Monetary versus Real, Part 2: Barter as a veil

A friend of mine once lived in a small Swiss village, in which his favorite restaurant closed during dinner time, so that the waiters and chefs could eat.

In theory one can overcome the problem of  coincidence of wants. But it is not possible to overcome the coincidence of time. The dispute is all about the role of time, as money is the link between present and future.

Imagine a small economy in which a baker bakes bread in the morning, sells it to a restaurant, and then in the evening goes to the restaurant to eat dinner.  He cannot eat dinner while he is baking (and selling) the bread. And the restaurant cannot buy the bread from the baker while it is serving it to customers. The transactions are necessarily separate by time.

Therefore the baker sells bread to the restaurant on credit, and then extinguish the debt when he eats. When he is selling the bread for an IOU he is saving. When he buys the dinner he is dissaving. But it depends on your perspective; it could be that the restaurant sells a dinner to the baker on credit, saving, and then buys bread the next morning, dissaving. The two operations are equivalent.

More importantly, imagine a farmer taking a loan of seed, planting it, and then producing a harvest. He then repays the debt.  In the exchange of a good for a paper claim — both sides are receiving something “real”, except that only one of those goods exists at that point in time, and the other does not yet exist.

To remove this exchange and pretend that only goods are being exchanged for goods, you are removing time. That would require compressing the transaction so that time (and production-in-time) are squeezed out.

The reader is invited to drape a thin blue veil over the computer screen and view the exchanges as real goods for goods.

Here, time has been compressed, but prices are determined at each point in time, not across time. At each point in time, as one farmer is taking out a loan, a different farmer is delivering finished product. Both are exchanging goods for money. Prices will be determined by relative shifts of one over the other at each point in time, not by the personal intertemporal trade-off of each.

When looked at from the point of view of each individual, the transaction is good-now-for-good-later. And that may well be how each individual thinks of the transaction. But that personal view is not what sets aggregate prices or output — those are set by the time slice, in which the exchanges are goods for money, not goods for goods.

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2 responses to “Monetary versus Real, Part 2: Barter as a veil

  1. from investopedia:

    on Real Economic Growth Rate:

    A measure of economic growth from one period to another expressed as a percentage and adjusted for inflation (i.e. expressed in real as opposed to nominal terms). The real economic growth rate is a measure of the rate of change that a nation’s gross domestic product (GDP) experiences from one year to another.

    and on the Real Interest Rate:

    An interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower, and the real yield to the lender. The real interest rate of an investment is calculated as the amount by which the nominal interest rate is higher than the inflation rate.

    Real Interest Rate = Nominal Interest Rate – Inflation (Expected or Actual)

    It seems, the standard assumption is real always equals inflation adjusted nominal. Apart from your critique above, I guess the word ‘real’ is used in this way because economists have found no other way to denominate the prior, but with the latter, and so the nominal term has become a proxy for both, while change over time is dealt with with a magic variable called inflation. The world neatly packed in a number and money as a mirror of the world.

    With your introduction of time, if I understand correctly, you are trying to ‘refill’ standard econ usage with a more realistic, and more complex content which then leads to the discussion about what it is that makes time such an uncertain companion. Smart :-). I wonder whether it would be feasible to use new terms, such as past, current and future numerical vs. material e.g. to better distinguish your idea from standard assumptions? The epithet ‘real’ seems to be at the root of so much confusion because it carries so much ‘nominal’ baggage. Or am I missing the point?

    Anyway, I like your site and I always follow your comments in the interblogs. I have learnt a lot from them. Thank you!

    • Thanks, Oliver — that’s exactly what I’m trying to do. But the situation is even *worse*, because economists do not just use “real” to denote inflation adjusted. For example, when they talk of real savings, they mean the real capital stock. You can have a situation in which capital goods prices are increasing in value so that the nominal savings is going up but real savings is not going up, even with low inflation. Moreover, nominal savings will include holdings of things such as land or other pet-rock type objects that do not correspond to an increase in productive capacity. Finally, the individual household can purchase a capital good (or land on credit). As a result, the economy has one more capital good, but the household does not have more nominal savings. Some *other* household has more nominal savings — which ever households obtain the payments arising from the production of the capital good.

      So the actual situation between real and nominal is complex. You cannot just take nominal, divide by the price level, and get real. Not when you are talking about *individual* households or economies in which capital goods are not perfectly elastically supplied.

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