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Why economists should be neutered…

September 12, 2009 Leave a comment

Exhibit 1: An economist explains how going into debt will make us wealthy.

… John Cochrane is saying (unless I have totally misunderstood him) that Keynesian economics is logically inconsistent in requiring that people make plans that violate their budget constraints. If correct, this criticism would apply equally to monetarists as well as Keynesians.

This criticism would be correct in a barter economy; it is not correct in a monetary exchange economy. But Keynesian economics makes no sense in a barter economy, and nor does monetarism (unsurprisingly).

Forget investment and taxes (and forget exports and imports, government expenditure, borrowing and lending, land, used furniture, and everything else, while we are at it). Let’s just leave consumption on newly-produced goods, and income. Can people plan to spend more than their (planned/expected) income?

In a barter economy: no. In a barter economy, an offer to buy is an offer to sell. “Wanna swap 5 of your bananas for 10 of my apples?”. I plan to earn 10 apple’s worth of income and spend it on 5 bananas, but we cannot distinguish the act of earning income from the act of spending it. And anybody who planned to buy goods of a greater or lesser exchange value than those he planned to sell has made some sort of arithmetic mistake.

But in a monetary exchange economy, offers to buy goods with the medium of exchange, and offers to sell goods for the medium of exchange, are distinct acts. I can plan to buy goods of greater exchange value than the goods I plan to sell, if I plan on reducing my stock of money. And if everyone plans to do the same, and if they realise those planned expenditures, they will be surprised to find their incomes rising by the same amount. There is no logical inconsistency in people planning to spend more with the same income in a monetary exchange economy.

General gluts are always and everywhere a monetary (medium of exchange) phenomenon. The very distinction between Aggregate Demand and Aggregate Supply is a monetary (medium of exchange) phenomenon.

We refuse to comment on this as it would devalue the simple elegance and purity of the thing.

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