Responding to Scott Sumner

Scott Sumner cites this passage from my previous post about coordination failures.

I can envision a pure barter economy with incorrect price expectations in which individual plans are in a state of discoordination. Or consider a Fisherian debt-deflation economy in which debts are denominated in terms of gold and gold is appreciating. Debtors restrict consumption not because they are trying to accumulate more cash but because their debt burden is so great, any income they earn is being transferred to their creditors. In a monetary economy suffering from debt deflation, one would certainly want to use monetary policy to alleviate the debt burden, but using monetary policy to alleviate the debt burden is different from using monetary policy to eliminate an excess demand for money. Where is the excess demand for money?

Evidently, Scott doesn’t quite find my argument that coordination failures are possible, even without an excess demand for money, persuasive. So he puts the following question to me.

Why is it different from alleviating an excess demand for money?

I suppose that my response is this is: I am not sure what the question means. Does Scott mean to say that he does not accept that in my examples there really is no excess demand for money? Or does he mean that the effects of the coordination failure are no different from what they would be if there were an excess demand for money, any deflationary problem being treatable by increasing the quantity of money, thereby creating an excess supply of money. If Scott’s question is the latter, then he might be saying that the two cases are observationally equivalent, so that my distinction between a coordination failure with an excess demand for money and a coordination failure without an excess demand for money is really not a difference worth making a fuss about. The first question raises an analytical issue; the second a pragmatic issue.

Scott continues:

As far as I know the demand for money is usually defined as either M/P or the Cambridge K.  In either case, a debt crisis might raise the demand for money, and cause a recession if the supply of money is fixed.  Or the Fed could adjust the supply of money to offset the change in the demand for money, and this would prevent any change in AD, P, and NGDP.

I don’t know what Scott means when he says that the demand for money is usually defined as M/P. M/P is a number of units of currency. The demand for money is some functional relationship between desired holdings of money and a list of variables that influence those desired holdings. To say that the demand for money is defined as M/P is to assert an identity between the amount of money demanded and the amount in existence which rules out an excess demand for money by definition, so now I am really confused. The Cambridge k expresses the demand for money in terms of a desired relationship between the amount of money held and nominal income. But again, I can’t tell whether Scott is thinking of k as a functional relationship that depends on a list of variables or as a definition in which case the existence of an excess demand for money is ruled out by definition. So I am still confused.

I agree that a debt crisis could raise the demand for money, but in my example, it is entirely plausible that, on balance, the demand for money to hold went down because debtors would have to use all their resources to pay the interest owed on their debts.

I don’t disagree that the Fed could engage in a monetary policy that would alleviate the debt burden, but the problem they would be addressing would not be an excess demand for money; the problem being addressed would be the debt burden. but under a gold clause inflation wouldn’t help because creditors would be protected from inflation by the requirement that they be repaid in terms of a constant gold value.

Scott concludes:

Perhaps David sees the debt crisis working through supply-side channels—causing a recession despite no change in NGDP.  That’s possible, but it’s not at all clear to me that this is what David has in mind.

The case I had in mind may or may not be associated with a change in NGDP, but any change in NGDP was not induced by an excess demand for money; it was induced by an increase in the value of gold when debts were denominated, as they were under the gold clause, in terms of gold.

I hope that this helps.

PS I see that Nick Rowe has a new post responding to my previous post. I have not yet read it. But it is near the top of my required reading list, so I hope to have a response for him in the next day or two.

12 Responses to “Responding to Scott Sumner”


  1. 1 W. Peden September 14, 2014 at 10:10 am

    I’m starting to get my head around this debate, I think. For what it’s worth, I find your argument in this post persuasive.

  2. 2 Lord September 14, 2014 at 11:19 am

    You can’t just consider debtors though. Creditors are doing better and that money they are piling up, whether due to satiation for consumption, fear of needing it in the future, lack of investment opportunities foreseen, or simply inertia, still presents a default demand for money even if more a greater lack of demand for everything else. If they were increasing their spending on consumption or investment as much as they were gaining, there would be no recession, but their expectations aren’t rising as much to compensate for the diminshment of those of debtors. Debtors seeking to reduce their debt still represent a demand for money through a negative demand for its opposite.

  3. 3 Lord September 14, 2014 at 12:42 pm

    One can read all the explanations into the debtor creditor dynamic though. From low to high propensity to save, spending to hoarding, investment to liquidity, optimism to pessimism, confidence to uncertainty, reward to risk, greed to fear, opportunities to their dearth, advancement to regression, growth to decay, boom to bust. The asymmetry being people don’t borrow money to save it, nor lend money to lose it.

  4. 4 Tom Brown September 14, 2014 at 12:46 pm

    David, I’m a rank amateur, but I undertook one day to really dig in and try to understand one of Nick Rowe’s posts by making a plot of what the heck he was talking about. Scott Sumner also had a related post about the same time, so it worked out great for me in that regard. I put up a post myself, including my notional plots, just for the purpose of trying to work through Nick’s (highly contrived) example and relate it to Scott’s post.

    Re-reading that now, and looking at your statement above:

    “I don’t know what Scott means when he says that the demand for money is usually defined as M/P. … To say that the demand for money is defined as M/P is to assert an identity between the amount of money demanded and the amount in existence which rules out an excess demand for money by definition, so now I am really confused.”

    Here’s a thought I had: Nick always distinguishes between “the demand for X” (which he emphatically describes as a curve or a function) and “the quantity of X demanded.” X could be money. Is that’s what’s going on here?

    I noticed in my old plots above, I had 1/P on the y-axis. The money demand curves (Md0 and Md1) in my plot carve out “rectangular hyperbolas” with Nick’s simplified equations for his hypothetical economy:

    Md = P*Y

    So with 1/P on the y-axis, and Y fixed, the Md curve draws out a classic rectangular hyperbola:

    (1/P)*Md = Y

    if we take the x-axis to be the quantity of money supplied and set the quantity of money supplied equal to the quantity of money demanded by definition.

    So to make a long story even longer, perhaps Scott is thinking quantity supplied = quantity demanded always, but this is different from the money demand curve, which might have a functional form such as (1/P)*Md = Y.

    That’s how I think Nick’s old example worked: the CB lowers the interest rate from r0 to r1 (my upper plot), which, through the action of the borrowers’ “supply of loans” curve forces Ms up from Ms0 to Ms1. If prices are sticky and P stays fixed at P0 for some time, then we are forced from the Md0 curve in the lower plot, to the Md1 curve in the near term. Or somewhere between the two (assuming a combination of increases in Y and or P get us to the new Ms1, where quantity demanded must equal quantity supplied).

    I like to think of it like this: we’re in long term equilibrium at Y=Y0 and P=P0. The CB lowers the interest rate from r0 to r1 forcing Ms up from Ms0 to Ms1, but prices are sticky so P initially stays put at P0, forcing us from the Md0 curve to the Md1 curve (an excess supply of money, which is equivalent to a negative excess demand for money), and forcing Y from Y0 to Y1. As time goes by and Y returns to Y0 from Y1, then P simultaneously increases from P0 to P1, and we return to our original Md0 curve (no longer an excess supply of money). I realize that wasn’t either Nick’s or Scott’s intent with that example precisely, but that helped me imagine what’s going on.

    So the “excess supply” or “excess demand” for money is determined by which Md curve you’re on at the moment vs what Md curve you should be on long term. This is different than the quantity of money demanded, which is always equal to the quantity of money supplied.

    Did any of that make any sense or should I seek “professional help?”

  5. 5 sumnerbentley September 15, 2014 at 6:53 am

    David, You said:

    “The case I had in mind may or may not be associated with a change in NGDP, but any change in NGDP was not induced by an excess demand for money; it was induced by an increase in the value of gold when debts were denominated, as they were under the gold clause, in terms of gold.”

    I think we are talking past each other. I define “money” as the medium of account. So if more gold demand is the problem, then it is a money demand problem using my terminology. In that case we agree, we are simply using different terms. And in that case you’d want a central bank policy lowering the demand for gold. Whether they had the ability to do this is of course debatable. (I suppose the value of gold could have also risen due to revaluation, or less supply, but I assume you had more gold demand in mind.)

    And yes, when I said the “demand for money is M/P or K” I should have said the “quantity of money demanded.” Of course in the money demand literature you almost never see anyone say “the quantity of money demanded,” AFAIK.

    In my terminology, any change in NGDP not caused by a change in the money supply, is caused by a change in money demand, using the term loosely to apply to the Cambridge K. The relevant distinction is not between “monetary” and “non-monetary” in the usual sense of money supply shocks, it’s between problems that would occur under NGDP targeting, and those that would go away under NGDP targeting.

  6. 6 Tom Brown September 15, 2014 at 11:10 am

    Scott writes:

    “And yes, when I said the “demand for money is M/P or K” I should have said the “quantity of money demanded.” Of course in the money demand literature you almost never see anyone say “the quantity of money demanded,” AFAIK.”

    Well if you count Nick Rowe’s blog as “money demand literature” I know form personal experience he’ll admonish commentators who mix up “supply” and “quantity supplied” and “demand” and “quantity demanded.”

  7. 7 sumnerbentley September 15, 2014 at 3:45 pm

    Tom, I do too, but not on money demand for some reason. Perhaps I should. It’s understood that when we talk about an increase in Md we mean both that the curve shifted and that the real quantity of money demand shifted.

  8. 8 David Glasner September 15, 2014 at 6:45 pm

    W Peden, Good to hear. Keep me posted as your thinking evolves.

    Lord, Good point, but a willingness to hold cash is not the same as an excess demand for cash. Also, don’t forget that as the deflation proceeds, many creditors don’t get paid, and income keeps contracting. I find it implausible to think that the contraction is being driven by an excess demand to hold cash balances.

    Tom, Yes I think, and Scott confirms this in his subsequent comment, that he was not distinguishing between demand as a function and quantity demanded at a point on the function. The rectangular hyperbolic demand curve is not really a demand for money. It is just saying that a given real demand for money, M/P, is consistent with all the combinations of M and P on a particular rectangular hyperbola. The rectangular hyperbola could shift for a variety of reasons such as the state of the economy, or the interest foregone when holding cash. But you seem to have the basic idea.

    Scott, I was trying to avoid assuming that gold was the medium of account. I was thinking of a case in which dollars were the medium of account, as in the USA under the gold standard, but with gold clauses added to loan contracts entitling the creditor to be paid back in dollars adjusted for depreciation against gold. I understand that you are using excess demand for money as a kind of shorthand, but I am trying to suggest that it is useful to think more deeply about why NGDP could fall. In other words, I am saying that there can be deeper causes of a recession than merely too little cash. I hate to give aid and comfort to the enemy, but there can be some — for want of a better term — structural problem afflicting an economy in recession. I wouldn’t say that the problem is that the production process became excessively roundabout – that seems totally implausible to me – but there may be other ways in which the economy has become discoordinated, a discoordination that may well lead to a reduction in total factor productivity, and thus superficially resemble a supply shock. Of course, if there is a debt-deflation spiral, the problem is relatively easy to solve with monetary expansion, but there may be other more intractable problems that cannot be so easily addressed. But I am not really thinking about policy, just trying to clarify what the process is that leads to a recession.

  9. 9 Frank Restly September 16, 2014 at 7:56 am

    David,

    “But I am not really thinking about policy, just trying to clarify what the process is that leads to a recession.”

    I can think of several non-monetary causes of a recession:

    1. Breakdown of the legal system – theft, fraud, and looting become rampant
    2. Natural / manmade disaster – plague, war, etc.
    3. Voluntary reduction in standard of living – people revert to “simpler” lives

    One other thing, one or more qualities of the medium of exchange may be insufficient at some point in the future. It took several thousand years for mankind to move from stones / seashells as a medium of exchange to ink covered paper notes. There is no reason to believe that ink covered notes will be a viable medium of exchange a thousand years from now.

  10. 10 nottrampis September 17, 2014 at 6:58 pm

    David,
    your last link is Nick Rowe not Scott Summer.
    I am tempted to say it is the front rowe and out of season!

  11. 11 sumnerbentley September 21, 2014 at 4:54 pm

    David, I don’t think it makes sense to think about “causation” without thinking about policy counterfactuals. There are supply shocks, and problems that can be addressed with suitable monetary policy. That’s all, there are no other causes of recessions. Or at least none that I’m aware of. But perhaps that’s because I define “supply shocks” as things that would make RGDP fall even if NGDP was stabilized. But I also think my approach is consistent with the AS/AD model taught in econ 101.

  12. 12 David Glasner October 5, 2014 at 2:36 pm

    Frank, I agree that those are potential causes of recessions. There are many others as well. I also agree that there may be a point in the future when tangible assets will no longer be used as money, but, even though we seem to be moving very rapidly in that direction, the amount of physical currency being held continues to increase.

    nottrampis, Sorry, couldn’t figure out which link you were referring to.

    Scott, The simple AS/AD model cannot easily accommodate the kinds of coordination failure that I think may be important. That’s a consequence of the highly aggregated nature of the standard Keynesian and most other macro models, which is one reason why macroeconomics, since Keynes, has lost the intuitive understanding of coordination failures that was being developed in the pre-Keynesian period. That is the subject of an as yet unwritten post.


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. 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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