Mackerels and Money

Arnold Kling asks: why are mackerels different from money? Why should the M in MV=PY stand for money, and not mackerels?

Why can't an excess demand for mackerel cause a recession? Why can't an excess supply of other goods be matched by an excess demand for mackerel?

Keynesians don't know the answer to this question either*. Keynes himself never mentioned mackerels as potentially causing a violation of Say's Law, but he did mention land, which is essentially the same as mackerels.

Funnily enough, I have already answered Arnold Kling's question several times in previous blog posts. But I was talking about land, bonds, bling, or used furniture. I forgot to mention mackerels specifically.

The textbooks mention three properties of money:

1. Money is a store of value. So are mackerel (if frozen or canned). Forget that.

2. Money is a medium of account (we measure prices in money). Mackerel aren't. But so what? Prices are sticky in terms of money. But the price of mackerel is also sticky in terms of money. So prices are sticky in terms of mackerel as well, by transitivity. So no difference there between money and mackerel.

3. Money is a medium of exchange. Aha! Because (outside of US prisons) mackerel is not a medium of exchange. An excess demand for mackerel might cause a general glut and recession in US prisons, but only an excess demand for what the rest of us law-abiding folk use as money can cause a general glut and recession elsewhere.

To see why, suppose there were an excess demand for mackerel, and the price of mackerel in terms of other goods did not rise to clear the market. By Walras' Law, the excess demand for mackerel must be matched by an excess supply of other goods. But that's only true of notional demands. Frustrated by an inability to buy as much mackerel as they wanted, people would give up, and buy something else instead, like sardines, pilchards, beans, rice, furniture, land, bonds, or maybe even supply less labour (what's the point in working, when you can't buy more mackerel with your wages?). The excess constrained supply for other goods would go right back to zero, as soon as people realise they can't satisfy their excess demand for mackerel. End of general glut.

Mackerel can't stop the inexorable logic of Say's Law. If you have an excess demand for mackerel, and so does everyone else, you are stuck. Unless you are prepared to go out on a fishing boat, the only way to get more mackerel is to buy it, and you can't, because you are on the long side of the mackerel market.

Money can stop the inexorable logic of Say's Law. If you have an excess demand for money, and so does everyone else, you can't get more money by selling more goods. But you can get more money by buying less goods. Of course, in aggregate these attempts will fail, but that doesn't stop individuals buying less goods, just like confessions in Prisoner's Dilemma.

If there's an excess demand for mackerel, very few of us normally sell mackerel (and even fewer both buy and sell it), so very few of us can try to satisfy our desire for more mackerel by selling less. But everyone sells money; we do it whenever we buy something else. So every one of us can try to satisfy our desire for more money by selling less money. And that causes a general glut, a recession, and a drop in nominal and real income.

MV=PY works for money, because money really does have a velocity; it goes both into and out of our pockets. Mackerel doesn't.

*There is one exception to what I say about Keynesians, but it's an exception that proves the rule. Like a full moon to a werewolf, the mention of Say's Law turns Brad DeLong into a monetarist; he starts talking about velocity, and quoting Hume, Fisher, and Friedman.

Comments

[fourthtimeanon]

Kling's use of the mackerel analogy is completely unnecessary to his theme, which is the behaviour of money velocity due to something he calls the “great recalculation”.

“In my view, the fall in nominal GDP was due to the fact that real GDP had to fall. Real GDP had to fall, because the economy was beginning a Great Recalculation.”

As far as mackerel are concerned, he's simply using this as a pretend depiction of money; why I don't know. His own view of the usefulness of the analogy seems to be in the following:

“However, if we go back to the case where the government is behaving, then the quantity of money is more like the quantity of mackerel ... As long as we know that the Fed is afraid of hyperinflation, then it has a limited supply of money, just as it would have a limited supply of mackerel.”

Again, I have no idea what this adds to his argument about the “Great Recalculation”

But I don’t think it has anything to do with the idea of barter or with Say’s Law:

“I do not see how the Recalculation would have been helped by the Fed suddenly printing a whole lot more money. In terms of MV = PY, I see PY as largely outside of the Fed's control--the P part was determined by the combination of habit and gradual adjustment in the Great Recalculation, and the Y part was determined by the frictions involved in the Great Recalculation. So if we could rewind the tape to sometime in 2008, hold everything else equal, and have more M, I think we would see essentially a 100 % offset in V. Just as we would if M stood for mackerel.”

[Too Much Fed]

What happens when someone starts raising mackerel to create more of them?

[Too Much Fed]

How about trying different money supplies for M in MV=PY?

[Greg Ransom]

Say's law defines an equilibium condition in an logical / math construct --
there's really no room for money in this construct.

[Kevin Donoghue]

Land and mackerel were not "essentially the same" for Keynes. He thought of land as a non-produced good or, as he put it, a good with a low elasticity of production. If demand for non-produced goods is not diminished by a fall in the price of produced goods (elasticity of substitution is low) then price flexibility may not be enough to ensure full employment. He seems to have had second thoughts as to whether that particular argument is sound or not. It's an open question AFAIK. GE theory tells us that we need a gross substitutes axiom to guarantee the existence of a Walrasian equilibrium, but that doesn't get us very far.

[Min]

"2. Money is a medium of account (we measure prices in money). Mackerel aren't. But so what? Prices are sticky in terms of money. But the price of mackerel is also sticky in terms of money. So prices are sticky in terms of mackerel as well, by transitivity."

Is stickiness transitive? Please explain that a bit.

My impression is that stickiness is a kind of inertia, which is not transitive.

Many thanks. :)

[David Chester]

Keynes did not take the subject of land far enough. He should have been aware of the previous writing of Henry George, an Americal economist of the previous centuary who wrote his seminal book "Progress and Poverty" in 1879. Amongst much discussion and philosophy, George describes the way that land-value speculation cause business cycles and the economic crisis we are presently facing is due to this effect.

George proposes to tax land-values instead of personal incomes and property of other kinds. This would eliminate speculation in the unstable and often rising values of this natural resource. It would reduce production costs whilst allowing earners to use all of their incomes with the result that demand would increase and poverty and unemployment become obsolete concepts. This subject is currently supported by the Banniker Foundation (and others), see http:/www.progress.org

[Bill Woolsey]

Kling has responded:

http://econlog.econlib.org/archives/2009/09/responses_to_tw.html

Nick:

Is it really true you have never heard of structural unemployment? Or is it that you have never imagined that it could change or thought about what that implies regarding potential output? (My view is that most monetary economists would say, well, duh. Now lets get down to some interesting stuff.)

Sumner and I take you to task for downplaying the medium of account:

http://blogsandwikis.bentley.edu/themoneyillusion/?p=2377

http://monetaryfreedom-billwoolsey.blogspot.com/2009/09/rowe-on-klings-macrkeral-velocity.html

Please note that I am not making any strong claims about how barter economies with a medium of account would come to equilibrium. I am not sure I understand how it would work. My point is that the supply and demand for the medium of account necessarily determine the equilibrium value of the price level and nominal income--in terms of the medium of account.

Also, I haven't figured out how to track back.

[Andy Harless]

Is the critical thing about money that it is a medium of exchange or just that it is a good of which most people hold inventories? If you have an excess demand for mackerel and so does everyone else, all you need to do is sell less mackerel out of your inventory. Just like with money, it won't work in aggregate, but it works for individual budgeting. It sounds like the money argument is a special case of a broader argument that Say's Law doesn't work when there are inventories.

[Rob Parenteau]

Doesn't Arnold Kling take us right into the fallacy of composition when he argues "you can get more money by purchasing fewer goods", which get you the general glut deemed impossible under Say's Law? Each of us may conclude individually if we spend less of our income, then we will have more money saving at the end of each accounting period. As we each pursue this individually rational solution, then income turns out to be less than anticipated, saving a particular money amount becomes more difficult, inducing further cutbacks in spending...which is the route to the vicious cycle.

In addition, Keynes was keen on placing the demand for money as an influence on the prices of less liquid assets, so the matter of getting more money may also have to do with buying fewer illiquid assets or selling more illiquid assets held in a portfolio of wealth. But I suppose Say's Law is for a barter economy, or at least one where money is a veil for the exchange of goods and services. Problem is, if this exchange is done over time, the true exchange rate is unknowable in monetary economies unless prices are fixed in perpetuity.

[Richard H. Serlin]

You know Arnold probably chose Mackerel because cans of it are used as currency in some prisons. If you're not familiar with this, the Wall Street Journal had an interesting article, "Mackerel Economics in Prison Leads to Appreciation for Oily Fillets", at:

http://online.wsj.com/article/SB122290720439096481.html

[Nick Rowe]

fourthtimeanon: I too am a bit puzzled as to why Arnold Kling introduced mackerels. My guess is that he wanted to show that money could not have any special importance in explaining the current recession, because any theory based on money could be replicated by a theory based on mackerel, which is a reductio ad absurdam of monetary explanations. I think Bill Woolsey's post on his blog elucidates it. Bill argues that Arnold is implicitly assuming that the demand for money is independent of income. My response is that money is a medium of exchange, and mackerel aren't.

Too much Fed: If you increase the supply of mackerel, and the price of mackerel is flexible, the price of mackerel falls. If it's fixed, you get an excess supply of mackerel, and nothing else. If you increase the supply of money, and the price of everything else rises. If it's fixed, you get an excess demand for everything else.

Greg: no room for money in Say's Law: agreed. But not because it's a logical/math construct.

Kevin: as far as I can see, I don't think it matters whether land/mackerel is produced or not. Provided the supply curve were not perfectly elastic, you would still get an excess demand for land/mackerel if the price were fixed. The question is: does that create an excess supply of other goods?

David: But I think Henry George was looking more at the tax angle, rather than the Say's Law implications.

Bill: I can't figure out trackbacks either. I always click the "trackbacks allowed" box, but don't know what it means.

Yes, "recalculation" does sound a lot like structural unemployment.

"My point is that the supply and demand for the medium of account necessarily determine the equilibrium value of the price level and nominal income--in terms of the medium of account."

I think you are right about this determining the equilibrium value of the price level. Not nominal income though. And when we are out of equilibrium (because of sticky prices) I don't think the supply and demand of the medium of account matter much at all. It's the supply and demand for the medium of exchange that matters.

I wish I had thought of that earlier.

S&D of MoA determine equilibrium P.

S&D of MoE determine disequilibrium Y.

Does that make sense? (It's too early).

Andy: I need to think more about inventories. The ability to vary your inventory of money is clearly important. Would other inventories do the same job? Dunno. My guess is no.

Rob: I don't think Arnold made any fallacy of composition. It's true that each of us individually can get more money by buying less goods, but the aggregate attempt to do this merely results in lower income and the same money. But I see this as more like prisoners dilemma.

Richard: Yes. I was wondering if I was confused between mackerel and pilchards.