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Nick:

How about a monopoly's ability to suppress wages?

If a monopoly or pricing cartel, via its size, dominates employment of certain professions, it can set wage prices too - as employees have few competitors to move to.

Anon: that is already in my model. A fall in E reduces W/P. I could add monopsony power in the labour market into the model too. It has the same effect, of reducing W/P and reducing Y and L (unless it offsets monopoly power in the labour market). But monopsony power would (unless the AD curve is horizontal) be *in*flationary, not *de*flationary. That's where the fallacy of composition comes out and bites.

Nice!

This is a great resource for us younger historians of economics (I hate to call your youth "history", Nick, but I regard parts of my youth now as history too) because I'd always found a lot of the cost-push arguments levelled against the monetarists back in the 1960s and 1970s confusing. I initially thought that it was something to do with RGDP growth falling and NGDP growth being at the same rate; then I read some of the British literature from that period (Kaldor, Balogh et al) and got even more confused because they seemed to be basing cost-push inflation on a very silly model of the financial system, i.e. "Costs go up, so businesses borrow more to meet costs, which the banking system then accomodates with new fountain-pen money".

I still think that the model of the financial system that Kaldor et al were using is terrible (e.g. the financial system most definitely does not adjust to the "needs of trade", as anyone who has tried to get a business loan in a liquidity squeeze will know) but I now see that that's a separate issue from cost-push inflation. That would explain why American Keynesians, who generally weren't into Kaldorian endogenous money, would take cost-push inflation so seriously before the 1980s.

So it comes down to the Phillips Curve again?

On a not-completely related point; Nick, what do you think about this post by Miles Kimball, laying down his "Neomonetarist" perspective? Some folks are reading it as a critique of the market monetarist/money disequilibrium view, but it would be nice to have your perspective as well.

Anon,

Actually, I'd say that that looks a lot like (in particular) Scott Sumner's view. In particular-

"Attributing the fluctuations at business cycle frequency primarily to the interaction of real and monetary shocks with sticky prices."

- is straight Sumner. Of course, there may be something in neomonetarism that differs from market monetarism (perhaps denying the existence of exogenous monetary shocks, but then why call it "monetarism"?) but my amateur eyes couldn't see it in that post.

anon: from a very quick read, I would read it as a fairly standard New Keynesian approach. The pictures look similar to the ones in my old post on NK macro. I don't read it as a critique of monetary disequilibrium or market monetarism.

W Peden: Thanks! Yep. If you have a vertical LRPC, you can't really think about monetary policy as targeting Y. So you have to change all the framing.

Nick Rowe,

When one drops the assumption that the natural rate of unemployment is stable and starts reinterpreting economic history using that, plus some assumptions about what could affect it, economic history starts to get very interesting. For instance, if the causes of changes in the natural rate are secular, then we can hypothesise changes in one decade as a key cause of major phenomena decades down the line.

For example: changes in benefits and labour-bargaining procedures after WWI push up the natural rate in the UK; this leads to high unemployment in the later 1930s even after NGDP and broad money had recovered from the Great Depression; that leads to the theoretical dominance of Keynesianism after WWII and the dominance of policy by the early 1970s; meanwhile, the natural rate gets raised by Harold Wilson/Edward Heath's boosting of non-workers' incomes and union power in the 1960s and 1970s, such that even 25% inflation will not get unemployment below 5%; then, when inflation is brought down, there is an extreme disruption effect on unemployment at the same time that demographic changes are raising the natural rate, and we get the 1980s unemployment horrors.

So cost-push factors CAN cause both inflation and unemployment, if one puts an unemployment-targeting monetary policymaker into the model. If that's true, then on this issue the Neo-Keynesians were onto something and suffered only from the lack of an upside-down & non-accelerationist understanding of the causal relations between inflation and unemployment, and I have a lot more respect for them.

As you point out, increased monopoly will cause capital to take an increasing share of a diminishing pie. Double whammy for labour. Hard to see how you are going to get accelerating inflation under those circumstances, especially in a recession where consumers [read *wage earners*] are the ones with the balance sheet trouble/liquidity constraints. Wouldn't the natural rate drop with increasing rent seeking? A good lab model for this question might be Eggertsson-Woodford 2010, and see how varying theta in the Dixit-Stiglitz aggregate affects the endogenous natural rate.

K: you get accelerating inflation because the employement-targeting central bank doesn't realize the natural rate of unemployment has risen and so creates more and more inflation to try to reach what it thinks is full employment.

Alex,

Good point. Bad CB not in my model.

Unless they are liquidity trapped and *can't* create inflation. Or they use a Taylor rule.

W Peden: "So cost-push factors CAN cause both inflation and unemployment, if one puts an unemployment-targeting monetary policymaker into the model. If that's true, then on this issue the Neo-Keynesians were onto something and suffered only from the lack of an upside-down & non-accelerationist understanding of the causal relations between inflation and unemployment, and I have a lot more respect for them."

I tend to agree a bit. It's sometimes possible, with some difficulty, to translate what they are saying into a more "modern" framework, so that you can get some good insights out of it. But so much of it got drowned out in a big battle of mutual incomprehension.

K: There is no "capital" in my little model. Implicitly there is some sort of ownership of the rights to produce a particular good, and firms' "profits" are returns to that right. And remember, "capitalists" (or the owners of firms) are people too. They consume. And, consumption is not the only component of demand, there's investment too.

I could change my little model by introducing a fixed cost f, so the firm's production function becomes y = l - f, and the Aggregate production function becomes Y=L-nf, then make n endogenous, as firms enter if profits are positive, so that profits are zero and Y=L.W/P in equilibrium. (It would take some competent person 5 minutes to do the math.) So that if E falls, n increases, so we get a double fall in Y, both because W/P falls, so L falls, and because nf rises.

What is "theta" in the Dixit-Stiglitz? Is that the taste for variety parameter? (my E)?

"Didn't someone build a similar model a couple of years back, where an increase in distorting taxes to reduce labour supply was one policy to get you out of the liquidity trap?"
Sounds like the "paradox of toil" which Casey Mulligan spent a lot of time complaining about as an example of Keynesian extremism:
http://caseymulligan.blogspot.com/search?q=%22paradox+of+toil%22
The last post there has his history of the back-and-forth between him and Gauti Eggertsson, the primary exponent of the paradox.

Wonks: thanks. That's the one I was thinking of.

Nick,

"Unless my memory has failed, that is how many people (economists and non-economists) used to argue back in the 1970's. And the Monetarist counter-argument, that monopoly power only affects relative prices, not money prices, and that we need to look at the demand and supply of money if we want to understand inflation, was never totally convincing."

You need to look at the cost of money and the demand for money. The supply can be created by typing a few numbers into a computer terminal.

IR = [ ( INT * ( 1 - LP ) / LP + f'(t) / LP ) / PROD ] - 1

IR = Inflation Rate
INT = Nominal Interest Rate
LP = Liquidity Preference
f(t) = Growth rate of outstanding debt (money)
PROD = Productivity

Starting from this credit model you can then add in government effects (taxes, borrowing, and spending), equity capitalization effects, and whatever else you like.

"To maximise profits, the individual firm sets Pi equal to a markup over marginal cost, and since its marginal cost is the wage W:
Pi = (1/(1-(1/E))).W"

Wages are not the only cost of a firm. Firms also have a cost for money (as well as other materials). That money can be obtained by borrowing money or issuing equity.

Frank: Aaaaaaargh!

Frank: what you are describing is typically called the cost of capital, and doesn't apply to his model because his model doesn't have capital. (Not counting the non-tradeable "right to produce the firm's unique good" Nick mentioned.)

Alex,

The economic model Nick is presenting is based on a fiat currency or fixed money supply model with no capital financing (no equity / no debt) - yes? I mean wages and prices are still measured in some medium of account / exchange - yes?

But then there is this statement:

"My answer: yes/no/it depends. It depends on the shape of the AD curve, which depends on what the central bank is trying to do."

Either there is capital financing ( debt or equity ) or there isn't. If there is no debt then what does it matter what a central bank does. Fiat currencies are currencies issued by governments not banks.

Nick, just to spell out the subtext of Mark Thoma's post:

==> Krugman wrote his famous robots/monopoly power piece to explain how The Man was screwing the little guys, whom Krugman was placed on this Earth to defend from Republicans.

==> Mickey Kraus in The Daily Caller thought he spotted a Krugman Kontradiction: How could Krugman be complaining here about monopoly power by big bad businesses, if elsewhere he is always warning about deflation?

==> Some big economist (I honestly don't know who) must have linked to the Daily Caller piece favorably.

==> Mark Thoma can't believe an actual economist would sully his good name by thinking there is some sort of contradiction here.

Frank:

Either there is capital financing ( debt or equity ) or there isn't. If there is no debt then what does it matter what a central bank does. Fiat currencies are currencies issued by governments not banks.

Debt can exist in the absence of capital. Imagine an economy in which the only good is backrubs. Alice could borrow money from Bob in order to buy a backrub from Charlie today, and Bob agrees to this because she offers to pay him back double tomorrow, which will let him buy two backrubs from Dave.

Bob: Ah, thanks. I take it that Mickey Kraus and the Daily Caller are Republican(ish)? I vaguely remember the name Mickey Kraus, but not the Daily Caller. I wonder if I have just sullied my reputation (assuming I have some to sully)? My guess is that my fellow monetarists might dislike this post more, because I have slightly defended the old keynesians against Milton Friedman.

Thanks Alex.

And "capital" has got nothing to do with money. Capital is the time structure of production.

I'm tempted to say that Frank is forgetting that firms make money in my model, because their profits will equal (1/E)Y. But perhaps I had better not.

Alex,

So if Charlie borrows money from Ted to pay his back rub givers we call that capital and if Alice borrows money from Bob to buy a back rub we call that consumer debt?

And so does Nick's model reflect a single entry point model for new money ( only consumers borrow )?

Nick,

http://en.wikipedia.org/wiki/Capital_(economics)

"Capital refers to sums of money or assets put to productive use."

I guess we are dealing with different definitions of capital. I would agree that capital is not exclusively money.

"I'm tempted to say that Frank is forgetting that firms make money in my model."

But do they operate on a cash flow only basis? Even if they are profit maximizing monopolies, they still can't get around the time delay between start of production and sale of goods.

Frank: Here is Nick's model (roughly):

The world has N people in it (N is large and fixed). Each person is capable of giving backrubs. Each person's backrubbing style is unique, so backrubs from Alice are not good substitutes for backrubs from Bob, etc. You cannot give yourself a backrub. Within a given time period, a backrubber will charge all customers the same price (no price discrimination). A backrub costs nothing beyond the time of the backrubber.

The world only contains three other things besides this:

1. Green pieces of paper. By social convention, these are used as a means of exchange. It is very rare that two people meet who want backrubs from each other (and besides it is impossible for two people to rub each others' backs simultaneously), so backrubs are only ever given in exchange for green paper.

(Everyone in this world posses incredible skill at folding and tearing paper, so these green pieces are infinitely divisible. They also possess unlimited quantities of glue that they can use to recombine the pieces.)

2. White pieces of paper with a date on them. The date is the day after the piece of paper was printed. Each white paper is redeemable for one green paper on the printed date, and worthless thereafter. No one ever forgets to redeem their white papers.

(Like the green paper, the white paper can be infinitely divided and recombined.)

3. A central bank. Each time period, the central bank prints sufficient green paper to redeem all of the outstanding white paper. Then, the central bank decides an exchange rate between newly-printed white paper and existing green paper, and offers to print unlimited white paper in return for green at that rate.

(Alternately, the central bank decides on the quantity of privately-held green paper it wants there to be, and auctions off enough white papers to hit that target.)

The world has existed for a long time and people already have stocks of green paper (how they came into existence is a mystery). No one trusts anyone else enough to lend him green paper in return for a promise of repayment in the future (but they do trust the central bank).

I think that's it, pretty much.

Alex,

In the situation you describe, all back rubbers must allocate both time and green pieces of paper. And so the back rubbers capital is the time they allocate to giving back rubs. The notion of wages and profits gets clouded at that point unless we consider that the central bank in setting the exchange rate is affecting the cost of time. Meaning that wages are in green pieces of paper / time period but profits / losses are measured in green pieces of paper / time period minus the cost of time set by the central bank.

For instance if a certain back rubber is charging 2 green pieces of paper per back rub and completes 8 back rubs per time period his wages for that time period are 16 green pieces of paper. If the central bank is offering an exchange rate of 18 white pieces of paper per green piece of paper, then the back rubber has realized a loss.

The back rubber must either increase his productivity unless he is part of a cartel in which case he tries to change price.

To answer Nick's question - does monopoly power cause inflation. Monopoly power reduces the incentive to improve productivity and so it can result in inflation.

Frank:

In the situation you describe, all back rubbers must allocate both time and green pieces of paper.

Where did you get the idea that giving a backrub takes time? OK, I will stipulate that backrubs are instantaneous. A person can give out an infinite number of backrubs per period.

Also, a backrubber doesn't need green paper to give backrubs, obviously. Only the person purchasing the backrub needs green paper.

The notion of wages and profits gets clouded at that point unless we consider that the central bank in setting the exchange rate is affecting the cost of time. Meaning that wages are in green pieces of paper / time period but profits / losses are measured in green pieces of paper / time period minus the cost of time set by the central bank.

As I said, backrubs have nothing to do with time. They are instantaneous.

Note also that the actual "time" in this model is not continuous. The only times that exist are t=0, t=1, t=2, etc. There is no t=1.5. That time just doesn't exist. All economic activity happens at those integral moments.

For instance if a certain back rubber is charging 2 green pieces of paper per back rub and completes 8 back rubs per time period his wages for that time period are 16 green pieces of paper. If the central bank is offering an exchange rate of 18 white pieces of paper per green piece of paper, then the back rubber has realized a loss.

Not at all. He had no way to transform those backrubs into white paper. He can only exchange them for green paper.

Before someone asks why no one uses white paper as a medium of exchange, I will amend the model slightly: they white paper is instead stone tablets (they haven't invented ink, so this is the only way to write things down) and they are too heavy to lug around, so they just leave the tablets in safety deposit boxes at the central bank.

Alex,

"The world has N people in it (N is large and fixed). Each person is capable of giving back rubs." and "Only the person purchasing the backrub needs green paper."

The back rubbers and the recipients of back rubs are the same people - yes?

"Not at all. He had no way to transform those backrubs into white paper. He can only exchange them for green paper."

He is both a giver of back rubs and a recipient of back rubs - yes? He (like anyone else) is able to exchange green paper for white paper - yes?

"The world has existed for a long time and people already have stocks of green paper (how they came into existence is a mystery)."

The back rubbers already have a stock of green paper - yes? They can either give back rubs if their productivity is greater than the exchange rate (they are profitable) or they can receive back rubs if their productivity is less than the exchange rate - yes?

"A person can give out an infinite number of backrubs per period."

Even if he can, it does not mean that he will. There is a difference between the potential productivity of a back rubber and the realized productivity of a back rubber. So a back rubber may have the potential to give out an infinite number of back rubs but only give out 8 or 20 or 3000 or a million. If a person can give out an infinite number of back rubs per period and does give out an infinite number of back rubs in a period, why would he ever exchange green paper for white paper?

Frank:

The back rubbers and the recipients of back rubs are the same people - yes?

Er, as a population sure, but in any given transaction you've got one backrub-er and one backrub-ee. Alice gives Bob a backrub in return for green paper; Alice doesn't need to have green paper to do that.

He is both a giver of back rubs and a recipient of back rubs - yes? He (like anyone else) is able to exchange green paper for white paper - yes?

Yes, there is a backrub-green paper market and a green paper-white paper market. But he can't directly trade backrubs for white paper or vice versa.

The back rubbers already have a stock of green paper - yes? They can either give back rubs if their productivity is greater than the exchange rate (they are profitable) or they can receive back rubs if their productivity is less than the exchange rate - yes?

That sentence is semantically empty.

Each person sets a price for their backrubs, and gives a backrub to each person willing to pay that price. The people in this world are essentially monopolistically competitive firms; they set the price equal to (1/(1-(1/E)))*MC (as Nick said above). MC is marginal cost; the cost of the backrub is the inconvenience of giving it (presumably at some margin people prefer not-backrubbing to backrubbing) and E is the price elasticity of demand for that person's backrubs.

I have made no mention of "productivity", and it would be weird for it to be expressed in the same units as the exchange rate (green / white). Before you use a term like that, define it.

Even if he can, it does not mean that he will. There is a difference between the potential productivity of a back rubber and the realized productivity of a back rubber. So a back rubber may have the potential to give out an infinite number of back rubs but only give out 8 or 20 or 3000 or a million. If a person can give out an infinite number of back rubs per period and does give out an infinite number of back rubs in a period, why would he ever exchange green paper for white paper?

People prefer not-backrubbing to backrubbing, but they also like to receive backrubs. People give out backrubs in order to acquire green paper so that in the future they can exchange that green paper for backrubs.

People get diminishing marginal utility from backrubs (equivalently, they get increasing marginal disutility from backrubbing) so they only consume/give out a finite number of backrubs.

Alex,

"I have made no mention of "productivity", and it would be weird for it to be expressed in the same units as the exchange rate (green / white). Before you use a term like that, define it."

I didn't say that productivity should be expressed in the same units as the exchange rate. I said the exchange rate represents the growth rate of the green paper supply ( new green pieces of paper per time period ). Likewise the wages represent the growth rate of the green paper holdings for an individual back rubber ( new green pieces of paper per time period ).

"People give out backrubs in order to acquire green paper so that in the future they can exchange that green paper for back rubs."

Or they buy white pieces of paper at the exchange rate and later convert them to green pieces of paper. And so a person has two means to acquire additional back rubs - give back rubs or buy white pieces of paper. If a person can get more future back rubs by buying and selling white pieces of paper than he can by giving back rubs then why wouldn't he.

Wages = Number of Back Rubs * Price of Back Rub / 1 Time Period = Productivity * Price ( Units are green pieces of paper per time period )
( Green Paper Later - Green Paper Now ) / 1 Time Period = White Paper Now * Exchange Rate / 1 Time Period ( Units are green pieces of paper per time period )

Compare the growth rate of wages ( % / Time Period ) with the growth rate of green paper ( % / Time Period ). If wage growth is less than green paper growth rate, then the individual is better off trading with the central bank.

Or they buy white pieces of paper at the exchange rate and later convert them to green pieces of paper. And so a person has two means to acquire additional back rubs - give back rubs or buy white pieces of paper. If a person can get more future back rubs by buying and selling white pieces of paper than he can by giving back rubs then why wouldn't he.

Why are you talking about those as if there is a tradeoff between them?

Wages = Number of Back Rubs * Price of Back Rub / 1 Time Period = Productivity * Price ( Units are green pieces of paper per time period ) ( Green Paper Later - Green Paper Now ) / 1 Time Period = White Paper Now * Exchange Rate / 1 Time Period ( Units are green pieces of paper per time period )

Compare the growth rate of wages ( % / Time Period ) with the growth rate of green paper ( % / Time Period ). If wage growth is less than green paper growth rate, then the individual is better off trading with the central bank.

There is no tradeoff between giving backrubs and buying white paper. You don't need your own stock of green paper to give backrubs.

Alex,

"There is no tradeoff between giving backrubs and buying white paper. You don't need your own stock of green paper to give back rubs."

There is a tradeoff between getting a back rub and buying white pieces of paper. If you trade in all of your green pieces of paper for white pieces of paper then you can buy no back rubs in a time period. Your implication is that a person faces only a demand choice when approaching the central bank - buy white pieces of paper at the exchange rate or retain green pieces of paper to buy back rubs in this period. That person must also recognize that the demand decisions of the aggregate affect the number of back rubs that he will be able to give in a given period. If he converts all his green paper to white paper and everyone else does the same, then he can receive no back rubs AND can give no back rubs.

"People prefer not-backrubbing to backrubbing, but they also like to receive back rubs."

If a person prefers not back rubbing to back rubbing and a person can obtain enough green pieces of paper in a period to buy their fill of back rubs by trading white pieces of paper with the central bank, why would they give back rubs?

Each person can give an infinite number of back rubs. Does each person have an infinite demand for back rubs?

There is a tradeoff between getting a back rub and buying white pieces of paper. If you trade in all of your green pieces of paper for white pieces of paper then you can buy no back rubs in a time period. Your implication is that a person faces only a demand choice when approaching the central bank - buy white pieces of paper at the exchange rate or retain green pieces of paper to buy back rubs in this period. That person must also recognize that the demand decisions of the aggregate affect the number of back rubs that he will be able to give in a given period. If he converts all his green paper to white paper and everyone else does the same, then he can receive no back rubs AND can give no back rubs.

AHA! And now we hit the crux of macroeconomics, composition. Remember N is large? Any individual person's decision to buy white paper or backrubs has only a tiny, indiscernible effect on the number of backrubs he will sell. When you buy a coke from a vending machine, do you consider in your decision the fact that some infinitesimal portion of that dollar might return to you in increased demand for your labor? (I hope not.) Neither do any of these people. And even if they DID actually calculate out that effect, it would only have a tiny effect on their decision.

If for some reason the central bank sets the exchange rate "too low" (i.e. it costs too few green papers to buy a white paper; IOW the interest rate is "too high") and the people don't adjust their backrub-prices to compensate, then collectively people might give/receive "too few" backrubs in a given period (relative to what would be utility-maximizing). You could object, "but if everyone recognizes the demand decisions of the aggregate affect... therefore they should choose to purchase more backrubs and fewer white papers", but one of the main reasons money exists in the first place is that people can't coordinate on those scales. It is just too hard.

The situation I described above is a recession. Recessions happen because solving the coordination problem is hard.

If a person prefers not back rubbing to back rubbing and a person can obtain enough green pieces of paper in a period to buy their fill of back rubs by trading white pieces of paper with the central bank, why would they give back rubs?

A person with a sufficiently large endowment of green paper might indeed set his price-per-backrub so high that no one chooses to buy one from him, then live off the interest he earns from exchanging all his green paper for white paper at the beginning of each period. However, there's no particular guarantee that he will, in fact, earn any interest, or that the price of the backrubs he favors won't rise. Maybe it costs two green papers for one white paper (-50% interest), and maybe the price of his favorite backrubber will double in the next period.

And if EVERYONE tries this strategy, they will all be frustrated by their inability to buy ANY backrubs, and once they recognize how high prices are they will realize they need to sell some backrubs to earn enough green paper to be able to buy some. Each person that recognizes this will lower his price in hopes of selling some backrubs, so collectively all (or most) of the prices will fall.

Each person can give an infinite number of back rubs. Does each person have an infinite demand for back rubs?

You can say that giving a backrub has a constant disutility cost and receiving a backrub has a decreasing marginal utility benefit. Equivalently, you can say that giving a backrub has an increasing marginal disutility cost and receiving one has a constant utility benefit. The answer comes out the same (it's like moving a constant multiplier from the numerator of one side of an equation to the denominator of the other).

Alex,

"AHA! And now we hit the crux of macroeconomics, composition. Remember N is large? Any individual person's decision to buy white paper or backrubs has only a tiny, indiscernible effect on the number of backrubs he will sell."

If the back rub economy is supply constrained ( more demand than possible supply ), yes then the effect of his white paper / back rub decision will be small in regards to the number of back rubs he can give. But we have already established that the economy is not supply constrained.

If the back rub economy is demand constrained ( more supply than possible demand ), then the effect of his white paper / back rub decision can be quite large in regards to the number of back rubs he can give.

I don't think that it is guaranteed that any individual person's decision to buy white paper or back rubs will always have a tiny effect on the number of back rubs he will sell. I think that it would be difficult for that person to determine the effect of his decision without prior knowledge of everyone else's decision.

If the back rub economy is supply constrained ( more demand than possible supply )

This is already semantically empty.

These are all different things:

Demand
Quantity Demanded
Quantity Traded
Quantity Supplied
Supply

Demand and Supply are curves, not numbers, so you can't say "supply is less than demand". Quantity Demanded is the number of (a particular type of) backrubs people are willing to buy at the given price. Quantity supplied is the number of backrubs a person is willing to offer at the given price. Quantity traded is the number of backrubs actually given.

I don't think that it is guaranteed that any individual person's decision to buy white paper or back rubs will always have a tiny effect on the number of back rubs he will sell. I think that it would be difficult for that person to determine the effect of his decision without prior knowledge of everyone else's decision.

You are flat-out wrong on this point. Say N = 100 trillion. The (marginal) decision to spend 1 green paper on a backrub vs on a white paper will probably have no discernible effect on your income, any more than your (real-world) decision to buy a coke from a vending machine has a discernible effect on your salary.

Alex,

"The (marginal) decision to spend 1 green paper on a backrub vs on a white paper will probably have no discernible effect on your income, any more than your (real-world) decision to buy a Coke from a vending machine has a discernible effect on your salary."

Please, let us just stick to the back rub economy. Coca Cola has a cost of capital, a production time frame, and a lot of other things that are missing from the back rub economy.

Okay, N = 100 trillion. My marginal decision to spend 1 green paper on a back rub vs on a white paper will have a discernible effect on the number of back rubs that I give IF the pool of back rub buyers is a small percentage of the 100 trillion. Even if N is 100 trillion, the number of back rub buyers in any period could be 1, could be 10, could be 100, could be N. If it is just me buying back rubs, then my decision to buy back rubs has a very significant effect on the number of back rubs that I can sell. Obviously I can't sell back rubs to myself, but because I am the only one with green paper (everyone else converted green paper to white paper or may have no green paper), then the only green paper that can pay me for back rubs is the green paper that I initially spent on back rubs.


Is that supposed to be a clever objection? "Oh, if I construct a pathological case where N is big but the vast majority of the N don't participate in any economic activity at all, it's as if N is small!" We're talking about non-degenerate cases.

That crosses the line from ignorance to deliberate obtuseness.

Please, let us just stick to the back rub economy. Coca Cola has a cost of capital, a production time frame, and a lot of other things that are missing from the back rub economy.

None of that is relevant to the point of "you are a tiny piece of the economy and an only an infinitesimal fraction of the money you spend end up back in your pocket".

Alex,

I didn't say that the vast majority of N don't participate in any economic activity at all.

My statement - "everyone else converted green paper to white paper or may have no green paper"

This does not preclude the N people from giving back rubs in the time period in question.

"None of that is relevant to the point of you are a tiny piece of the economy and an only an infinitesimal fraction of the money you spend end up back in your pocket".

That would depend on whether I find a person who gives back rubs I like and who likes back rubs that I give. Or if you don't like two person chains, then perhaps a family of 5 that only trades with each other, or a social circle of a couple dozen that only trade with each other. I may be a tiny piece of the broad back rubbing economy but I may be a significant piece of the back rubbing economy that I deal with every time period.

This does not preclude the N people from giving back rubs in the time period in question.

Backrubs are only given in exchange for green paper.

I also specified at the beginning that everyone already has a stock of green paper (which was originally created in the distant past).

That would depend on whether I find a person who gives back rubs I like and who likes back rubs that I give. Or if you don't like two person chains, then perhaps a family of 5 that only trades with each other, or a social circle of a couple dozen that only trade with each other. I may be a tiny piece of the broad back rubbing economy but I may be a significant piece of the back rubbing economy that I deal with every time period.

Yes, yes, all of those are theoretically consistent with my rough outline of the model and none of them are interesting. In the real world the purpose of money is to solve the coordination problem; it's to let us conduct mutually beneficial transactions without actually finding a double coincidence of wants.

Just like in real life, you can assume that this graph has very few small cycles but many large ones.

Alex,

Thank you for all the step through. One final thing. You mentioned that in this model each person has a unique back rubbing technique that he gives. I would presume that each person has a preferred technique (no substitution) that he wants to receive as well. The back rub economy would seem to be a set of closed loops economy, as opposed to a lattice network economy. In the real world, there is typically a lattice network of consumers and producers except for highly specialized equipment. With closed loop economies ( even ones with big loops ), it just seems to me that individual behavior can have a greater impact on the macro-economic outcome. I don't know how exactly to quantify it.

"In the real world the purpose of money is to solve the coordination problem; it's to let us conduct mutually beneficial transactions without actually finding a double coincidence of wants."

Within the back rub economy, money is used to solve the time coordination of wants. Joe may want a back rub from Alice right now but Alice may want a back rub from Joe two periods from now. Money bridges the gap in time between wants. But the coordination of wants is also a function of how the back rubbing styles and preference for styles are allocated among the N people. The loop sizes and quantities are indeterminate of money.

Frank: "Within the back rub economy, money is used to solve the time coordination of wants. Joe may want a back rub from Alice right now but Alice may want a back rub from Joe two periods from now. Money bridges the gap in time between wants."

You don't need money for that case, provided Alice trusts Joe. Alice would just get an IOU from Joe for one backrub. There's a coincidence of wants there, even with a time-lag. Joe wants to buy what Alice wants to sell, and Alice wants to buy (2 periods later) what Joe wants to sell.

Suppose Alice wants a backrub from Bill, who wants one from Clara, who wants one from Dick, who wants one from Emily...etc....who wants one from Zeba, who wants one from Alice. That's where you need a medium of exchange, because otherwise all 26 people need to meet and do a 26-person deal, which is tough to organise.

(Good discussion Frank and Alex).

Frank:

Thank you for all the step through. One final thing. You mentioned that in this model each person has a unique back rubbing technique that he gives. I would presume that each person has a preferred technique (no substitution) that he wants to receive as well. The back rub economy would seem to be a set of closed loops economy, as opposed to a lattice network economy. In the real world, there is typically a lattice network of consumers and producers except for highly specialized equipment. With closed loop economies ( even ones with big loops ), it just seems to me that individual behavior can have a greater impact on the macro-economic outcome. I don't know how exactly to quantify it.

The "unique back rubbing technique" is what makes it monopolistic competition vs. perfect competition. If the backrubs were all identical then it would be perfect competition.

And no, a person may have many different types of back rubs that he likes. However, they cannot be on the same diminishing returns curve, otherwise they would be partially substitutable.

(It occurs to me that this means you CAN'T just have increasing marginal disutility of backrubbing, because that puts all the other backrubs on a share DR curve.)

Nick:

You don't need money for that case, provided Alice trusts Joe. Alice would just get an IOU from Joe for one backrub. There's a coincidence of wants there, even with a time-lag. Joe wants to buy what Alice wants to sell, and Alice wants to buy (2 periods later) what Joe wants to sell.

I actually ruled that out at the beginning (no one trust each other) because I wanted to prevent any possibility of private credit - and thus private credit-money - in the model.

And thanks :)

Nick and Alex,

"You don't need money for that case, provided Alice trusts Joe. Alice would just get an IOU from Joe for one backrub. There's a coincidence of wants there, even with a time-lag. Joe wants to buy what Alice wants to sell, and Alice wants to buy (2 periods later) what Joe wants to sell."

I guess it would depend on the monetary system (credit based versus government fiat). That is how credit based money originates - as an IOU.

"Suppose Alice wants a backrub from Bill, who wants one from Clara, who wants one from Dick, who wants one from Emily...etc....who wants one from Zeba, who wants one from Alice. That's where you need a medium of exchange, because otherwise all 26 people need to meet and do a 26-person deal, which is tough to organize."

It would be tough to organize because.....it would take time to achieve that level of organization? If the 26 people can meet and agree in the same amount of time that it takes to give a back rub then where is the difficulty? I really don't think you can take time out of the equation - how else do you measure difficulty or ease?

There were rather large changes in Western economies between 1965 and 1975. In 1965, most Western economies had fixed interest rates and fixed currency flows, and the assumption was that the ideal firm structure were large corporations which were either vertically integrated or with large horizontal structures. The idea was that most resource transfers would happen internal to the corporation with relatively few inter-corporate resource transfers leading to behavior which were relatively insensitive to external financial signals.

Between 1965 and 1975 that system broke done. Because of the London interbank market, governments could no longer control interest rates and with the break down of Bretton Woods the world of fixed currency exchange broke down. Once you had money markets, then instead of intra-firm resource allocations, firms could them access the financial markets, and once that happen (and firms got smaller) they became more responsive to market signals.

So what I'm basically suggesting is that maybe the Keynesians *were* right, but they were responding to the economy circa 1965 in which firms were relatively insulated from market signals which led to a vertical aggregate demand curve, and in some ways they were *forced* to assume this because the economy in 1965 was not able to conduct monetary policy in the way that it was after 1975 because of fixed interest rates (i.e. Regulation Q). Without monetary policy, the only thing that you have is fiscal policy and Vietnam killed that.

It's possible to have a system of debt without money. You have an economy which is run by say eight families who control all of the major corporations. Within each corporation you have a bureaucratic system for control, and at the top, people can trade favors (i.e. you give me X, and then at some point I'll give you Y). Since everyone runs in the same social circles there are large social sanctions that enforce deals.

People tell me that this is how the NYC financial industry worked until the 1970's (i.e. back when in order to run Lehman Brothers, you had to be a brother named Lehman, and how London worked until the 1980's, and for better or worse, it's a reasonable description of the South Korean and Japanese economy.)

One thing that killed this was technology. The people at the top can keep control as long as you can't exchange information except through the top level. Once the cost of long distance phones go down, the hierarchy becomes a network, and once the network more than 20 people and socially hetreogenous, then you can't enforce informal deals so people start cheating and the system falls apart.

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