Say's law refutation : scarcity of money

Economics Economics Questions
1

Recently published in econlog :
http://econlog.econlib.org/archives/2011/01/nick_rowe_vs_sc.html
I am really perplexed by Bill Woolsey arguments. Is quantity of money really “the” problem ? I always think that price-wage flexibility could clear the market.

It isn’t really that complicated.
Suppose there are price floors on all product prices.
Wages, on the other hand, can be cut.
The quantity of money falls in half.

Spending falls. Firms cut production to match sales. There is no continuing flow of production beyond the flow of spending. There may be surpluses in the sense that desired sales are greater than purchases, but actual production doesn’t exceed purchases.

Firms are producing less so they reduce new hires and layoff people. Employment falls and unemployment rises. There are actually people looking for work.
Assuming money wages didn’t rise in the face of this mass unemployment, the real wage is unchanged.
There was no higher real wage to cause higher unemployment.

Suppose money wages fall in the face of the massive unemployment. While the firms would have lower costs and would be motivated to sell more, they cannot sell more because people won’t buy. (The price floors prohibit them from cutting prices.)

Now, the lower real wages might cause people to want to work less. And, eventually, firms might shift to techniques that use more labor and less other resources. So, employment might actually increase. The unemployment rate might drop.

Monetary disequilibrium theorists would say that the problem was the drop in the quantity of money or the price floor. The problem was never that real wages were too high and needed to drop.

Now, remember that wages are a prices–the prices of labor. We all know that. If we consider a scenario where all prices, including wages, are free to drop, the problem is still that either prices have not fallen enough or the nominal quantity of has fallen and remains low.

If all prices, including money wages were perfectly flexible, then there would be no problem. And at no point would real wages fall. Prices and wages would fall in proportion. There was never a reason for real wages to fall. They were never too high.

If all prices (including wages) were equally sticky, then they would all fall pretty much in proportion. Output would be depressed until they fall enough, but at no point would real wages be too high, despite the unemployment of labor. This could all occur with firms keeping producion matching sales so that there is no inventory buildup.

If some prices are more sticky than other prices, then the relative prices of the more flexible ones will fall. While the normal situation would be that they should contract output, that really doesn’t work in this situation. The problem would need to be that their selling prices are falling faster than the prices of inputs. Anyway, these relative prices rise again once the stickier prices catch up, dropping the needed amount.

It is possible that some product prices are more sticky than some types of labor. That some product prices are more flexible than some types of labor. Some wage rates relative to some product prices might might rise and others might fall. And then they will reverse. The relative prices of goods with more sticky prices rise and then fall. The relative prices of goods with more flexible prices fall and then rise.

But the “problem” isn’t that goods with sticky prices have high relative prices.
I think it is realistic that most wage rates are more sticky than most product prices, so that the real wages in the adjustment process rise and as wages catch up (in a downward direction) real wages fall.

But the problem isn’t that real wages are too high. And, of course, lower money wages with unchanged goods prices (which lowers real wages) would not solve the problem!
The solution is to avoid decreasing the quantity of money to start with. Or, if it does decrease to get it back up as soon as possible.
And, of course, changes in the demand to hold money cause the same problem.

And there is another refutation of wage flexibility (and Say’s law) :
http://cowles.econ.yale.edu/news/bewley/tfb_00-02_wages.htm

Mr Bewley concludes that employers resist pay cuts largely because the savings from lower wages are usually outweighed by the cost of denting workers’ morale: pay cuts hit workers’ standard of living and lower their self-esteem. Falling morale raises staff turnover and reduces productivity.

Does Bewley’s argument make any sense ? If people refuse to work hard, they become unemployed, then they will die from illness and starvation. So they accept lower wage and work harder : there is no glut. Am I wrong ?

2

What constitutes a sticky price as oppose to a “normal” price? Can it be objectively defined?

Like “fair” and “just” prices, the notion of “sticky” prices is empty of any scientific meaning in the unhampered market economy.

3

The supposed problem of monetary disequilibrium goes as follows. Imagine that the quantity of money in circulation falls by some relatively large amount. Prices take time to adjust completely to the fall in nominal spending, and so effectively resources get “priced out of the market” (not sure if that’s the right way to explain it). There isn’t enough money to buy these goods and services, because their prices reflect a larger quantity of money in circulation. Therefore, businesses a forced to contract (real income falls) . This is the problem; the fall in nominal spending doesn’t fall throughout all industries simultaneously nor proportionally. It affects certain industries, and so the question remains: how will an increase in the quantity of money remedy the fall in income of certain industries? The fact is that it can’t, because you can’t control where any new fiduciary media will be spent, and so you will have some industries expanding, and the same industries that were contracting still contracting.

I am a monetary disequilibrium theorist, but for the above reasons (and other connected reasons) I have always tended to oppose countercyclical monetary policy, including that championed by Horwitz and Selgin (not QEI or II, but limited fiduciary expansion by the banking industry in the loanable funds market). You can’t solve changes in expenditure flow between different industries by increasing the supply of fiduciary media; that is not how the pricing process works, and an Austrian should know better.

Regarding wage cuts, Bewly might be correct (I don’t know), but I’m sure that when businesses have no other alternative but to reduce workers’ wages they’l reduce workers’ wages.

4

Why not? For example: contractual obligations could cause sticky prices downwards, because if the DMVP of someone lowers, the entrepreneur would want to lower the wage. But it could be sticky for the contractual duration. No?

That’s the difference between the relevant short and long run. Some prices can be instantly changed - excluding menu costs - other prices are ‘fixed’ in contractual relations. It’s true that this insight isn’t all that important, but I’m not sure about calling it ‘empty of any scientific meaning’. Accepting ‘there can be such a thing as a sticky price in the short run’ isn’t all that problematic.

5

Labor contracts tend to be pretty open ended, unless there’s some gov. regulations which dictate the terms by which firms can break contracts. On the whole, labor contracts themselves tend to favor the business during bad times and the worker during good times. Also, the form of labor contracts tend to change with changes in economic growth. For example, in Spain many labor contracts are short-term to go around gov. regulations (IIRC, they are weekly, or something like that).

If the firm cannot survive with high wages, I guarantee that it will find a way to reduce the price of labor (if there are people willing to work for a lower price).

6

The uneven adjustment process is merely one variable, but during an economic contraction, the demand for money may rise substantially, elevating the money rate of interest above the natural rate, yielding what Hayek called “secondary phenomena.” But as long as the fiduciary media satiates the demand for money as money, rather than the demand for money as capital, then it cannot distort the structure of production. Hayek writes about this a lot in Lecture 4, Prices and Production (he says that it’s problematic in practice).

7

‘It tends to be not-x’ is not a refutation of ‘it’s conceptually possible that x’.

At my work; our boss economizes on the amount of work demanded and not on the marginal wage as such.

8

Yes but frequently firms will choose to layoff workers rather than reduce wages in order to avoid productivity losses (lower morale).

9

That’s it. I’m starting to study prices and production tonight.

10

You really should, imo. It literally changed my life (read it 3 times and wrote a 30 page study guide).

11

Can you mail the study guide to me?

12

My problem with that is that what we see during an economic contraction is both a rise in the demand for money and a fall in the supply of money independent of a rise in demand (i.e. a reduction in the volume of outstanding loans)—i.e. credit contraction. I think it’s best to think about this in a world with a free banking system (a world, admittedly, in which this is not likely to happen—but, all of this is for the sake of argument). If you have a large number of banks suddenly facing a contraction of outstanding liabilities, and a fall in entrepreneurial confidence, then the ability for banks to issue more fiduciary media is put into question. I see the post-inflationary economy as one marred by two separate factors: a fall in the supply of money as a result of credit contraction (not driven by an increase in demand), and an increase in demand for money. I see the latter factor—an increase in demand for money—as a stabilizing factor, as it provides the necessary savings to (partly) justify what was originally an excess of fiduciary media.

The most popular argument that has been used against my thesis is that after the inflationary bout, prices tend to adjust to the new supply of money (i.e. the true scarcity of capital goods reveals itself), and so it doesn’t make sense to allow the supply of money to contract. This is where I bring my prior point into consideration—these changes in prices can’t be stopped (and, the ability for banks to issue more fiduciary media is questionable, given the general environment they are now operating in).

I don’t know if my argument is any clearer in these past two posts:

It’s a movement of both supply and demand, not just the latter, and so I think it’s more complicated than just “meeting the demand for money” to allow the market to coordinate the market rate of interest with the natural rate of interest.

13

Yes but frequently firms will choose to layoff workers rather than reduce wages in order to avoid productivity losses (lower morale).

Well, the firm can do whatever it wants, but it all remains true to my point. Wages on average still fall, because those now unemployed will prob. have to accept lower wages to find new work, or they’ll have to ride their savings until the going wage rate meets or exceeds their reservation wage. The point is only that aggregate nominal demand for wages fall, and that wages as a whole will tend to conform with the new amount of money being bid towards them (whatever worker does not conform, he becomes voluntarily unemployed).

14

Thank for your comments !
I’m actually re-reading “La crise de 1929” [Hautcoeur]. Unfortunately (for you) there is no english version.
He says : “…c’est ce qui distingue la grande dépression de la crise de 1921 (où une forte chute des prix avait conduit à une rapide et forte baisse des salaires, permettant une reprise rapide)”
Traduction : “…this is what distinguishes the great depression from the crisis of 1921 (where a sharp drop in prices led to a rapid and sharp decline in wages, allowing a quick recovery)”
http://img155.imageshack.us/i/sdc12967d.jpg/

I’m fine with Bewley’s works, and I really think entrepreneurs are naturally (and probably) reluctant to the idea of wage cuts. They prefer to layoff workers. But I know about economic forces.

Eschewing “top-down” theorizing, Truman Bewley explored the puzzle by interviewing — during the recession of the early 1990s — over three hundred business executives and labor leaders as well as professional recruiters and advisors to the unemployed. […] He found that the executives were averse to cutting wages of either current employees or new hires, even during the economic downturn when demand for their products fell sharply. They believed that cutting wages would hurt morale, which they felt was critical in gaining the cooperation of their employees and in convincing them to internalize the managers’ objectives for the company. Bewley’s findings contradict most theories of wage rigidity and provide fascinating insights into the problems businesses face that prevent labor markets from clearing.

http://cowles.econ.yale.edu/books/bewley/tfb_wages.htm

Jonathan,
That’s my opinion too. Even if you were interviewed and respond you’re indeed opposed to cut wages, economic forces and market clearing (i.e. increase of unemployment) will force you to readjust your actions because unemployed are scrambling to find jobs. They accept less wages and they will work harder because they refuse to stay unemployed and uninsured, relying on unemployment insurance (and Medicare/Medicaid. Holy crap !). And this is why I think the theory of “efficiency wage” is a fallacy.
And I don’t know what Bill Woolsey mean in saying “The problem would need to be that their selling prices are falling faster than the prices of inputs.”. I don’t see the problem he pointed out.

Esuric,
Ok, I go to re-read this chapter.

15

No contract in the world can enslave one human being to another. Besides, there is nothing special about such “obligations” during a deflationary period as oppose to a non-deflationary period where prices must be adjusted downward (while in some places upward) all the time. You must then argue that the problem of price stickiness is a permanent problem of the market.

Nothing changes instantly, and changes are always nothing but the result of mere speculative actions anyway. If certain economists want to define “sticky” prices as any price that does not change instantly, then I have no problem with that. That is indeed an objective definition. However, such a notion has no place in the realm of human action, and therefore, no place in economic science. It exists only in the realm of imaginary constructs and models that have nothing to do with the market economy.

Are we still talking about economic science? If yes, then please objectively define a sticky price. When does a price become sticky. What is the criterion for differentiating between the two?

16

It’s a myth that employers don’t like to reduce wages for “morale” or “productivity” reasons. They are afraid of rabble rousers. Unions didn’t get to where they are without putting a few businesses six feet under. People that proactively negotiate escape downsizing.

17

I don’t see any refutation of Say’s Law there at all. Say’s Law says that if man produces something, then he can sell that something and buy stuff. Where is this refuted, or even mentioned?

Say never said there will never be a glut of a particular good or service. If every single person in the USA opened a McDonald’s, there will probably be a glut of fast food hamburgers. What he did say was that there will not be a glut of EVERYTHING, a situation Keynesians say happens all the time, calling it lack of aggregate demand.

Mr Bewley argument makes tons of sense. Now Austrian Economics may not have reached that insight, but neither does it say that such a state of affairs is impossible.

Your analysis of people refusing to work hard etc. makes a lot of sense, but it is not relevant to Mr Bewley’s excellent field work. The employee will never walk over to the employer and say “Pay me less.” And even if he does, Mr Bewley is saying that the employer’s response is “I’d rather fire you altogether. It’s better for my business that way.” So that the option you mentioned of accepting lower wages is just never raised in practice.

18

An economist making the above typical assertion is operating under the same pretense of knowledge as any central planner. Apprerently the economist knows what the businessman doesn’t; that he should cut wages and not layoff workers. This is again, to misconstrue entirely the phenomena under investigation, and to resort to useless imaginary constructs of equilibrium models.

19

How do you know this?

20

" You must then argue that the problem of price stickiness is a permanent problem of the market. " <= Why would that be necessary? Why would it follow from ‘some prices are easier to adjust than others’ (which is basically the issue of sticky prices) that it is ‘a permanent problem of the market’?

A sticky price could be any price that is a price that because of prior actions can’t be changed to it’s current DMVP without undoing those actions or something like that. Again; if a contract stipulates that one works for 10 dollar/hour but his DMVP drops to 7, this could be considered a sticky price if there are certain obligations to uphold the previous agreed upon price.

Nobody is calling that a (market) problem - people make mistakes. Shit happens. That doesn’t mean that people mistakes can’t cause the conceptual idea of pricing adjusting slower than otherwise reasonably could have happened.

“What is the criterion for differentiating between the two?”

<= Are you saying that we need a criterion to distinguish the two as in ‘this is a sticky price’ and ‘this isn’t a sticky price’ in the real world, because else it would be devoid of any concept?

Why isn’t it enough to have a conceptual understanding, without the possibility of telling if any real world price is a sticky price?