Scott of course “Recessions are always and everywhere a monetary phenomena”

Scott Sumner has a new post in which he claims that “I do not think all recessions are caused by demand shocks”. Well, Scott I disagree as I like Nick Rowe believe that “Recessions are always and everywhere a monetary phenomena”.

It is still Christmas so the rest of this blog post is a re-run (with small corrections) of a post from October 2011, but my views on the matter is unchanged. Read the text with Scott’s comments in mind….

At the core of Market Monetarist thinking, as in traditional monetarism, is the maxim that “money matters”. Hence, Market Monetarists share the view that inflation is always and everywhere a monetary phenomenon. However, it should also be noted that the focus of Market Monetarists has not been as much on inflation (risks) as on the cause(s) of recessions as the starting point for the school has been the outbreak of the Great Recession.

Market Monetarists generally describe recessions within a Monetary Disequilibrium Theory framework in line with what has been outline by orthodox monetarists such as Leland Yeager and Clark Warburton. David Laidler has also been important in shaping the views of Market Monetarists (particularly Nick Rowe) on the causes of recessions and the general monetary transmission mechanism.

The starting point in monetary analysis is that money is a unique good. Here is how Nick Rowe describes that unique good.

“If there are n goods, including one called “money”, we do not have one big market where all n goods are traded with n excess demands whose values must sum to zero. We might call that good “money”, but it wouldn’t be money. It might be the medium of account, with a price set at one; but it is not the medium of exchange. All goods are means of payment in a world where all goods can be traded against all goods in one big centralised market. You can pay for anything with anything. In a monetary exchange economy, with n goods including money, there are n-1 markets. In each of those markets, there are two goods traded. Money is traded against one of the non-money goods.”

From this also comes the Market Monetarist theory of recessions. Rowe continues:

“Each market has two excess demands. The value of the excess demand (supply) for the non-money good must equal the excess supply (demand) for money in that market. That’s true for each individual (assuming no fat fingers) and must be true when we sum across individuals in a particular market. Summing across all n-1 markets, the sum of the values of the n-1 excess supplies of the non-money goods must equal the sum of the n-1 excess demands for money.”

Said in another way, recession is always and everywhere a monetary phenomena in the same way as inflation is. Rowe again:

“Monetary Disequilibrium Theory says that a general glut of newly produced goods can only be matched by an excess demand for money.”

This also means that as long as the monetary authorities ensure that any increase in money demand is matched one to one by an increase in the money supply nominal GDP will remain stable (Market Monetarists obviously does not say that economic activity cannot drop as a result of a bad harvest or an earthquake, but such “events” does not create a general glut of goods and labour). This view is at the core of Market Monetarists’ recommendations on the conduct of monetary policy.

Obviously, if all prices and wages were fully flexible, then any imbalance between money supply and money demand would be corrected by immediate changes prices and wages. However, Market Monetarists acknowledge, as New Keynesians do, that prices and wages are sticky.

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  1. Can’t structural unemployment temporarily increase?

    • rhmurphy, changes in structural unemployment or “potential growth” are not recessions. Recession are periods where unemployment increase above the level of structural unemployment and RGDP growth drops below “potential growth”.

      Therefore, NGDP level targeting obviously can not increase RGDP growth in the long run or reduce the level of unemployment in the long run.

      • But that begs the question regarding the effect of real shocks. The “official” definition of recessions I’m aware of isn’t about potential growth, but consecutive quarters of negative growth. Real shocks can hypothetically cause that. I don’t think they do, but I don’t think it’s fair to throw out thirty years of research in macro by defining recessions in such a way that they cannot be caused by real shocks.

  2. rhmurphy, you are right. My definition is not the same as the typical US definition.

    In fact I have also found that definition quite odd – particularly because of my work with Emerging Markets economies. An Emerging Markets economy with potential RGDP growth of 5% or 8% could easy experience what feels like a very hard recession without being in a recession in the US sense.

  3. Lars, you’re merely defining recessions differently from Sumner. He’s saying that supply shocks can cause recessions, i.e. drops in real output, while you’re defining recessions as something different (in the comment above, “periods where unemployment increase above the level of structural unemployment and RGDP growth drops below “potential growth”.”)

    The commonly accepted definition of a recession is certainly the one Sumner uses, no?

    • BH, yes you are right – this obviously is partly a discussion of how to define recessions and maybe I should actually write a post about the silliness of the common US definition of recessions.

      A way to illustrate this is to look at a country with very challenging demographics where the labour force drops by 5 or 10% every year. That country would very likely be in permanent “recession” given the US definition, but there would not be a “general glut” of labour and goods. Another example is countries with very high potential growth – such a country will likely see high GDP growth even in period of strongly rising unemployment.

  4. Jon

     /  December 26, 2012

    Well 2q of negative real growth is the newspaper definition. NBER does not define recessions that way.

    Q: The financial press often states the definition of a recession as two consecutive quarters of decline in real GDP. How does that relate to the NBER’s recession dating procedure?
    A: Most of the recessions identified by our procedures do consist of two or more quarters of declining real GDP, but not all of them.

    I think Scott would agree that unemployment above structural unemployment is a demand side event. AS shocks do exist and they do reduce rgdp relative to trend. That’s what Scott means when he says not all recessions are monetary.

  5. Yep. I think it depends on how you define “recession”.

    If you define “recession” as a decline in output (or a decline in output and employment), we get a recession every night, or every weekend. And there is no doubt that supply shocks can cause recessions in that sense, even in an economy with no money.

    But I don’t think it is useful to define recessions that way, and that’s not how we usually use the word. One of the things we notice about the things we call “recessions” is that it gets harder to sell stuff and easier to buy stuff (with money), and the volume of monetary trade (not just output and employment) declines. Barter trade, and home production, typically expand in a recession.

  6. I like to use the word “recession” conventionally, and use “general glut” for what Nick is talking about. Then it becomes obvious that the problem is monetary – a general glut of what? in terms of what? The world is in a general glut right now. The important thing is to look at the aggregate stream (flow) of money, not the outstanding money stock or the flow of credit.


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