Models are not about "essentials"...



They are abstractions that highlight an aspect of the thing being modeled.

That is why I deny that, by making a model of a recession in which "recessions are not about output and employment and saving and investment and borrowing and lending and interest rates and time and uncertainty... the only essential things are a decline in monetary exchange caused by an excess demand for the medium of exchange," Nick Rowe has shown that in real recessions, those are the only essential things.

For instance, what about the proposition that "The Ptolemaic model of the solar system proves that it is not about rock-and-ice-and-gas planets orbiting a giant plasma orb: The only essential thing is pure circular movement"?

But perhaps the problem there is that that is not a good model. So let's say we get a better one: Newton's. Now we have a planet as a point mass, orbiting the Sun, another point mass. Is this the "essence" of the solar system? That doesn't seem right at all: these point masses aren't the essence of planets and the Sun. They are just an abstraction of one aspect of these bodies, among countless others they possess. And for different problems, a model based on the idea of point masses would be disastrously misleading: You don't want to try to land your spacecraft on Mars based on modeling it as a point mass, nor would humans survive long if the Earth were one!

In particular, one may question whether, in Rowe's model which purports to show that recessions are all about "an excess demand for the medium of exchange," there is really a medium of exchange at all. Consider this quote from Mises:

"Thus the 'money' of this system is not a medium of exchange; it is not money at all; it is merely a numéraie, an ethereal and undetermined unit of accounting of that vague and indefinable character which the fancy of some economists and the errors of many laymen mistakenly have attributcd to money. The interposition of these numerical expressions between seller and buyer does not affect the essence of the sales..." -- Human Action

Let us look at what role "mangoes" play in the model economy Rowe has created. In his barter economy, he makes mangoes the "numéraie," and shows how the "price" of apples and bananas in terms of mangoes makes no difference to what trades take place at all. But in what sense, then, are these "prices" at all? What possible actors would choose to evaluate their trades in terms of a "price" that made no difference to what they traded? If we want to look at "essences," I would suggest that the "essential" feature of any price is that it enables us to evaluate whether or not some exchange is worthwhile.

Rowe then proceeds to a model where apples are not traded directly for bananas, but each are traded for mangoes. Why don't actors simply trade apples directly for bananas in this economy? He says:

"This means there is a market in which mangoes are traded for apples (the 'apple market'), and a market in which mangoes are traded for bananas (the 'banana market'), but no market in which apples are traded for bananas directly. The reason is that mangoes are portable, but apples and bananas must be eaten directly off the tree, or they taste bad, and agents are anonymous so can't swap IOUs for apples or bananas. So the only way agents can trade apples and bananas is by using mangoes as the medium of exchange."

Rowe recognizes that, even in the case where apples and bananas can only be eaten directly from their trees, IOUs could suffice to permit exchange: each actor could signal, through whatever IOU mechanism they employ, "You can go eat 100 of my apples, if I can go eat 100 of your bananas." And he tries to foreclose this possibility by positing that "agents are anonymous." But what in the world can that mean? I just go and dump 10 mangoes out on the beach, and trust that somehow ten bananas will appear in exchange? No, if transacting agents are anonymous to each other, then they must have some exchange through which they are transacting, and that exchange must know the identity of each transacting agent. If I offer ten mangoes for ten bananas, then for me to have any faith that I simply haven't lost my mangoes, someone or something (e.g., a computer) must know exactly who has accepted my offer, and have some way to ensure that non-anonymous agent actually delivers. In which case, we could simply transact through IOUs, and skip the mangoes.

Finally, let us assume that, for some unknown reason, mangoes would actually serve as the medium of exchange in Rowe's model. A recession sets in when people suddenly desire to hold more mangoes than they previously had held, raising P above 1. But what could possibly cause such a price change except increased uncertainty about the future? Indeed, what could ever create the need for a medium of exchange at all, except uncertainty about the future?

Rowe's model is interesting, and I am glad he has forwarded it. But it does not prove what he thinks it proves.

4 comments:

  1. Thanks Gene!

    1. That quote from Mises. Is he talking about the Walrasian system? (I think he is)

    2. In the barter version of my model, a change in P makes no difference to *actual* trades, but it does affect excess demand/supply for mangoes. It does affect the amounts that people *want* to trade. If P > 1, then everyone wants to buy more mangoes (with apples or bananas). So even in my barter version, P does meet your test of "I would suggest that the "essential" feature of any price is that it enables us to evaluate whether or not some exchange is worthwhile." Mangoes are a real good, not some abstract numeraire. (I'm wondering whether I should have said mangoes are "Medium of Account", rather than "numeraire".)

    3. Am I "anonymous" when I go to get a haircut at a place I'm not known? Well, yes and no. If I try to run off without paying they will run after me and try not to lose me in the crowd. I'm not anonymous in that sense. But they won't know where to find my lecture theatre to get an economics lecture in exchange for the haircut, so they insist on cash on the nail, and trust I will pay immediately. (And of course, the Wicksellian circle is much larger than two people, but two is enough to make my point, hence my minimalist model only has two types of people.)

    4. A minimalist model useful for landing on the moon will be different for a minimalist model useful for predicting the tides. My model is minimalist for understanding recessions, but will not be minimalist for other uses.

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    1. 1) General equilibrium.

      2) I don't understand: if mangoes aren't trading, why do I care what their "price" is? Since no one is offering mangoes on the market, what does it mean to say I want to buy more. Isn't that a bit like wanting to buy more flying cars? I understand what is up in your model, and don't object to it... as a model. My objection is to saying "now we have the essence of what is going on."

      3) But you could give them your lecture hall address.

      4) I like your model. It is very interesting. It's the "essence" claim that troubles me.

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    2. Gene:

      2. Take any good in inelastic supply. Lowering the price below the market-clearing price doesn't affect quantity of sales, but it does affect the length of queues. E.g. rent controlled apartments. Involuntarily unemployed still exist, even though they can't get jobs.

      3. But I would lie, and give them your lecture hall address, so you would be asked to pay for my haircut.

      4. It's the "essence" in the following sense: you can add other stuff to the model without changing it (much). OK, the "much" is a cop-out. But I can add employment and output to the model without changing it *at all*.

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    3. Nick I will contemplate these points. But in the meantime, have a look at my spreadsheets for some macro I models. I've found them (or will find... I just finished PPF) them pretty handy. Let me know what you think if you have a chance. They are free for all to use.

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