Fluttering Veil: Essays on Monetary Disequilibrium

"This is a book that that had a tremendous influence on my thinking about monetary theory. Leland Yeager is a very overlooked economist; he is not well known. This particular book consists of a number of his essays and articles, collected by my friend, George Selgin, now at the Cato Institute. The essays essentially describe a framework for understanding monetary policy. At the core of that is the price level, or rather nominal demand in the economy. (Nominal demand is the number of goods times the price of those goods, which is also the money circulating in the economy.) This is often described by the equation of exchange MV=PY times, which says the quantity of money (M) times the velocity of money (V)—a measure of the circulation of money in the economy—equals prices (P) times GDP/production (Y). This central to what we call monetarist thinking today. But what Leland Yeager does in his book is to lay out a framework for a theoretical understanding of money. Central to this is an understanding that money is not only about the printing of money, but also about the demand for money. He tells us that if the demand for money increases, we need to increase the supply of money to match it, otherwise we get deflation. A failure to increase the supply of money is essentially what happened in 2008. I would argue that the crisis of 2008 had very little to do with a housing market bubble or excesses prior to 2008, but was rather related to the demand for money increasing sharply and the Federal Reserve and the ECB and all central banks, initially, failing to respond appropriately in terms of increasing the supply of money, the money base. Get the weekly Five Books newsletter What Yeager does in his book is describe what happens where there is that disequilibrium between the demand and supply of money. We either get inflation or deflation, both being harmful. And he argues that what we need to do when we think about money is to create a monetary system where, by some automatic rule, for example through the private issuance of money, which Leland Yeager actually advocated, or through monetary policy rules that adjust so the demand and the supply of money meets to ensure either a stable price level, or stable monetary demand in the economy, or stable nominal demand in the economy. That’s Yeager’s project for understanding monetary theory. And I think it’s a very, very overlooked book. I read it early on when I was a young economist, but later rediscovered it after 2008 and really learned to appreciate it. It first came out in 1997. It was very much in line with what I read in Milton Friedman. But Yeager continually argues that the focus needs to be on both the supply of, and the demand for, money and that there can be a disequilibrium. In a world without money, where there is never a recession, the price of coconuts and the price of hammers will always find an equilibrium for trade between Crusoe and Friday. But, in a monetary world, if a central bank fails to print enough money when money demand goes up, as happened in the 1930s and in 2008, there will be disequilibrium in the money market, which spills over to the real world, leading to unemployment and low capacity utilisation in the economy in general. It’s only when prices then adjust or monetary policy adjusts that we re-establish equilibrium in the real world and unemployment comes down again. I think these are the very important insights. This book helps us to understand what happened in 2008, even though, of course, these articles were written way before that."