I noticed something a bit strange about the responses to my last post.
For the last couple of years I have been writing lots posts saying (in various different ways) that recessions are always and everywhere a monetary phenomena. That Keynesian models do not make any sense except in a monetary exchange economy (which is not, I repeat, a criticism of Keynesian models, except insofar as they ought to make that assumption explicit and show exactly where money fits into the model). And that an excess of desired saving cannot create a recession unless it creates an excess demand for the medium of exchange. With loads of weird thought-experiments involving antique furniture, hairdressers, pro-usury parties, etc., trying to make my point.
And I've always felt that I was pushing against the mainstream view. And I've always gotten lots of pushback in the comments, saying I'm mistaken.
But in my last post I said the same thing, said that Paul Krugman agreed, and got almost no pushback at all (except for two, which I will come to later).
I can only conclude that suddenly my views on this are mainstream. Simply because Paul Krugman says the same thing. (Neither of us really put forward any real arguments to support that proposition.)
Which I think demonstrates that Paul Krugman has a lot of "authority". Which is not to say it isn't warranted authority, because he obviously has a much better economist's track record than me. But I'm still a bit surprised at being suddenly so mainstream on this question.
Greg Ransom is the first honourable exception. But he's an exception that proves the rule. Greg, as an Austrian, naturally won't take Paul Krugman as authoritative on anything about understanding business cycles. Greg argued, to paraphrase, that I was just defining a recession as an excess demand for money. I'm going to come back to Greg's point.
JW Mason is the second honourable exception. He(?) wrote a post questioning the assertion that recessions are all about money, and laid out a simple model of recessions in a barter economy (that did not involve the obvious bad harvest/earthquake shock to supply). [Update: just to show it was possible, not because he necessarily disagreed with the assertion as a matter of fact.]
JW's model contains what is often called a "thick market externality". The more traders there are in a market, the easier it is for each trader to find a trading partner, so the bigger the incentive for each person to become a trader in that market. There's a positive feedback process. And if that positive feedback is strong enough, over some range, you can get multiple equilibria, some locally stable and some locally unstable. A recession is an equilibrium with a lower level of trade than in some other equilibrium.
I like JW's model. And I think it's a useful model of a lot of things. But I don't think it's a useful model of recessions. It doesn't work empirically.
When I look at recessions, this is what (I think) I see: it gets harder than normal to sell stuff; and it gets easier than normal to buy stuff (if you've got the money). In a boom it's just the opposite: it gets easier than normal to sell stuff; and harder than normal to buy stuff (even if you've got the money). This is especially true for labour as the stuff you are trying to buy or sell.
There's an asymmetry in the ease of selling and buying that fluctuates over the business cycle. And that stylised fact seems to me to be equally as important as the stylised fact that output and employment fluctuate over the business cycle.
JW's model does not fit that stylised fact. In his model, because it is a barter model, buying is selling. Both buying and selling are harder in JW's recession than in JW's boom. They are equally hard. They must be equally hard, because they are the same thing.
Another way of looking at it is to say that money gets easier than normal to sell in a recession, and harder than normal to buy. And any model that does not contain monetary exchange simply cannot speak to that stylised fact of the business cycle.
So I reject JW's model on purely empirical grounds.
Which brings me back to Greg. How should we define "recession"? Dunno. How should we define "horse"? Dunno either. But I think I know one when I see one. Most of the time, because there are a few borderline cases where, even if I can see everything clearly, I'm not sure if we should really call it one or not.
If those borderline cases are rare, it doesn't matter much. Economists are like taxonomists who can't yet observe the underlying DNA of what we are categorising. So we come up with a list of observable characteristics that tend to correlate together, and use those characteristics to define categories. And because reality is lumpy, so that borderline cases are rare, this works. If reality were smooth, and characteristics were independently uniformly distributed, we wouldn't be able to talk about recessions or horses at all.
Which of the many characteristics of a horse is the defining, essential characteristic? None. A horse is a collection of empirical characteristics that tend to go together. Same with recessions. But there's something very wrong with a theory of recessions which ignores one of those semi-definitional characteristics. "Recessions are always and everywhere an excess demand for money". Is that a definition, or an empirical statement? A bit of both, really.
But what precisely do we mean by an excess demand for money? And where do we observe it? Is the excess demand for money that causes the recession the same as the excess demand for money we observe during a recession?
(You can stop reading this post now, unless you are really into that sort of stuff.)
I know what it means to talk about an excess demand for apples. It's the quantity of apples people want to buy (given current prices etc.) minus the quantity of apples people want to sell (given current prices etc.)
I know that, if prices are sticky, so that some markets do not clear, and some people are unable to buy or sell as much of some goods as they want, these quantity constraints may spill over to affect their demands and supplies of other goods. So we need to distinguish between the notional and the constrained (effective) excess demand for apples. I go to the supermarket planning to buy 3 apples and 2 pears, but they are out of pears, so I buy 5 apples instead. My notional demand for apples is 3; my constrained demand for apples is 5. I go to the labour market planning to sell my labour and then buy 3 apples. But when I get to the labour market I find I can't sell my labour, so I decide to buy only 1 apple. My notional demand for apples is 3; my constrained demand for apples is 1.
I know where to look if i want to see if there's an excess demand for apples. I look in the apple market. And I know that what I will see there is the excess constrained demand for apples, not the excess notional demand for apples. Unless by sheer fluke there is exact market clearing for all the other goods.
What about the excess demand for money (the medium of exchange)?
We are of course talking about a desired stock of money. And that desired stock of money is like a desired stock of inventory. And we desire to hold a stock of inventory because it is costly to exactly synchronise the flows in and the flows out, especially if those flows are lumpy. (Pedants might insist that a lumpy flow is not strictly a flow, but never mind.) But we adjust the actual stock to the desired stock by adjusting the flow in and/or out.
I understand what it means to talk about an excess notional demand for money. People desire to hold a larger stock of money than they actually hold, and so will want to increase their flows of money in by selling more goods and/or will want to decrease their flows of money out by buying less goods. And I understand that this notional excess demand for money, if unresolved, will create an excess supply of goods. A general glut. Because we live in a monetary exchange economy, where all goods (OK, the goods I'm talking about) are bought and sold for money.
And I understand that if goods are in excess supply, people will be unable to sell as much as they wish. The sales of goods will be demand-constrained. So individuals will be unable to implement their plans to increase their stocks of money by increasing the flow in.
And I understand that individuals will nevertheless be able to implement their plans to increase their stocks of money by buying less, and reducing the flow out. And that this plan, even though it works for each individual, cannot work in aggregate. Because one person's purchases of goods is another person's sale of goods. On person's reduced flow out is another person's reduced flow in.
But the attempt by each individual to increase his stock of money by reducing the flow out will result in a reduction in sales of goods. A recession.
OK so far.
But at this point we need to stop talking about an excess notional demand for money. When people realise they cannot sell as much as they want, when people realise they are quantity constrained, they will adjust their demands and supplies of goods in response. We switch from notional to constrained demands and supplies. And that includes the demand for money. We must stop talking about the notional demand for money and start talking instead about the constrained demand for money.
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.
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.
In that example, the notional excess (stock and temporary flow) demand for money of $1,000 creates an (indefinitely long flow) excess constrained demand for money of $30,000 per year.