Of Marginal Utility

I used to read Marginal Revolution in the hope of learning a bit of economics. That doesn't seem to be happening, but I do get an occasional glimpse into a rather strange mind. Consider Tyler Cowen's post on the liquidity trap, a concept I'm pretty sure he doesn't believe in.

Here's another simple thought experiment. Let's say that, for reasons of technology, currency disappeared. All transactions would be made with POS or cell phones, backed by interest-bearing assets, in one form or another. You might think that's unlikely today but it's at least possible in the future. In any case, it's a thought experiment.

Economists of the Chicago faith seem to disbelieve in the reality of money. It presents certain problems for their neat mathematical models. I'm guessing that this is Cowen's attempt to banish it.

More Keynesian views, I gather, think that depressions happen when there is a flight to liquidity, and people decide that they would rather hold on to money than anything that they might buy with it. This condition leads to a collapse of trade, unemployment, and recession or depression. The idea offends Chicago, since their models assume that money only exists to spend.

I'm guessing (since I can't really make any sense out of the rest of Tyler's commentary), that he wants to eliminate the possibility (in his thought experiment) that people really might put money under the mattress when times are scary.

If that's the case, I think his thought experiment falls apart when one considers the nature of his interest-bearing assets. What is an interest-bearing asset (iba)? It's a loan! That's not too strange, because currency too can be considered a sort of loan - a token we accept from the government whose value is guaranteed by the taxing power of the state. So what about those ibas? Are they all of the same sort? Who get's the loan and who negotiates the interest rate? If it's a government, then it's just money by another name, and it will pay whatever interest it likes. If it's other people, then valuation becomes a challenge because the most fundamental characteristic of a loan is the risk that it might not be paid back.

The point is, that even in Tyler World, different kinds of ibas have different values, and in times of panic, funds flow out of risky loans and into the safest ones, choking the economy's potentially most productive opportunities. Then, when nobody want's to lend money to anyone who wants to borrow it, the supply of ibas will evaporate, and a deflationary spiral ensues.