Scott Sumner nods with approbation toward this Ychuan Wang post at Noahpinion. For which hat tip I must thank him because Wang so clearly explicates what he calls the “canonical” understanding, and illustrates so perfectly the wackiness and incoherence of of the Walrasian view:
Prices don’t always adjust instantly, so we can have excess supplies and excess demands. However, economists do have a way to constrain what this non-clearing state looks like. In particular, according to Walras’ law, assuming everybody spends all of their wealth, if there are excess supplies (i.e. too much produced) in some markets, then they must add up to excess demands (i.e. too little produced) in other markets. In other words, even if supply does not equal demand in each market, supplies must add up to demands across markets.
The requirement that everybody spends their endowment is crucial. It means that Walras’ law doesn’t apply just to the market for apples. Not everybody spends all their wealth on apples. Instead, some people may put their wealth into money. But once we include the money market, we do have the condition that everybody spends their endowment, and therefore Walras’ law does apply to the entire macroeconomy of apples and money.
In case you missed it, the legerdemain here hinges on the word “spend,” and on the hidden assumption that “spending” on stock or bond purchases is equivalent to spending on carpenters or clams. (I sure wish “oyster” started with a C. But the clam/dollar thing is a nice play…)
Wang doesn’t seem to understand some basic facts about national accounting. Viz:
Purchases of financial assets (including existing homes) don’t count as “spending.” Those are asset swaps, and are not included in the national accounts.
“Investment” in financial securities is not the same thing as (has a quite vexed and complex relationship to) real investment spending on drill presses and such as tallied in the national accounts. It’s not “spending.”
If people use all their income or wealth to buy bonds, they are not “spending” all that money.* So Wang’s stated precondition for Walras’ law to be true is not met. So Walras’ law does not apply to the entire macroeconomy of apples and money.
* Though many will seek to convince you that it is effectively so, all worked out by the magical, instantaneous, Walrasian auctioneer. This is equivalent to the widespread fuzzily held belief that when you purchase a share of Apple stock, that money is instantly funneled into real investment.
Cross-posted at Asymptosis.