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Changing the price level changes relative prices and shifts resources -- which is Hayekian macro 101.

Bill writes:

"What is special about an excess demand for money and a matching "general glut" of goods, is that there is no need to shift resources. If the process that brings the market to equilibrium is a change in the price level so the real quantity of money adjust to the demand, then any decrease in quantities are just errors."

Greg:

My short answer, is not necessarily. Nothing about an excess demand for money requires a shift in the allocation of resources. (Unless we have a gold standard and there is a need to shift resources to gold mining.)

My long answer is that an excess demand for money never requires a decrease in the production of everything. Or, more specifically, a shift away from the production of consumer and capital goods and an expansion in the "production" of leisure. (I suppose idle capital goods might involve less depreciation cost and so allow for more future production too.)

I want to hold more money doesn't mean I want to take more time off from work. I want to hold more money so you all should take time off from work until I accumulate enough money so that I want you to start working again to produce things for me looks like a problem. Goods are scarce. Resources are scarce. Prices should coordinate in this situation, and the above isn't coordination.

To the degree that an increase in the demand for money is a shift away from the production of some particular things (which is likely,) then it is not expecially likely that those changes would be entirely reversed as either the real quantity or nominal quantity of money rises. But what _is_ almost certainly true is that the real demands for some other goods and services rise to offset the decrease in the real demands for the particular goods whose purchases are curtailed to allow for more money to be accumulated. (And leaving aside an increase in the demand for leisure or saving on depreciation, it is _certainly_ true.)

My view, and I take this to be the monetary disequilibrium view, is that an increase in nominal demand provides a clearer signal of an increase in real demand for those things whose demands in fact need to increase.

The alternative is that the nominal demand for some things falls more than the nominal demand for other things. The imputed nominal demands for resources fall. Those things whose demand fall relatively less become profitable first (or, with perfectly flexible prices, immediately become profitable) while those things whose demand fall more continue to lose money (or are the goods that result in losses with perfectly flexible prices.)

I have never claimed that the allocation of resources associated with an increase in the real quantity of money due to a lower price level are exactly the same as what would happen with an increase in the nominal quantity of money--particularly one generated by lending. I think they will be different. But it is a mistake to treat one as sustainable and the other as not.

If there is some process that tends to stabilize the price level in the long run, which includes a gold standard, then the price level falls enough below its long run level so that it expected future rate of increase (to return to that long run level) generates a real market interest rate sufficiently low for saving to equal investment. This could be negative. Or, if there is outside money, like in a gold standard, then the lower price level raises real wealth, which reduces saving, and raises the natural interest rate until it is equal to the market interest rate. A decrease in saving is an increase in consumption.

This is not inconsistent with some demands falling more than other demands and resource prices falling by more and profitability shifting. The "pigou" effect, which is a higher natural interest rate, says that there will be a consumption led recovery. The lower real interest rate through expected inflation (the price level falls below its long run level and is expected to return) can allow for an "investment" led recovery, where that includes consumer durables.

The notion that monetary disequilibrium theorists don't understand how the market returns to equilibrium with a fixed quantity of money and an excess demand for money is incredible.

To me, the "micro" people who talk about this seem so...ignorant. Here I really speak of free market, neoclassical, microeconomists. It is the same supply and demand tools, but it is like they speak as if the relative price of everything can fall relative to the relative price of everything else. Surpluses lower prices and the surpluses go away. Yes. But there is alot more to it. In the end, they end up with the new classical/real business cycle view that it must be that we just want more leisure. Take a break while we decide exactly what we want to produce. In other words, no scarcity. Which is counter to macro.

My only criticism of "Austrians" including those with whom I mostly agree, is that focusing too much on the thought experiment of an increase in the quantity of money given the demand for money, the supply of saving, the demand for investment and, so, the natural interest rate, is a mistake.

oops..

No scarcity is counter to basic micro.

Doesn't the supply and liquidity and price of of "shadow money" (near money assets) change dramatically during all of this -- and doesn't that shift resources?

Bill writes:

""What is special about an excess demand for money and a matching "general glut" of goods, is that there is no need to shift resources. If the process that brings the market to equilibrium is a change in the price level so the real quantity of money adjust to the demand, then any decrease in quantities are just errors."

Greg,

The yields on nonmonetary short term assets (which I think you are calling "shadow monies") can go either way. T-bill rates fell during this crisis. But when the Fed disinflated in the late seventies, T-bill rates rose.

I still think I see too much emphasis on one particular process--how an increase in the quantity of money, given the demand for money, the supply of saving, and the demand for investment, at first results in lower market interest rates and then, later, results in both a higher price level and a return of the market interest rate to its initial value. And then a bunch of reasons why this necessarily results in an unsustainable change in the allocation of resources. Well, maybe. But my point isn't to argue that such changes in the allocation of resources are insignificant, but rather that this scenario is just one possible one. Higher demand for money, more investment, less saving, smaller quantity of money... and all the different combinations. All the combinations that end up with excess demands for money result in general gluts of goods. Which goods have the worst gluts? What are the exceptions? Well, it depends.

As I explained in my previous post, I recognize that changes in the demand for money can be combined with shifts in the demands for various goods. But not necessarily.

Bill -- when my neighbors in Ladera Ranch, CA wanted more money, they did in some large measure by reducing there consumption of luxury goods, and by changing there time preferences for goods.

And they wanted more money in part because they were aware of market discoordination which also involved dramatically falling asset values (i.e. the value of their homes fell in 1/2, and their recent source of consumer cash via 2nd mortgages was killed).

The demand for money was directly tied to dramatically changing differential demand for goods.

But this example is just for reference.

I'd suggest that only actual magic could make this true:

Bill writes,

"My short answer, is not necessarily. Nothing about an excess demand for money requires a shift in the allocation of resources."

Greg, quoting me: ""general glut" means that the excess demands for all goods sum to a negative number. That entails no uniformity of excess demands at all. Some could be positive."

You: "This means that money reserves have increased relative to purchases and output streams -- and this is what people wanted, right?"

Well, no; and I find the interpretation rather mystifying.

Bill, in the recent boom / bust all sorts of highly liquid financial assets / securities ("shadow money") lost nearly all of their liquidity and in many cases nearly all of their value.

See this paper and related podcast from Sweeney, Lantz, et al:

http://hayekcenter.org/?p=2954

Ok, we're not doing barter economy economics. So the argument is that people and firms have changed preferences, and are preferring to hold some money which they previously exchanged for some particular goods or assets -- people must be actually doing this if this is their actual preference (revealed preference).

But George says they are not increasing their cash balances or cash reserves.

Is there some vicious process at work that makes this impossible? (e.g. a liquidity trap makes the acquisition of greater cash balances impossible?)

So were did I go off the road?

But let's go back to what George originally wrote:

"""general glut" means that the excess demands for all goods sum to a negative number. That entails no uniformity of excess demands at all. Some could be positive."

I assume I'm not getting what "positive excess demand" is, and I'm not getting what "negative excess demand" is.

So what are they?

Greg,

Suppose, given the current money supply, people wish to hold higher cash balances than they currently have. At that moment, we have excess demands for money - at the current price level people's demand for real money balances is in excess of the value of the real money balances available.

The only way they can satisfy that excess demand is to reduce their expenditures. As they do so, demand curves fall in some number of markets. Because prices don't adjust immediately, those markets will (for a period) have prices above market clearing, meaning there are excess supplies of those goods. If you restate "excess supplies" as "negative excess demand" then George's point becomes clearer.

When money is in excess demand, goods are in excess supply. Or, the same thing, when the excess demands for money are positive, the excess demands for goods are negative.

As people reduce their expenditures *in the aggregate*, it need not mean that they reduce their expenditures on *everything.* (The same is true of an increasing demand for money of course.) So saying that the sum of excess demands for money is positive and that the sum of excess demands for goods is negative need not mean that *every single* person has an excess demand for money or that *every single* good is in excess supply.

This is a statement about the sum of those excess demands/supplies.

Does that help clarify?

To the degree that the monetary system fails to respond to an increase in MD, there will be excess supplies of goods (and labor!).

Greg,

If the supply of money is fixed, then it is impossible for aggregate cash balances to increase, because people cannot hold more money than is supplied.

If the aggregate demand for cash balances increases, and the money supply is fixed, then it is impossible to satisfy that demand at the existing level of prices.

Steve, that puts things in clear terms, but I think I actually got all that -- what I can't accept is the picture Lee Kelly paints.

So the supply of money is fixed.

If I increase my cash balances by refusing to take a vacation to Las Vegas or Atlantis, I've increased by cash balances, and some casinos lost money, reducing their cash balances.

And etc. all through the economy.

The assumption to start with is that people and firms aren't buying goods in order to increase their cash balances or cash reserves.

An increase in the "aggregate demand" for cash balances doesn't matter -- the only thing that matters is demand that is revealed in actual trades on the market, which do changes cash balances for particular people, and shifts in resource "allocations" in particular places.

I'm wondering it this isn't the fulcrum on which Pete's objection pivots (the methodological individualism, actual actions in the market point).

Lee writes,

"If the aggregate demand for cash balances increases, and the money supply is fixed, then it is impossible to satisfy that demand at the existing level of prices."

So what?

So I have fewer cash balances than I'd like, and I continue to change my spending patterns. In the mean time I have an unmet demand for money -- this unmet demand for money would seem to have no causal effect on the world, other than the sort of changes already mentioned.

It looks like the question is, how is that adjustment process worse than the central bank or the central government attempting to freeze in place a conception of "healthy economic order in the economy" which made sense at some time in the past, but which people have discovered does not make sense -- creating their increased demand for money in the first place.

How do we evaluate that?

Greg:

How is accomodating an increase in the demand to hold money by an expansion in the quantity of money amount to freezing anything into place?

Why would you assume that an increase in the demand for money is necessarily in response to something that was discovered that does not make sense?

You do understand that accomodating an increase in the demand for money so that money expenditures remain on an unchanged growth path is perfectly consistent with reduced expenditures on housing, net debt repayment, and any number of other things. It just means that there is some other type of expenditures that expands to offset the decrease in expenditures on housing.

Greg,

As Bill states above, satisfying an excess demand for money with an increase in (nominal) supply will not 'freeze in place' relative prices. I expect more from you! This is the kind of aggregation fallacy that you often scold others for making.

All else being equal, satisfying an excess demand for money with an increase in (nominal) supply will stabilise nominal income/spending -- think of Hayek's nominal income stabilisation norm for monetary policy. The general level of prices can be expected to remain stable too. However, radical shifts in the composition of nominal income/spending, and sweeping changes in relative prices, may occur despite the aggregates and averages being unchanged.

Oops!

"All being equal" is in the wrong place. It belongs with the sentence about the price level.

"If the supply of money is fixed .. " -- that's a direct quote from Lee.

So I tried to play out Lee's thought experiment taking Lee's premise as one of the givens: "So the supply of money is fixed."

And I wasn't assuming a freeze in place of relative prices -- George and Bill were talking about backward looking measures of value, and resources which didn't shift"

"Nothing about an excess demand for money requires a shift in the allocation of resources .. " -- that's a direct quote from Bill.

"["general glut"] means merely that production is artificially constrained by lack of means of payment. Relaxing the constraint by expanding the nominal money stock serves, not to make goods drop like manna from heavan, but merely to allow them to be purchased at prices that cover historic costs .. " -- That's a direct quote from George.

I'm taking your starting premises and your account of is taking place and what central banks and government spending authorities are attempting to do, and I'm working through the causal logic.

Bill writes,

"How is accomodating an increase in the demand to hold money by an expansion in the quantity of money amount to freezing anything into place?"

Well, lets look at how that function in the real world -- the expansion of money typically goes first and most directly to financial institutions which had a moral hazard incentive to get in trouble, and who are now facing solvency problems.

The money does NOT go magically to were it best coordinates the economy, or exactly to those individuals with an excess demand of money in exactly those quantities which would bring that excess demand to an end.

And people are clearly, explicitly talking about attempting to make past production and investment and consumption plans continually viable into the future (e.g. Las Vegas casino construction projects, Wall Street investment assumptions, car production schedules, housing construction and mortgage solvency, etc.) rather than allowing them to adjust to reflect changing individual demands for cash balances and reserves.

All I meant was to gesture towards that. Like all words, the words "freeze into place" has multiple uses and shades of meaning. I meant the phrase in the sense of attempting to hold the shape of something that is moving and always becoming new.

The principle of charity, I think, would rule out any "absolutely no movement at all" reading of the remarks in context. If there was a misreading of my words, I correct it now.

Because that is what we repeatedly see in the real world -- as we did in 2007 and 2008.

"Why would you assume that an increase in the demand for money is necessarily in response to something that was discovered that does not make sense?"

I get this in theory. In the real world, the institutional structure and the knowledge problem barriers and the political economy realities do NOT put the money were it best coordinates the economy, or exactly to those individuals with an excess demand of money in exactly those quantities which would bring that excess demand to an end.

Actually, it usually puts it right back into the hands of those got the money expansion first the last time -- and to those with massive moral hazard incentives which created the crisis. A lot going back right into the same old pathological "growth path" economic players you identify below.

Bill writes,

"You do understand that accomodating an increase in the demand for money so that money expenditures remain on an unchanged growth path is perfectly consistent with reduced expenditures on housing, net debt repayment, and any number of other things. It just means that there is some other type of expenditures that expands to offset the decrease in expenditures on housing."

Of course, I didn't say this or assume it or imply it.

It's clear, however, that one of the goals of an increase in the money supply is some rough attempt to vindicate at least roughly some prior production, investment and consumption paths built on relations of relative prices -- at least compared to what these relations would be without the attempt to satisfy the "excess demand for money".

Lee writes,

"As Bill states above, satisfying an excess demand for money with an increase in (nominal) supply will not 'freeze in place' relative prices."

Steve, all due respect but I don't think you're really answering my question. BTW, I didn't say price stickiness is "the" case against 100% reserves, you'll see from my post I said "a" case; but surely you're not denying that price stickiness is a heavy weapon in the free bankers' arsenal? Also, I can't say I understand why you keep bringing up this point about an asymmetry between deflation and inflation?

I should say from your responses, it would seem here that there are fundamental points that the two sides can have honest disagreement over (e.g., claims about the "cost" of "idle" resources)? Some of the ayatollah-like fulminations I often see directed against Rothbardians are really out of line (not saying you do this, Steve, at least not nearly as much as others).

Gregg:

It is not at all correct that I think that the purpose of meeting inceased money demand with an increase in the nominal quantity of money, or alternatively, keeping money expenditures on a stable growth path, is aimed at vindicating past allocations of resources.

Monetary equilibrium and stable growth in money expenditures won't keep resources from moving to more highly valued uses. And I certainly don't favor keeping resources from shifting to higher valued uses.

Further, maintaining monetary equilibrium and stable growth in money expenditures doesn't protect banks and other financial intermediaries from faiure. And I don't support protecting banks and other finanical intermediaries from failure.

However, monetary disequilibrium will cause waste--less valuable leisure in place of fewer consumer and capital goods. And it could well cause the failure of finanical institutions as well. I favor neither consequence. They are both bad things.

I will grant that some of those who advocate quantitative easing or whatever really do want to avoid reallocation of resources and bail out financial insititutions. But not me. Never.

Greg,

You are correct, but I sense you are missing the important point. You wrote:

-----quote-----
It's clear, however, that one of the goals of an increase in the money supply is some rough attempt to vindicate at least roughly some prior production, investment and consumption paths built on relations of relative prices -- at least compared to what these relations would be without the attempt to satisfy the "excess demand for money".
-----quote-----

Suppose prior malinvestment is responsible for an excess demand for money (i.e. people desire to hold more money for liquidity and safety). The contention is whether the excess demand for money is part of the correction or just another discoordination. Rothbardians claim that an excess demand for money is a necessary part of the correction, and that attempts to satisfy it with an increase in the nominal supply of money only prolong malinvestment. Monetary equilibrium theorists claim that an excess demand for money is just another kind of discoordination -- the flip-side of an excess supply of money. While an excess demand for money is being resolved by deflation, it actually creates its own type of malinvestment -- typically called a 'general glut' or 'idle capacity'. In other words, an excess demand for money is no more a necessary part of the correction than malinvestment is a necessary part of correcting for an excess supply of money.

ABCT describes how an excess supply of money, created with credit expansion, can unsustainably distort the structure of production. In the short run there is a boom; business projects that would otherwise be unprofitable can survive for a while given the monetary expansion. But ultimately there are not enough real resources --prices begin to rise and slowly choke the malinvestment. A central bank may be able to sustain the artificial boom for a short time with more monetary expansion, but ultimately it is just delaying the day of reckoning. The eventual bust will be all the more painful because of these attempts to "stimulate", since the degree of malinvestment is being incrementally increased.

The argument being made by monetary equilibrium theorists is more or less just the same but the other way around. In short, business projects that would otherwise be profitable cannot survive in the short run given the excess demand for money. This is no less unsustainable malinvestment than in the case of an excess supply of money. Once the *real* money supply has increased by deflating prices, these business projects will become profitable once more and must be started anew.

Bill, we are on the same page here:

"monetary disequilibrium will cause waste--less valuable leisure in place of fewer consumer and capital goods. And it could well cause the failure of finanical institutions as well."

Bill, there is a differences between this ..

"maintaining monetary equilibrium and stable growth in money expenditures"

.. and an attempt 4 years after the fact to return to a prior monetary growth path that went "KAPOW" because there was a prior systematic monetary disequilibrium which created an unstable and unsustainable growth path, e.g. massive and systematic disequilibrium in the time structure of production, investment, savings, and consumption.

I understand the case for "maintaining monetary equilibrium and stable growth in money expenditures".

I even think I have some sense of the intuitions behind QE to prevent waste and get back to a regime which is "maintaining monetary equilibrium and stable growth in money expenditures".

What I'm trying to do is understand the role of an "excess demand for money" and a "general glut of goods" plays in all this -- and the causal pathways through which QE would solve these problems and create greater coordination and less waste than an alternative world without QE.

I'll emphasize again. I'm trying to understand these things.

I've already learned that -- in the coherent explication of the concept -- a "general glut" isn't general, and isn't principally about gluts.

I'm still trying to get a handle on the causal consequences in the real world of unmet "excess demand for money" by each person and each firm -- and interacting with each other and production processes and good and assets on hand. If it is unmet, then a trade has not been made to satisfy it -- yet trades of money for goods are being made every day. What's up with that?

Just one question of many.

Bill says,

"monetary disequilibrium will cause waste--less valuable leisure in place of fewer consumer and capital goods. And it could well cause the failure of finanical institutions as well. I favor neither consequence."

Right. And the problem here is that the deficiency of money causes prior plans to turn out bad (creating waste and unemployment) when a more stable supply of money would have allowed these plans to work out (profits to be made, goods to be sold, etc.)

In other words, it would allow plans to be vindicated.

You are playing word games with me again.

Greg,

I believe that houses were over produced in the past. More importantly, producing additional homes at the rate of 5 years ago would be over production.

What over production _means_ is that the resources devoted to those addtional homes have more valuable alternative uses.

If homes were produced at the rate of 5 years ago, homes would still be scarce. Each and every one of them would have some value and be better than nothing.

However, other goods that could be produced with the resources would be more valuable.

And so, to say that that producing still more new houses at the rate that they were produced 5 years ago would be a less valuable use of resources is to _mean_ that there are other goods that can be produced with the resources that are more valuable.

By far the best signal that more of those other goods should be produced now is for the nominal demands for those other goods to rise. People should spend more money for them. Less on the houses that are not appropriate, more on the other goods.

The notion that the purpose of maintaining monetary equilibrium is to maintain the level of production of homes at past levels is false.

If that is the lens through which you interpret everything your read, you will never understand.

Quite the contrary, the point is to provide a better environment for a shift in resources away from the production of additional homes to the most valuable alternative use of the resources.

The "argument" that an increase in the nominal quantity of money doesn't appear magically in the hands of those particular people who want to hold more money, so, I guess, they do the same thing as they were doing before is wrong headed.

Try thinking about how it all works out if there is no monetary disquilibrium. If at each step of the process you assume that the quantity of money and the demand for money stays the same. If that happens, there is no change in aggregate money expenditures. Money expenditures on some things increase, and money expenditures on other things decrease.

People don't want to buy houses because they overestimated their resale value, so they buy whatever was their next best choice.

I have explained in detail that an increase in the quantity of money that matches an increase in the demand to hold money has the same consequences as an increase in the demand for bonds--nonmonetary financial assets.

If poeple decide they don't want to buy houses because they were a bad investment, but rather than buy drill press machines, they instead buy bonds, the result is changes in market interest rates creating appropriate signals and incentives for people to sell bonds and buy consumer goods or else capital goods. Whatever they like best.

If the quantity of money rises, and it funds new loans, the exact same thing happens as if they purchased bonds. What is the problem?

If housing is discovered to be a bad investment, then people who invested in houses lose money. Banks that lent too much money to people who invested in houses lose money. It is even possible that poeple who put money into banks that lent too much to people that invested in houses lose money. None of this means that the quantity of bank money cannot remain equal to the demand to hold money, and rise to meet any increase in the demand to hold money.

To say that too much was invested
into houses means that something else was better. The demand for that something else needs to increase.

If the quantity of money remains constant and the demand for money rises, then a decrease in the price level raises the real quantity of money to meet the demand. How exactly does this return the market to equilibrium? The price level falls enough so expected increses to its long run level lower real interest rates? Or extra high real money balances lead to more consumption? What eactly happens?

With perfectly flexible prices, a higher demand for money and given quantity of money will reduce money expenditurs but leave real expenditures equal to the productive capacity of the economy. Any surplus of houses is matched by shortages of other goods. The excess demands for all the goods and services add up to zero.

If the quantity of money rises to match the increase in the demand for money, money expenditures are the same and real expenditures remain equal to the productive capacity of the economy. The excess demands for goods and services add up to zero.

In a sticky price world, an increase in the demand for money and a given quantity of money leads to lower money expenditures, lower real expenditures, and real expenditures less than the productive capacity of the economy. I think you want to argue that this must somehow be a good thing. We really need to cut output below the productive capacity of the economy because there were some kind of mistakes.

The surplus of houses is right, but the problem is there is not a matching shortage of whatever it is that is the best alternative use of the resources. The excess demands are not adding up to zero. It isn't less real expenditures on houses and more real expenditures on the next best alterative. It is less real expenditures on houses, and the increases on the next best alternatives are less.

With a sticky price world, then an increase in the quantity of money that matches an increase in the demand for money leaves money and real expenditures unchanged and equal to the productive capacity of the economy. This is the same result as what would happen in the flexible price world. There is less money and real expenditures on houses and more money and real expenditures on the next best options.

Will the exact pattern of resource allocation be the same--I don't think so. But there is nothing better or worse, or more sustainable or less sustainable in either case.

You continue to apply analysis of what happens with an increase in the quantity of money with a given money demand and a given supply of saving and demand for investment to a situation where the quantity of money, the demand to hold money, and the supply of saving and demand for investment are all changing.

The "villan" of the increased quantity of money that is creating all sorts of disequlibrium in the base scenario just doesn't have the same consequence when the demand for money, the supply of saving, and the demand for investment are all shifting too.

Always remember scarcity.

Right. And the question remains, will QE four years after the monetary disequilibrium event -- in the institutional environment we actually have -- will it actually go toward "those other goods" or will it go right back into the more relatively pathological paths?

And again, we are NOT talking about maintaining monetary equilibrium in the case at hand -- we are talking about what goes in a post- disequilibrium period, after we came to recognize that production/investment/consumption equilibrium and monetary equilibrium had not been maintained.

And a significant part of the "excess demand for money" problem comes because of the collapse of the value and liquidity of near money assets -- and because firms and households find out at the peak of the artificial boom that they cannot complete their plans without more borrowed cash than they had previously anticipated, and they can't sell their stuff at the prices they had anticipated, and they don't have the assets they thought they had to back additional borrowing.

So the people who have an "excess demand for money" are people with pathological plans that need to be adjusted -- and not easing credit and expanding money to satisfying there needs is part of the scarcity signal telling them to live within their means and within the coordination system and scarcity constraints of the rest of the economy.

Bill writes,

"By far the best signal that more of those other goods should be produced now is for the nominal demands for those other goods to rise. People should spend more money for them. Less on the houses that are not appropriate, more on the other goods.

The notion that the purpose of maintaining monetary equilibrium is to maintain the level of production of homes at past levels is false."

Bill, I don't believe in a given "productive capacity of the economy" regardless of the changing productive and consumption structure of the economy -- if resource uses and production process change, then some input goods loose there status as economic goods, and all of them change their value status.

Mile after mile of lumber rail cars are left rusting on railroad spurs, uncompleted houses are bulldozed, under construction casinos are left to rust uncompleted, etc.

Bill writes,

"With a sticky price world, then an increase in the quantity of money that matches an increase in the demand for money leaves money and real expenditures unchanged and equal to the productive capacity of the economy. This is the same result as what would happen in the flexible price world. There is less money and real expenditures on houses and more money and real expenditures on the next best options."

I have never claimed that the productive capacity of the economy is unchanging, or even that it is independent of changes in what people want to buy. In fact, I have written on the matter frequently.

I think the shift from housing to other goods has depressed the productive capacity of the economy, both as an implication of structural unemployment and the losses of specific capital goods.

If you read carefully, none of my arguments said that the productive capacity of the economy was unchanging.

With money expenditure targeting, changes in the productive capacity of the economy result in changes in the price level, and inflation or deflation as the price level shifts.

What you need to do is reflect why you thought that anything in my argument assumed constant productive capacity.

I think that the problem is that you are assuming that when the demand for houses falls and the demand for other goods rises, the productive capacity of the economy falls in proportion to the decresae in the demand for houses. This would only occur if all resources used to produce housing were specfic. If that were really true, then as long as additional houses have any value, then they should be produced. There is no opportunity cost to producing the houses.

However the reason to reduce the production of houses is to free up resources to produce other goods. Why not finish the houses? Because the resources that would be needed to finish the houses have better alternative uses. Why not finish the casinos? Because the resources that would be used to finish the casinos (or at least the buildings) have other better uses.

By the way, these are bad examples of malinvestment. The lumber rail cars are better. Saw mills, hammers, and the like, all are better examples of malinvestment. They are already built, but the complementary resources have better uses and they are abandoned.

But always.. always..there is something else needed. There are only surpluses of somethings because there are shortages of other things.

Anyway, if the productive capacity of the economy falls, this reduces real income. This reduces the real demand for money. If the quantity of money doesn't change, the result is an excess supply of money. The price level must rise until the real supply of money falls to meet the demand. If the real demand for money is proportional to real income, then the price level must rise in inverse proportion to the decrease in the productive capacity of the economy. Money expenditures and nominal income remain unchanged.

It is hard to see how this process could involve anything other than shortages at current prices. The effect of a decrease in productive capacity isn't surpluses, but rather shortages. Isn't it obvious? We can't produce as much, and so there will be shortages?

Price level targeting would require a decrease in the quantity of money when productive capacity falls. Money expenditures fall with real expenditures to match the decrease in productive capacity. No changes in the price level are necessary.

Money expenditure targeting has the same consequence as holding the quantity of money constant in the face of a decrease in productive capacity (well, this is only exactly true if the demand for money is strictly proportional to real income.)

There are constant changes in the composition of demand and the allocation of resources. There is unemployment of labor all the time. Capital goods are constantly becoming obsolete. This state of the world _is_ the productive capacity of the economy.

Singling out malinvestment due to a past excess supply of money is an error. Malinvestment is a normal part of the world of creative destruction.

Real expenditure equaling the productive capacity of the economy is a situation where the expanding industries and contracting industries are in balance. With secular growth--more population, improved technology, saving, investment and capital, the growing industries will grow more than the shrinking industries shrink--matching the growth in potential income.

The some things need to contract and nothing needs to expand is inconsistent with scarcity.

That structural unemployment and lost capital goods are worse than usual, is possible. The productive capacity of the economy is not growing at a constant rate. Sometimes faster, sometimes slower. Maybe it falls from time to time.

But real expenditure being equal to that changing productive capacity is shortages matching surpluses.

I think growing money expenditures on the things people like better than houses is the best signal that those industries need to expand. The result is higher prices, more nominal profits, and these signal produce more and hire more.

I don't think that reducing the quantity of money so that it remains balaned with the demand to hold money as the quantities of the goods in surplus shrink, while the capacity constrainted outputs of the goods in demand hardly rise. And then, as those goods that are capacity constrained can increase, so the capacity to produce those goods rise, the rising output and so rising money demand be matched by an increase in the quantity of money.

I don't think there is an automatic market process that causes the quantity of money or money demand to automatically shfit in this way.

Perhaps that is my error. People don't want to buy houses, so they hold money. The demand for money rises, and money expenditures fall. The productive capacity of those things people do want to buy are limited, and as resources shift and that capacity expands, people spend their money balances on these goods, and the demand for money falls, and money expendituers rise as the productive capacity recovers.

Greg:

Money and credit confused.

"So the people who have an "excess demand for money" are people with pathological plans that need to be adjusted -- and not easing credit and expanding money to satisfying there needs "

Wow.

You really think that an excess demand for money has anything to do with borrowing?

People borrow to spend, not hold money.

An excess demand for money doesn't mean that there are people who want to borrow money to spend and people don't want to lend it to them.

It is rather that people want to spend less and hold money. With bank money (and I think all money really) this is a kind of lending. An excess demand for money is that those wanting to hold money want to lend, which they do by spending less and accumulating money. If the quantity of money doesn't rise, then the money issuers don't borrow by issuing more money. Banks as financial intermediaries accumulate assets, which could be loans, but maybe already outstanding bonds.

So, an excess demand for money is, if anything, a desire to lend unmatched by a desire to borrow.

The people who increase their demand for money are generally people in a relatively strong finacial position. They are continuing to earn income and then don't spend.

This situation results in disruption in a variety of ways, and all of them mean the the shortage of money is corrected, but the result in interest rates on nonmonetary assets are too high, real income is too low, or, finally, the prices of goods and services adjust.

So, today, "who has the excess demand for money" is the wrong question to ask. The real economy has shrunk to the point where we are satisfied with the actual size of our money balanaces.

But the notion that the excess demand for money is somehow people who want to borrow and to whom no one will lend is.... wow.

Money and Credit confused.

I mostly agree with Bill here. Though I'm not as confident as he is that demand to hold money relates very closely to money income. I'm not sure that the flow equation MV=PQ is always closely proportional to rest equation MV=PT.

As Bill points out it's important here that the demand to hold money is what's relevant. The problem is not those who borrow in order to hold money (by which I mean money-in-the-broader-sense). If someone does that then, if we have a fixed stock of money, others must reduce their money holdings to facilitate that. In the situation with a fixed stock of money banking allows money to be circulated to even out local supply and demand issues, but it doesn't allow it to be created. But, without a variable stock of money banking cannot cope with an *overall net* raise in demand, an aggregate rise in demand.

In my view the recession now has less to do with capital structure and more to do with regime uncertainty. The Fed and the other central banks have proven themselves incompetent. The markets fear inflation or deflation in the future and are consequently sticking to very low risk stocks.

If we fear that strange local phenomena will cause malinvestments to be perpetuated then we should be very worried. Because, as Bill mentions malinvestments happen all the time, just not normally in huge clusters created by ABCT. So, we could have the situation where a malinvestment causes a money demand rise in place X and coincidentally in the rest of the economy demand for money is falling. That would threaten market coordination in normal times.

But, I don't think this happens. I wrote the following about that on the Cobden centre blog, I think it's relevant here ...

It’s simplest to discuss this by considering a non-progressing economy first. That is, an economy without productivity growth where the real price of goods and services remains the same.

It’s also simplest to describe relative changes first. Imagine a steady state where the demand for money across the economy is stable. It could be that one group, perhaps fishermen in the north increase their demand for money. Meanwhile, another group, perhaps farmers in the south decrease their demand to hold money by an equal amount. These demands could be met in several different ways.

Firstly, the change could occur “directly”. The farmers could spend their surpus money on goods and services. The fishermen could live more frugally on their earnings and spend less of them until they have the holding of money that they demand.

Consider a business selling goods and services to the northern fishermen, these could be consumer goods or producer goods. As they fishermen tighten their belts the profits of those businesses will fall. Similarly, the profits of businesses that supply those businesses will temporarily fall. Exactly the opposite will happen in the case of the southern farmer. As they spend their money prices will rise. Profits of those who supply them with goods and services will temporarily rise.

Secondly, rather than the change happening directly the finance industry can become involved. The southern farmers could save their money in savings accounts or shares. The northern fishermen could borrow money from banks. In practice a change like this would take place both directly and through the banking industry.

There is nothing harmful about these movements. The overall price level of consumer goods is unlikely to change. The prices of consumer goods bought by southern farmers may rise, but that of consumer goods bought by northern fishermen would similarly fall. The overall price of producer goods is similarly unlikely to change. Disturbances will occur, prices will take time to change, and then things will return back to normal. In both of these cases there may be some changes due to the different supply elasticities in the various markets, different price stickiness and whether each group decides to change their buying decisions in the consumer goods or producer goods markets, or both. (As a sidenote, it could be argued that those complicating factors have large effects. But, these sorts of relative change in money demand can’t be truly dangerous. They happen all the time as branches of industry wax and wane, and as geographical locations become more of less successful. If they did cause recessions then we would never be out of a recession, a market economy would be impossible.)

The accounts of the farmer, fishermen and those they trade with remain accurate. Since the consumer goods price level doesn’t change there is no falsification. It may be considered by some “unjust” that those who sell goods to the farmers see a temporary rise in profits, and those who sell goods to the fishermen a fall. But, it doesn’t mean that the accounts of either are affected. The profits and losses involved are, in that sense, real profits and losses.

Greg,

Suppose that you maintain cash balances of $100. If your cash balances fall below $100, then you exchange goods and services for money; and if your cash balances rise above $100, then you exchange money for goods and services.

One day you decide to increase your cash balances by $50. But suppose that everyone else decides to do the same thing.

With cash balances $50 less than desired, you begin trying to exchange goods and services for money until your cash balances reach $150. You begin trying to find someone who will exchange money for goods and services. However, everyone else is in the same predicament as you; they have $50 in cash balances less than desired. Everyone is trying to exchange goods and services for money, but nobody is trying to exchange money for goods and services. Therefore, it is impossible for you (and everyone else) to satisfy your (and their) greater demand for cash balances.

We're not talking about credit.

I have no easy answer as to when one stops advocating a return to the previous growth path of money expenditures and starts on a new growth path.

If I thought that current economic conditions showed that real expenditures were equal to potential income, with shortages matching surpluses, then returning to the old growth path would have little value.

I must admit that if unemployment were only modestly higher than the levels typical in the great moderation, and real output was on only a slightly lower growth path, I would take that as evidence that readjustment has been completed.

But when most firms still complain that their problem isn't inadquate capacity (as you seem to think the problem must be) but rather poor sales, I don't see a situations of shortages and surpluses matching.

Where are the sectors of the economy with strongly growing demand and capacity constraints? Do they even today come close matching those with excess capacity?

Why are job vacancies so low? They aren't zero, but they are low, not extra high?

Anyway, I think money expenditures are too low.

And I don't think three years is too long to propose a return to the previous growth path.

My own preference is to return to a new growth path with a base starting in 2008 and growing at 3%. In other words, I am willing to go for some opportunistic disinflation. But I still advocate substantial growth in money expenditures over the next year.

Wow, Bill. Of course my demand for cash balances is related to my ease of access to credit and my unanticipated need for it, and these are relates to the changing liquidity and value of my assets.

My wealth crashes, my income crashes, I can no longer use my equity as cash via credit, I can no longer depend on my income for cash. My demand for alternative sources of ready cash goes up, e.g. selling goods for cash.

That's just one scenerio.

Lee, people are making trades every day.

I don't see people actually making real tradeoffs in your Hume like scenerio.

And the elimination of heterogeneity also is troubling -- you are eliminating the factors motivating the existence of money.

Greg,

No one denies that one of the factors that might affect our willingness to hold money balances is our access to credit, but that's a red herring to the question of what is meant by an excess demand for money. It simply means our desired balances are greater than our actual ones, for whatever reason.

What the DEMAND is for is money balances to HOLD not credit with which to spend. That was Bill's quite correct point.

Greg:

I find your scenario implausible. Someone's wealth and income have collapsed, so they choose to accumulate more cash balances to fund all of their transactions because they cannot use credit.

Usually, individuals and firms that are in the process of going broke use up their money reserves.

It is those that would have lent to them that choose to hold more money instead.

In my view, the big increase in money demand wasn't because people lost their wealth in the stock market and they needed bigger cash balances because they could not longer get loans from their stocks, it was rather that they projected the sharp decreases in stocks from the previous month into the future, sold stocks, and held money and waited to see what would happen.

I will also grant that a smaller, initial problem was that people had been lending overnight to investment banks with the loans secured by mortgage backed securities. When they lost confidence in the investment banks, they quit lending to the investment banks and instead held money. What happens is that as the overnight loans were repaid, they held the money rather than lend it back overnight another time. The demand for money rose.

It wasn't that the investnment banks, going broke because they had to pay off all of the overnight loans somehow accumulated money.

But I really don't care. It doesn't matter why the demand to hold money rose. The quantity should rise and money expenditure maintained. Lower money expenditure, and depending on lower prices and wages to get real expenditure back up is a mistake.

This thread starts with a claim that no general gluts are possible because of Say's Law. For every surplus there must be a shortage.

The money equilibrium theorists point out that this requires that there be no shortage of money--that there is money equilibrium.

As long as monetary equilibrium is maintained, then every surplus is matched by a surplus. More spending on some things, less spending on other things. Too little spending on everything can't happen.

All of your talk of credit market problems look to me to be arguing that a general glut is possible and due to some kind of financial imbalances. Too much debt. Credit expanded too much and must shrink. Somehow, real expenditures must fall and that this is some kind of contraint on output.

No, this is inconsistent with Say's Law. For every borrwer there is a lender. For every lender who can't collect, there is a debtor who doesn't pay as much. For every debtor who must spend less to pay down debt, their is a creditor who can spend more out of the debt repayments.

Spending is low because of deleveraging is just the vulgar Keynesian paradox of thrift.

Sure, those who argue that real expeditures must be low now because of deleveraging will say that there was too much lending in the past. That may sound Hayekian too you, but it is not.

Too little spending must be an excess demand for money. The quantity of money can increase with total credit decreasing. Firms and households can pay down debt, money and real expenditures increase, and the quantity of money increase, all at the same time.

And, by the way, people can take losses on bad investments and some industries can shrink while real expenditure and real output are increasing too.

Thanks for your patience in going through this Bill.

Steve, I'm get what a demand for money is about, I have more trouble getting what an individual's unrealized "excess demand for money" is, and what its causal consequence in the world is.

I don't really buy your own definition "it means our desired balances are greater than our actual ones".

Economics focuses on actions and choices in action. People can tell us that "desire balances greater than there actual balances" but what matters for economics is not what people say they desire, but what they do. If they continue to spend money on goods, that "money demand desire" is a secondary one, and their revealed choices show that other preferences outrank this desire.

I can desire to have televisions greater in size than the televisions I now have, but if I make choices that show I desire other things more, what causal consequence does this "desire" have in the world? Not any.

On your definition I could have an "excess demand for large television sets" -- and I could still be making trades that do nothing to change this, just as those with an excess demand for money continue to trade cash for goods, rather than holding that cash and increasing their cash balances.

Greg,

At the equilibrium price for something the accepted supply equals the accepted demand. But, if the demand shifts and there is some stickiness then the price doesn't immediately adjust. Before the adjustment happens we have a situation of excess demand or excess supply.

Your criticism of an excess demand for money is destructive to basic economic principles.

If the price of apples are too low (below the market clearing level) the quantity demanded is greater than the quantity supplied. This is a shortage of apples or an excess demand for apples. Excess demand = shortage. Excess supply = surplus. Negative excess demand equals excess supply = surplus. Negative excess supply = excess demand = shortage.

A shortage of apples doesn't mean that no apples are are produced, sold, or consumed. The amount actually produced, sold, bought, and consumed is the quantity supplied. What do we mean there is a shortage of apples? What action do those potential apple buyers take? Well, I suppose they could go around looking for apples and find there are none. Or they could say, I would like to buy more apples.

Now, suppose that instead there is a surplus of apples. The price is too high, (above the market clearing level.) Quantity supplied is greater than quantity demanded. This doesn't mean that no apples are produced, sold, bought, and consumed. The amount is the quantity demanded. Now, we could imagine that extra apples are grown and accumulate at the shops. But it is also possible that the apple growers will reduce their production to match their sales. How do we know that there is a surplus? We could ask. But to say there is no surplus because there is just buying and selling going on seems.. wrongheaded.

With an excess demand for money, the analytical problems are more challenging. For example, if those short on money sell bonds and the yields on bonds rise, and the interest rates paid on money don't rise in proportion, then the opportunity cost of holding money rises. This reduces the demand to hold money conceivable to equal the quantity.

If reduced spending results in less production, and less real income, then the demand to hold money will fall, assuming money is a normal good. The demand to hold money may fall to equal the quantity of money.

However, interest rates have an inter-temporal coordinating role, and having them change to clear up a shortage of money interfers with that. Further, consumption and investment need to be adding up to full resource utilization.

Similarly, the point of economic activity is the production and consumption of goods. In a world of scarcity, reducing the production of goods so that the demand for money falls to match the quantity interferes with that core function.

The analytical problem is that if interest rates and/or output are disturbed so that the demand for money has adjusted to the existing quantity of money, then were is this excess demand for money?

It is that the amount of money people would want to hold if output was at the right level and interest rates were at the right level is less than the existing quantity.

It is a bit like looking at an industry with a price floor, and noting that firms produce no more than people are buying and asking what is the quantity supplied? It is the amount that firms would like to produce and sell to maximize profit at the floor price, and amount they don't produce becaues they cannot sell because of the price floor.

But with an excess demand for money, it is much more complicated.

too many typos.

With monetary equilibrium, surpluses match shortages, not surpluses match surpluses.

Intererst rates can conceivably result in the amount of money people choose to hold to adjust to the exising quantity. This is the liquidity effect and is really the basis for neo-Wisksellian macro. Monetary policy sets the intetest rate and they should be manipulated to stay at the correct level. The quantity of money and the demand for money are entirely subsumed into this interest rate effect. One key problem with is approach is that current income and expected future income impact the level of interest rates needed to provide inter-temporal coordination. But, of course, mainstream macroeconomists regularly ask with you, what excess demand for money?

Once output and income are depressed, and so poverty results in people reducing desired money balances to the existing quantity, then the question of who has an excess demand for money is a bit puzzling. I suppose that it is the unemployed workers who have an excess demand for money. If they were working, they would be earning income and spending most of it. But they would also be holding money balances. Given there current situation, then don't. They have been reducing their money balances, presumably to maintain consumption.

However, the purpose of raising the quantity of money to match the amount people would want to hold if real income and interest rates were at the proper levels is not to put money balances into the hands of those unemployed workers. Suppose Smith held a money balance of $200. Because he was laid off, he has reduced that to $50. Sending him $150 would not be the solution.

If lower interest rates on money or an increase in the nominal quantity of money are impossible, then the market process that corrects this is lower prices, including the prices of resources. As real balances expand, people may purchase securities, lowering nominal interest rates. This should result in more expenditures on capital and consumer goods. Because prices are lower, the money expenditures don't necessarily rise, and may even fall, but the real expenditures rise. If nominal interest rates cannot fall, then there is an overshooting possibility, where the price level gets low enough, so that it is expected to rise again to some kind of long run level (this would work with a gold standard,) and higher expected inflation reduces real interest rates even when nominal rates don't fall. Further, the higher real money balances respresent more real wealth (at least with base money in a gold standard.) This reduces saving and raises consumption spending. Again, because prices are lower, money spending on consumer goods might not rise, but real spending rises.

With this increase in spending, firms sell more, and hire more people. Output and employment recover. In equilibrium, real money balances have risen to match the demand. (With the overshooting case, there are excess money balances at the low price level, and the price level must rise again to its long run level. Yikes!

Anyway, the new money balances don't just appear in the hands of unemployed workers. They get hired and work and spend and accumulate balances. It was rather than the lower prices resulted in increases in the real money balances of those with them, most of whom were happy with their balances before, and so they now spend them on assets and goods and services. That excess supply (given the depressed level of output) is what generates the real recovery.

If we think of the status quo, and we consider an increase in the nominal quantity of money, it will create an excess supply of money given the the current depressed level of real income. Thsi will be spent, raising the demand for capital and consumer goods. Output rises, raising the demand for money. What was an excess supply of money at the depressed level of output is not at the higher, right level of income.

Will the composition of demand and the allocation of resources be exactly the same if the process is a lower price level or else a higher quantity of money (or lower interest rates on money?) Probably not, but it is not at all obvious that there is anything wrong or unsustainable with the higher nominal quantity of money approach.

As Bill said Greg, if you don't buy the excess demand concept, you throw Econ 100 out the window. No matter, pretty much, how Austrian one is, I think we still need the concept of demand and supply as quantities demanded or supplied at various prices.

Recognition of the distinction between demand for money balances to hold as part of one's wealth portfolio and mere demand for "stuff in general" where the latter manifests itself in willingness to trade, say, labor for money, or a promise of a larger sum of money in the future for a smaller sum today, always with the intent of trading most or all of the money balances so acquired for other goods, is perhaps THE key requirement for "doing" monetary economics properly. For anyone to whom the distinction in question remains vague, I highly recommend the classic article by Edwin Cannan, "The Application of the Theoretical Apparatus of Supply and demand to Units of Currency," available at EconLib.

Thanks for the reference, George. I'll read it.

Steve, I understand a "pent-up" demand for apples, when there is a shortage of apples -- people are ready in the future to spend more for apples, and more apples are going to be produced.

This is what the "excess demand" language is about, I take it.

I'm not throwing out "excess supply" and "excess demand" talk about reproducible, non-permanent goods exchanged for money.

But with money, if I am trading away my money for goods right now, how can we say that I have a "pent up" demand for money? I've just shown I demand other things more than the money.

And what is the significance of saying that people ready in the future to spend more (in non-money goods) for money -- and what of the fact that we can't say that more money is going to be produced in the future as a result of "excess demand".

The analogy with apples does not go through.

Let me re-say that:

What is the significance of saying that people are ready in the future to spend more in goods for money?

And what of the fact that we can't say that more money is going to be produced in the future as a profit making response to "excess demand"?

Without these analogies present, how does the language of "excess demand" possibly do the same work applied to phenomena of a very different order.

The starting premise in this conversation is that supply and demand applies to money, but it does not work the same there.

That's the beginning premise shared by everyone.

The question is -- how does it not work the same?

So you are coming close to simply begging the question, Steve.

Or, alternatively, what does it mean saying that people are ready in the future to trade less money for goods, as compared to their behavior now -- and what effects does this have on the world?

Gregg:

I don't think shortages of apples are usefully thought of as "pent up demand" that will generate future purchases of apples.

It is a plan mismatch. What the buyers and sellers want to do are not coordinated at current prices.

What the buyers are usually expected to do is offer higher prices so that they obtain the apples rather than some other buyer--or perhaps to illicit a higher quantity supplied from sellers.

However, for most markets, the emphasis is that sellers are leaving money on the table, they could sell all they are now at higher prices.

The prices that create the mismatch in plans also leave incentives to change the prices.

I don't see "pent up demand" as part of the story.

In an earlier post you discussed an "excess demand" for TVs and wrote as if someone said they wanted a big screen TV and instead bought other things because those were priorities. That was a bit of an eye opener, and led to the discussions of what an excess demand is. However, when you say "pent up demand," it seems as if you are still thinking about the big screen TV's that poeple are buying.

An excess demand for money is a plan mismatch. Those creating money, like banks or the goverment, would like to create some. Those who want to hold money, would like to hold some. They are added up, and if the amount the issuers want to issue is less than the amount the holders want to hold, there is a plan mismatch.

Those issuing money are leaving money on the table, and they could lower the yields they pay, perhaps to negative levels, charging people to hold money. It is not at all clear how those who want to hold money would offer to accept lower yields to get the money.

Leaving aside the yield adjustment, (which is often ignored with yields assumed to be zero and money taken to be hand-to-hand currency) then the offer process would be for those selling goods to offer lower prices on them so that they can get the money. This raises the "price" or purchasing power of money. It is a lower price level.

I suppose that the "leaving money on the table" story would be that those with money would offer only lower prices of goods. Go to merchants selling goods and say, "I will buy at a price at 2% lower."

However, none of these activities can take place in a special "supply and demand more money market," but rather take place simultaneously in the markets for the flow of output and expenditure. Most of those selling goods don't do so because they want to hold more money, but rather because they want to obtain money to spend on other goods.

The shortage of money actually shows up as a general glut. There are surpluses of all other goods. Those whose sales are frustrated don't necessarily want to hold more money, but rather want to obtain money to spend on other goods. This is disrupted.

The process of offering lower prices to get the money really isn't about "buying" money balances, but rather about frustrated sellers of goods undercutting each other to obtain sales, to get money, to mostly buy other things.

Anyway, I can repeat basic monetary economics, over and over in various ways, but to understand a shortage of anything as a "pent up demand" seems odd. To speak of shortages of goods as if they are something people say they want to buy but they instead buy other things more important is really odd.

An excess demand for money doesn't mean that no one buys anything. And excess demand for apples doesn't mean that no one sells apples.

With an excess demand for apples, actual apple sales and purchases are limited by the quantity of apples supplied.

With an excess demand for money, actual money holdings are limited by the quantity of money supplied.

The matching imbalance, the excess supplies of various goods, could involve unplanned inventory investment--goods produced and not sold, but generally, the quantities of the various goods will actually equal the quantities demanded, and the surplus means that the sellers want to sell more.

Money is special because a shortage of money shows up as a surplus of other things rather than buyers showing up to the money producers, and some buyers being turned away because the amount of money that was produced was too small. The money producers don't see those who want to hold money turned away, and so don't see the money on the table they could get by lowering the yields for money. Leaving aside the nominal yield, there is no price of money for money speculators to adjust. There are just the money prices of all the other goods.

With monetary equilibrium, shortages and surpluses match. People buy less on one thing and more some something else. Firms sell less of those things people want less of, and more of those things people want more of. Firms produce less of the things people want less of, and more of the things people want more of. Firms reducing hiring and perhaps lay off workers who were producing things people want less off. They don't lay off workers and expand new hires for people to produce the things people want more of. This is how labor and other resources shift to reflect what people want to buy most.

With a shortage of money, too many firms, and possibly every single firm, can get the signal, people buy less, which means that they should reduce production and lay off workers to free up resources to produce something else. With monetary equilibrium, there would be other firms with higher demands who do need the resources.

But with monetary disequilibrium, a shortage, there are no such firms. The signal is wrong. What needs to happen is that everyone just lower prices and wages, clearing up the surpluses and increasing the real quantity of money to match the demand, returning to monetary equilbrium.

The notion that there is no excess demand for money, or that it must involve some kind of pent up demand for money, or that they say they want money but the really want other things... is weird.

The problem is that prices aren't perfectly flexible so that there isn't an instant move to this new monetary equilibrium. We instead go through this extended period where production and employment are limited to quantities demanded and in respose to frustrated sales, firms undercut one another and take the money left on the table by workers wanting jobs by cutting their pay. While there are some perverse effects of falling prices and wages, the lower price level and lower wage level clears up the surpluses of products and labor at the same time they clear up the shortage of money.

Money is a stock, and the various goods and services are flows, which is a bit of a complication. But other than that, the use of shortage (which is the same as excess demand) for money is straightforward.

Thanks Bill. It's time for me to think about this, read the Cannan piece recommended by Selgin, and perhaps go back to Heyne's 101 discussion of supply and demand, linked to human choice and marginalist analysis.

Economists use the words "supply" and "demand" in at least 2 different senses, sometimes more. It can be tricky keeping them straight. Sometimes economists don't even recognize their own puns.


Bill, this was your "apples" story earlier:

"If the price of apples are too low (below the market clearing level) the quantity demanded is greater than the quantity supplied. This is a shortage of apples or an excess demand for apples. Excess demand = shortage. Excess supply = surplus. Negative excess demand equals excess supply = surplus. Negative excess supply = excess demand = shortage."

A shortage of apples doesn't mean that no apples are are produced, sold, or consumed. The amount actually produced, sold, bought, and consumed is the quantity supplied. What do we mean there is a shortage of apples? What action do those potential apple buyers take? Well, I suppose they could go around looking for apples and find there are none. Or they could say, I would like to buy more apples.

Now, suppose that instead there is a surplus of apples. The price is too high, (above the market clearing level.) Quantity supplied is greater than quantity demanded. This doesn't mean that no apples are produced, sold, bought, and consumed. The amount is the quantity demanded. Now, we could imagine that extra apples are grown and accumulate at the shops. But it is also possible that the apple growers will reduce their production to match their sales. How do we know that there is a surplus? We could ask. But to say there is no surplus because there is just buying and selling going on seems.. wrongheaded."

Bill, I still go back to this.

If there is a shortage of apples among sellers, and an "excess demand" for apples among buyers, we understand this by thinking about what would take place in an hypothetical world where things were different, e.g. prices changed, production output changed, people learned the correct market clearing price, etc.

It is this comparison of two different worlds which gives meaning to the language.

But what also gives meaning to it is what people can do and can't do in the original scenario -- some people can't get apples they would willingly trade for.

Now, in the money case, you exploit general equilibrium and disequilibrium to cash out the alternative world.

But you also assume the "can't get the stuff I'd willingly pay for" conditions are the same between apples and cash holdings.

This is the place where I am stuck. In a case of "excess demand" I can't make the trade for apples I'd like because the apples aren't there -- they were priced to low and were sold out, and they weren't produced because the grower underestimated future demand (another alternative world cash out of the meaning of our language).

But in the case of money, I'm always able to make the trade-off between cash balances and purchases -- I can refrain from buying stuff, I can sell more of my stuff.

Help me understand the trade _right now_ that I can't make to satisfy my demand for cash balances.

What is it I would be willing to trade away that I can't get that puts me in the position of one of those people who are part of the "excess demand" for apples, in this situation where the demand is for cash balances, not apples.

This still hasn't been made clear to me -- or what mistake I'm making in asking the question.

Firm A, B, and C each want to sell 10 apples for a total of 30. Household D, E, and F each want to buy 12 apples for a total of 36. Household D and E purchase 12 each, for 24. That leaves 6, and slowpoke household F only gets 6 apples.

Household D and E have all the apples they want to buy. Firm A, B, and C have each sold 10.

Still, there was an excess demand. But only poor household F purchases fewer apples than they would like.

By the way, the other state of the world is perfectly understood. If the firms had produced a total of 36, then the households would have purchased 36 altogether. That is what quantity demanded means.

So, people short on money reduce expenditures or sell assets to obtain money. They adjust their actual money holdings to their desired holdings. If the quantity of money is given, they cannot all get more money in this fashion.

But we have seen, household D and E purchased all the apples they wanted, but there was still a shortage of apples because household F only got 6 when household F was wanted to buy 6.

So, the fact that lots of people can actually obtain more money balances doesn't mean there is no excess demand on the market. If there is someone left short, then there is an excess demand.

Generally, what happens is that firms with falling sales and losses or unemployed workers reduce their money holdings to try to maintain expenditures. So, not only do they have low incomes and expenditures, they also have lower money balances.

Some people do hold more money. Other people hold less money. The amount of money actually held is equal to the quantity.

It is possible that it could work out that no one holds more money, however. Everyone's business loses money. They all produce less. They are all poorer, They all reduce their desired money holdings.

This would be like household D, E, and F each buying only 10 apples, and each is short 2.

So the shortage of money results in less production and income, and given this depressed income, people are so poor they are satisfied with the existing quantity of money. In what sense is there a shortage? Well, if real income was at the level is should be, then the amount of money poeple would want to hold is greater than the quantity that exists.


In the apples case, household F has potentially actualized demand that isn't realized in a trade, although, ceteris paribus, there was potential for gains from trade of an exchange between F and the suppliers.

We think about the market in a way where the market will adjust and suppliers will meet the demand in the future and household F will figure out how to actualize it's demand in a trade.

Parallel case:

In the money cases, firm F has potentially actualized demand for greater cash balances that are not realized in trades of goods for money, or money that is withheld from exchange for goods not purchased, or in money that is lent to firm F in an obligation that could have been paid off.

We think about the market in a way where the market will not adjust, and the suppliers of money will not meet the demand for cash balances in the future, and household F will not figure out how to actualize it's demand for cash balances by restricting its purchases of goods for money, or in selling goods for money, etc.

OK.

The case I was considering was the case were firm F could not figure out not to actualize it's demand for cash balances by restricting its purchases of good for money -- i.e. I asked, why doesn't it do this? If it has the demand, it will reveal its preference by refraining from exchanging the cash it would prefer to the goods it would otherwise trade away its cash to have.

But I think I see potential alternative scenarios -- firm F simply goes bankrupt and cannot survive even if it stops trading cash balances for goods.

What other alternatives make any sense? Are there any?

Or, if I went off track, where did I go wrong?

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