Excess demand (or supply) for money?

Nick Rowe has a new post that discusses the concept of an “excess demand for money.”  I’m not sure what that concept means, so I’ll address his post obliquely, by describing what I think is actually going on.  I’ll let readers decide how my monetary transmission process should be described.  Let’s look at a (permanent) 10% increase in the base, in 6 easy steps.  For those that don’t think the Fed controls the base, just assume an interest rate targeting change that forces the Fed to increase the base by 10% in order to hit their new interest rate target.

1.  Immediately after the money is injected there is an excess supply of money if we were to assume that there was no change in NGDP or any asset price.

2.  However asset prices and expected NGDP growth change immediately, so that Ms is again equal to Md.  There would be no excess supply or demand for money in that sense.  But the goods and labor markets don’t clear, so there may be an excess supply in some other sense.

3.  Time passes by . . .

4.  Output and semi-sticky prices adjust.  Semi-sticky prices include things like gasoline, food and real estate.

5.  More time passes by . . .

6.  Wages and sticky prices adjust.  Output and employment return to the natural rate, and NGDP rises by 10% relative to the level that would have occurred if there were no increase in the base.  Real asset prices are unchanged.  Nominal interest rates are unchanged.

That’s how I see things.  I prefer to call step two “monetary equilibrium,” but I don’t really have any substantive disagreement with those insist it should be called “monetary disequilibrium” because goods markets are not clearing.  That’s just semantics.  To me, disequilibrium is a psychological concept—frustration.  I want to buy tickets to see the Stones, but the concert is sold out.  I’m frustrated.  When the Fed increases or decreases the base I do not walk around weeks later frustrated that my wallet contains $260 in cash, rather than $240 or $280.  I’m holding exactly as much cash as I prefer to hold, given current asset prices.  Any increased frustration occurs in the goods and labor markets, where people can’t sell as much as they’d like, where they are forced to work overtime against their will.

Again, I’m not saying people who disagree with me on excess money demand are wrong, just that our disagreement is mere semantics, nothing more.

PS.  What causes the changes in step 4?  The increase in the money supply?  Yes.  Or the increases in asset prices and expected NGDP growth?  Yes.  Either/or questions are not supposed to be answered “yes” in both cases, but this is an exception.

PPS.  Those in the underground economy may feel frustration after a change in monetary policy, as it is costly to rapidly adjust cash balances via consumption, and they can’t adjust via asset purchases or sales without the IRS noticing.


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22 Responses to “Excess demand (or supply) for money?”

  1. Gravatar of Geoff Geoff
    26. February 2013 at 15:06

    Dr. Sumner:

    “Nick Rowe has a new post that discusses the concept of an “excess demand for money.” I’m not sure what that concept means, so I’ll address his post obliquely, by describing what I think is actually going on.”

    No offense to Rowe, but it really means “I know more about the supply and demand of money, concerning other people, than they do for themselves. Since my belief cannot be communicated in any market exchange, I will insert an arbitrary standard for what others SHOULD be doing for themselves, and ignore what they think they should be doing for themselves. Hopefully, some “powerful” non-market institution can fix what I see as a problem, so I don’t have to display any failure myself. I need this concept because I want to find a justification for the central bank to print more or less money according to that same arbitrary standard.”

    You said:

    “To me, disequilibrium is a psychological concept—frustration.”

    Agreed, to an extent.

    I think it can also be interpreted objectively. Suppose a master builder decides to build a house that requires 50,000 bricks. Suppose he believes he has 50,000 when in reality he only has 40,000. He doesn’t realize it just yet. He’s partially completed the house.

    I would say that his plan and his real capital are in “disequilibrium” in an objective sense, in addition to the psychological frustration sense he would likely experience once he finds out the truth.

  2. Gravatar of Geoff Geoff
    26. February 2013 at 15:24

    Given a particular supply of money, and given that every dollar is held by an owner at any given time, why can’t we say that the supply of money exactly matches the demand for money at every moment in time?

    If I want to earn more money than what I do earn (don’t we all!), then does this not imply that I want to hold more money than I am otherwise holding, given my desire for goods at the prices that prevail? If so, then isn’t there always an “insufficient supply of money”, and hence isn’t there always an “excess demand for money”, short of absolute hyperinflation and burning of paper notes for heat and cigar lighting?

    If I want to get rid of money, in order to hold goods, then there must be an equal and opposite increase of someone else wanting to get rid of goods, in order to hold money. Every desire for me to get rid of money, that you and everyone else can observe, requires someone else to want to hold money, that you and everyone else can observe.

    Everything else is mere guessing what other people are thinking.

    In the aggregate then, isn’t there always zero excess demand for money and zero excess supply of money? What does it mean for there to be an observable excess demand or supply of money anyway? What is being observed that one concludes this?

    It is inevitable that one must insert an arbitrary standard for what one believes others SHOULD be doing, which of course requires introducing some arbitrary standard of measurement. Be it NGDP or prices or whatever, it is arbitrary because it isn’t based on finding out what others actually want for themselves, but assuming what they want by looking at particular statistics and imposing that on them “for their own good.”

    There is no escaping this if one really believes one can observe excess or insufficient demands and supplies of anything, let alone money.

    Try it yourself. Just consider me without knowing my thoughts, and you can only observe my actions. Suppose I am holding $1000 right now in cash. Can you tell just by looking at that, whether I myself think this is too much money and too little goods, or too little money and too many goods? It’s ridiculous to even consider anyone other than me being able to know such a thing.

    Well, the same is true for millions of others in a division of labor. Nobody knows what the correct supply of money should be. Nobody knows what the correct spending and holding of money should be. The only people who know this are the individual for themselves, and taken in the aggregate, the aggregate statistics that result from these desires are what the “correct” supply of money and volume of spending should be.

  3. Gravatar of Nick Rowe Nick Rowe
    26. February 2013 at 15:42

    Scott: thanks!

    “However asset prices and expected NGDP growth change immediately, so that Ms is again equal to Md.”

    Some asset prices (stocks and bonds) change very quickly; other asset prices (houses and cars) change more slowly.

    Why “privilege” some subset of assets, and say that Ms=Md if and only if the markets for those particular goods clear? Why not just say “the stock and bond markets are clearing”?

    Is this just a semantic disagreement?

    Well, at a minimum, sometimes words matter. Because saying “Md=Ms” instead of “the stock and bond markets are clearing” may lead you to forget that, unlike all the other goods, money is traded in every market. Plus, people who have an excess demand for money may nevertheless be selling money (when they buy groceries); we would never observe someone who had an excess demand for stocks and bonds selling stocks and bonds. We all hold inventories of money, and will be both selling and buying money even if our stocks of money are smaller or larger than desired.

    Talking about “the demand for money”, or an “excess demand for money” fools us into thinking that money is just another asset, when it isn’t.

    Suppose a used car dealer had an inventory of used cars, that was smaller than he desired. He would both increase his demand for cars *and* reduce his supply of cars. He would reduce his velocity of circulation of cars, because his actual velocity of cars is greater than his desired velocity of cars.

    We are all dealers in money in the same way used car dealers are dealers in used cars.

  4. Gravatar of Geoff Geoff
    26. February 2013 at 16:13

    “Suppose a used car dealer had an inventory of used cars, that was smaller than he desired. He would both increase his demand for cars *and* reduce his supply of cars. He would reduce his velocity of circulation of cars, because his actual velocity of cars is greater than his desired velocity of cars.”

    One cannot observe the car seller’s mental thought processes in order to conclude that there is any “excess demand” or “excess supply” of cars in his lot.

    Saying that it is possible for him to want more cars than he has, or want fewer cars than he has, is not the same thing as saying there can be an external car issuer who can ensure that there is never any excess supply of or demand for cars felt by car sellers or buyers that would put the car market “in equilibrium.”

    I always want more money than what I have. The same is the case for pretty much everyone else. Does this mean that there is an “excess demand for money” that requires a money printer to keep printing notes until the money printer is satisfied by what it believes I and others think in our minds? I don’t think so.

  5. Gravatar of Michael Michael
    26. February 2013 at 16:42

    Geoff writes:

    “I always want more money than what I have. The same is the case for pretty much everyone else. Does this mean that there is an “excess demand for money” that requires a money printer to keep printing notes until the money printer is satisfied by what it believes I and others think in our minds? I don’t think so.”

    Untrue.

    Sometimes, you’d rather trade your money for food, or a place to live (owner or rented), or clothes to wear. Sometimes holding money is less important to you than giving it up simply to do something you think is fun. Sometimes you’d rather exhange your money for an ownership interest in a company. Other times you would rather let some one or some entity borrow your money rather than just holding on to it.

    Having said all of that, there is certainly some amount of money that you want to just hold as money, or hold in a liquid form (e.g. checking account). If you happen to have more money in your possession than the amount you want to have, you are more likely to spend, lend, or invest some of it than you would be otherwise. If you happen to have less than your preferred amount, you are more likely to forego some consumption, cash in investments, sell bonds, etc. If you acquire some new money, your decision about what to do with it will depend to some extent whether you currently have more or less cash on hand than your preferred amount.

    Your interest in holding money (relative to other things you could do with it) will change over time, of course. Sometimes your preferences will change due to your own individual life circumstances; other times they will change in concert with those of everyone else, or most everyone else.

  6. Gravatar of W. Peden W. Peden
    26. February 2013 at 17:09

    Geoff,

    I think you’re right. I like to put it this way: one cannot OBSERVE someone’s mental thought processes. You can only observe people’s actions.

    You can’t see someone having “difficulty” selling or buying apples. The only connection here to the concept of “excess” demand is until the relevant events are already past and settled and people tell you about their historical experience relative to their planned intentions. You can’t see such difficulty while it is taking place, without inserting an arbitrary standard of how many apples you believe people “should” be selling at that time.

    The concept of an excess demand for money is as equally arbitrary.

  7. Gravatar of ssumner ssumner
    26. February 2013 at 18:05

    Nick, You said;

    “Talking about “the demand for money”, or an “excess demand for money” fools us into thinking that money is just another asset, when it isn’t.”

    Us? I think you mean “them.” I can’t imagine you or I ever being confused on this point. :)

    I think it is a question of semantics because the language here (excess supply and demand) evolved to deal with radically different conditions, such as what occurs with rent controls. When we apply it to a very different circumstance (money and macro instability) it’s not clear how the term should be applied. An excess demand for money is in some respects like an excess demand for apartments under rent controls. But in other respects it is nothing like an excess demand for apartments under rent controls. You seem to think the way in which it is like an excess demand for apartment under rent control is in some sense the “real meaning of excess demand.” I seem to think the way in which it is not like an excess demand for apartments under rent control is in some sense the “real meaning of excess demand.” Because the term has never (to my knowledge) been adequately defined, it is just a question of semantics. You take more of a “flow of money expenditures” approach to excess demand, and I take more of a “stock demand for money” approach to excess demand.

    I don’t have any problem in thinking about money and business cycles from the perspective of my definition of monetary equilibrium, but I don’t dispute that it might lead others astray. All I can do is keep trying to convince people that my steps one through six above are what’s “really going on.”

  8. Gravatar of Nick Rowe Nick Rowe
    26. February 2013 at 18:09

    I can see people standing in line. With some guy selling or buying something at the front of the line.

    OK. Maybe they like standing in line.

    I expect I could ask them why they are standing in line.

  9. Gravatar of ssumner ssumner
    26. February 2013 at 18:14

    Nick, I agree of course. The interesting question here is how do we know the difference between a equilibrium business cycle and a disequilibrium business cycle. You and I think it’s obvious, but I suppose there are some quite intelligent RBC-types who disagree.

    Of course when I refer to disequilibrium business cycle I mean labor market (and perhaps goods market) disequilibrium, not money market. But I’m not opposed to monetary disequilibrium language, and I certainly think I know what people mean when they use that language.

  10. Gravatar of dtoh dtoh
    26. February 2013 at 19:22

    Scott,
    I think this is fundamentally a good explanation, but as I have noted before, “injection” is a misleading term. What is taking place is an “exchange” of money for financial assets, and what causes the ultimate counter-party (not the market maker) to enter into the exchange is because the counter-party intends to spend the money on real goods and services. So essentially from the counter-party’s perspective they intend to enter into an exchange of financial assets for real goods and services. What induces this exchange is a) an increase in the real price (1/expected real risk adjusted return) of financial assets relative to the price of real goods and services, and b) a change in expected NGDP.

  11. Gravatar of dtoh dtoh
    26. February 2013 at 19:29

    Scott,
    Further to Nick’s point, I think you need to distinguish between assets generally and financial assets. The triggering mechanism for monetary transmission is an exchange of financial assets for real goods and services (including real assets). If the price of real goods and services (and real assets) changed immediately then the marginal increase in the exchange of financial assets for real goods and services would be significantly diminished.

  12. Gravatar of edeast edeast
    26. February 2013 at 19:56

    How do you know your labor market is at disequilibrium, they are receiving benefits after all. (not rbc, just subbing)

  13. Gravatar of Rajat Rajat
    26. February 2013 at 21:01

    Concrete steppes – excellent!

  14. Gravatar of Morgan Warstler Morgan Warstler
    26. February 2013 at 22:49

    “Doing nothing is a highly risky policy.”

    no

  15. Gravatar of TravisV TravisV
    26. February 2013 at 22:59

    Morgan Warstler,

    You are wrong. Doing nothing IS a highly risky policy.

  16. Gravatar of TravisV TravisV
    26. February 2013 at 23:05

    In case anyone’s interested, this is up on Zero Hedge:

    Gold Manipulation: The Logical Outcome Of Mainstream Economics Part 1
    http://bit.ly/157Wntp

    Gold Manipulation, Part 2: How They Do It (And How To Hedge It)
    http://bit.ly/13hH1EF

    The first flaw I see is here:

    “They want to induce an excess of demand on the real side of the economic system through an excess of supply in the global fiat money market. But as money is simply another necessary good, people need sound money; a sound asset as a medium of indirect exchange. If the idea of central bankers is to weaken the liabilities of the banks they lead, people will simply switch to gold. This, of course, is unacceptable to the existing rulers.”

    But IT IS acceptable to central bankers if people exchange dollars for things like oil and real estate. How the heck is gold any different?

  17. Gravatar of Nick Rowe Nick Rowe
    26. February 2013 at 23:44

    edeast: “How do you know your labor market is at disequilibrium, they are receiving benefits after all. (not rbc, just subbing)”

    Labour is a rather illiquid good. It is always harder both to buy and to sell than other, more liquid, goods. But when I see signs that labour is harder to sell than it usually is, and easier to buy than it normally is, I infer that the labour market is what would be equivalent to excess supply for a more liquid good.

  18. Gravatar of Sumner on Monetary Disequilibrium | Fifth Estate Sumner on Monetary Disequilibrium | Fifth Estate
    27. February 2013 at 06:16

    [...] Sumner doesn’t like the concept of monetary [...]

  19. Gravatar of ssumner ssumner
    27. February 2013 at 06:52

    dtoh, You said;

    “What is taking place is an “exchange” of money for financial assets, and what causes the ultimate counter-party (not the market maker) to enter into the exchange is because the counter-party intends to spend the money on real goods and services.”

    No, the counterparty will usually simply buy other financial assets with the new money. More G&S will be bought, but by someone else.

    You said;

    “If the price of real goods and services (and real assets) changed immediately then the marginal increase in the exchange of financial assets for real goods and services would be significantly diminished.”

    Never reason from a price change. It depends why the prices rose. If it’s because goods are traded in highly competitive markets, and if wages are sticky, then real output would rise sharply.

    edeast, It is not always easy to tell. But over the past 4 years I have many blog posts presenting evidence that unemployment is currently above the natural rate.

  20. Gravatar of dtoh dtoh
    27. February 2013 at 07:57

    Scott,
    You said;

    No, the counterparty will usually simply buy other financial assets with the new money. More G&S will be bought, but by someone else.

    Not the ultimate counter-party. At the end of the chain, someone is making a decision to hold fewer financial assets (e.g. reduce Treasuries held for liquidity, issue CP, draw down on a credit line, take out a car loan, etc). It doesn’t matter if there is just one intermediary (e.g. a primary dealer) or a dozen intermediaries who are exchanging one FS for another. Ultimately there is a counter-party who is making the exchange into cash in order to buy G&S.

    You also said;
    Never reason from a price change. It depends why the prices rose. If it’s because goods are traded in highly competitive markets, and if wages are sticky, then real output would rise sharply.

    Everything else being equal, if the change in prices of financial assets relative to G&S is less because the price of G&S has risen, then the marginal increase in the exchange of FA for G&S will be reduced. (AD may still rise sharply….just not as much as it would if G&S prices had not increased).

    BTW – Any comments on the recent Mishkin paper or Bernanke’s comments about unwinding QE?

  21. Gravatar of Geoff Geoff
    27. February 2013 at 18:31

    Michael:

    “Sometimes, you’d rather trade your money for food, or a place to live (owner or rented), or clothes to wear.”

    I still want more money than what I have with or without such trades. I’d rather spend less money on the same goods.

    And if I wanted to get rid of my money, for goods, someone else must want money. In the aggregate, there is no possible “excess demand for money” that can be observed. Anyone who is observed as accumulating money, must be trading with others who are decumulating money.

    “Sometimes holding money is less important to you than giving it up simply to do something you think is fun. Sometimes you’d rather exhange your money for an ownership interest in a company. Other times you would rather let some one or some entity borrow your money rather than just holding on to it.”

    Someone else must want money if that’s true. You would observe equal offsetting demands for money.

    Nick Rowe:

    “I can see people standing in line. With some guy selling or buying something at the front of the line.”

    You can’t see their thoughts. But it is their thoughts that are necessary in order for one to conclude that they are “having difficulty buying and selling.”

    Add to this the fact that there are millions of other people that you can’t even observe in this way, because you can’t be everywhere at once, and it is even more problematic to believe one can know that there is an economy wide “difficulty” of selling and buying, i.e. “excess” or “deficient” demands for money or goods.

  22. Gravatar of ssumner ssumner
    28. February 2013 at 16:44

    dtoh, I’m afraid I don’t agree with either point. The increase in the money supply could easily lead to more financial assets being created, hence it’s not clear that there is any “end of the line.”

    Inflation is a part of AD, so I don’t see how more inflation would reduce AD.

    I have a new post on Mishkin.

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