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 
Great post Nick.
You should mention Yeager with this stuff.
Scott, Nick’s response is right. What does it mean to say that interest rates impact the transactions demand for money other than that bonds are a close substitute for money. While the rationing stories are usually not too relevant, I think it is the best way to understand zero bound phenomenon. There is a shortage of T-bills at price of one, and it clears by a shift in the demand to hold money. This is important because open market operations in T-bills take away T-bills, worsening the shortage, leading to a further spillover to money demand at the same time they create money. Not very effective.
I think Andy’s confusion, and this is common, it to assume we are always talking about an “exogenous” money demand shock. Suddenly, tastes change and people what to hold more money. When, instead, they think of something else (say a change in saving) and as part of the process there is an increase in the demand for money, then they refuse to see that it is that step in the process that is causing the problem for aggregate nominal expenditures.
The actual arguments he made seem uninformed by basic supply and demand. Suppose investment demand is perfectly inelastic with respect to interest rates. Saving supply increases. The interest rate falls enough so that quantity of saving supplied drops enough so the amount saved remains the same. There was still an increase in the supply of saving.
Suppose the demand for peaches rises. The supply of peaches is perfectly inelastic. The price of peaches rise so that the quantity of peaches demanded falls enough, so that the equilibrium quantity of peaches is unchanged. There was still an increase in the demand for peaches.
Thanks Bill! Yes, I should have mentioned Yeager. But I don’t know how to characterise him. Not really Keynesian, but I’m not sure I would call him monetarist either. He’s even harder to pigeonhole than Clower. With Clower, at least you can say he was “Keynesian” in the sense of re-interpreting Keynes (“what Keynes should have meant, whether he meant it or not”). Even if Clower rejects the label.
In fact, what the hell do we call this whole approach?
Bill: ” There is a shortage of T-bills at price of one, and it clears by a shift in the demand to hold money. This is important because open market operations in T-bills take away T-bills, worsening the shortage, leading to a further spillover to money demand at the same time they create money. Not very effective.”
Funny thing is, this is almost identical to what Brad DeLong said:
Here’s Brad:
“Could I make Nick Rowe happy by saying that there is too a “paradox of thrift,” in this sense:
When there is an excess of (planned) savings over investment, savers will be unable to find enough bonds to satisfy their demand and will park the excess demand in liquid cash money instead, which they will hoard. They will thus diminish the supply of money available to meet the transactions demand for money and that imbalance creates the excess demand that breaks Say’s Law. Thus even though the problem as an excess demand for money, standard open-market operations will not resolve it: they will increase the money supply, yes, but by diminishing the supply of other savings vehicles they will also increase the amount of the money stock not available for transactions purposes because it is being held as a savings (or a safety) vehicle
?
Does that make anything clear, or just deepen the darkness?”
Endquote from Brad.
Basically, when Brad DeLong really gets into why Say’s Law is wrong, what he says is really the same as you and me. He even talks about velocity at times.
And don’t let anyone know I said this, but I sometimes suspect him of “quasi-monetarist” tendencies.
P.S.
Suppose the demand to hold money rises. The quantity of money is unchanged. The purchasing power of money rises (or the price level falls) so that the amount of nominal money balances people choose to hold falls back to its initial level. The demand for money still rose.
Suppose the equilibrium process does not occur, and instead, the demand for money rose, and real income falls enough so that people are poorer and choose to hold less money. The amount of money they want to hold given the lower income, equals the existing quantity. Still, the demand for money rose.
Of course, I am just a supply and demand kind of guy, but it all makes sense to me thinking about “quasi” changes in supply or demand and changes in quantity supplied or demanded. Of course, there are multiple methods of adjustment to monetary disequilibrium==at the very least, interest rates on money, interest rates on other assets, real income, and the price level.
In some sense, I want to say the interest rate on money or the price level adjustments are the “right” ones, because interest rates have an intertemporal adjustment function and real income is the entire point of economy activity.
Nick,
I think Andy Harless is right in his comments, and that you’ve effectively just renamed the paradox of thrift. The paradox of thrift always equates to the hoarding of money in some sense, because it requires a failure/contraction in aggregate demand, which in a monetary economy is a failure of people to spend money, which must imply hoarding of money at some level compared to the previous level of activity. If the supply of money is fixed, a recession means a slowdown in the velocity of money, which must equate to hoarding at the margin. So I don’t think you’ve disproved the paradox of thrift in the full breadth of its logic at all.
Andy’s second comment points to a fallacy of composition and internal contradiction in your argument, explained by him in according to the deconstruction of the macro outcome into micro subsets and potential outcomes.
The key sentence is:
“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).”
This is consistent with my earlier point. While the paradox of thrift is a macro phenomenon, the assumed micro composition of behaviours contributing to the macro paradox must be internally consistent as preconditions for the macro outcome. E.g. in a pure service economy, the desire to save will translate into a distribution of actual micro saving and actual micro dissaving that sum to a net saving of zero. The micro dissaving distribution is a reflection of the evolving contraction. When I said that the fallacy of composition assumes actual saving at the micro level, I certainly didn’t intend to mean that it doesn’t assume desired saving at the macro level.
Nick,
I also think there are two quite separate ideas being debated here:
a) The relationship between the paradox of thrift and the paradox of hoarding
b) The relationship between the central bank risk transformation function and the operational resilience of either paradox
By the central bank risk transformation function, I mean that the swapping of money for equity risk is likely to have a greater effect in combating the paradox than will the swapping of money for t bills. And the swapping of money for t bills will have a greater effect at higher rates than at the zero bound.
Yeager calls his approach “monetary disequilibrium.”
At some point, Yeager was a “monetarist” and was very sympathetic to quantity of money rules. And he understood, Friedman, for example, of
having more or less the same understanding that he did.
Yeager always insists that there were pre-Keynesians who understood monetary disequilibrium quite well. But that there were others who were off. And, he was very critical of the liquidationists.
Yeager criticized Clower and Leijonhuved (yikes) for reinterpreting Keynes with a focus on monetary disequilibrium. There were plenty of pre-Keynesians who understood this better, and Keynes just created a mass of confusion–a diversion.
But, if the “new Keynesians” finally get it straight, then fine, we can be hold our noses and be “new Keynesians” regarless of these history of thought points. Of course, now that they are all focused on targeting the Federal Funds rate, and have become neo-Wicksellians, well, I guess that is out the window.
And Yeager has always been very critical of market clearing assumptions, and so new classical and real business cycle theories.
Anyway, “quasi” monetarist might be it.
The free banking Austrians say “monetary equilibrium” theory, and it does have a nice sound to it. They tend to favor mild deflation and are very worried about malinvestment, but I think they have the basics of monetary theory straight. Selgin edited a book of Yeager’s essays.
Nick,
I have a post that argues that 2008 crisis was caused by a flight to liquidity, not by a flight to safety. The relative price of very safe but less liquid assets such as TIPS has crashed after Lehman, this indicates that monetary disequilibrium was the most important issue:
http://themoneydemand.blogspot.com/2010/10/brad-delong-and-flight-to-safety.html
Nick,
I read DeLong. I thought that he was right. And that Yeager explained this in 1956–explaining how the liquidity trap fit in with monetary disequilibrium. Your points
Nick, I think our differences may be mostly semantic, but my real point is that the “paradox of thrift” semantics are useful. What will happen if people get more thrifty? Unless there is some mechanism (such as an IS curve without a binding zero constraint) for channeling thrift into real demand for new products, the answer (assuming sticky prices) is that there will be a recession. Provided that there exists some asset (call it money) whose value does not rise in response to increased demand and which can still be obtained when it is in excess demand. People may try to buy other assets first, but eventually they will give up and keep their savings in the form of money. Because they can. (Or rather, because each of them can, although, collectively, they can’t.)
I’m implicitly assuming that money is the only bubble asset, so maybe I should call it the paradox of undeluded thrift. There could also be a bubble in antique furniture, where people keep buying despite price increases because they don’t realize that prices will eventually fall again. In that case they will overestimate their wealth and consume more (relative to their actual wealth/incomes) despite their thrift. In the absence of such a bubble, though, any increase in the value of another asset will make money more attractive, so people will eventually channel their thrift into money and cause a recession.
A couple of points, when you are disagreeing with Krugman and DeLong on the paradox of thrift v. paradox of hoarding, you all seem to be describing the same thing. Are you doing this just to keep on good terms with the Krugman phobes since Krugman is no longer a respectable economist (having gone all heterodox like Quiggin, Keene, Dean Baker, Jamie Galbraith, Minksy e.g. all the folks who have been right these last 10 years).
See DeLong’s brief historical discussion of Say, J.S. Mill, and successors about how “money” changes everything in a financial crisis.
http://delong.typepad.com/sdj/2010/10/a-picky-historical-correction.html
Also, I just note that Keynes magnum opus was “A General Theory of Employment, Interest, and Money.” See, it is right there in the title “Money.”
I don’t like the term hoarding because to me it implies intent, where the intent may be quite different. If antique sellers maintain larger cash balances waiting for the opportunity to buy antiques at a better price, they may be hoarding in the sense of maintaining high cash balances, but it is not high cash balances that they actually desire. It doesn’t seem untoward to me to call this thrift.
Andy,
I think balling up bubble theory with an excess demand for money
is just confused. I can see why a popping bubble might lead to an increase in the demand to hold money, but expanding bubbles don’t do that except through the effect on the difference between the yield on the asset and the yield on money. Higher price, lower yield, lower difference between the yield on the asset and money, increase in the demand to hold money. But this hardly requires that the increase in the asset price is a bubble.
Your notion that if an increased supply of saving doesn’t cause reduced real output, then it wasn’t really an increase in the supply of saving is confused.
Or, perhaps, the “semantics” is that I see the paradox of thrift as being a situation where a shift in the supply of saving to the right supposedly causes a reduction in income and output. The monetary disequilibrium theory is that this is only true if at some point in the process, the result is an increase in the demand to hold money that is not accommodated by an increase in the quantity of money.
If there is no excess demand for money in the process, then the usual impact occurs–the quantity of investment demanded rises and the quantity of savings supplied falls. In the end, the interest rate is lower and the amount saved and the amount invested are higher. Make investment demand perfectly inelastic, then the amount saved and invested don’t change. It is just supply and demand.
If you start getting into negative nominal interest rates on some assets, and you assume that any increase in the nominal quantity of money can only occur if banks, or the central bank purchases those very same assets, then you have a problem.
But you have got to get used to thinking about negative nominal interest rates, and of course, negative real interest rates.
Sure, issuing zero nominal interest currency on demand is a problem if you need negative nominal interest rates. But isn’t then obvious that the problem is that there is going to be an excess demand for this zero interest currency when market clearing nominal interest rates are negative?
By the way, it is false that central bank portfolios are made up of Treasury bills!!!!!! This is a story we Money and Banking economists have been telling, long after it was false. The government bond portfolio
of the Fed is made up securities of longer terms to maturity for the most part, nearly all of them with yields above zero.
If you assume the central bank is targeting an interest rate, and the increase in the supply of saving requires that particular interest to go negative (even though others may well be positive,) then there are problems with the central bank’s rule. This could easily involve a decrease in the quantity of money as well as a failure of the quantity of money to rise enough to match some increase in demand. Why do you think we “quasi-monetarists” always gripe about interest rate targeting.
So, paradox of thrift– occurs when market clearing nominal rates are zero, and so, there is an excess demand for zero interest currency. Or, it is caused by a central bank targeting the interest rate, causing an excess demand for money when they fail to reduce their target for the interest rate, perhaps because it has hit zero, resulting in an excess demand for money.
There is no excess demand for money, but people want to buy financial assets or antiques, and this creates an excess supply of currently produced goods. Impossible.
Shifts in saving and investment occur all the time. Interest rates are the prices that clear that market. If the interactions between interest rates and monetary institutions mean that changes in interest rates lead to excess supplies or demands for money, then the problem is with the monetary institutions, not changes in saving or investment behavior.
That is what monetary disequilibrium theory is about.
Frankly, trying to fix the economy so that the supply of saving never rises or the demand for investment never falls is a fools errand.
The “paradox of thrift” is a misnomer, because has nothing to do with thriftiness per se. The problem arises when the money supply is inelastic, prices are inelastic, and money demand unexpectedly increases. Since each of these conditions can be satisifed while aggregate saving is actually in decline, calling it the “paradox of thrift” just gives thriftiness a bad name. Although learned economists might understand that it is just a name, and that thriftiness is not actually the problem, do not expect laypeople, journalists, and politicians to understand these subtleties. (Moreover, it only ever seemed like a paradox because of the contorted manner in which it is traditionally expressed — understood in terms of MET the so-called paradox is as sensible as “1 + 1 = 2”.)
Fiscal policy works only insofar as it reduces money demand. That is, by offering a safe and liquid alternative to money, some part of the demand for money balances will be “mopped up” — at least presuming the government does not merely increase its own money balances in proportion. But this seems like a very inefficient, unpredcitable, costly, and even foolish way to go about trying to restore monetary equilibrium.
Sorry I’m not keeping up with responding to all the comments. (Hey, you are all arguing well among yourselves anyway!)
Lee Kelly: “The “paradox of thrift” is a misnomer, because has nothing to do with thriftiness per se. The problem arises when the money supply is inelastic, prices are inelastic, and money demand unexpectedly increases. Since each of these conditions can be satisfied while aggregate saving is actually in decline, calling it the “paradox of thrift” just gives thriftiness a bad name.”
Damn! Lee is right. An increase in desired savings in the form of an increased demand for money causes a recession. But whether desired savings actually increases or not is irrelevant. It’s just that the normal story of the paradox of thrift (implicitly or explicitly) assumes that it’s thrift in the form of money. What did Lady Joan Robinson say about incantations being very effective at killing sheep, if delivered with arsenic at the same time?
sherparick: “A couple of points, when you are disagreeing with Krugman and DeLong on the paradox of thrift v. paradox of hoarding, you all seem to be describing the same thing. Are you doing this just to keep on good terms with the Krugman phobes since Krugman is no longer a respectable economist (having gone all heterodox like Quiggin, Keene, Dean Baker, Jamie Galbraith, Minksy e.g. all the folks who have been right these last 10 years).”
Thrift and hording are different. There’s a disagreement here, though with Brad DeLong it’s more a difference of perspective.
Paul Krugman and Brad DeLong are both very respectable economists in my eyes. I don’t think either is very heterodox at all. And, I agree with them much more than I disagree with them. (Though I rarely, if ever, do a post to say I agree with them. What’s the point?)
Nick, thanks for the response. Reading the comments I get the sense that your post means different things to different people and I suspect my reading is a bit further off than most. But anyway:
“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.”
Agreed, although Keynes himself did talk about it quite a bit. He saw the excessive demand of the Indian princes for barren treasure as a reason why the Indian economy had failed to develop satisfactorily. But that’s by the way and has to do with the Juncker ‘Fallacy’ rather than money.
“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.”
It’s an idealized barter economy. Your quoted statement isn’t quite true, surely? The relative price of C and N is just the real product wage. If the antique-wage is somehow prevented from adjusting then in general the real product wage won’t find its way to the full-employment equilibrium level. Obviously you know that and I don’t want to be nit-picking, but I do have trouble seeing how this barter model of yours actually works. It seems even more Panglossian than a simple micro textbook GE model, but I’m sure that’s not your intention.
I’m not under the illusion that I’m saying anything profound here: all I’m saying is that, even in a very simple static model with no money, you can have a paradox of thrift (of sorts anyway). All it takes is an inflexible price for the non-produced good in terms of labour. If I’m wrong about that then I’m in distinguished company. The ‘money’ in many Old Keynesian models is really nothing more than the Nth good in a GE system. Yet the Old Keynesians never had any problem using models like that to explain their paradox of thrift. Krugman still trots out the “World’s Smallest Macro Model” which Robert Hall taught him; you could substitute antiques for the ‘money’ in that model and it wouldn’t change a thing.
PS: re your latest: it was Voltaire, not Joan Robinson and she was never elevated to the peerage.
Kevin: “If I’m wrong about that then I’m in distinguished company.”
Yes, to both! (Unless I’ve misunderstood you).
In a true barter economy, with n goods, there are (n)(n-1)/2 markets, and the same number of relative prices. If there are three goods there are three markets, and each market has a relative price of the two goods traded. If all three markets are in equilibrium, then arbitrage ensures all three relative prices must be mutually consistent, so there are only 2 degrees of freedom. This means we can arbitrarily make one good the numeraire, set its price equal to 1, and just have two prices.
But if one or more of those markets is not clearing, one or other side of the market (the “long” side) will be quantity-constrained, so arbitrage won’t work. Suppose there is a law fixing the price of the non-produced good “M” in terms of labour in the LM market. There can be one price of output in the YM market, and a quite different price for output in the YL market, with no possibility for arbitrage via M.
But if M is money, i.e. barter is not allowed, then there are (n-1) markets, and the same number of relative prices. And it means there is no YL market. So the labour market can’t clear, if you fix the price of L in terms of M.
I think I’ve explained that right.
Lee:
“The “paradox of thrift” is a misnomer, because has nothing to do with thriftiness per se. The problem arises when the money supply is inelastic, prices are inelastic, and money demand unexpectedly increases. Since each of these conditions can be satisifed while aggregate saving is actually in decline, calling it the “paradox of thrift” just gives thriftiness a bad name. Although learned economists might understand that it is just a name, and that thriftiness is not actually the problem, do not expect laypeople, journalists, and politicians to understand these subtleties”
Calling it something else gives thriftiness an unjustifiably good name. Empirically observed central bank reaction functions are such that, when interest rates are very low, they do not fully accommodate (or act to reverse) increases in money demand. In fact, they don’t even come close. As a result, there exists, in practice, a paradox of thrift. Given the limited understanding of laypeople, journalists, and politicians, to deny the paradox of thrift is, in effect, to argue for socially suboptimal policy.
And central banks are not necessarily behaving unreasonably by failing to accommodate money demand. There are highly regarded arguments against allowing inflation rates to rise above 2%, and a 2% inflation rate may not be feasible (because the Wicksellian natural interest rate is less than negative 2%), or it may be feasible only with unacceptably high uncertainty, or the actions required to produce it may produce unacceptable future costs/risks. Or the ultra-low interest rates produced by accommodating money demand may lead the formation of asset bubbles.
Under these circumstances, thrift is demonstrably a bad thing and deserves to have a much worse reputation than it actually has among non-economists (and economists for that matter).
If you have mastered alchemy to the point where your incantations can actually produce arsenic, then I submit that the incantations themselves deserve much of the blame for the dead sheep, even if there were other potential ways of producing the arsenic, and even if lesser enchanters could not have brought forth the arsenic with their incantations.
Nick and Bill, I think you are confusing “substitutes” with “close substitutes,” which is what I said. Obviously I was assuming that cash and bonds are substitutes, but so are bonds and wallets. After all, if you carry more cash you need bigger wallets. I don’t know of any evidence that cash and bonds are close substitutes. That would imply a tiny change in the price of bonds would cause a massive change in the demand for currency. Is they any evidence for this? The demand for currency in America has changed very little in recent years, even as the yield on T-bills has fallen to near zero. How can they be close substitutes? Close substitutes means a small fall in the price of bonds (i.e. a small rise in rates) would cause the demand for cash to fall to near zero.
The problem with IS-LM is that it doesn’t explain business cycles in an economy w/o bonds. If there is just cash and goods, and the supply of cash falls, the price of goods falls. Because wages are sticky, unemployment rises. If there are no bonds, how can that recession be explained with IS-LM? And if you add bonds, does the sticky wage mechanism suddenly stop causing recessions, and interest rates suddenly start causing recessions? If so, why? Indeed I think the same argument applies if we use your medium of exchange approach.
Kevin: a simpler thought experiment.
Assume the MRS between labour and consumption of the output good is independent of M for simplicity (seperable utility function). M is numeraire.
Start in equilibrium. Double W and P. There’s now an excess demand for M. But W/P is unchanged. If there’s a barter economy, so you can trade labour for output directly, the labour market still clears at the same level of employment. MRS(L,Y)=W/P=MPL(L). But there’s excess demand for M in both the other markets. If it’s a monetary economy, you can’t trade L for Y directly, and since firms can’t sell Y for M, they hire less L. Barro Grossman 1971.
Under certain empirically reasonable (for the present) conditions, an increase in the propensity to save results in a decrease in aggregate savings. That is thrift. That is a paradox. That is the paradox of thrift. The details of why it happens are a separate issue. I don’t get how y’all are denying it.
Andy, it’s painfully obvious you’re right. However, don’t expect anyone else to admit it because they never, ever, do.
Andy,
W would calling the paradox of thrift something else give thriftiness an undeservedly good name? Besides the fact that it would be more accurate, since it really has nothing to do with aggregate saving, why would calling the paradox of thrift “an excess demand for money” give thriftiness a good name? That just makes not a jot of sense.
In any case, I believe thriftiness really does deserve a good name, and that the legacy of Keynes has been quite detrimental on this point. Any apparent problem with thriftiness in our current monetary and banking system is better understood as a problem with monetary policy. That is, given the monetary and banking order we have inherited, it is the responsibility of the central bank to ensure that the supply of money is adjusted to the demand to hold it. Without such assistance, financial intermediaries cannot smoothly redistribute purchasing power among savers and borrowers so as to coordinate the allocation of resources between consumption and production over time.
To deny the paradox of thrift is not to deny that a real problem exists, but rather that it is too often misidentified because of misleading language and sloppy assumptions. An excess demand for money is the real problem and always was the real problem, and we’ll all do much better to focus on that.
Who said anything about 2% inflation? The best macroeconomic measure of monetary equilibrium is nominal spending. If it rises or falls sharply it normally implies an excess supply or demand for money. Think of “MV = PY”.
Or equivalently, contractionary monetary policy, without which the “paradox of thrift”
cannot occur, deserves a bad name. I much prefer this formulation.
Thrift is bad because “reasonable” central bank policies mean thrift causes recession.
How about explaining that the reason for the recession is that the central bank, which monopolizes the issue of the monetary base, believes that accommodating the demand for money might cause other problems.
Then we can ask exactly what those problems might be and how likely they are to occur and whether those chances are worth taking.
Your approach is to instead blame households and firms for the problem. You all are just saving too much. And that way, the Fed doesn’t have to explain why it is failing to supply the quantity of money demanded.
I know what central bankers like this approach. But it makes me ill.
Nick wrote:”Unable to buy antique furniture, people have to buy newly-produced furniture instead, so there’s no recession.”
Because there is no thrift and thus no paradox, right? Why still call it thrift when people buy newly-produced furniture instead?
‘Attacking’ Krugman on a distinction between between thrift and hoarding serves what purpose? Both are ‘not-spending’ on new goods and services, the latter chooses to hold financial assets and while the former chooses non-financial assets. Both will lead to recession.
Moving on, you do need a better distinction between monetary and fiscal policy.
Try….
Monetary policy involves spending FRN (federal reserve notes) on Tsy Secs (treasury securities). Fiscal policy involves spending FRN on new, non-financial assets (including labor which if not purchased goes wasted) and then removing the FRN from the economy with sales of new Tsy Secs.
If you want the gov/Fed to start spending FRN on new, private sector issued financial assets, call it fascism or something else (like corruption).
Having the Fed purchase the stocks of the S&P 500 just doesn’t qualify as monetary policy. Besides, why would those purchases be anymore appealing to Middle America than bank bailouts, except they benefit the top 10% rather than the top 1%? I know you could come up with a better economic outcome than S&P 500 purchases.
Nick wrote: “Fiscal deficits, if they work, will have future costs.”
The ‘big’ difference between you and Krugman?
Krugman will sometimes state fiscal deficits could have future benefits as well. When he is in a really good mood, he will say the future benefits of fiscal deficits tend to easily outweigh future costs especially in a liquidity trap.
Perhaps Nick is never in a good mood?
Nick, the discussion might have been clearer IMO if you’d started with the question – what is the intersection of monetary theory with the paradox of thrift – and then developed your conclusions. That way, you might have avoided the interpretation that you’ve simply renamed the paradox of thrift.
Seems to me the paradox of thrift is developed around a fiscal as opposed to a monetary framework – it describes the nature of a particular type of dynamic relationship between income and saving.
Your foray into antique transactions is a balance sheet adventure – not an income and saving one. That’s where the confusion of your logical argument begins for me. Money plays a role in either type of transaction – income (GDP, including fiscal policy) or balance sheet (asset transactions, including monetary policy). But the relevant role of money in the paradox of thrift is in the context of income and saving.
If T, under conditions M, causes R, what’s to blame for R? T or M?
Andy’s got a point though. It is paradoxical, that T causes notT, even if the mechanism only sometimes works and is via M. Most non-economists would not see that one coming.
Winslow R: If there are two policies, fiscal and monetary, that could achieve those same future benefits, but fiscal also has future costs, and monetary doesn’t, that leans me in favour of monetary.
Canada is a bit different. I was much less worried about Canada’s recent fiscal policy. I’m not sure it was really needed, but it could be defended as an insurance policy. We don’t have the same “structural” debt and deficit problem. We bought a load of stuff we probably needed to buy sometime anyway, and last year seemed a good time to buy.
JKH: “Nick, the discussion might have been clearer IMO if you’d started with the question – what is the intersection of monetary theory with the paradox of thrift – and then developed your conclusions. That way, you might have avoided the interpretation that you’ve simply renamed the paradox of thrift.”
Maybe.
“Your foray into antique transactions is a balance sheet adventure – not an income and saving one. That’s where the confusion of your logical argument begins for me.”
I intended it as a income statement adventure. Balance sheets are stocks, income statements are flows, of $ per year. Saving is a flow. I was intending to mean a flow of desired expenditure on antiques, $ per year, and a flow of desired hoarding $ per year. It’s a bit tricky because antiques are lumpy. But then so are new cars. But if we average over the whole economy, those lumps get smoothed out into a smooth flow.
Bill,
It’s appropriate for an analysis of each party’s actions to assume the likely reaction function of the other parties. This does not mean one excuses the actions of the other parties, just that one takes them into account. It works both ways: given the central bank’s reaction function, there is a paradox of thrift; given the public’s and fiscal authority’s behavior, there is a non-paradox of tight money.
If we’re going to talk in terms of deeper causes, the fact that the central bank “monopolizes the issue of the monetary base” is a good thing, given the likely alternatives. At least the Fed partially accommodates the demand for base money; gold mines wouldn’t do that.
Nick,
It’s not obvious to me that the net future costs of fiscal policy exceed those of monetary policy. Monetary policy could cause asset price instability, and the type of monetary policies that the Fed can legally pursue have potential fiscal costs, and we don’t get any infrastructure investment or tax relief out of the bargain.
My objection to fiscal policy is that it’s only a temporary solution, whereas monetary policy, if it is to be effective at all, probably has to be a permanent one. If I were a dictator, though, I would use both: monetary policy, if you like, as the ultimate solution to aggregate demand deficiency, and fiscal policy to reduce asset price instability.
I don’t favor using “fiscal policy” to stabilize asset prices.
Creating a clear signal for taxpayer-voters about the cost of public goods should be the key goal of “fiscal policy.”
Keeping money expenditures on target should be the goal of monetary policy of monetary institutions.
The role of interest rates should be to provide for intertemporal coordination. There is no particular reason to expect them to be “stable.”
Of course, I suppose there are some people who favor having the government vary stores of wheat to stabilize wheat prices.
Bill: “Creating a clear signal for taxpayer-voters about the cost of public goods should be the key goal of “fiscal policy.””
Wandering off-topic, next to most of the big fiscal stimulus projects in Canada recently, there was a big sign saying how much was spent on the project. My immediate reaction was disdainful: it seemed they were just boasting “Look how much money we’ve spent for you!”. But on second thoughts, it seemed like there was another way to interpret those signs. “This new road cost $x million; this is how we are spending your tax dollars; you decide if it’s worth it”. Sort of public accountability/auditing.
Actually, isn’t there a big debate going on in the US right now that is related to this? Something about issuing taxpayers with itemised receipts? (I never bother to click past the headlines on the blog posts).
Something for Mayors like Bill to think about? 😉
Nick,
“I intended it as an income statement adventure. Balance sheets are stocks, income statements are flows, of $ per year. Saving is a flow. I was intending to mean a flow of desired expenditure on antiques, $ per year, and a flow of desired hoarding $ per year.”
You may have misinterpreted my point, which is that it can’t be an income statement adventure.
Yes, balance sheets are stocks and income statements are flows. But not all flows qualify for inclusion in the income statement. A complete measurement system must include balance sheets, income statements, and flow of funds statements.
Antique purchases belong in the flow of funds statement, not the income statement.
The correct flow of funds statement includes asset and liability transactions that are required by construction to bypass the income statement entirely. Among these are “old asset” transactions, such as the swap of money for antiques. Flow of funds transactions and income/expenditure transactions (and saving) can’t be consolidated simply because they are flows.
I suspect you may dismiss this as “just accounting”, as you’ve done on occasion before, but the fact is that it maps directly to the logical structure that explains the paradox of thrift, which is an income statement paradox.
JKH: I did misinterpret your point. I still don’t fully get it though.
I think I must be talking about flow of funds. On the income statement, is there a distinction between flows of expenditures on the various types of assets? If not, if they are all lumped together into “savings”, then i must be talking about flow of funds.
(Just remember though, there’s a very important distinction here between the desired flow of funds and the actual flow of funds.)
Nick,
In the monetary system, income is (normally) paid in cash. Saving is a subset of income. So saving is paid in cash. In that sense, saving can be interpreted as the hoarding of cash as an income statement flow. And in that sense, if you wish, you are free to rename the paradox of thrift as the paradox of hoarding.
What happens next occurs on the flow of funds statement.
If the cash is left as is, the flow of funds statement reflects an increase in household net worth (saving) as a source of funds, and an increase in cash as the use of funds.
If the cash is swapped for antiques, the flow of funds statement reflects an increase in household net worth (saving) as the source of funds, and an increase in antiques as the use of funds.
In the first case, you can interpret the retention of cash as the hoarding of cash in the flow of funds. But this has nothing directly to do with the paradox of thrift, which is an income statement effect.
In the second case, you can interpret the swapping of cash as the dishoarding of cash in the flow of funds. But this has nothing directly to do with the paradox of thrift, which is an income statement event. And you must also allow for the fact that the antique seller has done the opposite transaction.
“Just remember though, there’s a very important distinction here between the desired flow of funds and the actual flow of funds.”
I’m aware of that. But consider this question. In a pure service economy (for example), how likely is it that the paradox of thrift can operate without at least one entity actually saving from income. Therefore, to the degree that some micro units achieve actual saving, other units must be forced into dissaving. E.g. if an antique transaction actually took place, the buyer would have actually saved, but the seller might be forced into dissaving as a result of losing his job and income (because of the buyer’s saving), and being forced to spend more than his income. His spending would appear as a deficit on his income statement, assuming his gross income was now zero. His flow of funds would reflect the antique sale as the source of funds and his own deficit financing as the use of funds.
(Income statements and the flow of funds intersect through the equity account – saving is an increase in equity, which is a source of funds; negative saving (deficit) is a decrease in equity, which is a use of funds.)
(Damn. I’m trying to watch the Ryder Cup. But there’s some serious shanking going on here as well.)
Nick,
“On the income statement, is there a distinction between flows of expenditures on the various types of assets?”
This a somewhat self-referential classification, but the income statement would include revenues and expenses that in general would qualify as gross contributions to GDP type calculations. E.g. antiques would not be a GDP item and so would not be included as an expense if bought or as revenue if sold.
The flow of funds statement can include both GDP items (e.g. new investment goods as a use of funds) and non-GDP items (e.g. antiques as a use of funds).
That’s how it would work for corporate statements, and there’s every reason not to be inconsistent in simulating comparable household statements.
(May be over simplified)
Nick,
Debt and equity issuance are also included in the flow of funds as a source of funds. Unlike saving (= profits or surplus) which is also a source of funds, debt and equity issuance are not part of the income statement.
(Dividends from profits are a use of funds.)
So Nick, if the economy is cashless, but has bonds, then you’re saying there is no paradox of thrift?
Take for example your back-scratching economy. Trade is either exchange of service, I scratch your back and you scratch mine, or one person receives a backscratch in return for a debt instrument that entitles the holder to one backscratch (from the issuer) the next day.
The catch is that the bonds are not bearer bonds, they aren’t fungible, only the person the bond was issued to can collect the service so he can’t sell it on the day he got it for a backscratch. This rules out the bonds being a medium of exchange.
Also, assume that nobody can give more than one backscratch per day, though you can receive more than one in a day. So an individual can, in principle, make the trade of consuming one less today for one more tomorrow but total output can’t exceed the number of people in the economy (it can only be less).
Is there no paradox of thrift here?
“Antique purchases belong in the flow of funds statement, not the income statement.”
I’m not sure that these accounting distinctions are relevant to the macroeconomic question. What distinguishes the income statement is its relationship to the business as a going concern rather than a pile of assets of in a box.
So when the CFO moves the company hoard out of tbills and into grandfather clocks that’s not an income statement event. But so what? If the company were in the clock business, it would be a different matter.
That the same transaction means different things to different firms, means this whole discussion is confused.
This is how I understand it.
Income equals saving plus consumption. Saving is deferred consumption. Therefore, income equals consumption in the long run. All income is spent immediately, because income and spending are two sides of the same coin. In other words, it is impossible for aggregate spending to fall as a proportion of income. When someone saves by increasing their money holdings, they do not refrain from spending income, but instead they spend income on increasing money holdings.
But increasing money holdings is just one way of deferring consumption; to identify thriftiness with spending income on increasing money holdings is simply false. Since it is possible for an aggregate decline in savings to occur alongside an aggregate increase in money demand, calling macroeconomic problems associated with an excess demand for money a “paradox of thrift” is, at best, misleading.
This talk about the “reaction functions” of other parties is nonsense. It is not as though such “functions” are unchangable. So perhaps instead of trying to work around broken institutions (and blaming recessions on thrift), we should work to improve them. Just a thought.
Nick’s assumption was that people spend income immediately on antiques instead of other non-monetary goods. Suggesting that people hold money in anticipation of buying antiques merely contradicts this assumption, because it means that people are not spending income immediately on antiques but are deferring the purchase of antiques by increasing their money balances.
Jon,
It matters.
The paradox of thrift is intended to explain GDP income and saving behaviour.
The sale of antiques does not generate income according to the capital cost of the antique – not unless you implicitly contort the definitions and the accounting so that the sale of money (for antiques) generates negative income – which is beyond nonsense.
Since the sale of antiques doesn’t generate income, it matters to the interpretation of the paradox of thrift.
“If the company were in the clock business, it would be a different matter.”
Not for a company in the business of building new clocks. It matters to an auctioneer or an antique shop, but only with reference to the business of earning what is effectively a broker’s commission or spread. The capital cost of the antique clock does not generate income and is not part of GDP and therefore is not directly relevant to the paradox of thrift.
Let me make this plain: paradox or not, THRIFT IS BAD!!!! In a barter economy, in which (for the sake of argument) there is no paradox of thrift, thrift is still bad, because it leads to asset price instability. And asset price instability is bad. (How can anyone who has lived through the past 15 years, or the past 25 years in Japan, deny this?)
In the simplest case, suppose an asset whose return is expected to grow (on average) at a fixed (but not precisely known) rate forever. If the risk-adjusted expected growth rate is close to the discount rate, the price of the asset will change dramatically in response to small shocks, including subjective shocks. Obviously the example is extreme, but the general principle is not merely a theoretical curiosity. We have, as I implied above, observed the adverse effect of a low discount rate on asset price stability and the real damage that that effect can wreak. The way to avoid it is to raise the discount rate, which is to say, to be less thrifty.
In principle, this is only a problem with “excessive” thrift — that is, thrift that is reflected in a discount rate low enough to produce a damaging degree of instability. But excessive thrift is a wolf in sheep’s clothing. One might think it impossible to accuse Americans of excessive thrift in 2005, when their saving rate was near zero. But one would be wrong. Their low saving rate was not due to a high discount rate (low thrift) but to an overestimation of their wealth. Why did they overestimate their wealth? Because they were confused by asset price instability. Why were asset prices unstable? Because of thrift. (Specifically mostly because of Asian thrift; but a little less thrift on the part of Americans would have improved matters, as Americans were not lacking in thrift but merely confused, and reduced thrift would have stabilized asset prices and reduced their confusion.)
People who say reaction functions are irrelevant remind me of a dance instructor I once had. He was teaching us how to do dips, and he said to the women in the class, “Ladies, you have absolutely nothing to worry about. If the gentleman drops you, it’s entirely his fault.”
Nick,
Going back to your post:
“Hoarding is a subset of thrift”
You must mean that hoarding is a proper subset of thrift. Otherwise, hoarding is the same thing as thrift, and you’ve only renamed thrift, which I don’t think was your intent.
So if hoarding is a proper subset of thrift, that means there are two types of thrift:
– Thrift that is hoarding
– Thrift that is not hoarding
Perhaps you feel you’ve already done this, but I’d like to see a side by side comparison of the two that shows what you intend by this difference – particularly as it reveals the one by comparison where thrift is not hoarding.
Nick wrote: ” If there are two policies, fiscal and monetary, that could achieve those same future benefits, but fiscal also has future costs, and monetary doesn’t, that leans me in favour of monetary.”
I still don’t understand your fiscal/monetary framework.
In your framework, is any action taken by the Fed considered ‘monetary policy’?
Does Fed hiring of thousands of economists to do economic research qualify as monetary policy?
JKH: “So if hoarding is a proper subset of thrift, that means there are two types of thrift:
– Thrift that is hoarding
– Thrift that is not hoarding”
Suppose I earn $1,000 per month.
1. I spend $1,000 per month on newly produced goods and services – zero thrift, zero hoarding.
2. I spend nothing, and leave the whole $1,000 in currency. $1,000 thrift, $1,000 hoarding.
3. I spend $1,000 on antique furniture. $1,000 thrift. Zero hoarding.
Adam: “So Nick, if the economy is cashless, but has bonds, then you’re saying there is no paradox of thrift?”
Yes, in the sense that an increase in desired savings cannot cause a recession. This is how I would think about it, if I’ve understood your cashless backscratching economy correctly.
Start in equilibrium. Then suddenly everyone wants to save in backscratch bonds. You go to another person, and offer to scratch his back in return for one bond. He refuses the deal, because he was about to offer you the same deal. Excess demand for bonds. Either the price of bonds rises (r falls) until they don’t want to save, or it doesn’t (for some reason) and the excess demand for bonds remains. But if you can’t swap your labour for bonds, you swap it for a current backscratch as the next best alternative (it’s better than sitting idle). So, no recession.
Winslow: if current or future money supply changes, it’s monetary. If government spending and/or taxes change, it’s fiscal. Yes, this is different from MMT definitions, but it’s standard. Fed hiring economists with new money is both fiscal and monetary.