[As Krugman would say, wonks only.]
So the recent post I did defending Tobin led to a comment section discussion with Nick Rowe, George Selgin, Saturos, etc., which eventually ended up on this knotty problem of what is “money.” Is it all about the medium of account, or the medium of exchange? They are almost always the same, so it’s hard to find good real world examples. And it’s even hard to construct thought experiments, as if you separate them, or drop one entirely, it’s hard to know what auxiliary assumptions to make. I’ll try to show this with four examples, three of which support my view, and two of which support Nick’s (one is consistent with both.) I’ll let the comment section sort it out:
1. I’ll start with a sticky wage model (which I prefer), but don’t worry the other examples will all be sticky prices. We have a tropical country called “Barteria”, where the workers produce fruits and coconuts on large plantations. They are paid in what they produce, and barter these goods for other fruits, so they can have a diverse diet. However their wages are denominated in coconuts, and are “sticky” in coconut terms. But they aren’t paid in coconuts! Thus suppose they were all paid a wage equivalent to one coconut per hour, and their productivity is 1.2 fruit per hour. To make the math easy, assume the market price of all types fruit is initially equal to one fruit per coconut. Thus initially the equilibrium allows the owners to earn 0.2 fruit/worker/hour in profit, and everyone has a job. Their contract specifies they be paid 8 coconuts worth of fruit per 8 hour day, which at initial prices means 8 fruit for an 8 hour day, and they trade fruit with each other in flexible price markets.
Then a coconut blight kills many of the coconuts, so coconut worker productivity falls in half. The price of coconuts in terms of other fruits soars, and yet workers continue to insist on being paid (the equivalent of) one coconut per hour. So if the price of bananas fell to 1/4 coconut, the workers would insist on being paid 4 bananas, so that they would be earning the one coconut that their contract specified. Unemployment results, as they are just not that productive. (Although liberals would accuse me of blaming the victim.)
Think my example is far-fetched? Think the workers would be happy getting their usual one fruit per hour? Think again. In 1930 the workers of the major industrial countries were paid in gold. Not gold itself, rather their wages were denominated in terms of so much gold per hour, paid in some other medium. Then in 1930 global gold hoarding caused the value of gold to soar. The price of the commodities that workers buy fell in terms of gold. You might think workers would say to their boss; “We understand that gold has become more valuable, and thus we don’t need as much to buy our usual purchases, so you can pay us an amount of MOE that buys less gold, as long as we can buy our usual goods.” But the workers did not say that. Why not? What’s the title of this blog? They said “We insist on being paid in gold, even though there isn’t enough gold in the world for full employment. We don’t care that our gold wages will now buy more goods and services, we demand payment in gold.” And keep in mind that many workers never owned a gold coin in their life. They were poor. Yet it remained a token with mystical powers to the workers, a sort of barbarous relic. The workers crucified the owners on a cross of gold. (Wow, I’m inventing some great metaphors phrases today!)
BTW, America’s labor leaders opposed FDR’s devaluation.
In this coconut example there is no medium of exchange. It’s a barter economy. But there is a medium of account. And changes in the value of the MOA cause business cycles.
2. Now for a sticky price version. We will assume that prices are sticky in terms of coconuts, but coconuts are not the MOE. Goods are bartered. Once again, we assume a coconut market shock that makes coconuts worth more. What happens? I seem to recall Nick arguing that nothing happens, people continue to barter as before. There may be a problem in the coconut market, but no generalized problem of deficient AD. Yes, that’s one possibility. Score one for Nick.
3. But it depends on what you mean by “sticky prices.” In case 2 all transactions occur at market clearing prices. So in a sense the problem of stickiness is being assumed away. So I like to imagine a world with a MOE and MOA that are different. No more barter. And also assume flexible prices between the MOA and MOE. Prices are sticky in terms of the MOA, but a varying amount of MOE is needed for transactions. Real world analogies might be with US dollars as the MOA and Zimbabwe dollars as the MOE, or gold as the MOA, and silver coins as the MOE. Let’s do the latter.
Assume once again that the demand for gold rises, and gold become more valuable in terms of both silver and all other goods. Assume the equilibrium value of silver in terms of all other goods is unchanged. Recall that prices are denominated in terms of gold, the MOA. Thus something that used to cost 1 silver coin might now cost two. Because the quantity of silver is unchanged, and thus it’s relative value in terms of goods is unchanged, this is a negative demand shock. But there are two ways to visualize this case:
a. The MOA got more valuable while nothing happened in the MOE market; hence the MOA is the key variable. (My view)
b. The stock of MOE measured in terms of gold has fallen in half, thus it’s a MOE shock that causes the recession. (Nick’s view.)
I think in terms of the quantity of MOE, whereas Nick thinks in terms of the value (in MOA terms) of the MOE.
So I’ve considered four cases. Case 1 and 3a and 3b are all consistent with the MOA driving the cycle.
Cases 2 and 3b are consistent with Nick’s view; the MOE is the key variable.
So it’s three to two, but somehow I don’t expect to maintain the lead when he replies.
PS. I vaguely recall Keynes saying around 1930 that the basic macro problem was that British wages were too high relative to the amount of gold in the world. Does anyone recall? It was when Keynes served on a commission looking at monetary problems.
Update: Commenter Arthur pointed to a good example of a split MOA/MOE in Brazil, from Marcus Nunes.