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 sticky? Well, 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?
Senior Quantitative Portfolio Manager, Co-Fund Manager
Jul 3, 2011 at 3:24pm