A Clarification of the Excess Demand for or Excess Supply of Money
Rabin, Alan A., Economic Inquiry
This article focuses on many economists' neglect (and even denial) of monetary disequilibrium. I am convinced that one of the most misunderstood and neglected concepts in all of economics is the notion that money may indeed be in excess supply or excess demand. For example, McCallum |1989, 84~ argues:
Since it does not take long to alter the amount of currency that one holds, either by purchasing interest-bearing bonds or consumption goods, it is reasonable to assume that actual holdings correspond very closely to desired (demanded) holdings for each household. Thus in the aggregate we have
|M.sup.d~ = |M.sup.s~;
that is, the quantity of money demanded equals the quantity supplied.
McCallum then goes on to argue that given the above equality, "there should be no loss in content if we simply use the symbol |Mathematical Expression Omitted~ to denote both |M.sup.d~ and |M.sup.s~." Accordingly, McCallum assumes money demand and money supply coincide. Although his book is about monetary theory, McCallum completely overlooks the importance of monetary disequilibrium.
Dornbusch and Fischer |1990, 137~ also commit this oversight when they argue:
For many purposes it is useful to restrict the dynamics by the reasonable assumption that the money market adjusts very quickly and the goods market adjusts relatively slowly. Since the money market can adjust merely through the buying and selling of bonds, the interest rate adjusts rapidly and the money market effectively is always in equilibrium. Such an assumption implies that we are always on the LM curve: any departure from the equilibrium in the money market is almost instantaneously eliminated by an appropriate change in the interest rate. In disequilibrium, we therefore move along the LM curve....
If one is going to discuss the dynamics of macroeconomic adjustment, then surely one should not disregard monetary disequilibrium. Similarly, other economists, as in Serfaty |1979~, Kaldor |1982~, and Moore |1988~, argue that money can never be in "excess supply."
Much of what this article says has been written elsewhere. While this repetition may be tedious to some, "only by varied iteration can alien conceptions be forced on reluctant minds."(1)
II. MONETARY DISEQUILIBRIUM
By "money" is meant "narrow money," "the medium of exchange" (that is, currency plus demand deposits). Some economists seem to imply that "money demand" and "money supply" are almost conceptually the same, since they are always equal. For example, Kohn |1991, 678~ argues: "Since all of the money in existence must be held by someone, the aggregate demand for money must equal the total amount in existence." One of the critical errors in such assertions is the assumption that newly accepted cash balances are fully demanded. Because of money's role as a medium of exchange, people are always willing to accept newly created money. However, that does not mean that they are actually demanding these additions to their money holdings. Rather, they may try to dispose of these acquired (but excess) money balances with appropriate speed. Yeager |1968, 51-52~ discusses this crucial distinction for a closed economy:
A person accepts money not necessarily because he chooses to continue holding it but precisely because it is the routine intermediary between his sales and his purchases or investments and because he knows he can get rid of it whenever he wants....People's initial unwillingness to hold all newly created actual money would not keep them from accepting it and would not prevent its creation.
Yeager |1968, 50-51~ further elaborates on the process by which these excess money balances eventually become desired:
A holder of unwanted money exchanges it directly for whatever he does want, without first cashing it in for something else. Nothing is more ultimate than money. Instead of going out of existence, unwanted money gets passed around until it ceases to be unwanted. …