There Ain’t No Such Thing as a Sticky Price

Proponents of monetary disequilibrium theory (MDT) emphasize “sticky prices” as a hindrance to achieving monetary equilibrium.^[1] According to this theory, monetary disequilibrium occurs when there is “a discrepancy between actual and desired holdings of money at the prevailing price level,” and price stickiness implies that “automatic market forces, working alone, correct a severe monetary disequilibrium only slowly and painfully” (Yeager 1986, 370, 376). Some MDT proponents claim that sticky prices prevent markets from clearing (Yeager and Greenfield 1989, 408). Others attribute stickiness to factors such as menu costs and price elasticity, which are already present in the supply and demand schedules in goods markets. This implies that individual goods markets may clear, but the overall price level cannot adjust to maintain monetary equilibrium (Selgin 1997, 16–17).

The present article offers a single solution to two problems within the MDT literature. The first problem is that sticky prices prevent market clearing. The second is that decentralized markets cause monetary disequilibrium. The solution is this: all realized prices in unhampered markets represent a momentary clearing of the market; there are no excess demands for or supplies of goods or money after successful trades. ^[2] Monetary disequilibrium theorists err by assuming that a change in the aggregate price level is required for monetary equilibrium and overall economic coordination after a change in the money relation. Under the sway of the price level illusion (Newman 2025), MDT proponents misconstrue the money relation by expecting all prices or the aggregate price level to adjust in order for monetary equilibrium to obtain and, in so doing, ignore the market-clearing characteristic of individual transactions for both the goods and the money sides. The solution is most obvious in the Misesian “plain state of rest” equilibrium construct, which is realized in real-world markets after every exchange, unlike other equilibrium conditions, which are unobtainable in our world of constant change. The present article makes this case and concludes with a short discussion of Israel Kirzner’s (1999, 218) claims that the market-clearing aspect of the plain state of rest is “merely trivially true” and that it has “little to do with . . . the effectiveness of markets in tending to stimulate the exhaustion of all possible opportunities for mutually gainful exchange.”

The Plain and Wicksteedian States of Rest

Markets clear with each voluntary exchange. As Ludwig von Mises (1998, 245) explains in Human Action, “People keep on exchanging on the market until no further exchange is possible because no party expects any further improvement of its own conditions from a new act of exchange. The potential buyers consider the prices asked by the potential sellers unsatisfactory, and vice versa. No more transactions take place. A state of rest emerges. This state of rest, which we may call the plain state of rest, is not an imaginary construction. It comes to pass again and again” (emphasis original). Buyers and sellers exchange goods and money according to their preferences regarding the stock of the good. They continue with their exchanges until all known mutually beneficial exchanges have been exhausted and a plain state of rest occurs. The plain state of rest logically and chronologically precedes the Wicksteedian state of rest, which occurs after market participants discover price discrepancies and eliminate them by arbitrage.^[3]

This conception of market equilibrium is not an imaginary construct, but is what Carl Menger (1981, 188, 192), Eugen von Böhm-Bawerk (1959, 2, 231), Frank A. Fetter (1910, 133; 1915, 67), and Mises (1998, 241)^[4] describe as a real phenomenon that actually transpires on the market with each passing moment.^[5] Each market price represents a “meeting of the minds” (Fetter 1915, 59) in which the buyer and the seller find mutual benefit in the exchange according to their individual preferences. These preferences are informed by all the information the buyer and seller deem relevant for the transaction, including the prospect that other market participants will exchange at different prices in the future. Thus, each exchange represents a cleared market, if only for a moment, in which the quantity supplied equals the quantity demanded.^[6] Importantly, the equality of the quantities supplied and demanded applies to both the item demanded by the buyer (supplied by the seller) and the item demanded as payment by the seller (supplied as payment by the buyer). After each exchange, a plain state of rest is established in which no additional exchanges take place, because market participants have exhausted the possibility of mutual benefit for the moment (Mises 1998, 241; Menger 1981, 188).

One of the clearest explanations of this phenomenon is found in Marget (1966, 2:239–40, cited in Salerno 2010a, 98): “The prices which we must ultimately explain are the prices ‘realized’ at specific moments in clock time[, and] the only demand and supply schedules which are directly relevant to the determination of these ‘realized’ prices are market demand and supply schedules prevailing at the moment the prices are ‘realized.’” The quantities supplied and demanded are equalized at the intersections of “instantaneous” supply and demand “curves, whose shape and position are influenced by forecasting errors and incomplete knowledge of arbitrage opportunities” (Salerno 2010a, 101). Any inventory that is not sold represents the “sellers’ reservation demand for the existing stock of the good” (102).

The logic extends to the money side. Each exchange brings about equilibrium in the goods market and in the individuals’ supply of and demand for money. The number of units of the good exchanged represents the buyer’s demand and the seller’s supply. Money offered by the buyer is the seller’s exchange demand for money, and money held by the buyer after the exchange is his reservation demand for money. This equilibrium is established moment by moment, and any aggregate conception of the money relation is merely the sum of phenomena that occur for all individuals. This implies that the aggregate money relation repeatedly establishes equilibrium as well.

The demand for money is based on individuals’ value scales, which include other goods. The demand for money, while distinct as a concept, refers to the same value scale used to construct the demand schedules for nonmonetary goods. When Murray purchases one burrito from Ludwig for ten dollars, Ludwig purchases ten dollars from Murray for one burrito. Their exchange immediately clears the market for burritos and for money. Any money held by Murray after the exchange is a part of his reservation demand for money. Ludwig’s exchange demand for money is satisfied in the sale of the burrito. There is no excess demand for money, excess supply of money, excess demand for burritos, or excess supply of burritos. Thus, all realized prices in real-world markets represent a cleared market for the individuals involved. One would have to inappropriately bring yesterday’s preferences to bear on today’s outcomes (or otherwise make incorrect assumptions about the shape of today’s supply and demand curves) to conclude that a market is not clearing due to sticky prices.

Leland Yeager (1986, 386) claims there is “no warrant for assuming that [market] processes work so fast as to preclude disequilibria.” But the reverse could be said about sticky prices: there is no warrant for assuming that those processes do not work so fast as to preclude cleared markets. Since market participants actually do exchange the quantities they exchange at mutually-agreed-upon prices, the burden of proof is on the economists claiming there is something wrong with what transpires. They must show that there is some “real” demand curve or “optimal” supply curve that differs from what is implied by realized market outcomes and that such curves could be drawn with the existing knowledge and preferences of the suppliers and demanders. Showing, ex post, that the price eventually changes is insufficient evidence because all that a price change means is that preferences changed, the stock of the good changed, or arbitrage opportunities were found and exploited.

This implies that MDT proponents commit the nirvana fallacy by conflating market disequilibrium with the fact that realized market prices differ from what would prevail in an idealized, unattainable state of full information, full arbitrage, and resolution of the “who-goes-first problem.”^[7] If these conditions are lacking, however, market clearing is not prevented. Market participants always transact with the information they have according to their own preferences. Consider Yeager’s (1986, 375) description of the who-goes-first problem: “Even if an especially perceptive businessman did correctly diagnose a monetary disequilibrium and recognize what adjustments were required, what reason would he have to move first? By promptly cutting the price of his own product or service, he would be cutting its relative price, unless other people cut their prices and wages in at least the same proportion.” The businessman’s reluctance to lower his price merely reflects his own preferences, and so is already accounted for in his supply schedule. There is no problem for market clearing if the businessman delays reducing the price of his product because he anticipates that it is not yet profitable for him do so. That he is “perceptive” and anticipates changes in the money relation such that it may become profitable for him to do so later does not mean that his current prices do not reflect market-clearing plain states of rest. An individual’s reluctance to reduce his price simply means that he prefers to keep inventory in anticipation of more profitable sales at a later time. Holding inventory is not a sufficient indicator of disequilibrium.

Irrational Market Participants?

MDT posits that even when all mutually beneficial exchanges from the goods side are exhausted (and hence no irrationality is ascribed to individual market participants), the money relation can remain in disequilibrium because the aggregate price level is slow to adjust. While individual goods markets may be in some sort of equilibrium based on exhaustion of mutually beneficial exchanges, money is stuck in disequilibrium until all or enough goods prices change. Yeager (1986, 375) provides an example of an exchange that does not occur as evidence that the lack of potential mutual benefit does not imply irrational buyers and sellers: “Suppose that I and a teenage neighbor want to make a deal for him to mow my lawn. Somehow, however, lawnmowers and lawnmower rentals are priced prohibitively high. At no wage rate, then could my neighbor and I strike an advantageous bargain. The obstacle is not one that either or both of us can remove, and our failing to remove it is no sign of irrationality” (emphasis added). Thus, MDT holds that the lack of a double coincidence of wants among rational market participants evidences monetary disequilibrium.

Yeager (1986) conflates the lost exchanges in the case of a price-controlled market with the lost exchanges after a shift in supply or demand in an unhampered market.^[8] For example, consider a binding price floor that results in quantity supplied exceeding quantity demanded. There are some mutually beneficial transactions that could occur but do not, due to the externally coerced constraint on demand at the price floor. These “lost” transactions are symptomatic of a market in disequilibrium. But now consider the case of an unhampered market with a decrease in demand. The quantity transacted decreases similarly, and we may even casually refer to the transactions that would have occurred without the decrease in demand as “lost transactions,” but this is a categorically different situation. The outcome is a new equilibrium and a new market-clearing price and quantity combination. To summarize: in the case of the binding price floor, we have disequilibrium and excess supply; in the case of a decrease in demand, we have a new equilibrium with a lower price and quantity transacted.

The lack of exchange is not sufficient evidence to conclude that a market is not clearing. MDT claims that after an increase in the demand for money, exchanges that took place before are no longer possible. But if the preferences of buyers and sellers are such that a mutually beneficial exchange cannot take place, then there is simply not a double coincidence of wants; the demand and supply schedules do not allow for any exchange. If, due to their own preferences, market participants cannot find a mutually beneficial price—including the previous price—then it is incorrect to conclude that this is necessarily a disequilibrium (by any definition) or that the market is not clearing. And since value scales are in constant flux, yesterday’s prices are irrelevant for diagnosing disequilibrium today. Present prices are the result of the present stocks of goods and the present value scales of the present market participants.^[9]

Previous prices emerged on previous markets. Even if the physical good or service is the same, economists should consider each realized price as an artifact of a momentary market. Joseph Salerno (2019, 10) cites Frank Fetter’s conception of “a succession of different markets”:

For Fetter (1915, 68), a temporal succession of different prices of a given good evinces not a changing market but a succession of different markets, comprising changed valuations, endowments of goods, and choices of market participants: “Price seems to be a continuous fact, altho [sic] there is properly speaking no continuous price: there is merely a succession of separate prices, as shown by the trades from moment to moment. We watch price change as in a moving picture made up of many instantaneous photographs. . . . Trade and succession of prices appearing are the index and the resultant of the continuous changes in the economic conditions, desires and choices of the members of the community.” (emphasis original)

Consider the moment after any exchange, even in the strictest, most unattainable equilibrium construct. A trade occurs due to a double coincidence of wants, but the reverse trade is not possible immediately afterward, because the participants’ value scales are held constant. The impossibility of such a trade does not indicate disequilibrium or a lack of market clearing, for the market had just cleared with the original transaction. Similarly, consider all the infeasible trades beyond the market-clearing quantity that do not occur in any market. Surely there are some sellers who would sell at a higher price and some buyers who would buy at a lower price, but no exchange is possible. The lack of exchange in such cases is merely a consequence of scarcity and the resource-economizing process of the market. When markets clear, some people trade and others do not. Some goods are exchanged, and others are retained by the original owners. Likewise, some money is exchanged, and some money is retained in cash balances.

Sticky Price Mechanisms

George Selgin (1997, 16) lists commonly cited sticky price mechanisms:

Several obstacles stand in the way of instantly-equilibrating general price changes. First among them are fixed money contracts that cannot easily be “indexed” to general price movements. Such contracts include both wage contracts and nominal debt contracts. . . . Second, “menu costs” and other expenses involved in posting and sometimes negotiating new money prices can make the price level “sticky” in the short run. Finally, sellers may be reluctant to change, and especially to lower, their prices in response to monetary disequilibrium even when the fixed costs of doing so are very small.

In what follows, we will discuss whether any of these mechanisms would prevent market clearing. Selgin’s list is representative of what can be found in the broader MDT literature—see, for example, Horwitz (2000, 166) and Pender (2024, 47–50). While Selgin (1997, 16) claims that these mechanisms are only “obstacles” that inhibit “instantly-equilibrating general price changes,” and do not necessarily prevent market clearing in the individual goods markets, it will be shown that the market-clearing characteristic of individual transactions is essential for understanding the nature of monetary equilibrium.

Fixed Contracts

Fixed contracts involve individuals today exchanging promises regarding the future. For example, an employer and an employee might agree today (day zero) that the employee’s remuneration will be fifteen dollars per hour of labor for the next three months.^[10] This contract may include other stipulations about the kind of labor, the number of labor hours, and the possibility of termination or renegotiation at a later date. Both the employer and the employee evaluate the wage and the labor services in light of all the stated options and conditions in the contract based on the anticipated factors that could influence the value of the arrangement over the course of the next three months. Despite the fact that the wage is paid and the labor services are performed in the future, the relevant exchange for the economist interested in analyzing markets and prices occurs at the beginning of the three-month period, when the promise to pay fifteen dollars per hour and the promise to perform certain duties are exchanged. This exchange clears the market between the two actors on day zero. All realized payments and labor performed over the three-month period are then mere fulfillments of the original terms. When, for example, the employee works five hours on the forty-seventh day of the three-month period and the employer pays the employee seventy-five dollars, this payment does not represent a market price for labor on day forty-seven. It is a partial fulfillment of promises that were exchanged on day zero.

If market conditions change such that the demand for labor decreases, the employer and employee will work within the bounds of the contract to minimize losses or maximize gains. This could take the form of capital or labor substitutions, attempts to renegotiate the contract, termination of the contract, and so on. However, nothing the employer might choose to do would pose an issue for market clearing because the market already cleared on day zero.

Salerno (2010b, 191) summarizes W. H. Hutt’s (1979, 144) analysis of prices that have been “fixed” by contract: “Such prices, as Hutt emphasizes, do not constitute rigid market prices that distort the allocation of resources. In fact, in the instant after they are contractually established, prices governing future transactions lose the character and function of market prices and begin to operate merely as terms upon which speculative gains and losses resulting from fluctuations of spot prices are distributed between buyers and sellers in the structure of production, for example, laborers and employers, materials suppliers and materials users, retailers and wholesalers, and so on.” Thus, any frustration on the part of buyers or sellers in cases like these is merely due to hindsight (“Now that I know the market conditions that actually transpired, I wish I had not made the contract in the way I did”). It is the same as any entrepreneurial error realized ex post. These errors do not indicate that the market in question is not clearing, only that the outcomes are not what the actor had hoped for. This is not the sort of frustration that economists say is the result of an uncleared market, in which there are mutually beneficial exchanges that could occur but do not, due to some external constraint (typically government force).

Menu Costs and Reluctance to Lower Prices

The rationale for sticky prices often refers to the preferences of the market participants. Consider Yeager (1986, 374): “Producers, dealers, and workers do not easily see why they should accept reduced prices and wages; owners of land or buildings will not see why they should accept lower prices or rents.” Yeager (1986, 374) also quotes Harry Gunnison Brown’s (1931, 104) textbook: “There are various customary notions of what are reasonable prices for various goods and reasonable wages for labor of various kinds and, furthermore, each person hopes to be able to get the old price or the old wage for what he has to sell and does not want to reduce until sure that his expenses will also be reduced.” The factors that make sellers reluctant to change prices include so-called menu costs—the costs associated with changing prices—which similarly pass through the filter of the seller’s preferences and therefore bear on the supply schedule and the total demand to hold. These factors, therefore, are not an external constraint on the market that prevents market clearing, but rather are already present in the supply and demand schedules.

For example, consider the case of a decrease in exchange demand for a good and constant preferences on the part of sellers, but no change in price (figure 1). Suppose that a few sellers have the same minimum selling price over the range of the shift in demand, or that a given seller would be willing to part with multiple units of the good for the same price. We would observe a decrease in the quantity transacted, but the price would appear “sticky.” Unsold inventory remaining in the sellers’ possession would represent their reservation demand for the good. This implies that the total demand to hold (TD) maintains equality with the total stock (TS) of the good. All known mutually advantageous trades are exhausted, and a plain state of rest emerges. To avoid confusion, in figure 1, the first equilibrium point (EQ₁) is located at the left-hand kink in the original total demand curve (TD₁), and the second equilibrium point (EQ₂, superimposed upon EQ₁) is located at the right-hand kink of the shifted total demand curve (TD₂). The total demand curves are the sums of the reservation demand curve (RD) and the respective exchange demand curves (ED₁ and ED₂), and therefore follow the contours of the reservation demand curve with a perfectly horizontal section at \(P = \$10\). For visual clarity, the total demand curves are set farther to the right than where they would be if the graph were drawn to scale.

Figure 1.Decrease in exchange demand with no change in price

This is how virtually all retail markets operate on a daily basis. Vendors place inventory on shelves with price tags, and customers purchase a certain quantity each day. Market demand for a given good may fluctuate day-to-day while vendors keep the price the same. This implies a flat section of the vendors’ reservation demand curves—inventory on the shelves at the end of the day (really at any given moment) represents the vendors’ reservation demands for those unsold goods. A vendor could at any time announce a lower price to clear out unsold inventory; this means that unsold inventory is purposefully retained, likely due to the prospect of selling it at an unchanged price in the days to come. Instead of negotiating with and changing prices for each potential customer, a costly prospect, the vendor allows variable consumer demand to determine the amount of unsold inventory at the end of each market period.

Contrast with Marshallian Supply and Demand

Sticky wages and sticky prices are typically depicted and explained in textbooks with Marshallian supply and demand curves, which neglect reservation demand and obscure the market-clearing equilibrium. Consider, for example, the depiction of a labor market with a sticky wage from one of Marginal Revolution University’s online videos (figure 2).

Figure 2.Market for labor

Source: Cowen and Tabarrok (2016).

Figure 2 depicts a labor market with a sticky wage that prevents market clearing, resulting in an excess supply of labor (i.e., unemployment). If, however, the wage does not decrease after a decrease in demand for labor, then the supply of labor must have decreased as well, depicted as either a shift in the labor supply curve or a flat section at the workers’ voluntary minimum wage.^[11] Employees might value leisure^[12] or anticipate alternative employment elsewhere that is at least as remunerative.^[13] Employers, anticipating this response from employees, might not offer reduced compensation, choosing instead to lay off workers. Either scenario satisfactorily explains the appearance of “sticky wages” without recourse to uncleared markets.

If one observes a smaller quantity transacted but no change in price and has reason to believe that only one curve shifted, this means that the supply or demand curve is elastic over the range of the shift. An economist who concludes that a price is “sticky” and preventing the market from clearing is assuming that the curves are more inelastic than market participants’ demonstrated preferences imply. It is widely known that one cannot reason from a price change (since both supply and demand bear on market prices), but the same can be said about reasoning from a lack of a change in price regarding prior assumptions of price elasticity, constant supply, or constant demand.

Yeager and other monetary disequilibrium theorists insist that there is no irrationality on the part of market participants who fail to make mutually beneficial trades: “It is a misconception to blame these people for irrationally throwing away gains from trade by leaving prices at non-market-clearing levels” (Yeager and Greenfield 1989, 409). It is difficult to reconcile this claim with the claim that sticky prices prevent markets from clearing as depicted in figure 2. Claiming that an unhampered market does not clear while holding on to rational market participants is a contradiction—it implies that market participants are acting against their own interests (“I am willing to accept this price, but I will not accept it”).

If monetary disequilibrium theorists agree that figure 1 is the proper way to analyze a scenario in which demand decreases but the price does not decrease, then they must explain how such a cleared market can be reconciled with monetary disequilibrium. How can all markets clear except the market for money? If we merely switch our perspective of goods markets and consider demanders as supplying money in exchange and suppliers as demanding money in exchange, then it becomes clear that money is also in equilibrium. There is no surplus or shortage of money as long as all markets clear.

Conclusion

MDT proponents may respond that the foregoing analysis is mere wordplay: “Austrian economists in the tradition of Menger, Böhm-Bawerk, Fetter, Mises, and Rothbard have their own idiosyncratic definition of a momentary equilibrium that results in the contrived conclusion that markets always equilibrate.”^[14] However, the plain state of rest is not an imaginary construct designed to force such a conclusion—it is an explanation of what occurs in markets in the real world. The burden of proof for diagnosing disequilibrium is on the economists who hold that they know about some better (welfare-enhancing or cost-reducing) array of prices and wages that differs from the prices and wages established on markets by individuals they dissonantly admit are rational actors.

Indeed, Israel Kirzner (1999, 218) cautions against the use of the Misesian plain state of rest as a short-run equilibrium construct, saying it is “merely trivially true” that real-world markets achieve “optimality” in the plain state of rest: “The optimality achieved every day in the market is optimality only within the extremely narrow framework relevant to real-world conditions. . . . But this has little to do with the central insight that all economists share concerning the effectiveness of markets in tending to stimulate the exhaustion of all possible opportunities for mutually gainful exchange.” Kirzner contrasts the plain state of rest with “the intersection of the Marshallian demand and supply curves” (217), noting that the latter is conditioned on “hypothetical conditions of relevant omniscience” (218).

Does Kirzner’s conclusion that real-world prices clear the market in a merely trivial sense invalidate the argument presented here, that sticky prices are an illusion and are not obstacles to monetary equilibrium? The answer is implied in Kirzner (1999, 218): “Real-world prices are indeed likely to be ‘false’ prices, setting off entrepreneurial-competitive activity modifying the pattern of resource allocation” (emphasis added). While the initial prices of a market period may be described as “false” due to “the inescapable spatial and temporal constraints on market participants” resulting in “ignorance and speculative errors” (Salerno 2010a, 96), they are still meaningful and useful for economic calculation and Kirzner’s (1999, 218) “entrepreneurial-competitive activity.” They provide an indispensable starting point for subsequent kinds of equilibria, including the Wicksteedian state of rest^[15] which is quickly established as arbitrage opportunities are found and exploited, resulting in interspatial equilibrium in goods markets (i.e., the law of one price) and “interspatial equalization of the purchasing power of money” (Salerno 2010a, 102).^[16] Thus, whether MDT proponents diagnose disequilibrium based on a lack of market clearing or based on a discrepancy between “false” prices and prices that reflect full arbitrage is immaterial: neither basis is sound. Plain-state-of-rest prices are real-world equilibrium prices and the direct antecedents to Wicksteedian-state-of-rest prices, which are also real-world equilibrium prices.

It is a strength and not a weakness of the plain state of rest that it does not assume market participants have “relevant omniscience” (Kirzner 1999, 218). Dismissing the nature and implications of the plain state of rest as “trivial” leads to a misdiagnosis of market disequilibrium in the market-clearing sense simply because real humans lack omniscience. Moreover, it leads to the inappropriate conclusion that real-world prices have “little to do with the central insight that all economists share concerning the effectiveness of markets in tending to stimulate the exhaustion of all possible opportunities for mutually gainful exchange” (218). On the contrary, plain state of rest prices have everything to do with the market process and the progression toward subsequent equilibrium states, both obtainable ones (e.g., the Wicksteedian state of rest) and unobtainable ones (e.g., the final state of rest and the evenly rotating economy).^[17] Finally, dismissing the nature and implications of the plain state of rest leads to unnecessary and distortionary prescriptions designed to correct what appear to MDT proponents to be inadequate or inferior market outcomes. For example, MDT proponents often prescribe monetary inflation in the case of an increase in the demand for money to avoid the monetary disequilibrium caused by sticky prices. But if there’s no such thing as a sticky price, then there’s no such thing as an equilibrating inflation.^[18]