Salerno on Market Monetarism

Tom Woods and Joe Salerno explain what is wrong with Market Monetarism.

The most glaring error is Salerno's claim that any increase in the quantity of money pushes the market rate below the natural rate of interest  because the new money is injected into credit markets.   However, an increase in the quantity of money that matches an increase in the demand to hold money rather keeps the market interest rate equal to the natural interest rate.   If saving occurs by accumulation of money balances, then the natural and market interest rates decrease.   If instead, the added money balances are accumulated by reducing spending on capital goods or other financial assets or even selling capital goods or other financial assets, then the natural and market interest rates remain unchanged if newly created money is injected into credit markets.

The oddest portion of his argument is the admission that prices and wages are sticky but that this is OK because entrepreneurs can choose to adjust them if they want.   There was a rather odd notion that these are small little blips.   Well, I suppose some of them are minor and don't make much difference.  It is when a large change in the demand to hold money leads to a large change in market clearing prices that sticky prices and wages result in large changes in output and employment which are serious problems.

Also, the entire discussion carries on ignoring a decrease in the demand to hold money.  Market monetarists favor a decrease in the quantity of money in that circumstance.   The Salerno view is that the inflation (or reflation) of prices is harmless?   Entrepreneurs just need to take care of it?

Anyway, the key question is what sort of monetary regime is best.  Is it better to have a monetary regime that requires changes in the price and wage level so that real money balances adjust to the demand to hold them given a fixed nominal quantity of money, or is it better to have a nominal quantity of money that adjusts with changes in the demand to hold money.    While price and wage adjustments are still necessary to coordinate economic activity, they aren't necessary to provide for monetary equilibrium if the nominal quantity of money adjusts to changes in the demand to hold money.

Salerno also suggests that entrepreneurs should not be treated as fragile flowers unable to maintain monetary equilibrium.   "Unable" shows an unfortunate tendency of some Austrians to confuse sticky with stuck prices, and really, to continue to fight past battles regarding long run unemployment equilibrium rather than what is really at issue--whether sticky prices and wages result in temporary fluctuations in output and employment that are both painful and avoidable.

Again, the issue is what monetary regime is best.   One key issue is specialization.   Entrepreneurs specialize in particular products.   The requirement that everyone set their prices and wages to make the real quantity of money accommodate the demand to hold money balances requires every entrepreneur to specialize in two areas--the production and demand for their particular product, but also the production and demand for money.    (One of the goals of index futures convertibility is to allow some entrepreneurs to specialize in maintaining monetary equilibrium.)

The argument that I found most challenging is Salerno's claim that spending has no causal significance.   I think his description of the market process where buyers and sellers first negotiate a price and then choose the amount transacted and so spending is a bit off.   Though in another passage it seemed to be suggesting that prices and quantities are jointly negotiated--I want 3 units at $2 each.   Well, I will sell you 5 units at $1.50 each.   That this involves expenditure of $6 or $7.50 is of no causal significance.

Well, perhaps I am an unsophisticated consumer, but I operate on a relatively fixed nominal budget constraint.   My income both recently earned and expected in the near future is an aggregate nominal amount.   And that constrains my total spending on goods and services.   How much I can spend on this or that good or service must add up to what I have available to spend.   I care about how much of each product  I get, but what I spend on any one purchase is what determines what I have left to spend on other stuff.

My vision of the market process is each firm setting both its price and production.  And the nominal value of the firm's output is found by multiplying that price and quantity.   That is added up for all the firms to get the aggregate value of output.   Of course, service firms, which play too small a role in my vision compared to their actual role in the economy, involve choosing a price and then producing what is sold.

Still, I do think that anticipated revenues from this output and pricing decision is very important to firms.  Revenue is what they will need to cover costs and generate a residual profit,.   It seems to me that nominal sales, and especially, expected nominal sales do play a key role in entrepreneurial decisions.  

Now, suppose we have two individuals who are self-employed, consuming part of their own product and then bartering the excess for the product of the other.   I think it is fair to say that the amount of money earned and the amount available to spend would hardly matter.   It is a barter economy after all.   Isn't this Salerno's bargaining economy where "spending" means nothing and it is all about the scale of values?

In a monetary economy where people consume close to nothing of what they produce and instead sell nearly all of it to fund purchases, how much money they earn, and more importantly, what they expect to earn, means something.  In the two person barter economy, the key question is how much corn do I eat and how much will I trade for beans which I will then eat.  In a money economy, I sell my corn for money and then that money income determines how much I can spend on a huge variety of goods and services.    How much revenue I get from selling my corn is very important.    And if I am actually paying for seed corn and fertilizer and making payments on my tractors, how much money I will make from selling corn is more obviously important--it determines the residual, which will be how much I can spend on a variety of consumer products for my own use.

To me, it is obvious that it isn't the Market Monetarists who are foolishly assuming that we can separate the real economy and the monetary economy.   Our emphasis on spending on output and nominal income clearly shows that we consider the role of money in the market process very important.

Finally, suppose that the economy is made up of a gold miner who uses most his gold to fill his teeth and for jewelry.   He trades some for corn to eat.  The corn farmer eats most of his corn, but trades some of it for gold to fill his teeth and for jewelry.   Why is money expenditures more important in this economy than when the corn farmer is bartering with the bean farmer?

Well, it isn't.     It isn't a monetary economy, and so nominal income and expenditures are not important.  In such an economy, I don't think that the exchange of gold and corn would cause any special problems.  And I don't think that having the supply of gold be more elastic would be nearly as desirable as it would be in a world of many goods and services, where firms purchase resources such as labor and use it to produce goods for sale.