Tuesday, August 12, 2014

Davidson on Nominal Contracts and Uncertainty

From Davidson (1988):
“In the absence of money production-hire contracts over time in a nonergodic environment, entrepreneurs would be foolish to start up a long duration production process, for they would not possess any knowledge of the ultimate future costs of production! (How could a profit-maximising manager calculate the marginal cost associated with varying production flows, in a nonergodic world, without fixed nominal wage contracts?) The institution of forward money contracts where delivery and payment is specified at a future date is an institutional arrangement which permits agents to deal with, and control the outcomes of, an otherwise uncertain future. Long-lived forward contracts are the way a free market economy, in an uncertain world, builds in institutional price and wage stickiness over time. In a nonergodic world, such explicit money contractual anchors for future events are necessary conditions for encouraging entrepreneurs to carry out economic activities in a market economy” (Davidson 1988: 335).
Of course, we can add mark-up pricing/administered pricing to nominal contracts as well.

The rise of a high degree of price and wage rigidity in modern economies is, contrary to neoclassical theory, a development that many businesses actively desire because it promotes stability and increases their ability to successfully plan for the future. In that sense, contrary to Austrian and neoclassical theory, relative price and wage rigidity greatly aids economic calculation, because such rigidity allows more successful forward planning.

Both fixed nominal contracts and administered prices are simply private sector institutions to decrease the uncertainty that economic agents face when dealing with an unknown future: they have emerged from within markets, and are not some artificial or unnatural imposition on markets.

Davidson, P. 1988. “A Technical Definition of Uncertainty and the Long-Run Non-Neutrality of Money,” Cambridge Journal of Economics 12.3: 329-337.

1 comment:

  1. I remember first coming across this essential point by Paul Davidson, and finally getting that money contracts were a way to control uncertainty to some degree, and so prices fixed under contract were a rational response to uncertainty, which challenged the flexible price/auction view of markets. This especially makes sense under an economic system that encourages the maximization of money profits and has the feature of bankruptcy when money liabilities are not met. It leads one to ask why contracts to exchange real quantities were not also prevalent, and then the "money is just a veil" position tends to fall to the ground.Under capitalism, it is all about the money. Fulfilling human needs/demands with real goods and services is a secondary consideration. Financialization starts to make more sense from this perspective.