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Monetary equilibrium and price stickiness: A rejoinder

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Luther and Salter argue for a regime where aggregate demand is restored by an increase in the money supply in response to an increase in the demand for money. They claim that, 1) monetary equilibrium policy prescriptions do not necessarily rely on sticky prices, 2) Cantillon effects can be neglected without consequence, 3) wealth redistributions from monetary policy are unimportant, 4) monetary disequilibrium theorists strive for a stable price level, 5) fewer price adjustments are necessary in their proposed regime than in ours, 6) savings and saving are equivalent, 7) changes in the composition of savings do not alter time preference, and, 8) in their proposed regime economic calculation is easier than in a 100 % reserve system. All these claims are false. They furthermore misconstrue us as preferring negative quantity adjustments to positive price adjustments. This too is false.

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  1. They furthermore brush aside the chief contribution of our original article, which is the focus on sticky prices. Indeed they claim that any policy norm resulting from monetary equilibrium theory does not depend on prices being sticky, but rather just that the cost of adjusting the money supply be less than the costs of changing prices. They then go on to list examples of the costs of changing prices: menu costs, the opportunity cost of establishing new prices, and “some other source”. We would be interested in knowing what the “other source” of these costs could be, as the other two only arise if prices are indeed sticky. If prices were flexible there would be no “cost” to adjust them as they would already be at the market clearing level. Alternatively, since we gave three reasons for sticky prices in our original exposition—long-term contracts, workers not accepting lower wages, and menu costs—it could be that they consider only menu costs when explaining sticky prices. This too would beg the question of why reducing the price of a meal and incurring the associated costs (i.e., printing a new menu) differs from reducing the price paid to labor and the associated costs it incurs (i.e., demoralization, the risk of losing an employee to another employer, etc.).

  2. Luther and Salter think we make a “non-economic explanation” when we discuss the redistribution implications of Cantillon effects, pointing out that all economic changes result in wealth transfers. We argued merely that changes to the money supply to offset one set of redistributions leads to an alternative set. In incorrectly indicting us for judging one set of redistributions as preferred to another, Luther and Salter go on to say that one “should” always prefer the adjustment process with the lowest costs. These costs are, however, subjective and advocating one to another as they do imposes a value statement and an unscientific interpersonal utility comparison.

  3. We further challenge that monetary equilibrium theory is a poor tool for understanding an Austrian Business Cycle (Bagus and Howden 2012: sect. 4).Critics could take recourse in asserting that since the money interest rate would be altered by such an expansionist policy, intertemporal coordination would be skewed accordingly. Yet as the interest rate is just a value spread between goods, this discoordination could not occur unless relative factor prices were also skewed. Rothbard (1962: chap. 11, sect. 5G) and von Mises (1949: 526–32, esp. p. 527) make a similar point, reminding the reader that the interest rate is determined not through the money side (not even the “loan” rate of interest) but rather by the goods side of the market, through the structure of production and the array of relative prices.

  4. Some prices may be sticky out of preference, as is the case in Hutt (1977) and Rotemberg (1982). Since this stickiness is preference based, we are unsure why monetary equilibrium theorists want to change the money supply to affect the general price level, thus forcing these prices to be reset and entrepreneurial plans frustrated. Consider an investor who thinks the market is overbought (as in Bagus and Howden 2011b). He sells his assets to increase his cash balance, and plans on buying again when the market deflates to a lower level. As he increases his cash balance his fractional reserve bank expands credit, and the market reflates. Not only is a potentially oversold market promoted or prolonged, but the investor’s personal plans have been frustrated. In an extension of this example, Luther and Salter erroneously state that we “view the contraction in output following an exogenous increase in money demand as an optimal response.” The actual implication of Bagus and Howden (2012) is that if people want to work less, as in the scenario where people for ideological reasons are harshly opposed to reductions in nominal wages, then a contraction in output is the consequence. They also claim that monetary equilibrium theorists prefer stable output and stable prices. Prominent modern equilibrium theorists have gone to great lengths to demonstrate that instead of price stability, their policy norm allows prices to fluctuate inversely with the velocity of money. See Selgin (1988: pp. 103 and 126–29; 1997) for two excellent examples of this reasoning.

  5. Note the Keynesian terminology of “aggregate demand”. We think that the majority of Luther and Salter’s errors stem from a too aggregative approach to economic theory that inhibits them to see microeconomic problems of adjustments of individual cash balances or relative prices. Further note that no one argues that an aggregate nominal variable can be maintained by money supply changes—what is up for debate are the microeconomic implications that result from such a policy.

  6. It is also an illusion, as Luther and Salter claim, that entrepreneurs can ignore changes in the demand for money in their proposed alternative, thus making economic calculation easier. In their alternative, entrepreneurs must forecast changes in consumer demand for their product, the impact on the increase of the money supply on relative prices, and the amount of the increase of the money supply that depends on the increase in the demand for money.

  7. Their example distils to a two-sector, one good economy with one relative price to equilibrate. This over-simplification and disregard for a full array of relative prices obscures the equilibration process, as we explain below. Salerno (2012: sec. 3) provides an overview of the errors of this type of simplistic model building.

  8. The reasoning in this “water disequilibrium” example is similar to that employed in Yeager (1994: 159–60). Yeager notes that a “chairs” version of the equation of exchange can be written, whereby CVc = PQ, with P an Q given as per convention, C the average number of chairs in existence in a given area during a time period, and Vc the “velocity” of chairs (or, more correctly, the ratio of nominal income to the average number of chairs). Although the example does correctly extend the tautology, it is not relevant on any level other than the formal truism. Any increase in the number of chairs does confer a social benefit, as chairs are directly able to confer utility and thus increase our wellbeing. Money, particularly fiat money, has no direct use value and as such cannot change the total utility of a system.


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Correspondence to Philipp Bagus.

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Bagus, P., Howden, D. Monetary equilibrium and price stickiness: A rejoinder. Rev Austrian Econ 25, 271–277 (2012).

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