In the olden days, economists used to talk about the trade cycle. (They meant a cycle in the amount of all trade, not just international trade). They meant a cycle in the amount of exchange. There are fluctuations over time in the amount of buying and selling that people do. In a boom, trade speeds up; and in a recession, trade slows down.
I think we should resurrect that old term. Thinking about the trade cycle is a better way of thinking about short run macroeconomics than how we currently think about it. Nowadays we don't talk about fluctuations in trade; instead we talk about fluctuations in output. It's not the same thing. We are wrong; the old guys were right. Somewhere, maybe around the 1920's or 1930's (I wish I were better at history of thought) macroeconomics took a wrong turn.
This post is a follow-up to my previous post.
Thinking about fluctuations in output is both too narrow and too broad a way of thinking about fluctuations. And that way of thinking about the question to be answered also distorts the sort of theoretical framework we use to answer it.
Another old term for the subject matter of short run macroeconomics is the "conjuncture". It means a coming together. This word has almost disappeared from economics in English, but it survives in French, Spanish, German, Russian, and maybe other languages too. Short run macroeconomic fluctuations are a conjuncture. A lot of different data series tend to move together cyclically. Lucas drew attention to the conjuncture in his 1975 paper "Understanding Business Cycles". He said that business cycles have different amplitudes and frequencies, and it is only the conjuncture (co-movements) of different things moving together cyclically that allows us to say that all business cycles are alike, and so possibly amenable to a common explanation. If each episode were unique, we couldn't really have a business cycle theory. We would have one theory for the 1982 recession, a different theory for the 1991 recession, and so on. And each theory would have just one data point, so it wouldn't really be a testable theory.
Fluctuations in the output of newly-produced goods and services is a bad proxy for the conjuncture. It is both too narrow and too broad. The trade cycle is a better proxy for the conjuncture.
It is too narrow because it ignores trade in goods that are not newly-produced. Things like old houses and old cars and old furniture and old land.
It is too broad because it includes production of goods and services for one's own use. The unemployed worker is not unemployed. He is employed digging his own garden, fixing his own car, doing his own labour market search. He is not unhappy because he is unemployed. He is unhappy because he is self-employed and doesn't want to be. He wants to sell his labour to someone else, but can't, so has to consume it himself. A recession is not a fall in employment; it is a fall in the amount of employment that is traded. A recession is not a fall in output; it is a fall in the amount of output that is traded.
We could even imagine an economy in which employment would rise in a recession. You might have to work a lot harder to grow your own food to feed yourself than if you could sell your labour and buy food.
A house with nobody living in it is unemployed. A house with somebody living in it, who wants to live somewhere else, but can't sell his house, might as well be unemployed. If something disrupts trade in old houses, so owner-occupiers are living in the wrong houses, and consuming the wrong housing services, because they can't trade, that is a recession in housing. It's just like workers who want to trade their labour but can't, and so are consuming the wrong labour services, their own, when they would rather be trading and consuming someone else's labour services. Comparative advantage, and all that.
A recession is not a drop in output and employment. A recession is a failure to exploit the gains from trade.
Microeconomists start out thinking about trade. And not just trade in newly-produced goods and services. Macroeconomists ought to start out thinking about trade. And not just trade in newly-produced goods and services. Trade is supposed to make people better off. If something makes trade harder, and reduces the amount of trade, that would make people worse off. Maybe that's why people seem to be worse off in a recession. It's because there's less trade. And not just less trade in newly-produced goods and services.
Now, what might that something be? What could cause trade to fall and make people worse off? An increase in transportation costs? Nope. An increase in marginal tax rates? Nope. Those make theoretical sense, but don't work empirically to explain recessions.
The obvious candidate is a shortage of the medium of exchange. If there were a shortage of shopping bags, all trade that required shopping bags would be disrupted, and people would be worse off. If there were a shortage of money, all trade that required money would be disrupted, and people would be worse off. Nearly all trade requires money. The exceptions, barter trades, merely prove the rule. As far as I can tell, barter increases in a recession. People resort to barter, where they can, because there's a shortage of money. But trying to trade without money is like trying to carry stuff home from the supermarket without a shopping bag. It's not as good, so you buy less stuff, and you buy different stuff, and it's very inconvenient.
But somewhere macroeconomics took a wrong turn. We started thinking about the output of newly-produced goods and services, instead of the trade cycle. So macroeconomists started thinking about the demand and supply of newly-produced goods and services, not about trade. So they wrote down "I=S" as their equilibrium condition, and started thinking about what determined desired investment and saving. And they focused on the real rate of interest, defined as the relative price of current newly-produced goods to future newly-produced goods.
If you start out by asking the wrong question, your answer will be wrong, even if it looks right. "What causes fluctuations in the output of newly-produced goods and services?" is the wrong question to ask. "Investment, saving, and the rate of interest" is the wrong answer, because it is an answer to the wrong question.
It's a bit like defining recessions as fluctuations in the output of cars, and explaining the business cycle in terms of the demand and supply of cars, and the relative price of cars. Then trying to explain everything else that happens in business cycles as a side-effect of the fluctuating output of cars.
"What causes fluctuations in the amount of monetary trade?" is the right question to ask. "Money" is the right answer, because it is an answer to the right question.