Nick Rowe quotes me in a comment section (first paragraph), and responds (second paragraph):
Scott: “2. I assume the market for the MOA is in equilibrium (in terms of the MOE.) And in that case I’m pretty sure that I am right. A huge rise in the demand for gold makes the silver price of gold soar. That reduces the stock of MOE when priced in MOA terms. Since goods are priced in MOA terms, that’s very deflationary. QED?”
We are on the same page. I would say it differently. ‘A huge rise in demand for gold makes the silver price of gold soar, which reduces the real stock of MOE when priced in MOA terms, which creates an excess demand for MOE/excess supply of all other goods that have sticky prices, which is a recession’.
Thank God we are on the same page. For those who have trouble following, I’m going to switch from silver to Zimbabwe dollars, as in my earlier post. I’ll do an example where Nick and I agree, and then discuss the disagreement. Suppose Zimbabwe goods are priced on gold terms, and a strange phenomenon causes 1/2 of all the gold in the world to disappear. The equilibrium price level and NGDP will fall in half. The value of gold (in terms of goods) will double. If gold had been used as money, the amount of gold coins would have fallen in half. If we assume prices are very sticky in the short run, then the real stock of gold money would initially fall in half. If we instead assume that Z$s are used as a (medium of exchange) MOE, then the Z$ price of gold would double. This means that if the supply of Z$ (the MOE) was unchanged in nominal terms, it would fall in half in real terms, or gold terms. (Remember, real terms and gold terms are the same in the short run, as we hold goods prices in gold terms constant in the short run, and gold is the medium of account (MOA.)
I claim that if the supply of gold fell in half, and gold is the MOA, then the long run equilibrium price level and NGDP will fall in half. In the short run wages and prices are sticky, so this shows up as less real output. There was no change in the number of Z$s in circulation, so the MOE was not responsible for the recession.
Nick would say that the increased demand for MOA did start the ball rolling, but what actually caused the recession was the effect it had on the MOE. And even though it did not reduce the number of Z$s by one iota, it did reduce the real quantity of MOE, which led to fewer purchases, and a recession (because prices are sticky.)
Nick (and Bill and Saturos) see things from a disequilibrium perspective. More or less money puts the money (MOE) market into disequilibrium, and this gets resolved via a change in aggregate spending. The change in aggregate spending has effects on both prices and output, because wages and prices are sticky. Indeed we all agree on that last point, so let’s explore whether this is a case of disequilibrium in the money market, or elsewhere.
Consider this famous diagram of the money market:
The classic thought experiment for demonstrating the quantity theory is to double the money supply, while holding the real demand for money unchanged. In the long run you go from A to C, and the price level doubles to push the nominal demand for money in line with the newly enlarged nominal supply of money. In the short run prices are sticky, and you go to point B. I believe that point B is what my opponents call “monetary disequilibrium.” The money supply is too high to provide equilibrium at the current price level. I claim that at point B the labor market (and perhaps goods market) is in disequilibrium, but the money market is in equilibrium.
In my view the term “shortage” should apply to a situation where it is actually difficult to get money. I’ve read that there were shortages of money in Colonial America, due to British policies prohibiting the import of coin, combined with America using British pounds as the MOA. I recall a shortage of coins in 1964-65, when silver prices rose above the face value of quarters and dimes. But that’s not what happens in most recessions. People don’t say “I have plenty of wealth, I can afford that new BMW, but I just can’t find any MOE so I won’t buy it. They don’t buy the new BMW because they are poorer during recessions. Now let me be clear that they are poorer because the MOA (which is of course also the MOE in modern America) has either fallen in supply or risen in demand, depressing NGDP and throwing millions of people out of work (due to sticky wages.) So recessions are monetary problems in the sense of being caused by MOA shocks, but they don’t reflect a situation where people with plenty of wealth and a desire to buy just can’t find a way to convert stocks and bonds into cash and checking balances. So that raises the question of why there is no money shortage at point B. It sure looks like a disequilibrium point. The answer is that the opportunity cost of holding the MOA falls when the money supply doubles, as you can see in the famous “liquidity effect” graph below:
At point B the increased money supply has depressed interest rates. On the first graph this would show up as a shift in the demand for money. I didn’t draw the new demand curve on the first graph, but it would go right through point B (on the graph with 1/P on the vertical axis.) The money market is now in equilibrium. Even at point B when you take your paycheck to the bank to get some MOE to spend, the teller doesn’t say “sorry we are out of vault cash,” he hands over some MOE, whenever you need it. But there is also clearly a sense in which we are not in equilibrium in a broader macroeconomic sense. At point B the prices of all sorts of assets have changed (stocks, bonds, commodities, forex, perhaps even commercial RE), and this changes lots of relative prices since goods prices are sticky. In addition, at point B the expected rate of NGDP growth has risen sharply. In the short run these forces will push output above the natural rate, although in the long run the only effect will be a doubling of the price level.
The deeper question is whether the disagreement between myself and other MMs reflects something important, or do we agree as to what is going on, but simply characterize it differently.
That which has no practical implications, has no theoretical implications. I had originally assumed that my thought experiment with Z$s as MOE, but gold as the MOA, showed the practical advantage of my approach. But Nick’s comment convinced me otherwise. He saw the same set of facts as I did, but was able to interpret the hypothesized recession by using a “change in the real quantity of MOE” framework.
So right now I’m stuck. I can’t think of any experiment, no matter how far-fetched, that would resolve our dispute. If I’m not able to think of one, then I’ll end up filing this issue away as being unimportant. That is, I’ll assume we actually do agree, but we describe the exact same situation using different language (i.e. ‘equilibrium’ vs. ‘disequilibrium.’) In order to be convinced that there is a meaningful difference here I need to see a thought experiment that would produce different results from a MOA perspective as compared to a MOE perspective. Perhaps removing the MOE entirely would do that. But I’m not convinced. Does removing the MOE shows that the MOE is important, or that there is no such thing as sticky wages/monopolistic competition under barter?
PS. Saturos recently said this in response to an earlier post:
Scott, I’ll restate what I said. Of course employers can always liquidate their assets to pay wages. That’s not what I meant.
I want you to visualize the circular flow of income. When I say money, I mean an inflow of money. I mean money income.
Then we are in agreement, because I also think money income (NGDP) is the key. But it has to be money income measured in MOA terms, not money income measured in MOE terms.