Monday, December 13, 2010

Scarcity and Unemployment

A key principle of macroeconomics is scarcity. There are not enough resources, including labor, to produce all goods and services in quantities sufficient for everyone to achieve their goals. While it is possible to over produce one or a few goods, perhaps even to the point where those particular goods are no longer scarce, what that overproduction means is that resources are devoted to expanding production to a point where those goods are worth less than their opportunity cost. The opportunity cost is the value of the other goods that could have been produced instead. Overproduction of some goods means underproduction of other goods. In a world of scarcity, a general glut of goods must be due to a coordination failure.

Arnold Kling fails to grasp this important principle of macroeconomics. He argues that a general glut of goods is not necessarily due to an excess demand for money. He instead sticks with his "recalculation" story. That story combines a common place and correct idea with a novel and absurd idea.

The common place idea is structural unemployment. Some parts of the economy shrink and others grow. People lose jobs in the shrinking sectors of the economy and obtain new jobs in the growing sectors of the economy. Because of a mismatch of skills, this process can be painful and gradual. Those who lose their jobs in shrinking sectors may remain unemployed for a substantial period of time before they are employed in the growing sectors of the economy.

A situation of structural unemployment involves matching shortages and surpluses in product markets. For example, if the demand for new homes falls 50 percent and new homes make up 10 percent of the economy, then the demand for other products in the economy should grow more than otherwise. To offset those shrinking sectors, the real volume of demand for the other products of the economy should grow approximately 5 percent. With growing productive capacity due to a growing labor force, saving, investment and capital accumulation, and improved technology, the real volume of demand in the rest of the economy should be growing a bit more than 8 percent.

If, on the other hand, the demand for other goods and services grows less than 8%, which would include zero or else the demand for other products shrink as well, then the problem isn't "structural." That is, the problem isn't simply difficulties in shifting labor from where it is needed less to where it is needed more.

Kling's innovation is to claim that some industries are shrinking because people don't want the products any more, and nothing is growing because people don't know what they want instead. It is necessary to recalculate and discover what people want to buy. Certainly, this view has a certain appeal. If those spending less on houses had wanted to spend on something else instead, the demands for those goods would have risen.

The problem with this argument is that it ignores scarcity. There are not enough resources (including labor) to produce all good in quantities sufficient for everyone to achieve their goals. There are any number of goods, currently being produced, that could be produced in larger quantities and help people achieve their goals. Resources would be needed to produce those goods and services.

To say that houses are over produced is to mean that the value of the additional homes is less than their opportunity costs. The opportunity cost is the value of the other goods that could have been produced with the resources. The reason to reduce the production of houses is to free up labor and other resources to expand the production of those other goods that are the opportunity cost of producing the houses.

But clearly, individuals who don't want to buy houses can instead just hold money. And that is the problem. When people choose to hold more money than the existing quantity, then total spending in the economy falls. It is still true that scarcity exists and that the reason to reduce the production of homes is that the resources could be used to produce other more valuable goods, but nominal expenditures on those other goods doesn't increase.

What happens? It depends on monetary institutions.

Suppose the monetary institution is a 100 percent reserve gold standard, and people decide that they don't want to purchase new houses, and instead want to hold more gold rather than spend on some other good or service. People are laid off from the housing industry. There is no increase in demand for any other good, other than gold mining. So, it is necessary for the unemployed workers to just wait until someone comes up with a new product that tickles the fancy of the former home buyers. Right?

WRONG!

What happens is that the surplus of labor and other resources results in lower resource prices, including wages. This reduces the costs of producing various products, and so, firms expand output of those goods and lower their prices enough so that people will purchase the additional output.

While the lower prices appear to make it possible for people to be able to buy more products, the lower wages and other resource prices means that money incomes are lower as well. However, the real value of the gold has increased. Everyone who holds money earns a real capital gain. Now, if the former home buyers still have no desire to buy anything, they just have higher real money balances. But other people, who also hold money, earn a real capital gain. And some of them could use more consumer goods and services. And they buy more of them.

The real volume of expenditures on various goods (and perhaps, to some degree housing) rises enough to match the productive capacity of the economy. By far, the most likely scenario is that the real demand for houses is lower and the demand for other goods rise. There is still a need to redeploy resources from the housing industry to other industries. However, there is no need to wait for somone to find some product that appeals to those who don't want to buy houses and instead want to hold money. The level of prices (and wages) fall enough that the real quantity of money rises enough that some of those holding money expand their expenditures on goods and services. Other people holding money who do want more of the existing goods buy them.

Suppose instead the nominal quantity of money is increased to match the additional demand for money. Those who don't want to buy houses and just don't want to buy anything else, hold more money. The quantity of money is increased enough to offset the increase in the demand for money and keep money expenditures growing with the productive capacity of the economy.

How is the quantity of money increased? Suppose it increases by helicopter drop. New money is printed and dropped out of helicopters. People pick up the money. Those people who have nothing they want to spend money on, presumably just hold the additional money. (I suppose they rake up whatever appears in their yard because some good may appear at some unknown future time that they will want.) However, all of those people who are currently holding money, not because they don't want additional goods and services, but instead only because they prefer holding the money, spend at least some of the additional money on whatever it is that they want.

Given a sufficient increase in the quantity of money, the demand for the scarce goods that those picking up the money want will increase enough so that total spending matches productive capacity. Perhaps some of those picking up money buy houses, but the likely result is that there will still be less spending on houses and more on other things. There remains a need to redeploy resources away from houses and towards other goods.

In the real world, the closest thing to a helicopter drop of money is a tax cut financed by money creation. The government cuts taxes and instead borrows money by selling bonds. The central bank buys the bonds with new money created out of thin air. Again, those people who used to buy houses and were holding more money because they could think of nothing else to do with it, presumably just hold on to the additional money they receive. However, other people, who are holding money despite valuing the additional goods they might buy, spend the additional money on whatever goods they want the most. Perhaps some of them spend more on houses. Given sufficiently large tax cuts funded by money creation, total spending will rise enough to match the productive capacity of the economy. The most likely scenario will be that fewer houses are demanded and more other goods are demanded. There remains a need to redeploy resources, including labor, from the production of houses to other goods.

Suppose that instead of these schemes of creating "outside" money and giving it away, instead, money is "inside" and lent into existence. Those who used to buy houses and instead hold money because they have nothing else they want to buy are clearly saving. By holding money, they are choosing to lend additional funds to the banking system. The demand to hold inside money represents increased lending to the issuing banks--either private banks or the central bank. The money issuer (or issuers) then expand the quantity of money enough to match that increase in demand to hold money. With inside money, new money is issued by lending. This could be in the form of loans, but it can also occur through the purchase of already existing bonds.

As the money issuers expands loans (or purchases bonds,) they lower interest rates. The lower interest rates provides an incentive to reduce saving and so, increase consumption, or else expand investment. Further, the reduced interest rates that the money issuer or issuers can earn also reduces the interest rates they can pay on the money. This reduces the benefit from holding money, and so results in some of those holding money spending it on consumer goods or capital goods.

Superficially, the increase in the quantity of inside money requires an increase in debt. And it certainly requires that the money issuers hold more debt. However, it is entirely possible for the money issuers to expand their market share in the credit market, so that while the quantity of money expands, total lending actually shrinks. How can spending on goods and services expand, even if total lending shrinks? All that is necessary is that some of those who would have lent by holding existing bonds instead sell them and spend on consumer good or capital goods.

Interestingly, because money issuers pay lower interest rates than they charge, it is possible that the decrease in interest rates could go so far as to make the interest rates "paid" on money negative. This is interesting, because those who spend less on housing and then just hold money because they have nothing better to do with it, may have to pay.

The changes in interest rates motivate people who have use for additional goods ands services to purchase them. To some degree, this will be people borrowing money that they must pay back later, but it also could involve people spending more out of current income on consumer good and services or capital goods. And it can involve people selling off previously accumulated assets to fund purchases of consumer goods and services or capital goods. (And, yes, the zero nominal bound on interest rates can cause problems with a pure inside monetary system.)

The resolution of monetary disequilibrium, either through a lower price level and increased real balances, or an increase in the nominal quantity of money, results in increased real expenditures on scarce goods and services. Resources are shifted from the production of goods that people don't want to the production of goods that people do want. As long as there are scarce goods, as long as there are some people who want to purchase consumer good and services or capital goods, the correction of monetary disequilibrium will result in increased production of those goods. There is no need for the particular individuals who chose to reduce spending and accumulated money balances to choose to spend on anything in particular. The process that corrects monetary disequilibrium, whether a lower price level, helicopter drops, or reduced interest rates, results in increased expenditures on goods and services by other people.

The notion that it is necessary to wait until some new good is found that will appeal to those demanding fewer existing goods, and that production should or must be reduced until such products are found is an error. It is an error that ignores the fundamental reality of scarcity.

11 comments:

  1. I like this debate. How would you explain the unemployment concurrent with inflation in the 1970s? The inflation would to me indicate sufficient demand. Would you chalk it all up to changes in the rate of inflation or anticipated inflation?

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  2. Bill, could you please me understand the following, given your exposition above? I have tried to lay this out with realistic options.

    Assume everyone that wants/needs to work is working as much as they want/need to work.

    Scenario A:
    Some people buy fewer houses, all other money expenditure being held constant and buy nothing additional. They put their former housing money in a safe in their basement because they have decided they need to hold more liquid savings for emergencies. Prices and wages in housing fall until the housing inventory clears but do not rise elsewhere in the economy.

    Scenario B:
    Some people buy fewer houses. Prices and wages in housing fall until the housing inventory clears. Those people spend their former housing money on cars instead. Prices and wages rise in the auto industry which draws in new people. We have no idea if any of the construction workers are the ones who get those additional auto jobs.

    Scenario C:
    Some people buy fewer houses, all other money expenditure being held constant and buy nothing additional. They put their former housing money in a safe in their basement. Prices and wages in housing fall until the housing inventory clears. The government runs a deficit equal to the increased cash holdings by former housing buyers, issuing bonds to pay for the new spending. We have no idea who buys the bonds, but they must reduce their spending on something else in order to buy the bonds. The government spends money on corn-based ethanol, driving up farming prices and wages. We have no idea if any of the construction workers are the ones who get those additional farming jobs.

    Scenario D:
    Some people buy fewer houses, all other money expenditure being held constant and buy nothing additional. They put their former housing money in a safe in their basement. Prices and wages in housing fall until the housing inventory clears. The Fed buys government bonds from a bank who lends it to a new business to hire new people. We have no idea if any of the construction workers are the ones who get hired.


    What are the differences between the scenarios above? How do we judge which situation will deliver "better" overall economic performance? What does that mean? Given the increased demand for other goods in scenarios B-D, how do we judge the impact on unemployment of construction workers (to the extent that they are unwilling to cut their wages to the new market wage)?

    How are the ways in which we judge the above based on "macroeconomics" versus plain old microeconomics? Does including money as a good bring microeconomics up to speed as a means to address the coordination challenges that arise out of the scenarios above? Am I missing an important alternative story?

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  3. @JW:
    Unemployment has almost nothing to do with inflation, its just what they teach in introductory Macro so its managed to survive the 70's which should have killed it dead.

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  4. I liked your post, but I had some difficulties with it.

    You write that "if the demand for new homes falls 50 percent and new homes make up 10 percent of the economy, then the demand for other products in the economy should grow more than otherwise." I'm not sure how you're measuring demand; my guess is that you mean the demand for new homes falls in such a way that the economically rational response from builders is to produce new homes at half the rate they had been doing. Provided consumers have not suddenly increased their desire to hoard money, they must have increased their desire to buy things other than new house (but not necessarily other consumer-durables: perhaps goods and services immediately consumed, perhaps physical investment goods or financial assets). This sudden change in consumer desires will throw the economy into (greater) disequilibrium. Many of those employed in new homes construction will lose their jobs (especially if the change in consumer desires is expected to be permanent), and will have to take jobs in which they are less productive than they had been; GNP will tend to decline, and so "the real volume of demand for the other products of the economy should grow" at [but this should be "increase" rather than "grow at"] *less than* "approximately 5 percent." A shock to the economy, requiring greater-than-normal "recalculation," should be expected to reduce the normal growth rate.

    In your gold-standard scenario you might have mentioned that the rate of gold production is assumed not to increase, in spite of the increased demand for gold. Then, in the statement, "Everyone who holds money earns a real capital gain," you might tell us how you are using the term 'real'. You evidently have in mind some unit of account *other than ounces of gold* (in spite of the fact that in this scenario gold *is* money); what is it? Later you refer to "[t]he real volume of expenditures on various goods" and "the real quantity of money." Obviously this "real volume" or "real quantity" is not being measured in ounces of gold; what *is* the numeraire?

    I still seem to detect some stock/flow confusion in your discussion. You write: "if the former home buyers [I think this should be: "those who formerly would have bought a new home or homes"] still have no [increased] desire to buy anything [else], they just have higher real money balances." No, they just continue to *increase* their money balances: instead of accumulating a new home or new homes, they accumulate (rather than just "hold") more money. The topic is their flow of spending (or the lack thereof) rather than the stock of their holdings.

    In the subsequent helicopter-drop scenario, are we supposed to have abandoned the gold regime and moved to fiat money?

    I found the discussion of "inside money" confusing. I thought we were discussing various scenarios brought on by a shock to the system in the form of a sudden decrease in consumers' willingness to buy new homes and a corresponding increase in their desire to *accumulate currency*. But in the "inside money" discussion, it seems the topic has shifted: the consumers now want to hold more "money" in some broader sense, and in fact what they want to hold more of are *bank deposits*, which are really *loans to banks*. It's not more currency that people suddenly want (along with fewer new houses): it's more *savings* (of a super-safe, short-term variety). The banks then relend the funds deposited with them--but they have trouble finding borrowers, since people in general are more determined to *save*. So interest rates have to fall, etc. But the original scenarios, involving *currency*, had nothing to do with interest rates.

    Thanks for whatever clarifications or comments you care to offer.

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  5. I liked your post, but I had some difficulties with it.

    You write that "if the demand for new homes falls 50 percent and new homes make up 10 percent of the economy, then the demand for other products in the economy should grow more than otherwise." I'm not sure how you're measuring demand; my guess is that you mean the demand for new homes falls in such a way that the economically rational response from builders is to produce new homes at half the rate they had been doing. Provided consumers have not suddenly increased their desire to hoard money, they must have increased their desire to buy things other than new house (but not necessarily other consumer-durables: perhaps goods and services immediately consumed, perhaps physical investment goods or financial assets). This sudden change in consumer desires will throw the economy into (greater) disequilibrium. Many of those employed in new homes construction will lose their jobs (especially if the change in consumer desires is expected to be permanent), and will have to take jobs in which they are less productive than they had been; GNP will tend to decline, and so "the real volume of demand for the other products of the economy should grow" at [but this should be "increase" rather than "grow at"] *less than* "approximately 5 percent." A shock to the economy, requiring greater-than-normal "recalculation," should be expected to reduce the normal growth rate.

    In your gold-standard scenario you might have mentioned that the rate of gold production is assumed not to increase, in spite of the increased demand for gold. Then, in the statement, "Everyone who holds money earns a real capital gain," you might tell us how you are using the term 'real'. You evidently have in mind some unit of account *other than ounces of gold* (in spite of the fact that in this scenario gold *is* money); what is it? Later you refer to "[t]he real volume of expenditures on various goods" and "the real quantity of money." Obviously this "real volume" or "real quantity" is not being measured in ounces of gold; what *is* the numeraire?

    I still seem to detect some stock/flow confusion in your discussion. You write: "if the former home buyers [I think this should be: "those who formerly would have bought a new home or homes"] still have no [increased] desire to buy anything [else], they just have higher real money balances." No, they just continue to *increase* their money balances: instead of accumulating a new home or new homes, they accumulate (rather than just "hold") more money. The topic is their flow of spending (or the lack thereof) rather than the stock of their holdings.

    In the subsequent helicopter-drop scenario, are we supposed to have abandoned the gold regime and moved to fiat money?

    I found the discussion of "inside money" confusing. I thought we were discussing various scenarios brought on by a shock to the system in the form of a sudden decrease in consumers' willingness to buy new homes and a corresponding increase in their desire to *accumulate currency*. But in the "inside money" discussion, it seems the topic has shifted: the consumers now want to hold more "money" in some broader sense, and in fact what they want to hold more of are *bank deposits*, which are really *loans to banks*. It's not more currency that people suddenly want (along with fewer new houses): it's more *savings* (of a super-safe, short-term variety). The banks then relend the funds deposited with them--but they have trouble finding borrowers, since people in general are more determined to *save*. So interest rates have to fall, etc. But the original scenarios, involving *currency*, had nothing to do with interest rates.

    Thanks for whatever clarifications or comments you care to offer.

    ReplyDelete
  6. John:

    You are assuming that the supply of housing is perfectly inelastic. If this is true, then the resources that were used to produce houses have no alternative uses.

    If the supply of housing is less than perfectly inelastic, what that means is that the resources used to produce housing have alternative uses.

    While we don't know what exactly those resources shifted out of housing will produce, the notion that they do nothing is inconsistent with the supply of housing having a positive slope rather than being vertical.

    In account A, you failed to completely describe the equilibrium. You stopped.

    But it doesn't stop. The prices of other goods and services fall. The real value of the money holdings of people, not limited to those who locked it in the basement because they don't buy houses, rise in real value. They spend it on whatever it is they want the most. The real demand for these goods rise. The production of these goods requires more resources. Where do they come from? They come from the housing industry. That is what it means for the supply of housing to be less than perfectly inelastic.

    In your scenario, the spending on housing falls, and all other spending remains the same. While possible, it is unlikely. Those who used to sell houses at higher prices and wages now earn less, and so their demands for other products fall. Of course, when the prices of the products they used to buy fall, and the prices of the resources used to produce them fall, then the real demand recovers. That is because the real value of the money rises.

    In scenario B, the signal is clear. People buy less houses and more cars. if the supply of cars were perfectly inelastic, then no more cars can be produced. And so, the resources freed from the housing industry cannot possibly be used to produce more cars. But if the supply of cars is less than perfectly inelastic, then car production expands, and more resources are used to produce cars.

    Those resources don't necessarily come from the housing industry, but the higher demand for cars directly raises the profitability of car production and pulls the necessary resources to cars. This raises the demand for those resources and their prices. Those producing goods that lose resources to the car industry have an incentive to use alternatives, and further, they raise their prices. This results in higher demand for substitutes. The profitability of production in those industries rises. They need more resources. Now, in the end, the demand for some product that uses the resources that were used to producing housing rises. It must be, because that is what it means to have a positive slope to the supply of housing curve.

    I don't believe that the pattern of real demands that would occur if an increase in demand for money (even locked in basement) are matched by an increase in lending is the same as if the real quantity of money rises enough to meet the demand through a lower price level. But the process by which resources are reallocated are similar to that where there is an increase in the demand for cars.

    And, of course, the people locking their money in the balance are saving. If they locked it up forever, then perhaps it wouldn't matter. But when they spend it, where will the goods come from from them to buy? What signal is created for firms to expand their ability to produce more in the future?

    If "microeconomics" means that prices and wages adjust in one market and all the indirect effects are ignored, then it is a very barren sort of microeconomics.

    Really, microeconomics is about the interrelations among markets.

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  7. Ogden:

    Quasi-monetarists aren't too different from old-fashioned monetarists regarding inflation in the seventies. At least, I am not.

    First, macroeconomic equilibrium doesn't imply an unemployment rate of zero. The natural (or neutral) rate of unemployment is made up of frictional, structural, technological, and institutional unemployment. In equilibrium, the real quantity of money is growing with the demand to hold real money balances, and real expenditures are growing with the productive capacity of the economy. The unemployment rate is equal to the natural unemployment rate.

    If money expenditures are growing 3 percent and if the productive capacity is growing at trend--3 percent too--then the price level is constant, inflation is zero, and wages and other nominal incomes are growing 3 percent. The unemployment rate is equal to the natural unemployment rate.

    If money expenditures were growing 10 percent, then everything would be the same, except the inflation rate would be 7 percent and wages and other nominal incomes would be growing 10 percent. In particular, the unemployment rate would remain equal to the natural unemployment rate. So, we have inflation and unemployment.

    Slower growth in money expenditures implies slower growth in sales. Firms typically respond to this by slowing their growth of production and the rate at which they raise prices. The slower growth of output implies slow growth in the demand for labor and other reserves, and so, slower growth in employment. This results in a higher unemployment rate. So, lower inflation goes with higher unemployment when money expenditure growth slows. If the slowing is enough, the "growth" in output could be negative, while inflation remains positive. For example, spending growth drops from 10% to 4%. Inflation drops from 7% to 5%. The production of goods and services goes from 3% to -1%.

    Inflation continues to exist at a lower rate, while production is shrinking, as is employment. The unemployment rate rises, even though there is inflation.

    Higher inflation associated with higher unemployment and lower inflation with lower unemployment can easily occur when the economy returns to equilibrium. However, I think the problem in the seventies were productivity shocks.

    First, the transitions. Suppose spending growth rises to 10 percent. In the short run, firms respond to the growing sales by expanding production and raising prices more quickly. Inflation rises, production and employment grow more quickly, and the unemployment rate falls. The unemployment rate is below the natural unemployment rate. The economy readjusts. Firms raise prices more quickly and slow production growth to return to the previous real growth path. Employment grows more slowly, and the unemployment rate rises. Inflation rises and the unemployment rate rises (from an unsustainably low level.)

    The opposite adjustment is possible too. When spending slows (as above,) prices and output grow more slowly in the short run, but when real output recovers to its long run growth path, it grows more quickly for a time, and the unemployment rate falls (from an excessively high level). Given the growth rate of money expenditures, the more rapid growth in real output implies that firms raise prices more slowly for a time. Inflation slows and the unemployment rate falls.

    If the natural unemployment rate were unchanging, then these changes would be easy to identify. But it isn't.

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  8. Adverse productivity shocks, such as Saudi Arabia supporting OPEC, reducing production, and raising the price of oil, result in higher prices (of oil and related products) and less production (of things produced with oil.) If money expenditures were on a 3 percent growth path, then the price level rises, there is inflation as it increases, and output grows more slowly, and if it is bad enough, production falls. As people adjust their pattern of purchases to the new relative prices, the demands for some goods rise and other goods fall. People are laid off in the shrinking sectors, so structural unemployment increases. So, there is inflation, recession, and higher unemployment.

    If this is superimposed on an inflationary equilibrium (say 10% money expenditure growth) then inflation rises, say from 7% to 11%. Real growth slows from 3% to -1%, and the unemployment rate rises with the natural unemployment rate.

    Suppose the Fed responds to this by slowing money expenditure growth to 8%. It is possible that inflation rises from 7% to 10%, while output growth shrinks from 3% to -2%. Inflation worsens (but less than it would have without the Fed's contractionary policy,) and the recession is worse. The unemployment rate would rise above the natural unemployment rate in this situation. The Fed's contractionary policy has slowed real expenditure growth to get nonenergy sectors of the economy to slow price increases (as well as dampening the more rapid increases in energy prices.) Firms in those sectors expand production more slowly or perhaps lower it as well.

    I find nothing puzzling about the seventies. I guess it is involves accepting stickyness in the trajectory of the prices of goods and resources (especially wages) If prices and wages only rise in response to actual shortages, then it would be a puzzle. If prices (and wages) are set based on expectations, then there is nothing all that puzzling.

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  9. I liked your post, but I had some difficulties with it.

    You write that "if the demand for new homes falls 50 percent and new homes make up 10 percent of the economy, then the demand for other products in the economy should grow more than otherwise." I'm not sure how you're measuring demand; my guess is that you mean the demand for new homes falls in such a way that the economically rational response from builders is to produce new homes at half the rate they had been doing. Provided consumers have not suddenly increased their desire to hoard money, they must have increased their desire to buy things other than new house (but not necessarily other consumer-durables: perhaps goods and services immediately consumed, perhaps physical investment goods or financial assets). This sudden change in consumer desires will throw the economy into (greater) disequilibrium. Many of those employed in new homes construction will lose their jobs (especially if the change in consumer desires is expected to be permanent), and will have to take jobs in which they are less productive than they had been; GNP will tend to decline, and so "the real volume of demand for the other products of the economy should grow" at [but this should be "increase" rather than "grow at"] *less than* "approximately 5 percent." A shock to the economy, requiring greater-than-normal "recalculation," should be expected to reduce the normal growth rate.

    In your gold-standard scenario you might have mentioned that the rate of gold production is assumed not to increase, in spite of the increased demand for gold. Then, in the statement, "Everyone who holds money earns a real capital gain," you might tell us how you are using the term 'real'. You evidently have in mind some unit of account *other than ounces of gold* (in spite of the fact that in this scenario gold *is* money); what is it? Later you refer to "[t]he real volume of expenditures on various goods" and "the real quantity of money." Obviously this "real volume" or "real quantity" is not being measured in ounces of gold; what *is* the numeraire?

    I still seem to detect some stock/flow confusion in your discussion. You write: "if the former home buyers [I think this should be: "those who formerly would have bought a new home or homes"] still have no [increased] desire to buy anything [else], they just have higher real money balances." No, they just continue to *increase* their money balances: instead of accumulating a new home or new homes, they accumulate (rather than just "hold") more money. The topic is their flow of spending (or the lack thereof) rather than the stock of their holdings.

    In the subsequent helicopter-drop scenario, are we supposed to have abandoned the gold regime and moved to fiat money?

    I found the discussion of "inside money" confusing. I thought we were discussing various scenarios brought on by a shock to the system in the form of a sudden decrease in consumers' willingness to buy new homes and a corresponding increase in their desire to *accumulate currency*. But in the "inside money" discussion, it seems the topic has shifted: the consumers now want to hold more "money" in some broader sense, and in fact what they want to hold more of are *bank deposits*, which are really *loans to banks*. It's not more currency that people suddenly want (along with fewer new houses): it's more *savings* (of a super-safe, short-term variety). The banks then relend the funds deposited with them--but they have trouble finding borrowers, since people in general are more determined to *save*. So interest rates have to fall, etc. But the original scenarios, involving *currency*, had nothing to do with interest rates.

    Thanks in advance for whatever clarifications or comments you care to offer.

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  10. Very powerful application of scarcity!

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    ReplyDelete