Money, prices, and coordination failures

[This is very long, and covers a lot of old ground for me, as well as some new. It was supposed to be a belated reply to Brad DeLong's post. But my thoughts wandered. (By the way, for some reason I never remember being annoyed at Simon Wren-Lewis, even when I disagree with him; but I do get very annoyed and frustrated when monetary policy does not do what I think it can do and is supposed to do.)]

I have what might appear to be a peculiar obsession with money as the cause of recessions, and monetary policy as the cure.

I am right. Those who do not share my obsession are wrong. Here's why:

1. Coordination.

The central problem in economics is the problem of coordination. How the hell is it possible, for decentralised decisionmakers, each acting only in his own interest with only his own local knowledge, to generate a result that isn't always just a total mess? How does anything ever get produced and consumed at all? Hayek's famous essay is the best on this.

The answer we normally give is "market prices". That answer is right, but it is only half right. The correct answer is: "market prices and money". (It's funny that Hayek doesn't mention money in that essay, because I don't think he would disagree with me.)

Suppose we had market prices and a barter economy. With n goods there would be n(n-1)=n²-n markets, and so n²-n market prices. One market and one price for each possible pair of goods. Even for a very simple economy, with only 100 different goods, there would be 9,900 different markets and 9,900 different prices. Hayek's user of tin would need to know not just one price of tin: he would need to know 99 different prices of tin. And in order to know which of those 99 prices was the cheapest price of tin, he would need to know all 9,900 prices. It would take an army of arbitrageurs to keep all the cross-prices in line. And those arbitrageurs would need to be experts in all the goods they traded, so when they sell tin for apples, and apples for bananas, and bananas for tin, they didn't get stuck with a lemon somewhere along the line. Not to mention ensuring the warehouse receipts were worth the paper they were written on, and the apples and bananas were safely stored.

If one of the 100 goods is used as money, as medium of exchange and unit of account, that army of arbitrageurs can be put to more productive uses. The user of tin needs to know only one price of tin: the price of tin in terms of money. He needs to be an expert in only two goods: tin, and money. He needs to be able to warehouse only two goods: tin, and money.

Buying and selling tin is hard enough, even in an economy with a well-functioning monetary system. (Would you be able to tell if the tin is good quality and real tin?) In a barter economy it would be much harder.

And prices don't just set themselves. The price of tin is set by the buyers and sellers of tin, in the market for tin, by the demand and supply of tin. In a barter economy, there would be 99 prices for tin, and 99 markets for tin, and 99 demand curves for tin, and 99 supply curves for tin. I think I could teach demand and supply if there were only two goods. The demand curve for apples is the supply curve for bananas; the demand curve for bananas is the supply curve for apples; the price of apples is the reciprocal of the price of bananas; and there is only one market for the whole economy. But if a student asked me to include carrots in the model, I'm not sure I could do it. I would cheat, like all microeconomists cheat, and assume a centralised Walrasian market, where all three goods can be exchanged at once in a single market, and assume the Walrasian auctioneer handles all the arbitrage and coincidences of wants behind the scenes. The Walrasian auctioneer is an expert in all goods, keeps perfect records of who owns what warehouse receipts, and is trusted by everyone to deliver what he contracted to deliver. But he doesn't exist.

Any economy that was simple enough to work without money would also be simple enough to work without markets.

The only reason that microeconomists can get away with talking about markets while ignoring money is that money usually works well enough that it can be ignored. Except when it doesn't.

If coordination depends on market prices and money, it is not at all surprising that monetary problems would cause coordination failures, and that coordination failures might be caused by monetary problems.

2. Monetary coordination failures.

All "market failures" are coordination failures. A bad harvest due to bad weather is a bad thing, but is not a market failure and not a coordination failure. An example of a coordination failure is where if everyone planted more wheat than was individually rational in Nash Equilibrium then everyone would be better off.

The wheat market is not a market for wheat; it is a market for wheat and money.

Simply on a priori grounds, if you suspected a coordination failure in the wheat market, you should think about both wheat and money. If it's asymmetric information, would it be people afraid of buying bad wheat? Or would it be people afraid of buying bad money? If the price of wheat is too high, so producers of wheat can't easily sell wheat, and so plant too little, doesn't that also mean the price of money is too low, so they can't easily buy money? One is just the reciprocal and the mirror-image of the other.

If it were only the wheat market that looked wrong, while all other markets seemed to be functioning normally, then it would make sense to ignore money and ask what is special about wheat, or what is especially special about wheat this year. But if all markets seemed to be functioning badly, then it would make sense to ignore wheat and ask what is special about money, or what is especially special about money this year.

A recession is not just a fall in the quantity of newly-produced goods traded. It is not even just a fall in the quantity of all goods traded, both new and old. That is just a symptom. The symptom that is the identifying signature of a recession, and that explains those other symptoms, is that it becomes harder than normal to sell other goods for money and easier than normal to buy other goods for money. Shouldn't anyone looking at that symptom immediately ask what is special about money, and what is especially special about money this year?

And yet many macroeconomists, those who do not share my obsession with money, do not look at recessions this way. They define recessions as a drop in production. They are the ones with an unhealthy obsession with the quantity of newly-produced goods.

It is the exceptions that prove they are wrong and I am right.

2.1 Home production increases in a recession. People grow their own veggies, cook their own meals, fix their own cars, and go back to school. Because investment in human capital is a form of investment that requires mostly one's own time, on top of inputs bought for money. Home production of investment goods rises, even as all other forms of investment fall.

2.2 If trade were harder in a recession, we would expect to see trade in all goods falling, and not just trade in newly-produced goods. And, as far as I can tell, that is what we do see. It gets harder to sell old houses, as well as newly-produced houses.

2.3 Barter increases in a recession, as far as I can tell. Barter is usually very difficult, but some barter exchanges are more difficult than others. If recessions were caused by something that made monetary exchange more difficult than normal, we would expect to see abnormally high levels of barter in a recession. I think we do.

2.4 Some goods are easy to sell for money even in a recession. Which goods are those? It is those that are traded in organised central markets, where problems due to asymmetric information are small, and where prices are very flexible. It is precisely those goods that are more like money, where if all goods were like that we wouldn't need money as much to help economic coordination. It is those goods that are traded in markets that approximate the market of the Walrasian auctioneer. If all goods were like that, and if all markets were like that, we wouldn't observe recessions. And we wouldn't need money.

Macroeconomists who simply ignore empirical facts like that are throwing away data. They are ignoring a large part of the evidence about the nature of recessions. They start off in the wrong place by defining recessions as a drop in production. If we instead start out by asking what is special about money, and what is especially special about money in recessions, and defining recessions as a period of greater than normal difficulty in selling goods for money, it is easy to understand why production of some goods would fall, and why trade in some goods would fall. And it is also easy to understand the exceptions as well.

For any model of recessions that does not include a role for money as the medium of exchange, like Michael Woodford's, ask yourself this question: if barter were easy, even if people had to swap their goods at pre-announced sticky money prices, would the recessionary equilibrium still be an equilibrium? (In Michael Woodford's model the answer is "no"; the underemployed workers and firms would immediately barter themselves back to something approximating the perfectly competitive equilibrium, even if the central bank set a ridiculously nominal high interest rate given expected inflation. It would be a Pareto-improving trade, which all rational agents would agree to.)

And ask exactly the same question of the real world. Just suppose, hypothetically, that barter were really easy rather than impossibly difficult in a modern economy. If you had a bird's eye-view of the economy, and knew everything that a hypothetical central planner is supposed to know, couldn't you figure out a barter deal that made everyone better off, and that everyone involved in the deal would accept, even if nobody had to cut his price of anything? The idea that you could is what lies behind the correct intuition that "we would all be better off if we all agreed (billion-person barter deal) to spend more money". Except, of course, that it's far too complex a problem for any one individual to get that hypothetical central planner's perspective and propose such a deal.

If a barter deal could solve the problem of recessions, in a hypothetical world where barter was easy, that strongly suggests that the problem is monetary in nature.

3. Walras' Law and Whack-a-Mole.

Walras' Law says that if you have a $1 billion excess supply of newly-produced goods, you must have a $1 billion excess demand for something else. And that something else could be anything. It could be money, or it could be bonds, or it could be land, or it could be safe assets, or it could be....anything other than newly-produced goods. The excess demand that offsets that excess supply for newly-produced goods could pop up anywhere. Daniel Kuehn called this the "Whack-a-mole theory of business cycles".

If Walras' Law were right, recessions could be caused by an excess demand for unobtanium, which has zero supply, but a big demand, and the government stupidly passed a law setting a finite maximum price per kilogram for something that doesn't even exist, thereby causing a recession and mass unemployment.

People might want to buy $1 billion of unobtanium per year, but that does not cause an excess supply of newly-produced goods. It does not cause an excess supply of anything. Because they cannot buy $1 billion of unobtanium. That excess demand for unobtanium does not affect anything anywhere in the economy. Yes, if 1 billion kgs of unobtanium were discovered, and offered for sale at $1 per kg, that would affect things. But it is the supply of unobtanium that would affect things, not the elimination of the excess demand. If instead you eliminated the excess demand by convincing people that unobtanium wasn't worth buying, absolutely nothing would change.

An excess demand for unobtanium has absolutely zero effect on the economy. And that is true regardless of the properties of unobtanium. In particular, it makes absolutely no difference whether unobtanium is or is not a close substitute for money.

What is true for unobtanium is also true for any good for which there is excess demand. Except money. If you want to buy 10 bonds, or 10 acres of land, or 10 safe assets, but can only buy 6, because only 6 are offered for sale, those extra 4 bonds might as well be unobtanium. You want to buy 4 extra bonds, but you can't, so you don't. Just like you want to buy unobtanium, but you can't, so you don't. You can't do anything so you don't do anything.

Walras' Law is wrong. Walras' Law only works in an economy with one centralised market where all goods can be traded against each other at once. If the Walrasian auctioneer announced a finite price for unobtanium, there would be an excess demand for unobtanium and an excess supply of other goods. People would offer to sell $1 billion of some other goods to finance their offers to buy $1 billion of unobtanium. The only way the auctioneer could clear the market would be by refusing to accept offers to buy unobtanium. But in a monetary exchange economy the market for unobtanium would be a market where unobtanium trades for money. There would be an excess demand for unobtanium, matched by an equal excess supply of money, in that particular market. No other market would be affected, if people knew they could not in fact buy any unobtanium for money, even if they want to.

4. But money is different. Money is special.

If you want to buy more unobtanium, or bonds, or land, or safe assets, or whatever, than you are actually able to buy, there is nothing you can do about it. And if you suddenly stopped wanting to buy more unobtanium than you were able to buy, nothing would change.

If you want to buy more money than you are actually able to buy, there is something you can do about it. You can sell less money, and get to have more money that way instead. And if you suddenly stopped wanting to buy more money than you were able to buy, something would change. You would stop selling less money.

The same is true for used cars, for a used car dealer who keeps an inventory of used cars. If he wants to buy more but can't, he might sell fewer instead. And if he suddenly stopped wanting to buy more, he might also stop selling fewer. Money is to all of us what used cars are to the used car dealer.

In a recession, it's easier to buy goods for money, and harder to sell goods for money. To say the same thing another way, it's easier to sell money for goods and harder to buy money for goods. The used car dealer can't sell as many cars as he wants to sell, so buys fewer cars instead. And all of us can't buy as much money as we want to buy, so we sell less money instead. If you can't adjust the flow in/out, you adjust the flow out/in instead.

But the used car market is just one market. The money market is every market (except for barter markets).

An excess demand for unobtanium/bonds/land/safe assets/whatever doesn't matter. If people stopped wanting to have more unobtanium than they actually had, nothing else would change.

An excess demand for money does matter. If people stopped wanting to have more money than they actually had, everything else would change. They would buy more of other goods, and so find it easier to sell more other goods.

5. Root causes, original causes, and the decentralisation of cures.

Lots of things can cause coordination failures. Not all coordination failures are monetary coordination failures. There are many coordination failures that monetary policy cannot cure.

The more interesting cases are where a non-monetary coordination failure has spillover effects, and causes a monetary coordination failure. A worsening of asymmetric information problems in financial markets, which is a coordination problem in its own right, also causes an increased demand for money and a monetary coordination problem.

Should we say that the problem in financial markets is the "root cause" of the recession, and one that should be addressed directly, if possible, by something other than monetary policy?

No. Monetary policy should take the world as it is, warts and all, and do what it can do. And what it can do is eliminate that excess demand for money, even if it cannot eliminate that original problem that initially caused the excess demand for money. It does not matter, for the monetary authority, whether that increased demand for money was caused by some natural event like the weather, which nobody can change, or whether it was caused by some other problem, which the fiscal authority can and should fix.

Governance is itself a coordination problem. It's too big for one monarch to act as central planner. Successful countries have decentralised governance, just as they decentralised market economies. An autonomous central bank targets inflation, or NGDP, just like Hayek's user of tin targets his own profits or utility. And just as Hayek's user of tin does not need to know why the price of tin has fallen, so the central bank should not need to know why inflation, or NGDP, has fallen below target.

The whole point of having a good monetary policy target, just like the point of having a market system, is that the central bank can do what's right without knowing everything about the economy, and do what's right whether or not the rest of the government does what's right in their jobs.

6. I think I will stop there.

Comments

[Sandwichman]

"Walras' Law is wrong."

I'm sure Brad will argue for making it true in practice even though it is wrong in theory.

[Nick Rowe]

Sandwichman: and I think he won't. He has argued (and I agree with him) for making Say's Law true in practice even though it is false in theory. But Walras' Law is very different. Most arguments against Say's Law are based on the truth of Walras' Law.

[Sandwichman]

I've compared DeLong's "making Say's Law true in practice" to the Leninist project of substituting "Marxist science" for the historical failure of the proletariat to fulfill the prediction of becoming the revolutionary subject. Harold Rosenberg wrote a brilliant critique of the Leninist conceit, "Pathos of the Proletariat."

http://econospeak.blogspot.com/2014/08/the-pathos-of-aggregate-demand.html

It seems to me that there is an ethical appeal in the notion of an "obvious and simple system of natural liberty." Having central bank technocrats simulate the (non-occurring) "self-adjustment" is kind of like hiding the human chess player inside to operate the ersatz "automaton" chess player. This makes of the market an elaborate charade whose rationale is no longer grounded in obviousness, simplicity or natural liberty.

[Sandwichman]

but I digress...

[Nick Rowe]

Some (soi-disant) "Austrian" commentators have a similar reaction. They object to central bank "activism", on the grounds that it interferes with and disrupts free markets. They want monetary policy to "do nothing". But there are 1,001 different definitions of "doing nothing". Doing nothing to the price of gold, silver, a rate of interest, base money, M1, the rate of inflation, the level path of NGDP, or what? You can't even talk about whether a market economy will be "self-adjusting" independently of the monetary system. Under a stupid enough monetary system, it won't be.

[Market Fiscalist]

Suppose there are 2 types of good.

TypeA is highly marketable and its prices are flexible (like money and bonds and perhaps company stock)
TypeB is not marketable and its prices are not flexible (like toasters and shoes and bridges and buildings)

People start demanding more typeA relative to typeB. Total trade between goods of typeA and typeB will fall since prices of typeB are sticky.

If someone wants to increase the level of trade they will need to increase the supply of goods of typeA to meet the demand. They can do this by buying goods of typeB for new entities of typeA (or just giving typeB goods away). But just swapping one kind of typeA for another kind of typeA will not obviously help.

What if all trade takes place in state issued money and money is of typeA ? When demand for goods of typeA increases then to avoid a recession you still need to increase the supply of typeA (again by giving it away or by swapping it for typeB). Even if money is a small part of total typeA, and the increase in typeA is in something other than money then by increasing typeA enough you will eventually cause money spending on typeB to return to normal. Increasing money by swapping it for other types of A may not help.

A recession can also be caused by changing relative demand for the various things that make up type A. So an optimal monetary policy will allow people to freely swap between different types of A by adjusting supplying to match demand.

I think one of Brad's main points was that recessions caused by changing relative demand for different forms of liquid asset will be solved by "conventional" monetary policy. Recessions caused by heightened demand for the class of assets of which money is a part may not be.

[Nick Rowe]

MF: If the central bank ran out of class A assets to buy, and it still wasn't enough, or they thought the central bank was getting too big, then maybe raise the inflation target or NGDP growth target instead.

[Market Fiscalist]

"If the central bank ran out of class A assets to buy, and it still wasn't enough, or they thought the central bank was getting too big, then maybe raise the inflation target or NGDP growth target instead."

But if they have bought up all class A assets and not induced inflation or hit the old NGDP target how will they implement the higher targets ? At what point do they just take route one and directly increase the supply of liquid assets relative to non-liquid assets (that is: just print new money). They can always privatize some stuff later on to hoover the money back up :).

[Market Fiscalist]

BTW: I'm thinking of getting some T-shirts made up with the slogan 'Even though we normally think of "pure" monetary policy as an open market operation, the theoretically "pure" monetary policy is a helicopter drop (Nick Rowe, July 28th 2014)' printed on them.

[Sandwichman]

Nick: "Some (soi-disant) "Austrian" commentators have a similar reaction."

Granted -- except theirs is from faith in the core proposition and mine is from fundamental disbelief. I mean it sounds like a nice idea: invisible hands, social harmony, everyone free to do their own thing. Can I have a pony with that? World peace?

Nick: "You can't even talk about whether a market economy will be 'self-adjusting' independently of the monetary system."

No need for the self-adjusting qualification -- you can't talk about a market economy, period, independently of the monetary system. So either the monetary system is "stupid" -- in which case there won't be adequate and timely adjustment -- or it is intelligent -- in which case the adjustment need not be attributed to the spontaneous movement of prices and market equilibrium.

I would prefer the latter but I don't see any value in mislabelling it as spontaneous when it isn't (with reference to DeLong's 'true in practice' refrain). Policy intervention is policy intervention is policy intervention. I'm an interventionist and I'm O.K.

But is monetary intervention sufficient? Is it indifferent as to the distribution of benefits?

[Nick Rowe]

MF: name me one time in history when a central bank bought everything, and it still wasn't enough.

And even if you could name me such a time, it would be temporary. The commitment to raise NGDP when that time had passed would do the job. Expectations matter.

And the name and date on the T-shirt should be Don Patinkin, 1965.

Sandwichman: it takes no more or less intelligence to hit a sensible monetary target than to hit a stupid one. (Actually, targeting P.Y (sensible) would be easier than targeting Y/P (really stupid, because the AD curve slopes the wrong way).)

And the market "mechanism" itself is not a mechanism. It is people, planning, and making choices, either more or less intelligent ones, within the institutional framework of the market. Just like monetary policy. We want a good institutional framework, for markets and for money.

But yes. We digress.

I have done other posts on whether or not the economy is "self-equilibrating. And if you want my view on the nitty gritty on Walras' Law.

[Brad DeLong]

As you know, James Tobin would say that if the root problem is a shortage of *money* then all other assets should go to a discount vis-à-vis cash--which means that yields on everything should be high, and that the government's swapping anything else into its portfolio and cash out into the general public's portfolio should alleviate the problem.

And as you know, I think James Tobin has the better of you here...

[Market Fiscalist]

"name me one time in history when a central bank bought everything, and it still wasn't enough."

I suppose the problem is that when the CB has bought some trillions worth of assets and NGDP is still below trend then people get nervous. I find it impossible to believe that had the monetary base been increased by helicopter drops rather than OMO they would have achieved better results for less pumping (because at the ZLB OMO gives less bang for the buck than HD). But of course fiscal policy has its own baggage and that makes it a hard sell too.

That's why I like the Rowe/Patinkin view on pure monetary policy - it takes the operational issues of OMO out of the equation.

[Market Fiscalist]

"they would NOT have achieved better results "

[Lorenzo from Oz]

Very informative post, thanks Nick. On Brad DeLong's post, specifically his claim that:
a general glut of currently-produced goods and services can be the result of any one of three things:

1. A shortage relative to demand of the stock of the liquid medium of exchange, with no fundamental mismatch in the supply and demand of either savings vehicles as a whole or of risk-bearing capacity.

2. A shortage relative to demand of the stock of safe assets, of which the stock of the liquid medium of exchange is an important component, because of the inability of private financial intermediaries to mobilize the risk-bearing capacity of society and do the risk transformation to match the profile of the assets they can create to the assets that safety-loving wealth-holders wish to hold.

3. A shortage relative to demand of savings vehicles as a whole, of which the stock of the liquid medium of exchange is an important component.

I am tempted to say something along the lines of "never argue from a demand shift", since if it makes such a big difference which of those is operating and to what extent, clearly why demand has shifted in which of those three ways matters. One suspects it will have something to do with income expectations ...

[Luis Enrique]

As Chris Dillow likes to say, the solution to a problem need not resemble its cause. I am completely convinced by your depiction of recessions and the importance of money, but I am not sure it follows that monetary policy *as currently practised* is the solution.

I wake up one day and decide my future income prospects have worsened and the probability of me losing my job has risen. I look at my bank account and decide I need to accumulate buffer stocks. I want to sell things for money, but I don't want to buy (so many) things with my money so I have a demand for money, but I do not see how the central bank buying bonds gets it into my hands. Or at least if you can tell a story via indirect means, there may be other more effective channels that do not look like monetary policy. Although of course a helicopter drop would get money into my hands, and as I understand it a helicopter drop could equally be seen as fiscal policy, which would in turn be an argument for using fiscal policy because it is actually more like the policy you want (a helicopter drop) than actually existing monetary policy is, for example if the government either removed my concerns about my future income prospects or bought what I had to sell until I have accumulated the buffer stocks I desire and am ready to start spending again, that would work, no?

as always, apologies if you have answered queries like this a thousand times already

[Nick Rowe]

Brad: Let's put PY, rather than Y, on the horizontal axis of the ISLM (even though it's not strictly legit, theoretically).

Can the IS curve shift left? Of course it can.

Will a leftward shift of the IS curve be followed by a recession? That depends on the shape of the LM curve. If the central bank makes the LM curve vertical, it won't.

If the central bank does not make the LM curve vertical, and the IS curve shifts left, what caused the recession? Was it caused by the IS shifting left? Or was it caused by the central bank making the LM curve slope up? Since we can and should make the LM vertical (target NGDP), and we don't always want to prevent the IS curve shifting left, I say it is the upward slope of the LM that "caused" the recession.

(I say that failing to get the vaccine is what "caused" the illness.)

Plus, the IS curve can slope up, so that leftward shifts of the LM curve can cause recessions accompanied by falls in nominal and real interest rates.

Plus, Tobin was a bit Walrasian. In his portfolio models, money is just one of many assets, rather than a special asset that everyone both buys and sells, in exchange for everything else.

[Nick Rowe]

Lorenzo and Luis: sometimes I wonder if we aren't arguing about framing effects in trolley problems. But at least in trolley problems the tram lines are already there, at the start of the problem. Here we are deciding which way the tram lines run, before the fat guy stands where he stands.

There is "cause", "cure" and "prevent".

If I drive a car with faulty brakes, what caused the accident? Was it caused by the bend in the road, or by the faulty brakes?

If bends in the road are inevitable, or even desirable, we blame the faulty brakes. And if we are talking about the mechanic's job, rather than the road builder's job, we blame the mechanic for not fixing the brakes, even if the road builder screwed up in this particular case too, and the bend didn't need to be there.

Luis: in this case you hold no bonds. If everyone were like you, the bank would not even be able to buy bonds. If the bank were restricted to buying bonds, the bank would run out of bonds to buy. So it has to buy something else instead.

Again, in the whole of history, has any central bank ever run out of assets to buy?

[Luis Enrique]

Thanks Nick.

But suppose I did own bonds or any other sort of asset that a central bank might buy, my problem is that I want to pay off debts and accumulate savings, I am worried by income low relative to outgoings. My bonds and other assets are already factored in to my net asset position that I wish to improve, and swapping them for money won't help me. Being *given* bonds or antique furniture, or being able to sell more of my goods / services (labour) in exchange for money, bonds or even sufficient antique furniture would also help me. So fiscal policy could help me directly if the government wades into the economy and starts buying stuff.

I want to sell goods and not buy them, hence I demand money, because I want to make myself better off, but having my assets swapped for money does not achieve that. Or are you thinking I can be made better off via being able to sell my assets at high prices?

Plus there are distributional concerns. Why choose a policy (CB buying bonds, assets) that works by making the well off better off when you could choose one that for example increases employment and wages of the poor?

[Luis Enrique]

sorry that was very badly worded, when I wrote "So fiscal policy could help me directly if the government wades into the economy and starts buying stuff." I meant "So fiscal policy could help me directly if the government wades into the economy and starts buying the goods and services that I have to sell but would otherwise be failing to."

[Nick Rowe]

Luis: should the government impose a net liability on future taxpayers, just so that you can achieve your positive net asset position? Maybe. It depends.

Or wouldn't it be better if you instead bought newly-produced investment goods, or land? Or bought financial assets from some other individual who bought newly-produced investment goods, or land?

Even if everyone wants to hold paper, and not land, couldn't the central bank issue paper, and buy land? Has any central bank ever run out of land to buy?

[Luis Enrique]

Nick,

yes as you say it depends, maybe by avoiding a recession fiscal policy could actually reduce the liability of future tax payers.

I don't thinking running out of assets to buy is what I am worried about. I am suggesting that although recessions happen because we live in a monetary economy and manifest themselves via households and firms wanting to sell more stuff for money than they buy with money, hence they "demand more money", that swapping *assets* households and firms own for money is a pretty indirect way of helping them, and doesn't address *why* they want more money (the wish to raise their incomings relative to their outgoings) whereas buying the things that households and firms produce and want to sell (particularly labour services) may be a more direct route. Or gifting money via helicopter.

Plus whilst central banks may never run out of assets to buy, if the mechanism of buying assets works by making asset owners better off then distributional concerns are obviously important, but I repeat myself.

(What would the CB do with newly produced investment goods it buys, sell them on again at lower prices (at a loss)? That might help, but more like fiscal pol I think)

[Philippe]

Nick,

it seems to me that the problem could just as easily be a lack of financial wealth as a lack of 'money' in particular.

Say someone is currently unemployed and poor. The government prints a new $1 million government bond and gives it to that person. That person's spending on goods is likely to increase dramatically, right?

In contrast, if a rich person currently owns a $1 million government bond, and the government prints money and gives it to that person in exchange for the bond, that person's spending on goods is less likely to increase.

In the first case, the poor person's financial wealth increased, leading to an increase in spending, whereas in the second case the person's financial wealth did not change.

[Market Fiscalist]

"Since we can and should make the LM vertical (target NGDP), and we don't always want to prevent the IS curve shifting left, I say it is the upward slope of the LM that "caused" the recession."

This seems like a very valid thing to say and I agree but the issue is how do we do it ? If the only thing that causes IS to shift is that people want to hold more of their wealth in money then OMO will work. But if it shifts because people want to get more liquid, or rebuild their wealth, then increasing the money supply by swapping it for other already liquid assets may not have much effects especially when interest rates are low. Now it may be that if the CB does buy up all the assets in the world it can keep the LM curve vertical. But isn't that likely to have side-effects? Just increasing the money supply directly via deficit spending or HDs) is both a purer from of monetary policy and (unless I'm missing something) has fewer potential side-effects.

[Odie]

"Has any central bank ever run out of land to buy?"

Which central bank has the legal ability to buy land (other than its own premises)? I think there is a reason why an appointed, electorate-independent institution like the central bank is restricted in exchanging monetary assets while only an elected body like congress/parliament can buy real (productive) assets. That's a question of political philosophy not unlike which relative powers executive, judicative and legislative branches should have, not really an economic argument anymore. Philosophers like Locke, Hobbes, Rousseau etc. would certainly be able to add some interesting points to that debate.

[Herbert]

Nick, analytically the unobtanium is perhaps the most important point. I am not convinced. Let me explain why.

Assume unobtanium stopped aging. My willingness to pay is at least 100k. Following Walras' law, I would have to cut spending on newly produced goods by 100k, thus contributing to a lack of aggregate demand for newly produced goods.

But how long would that situation last? I guess that I and others learned quickly that unobtanium is not available as yet. Hence, I would revise my plans (the dual decision hypothesis) and buy newly produced goods.

With money it's different. If, in a recession, I wanted to increase my money balances by cutting spending on newly produced goods, this would be actually possible. And the plan to increase money balances would contribute to a lasting deficiency of demand for newly produced goods. That deficiency could only be removed by a deflation.

In sum, I really believe that a notable fall in aggregate commodity demand could only stem from an excess demand for money balances. An excess demand for bonds, land etc. would be quickly wiped out by increases in prices which move faster than the general price level.

[Jeff]

I'm not sure it impedes the gist of your argument, but this statement is literally false: "An excess demand for unobtanium has absolutely zero effect on the economy." First of all, the existence of that demand will quickly result in charlatans able to sell faux unobtanium to the gullible. Second of all, it will result in speculators "mining" on the chance of actually finding some. Your argument seems to be banking not only on a "metaphysically impossible to fulfill" demand, but also on every person understanding and accepting that metaphysical impossibility. Real-world demand and real-world people are not like that. At all. Maybe I am misunderstanding something here though?

[Nick Rowe]

Herbert: But I agree with everything in your comment. That is what I thought I was arguing. Maybe I wasn't clear. I see my unobtanium example as a reductio ad absurdam of Walras' Law.

BTW: I am doing a post on land and liquidity traps. Up your street, I think. Applying the Stefan Homburg stuff to a monetary economy.

Luis, Phillippe, Odie, and MF: I will better address this point in a new post on land and liquidity traps.

Gotta drive to London (Ont). Back soon.

[Herbert]

"BTW: I am doing a post on land and liquidity traps. Up your street, I think. Applying the Stefan Homburg stuff to a monetary economy."

Can't wait to see it ...

[Max]

If you assume that there is a riskless asset (i.e. overnight loan with no credit risk) for banks to buy, then creating money is a frictionless process. There will never be a shortage of money unless there is also a shortage of the riskless asset.

This is why is makes sense to dispense with talk of money and just talk about interest rates.

If the central bank buys risky assets, then it's addressing a financial friction (such as under-capitalized banks), not a shortage of money. Whether the CB funds itself with money or loans doesn't matter for this purpose.

[Sandwichman]

What Jeff said.

How about a real world equivalent to unobtanium: "featherbedding"? Not beds stuffed with feathers but the alleged purpose of union work rules. Union featherbedding became a big issue during World War II. Barron's published and Reader's Digest reprinted an article titled, "'Featherbedding' hampers the war effort." Congressional hearings were held. Outrage raged.

After the war, Taft-Hartley "outlawed" featherbedding. The clause outlawing demands for pay for services "not to be performed" was unenforceable as written. As Berg and Kuhn pointed out, an outside observer could only determine what constituted featherbedding on the say-so of the employer (see Nick Rowe's comment above on the "1,001 different definitions of 'doing nothing'"!).

If featherbedding could be conjured from the imagination of propagandists and shrewd negotiators, why not unobtanium?

[Sandwichman]

BTW, the Potter Stewart obscenity rule, "I know it when I see it" doesn't apply to featherbedding because only the employer can "know" it.

[Min]

"If you want to buy more money than you are actually able to buy, there is something you can do about it. You can sell less money, and get to have more money that way instead."

OC, that may not work.

[Min]

"After the war, Taft-Hartley "outlawed" featherbedding. The clause outlawing demands for pay for services "not to be performed" was unenforceable as written."

Well, there goes a lot of executive pay, doesn't it? ;)

[Min]

Nick Rowe: "should the government impose a net liability on future taxpayers, just so that you can achieve your positive net asset position? Maybe. It depends."

Interesting choice of words. "Impose a net liability on future taxpayers" means running a gov't surplus at some time in the future. But somehow "impose a net liability on taxpayers" sounds worse than "run a gov't surplus". ;)

[Min]

Luis Enrique: "I want to sell goods and not buy them, hence I demand money, because I want to make myself better off, but having my assets swapped for money does not achieve that. Or are you thinking I can be made better off via being able to sell my assets at high prices?"

Isn't that what happens with bonds? If the CB buys enough of a certain class of bonds, then the price of the remaining bonds of that class will tend to rise, and the net worth of the bondholders will increase, which may induce them to spend money on new goods and services. Also, issuers of that class of bonds may be more able to issue new bonds, which will also pay for new goods and services, which may increase the velocity of money.

[Adam P]

seen this Nick?

http://www.theguardian.com/business/economics-blog/2014/aug/12/financial-policy-committee-boom-and-bust?commentpage=1

interesting...

[Luis Enrique]

Min,

yes -- although for the sums involved the wealth effect is pretty small - I already own a liquid assets (a gilt) and its price increases by a tiny amount thanks to monetary policy. That's a pretty round about way of helping households and firms who are experiencing a lack of demand for what they produce, even if you factor in possible spending via credit expansion. And then there's the distributional worries.

[Min]

Luis Enrique: "although for the sums involved the wealth effect is pretty small - I already own a liquid assets (a gilt) and its price increases by a tiny amount thanks to monetary policy."

Well, you have to multiply by the assets outstanding and out of CB hands. A small infusion of money by the CB can have an outsized wealth effect.

Luis Enrique: "That's a pretty round about way of helping households and firms who are experiencing a lack of demand for what they produce, even if you factor in possible spending via credit expansion. And then there's the distributional worries."

Well, yes, it's round about. And in normal times being round about may be best. And as for distributional worries, who are the bond holders? Making the rich richer is hardly neutral.

[Jeff]

Nick, SM: Thinking about this some more, the unobtanium problems in the argument seem to derive from an (unrealistic) assumption of perfect information and/or a narrow technical definition of "demand" (i.e. as only consisting of formal/binding "buy" offers communicated (perfectly) into a global market)? It's somewhat ironic that the argument raises the "lemon" problem only in the barter market context, while "forgetting" it in the money market context, despite the real-(money-market-)economy facts that such things as "lemons" (faux unobtanium) and hucksters do still manage to exist.

[Michael Byrnes]

By far the worst line in this whole long post:

"6. I think I will stop there."

[Nick Rowe]

Max: then why doesn't that "riskless" asset become money, and always pay the same interest rate as money?

Sandwichman: "featherbedding is waaaay off-topic.

Adam: yes I saw it. It is interesting. But one problem is that the P/E ratio is a real variable, and monetary policy can't target a real variable.

[Min]

Nick Rowe: "monetary policy can't target a real variable."

Hmmmm. Unemployment is a real variable, right?

[Too Much Fed]

Luis said: "I meant "So fiscal policy could help me directly if the government wades into the economy and starts buying the goods and services that I have to sell but would otherwise be failing to.""

1) Assume you are a monopoly for selling one type of good. Assume you are able to produce more than the economy wants to buy. Should fiscal policy be used to buy the excess?

2) By fiscal policy, do you mean more gov't debt?

[Too Much Fed]

Philippe said: "In contrast, if a rich person currently owns a $1 million government bond, and the government prints money and gives it to that person in exchange for the bond, that person's spending on goods is less likely to increase."

And if it is Apple or Warren Buffett that is selling the gov't bond, they may not increase spending at all. They may just book a capital gain, and hold the demand deposit.

[Nick Edmonds]

If people want more bonds, and provided they respect their budget constraint, then they must also either want less money or want less goods.

If they want more bonds and less money, then this may well have no impact on the goods market.

If they want more bonds and less goods, then they will first buy fewer goods to try to get the money to buy the bonds. This will affect the goods market.

You may say it is really the transitory demand for money that is causing the fall in demand for goods and in some sense I would agree with that. However, that is just the proximate cause - the ultimate cause is the increased demand for bonds. The distinction is important, because it relates to the effectiveness of swapping bonds for money as a policy to deal with a shortfall in demand for goods.

Unobtainium is a bit misleading. If everyone knows unobtainium does not exist, they will not bother buying fewer goods to get the money to buy it.

[Jeff]

Following on from my earlier lemon/huckster arguments. Is there any such study as "the macroeconomics of lies, fakes, and misplaced trust"? To include the phenomena of fake demand, fake supply (false advertising), affinity fraud, outright fraud, and politics?

[W. Peden]

Min,

"Hmmmm. Unemployment is a real variable, right?"

Yes, and not a good target for monetary policy, even with a sophisticated approach. (I assume that it is obvious that monetary policymakers can't hit an arbitrary unemployment rate in the long-run.) For example, the US unemployment rate seemed to drift below the NAIRU in the late-1990s, but the supposed inflationary surge never happened. More recently, trying to link unemployment and interest rate rises in the UK has suffered from what may be a significant shift in the UK NAIRU (or may not!). Neither the NAIRU nor the various versions of the Phillips Curve seem to be good guides.

[Jeff]

Nick E.: "If everyone knows unobtanium does not exist, they will not bother buying fewer goods to get the money to buy it."

That's the black-and-white economic reasoning I was questioning in my comments. Nick R. may be defining "demand for unobtanium" out of existence (to be zero) by *defining* demand as "will bother buying fewer" other goods. (Thus self-refuting the premise in the argument that there was any such demand in the first place.) Or he is saying there *is* such an unsatisfiable demand, but it will have literally zero effect on the economy (which I also rebutted above). He hasn't clarified which yet.

The whole analysis also seems to fly in the face of any Field-of-Dreams type of effect (if you produce it, some demand will follow). Even if that effect is almost always close to zero in general, it could be really large for some truly good-innovative products like the iPad.

[Major.Freedom]

Nick, you wrote:

"If the price of wheat is too high, so producers of wheat can't easily sell wheat, and so plant too little, doesn't that also mean the price of money is too low, so they can't easily buy money? One is just the reciprocal and the mirror-image of the other."

That is not necessarily true. The price of wheat being too high is not an event limited to the supply of wheat and the expenditures on or prices of wheat. If the price of wheat is too high, what that actually means is that the supply of wheat is too low relative to the supply of other goods, such that the relative nominal demands for wheat and everything-else-except-wheat, leads to too much sacrificing of everything-else-except-wheat if one wants to buy wheat.

More money and spending, or less money and spending, in the aggregate, does not solve this problem, because it is a relative supply problem.

To solve the problem of wheat being too expensive, the only solution, that does not itselfcreate more of the same problem, is a greater supply of wheat. That will tend to make wheat less expensive, because people would have to sacrifice fewer of other goods in order to buy wheat, since the price of wheat will tend to be lower.

Nothing of the above changes if instead of problems in only wheat supply, there were problems in the supply of everything observable. It is still a relative supply problem. The way to integrate money into this is by treating money as an economic good as well, and not moving it to some special place that transcends economic analysis, where it inevitably becomes an ideological tool of centralized political/social control.

A healthy free market does not consist of a constantly growing production and sale of a specific good like hoola hoops, or Ford Pintos, or Dubstep CDs. A healthy free market has variation and diversity in production and sale. This includes money. A healthy free market can have volatility in production and sale of money. But this does not mean that volatility is per se a requisite or always beneficial no matter the cause. States who have monopolies over money can cause tremendous damage by determining the volatility of money supply growth via political means and not market means. The same way it would cause problems by bringing about politically driven volatility in food production, or medicine production. If people's tastes are such that more food is desired now, and less next month, then a government that caused volatility in food production of less this month and more next month, would be bad volatility.

Money is no different. A politically driven constant growth in the supply of money, which would imply a politically driven volatility in aggregate spending, or constant growth in aggregate spending, which would imply a politically driven volatility in money supply (since targeting AD via money printing, is controlling money printing), would cause coordination problems.

Money is an economic good. Its supply should be controlled entirely by market forces. A good money is a money that can be made volatile according to market preferences. A healthy economy has non-constant productions and supplies of everything, including money. We consider it a good and healthy thing when labor changes from obsolete methods and goods with declining demand, towards better methods and goods in rising demand. This means temporary unemployment.

It is absurd to believe that it is a good thing to stop unemployment from appearing in an increasingly obsolete candlestick making industry, by using political means. It is also absurd to believe that it is a good thing to stop unemployment from appearing in general by using political means in money, especially when it was past political activity in money that caused the labor misallocations that were later revealed.