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That's where both monetarist and Keynesian explanations of money are important (and Krugman's criticism of Ferguson is that Ferguson never shows that he really understands what either Keynes or Friedman was talking about).  

Keynes breakthrough in knowledge about money was to show that deflation occurs when values for bonds -- which he deemed like money in their ability to store wealth -- dropped precipitously, thus causing people dump their bond investments and demand hard currency.  Inflation is the opposite -- when bond investments increase in value people dump their currency holdings in order to hold bond investments.

Friedman's breakthrough was to generalize Keynes even further -- it wasn't just bond markets that determined demand for money, rather it was markets for all other assets.  Friedman showed this by adding stocks and bonds together to show the relationship between asset values and deflation or inflation, but the same idea can be extended to all other assets, including residential homes in the current crisis.  

If prices did not rise in the Balkans with expansion of credit there, it was likely because demand for non-currency assets was also high -- people were investing in real estate, construction, foreign investments, etc., and not trying to hold Balkan currency.

by santiago on Wed Sep 2nd, 2009 at 09:45:33 AM EST
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In the book, Ferguson cites James Carville, when he was Bill Clinton's campaign manager:

"I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market: You can intimidate everybody."

Such is the power of financial democracy (or oligarchy?!).

I see a lot of subjective demand and supply in the modern economy and financial world - perceptions or anticipations, what the supplies and demands should be, or blind herd following of investment fashions or "best available" strategies. The two big theories do not apply well to bubble periods; they basically ignore relevance of bubbles. Regarding post-bubble depressions, I don't see how Friedman helps.

by das monde on Thu Sep 3rd, 2009 at 12:43:55 AM EST
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