow) the demand curves for goods and labour become less elastic in a recession, for which I have little or no independent evidence.

JCD: There is one (out of many) versions of Say's Law that is correct. The income we could collectively earn from selling the goods we produce and offer for sale must be sufficient to buy those same goods. Now, that doesn't mean we will *want* to spend all that income on buying those goods. And different people may have different propensities to want to spend. But you have to do something with your income, unless you decide to hold it in the form of money. We can all *try* to buy non-produced goods like antique furniture, land, bonds, etc., but we can't all succeed, if nobody wants to sell. So, ultimately, it's hold our income as money, or buy the newly-produced goods that people want to sell.

Joe: "After several years, this is the last area of macro that I keep banging my head against the wall about."

Join the club! I've been doing it for 40 years!

"For example, doesn't the theory of liquidity preference assume that the money market is always in equilibrium?"

Yep. But think about it. There isn't a "money market". All markets are money markets. Why does the fact that one particular market, the bond market, clears (for most people, since some people can't borrow) tell us everything we need to know about the demand and supply of money? I tried to tackle that point in my post:

http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/07/the-peanut-theory-of-recessions.html

"In fact, concerning the income accounts, Consumption, Savings, and Investment are all really metaphysically the act of purchasing some asset in some marketplace. Yet, no one ever actually defines precisely what those three entail, especially savings. They are simply "spoken of," without being given a precise definition of which categories of assets fall under which terms and markets."

Exactly! It's "saving" that is the problem. It includes: demand for newly-produced investment goods, demand for land, and antique furniture, and demand for stocks and bonds, and it also includes, crucially to my mind, the desire to accumulate a flow of the medium of exchange.

Kevin: "It is because they must see the silliness of sticky price explanations of a Depression, as opposed to a recession, but reject, rightly, the supply-side, Panglossian RBC account, that Keynesians are forced to put so much weight on the idea of a Liquidity Trap."

To my mind, there are two separate questions:

1. Why don't wages and prices fall?

2. If they did fall, would that help?

In the ISLM model, the liquidity trap makes the LM horizontal, and this makes the AD curve vertical. All that does is provide an answer to question 2. If the AD curve were vertical, or didn't cross the vertical AS curve, prices and wages would fall at an ever-accelerating rate. Now I know that some P and W did fall quite a bit during the 1930's. But they didn't keep on falling faster and faster.

I was struck recently re-reading Diamond's Wicksell Lectures on Search Theory by something he says in passing. After presenting his famous coconut model, he says that a more realistic source of strategic complementarities might be the credit market, because a lender's willingness to lend might well be increasing in the number of others who lend.

Now this is interesting.

(Not that the rest of the conversation isn't interesting too.)

Nick: I agree with you, I think. One of the reasons I don't think the liquidity trap can't bear all the explanatory weight it is given is that it would predict accelerating disinflation, which we don't see.

In response to me (first comment), Nick replies:

fmb: you might be onto something there. But my hunch is that if you developed it further, and added transactions costs as well as storage costs into your model, in the final analysis of the equilibrium to that model your "flexible" commodities might end up being indistinguishable, functionally, from "money". The "inflexible" goods would almost always be bought and sold for your "flexible" goods (with just a few "barter" trades on the side where the double-coincidence of wants just happens to line up right). In other words, you are doing monetary economics with deep microfoundations of money, while I am just assuming (shallowly) that people have to use monetary exchange.

Let me try a more concrete example:

In JW Mason's model, people essentially are bartering custom forward contracts: Adam will babysit for Barbara next Tuesday if Barbara agrees to babysit the following Friday. Given the nature of babysitting, there will inevitably be a period where one of these is closed and the other is still pending (e.g. next Wednesday). If we further allow Adam to propose to Charlie: babysit for me on Thursday and Barbara will babysit for you on Friday, then I think we have a situation where we can have a glut of current production: the clearing price for long-dated babysitting forwards in terms of short-dated forwards might start out at an equilibrium of 1:1, but, the Krugman argument about tokens can work about the same for long-dated forwards. If prices are sticky (lots of reasons that could happen here), it becomes hard to sell babysitting tonight in an attempt to accumulate future babysitting.

Perhaps you'll tell me that long-dated babysitting forwards for specific dates with specific sitters are money in this economy. If so, I think I might agree. But, wouldn't that be true of any remotely interesting barter economy?

[I may need to introduce credit constraints on some people to fully make this work: if Dan wants to hold a long-dated contract for its flexibility properties (he doesn't intend to use it on the date it is actually for, but has plenty of time to trade it for a better date), then he could just create one where he is the provider. However, if Dan is not trusted, then he can trade his service today for Ed's service tomorrow, but not vice versa. Clearly Dan needs to hold someone else's liability if he's ever to get an emergency sitter with no notice.]

The Great Depression's easy to explain (in the US.) Wages and prices fell quite a bit from 1929-33. That fits. Then we got a pretty good recovery, but it was delayed by some atrocious supply-side policies that sharply raised wages. So wages and prices stopped falling despite still high unemployment.

I'm still having trouble with the idea of excess demand for money. For some reason I keep thinking in terms of increased demand for money during recessions, not excess demand. Suppose you have an economy of affluent stockholders, like Singapore. But they also work and nominal wages are sticky. Now suppose the Cambridge K suddenly doubles, but the central bank adds no base money. Is the money market out of equilibrium for very long? I don't see how. Who has trouble getting all the base money they need? Not me. I'd just sell some stock. Remember that base money is a tiny percentage of total wealth.

But there's also the fallacy of composition. If everyone doubles their Cambridge K, and the base is unchanged, then NGDP must fall in half--really fast. Indeed almost right away. And if wages and prices are sticky you have mass unemployment when NGDP falls in half. But the money market is quickly back in equilibrium, it's the goods and labor market that are out of equilibrium. The unemployed workers sell stock when they need base money, and stock prices are perfectly flexible. No one has less base money than they want. NGDP has fallen in half, base money is unchanged, and people have the doubled Cambridge K they seek.

For two years the recession grinds on, until wages and prices fall in half and restore full employment. During that entire period the money market is in equilibrium--except the initial few weeks when NGDP plunged as people frantically tried to double their Cambridge K.

OK, I must be making a mistake somewhere, but I don't see where. Someone help me out.

Scott: "Who has trouble getting all the base money they need? Not me. I'd just sell some stock."

Why do you want base money? Sell some stock to the banks and get some new deposits. No fallacy of composition: everyone can get all the deposits they want.

Scott: the stock market is not the money market. Every market is the money market. The stock market may clear (since stock prices are perfectly flexible) but the excess demand for money still shows up in the labour market and the output market (and any other market that has sticky prices, but not in markets that have perfectly flexible prices). People are trying to sell labour for money, and if they were to succeed would plan to spend most of that money in the output market (and other markets, like the stock market). But they don't succeed, so we never observe that notional (flow) supply of money in the output market.

Exactly, these arguments quickly fall apart once the economy contains institutions (e.g. banks) that can supply as much money to the non-financial sector as they want. The purpose of central banking is to ensure that this happens, so if the CB is doing its job, bank liabilities are perfect substitutes for currency (and in may ways are superior to currency). At that point, the non-financial sector can easily double its money holdings without any increase in base money, merely by shifting their claims on the financial sector away from bond claims and towards deposit claims.

The fact that this has not happened shows that households already (and at all times) hold the proportion of money that they demand. There can never be an excess demand for money.

There can, however, be an excess demand for market wealth. Market wealth is extremely volatile. It is constantly re-valued up and down, and households see their real savings move up and down as a result, which causes them to adjust their consumption plans. Moreover, returns demanded for risky investments can be excessively high, so that firms will employ and invest less.

All sorts of things can go wrong, but the one thing that cannot go wrong is an excess demand for money. In fact, money is the *only* thing that is perfectly demand determined in the short and long run.

All other things -- the real capital stock, wages, prices -- take time to adjust. But the money holdings of the non-financial sector adjust in real time to exactly equal money demanded.

fmb: If I've got it right, I think Barbara's services are being used as a medium of exchange in your example, to resolve a case where there isn't a double coincidence of wants. If everyone's services can be used the same way, it's a barter economy, because every good can be traded against every other good.

rsj: assume the price of peanuts is perfectly flexible, but every other price is fixed. Then the peanut market always clears. Therefore there can never be an excess demand for money, since you can always get more money by selling peanuts.

Nick: Therefore there can never be an excess demand for money, since you can always get more money by selling peanuts."

If you have assets, you can just borrow the money. It's all borrowed anyways. No need to sell peanuts.

K: "borrowing money" = selling bonds. Peanuts are a metaphor for bonds, or anything else that has a flexible price.

OK. But I thought peanuts also meant something you couldn't sell to a bank. Therefore selling them doesn't increase the supply of money, which is the fallacy Scott was talking about (I think). Borrowing money from a bank can increase the money supply as much as we want.

RSJ,

Bank credit creates money.

If there is an unsatisfied demand for bank credit (due to lack of creditworthiness or insufficient bank capital), does that imply an excess demand for money, notwithstanding other adjustments in the system?

Or is that what you mean by the CB doing its job.

We need to distinguish "selling bonds" from "borrowing". If I sell you a bond that does nothing to the money supply. If I borrow money from a bank (sell a bond to a bank, if you want) then the money supply goes up.

K: OK, let me extend my original peanut theory of recessions slightly. Suppose there is a banker who will create as much money as we want, in exchange for peanuts. So the total stock of money is not fixed. And suppose the price of everything, except peanuts, is sticky. Does that mean there cannot be a recession? Does it really make any significant difference to the model? Start in equilibrium. Then destroy half the existing stock of money. All prices except peanuts stay fixed. The price of peanuts gets driven up as everyone sells their peanuts to the banker to get more money. Other than a few more workers who get jobs producing peanuts, it doesn't affect the equilibrium much.

Hmm. I'm not sure if that thought-experiment is at all clear. Never mind. It's late.

"Assumme the price of peanuts is perfectly flexible, but every other price is fixed. Then the peanut market always clears. Therefore there can never be an excess demand for money, since you can always get more money by selling peanuts."

How many peanuts you sell and at what price has nothing to do with the quantity of money held, nor with the quantity of money demanded.

FIrst, peanut selling and buying is a flow, and changes in flows do not cause changes in stocks.

The quantity of money is a stock. Demands for money are demands for stocks.

You cannot add a demand for a flow to a demand for a stock and conclude that the sum of these demands must be zero (or non-zero). The sum is not defined.

You can talk of walras law for flows or for stocks, or both, but you cannot combine the two as they have different units.


More importantly, whether the price of peanuts rises or falls has no effect on household deposit holdings. The failure of the peanut market to clear will not cause household to have more or less money.

What is important is that the household sector, as a whole, owns the discounted future earnings of the peanut producers -- whatever those earnings happen to be. That is the wealth of the household sector. This sector can choose to allocate and re-allocate that wealth in whatever proportion of deposits or bonds that it wants.

And this is the *only* way that the household sector can increase or decrease its money holdings. It must sell a bond for a deposit or buy a bond with a deposit. Flows of peanut sales can neither increase nor decrease household money holdings.

If, for some reason, the peanut market fails to clear and the NPV of the peanut producers dramatically falls, then household wealth declines as well. It is re-valued.

That will be borne by the non-deposit portion of household wealth (typically 80% of total wealth, with 20% of wealth held as deposits). If such a decline causes households to want to hold even more of their wealth as deposits, then they can do that.
As long as total wealth exceeds the quantity of money demanded, then households can shift their portfolios out of claims on peanut producers and into claims on banks. The peanut producers then sell bonds to banks instead of to households, and banks buy the bonds of the peanut producers and sell deposit liabilities to households.

It's a general portfolio re-allocation that can be performed at any time, and this re-allocation is not helped or hindered by the price of peanuts or whether the peanut market clears.

You would only get into problems when total wealth falls below the deposit wealth, in which case the government needs to backstop the banks. By definition, banks are insolvent in such a scenario. At that point, you can talk about a demand for money that the household sector cannot meet, but only at that point.

JKH,

Yes, that's what I meant.

Operationally, bank credit credit creates money, the repayment of debt destroys money, the purchase of bank non-deposit liabilities destroys money and the redemption of bank non-deposit liabilities creates money.

Therefore additional bank capital is not required to cause the quantity of deposits to increase or decrease. However, if the banks are insolvent, then yes, you can get into real problems.

rsj: but we also own a stock of peanuts. I can sell part of my stock of peanuts for a stock of extra money. And if we want to increase our stock of money over time, at so many dollars per month, that is a flow of dollars per month, and can be met with a flow of sales of peanuts.

BTW, you do realise I was being ironic, when I said "Therefore there can never be an excess demand for money, since you can always get more money by selling peanuts."?

fmb: If I've got it right, I think Barbara's services are being used as a medium of exchange in your example, to resolve a case where there isn't a double coincidence of wants. If everyone's services can be used the same way, it's a barter economy, because every good can be traded against every other good.

Your restatement sounds approximately right. More precisely, though: Barbara's promise to deliver a specific service on a specific future date is, ex post, being used as a medium of exchange, though at the time Adam bartered for it he might have intended to consume it (possibly even with high probability). My intent was that anyone who can produce a credible and transferable promise to deliver something in the future presumably could find their promise re-bartered, even if that was an unusual occurrence. Every good can be traded against every other, but only some can be re-traded, and not everyone can produce goods with that property.

So I think you've agreed that my set up counts as barter. Do you also agree that it has the "hard to sell" feel I'm trying to create? It may be a stretch, I'm not completely sure I agree myself, but I can't yet pin down a specific flaw. Obviously you can't have stuff that's hard to sell without other stuff that's easier to sell, but I think that (in any non-trivial barter economy) there's a spectrum from use-it-or-lose-it goods (like spot labor) to slightly re-barter-able goods (like apples, or promises to provide future services), and that price stickiness between ends of that spectrum can make either end "hard to sell" while the other is "easy". To me, when spot labor and similar goods are hard to sell (and rebarterable goods easy), it will feel like a recession, and when it's vice versa, it will feel like a boom.

Note that the current recession has this counter-balancing flavor, too: credible claims on future production are hard to buy.


Nick: I think it matters whether they sell the peanuts to the bank (QE) or just borrow with peanuts as collateral. In the first case, the banks deposits become a proxy for the value of peanuts. In the latter, the value of money can still be independent of the price of peanuts. If bank assets could truly be made up of the consumer basket and we could exchange deposits for that basket on demand, we'd obviously have no more money problems. Alas.

Nick, if you get a chance to look at my lengthy reply to you on the Response to Paul Krugman post, I would be very grateful. rsj, there's a (minor) comment for you there too.

Nick's post said: "Suppose there is a banker who will create as much money as we want, in exchange for peanuts. So the total stock of money is not fixed."

I'm going to skip the peanuts part. Does that mean for the amount of medium of exchange (demand deposit(s) for banks) to increase that someone has to go into debt?

EDIT: "debt" to "currency denominated debt".

Too Much Fed: either a bank has to buy something or someone has to go into debt. Mostly, by far, it's the latter. So generally the answer is yes.

fmb: Let me give my interpretation of what you are saying: there's a spectrum of goods, from the most liquid to the least liquid. In normal times, it is very easy to swap 2 liquid goods, very hard to swap 2 illiquid goods, and moderately easy/hard to swap a liquid good for an illiquid good.

Now I've lost it.

What happens in a recession? Think about that intermediate case, where a liquid and illiquid good are being swapped. Is there an asymmetry? Does the seller of the liquid good have an easier time than normal, and the seller of the illiquid good have a harder time than normal?

Because that's what I think recessions look like. And your model seems to be looking like a generalisation of the model in my head, where "money" is just the good at the most liquid end of the spectrum.

K: "Nick: I think it matters whether they sell the peanuts to the bank (QE) or just borrow with peanuts as collateral. In the first case, the banks deposits become a proxy for the value of peanuts. In the latter, the value of money can still be independent of the price of peanuts."

I was trying to get my head around that as well. I think I disagree with you though. In principle, you could sell peanuts for money, but the money might be denominated in something else. In other words, peanuts don't have to be the medium of account.

Brad DeLong's thought-experiment: suppose the unemployed could pan for gold, and gold is money. In effect, they are "selling" their labour for gold. If there were plenty of gold mines, without diminishing returns to labour input (a horizontal MPL curve), this would be a very good self-correcting monetary system. The unemployed all go off panning for gold, and the extra gold cures the recession. (It's theoretically the same as printing CB money to pay for UI/EI, or make-work). But if the MPL curve in gold mining slopes down steeply, the self-equilibrating mechanism would be very slow to work.

Actually, I'm just going to steal what Brad DeLong said. Forget my "peanut theory of recessions". Think about this one:

"There cannot be an excess demand for money under the gold standard. If there were, people would just go and mine gold and get more money, both individually and in aggregate."

It is true that there could never be an excess supply of labour. The unemployed would just go off and pan for gold. But if the Marginal Product of Labour curve in gold mining sloped down steeply, the flood of unemployed panning for gold would push wages down so low in gold mining many would stay at home instead.

Liquidity isn't quite right (re-barter-ability is more what I'm after), but I think we can proceed without straightening that out. Yes, the asymmetry you propose is arising in my model.

And yes, I'm trying to generalize your model to suggest how similar-feeling recessions could happen in a minimally interesting version of a barter economy ("MIVBE"). I could certainly accept that there's no such thing as a MIVBE, that there are only trivial barter economies and monetary economies with nothing in between. But, I think that requires that you have a more inclusive definition of "money" than I previously expected you had. "Money" in my MIVBE is a bunch of tiny non-homogeneous barely-fungible rarely-re-traded goods.

When you say you can't have a recession in a barter economy, are you restricting that to only trivial barter economies? I wonder if there's a MIVBE you think has no money. I think you need very few things before something will take on enough money-like properties to create the potential for Rowe-recessions.

Scott --

I think there is a big semantic component to your distinction here. In your world, the excess demand for money is quickly satisfied by an increase in real balances with respect to stock prices *and* with respect to newly produced goods (NGDP has finished its descent until k is satisfied). Okay, NGDP has already fallen (stage 1 is over) and so wages and other sticky prices are too high relative to money and flexible prices. This can be reasonably be described as a relative price distortion, but it can alternatively be described as a constrained equilibrium. There is no excess demand for money at current NGDP. But... there is an excess demand for money relative to notional NGDP (NGDP at full employment). By definition, a quasi-equilibrium where the demand for money is not increasing at current depressed output but is too high to allow for full output requires either that 100% of prices are equally stick or that price distortions exist. I'm not sure it matters whether you describe that moment in terms of the stickier prices or inadequate money relative to notional demand.

Nick, You have a definition of excess demand that I have trouble understanding. When I hear the term "excess demand" I think in terms of shortages. You can't buy as much gas as you want because the price is controlled. You can't get those Rolling Stones tickets you want because they charge less than equilibrium. You want X, and you have less than X. But that's not true for base money, except for a very short transition period. You want X dollars of base money and you have X dollars. There is no stock shortage. NGDP adjusts to provide equilibrium. You have an excess supply of labor, but that would still be true if workers were paid in some sort of non-base money assets, and the wages were fixed in terms of a given US dollar market value of that non-base money asset (say gold or forex).

On the other hand I can't think of a single practical implication of my criticism of your post--which makes me think I am wrong. Everything meaningful should have a practical implication--if it doesn't it's probably not meaningful.

As far as the question of whether recessions are monetary, the practical implication is that monetary policy can prevent recessions due to wage and price stickiness. We both think so. But I think that's all we can ever mean by saying recessions are monetary. One can never say recessions are "intrinsically monetary." It's all about policy counterfactuals. One might also be able to prevent recessions with an optimal wage/price indexing scheme, with monetary policy playing no role.

Re: Scott Sumner, substitute "excess supply of non-money goods" for "excess demand for money" and the implications follow. You can't sell goods, because they're being priced too high in terms of money. (Or perhaps, if you prefer, money and peanuts and all other flexibly-priced stuff.) You want to exchange X goods for Y money+peanuts, but you can't, because there is a glut of goods and a countervailing shortage of money.

"There cannot be an excess demand for money under the gold standard. If there were, people would just go and mine gold and get more money, both individually and in aggregate."

People can go panning for gold even today. No one has trouble selling gold.

But try telling an unemployed person to pan for gold -- it's crazy. To mine for gold today is extremely capital intensive. This has nothing to do with being on the gold standard or not.

Why not hand them a bucket and ask them to dig up some crude oil instead?

With this, as with anything else, the problem is that firms are not hiring. And firms are not hiring, even though they are earning record profits, because the return expectations placed on them are too high.

If that is the case, then there is no difference between asking the unemployed man to borrow a few hundred million to start his own mining company, or asking the gold miner to hire the unemployed man.

In both cases, it doesn't pencil out, and not because we are on or not on the gold standard. It doesn't pencil out but because neither the unemployed man, nor the firm that is deciding to expand production expects to earn the return demanded of them given the current environment.


As David Hull explains, horses as biological entities are _not_ natural kinds with necessary & sufficient conditions for class membership. Darwinian biology helps us to appreciate this fact -- horses are particular temporal individuals taking part in an historical process, where the larger "historical individual" of the population of reproducing and evolving replicators is tied together by historical chains of causation, and not any fixed set of Platonic qualities.

The lesson from the philosophy of biology / science is that are causal explanatory mechanisms help us to understanding various things about the nature of things -- but this doesn't necessarily happen through the classic image of providing Platonic definitions of particular historical entities or exemplars.

Nick writes,

"How should we define "horse"? Dunno either. But I think I know one when I see one."

Nick, your reply to my objection just won't do.

But I think you are on the right track, in pointing to patterns that -- for generations -- have been associated with booms & busts.

So, let's start with first things.

Most of science begins with problem raising patterns in our experience -- e.g. the problem of the concomitant origin, transmutation, adaptive specialization & geographic dispersal of species.

The puzzle raising patterns grab our attention first -- then aspects of those patterns are highlighted and shaded out and their significance re-colored by alternative attempts to causally explain those patterns. Imagine examples from the history of Lamarckian or Darwinian biology.

Now, something important needs to be flagged right off the bat.

There were problem raising patterns -- for which trade cycle language was used -- that attracted widespread attention before much of any theorizing ever took place.

Here is what is of signal importance. These patterns showed far more structure than is suggested by your own account, Nick.

The "stylized facts" identified with 19th century booms and busts showed all sorts of structure, changes in prices and demands in different sectors of the economy across the course of the boom and bust, as sketched briefly in Hayek's _Monetary Theory and the Trade Cycle_, and elsewhere.

Now, here is an important set of facts. When theory comes in, two important things happen. (1) The empirical patterns are perceived differently; and (2) what is quantified and measured changes, and even what is talked about as taking place changes. This is a common theme in the philosophy of science, well documented by Thomas Kuhn in his books and essays.

So what happens when the image of a "general glut" takes hold -- and an explanatory project involving mathematical tinker toys and premised in that images begins to dominate the imagination?

Well, people stop seeing or attending to all sorts of patterns taking place in front of them -- their interests are elsewhere, and their quantities and measurements are of other things.

The historical entity which is the evolving concept of "the trade cycle" evolves and becomes transformed -- a concept once grounded in the complex and patterned experiences of businessmen is replaced by the narrowed vision and narrowly conditioned empirical diet of paid explorers of the "general glut" paradigm.

Hundreds of miles of mothballed lumber hauling rail cars are not seen -- are not measured -- and are not even imaginable. Nor Iphones & Ipads selling by the tens of millions, or boom regions like the oil lands of North Dakota. Such structural _non-glut_ phenomena -- which can exhibit itself in patterns across both geography and time -- simply doesn't come into focus when one is using the "general glut / excess demand for money" lens to (1) assemble empirical patterns; (2) see empirical patterns; and final (3) to account for them.

Very tired, so I'll wrap up.

If we start with a more theory-neutral set of problem raising patterns that typify the "stylized facts" of hyper growth and consequent recessionary phenomena, we find that there is far more structure than is suggested or implied by the "excess demand / general glut" picture.

And these facts can be accounted for by a causal mechanism whereby specialized resources are misallocated across time -- only to be discovered after the passage of time during time-consuming production processes when eventually unanticipated competition for scare goods leads to excess demands, scarcities, losses, and business failures.

The misallocation comes about via distorted prices in financial markets, snowball effects, the lack of transparency, the expansion of leverage, etc. -- pathologies of the sort we've seen with Fed interest rate policies, Fannie & Freddie & the CRA, and all of the other pathologies recounted in a series of best-selling books on Wall Street, credit default swaps, securitized mortgages, and the housing bubble.

So "money" -- the existence of credit, interest, currency, debt, banking, financial instruments, etc. -- is what allows for the distortion of the economy into an unsustainable misallocation of specialized resources.

But if an "excess demand for money" occurs, this is an _effect_ of the prior miscoordination -- whose unavoidable discovery causes the collapse of shadow moneys and the illiquidity of near money financial instruments.

So so you can have discoordination / recessionary consequences from "the excess demand for money", but these are secondary effects of the ultimate explanatory cause. I.e. the "excess demand for money" explanation is a proximate cause -- which may or may not have large effects -- but it is not necessarily the underlying and ultimate cause.

In other words, there is a viable and empirical sound alternative causal explanatory frame, and it can't be ruled out by any stipulative definition of the word "recession".

This doesn't mean that an "excess demand for money" can't be the cause of a recession. It simply means that there is no necessity that it must be the cause of a recession, and, indeed, this causal factor may be the causal offspring of a deeper, more fundamental ultimate causal mechanism, of the type described above.

rsj: when I said

"There cannot be an excess demand for money under the gold standard. If there were, people would just go and mine gold and get more money, both individually and in aggregate."

you do understand I was using irony, right? I was saying something I knew to be false. I was drawing a parallel between the above and the argument I commonly hear:

"There cannot be an excess demand for money today. If there were, people would just go to the bank and borrow more money, both individually and in aggregate."

If the first is false, so is the second. If the second is true, so is the first. I believe both are (generally) false. Only under very special (imaginary) circumstances will they be true.

Greg: interesting pair of comments. I won't (can't) respond fully. But I will say I agree with you in seeing the excess demand for money as the *proximate* cause of the recession. Something else caused that excess demand for money. And that "something else" could be a number of things. It might be the central bank suddenly reduced the supply of base money. Or bank failures. Or something that increased the demand for money.

Scott: "On the other hand I can't think of a single practical implication of my criticism of your post--which makes me think I am wrong. Everything meaningful should have a practical implication--if it doesn't it's probably not meaningful."

That's sort of the point I was trying to make in my peanut theory of recessions post, where the price of peanuts is assumed to be perfectly flexible so you can always get more money by selling peanuts. And I was trying to make the same point again above when saying that, under the gold standard, the unemployed could always get more money by panning for gold. It's true, but (generally) it doesn't have any practical implications.

Nick, earning money by panning for gold is income. I would agree 100% with you if you just took all of your flow market conditions, and used a flow of money -- income. Divide by t! But when you divide by t, then the central bank no longer helps, because it is conducting asset swaps.

So when you say if the first is false then so must the second, then I would say this is not the case.

Earning income by panning for gold is not the same as a portfolio shift. One is a demand for flows and the other is a demand for stocks. One is a demand for income, which OMO cannot satisfy, and the other is a demand for assets, which OMO can satisfy.

rsj: assume the flow of mined gold is fast, relative to the stock of gold. Assume the CB's flow of asset purchases is slow, because they can only process so many trades per day. We can make them the same on the stock/flow question.

Is the flow of mined gold part of income? If all the new gold is used as money? Accountants would say "yes", but economists would say "no", it's not really part of *national* income, any more than a counterfeiter's income is part of income. You can't eat it. It will *cause* an increase in income, if it cures the recession. But it's not itself income. For example, if you were at full employment and had perfectly flexible prices, and diversion of labour into gold mining would lower utility, since fewer useful goods are being produced.

"Accountants would say "yes", but economists would say "no", it's not really part of *national* income, any more than a counterfeiter's income is part of income. "

OK, but aggregate economics, if it is to have micro-foundations, must require that behavior is sourced from individual choices.

And individuals do not care about the national accounts, they care about their own accounts.

Assume individuals want $100 in savings in case they break a leg and can't work for a week.

But if they only have $50, then they will all want to save $50.

Obviously they cannot all save $50 unless firms decide increase investment by $50.

But in the face of declining sales, firms may not increase investment by $50, even if the overnight rate is cut.

And if the central bank offers to swap $10 of households savings (which are in the form of capital) and replace them with $10 of cash, then households still only have $50, and they are still $50 short.

So the recession continues even as the central bank is madly rushing to exchange bonds for cash.

And the recession will continue until households believe that prices are permanently 50% lower (so that if they break a leg in 2 years, they can still get by on the 50 bucks), or until households can obtain $50 of additional savings, whether by gold raining from the sky, or export income, or some other mechanism that increases their net-worth.

Alternately, the recession may end if the government promises to provide for anyone who breaks a leg, so that the demand for saving $100 is reduced to a demand to save only $50.

But in all these cases, open market operations are impotent, and promising more inflation is harmful.

Is a "excess demand for money" EXACTLY the same thing as a "shortage of AD"? I.e., you can not observe a exess demand for money in itself - but whan a lot of people want to supply stuff and no one is bying there has to be a "excess demand for money" due to Say´s law?

Furthermore - is a "excess demand for money" always a "exess demand for savings" given current prices and subjective expectations (why else would it matter whether we barter or use money)?

Fianlly - does the "money supply" have a "price"? Is the interest rate the "price" - and, if so, is the "price" of money always zero in a static framework?

dlr, I basically agree, it is a question of semantics. The question is which semantics are most useful. I could say:

1. NGDP is too low, and because wages and prices are sticky we have suboptimal employment.

or I could say:

2. There is a shortage of money, which we know because NGDP is too low, and since wages and prices are sticky we have suboptimal employment.

Or I could say:

3. There is no shortage of money, but the demand for money rose, and in the new monetary equilibrium NGDP fell until the desired Cambridge K was reached, and since wages and prices are sticky we have suboptimal employment.

I'm having trouble seeing how monetary disequilibrium allows me to better understand the problem. Example 3 doesn't use monetary disequilibrium, but it seems to describe the problem just as effectively. Are there any policy implications from insisting on disequilibrium?

Scott --

Are there any policy implications from insisting on disequilibrium?

I think the answer is no, but I think there are probably pedagogical implications. Policy conversations often start "in the middle," i.e. without reference to a more complete model. It's confusing to many people who haven't thought through a money-centric model to connect later-stage relative price distortions with the supply and demand for the medium of account. Although sticky prices is the short answer it is often intuitively inadequate. A story that starts and ends with an inadequate supply of money relative to demand often forces the telling of a more complete picture.

Most of Nick's best posts are about forcing people who speak different languages to tell each other some rough version of their complete model so they can figure out where they disagree. So he concludes that the QM IS curve slopes up (I don't like that one) or that MMTers implicitly or explicitly believe there is no meaningful relationship between the real interest rate and savings/investments, so the IS curve is either vertical or can't be drawn. Here, there is nothing to tease out because it's the identical story, but telling it from both angles is still worthwhile because not everyone will realize it.

rsj's last comment has me a little confused. Here the demand for precautionary savings takes the form not of a demand for liquidity, but a target ratio of net worth to income. For the community as a whole, net worth is just the stock of capital goods. So in principle, households should satisfy their demand for precautionary saving by simply purchasing less consumption goods, and more investment goods. The problem seems to be the separation between households and firms. Given that only firms spend on capital goods, households can't buy them directly but have to buy financial claims on their future output. Now if the firm could offer those claims directly, again, there wouldn't be a problem, but in fact those claims have to take the form of money, the supply of which is fixed exogenously. And when households try collectively to buy more money than the existing stock, that doesn't send a signal to firms to produce more capital goods. The opposite, since what firms see is that it's harder to sell their current output.

So I'm confused when I read this:

And if the central bank offers to swap $10 of households savings (which are in the form of capital) and replace them with $10 of cash, then households still only have $50, and they are still $50 short.

If households own capital goods, then why do we need the firms to be the ones investing in order to increase net worth? On the other hand, if the central bank is buying capital from firms in return for money, then that should send the correct signal to firms to increase investment. You can't simultaneously assume that a change in household saving implies an equal change in investment by firms, *and* that households own capital goods directly.

And I don't think we want to throw out the distinction between more and less liquid assets. I think precautionary saving really has to be demand for liquidity.

It might be time to retreat a step.

I've been on the side that wants to deny that demand constraints are strictly equivalent to excess demand for money. But it may be better to admit defeat at the level of abstraction we're talking at here, and say instead that while the two may be formally equivalent it's better to distinguish them in practice. A couple reasons:

1. In the real world, there isn't an observable *substance* money (belief in a discrete measurable money stock is what distinguishes old-school monetarists) but instead a *property*, liquidity, which is distributed in different proportions across a whole range of assets. This makes it hard to know in practice how much, or whether, a given central bank operation in the financial-asset market is actually changing the liquidity available to the private sector. It's much more reliable to start from the least-liquid end of the spectrum (labor) than from the most-liquid end. As soon as monetary policy involves trading money for stuff that also can function as a store of value, the net effect on liquidity gets fuzzier.

2. Even though it's true, in a formal sense, that insufficient demand for currently-produced output equals excess demand for money (where "money" means the moneyness embodied in all kinds of assets) we really don't see in the aggregate anything that looks like a well-defined money demand function. (Outside of housing, it's very hard to find real activity with an economically significant responsiveness to interest rates.) I think this is because binding credit constraints are ubiquitous, and most private borrowing involves large additional costs for both sides. (It may also be important here that the most important economic units are maximizing wealth rather than consumption.) The result is that even though there is excess demand for money in the aggregate, it is hard for an injection via monetary policy to flow through the financial system to the units with excess demand. Here, I think, is the genuine coordination-failure aspect to real-world recessions. (It also suggests that the effectiveness of monetary policy historically was more dependent on the specific institutional regulatory structure of the financial system than we usually acknowledge.) So again, it's likely to be much more effective in practice to focus on the insufficient demand for current output, rather than the excess demand for money.

I don't know if it helps you, JW Mason, but on a previous thread Nick said he was odd in insisting that all recessions are monetary. It was in the context in which I asserted that there is more than one kind of recession.

The thread eventually came to the conclusion that when economic activity falls due to supply constraints, that is a "contraction", not a recession. It is a supply side problem.

A "Recession", OTOH, is a demand-side problem. Money is scarce, or there is an excess demand for money, because we observe a glut of good in terms of money but lower economic activity and there is an output gap with idle capacity.

Nick said he doesn't agree with my dual supply-side/demand-side description of periods of economic activity and that he is odd in this.

I have made it my personal mission to get the world to describe supply-side slumps as "Contractions" and demand-side slumps as "recessions" and not confuse the two.

Thanks, Determinant. But I'm coming from somewhere different. My view is that all short-term declines in output in modern economies are demand-determined. It is never the case (outside of wartime) that an economy that is not primarily agricultural faces a short-term decline in aggregate supply of several percent of GDP over a few quarters or a year. So I don't think contractions in your sense exist.

I think this view is widely shared. Thirty years ago, it was universal. I think it still is universal outside of economcis departments, in the world of professional forecasting in government and business and the like.

The question is, is the statement that all recessions are demand determined, the same as the statement that all recessions are due to an excess demand for money? Nick says Yes, and that's the claim -- I think -- that he was acknowledging is not widely shared. I'm one of those who says No, but I'm undecided if there is a difference in principle, or just in practice.

J.W.

"For the community as a whole, net worth is just the stock of capital goods."

What matters is the position of each individual on their life-cycle savings path. Their real market net worth is the resale value of the assets that they hold, divided by the price of consumption -- we are assuming that households are saving in order to sell of their assets (to someone younger, or who is not in trouble) and use the proceeds to purchase consumption at a later time.

To be strictly accurate, what matters to households is the expected future re-sale value of their assets at the time that they expect to sell those assets and purchase consumption.

Therefore asset prices and real wealth of individuals diverges from the market price of capital equipment and software, as it includes non-produced goods such as land, and even for claims on firms that sell into the output markets, the market value of the firms take into account things such as human capital, market power, brand name, the expected future state of the above, current and future inflation, as well as current and future nominal interest rates.

None of the above factors can be purchased in the output markets. Nothing forces total household net worth to be equal to the size of the capital stock -- if one could even supply a convincing definition of the latter.

Therefore it is not the case that for each dollar of income one saves, one dollar of newly produced investment goods are purchased in the output market. There is no asset-price policeman forcing this occur.

Rather what we observe is that firms purchase fewer investment goods as their market value decreases, just as households invest less in residential investment when house prices decrease.

Moreover, we observe that as households decrease their consumption expenditures, firm earnings decline, and the market price of firms declines as well. As savings is, by definition, the change in net-worth, households experience less savings in aggregate as a result of trying to save more individually.

We do not see a spill-over from the consumption goods market to the equity markets so that a decrease in the demand for consumption must be matched dollar for dollar with an increase in the demand for equities, leading to a reduction in the overall cost of equity.

I think (hope) we can all agree that the above dynamics are what we observe.

In that case, how to explain it?

This may appear to be a violation of Walras' Law. One out is to say that there is no Walrassian auctioneer, so prices are stuck at some bad level.

Nick Rowe's favorite explanation is to point out that Walras' law is meaningless in a monetary exchange economy. If there are N types of goods, then there are effectively N Walras' Laws, and you learn nothing.

My favorite explanation is similar to Nick's but is a bit simpler. I prefer a model in which there are two different types of markets: markets for stocks and markets for flows. These correspond to balance sheet and income operations.

Buying and selling in the markets for stocks -- e.g. equities, bonds, deposits, corresponds to portfolio shifts. Those are balance sheet operations. That's what central banks do.

Buying and selling in the output markets in which consumption goods, investment goods, and labor is purchased correspond to operations recorded on the income statement. Government intervention in these markets is fiscal policy.

Everyone participates in both types of markets.

Even if we were to have a Walrassian Auctioneer, there would not be one Walras' law, but two laws, in that the sum of excess demands for stocks is zero and the sum of excess demands for flows is zero. But an excess demand for flows does not spill-over into an excess supply of stocks or vice-versa.

Therefore, if the only firm in our economy was Walmart, then nothing forces an increased demand for shares of Walmart stock when households decide to purchase fewer goods at Walmart.

More generally, a reduction in the demand for consumption goods does not spill-over into an increase in the demand for assets. It can spill-over into an overall reduction in income. There is no need to posit that prices in either market are rigidly fixed. We do not need to shoot the auctioneer just yet. It is enough to split him in two.

And in no market can an individual purchase "savings". Rather savings is an ex-post accounting state, not a good that is bought or sold in any market.

The core of the problem is that when individuals take steps to obtain more savings -- i.e. they purchase less consumption -- then the net result is that firms see their earnings decline, which causes their stock values to fall, and this decreases, rather than increases, firm demand for investment goods, as well as decreasing the net-worth of the households.

In order to make the above very simple, I need to posit that there are no consumer durables. Consumer durables throw a wrench into the process, but I don't think this assumption does a lot of violence. As households do not purchase consumer durables in order to re-sell them at a later time to fund their retirement or in case they become ill. Just assume that households rent all consumer durables from firms.

rsj: your explanation also shows why central banks and monetary policy is not enough to end all recessions: the CB has no direct influence over the flow market.

It also shows that Nick is wrong: recessions are not an artifact of money but an artifact of the market of stocks - which can occur in barter economies as well.

Suppose you had a discrete time model. Purchases of flows and stocks are then indistinguishable. We can add them together. Every week I earn an income of $100, and can either buy $100 worth of apples, or add $100 to my stock of bonds, or add $100 to my stock of money (or any mixture).

M(t)-M(t-1) +B(t) -B(t-1) = Y(t) -C(t) is the only budget constraint.

Take the limit as the length of the period goes to zero and we move to a continuous time model. (This actually gives the bizzarre result that you would never hold a stock of money if bonds gave a higher rate of return, markets were open continuously, and all individuals were always participating in each market, because you would switch between bonds and apples via money holding the money for only a millisecond, but never mind that).

Then yes, the budget constraint bifurcates, because Y and C cannot go to plus or minus infinity.

You get M+B=A for stocks, and Adot=Y-C for flows. Where A is the total stock of assets.

But:
1. You can still meaningfully talk about the flow demand for M and B. ("I want to increase my stock of money at the rate of $1 per week and increase my stock of bonds at the rate of $2 per week".)

2. Both discrete and continuous time versions of the budget constraints leave something very important out: money buys goods (and bonds), and goods (and bonds) buy money, but goods (and bonds) do not buy goods (and bonds). (Clower, paraphrased by adding "and bonds"). You get your income in money, spend some of that money to buy apples, spend some more to buy bonds, then keep what remains in your pocket.

Whether we model in discrete time or continuous time ought to be (approximately, in the limit) irrelevant. If it isn't, there is something seriously wrong with what the modeller is saying about the world.

Regardless of the discrete/continuous time question, the budget constraints by themselves ignore the crucial fact of monetary exchange. Why don't the unemployed hairdresser, manicurist, and masseuse simply barter for each other's services, and get back to full employment that way, even if each of the three women would prefer to accumulate a flow of assets from the fruit of her labour?

To say the same thing another way: where in any of those equations do we see that it is "M", rather than "B", that is used to buy and sell everything else? We don't. There is something seriously missing from a model which just has budget constraints and preferences and technology. We need to say something about what markets exist, and what markets don't exist.

Nick, the point about distinguishing between stocks and flows has to do with the auctioneer process. Assume the stock of capital goods is 100 units. The flow of production is 10 goods per year. If your time period is 1 day, then an increase in the flow of capital goods produced -- i.e. investment -- will have a negligible affect on the market clearing price of capital goods. The price of capital goods doesn't clear savings and investment flows -- it can't, as the units are all wrong.

In the continuous limit, it has zero effect. In this sense the markets bifurcate.

That is why the auctioneer, when determining prices, needs to distinguish between supply and demand for stocks versus flows.

Changes to demands in the flow markets don't cause prices in the stock markets to shift, and that is really the point.

When households decrease consumption expenditures, interest rates need not fall.

I like to think of consumption services delivered as flows, capital goods as persistent stocks, and flows of investment and saving.

"1. You can still meaningfully talk about the flow demand for M and B"

In the auction sense, "demand" corresponds to a bid in a market. We can also use "demand" more generally to mean "desire". But if there is no market, then we shouldn't really talk about excess demand.

While there may well be a desire to have your bond holdings grow by a certain number of units per day, there is no market in which this desire can take the form of a bid.

Rather, having this desire, you alter all your other bids. You may decide to enter a series of bids in the labor market and in the consumption market in such a way so that your bond holdings can grow.

But the auctioneer clears the actual bids, not the desires behind the bids.

"where in any of those equations do we see that it is "M", rather than "B", that is used to buy and sell everything else? We don't."

I don't think this is necessary. I want something as close to the walrassian model that still gives me recessions similar to what I observe in the world. As long as the price of capital doesn't adjust as much as it should when households consume less, then I have my recession. This suggests (to me) that what is used to buy and sell isn't a fundamental cause of the recession.

Btw, it is rational to hold deposits under any time scale, if you add transaction costs and take risk aversion into account. You could, in principle, buy shares of IBM with your paycheck, and then sell shares of IBM as you spend. But if you have to pay a small fee each time you do that, and if you know that you will spend 80% of your paycheck, then you will want to keep a certain amount of deposits around to minimize your transactions in the stock market and to minimize your exposure to changing stock prices. So you can say that whenever your consumption expenditures exceed your income, then you are hit by fee unless you have enough deposits to cover the difference.

I think this is closer to describing the reality of why people hold deposits.


recessions are not an artifact of money but an artifact of the market of stocks - which can occur in barter economies as well.

This is pretty much what I was trying to say a bit earlier in these comments (about barter economies having "hard to sell" recessions, September 16, 2011 at 11:57 AM), but Nick seemed to suggest that the stock-ish goods were playing the role of money and that they weren't actually barter economies.

Even in barter, the hairdresser and manicurist only trade by, e.g. the hairdresser getting a manicure and delivering a "haircut bond" (perhaps maturing immediately after the manicure). If everyone is a good credit, they can create bonds denominated in their products of arbitrary maturities and trade them to satisfy any immediate consumption demand. If some people become bad credits, they will want to sell their current labor to accumulate a stock of bonds denominated in the products of good credits, but sticky prices might make that hard to do.

Is this still barter, or did I just describe a monetary economy with a zillion currencies and a very incomplete cross-rate market?

where in any of those equations do we see that it is "M", rather than "B", that is used to buy and sell everything else? We don't

My goal has been to offer examples of barter economies were it is B that is used to buy and sell everything else, with no M. Indeed, I think most barter would act that way, with a zillion customized bonds being created as one leg of most transactions. Perhaps once some of those start getting re-bartered they become M.

dlr, I think you make a very good argument--it is more intuitive to think in terms of a shortage of money.

My view is non-intuitive on two levels. The hot potato effect is less intuitive than say interest rates, and the sticky price explanation of why nominal shocks have real effects is also very non-intuitive. Put them together and you lose almost everyone.

I'll probably continue to think in terms of monetary equilibrium and sticky wages, because I don't have a problem with the intuition (having spent my whole life thinking about it.) But I think you are right that Nick's approach is a better way to sell the importance of money to the broader public. But even there you have to take care to distinguish between people not having enough "money" as a medium of exchange, and not having enough "money" as wealth. Most people find the latter a more intuitive explanation of demand shortfalls.

Wow, what a fantastic discussion.

rsj, I'm not sure I fully understand your reply. I'd like to go through it step by step and see if I'm following you, but a couple questions first: Would you say the story your telling here is basically equivalent to Keynes in the General Theory, or does it depart in some important way? Or is there some other body of theory that you're summarizing here, maybe even something you've written? Reading blog comments without context, it can be hard to tell what's being assumed, and what choice of words is important.

rsj: "Changes to demands in the flow markets don't cause prices in the stock markets to shift, and that is really the point."

Let me rephrase.

Changes to flow demands do not cause discrete jumps in equilibrium prices of stocks, unless they cause discrete jumps in stock demand.

I agree.

But does it work the other way around? Do changes in stock demands cause discrete jumps in equilibrium prices of flows?

I think they do.

Suppose people want to hold more land and less capital (but no overall change in desired flow of saving)? The equilibrium price of land rises relative to capital, and the equilibrium price of flows of newly-produced investment goods will fall relative to capital and land rentals.

Suppose people want to hold more money and less capital (but no overall change in desired flow of saving). If the stock of money does not adjust, the equilibrium price of money (i.e. 1/the price of goods) will rise. Equilibrium goods prices fall. If they are sticky, and can't fall, we get an excess demand for money and a recession.

"While there may well be a desire to have your bond holdings grow by a certain number of units per day, there is no market in which this desire can take the form of a bid."

That just seems wrong. It's the bond market. I can go to the bond market every millisecond, and buy a flow of bonds. I can also go to the bond market yearly, and buy a stock of bonds.

Yes, there are lump sum costs of visiting any market, from the supermarket to the bond market. And that's why we hold strictly positive stocks of money. And that's why we buy stocks of apples weekly. Electricity is the only pure flow market I can think of (in my case).

Scott: "Are there any policy implications from insisting on disequilibrium?"

Suppose we lived in a frictionless barter economy. But used bling as a medium of account. Let M represent the stock of bling. Let the demand function for bling be Md=kPY (because people only care about the real value of bling, M/P, they are wearing, so they can flaunt their wealth).

A halving of the supply of bling, or a doubling of the bambridge k (Kings bollege bambridge? sorry) would cause a halving of PY if prices were flexible. But if prices and wages were sticky, it would have no effect on PY in the short run. It would cause an excess demand for bling, and nothing else.

I had to think about that. Scott's question is a good one to ask.

Nick Rowe,

Isn't water just as much a flow market as a stock market? Sure, you can buy bottles of water and such, but you can also buy batteries. However, I might have misunderstood the flow/stock distinction.

W. Peden: OK. If you have a water meter, it's a flow market. I have my own well, with an electric pump! You haven't misunderstood.

Nick Rowe,

In my part of the world (Scotland) we're not used to thinking of water as a commodity at all: (1) it's a nationalised industry and (2) we spend enough time keeping water out of our houses!

So a market where one pays for X within time period Y is a flow market, like pay-as-you-go monthly utility bills, whereas a market where one pays for a total quantity of set units is a stock market like groceries?

I assume that an "all-you-can-eat" market (one where you can use/consume as much as you like in an allotted time period, like a contract phone, a buffet or a rented car) is also a flow market. I can't think of an analogues in finance, however: a loan is a loan of a set stock of money, rather than money on tap within a given time period!

Water is (usually) nationalised in Canada as well, but you often (sometimes?) have a water meter on your house, and pay so much per litre.

If you measure in continuous time, and plot how much you purchase over time, if you see only infinitely high spikes of infinitely short duration, and zeros, it's a stock. If you see finite purchases for finite periods of time, it's a flow. It doesn't matter if they bill you once a month. If the amount of the bill increases with the amount used, and you have a finite use per millisecond, it's a flow.

Did my BA at Stirling. Where in Scotland are you?

Water is a flow. LOL.

Consumption goods are consumed. Therefore we model them as flow. You consume every period and do not store the consumption up or re-sell it to someone else. Therefore we can reasonable argue that supply of final consumption output intersecting with the demand for consumption determines the price of consumption goods each period.

Capital is persistent. People accumulate it in order to re-sell it at a later time. When there is a market in which there is an existing pool of durable goods, with one group of producers selling more (indistinguishable) goods into that market, you can no longer claim that the price of durables will be set by the demand for net savings intersecting the supply curve of (new) investment. Therefore the concept of a loanable funds market in which savings and investment set rates is incoherent if capital goods are long lived.

But it needs to set the price if we are to believe that interest rates adjust to clear savings demands.

Loanable funds would still be incoherent even if we used a short-run discreet model or even if we added depreciation. Loanable funds only works if the capital stock fully depreciates in each period.

So let's quibble about clumping. Let's keep it simple and not get into disputations about how to classify jams and jellies.

J.W. -- I will make a blog and then post a reference. On my blog, I can use latex, and make diagrams, etc. Also, I have edit capabilities :)

A few miles north of Stirling in Callander. Stirling is the "big city", from our perspective! I studied my undergraduate degree in Edinburgh, however, and in a few weeks I'm going to study in Cambridge

K said: "Too Much Fed: either a bank has to buy something or someone has to go into debt. Mostly, by far, it's the latter. So generally the answer is yes."

Even if a bank buys something, can "debt" be involved?

Nick--

I agree with you that disequilibrium is necessary. You also agree that sticky prices are necessary. The MOA function of money is thus also necessary because it is the only realistic way we can tie an MOE to stickiness (if dollar-bling prices were flexible but bling prices were sticky, we could never have disequilibrium based on changes in the supply or demand for dollars because the bling-dollar rate would clear). I think Scott's point is that in economies that actually exist where the MOE is the MOA, there are no implications to describing recessions in terms of the necessary quality of stickiness rather than the necessary quality of disequilibrium. You seem to be arguing (if I'm getting you right) that there are implications because it is possible to have stickiness and monetary shifts without a recession if you don't have disequilibrium in the MOE. This is only true because disequilibrium always requires stickiness but stickiness doesn't require disequilibrium. But since the MOE and MOA are the same then stickiness DOES require disequilibrium and it doesn't substantively matter which way you describe it -- so I don't see any meaningful implications. But I guess you're right that if we are thinking about policies that would eliminate a medium of exchange entirely or attempt to divorce it from the MOE, then implications sneak in.

No, production goods are constantly being turned over, worn out, re-purposed, replaced by new technology, etc.

Production goods are a flow -- and they flow across time, across geographic space, and across alternative uses, etc. E.g. production goods sometimes flow toward longer term production processes -- like the supplying of (wood based) housing in the production of a house -- and sometimes toward short term production processes, like the supplying of (wood based) disposable chop sticks for eating a meal.

Flows have changing valuational significance across time, space & technological environments.

Production goods are a flow ...

It's fallacy derived from business firm accounting and imported into economic science to call "capital" a "stock".

"Capital is persistent. People accumulate it in order to re-sell it at a later time."

I studied (briefly) at the Scottish Institute of Textiles in Galashiels ( now Scottish Borders Campus of Herriot-Watt University). This blog is becoming a big family...

And York and East Anglia (Norwich) (see the Blog thread) And Cardiff (Long story in Ken Kesey's travels)

Everyone: sorry for the multiple comments. Some computer glitch..

[No worries. I unpublished the duplicates. NR]

"Production goods are a flow ..."

Knowledge is a stock.

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