Grasping Reality on TypePad, by Brad DeLong

I confess I am embarrassed for my great-grandfather Roland Greene Usher, who sweated blood all his life trying to help build Washington University in St. Louis into a great university, that WUSTL now employs people like David K. Levine:

Levine, you see, appears to believe that we live not in a monetary but in a barter economy. And so Levine claims that the Friedmanite-monetarist expansionary policies to fight recessions that recommended by Milton Friedman cannot, in fact, work:

David K. Levine: The Keynesian Illusion: "I want to think here of a complete economy peopled by real people...

...a phone guy who makes phones, a burger flipper, a hairdresser and a tattoo artist.... The burger flipper only wants a phone, the hairdresser only wants a burger, the tattoo artist only wants a haircut and the phone guy only wants a tattoo.... Each can produce one phone, burger, haircut or tattoo.... The phone guy produces a phone, trades it to the tattoo artist in exchange for a tattoo, who trades the phone to the hairdresser in exchange for a haircut, who trades it to burger flipper in exchange for a burger. All are employed... everyone is happy.

Now suppose that the phone guy suddenly decides he doesn't like tattoos enough to be bothered building a phone.... Catastrophe. Everyone is unemployed.... The stupid phone guy... is lazy and doesn't want to work.... The burger flipper would like to work making burgers if he can get a phone, the hairdresser would like cut hair if he could get a burger and the tattoo artist would like to work if he could get a haircut and yet all are unemployed....

Maybe the government should follow Keynes's [note: Levine means "Milton Friedman's" here] advice and print some money.... Then the phone guy can buy a tattoo, and the tattoo guy can buy a haircut and the haircutter can buy a burger, and the burger flipper--ooops... he can't buy a phone because there are no phones.... [Perhaps] the burger flipper realizes he shouldn't sell the burger because he can't buy anything he wants... and we are right back... with everyone unemployed.... Maybe he doesn't realize that and gets left holding the bag... a Ponzi scheme.... It seems like a poor excuse for economic policy that our plan is that we hope the burger flipper will be a fool and be willing to be left holding the bag....

DKL's argument that Friedmanite-monetarist expansionary policies cannot cure a downturn is, I believe, correct--if the downturn is caused by a sudden outbreak of worker laziness, an adverse supply shock that reduces potential output.

Expansionary monetary policy in such a situation will indeed produce inflation. People's expectations of the prices at which they will be able to buy are disappointed on the upside as too much money chases too few goods. It is not clear to me why DKL calls this a "Ponzi scheme" rather than "unanticipated inflation".

But does anybody--save DKL--believe that an extraordinary and contagious outbreak of worker laziness is what caused the downturn that began in 2008?

No. Everybody else believes that the downturn that began in 2008 occurred not because of a supply shock in which workers suddenly became lazy but because of a demand shock in which the financial crisis caused nearly everybody in the economy to try to rebuild their stocks of safe, liquid, secure financial assets. Everybody else believes that the right way to model the economy is not the barter economy of DKL--trading phones for tattoos, etc.--but as a monetary economy, in which people hold stocks of financial assets and trade them for currently-produced goods and services.

This matters.

This matters a lot.

So let's rerun DKL's scenario, with one small change--adding money to the economy--that makes all the difference:

Suppose that the phone guy has a bunch of Mortgage-Backed Securities in her retirement portfolio, which suddenly crash in value with the financial crisis.

The phone guy looks at her zero-value retirement portfolio and sets to work building a phone--but decides to use her earnings not to get a tattoo but to hold them in the form of outside money: cash. Catastrophe. Everyone is unemployed.... The stupid phone guy who is causing the problem by not wanting to buy a tattoo but instead to accumulate financial assets--is 'voluntarily unemployed'--finds that she cannot sell her phone because the tattoo artist cannot sell his services to the phone maker, and the hairdresser cannot sell her services to the tattoo artist, and the burger flipper cannot sell his services to hairdresser, and so the burger flipper cannot even buy the phone. Everyone is "involuntarily unemployed". The burger flipper would like to work making burgers if he can get a phone, the hairdresser would like cut hair if he could get a burger and the tattoo artist would like to work if he could get a haircut and yet all are unemployed....

Should the government follow Milton Friedman's advice and print up some more money and so boost the phone guy's cash holdings? Yes! If the phone guy is happy with his real balances of cash, then the the phone guy will buy a tattoo, and the tattoo guy will buy a haircut, and the haircutter can buy a burger, and the burger-flipper will buy the phone!

This has all been worked out and well-known by economists since the early nineteenth century.

As economist John Stuart Mill wrote back in 1829, the problem in a "general glut" is that an excess supply of pretty much anything else is the flipside of an excess demand for safe, liquid, reliable financial assets. The way to fix this is to have the government, or somebody else acting as lender of last resort, to take steps to make sure that such an excess demand for cash money does not emerge or is quickly satisfied:

The sellers and the buyers, for all commodities taken together, must, by the metaphysical necessity of the case, be an exact equipoise to each other; and if there be more sellers than buyers of one thing, there must be more buyers than sellers for another.... 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....

There may be, at some given time, a very general inclination to sell with as little delay as possible, accompanied with an equally general inclination to defer all purchases as long as possible. This is always actually the case, in those periods which are described as periods of general excess... which is of no uncommon occurrence....

What they called a general superabundance, was... a superabundance of all commodities relatively to money.... Money... was in request, and all other commodities were in comparative disrepute. In extreme cases, money is collected in masses, and hoarded; in the milder cases, people merely defer parting with their money, or coming under any new engagements to part with it. But the result is, that all commodities fall in price, or become unsaleable. When this happens to one single commodity, there is said to be a superabundance of that commodity; and if that be a proper expression, there would seem to be in the nature of the case no particular impropriety in saying that there is a superabundance of all or most commodities, when all or most of them are in this same predicament...

John Stuart Mill could get his mind around the possibility of a "general glut" of currently-produced goods and services in a monetary economy 186 years ago. Thomas Malthus could get his mind around the possibility 196 years ago:

We hear of glutted markets, falling prices, and cotton goods selling at Kamschatka lower than the costs of production. It may be said, perhaps, that the cotton trade happens to be glutted; [but] it is a tenet of the new doctrine on profits and demand, that if one trade be overstocked with capital, it is a certain sign that some other trade is understocked.

But where, I would ask, is there any considerable trade that is confessedly under-stocked, and where high profits have been long pleading in vain for additional capital? The [Napoleonic] War has now been at an end above four years; and though the removal of capital generally occasions some partial loss, yet it is seldom long in taking place, if it be tempted to remove by great demand and high profits; but if it be only discouraged from proceeding in its accustomed course by falling profits, while the profits in all other trades, owing to general low prices, are falling at the same time, though not perhaps precisely in the same degree, it is highly probable that its motions will be slow and hesitating...

Yet David K. Levine is completely ignorant now of what they got right then. Back then chemists were still debating the Phlogiston theory of combustion, and trying to make reaction masses balance in combustion processes by attributing to Phlogiston the quality of Levity--i.e., negative mass. There is certainly, I must admit, Levity here, but not of the turn-of-the-nineteenth-century chemistry kind.

There are no Phlogiston-theory chemists today. But we have DKL, who thinks that the right way to model business-cycle downturns is as the consequence of adverse supply shocks in the form of a decline in worker moral standards in a barter economy. WUSTL has a Phlogiston-theory economist. Today. Teaching.

The Millian analysis of general gluts was, admittedly, cutting-edge in the early nineteenth century. But such total ignorance of it as DKL exhibits now? I am embarrassed for WUSTL. I am embarrassed for St. Louis, that my Richardson, Wyman, and Usher ancestors worked so hard to build. I am embarrassed for Missouri. I am embarrassed for economics.

Now can anybody tell me why DKL--and all the rest--are still making the freshman-level mistake of trying to analyze monetary business-cycle downturns in a barter framework, 186 years after John Stuart Mill got it right?

And do note that the passage I quote above is not the most bizarre thing DKL writes here. The most bizarre is this contrary-to-fact claim that businesses in the aggregate during World War II were "forced to produce and do things" that caused them losses:

Let's go back to the example of World War II... what the government did... [was] spend a lot of money that they borrowed or printed... [and] also draft... soldiers... and force... businesses to produce and do things they would really rather not have done.... Economic activity may have picked up a great deal during and after the war. [But] it is doubtful that the draftees who died in the war benefited much from this...

The claim that businesses were in some sense worse off because of expansionary World War II-era policies may be the most remarkably false thing I will read this year.