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but to the area as a whole, whose exchange rate with other moneys is floating.
It is the area as a whole whose nominal money supply can be controlled.

UNINTENDED CHANGES IN THE MONEY SUPPLY

The point that changes in the nominal money supply can occur without being
intended by holders is worth developing further. Money flows routinely through
cash balances. People take it in and pay it out even when not intending, except
passively and temporarily, to build up or run down their holdings. Fluctuations
in individual money holdings can be largely unintended, and changes in the
total of actual holdings can be unintended too.
When Americans fled from bank deposits into currency in 19323, they were
acting not to reduce their money holdings but rather to shift into what they
considered a safer form of money. Yet the unintended consequence was that the
money supply and so total holdings fell as banks lost reserves. The situation
could be similar in a country running a balance-of-payments deficit at a fixed
exchange rate. The money supply is shrinking, which necessarily means that the
countrys residents are running down their money holdings. It could sometimes
be true and may even typically be true that the payments deficit and money
supply shrinkage are occurring because people are deliberately reducing what
they consider to be excessive cash balances. But it is not always true: shrinkage
of the money stock can be quite undesired. The payments deficit might trace,
for example, to failure of an important export crop or to a collapse of foreign
demand (see Chapter 9).
Similarly, suppose the monetary authority has committed itself to whatever
open-market operations are necessary to hold interest rates at a target level.
Now tastes change; people want to acquire more bonds by reducing current
consumption (thus freeing resources for real investment), but they do not particularly want to change their money holdings. To keep interest rates from
falling below the target level, the monetary authority sells bonds, with the result
that money is removed from circulation, creating an excess demand for money.
Or suppose an opposite change in tastes occurs that, again, does not directly
involve desired money holdings. To keep interest rates from rising, the monetary
authority buys bonds, incidentally creating money.
When transactors deal with the authority, they do so because they find the
prices it quotes on particular bond issues attractive, not necessarily because
they want to change their money holdings. They use money to make or receive
payments for bonds because it is the medium of exchange used routinely in
those and other transactions. More generally, people are not deliberately trying
to reduce or increase their cash balances whenever they buy or sell something;
engaging in a series of individual transactions does not necessarily indicate a

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desire to alter cash balances held on average over time. People make the
purchases and sales they find attractive at the prices confronting them. If they
happen to be dealing with the monetary authority, the resulting change in the
money supply and thus in the total of their cash balances can be quite unintended
by them (compare Greenfield and Yeager, 1986, and pages below).
Now, assuming pegged-but-adjustable exchange rates for the moment,
suppose that the monetary authority revalues the home currency upward (for no
reason except to provide us theorists with an experiment); it cuts in half the
pegged home currency price of foreign exchange. In consequence of all the
related price changes, purchases of goods and services and securities abroad
become more attractive than sales abroad, the country runs a balance-ofpayments deficit, and the home money supply shrinks, with painful deflationary
consequences. In brief, by making foreign exchange a bargain and selling it
lavishly out of its reserves, the authority takes out of circulation the home money
received in payment. Yet this monetary contraction in no way represents an
intentional rundown of private cash balance holdings.
Suppose instead that the monetary authority pegs the prices of foreign
currencies too high. With the home currency undervalued, the balance of
payments goes into surplus; and the home money supply expands with inflationary consequences as the authority absorbs all the private offers of foreign
currency.
Thus, changes in a countrys money supply need not correspond (though
they sometimes may correspond) to aggregates of desired changes in individual
holdings. The monetary authoritys purchases or sales of bonds or foreign
exchange may create an inflationary excess supply of money or contractionary
excess demand. We elaborate on this theme throughout the book.

WALRASS LAW
Walrass Law is a tautology that illuminates interrelations among supplies of
and demands for commodities, labor, securities and money and among
supply/demand imbalances for these different things. The Law emphasizes that
no one thing or group of things can be in excess supply or excess demand by
itself. It thereby helps focus attention on the role in macroeconomic disorder,
especially in depression, of a distinctively functioning object of market
exchange money.
Yet complications arise, and Walrass Law has itself sometimes been called
into question. Yeager (1994a) and Yeager and Rabin (1997) note analogies
between the Law and the equation of exchange, a firms balance sheet, and a
countrys balance of payments. In our view, Walrass Law deserves broadly
the same status in money/macro analysis as the balance of payments in inter-

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national economics. We caution the reader not to confuse Walrass Law with
the Walrasian general-equilibrium model. In the latter, markets always clear;
the former is especially helpful in examining market disequilibrium.
Repeating what Lange (1942) and Patinkin (1965) have already done
adequately anyway translating the Law into symbols and spending time
defining the symbols would digress from our present purpose, which is not
mathematical decoration. Our purpose, instead, is to clarify the very concepts
that enter into the Law and into supposed difficulties. Distinctions between
notional and effective supplies and demands and between stock and flow
conceptions of quantities and imbalances require attention.
Our task illlustrates Harsanyis (1976, p. 64) point that social scientists
encounter not only formal or logical problems and empirical problems but also
conceptual philosophical problems.6 Impatience with conceptual problems goes
far, we conjecture, to explain the current state of the literature on Walrass Law.
In discussing the Law we clear up some puzzles found in the literature and
further illustrate the uniqueness, peculiarities and significance of money. We
address the puzzle of what matches an excess supply of labor (and commodities) in the depths of depression. We explain why the Keynesian underemployment equilibrium is in actuality a disequilibrium. We illuminate what
we call the stock-flow problem (Yeager and Rabin, 1997), and we shed
additional light on the fundamental proposition of monetary theory.
Lange (1942) gave the name Walrass Law to the following proposition,
which holds in disequilibrium as well as in equilibrium: the total value of
quantities of all goods supplied equals the total value of all quantities demanded.
The term goods is inclusive here, covering not only commodities but also
labor and other services, securities and money. Quantities are valued at the
prices, in money or other numraire, at which transactions are accomplished
or attempted as the case may be. If some goods are in excess supply and others
in excess demand, the excess supply and excess demand quantities are equal in
total value. Counting excess supplies as negative excess demands, the sum of
the values of all excess demands is identically zero (Lange, 1942; Patinkin,
1965, pp. 73, 229, 25862, and passim, 1987; Baumol, 1965, pp. 34042).7
The foregoing presents one version of Walrass Law, which might be labeled
the zero-aggregate-excess-demand-value version. It straightforwardly implies
another, the equation counting version. It states that if n goods exist and if
supply and demand are in balance for n 1 of them, then equilibrium must
prevail for the nth good also. (Lange, 1942, p. 51n, notes that this is the version
of the Law proved by Walras himself.) To the n goods correspond n equations
expressing the equilibrium conditions that market excess demand for each good
be zero. Mathematically, only n 1 of these simultaneous equations are independent. Consequently, any set of prices satisfying any n 1 equations must also
necessarily satisfy the remaining equation.

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Walrass Law is an identity,...little more than an accounting relationship;

it is difficult to imagine an economy in which it does not hold (Baumol, 1965,
p. 341). Where it does not hold, people must, by definition, be planning to
exchange goods which are not equal in value an odd assertion for any
monetary economy (Baumol, 1960, p. 30).8 The Law holds because budget
constraints operate and market transactions are two-sided. Anyone trying to
acquire something is by that very token offering something in exchange of
equal value at the price contemplated. Anyone trying to sell something is
demanding something of equal value in return. An attempted but frustrated
transaction, like a successful one, involves two goods and not just one. (In a
monetary economy, one of them is ordinarily money.)
Significance yet Disregard of the Law
Identities are far from useless. They can aid in focusing analytical questions
and in pinpointing and correcting error. Since Walrass Law is an identity, it has
to hold. Anything that conflicts with it or contradicts it is bound to be wrong.
Most important to our present purpose is the Laws insistence on one implication of the very concept of exchange, whether accomplished or frustrated:
supply/demand disequilibrium for some things necessarily entails opposite disequilibrium for other things. No single good or aggregate of goods, whether
peanuts or labor or labor and commodities combined, can be the object of
frustrated transactions and market disequilibrium by itself. When labor and
commodities are in excess supply when demand for them is inadequate to
clear their markets Keynesian oversaving is too superficial a diagnosis. In
particular, when labor is in excess supply in the depths of depression when
involuntary unemployment prevails what thing or things are in matching
excess demand? It is unhelpful to brush such questions aside with theories and
concepts that describe markets as always in equilibrium, or practically so.
Worse, perhaps, are the implicit denials of Walrass Law often found in
textbooks and the literature. Some texts assume that the money and bond
markets clear quickly, unlike the remaining market, the market for commodities, which requires more time. Describing the consequences of monetary
expansion, these texts wind up with an excess demand for commodities
unmatched by an excess supply of anything else, thus violating Walrass Law.
Such analysis is therefore logically flawed. Other texts avoid explicit violation
of the Law by assuming that of the three markets into which they simplify the
economy, only the money market clears continuously. Acknowledging an
excess demand for commodities created by monetary expansion, such texts necessarily if tacitly allow Walrass Law to imply that an excess supply of bonds
is the matching imbalance. While not a logical impossibility, such a condition
is to say the least empirically peculiar, as argued on pages 102107 below.

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Considering the case of monetary contraction, other texts assume that in the
ensuing depression the commodities, money and bond markets are all in equilibrium. Yet violating the Law they suppose an excess supply on a separately
recognized fourth market, the market for labor.
Some articles in the literature imagine two Walrass Laws, one for flows and
another for stocks. For example, they refer to the condition that an excess
demand for money must be exactly matched by an excess supply of bonds as
Walrass Law for stocks. (See Yeager and Rabin, 1997 for citations).

STOCKS, FLOWS AND TRANSACTIONS

For some goods it is convenient to think of quantities supplied and demanded
as amounts per time period. Examples are food and electricity and things like
haircuts that simply cannot be stockpiled. Quantities obviously must not pertain
to periods of different lengths for the two sides of the same transactions.
For some stockpilable things in some contexts, it is less convenient to think
of demand and supply quantities as amounts or rates over a period than as
desired and actual holdings at a point in time. Examples are land, houses and
cash balances (Cannan, 1921 [1951]).
In applying Walrass Law, it would be convenient to be able to speak interchangeably of the stock and flow senses of equilibrium and disequilibrium.
Does disequilibrium in the one sense imply disequilibrium in the other sense
as well?
Prevailing terminology causes complications. Some or most discussions of
these matters identify flow demand with demand for consumption or current use
and flow supply with supply from current production (for example, Bushaw
and Clower, 1957, pp. 912, 20; Clower, 1968; Clower and Due, 1972, Chapter
3; Harrison, 1987). Other discussions use the term flow more broadly to cover
transactions undertaken for whatever purpose, including adjustment of
holdings.9 Things neither currently produced nor currently used up, like Old
Masters, cannot be the object of flow transactions on the narrow conception of
flows but can be their object on the broader conception.
For flow transactions alone, narrowly identified with consumption and
production only, the sum of plus and minus excess-demand values is not necessarily zero. For example, one might attempt a flow supply without attempting
a flow demand, offering current output or labor to build up ones stock of money
or some other asset.
For pure flow goods like haircuts, the question of stock equilibrium or disequilibrium cannot arise. Their very existence suggests that the Law, which
embraces all goods, must refer to transactions actual and attempted rather than