Would a sudden fad for antique furniture cause a recession? If, like Paul Krugman, you believe in the paradox of thrift, and if you follow the remorseless logic of your mistaken model, you should answer "yes". I don't believe in the paradox of thrift, and would answer "no".
There is no paradox of thrift. There is a paradox of hoarding. Hoarding is a subset of thrift. "Thrift" means saving. "Saving", as defined in macroeconomic models, means anything you do with your disposable income other than spend it on newly-produced consumer goods and services. "Hoarding" means saving in the form of money. And "money" means medium of exchange.
We need to be clear on the distinction between thift and hoarding. Hoarding can lead to a general glut of newly-produced goods and services — like the current US recession. Thrift, unless it leads to hoarding, cannot cause a recession. A desire to buy antique furniture is a form of saving, because antique furniture is not newly-produced. But a sudden fad for antiques is very unlikely to cause a recession, because it is very unlikely to lead to hoarding (unless I'm wrong in my judgement that hoarding money is a very poor substitute for buying antique furniture). A desire to buy government bonds is also a form of saving. It is more likely to lead to hoarding, because hoarding money is a closer substitute for buying government bonds. And that's what makes a desire to buy government bonds more likely to cause a recession than a desire to buy antique furniture. A desire to buy government bonds is more likely to lead to hoarding, and the hoarding is what causes a recession.
Yes, this is very wonkish. It looks like angels dancing on pins. But it also has real policy implications.
Keynesian macroeconomics makes no sense whatsoever in a barter economy. Unemployed workers want jobs, so they can buy goods? Firms won't hire them, because they can't sell goods? What's the problem? Why can't the firms just pay the workers in goods?
The problem is: we live in a monetary exchange economy. We don't do barter. And we don't have a Walrasian autioneer trading everything for everything in one big market. Unemployed workers want to sell their labour for money, and firms want to sell goods for money. And if everybody wants to hoard their money, it ain't going to happen.
Yes, I'm a quasi-monetarist. And all Keynesians too should be quasi-monetarist. Because Keynesian economics makes no sense otherwise. It only works in a monetary exchange economy, where workers sell their labour for the medium of exchange, and firms sell their goods for the medium of exchange, and nobody swaps goods for labour in direct barter. It's an excess demand for the medium of exchange – hoarding – that causes an excess supply of labour and goods.
Start in full employment equilibrium. Then suppose there's a sudden fad for antique furniture. Specifically, people desire to spend less of their income on buying newly-produced consumer goods and services, and more of their income on buying antique furniture. That, by definition, is an increased desire to save. It's thrift. Does that fall in demand for newly-produced goods and services cause a recession? According to the simple Keynesian Cross model, or the slightly more sophisticated Keynesian ISLM model, that is exactly what it should do. The marginal propensity to consume falls, the AE curve shifts down, the IS curve shifts left, and AD falls, causing a recession.
But that prediction makes no sense whatsoever. This is what would happen instead. The supply of antique furniture is fixed. Either the price of antique furntiture rises to equilibrate the market, or it does not. If it rises, then the quantity of antique furniture demanded falls back to its original level, and people decide to buy newly-produced furniture instead, so there's no recession. If it does not rise, then people will be unable to buy the antique furniture they want to buy, because nobody wants to sell. Unable to buy antique furniture, people have to buy newly-produced furniture instead, so there's no recession.
Repeat the above paragraph, and substitute anything else (except money) for antique furniture, and the argument still works. Land, old houses, government bonds, whatever. Either the price rises until people stop wanting to buy it, or it doesn't rise, and they can't buy it, so they buy something else instead. And no matter what they try to buy instead (unless it's hoarding money) the only thing whose supply can expand to meet that demand is newly-produced goods and services. Unless people decide to hoard money, you cannot get a general glut of newly-produced goods and services. Unless people decide to hoard money, Say's Law is true. There is no paradox of thrift.
Now suppose people decide to hoard money. Or, suppose people decided to buy antiques, land, or bonds, and then switched to hoarding money because the price of antiques, land, or bonds rose, or because it didn't rise, and they couldn't buy any antiques, land, or bonds.
There is one way for an individual to get more antiques, land, or bonds, and that's to buy more. But money is different. Money flows both into and out of our pockets. There are two ways for an individual to get more money: sell more other stuff; or buy less other stuff. The first way won't work, if everybody else is trying to do the same thing. Individuals find themselves unable to sell more stuff, because everybody wants to sell more and nobody wants to buy more. You can't sell more unless someone else is willing to buy more. But the second way will always work, for an individual. You can always buy less stuff. Nobody can stop you buying less stuff. The short side of the market is what determines quantity traded. It's always the lesser of quantity demanded and quantity supplied. And when everybody is trying to get more money, quantity demanded is less than quantity supplied. So it's quantity demanded that determines actual quantity traded.
The logic of the paradox of hoarding is inexorable. If the total supply of money is fixed, individuals must fail in aggregate to hoard more money. But each individual can succed, given what others are buying and selling, by simply buying less stuff. So demand for stuff falls, and the quantity of stuff traded falls. And it keeps on falling until people stop trying to hoard. We get a recession.
There is a paradox of hoarding; there is no paradox of thrift, unless thrift happens to be hoarding, or thrift leads to hoarding.
And this has policy implications.
Yes, the in the current US recession there is indeed a very high demand for safe nominal assets, like government bonds. That's thrift. And that shortage of safe nominal assets, and the high prices and low yields on safe nominal assets, has spilled over into an increased demand for the medium of exchange, because that too is a safe nominal asset. That's hoarding. And that hoarding has caused the recession.
But that shortage of safe nominal assets is as much a consequence of the recession as a cause of the recession. When firms' sales are falling, and when there's fear of deflation, previously safe nominal assets become less safe, and the remaining safe nominal assets pay a higher real return.
How to get the US out of the recession?
Brad DeLong suggests fiscal policy. By running large fiscal deficits to increase the supply of government bonds, you can reduce the shortage of safe nominal assets, and reduce the spillover from that shortage into the demand for money. Satisfy the excess desire for thrift, and you eliminate the spillover into hoarding. I'm not sure it would work, though I think it probably would work. But it might come at a very high cost. I don't know how big an increase in the debt would be needed. It might be very large indeed. And it's not so much that the US government debt is already quite large, but that the US has a very "structural" deficit to begin with, and this would make it worse. I mean a "structural" deficit in the political sense, more than the economic sense. If the policy eventually worked, US fiscal policy would need to reverse course very quickly with some very big tax increases and/or spending cuts. Those would be very costly. Tax increases and spending cuts have real, microeconomic consequences. And I don't follow US politics that closely, but my hunch is there would be serious political problems in doing what would have to be done. The "exit strategy" to a fiscal solution looks very ugly.
Brad also suggests increasing the supply of safe assets by government policies that would make risky private assets safer. Again, the logic makes sense, and this sort of policy would probably help, but I worry about the costs.
If I thought that those were the only policies that would work, I would probably still argue that the benefits were worth the costs, because a recession is even more costly. But I think monetary policy could do the job more surely and with much lower costs. Maybe even negative costs.
I want a radical solution, and since the root of the problem is hoarding money, the radical solution is monetary policy. To the extent that fiscal policy works to end a recession, it's because fiscal policy is just monetary policy by other means. It works by increasing the supply of or reducing the demand for the medium of exchange.
I think we all agree with Scott Sumner that a temporary increase in the money supply will have little or no effect. If the Fed buys a 90 day Tbill, and promises to buy it back 90 days later, it's really just swapping one Tbill for another.
But a permanent increase in the money supply would have an effect, because it increases the expected future price level, and possibly expected future real output too. That will reduce the current demand for money (reduce hoarding). In fact, a permanent increase in the money supply will cure the liquidity trap in Paul Krugman's model too. How does the Fed make it permanent, which means perceived as permanent? By announcing a price level path target. A permanent increase in the price level would require a permanent increase in the money supply to support it. (Same with a nominal GDP level path target.)
If the Fed had had an explicit inflation target over the last 20 years, and had built up credibility, the announcement of a price level path target might have been enough. But in current circumstances, it might not be credible enough (Though it would certainly be better than the cacaphony of mixed signals currently coming out of the Fed). People need to see that the Fed is doing something concrete, and see that the Fed is moving some market signal, and see that market signal moving in the direction that indicates recovery from the recession.
If I had my druthers, the Fed would buy stocks. Something like the S&P500 index. The increase in stock prices, and increased money supply would have a direct effect on reducing the incentive to hoard. More importantly, when people see stock prices rising, that shows the Fed's policy is having an effect, and the expectation of recovery causes a further increase in stock prices, in a positive feedback loop. Bond price don't have this feature. If the Fed buys long bonds, bond prices should rise. But if the Fed's policy causes people to expect recovery, bond prices should fall. Bond prices give contradictory signals of the Fed's success. Low interest rates are not a simple signal of loose monetary policy; they are a signal that monetary policy has been tight in the past, and is expected to be tight in future.
The high demand for safe assets didn't spring out of nowhere. It is primarily a consequence of expected deflation and expected recession. If monetary policy can reverse those expectations, it can reverse that high demand for safe assets.
Fiscal deficits, if they work, will have future costs. The higher debt will mean very difficult future spending cuts or tax increases. Monetary policy, if it means buying assets that will rise in value if it works, like stocks, will have future benefits. The Fed, and thus the government, will make a profit on the deal.
Coda: Yes, it's fair to call me and David Beckworth "quasi-monetarists". I would accept that tag. But you must also recognise I'm at least quasi-Keynesian too. The funny thing is, the literature that has been most influential on forming my views in this area was all begun by Robert Clower, as an interpretation of Keynesian economics. It was he who insisted that monetary exchange was essential to understanding Keynesian macroeconomics and why Say's Law was wrong, and that money really was special. This isn't just quasi-monetarism. This is real Keynesian macroeconomics, as it should be done.
Worthwhile Canadian Initiative 
“JKH: this is right back at our old “accounting vs economics” argument. Quantity demanded is not the same as quantity bought. A change in demand can have an effect, and is real, even if it makes no change in quantity bought.”
Yes. That seemed to be what you were doing in your post example, and I got a bit lost as to why you would pursue that. It seemed like you were simulating the paradox of thrift as a risk that didn’t materialize for the reasons you gave – as opposed to the paradox of thrift as a risk that was present and that also materialized. I’m saying the materialization of the risk of the paradox of thrift requires micro saving by some unit that then throws the overall thing into a downward spiral.
I’m just not sure why you would deal with the paradox of thrift as a risk that doesn’t materialize. The paradox contends actual follow through in the form of GDP contraction.
“It may make another loan, at which time it might sell the treasury bills to net out the reserve effect of making a new loan. In making the loan, the proceeds will “land” in a new deposit somewhere in the banking system.”
Sorry, that’s wrong. If it sells the bills to a non-bank, the money won’t end up as an additional banking system deposit. The new loan will just be replaced by bills. If it makes the loan and does nothing else, the money will end up as an additional banking system deposit.
permutations, permutations …
JKH: “I’m just not sure why you would deal with the paradox of thrift as a risk that doesn’t materialize. The paradox contends actual follow through in the form of GDP contraction.”
Here’s another way of looking at it. The standard model says it does materialise (in a recession). I’m saying that it can only materialise if it’s hoarding, so the standard model implicitly assumes hoarding.
JKH: Okay that makes sense, but like you said: it’s like a poor assumption to think that debt is always paid down with savings. It seems like incomes are currently being disproportionately allocated to debt repayment in which case, incomes are deposited. A higher fraction of which is used to pay down debt. Thus, net-net, the banks’ liabilities drop LESS than its assets. Doesn’t this create more demand closer-to-money substitutes?
*Doesn’t this create more demand for closer-to-money (2 year t-notes rather than a construction loan) substitutes (assets)?
“Here’s another way of looking at it. The standard model says it does materialise (in a recession). I’m saying that it can only materialise if it’s hoarding, so the standard model implicitly assumes hoarding.”
I think that’s OK (maybe except for Adam’s model, but I think you’re assuming a monetary economy).
I know you object to being accused of merely renaming, since you have a point of substance. But maybe the paradox of thrift does implicitly assume it is money that is hoarded from income – without being explicit about what it is that it is being implicit about 🙂 Again, my simple interpretation is that income in a monetary economy is paid in money; therefore saving from income is saved in money, at least initially; therefore the paradox of thrift is about the paradox of saving money, or hoarding money. And I say initially, because saving money from income (as a flow) doesn’t preclude using that money subsequently to acquire bonds or other assets. But maybe you disagree with that last part.
MrRearden,
At the micro level, I think there’s no doubt that some people are using saving to pay down loans.
From a balance sheet perspective, saving increases the personal or corporate equity position and the cash asset position (e.g. bank deposit). They then use the cash to pay down the loan.
Alternatively, they can use the cash to acquire other assets.
The logical type of asset to acquire given the environment is a low risk one – e.g. your two year note. This is consistent with the risk aversion on the liability side of paying down loans.
So the result is some risk-averse combination of shedding liabilities and increasing low risk assets, which I think is consistent with what you’re saying.
Nick, how close are you to the all time comment record?
Frances: about 50 short, I think. A couple of old posts on economics and accounting, and MMT, I think, got past 200. I’m really running out of puff on this one though!
Nick,
Off topic – this thing from Krugman reminds me of some post you did, I think.
http://krugman.blogs.nytimes.com/2010/10/04/a-note-on-currency-wars/
Nick:
No comment on the BoJ’s announcement that it is looking into buying ETFs and REITs??
Click to access k101005.pdf
I had a look at the Barro-Grossman paper which is here (1.6 Mb PDF file).
If I understand Nick correctly, his point can be seen by looking at Figure 1, page 86. For anyone who has difficulty opening the file, this diagram is just a standard labour market diagram with supply and demand curves for labour, both ‘notional’ in this context. The curves cross at point A. To the left of that point is point B (same real wage, lower output), which represents a situation where “failure of the price level to adjust to clear the commodity market leads to excess supply in the labor market.” So B is off both curves.
Nick’s point, I take it, is that firms in this situation could hire workers on a barter basis, giving them a share of the extra output instead of money and making additional profit, also in the form of output. Obviously this workaround is fine for breweries, less so for makers of insecticide. But it’s true as far as it goes and it’s a fair criticism of Patinkin, whose model (according to Barro and Grossman; I haven’t done any fact-checking) predicts such a [dis]equilibrium. It doesn’t lay a glove on Keynes, whose model predicts that the price level will fall, driving the real wage up until it hits point D on the demand curve, directly above B.
Keynes’s model has a problem too, since it predicts a countercyclical movement in the real wage. Barro and Grossman note that Keynes struggled with this criticism (see GT Appendix 3). But that’s an empirical matter, not a failure to make sense.
I find barter models distracting. I think the better approach is to assume away monetary disequilibrium, and consider what happens in a money economy.
First, suppose there is an increase in thrift. I don’t think of this as a lower discount rate, but rather a shift in the supply of saving to the right. At the initial real interest rate, saving is greater than investment.
If the real interest rate falls, the quantity of investment demanded rises. Firms purchase more capital goods. Also, the quantity of saving supplied falls. Households purchase more consumer goods. The usual effect is a shift in the composition of demand away from consumer goods to capital goods. And so, a shift in the allocation of resources away from the production of consumer goods to the production of capital goods.
But wait.. Suppose that the decrease in the quantity of saving supplied and increase in the demand for current consumption includes an increase in the demand for leisure. Then this response involves a decrease in labor input and a decrease on current output and income. The increase in thrift has resulted in less output and income. Now, this isn’t a “paradox of thrift” as it stands. The amount saved should increase. And, of course, there is no market failure involved in this process. And it is a type of RBC.
Since real output and real income are lower (in the short run,) so is real aggregate demand. Still, the “problem” wasn’t caused by an inability to sell, but rather by an increase in the demand for leisure (and so decrease in the supply of labor.) Another way to say this is that some people were working to save, and with lower real returns on saving, choose to work less. (Further, if the initial increase in the supply of saving was at least partially funded by working more, then this effect would be partially or wholy, or more than, offset.)
Now, suppose that there is a price floor in credit markets so that the interest rate doesn’t clear. This, of course, is an old Yeager thought experiment, and it is supposed to explain that “interest rates” are the wrong way to think about monetary policy.
Anyway, the interest rate is above the market clearing level, and so the amount saved is greater than the amount invested. Some of those who would like to save are frustrated. Now, if we assume that the frustrated savers just hold more money, then we have an excess demand for money, and reduced expenditures. This possibility will be assumed away. Perhaps the demand for money is unchanging.
Since some saving is frustrated and the actual amount saved will be limited to the amount invested at the interest rate floor, there is no choice but to consume. Sure, there are gains from trade that are frustrated. People would be willing to give up consumption today, free up resources to produce capital goods today, and obtain greater consumption in the future. But, the price floor makes it impossible.
But suppose to some degree the good consumed by frustrated savers is leisure. Frustrated savers don’t buy consumer goods, they work less. There is less income, and less output. The price floor on the interest rate results in people choosing to work less. With real output and income lower, real aggregate demand is lower. Still, the problem isn’t an inability to sell. It is that people don’t want to work if they cannot save and obtain future consumption.
Now, let us drop saving for a minute, and consider a price ceiling on gasoline. This leads to frustrated buyers. Now, if the frustrated gasoline buyers just hold money, there is an excess demand for money, and lower expenditures on output. But, let’s leave that out by assumption. And so, the frustrated buyers just purchase other consumer goods. The amount of gasoline purchased will be the quantity supplied. Now, suppose one of the goods people choose to buy instead of gasoline, is leisure. They work less, and output and income are lower. Real aggregate demand is lower. People were working to get gasoline, and since they can’t get gasoline, they don’t work as much. This is part of the disruption caused by the price ceiling. Is this a paradox of gasoline demand?
Now, back to the price floor on interest rates. Now the supply of saving increases. And so the price floor is more disruptive. Given the price ceiling, the amount actually saved equals the amount invested, which isn’t changing. If some of the additional frustrated savers choose leisure rather than some other good, then there is less labor input, output, income, and real aggregate demand. The amount saved is actually unchanged (equal to the given amount invested.)
But the problem isn’t a decrease in aggregate demand. The problem is that people don’t want to work as much. They choose less current consumption, but if they can’t get future consumption for it, they would rather have leisure. This preference ordering is possible.
One the margin, people want more future goods most, then more leisure, and then current consumption. If markets clear, then the price change could result in people working less, and the amount saved and invested rise. If the markets don’t clear because of the price floor, the amount saved can’t rise, and if people work less, then output falls.
I don’t think this counts as the paradox of thrift. And I think this is what all that back scratching and bonds was all about.
I think that Adam P’s approach is unable to distinguish between monetary disequilibrium and price floors or ceilings. I, at least, don’t deny that market distortions like price controls will reduce real output and so real aggregate demand, even if there is no monetary disequilibrium. I think Hutt focuses on this sort of thing.
But I don’t think a central bank creating or destroying money to manipulate credit market conditions to target interest rates is creating a price ceiling or floor. Nor do I think that the sort of changes in the willingness to work because of an inability to buy future consumption goods explains existing recessions.
Kevin: exactly. And that Barro Grossman point B (I can even remember it’s called “B”, without looking) shows that if there were no problem with barter we would go right to full employment point A. Even the insecticide workers could be paid in insecticide, and barter some of it for beer, with the brewery workers, and so on.
The problem with Keynes’ point D, apart from the empirical problem, is that it’s conceptually unclear whether the underlying problem is W/P being too high, or M/P being too low. In his verbal discussion, it seems to me that it’s the latter interpretation he has in mind. But you can’t really tell from his model.
BTW, in the second edition of Patinkin, IIRC, he did in fact conceptually discover the constrained demand curve for labour. He has priority over B&G. But Patinkin missed the constrained consumption demand curve (aka the Keynesian consumption function). B&G put them both together.
Bill: I agree with the whole thing. (But I have to keep reminding myself of your first line, that we are assuming it never spills over into monetary disequilibrium!) Who is Hutt? The name sounds vaguely familiar.
Nick: thanks, I’m glad that I now seem to be clearer as to what your concern is. I’m not persuaded that it’s really best expressed as a matter of money being a medium of exchange. The barter fix amounts to setting up a model of a well-functioning barter market inside a model of a dysfunctional monetary economy. But if the solution was that simple the bungling auctioneer, who causes the trouble in the Barro-Grossman story, would hardly have bungled in the first place. His problem isn’t so much that money thwarts him; it’s more to do with finding the right price for the stock of assets relative to the flow of goods and services. Really, what’s the correct ratio between the hourly wage of a semi-skilled worker and the price of an oil refinery, or the market capitalisation of IBM? In a Walrasian model the auctioneer gets that price right before anybody is contractually committed. It’s a lot to ask of the invisible hand.
“The problem with Keynes’ point D, apart from the empirical problem, is that it’s conceptually unclear whether the underlying problem is W/P being too high, or M/P being too low. In his verbal discussion, it seems to me that it’s the latter interpretation he has in mind. But you can’t really tell from his model.”
That’s a feature, not a bug. There are two exogenous nominal variables, M and W, and what matters for demand is the ratio between them, the money supply measured in wage units, M/W. (Since goods are heterogeneous in Keynes’s model while labour isn’t, he rarely brings P into it.) So formally, wage-cuts come to precisely the same thing as an expansion of the money supply, but for Keynes the formal model is just the starting-point for the discussion of policy options:
My paraphrase of the four reasons which follow: (1) we don’t live in a dictatorship, where W can be cut by decree; (2) many non-wage contracts will be in money too, and justice would require changing them also; (3) cutting W crushes debtors and (4) the prospect of deflation will deter investment.
Nick:
“3. I spend $1,000 on antique furniture. $1,000 thrift. Zero hoarding.”
You and your counterparty exchanged assets: cash for old furniture. Assuming the counterparty hoards, (3) is equivalent to (2) — no consumption/investment happened, GDP is unchanged.
Substitute existing gold for antique furniture with the same result.
Kevin: basically agreed, but:
If barter were frictionless, there would be a way around a disfunctional monetary system, but then we wouldn’t have a monetary system in the first place. I introduce barter purely hypothetically just to show there must be some frictions, and it’s those frictions that create a monetary exchange economy, and also show why monetary exchange matters. (You probably don’t disagree on this).
Keynes: if Keynes had held P exogenous, instead of W, or in addition to W, he could also have shown that whatever P cuts could do, M increases could do just as well, or better.
(That bit about monetary policy by the Trade Unions always struck me as ironic, in the 1970’s, when we had the Trade Unions targeting real wages, and the Bank of England targeting full employment, and the two targets weren’t compatible, so we got an inflationary spiral.)
vjk: Sure. But will the counterparty want to sell antiques? And will he want to hoard money? Actual savings always equals actual investment, by accounting definition. But that’s not what’s at issue here. If desired savings is greater than desired investment, what is it that adjusts to bring them into equilibrium?
Apples bought always equals apples sold. But what adjusts, if quantity demanded is not equal to quantity supplied? The accounting conventions won’t answer that question. They weren’t designed to.
Adam P said: “Now suppose that every day 5% decide they’d like to save (a different 5% each day), they will offer a backscratch today but won’t consume one. Instead they’ll take a bond. First problem, does a non-saver, who expects to be a non-saver tomorrow accept the deal? Yes, tomorrow he pays back the backscratch and consumes by issuing his own debt to one of the savers. Today total output of backscratches is 95% of max.
Tomorrow arrives and yesterday’s savers consume 2 backscratches and provide 1. Those who issued debt provide a backscratch to redeem the maturing bond and issue debt to the current savers to consume.
It’s easy to see that we know have an equilibrium in which output is 95% of the max forever. Yet there is no hoarding of bonds and bonds are not the medium of exchange. Most transactions are bilateral exchange of service.
So, a 5% increase in aggregate saving decreases income by 5%. That’s not a paradox of thrift?”
And, “PS: and of course aggregate saving remained zero. In aggregate the reduction in consumption from 100 to 95 was not offset by aggregate consumption of 105 tomorrow. Aggregate saving was still zero, some individuals manage to save some periods but the net result is just a fall in income.”
What happens if you run this scenario with say 1,000 people and the SAME 2 people continually save?
Adam P said: “But then this puts the US in paradox of thrift land, since (X-M) will always be negative you have that Y < C + I + G, so either the private sector dissaves or the public sector dissaves (or both) and that’s true no matter what the level of Y!”
current account deficit = gov’t deficit plus private sector deficit?
Dissaving with currency denominated debt is the big problem with running a current account deficit even if it lowers price inflation. I would also say that selling financial assets or “dissaving” with currency can be a problem too.
“Keynesian macroeconomics makes no sense whatsoever in a barter economy. Unemployed workers want jobs, so they can buy goods? Firms won’t hire them, because they can’t sell goods? What’s the problem? Why can’t the firms just pay the workers in goods?”
This is just an artifact of your timeless production model.
Suppose you have farms that, in period 1 employ planters and in period 2 employ harvesters. You can pay harvesters with food, but you cannot pay planters with food, because they do not create food, they create the capacity to sell food in the next period.
The general gluts are not caused by lack of barter — they became widespread and recurring with the industrial era when large amounts of long term capital investment were necessary, and these investments were funded by selling debt. Also a period when you saw the rapid growth of credit markets to fund that investment.
Keynes highlighted the volatility of long term investment and the inability of money market interest rates to ensure that a sufficient quantity of investment occurs to maintain aggregate demand.
All of that is “real”, and this is close to observed behavior. I think the effort should try to be to create models in which the observed behavior is explained, rather than promote models that trivialize interest rates and investment and instead argue that people are hoarding the medium of exchange — something that is not observed.
There is a lot of data as well as logic pointing out that investment demand is relatively inelastic to the overnight interest rate. The cost of capital includes an earnings growth component as well as a dividend component, and both are long term. Now perhaps, if development of a factory could be achieved overnight, then overnight rates might be more effective, and the CB control of these rates might be enough to maintain demand.
But look at what is happening — the pension fund industry standard is still for a return of 8%. The economy is growing at 6%. The institutional investors have not lowered their return demands in response to central bank rate targeting. What about businesses? Their cost of capital has not fallen either. More than a year of zero interbank rates and still the non-financial business community does not face a materially lower cost of capital. Now if you combine the same cost of capital that market the secular earnings boom with reduced investment demand, you have a recipe for idle resources.
As an aside, Adobe’s stock plunged recently after their earnings call. They met earnings, but they lowered their earnings growth rate guidance. They are laying off about 15% of their workforce now — and this is the third such round of layoffs since the recession began, even though they consistently met their earnings targets throughout. When they lay off, they are not firing employees who are too expensive, but closing down business units and projects that fail to meet their 15% future profit growth needs. As collateral damage, labor is cut when the capital is liquidated.
Now if enough businesses face a cost of capital that is too high — remember the 8% pension fund assumption — then they will all individually cut investment in an attempt to climb back up their MPK curve, but the paradox of thrift comes in, so that in aggregate they will fail to grow their earnings at the required rate. All of this is “real” — e.g. the earnings can be in terms of goods. Spot prices can be perfectly flexible, as long as the earnings growth requirements are sticky. None of this reflects a desire to hoard the medium of exchange.
RSJ: “the pension fund industry standard is still for a return of 8%”
This doesn’t tell me that the cost of capital is high; this tells me that there’s a pension fund crisis brewing.
Andy, it’s been 8% for a very long time now.
We have had a secular earnings boom, in which the corporate profit share of GDP was steadily climbing, so that 8% was justified during that boom period. That 8% figure, or it’s equivalent, has become embedded in firm management, investment advisors, the institutional guys — basically everyone. Unfortunately, try telling people that this is unsustainable — it’s been working since 1980, after all — for all of their professional lives.
No individual firm is going to be willing to accept lower growth rates going forward because the last 30 years were a debt driven fluke. They all think that they are special and need to grow at high rates, and when those rates don’t materialize, they interpret that as a signal to cut investment in the existence projects and find something else that will deliver earnings growth. I’ve know many profitable projects that were cancelled because the growth rates weren’t high enough.
Curiously enough, none of the non-financial actors look at the CB policy rate as guidance to their cost of capital. Why don’t the economic models also make this distinction?
You make negative remarks about fiscal stimulus, writing: “Fiscal deficits, if they work, will have future costs. The higher debt will mean very difficult future spending cuts or tax increases.” Which will it be: spending cuts or tax increases? That matters to a voter who (like me) prefers smaller government. He would like, let us say, a Federal government that spends only 13% of GDP. But the Federal government will tend to bump up against the upper limit of what is tolerable to the voters, which (let us say) is 26% of GDP; so our small-government voter is destined not to get his first preference. Turning to second-best, he would probably prefer a government that spent 13% on actual programs and 13% on interest on the national debt to a government that, because it had no debt, spent all 26% on programs. So he would be happy to see the government burdened with debt; that would constrict its activities by its need to pay interest. Debt cripples the government, which is what the small-government voter wants.
So long as future tax increases are perceived, in political terms, as even more “difficult” than future spending cuts–so long as there really is a practical upper limit on what taxpayers are willing to bear–increases in the debt are not “costly” at all (from the pro-small-government point of view). Fiscal stimulus: bring it on!
“A desire to buy antique furniture is a form of saving, because antique furniture is not newly-produced.” This implies a truly bizarre definition of ‘saving’. First, how new is “newly”? One minute ago? A decade ago? Something in between (but where, exactly)?
A piece of furniture is a “consumer durable,” which means that its acquisition is partly consumption and partly saving/investment. It provides current services–for example, one can sit on it or gaze at it–and it also provides future services of the same sort, besides serving as a store of value through its potential to be resold. Acquiring and holding/using an antique chair is not pure saving; it is partly consumption. And the same can be said for acquiring and holding/using a newly produced chair; there is no difference with regard to consumption/saving.
Increased hoarding of money will cause a recession only if the fiat-money authority does not sufficiently increase the supply of money to accommodate the increased demand (i.e., the reduced velocity). If one views keeping the money supply constant as doing nothing one will consider that the only basic change in the economy has been the increased desire to hold money, so this must be the cause of the recession. But suppose there were in place an automatic mechanism for adjusting the supply of money to the demand. Then the authority would have to do something to thwart this mechanism in order to keep down the quantity of money when the demand to hold it increased. Then there would seem to be two causal factors in producing the recession: the increased desire to hold money and the action by the monetary authority preventing the quantity of money from rising. We would not want to ascribe the recession simply to increased hoarding, ignoring the monetary authority’s (perverse) action. Indeed, if we viewed fluctuations in the demand to hold money as normal, we might even want to offer the monetary authority’s extraordinary action as the cause of the recession.
Philo: My guess is that current fiscal deficits will imply both future spending cuts and future tax increases. Both are politically unpopular, and undesirable, so a rational government will equalise the marginal costs on both margins. And unless the marginal cost curve is perfectly elastic or inelastic on one of those two margins (which seems implausible), they will move up the MC curve on both.
You can measure the “size” of government as government spending/GDP, or government taxes/GDP. (Both measures are very flawed, but that’s just an aside.) By the first measure, government will get smaller, by the second measure it will get larger. People who like “small government” are normally objecting to the latter. (As a thought-experiment, suppose someone else voluntarily gave our government aid so it could spend more without increasing taxes; how many people would dislike this increase in the size of government?)
Everybody wanting to buy an antique chair is neither desired consumption nor desired investment. Only newly-produced goods count, because it’s the demand for newly-produced goods and services that creates the demand for the labour and other resources needed to produce them. We can argue over whether a demand for newly-produced chairs is desired consumption or investment (I say it’s investment), but which one it is doesn’t affect the standard paradox of thrift argument, which recognises that an increase in desired savings matched by an equal increase in desired investment will not cause a fall in desired aggregate expenditure or a recession.
I basically agree with your last comment, about the response of the money supply. (I was assuming it fixed, for simplicity).
Contra Brad DeLong and like-minded proponents of fiscal stimulus, you write: “The ‘exit strategy’ to a fiscal solution looks very ugly”–a remark that seems designed to inject some political realism into the discussion. But this may be unfair to DeLong. He is not much interested in whether gracefully exiting from running large deficits would be politically possible–or even whether running the deficits to begin with would be. His contention (as I interpret him) is that under certain political conditions–roughly, what would prevail if most people had economic insights comparable to DeLong’s–large deficits would work to end the recession. And under those conditions, a graceful (by DeLong’s lights) exit from deficit spending would also be possible–indeed, it would be guaranteed!
Policy recommendations almost always take this form: the proponent is saying that if only most people agreed with his thinking on the subject, such-and-such policy would work well. That usually makes them rather far removed from being “practical”; considerations of realism are inappropriate.