A great lesson from J. Bradford DeLong of U.C. Berkeley. It’s a great example of the velocity of money and why the government doesn’t need to “just print money” to get our economy going:
Suppose that we have four agents: Alice, Beverly, Carol, and Deborah.
Suppose that Beverly has $500 in cash that she owes Carol, due in two months. Suppose that Alice and Carol are both unemployed and idle.
In one scenario in two months Beverly goes to Carol and pays her the $500. End of story.
In a second scenario Beverly says to Alice: “I have a house. Why don’t you build a deck–I will pay you $500 after the work is done. Here is the contract.” Alice takes the contract and goes to Carol. She shows the contract to Carol and says: “See. I will be good for the debt. Cook me meals so I will have the strength to build the deck–here’s another contract in which I promise to pay you $500 within 90 days if you cook for me.” Carol agrees.
Two months pass. Carol cooks and feeds Alice. Alice goes and builds the deck.
Alice then asks Beverly for payment. Beverly says: “Wait a minute.” She goes to Carol and says: “Here is the the $500 cash I owe you.” Beverly pays the money to Carol. Beverly then says: “But now could I borrow the cash back by offering you a long-term mortgage at an attractive interest rate secured with an interest in my newly more-valuable house?” Carol says: “Sure.” Beverly files an amended deed showing Carol’s mortgage lien with the town office. Carol gives Beverly back the $500. Beverly then goes to Alice and pays her the $500. Alice then goes to Carol and pays her the $500.
The net result? (a) Alice who would otherwise have been idle has been employed–has traded her labor for meals. (b) Carol who would otherwise have been idle has been employed–has traded her labor for a secured lien on Beverly’s house. (c) Beverly has taken out a mortgage on her house and in exchange has gotten a deck built. (d) Carol has the $500 cash that Beverly owed her in the first place.
Alice has more income and consumption expenditure than if she hadn’t taken Beverly’s job offer. Carol has more income and saving than if she hadn’t cooked for Alice and then invested her earnings with Beverly. Beverly has an extra capital asset (the deck) and an extra financial liability (the mortgage) than if she had never offered to hire Alice.
A deck has gotten built. Meals have been cooked and eaten. Two women have been employed. And all this has happened without printing any extra money.