Do Keynesians understand their own models? (2011)
&gt;But do Keynesians understand this?<p>Uh, is this a joke? Ever heard of liquidity preference? Liquidity preference is the central concept of Keynes General Theory and it is about how people prefer liquid assets over illiquid assets as a store of value.<p>In a world of barter exchange there would be no money and therefore no perfectly liquid asset that is preferred over all other assets. Money affords advantages over physical goods and services because it can be easily stored, even if products and services in the real world are difficult to store, leading to a money hoarding bias because you can force the cost maintaining and storing wealth on the rest of the economy like an externality.<p>&gt;Do they understand the central role of money and monetary exchange in generating recessions? If so, why the emphasis on fiscal policy?<p>Fiscal policy is supposed to drive aggregate demand and hence inflation to a steady x% every year to neutralise liquidity preference.<p>&gt;Take a Keynesian model. Any Keynesian model. Start in long run equilibrium. Now hit it with the sort of shock that would cause a recession. Aggregate Demand falls, which causes output and employment to fall. Unemployment increases. OK, what&#x27;s really going on here?<p>&gt;The unemployed hairdresser wants her nails done. The unemployed manicurist wants a massage. The unemployed masseuse wants a haircut. If a 3-way barter deal were easy to arrange, they would do it, and would not be unemployed. There is a mutually advantageous exchange that is not happening. Keynesian unemployment assumes a short-run equilibrium with haircuts, massages, and manicures lying on the sidewalk going to waste. Why don&#x27;t they pick them up? It&#x27;s not that the unemployed don&#x27;t know where to buy what they want to buy.<p>You need money to trade between two or three people, but that requires borrowing money. In a barter economy you don&#x27;t have to borrow the &quot;talking stone&quot; I.e. money. Borrowing isn&#x27;t happening because the return on these loans does not exceed liquidity preference. Banks don&#x27;t want to lend out money to the unemployed. So the government spends new money into the economy so people have talking stones to trade with each other.<p>&gt;The $20 reappears as soon as it is spent. But the widow&#x27;s cruse fails unless all three increase spending at once. And, in Nash Equilibrium, none of the three wants to do that. She prefers the $20 in her purse.<p>With barter, it is impossible to wait for the other person to buy your products. With money it is possible to buy a product and then the other party never buys a product from you, hence waiting for employment forever. This means liquidity preference is partly about feeling save, having choices and options that money gives you.<p>&gt;Update: as Yeager noted, there are two ways to get more money. The first is to sell more stuff; the second is to buy less stuff. And nobody can ever stop an individual from getting more money by buying less stuff.<p>Basic human needs like shelter and food have called. If you are unemployed you have no choice other than to spend more than you earn.<p>&gt;OK. There is a legitimate Keynesian defence. If a doctor can&#x27;t fix a broken leg, he might recommend a wheelchair as a second best fix until the leg heals itself. He might argue that it will help the leg heal quicklier. OK. But he should admit that it&#x27;s a second best, and be looking for a first best, and encouraging others to seek a first best. He shouldn&#x27;t be selling wheelchairs.<p>It actually is very much like that. Inflation is a bandaid. Inflation rate targeting is trying to simulate a demurrage currency by constantly devaluing currency.<p>&gt;The trouble with Keynesians is that they aren&#x27;t radical enough. They need to look at their own models and see the root of the problem, and recommend policies to get at the root of the problem. The root of all Keynesian recessions is monetary.<p>Keynes himself was inspired by Silvio Gesell who introduced the concept of a demurrage currency being the answer to make money a neutral medium of exchange that is equivalent to barter. The demurrage fee essentially forces people to make decisions sooner rather than later which is usually a good thing as it encourages planning and long term thinking. When you barter, you trade one thing for another. When you buy something with money, there is no expectation that someone will buy from you, hence the problem of unemployment. A demurrage currency effectively acts like a boomerang. If you spend money, the other side must eventually spend their money. This will make people feel more confident in spending their money because they don&#x27;t have to fear unemployment. If the other person doesn&#x27;t want to buy anything and is angry to acquire evaporating money, that person should simply work less or lend the money to someone who needs it at zero interest to dodge the demurrage fee. The person with too much money is incentivized to preorder products to make it easier for companies to plan their production ahead of time. With a normal currency, companies must speculate demand ahead of time.