Brad DeLong flatters me (but he's right that this is right up my street), then sends me to David Levine . Here's the "money quote" (sorry).

I confess this is a bit of a "Gotcha!". But it's a bit more than that as well. It illustrates the difficulty that people (even economists) have in "seeing" money.

" I want to think here of a complete economy peopled by real people who produce and consume things. Let's say four of them: a phone guy who makes phones, a burger flipper, a hairdresser and a tattoo artist. Let's say that the burger flipper only wants a phone, the hairdresser only wants a burger, the tattoo artist only wants a haircut and the phone guy only wants a tattoo - around the circle in effect. We'll suppose that each can produce one phone, burger, haircut or tattoo and that each values the unit of what they want to buy more than the unit of what they can sell. That is, the hairdresser happily cuts hair if he can get a burger and so forth. What happens is clear enough: the phone guy produces a phone, trades it to the tattoo artist in exchange for a tattoo, who trades the phone to the hairdresser in exchange for a haircut, who trades it to burger flipper in exchange for a burger. All are employed, all get what they want - everyone is happy.



Now suppose that the phone guy suddenly decides he doesn't like tattoos enough to be bothered building a phone. Now the circle is broken and this is a complete catastrophe. Everyone is unemployed. Demand is insufficient. There isn't enough consumption - none at all in fact. And notice how this works: one person - the stupid phone guy who is causing the problem by not wanting to buy a tattoo - is "voluntarily unemployed" - he is lazy and doesn't want to work. The other three are "involuntarily unemployed" each one is willing to work in exchange for pay. The burger flipper would like to work making burgers if he can get a phone, the hairdresser would like cut hair if he could get a burger and the tattoo artist would like to work if he could get a haircut and yet all are unemployed." (bold added).

Notice the bit I bolded. Notice how the tattoo artist accepts the phone in exchange for a tattoo, not because he wants a phone, because he plans to use the phone to buy a haircut from the hairdresser, who doesn't want a phone either, but plans to use the phone to buy a burger.

In this model economy, phones are used as the medium of exchange. And they need to use a medium of exchange because there's a Wicksellian triangle (or quadrilateral in this case) with no double-coincidence of wants, so direct barter won't work.

Now if this were my story, I would translate the metaphor by saying that phones are money, so the phone guy who makes phones is the central bank which makes money. And the stupid phone guy who creates the whole mess by not making enough phones is the stupid central bank which creates the whole mess by not making enough money. It's a very monetarist story.



But that's not where David Levine goes with his story.

" Is the basis of Keynesianism that we should assume that the government has a phone to give away? Well maybe not. Maybe the government should follow Keynes advice and print some money (or bury it) and give it to the phone guy. Then the phone guy can buy a tattoo, and the tattoo guy can buy a haircut and the haircutter can buy a burger, and the burger flipper - ooops...he can't buy a phone because there are no phones. "

No. The phone guy is the government (or rather, the government-owned central bank). The phone is money. And so the phone guy/central bank does have phones/money to give away (or sell).

And the neat thing about money is that it can circulate round and round the Wicksellian circle forever, with nobody every stopping to ask "Hey, do I really want this intrinsically worthless bit of paper?", because each person knows that the next person will accept it in turn. And because using money reduces transactions costs, people will hold money temporarily even if the real rate of return on holding money is negative (as long as it is not negative to a Zimbabwean extent). And if Mr Ponzi could have produced an asset so liquid that people would want to hold it even at negative real interest rates, then Mr Ponzi's business plan would have been perfectly sustainable forever. People would pay Mr Ponzi for the privilege of holding his IOU's.

There are no free lunches in standard competitive equilibrium theory. But standard competitive equilibrium theory ignores transactions costs. And the only way the real world can get anywhere near the zero transactions cost world of standard competitive equilibrium theory is if people use money to help reduce those transactions costs. Because n-person barter is (usually) very very costly for n > 2. And if the central bank can produce money for free (they usually make a profit from producing money, even after paying for paper and ink), and if producing more money reduces those transactions costs (because barter is very costly), then there is a free lunch. And our job as economists (I think this is an Arthur Laffer saying) is to find those free lunches and make sure they are eaten.

David Levine's model/story is a very Monetarist model/story. (OK, a Keynesian model/story too, if by "Keynesian" we mean theoretically correct Keynesians who recognise the central importance of the medium of exchange.) But he misses seeing the point of his own model/story because he misses seeing that phones are money in his story.

[From one of my old posts:

The unemployed hairdresser wants her nails done. The unemployed manicurist wants a massage. The unemployed masseuse wants a haircut. If a 3-way barter deal were easy to arrange, they would do it, and would not be unemployed. There is a mutually advantageous exchange that is not happening. Keynesian unemployment assumes a short-run equilibrium with haircuts, massages, and manicures lying on the sidewalk going to waste. Why don't they pick them up? It's not that the unemployed don't know where to buy what they want to buy.

If barter were easy, this couldn't happen. All three would agree to the mutually-improving 3-way barter deal. Even sticky prices couldn't stop this happening. If all three women have set their prices 10% too high, their relative prices are still exactly right for the barter deal. Each sells her overpriced services in exchange for the other's overpriced services.

But barter is not easy. There is no double coincidence of wants here, and it is costly to find all three people in the Wicksellian triangle to do the barter exchange. So people use money.

The unemployed hairdresser is more than willing to give up her labour in exchange for a manicure, at the set prices, but is not willing to give up her money in exchange for a manicure. Same for the other two unemployed women. That's why they are unemployed. They won't spend their money.

Keynesian unemployment makes sense in a monetary exchange economy, where money is what Hahn calls "essential" for trade. It makes no sense whatsoever in a barter economy, or where money is inessential.

Keynesian unemployment is an excess demand for the medium of exchange. It's a coordination failure, because if all three spent the $20 to buy what they wanted, all three would find her purse is a widow's cruse. The $20 reappears as soon as it is spent. But the widow's cruse fails unless all three increase spending at once. And, in Nash Equilibrium, none of the three wants to do that. She prefers the $20 in her purse.]