Steven Landsburg asks more about Keynesianism and Money. The key question

Once again, money is provided at zero social cost. Once again, it seems to me that the private cost of holding money is positive (that old forgone consumption again). Therefore, once again, people must hold too little money. Therefore, once again, they spend too much. Therefore, once again, an additional dollar spent must do more external harm than external good.

The problem, then, is to identify the bearer of that external harm. Well, what happens when I spend a dollar? Back in the old flexible-price world, I bid up prices. But in the fixed-price world, I can’t bid up prices, so I must bid up the real interest rate instead. That’s good for lenders and bad for borrowers, but that washes out because every lender is matched with a borrower. So where is the missing extra external harm?

My answer, also posted in his comments section.

The issue is that the net private marginal cost of holding a dollar is negative in Keynesian story.

So to be clear – because this wasn’t in your set up – money has private benefits as well as private costs. That is people desire liquidity, or there is money in the utility function, or a cash-in-advance constraint. Whatever, you want.

However, the fact that positive money balances exist tells us that they must have some private benefit or else everyone would attempt to spend down to zero.

Now, what is it that people want? Well, we assume they want real purchasing power. So, what they care about is not the face value of the money in their wallets but what it can buy.

Now imagine that by some magical trick the amount of money in everyone’s wallet is cut in half, but prices remain the same. Real purchasing power is now less than what it was.

Because people were previously holding optimal money balances, they must be holding sub-optimal money balances now.

This means that the net private marginal cost to holding money is now *negative.*

So you get the exact opposite result, spending a dollar causes external benefit because it allows another person to build up their real money balances which makes them happier.

About these ads