There are two problems with musical chairs:
- The obvious problem: there aren't enough chairs for the kids that want to sit on them.
- The less obvious problem: chairs and kids are heterogeneous, so if kids grab any chair they can get, some tall kids will be sitting on short chairs and some short kids will be sitting on tall chairs. The tall kid sitting on a short chair won't swap seats with a short kid sitting on a tall chair, because they fear some kid without a chair will grab their seats if they try to change places.
There are two problems with a binding price floor (or binding price ceiling) on apples:
- The obvious triangular problem: there's an excess supply of apples, so Marginal Benefit = Price > Marginal Cost, so MB > MC.
- The less obvious fuzzy (or striped) trapezoidal problem: the apples that do get produced and sold aren't always going to be the apples with the lowest Marginal Cost. It all depends which apple orchards are lucky enough to have a customer nearby when the music stops.
There are two problems with a recession caused by an excess demand for the medium of exchange:
- The obvious problem: there's a fall in the volume of monetary exchange, so some potentially mutually beneficial exchanges do not get made, because barter is difficult, and buyers are stuck in a Prisoners' Dilemma where it is collectively rational but individually irrational for each to hand over money to the others to trade more goods.
- The less obvious problem: the limited number of potentially mutually beneficial exchanges that do in fact get made are not necessarily the most potentially mutually beneficial. It's not just that the dollar value of exchanges is too low; but the subjective value of the exchanges is lower than it could be even given that constraint on the total dollar value. It all depends on which seller is lucky enough to be in the right place at the right time to find a buyer.
There are two problems with the fall in employment during a recession caused by an excess demand for the medium of exchange:
- The obvious problem: the fall in employment and rise in unemployment mean that some workers won't have jobs and won't be producing output.
- The less obvious problem: even taking as given the total number of jobs being too low, the wrong workers will be doing the wrong jobs. Some tall workers will be sitting in short jobs, and some short workers will be sitting in tall jobs. The monetary disequilibrium prevents sorting by comparative advantage, which reduces total output for a given level of resources employed. Productivity is reduced.
This is actually good news. Because it means that output (and more importantly welfare) can actually be increased by more than the obvious amount by better monetary policy. We don't just gain a Harberger triangle; we gain a fuzzy Okun trapezoid as well.
I stole the musical chairs metaphor from Scott Sumner. A Twitter exchange between Miles Kimball and Narayana Kocherlakota prompted this post. Narayana was optimistic about the prospects for increasing output by loosening monetary policy despite the near recovery in unemployment.
A model is a parable told with math. A parable is a metaphor told as a story. I'm not quite there yet.