David Eagle’s framework and the micro-foundation of Market Monetarism

Over the last couple of days I have done a couple of posts on the work of David Eagle (and Dale Domian). I guess that there still are a few posts that could be written on this topic. This is the next one.

Even though David Eagle’s work has been focusing on what he and Dale Domian have termed Quasi-Real Indexing I believe that his work is highly relevant for Market Monetarists. In this post I will try to draw up some lessons we can learn from David Eagle’s work and how it could be relevant to formulating a more consistent micro-foundation for Market Monetarism.

There are a no recessions in a world without money

The starting point in most of Eagle’s research is an Arrow-Debreu model of the world. Similarly the starting point for Market Monetarists like Nick Rowe and Bill Woolsey is Say’s Law – that supply creates its own demand. (See for example Nick on Say’s Law here).

This starting point is a world without money and both in the A-D model and under Say’s Law there can not be recessions in the sense of general glut in the product and labour markets.

However, once money and sticky prices and wages are introduced – both by Market Monetarists and by David Eagle – then we can have recessions. Hence, for Market Monetarists and David Eagle recessions are always and everywhere a monetary phenomenon.

N=PY – the simple way to illustrate some MM positions

In a number of his papers David Eagle introduces a simplified version of the equation of exchange where he re-writes MV=PY to N=PY. Hence, Eagle sees MV not some two variables, but rather as one variable – nominal spending (N), which is under the control the central bank. This is in fact quite similar to Market Monetarists thinking. While “old” monetarists traditional have assumed that V is constant (or is “stationary”) Market Monetarists acknowledges that this position no longer can be empirically supported. That is the reason why Market Monetarists have focused on the right hand side of the equation of exchange rather than on the left hand side like “old” monetarists like Milton Friedman used to do.

I, however, think that Eagle’s simplified equation of exchange has some merit in terms of clarifying some key Market Monetarist positions.

First of all N=PY gets us from micro to macro. Hence, PY is not one price and one output, but numerous prices and outputs. If N is kept constant that is basically the Arrow-Debreu world. That illustrates the point that we need changes in N to get recessions.

Second, N=PY can be a rearranged to P=N/Y. Hence, inflation is the “outcome” of the relationship between nominal spending (N) and real GDP (Y). In terms of causality this also illustrates (but it does not necessary prove) another key Market Monetarist point, which often has been put forward by especially Scott Sumner that nominal income (N) causes P and Y and not the other way around (See here and here). This is contrary to the New Keynesian formulation of the Phillips curve, where “excessive” growth in real GDP relative to “trend” GDP increases “price pressures”.

Third, P=N/Y also illustrates that there are two sources of price changes – nominal spending (N) and supply shocks. This lead us to another key Market Monetarist position – also stressed strongly by David Eagle – that there is good and bad inflation/deflation. This is a point stressed often by David Beckworth (See here and here). David Eagle of course uses this insight to argue that normal inflation indexing is sub-optimal to what he has termed Quasi-Real Indexing (QRI). This of course is similar to why Market Monetarists prefer NGDP targeting to Price Level Targeting (and inflation targeting).

The welfare economic arguments for NGDP targeting

In an Arrow-Debreu world the allocation is Pareto optimal and with fully flexible prices and wages changes in N will have no impact on allocation and an increase or a drop in N will have no impact on economic welfare. However, if we introduce sticky prices and wages in the model then unexpected changes in N will reduce welfare in the traditional neo-classical sense. Hence, to ensure Pareto optimality we have two options.

1)   The monetary institutional set-up should ensure a stable and predictable N. We can do that with a central bank that targets the NGDP level or with a Free Banking set-up (that ensures a stable N in a perfect competition Free Banking system). Hence, while Market Monetarists mostly argue in favour of NGDP from a macroeconomic perspective David Eagle’s framework also gives a strong welfare theoretical argument for NGDP targeting.

2)   (Full) Quasi-Real Indexing (QRI) will also ensure a Pareto optimal outcome – even with stick prices and wages and changes in N. David Eagle and Dale Domian have argued that QRI could be used to “immunise” the economy from recessions. Market Monetarists (other than myself) have so far as I know now directly addressed the usefulness of QRI.

Remaining with in the simplified version of the equation of exchange (N=PY) NGDP targeting focuses on left hand side of the equation, which can be determined by monetary policy, while QRI is focused on the right hand side of the equation. Obviously with one of the two in place the other would not be needed.

In my view the main problem with QRI is that the right hand side of the equation is not just one price and one output but millions of prices and outputs and the price system plays a extremely important role in the allocation of resources in the economy. It is therefore also impossible to expect some kind of “centralised” QRI (god forbid anybody would get such an idea…). I am pretty sure that my fellow Market Monetarist bloggers feel the same way. That said, I think that QRI can useful in understanding why the drop in nominal spending (N) has had such a negative impact on RGDP in the US and other places.

Furthermore, as I stressed in an earlier post QRI might be useful in housing funding reform in the US – as suggested by David Eagle. Furthermore, it is obviously QRI based government bonds could be used in the conduct of NGDP targeting – as in line with what Scott Sumner for example has suggested and as in fact also suggested by David Eagle.

David Eagle should inspire Market Monetarists

In conclusion I think that David Eagle’s and Dale Damion’s on work on both NGDP targeting and QRI will be a useful input to the further development of the Market Monetarist paradigm and I especially think it will be helpful in a more precise description of the micro-foundation of Market Monetarism.

PS David Eagle has also done work on interest rates targeting and is highly critical of Michael Woodford’s New Keynesian perspective on monetary policy. This research is relatively technical and not easily assessable, but should surely be of interest to Market Monetarists as well.


See my other posts on David Eagle and Dale Domian:
Quasi-Real indexing – indexing for Market Monetarists
A simple housing rescue package – QRI Mortgages and NGDP targeting
David Eagle on “Nominal Income Targeting for a Speedier Economic Recovery”

Leave a comment


  1. Alex Salter

     /  December 4, 2011

    No! No, no, no! Houston, we have a problem! Say’s Law is NOT “that supply creates its own demand”. This is Keynes’s straw man all over again. Say’s Law states that the supply of X is dependent on demand for goods and services !X (not-X). In other words, because I must first produce before I consume, the degree to which I supply goods and services on the market is a function of how much of other goods and services, specifically those which I myself do not produce, I demand for my own consumption. Mathematically, it means the excess demands of the n goods/services markets is equal to zero. If you include money, that changes to n+1 markets, meaning Say’s Law is not true if (and some would say only if) the money market is out of equilibrium.

  2. Hahaha Alex…that Straw works fine with me. To me the point is that without money we have to produce to consume and to supply to demand. And yes, that does not hold in a world with money in disequilibrium – then the disequilibrium “spills-over” to the real world. The same of course the case in a Walrasian/A-D world.

  3. Alex Salter

     /  December 4, 2011

    Even with money you have to “produce to consume and supply to demand.” That’s true in any economy, regardless of whether the division of labor has progressed to a point conducive to the emergence of a medium of exchange. Stating Say’s Law as “supply creates its own demand” is saying “Supply for X creates demand for X” which implies that the economy must always be at its full employment level of output. Keynes was correct in noting that this isn’t the case, but he attacked a straw man in the sense that Say’s Law really said something else entirely.

    The main implication of Say’s Law is that underconsumptionist theories of recession are flawed; it’s not that too much was produced, but that the wrong stuff was produced. If we get Say’s Law “wrong,” i.e. if we accept Keynes’s interpretation, then we’re going to miss this key insight and conclude (incorrectly) that the way to fix recessions is to consume more. Say’s Law properly understood suggests the necessity of a realignment of the structure of production towards underlying consumer demand.

  4. Alex, I totally agree on that. I was however not trying to make a point about Say’s Law as such, but rather that both Say’s Law and the A-D world is the same thing in the sense that there is not a general glut in labour and product markets. So whether your starting point is a A-D world or Say’s Law you basically think the same thing in terms of NOT being Keynesian.

  5. Richard A.

     /  December 4, 2011

    Of course, N=PY can be rewritten as GDPn = P x GDPr.

    N=PY can be differentiated

    dN = d(PY)

    dN = Y x dP + P x dY

    divide by N=PY to get

    dN/N = dP/P + dY/Y

    which means for small percentage changes

    N% = P% + Y%


    GDPn% = P% + GDPr%

    which leads to the dynamic aggregate demand-aggregate supply model:

  6. Richard, yes that is pretty clear, but I am not entirely sure what your point is.

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