Why Y? A disproof of Keynesian macroeconomics?

There's something really wrong with the way we do short run macroeconomics. We focus all our attention on the output of newly-produced goods and services. That's what we call "Y". We talk about Aggregate Demand and Aggregate Supply, and what we mean by AD and AS is the demand and supply of those same newly-produced goods and services.

Keynesians then go on to divide Y into C+I+G, and C+S+T. Monetarists talk about MV=PY. Both agree that a recession is a fall in Y, caused by a drop in demand for Y.

But a moment's reflection tells you this is wrong. It's not just new stuff that is harder to sell in a recession; it's old stuff too. New cars and old cars. New houses and old houses. New paintings and old paintings. New furniture and antique furniture. New machine tools and old machine tools. New land and old land.

If you want to sell new stuff in a recession, you have to either drop the price, or not sell it. If you want to sell old stuff in a recession, you have to either drop the price, or not sell it. And some people can't or won't drop their price, and some stuff doesn't get sold. That's true for both new and old. There is absolutely nothing special about new stuff.

Imagine, just imagine, a world in which newly-produced goods and services never ever get bought or sold. There are apple trees, that produce apples, that live for ever, and have existed since the beginning of time, and you can't grow a new tree. But nobody ever buys and sells the apples. It's tabu. They only buy and sell the apple trees. And pear trees, and peach trees, etc. And imagine that people's tastes change, year by year, so one year I want to eat only apples, and the next year I want to eat only pears, and so on. But in order to switch from eating apples to eating pears I have to sell my apple tree and buy a pear tree. And suppose everyone else's tastes are constantly changing too, in random ways. And that it's very unlikely there will be a double coincidence of wants, and that multilateral barter is hard, so we all buy and sell trees for money. We live in a monetary exchange economy.

By assumption, there cannot be a drop in the output of newly-produced goods and services in this economy. The trees keep on producing fruit, regardless. And that fruit will get consumed, regardless. And we can't even talk about an excess supply of fruit, because there is no market in which fruit is bought and sold. Y=C, and both Y and C are fixed.

But there can be a recession, nevertheless.

Suppose the price of trees is sticky, and the stock of money falls. There is now an excess demand for money. People stop buying trees, because each person wants to increase his stock of money. And because people stop buying trees, people find they cannot sell trees. There's an excess supply of trees. The quantity of trees bought and sold falls. And everybody is worse off, because they are stuck eating apples when they want to eat pears, or stuck eating pears when they want to eat peaches, or stuck eating peaches when they want to eat apples.

That's a recession, even though Y hasn't changed. Recessions aren't (just) about Y.

I have no idea how I would modify Keynesian macroeconomics to handle an economy like that. How can you talk about a demand function like C=a+bY, when C and Y are never bought or sold, and Y is fixed anyway?

I know exactly how I would modify monetarist macroeconomics to handle an economy like that. You know that MV=PY equation? OK, scrap it. Replace it with the original MV=PT. Where T is the quantity of transactions in trees. No problem.

Comments

[Martin]

Isn't Y=E and what's the big difference between T and E? Don't Keynesians mean E, when they're talking about Y anyway? 'Simply', rewrite all equations in terms of E instead of Y and you're done. Y then just serves as a 'check' on E.

[Kevin Donoghue]

"But there can be a recession, nevertheless."

Not in the usual sense of the word. There's no unemployment, is there? What you're describing is something akin to a property bust, where every second house has a For Sale sign on it, but nobody is buying.

[Nick Rowe]

Martin: "E" is desired expenditure on *newly-produced* goods and services. "T" is transactions in everything.

[Nick Rowe]

Kevin: an apple tree, owned by someone who would rather be eating some other fruit, is as unemployed as a worker digging his own garden, when he would rather be paid for digging somewhere else.

[W. Peden]

I actually had a comment on The Money Illusion that made a similar point, albeit with no such elegance or confidence: if the ratio of PT to PY is very high, then you can have instability in PT (over prolonged periods) without any such instability showing up in PY. You might even have, say, 15 years of PY growing at a steady 5% or so while PT is exploding; in such a situation, you would expect to see major asset price inflation and financial instability even when the "real" economy was chugging along quite nicely. You'd expect to see periods of wild instability in the income velocity of money, with the money stock following/leading assets well but NGDP poorly. That sounds to me a lot like the world in which we have lived since the beginning of the Great Moderation.

At one point in "Keynes, the Keynesians and Monetarism", Tim Congdon criticises the textbook income-expenditure model on about three counts: (1) it has no place for private property and therefore no place for running down assets, (2) it has no place for saving in one period and consuming in the next, and (3) it has no place for our portfolio preferences that are central to understanding expenditure decisions.

I think one can extend the point: if we are to understand economies with private property and financial systems, then we have to include wealth and net transactions in our analyses. Your hypothetical brings that out very well. A real world example would be: the West has had an external productivity shock from East Asia. It should be obvious that such a shock should lower inflation ceteris paribus. However, it didn't even boost NGDP, because people used the skimmed savings from their purchases on importable goods (cars, electronics, clothes, toys etc.) to spend on existing goods that couldn't be imported and which concomitantly were going up in price i.e. property and stocks. Since asset price inflation doesn't show up in NGDP, the US had stable NGDP from 1995-2007 even though total inflation (inflation of ALL prices) was running out of control.

PT may be very hard to measure and it may have been legitimate to use PY as a proxy when the financial sector was a smaller proportion of GDP. However, that ship has sailed and one of the challenges for macroeconomics in the 21rst century is to understand the business cycle in economies where financial transactions make up the overwhelming majority of transactions. After all, if Scott Sumner is right and large financial sectors are necessary for proper capital allocation in an advanced economy, then one day the most recent business cycle is going to be the norm for all economies.

Call it "paleo-monetarism": back to the MV = PT of Hume and Fisher.

An interesting empirical paper on PT and PY-

http://cemf.u-bourgogne.fr/z-outils/documents/communications%202009/Howels.pdf

[W. Peden]

(I started thinking about this topic when thinking about the endogeneity of broad money. Deposits expand when loans are made and when bonds are bought by banks. Since they pursue expected profits, banks lend on the basis of creditworthiness. What determines creditworthiness? The probability that someone will pay back. What determines the macroeconomic ability to pay back of an entire economy of borrowers? Their net wealth i.e. the price of their total assets, which is the P in PT. So PT determines the expansion or contraction of M.

Imagine a central bank targeting NGDP. Let's say it engages in some OMOs. These alter the value of P in PT by changing the quantity of appreciating liquid assets, which alters M through the endogenous determination of broad money in the financial sector, which alters PY. It also alters interest rates and V, of course, but I like to think of interest rates as an epiphenomenon of the supply of credit and the demand for credit.)

[Min]

"There are apple trees, that produce apples, that live for ever, and have existed since the beginning of time, and you can't grow a new tree. But nobody ever buys and sells the apples. It's tabu. They only buy and sell the apple trees. And pear trees, and peach trees, etc. And imagine that people's tastes change, year by year, so one year I want to eat only apples, and the next year I want to eat only pears, and so on. But in order to switch from eating apples to eating pears I have to sell my apple tree and buy a pear tree."

Too clever. If the reason that I buy a pear tree is to consume the pears, I am really buying the (current and future) pears.

[Frances Woolley]

Nick "It's not just new stuff that is harder to sell in a recession; it's old stuff too. "

Nick, do you actually know this for a fact? Sure, old houses might be harder to sell, but what about old clothes? Old cars?

Think back in time - when we as people were far poorer than we are today there used to be thriving markets for things that we just trash today.

E.g. remember ('cause it's Christmas) that scene in the Christmas Carol where people are selling off Scrooge's bedclothes, bed curtains, even the shirt that he was to be buried in...

This doesn't necessarily invalidate your overall point about the need think carefully about what Y means however.

[vimothy]

But a moment's reflection tells you this is wrong. It's not just new stuff that is harder to sell in a recession; it's old stuff too.

And not just old stuff--Y is final goods and services, but presumably intermediate goods are also harder to sell in a recession.

[Kevin Donoghue]

"...an apple tree, owned by someone who would rather be eating some other fruit, is as unemployed as a worker digging his own garden, when he would rather be paid for digging somewhere else."

Nick, that's why I wrote "Not in the usual sense of the word." I'm quite well aware that you can think of my apartment as unemployed if you want to define your terms that way. I'm pretty sure you can't think of my bond-holdings as unemployed however. Humpty-Dumpty could, but not you. And why not? Presumably because that's what Hicks called a flexprice market. Or do you have some other reason?

[David Beckworth]

So are there any direct or indirect measures of PT?

[Frances Woolley]

Nick - another old thing that's easier to sell during a recession: wine. This is a newspaper report from last summer...

Buy gold—the real thing, or the liquid version, i.e. Château d'Yquem. Both of them are apparently recession-proof: The precious metal topped $1,500 an ounce for the first time this year; 200-year-old Yquem, on the other hand, is trading closer to $4,600 an ounce this week. A bottle of 1811 Château d’Yquem was purchased in London for a Guinness World Record price of $117,000, making it the most expensive bottle of white wine ever sold.

I guess this is similar to W. Peden's point - if we are to understand economies with private property and financial systems, then we have to include wealth and net transactions in our analyses.

[W. Peden]

David Beckworth,

Howell and Mariscal get their series from the various facilities used for non-cash transactions in the UK.

[primedprimate]

It seems like you have multiple goods. In this case it appears that aggregation is extremely important. C and Y will both be low in this model if the misallocation is treated in a serious and logically appropriate manner while doing the aggregation. Every person will have an 'unintended inventory' of the wrong kind of trees. People will be 'underconsuming' (just like with underemployment) because they will be consuming less (in terms of the quality of consumption) during the recession. An accurate measure of C would capture this drop in C, just as an accurate measure of unemployment would capture the underemployed. Similarly, an accurate measure of Y would capture the misallocation effects there as well (there would be underproduction, i.e. people will throw away fruit they don't like).

[Mike Sproul]

Nick:

Start with MV=PT and replace M with "shares of GM stock". The equation is just as 'true' of GM stock as it is of money, but it tells you nothing about what determines the value of GM shares. Same for money.

[Nick Rowe]

W. Peden: "Call it "paleo-monetarism": back to the MV = PT of Hume and Fisher."

That was sort of my thinking too. I had thought of MV=PT as just a way-station on the road to MV=PY. But now I think that MV=PT is more like the real deal, and MV=PY is just a subset of what's happening in a recession. And yes, by adding old goods to new goods I'm still leaving out a lot of stuff, like financial assets, and intermediate goods.

Min: "Too clever. If the reason that I buy a pear tree is to consume the pears, I am really buying the (current and future) pears."

If all markets work perfectly, then it doesn't matter if I buy the apple tree or buy the apples. We get exactly the same allocation of resources, whether it's an Arrow-Debreu economy or a central planner. But if markets don't work perfectly, and they don't in a recession (IMHO), then it really does matter what markets exist. For example, it matters whether we have a monetary exchange or a barter economy. It matters whether there's a market in consumer durables or in the services of consumer durables.

Frances: "Nick, do you actually know this for a fact? Sure, old houses might be harder to sell, but what about old clothes? Old cars?"

Ummm. No. I was bluffing, and hoping nobody would ask me that question!

I think it's true for old and new houses, and for any other good where old and new are close substitutes, and where the prices of old and new are roughly equally sticky. It might be false if the old good is an inferior good and the new good is normal. But then it would be equally false for any new good that happened to be an inferior good. KD is probably easier to sell in a recession.

Other than houses, I'm not sure if there's good data on sales of old goods.

vimothy: "And not just old stuff--Y is final goods and services, but presumably intermediate goods are also harder to sell in a recession."

Yep. But if intermediate goods are sold in a fixed ratio to new goods, existing theory can handle that more easily, I think.

Kevin: "Presumably because that's what Hicks called a flexprice market. Or do you have some other reason?"

Suppose a monetary disequilibrium causes an excess supply of everything at the initial price. If half the goods have flexible prices, and the other half have sticky, then the flex prices fall, and there's a micro substitution away from the fix-price towards the flex-price goods. That's true for new goods, old goods, and financial assets too. Sure, financial assets are more likely to be "commodities", in the sense that they are all alike (like oil and wheat), and have lower transactions costs, and hence more flexible prices.

David: "So are there any direct or indirect measures of PT?"

I don't know. Ah! W. Peden has answered you!

Frances: that's strange. I wouldn't have thought that expensive wine would be recession proof. Maybe it's just this recession, with low real interest rates. Farmland prices, and gold prices, are rising too.

primedprimate: I think you are right. I think that GDP, or employment, as conventionally measured, couldn't really capture more than a small amount of what is happening in a recession (and in my hypothetical economy they capture nothing). The only way we could really capture it would be if we could measure utility??

[Nick Rowe]

Mike: GM stock are not used as a medium of exchange. If GM stock disappeared, the rest of the economy could carry on as usual. If money disappeared, the rest of the economy would grind to a halt as we figured out how to do barter, or else gave up on exchange altogether.

[W. Peden]

Mike Sproul,

Why would the equation of exchange tell you about "what determines the value of money"? It's primary function is to give us a way of calculating velocity (and thereby the demand to hold money).

[W. Peden]

Nick Rowe,

It seems that top-end luxuries (like fine wines and fancy chocolates) and low-end luxuries (popcorn, cinema tickets and ice-cream) both do well in recessions. That makes sense though: the former are mostly consumed by people who aren't income-constrained in their annual consumption, while the latter are ways that people on lower incomes can have a good time without spending too much money.

[Min]

"And we can't even talk about an excess supply of fruit, because there is no market in which fruit is bought and sold."

What about fruit rotting on the ground?

[K]

Luxury Giffen goods? Maybe. Certainly most high end consumption does not hold up in a recession. High end tourism Caribbean economies (Barbados, BVI, etc) basically collapsed in winter 08-09. But I can see "Maybe I can't justify $25K on vacation this year so I'm going to stay home and drown my sorrows in really excellent wine (that I deserve). "

[Jon]

Is the observation about gold and wine a reflection of a two distinct populations?

There have been several indications that some people believe in high inflation and others in low inflation. So there at two disjoint populations each driving the value of its preferred asset class. Shorting markets isnt as easy or as powerful as some people think it is. So it's quite reasonable for this sort of thing to happen.

Touching on old clothes though; I plead differently. Old clothes are inferior goods. So there is a boom in old clothes during a recession--just as there is a boom in fast food.

Old houses are not inferior goods or at least not as a rule.

[Determinant]

If Y = C+I+G and MV=PY then what's stopping me from saying MV/P=C+I+G and going from there? When I see two equations with a common variable, my first instinct is to equate them and break out the analysis from there.

[Mike Sproul]

Nick: Agreed that money shortages cause recessions. What bothers me is that Keynesian types can't just leave it at that, and instead go on to invent these twisted concepts of aggregate demand and aggregate supply.

Also: Suppose GM shares (and various derivatives of GM) were used as a medium of exchange. The share price wouldn't have to rise as a result, since GM (and issuers of derivatives) could easily issue new shares whenever the share price exceeded backing value. The equation of exchange would still be just as irrelevant to the share price. The same could easily be true of money.

W. Peden: I'd go further and say that the equation of exchange is also useless for calculating velocity, which is itself an empty concept.

[Determinant]

Why? If S and I form a time-shifting pair, then you would expect V = 1/sqrt(SI) which is common to see in second-order differential equation models.

[Nick Rowe]

Min: eating apples is better than nothing, even if you would prefer to eat pears. They won't leave fruit on the ground. In any case, "excess supply" means the quantity they want to *sell* exceeds the quantity people want to *buy*. If things are never bought and sold, we can't really talk about demand and supply.

Determinant: But MV=PY is useless. And MV=PY is only a sub-category of MV=PT anyway. MV=PT works fine. And MV=PT has no variables in common with Y=C+I+G.

[Determinant]

Ok, but if V = 1/sqrt(SI) then M/(P*sqrt(SI)) = Y

More to the point, in a second-order differential model S can be expressed as = -j/vS and I as jvI. There is a fundamental velocity determined by S and I where everything is in balance. At low velocities S forms a limiting factor as its resistance increases. At high velocities I forms a limiting factor. Or turning it around, at low economic velocities the economy needs more I to compensate for S or less S, while at high velocities we need more S to compensate for I or less I.

This is all university-level Laplace modelling with differential equations. Your colleagues over in the Engineering Faculty torture students with it every year Nick, it's what they do.

[Kevin Donoghue]

MV=PT works fine? In what sense? Can we do something with it?

[Determinant]

Do something with it? Sure, you can do this: http://www.eurojournals.com/ejsr_40_1_03.pdf

BTW "Aggregation" in this context is simply a justification to have a simple enough model to be solvable by hand.

[Frances Woolley]

Nick - "Ummm. No. I was bluffing, and hoping nobody would ask me that question!" yeah, sorry, I know that was kind of a low blow. Couldn't make any more substantive comments however. On the bright side, 3/8 questions marked.

[W. Peden]

Mike Sproul,

Then you'd be wrong twice.

[anon]

Isn't there a rather foundational difference between transactions and final expenditure--namely, that demand for money is roughly proportional to income? Suppose that Alice is willing to reduce her holdings of money balances and buys a newly produced consumption good from Bob; Bob will want to keep some of the money he got from Alice and save the rest; so he'll buy something else from Charlie and so on. But there is no "hot potato effect"; the process is dampened as real income rises. With transactions, there is no such dampening factor, because transactions such as selling a tree leave demand for money mostly unchanged. So excess transactions happen which can only stop with a rise in P or Y.

[Nick Rowe]

anon: I would say that the demand for money depends both on transactions and on income. We only need to hold money to make transactions, but we want to "spend" part of our income on convenience, and the bigger the bigger the stock of money we hold, as a proportion to the flow of transactions, the greater is our convenience.

[Zac]

Maybe we focus on new stuff, because the supply for old stuff is perfectly inelastic. Only the production of new stuff is dependent on the current/expected state of the economy, so that is the variable we seek to optimise.

[Nick Rowe]

Zac: fair point. The total supply of old stuff is (approximately) inelastic, but that leaves open the question of whether the people who own the old stuff are the people who value it most. Old stuff does get traded, for a reason, and if that trade diminishes, the allocation of resources won't be as good.

[Ryan]

So basically what we're looking at here is "money times the number of circulations" multiplied by "value times the number of transactions."

That's worse than a circular argument, as Benjamin Anderson noted, it's a tautology.

In 1917, he wrote: "The equation asserts merely that what is paid is equal to what is received. This proposition may require algebraic formulation, but to the present writer it does not seem to require any formulation at all. The contrast between the 'money side' and the 'goods side' of the equation is a false one. There is no goods side. Both sides of the equation are money sides."

When you "solve" this relationship for M, you have an identity that suggests that the money supply is a function of the price level (but why?) multiplied by T/V. Can anyone give me a good, solid economic description of what the expression "T/V" is supposed to mean?

[david]

Old stuff is grouped broadly under 'capital'. When it is traded, someone purchasing it is grouped under 'investment' and the seller dissaves. That works, no?

[Jon]

David: "savings" is word best reserved to mean accumulating cash balances, not increases in your capital stock.

[Nick Rowe]

Ryan: MV=PT is a tautology. So is Y=C+I+G. But if you add some sort of behavioural relation, they can be converted into a theory.

david: "Investment" means "newly-produced capital goods". My trees are old trees. If you buy a tree, it's more like buying land.

Jon: given the existing meaning of the word "saving" (Y-T-C), my preference is to use the word "hoarding" to refer to accumulating cash balances.

[david]

Yes, and "consumption" means "consuming newly-produced goods". But let's be fair here, the terminology isn't accurate and we do a lot of vague handwaving about what "inventories" is defined to mean to cover all the situations where economic activity avoids monetary trade anyway.

The desired point about "I" is that it is sensitive to the interest rate on money, decreases with it, and is durable and that's pretty much it as far as desirable features go, yes? "I" is stuff humans pay money for in order to postpone consumption. Behaviorally, that's about it. That "I" also should be new is to render collecting data simpler, because running around collecting all that fine data at garage sales is annoying whilst new stuff is made in businesses that often have accountants to fill out all their statistical forms.

[Nick Rowe]

david: even if you consider an individual buying a tree to be "investment", there is no investment at the aggregate level in my model. The aggregate stock of trees is fixed. A recession is bad because the trees are owned by the wrong people, not because there are too few trees.

[david]

If investment-trees are stickily owned by the wrong people, doesn't their real value change? You get the same physical amount of fruit but not the same value of fruit.

[david]

(and by god, if we descend into cambridge capital debates again, I am going to, I don't know, murder a kitten. And cry of the tendency of macroeconomics to rehash itself.)

[david]

Okay, it's like this. Y=C+I+G. Trees are I. Fruit is never traded and makes no impact on Y, so C=0. No state, G=0. I varies cyclically because the real value of trees drops when the wrong people own them, even though the amount of trees never goes away. The wrong people own them because monetary problems jam up the exchange mechanism. Is that an appropriate description?

[Kevin Donoghue]

Can anyone give me a good, solid economic description of what the expression "T/V" is supposed to mean?

Well, it's just M/P a.k.a. real balances. As Nick said, to get a theory you need to add a behavioural relation. AFAICT, he hasn't. I suppose the obvious thing to do is make V=V(x) some sort of money demand function, where x is a vector of exogenous variables. I can't see that leading anywhere however.

[Nick Rowe]

david: nearly. Trees are the stock K, not the flow I. (Strictly, trees are land, not Kapital, because they cannot be reproduced, but never mind that). Y=C is positive and fixed. The value of K varies cyclically, because the wrong people own them, because monetary problems jam up the exchange mechanism.

BTW, I think this is happening in the US, where trees are houses. People are stuck owning and living in the wrong house. Mobility has fallen. (It doesn't work exactly, because you can rent houses, which is like selling the fruit.

In the olden days, economists talked about the "trade cycle". The amount of trade varies cyclically. That's what is happening here. The amount of trade in old goods (trees) varies cyclically.

Kevin: yep. But in my story, I implicitly assumed desired V=Vbar. So a fall in M, with P sticky, causes a fall in T.

[david]

Yes, but people buy and sell trees, not fruit. NGDP is made out of transactions of money for trees. So, Y=I, not C, which is zero: economic activity that is not made in money terms doesn't show up in Y. Although physical trees cannot be reproduced, their real value can appreciate or depreciate (depending on who owns them) so the aggregate capital stock measured in dollars changes. Physically it doesn't, but that is irrelevant; K is not aggregated in physical terms. It is no different if the each tree remained the same real value and a hurricane removed some instead, shrinking K by the same amount.

If you want to link to the housing stock, one might observe that real household wealth (which often counts a house as much of its store of value) has fallen. That the amount of physical houses remains largely the same is, again, irrelevant. But the analogy seems tenuous; the point of interest is what the future path of housing value should be and the model makes some strong assumptions there, so it is not especially illuminating.

[reason]

Nick,
disproof of Keynesian economics? A bit strong isn't it. You are showing that in a very special case, the Keynesian view of the world is not sufficient. I'm sure I can find a special case that disproves monetarism.
But yes, I think this is a useful way to think about things - particularly with the post by W. Peden.

BUT

"PT may be very hard to measure and it may have been legitimate to use PY as a proxy when the financial sector was a smaller proportion of GDP. However, that ship has sailed and one of the challenges for macroeconomics in the 21rst century is to understand the business cycle in economies where financial transactions make up the overwhelming majority of transactions. After all, if Scott Sumner is right and large financial sectors are necessary for proper capital allocation in an advanced economy, then one day the most recent business cycle is going to be the norm for all economies."

I don't think any of this speculative stuff is right. I think the 1930s, 1990s Japan and the 2010s rhyme. And I think the size of the financial sector has a lot to do with income/wealth distribution and middle class stagnation not the real need for a massive financial sector. I think a lot of financial transactions are, in a social welfare sense, wasteful.

[reason]

"I actually had a comment on The Money Illusion that made a similar point, albeit with no such elegance or confidence: if the ratio of PT to PY is very high, then you can have instability in PT (over prolonged periods) without any such instability showing up in PY. You might even have, say, 15 years of PY growing at a steady 5% or so while PT is exploding; in such a situation, you would expect to see major asset price inflation and financial instability even when the "real" economy was chugging along quite nicely. You'd expect to see periods of wild instability in the income velocity of money, with the money stock following/leading assets well but NGDP poorly. That sounds to me a lot like the world in which we have lived since the beginning of the Great Moderation."

Yes and no. I see no need for a definitive relationship between PT -(by which I think he actually means nominal transactions - I'm not sure what P means in that case) - and asset prices (except that if PT growing is more likely to correspond to asset prices growing than merely a growth in T). Assets could also change hands rapidly when the prices are sinking. It seems to me the key relationship is between asset prices and growth in private debt. And that seems to be missing (except that it is part of M).

[reason]

Krugman - make banking boring?
http://economistsview.typepad.com/economistsview/2009/04/paul-krugman-making-banking-boring.html

[Nick Rowe]

reason: "disproof of Keynesian economics? A bit strong isn't it."

Yep. That's why I put the "?" at the end. But I do think I'm onto something here. The business cycle is a trade cycle. Something goes wrong with trade (exchange) generally. Trade in newly-produced final goods is just a part of a more general phenomenon. So to start out doing macro with an IS curve for newly-produced goods, as the New Keynesians do, is somehow very peculiar. What's the big deal about the demand for newly-produced goods, relative to the demand for other things? If you start out thinking about business cycles as a trade cycle, in which all sorts of trades stop happening, you can't help but think: "what do all those trades have in common?" And you can't help but answer: "Money". It's a monetary problem, not an interest rate problem.

I have now skimmed the paper W. Peden linked. It's very good and relevant. But is it just financial transactions? Think about houses. Assume the average house is worth 3 times the income of the people living in it, and that it changes hands once every 10 years. Just by itself it means PT from houses alone is 30% as big as PY. And everybody living in the right house matters. Buying and selling houses is not all wasteful. People want to move.

[reason]

And I'm sure you realise Nick that you cheating on this one. Lets make the Trees into houses, then suddenly Y expands because we count implicit rent in GDP. But we are not counting the implicit fruit.

[reason]

And don't I vaguely remember Keynes (and I suppose he is Keynesian) talking about the "speculative" demand for money?

[Nick Rowe]

reason: "Lets make the Trees into houses, then suddenly Y expands because we count implicit rent in GDP. But we are not counting the implicit fruit."

Yes we are (or I was, anyway). In my economy, GDP=fruit produced per year. Sure, none of it is bought or sold, but it's still GDP, just like the implicit rentals on owner-occupied housing. Y=fruit produced, and consumed. It's a constant, but not zero.

[reason]

"I have now skimmed the paper W. Peden linked. It's very good and relevant. But is it just financial transactions? Think about houses. Assume the average house is worth 3 times the income of the people living in it, and that it changes hands once every 10 years. Just by itself it means PT from houses alone is 30% as big as PY. And everybody living in the right house matters. Buying and selling houses is not all wasteful. People want to move."

Yes and no again - that 30% figure is misleading because people are BOTH buying and selling.

[reason]

"What's the big deal about the demand for newly-produced goods, relative to the demand for other things?"

Because when I buy and sell something new, somebody is employed to make it? And there are some new things (food, clothes, energy, waste disposal) that I need to live - so there will always be demand for new things.

[Nick Rowe]

reason: "Yes and no again - that 30% figure is misleading because people are BOTH buying and selling."

That's true for everything. All exchange is goods being moved from someone who values them less to someone who values them more. Employment is exactly the same thing. My employer values my leisure time more than I do, so I sell it to him. The Smiths value my house more than I do, so I sell it to them. And what we call "output" is just congealed labour (and land and kapital) anyway ;-). It's all just exchange.

[reason]

Nick,
"It's a monetary problem, not an interest rate problem."

Mostly, I don't see why the difference matters to be honest. If interest rates go down, more money gets created because demand for loans go up. (And the opportunity cost of holding money rises so demand goes up). And vice versa.

And would Paul Krugman disagree with you?

[reason]

"All exchange is goods being moved from someone who values them less to someone who values them more. "

Nick that is NOT the point. The point is that a majority of house purchases are by people who are selling another house in order to move. So their net financial transaction is a lot less than the gross transaction.

[Nick Rowe]

reason: fair point. But only because we live in a strange world with a very bizarre monetary system where the supply of money is linked to the demand and supply of loans. If we had bike banks instead, we would be saying that the trade cycle was caused by the supply and demand for bike rentals.

[Nick Rowe]

reason: "Nick that is NOT the point. The point is that a majority of house purchases are by people who are selling another house in order to move. So their net financial transaction is a lot less than the gross transaction."

I sell my house and use the proceeds to buy someone else's house. I sell my leisure and use the proceeds to buy someone else's leisure.

[Nick Rowe]

I think it was a bit unfair of me to dump on Keynesians in this post. I could equally dump on Austrians too. Anyone who starts out doing macro with I=S, which is about new goods, should all be dumped on. When did we all start doing macro with I=S? Wicksell? Let's blame Wicksell.

[reason]

Nick,
that is not the same thing at all, your leisure is a flow not a stock.

Consider two couples one living in small coastal town and the other in a big city, one young and one old and they swap houses with an additional payment (say 25% of the gross transaction amount) from the young couple to the older couple for the difference in land prices. Then the gross transaction is the sum of the land and house prices but the net transaction is the difference in the land prices. Sure this transaction creates value. But that value is not equal to the gross transaction.

With respect to the leisure transaction you have mistated the transaction, what is bought is not the leisure, it is the skilled product of an alternative time use instead of leisure - i.e. new production that was not there before. I'm all for regarding leisure as something of importance but it is not normally counted in our measures of the economy, housing is.

[Gepap]

When I, as a relatively well-educated layperson (to economics) sees this kind of discussion, all I can think about is: this is what this profession wastes its time doing, as opposed to trying to gather better empirical data or conducting even the most basic forms of experimentation? Really?

I get the necessity of thought experiments, and the allure of math and its universal never changing logical truths, but putting together an utterly unrealistic model and then trying to garner some "truth" from it makes little sense. For example, in the real world in which the actual economy happens fruit trees die, the population grows, so new trees need to be planted, not only just to replace the dead ones, but also to meet the fruit eating needs of new people. What function does ignoring the centrality of time have for economics? Fine, your equation might work in a place without time - please point to the place in the universe that exists free of time and you can point to the one place your model might have relevance.

Perhaps the reason macro focuses on "new stuff" (and if I buy a 200 year old house, that house happens to play no different role for me as a consumer than a 2 month old house - to me its a "new" house)because as they say time and chance happens to all, and everything that exists is NOT immortal or immune from the inherent decay that comes from existance.

[Nick Rowe]

reason: "that is not the same thing at all, your leisure is a flow not a stock."

OK, but that's no big deal. And if I agree to give 6 month's notice, it's a stock.

"Consider two couples..."

You are describing a (75%) barter transaction. Sure, barter is different. I can barter with Carleton University too, a little bit.

And the value created in a transaction is *never* equal to the gross value of the transaction. The value created when I get a job is what my leisure is worth to the buyer *minus* what it was worth to me.

"With respect to the leisure transaction you have mistated the transaction, what is bought is not the leisure, it is the skilled product of an alternative time use instead of leisure - i.e. new production that was not there before."

Most of GDP is services, not physical goods. I'm buying my mechanic's time. My mechanic rearranges material matter (my car). So do the workers who produced my car originally. They don't create matter. My students are buying my time.

"I'm all for regarding leisure as something of importance but it is not normally counted in our measures of the economy, housing is."

We shouldn't let our macro theory be determined by the whims of the accountants who measure GDP.

[Gepap]

And on a more constructive note:

Again, as a layperson, my understanding of a recession is that it is a decline in production of new stuff - a recession like the current one is not caused by the destruction of the existing stock of stuff (its not like the factories are being dymanited or the fields sown with salt), so it makes perfect sense that if you are going to discuss the reason for a recession, its the drop in making of new stuff that matters. Also, the existing stock of goods constantly needs to be replaced or maintained, so a drop in the production of new stuff, or at least the act of carrying out services, can in the long term lead to a real decline in existing value because things are left to decay.

Also, for most people, their source of money is doing things now (and in the future). I don't earn an income from just sitting there, and I can only earn income from my existing wealth if I find people willing to pay me some rent on it, but I can only assume my rent-payers get their money from doing new stuff, unless you can design a system in which everyone pays some form of rent to everyone else and the payments just go round and round.

Perhaps the bigger problem regarding time and money is that money, which is an idea, is free from the pressure of time. The value of a dollar may change, but so as long as people believe in the idea of dollars as worth something, they never rot or decay, unlike everything else in this universe, including us the users of money. That disconnect between the means of exchange and the objects and subjects of exchange is bound to cause problems.

[reason]

Gepap,
no clearly the difference is that a new house requires much (paid) work to create it. We don't count the lost leisure (as Nick notes) so that is net gain in the stock of houses (and if it is financed by new borrowing from a bank also a net increase in money - so long as the money paid is not used to pay off an existing loan from a bank). An old house transfers ownership for money but there is no measured gain - the money cost to one person is the money win to the other. The stock of houses remains unchanged. Depending on the circumstances, there might be a change in the stock of money.

[Bill Woolsey]

The reason for MV = Py is that V = 1/k where k is Md/y.

Md = f(P,y,Rb-Rd) If the demand for money is a demand for real money balances, then md = P z(y,Rb-Rd).

If the flow of services from money is normal, and the income elasticity of real money balances is one, then:

Md = kPy.

with k = g (Rb-Rd)

Ms = Md, so Ms = kPy. with V = 1/k, MV = Py

Suppose you put wealth in the money demand function instead of income. People hold a certain fraction of their real wealth in the form of real money balances. A shortage of money and people sell assets for money. The quantity of old assets stay the same. There is a buyers market. For auction type markets, prices fall. Real balances evaluated using asset prices rise. Return to equilibrium.

But because the prices of existing houses are sticky, housing prices don't fall enough and instead we just get less T. In the GDP figures, this shows up as just lost realators services and undestates the sacrfice from gains of trade. (On the other hand, I don't know that the incomes earned from producing cars captures all of the gains from trade. Or rather, I am sure it doesn't show the entire consumer surplus from cars.)

Anyway, I have had parellel concerns and think it is approapriate to focus on the exchange of labor for consumer goods.

I will grant that the exchange of already produced homes is also important.

But second place still goes to replacing existing capital goods as they were out.

Adding to the amount of capital goods such that the production of consumer goods can be expanded in the future ties for third along with providing motivation to introduce new products and improved methods of producing them.

In my view, the purpose of financial markets is to help with the above.

(After deleting piles of reflections on financial markets...) Coventional macro, both Keynesian and non-paelo monetarist puts the focus where it should be-- the flow of production and consumption.

Imagine the economy has a certain amount of money and a certain quantity of goods. The money exchanges for the goods. Surely, the average money price of the goods must equal the quantity of money devided by the quantity of goods? So, we have a theory of the price level. Ah.. but that isn't right. We don't just exchange the money for the goods one time. Money is spent multiple times. Velocity.... And what are the goods? Well, all of them, apples, oranges, new houses, old houses, stocks, bonds.. everthing.

MV = PT.

What a mess. The really important stuff, the employment of labor to produce consumer goods and the purchase of those consumer goods, requires money transactions over time--per month, quarter, or year. But equity claims to the firms exist whether any of them are traded or not. They can even change in value without there being any trades.

Of course, investors earn income too and buy consumer goods, and workers and investors can save their income. And firms can produce and buy capital goods of various sorts. They need to replace the ones that wear out if production is going to be maintained.

Anyway, in my view, keeping the flow of nominal expenditure on output is the least bad approach. If people decide they want to shift from buy and hold on equities and try to out game one another and switch between stocks, I don't really think their added money demand so they can do all of this churn should result in less spending on output and so lower nominal incomes. (Oddly enough, the greater demand for the services of brokers, the transactions costs of the activity, does cause the rest of nominal GDP to fall, but this exactly reflects the call on resources useful for current production by this activity.)

And even if people become more optimistic about future profits from production, and stock prices rise on the whole, I don't think that this should require everyone to have lower current nominal incomes so that PT doesn't rise.

If the higher stock prices motivates new issues of stock to fund the purchase of new capital goods--in other words, if it creates a demand for resources to produce output now, then and only then demand for other types of output fall--freeing up the resources.

PS. Intermediate goods impact nominal GDP as inventory investment. They only "disappear," as they are used up.

If car manufacturers purchase fewer car parts but keep on making cars using their current inventory of parts, then nominal GDP falls because of negative inventory investment in car parts.

[Nick Rowe]

reason: but if you said that *some* transactions create more net value, as a percentage of gross value, than others, you would be right. Yep, that's important.

Gepap: "When I, as a relatively well-educated layperson (to economics) sees this kind of discussion, all I can think about is: this is what this profession wastes its time doing, as opposed to trying to gather better empirical data or conducting even the most basic forms of experimentation? Really?"

If ALL economists spent ALL their time doing stuff like this, I would be worried. If NO economists spent ANY of their time doing this, I would be worried too. As any economist would tell you, it's a question of costs and benefits AT THE MARGIN!

"...but putting together an utterly unrealistic model and then trying to garner some "truth" from it makes little sense."

It makes an awful lot of sense. In this case, by eliminating all the things we normally look at, it forces us to look at all the things we normally miss seeing. Then we can go back and see the other things we were looking at before, and see them in a totally different way.

[reason]

Nick,
I'm happy you brought this up, it is actually an interesting point. But this opens a whole can of worms regarding national income accounting. No argument, national income statistics are sometimes misleading.

[Nick Rowe]

Gepap: "Again, as a layperson, my understanding of a recession is that it is a decline in production of new stuff - a recession like the current one is not caused by the destruction of the existing stock of stuff (its not like the factories are being dymanited or the fields sown with salt), so it makes perfect sense that if you are going to discuss the reason for a recession, its the drop in making of new stuff that matters."

And that's how most economists see it too. And I'm saying that's the wrong way of seeing it (or, at least, a very incomplete way of seeing it).

[Jacques René Giguère]

Gepap:
we learn a lot when we "go to the limits" of an equation system or when engineers do destructive testing.

[reason]

Nick,
"Most of GDP is services, not physical goods. I'm buying my mechanic's time. My mechanic rearranges material matter (my car). So do the workers who produced my car originally. They don't create matter. My students are buying my time. "

All true, but I think it is worth pointing out, that although the price of that time is usually constant to you, its value is not constant to the mechanic. (In fact I have a toy theory called the "leisure" theory of value, where REAL production requires a combination of goods and services as normally defined - which I see as always intermediate - PLUS leisure and too much of one or the other leads to decreasing returns.) The non-linearity makes measurement based on this almost impossible. So leisure is of little value to me when I have lots of it, in a slack economy, maybe I can ignore it.

[Gepap]

Jacques Rene Giguere:

Denying the existance of time is not going to the limits - its going beyond it to a circumstance that is impossible. I doubt engineers spend much time imagining what is utterly impossible - I would not waste my time thinking about what would happen if Godzilla were to blast my bridge with his nuclear breath when deciding on its construction.

reason:

Old houses require work (paid or unpaid) to maintain from collapse. A new house may require more work (or it may not if the old house is in really bad shape), but what is the point of discounting depreciation?

Prof. Rowe:

I appreciate the sentiment that by stripping away the covers you might uncover what is actually there, but in my opinion your model hear does not do that sucessfully.

To go back to your example, your provided no mechanism by which the supply of the stock of money would drop in this fruit-tree economy, which seems to me to be the cause of a recession since now the supply of money is unable to meet the demand for money. Wouldn't your example need to show what the mechanism for a drop of the money supply would be in this system?

Yes, selling anything, just not new stuff, becomes harder in a recession, but I would posit that this is because people have different expectations of the future than before. I might have thought my income would climb steadily but now I fear it will stagnate, or I might have been counting on a steady income but now I fear it declining, possibly to zero. In these conditions trying to suppress current consumption in order to save for my expected future consumption is how most will react. The issue is that the fear for a negative change is driven by the decline in current and future production, not a decline in the real stock of stuff that already exists. Its a subjective change in future expectations that matters, and it is what leads to my change in the demand for money, that one eternal commodity that unlike food or clothes, or houses, can never decay, and in which I can put a faith (however irrational faith always is) that somehow it will last and be able to provide for me in the uncertain future.

So time is again the key. I demand money not only because it is the medium of exchange, but also because it is free from the ravages of time and in my mind I can squirel it away "for ever". The fact that it magically can also, while sitting, make more of itself, is another key. After all, no other commodity magically self-replicates.

[Chris J]

Nick,
I hope you know that the vast majority of academic articles titled with a question (ie "Do neutrinos travel faster than light?", from my field) has an answer, "Probably not".

[john]

you're choosing a definition of a recession that hinges on sub-optimal allocative efficiency, and you're trying to figure that in an old keynesian framework? good luck with that...

[Gepap]

To further develop my last comment:

Y is important not because there is some difference between new stuff and old stuff but because the demand for money is affected by people's expected income, and for most people, income is based on the production of new stuff or services, or Y. A negative change in the production of new stuff or services will negatively affect income expectations, which is one of the key drivers of money demand. So a drop in Y will depress demand, for old and new stuff both. Now, a decline in old stuff, a destruction of existing value, could also cause a recession, but that would also lead to a drop in demand for both old and new stuff. The thing is, Y can NEVER be fixed because, money aside, no services or goods are immortal, so new production always needs to be happening. Most recessions we speak about are not based on the destruction of existing material goods or productive ability, but the change in current activity, or loss of imaginary (in the sense that it exists in people's heads without a material form) value.

[Min]

@Gepap

If you don't understand the toy stuff, how can you understand the real stuff?

(That's the general 'you', not the personal 'you'. :))

[Gepap]

Min:

Well, by not falling for the baby mistakes I avoid the even bigger whoppers many economist have taught themselves to believe. :)

[OliverD]

my guess would be that Y represents growth, i.e. new stuff being added to the economy, whereas old goods only represent past growth or natural resources. and the apple tree example seems somewhat of an exception. apart from plants in nature, is there anything else that produces without input?

Suppose the price of trees is sticky, and the stock of money falls. There is now an excess demand for money.

maybe a silly question:(why) does price stickiness necessarily lead to a fall in the stock of money?

p.s. I've changed my name from Oliver to OliverD because someone else was trolling under my usual name here recently.

[Nick Rowe]

Bill: suppose I had very high wealth, and very high income, but made very few transactions? (At the limit, suppose I were Robinson Crusoe living in paradise, or someone on a luxurious hippy commune.) I would say that the demand for money depends not just on income (wealth) but on transactions. There are some benefits to thinking of money as an intermediate good, rather than as a final good.

[Nick Rowe]

OliverD: "maybe a silly question:(why) does price stickiness necessarily lead to a fall in the stock of money?"

It doesn't. I can't have written it clearly enough. What I meant was: suppose prices are sticky; now suppose the supply of money falls.

Gepap: The whole point of my model was to show that I can *still* get a recession *even if* I leave out all that stuff.

[reason]

Gepap
"Old houses require work (paid or unpaid) to maintain from collapse. A new house may require more work (or it may not if the old house is in really bad shape), but what is the point of discounting depreciation? "

I'm not sure what your point is. The depreciation (and I'm not sure that depreciation on old houses is discounted from the national accounts - I suspect it is an inconsistancy, depending on whether the house is owned for renting or owner occupance) occurs whether the house is sold or not.

[david]

Was what I said just too stupid :(

[Nick Rowe]

david: No, but it was incorrect. (I missed seeing your previous comment earlier).

"Yes, but people buy and sell trees, not fruit. NGDP is made out of transactions of money for trees."

When old goods are bought and sold, those transactions are *not* included in GDP.

When new goods are produced, even if they are not sold, they *should* be included in GDP (though Statistics Canada often misses or ignores them, because they are too hard to meaure). E.g. unsold inventory, and the implicit rentals on owner-occupied houses, *are* included.

[Steve Roth]

Again, haven't had time to read all the great comments.

The post, and this:

"MV=PY is just a subset of what's happening in a recession. And yes, by adding old goods to new goods I'm still leaving out a lot of stuff, like financial assets, and intermediate goods"

Maybe: "what's happening in an *economy*"?

Again has me pondering a question that's been bouncing around in my head: would total transaction volume be a better (or good additional) measure of economic activity than GDP? IOW, including sales of intermediate good (and used/old goods)? Still real goods only, excluding financial assets.

Yes, presumably the gain from trade in intermediate goods is captured in the final value-added of the GDP number, but suppose you needed a much larger transaction volume to generate that GDP? Wouldn't that tell you something interesting about how the economy's operating? Especially cross-country and year-to-year comparisons and similar?

I realize I'm asking at least two different questions here, but gotta run out the door...

[Nick Rowe]

Steve:

1. "Maybe: "what's happening in an *economy*"?"

Yes. Why did I restrict myself to "what's happening in a recession"?

Because it's really only people who do short run macroeconomics (booms and recessions) who seem to have this peculiar fixation on newly-produced goods. For microeconomists, it's all just trade. Trade in new goods, trade in old goods, it's all the same. And I wanted to say that we should adopt the same perspective when we look at booms and recessions.

2. We normally say that trade in intermediate goods doesn't really matter, because if the miller and baker have a merger, all that trade in flour disappears, but the economy produces the same amount of the final good -- bread -- which is what matters. But, if monetary problems disrupt all trade, including trade in intermediate goods, it might matter. Not sure.

[Mike Arafat]

@Nick

This problem is only a matter of definition of what a "new good" means. I will start by saying that it is probably best to think of these trees as investment. Whenever these trees change hands, they are no longer the same tree, they are now new trees. The tree belonging to Joe is not the really the same good as a tree belonging to Adam. Will the fact that Adam urinated on the tree after he purchased it change your mind that it is no longer the same tree?

Your insistence that these trees are not new goods even after they have changed hands because "the stock of trees are fixed" will imply that there are really no new goods. The first law of thermodynamics tells us that all we are doing is transforming energy from one form to another, we are not really creating anything new in terms of the energy in our universe. As the Bible says, there is NOTHING new under the sun, newness is only a perception. Keynesian economics should get a chance to redefine newness, as the old idea of new was developed under a different model.

[Nick Rowe]

Mike: I think I sort of agree with you. An apple tree in the hands of someone who likes eating the apples is, in an economically relevant manner of speaking, a different good from the physically identical apples tree in the hands of someone who doesn't like eating the apples. When the tree changes hands, it is as if there were an investment in making the tree a lot more productive, even though any physical measure of that productivity (kg of apples per year) will say that nothing has changed.

But our current ways of thinking about and measuring the business cycle just don't see it like that. "It's the same tree, producing the same number of apples, therefore we can ignore the fact that it changed hands; because nothing new was created". It is not part of GDP, as currently measured.

Put it this way: the business cycle is not a fluctuation in GDP (though that is one symptom of it); it is a fluctuation in the amount of trade (exchange). It's a trade cycle, not a GDP cycle.

But rather than trying to give Keynesian economics a chance to redefine newness, it might be better to start afresh, and ask: what could cause trade to be disrupted? "Money" is the natural answer.

[Meg]

If we stopped measuring sales or money and started measuring, somehow, utility, we might be able to get at this.

[Steve Roth]

David Beckworth: "So are there any direct or indirect measures of PT?"

Nick: "I don't know. Ah! W. Peden has answered you!"

W. Peden's reffed paper draws its data from "the Association for Payment Clearing Systems (APACS)" which google reveals to now be called the UK Payments Administration. Their site sez:

"Historic annual clearing statistics dating back to 1868 are available either as a PDF document or Excel spreadsheet. For further information please contact the Information Management Unit:
Email: inform@ukpayments.org.uk"

Is anyone out there working with similar U.S. data? Any immediately web-available data sets?

[Jacques René Giguère]

Nick (20/12 10.05 pm):
"We normally say that trade in intermediate goods doesn't really matter, because if the miller and baker have a merger, all that trade in flour disappears, but the economy produces the same amount of the final good -- bread -- which is what matters. But, if monetary problems disrupt all trade, including trade in intermediate goods, it might matter. Not sure."

Not sure if in the context of this thread it's macro or micro but vertical integration is usually considered as a sign of ( and found in) underdevelopped economies. Another sign of underdevelopment is the lack of efficient banking systems.
The dislocation of trade in dissolving monetary unions is similar and we think of it as macro. Inasmuch as it is a consequence of a monetray phenomenon, it ia part of macro.

[Steve Roth]

Nick: "it might be better to start afresh, and ask: what could cause trade to be disrupted? "Money" is the natural answer."

Corollary?:

It's not the "business cycle." It's the financial cycle. Which brings us back to Minsky and (gross) private debt?

[Wonks Anonymous]

"Suppose the price of trees is sticky, and the stock of money falls"
Didn't you just recently tell Bryan Caplan that price stickiness vs flexibility doesn't matter as long as there are problems with the supply vs demand for money? Or do you mean that introducing flexibility after a recession has begun won't fix things, but having it in the first place can prevent the recession?

[Nick Rowe]

Jacques: Hmmm. Could be related.

Steve: "finance" is just buying and selling IOUs. Trade is the buying and selling of everything, not just IOUs. And money is involved in the buying and selling of nearly everything, except barter.

Wonks: whether or not price flexibility fixes things depends on how it affects the supply and demand for money. If a fall in prices eliminates the excess demand for money, it fixes things. If it doesn't, it won't fix things.

[Peter T]

"Trade is the buying and selling of everything, not just IOUs. And money is involved in the buying and selling of nearly everything, except barter."

But money is an IOU too (if you doubt this, try using South Vietnamese piastres). So trade is about time and trust (more nearly, confidence). So money supposes time - which in this post-Paradisiacal world supposes entropy. Trust or confidence vary the desired level of consumption. Doesn't your experiment hold this constant - in it everyone has fruit, and presumably everyone eats?. In which case, it misses the heart of the Keynesian analysis.

Further - only economists suppose that most work exchanges leisure for money (or goods). Work is, for most people, a positive thing - a source of social status, the most interesting thing they do, a key part of what they are. It also provides food/shelter etc appropriate to their social place. In your thought experiment, some people end up eating apples when they prefer pears but no-one starves. In the real world, some people lose shelter, appropriate (or even adequate) food, companionship, social place and more. "Loss of utility" for this comparison would be an egregiously unfortunate euphemism.

[Nick Rowe]

Peter T: "But money is an IOU too..."

*Some* money is an IOU. *Some* IOUs are money.

""Loss of utility" for this comparison would be an egregiously unfortunate euphemism."

Some losses of utility are small. Some losses of utility are very big. They are all losses of utility.

And this is a *model*. It is not supposed to be realistic. In this case, I very deliberately made it unrealistic. I deliberately excluded new production, so I could focus attention on other stuff that gets ignored in models that focus only on new production.

[Peter T]

Nick

I agree *some* IOUs are money, but surely all money is IOUs. Can you point to any form of money that is (in it's money form) actually useful - that is, NOT intended for LATER exchange for some good or service?

On utility, I recall an article in the Economist on some economic research that found that earlier colonisation of a territory raised current GDP there by some considerable amount - only not for the original inhabitants. Presumably their deaths count as "loss of utility", to be balanced against the "gain of utility" expressed by higher current GDP? I realise that a a rather naive utilitarianism is embedded in economics, but hope to see, from time to time, at least a nod to the limits of this philosophy.

[Steve Roth]

Nick: "*Some* money is an IOU. *Some* IOUs are money."

Randall Wray's formulation makes more sense to me:

All money is credit. But not all credit is money. And the only way to store money is to lend it.

[Nick Rowe]

Peter, Steve: there's gold, silver, cowrie shells, cigarettes, cans of mackerel etc.

Also, regular banknotes, like Canadian dollars, are not IOUs.

Not all money is credit.

"And the only way to store money is to lend it."

That just seems plain wrong to me. I'm storing money right now, in my pocket. And when i lend money I don't store money, I store wealth. Just like if I lend wheat I don't store wheat, I store wealth. Money is not the same as credit. Money is not the same as wealth.

Peter. Whenever I cross the road I am deciding that the utility of being on the other side of the road exceeds the expected loss of utility from death. Almost every action we take affects the risk of death. There are limits to Utilitarianism, but death isn't obviously one of them.