Who’s Afraid of Say’s Law?

There’s been a lot of discussion about Say’s Law in the blogosphere lately, some of it finding its way into the comments section of my recent post “What Does Keynesisan Mean,” in which I made passing reference to Keynes’s misdirected tirade against Say’s Law in the General Theory. Keynes wasn’t the first economist to make a fuss over Say’s Law. It was a big deal in the nineteenth century when Say advanced what was then called the Law of the Markets, pointing out that the object of all production is, in the end, consumption, so that all productive activity ultimately constitutes a demand for other products. There were extended debates about whether Say’s Law was really true, with Say, Ricardo, James and John Stuart Mill all weighing on in favor of the Law, and Malthus and the French economist J. C. L. de Sismondi arguing against it. A bit later, Karl Marx also wrote at length about Say’s Law, heaping his ample supply of scorn upon Say and his Law. Thomas Sowell’s first book, I believe drawn from the doctoral dissertation he wrote under George Stigler, was about the classical debates about Say’s Law.

The literature about Say’s Law is too vast to summarize in a blog post. Here’s my own selective take on it.

Say was trying to refute a certain kind of explanation of economic crises, and what we now would call cyclical or involuntary unemployment, an explanation attributing such unemployment to excess production for which income earners don’t have enough purchasing power in their pockets to buy. Say responded that the reason why income earners had supplied the services necessary to produce the available output was to earn enough income to purchase the output. This is the basic insight behind the famous paraphrase (I don’t know if it was Keynes’s paraphrase or someone else’s) of Say’s Law — supply creates its own demand. If it were instead stated as products or services are supplied only because the suppliers want to buy other products or services, I think that it would be more in sync than the standard formulation with Say’s intent. Another way to think about Say’s Law is as a kind of conservation law.

There were two famous objections made to Say’s Law: first, current supply might be offered in order to save for future consumption, and, second, current supply might be offered in order to add to holdings of cash. In either case, there could be current supply that is not matched by current demand for output, so that total current demand would be insufficient to generate full employment. Both these objections are associated with Keynes, but he wasn’t the first to make either of them. The savings argument goes back to the nineteenth century, and the typical response was that if there was insufficient current demand, because the desire to save had increased, the public deciding to reduce current expenditures on consumption, the shortfall in consumption demand would lead to an increase in investment demand driven by falling interest rates and rising asset prices. In the General Theory, Keynes proposed an argument about liquidity preference and a potential liquidity trap, suggesting a reason why the necessary adjustment in the rate of interest would not necessarily occur.

Keynes’s argument about a liquidity trap was and remains controversial, but the argument that the existence of money implies that Say’s Law can be violated was widely accepted. Indeed, in his early works on business-cycle theory, F. A. Hayek made the point, seemingly without embarrassment or feeling any need to justify it at length, that the existence of money implied a disconnect between overall supply and overall demand, describing money as a kind of loose joint in the economic system. This argument, apparently viewed as so trivial or commonplace by Hayek that he didn’t bother proving it or citing authority for it, was eventually formalized by the famous market-socialist economist (who, for a number of years was a tenured professor at that famous bastion of left-wing economics the University of Chicago) Oskar Lange who introduced a distinction between Walras’s Law and Say’s Law (“Say’s Law: A Restatement and Criticism”).

Walras’s Law says that the sum of all excess demands and excess supplies, evaluated at any given price vector, must identically equal zero. The existence of a budget constraint makes this true for each individual, and so, by the laws of arithmetic, it must be true for the entire economy. Essentially, this was a formalization of the logic of Say’s Law. However, Lange showed that Walras’s Law reduces to Say’s Law only in an economy without money. In an economy with money, Walras’s Law means that there could be an aggregate excess supply of all goods at some price vector, and the excess supply of goods would be matched by an equal excess demand for money. Aggregate demand would be deficient, and the result would be involuntary unemployment. Thus, according to Lange’s analysis, Say’s Law holds, as a matter of necessity, only in a barter economy. But in an economy with money, an excess supply of all real commodities was a logical possibility, which means that there could be a role for some type – the choice is yours — of stabilization policy to ensure that aggregate demand is sufficient to generate full employment. One of my regular commenters, Tom Brown, asked me recently whether I agreed with Nick Rowe’s statement: “the goal of good monetary policy is to try to make Say’s Law true.” I said that I wasn’t sure what the statement meant, thereby avoiding the need to go into a lengthy explanation about why I am not quite satisfied with that way of describing the goal of monetary policy.

There are at least two problems with Lange’s formulation of Say’s Law. The first was pointed out by Clower and Leijonhufvud in their wonderful paper (“Say’s Principle: What It Means and Doesn’t Mean” reprinted here and here) on what they called Say’s Principle in which they accepted Lange’s definition of Say’s Law, while introducing the alternative concept of Say’s Principle as the supply-side analogue of the Keynesian multiplier. The key point was to note that Lange’s analysis was based on the absence of trading at disequilibrium prices. If there is no trading at disequilibrium prices, because the Walrasian auctioneer or clearinghouse only processes information in a trial-and-error exercise aimed at discovering the equilibrium price vector, no trades being executed until the equilibrium price vector has been discovered (a discovery which, even if an equilibrium price vector exists, may not be made under any price-adjustment rule adopted by the auctioneer, rational expectations being required to “guarantee” that an equilibrium price vector is actually arrived at, sans auctioneer), then, indeed, Say’s Law need not obtain in notional disequilibrium states (corresponding to trial price vectors announced by the Walrasian auctioneer or clearinghouse). The insight of Clower and Leijonhufvud was that in a real-time economy in which trading is routinely executed at disequilibrium prices, transactors may be unable to execute the trades that they planned to execute at the prevailing prices. But when planned trades cannot be executed, trading and output contract, because the volume of trade is constrained by the lesser of the amount supplied and the amount demanded.

This is where Say’s Principle kicks in; If transactors do not succeed in supplying as much as they planned to supply at prevailing prices, then, depending on the condition of their balances sheets, and the condition of credit markets, transactors may have to curtail their demands in subsequent periods; a failure to supply as much as had been planned last period will tend reduce demand in this period. If the “distance” from equilibrium is large enough, the demand failure may even be amplified in subsequent periods, rather than damped. Thus, Clower and Leijonhufvud showed that the Keynesian multiplier was, at a deep level, really just another way of expressing the insight embodied in Say’s Law (or Say’s Principle, if you insist on distinguishing what Say meant from Lange’s reformulation of it in terms of Walrasian equilibrium).

I should add that, as I have mentioned in an earlier post, W. H. Hutt, in a remarkable little book, clarified and elaborated on the Clower-Leijonhufvud analysis, explaining how Say’s Principle was really implicit in many earlier treatments of business-cycle phenomena. The only reservation I have about Hutt’s book is that he used it to wage an unnecessary polemical battle against Keynes.

At about the same time that Clower and Leijonhufvud were expounding their enlarged view of the meaning and significance of Say’s Law, Earl Thompson showed that under “classical” conditions, i.e., a competitive supply of privately produced bank money (notes and deposits) convertible into gold, Say’s Law in Lange’s narrow sense, could also be derived in a straightforward fashion. The demonstration followed from the insight that when bank money is competitively issued, it is accomplished by an exchange of assets and liabilities between the bank and the bank’s customer. In contrast to the naïve assumption of Lange (adopted as well by his student Don Patinkin in a number of important articles and a classic treatise) that there is just one market in the monetary sector, there are really two markets in the monetary sector: a market for money supplied by banks and a market for money-backing assets. Thus, any excess demand for money would be offset not, as in the Lange schema, by an excess supply of goods, but by an excess supply of money-backing services. In other words, the public can increase their holdings of cash by giving their IOUs to banks in exchange for the IOUs of the banks, the difference being that the IOUs of the banks are money and the IOUs of customers are not money, but do provide backing for the money created by banks. The market is equilibrated by adjustments in the quantity of bank money and the interest paid on bank money, with no spillover on the real sector. With no spillover from the monetary sector onto the real sector, Say’s Law holds by necessity, just as it would in a barter economy.

A full exposition can be found in Thompson’s original article. I summarized and restated its analysis of Say’s Law in my 1978 1985 article on classical monetary theory and in my book Free Banking and Monetary Reform. Regrettably, I did not incorporate the analysis of Clower and Leijonhufvud and Hutt into my discussion of Say’s Law either in my article or in my book. But in a world of temporary equilibrium, in which future prices are not correctly foreseen by all transactors, there are no strict intertemporal budget constraints that force excess demands and excess supplies to add up to zero. In short, in such a world, things can get really messy, which is where the Clower-Leijonhufvud-Hutt analysis can be really helpful in sorting things out.

65 Responses to “Who’s Afraid of Say’s Law?”

  1. 1 nottrampis February 20, 2014 at 7:20 pm

    Too many David Glasner articles are barely enough!!

  2. 2 Tom Brown February 20, 2014 at 7:55 pm

    David, I wasn’t afraid of Say’s Law, but I think I might be now… Thanks :(

    … and maybe I should have been afraid all along!

    (It’ll take me a bit to digest your post here)

  3. 3 Tom Brown February 20, 2014 at 8:05 pm

    David, this bit here:

    “Thus, any excess demand for money would be offset not, as in the Lange schema, by an excess supply of goods, but by an excess supply of money-backing services. In other words, the public can increase their holdings of cash by giving their IOUs to banks in exchange for the IOUs of the banks, the difference being that the IOUs of the banks are money and the IOUs of customers are not money, but do provide backing for the money created by banks.”

    Seems like it might be at odds with my “schooling” on the subject (basically reading one of Nick Rowe’s blog posts). I’ll have to go look it up, but I could swear he asserted something different on this, because he divided the world into to kinds of goods: money and everything else, where everything else included IOUs (loan documents) that you might be trying to sell to the banks. You seem to be saying something different, but I’m not quite grasping it. I think I will attempt to direct Nick’s attention to your post… I’d be very happy to see his response to it. Maybe I’ll discover that I didn’t quite understand Nick in the 1st place.

  4. 4 Tom Brown February 20, 2014 at 8:26 pm

    Wow, David, thanks for writing this. I re-read it in parts again (and this time saw that I got a mention in your post! Awesome! … I missed that the 1st time through somehow). I’m going to have to give it a rest for now… maybe read some of your references there. But this subject turns out to be more complex than I’d first imagined. Fancy that!

  5. 5 Greg Ransom February 20, 2014 at 11:38 pm

    “Hayek .. didn’t bother proving it”

    Nonsense. Hayek explicitly identifies the need to prove why the existence of money and credit make both possible and inevitable the “loose joint” / trade cycle as the task of his book *Monetary Theory and the Trade Cycle”.

    The whole point and explicitly stated burden of the book is to prove it.

  6. 6 Greg Ransom February 20, 2014 at 11:39 pm

    In his *Pure Theory* Hayek identifies “Say’s Law” as nothing more than a way to express a tautological equilibrium condition that never exists in the world but only exists in the world of math / logic constructs.

  7. 7 Johnson Nderi (@nderi_j) February 21, 2014 at 12:48 am

    You mis-state Say’s law… Say’s law is, simply put, you pay for your demand for goods and services with production of your own. An individual’s production creates the ability to buy ergo… supply creates demand!

  8. 8 Johnson Nderi (@nderi_j) February 21, 2014 at 12:53 am

    Say’s law was not a statement to derive a mathematical identity, it is meant to be a statement of logical necessity that applies even in a monetary system. Say’s law can be used to prove that credit creation by banks and printing of money by central banks is actually redistributive and a form of stealth tax.

  9. 9 Pontus February 21, 2014 at 2:49 am

    “There can never, it is said, be a want of buyers for all commodities; because whoever offers a commodity for sale, desires to obtain a commodity in exchange for it, and is therefore a buyer by the mere fact of his being a seller. /…/ If, however, we suppose that money is used, these propositions cease to be exactly true. /…/ Although he who sells, really sells only to buy, he needs not buy at the same moment when he sells; and he does not therefore necessarily add to the immediate demand for one commodity when he adds to the supply of another. /…/ In extreme cases, money is collected in masses, and hoarded /…/ [T]he result is, that all [other] commodities fall in price, or become unsaleable.”

    John Stuart Mill, Essays on Some Unsettled Questions in Political Economy. 1844.

  10. 10 g2-dcc29df00acec64526eaf79ab9d19b3e February 21, 2014 at 3:44 am

    Thank you for another great post , Dr. Glasner I have a question regarding Clower-Leijonhufvud analysis of the demand failures and the income constrained process, once on a post you stated that Leijonhufvud had demostrated that trading at disequilibrium prices might have profound consequences on income constrained process and hence constraining trade and creating amplified periods of demand failure and depressions, it seems to me, that following a market process (Thompsen’s view of prices) approach, that economic activities are all the time being performed under disequilibrium prices, however disequilibrium money prices possess inherently the market incentives for economic actors to act upon them and generate profit actions to correct those prices and through a try an error process seek to steer those prices closer to equilibrium or a higher degree of plan compatibility (coordination), now when you say that “If the “distance” from equilibrium [large fluctuations of disequilibrium prices] is large enough, the demand failure may even be amplified in subsequent period” if we see real economic activity this severe large demand failures do not seem to happen inherently on trading at disequilibrium prices, but rather they stem out of trading at disequilibrium prices when monetary disequilibrium severely move those prices away from equilibrium (increasing the distance from it) and exacerbating demand failures. It seems to me that the insight of the Clower-Leijonhufvud analysis should be complemented with monetary disequilibrium theory otherwise the analysis explain too much. If just disequilibrium prices move by themselves away from coordination levels we will see income constrained processes and depressions on larger scales more often that we currently see, what are your thought on this?


  11. 11 Becky Hargrove February 21, 2014 at 5:42 am

    This post is incredibly valuable for people such as myself who can’t find enough time in a day to read everything they would like to, in terms of source literature. Thanks, David.

  12. 12 Nick Rowe February 21, 2014 at 5:58 am

    Very good post David!

    One small bit I would quibble with: “…that there is just one market in the monetary sector, there are really two markets in the monetary sector: a market for money supplied by banks and a market for money-backing assets.”

    I think Clower would object to that bit. Every market is a market in which money is traded. What Earl Thompson would be adding is that competitive banks may create an additional market in which an increased stock of money may be created in exchange for non-money goods (or non-money IOUs).

    But then it makes me wonder: a central bank on the gold standard will also create an additional market in which an increased stock of money may be created in exchange for non-money goods (gold in this case). (And a central bank on the CPI standard will also, indirectly, do the same thing.) But if the price of gold is too low, Say’s Law will fail.

  13. 13 Benjamin Cole February 21, 2014 at 6:15 am

    Krugman just mentioned this blogpost. David Glasner is famous!

    I still think demand can create its own supply. If I print a perfect counterfeit Benjamin Franklin, than I can get my haircut, buy a bowl of soup etc. People will be happy to serve me. They go on trading the bill around, creating more supply.

    What if I print money and buy a machine that improves productivity of workers in my factory?

    The new bill will not create new supply when the economy is going full out. It will then create inflation.

  14. 14 Noah P-H February 21, 2014 at 8:29 am

    Interesting and challenging post, and kudos to the intelligent civil debate being engaged in by those who’ve commented before me. My fundamental disagreement with the notion that supply creates demand or that demand creates supply stems from this question: What came first, the chicken or the egg? What came first, supply or demand? I think one CAN argue that supply can exist without demand, and not the other way around (though now we’re into the whole tree falling in a forest debate) though no human being can certifiably prove one creates the other out of a thin air (think about the history of science: there was a time when humans believed in the spontaneous generation of matter out of thin air, until we invented microscopes and realized there is a whole lot more to life than what meets the eye)

    Ultimately the point of this comment is to state that I think its unethical of any self styled economist to assert either side of this argument with any level of certainty. Does it matter whether the egg came before the chicken, or the supply before the demand? Neither one can possibly exist in its current known form without the other. Supply is demand, demand is supply: Supply=Demand.

    I will be following this blog as often as I can, please keep the posts coming

  15. 15 Tom Brown February 21, 2014 at 8:57 am

    Benjamin, I think it’s been established before that David is definitely on Paul’s reading list: this is not the 1st time he’s been mentioned.

  16. 16 doncoffin64 February 21, 2014 at 9:45 am

    You should have seen the discussion of the Society for the History of Economics listserv about this. So far, I’d estimate over 50 posts, and some of the discussion has been far from civil. And, incidentally, a lot of it has been far less well informed than this.

  17. 17 jientho February 21, 2014 at 9:46 am

    Seems to me the whole thing, whether Law, Principle, or mere intent, is shown to be a fallacy of “argument by redefinition” when one starts with goods “supplied by” nature. If I see the red fruit of a wild apple tree from a distance, are the apples a “supply” (paid for by my effort to look)? If I’m already sated by other food and have no “demand” whatsoever for the apples, are they “not a supply” of food thereby? Do they *become* a supply as I get hungrier, and am willing to “pay” by walking to the tree?

    I don’t see how the situation changes if it is an orchard “supplied” by a farmer’s labor. (Let’s say the harvesting remains “you-pick”.) If everyone in the vicinity loses all their taste for apples to eat and has other food to eat (no demand), is the farmer then “not a supplier” after all, despite all his labor and his intention to profit? Are you Saying that a negative equilibrium price (the farmer has to pay people to eat his apples) keeps the law intact? That would be quite some redefinition of “supply” and “demand”.

  18. 18 David Glasner February 21, 2014 at 9:54 am

    nottrampis, Thanks, I will try to keep supplying them.

    Tom, IOUs may be sold in a market of their own, but they aren’t providing money backing services unless they are exchanged with a bank for a banknote or deposit.

    Greg, You misunderstood me. I meant he didn’t feel a need to prove that the loose joint idea implied a violation of Say’s Law. He seems to have considered that interpretation of Say’s Law so obvious that it could simply be asserted and left at that.

    Johnson, I’m suggesting that Say’s Law can be (and has been) interpreted in a variety of ways. Certainly your interpretation is legitimate and widely accepted. However, I disagree that Say’s Law can be used to prove that credit creatin by banks is redistributive and a form of stealth tax.

    Pontus, That is a famous quotation from Mill, and it highlights the savings issue that I mentioned. In Mill’s formulation, Say’s Law is being understood as an equilibrium condition, not an identity and would correspond to Nick Rowe’s idea that the goal of monetary policy should be to make Say’s Law valid, by preventing an excess supply or excess demand for money from occurring.

    Pablo, You raise an interesting question about what conditions can give rise to a cumulative contractionary process. I think it is really all guesswork. Historically well-developed market economiiess have been fairly robust and have usually snapped back from recessions with only mild monetary or fiscal stimulus. The Great and the Little Depressions seem to differ from the historical norm. I think bad policy certainly has something to do with it, but that is just my own impressionistic take on economic history.

    Becky, Thanks for your kind words. I am glad that you found it helpful.

    Nick, You may be right about that quibble. My memory is that Bob Clower and Earl Thompson had their share of disagreements, and this may have been one of them. Can you explain what you mean by a failure of Say’s Law if the price of gold is too low?

    Benjamin, For about 15 minutes or so.

    Noah, That is the point, neither one comes first, they are, to introduce a new metaphor, opposite sides of the same coin.

  19. 19 Tom Brown February 21, 2014 at 10:05 am

    David, I think Nick nailed the part better than I did that seemed different than what I’ve heard him say. I’d like to know about the gold comment too.

    Also, I think I mentioned that I’m doing an informal survey about Nick’s comment. I’d put Mark A. Sadowski in the “for” category, but I wasn’t sure… well I just happened to have stumbled upon his answer this morning (while looking for something else):

    “My take on this is that the idea that good macroeconomic policy would make Say’s Law true is an idea first thought of by Keynes.”


    What say you David? Would Keynes have agreed with Nick?

  20. 20 Jesse February 21, 2014 at 10:08 am

    Say’s Law falls into the same category as the efficient markets hypothesis, in that it describes a mathematical ideal that does not exist in the real world. It assume a justice in wages and labor, productivity and wealth, that is alas merely a phantom. It is a useful idea for economists to consider, but otherwise is the source of much mischief in that it directs policy towards a netherworld that has little traction in the real economy.

  21. 21 Nick Rowe February 21, 2014 at 12:54 pm

    David: assume the price of gold is perfectly flexible, but all other prices are sticky.

    Start with a central bank not on the gold standard. And suppose the price of gold is P’. If it suddenly halves the stock of money, the price of gold will fall to P* to clear the gold market, but all other prices will be stuck too high, so there is an excess supply of goods. Say’s Law (in the non-Clower sense) fails, because there is an excess demand for money.

    Now repeat exactly the same experiment, but now with a central bank on the gold standard. It initially sets the price of gold at P’, and then it suddenly cuts the price of gold to P*.

    We should get exactly the same excess supply of goods in the second thought-experiment as in the first, even though the central bank is now willing to sell money for gold at P*.

    Someone who said “there cannot be an excess demand for money, if the central bank is willing to increase the stock of money in exchange for gold, so Say’s Law must be true” would be mistaken.

    How is it different if we replace the central bank buying gold with private banks buying non-money IOUs?

  22. 22 Dan Thorn February 21, 2014 at 1:06 pm

    Don’t recessions and depressions make up the two most famous objections to Say’s Law? If Say’s law were true we wouldn’t have either? or?

    So the challenge is to explain why or how a coin can have one side. (I like that new metaphor you coined).

    Money and time shifting seem like a big part of any explanation, in as much as money allows time to transpire between the two sides of the coin.

    This may not be the whole explanation, but the basic point is that the two sides of the transaction supply and demand do not have to happen at the same time. And there are multiple situations that do and have, and could and will develop where that happens.

    This feels similar to the point you made in the comments about a market that failed to clear by definition having sticky prices.

  23. 23 Greg Ransom February 21, 2014 at 4:03 pm

    David, I did misunderstand you.

    I essentially agree with you.

    I would add, however, that at the time in Germany it was doubted that monetary theories could explain cycle phenomena & it was unclear how marginal valuation formalism could help us think about or causally explain non-equilibrium, Say’s Law violating phenomena.

    What is more, it was unclear if money & credit and choice over more or less lengthy production processes producing superior or inferior output could helpfully be thought about using marginal valuation formalism.

  24. 24 Tom Brown February 21, 2014 at 4:12 pm

    Nick, in the story you tell above about the price of gold, in the first case (not on the gold standard) it seems that the price of gold is one price in the economy that is not sticky. Is that your assumption there? Otherwise I don’t see why the price of gold changes before other prices. Is that your assumption there?

  25. 25 doncoffin64 February 21, 2014 at 4:40 pm

    Dan Thorn–All you have to do is assume that Say’s Law holds in the medium and long run, and that there can be a (brief) adjustment. Say’s Law only holds in the short-run (even the classical economists, I think, conceded this) if the adjustment to any out-of-equilibrium situation was instantaneous.

  26. 26 Tom Brown February 21, 2014 at 4:49 pm

    doncoffin64, is assuming that Say’s Law holds in the long run the same as assuming the long term neutrality of money?

    Take a look at this interesting quote from Lars Christensen:

    “However, in Real Business Cycle models money are assumed to always be neutral – both in the short and the long run. I fundamentally think that is completely crazy and all empirical evidence is telling us that money is certainly not neutral i the short-run. Keynesian and monetarists (and even Austrians) agree on that, but the Real Business Cycle theorists do not agree. They basically think that recessions are a result of people suddenly wanting take have very long vacations (ok, that is not what they are saying, but it is fun…)

    PS As I have stressed before all the different models of the business cycle are basically about different assumptions about the monetary policy rule. Hence, we would in fact be in something, which looked like a Real Business Cycle world if the central bank targets nominal GDP. So if the central bank had got it “perfectly right” then Prescott would have been sort of right, but we of course know that central banks tend to get it horribly wrong.”


    He doesn’t bring up Say’s Law there, but I can’t help but think his sentiment there (concerning RBC) is related. What do you think?

  27. 27 doncoffin64 February 21, 2014 at 4:59 pm

    Tom–I do think that classical economists mostly believed in the long-run neutrality of money (and even, mostly, in the short-run neutrality of money). But I think that’s mostly in connection with the quantity theory of money rather than Say’s Law (Malthus, for example, accepted the quantity theory, as far as I can tell, but not Say’s Law). Note that the operation of Say’s Law really has nothing to do with changes in the quantity of money per se, and it’s the reaction of the economy to changes in the quantity of money (specifically the stability of the velocity of money) that generates neutrality. (And if I’m getting parts of this wrong, someone else will get them right.)

  28. 28 Tom Brown February 21, 2014 at 5:07 pm

    doncoffin64: thanks for your response: but here’s how the quantity of money could tie into Say’s Law… well, for one, just read Nick Rowe’s 2nd comment above. Basically, changing the quantity of money can affect demand for it. Say’s Law say’s there can’t be an excess demand for it. Nick is saying otherwise there: he’s saying changing the quantity of money does change demand, and can create an excess demand in particular. Agree or disagree?

  29. 29 Tom Brown February 21, 2014 at 5:10 pm

    …also, I think more than just the classical economists believe in the long term neutrality of money: so do MMs, and RBCers and probably a lot of other current schools of thought. MMs and a lot of others simultaneously don’t believe in the short term neutrality of money (while RBCers apparently do: if Lars is correct on that score).

  30. 30 doncoffin64 February 21, 2014 at 5:31 pm

    Oh, I agree with Nick. But I don’t think the classical economists really thought of it that way, at least in the long-run. Here’s Mark Blaug (Economic Theory in Retrospect, 5th Ed., p. 616)::

    “Hume clearly grasped the difference between the long-run neutrality and the short-run non-neutrality of money…every classical economist conceded that money was non-neutral in the short run, and, since the label ‘classical economist’ is frequently misused, I mean Malthus, Thornton, Bentham, McCulloch, John Stuart Mill and Torrens. Only Ricardo and James Mill insisted on the proportionality theorem in both the long run and the short run and admitted non-neutrality in the short run only grudgingly when forced, so to speak, in to a corner.”

    Blaug elsewhere notes that hoarding also breaks down the proportionality theorem. (I think that hoarding also punches a hole in Say;s Law.

    I’m not really aware of any classical economists who recognized that money enters into all markets, that is, that there is no single market for money. (Note also Glasner’s argument that it was not until Oskar Lange that the point was clearly made that Say’s Law really applies only in a barter economy.)

  31. 31 doncoffin64 February 21, 2014 at 5:32 pm

    Incidentally, RBC types would appear to believe in the *short-run* neutrality of money as well as in its long-run neutrality.

  32. 32 Tom Brown February 21, 2014 at 7:55 pm

    doncoffin64: re: RBCers, agreed. That was my point about them.

    David: O/T: Sumner says that booms and busts exist (and that monetary policy won’t help much with them), but that bubbles don’t because the EMH is true. I asked Scott a bit about this, but I couldn’t understand his very brief answer. Perhaps you’d be so kind as to give me your view:

    1. A boom is to a bust as a bubble is to a __________? A popped bubble? A recession?

    2. If bubbles did exist, what would distinguish them from booms?

    3. In your view, if monetary policy were perfect, would there still be booms and busts? If so, then if we had perfect monetary policy but still experienced a boom or a bust, would the NGDP level still keep on trend?

    4. How is a bust different than a recession caused by a modest nominal shock in combination with poor monetary policy?

  33. 33 Ludovic Coval February 22, 2014 at 12:07 am


    Could be the question asked in a different way ?

    Like : “Who need Say’s Law and why ?”

    I see some kind of asymmetry between anti-Keynesian and Keynesian here.

    Later don’t need the law to be proven false only to prove why it is false (and Pr Krugman posted a text of this kind on vox some years ago IIRC).

    Classical and Neo-Classical need to prove Say’s Law in order to support the idea that only voluntary/’technological’ unemployment exist.

    Political implications seem to play a greater role than pure economic analysis since a valid Say’s Law allow only for supply side policies.

    NB : Sorry for my bad English, this is not my native language.

  34. 34 JP Koning February 22, 2014 at 5:27 am

    “Now repeat exactly the same experiment, but now with a central bank on the gold standard. It initially sets the price of gold at P’, and then it suddenly cuts the price of gold to P*.”

    Nick, I puzzled over this for a bit. I think that if this were to happen, everyone would very quickly bring their banknotes to be converted into gold at the central bank’s till and the central bank would very quickly cease to exist. By reducing the price of gold to P*, The central bank is essentially offering people an arbitrage opportunity. They can continue to spend their dollars to buy the same quantity of stuff as before (prices are sticky, after all), or they can sell those dollars to the central bank for a larger quantity of gold, and then sell that gold in the market for a larger quantity of stuff than they otherwise would have been capable of purchasing. People will take the second option… at least until the central bank closes this opportunity off, or all its notes have been extinguished and it has no more liabilities outstanding.

    The same would apply in a competitive setting. It’s not apparent to me why banks would ever collectively cut the price of gold to P* if doing so threatened their existence.

  35. 35 Tom Brown February 22, 2014 at 3:15 pm

    David, JP, Nick, or anybody else: what do you think of the following as an alternative (more general) description of good monetary policy:

    “Good monetary policy should seek to do no harm to the economy.”

    Because given that you have a CB, then it will have a policy, right? Some policies will do more harm than others. Can we estimate what would have happened had monetary policy done no harm?

    I’m partly inspired by Information Theory here: An information engineer can precisely calculate the theoretical upper bound on the information capacity (in bits/sec) of a communication channel w/o having to specify how to achieve it. That’s the Shannon Capacity:


    A related concept in engineering (producing another bound, but not necessarily a very tight one) is the “Fischer Information Matrix” (FIM):


    It’s “a way of measuring the amount of information that an observable random variable X carries about an unknown parameter θ upon which the probability of X depends.”

    I’m used to thinking of the inverse of the FIM, which gives the smallest possible covariance achievable on an estimation error. The bound is not very tight in all circumstances, but it’s useful because it’s generally easy to calculate, and thus gives you a quick estimate for how well it’s possible to do. Can you guess what’s required for the bound to be tight? Everything’s got to be Gaussian. Ha!

    Anything like that in macro?

  36. 36 Tom Brown February 22, 2014 at 3:18 pm

    David I’ve got one in “moderation”… probably because it had links?

  37. 37 Tom Brown February 22, 2014 at 4:03 pm

    JP, while you’re looking at this, what do you think of Nick’s summary of good monetary policy (in David’s post): I’d asked you on your blog some time agao… about the time you were swamped, so you probably had better things to do at the time. But now that it’s come up again… what say you?

  38. 38 David Glasner February 22, 2014 at 6:16 pm

    Tom, Here’s the point about that quote. It implies that Say’s Law is characteristic of an economy that is to use a term I once picked up from Kartik Arthreya “functioning well.” My discussion of Clower and Leijonhufvud and Hutt was intended to show that that may be a misunderstanding of Say’s Law.

    Jesse, Maybe you’re right, but, as I just remarked to Tom Brown, that’s not the interpretation of Say’s Law suggested by Clower and Leijonhufvud and Hutt.

    Nick, I will have to think some more about your thought experiment before responding.

    Dan, Refer above to my two responses to Tom and Jesse. The point is to get people to think about Say’s Law in a different way than they are used to thinking about it.

    Don, Actually, by citing Hayek’s early mention of Say’s Law, I was trying to show that Lange was just formalizing an idea that was already well established, that Say’s Law only holds strictly in a barter economy.

    Tom, As far as I am concerned, there is no clear distinction between boom and expansion and bust and recession. That doesn’t mean that there is no way of making a distinction, just that I don’t have one at the tip of my tongue. I don’t believe in EMH, but I don’t have a good definition of a bubble, but if the value of an asset implies a flow of revenues that are extremely unlikely to be realized, that seems like a bubble.

    Ludovic, I am trying to move the discussion away from the simple dichotomy that you are proposing. Apparently, no one is paying any attention to me. This post the third most traffic in any single day in the two and a half years since it started. Obviously people seem to have a lot invested in whatever way they have been brought up to think about it. And they don’t want to change.

    JP, I will have to think about your response to Nick as I try to figure out what my response to him should be.

    Tom, Sorry, but I don’t think that I have anything to offer on your suggestion.

  39. 39 Tom Brown February 22, 2014 at 6:56 pm

    David, thanks for your responses. I’m going to re-read your article here once again and see if I can get more of what you’re saying. BTW, Becky Hargrove has put up her own post on the subject:

    I’m very interested to see what you come up w/ as a response to Nick and JP. But what about Krugman?

    Also, you might be interested in this (I asked Mark the same O/T question):
    I didn’t know you were not an EMH fan. Interesting.

  40. 41 Ludovic Coval February 22, 2014 at 11:30 pm


    Sorry if my post don’t seem to fulfill your expectation and I certainly did not had any intend to derail your proposition. My reply was triggered by :

    “…in which I made passing reference to Keynes’s misdirected tirade against Say’s Law in the General Theory.”

    I’m not arguing that you are wrong there but, as I understand GT, Keynes emphasizes on Say was about convincing economist of the time. I may well be corrected on this point, but I’m under strong impression that GT could have been wrote without any mention to Say’s Law.

    Since your post title is “Who’s Afraid of Say’s Law?” I see, for now, no reasons for which Keynesians (Marxists ?) should be afraid of Say’s Law, but they would most likely if nothing like involuntary unemployment exist.

    This said, as I consider myself as a ‘Keynesian’ there could be some truth on willing to change but ‘resistance’ was not my intent.

  41. 42 David Glasner February 23, 2014 at 11:13 am

    Nick, I am trying to gradually think my way through your thought experiment, so I will just offer some initial reactions.
    Starting with your first case in which the central bank cuts the stock of money in half. Just to keep it simple, I will suppose that there is no private banking system, so that all money is government issued fiat money. The price of gold is initially P’ and after the 50% reduction in the stock of money, the price of gold falls to P*. You intentionally or inadvertently failed to specify the relation of P’ to P*. Because the price of gold is the only price that is changing quickly, it is not clear that P* corresponds to value of gold in an equilibrium price vector corresponding to a money stock only half as large as the initial money stock. Presumably in the new equilibrium price vector the value of all nominal prices would be half of the corresponding nominal price in the original price vector. But it’s not clear what the value of gold will be in the price vector immediately following the reduction in the stock of money.

    However, by comparing the second thought experiment to the first one, I am guessing that you are implicitly assuming that P* is indeed 50% of P’, otherwise I don’t see how you could assume that the two thought experiments would arrive at the same solution. Now I agree that you would be pretty likely to get an across the board reduction of all nominal prices in the second experiment. But that is because there would be a basis for everyone to form expectations that all prices would fall by 50% since it would be clear that the value of the currency unit was simply being revalued. If the first thought experiment were conducted in such a way that everyone could form expectations in advance that all prices would fall by 50% (a currency reform), then you would get a quick transition from one equilibrium to the other without much disruption, but the key would be that expectations would be governed in a fairly direct way by a simple and unambiguous change in the monetary regime.

    You said:

    “Someone who said ‘there cannot be an excess demand for money, if the central bank is willing to increase the stock of money in exchange for gold, so Say’s Law must be true’ would be mistaken.”

    I am having a little bit of trouble with this for the following reason: If restoration of equilibrium in response to a policy change requires an exchange of gold between the public and the central bank, it seems to me that the relative price of gold will have to change to induce the public to change its desired holdings of gold correspondingly. Monetary policy will have had a real effect on relative prices, so monetary policy is not neutral. So something is wrong here.

  42. 43 Tom Brown February 23, 2014 at 4:14 pm

    I think I have one in spam, but not a biggie (I can’t recall what it was).

  43. 44 Tom Brown February 23, 2014 at 4:16 pm

    Ah, one thing in my spammed comment was to alert you that Becky Hargrove has a Say’s Law post up (Feb 21). I’ll skip the link this time.

  44. 45 Nick Rowe February 24, 2014 at 6:42 pm

    David: Let me restate more clearly:

    Assume the price of gold is perfectly flexible, but all/most other prices are sticky.

    1. If the central bank suddenly cuts the money supply by 50%, the price of gold will fall by X%. (We don’t know what X is, but only by sheer fluke would X=50%, except if all prices were perfectly flexible, which they aren’t.) And we get a recession, with an excess supply of goods.

    2. Now suppose we have a central bank that buys and sells gold on demand at an announced target price. Suppose the bank suddenly cuts the target price of gold by the same X% as in 1 above.

    I say that the effects of 1 and 2 are (almost exactly) the same.

    JP: In 1, we can imagine that the central bank cuts the money supply in half by selling half its stock of gold reserves. Same as in 2. Or we could imagine it sells bonds, or whatever else it owns. Same as in 2.

  45. 46 Tom Brown February 26, 2014 at 1:45 pm

    David, O/T: I asked a question to which Nick Rowe responded here:
    I outlined a method by which the gov could increase the quantity (and thus the supply) of base money: nationalize the commercial banks, thus making their deposits base money. Nick said this would increase demand proportionately and thus nullify the effects on long term price levels. Do you agree? If so, how can we distinguish between various methods of increasing base money supply given that some may affect demand as well? Thanks.

  46. 47 Tom Brown February 26, 2014 at 2:10 pm

    David, keep in mind in my hypothetical world, before nationalization reserves = $1 and bank deposits = $10.

  47. 48 Tom Brown February 26, 2014 at 6:20 pm

    David, you can ignore the above two comments… Mark Sadowki shed some light… but still I’m left unsatisfied. This is a summary of my pursuit of this matter:


  48. 49 David Glasner February 27, 2014 at 9:15 am

    Nick, Thanks for your clarification.

    As I indicated in my earlier response, I am not so sure that two cases under comparison are as close as you are suggesting. One problem is that you haven’t stated whether you are assuming that the central bank in the second case is announcing its intention in advance to reduce the quantity of money by x%. If it does so, that would tend to make the two cases more similar, but I am still dubious that the responses would be very close. The reason I think that they are different is that when the central bank announces that it is increasing the gold content of the currency by x%, I think that that information is very rapidly incorporated into the plans of agents, so that despite your assumption that prices are generally sticky, in this case I think that nominal prices would actually adjust pretty rapidly. In the second case, if the central bank pre-announces that it is reducing the money supply by x%, there might be an immediate response in sticky nominal prices, but I think it would be a weaker response than in the gold standard case. The difference I suspect would be that the effects of a change in the gold content of the currency is more transparent than the effect of an announced change in monetary policy, so there would be more price friction in the latter case than the former. Anyway, that’s my hunch.

    Tom, After about 90 seconds of thought, I think I agree with Nick (usually a pretty safe decision rule). If the deposits of the nationalized bank were held willingly, then, unless there is some reason to assume that the demand for those deposits changes as a result of the nationalization, I don’t see any reason why we should assume that the demand for and the supply of base money have not increased by the same amount so that there is approximately no effect on prices as a result of the nationalization. How to distinguish between different methods? You have to analyze each case. But usually the assumption is that the increase in the supply of the monetary base is independent of the demand. However, with the payment of interest on reserves, that assumption has clearly not been correct.

  49. 50 Tom Brown February 27, 2014 at 12:30 pm

    David, thanks for your reply. If you follow that thread down further it gets a bit more messy with Sadowski and Sumner answering my questions on this as well. It’s interesting that you side with Nick here… I realize that’s only a 90 second analysis. :D

    It’s not clear that Nick’s views are compatible with Sadowski/Sumner on this to me. Sadowski is somewhat “mystified” by what Nick wrote (and I am too after absorbing his argument)

  50. 51 Tom Brown February 27, 2014 at 3:59 pm

    David, briefly, it sounds like your view is:

    1. The fact that there was a demand for bank credit (bank deposits) prior to nationalization, just means this demand was transferred to money when bank credit was replaced with national bank deposits. True?

    2. Unlike nationalization, methods to increase money stock typically don’t affect demand for money, and thus do have an effect on P

    MMs typically say that the neutrality of “money” does not work on credit, but on base money I think. When Sumner writes “money” he means “base money.”

    Your explanation for why demand for money went up when supply went up seems to hinge on a substitution principle: Demand for a non-money item (credit) was replaced with a close approximation (money) when the latter disappeared. Close?

    What if rather than nationalization, a gov national bank simply out-competed the private banks with the same result: only a single national bank in the end (maybe they offer a better deposit rate). Any difference?

    Could this transfer of demand from non-money to money happen with other non-money items, like Tsy bonds?

  51. 52 ikpeba March 13, 2014 at 5:39 am

    In your passage, requoted below, where you introduce the argument that Say’s Principle may be restored once consideration is given to the adoption of bank money, and corresponding private credit instruments that can be exchanged for bank money; my question to you is whether you think this is a roundabout way of introducing, if only in the theory, the possibility of negative interest rates ie demand for money being sufficient to take rates below zero, and therefore clearing the glut of supply?

    “Thus, any excess demand for money would be offset not, as in the Lange schema, by an excess supply of goods, but by an excess supply of money-backing services. In other words, the public can increase their holdings of cash by giving their IOUs to banks in exchange for the IOUs of the banks, the difference being that the IOUs of the banks are money and the IOUs of customers are not money, but do provide backing for the money created by banks. The market is equilibrated by adjustments in the quantity of bank money and the interest paid on bank money, with no spillover on the real sector. With no spillover from the monetary sector onto the real sector, Say’s Law holds by necessity, just as it would in a barter economy.”

  52. 53 David Glasner March 14, 2014 at 9:21 am

    ikpeba, That’s not what I was thinking. I guess I need for you to explain to me the connection between the two.

  53. 54 ikpeba (@wealthoflabour) March 17, 2014 at 2:41 pm

    My query is whether in a system of private money, where the exchange between money and private IOUs is regarded as insulating the real economy from adjustments associated with rising demand for money, this is because money can be bid up above par? If not, it is not clear to me why the existence of this intermediary IOU market should be relevant in conserving Say’s Law?

    I have a vested interest in the concept of negative rates as a key pillar of financial stability, and wider economic stability, because this is something I have written about at http://wealthoflabour.wordpress.,com

    Thanks for your interesting posts!

  54. 55 Babatunde Valentine Onabajo April 2, 2014 at 11:49 am

    Reblogged this on The Lucas Critique.

  55. 56 assman November 1, 2015 at 7:44 am

    “In other words, the public can increase their holdings of cash by giving their IOUs to banks in exchange for the IOUs of the banks, the difference being that the IOUs of the banks are money and the IOUs of customers are not money, but do provide backing for the money created by banks. The market is equilibrated by adjustments in the quantity of bank money and the interest paid on bank money, with no spillover on the real sector. With no spillover from the monetary sector onto the real sector, Say’s Law holds by necessity, just as it would in a barter economy.”

    And what if the part of the public that has an increased demand for cash, is the one you would never consider loaning money to because regardless of interest rates there is very low probability they will ever pay in back? You are assuming that there is an interest rate high enough to compensate the bank for default risk and thus induce the bank to take the IOU’s of the public. However there may not be since the bank may conclude that the IOU’s have no chance of being liquidated.

    But all these cases are too theoretical and filled with big words. You would do better for us if you actually gave specific examples and explained the mechanics. Basically you are saying that in the event that for instance sub-prime borrowers or an investment bank like Lehman had a huge demand for cash they could just go to the banks. Interest rates would go up until they sufficiently compensated the banks for default risk and the trade would take place. I’m saying it wouldn’t. The banks would simply refuse to lend because they would consider it too risky and the excess demand would never be met.

  1. 1 Links for 02-21-2014 | The Penn Ave Post Trackback on February 21, 2014 at 12:16 am
  2. 2 HearSay Economics | NEWS.GNOM.ES Trackback on February 21, 2014 at 5:27 am
  3. 3 Sobre la ley de Say | Método socrático Trackback on February 21, 2014 at 7:18 am
  4. 4 [21-2-14] Sobre las sombras de las guerras Macro | Caótica Economía Trackback on February 21, 2014 at 1:10 pm
  5. 5 Who’s Afraid of Say’s Law? « Economics Info Trackback on February 22, 2014 at 12:00 am
  6. 6 Krugman’s blog, 2/21/14 | Marion in Savannah Trackback on February 22, 2014 at 4:02 am
  7. 7 What Does Say Say? | Economics 411: Monetary and Financial Theory Trackback on February 26, 2014 at 9:35 pm
  8. 8 The Pot Calls the Kettle Black | Uneasy Money Trackback on July 17, 2015 at 11:26 am
  9. 9 Krugman’s Second Best | Uneasy Money Trackback on July 30, 2015 at 1:22 pm

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About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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