The True Gold Standard (Second Edition)
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If Wanniski does not object to the Quantity Theory as an analytical tool, when what is his problem? His objection is precisely to treating money as a commodity. That in his view, would violate Say’s Law – when in fact, as we have seen, it’s the only way to defend Say’s Law in a money economy.
The sharp either/or distinction between “supply-side” and “demand-side” economics, on which Wanniski places so much emphasis, is the subject of one of the murkiest chapters in Wanniski’s book. It is the distinction about which Wanniski most often quarrels. But it is based purely on Wanniski’s own confusion.
Mundell, whose ideas Wanniski purports to follow, does not see a sharp supply-side/demand-side distinction; for him it is a question of both/and, not either/or. That’s the whole idea of his “policy mix.” The following is typical of Mundell’s approach:
“Supply-side theory does not discard the valid Keynesian idea of balancing aggregate demand and supply at full employment, indeed that is a prime feature of our ‘voodoo’ school. But to this basically Keynesian insight we add the idea of using incentives to increase the ‘marginal efficiency of labor,’ if I may use that term. We need also to increase the marginal efficiency of capital. The real sinner in our economy is our obsolete tax structure, and raising taxes won’t make it any more holy.” (“Idle Resources, Easy Money, Hard Choices,” Manhattan Report on Economic Policy, Manhattan Institute, July 1982, p. 7).
Unlike Mundell, but like the classical economists, Wanniski does not in practice have a single theory of a money economy; he has two disconnected theories: a barter theory and a separate theory of money, which is a variation of the Quantity Theory.
Wanniski ordinarily speaks in terms of the barter model – with butchers and bakers exchanging their meat for bread and so forth. Occasionally, Wanniski will graft money onto his barter model as a unit of account that exists only in the minds of all economic agents – not as one of the goods that they exchange. This way of looking at things is not debilitating for certain purposes. But the barter theory cannot explain inflation, because it contains no money.
Wanniski fails to consider money as a commodity which is supplied and demanded, which has both a price and a cost of production, like any other commodity. To Wanniski, doing so is the very essence of the “demand model,” because it seems to him to violate Say’s Law. For this reason, any accurate description of a money economy is, in Wanniski’s view, a “demand model” – only barter theory can be a “supply model.”
At most, Wanniski will permit money to be a unit of account and a medium of exchange, but not a store of value. In reality of course, money must first be a store of value before anyone will use it as a unit of account or a medium of exchange.
“Once we come to understand the concept of money we automatically introduce a confusion into our understanding of the economy, forgetting that we only work in order to trade our labour supply for the supply of other workers. Instead, we come to think that we work for ‘money,’ and that money is the object of work,” Wanniski writes (The Way the World Works, p. 107).
This, he says, is exactly the error of the monetarists: “The electorate does not view money as a storehouse of value, i.e., a commodity that has worth beyond its usefulness as a medium of exchange. The electorate will exchange its labor for a precise quantity of money, that which it precisely needs to lubricate the wheel of commerce. It will not exchange its labor for money not needed for transactions. This, though, is the theory of the monetarists” (idem, p. 163).
Wanniski argues that the monetarists believe in “money illusion,” which he defines as follows: “Money illusion implicitly assumes that prices do not change as a result of the amount of money issued” (idem, p. 160). That is, he complains the monetarists don’t follow the Quantity Theory.
Wanniski accuses the monetarists of believing that an increase in the money supply will permanently increase real output. Citing Friedman, he says: “The monetarists argue that by increasing the supply of money, both Smith and Jones will want more – not as a medium of exchange, but as a storehouse of value, a form of wealth. In coming into the market and trading their labor for this incremental wealth, Smith and Jones increase the economy’s output. There is now more money in the system and the monetarists agree that prices will rise, so that Smith and Jones are back to where they began…. But at least the economy has gotten one transaction out of them, so that all of the increase in money has not gone exclusively into price increases, but has yielded a little output, too” (idem, p.163).
The monetarists say nothing of the sort: they argue that the money supply cannot have any permanent effect on output, only on prices. And they are right on this. During the period when the economy adjusts to excess money, there is a temporary up-and-down fluctuation in output, around a trend determined independently by supply factors; but Wanniski has only heard the “up,” not the “down.”
Wanniski’s confusion – which is the source of a goodly share of his anathemas – stems from the fact that he has not successfully worked out what Say’s Law means in an economy with money. Money can produce no temporary fluctuations in output in Wanniski’s barter theory, for the simple reason that there is no money for a barter economy to adjust to. This is why Wanniski tries to find fiscal explanations for monetary problems.
Wanniski has been sufficiently answered by the earlier discussion of Rueff’s restatement of Say’s Law. The interesting thing is that Goldman does not seem to have read Wanniski’s book.
Goldman tells us that “LBMC’s model is a variation on old-fashioned monetarism, which asserts that the price level varies with some measure of the quantity of money (M1 or M2), after a two-year lag.”
One of the main problems with that idea, Goldman explains, is that:
“An enormous amount of U.S. currency is held as a store of value or used as a circulating medium by countries with high inflation rates, or by tax evaders, drug traffickers, and so forth. About two-thirds of the $240 billion U.S. currency in circulation as of October 1990, is circulating abroad, according to Federal Reserve estimates. Federal Reserve Chairman Alan Greenspan estimates that $5 to $7 billion is circulating in just one South American country. It is hard to imagine what effect a stack of $50 bills under an Argentine or Bolivian mattress has on the world price level. (p. 2).
To summarize, then: Wanniski charges the monetarists with believing that “prices do not change as a result of the amount of money issued”; while Goldman indicts them for believing that “the price level varies with some measure of the quantity of money.”
Next installment: Reply to Polyconomics: Part 3
The Rueffian Synthesis