If we lived in a world of barter exchange, or in a world where people could use barter exchange at minimal cost, Keynesian macroeconomics would make no sense whatsoever.
That is not, of course, a criticism of Keynesian macroeconomics. We do live in a world where people use monetary exchange, not barter. And people (usually) use monetary exchange because barter is (usually) very costly.
But do Keynesians understand this?
Milton Friedman understood this. Monetarism, rather obviously, would make no sense whatsoever in a non-monetary economy. As Milton Friedman (almost) said, recessions are always and everywhere a monetary phenomenon. He (and Anna Schwartz) wrote a very large book arguing that the Depression was a monetary phenomenon.
If you drew a line, and put Real Business Cycle theory at one end of the spectrum, who would be a natural candidate to put at the other end of the spectrum? I can't think of a better candidate than Milton Friedman. At one end of the line you have people who say that money plays no role in the business cycle. And at the other end you have Milton Friedman. Keynesians are somewhere in between.
So it seems counter-intuitive for Brad DeLong to blame Milton Friedman for the rise of Real Business Cycle theory. The two are polar opposites.
You could argue that the research program called RBC theory, or Classical Macroeconomics (a strange name for something that only started in the 1980's), is an example of the Ricardian Vice. RBC theory is what happens when you insist on modelling everything formally. But who should we blame for the Ricardian Vice? Ricardo, obviously. But if we are looking for more recent culprits, you could argue that, say, James Tobin, an excellent Keynesian economist, is at least as guilty as Milton Friedman.
IIRC, one of the complaints that the Keynesians like James Tobin had against Friedman was that Friedman didn't write down his macroeconomic model in equations so they could see precisely where Friedman's Monetarism differed from their Keynesianism. "OK Milton, we've written down our model, now let's see yours! Stop waving your hands and talking!"
Friedman wouldn't, or couldn't, so Robert Lucas did it for him. And Monetarists can argue whether Lucas' model captured the essence of Friedman correctly just as Keynesians can argue whether John Hicks' ISLM model captured the essence of Keynes correctly. But Lucas set new standards for macro model-building just as Hicks had set new standards for macro model-building a generation earlier.
It makes about as much sense to blame Friedman for the consequences of the Ricardian Vice as it does to blame Keynes. Both gave the model-builders something to model, but they themselves were more talkers. Personally, I blame Tobin for Lucas, and everything that followed. Well, maybe that's a bit unfair.
Actually, you could argue (as I did here) that New Keynesian models capture the essence of Friedman about as well as the old New Classical models of Lucas. Friedman never said that all nominal prices and wages adjusted instantly. Permanent Income Hypothesis: check. Vertical Long Run Phillips curve and non-vertical Short Run Phillips curve: check. Central bank responsible for keeping inflation at the right level: check. Fiscal policy rarely mentioned: check. A Keynesian Rip Van Winkle from the late 1960's seeing a New Keynesian model would be surprised to see that Friedman's followers were now calling themselves New Keynesians, and that Friedman had obviously won his war.
The only thing missing is the k% rule for monetary policy. It gets replaced by the Taylor Rule. But the k% rule was never central to Friedman's vision. He abandoned it later, when he saw it wouldn't work very well. And it was only ever a rule of thumb anyway; something he thought might work reasonably well and better than actual historical policy.
OK, if you want to blame someone for the emphasis on monetary policy and the de-emphasis on fiscal policy, then Milton Friedman is guilty as charged. Though New Keynesian macroeconomists were willing accomplices. "But Milton Friedman made me do it; he made me forget about fiscal policy" doesn't really cut it as a defence.
And it's here I want to return to my opening theme. Do Keynesians really understand their own models? Do they understand the central role of money and monetary exchange in generating recessions? If so, why the emphasis on fiscal policy?
Take a Keynesian model. Any Keynesian model. Start in long run equilibrium. Now hit it with the sort of shock that would cause a recession. Aggregate Demand falls, which causes output and employment to fall. Unemployment increases. OK, what's really going on here?
The unemployed hairdresser wants her nails done. The unemployed manicurist wants a massage. The unemployed masseuse wants a haircut. If a 3-way barter deal were easy to arrange, they would do it, and would not be unemployed. There is a mutually advantageous exchange that is not happening. Keynesian unemployment assumes a short-run equilibrium with haircuts, massages, and manicures lying on the sidewalk going to waste. Why don't they pick them up? It's not that the unemployed don't know where to buy what they want to buy.
If barter were easy, this couldn't happen. All three would agree to the mutually-improving 3-way barter deal. Even sticky prices couldn't stop this happening. If all three women have set their prices 10% too high, their relative prices are still exactly right for the barter deal. Each sells her overpriced services in exchange for the other's overpriced services.
But barter is not easy. There is no double coincidence of wants here, and it is costly to find all three people in the Wicksellian triangle to do the barter exchange. So people use money.
The unemployed hairdresser is more than willing to give up her labour in exchange for a manicure, at the set prices, but is not willing to give up her money in exchange for a manicure. Same for the other two unemployed women. That's why they are unemployed. They won't spend their money.
Keynesian unemployment makes sense in a monetary exchange economy, where money is what Hahn calls "essential" for trade. It makes no sense whatsoever in a barter economy, or where money is inessential.
Keynesian unemployment is an excess demand for the medium of exchange. It's a coordination failure, because if all three spent the $20 to buy what they wanted, all three would find her purse is a widow's cruse. The $20 reappears as soon as it is spent. But the widow's cruse fails unless all three increase spending at once. And, in Nash Equilibrium, none of the three wants to do that. She prefers the $20 in her purse.
We buy newly-produced goods with money. A Keynesian recession is an excess supply of newly-produced goods, and a deficiency of Aggregate Demand. In a monetary exchange economy, a deficiency of Aggregate Demand, and an excess supply of goods, is an excess demand for money. Money is what we demand goods with.
[Update: as Yeager noted, there are two ways to get more money. The first is to sell more stuff; the second is to buy less stuff. And nobody can ever stop an individual from getting more money by buying less stuff. That's what makes money unique. That's what makes an excess demand for money qualitatively different from an excess demand for any other type of savings.]
Keynesian unemployment only makes sense as a monetary phenomenon. What's fiscal policy got to do with it? Fiscal policy is supposed to be about micro stuff, like providing the goods that the government is better at providing. Fiscal policy can't do that micro stuff properly if it's being asked to also do the job that monetary policy is supposed to be doing.
OK. There is a legitimate Keynesian defence. If a doctor can't fix a broken leg, he might recommend a wheelchair as a second best fix until the leg heals itself. He might argue that it will help the leg heal quicklier. OK. But he should admit that it's a second best, and be looking for a first best, and encouraging others to seek a first best. He shouldn't be selling wheelchairs.
The trouble with Keynesians is that they aren't radical enough. They need to look at their own models and see the root of the problem, and recommend policies to get at the root of the problem. The root of all Keynesian recessions is monetary.
Just like Milton Friedman said.
[Afterthought: None of us ever really understands our own models. It's one thing to write down some equations and solve them; it's another thing to really understand what's going on. And there's always an implicit assumption, hidden implication, or new interpretation waiting to be discovered. It's an occupational hazard of model-building. It comes with the territory. It's why theory is challenging.]
Worthwhile Canadian Initiative 
Joe: “Can you recommend any books or papers that explain the history of post WWII macro. I would like to learn more.”
There are very detailed overviews in ch. 16 of Mark Blaug, Economic Theory in Retrospect (5th ed., 1997), and in ch. 15 of in Landreth and Colander, History of Economic Thought (4th ed., 2002).
To get a good idea of the fundamental elements of the two main competing paradigms (i.e., scarce-resource allocation vs. Keynesian resource-underutilization) and how the dispute between them has progressed in theory and in policy up to the present time, see Melvin W. Reder, Economics: the Culture of a Controversial Science (1999). The contemporary debates are entirely laid out in this book (with the exception of the recent financial crisis).
A well known economic historian and of economic thought was Mark Blaug.
1. Economic Theory in Retrospect [from Smith to Keynes], Mark Blaug
2. Economic History and the History of Economics, 1986, Mark Blaug
Although dated, Schumpeter’s History of Economic Analysis published after his death in 1952.
I feel I’ve missed something very important here, probably because I’m not a professional economist. How does an unemployed person INCREASE his/her supply of money by not buying stuff? An unemployed person generally does not have an income, or at best has a very much reduced income. Your three people can agree to the barter deal because they have an excess of their own labor available, but they don’t have any money. I read that large corporations are sitting on 2 trillion dollars of cash, the big banks have excess reserves over 1 trillion dollars (historically unprecedented, by the way, why don’t I ever see any discussion of that?), and 15 million people are out of work because the people with the money don’t see any investment opportunities? It seems to me there’s a distribution problem here. Fiscal policy works (or is supposed to work) by putting money in the part of the economy where there isn’t any — in the hands of the unemployed. It worked in the 1930s, but unfortunately it wasn’t tried this time around, and clearly isn’t going to be tried.
JP Koning:
thanks for the link; looks like a very comprehensive study. My recollection of the number of participants seems to be too high:
“2.5 million participants (Ovalles, 2002), though some estimates went as high as 6 million individuals directly or indirectly associated with the trueque.”
Nick,
“If I understand your example correctly, what you are saying is that the stock demand for money depends not just on income (the flow of expenditure on goods and services) but also on the flow of expenditures on bonds (deleveraging).”
No, I am saying that people have nominal savings demands for both money and bonds. But if each person measures their savings of bonds on a net basis (e.g. bond savings = bonds owned – bonds owed) — which seems like the rational thing to do — then a general increase in the demand for bonds cannot be cleared by the interest rate alone, as the bond market clears when bonds purchased = bonds sold. I.e. draw a increasing curve of lenders and an decreasing curve of borrowers. The interest rate clears when the change in aggregate bond savings = zero, but what people want is more lenders than borrowers.
Now instead of assuming that, on the margin, someone wanting positive bond savings must purchase more bonds, bidding down the rate, assume that they have the option of repaying their own debt as well. Suppose they do both equally, so that in aggregate, there is an aggregate demand for positive bond savings of $100, half of which corresponds to a desire to repay debt and half of which corresponds to a desire to purchase more bonds.
Then the amount spent on debt repayment subtracts from nominal income, and the amount spent on bond purchases lowers the rate. At some point, the (aggregate) bond savings demands are again zero, but this point corresponds to reduced nominal income.
I think if prices of consumer goods were perfectly flexible, then by this argument real rates would rise during the adjustment.
I’d also recommend this:
Snowdon and Vane, A Macroeconomics Reader
Something really bothers me about this. (I’m not an economist).
What if the aggregate demand for money in an economy is distorted by a handful of institutions whose disaggregate demand for money is A) infinite and B) based on money as a store of future value and not as a means of exchange for any existing good or service.
…I suppose the post directly above is pretty much what Brad Delong is saying…
…and reading a bit now I see that two posts above I have simply given an example of what Keynes meant by defining a liquidity trap as inelastic demand for money…
I hope everyone enjoyed me educating myself on this one. But now to the main course.
What If I am a 20 trillion dollar banking industry with no effective regulation and no (long term, intrinsic, effective) aversion to risk? How does is the elasticity of my demand for money effect the aggregate elasticity of demand?
Ergo a penalty rate on bank reserves at the Fed?
Edit: infinitely elastic, not inelastic.
RSJ, repaying debt has the same effect as buying back bonds. So yes, it is an increase in bond purchases and lowers the interest rate. Nominal income does not necessarily decrease: it gets transferred to those who value it the most over balance sheet assets.
Michael Carroll, even if demand for money is very high and elastic, the central bank can always increase supply to match. There needn’t be any “liquidity trap”, anthough there might still be a problem, in that you’d want inflation to be a lttle higher so that real rates are not constrained by the ZLB on money.
Anon,
“repaying debt has the same effect as buying back bonds.”
No, repayment of debt happens outside the bond market. It is the fulfilling of a contractual obligation between creditor and debtor, and only requires the movement of cash from one party to another. No bonds need to be purchased in the telling of this story.
You are assuming that the creditor, when principle is returned to him, will re-invest the proceeds by purchasing more bonds. That is the mechanism by which debt repayment can affect rates.
I just paid some credit card debt, and didn’t buy any bonds at all. My payment did not cause the interest rate to decrease. The interest rate decreases if the holder of the ABS, on seeing his principle reduced, rolls the proceeds over into the purchase of more paper. Then, my credit card payment will indirectly cause rates to decline. But if my creditor is in run-off mode, and decides to use the proceeds to repay his own creditors, who themselves are in run-off mode, etc — then interest rates do not decline.
Incomes decline. That was what happened in my simple example.
Now, why would they only repay debt? It will be both — both incomes and rates decline.
RSJ, if everyone is in “run-off mode” and have to rebuild their balance sheet, then folks will be all the more unwilling to issue new debt or roll ther debt over in the bond market. So interest rates will tend to fall due to scarcity of willing bond issuers. Ultimately, ISTM that income will tend to flow towards those who are most willing to incur debt or least willing to lend (depending on balance-sheet and liquidity preferences), and interest rates will be again set by the convenience yield of money over other assets.
“If everyone is in “run-off mode” and have to rebuild their balance sheet, then folks will be all the more unwilling to issue new debt or roll ther debt over in the bond market.”
Agreed. Demand to borrow decreases.
But also everyone will be more unwilling to buy debt as they prefer to pay down their own debt instead.
Remember the assumption: Try to increase your net bond savings via debt repayment rather than via bond purchases.
Therefore the supply of lenders also decreases, and by the same amount.
So interest rates are not going to change — both supply and demand decline.
Quantity will change, not price, and the example I gave showed how the change in quantity caused a change in nominal income.
One might think that the internet would allow the coordination problem of barter to be (partially) solved. Does anybody know of any attempts to do this?
It would be a great, countercylical business opportunity.
Quote: “But do Keynesians understand this?”
Those who follow Keynes’ view know that “ If we lived in a world of barter exchange, or in a world where people could use barter exchange at minimal cost, Keynesian macroeconomics would make no sense whatsoever. That is not, of course, a criticism of Keynesian macroeconomics. We do live in a world where people use monetary exchange, not barter. And people (usually) use monetary exchange because barter is (usually) very costly.”, because it is explained in Chapter 17 of ‘General Theory’ in his argument on own rates of interest of capital in view of carrying cost.
Ask such a question to American Keynesians instead. They don’t get the knack of Keynes’ thought at all.
As the author cites Milton Friedman that way he doesn’t get the knack either. Friedman’s argument lacks a viewpoint on fixed factors of production which decides the flow of capital or money supply between the enterprise and the speculation. By the way suppose ‘Keynesians’ mean the American Keynesians, the way that the author places Keynesians is right. Otherwise, the author’s positioning is too superficial because all the three – RBC, monetarism and American Keynesianism – draw inelastic policies at the cost of some unignorable variables related to real human life. The author may get it if he reads Chapter 22 of ‘General Theory’.
“Keynesian unemployment makes sense in a monetary exchange economy,”
It needn’t be a monetary exchange economy, if a substitute for money is found, which must be a capital whose carrying cost can be as extremely low as money. Keynes cites land as an example, because the liquidity premium of land is also very high.
“A Keynesian recession is an excess supply of newly-produced goods, and a deficiency of Aggregate Demand.”
I am sorry that the author doesn’t seem to understand Keynes, because he seems to regard American Keynesianism as identical with Keynes’ thought. The excess supply of newly-produced goods is observed in the early stage of a recession. If you implement an inelastic policy there, then the money for enterprise keeps stagnating while the money for speculation is encouraged by the same policy. This is the very cause of the blunders done by the American Keynesianism in the 1970s. Needless to say, the same structure of failure is being observed with the inelastic monetary policies adopted by Mr Greenspan and Mr Bernanke.
“Keynesian unemployment only makes sense as a monetary phenomenon. What’s fiscal policy got to do with it? Fiscal policy is supposed to be about micro stuff, like providing the goods that the government is better at providing. Fiscal policy can’t do that micro stuff properly if it’s being asked to also do the job that monetary policy is supposed to be doing.”
Ugh. No. A fiscal policy to shift the money supply from the speculation to the enterprise IS about macro stuff. I strongly recommend the author to read Chapter 15 of ‘General Theory’, where Keynes explains the difference of two forms of money. The chapter is actually extremely famous, and I wonder why the author overlooks this very famous point Keynes emphasises. Should the author doesn’t get it he must read the other chapters as well.
Anon,
“even if demand for money is very high and elastic, the central bank can always increase supply to match. There needn’t be any “liquidity trap”, anthough there might still be a problem, in that you’d want inflation to be a lttle higher so that real rates are not constrained by the ZLB on money.”
And so I am suggsting that the CB supplying the money and the Banking sector hoarding it at the same rate might not in fact boost aggregate demand for existing goods and services. I take stock in Jasiek w japonii saying:
“The excess supply of newly-produced goods is observed in the early stage of a recession. If you implement an inelastic policy there, then the money for enterprise keeps stagnating while the money for speculation is encouraged by the same policy.”
Which is a direct response to unease I felt about Nick Rowe’s OP.
Axel Leijonhufvud. Very famous article about the economics of Keynes (not “Keynsian economics”) as fundamentally about failure to coordinate. Check it out.
Kien
“on my reading of Krugman, I understand him to be saying that QE is not credible because of political constraints. While I have a lot of sympathy for that view, a monetarist could counter by saying that political constraints also rule out fiscal intervention.”
I think Krugman is equally sanguine on the political contraints for fiscal intervention. That was in part why he argued for a much larger fiscal stimulus in 2009 – he figured it was a one-shot deal, and political considerations would likely close off the door to future fiscal intervention unless the first one was big enough to really make a difference.
But Krugman is more of a proponant of monitary intervention than he is being given credit for (or perhaps that is Nick’s point). If you look at his work on Japan and the ZLB, he is advocating that the central bank set an inflation target much higher than it is currently, and that they be committed to do whatever easing is needed to get there. I think his concern is that a political environment where leading politicians are arguing that money SHOULD be a store of value and advocate a return to the gold standard is not one where QE is likely to be allowed to be successful.
John
Repost from my MR comment:
http://www.google.com/insights/search/#cat=5&q=trade&geo=US&cmpt=q
comparing the results for the word ‘trade’ in the tech category against the broad category…click on “Growth relative to the Computers & Electronics category”
look where the divergence happens.
@Paul Johnson
That’s it. But, we need to explain the basic idea of the old paper in plain words and expressions so that even those who are not familiar with General Theory can get the point, because even those among the best brainers in North America still confuse the two different thoughts, so that they can re-start from comparing Robinson with Samuelson.
Regards,
Jasiek
“Keynesian unemployment is an excess demand for the medium of exchange.”
You’ve always been wrong on this.
It’s an excess demand for saving.
The medium of exchange is a tiny cog in the full wheel.
Sorry, you’re just forcing your monetarist framework into what persists as a complete misinterpretation of Keynesian economics.
“So why aren’t more economists calling for completely coordinated monetary and fiscal policy? The conclusion that flows from this analysis would seem to be advocating congress to pass a stimulus package that allows the Treasury to finance the expenditure with zero maturity debt – brand new money.”
“However, what people need in order to buy goods and services is income. And monetary policy can not provide income.”
“What if the aggregate demand for money in an economy is distorted by a handful of institutions whose disaggregate demand for money is A) infinite and B) based on money as a store of future value and not as a means of exchange for any existing good or service.”
Some people get it. If some money flows in a hole, you need to have a spring somewhere else to keep the flow going.
Distribution really does matter!
Greg Ranson – I always thought your view of the world was bit backwards oriented – but this
“Hayek’s 1929 book explains how Hayek’s landmark 1945 paper is directly relevant to thinking about money and monetary theory” is just ridiculous. Maybe you want to try to express that again.
jasiek w japonii
“I am sorry that the author doesn’t seem to understand Keynes, because he seems to regard American Keynesianism as identical with Keynes’ thought. The excess supply of newly-produced goods is observed in the early stage of a recession. If you implement an inelastic policy there, then the money for enterprise keeps stagnating while the money for speculation is encouraged by the same policy. This is the very cause of the blunders done by the American Keynesianism in the 1970s. Needless to say, the same structure of failure is being observed with the inelastic monetary policies adopted by Mr Greenspan and Mr Bernanke.”
I would love to understand what you mean here – but, unfortunately I’m not sure that I do. What exactly do you mean by an “inelastic policy” in this case? What policy do you actually recommend? (My own view very unconventional view is that you should increase the income of the least well off, print money to pay for it – not issue bonds – and even raise interest rates.)
anon, saying that “the medium of exchange is a tiny cog in the economy” is just wrong, since the real world economy mostly uses monetary exchange, not barter. Although you could state that excess demand also creates problems for the other functions of money: unit of account (because it forces all nominal prices to adjust downwards at the same time) and saving/store of value (because money effectively sets a floor on real interest rates).
@reason
I will, though very roughly and briefly. I’m hastening to explain, so I might forget to cite some factors or items. But, I think you’ll at least get the knack of the idea.
In the early stage of recession with loads of excessive stocks at enterprises I would recommend that:
1. both quick and massive expansionary fiscal and monetary policies should be implemented to both forestall a chain-reaction of black-ink bankruptcy and prevent the schedule of marginal efficiency of capital from sharply shifting downwards (= to prevent the discount rates of capital from sharply expanding).
As a result, the public finances deteriorate, but this is just a necessary evil. It is important not to set a policy-target in output growth or employment in this stage. It matters how you go through the next stage.
In the second stage, the excessive stocks have been sorted out to some extent, because even in a recession the consumption doesn’t become zero thus businesses try to sell off their goods and services to maintain their cash flow even though production capitals are not working full, but the schedule of marginal efficiency of capital is somewhere lower than before the recession. In addition, due to the above massive injection of high-powered money, the money supply must be growing in the money held by speculative-motives (i.e. speculation) rather than in the money held by transaction- or precautionary-motives (i.e. production, or enterprise). In other words, in the first stage the savings will grow by the speculation, and not by the production. In that case, the household income gap must increasingly widen while in most cases you must be observing a symptom of what you call semi-inflation, and not real inflation, as a result of the escalating speculation when the production is stagnating due to the open market being drenched with the massive money. Roughly, these are the factors to consider. Therefore, the tasks which you’ll have to take on in this stage are:
1) Reconstructing the public finances
2) Shifting the money supply from the speculation to the production
3) Shifting the schedule of marginal efficiency of capital upwards (i.e. contracting the discount rates of capital, or, in plainer words, encouraging the long-term expectations)
Therefore, I would recommend:
1. that, considering the propensity to save, the government should raise the marginal tax rates on income and inheritance – on the effective basis (i.e. with no virtual loophole)
2. also should raise the tax rates on capital gains – also on the effective basis
3. and, that the government should increase its expenditure on items to rewind, to some extent, urban sprawls and motorisation as the biggest factor that has aggravated urban sprawls. (i.e. geographical restructuring)
By the policy-package I expect the following phenomena to occur as goals:
i) The public finances will improve due to the progressive taxation.
ii) The money supply (i.e. the money in the open market) will shift by large from the speculation to the production, because the higher-income households, who have increased their savings due to the speculation, will have to pay more to the public coffer. That is, the rentiers will murmur. (i.e. euthanasia of rentiers?)
iii) As the capital resource shifts thus while the government increases its expenditure in an attempt of restructuring the geographical and industrial structures of the economy, the production will expect the schedule of marginal efficiency of capital to shift upwards again. Industrialists, instead of gentlemen, will be encouraged – as long as they don’t expect high pay.
iv) As people live closer, capital is no more diluted so that capital is more likely to be fixed to make the production more feasible. This is identical with lowering the weighted average cost of capital. Therefore, rentiers murmur while industrialists are highly motivated to accumulate what you call fixed factors of production.
v) Therefore, fixed capital will be encouraged.
vi) The production will be in need of more employees again.
In the third stage that gradually emerges during the second stage:
1. The central bank should gradually raise the rates of interest as its exit strategy.
Now that the lengthy but rather rough preface has come to an end, I’m telling you the most important point of my criticism of the present economic policy. The present-day ‘inelastic’ economic policy:
1. either skips the second stage or extend the policies for the first stage to the second stage;
2. considers trying to increase the output and employment by the expansionary fiscal and monetary policies;
3. when the economy observes inflation, confuses semi-inflation and real inflation and tries to tackle semi-inflation by a contractionary monetary policy;
4. either even insists on implementing austerity to reconstruct the public finances without tax increase or expanding public spending to prop up the aggregate demand without a concrete plan to fill the gap between the revenue and expenditure;
5. resulting in encouraging the speculation and thus semi-inflation, and probably a more contractionary policy, with wondering why their policy doesn’t work.
Sounds ridiculous to me, to be honest. They don’t divide between the money held for enterprise and the money held for speculation or between real inflation and semi-inflation. They must be either just fools who try to adopt the quantity theory of money to the real world in the belief that all economic variables can be sufficiently malleable or afraid of a large political fuss over various inconveniences foreseeable with the tax system and geographical restructuring.
No need of explanation on inconveniences with the tax system, especially to high-income households, as a matter of course. As for geographical restructuring, it means that, for example, if you drive a car the government imposes heavier social costs on you so that you will regard using public transportation system as better than driving a car and that, for another, if you live in the suburbs the life will be much more costly than before so that you will regard living in town as more reasonable or comfortable. (The Dutch have been implementing such a geographical restricting for the last forty years since the era of what you call the Dutch disease).
Regards,
Jasiek
PS As for ii) the money supply starts to shift because of the increase in tax rates on capital gains. The attempt didn’t work during the 1970s, because there emerged a number of loopholes.
Jasiek:
One person’s speculation is another person’s investment. 90% of all business startups fail. The owner thought it was a good idea….
Futhermore, you seem to focus on the idea of fixed assets and industrialism. But most of our economy isn’t production, it’s services.
“But most of our economy isn’t production, it’s services.”
Yes, more of final output is delivered as a service rather than as a good. But there is a huge industrial supply chain backing it.
You go to a hospital and receive an MRI. Go to a fast food restaurant and eat a meal. Fly to another city, rent a car and stay in a hotel. You are buying a service, but behind that is the hotel, airport, plane, and auto-manufacturer, each with their own supply chain. Not to mention the industrial empire that sources beef from all over the world, processes it in automated factories, freeze dries it and ships it to your local fast food chain, to be consumed “as a service”.
If they buy food to eat at home, they are purchasing goods — food, plates, utensils, kitchen appliances, etc. But if they go to a restaurant to eat food made professionally in industrial kitchens, then final output becomes delivered more as services. If they rent a car, then it’s a service, but if they buy the car, its a good. If they buy a DVD and watch it on their TV, it’s a good. If they have the movie streamed to their TV via their cable provider, then it’s a service.
Ultimately consumption is about services, not goods, but technological limitations prevent us from enabling all consumption to be delivered on a pay-as you go basis, so people purchase goods and then consume gradually on their own.
Over time, we overcome those hurdles and deliver consumption in such a way that each person does not need to run their own kitchen, buy their own book, or buy their own car. They pay for consumption as they consume. This process of substitution means that the consumption component of final output consists of more services and fewer goods, but it does not mean that the economy is de-industrialized or requires fewer fixed assets or capital inputs. If anything, it is more industrialized.
We didn’t have depressions before the industrial era. We had crop failures, plagues, etc. But something happened to the economy in the 19th century that caused it to suffer from depressions that were not supply-side problems, or “real” problems. Any model that purports to explain that has to be able to explain the difference.
And it seems plausible to me to point your finger at the fact that capital goods can be produced in an industrial economy, wheres the factor inputs in an agricultural economy are land and labor, which are basically fixed.
In an agricultural economy, the quantities of land cannot adjust, so the price at which land is rented out will match whatever the marginal productivity of land happens to be. Incomes will be constant if prices are free to adjust.
But Keynes was arguing that you can’t make that argument in an industrial economy in which there is investment. Now the quantity of capital is a variable, and if the marginal productivity of capital falls below the interest rate, you do not know that the interest rate will fall. It could be that investment decreases — e.g. that less capital is supplied. But if less capital is supplied, then incomes also decrease. There is no bidding war for capital when output is declining because incomes are declining at the same time, so people have less money with which to bid. So for every interest rate, you have a level of employment, and there is no guarantee that all on their own, interest rates will adjust to reach the full employment level. At least, that is my reading of Keynes — perhaps it’s the wrong reading 🙂
Honestly, I don’t know why this reading was rejected. It seems to me that in order to reject it, you have to assume that incomes are independent of investment, so that you are given an income exogenously, and then decide how much of your income to invest. At best, that seems like a partial equilibrium analysis that misses Keynes’ insight entirely.
No, RSJ, you’re entirely right. Your second-last paragraph actually seems to capture just what is wrong in the current economy.
I should say that I take issue with analyses that fixate on fixes assets and production without their associated services. It’s those services that actually make people WANT to buy products. That’s why don’t all drive Model T Fords coloured black anymore.
ISTM that the difference between “real investment” and “make-work”, the terms that get thrown around when discuss this topic is that “real investment” is backed up by a large train of services that integrates the product into the economy in a way that the economy finds useful.
As opposed to building a manufacturing plant to produce 100 million Robertson Screws a year, hiring 100 people to make them but not having any service to integrate that into other areas of production or consumption. The screws then lie around in boxes, unused, unloved and unwanted.
@Determinant
Quote: “One person’s speculation is another person’s investment.”
That sounds like the neoclassical way of analysis. You need to distinguish the domestic income between household from production in the first place as Keynes did in his analysis:
(1) In view of household: Income = Savings + Consumption
(2) In view of production: Production = Investment goods + Consumer goods (NB: in this context ‘goods’ include ‘services’)
1. As Income is identical with Production, Savings equals with Investment goods at the equilibrium. Thus, Savings equals Investment.
2. Investment=Savings can be either in Enterprise or Speculation.
3. Therefore, Speculation is not identical with Investment
Quote: “Futhermore, you seem to focus on the idea of fixed assets and industrialism.”
It doesn’t matter if its goods or services, as just explained. When I say ‘export (of goods)’ it means ‘sale of goods and services abroad’. The fixed capital is essential because with less of it a larger chunk of circulating capital emerges to increase leverage in the open market and thus speculative activities while it expands the Savings. Let me briefly explain:
1. Now, Keynes divides the Money supply into two: Money supply(M) = M(1) + M(2)
(1) M(1) is the money held by transactions- and precautionary-motives (i.e. Enterprise)
(2) M(2) is the money held by speculative motives (i.e. Speculation)
2. Therefore, all Savings=Investment, as part of Money supply, can be either in Enterprise or Speculation.
3. M(1) = Output(Y)/Income velocity of money(V)
4. M(2) = Liquidity preference (on the market rate of interest) (L(r))
5. Therefore: M=Y/V + L(r)
6. Given a level of Output, when the Income velocity of money expands the Liquidity preference expands and thus the Speculation outclimbs the Enterprise.
7. This means that the Enterprise stagnates and thus the Employment stagnates when the Income velocity of money expands.
8. That is, given the Output, the Speculation expands while the Employment stagnates in case the Income velocity of money expands. This is the background of my previous post.
9. When the Enterprise stagnates this doesn’t mean the Enterprise stagnates. Sounds strange? This should be interpreted that the portion of Savings directly coming from the Household income and going into the Enterprise stagnates while the Enterprise can be financed by capital flowing in from abroad. That is, the capital shortage can be filled by capital inflow from abroad, which expands the Savings.
10. The expanding Savings can also encourage the Consumption.
11. As a result of those phenomena combined, the balance of payments deteriorates while the Enterprise, Employment and Output growth may be supported as targets of the inelastic economic policy.
I personally call excessive income-velocity economy (i.e. economy with expanding income velocity despite the deteriorating balance of payments) grasshopper economy. This phenomenon can be observed here and there throughout the world today. The US economy is the most die-hard grasshopper, because it issues the virtually sole key-currency, with which you can buy almost all sorts of commodities.
Now, you may have understood that I’m not advocating what you call industrialism while I attach great importance to various fixed factors of production. Instead, I’m advocating a structure that will shift the money into the Enterprise (M(1)) than the Speculation (M(2)). As I explained in my previous post, it’s the government, and not the central bank, that should take the initiative in the capital shift. The goal of the shift may be translated as causing real inflation, not semi-inflation, so that the central bank can gradually and safely withdraw the high-powered money it has injected into the open market by then. Read my previous post again.
You cannot elimilate business cycles from the real world; because you cannot eliminate all fixed factors of production from the real world. For example, we are human being who have individual lives that create fixed factors, and not robots. We should forge a method of ‘gettig along’ with business cycles instead, and that’s what Keynes called ‘General Theory’ against ‘special’ theories – such as Maxism, Austrian school eocnomics, (American) Kenesianism and neoclassical economics – that respectively assume special, unreal conditions and try to change fixed factors to the extent that you are not supposed to reach. Now you may have understood why and how the author’s perception is funny.
Regards,
Jasiek
By QE, Bernanke is trying to both expand the money supply (M=M(1)+M(2)) and reduce the market rate of interest (r of L(r)=M(2)), with overlooking the high income-velocity of money (V of Y/V=M(1)). Naturally, he is encouraging the Speculation (M(2)) and thus retaining the structure that deteriorates the balance of payment as I explained.
But, with the dollar the US economy is die-hard. Thus, Robert Solow’s model of economic development can possibly feasible only in the US.
Regards,
Jasiek
I forgot to add at the last: ‘as long as the market trusts the value of the US dollar despite the structural deficit on current account’.
Regards,
Jasiek
Jasiek,
I’m still not sure I understand your viewpoint – and I definitely don’t see how you get from your analysis to your solution (raising tax rates) – not that I am entirely unsympathic with that view. Your view seems somewhat coincident with that of Steve Waldmann (Interfluidity), who thinks that the rich try to accumulate financial assets and this is destabilising. I think it is sufficient (to encourage productive investment) to move income to poorer people (who are more likely to either consume it, or pay down debt – promising more consumption in the future). I think the key mistake made in Japan was to issue bonds to cover their anti-depression stimulus. The need was to delever – and clearly giving the private extra high quality assets (a la De Long) is not wrong from that point of view. BUT distribution matters. Issuing bonds underwrites the income of rich (allowing them to make safe rents instead of seeking out productive investments). We need to force them to make their money by providing goods and services to the general public. Re-distribution is needed. Replace debt money with base money and distribute it at the bottom of the pyramid from where it will trickle UP.
@reason
“I’m still not sure I understand your viewpoint – and I definitely don’t see how you get from your analysis to your solution (raising tax rates)”
The point is discouraging the money held by speculative motives as I have already explained. When the central bank is injecting high-powered money to sustain the output growth, it is achievable by reducing the income velocity of money. Taxation-wise there can be two approaches: raise the marginal income/inheritance tax rates (i.e. approach from direct tax) and tax rates on capital gains (i.e. approach from indirect tax).
“Steve Waldmann (Interfluidity), who thinks that the rich try to accumulate financial assets and this is destabilising.”
No. Everybody tries to accumulate financial assets. It is the propensity to consume and thus the propensity to save that you should focus on. I am not blaming people for their desire to accumulate wealth.
“I think it is sufficient (to encourage productive investment) to move income to poorer people (who are more likely to either consume it, or pay down debt – promising more consumption in the future).”
There are two different approaches to make the curve of household income less steep. One is to, as you may be thinking now, give them money direct from the public coffer either via forms of cash or forms of social welfare. The other is to provide jobs and higher wages by profit-making production-enterprise, which is in my mind.
“I think the key mistake made in Japan was to issue bonds to cover their anti-depression stimulus. The need was to delever – and clearly giving the private extra high quality assets (a la De Long) is not wrong from that point of view. BUT distribution matters. Issuing bonds underwrites the income of rich (allowing them to make safe rents instead of seeking out productive investments). We need to force them to make their money by providing goods and services to the general public. Re-distribution is needed.”
That is the approach taken by Tony Blair and Bill Clinton. It is exactly the Third Way policy, as Tony the tosser named it. It is to give the poorer money direct from the public coffer either via forms of cash or forms of social welfare including job-creation in various social welfare services which the government used to provide but have been privatised, and not production-enterprises, so that the assets and liabilities are put – or ‘tossed’ – off the government’s balance sheet. The method is very dangerous: Nazi-Germany did the method of off-balance public finances by issuing the Mefo bills and when the earliest of the bills were about to mature Germany invaded Poland. In other words, Germany did eat and beat. The latent debt in the sector of pseudo-privatisation balloons as highly leveraged money flows in from the Savings. It is not a coincidence that the party professed itself to be national-socialist.
“Replace debt money with base money and distribute it at the bottom of the pyramid from where it will trickle UP.”
Thus, only will the Speculation escalate with such a method. It’s very dangerous indeed. It will ruin the public finances, because the sector is largely re-nationalised – or ‘tossed’ to the government – at a recession, causing a massive and desperate shift of ballooned liabilities to the government. In some cases of privatisation efficiency by market-mechanism is a pie in the sky. With radical privatisation, you observe numerous regulators propagating here and there, causing a correspondingly ballooning financial burden onto the contracting public coffer.
Regards,
Jasiek
(My pseudonym is Polish, but I’m not Polish. I use this pseudonym on various sites).
Sorry – I now don’t understand your answer regarding “Third-way” policies – and I call a Godwin’s! Perhaps you misunderstood my point – I never mentioned privatisation. I think the government should borrow directly from the central bank (but only in these extraordinary circumstances).
It is true that everybody tries to accumulate financial assets (but NOTE financial assets not all assets), but the vast majority of financial assets accumulate to the rich (more than proportional to income). If you like, financial assets are a passion of the rich. And they take more risk (partly because they can take more risk AND limit their their liability through limited liability intermediaries). But saying that in the same breath as you talk about savings and consumption is confusing to me. I strongly believe that the problem with the US economy today is not extroardinarily high savings rates, but extroardinarily low investment levels. Forgive me if I am wrong.
Jasek,
I think maybe something is amiss with our understanding about what speculation is – and how to go about stopping it.
Let us be clear on the term, by speculation we mean leveraged bets on the sale price of assets. The more people are doing this – the higher the price of the assets will be (since the leveraging increases the money chasing a fixed pool of underlying assets). We both want to discourage it. My idea is to reduce leverage directly via the banking system, and replace the missing money with base money from government redistribution. The works in two ways:
1. tighter monetary policy makes open ended bets on the future riskier and more expensive and credit harder to obtain;
2. money flowing to those at the bottom of the income distribution increases effective demand in the economy. So the return to physical investment should rise.
Naturally, combining this with higher taxes at the top of the income distribution is fine with me as well.
You just want to cut down the after tax returns to this sort of activity. But taxes only bite if you win (so won’t necessarily have a great effect in a bubble), and they hit the returns to physical investment just as hard as speculation.
Basically, for everyone, I think the success story of the 90s – the combination of tight fiscal and loose monetary needs to be reversed. The problem is that it necessarily – pushes up the level of leverage in the economy to unsustainable levels. Leverage of course is harmless, in a world without risk. But risk is real.
The main point of most “Keynesians” is to find a way to justify higher gov’t spending.
The other “fiscal policy” is far better — lower taxes. Both create gov’t deficits, but lower taxes leaves more money with the producers of wealth.
Speculation = investment. No feasible way to say day traders buying and selling on their own version of “upticks” and “breakouts” are really any different than those buying houses for 30 year fixed rates in order to get net profit as they rent them out (buying for own use is a bit different).
Not all investments have positive rates of return. The US problem was too much investment/ speculation in housing, which after 40 years of non-negative rates of return (nationally), became over-invested and had negative rates. Usually such mal-investment is only a micro problem, counterbalanced by other postivie ROI investments at the macro level. The current post 2006 production-financial crisis is because the unprecendented magnitude, in money and contracts, of bad investments.
Printing the money and giving it to the poor is a far better policy than the bailouts for the rich that the Dem Party (led by Bush! and McCain! and Obama) voted for in 2008, before the election.
Jasiek:
Me, a Neo-Classicist? Say it not in Kingston, nor the streets of Ottawa! You obviously haven’t read the bulk of my posts on this blog!
That sounds like the neoclassical way of analysis. You need to distinguish the domestic income between household from production in the first place as Keynes did in his analysis:
(1) In view of household: Income = Savings + Consumption
(2) In view of production: Production = Investment goods + Consumer goods (NB: in this context ‘goods’ include ‘services’)
1. As Income is identical with Production, Savings equals with Investment goods at the equilibrium. Thus, Savings equals Investment.
2. Investment=Savings can be either in Enterprise or Speculation.
3. Therefore, Speculation is not identical with Investment
Nice, but your last conclusion [3] doesn’t answer my point. How, a priori, are we to determine what is speculation and what is enterprise? For instance, if I work for a firm that makes small passenger jets and the jets get cancelled, is it speculation? The market for the jets was high-income individuals who aren’t high-income anymore. Likewise when I went to the Bahamas in 2005 there were tons of large luxury motor yachts moored in the marinas that just sat there. Their owners had no money after the dot.com crash. Are the service people who staff the marinas and the builders of the yachts engaged in speculation too?
If I take you on a walk of the south end of Peterborough where the industrial plants are, could you tell me what is enterprise and what is speculation?
How do you tell your horses from your zebras when you have defined investment to merely be four-legged equids?
I also think your model tends toward a view of a closed economy, and that simply isn’t Canada. I have worked for companies who only had one Canadian customer. 95% of their business was to foreign customers. They used to put the flag of the customer out on the flagpole out front when they visited. I have worked for a French company at a plant in Canada contracted for work with an American customer to sell planes to people of any nationality.
I really take issue with analyses that artificially create lines between domestic business and exports. In Canada the import/export sector IS our economy. It is non-negligible. Instead of our customers being in Vancouver they are in Phoenix. I don’t like analyses that make artificial barriers between the two.
My guess is that Jasiek was expressly referring to the “speculative motive for holding cash”, i.e. the option value of cash as a way of deferring investments about which there is temporary uncertainty. There’s nothing wrong with this in principle, except that (1) the short-term equilibrium interest rate may shift far into negative territory (2) the central bank cannot necessarily fix the situation by buying long-term bonds: in fact, there is a risk that the CB may incur a capital loss on these bonds as uncertanty is resolved and interest rates rise. If this happens, the Treasury will get less seigniorage revenue and may even have to bail out the CB.
Whether traditional monetarist ideas should be viewed as part of a more “modern” freshwater tradition or as a separate and quite distinct line of thought is something that was discussed by Laidler (1990) in his “Legacy of the Monetarist Controversy.” http://research.stlouisfed.org/publications/review/90/03/Legacy_Mar_Apr1990.pdf This particular discussion begins on p. 55 but the entire essay covers topics that seem to have been forgotten by some/many/most in the blogsophere.
mb: very good find! I can remember David Laidler teaching us about that exact same p. 55 distinction in MA macro in 1977. (I still have my lecture notes.) My own (quasi-)monetarism comes mostly direct from David Laidler. I think of it as “disequilibrium monetarism”. It is quite distinct from New Classical macroeconomics.
“Take a Keynesian model. Any Keynesian model. Start in long run equilibrium. Now hit it with the sort of shock that would cause a recession. Aggregate Demand falls, which causes output and employment to fall. Unemployment increases. OK, what’s really going on here?
The unemployed hairdresser wants her nails done. The unemployed manicurist wants a massage. The unemployed masseuse wants a haircut.”
If everything is still demanded, where is your negative aggregate demand shock? If by “hit it with the sort of shock that would cause a recession” you are actually referring to a monetary contraction, then it’s a tautology that money is central to recessions.
Paul Krugman is emphasising fiscal policy because he thinks we’re in a liquidity trap, not because he thinks that monetary policy is generally useless.
@reason
In view of household income, if it’s not consumption it is regarded as saving. This is the way Keynes uses in his analysis. I recommend you to read Chapter 2 and Chapter 3 of General Theory so that we can avoid such a cross-purpose discussion.
Before then, let me comment on your proposal
1.tighter monetary policy makes open ended bets on the future riskier and more expensive and credit harder to obtain;
That’s dangerous. A tighter monetary policy should not be used to discourage the Speculation. Read my post dated March 22, 2011 at 12:58 PM again: A monetary tightening should be implemented in the ‘third stage’.
2. money flowing to those at the bottom of the income distribution increases effective demand in the economy. So the return to physical investment should rise.
No. That’s upside down. A higher level of the effective demand increases money flowing to those at the bottom of the income ladder – by my method of fostering the domestic capital for the domestic production.
@Tom Grey
Speculation ≠ investment. You might be thinking that risky investment is speculation thus there’s no border between speculation and investment: That’s wrong, or rather meaningless for any analysis. Instead, Kenyes description, as I explained, is clear.
“Nice, but your last conclusion [3] doesn’t answer my point. How, a priori, are we to determine what is speculation and what is enterprise? For instance, if I work for a firm that makes small passenger jets and the jets get cancelled, is it speculation? The market for the jets was high-income individuals who aren’t high-income anymore. Likewise when I went to the Bahamas in 2005 there were tons of large luxury motor yachts moored in the marinas that just sat there. Their owners had no money after the dot.com crash. Are the service people who staff the marinas and the builders of the yachts engaged in speculation too?
You are being confused. To the jet maker it is an act of accumulating fixed and circulating capitals, which is called ‘enterprise’. To the high-income individual this cancellation is a case of cancellation of purchasing a consumer good, thus the saved money stays as part of the saving. Those motor yachts are nothing but consumer goods if they were purchased back in the US it contributed the production output. The services offered by the marina staff are not domestic but foreign consumer goods, which is identical with imported goods. The builders, if within the US, have only accumulated the fixed and circulating capitals for producing yachts, which is the act of enterprise. Speculation is about analysing the money supply, and not for analysing household income or production. The potion of money supply that is not for accumulating fixed or circulating capital is speculation. Simple and clear.
“If I take you on a walk of the south end of Peterborough where the industrial plants are, could you tell me what is enterprise and what is speculation?”
Plants are forms of fixed capital accumulation, thus forms of enterprise in this regard, as a matter of course.
“How do you tell your horses from your zebras when you have defined investment to merely be four-legged equids?”
By that question it is crystal clear that you are putting speculation on the extent of investment. In Keynes terminology the (production of) Investment goods equals the Savings, thus at the equilibrium the Investment equals the Savings. You don’t understand this.
“I also think your model tends toward a view of a closed economy,”
No, no. Of course not.
@anon
“ deferring investments about which there is temporary uncertainty”
That’s, if happened in the entire economy, identical with the phenomenon that the discount rate of capital increases and thus the marginal efficiency of capital shifts downwards.
“(1) the short-term equilibrium interest rate may shift far into negative territory (2) the central bank cannot necessarily fix the situation by buying long-term bonds”
In that case the yield curve becomes less steep, discouraging inflation expectations, which may also have been observed during the era of Operation Twist. The central bank cannot fix the situation even though the authority buys short-term bonds, because the market-rates of interest, unlike the policy-rates, cannot become lower than a level which is conventionally regarded as the lowest, as Keynes explains. In the former case, it will cause a disinflationary pressure, possibly causing deflation. In the latter, an inflationary pressure, possibly causing semi-inflation. In both cases, the real wages will not increase by only implementing an expansionary monetary policy. That’s why I recommended the three-stage method in my comment dated March 22, 2011 at 12:58 PM. (To understand the first stage, Richard Koo’s ‘balance-sheet recession’ may help).
@Brad
Krugman doesn’t seem to be proposing the fiscal policy I am proposing above. He is rather close to monetarists in this regard, and I may think of him as a typical ‘American Keynesian’.
Regards,
Jasiek
Keynes real problem is that he assumes that aggregate supply is unlimited. That’s why his General Theory isn’t general and no amount of armwaving will make it so. It describes a world where exogenous shocks knock the economy off the production possibility frontier, while that frontier stays the same. That was the world of the 1930’s. The specific causes based in money and financial markets. It’s also the world of today. It’s the world of the balance-sheet recession.
Keynes explicitly in the introduction of his book rules out the possibility that an exogenous shock may itself contract the price-possibility frontier. That’s what demand in excess of supply mean or a short aggregate supply means. That seems to me what the oil shocks did in the 1970’s and in that case Hayek’s economics are the order of the day. It’s the world of inflationary recessions. Prices are increasing because something is truly getting more rare. We can print as much money as we want but it won’t solve the underlying rarity. That’s the world with no more cheap oil.
The case where the economy’s equilibrium point lies below the production possibility frontier is where Keynesian economics is valid and its prolicy prescriptions appropriate. The case where the economy is above the production possibility frontier is Hayek’s territory.
He at best offers only half a theory. ISTM Hayek only offers half a theory too. Much as I disagree with Roger Garrison, he offers a wonderful slide show on this point, though he decries the Keynesian bit of it, which is obvious.
Neither Hayek nor Keynes put forth a general theory on anything because their assumptions limited them to one half of the possibilities.
The real, unanswered question in economics seems to me how do we distinguish what world we are in, if we can be in both worlds, a Hayekian world or a Keynesian world. I explicitly forbid the use of politics or political dogma to justify answers to this question because I said both possibilities are valid and can happen.
Even better, how can you migrate between the two to have an optimum economic policy?
@Determinant
“Nice, but your last conclusion [3] doesn’t answer my point. How, a priori, are we to determine what is speculation and what is enterprise? For instance, if I work for a firm that makes small passenger jets and the jets get cancelled, is it speculation? The market for the jets was high-income individuals who aren’t high-income anymore. Likewise when I went to the Bahamas in 2005 there were tons of large luxury motor yachts moored in the marinas that just sat there. Their owners had no money after the dot.com crash. Are the service people who staff the marinas and the builders of the yachts engaged in speculation too?
You are being confused. To the jet maker it is an act of accumulating fixed and circulating capitals, which is called ‘enterprise’. To the high-income individual this cancellation is a case of cancellation of purchasing a consumer good, thus the saved money stays as part of the saving. Those motor yachts are nothing but consumer goods if they were purchased back in the US it contributed the production output. The services offered by the marina staff are not domestic but foreign consumer goods, which is identical with imported goods. The builders, if within the US, have only accumulated the fixed and circulating capitals for producing yachts, which is the act of enterprise. Speculation is about analysing the money supply, and not for analysing household income or production. The potion of money supply that is not for accumulating fixed or circulating capital is speculation. Simple and clear.
Regards,
Jasiek
Jasiek w japoonii – you are coming across as dogmatic, so I don’t see any point in continuing. Sorry.
Tom Grey – I partly agree and partly strongly disagree with what you wrote. So lets take it all in detail:
“The main point of most “Keynesians” is to find a way to justify higher gov’t spending.”
No the main point of most “Keynesians” is that unemployment is a waste that you never retrieve.
“The other “fiscal policy” is far better — lower taxes. Both create gov’t deficits, but lower taxes leaves more money with the producers of wealth.”
It rather depends on the marginal propensity to consume – see endless discussions on permanent income.
“Speculation = investment. No feasible way to say day traders buying and selling on their own version of “upticks” and “breakouts” are really any different than those buying houses for 30 year fixed rates in order to get net profit as they rent them out (buying for own use is a bit different).”
No this is just not true and is a confusion of terms. All investment is speculative – in the general sense – yes. But simply making bets on asset prices (especially leveraged bets) increases the level of debt without creating any additional real assets. This is a clear difference. Your example is misleading because part of the cost of housing is the cost of land – so a single “investment” can be part investment and part pure speculation.
“Not all investments have positive rates of return. The US problem was too much investment/ speculation in housing, which after 40 years of non-negative rates of return (nationally), became over-invested and had negative rates. Usually such mal-investment is only a micro problem, counterbalanced by other postivie ROI investments at the macro level. The current post 2006 production-financial crisis is because the unprecendented magnitude, in money and contracts, of bad investments.”
So you consider that there were good investments going begging? My view of the real primary cause of the problem lies in disfunctional exchange markets – basically overvaluation of the US dollar – and the resultant chronic huge current account deficits – meant that there were hardly any profitable real domestic investments available to be found. Monetary policy had to be pushed to the zero bound to stop unemployment from rising.
“Printing the money and giving it to the poor is a far better policy than the bailouts for the rich that the Dem Party (led by Bush! and McCain! and Obama) voted for in 2008, before the election.”
Aha – on something we agree.
@Determinant
“Keynes real problem is that he assumes that aggregate supply is unlimited. That’s why his General Theory isn’t general and no amount of armwaving will make it so.”
Both aggregate supply and aggregate demand are flows, not stocks. You must be thinking of aggregate supply as a stock.
“It describes a world where exogenous shocks knock the economy off the production possibility frontier, while that frontier stays the same. That was the world of the 1930’s. The specific causes based in money and financial markets. It’s also the world of today. It’s the world of the balance-sheet recession.”
Are you talking about excessive supply? Suppose so, then what if aggregate supply is a flow? Excessive stock is stock indeed, but aggregate supply does not only imply inventory but also supply capacity while supply capacity reflects various fixed factors of production. Excessive stocks is the cause of balance-sheet recession as a matter of course, but you interpret it with the wrong perception that aggregate supply is a stock.
“Keynes explicitly in the introduction of his book rules out the possibility that an exogenous shock may itself contract the price-possibility frontier. That’s what demand in excess of supply mean or a short aggregate supply means.”
Thus, your interpretation is wide of the mark.
“That seems to me what the oil shocks did in the 1970’s and in that case Hayek’s economics are the order of the day. It’s the world of inflationary recessions.”
Wide of the mark, also. What you call inflationary recessions reflects what Keynes calls semi-inflation.
“Prices are increasing because something is truly getting more rare.”
No. It largely depend on the size of money supply (i.e. M=Y/V +L(r)). When money for speculation outclimbs money for production semi-inflation is likely to observable. Hayek doesn’t distinguish the former money-possession from the latter.
“We can print as much money as we want but it won’t solve the underlying rarity. That’s the world with no more cheap oil.”
If we follow Keynes’ vision, it is because of the liquidity preference that some real commodity-prices outclimb the real wages.
“The case where the economy’s equilibrium point lies below the production possibility frontier is where Keynesian economics is valid and its prolicy prescriptions appropriate. The case where the economy is above the production possibility frontier is Hayek’s territory…. He at best offers only half a theory. ISTM Hayek only offers half a theory too. Much as I disagree with Roger Garrison, he offers a wonderful slide show on this point, though he decries the Keynesian bit of it, which is obvious. Neither Hayek nor Keynes put forth a general theory on anything because their assumptions limited them to one half of the possibilities.”
That’s a meaningless analysis. You are assuming the state of full employment when you’re talking of “the economy’s equilibrium”. That is a theoretical pitfall. You must be thinking that the Investment is identical with the Savings and thus Say’s law is valid in the real world, which is a classical view. (Shall I present formulae to explain this? But, those who have learnt economics must be aware of them). In practice, the assumption is not true. Though superfluous, the state where full employment is stable is the territory of both Austrian school economics like Hayek’s and Neo-classical economics, where the quantity theory of money (i.e. the theory of money supply which doesn’t distinguish the speculation from the production) is applicable. It is, therefore, Austrian economics and Neo-classicism that are ‘special’ theories.
“Neither Hayek nor Keynes put forth a general theory on anything because their assumptions limited them to one half of the possibilities.
As, unlike Austrians or neo-classicists, he uses the dichotomy on money supply, his theory is more ‘general’ than the two.
“The real, unanswered question in economics seems to me how do we distinguish what world we are in, if we can be in both worlds, a Hayekian world or a Keynesian world.”
In Mr Rowe’s view, Keynesianism is identical with what you call American Keynesianism. In this regard, we are neither in a Hayekian nor a Keynesian world. Instead, we live in Keynes’ world.
“I explicitly forbid the use of politics or political dogma to justify answers to this question because I said both possibilities are valid and can happen.”
This issue is by nature not about political dogma. It actually tends to become part of politics because people don’t understand Keynes’ vision.
“Even better, how can you migrate between the two to have an optimum economic policy?”
Already answered.
Regards,
Jasiek
PS Today I was in Fukushima and drove home about an hour ago. I read your reply via mobile phone at a service area on the motorway back home.