I Saw a Monetarist Drinking a Pina Colada…: Thursday Focus: April 17, 2014

…at Trader Vic’s: and his hair was perfect!

Nick Rowe writes:

Nick Rowe: Mackerels and Money: “Arnold Kling asks….

…Why should the M in MV=PY stand for money, and not mackerels? Why can’t an excess demand for mackerel cause a recession? Why can’t an excess supply of other goods be matched by an excess demand for mackerel? Keynesians don’t know the answer to this question either…. There is one exception to what I say about Keynesians, but it’s an exception that proves the rule. Like a full moon to a werewolf, the mention of Say’s Law turns Brad DeLong into a monetarist; he starts talking about velocity, and quoting Hume, Fisher, and Friedman…

Well, I can think of two responses. First, response 1: http://youtu.be/AbmS5Pq6e7A

Second, response 2:

It seems to me that there are three largely-orthogonal analytical issues here.

1. “Say’s Law” itself: If an economy starts at full employment with total planed expenditure equal to projected income, is it likely that economic shocks might well then send planned expenditure below full-employment projected income, thus creating a “general glut” of currently-produced commodities?

2. MV = PV: Is the monetarist equation of exchange MV = PV, the money stock times the annual or quarterly velocity of money equals the price level times the level of annual or quarterly production, the best way to conceptualize thinking about what the short run level of production, income, and employment will be in the aftermath of the creation of such a “general glut”?

3. Modelling the structure of exchange: Is the Walrasian atonement excess-demand function framework, with counterfactual excess demands and supplies of the n+1 commodities available for sale and purchase at this specific moment, the best way or even an adequate way to think about the creation of a “general glut”–with liquid cash money simply being one of the n+1 commodities, albeit a somewhat special one?

I would say that on (2) I have definitely changed my mind. Back in 2007 I would’ve characterized myself as mostly a monetarist–75% or so. (The other 25%, I would have said, was something like 15% Keynesian, 5% Minskyite, and 5% Austrian). I believed, that is, that unless financial regulation with badly awry and unless the inflation target was disastrously low the monetarism of Fisher and Friedman was likely to be an adequate rough guide to the economic policy situations we were likely to see in the next decade or two, but that Keynesian, Minskyite, and Austrian considerations have been important at times in the past and might become important again in the distant future. But, clearly, reality disagreed with me. And to attempt to understand the past decade through the equation of exchange MV equals PY is to throw everything interesting into V, where it is then stuck in a black box that Fisher-Friedman monetarism has little useful in the way of tools to analyze. (By contrast, both Keynesian and Minskyite perspectives bring an awful lot of what is going on that is analytically interesting into the foreground, and focus on it.)

I would say that on (1) John Stuart Mill, Fisher, and Friedman did indeed nail the issue to the floor. A “general glut” of currently-produced goods and services does indeed arise when the shifting pattern of demands does produce a substantial excess demand for “money”, the flip side of which is a substantial excess supply for nearly all currently-produced goods and services (including, most importantly, labor services). But for the working-out of the consequence of that general glut–well, then we must resort to Keynes and Minsky. But for why it arises, the olde monetarist religion is still the best–provided that you recognize that “money” can have a shifting meaning. The key is that “money” in this context is a class of financial assets that the private market system cannot easily generate substantially more of quickly. At times it may be best to identify “money” with liquid cash assets that shopkeepers and workers will accept as generalized purchasing power, but at times “money” may be better thought of as financial savings vehicles for moving purchasing power from the present into the future, and at times “money” may be better thought of as safe liquid nominal assets of known and trusted collateral value.

And as for (3), I would like to be on a planet in which we would all agree that we can do better thinking along Clower and Leijonhufvud lines than along Walrasian tatonnement lines. But, as Buzz Lightyear said: “We’re not on that planet, are we?” Walrasian tatonnement cuts the Gordian knot well enough so that we can then proceed, even though it leads people like Nick Rowe (and David Glasner) to whimper at the analytical violence it commits against Truth-with-a-capital-T.