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to take advantage of the shift in their favor if disequilibrium prices impede their
purchases of necessary inputs. What keeps the rot from spreading?
To answer, let us tentatively suppose that real income does fall. Now, even
with the demand-for-money function unchanged, the quantity of money
demanded at the existing price level declines along with income. A quantity of
money adequate for full employment is overabundant for underemployment.
People cannot afford to hold as much money as before, so they try to reduce
their now excessive cash balances. The spending sustained by an adequate
money supply checks the spread of rot from the sectors initially depressed by
adverse shifts of demand. Moneys intermediary role in the two-stage process
of exchanging goods for goods keeps the production of goods to be exchanged
from being disrupted as badly as it might be in a barter economy. Just as a badly
behaved money supply can inflict burdens on a monetary economy from which
a barter economy is exempt, so a well-behaved money supply can confer
benefits. (Compare our discussion of Leijonhufvuds corridor theory of
economic fluctuations on pages 1823 below.)
The aspect of the Wicksell Process just alluded to is more than a wealth
effect, narrowly conceived.3 It is more nearly what might be called a Cambridge
effect. People demand cash balances in relation to their flows of income and
expenditure. (Pages 1267 below elaborate on this effect.) As their incomes
fall, people will not want to continue indefinitely holding absolutely unchanged
and so relatively increased cash balances. The steps that households and firms
take to reduce their money holdings promote the recovery of spending and
aggregate income until cash balances no longer seem too large or those steps
check the decline in the first place.
None of this is to say that an adequate money supply can avoid all wastes due
to a wrong and rigid pattern of prices. It cannot keep prices from conveying
misinformation about wants, resources, technology and market conditions. In
a monetary economy, misallocation waste the loss of utility from a mispatterning of activity can persist even without extensive waste through
involuntary idleness. In a barter economy lacking a monetary cushion, however,
misallocation waste and idleness waste would go together, idleness being an
extreme form of misallocation.
With regard to these wastes, the cases of too much and too little money in
relation to a wrong level and pattern of prices are not entirely symmetrical.
When money is in excess supply and commodities in excess demand, nonprice
rationing (probably informal, accidental rationing) shunts frustrated demands
onto other commodities from commodities whose prices are furthest below
market-clearing levels. But when money is in deficient supply, nothing shunts
demand around so as to maintain aggregate productive activity. Nonprice
rationing has no close counterpart in the opposite direction. The possibility that

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producers frustrated in selling some things might shift into other lines of
production avails little when demand is deficient even for the latter products.
Demand, to be effective, must be exercised with money.
Monetary-disequilibrium theory tells us more about depression than about
inflation. It shows why nonmonetary disturbances alone, even when leaving the
existing pattern of relative prices wrong, cannot cause a general deficiency of
aggregate demand. (Extreme nonmonetary shocks perhaps a sudden mysterious
failure of all electronic communications could conceivably cause a depression,
but not one characterized by a general deficiency of demand.) Maintaining an
actual quantity of money equal to the total that would be demanded at full
employment at the existing level of wages and prices would restrain any
cumulative contraction of demand. It follows that such troubles though not all
economic troubles must involve an inappropriate quantity of money.

WALRASS LAW AND A NONMONETARY DISTURBANCE

After imagining pervasive disequilibrium not traceable to monetary disorder,
we now ask whether Walrass Law would hold even in such a situation. Superficially it might seem to fail in the conceivable case of widespread involuntary
unemployment caused by a new minimum wage law. (We are interested here
in the initial stage of the disturbance in which Walrass Law might be called
into question. We are purposely choosing this extreme or worst-case scenario
in order to make our point.) The new law makes some workers no longer
profitably employable, much as if disease had removed them from the labor
force. With production, real incomes and the effective size of the economy
shrunken, pressure on the price level is upward, for people no longer wish to
hold the entire money stock at the old price level. It seems implausible, then,
to maintain that money is in transactions-flow excess demand, more or less
matching a transactions-flow excess supply of labor.
Yet the arithmetic of Walrass Law still holds. The workers who are frustrated
in obtaining jobs exhibit a frustrated transactions-flow demand for money.
Moreover, at the depressed level of income depressed because the minimum
wage thwarts transactions people now find they cannot afford to hold the
existing total of cash balances. Their frustrated supply of money is reflected in
an excess demand for commodities. This excess of demand over supply of commodities occurs because the minimum wage makes it unprofitable for employers
to hire the labor necessary for additional production.
Taking account of both the workers frustrated demand for money and the
frustrated supply of money being offered for commodities, one might ask
whether money is in overall transactions-flow excess demand or supply. Three

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comments are in order. First, no answer to this question is necessary to save the
arithmetic of Walrass Law. The frustrated demand for money is matched by
the excess supply of labor, while the frustrated supply of money is matched by
the excess demand for commodities. Second, the frustrated demand for money
and frustrated supply of money do not directly confront each other. No opportunity arises for them to neutralize each other, for the minimum wage is
disrupting coordination. Third, the aggregate of them if we insist on adding
them could be of either sign.
For an obvious example, consider how sensitive to income the demand for
money might be. If the demand for money at the depressed level of income is
only slightly below what it would be at full employment and if, accordingly, the
attempted unloading of money onto commodities is only slight, then the
workers frustrated demand for money predominates. The overall transactionsflow excess demand for money is positive. If, on the other hand, the demand
for money is highly sensitive to income, then the depressed level of income
causes the frustrated supply of money to be large enough so that the overall
transactions-flow excess demand is negative. At any rate, this excess demand
for money must be equal to but different in sign from the total of the excess
supply of labor and excess demand for commodities.
Though arithmetically unscathed, Walrass Law is not necessarily useful in
every case. The minimum wage is a basically nonmonetary disturbance, as a
failure of telephones, computer networks and other electronic communications
would be. Coordination is impaired, markets are thrown out of equilibrium,
and real incomes fall. Although its arithmetic still holds, Walrass Law is of
little help in explaining such a situation.
Three further observations are worth making about the minimum wage case.
First, no general deficiency of aggregate demand exists and hence no cumulative
decline takes place. (That is one reason why we say that Walrass Law is not
very helpful in explaining this situation.)
Second, as people tried to unload money onto commodities, might not prices
rise enough to whittle the nominal minimum wage down to a market-clearing
level in real terms? Could not employment and production revert to their fullemployment levels, with all nominal prices and wages simply marked up in the
same proportion as the legal minimum wage exceeded the lowest free-market
wage? No; for given an unchanged nominal money supply, real balances would
then be inadequate to sustain a full-employment level of activity. Monetary
considerations thus enter, after all, into analyzing the effects of a minimum
wage. Still, emphasis properly belongs on the nonmonetary character of the
disturbance.
Third, the involuntary unemployment resulting from the minimum wage
would be considered structural and not cyclical.

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113

INDIVIDUAL EXPERIMENTS AND MARKET

EXPERIMENTS
Patinkin (1965) introduces an illuminating distinction between two types of
experiment. This distinction is important in understanding the sections that
follow. An individual experiment involves discovering the desired behavior of
an individual person, of a small or large group, or even of all people in the
community, acting in certain capacities in specified circumstances. Whether
these circumstances are compatible with other economic conditions and whether
they can in fact prevail is beside the point. It is not the purpose of an individual
experiment, all by itself, to describe what equilibrium will tend to emerge.
The demand curve for an ordinary commodity is an example of the result of
a (conceptual) individual experiment. It shows how much of a particular
commodity its buyers and potential buyers will demand under various specified
circumstances, notably including alternative prices of the commodity. It is true
that facts other than the circumstances and tastes reflected in the demand curve
may rule out many and perhaps all but one of these prices as genuine possibilities. By itself, however, the demand curve is not meant to describe what
prices can in fact prevail. This description becomes possible only by an analysis
that takes all relevant circumstances into account, including the results of
individual experiments reflecting the circumstances and attitudes of people
besides buyers and potential buyers of the commodity in question. Most notably,
in the present example, these other people are the suppliers and potential
suppliers of the commodity.
This more comprehensive analysis consists of market experiments. It pulls
together the results of various individual experiments, examines the conditions
under which the plans of various people would and would not mesh, describes
the processes at work when plans fail to mesh, and describes the equilibrium
position.
In the market experiment that mainly concerns us, an initial equilibrium is
disturbed by a change in the money supply. We then inquire into the nature of
the new equilibrium position. The main individual experiment that concerns
us is how a change in a certain variable would affect the demand for money.
Chapter 2 illustrates that the demand for money is inversely related to the
interest rate. Patinkin (1965, p. 372) emphasizes that this proposition does not
imply that the equilibrium interest rate is inversely related to the quantity of
money. The first proposition describes an individual experiment, while the
latter describes a market experiment. He argues that Keynes (1936) repeatedly
confused the two propositions. Chapter 5 presents Patinkins exposition of what
we call the strict version of the quantity theory, in which the equilibrium
interest rate is invariant with respect to changes in the quantity of money.

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The discussion of the liquidity trap in Chapter 2 also invokes the above distinction. Figure 2.1 includes a demand-for-money curve portraying an individual
experiment, while Figure 2.2 includes a market-equilibrium curve portraying
the result of a series of conceptual market experiments. Similarly, Chapter 5
relates this distinction to the issue of the elasticity of demand for nominal money
with respect to the inverse of the price level. Following Patinkin, we show the
demand-for-money curve does not exhibit uniform unitary elasticity, while the
market-equilibrium curve does.

SOME POSSIBLE DIFFICULTIES CONSIDERED

A Shortage of Money
One conceivable line of argument questions the dire consequences of an excess
demand for money. It suggests that the demand will tend to adapt itself to the
actual supply in a relatively direct and painless way, so that the quantity of
money need not severely constrain transactions.4 When faced with a shortage
of coins in particular, people will cooperate to carry out their transactions
anyway. (The customer will give the retailer the extra dime or two cents needed
to reduce the amount of change due.) Similarly, Akerlof (1975) and Blinder
and Stiglitz (1983, pp. 297302, especially p. 299) suggest that people will
cooperate to keep their transactions going when total money is in short supply.
They may adjust payments schedules or make increased use of trade credit, or
financial institutions may devise new nearmoneys.
This argument is overoptimistic but instructive. If only coins are in short
supply, then even though demand for them presumably is related to income,
income, of course, does not fall to whatever level would choke off the excess
demand for coins. At so fallen a level, total money would be in excess supply,
exerting upward pressure on income. A shortage specifically of coins is fairly
easy to diagnose, and collaboration in coping with it works not only in the
general interest but also in ones private interest (to keep ones own transactions
going and to earn good will).
An overall shortage of money is harder for individuals to diagnose. The disequilibrium does not show up on any particular market, whereas coins do have
a market of their own in the sense that they exchange against money of other
denominations. Instead, monetary disequilibrium shows itself obscurely as a
generalized difficulty in selling things and earning incomes. Most relevantly,
the fact that it would be in the common interest of people in general to employ
money-economizing instruments and practices does not mean that it is in the
interest of any individual to do so even before such expedients have already