In Which Nick Rowe Says John Cochrane Commits "Small But important" Errors...
Nick Rowe writes:
Worthwhile Canadian Initiative: [T]here is one part where John Cochrane is definitely wrong.[1] It's small, but important...
But if analyzing a financial crisis as if we were in a barter economy,[2] is a little mistake, what would a big mistake be?
The mind boggles.
I suspect some dry Canadian humor at work here. At least I laughed louder than I have so far this month.
Nick Rowe:
John Cochrane is saying (unless I have totally misunderstood him) that Keynesian economics [and monetarist economics from Fisher to Friedman as well] is logically inconsistent in requiring that people make plans that violate their budget constraints.... This criticism would be correct in a barter economy; it is not correct in a monetary exchange economy....
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... 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.
What's wrong with macroeconomics? The same thing that's wrong with Finance, apparently. We need to integrate Finance into monetary theory. We need to integrate monetary theory into Finance.
UPDATE: Jason in comments calls Nick on his "small":
Doesn't sound like a small deal to me. If a guy cannot even distinguish between a monetary economy and a barter economy, then what business does he have in doing macroeconomics?
A very good question indeed. These issues were settled by the time of Fisher and Wicksell, after all. And it really is embarrassing to have tenured professors at major universities making eighty-year-old mistakes--it would be as if we had physicists who said that quantum theory is absurd because an electron must be either a wave or a particle and not both/neither.
Nick responds:
Yes, it's important. But we need to encourage Finance people to do macro, and macro people to do Finance, and part of the price of doing that is we will make mistakes.
[1] Nick actually means "two parts". He adds an Addendum:
[W]hat [Cochrane] says about Ricardian Equivalence is not necessarily wrong; it just depends on what you assume about the substitutability between government and private spending (which he forgot to mention).
But if you are assuming that government purchases are perfect substitutes for private consumption, you say that. It's not something you "forget to mention"--at least not if you know what you are talking about.
[2] I would put it slightly differently. I think Cochrane cannot do otherwise but think in a model in which there is a rigid cash-in-advance constraint and a technological governor on velocity--which is much the same thing as a barter economy for all relevant questions.
