• Monetarists misunderstanding their own argument

    Here’s Andy Harless in the comment section of this post trying to preach Milton’s gospel:

    There is absolutely an excess demand for base money, as evidenced by the many people who are eager to purchase base money with labor and are unable to do so at the current price.

    Now you are going to say that this is not an excess demand for base money, because these people would just as willingly purchase bank deposits, or bonds, or perhaps even stock, with their labor. But this is beside the point. Yes, there is an excess demand for other assets as well. But that doesn’t change the fact that there is an excess demand for base money. In fact, since bank deposits and high quality bonds trade freely against base money in liquid markets, there could not be an excess demand for base money if there were not also an excess demand for these other assets.

    Andy’s not off to a good start here.  Even in the standard monetarist story it’s not the unemployed who have the excess demand for money, it’s the people who would buy the output of their labour but don’t because they prefer to increase their money holdings. 

    Andy was actually doing a bit better on the previous post where he says:

    The whole point of “excess demand” is that prices are not changing in such a way as to equalize supply and demand. If the price of money fell sufficiently, the excess demand would disappear. Prices as such tell you nothing about whether there is excess demand or excess supply. The point is that the quantity of money demanded is greater than the quantity supplied.

    You’re apparently assuming that there is some incomplete equlibrating mechanism in place that will lead excess demand to be correlated with a rising price (of money, that is, which means a falling price of goods relative to money). The problem is that the equilibrating mechanism is not working.

    This is closer to a coherent story, the idea being that money is in excess demand and the corresponding excess supply is of labour.  Sticky prices/wages are why prices are failing to adjust to clear the markets. 

    Andy also says:

    If it could somehow be decreed that all prices and wages must drop by a certain (sufficiently large) percentage, then the output gap would be eliminated.

    So basically Andy’s story is that safe assets, of which money is one, are in excess demand, prices aren’t falling to clear markets and this leaves labour in excess supply.  Even if we ignore the problem of whether an excess demand for fruit is the same as an excess demand for oranges, casual observation shows that Andy’s story doesn’t even have a toehold on reality.

    Now, something’s price may not tell you if it is in excess demand or not but the rate of change of its price most certainly can.   And if that price is stickyWell, if that price falls then you can certainly say that the thing in question is not in excess demand.

    The heart of the problem seems to be confusion between something being in high demand and something being in excess demand.  The value of risky assets are below their peak, so we can agree that the demand for safety is higher than it was.  The supply of money has increased a lot without causing very much inflation so we can agree the demand for money is higher than it was.  However, the value of risky assets are rising, not falling.  The price level is rising, not stuck at a level or falling too slowly.  So, in what economic theory does the value of something that is in excess demand actually fall

    Adam Purzitsky
    Adam Purzitsky
    Senior Quantitative Portfolio Manager, Co-Fund Manager
    Jul 3, 2011 at 3:24pm

4 Comments in total
  • Being an undergrad, I feel a bit uncomfortable posting this, but I'll make three quick notes.

    FIrst, I don't understand the focus on "base money." Leland Yeager always said that a shortfall of aggregate demand is defined as an excess demand for the "medium of exchange," whatever it happens to be. Why not include M1, M2, and M3. Beckworth and Hendrickson, for example, prefer MZM as the best measurement of money.

    Second, concerning you're last two sentences, are you coming from the position that you cannot have inflation until you've hit full output/employment? Sumner has specifically stated that you can be below full output and still have inflation. He used the 30s as an example. You can be in a state of excess demand for money and have inflation at the same time. It is totally consistent.

    We can think of it in terms of a stock or flow. The current demand for money is greater than the existing stock. That is the way your question frames it. But as we speak, is the demand decreasing or increasing? That is what is crucial. Starting in the middle of summer 2008 the demand increased and we had falling prices/output as people cut spending. At present, people are decreasing how much of the cash in their pocket they want to keep by a little bit, and as people spend their money prices/output rise. That is why prices have gone up a little bit.

    I recommend Leland Yeager's "The Monetary Veil: Essays in Monetary Disequilibrium." It is the bible of such ideas.

    Wonderful blog. Best wishes!

    Posted by: JoeMac
    Jul 7, 2011 at 3:24 am

  • I just though about it, and perhaps an image works better.

    You have M and Md. The goal is to make them equal. When they are equal you have no AD shortfall and are at full output/employment. The question is, where are they moving in relation to each other?

    If M is moving above Md then you will observe increasing output (temporarily) and prices. If M moves below Md you will observe falling output and prices.

    If Md is moving below M then you observe increasing output (temporarily) and prices. If Md is moving above Md then you will observe decreasing output and prices.

    It should not be thought of in terms of "Are we or are we not in a situation of excess demand for money." Instead, the question to be asked is "In what direction are M and Md moving in relation to the other."

    However, I am total amateur. People with PHDs can better answer explain than me.

    Posted by: JoeMac
    Jul 7, 2011 at 3:37 am

  • Joe,

    on this: "Second, concerning you're last two sentences, are you coming from the position that you cannot have inflation until you've hit full output/employment? Sumner has specifically stated that you can be below full output and still have inflation."

    No, most certainly not. I absolutely agree you can, and usually do, have inflation even when below full employment.

    My claim is that you can't have inflation if money is in excess demand.

    Posted by: Adam P
    Jul 7, 2011 at 12:33 pm

  • "Now, something's price may not tell you if it is in excess demand or not but the rate of change of its price most certainly can."

    Only if you have the sort of negative feedback that exists in well-functioning markets. And only if that feedback applies to levels rather than rates of change. Again, you're assuming (as we ordinarily do) that an equilibrating mechanism, and a very specific type of equilibrating mechanism, exists. When the auctioneer calls out a price and finds that demand exceeds supply, then what does he do? In your world, he necessarily either calls out a higher price or at the very least, calls out the same price. In my world, no matter what the auctioneer hears about supply and demand, he calls out a price that's approximately 2% lower, adjusted to slightly more than 2% if demand exceeds supply and slightly less if supply exceeds demand. The auctioneer has been seeing supply increase by 2% regularly, and he's gotten set in his ways: he has always had to call out a price that was 2% lower, and generally things have worked out OK, so he keeps doing that, even when it doesn't have the right effect.

    By your argument, we would have to say that, because wages are going up, there is no excess supply of labor. (To alter your words slightly, "In what economic theory does the value of something that is in excess [supply] actually [rise]?" Is there any reason that your argument should not be symmetrical?) If you want to take that position when the US unemployment rate is close to the highest it has been in 29 years, OK, but I think the Keynesians are going to demand that you return your membership card.

    For the record, I don't necessarily claim to be telling "the standard monetarist story."

    Posted by: Andy Harless
    Jul 7, 2011 at 3:52 pm

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