## Specifying “Demand”: Nick Rowe Meets Steve Keen on His Own Ground

You might well ask: “Whaddaya mean by ‘his,’ buster?”

Nick does a full-faith effort hereÂ (including the comments) to characterize Steve Keen’s position (aggregate demand = GDP + change in debt), using Nick’s preferred language and mental modeling. It’s a darned good effort, but I think it’s crippled (as is Steve’s construct) by a conceptual failing about the nature(s) of “demand.”

The problem is perhaps best revealed here:

Aggregate actual nominal income equals aggregate expected nominal income plus amount of new money created by the banking system minus increase in the stock of money demanded.Nothing in the above violates any national income accounting identity.

The last statement is neither right nor wrong,Â because “demand” is not an accounting measure. You’ll never find “demand” anywhere in the national accounts, in balance sheets, income statements, or flows of funds. Demand is a (potentially) useful *economic* concept and construct.

In its general form, demand is conceived as a curve, not an amount. It describes what people, *at a given moment*, *would*Â spend over an ensuing period, *at various price points.Â *(You can’t include a curve in an accounting identity.)

But if you assume a price point — say, the price point that exists at that given moment — you can specify demand at that moment as a number, anÂ *amount,*Â a point on the curve: how much people would spend over the ensuing period at that price point, if nothing changed and supply was unconstrained. This works, for instance, if you assume that that moment’s price point will pertain over the ensuing period — not crazy for short periods. You can say “this is how much people, at this moment and this price point, *want* to spend over the ensuing period.”

That numerical amount — demand *at that moment* — couldÂ say something useful about the state of the economy at that moment (especially in the context of other measures).

Demand in the textbook understanding is always demand at a moment. It’s an “instantaneous flow.” (Google that term toÂ to see how flow-over-time measures for water, electricity, etc. that encompass or surround a moment can be used to estimate/derive such an instantaneous measure, and what formulas can be used to do so.)

Aside: Nick says in the comments that demand (or at least “”money demanded”) is a stock, and change in demand is a flow. I think he’s conceptualizing it wrong — the stock of demand?? — but he’s intuiting what I’m thinking: “demand” is like a stock measure because it describes a moment.

So here’s the question: “What was demand (for widgets, or aggregate demand) on July 31, 2011?” **Gimme a number.** How has that number changed over time? Graph it for me.

Have you ever seen a fever chart of aggregate demand over the decades? Would be darned interesting, no?

So I’m kind of amazed that economists aren’t, haven’t been, all over the problem of defining a formula to specify a measure of aggregate demand for an economy at a given moment. Steve Keen’s trying to do that. So is Ed Lambert.

You need a formula that draws on now-available, post-hoc accounting measures to derive an estimate of this economic measure for that moment. What accounting measures, and what formula combining those measures, deliver the *most useful*Â (accurate?) estimate of that moment’s “demand”? (The measure’s usefulness will ultimately depend on the larger model(s) in which it is employed, but we can begin by thinking in more general terms.)

Simple accounting measures don’t work. GDP over the ensuing period doesn’t do it, for instance. That’s “quantity actually supplied/bought/sold” during the period, not quantity demanded over the period, or demand at the beginning of the period. Supply constraints, price changes, etc. could (almost certainly do) mean that those numbers are quite different.

So what could work? There are an infinite number of possible formulas to estimate this measure, employing an infinite number of accounting measures. The most useful measures might be stock measures (describing the “demand moment” we’re examining), or flow measures (describing a period or periods preceding, succeeding, and/or encompassing that moment), or some combination of the two. It would be great if we could come up with a formula that relies on measures antecedent to the “demand moment” we’re estimating, because then we could estimate current “demand” in semi-real-time (subject to delays in measurement and reporting).

So what about Steve’s formula — GDP plus change in debt? I find it problematic because he seems to be specifying demand for a period, not a moment. Saying “demand for (the period) 2011 was GDP plus change in debt in 2011” is not very useful; it simply restates existing accounting measures for a period using a different word (“demand”). I want to know: what was demand on *January 1,* 2011? (If we’re using ensuing-period — say, 12-month — accounting measures to make the estimate, we may need to be precise in describing our measure: something like “ensuing-12-month-derived demand on January 1 was…”)

Also — assuming in my construct that Steve is deriving today’s “demand” from ensuing-twelve-month GDP and change in debt (I don’t think he’s actually doing that) — we don’t know what GDP and change in debt will be over the next twelve months. So the measure gives us no idea of what demand is today.

(It seems quite possibly or even likely to me, though, that Â useful measures of “instantaneous demand” Â will incorporate some debt/lending measures. Intuitively: when people borrow more they spend more, increasing the demand that producers face.)

This is all why I’m rather taken with Ed Lambert’s work. He’s given us a formula, based on most-recent accounting measures (Real GDP, Labor Share of Income, Capacity Utilization, and the Unemployment Rate), to calculate a measure he calls “effective” demand, at a given moment, i.e. now or any point in the reported past. And he graphs that measure over time relative to other measures.

Is it, will it, be a useful measure — allowing prediction or at least coherent understanding? That remains to be seen. But I’d sure like to see other economists developing competing measures of demand-at-a-given-moment, and accompanying models that make predictions based on those measures. It could result in some healthy Darwinian natural selection in the field.

*Cross-posted at Angry Bear.*

“GDP over the ensuing period doesnâ€™t do it, for instance. Thatâ€™s â€œquantity actually supplied/bought/soldâ€ during the period, not quantity demanded over the period, or demand at the beginning of the period.”

By the last 8 words I think you are saying that “demand at the beginning of the period” (since we must work in periods of time) is equal to the “quantity demanded over the period”. This makes good sense to me. As for the rest…

You say that the â€œquantity actually supplied/bought/soldâ€ is NOT the same as the “quantity demanded over the period”. This I don’t understand.

I need your definition of demand.

@The Arthurian “I need your definition of demand.”

From above:

In its general form… what people, at a given moment, would spend over an ensuing period, at various price points.

It’s easier to start by considering a measure like expenditure. Something like aggregate expenditure is necessarily an approximation. We measure it over a period, but clearly within that period it is changing. Measuring expenditure in a ten year period, say, hides a mass of information.

However, the more we shorten the period we measure it over, the more we run into a different problem. This is that expenditure is not a smooth uniform quantity, but is made up of a mass of discrete transactions. As we shorten the period, the more lumpy it becomes. Even for periods of less than a year, we start to need to make seasonal adjustments to correct for this. If you measured expenditure on a daily basis, it would be all over the place. Expenditure at a point in time hardly makes sense at all.

Demand is related to expenditure. Expenditure is what actually happens. Demand is one side of the equation that determines expenditure. We can talk about quantity demanded, given various other factors and then consider whether those factors will ensure that quantity demanded equals quantity supplied. But quantity demanded needs to be measured over a period, just as expenditure is. In theoretical models, you can take a discrete measure of demand for a particular period and convert it into a continuous measure. Doing this would allow you to compute the exact demand for apples at midnight on 5th September for example. This makes no sense in the real world.

For consistency, there needs to be a way to measure demand for stock concepts like money over a period as well. The best way to understand this is to look at the national flow of funds accounts. These are drawn up using the concepts of resources and uses. Uses includes expenditure over the period. It also includes net acquisition of assets over the period. The demand for money in a period is therefore the desired increase in money balances over that period. As the opening balance of money is a given, this is equivalent to determining the desired money balance at the end of the period.

…the very idea of a monetary equilibrium is at odds both with the banking nature of money and with the definition of money income. An equilibrium is a (more or less) stable condition in which distinct and opposite forces balance each other. Hence, a monetary equilibrium is a concept presupposing the existence of the demand for and supply of money as two distinct and opposite forces. But, if demand for and supply of money are to define two opposite forces, it is necessary that money exists independently of produced output. It is only in this case, and on condition that it had a positive value of its own, that money could be held as a net asset. The reader will recognise here the assumption made by neoclassical theorists and known in economic literature as the classical dichotomy. Now, modern monetary analysis shows that this dichotomy is an avatar of the old-fashioned conception of material money. Once it has been understood that money is issued as a simple numerical form, it is easy to see that its value is derived from its integration with current output. Thus, money income â€” the result of this integration â€” does not exist separately from current output. In fact, money income is current output and current output is money income, the two expressions describing the twin aspects of one and the same object. This being so, it should be clear that total supply (output) and total demand (money income) can no longer be considered as two autonomous entities. The very concept of equilibrium or conditional equality must therefore be replaced with that of identity. Similarly, we can no longer consider the supply of money income as distinct from its demand. As soon as a positive income appears in the economy, it is there to define a supply (of the current output it is identified with) and an equivalent demand. Moreover, because of the banking nature of money, income is, from birth as it were, necessarily deposited within the banking system, which means that it is necessarily demanded (by the agents entered on the assets side of the banksâ€™ balance sheet) and supplied (by the agents entered on the liabilities side). Double-entry book-keeping is a rigorous instrument that leaves no room for hypothetical adjustments between supply and demand, and rings the toll for any analysis based on the concept of equilibrium.

The identity between money income and produced output affects the traditional distinction between micro- and macroeconomics. In fact, every single process of production gives rise to a new positive income (output) and must hence be considered as a macroeconomic event even if it is carried out by a single unit of production. In these conditions it no longer makes any sense to consider the number or size of the economic agents as the discriminant criterion between micro- and macroeconomic events. A more rigorous principle, first proposed by Schmitt, consists in considering as macroeconomic all the events that modify the situation for the entire economic set-up and as microeconomic those events that while modifying the situation of any number of economic agents do not alter that of their set. As already mentioned, production is an example of a macroeconomic event, every new production giving rise to an income that increases the wealth of the whole economic set (as the concept of national income clearly suggests). On the contrary, the purchase of financial assets is a microeconomic transaction even if it is carried out by a large number of income holders, since it simply modifies the distribution of national income among economic agents without altering its amount…

from: http://www.quantum-macroeconomics.info/national-economics/

(French / Swiss school of monetary economics starting with Bernard Schmitt)

“Have you ever seen a fever chart of aggregate demand over the decades? Would be darned interesting, no? So Iâ€™m kind of amazed that economists arenâ€™t, havenâ€™t been, all over the problem of defining a formula to specify a measure of aggregate demand for an economy at a given moment.”

Two words

aggregate; demand

Second word first

It’s one of two things – an entire function, or a specific value of that function

So hypothesize the function

Then, however measured, only one value of the function can materialize at a time

Ex post, everything ELSE is hypothetical functions with hypothetical values

Ex ante, EVERYTHING is hypothetical functions with hypothetical values

So – are you looking for functions, or values of functions, or both?

Second word – add it up, somehow

I think the problem you are trying to solve is as difficult as making sense out of ISLM

I tend to think this is somewhat a fools errand. I think it is trying to unnecessarily complicate a relatively simple concept, as I understand it. The simple concept is sales. Are the producers selling all the products they can produce? If not are they not selling them because someone else has started selling them “better” or is this a general trend of decreased sales everywhere in that sector. Is the sector suffering because they have become replaced (horse drawn carriages in auto revolution) or they arenbecoming too expensive to produce.

From the buyers side, are there lots of unfilled orders, long waiting lists to receive the product/service?

If we see sales falling across the board it’s pretty safe to assume that consumers are running out of money. They likely didn’t run out of wants or needs.

Steve, Ive had a go at deriving this approach using accouting identititites, the trick I think is to use net present value to convent flow over time to demand at an instant now

Heres a summary of my approach here http://andrewlainton.wordpress.com/2013/09/03/alternative-ajebraic-definition-of-keens-walras-schumpeter-law/

Consider that by accounting identity the total value of all money used in the exchange of goods in any one period is equal to the value of all goods exchanged in that period.

II) Now cast to the future. The NPV of all money used in exchange from now till point T is by the same identity equal to the NPV of all goods exchanged between now and point T.

III) So consider that credit is issued to finance the production of those goods and is repaid in full at the end of that period. Assuming that production and consumptions plans are correctly anticipated then the addition to the stock of money is exactly cancelled by debt redemption , assume multiple overlapping period of production then it is the same as Clark parable of the forest, there is no net change to the capital stock, there is no net change to prices.

IV) Consider a net addition to credit and a net addition to production (over and above financing a depreciation fund) â€“ then the NPV of the increased stock of money â€“ the effective demand â€“ is increased â€“ and matched by the NPV of the increased stock of goods â€“ the effective supply, providing we include in our definition of effective supply as yet unsold inventory.

V) Then by accounting identity the aggregate demand would be equal (in a closed economy) to income + delta debt. As our definition is one based on money in exchange we could also define it as to income + delta debt â€“ delta savings.

I then go on to use this approach to derive the Wicksellian cumulative process and show how it is equivalent to the backing theory of value (real bills). This is a verbal approach but im working on a mathematisation of it. Not how the asset value of money the LHS is equal to the RHS liababilities to be paid in the goods produced or assets speculated on.