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 
this reminds me of an idea I once pitched to my PhD supervisor, who told me to go away and think up another idea*
Define consumerism as the frequency with which people want to replace durable goods. What I have in mind is people who wear a T-shirt a few times then buy a new one, versus people who wear them for years. What are the effects of changes in the degree of consumerism?
I had been thinking that there may be level effects on output – consumer societies have higher levels of economic activity and higher output – but perhaps welfare neutrality (the degree of consumerism is a preference thing, so you get what you want in either high or low consumer societies). Possible implication that changes in preferences could cause output growth.
But there is a link with hoarding. Trying to accumulate cash entails holding on to those T-shirts a while longer. A sudden decrease in consumerism causes a recession, and presumably increases in consumerism causes booms? Hey, either I’ve just come up with a new theory of business cycles, or I’ve just re-stated something obvious people thought of years ago (or C: I’m talking nonsense).
(Although decreases in aggregate consumerism don’t necessarily entail hoarding because you could switch to productive investment goods … but why would you do that if you don’t want the future consumer goods these investment goods will produce… and how does the quality and cost of producing more durable goods change things. Oh dear).
* be nice – if anybody out there thinks they could turn this idea into a paper, let me in on it! **
** or if anybody can point to the already existing people … post a link.
“Why can’t the firms just pay the workers in goods?” You’ve heard this answer before I’m sure: workers in the chemical industry really don’t relish being paid in sulphuric acid.
Now to the main point: imagine a model in which utility is a function of consumption, leisure and antiques (of which there is a fixed stock; the technology for making genuine Louis IV furniture does not exist and people will accept no fakes). In a full-employment Walrasian equilibrium the stock of antiques, measured in wage-units, is A*. The stock is worth that many hours of standard labour. For the sake of simplicity let’s assume the equilibrium is unique. If for some reason the wage is stuck above the full-employment level the result is a state of Keynesian unemployment, with zero excess demand for either antiques or produced goods. Yes, the excess supply of labour can perhaps be eliminated if W falls. Keynes didn’t deny that, but he also saw the possibility that falling wages might only make antiques even more desirable.
I know Clower says that Keynes was either anticipating Clower or else he was simply talking nonsense, but I don’t think he established that there really is no third possibility. Not that the labels matter – you and David Beckworth can describe yourselves as you see fit – but isn’t Clower usually called a Post-Walrasian? AFAICR he objects to being called a Keynesian.
I might be wrong, but I don’t think the Fed has the authority to buy stocks, though I suppose between Treasury and the Fed one could buy and the other could print and it comes to the same thing.
Does the BoC have the authority to buy stocks?
Luis, here’s an idea that I’ve been trying to pitch to Nick with no success*
My fledgling has just left the nest and set up her own apartment. Furnishing: table and chairs – free from L, moving overseas. Desk and chair – free from L, downsizing. Crockery – free from A, downsizing. Futon – free from M, downsizing. Sofa – scavenged for free from the sidewalk – the neighbours were downsizing. Endtables – one she took with her from home, a matching one bought for $5 at Value Village. Someone else was downsizing.
With an aging population, there will be more and more consumer durables chasing fewer and fewer people. Surely this explains why aging societies experience slow economic growth.
Nick, isn’t this a different scenario from the antique furniture scenario as antique furniture is basically a produced good – take someone else’s old stuff, buff it up, refinish it, and then hawk it as something special?
*you can have this idea for free, I don’t know anything about macro so can’t do anything with it.
NB if you really want a credible commitment to a higher price level, why not do a Caballero drop, buy a ton of govt bonds to finance teachers salaries and so forth, and then instead of talking about how you might drain the money from the system post-recovery, the Fed could just have itself a bond bonfire? Why wouldn’t that work?
(I’ve polluted David Andolfatto’s blog with my ignorance and now I’m doing it here – but still I don’t understand)
Francis, I like it – see also the housing stock and shrinking populations (Germany)
Patrick, the Fed does not have the authority to buy stocks.
By buying antique furniture, one is buying the services of the persons who gathered, fixed, displayed, and advertised for sale the item. These services are newly created. It matters not a bit that no factory was involved.
This even applies to crappy used items purchased on craigslist. Someone is being paid for their services.
asp
It doesn’t really matter that buying antiques (assets) involves a bit of production and services – even buying gold or shares involves paying dealers who have overheads etc. the point is merely that the paradox of thrift is about what happens when everybody tries to stop spending, not when everybody tries to start saving, because saving still involves spending (on assets).
Luis: if people decide to buy fewer new shirts per year, that is just a fall in the mpc, or a fall in labour supply (what’s the point in working such long hours if you don’t want new shorts?).
Kevin: it’s precisely because they don’t want paid in sulphuric acid that we live in a monetary exchange economy.
You lost me on your example. Is this a Walrasian non-monetary economy, with a central auctioneer? If there’s a notional excess supply of labour there must, by Walras’ Law, be an equal notional excess demand of something else.
Patrick, Adam: Yes, I keep forgetting the political constraints on monetary policy. But I still think it would be easier, politically, to get the Fed to buy stocks than to get House, Senate, and President to raise taxes and cut spending!
Frances and asp: suppose (say) 20% of the price of antiques is due to newly-produced services. Then an increased demand for antiques is still 80% an increase in savings.
Kevin: I didn’t know that Clower rejected the label Keynesian. I’ve always thought of him as Keynesian. He’s the one who made Keynesianism make sense.
Nick,
yes, a fall in mpc and labour supply. So I guess it’s trivially true that lower ‘consumerism’ would cause output to fall but be welfare neutral, and that variations in ‘consumerism’ could explain cross country variation in output, changes in preference cause growth.
I don’t know, maybe the fed could take equities on repo?
Say’s Law is never wrong, even in monetary disequilibrium. It’s analytic, and maybe tautological in some formulations (note: not all analytic statements have tautological forms). Does this make it non-empirical? Yes, but statements about the law and its relation to reality may be empirical. For example, does “consumption”, as defined by Say’s Law exist in the real world? If not, then Say’s Law is still true in a purely logical sense, but doesn’t describe our reality (like the theorems of Euclideam geometry?). In a peculiar way, tautologies and analytic statements can actually be false … kinda, at least insofar as we are interested in using them to interpret reality. All interesting empirical statements can be rendered in a purely analytic form, though such a procedure doesn’t enhance our empirical knowledge, because it merely shifts the type of questions we ask from “is it true?” to “is is true that these things exist?”
Say’s Law appears to break during an excess demand for money, but it doesn’t — not really. At least, that is my take on the matter.
Nick. Brilliant discussion. The Japanese government tried buying stocks and I am not sure it worked. What about buying government debt and use the impact on inflation expectations (or price level expectations) as the measure of success. Too crude? Too uncertain? Would seem consistant with adressing both the fiscal constraint and the recession risk.
Here’s a better solution: a competitive market for money.
An excess demand for one money would be a profit opportunity for competing money issuers. That is, when one money is frustrated in its role as a medium of exchange by appreciation, another money can step in and fill the excess demand with an alternative medium of exchange. Problem solved without any technocratic tinkering of the supply of base money; the “zero nominal bound” is jut not an issue; and no more using crystal balls to divine the Fed’s true purpose.
Nick,
I am probably not understanding what you mean by a “shortage of safe nominal assets.”
There are no illiquid markets or wide bid-ask spreads in broad asset classes (this would be evidence that, in aggregate, those that want to sell risk assets, can’t). Households are spending at a reasonable rate (it was reported as 5.7% for August today). Households are not de-levering by paying down debt, its just that some minority is defaulting. Credit spreads in high yield, corporates, emerging markets, or muni bonds are indicative of a healthy risk appetite. Equity P/E’s are not at historical lows, nor are dividend yields at historical highs. Consensus earnings growth estimates for the S&P 500 are a healthy 15% for 2011. Corporate, high yield and emerging bond issuance is literally booming. We just saw one of the largest equity placements in history (Petrobras). Covenants for LBO and CRE debt are getting much looser, and in some cases reaching practices last seen in early 2007. Finally, there seems to be an enormous appetite for commodities, and the CRB raw materials index is back to record highs (the CRB itself is held back only by lower oil than the peak).
Yes, real rates on term Treasuries are quite low. How much of this is an artifact of expected Fed buying? If deflation is the issue, then why are TIPS inflation spreads stubbornly positive, even while real rates are at zero? One would imagine, in the event of deflation fears, that the inflation spread would disappear before the term premium on 5yr bonds.
Nick: “Frances and asp: suppose (say) 20% of the price of antiques is due to newly-produced services. Then an increased demand for antiques is still 80% an increase in savings.”
O.k., let’s think of it from a micro perspective.
I have a nice little antique endtable that I picked up for $75.
Price of antiques increases.
My endtable is now worth $100. I’ve made $25.
Your argument is that this $25 is now being saved (I think – I tend to skim your posts because reading them carefully and trying to thoroughly understand them would take way too long).
However the endtable is producing a flow of services – imputed income that isn’t measured in GDP.
Presumably that increase in the price of endtables reflects an increase in the value of those services produced by the endtable – why else would people want more of these?
So my consumption has increased also – the flow of imputed income that I’m getting from the endtable is now worth more.
It’s just that these services aren’t measured in GDP.
So is it a real world problem, or simply an artifact of imperfect measurement of economic well-being?
Nick,
If A saves and swaps money with B for antiques, and B spends that money on goods and services, there is no thrift at the micro level, because there is no net saving. B has spent what A saved, which means A and B net to zero saving and zero thrift and zero hoarding.
That doesn’t contradict the paradox of thrift, which assumes saving at the micro level. Whether it’s an individual unit or a joint unit shouldn’t matter. You’ve assumed joint behaviour on the part of A and B that contradicts the assumption of initial conditions underlying the paradox of thrift.
i.e. above, your implicit assumption is that B is dissaving, which contradicts the assumption of initial conditions for the paradox of thrift
Hoarding sounds active though it may be passive. Panic is usually used when it is active and lenders don’t want to lend. I can’t think of a good term for when it is passive and borrowers don’t want to borrow.
Maybe slump. That is pretty much what we are in.
Nick,
It seems to me you have just defined away the paradox of thrift. Of course there is no paradox of thrift with antique furniture, because there is no net thrift. Somebody already owns the furniture, and for some individual to be thrifty by buying it, some other individual has to be un-thrifty by selling it.
One might state the paradox of thrift as, “When everyone tries to save at the same time, total savings declines.” If someone is selling their furniture assets, they aren’t trying to save, so furniture does not fit the premise wherein “everyone tries to save.” To the extent that collective thrift is possible, there is a paradox of thrift. What you call “hoarding” is the only kind of “thrift” that is collectively possible. You haven’t disproven the paradox of thrift; you’ve just renamed it. And you’ve argued that it can only happen with money as the thrift asset. I don’t know that Keynes would have disagreed. But it’s still thrift and it’s still paradoxical.
Adam: I think repoing shares is allowed. Not sure.
Lee: There’s the “accounting version” of Say’s Law, which says that stuff bought = stuff sold. That’s true tautologously. But the economists’ version, which says that the value of stuff people want to buy is equal to the value of stuff people want to sell, is only true in equilibrium.
Pierre: Thanks! Maybe buying the TIPS spread to target expectations? (Or would that be selling the TIPS spread? my brain’s not working).
I should not get up at 4.00am and start arguing with Paul Krugman!
Lee: My hunch is that we do see an increased supply of competitive monies during a recession. All the local hippy currencies, like LETS, seem to make a lot more sense when you can’t buy or sell stuff any other way. But it doesn’t seem to happen enough to make a big enough difference.
David: I took the idea from Brad DeLong. It doesn’t mean an excess demand for safe assets at current prices and income. It just means that demand is too high and supply too low for macroeconomic equilibrium.
Frances: I’m not talking about the capital gain you get on antiques. I’m talking about the macro consequences of everyone trying to buy more antiques. Would it cause an excess supply of newly-produced goods and unemployment? And I’m saying it wouldn’t, but that the standard Keynesian model says it would.
JKH: The paradox of thrift is about the effect of an increased desire to save at the macro level. Everyone wakes up one morning and decides they want to save more. And the standard (simple) Keynesian model says they will fail to actually save more (which is correct), but their failed attempts to do so will cause a recession (which is incorrect, unless they try to save in the form of money). Their income falls until they stop desiring to save more.
Andy: assume no investment, government, or foreigners, for simplicity.
Aggregate savings is of course impossible, by accounting identity. But the question is: will the aggregate desire to save cause a recession? I’m saying “no”, (unless it’s saving in the form of money).
Andy: and, (assume the supply of money is fixed, for simplicity) aggregate actual hoarding is also zero, by accounting identity. But the question is: will the aggregate desire to hoard cause a recession? I’m saying “yes”.
What JKH said. Nick, could you expand on your furniture analogy for those of us who aren’t economists? Because superficially, it seems wrong.
The reason is as follows. In your idealization, furniture is imperishable and its supply is completely inelastic. It can therefore serve as a unit of account and the premise is that we begin to use it that way. I have some money, and I can consume it by buying ordinary real goods or save it by buying antiques. But there is no net saving if the antique seller spends my money on real goods. Since the savings vehicle is antiques, that action is implied by the example.
Doesn’t the same apply when I buy a bond? No! Suppose that I buy the bond with cash. The cash is in the form of a demand deposit; if I spent the money on an antique, another demand deposit would be created somewhere else when mine is destroyed. But when I buy a bond, the bank erases my deposit (its liability) and transfers ownership of the bond (its asset) to me; it merely shrinks its balance sheet. This is the mechanism by which demand for the safe bond might “spill over” into reduced supply of (deposit-) money.
Nick,
Two questions:
If reasonable, within-historical-norm levels of risk appetite and savings are producing a macroeconomic disequilibrium, what does that tell us?
And if we are to address a causal driver of disequilibrium, don’t we need some evidence of causality (i.e., credit spreads are indicative of an unwillingness to take on risk, and these spreads are dampening investment and consumer spending below normal levels)?
Assuming that central bankers are allowed to buy stocks, why consider only select companies in the S&P? Why create an uneven playing field by giving these companies a lower cost of capital over other companies? Why not issue new money by funding new ventures instead?
Small business not listed in the stock market probably have better prospects for growing the economy, and returning better yields to government, no? If these businesses fail, the act still boosted money supply going around in the system, which is the intention anyway. Government getting into the public stock market only rigs the investing game more than it already is.
If I’m following Nick, I think part of the point is that nobody is making new antiques. Starting in equilibrium, if everyones suddenly refuses to sell their antiques it doesn’t put plumbers, factory workers, or university professors out of work. But if everyone starts to hoard money it does because it means that in all markets (since money is present in all markets) there must be a surplus of goods.
That last comment was in reply to Phil.
I hope to get this into terms Nick will like.
If positive productivity growth and cheap labor lead to more goods and services available to purchase, which lowers price inflation (maybe even produce price deflation) and creates excess savers that lowers the velocity of the medium of exchange(s) [currency and demand deposits from currency denominated debt], should more currency be created or more demand deposits from currency denominated debt?
Luis Enrique said: “NB if you really want a credible commitment to a higher price level, why not do a Caballero drop, buy a ton of govt bonds to finance teachers salaries and so forth, and then instead of talking about how you might drain the money from the system post-recovery, the Fed could just have itself a bond bonfire? Why wouldn’t that work?
(I’ve polluted David Andolfatto’s blog with my ignorance and now I’m doing it here – but still I don’t understand)”
Why not just mail $1,000 in currency to every citizen and legal immigrant in the USA?
Or, credit everyone’s bank account $1,000 with a guarantee of 1 to 1 convertibility to currency?
“You lost me on your example. Is this a Walrasian non-monetary economy, with a central auctioneer? If there’s a notional excess supply of labour there must, by Walras’ Law, be an equal notional excess demand of something else.”
No, it’s not a Walrasian economy since a Walrasian household faces only one constraint. My representative household faces an additional constraint: it can’t sell more labour than the representative firm is prepared to hire at the going wage. So in general Walras’ Law doesn’t apply, at least in its usual form. (There may be some variant which applies to problems with rationing; if so I’d appreciate a pointer.) Of course, if the wage is just right jobs are not rationed; that’s the (unique) Walrasian equilibrium.
But we’ve been over this ground before and I have an uneasy feeling that if I spell out a non-Walrasian model you’ll say I have money up my sleeve, so to speak. So let’s keep it strictly Walrasian. Households maximise U(C,N,A) = v.logC+(1-v).logA+a.log(N0-N), where C is consumption, A is antiques held and N0 is all the hours a body could possibly work. The production function is logY=s.logN. The parameters are all in the interval (0,1). Let antiques be the numeraire, so W is the number of antiques an hour’s labour will buy. At full employment, in the unlikely event that my calculus is right: N = s.v.N0/(a+s.v). Notice that N depends on v. Preferences have consequences. If demand shifts in favour of antiques, employment will fall. W = A.[(v+a/s)/(1-v)]/N0. If demand shifts in favour of antiques, wages must fall in order to maintain full employment. There’s your paradox of thrift: if wages are sticky, an increased desire for the asset in which wage-contracts are denominated will result in unemployment.
As I see it, the crucial difference between Keynes’s view on this issue and Clower’s, is that for Clower money is the medium of exchange while for Keynes money is just the standard of value used when wage bargains are struck. If contracts were denominated in diamonds then a surge in demand for diamonds would create unemployment (except in South Africa obviously). I can’t remember where I first read that Clower objected to Keynes as being insufficiently Clowerian, but Google quotes David Colander as saying that “Clower cringes when called a Keynesian.”
“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.”
What about working gold into this, assuming that the supply of gold grows around .5% per year and price deflation is 2% a year or more?
“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?”
There are some scenarios where this won’t work. Suppose that firms are monopolistically competitive in the product market: they sell their products above marginal cost in order to recover fixed costs. Conversely, firms may be monopsonistic in factor markets; perhaps some factor exhibits increasing average returns, in which case that factor will not earn its marginal product. Then some exchanges which are profitable (at least ex post) will not occur, even in a barter market. In the short run, though, welfare may be improved by raising demand for the ‘overpriced’ products or supply of the ‘underpaid’ factors.
“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,”
There are two problems here. One is that even though the physical quantity of furniture is fixed, a higher price means that a larger portion of the economy is now invested in furniture, rather than other kinds of capital. So real interest rates should increase and investment should fall.
The other problem has to do with the underlying reason for buying furniture. If the motive was precautionary “thrift”, then the whole effort amounts to a cornering of the antique furniture market: the thrifty savers will fail to “bury the corpse” and cash in on their paper profits. Rational savers will anticipate this problem and refuse to join the attempted market corner, especially if they are late in the game and the price of the asset is high. Perhaps this is the true “paradox of thrift”.
Nick,
Assume no investment &c.
Assume a time lag between when you commit to a consumption decision and when you learn your income.
Define “intended saving” as the difference between expected income and actual consumption.
If everyone increases their intended saving, there will be a recession.
What if they increase their intended saving by intending to buy more antiques? Given my definition, that question is meaningless. Either they’re consuming less or they’re not. Either their income expectations have changed or they haven’t. I can imagine several cases, and in each one of them, either intended saving never rises, or there is a recession.
Suppose everyone comes up with a new plan to replace some of their consumption with antique purchases. Do they immediately start consuming less (before getting a quote for antiques to purchase)? In that case intended saving rises, and there is a recession. Do they wait to see what antiques they can buy before reducing their consumption, then discover that the price has risen and go back to their original plan instead? In that case intended saving never rises. Do they purchase the antiques and simultaneously reduce their consumption? In that case the antique dealer either consumes more with the proceeds (in which case aggregate intended saving doesn’t rise) or “hoards” the proceed (in which case there is a recession).
Phil: you really need to make the distinction between quantity demanded and quantity bought. Between desired purchases of antiques and actual purchases of antiques. Between desired savings and actual savings.
In an economy without government, investment, or foreigners, (for simplicity) actual savings is always zero. People in aggregate cannot save. That’s not controversial in economics. Just as people in aggregate cannot buy more antiques.
The standard paradox of thrift says that if people desire/try/demand to save more, the result will be a recession. The standard argument is that consumption demand will fall, and since income comes from producing and selling consumer goods, so sales, production and income will fall, and keep on falling until they stop trying to save.
I am saying that if they desire/try/demand to save in the form of antiques, the result will not be a recession. But if they try/desire/demand to save in the form of money, it will cause a recession.
Too much Fed
well, if your concern is a supposed inability to credibly commit to inflation, why not?
[sings] I would do anything for inflation, but I won’t do that.
Kevin: I’m not sure I fully understand you. But let me make a couple of points that may (or may not) help:
1. In your model a decrease in v increases the Marginal Utility of antiques and reduces the MU of C. It leaves the MU of leisure unchanged. That means an increased preference for antiques changes the marginal rate of substitution between consumption and leisure, and thus shifts the labour supply curve to the left in real wage space (where real wage means the relative price of labour to consumption). So even if all prices are fully flexible, an increased desire for antiques will reduce the market-clearing level of employment. OK, but it’s not what Keynesians are talking about.
2. What markets exist in your model? If there’s no money, I assume it’s a barter economy. There’s a CN market, a CA market, and an AN market. Even if the price of antiques is stuck too low, so there’s an excess demand for antiques in both the CA and AN market, that doesn’t prevent the CN market from clearing, if the relative price of C and N can adjust.
AArgh! How do we turn off italics??
anon: agreed on monopolistic competition. But that’s not what the paradox of thrift is about. If we move away from perfect competition, the LRAS curve will shift left, so we get lower equilibrium output and employment, and not all mutually advantageous trades are executed. But that’s not an AD curve problem.
“There are two problems here. One is that even though the physical quantity of furniture is fixed, a higher price means that a larger portion of the economy is now invested in furniture, rather than other kinds of capital. So real interest rates should increase and investment should fall.”
I was keeping investment out of the model (or holding it constant) to keep things simple. The simplest paradox of thrift model does the same thing. If we allow investment to vary with the rate of interest (or anything else) the paradox of thrift model breaks down anyway. For example, if an increase in desired savings causes r to fall so that investment rises enough to fully offset the increased desire to save, there’s no recession. that’s not controversial.
You lost me on the last paragraph.
Andy: OK. I think I get where you are going.
I am implicitly assuming they learn that they cannot buy antiques before they revise their expectations of income. For example, suppose they visit the antique market first, then the market for new furniture second. They plan to spend $100 at the antique market, and $100 less at the new furniture market. And they learn they can’t spend anything at the antique market, so spend that $100 on new furniture instead.
You are saying (I think), suppose it’s the other way around? They visit the new market first, and spend $100 less, then go to the antique market, and find they can’t buy more, so go home with $100 more in their pocket than they had planned. Then that afternoon they learn that their income from sales of new goods is $100 less than they had expected. We get a recession. Right?
Here’s my response: That recession cannot persist. They will eventually learn they cannot buy antiques. So they learn they are holding too much money for their now lowered level of income. So they spend some. So output returns to normal. Your recession can only persist as long as people are willing to hold too much money, relative to their income, in the hope there will be antiques for sale. Ultimately, your recession is caused by an excessive demand for money.
Luis Enrique said: “Too much Fed
well, if your concern is a supposed inability to credibly commit to inflation, why not?
[sings] I would do anything for inflation, but I won’t do that.”
Would you borrow enough with gov’t currency denominated debt to send out checks to every citizen and legal resident for $1,000 each?
What are the differences between borrowing enough to send $1,000 to each person and actually printing currency with no bond to do it?
It seems to me there is one similarity. They both create more medium of exchange IN THE PRESENT.
Need to get the mechanism right.
http://www.ftportfolios.com/blogs/EconBlog/2010/9/27/the-myth-and-mistake-of-quantitative-easing
Remember how Canada’s quantitative easing was sterilized so you termed it qualitative easing. Maybe the same in the states.
“You lost me on the last paragraph.”
I might try to rephrase my concerns later, but the fact that “there is no investment” in your model makes it difficult, and it might be irrelevant to your basic point. The way I see it, any kind of intertemporal resource allocation is investment, at least in some sense.
Along these lines, is “hoarding money” really any different from “loaning real resources to the government at 0% nominal interest”? [Yes, there is a money multiplier, so the banking system is also involved, etc. But let’s suppose banks create no money to keep things simpler.] The monetary base is backed by government bonds, which represent claims to real resources; if the demand for money rises, either the price level drops (in which case the government gets more real resources for the same quantity of money) or the Fed creates more money and the price level stays on its planned path. Perhaps there is no paradox of hoarding, but merely a transfer from C to G–and possibly a price level shock, which of course creates severe frictions.
Under a gold standard, things would be rather different; hoarding money would involve current owners of gold rather than governments, and the desire to hoard money might have real effects on the supply of gold or its use in industry and jewelry. But the basic principle would be unchanged, AFAICT.
Nick and Andy. Andy’s comment also crossed my mind, but I don’t know enough about the Keynesian model to have a strong view. I’ve never liked analyses that revolved around differences between planned and actual saving, as I don’t see that as the key issue. So let me come at this from another angle:
Suppose people try to save more, and want to accumulate future money, not antique furniture. So they put money into banks, corporate bonds, etc. This attempt to save more depresses interest rates, and causes AD to fall. But I see the transmission mechanism differently from Nick, although I completely agree that what seems like the paradox of thrift, is actually the paradox of hoarding. I don’t think you need any disequilibrium models where planned and actual saving differ. Suppose people save more, and interest rates fall. The demand for base money will rise, even if it is not at all a close substitute for safe government bonds (and I don’t think it is a close substitute.) Instead, all you need is the Baumol-Tobin transactions money demand model. Interest rates fall and hence people go to ATM machines less often to stock up. Instead of carrying enough cash to buy one week’s worth of groceries, they carry enough cash to buy two weeks worth of groceries. If the Fed doesn’t adjust the supply of money, NGDP falls in half. What looks like the paradox of thrift, is actually the paradox of cash hoarding. But I can get the result w/o any assumption of planned saving differing from actual saving, or of cash being a close substitute for T-bills.
I once argued that the Keynesian model was essentially a gold standard model. Normally if the demand for cash balances doubled, the Fed would accommodate that demand by doubling the supply of cash. The only case where they couldn’t do that was under the gold standard, where gold reserves constrained the size of the base. The one example of a liquidity trap in the General Theory is a case where the Fed wasn’t able to increase the money supply because there was a huge outflow of gold. Thus under the gold standard, the paradox of thrift is really the paradox of cash hoarding, and the paradox of cash hoarding is only a problem because cash must be backed with a finite supply of gold bullion.
BTW, great post.
Frances@10:17AM: “With an aging population, there will be more and more consumer durables chasing fewer and fewer people. Surely this explains why aging societies experience slow economic growth.”
That is what I pointed out here. If that is the case, the problem is more structural than mere paradox of thrift or paradox of hoarding or whatever. And that structural problem could cause structural unemployment, as opposed to the structural problem Krugman has in mind here. However, maybe it isn’t major problem in US yet. Some people (such as Dean Baker) say it isn’t major problem even in Japan.
Good topic. I think, judging from the price of commodities, that the Fed’s strategy is working in the reduction of the hoarding of cash…sort of. Maybe the fed thinks by QE and low policy rates they will chase cash out of hoarders’ hands and into capital assets like equities and real estate, which will in turn help the economy expand. However, given the unsustainable debt levels, the chased money appears to be hoarding precious metals and basic commodities as safe havens from anticipated defaults and high inflation. It’s kind of going to physical cash substitutes as a statement of even deeper pessimism than going to cash.
Don’t you think the game is over for this kind of Keysian hopeful-ism? What if what we really need is big defaults to wipe clean the global balance sheet and set the groundwork for a genuine expansion, supported hopefully by a gold standard?
edeast: I had a quick read of that link you posted, but it didn’t really make sense to me.
anon: agreed, any type of intertemporal resource allocation is investment.
If one individual saves, and there is no change in investment, then some other individual must dissave. There is no aggregate intertemporal resource allocatation, only an intertemporal resource reallocation across individuals.
So if all individuals try to save, and there is no change in investment, they will fail.
I’m arguing that if all individuals try to save in antiques, nothing happens (except the price of antiques may rise).
And if all individuals try to save in the form of money, and the supply of money is fixed, something will happen. If prices are fixed (in the short run) we get a recession. If prices are flexible, we get deflation, so people succeed in getting more real money (M/P), even though they fail to get more nominal money (M).
Scott: Yep. Andy’s critique is a good one. The best I’ve had so far. But I think that ultimately Andy’s critique comes down to saying that an excess demand for antiques will cause a recession because people demand an extra $100 cash that they carry in their pockets in the false hope they will find an antique with a “for sale” sign on it, so they can rush and buy it immediately.
How do we define “substitute”? If an increase in the price of bananas causes the demand for apples to increase, then bananas are a substitute for apples. Similarly, if an increase in the price of bonds (a fall in their yield) causes an increased demand for money, then bonds are a substitute for money. So, I think you are implicitly assuming that bonds are a substitute for money.
The trouble for us Keynesians is that we naturally think in ISLM terms, where there are 3 goods: newly-produced output; money; and “bonds”, where bonds are everything else, and are a substitute for money. And it’s awfully tempting for us to see the causal chain going this way: demand and supply of money determines the interest rate (LM); the interest rate determines the demand for output (IS). It’s so hard for us to think though the causal chain the other way around: IS determines r, r determines Md, and Ms-Md determines Y. Of course, it’s all simultaneous at the ISLM intersection. It’s only when we consider weird cases, like antiques, or supposing buyers are rationed in markets for assets, that we are forced to think through the transmission mechanism.
himaginary: what’s puzzling though is that retired people are supposed to be dissaving. The people who do the big saving are supposed to be those about to retire soon, because they have already paid for their kids, house, furniture, etc, and can now save like mad for a few years before they retire. It’s the 55-65 group I would have thought would be the big savers. Still working and earning, but spending less.
Geoff: the rise in commodity prices is what we would expect to see from monetary easing. To me, it’s a hopeful sign. If there weren’t the threat of recession and deflation, those balance sheets would look a lot better. Plus, there’s a way to repair balance sheets without default: debtors spend less, and creditors spend more.