It’s the PSST, Stupid!

by Don Boudreaux on July 14, 2011

in Monetary Policy, Myths and Fallacies, State of Macro, Stimulus, The Crisis, The Economy

Ultimately it’s an empircal question – or, rather, a series of empirical questions.  The most germane of these questions is this two-part one:

Is the decline in demand for the outputs of many industries throughout the economy (1) chiefly the consequence of an increased demand for money, an increased demand (2) caused not by any structural mal-adjustments in the economy or by actual or anticipated destructive government policies but, instead, simply caused by an intensification of people’s desires to hold larger money balances?

If the answer to this question is “yes,” then the economy will indeed suffer a problem that can fairly be described as “inadequate aggregate demand.”  A better term, though, is “excess demand for money.”

As my great teacher, Leland Yeager, explained – for he is an able advocate of this “monetary disequilibrium” theory – because money “has no market of its own,” attempts by people to satisfy their demands to hold larger money balances have economy-wide repercussions in ways that people’s attempts to satisfy their demands to hold larger inventories of, say, apples do not.

Overlooking the important question of to what extent should consumption patterns, and patterns and techniques of production, in the “real” economy change as a result of people’s increased demand for money, we can nevertheless reasonably conclude that, ceteris paribus, a simple taste-driven or increase in the demand for money does not imply that patterns of resource allocation, production plans, and consumption plans are seriously out of whack.  Likewise for an increased demand for money driven by animal spirits.

The microeconomic conditions in this scenario are, by assumption, healthy.  All that must be done to avoid the negative external effects of each of us attempting to increase the real value of our money balances is for the nominal money supply to grow in order to accommodate this increased demand.  (In a fairytale world, prices of all goods and services and inputs would all adjust in unison downward to achieve the same goal.  But coordination problems make such price declines too unlikely to rely upon.)

In principle, increasing the supply of money will avoid the problem of inadequate aggregate demand.  I say “in principle” because the practical problem of how to get the increased supply of money into the market is real, although typically overlooked.

If the central bank simply injects this new money, (1) how do the central bankers know how much to inject? and (2) how do they avoid what Hayek called “injection effects”?  [The new money must enter somewhere, at least potentially distorting relative prices and then causing genuine resource misallocations and malinvestments.]  Indeed, how do central bankers know (with reasonable-enough certainty) that the observed declines in demands-for-output economy-wide are in fact the result of a taste-driven (or animal-spirits driven) increase in the demand to hold larger money balances rather than a reflection of serious microeconomic misallocations and malinvestments, or of greater concerns that government’s economic policies have taken a turn for the worse?

So back to my starting claim that it’s an empirical question.  Only if the above conditions – along with some other, smaller and not-worth-mentioning conditions – hold true does it make sense to talk of restoring “aggregate demand.”

But if the decline in GDP growth and in the rate of employment are caused, not by a taste- or animal-spirits-driven increase in the demand for money but, instead, by a large enough disruption in what Arnold Kling calls “patterns of sustainable specialization and trade,” then kicking up aggregate demand won’t solve the problem.  Neither kicking it up, or trying to, through monetary policy or through fiscal policy will work.  The problem is not originally one of widespread inadequate demand.  In this case, inadequate aggregate demand is a symptom; treating the symptom will not cure the disease and, indeed, will only worsen it.

Without venturing here an opinion on the underlying source of each and every recession throughout American history, I will express an opinion about the current recession: it is clearly the result of distorting government policies, regulatory and monetary, leading up to 2008 as well as of the symptom-treating policies since then that only worsen matters.  (And not to mention yet other actual and threatened policies – e.g., Obamacare -  that distort microeconomic patterns of sustainable specialization and trade.)

Curing the current recession simply with more money or more stimulus spending is as likely to restore the U.S. economy to health as would dumping more money on Chadians, and raising government spending in Chad, to start that nation on the path to genuine economic growth.

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GP Hanner July 14, 2011 at 2:48 pm

If most people are like me, they have no confidence in the good intentions of the Obama administration. Everything he does shakes my confidence that he has anything other than that he is determined to weaken capitalism as much as he possibly can.

Of course, he told the electorate what he intended to do with his glib remarks about an “imperfect constitution,” his intent to “soak the rich,” his intent to “spread the wealth,” and his intent to emphasis on technologies that are poorly developed and require subsidies even for them to exist.

Daniel Kuehn July 14, 2011 at 2:55 pm

re: “Curing the current recession simply with more money or more stimulus spending is as likely to restore the U.S. economy to health as would dumping more money on Chadians, and raising government spending in Chad, to start that nation on the path to genuine economic growth.”

This was an interesting comment.

You seem to treat secular economic growth and recovery from a downturn as identical processes, as if someone’s explanation of the latter is applicable to the former as well.

This seems fundamentally wrong to me.

Daniel Kuehn July 14, 2011 at 2:57 pm

People talk a whole lot about how the crisis ought to change the teachings of economics, and this distinction is going to be one of the biggest, I think.

My graduate macro classes were almost exclusively about growth theory. I’m not sure we had any business cycle theory. Of course, those are two very different lines of inquiry. I think growth theory is going to be downplayed for a while.

Don Boudreaux July 14, 2011 at 3:04 pm

Doesn’t seem wrong to me. Only the magnitudes differ.

The problem with ‘developing’ countries such as Chad is inadequate microeconomic institutions – inadequacies that prevent entrepreneurs from being able to better and better use resources to satisfy consumers’ demands.

“Recovery from a downturn” is – and this is my very point (from the Austrians) – precisely the same problem, just not as bad. U.S. microeconomic maladjustments and conditions are nowhere near as rotten as they are in countries such as Chad. But that fact doesn’t mean that whatever maladjustments and other microeconomic distortions we DO have can be ignored and the problem then kicked into the theoretical category “inadequate aggregate demand.”

Hayek’s point is (to use more modern language) that we must attend to microeconomic conditions – attend to those phenomena preventing as clean as possible patterns of sustainable specialization and trade – to understand downturns in developed economies such as the U.S. no less than to understand why very poor countries, such as Chad, continue to languish in poverty.

Daniel Kuehn July 14, 2011 at 3:10 pm

Can other Austrians confirm this?

I had no idea the position was that secular growth and cyclical performance were considered one and the same by Austrians. I thought business cycles had a quite distinct explanation.

I certainly agree that PSST has important explanatory power and no one ought to ignore microeconomic processes.

Don Boudreaux July 14, 2011 at 3:22 pm

Don’t be obtuse, Daniel; you’re too caught up in terminology.

What I’m saying is that microeconomic conditions matter and explain BOTH lack of development and economic downturns and recessions. The specific distortions and problems differ, obviously, in both form and extent, but that fact doesn’t mean that focusing on microeconomic discoordination to explain the failure of poor economies to develop disqualifies one from focusing on microeconomic discoordination to explain economic cycles and being rutted in recessions.

To whatever extent a recession in a developed economy is the product of microeconomic distortions and discoordination, pointing out that that problem will not be solved simply by increasing aggregate demand is just as justified as saying that the microeconomic distortions and discoordinations that prevent economic development won’t be solved simply by increasing aggregate demand.

The habit of modern economists to dismiss from the start the possibility that microeconomic distortions and discoordinations are a major source of what are called “macroeconomic” problems in developed countries is what allows you to distinguish “cyclical performance” from “secular growth” as if the same sort of explanation that might profitably be used to explain the latter cannot possibly be used to explain the former.

Jim July 15, 2011 at 3:29 pm

The challenge in both growth and recovery is the same.

The problem with ‘business cycles’ is the same as with equilibrium, as if an economy somehow returns to something, or hovers in an optimal state. Neither of those concepts are useful IMHO.

Part of the challenge of comparing recessions or other economic data points is at least partly like comparing man’s ability to adapt and survive at different times of his evolution, implying that he could somehow return or that studying cro-magnon man will help our evolutionary future. And without also capturing his exact relationship with his enemies and his environment, we know less than we think we do

I am not saying there is nothing to learn. I am saying that landscapes and interaction matter a great deal, and that we can never go back. If the economy is a complex system, maturation to adulthood or evolution would in my mind be much better analogies to economies than equilibrium or cycles or ‘recovery.’

Don Lloyd July 14, 2011 at 3:04 pm

In a modern economy the actual need for the holding of money for use as a medium of exchange is minimal. Whether I have a certain amount of cash beyond a bare minimum is primarily a matter of whim. What matters is the sum of an uncountable number of different kinds of assets that can easily converted to cash if necessary. Besides, especially today, there is no significant sacrifice in lost interest if an individual holds a little more cash than he really needs to. It just is not worth thinking about.

If a central planner of any type thinks that he can usefully and beneficially fine tune the supply of money, by any measure, he is just self deluded. If an individual doesn’t have enough money, it only matters if it’s actually wealth that he’s short.

Regards, Don

muirgeo July 14, 2011 at 5:28 pm

Recession???/ What Recession??? This is the best economy in a long time for those on the very top.

JP Morgan Profits Jump 13%
See todays FT

It is naive to think Obama’s policies are the problem. It’s his lack of policies and the policies of JP Morgan that will keep their current economic boom going. They have no incentive to change when they are making profits like this. They have empowered the Republicans to stonewall any real policy changes and keeping things the same works great for them.

Terc July 14, 2011 at 6:44 pm

Between patients are we?
I wish Cafe Hayek could attract some better trolls. The ones we have here are getting stale.

Greg Webb July 15, 2011 at 12:35 am

George, do you have any objective, verifiable evidence to support the following allegations as presented in your post:

1. It’s naive Obama’s policies are the problem
2. It’s his (Obama’s) lack of policies and the policies of JP Morgan…
3. They (Obama and JP Morgan) have empowered the Republicans…

You don’t have a coherent, logical argument. But, assuming you had made a coherent, logical argument, please provide the proof. And, no, comments made on The Daily Show and The Colbert Report do not count as evidence.

muirgeo July 14, 2011 at 3:28 pm

Recession???/ What Recession??? This is the best economy in a long time for those on the very top.

Please respect FT.com’s ts&cs and copyright policy which allow you to: share links; copy content for personal use; & redistribute limited extracts. Email ftsales.support@ft.com to buy additional rights or use this link to reference the article – http://www.ft.com/cms/s/0/761a22f6-ae11-11e0-a2ab-00144feabdc0.html#ixzz1S6pneYme

JPMorgan’s profit jumps 13%
By Justin Baer and Shannon Bond in New York

It is naive to think Obama’s policies are the problem. It’s his lack of policies and the policies of JP Morgan that will keep their current economic boom going. They have no incentive to change when they are making profits like this. They have empowered the Republicans to stone wall and really policy changes and keeping things the same works great for them.

Lee Kelly July 14, 2011 at 3:41 pm

Some comments.

(1) To my knowledge, no monetary disequilibrium theorist has claimed that our only problem is an excess demand for money. They often assume that microeconomic conditions are healthy for the purpose of explanation, but only to demonstrate that an excess demand for money sufficient to cause a recession. Even Sumner regularly states that our problems are about 75 percent monetary and 25 percent real. The assumption is normally that without unhealthy microeconomic conditions, an excess demand for money is unlikely to occur.

(2) However out of whack we are with regard to Kling’s patterns of sustainable specialisation and trade, that doesn’t explain the sudden fall and continual sluggishness of NGDP. Structural maladjustments should not reduce aggregate demand unless they somehow also cause an excess demand for money.

(3) Many monetary disequilibrium theorists would prefer some kind of NGDP level targeting by the Fed. In this case, structural problems should result in higher than normal inflation. The reverse is true during times of exceptional productivity.

(4) So-called “injection effects” are mostly bogus in this context. Read Yeager’s “Injection Effects and Monetary Intermediation.”

Daniel Kuehn July 14, 2011 at 4:04 pm

re: “To my knowledge, no monetary disequilibrium theorist has claimed that our only problem is an excess demand for money.”

And more than that – they recognize that there are ultimately microeconomic causes for excess demand for money (such as financial crises). I’ve been trying to make the point, but all it’s achieved is being called “obtuse” by Don.

Don Boudreaux July 14, 2011 at 4:13 pm

Lee Kelly:

I agree fully with your first point; I apologize if I unintentionally gave a different impression in the post. The point of my post was not to analyze – and certainly not to criticize – monetary-disequilibrium theory. It was, instead, to distinguish what seems to me to be the cleanest, clearest, and most compelling example of inadequate aggregate demand from other, I believe much more typical, reasons for observed ‘macroeconomic’ downturns – these other reasons being, of course, patterns of unsustainable specialization and trade.

I agree also with your second point: as a secondary matter – as a response to problems caused by patterns of unsustainable specialization and trade – people’s demand for money is likely to rise. But this increase in the demand for money is itself the result of the initiating problem – namely, the revelation that the existing pattern of specialization and trade is insufficiently sustainable.

I don’t see the sense in the policy advocated in your point three (although I concede that it is advocated by many monetary-disequilibrium theorists).

I’ve read the Yeager article you mention in your fourth point, but it’s been a while. I’ll do so again. I don’t recall, however, being persuaded by it. Either way, to note that monetary policy CAN be conducted in a way that eliminates injection effects or (if I recall Yeager’s article well enough) renders these effects no worse than the relative-price changes that would occur in the absence of accommodating monetary policy is not to prove, or even to present evidence, that the way monetary policy will actually be carried out is one in which the resulting injection effects are no worse than are the changes in relative prices that would occur in the absence of accommodating monetary expansion.

yet another Dave July 14, 2011 at 4:31 pm

The assumption is normally that without unhealthy microeconomic conditions, an excess demand for money is unlikely to occur.

If this is true why would anybody advocate a stimulus rather than addressing the unhealthy microeconomic conditions to reduce the excess demand for money?

Or, to put it another way, doesn’t the call for stimulus prove that the assumption you describe is not really the assumption after all?

Eric Hammer July 15, 2011 at 12:19 am

Good point! If folks really thought the issue was the micro conditions, they would be hammering on getting them fixed instead of pushing for stimulus that would at best cover up the symptom. The only way the words and actions of those pushing for stimulus makes sense in that sense is if they believe the microeconomic conditions will sort themselves out in the mid-term, so only taking care of the symptom in the short term makes sense.
While that is logical when dealing with a cold, say taking decongestants while waiting out the sickness, in the case of a cold your body is unconsciously sorting out the problem. I don’t think we can assume the unhealthy microeconomic conditions are being corrected, or will be if we don’t consciously remove them. As such, it would seem to me that those pushing for stimulus and inflation stating they believe it is necessary due to microeconomic factors while not also calling more strongly to fix those underlying factors are speaking out of both sides of their mouths. Much like claiming to cure a cold with Nyquil.

Eric Hammer July 15, 2011 at 12:21 am

Wow, used “sense” a few dozen more times than would be sensible in that post. Sorry about that, time for bed!

DG Lesvic July 14, 2011 at 3:46 pm

Admittedly I have merely skimmed through the discussion here, but it seems all wrong right from the start. In the first place, economics is not an empirical but a theoretical science. And the theory, properly understood, makes it clear that there is no such thing as an excess demand for money and never, ever any occasion for fiddling with the money supply.

Josh W. July 14, 2011 at 3:50 pm

Yes, there can be an excess demand for money if the central bank is not producing enough money relative to what is desired. Ordinary people can produce yoga mats and lattes but they can’t produce money.

Pretty simple actually.

Sam Grove July 14, 2011 at 9:20 pm

Ordinary people can produce yoga mats and lattes but they can’t produce money.

Actually, they can. They have done so throughout history.

Don Boudreaux July 14, 2011 at 3:58 pm

DG: You’re wrong. Period.

DG Lesvic July 14, 2011 at 4:56 pm

From the Cause and Cure of the Depression, at, and I hope the link works, http://econotrashtalk.org/#The Cause and Cure of the Depression

Roger Garrison, speaking for the Austrian School: “None of this is to deny that a sharp increase in money demand (or a collapse in the money supply) can seriously retard recovery—as certainly happened in the 1930s.”

By money demand he means saving, and, presumably, in a mattress, removed from circulation, rather than in a bank that would lend it right out again and back into circulation. But, in the wake of capital consumption and the face of more destructive policy, more saving, to restore the stock of capital, and, in a mattress, to keep it out of the path of an oncoming avalanche or rampaging government, is just what is needed; and any “multiplier” effect of throwing it under the avalanche would be a multiplier only of the malinvestment at the root of the problem.

Avoiding the avalanche is not what is retarding recovery, but the avalanche that is doing so. Avoiding it is essential for recovery, if and when the opportunity for it arises. If it doesn’t, that isn’t the fault of the saving. Saving, in the proverbial mattress, is purely an effect and not at all a cause of the problem, and not even, as Hayek and Keynes agreed, a secondary cause, but an essential part of the solution.
Since saving was the market’s own reaction to its circumstances, it had to be beneficial to it, according to the pure Austrians — but not the Keynesian Austrians.

They see the flight to safety as an “excess demand for money,” sending prices and markets into a deflationary tailspin, and, to stabilize them, would increase the supply of money until it equaled the demand for it. And that is not inflationary, they insist, for it would not raise but stabilize prices. But replacing the money “lost” to saving is not the same as replacing money lost at sea or in a fire. That money can no longer do anyone any good, nor ever come back into circulation. But the money “lost” to saving is still performing a service for someone and may still come back into circulation. So it is still a part of the overall money supply, and “replacing” it is adding to the supply, and inflation of it.

It is in vain. “All plans to render money neutral and stable are contradictory. Money is an element of action and consequently of change.”

Mises, Human Action, P 419

The plans of the Keynesian Austrians are doubly contradictory. The monetary discipline of their Free Banking would preclude the inflation for their Monetary Equilibrium, for, in a free market for banks, any that debauched its currency would lose its depositors and currency to those that didn’t do so.

They are confusing the medium with the objects of exchange, and marginal with total demand for money. While the supply of oil, apples and oranges, the objects of exchange, determines our wealth, that of money, the medium of it, does not. We are richer with 100 than with 50 barrels of oil, but no richer with oil at $100 than at $50 a barrel. While the greater supply of oil renders a greater service than the lesser supply of it, the greater supply of money renders no greater service. So there will be no market demand for any greater number of dollars. The greater demand for money in the market means something entirely different, a greater marginal rather than greater total demand for money.

As production and the supply of goods goes up, and there are more goods chasing the same number of dollars, there will be a greater demand for each dollar, but not for more dollars. Or, if the greater demand for money was for more savings, increasing the supply of money and reducing the value of savings would not be meeting but thwarting the demand.

There is an excess demand for money only in the mind of a dictator, for the market and its individuals are the best judges of how much they should save.

Daniel Kuehn July 14, 2011 at 4:02 pm

“Not an empirical science” is an oxymoron of a statement if there ever was one. When you take out empiricism, you’re just playing word games and logic games.

Logic is a nice tool for scientists, but it does not a science make.

Josh S July 14, 2011 at 4:07 pm

Is math a science or not?

Greg July 14, 2011 at 4:16 pm

Math is just as empirical as any other science. It’s just that we don’t need to check a theorem with numbers, because the theory came out of the numbers in the first place.

vikingvista July 14, 2011 at 5:34 pm

That is a too broad a notion of “empirical”. It is true that all we know and think is somehow linked to some observation–a person who never had sense perception will never know or think. But the perceptual similarities and differences our brains abstract from specific perceptions reveal truths that hold independent of any particular perceptions. That is mathematics, and logic–which underlies most of the mathematical relations.

Empirical knowledge, which is synonymous with scientific knowledge, is knowledge whose tentative truth is induced from the parts of repeated observations that remain similar without definite exception.

Eric Hammer July 15, 2011 at 12:24 am

“a person who never had sense perception will never know or think.”

I don’t know how you would test whether or not that is true, but it is really interesting to think about. What would a brain do without sensory input? I would expect it wouldn’t be nothing, but what would the imagination do with so little to work with?

vikingvista July 15, 2011 at 3:52 am

“I would expect it wouldn’t be nothing, but what would the imagination do with so little to work with?”

Not little to work with. Nothing to work with. If you want to know what kind of thoughts such a person would have, recall the thoughts you had 2 months before you were born. And at that time you had the advantage of at least some sensory perception. Even if your occipital or auditory or sensory cortex had random electrical discharges (totally independent of the external world), there would be no context or meaningful pattern for your conceptual faculties to build off of.

Daniel Kuehn July 14, 2011 at 4:32 pm

I personally think of it as being like logic. It’s a mental tool, just like the telescope is a visual tool, that we can use in science to correlate our empirical perceptions with theory.

That’s how I think of it. There’s been work since Godel that argues it is legitimately a science in its own right.

As for the question of “is it empirical”, I think a lot of numerical analysis could legitimately be called “empirical”.

PrometheeFeu July 14, 2011 at 5:27 pm

No.

Dr. T July 14, 2011 at 6:55 pm

The fact that mathematicians formulate and test hypotheses does not mean that mathematics is a science. Mathematics has nothing physical to observe, is not directly related to the physical universe, and does not apply the scientific method. For example, one does not use the scientific method to determine whether the set of all even integers is the same size as the set of all integers. Mathematics, statistics, computer modeling, and formal logic are tools that are used by scientists, but the tools themselves are not science.

vikingvista July 15, 2011 at 4:45 am

The truth of a mathematical or logical statement is dependent only upon errors of reasoning, and never upon an observation either real or imagined. The truth of a scientific statement is about observations, and always dependent upon the next one.

The truth of a scientistic statement, on the other hand, somehow always seems to be conveniently true for any observations either real or imagined.

BZ July 14, 2011 at 7:07 pm

Of course, we’re playing word games right now… deciding what does and does not get the magical power of legitimacy from being called “science”.

However, by the way I understand the word to be meant in modern English, no. By the understanding I prefer, yes (but by that understanding, physics and biology are not).

Daniel Kuehn July 14, 2011 at 7:33 pm

No, not word games. “Science” isn’t magical – it’s a pretty specific human activity directed at understanding the world around him. There have been other attempts at understanding this world, many quite different from what we’ve labeled “science”, and “science is a label that we’ve chosen to apply for a set of approaches to the world.

Applying a label to a related set of activities isn’t attributing “magical powers of legitimacy” at all.

DG Lesvic July 14, 2011 at 8:09 pm

Science is the systematic arrangement of knowledge by means of reason.

While feeling is subjective, varying from person to person and time to time, reason is objective, uniform through all time and space for all who are human like ourselves.

There are three divisions of reason: mathematics, logic, and praxeology. It is mathematics that tells us that two and two is four, logic that you may prefer A to B or B to A, but not both, and praxeology that quantity demanded goes down as price goes up.

While mathematics and logic are out of time and space, praxeology is within it, the science of human action, always through time and space. With semantic license, we may simply say logic when we mean praxeology. But there is a difference. For praxeology is specifically the science of human action, and, economics, its “best elaborated part…”

Mises, Human Action, P 3.

It is not a mathematical science. Quantity demanded goes down as price goes up, but not in a constant ratio. And, without constant ratios between magnitudes, there can be no mathematical laws. Statistics are not economics but history, and, curves, priestcraft. Real economics is not mathematical but logical, not diagrammatic but literary, an aprioristic, theoretical, logical, and literary science.

Don Boudreaux July 14, 2011 at 4:31 pm

Daniel: You’re right. Period.

DG Lesvic July 14, 2011 at 4:59 pm

Of course I disagree with you on this matter, but for the moment prefer to stay focused on the one issue of the business cycle.

DG Lesvic July 14, 2011 at 5:03 pm

What I mean is that I don’t agree that math is an empirical science nor do I agree that there is any numerical analysis in economics. But, again, I hope to stay focused on the business cycle theory, because that is so much more timely now and the deficiencies of the Austrian School in that matter more urgently in need of attention and correct.

In short, Mises and Rothbard were right and Hayek was wrong.

vikingvista July 14, 2011 at 5:11 pm

Mises and Rothbard were right and YOU are wrong.

vikingvista July 14, 2011 at 5:10 pm

You are severely weakened by your deliberate refusal to understand the shorthand that supply and demand plots give us for the simultaneous events occurring in markets. The plots correctly lead us to useful conclusions regarding shortages. Money is treated as a good. Instead of plotting $/Q vs Q, reverse the roles of the two goods and plot Q/$ vs $. An excess demand (shortage) for money occurs when the Q/$ is below equilibrium.

In any market, there are always people who won’t trade, because they don’t think the price is right (goods don’t fetch a satisfactory price, wage is too low, interest rate is too high). A shortage means that there are many people who think the price is right, but still can’t trade (sell their goods, get a job, take out a loan).

If sufficient holders of dollars (consumers, lenders) consider sufficient goods/services/returns to be overpriced in dollars, then they will hold back their purchases (supply of dollars) more than expected by demanders of dollars (merchants, would-be debtors). This mismatch is the excess demand for money.

It isn’t a question that it happens. The important question is why there ever is a significant disequilibrium. One way is if central banks suddenly and unexpectedly contract bank’s reserves against the banks’ existing plans. Another is imposed widespread wage and price floors. Another may be the initial effects of a recession before resource misallocations have had a chance to liquidate. Another is legislative action that draws out such liquidation.

DG Lesvic July 14, 2011 at 7:24 pm

Vike,

There can excess saving only in the mind of a dictator.

The amount that you are saving is the correct amount for your own needs according to your own valuations.

The amount that I am saving is the correct amount for my own needs according to my own valuations.

The amount that the market as a whole is saving is the correct amount for its own needs according to its own valuations.

And they are incorrect amounts only according to the valuations of financially irresponsible buttinskis and socialist dictators.

DG Lesvic July 14, 2011 at 7:42 pm

Vike,

You asked,

“The important question is why there ever is a significant disequilibrium.”

I’m sure you understand that there is always some disequilibrium because the market is always tending toward but never reaching equilibrium. And so I assume that by a “significiant disequilibrium” you mean something beyond the ordinary equilibrium in the market, a chronic massive disequilibrium, to the extent of a recession or depression, a widespread and persistent disconnect between buyers and sellers.

We know that, if something is keeping them apart, it couldn’t be the market, for the market is nothing but buyers and sellers. Why, if free to do so, would they not come together? And how could “regulation” coming between them not keep them apart?

So, the answer to your question, without any empirical observation, statistics, graphs, or any other such fancy folderol and econobabble, is that that market tends toward equilibrium and interference with it toward disequilibrium.

vikingvista July 14, 2011 at 8:05 pm

“market tends toward equilibrium and interference with it toward disequilibrium”

So now you understand how there can be an excess demand for money (or any other good). For once, and in the course of a few short hours, you have learned something. I am pleasantly surprised.

DG Lesvic July 14, 2011 at 9:15 pm

sorry, another typo.

Where I said “something beyond the ordinary equilibrium,” I meant disequilibrium.

Vike,

The point you just made about my admitting disequilibrium and therefore necessarily excess demand for money may be right, but I’m not too sure. Have to think about a bit. But it would be true only in the real world of an actual marketplace, and that is not what we analyze in economics. We analyze the hypothetical imaginary state of rest and equiibrium, and the effect of a single factor of change upon it. In that imaginary state, which is the only subject matter of economics proper, there is no excess demand for money. Where there is excess demand for it, in the real market, is irrelevant to economics.

vikingvista July 14, 2011 at 10:00 pm

“In that imaginary state, which is the only subject matter of economics proper, there is no excess demand for money.”

If the more than century old understanding of basic market shortages, which Mises, Rothbard, Keynes, and I presume every professional economist understands and accepts, is applicable to the real world, then so is excess demand for (i.e. shortage of) money.

I’m open to some new insight, in contradiction to Mises, that shows that money is a unique kind of good that cannot ever be in shortage or surplus, but I don’t see it.

DG Lesvic July 14, 2011 at 10:31 pm

Vike,

You wrote,

I’m open to some new insight, in contradiction to Mises, that shows that money is a unique kind of good that cannot ever be in shortage or surplus, but I don’t see it.

Here it is, my Mises contradicting your Mises, on P 421 of Human Agony.

“The services which money renders can be neither improved nor repaired by changing the supply of money…The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do.”

Even saving money in a mattress merely forces prices downward and the purchasing power of the money remaining in circulation upward. So, tho less money in circulation, there is no less purchasing power and demand, for all of the purchasing power saved is, in effect, lent to the spenders. So there could be just as much spending as before, just at lower prices. And if there isn’t, it is because the market actors consider it imprudent. Who are you to tell them otherwise?

DG Lesvic July 15, 2011 at 1:00 am

Vike,

Having thought a bit more about this matter of admitting disequilibrium in the market is to admit an excess demand for money, I now reject that notion altogether.

There is a difference between the objects of exchange, apples, oranges, and oil, and the medium of it, money.

While there could certainly be relative oversupplies of apples and undersupplies of oranges, there could be no such oversupplies or undersupplies of money, if, as Mises said,

“The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do.”

You can’t say that about apples and oranges, the objects of exchange, but only about money, the medium of it.

And that’s the difference, the difference between the objects of it and the medium of it, and why what applies to the one category does not necessarily apply to the other, and, in this case, most certainly does not.

There can be no such thing as too much or too little money.

vikingvista July 15, 2011 at 2:35 am

“The services which money renders can be neither improved nor repaired by changing the supply of money…The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do.”

Yes, of course. This is true. I’ve repeated it myself on occasion. There is no “correct” price for anything, so as long as money is sufficiently divisible, it always has sufficient quantity to supply an economy of any size. As a valued good, there will be price, affected by its availability, at which people can obtain money in exchange for something else.

But what you don’t realize is that this is not the same thing as a market shortage–a deviation from equilibrium. A shortage, as in an excess demand for money, refers not to an insufficient absolute quantity of something in the whole system, but rather to a failure of bidding for different exchange ratios, and thus a restriction of trade. Excess demand for money means that at the current prices, some people are willing to sell their goods & services for less, and others are willing to pay those lower prices for them, but these willing parties are frustrated from getting together and engaging in those trades. This differs from an equilibrium condition where the only reason people don’t trade, is that there isn’t a counterparty willing to make an exchange that is satisfactory to them.

It doesn’t matter what quantity of money is in the system–if the price is off of equilibrium, then you will have this population of frustrated buyers and sellers. (Of course people think you can affect a disequilibrium through manipulation of the money supply, but that is a different issue.)

DG Lesvic July 15, 2011 at 1:03 am

And any such thing as too much or too little demand is immaterial in economics. It simply means that the market actors change their minds and their valuations and desires to hold money.

That doesn’t mean some monetary authority should fiddle with the quantity of it, for the actor himself will bring his onw wishes into balance with his holdings much better than your fiddlers in the Fed.

DG Lesvic July 15, 2011 at 1:04 am

I meant to say too much or too little demand for money.

vikingvista July 15, 2011 at 2:41 am

“And any such thing as too much or too little demand is immaterial in economics.”

Actually, since equilibrium is only an unrealized tendency, you might say it is fundamental to economics. It is why people trade.

But it is usually only discussed when there is a widespread problem preventing those trades from occurring.

Josh W. July 14, 2011 at 3:48 pm

Your problem is solvable. The Fed sets a 5% NGDP growth target and trades their liquid assets for peoples’ illiquid ones until the target is met.

Paul Andrews July 14, 2011 at 8:01 pm

It is possible for real GDP to decline with 5% NGDP growth.

It is also possible that the decline would accelerate.

How does the proposed solution deal with those possibilities?

Charles R. Williams July 16, 2011 at 2:41 pm

What evidence is there that the fed can achieve a 5% NGDP growth target by buying assets? Maybe if they give me a good enough price for my 1998 Camry, I’ll buy a new car. And then they’ll need a garage to protect their investment.

Seriously, for the fed to impact normally functioning markets by engaging in financial intermediation would require intervention on an unimaginable scale. No one has shown that the fed can do this nor have they shown that this could be done without de-stabilizing the economy.

DG Lesvic July 14, 2011 at 3:49 pm

And, by the way, Hayek got this wrong, agreeing with Keynes that the flight to safety, though not the primary cause of the downturn, was a secondary cause of it. It was in fact nothing but an antidote to it.

DG Lesvic July 14, 2011 at 5:25 pm

But I still wouldn’t classify Hayek as one of the Keynesian Austrians, like our friends here who would fiddle with the money supply, for Hayek was against that. He made some mistakes. He agreed with Keynes where he shouldn’t have. But he was no Keynesian. Those who would fiddle with the money supply are, Keynesian Austrians.

Greg July 14, 2011 at 4:01 pm

Just saying, a lack of nominal money can very much translate into a lack of real wealth if the individual’s obligations are in nominal and not real terms.

Greg July 14, 2011 at 4:08 pm

Whoops, that was supposed to be a reply to Don Lloyd.

Anyway, we now have a clear choice: raise real wealth directly to compensate for nominal fluctuations, or arrest and redirect the nominal fluctuations so that real wealth increases as a result. Or the monetarists and the Keynesians can see the merit in each other’s arguments and do both.

That we should do something is obvious. To use the doctor analogy from before: chemo (government intervention) makes you sick (medium- and long-term distortions and minor social injustice), but does that mean we should let the cancer (low standard of living via no money via unemployment) worsen?

Paul Andrews July 15, 2011 at 2:15 am

Government intervention is more akin to heroin injections than chemo.

Sebastian Oberhoff July 14, 2011 at 4:04 pm

If people want more money for purely aesthetic reasons, will that not just increase the market value of money to a point where people are getting enough goods and services per dollar that a new equilibrium is found?

Also making an exception for money as the only good that cannot be created by the economy is completely false. Picassos and Da Vincis aren’t being produced anymore either, should we worry about those goods too?

Don Boudreaux July 14, 2011 at 4:21 pm

Sebastian asks: “If people want more money for purely aesthetic reasons, will that not just increase the market value of money to a point where people are getting enough goods and services per dollar that a new equilibrium is found?”

Answer: Only if the price level falls. And therein lies the problem, at least according to monetary-disequilibrium theory (which has much merit). With sellers and workers each reluctant to be the first to lower his prices or wages, nominal prices remain stuck at levels too high. Output declines, as does employment.

As Yeager often said, “the rot snowballs.”

muirgeo July 14, 2011 at 4:22 pm

“… it is clearly the result of distorting government policies, regulatory and monetary, leading up to 2008 as well as of the symptom-treating policies since then that only worsen matters.” Don

The distortion in policy is a result of preceding factors. Those being falling wages and increasing debt. Again, lead by Wall Street and the finance indutry to artifically keep demand up by every increasing debt. There is almost no policy you can point to that Wall Steet didn’t approve of… especially since they now write most of the policy.

So basically you are only desribing a symptom yourself… you need to go further up the change of causality….. we are here because of stagnating wages, increasing inequality and decreased demand.

http://ablankspotonthemap.blogspot.com/2011/06/neoliberal-economy-in-nutshell.html

Slappy McFee July 14, 2011 at 4:59 pm

You’re gonna have to pick a horse to ride:

“Again, lead by Wall Street and the finance indutry to artifically keep demand up by every increasing debt.”

You can’t blame Wall Street for artificially keeping demand up while at the same time wishing Government would artificially keep demand up.

muirgeo July 14, 2011 at 5:33 pm

Wall Street lending out their billions and the government providing jobs building the new grid for example are not the same.

The government is giving Wall Street free money not to lend to us… it should insted invest in the grid. Then when Wall Street relizes the gig is up and they have to earn money other the old fashion way they will invest the billions they stole from the real economy.

Methinks1776 July 14, 2011 at 6:13 pm

Translation:

“I literally haven’t the faintest clue what I’m talking about or what Wall Street firms do. BUT! whatever it is, I hate them all because those people are much richer and smarter than I am. Plus, they get all the good looking chicks. Thanks for letting me vomit that up on this blog.”

Terc July 14, 2011 at 6:47 pm

Four legs good, two legs bad!

The Other Tim July 14, 2011 at 7:55 pm

Indeed. It’s hard to tell these wall-street humans and “infrastructure” pigs apart anymore. Why let bad monetary policy allow bankers to realize fortunes in rents when you can use bad fiscal policy to allow “green”-energy manufacturers to realize fortunes in rents? These are supposed to be our options?

Maybe, just maybe, we should stop using government to assign rents altogether.

Craig S July 14, 2011 at 6:02 pm

“we are here because of stagnating wages, increasing inequality ”

This is such nonsense, you might as well say we are here because we have not sacraficed enough virgins. If my wages increase 5% and your increase 100%, I am not worse off. Wealth is not a zero sum game.

muirgeo July 14, 2011 at 9:33 pm

What about if your wages don’t increase and you have no job while the wealthiest on top saw signifcant increaases in their wages and wealth.

They are doing great during this reccession and they apreciate your support and patronage and will knight you a member of their royal family.

You supporters of these extremes of wealth are supporters of concentrated power and nothing more. You really are pushing into the realm of fascism… no actually you really are there.

I don’t envy these peoples wealth. I pity their lack of humanity. Eventually they all grow old and die miseable lonely deaths with nothing but heaps of money and retradred sociopathic children. Sometimes they get sent to jail… I wouldn’t want to be these people for all the money in the world. The problem for you guys is you are incapable of understanding the majority of people who want more to feel good about what they contributed to society than how much money they made. For some of us living the Wall Street live would be a very poor existence.

Methinks1776 July 14, 2011 at 10:08 pm

Translation:

“Just in case anyone doubted my bloodthirsty hatred for people who are smarter and more successful than I, I am vomiting it up in detail to remove all doubt. I only wish we could have a communist revolution so I could sign up for the firing squad. Better yet, to be one of the torturers. Nothing would give me more pleasure than to torture the people I don’t understand but despise”.

Andy July 14, 2011 at 4:34 pm

Serious question: Since Krugman has said that the key Keynesian insight is that the possibility of an excess demand of money causing a recession, how does it differ fundamentally from a monetary disequilibrium theorist (and where does the latter fit in modern macro)?

Matt Young July 14, 2011 at 5:47 pm

I do not get how some psychological fad overwhelms us with a medium term desire to hold greater money balances. I mean, either we were shocked by some prior distortion in the economy, or we are subject to some mass marketing convincing us to save.

The former explanation means we do not suffer an aggregate demand. The later explanation simply baffles me.

Dr. T July 14, 2011 at 6:46 pm

There probably is an increased demand for money because people were frightened (appropriately) by the magnitude and duration of a recession that struck when mean personal non-retirement savings were extremely low and mean household indebtedness was high. Improvement in the mean savings-to-debt ratio is useful and appropriate, as is reduction in absurdly high housing prices (in some regions). It would be stupid for the federal government to try to increase consumer spending (and debt) or to shore-up declining house prices. Naturally, our government is attempting both.

rhhardin July 14, 2011 at 8:01 pm

Injecting money: in normal times, the Fed decides in its monthly meeting that more money supply is needed, and reduces the interest rate target a tiny amount.

The interest rate is of no importance in itself; it is, however, an output from the economy that measures the local demand for money versus the supply of money.

The Fed buys back debt until the interest rate drops to the new target, and then buys and sells to keep it there.

All they know is that the money supply is a little bigger now. The economy itself tells the open market trading desk what to do until the next Fed meeting, when the Fed looks again and decides whether to lower, keep, or raise the target for the next interval.

Normally, again, the Fed is looking at leading indicators of inflation in deciding this. The leading indicators that they use have to be orthogonal to the overnight interest rate, which is a place where they blind themselves by their intervention. But on the whole the method lets the economy talk back, and is minimally invasive in how the money is injected or withdrawn.

Nowadays the Fed is completely blind, and the interest rate target is useless. So nobody knows what’s going on, including the Fed.

juan carlos vera July 15, 2011 at 12:01 am

Clearly, more fiat money is not the cure. More fiat money is poison. The money comes from the fiat system is poisonous. Fiat money is a kind of sophisticated trick that thieves of government, and his friends, use to defraud other men. Unfortunately, men of good faith have fallen into the trap of believing that fiat money is good… Fortunately, the fiat money goes to the house of the dead…

Jim July 15, 2011 at 2:51 pm

I have two take-aways from this beautifully and I suspect lovingly written post.

First, injecting the huge and fundamentally altering variable of monetary policy into the complex system of an economy not only makes it more difficult to understand, but itself becomes a foundational part of the landscape to which the complex system must adapt. In the face of so much expert disagreement on monetary theory, are we so sure of ourselves, including the harmful aspects of monetarism, that we should make it a cornerstone of fiscal policy?

Second, dare I mention the moral aspect of all this theory? For if in an effort to ‘save’ the financial system, is there not at least the chance that we are impeding ‘recovery?’ Further, is there not a fantastic chance that we are injecting heroin to placate a sick patient, and that at the least we are burdening the poor across the world with higher prices? Who has the moral right to do that?

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