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 
I disagree.
Let’s assume there are a large number of agents, say a continuum.
There are many equilibria, start in an equilibrium where nobody ever tries to save. No bonds exist and output is at its maximum, say 100%.
Now suppose that every day 5% decide they’d like to save (a different 5% each day), they will offer a backscratch today but won’t consume one. Instead they’ll take a bond. First problem, does a non-saver, who expects to be a non-saver tomorrow accept the deal? Yes, tomorrow he pays back the backscratch and consumes by issuing his own debt to one of the savers. Today total output of backscratches is 95% of max.
Tomorrow arrives and yesterday’s savers consume 2 backscratches and provide 1. Those who issued debt provide a backscratch to redeem the maturing bond and issue debt to the current savers to consume.
It’s easy to see that we know have an equilibrium in which output is 95% of the max forever. Yet there is no hoarding of bonds and bonds are not the medium of exchange. Most transactions are bilateral exchange of service.
So, a 5% increase in aggregate saving decreases income by 5%. That’s not a paradox of thrift?
PS: and of course aggregate saving remained zero. In aggregate the reduction in consumption from 100 to 95 was not offset by aggregate consumption of 105 tomorrow. Aggregate saving was still zero, some individuals manage to save some periods but the net result is just a fall in income.
Basically the idea is it is like an endowment economy where I don’t let the real interest change (it’s fixed at zero) and I don’t let the aggregate price level change (because there’s no money) so people end up throwing away part of the endowment. The things that adjust to make us, in aggregate, happy to consume the aggregate endowment can’t adjust.
“Fed hiring economists with new money is both fiscal and monetary.”
In what way?
Wouldn’t Fed purchases of the S&P 500 also be considered fiscal and monetary?
Nick,
I thought so.
The problem I have is that your thrift with hoarding and thrift without hoarding examples have the same macro result. There is no difference in the amount of macro income and macro saving in those two examples. The purchase of antiques is a balance sheet transaction. All it does is swap the ownership of money and antiques, without affecting anything else. In particular, it leaves the level of thrift and hoarding the same at the macro level. This is the problem I saw from the beginning. The paradox of thrift is a macro result corresponding to macro income and saving effects. I don’t think you can construct a paradox of thrift example where thrift isn’t equal to hoarding at the macro level.
Winslow R.,
Hiring Fed economists is effectively part of fiscal policy.
It’s an expense that affects the Fed’s net income, which is remitted to the Treasury, which affects the budget balance, which is fiscal.
That may be a fairly narrow accounting view of it.
But it’s also a fact.
Andy,
Are you an economist?
The reason I ask is that most economists (and certainly me) are focused on the flow of output–using resources to produce goods and services so that people can best achieve their goals.
Economists interested in monetary theory and banking constantly run into people whose focus suggests more of a focus on financial markets. For example, if people fear that stock prices may fall a lot, then maybe they won’t buy stocks. My view of that is.. so?
I am a bit puzzled as to why we would be focused on assets that have a constant return forever. What?
Adam: Now we are getting to the real issue. This isn’t “procrustian economics” (I can’t spell “procrustian” either) of trying to force everything into a quasi-monetarist perspective. This isn’t about “re-naming” the paradox of thrift, or just re-assigning “blame” for the problem. This is a real substantive disagreement. Your last comments show I’m either wrong, or am saying something that matters.
So, in your example, 5% of the backscratchers are idle. They have unsold backscratching services in period one (“today”). Why don’t that 5% all agree to scratch each others’ backs? If we assume there are gains from trade (that the marginal utility of a second back scratch is greater than the marginal disutility of scratching the first back) they would agree to that trade. (And if the MU of a second backscratch is worth less than the M disutility of providing the first, they would never have accepted the bond in the first place.)
Again, in a barter economy, there cannot be a deficiency of aggregate demand. Keynesian macro makes sense in a monetary exchange economy. Keynesian macro makes no sense in a barter economy. Keynesians need to understand that. They need to make their implicit assumption explicit. In a barter economy, the idle car workers and the idle farmers can just produce cars and food and swap them. But in a monetary exchange economy, the car workers won’t produce cars unless they can get money from the farmers, and the farmers won’t produce food unless they can get money from the car workers.
Nick,
I’m trying to understand this.
In a barter economy, why is it assumed that idle workers in industry 1 and idle workers in industry 2 would be willing to swap each other’s products if they’re employed instead? In the event they have no incentive to do so, why must they be employed?
Is it that auctioneer fellow?
If so, why is it assumed that the auctioneer is so smart?
Isn’t that rather wishful thinking?
But Nick, that’s the thing. The savers want to trade one less backscratch today (leaving them with zero today) for an extra one tomorrow (so they’ll have two tomorrow). They succeed so they are maximizing.
Everyone else wants 1 today and 1 tomorrow. They also succeed so they are maximizing.
There are no gains from trade left on the table. I think you’re wrong.
Now, if rates could be reduced (say by policy) so that the savers don’t want to save anymore then we can bring output back up to 100. But at the prevailing real rate (zero in this case) the exogenous increase in aggregate savings leads to a drop in aggregate income without leaving unrealized gains from trade. Given the prices they face everyone is maximizing.
And all without any money, not even hoarding of bonds. No hoarding of the medium of exchange (since there is none).
I’m having a mind block trying to resolve the back scratch GDP progression.
If yesterday’s savers consume 2 today, and today’s savers consume 0, why is today’s GDP not 100 rather than 95?
I just created a blog. My first post is about the paradox of thrift. I actually wrote this a while back along with a counterargument much along the lines adopted by people here. I intend to rewrite the counterargument and post it soon, because I want to make the argument that, overall, central banks actually help cause the paradox of thrift.
http://philosophyandeconomicsblog.blogspot.com/
yes, I guess in period two income is back to 100.
Nonetheless the example still works, the increase aggregate saving causes income to fall in the first period but it is never greater than 100 in subsequent periods. Aggregate saving is still zero, you still have an example of the paradox of thrift without any money.
There is something analogous to a paradox of thrift in a non-monetary economy.
Suppose that you are an apple farmer. You spend x resources to produce y apples, so your income is y apples. You do not want 1000 apples, so you try and trade some for meat, bread, and whatever other goods you like. But suppose that you save 200 apples and place them in cupboard to consume 3 months from now. This is obviously not a wise thing to do, because apples depreciate rapidly and will be nothing but waste in 3 months. Saving apples in this manner is clearly destructive. A better way to “save” apples would be to lend them to someone who consumes them immediately and promises to return the same quantity of fresh apples in 3 months time.
When there is monetary equilibrium, saving money allows resources to be used to produce furture goods and services. Although the composition of spending between consumption and producer goods changes, total spending remains constant — no paradox of thrift. This is bit like lending fresh apples now so that someone can return fresh apples in 3 months. The problem arises when there is an excess demand for money, because then saving money makes idle resources, i.e. the financial institutions that normally redistributes spending stop functioning. Savings just sit like mouldy apples in a cupboard, unemployed and depreciating, squandering precious time when they could be used for productive ends.
Does any of this make sense? I haven’t had much success trying to explain this in the past.
Adam: OK, I understand you now, I think. If you “need” a backscratch, it gives you MU of 1. If you don’t need a backscratch, it gives you a MU of 0. Savers need 0 today, and 2 tomorrow. Everyone else needs 1 today and 1 tomorrow. So if there are 95% savers the optimal employment level is 95%. That’s what the central planner would dictate.
The labour demand curve (VMPL curve) has a horizontal section at 1, then goes vertical at 95. It’s sort of Inverted L-shaped.
So, just to check I’ve understood your model (and to answer JKH’s question), then is we assume 5% savers today, and no savers thereafter (for example), GDP is 95 today, and 105 tomorrow? (people can supply two backscratches per day if it’s needed).
OK, assuming I’ve understood you correctly, your model makes sense. But to my mind, that’s not a Keynesian model; it’s an RBC model. The output and employment fluctuations are efficient. We make hay when the sun shines. The Value Marginal Product of Labour always equals the marginal disutility of labour. It’s just that the VMPL fluctuates over time. Now, just as in RBC models, the government could use fiscal policy to intervene, and buy backscratches during recessions, but it’s not efficient for them to do so.
RBC guys call those output declines “recessions”, but it’s not what I think of as a recession. It’s not a Keynesian recession.
JKH: the Keynesian assumption (which I share) is that unemployment in recessions is inefficient. If we could only get the unemployed back to work, the extra output that could produce would, in aggregate, be sufficient to compensate the unemployed for giving up their “leisure”.
If we could get all the unemployed together in one room, and strike a deal where the car workers produce cars for the farmers, and the farmers produce food for the car workers, with both groups keeping their money in their pockets, everyone would be better off. But we can’t get everyone together into one room (because it’s not just cars and food it’s millions of different things). And everyone wants to hang onto his money. So the car workers won’t buy food for money, and the farmers won’t buy cars for money.
Bill,
I am an economist, though I work in the financial industry, so perhaps that accounts for (or results from) my focus on financial markets. But my example doesn’t necessarily involve “financial markets” as such. It’s about assets, which aren’t necessarily financial (and in a barter economy, I don’t think the word “financial” would even be meaningful). A house is an asset, for example, but it’s not financial. And surely asset price stability is important. Why build a factory if you don’t know how much the factory will be worth once you build it? And if asset prices are highly sensitive to certain parameters, a lot of resources get diverted out of productive activities into estimating those parameters (and convincing people about what the parameter values are). I gave an example of an asset whose return grows at a constant rate forever just as an extreme case, but I don’t think it’s too far from reality: we’ve seen instability in stock and real estate prices; some people call that instability bubbles, but I call it excessive sensitivity to parameter values. And it seems pretty obvious that this instability has important real effects.
Nick,
“If government spending and/or taxes change, it’s fiscal.”
“Government spending” is an ambiguous phrase. I assume it includes unilateral transfers, but does it include asset purchases? And does it matter who (the Treasury or the central bank) does those asset purchases? (Seems pretty arbitrary.) If it doesn’t include asset purchases, does that mean that the TARP was not fiscal policy? If it does include asset purchases, does it also include conditional asset purchases (government guarantees)? Or does a government guarantee suddenly become fiscal policy if the government has to make good on it? And if it does include asset purchases, does this mean that “credit easing” is fiscal policy?
Actually GDP is 95 today and only 100 tomorrow. Remember we’ve assumed a max output of 100.
What happens when tomorrow arrives is the 5% yesterday’s savers consume 2, one from a bilateral exchange and one that is owed to them.
The 85% of yesterday’s non-savers who are also non-savers today consume one in a bilateral exchange.
The 5% non-savers with debt provide a backscratch to yesterdays savers, thus redeeming the debt. They then consume 1 by issuing new debt to todays 5% cohort of savers.
Todays 5% cohort of savers consumes 0.
This does require that there be a group of 5% who know they never want to save so they can go forever issuing debt and rolling it over (remember the assumption that you can only give one backscratch per day, even though you can receive more than 1). Effectively this group are financial intermediaries.
Again though, the point is that the exogenous increase in the aggregate propensity to save resulted in a fall in income and no aggregate savings. And all without having any hoarding of the medium of exchange.
Adam: OK. One day a saving virus breaks out, and affects a different 5% of the population each day, but each saver fully recovers the next day, and continues forever. So GDP goes 100, 95, 100, 100, 100 etc. But again, it’s an RBC model.
Andy: yes, distinguishing exactly between monetary and fiscal can get pretty arbitrary. Transfer payments are normally seen as negative taxes, rather than government spending, because the government is not buying newly-produced goods and services. (But that can be a judgment call).
If you buy the assets with new money, I would call it monetary. If the assets are newly-produced goods, bought with new money, it’s both monetary and fiscal. If you swap one financial asset for another, it’s…whatever. A portfolio operation?
How’s this an RBC model? No productivity shock, nobody withdrawing their labour due to temporarily low real wages. Nothing driven by the supply side.
GDP falls due to a shortfall in aggregate demand, this is Keynesian. Entirely Keynesian.
It looks like the ‘standard view’ and MMT both have operationally imposed limits.
The ‘standard view’ says monetary policy rules because new money is created by the Fed. But the Fed can’t buy beyond its operational surplus without political consequences.
The MMT view says fiscal policy rules because new money is created by the government deficit spending. But the government operationally must issue bonds to offset deficit spending.
We could have a showdown at the OK corral and see which institution is first to break its operational restriction and then retains strength enough to keep operating. I’d bet on the government.
Otherwise we could continue to operate within the established framework where the government deficit spends and the Fed buys the resulting bonds.
Nick wrote: “If you swap one financial asset for another, it’s…whatever. A portfolio operation?
The one you are talking about? Corruption.
Adam: it’s a preference shock, rather than a technology shock. The Marginal utility of consumption falls to zero when output exceeds 95. Backscratches are no longer a scarce good. There’s satiation in backscratching services. People might as well sit idle. You couldn’t give away backscratches for free. The central planner would replicate the competitive equilibrium. Recessions are efficient responses to changes in preferences.
The MRS between consumption and leisure falls to zero past C=95. It’s formally equivalent to a labour supply fall, because people place zero marginal value on what they can consume with their real wages, past 95. The unemployed already have had their back scratched once, and don’t want a second backscratch.
Nonetheless, is it a paradox of thrift or not?
I’m quite sure we can tweak the basic example to make the fall in income inefficient without needing money.
and anyway, what kind of shock is an increase in the demand for real balance then?
Nick wrote: “And “money” means medium of exchange.”
Let’s assume two mediums of exchange, currency and demand deposits created from currency denominated debt.
If loan losses exceed capital for the losses, does that mean demand deposit defaults? If so, can there be less supply of one medium of exchange instead of more demand for medium of exchange?
Nick wrote: “Fiscal deficits, if they work, will have future costs. The higher debt will mean very difficult future spending cuts or tax increases.”
What if the fiscal deficit was in currency? Would that be present costs instead of future costs?
“If you buy the assets with new money, I would call it monetary. If the assets are newly-produced goods, bought with new money, it’s both monetary and fiscal. If you swap one financial asset for another, it’s…whatever. A portfolio operation?”
I thought the link I posted was arguing that the QE1, wasn’t stimulus. I just throw up random comment’s sometimes. I was referencing these earlier posts. April 09, August 2010 I checked the bond numbers and it did look like the gov of Canada had more on offer through the fall of 2008/2009. I honestly don’t know anything about the U.S. QE1, but the post I linked to seemed to argue that it was a one time thing to make up for the mark-to-market error of accounting. And not as monetary stimulus per-se. Read through the Gorton papers and mark-to-market is apparently a big deal during a bank-run. Reason I posted it was that you and AdamP were arguing about buying stock. I’m just wondering how you want the Fed to increase money supply, and is it the currency money supply that needs to increase or some other.
But I don’t really care either, I would much prefer that you, Adam, Andy, Bill get this sorted.
Is the price of a backscratch bond pegged at par, i.e. one scratch tomorrow for one scratch today? If so I’m pretty sure you can have a paradox of thrift. I really don’t think you can have one without a rigged price, barter or no barter.
Nick, re your last reply to me: I haven’t read Barro and Grossman 1971; tried once and got tired. I’ll have a look later and see if it has improved.
yes Kevin, this was my point to Nick above. The model is Keynesian since the problem is that the real interest rate fails to adjust. I made this point to Nick somewhere above.
Although, any adjustment to the real rate would have to be for it to fall below zero. Since I’ve imposed a max output of 1 backscratch per “employed” labourer and no growth the real rate can’t be positive.
For what it’s worth I agree with edeast that the buying of MBS by the fed wasn’t monetary stimulus per se, in the sense of changing the available rates of intertemporal substitution.
It was preventing a total collapse in the money supply when a lot of paper that was functioning as money ceased to. After all, for a while there the fed was a net seller of treasuries as they bought up the MBS.
Adam: your model is of a pure consumption economy, with no investment or growth. But you could still have a positive equilibrium rate of interest, if there’s positive time preference.
No matter. Suppose there’s a law that pegs the price of bonds too low (the real rate of interest too high, sort of like usury laws, only in reverse). So there’s an excess demand for bonds in the market in which bonds are traded for backscratches. Remember that the short-side of the market in disequilibrium determines the quantity actually traded. People will want to sell backscratches for bonds, but won’t be able to. But if this is a barter economy, where backscratches can be traded for backscratches, that market can still clear. If the cost of giving a backscratch is less than the benefit of receiving one, people will scratch each others’ backs. Sure, they would prefer to get paid in bonds instead, but if nobody is willing to pay them in bonds (because of the excess demand for bonds at the pegged price), they will accept payment in current backscratches instead, as the next best option.
Kevin: yes, you do need some sort of price that is pegged too high to get Keynesian unemployment. But in a monetary exchange economy, you can get unemployment if the price of everything is pegged too high against money (i.e. the price of money is too low), even if all relative prices are at the right levels (i.e. the real wage W/P is at its equilibrium value). The “classics” said that an excess supply of labour meant that W/P was too high. Barro Grossman showed you could get an excess supply of labour in a monetary exchange economy even if W/P was right, but both W and P were too high relative to M.
Yes, Nick I’d implicitly assumed zero time preference.
Nonetheless, the question is still out there. Paradox of thrift or not?
Increase in the (average) individual propensity to save leads to lower aggregatge output (and some unemployment) and zero aggregate savings. Is that not the paradox of thrift?
Clearly no hoarding of the medium of exchange. No hoarding of anything in fact.
Adam: paradox of thrift or not?
What was paradoxical about the original paradox of thrift was that thrift could be good for the individual but bad for all individuals taken together. It makes the individual wealthier and better off (over time, of course, because there’s a current cost of foregone consumption) but if everyone does it (under certain conditions) everyone is poorer and worse off. A law banning thrift could make everyone better off. In your model, thrift does not make everyone worse off. A law banning thrift would make everyone worse off, if some people really do need 0 backscratches today and 2 tomorrow.
So yes, there’s a recession, and unemployment, but it’s a good recession and good unemployment. Now you could tweak your model to change this. Introduce some positive externality to employment and output, for example, and you could make recessions and unemployment into bad things. But even so, unemployment wouldn’t be an excess supply of labour. Again, you could tweak your model to add monopoly unions or efficiency wages, so you got an excess supply of labour because real wages were too high. And with the right tweaks, you could probably get real wages to rise relative to equilibrium real wages when time preference changed. But it’s still not Keynesian.
I wish I could convey my intuition more clearly. But in a frictionless barter economy there are more markets than in a monetary exchange economy. You can trade labour directly for produced goods, for example. So when a price control in one market prevents mutually advantageous trades in that market, people can get around the blocked market, and it doesn’t prevent them trading the correct amounts in other markets. But if we live in a hub-and-spoke world of monetary exchange, where all trade takes place via the hub, which is money, any problems with that hub will affect trade everywhere.
Nick: “What was paradoxical about the original paradox of thrift was that thrift could be good for the individual but bad for all individuals taken together. ”
I don’t think that’s right. The paradox is that it doesn’t turn out to be good for the individuals (in sum) because (in sum) they don’t succeed in saving (even if a few individuals do succeed).
It’s like the whole chinese control of the capital account thing. Whenever I ask people if they agree that China controls their capital account with the US (since they have capital controls and we don’t) they always agree.
I then ask if that implies that they control the current account with the US, most people answer no. However, you and I both know they’re wrong. But then this puts the US in paradox of thrift land, since (X-M) will always be negative you have that Y < C + I + G, so either the private sector dissaves or the public sector dissaves (or both) and that’s true no matter what the level of Y!
This is the paradox, if the US (public and private) attempts to stop dissaving by reducing expenditures they fail! They reduce C + I + G and the only thing that happens is that Y falls by an even greater amount. The attempted saving is not beneficial to the individuals in aggregate (perhpaps it benefits sum but their benefit comes at the expense of others and so in sum total the individuaals do not benefit).
Now, in my model the 5% who are “unemployed” and forced to finance their consumption by borrowing don’t want to do this. If we say that they are even taking a risk becuase now if they catch the virus in the future they’ll be unable to save then they are worse off. Yet they do it because the risk associated with going in to debt is still preffered to being unable to consume the backscratch today.
Thus, if you could reduce the real rate so the savers now willingly go back to 1 backscratch today and 1 tomorrow then you’d improve welfare.
The idea was never that if they don’t get the 0 today, 2 tomorrow consumption path they die, it was that they strongly prefer this while at the same time the unemployed would rather go in to debt and consume today (for sure) then try to force the bilateral exchange of service and risk getting nothing. Thus, the savings occur but a lower interest rate could prevent it. The point though is that at the real rate of zero the savers get their way at the expense of the unemployed. If you reduce the real rate to make them not want to save anymore then they are no worse off but the otherwise unemployed are better off.
Adam: I like your China example. I think you are onto something. If some people succeed in saving, they force others to dissave (in some circumstances) is non-obvious, and therefore deserves to be called a paradox. And if you want to call it a paradox of thrift, I can’t really object, since it is a paradox and it is about thrift.
I still think my interpretation (“What was paradoxical about the original paradox of thrift was that thrift could be good for the individual but bad for all individuals taken together. “) is the original, standard one, but that’s by-the-by.
Two points.
1. I did an old post, maybe nearly a year back, essentially supporting what PK said about China forcing the US to dissave, but arguing that money was an essential part of this story, because it forced the Fed to print more money to avoid a recession, and that it was attempted saving in a monetary economy that forced others to dissave or accept unemployment. In a non-monetary economy the US would and could just refuse to borrow from China, if they didn’t want to. I never did get my head fully around that subject, because it’s harder in an international context.
2. “Now, in my model the 5% who are “unemployed” and forced to finance their consumption by borrowing don’t want to do this.” That’s where I disagree. The unemployed have a choice: they can finance their current consumption by borrowing; or they can finance their current consumption by telling the potential lenders to get lost and trading backscratches between themselves in barter. If they prefer the latter, the savers fail to lend, and so fail to save.
Adam: Here’s another way of looking at it. If you want to save (and not invest) can you force someone else to dissave? You can’t force someone to borrow from you if they don’t want to borrow from you. But if you stop spending your money, and stick it under the mattress, nobody can stop you doing that, and it forces other people to hold less money (edit: or print more).
I wish I could clearly apply this insight to China.
Well I wasn’t claiming that in real life the paradox doesn’t manifest itself in money hoarding, certainly the problem with China is that they hoard our currency.
But you were making a theorectical point that I think is wrong, so I started thinking about a counterexample. It doesn’t have to be about money hoarding because it can in fact happen in a world without money. The counterexample is stretched because I thought it up in a few minutes but I think it makes the point.
Even if the savers go to one back scratch tomorrow, won’t they prefer to use their bonds rather then giving an exchange, dropping gdp back to 95. Still force people to save.
Adam: “..certainly the problem with China is that they hoard our currency.”
That’s what I assumed, in my old post, then commenters (Scott and others) pointed out that they hold US Tbills, not currency. But I still think, in a monetary exchange economy, the point still stands. Others can, in effect, force you to borrow from them, even if you don’t want to.
“If you want to save (and not invest) can you force someone else to dissave?”
That’s the point I was making way back.
That’s exactly how the paradox of thrift manifests itself in a service economy.
Actual micro saving forces other micro dissaving – in order for macro saving to be zero.
The paradox of thrift isn’t just an ex ante condition – it forces out actual economic events and the accounting events that measure them.
JKH: yes, but does desired micro saving manifest itself as actual micro saving and force others into actual micro dissaving? If the saving is hording, then yes. If not, then no.
yes, one of the reasons I didn’t comment on Nick’s post right away was that JKH and Andy were doing a fine job (I thought) in explaining why it’s wrong.
“does desired micro saving manifest itself as actual micro saving”
Yes, I’ve asked myself that exact question.
The answer must be yes. You derive this by asking how would you attempt to construct an actual economic event in a service economy that could be described as the live consequence of the “paradox of thrift” in action without actual micro saving taking place. You can’t do it. Somewhere, somebody must save at what turns out to be an excess in its macro consequence in order to get the ball rolling – i.e. to pass the tipping point for some economic consequence actually coming out of the paradox of thrift.
China gets paid in money (dollars) for its current account surplus. In that sense, it’s necessary for China to hoard dollars in order to save (CA surplus) and force dissaving (CA deficit) on the US.
The Chinese CA surplus equates to a component of Chinese GDP and income. It’s hoarding money in the sense of the flow of income that is paid in dollars and the corresponding saving that first appears as dollars.
But it swaps that money for bonds. That’s an asset or balance sheet transaction, subsequent to the income and saving event.
It requires hoarding of money in the sense the money is required to execute the subsequent balance sheet transaction.
But it does not require hoarding of money as a stock beyond that transaction. In fact, it requires the opposite (at the “micro China” level relative to the global macro).
On Beckworth’s blog you said…. JKH: If a bank loan is paid down, and so loans and deposits both fall (and stay down, let’s assume), and if those deposits were (say) chequable demand deposits, and so a medium of exchange, then the supply of money falls. If the demand for money stays the same, we now have an excess demand for money.
Do deposits necessarily fall when a bank loan is paid down? Banks receive a prepayment, but they don’t send their depositor’s money back. They buy 2-year t-bills or a FRE Hybrid arm…. hence, if anything, the private sector’s negative demand for debt (bank loans) means that we will still have an increase in demand for more-money-like securities. or am I crazy?
In the “standard model”, an individual who desires to save more can always do so, because in the standard model “save more” means “buy less consumption” and you can always buy less consumption if you want to. You don’t have to get the sellers’ agreement to buy less. But the standard model ducks the question “so, what does he do with his monetary income instead?”. If the answer is “buy more antiques”, then it’s problematic, because you do have to get the sellers’ permission — he has to desire to sell more. If the answer is “hold more money” the answer is unproblematic.
JKH: this is right back at our old “accounting vs economics” argument. Quantity demanded is not the same as quantity bought. A change in demand can have an effect, and is real, even if it makes no change in quantity bought.
Mr Rearden: The person has $100 in his chequing account, which he uses to pay down his loan. So there’s $100 less in demand deposits and $100 less in loans.
Nick, seems to me that JKH is just imnposing market clearing.
“Do deposits necessarily fall when a bank loan is paid down?
Banking system deposits typically* fall when a bank loan is paid down. The money used to pay down the loan will typically be sourced from a positive balance in a bank deposit account at some bank.
If the loan and the deposit are at the same bank, it’s a balance sheet wash for that bank – assets down; liabilities down.
If the loan and deposit are at different banks, the bank with the prior loan will gain reserves at the central bank and the bank with the prior deposit will lose reserves at the central bank. The transfer of reserves mirrors the interbank payment that’s required to settle the transaction between the two banks. The typical response to the reserve change at each bank is a money market transaction. E.g. the bank long reserves may buy treasury bills; the bank short reserves may sell them; the net system effect in this case would be a wash.
The bank with the prior loan will also free up capital for deployment somewhere else. It may make another loan, at which time it might sell the treasury bills to net out the reserve effect of making a new loan. In making the loan, the proceeds will “land” in a new deposit somewhere in the banking system.
Central bank reserves are a matter of operational transaction accounting. Capital deployment is a matter of internal risk accounting for a given level of capital.
* Not always, I suppose. The borrower could sell a treasury bill or some other asset to the banking system for example. But I think the natural base case for adjustment is through asset-liability balancing rather than asset-asset balancing.