Say’s Law and the Classical Theory of Depressions

Abstract

Say’s Law occupies a prominent, but equivocal, position in the history of economics, having been the object of repeated controversies about its meaning and significance since it was first propounded early in the nineteenth century. It has been variously defined, and arguments about its meaning and validity have not reached consensus about what was being attacked or defended. This paper proposes a unifying interpretation of Say’s Law based on the idea that the monetary sector of an economy with a competitively supplied money involves at least two distinct markets not just one. Thus, contrary to the Lange-Patinkin interpretation of Say’s Law, an excess supply or demand for money does not necessarily imply an excess supply or demand for goods in a Walrasian GE model. Beyond modifying the standard interpretation of the inconsistency between Say’s Law and a monetary economy, the paper challenges another standard interpretation of Say’s Law as being empirically refuted by the existence of lapses from full employment and economic depressions. Under the alternative interpretation, originally suggested by Clower and Leijonhufvud and by Hutt, Say’s Law provides a theory whereby disequilibrium in one market, causing the amount actually supplied to fall short of what had been planned to be supplied, reduces demand in other markets, initiating a cumulative process of shrinking demand and supply. This cumulative process of contracting supply is analogous to the Keynesian multiplier whereby a reduction in demand initiates a cumulative process of declining demand. Finally, it is shown that in a temporary-equilibrium context, Walras’s Law (and a fortiori Say’ Law) may be violated.