I've just come up with a new theory of what caused the recent recession.
There was a technological improvement in making gizmos. The productivity of gizmo producers increased, so the price of gizmos fell. The demand for gizmos is price-inelastic. So total revenue from gizmo production fell. So incomes from producing gizmos fell.
The fall in their incomes meant that gizmo producers couldn't afford to buy as many non-gizmos. Which meant demand for non-gizmos fell, and so the incomes of non-gizmo producers fell too. Which meant non-gizmo producers demanded fewer gizmos and non-gizmos. Which created a vicious circle of unemployment and deflation. Which caused the recession.
Monetary policy obviously won't help, since the cause of the recession is a structural problem that had nothing to do with money. We need more government investment to increase productivity, because increased productivity will help cure the problem that increased productivity caused.
That is my theory.
None of the above makes any sense. You just can't do macro like that. It all goes wrong from the very beginning. The fall in the price of gizmos, for a given quantity of gizmos sold, and for given prices of non-gizmos, reduces the real incomes of gizmo producers, but increases the real incomes of non-gizmo producers by an equal amount. If the price of gizmos falls by $1 each, and one million gizmos get sold each year, gizmo producers have $1 million less income, but non-gizmo producers now have an extra $1 million to spare which they can spend on something else.
Sure, an improvement in productivity may cause deficient demand, but it does this by increasing Aggregate Supply, not by reducing Aggregate Demand. And the appropriate response by the monetary authorities would be to loosen monetary policy to increase AD by the same amount that AS has increased, in order to prevent deflation.
Sure, if the unemployed gizmo producers are totally immobile, and can't produce anything else other than gizmos, there will be structural unemployment. But that simply means there's no increase in AS, and so no deficiency of demand. The unemployed gizmo producers can't put downward pressure on other wages and prices by assumption, if they are completely immobile and can't do anything else.
Sure, if gizmo producers are very different from non-gizmo producers, and have different marginal propensities to hoard their income, the change in the distribution of income from the first to the second group might have aggregate effects on Aggregate Demand. But my theory made no mention of that.
Joseph Stiglitz is a great economist. A great microeconomist. But this (HT RA of The Economist) is really bad macroeconomics. God it's depressing.
If you want to talk about a deficiency of aggregate demand, and why Say's Law sometimes fails, you really do need to talk about monetary exchange economies and an excess demand for money at the aggregate level. You can't just do partial equilibrium analysis and cobble it all together.
I'm trying to remember what Keynes said. Something about the pot containing all the ceteris paribus clauses bubbling furiously and boiling over.
Worthwhile Canadian Initiative 
Even simpler. Forget land and trade and anything. Assume I’m satiated. I can either produce lots of goods and give them away, or just produce enough for my own needs. So, on my whim, GDP either rises or falls.
Nick: You make a powerful case for a land value tax. Good idea!
K: it’s an equally powerful case for a labour value tax. All depends on what “L” stands for!
You mean assume Labour is satiated? Good one, Nick!
K: Yes. Think about it. Ever heard of people earning very high incomes from selling their labour? Watch TV sometime.
Gregor,
I am intentionally being very generous to Stiglitz (in a devil’s advocate sort of way), just as some were very generous to Fama when he said things that similarly seemed to show a lack of knowledge of macroeconomics. I think you overstate the case against him, however. If the monetary policy necessary to fix a depression is so extreme as to be ridiculous (for example, if you have to set a 30% annual inflation target and make massive quantities of loans to entities that are know to be likely to default), then, for practical purposes, one can simply say that monetary policy won’t work. The range of policies that are considered even vaguely reasonable may not include anything that will have a material impact on output.
It seems to me that Stiglitz and his critics are employing fundamentally different kinds of models and the critics are assuming that Stiglitz is or should be using the same kind of model as theirs. Stiglitz is trying to conceive of an explanation for things that have occurred. This is what in Marshallian terms would be called a “realistic investigation.” His critics are countering with a projective model of possibility that contains the implicit assumption that if A is better than B and can happen it will happen.
Stiglitz errs in assuming that the same retrospective model can be used to explain the 1930s and the 2000s. I think he also needed to have gathered a lot more facts than he did. The critics make the same errors to an ever greater extent. They have both missed the “third dimension.”
The third dimension? From Sydney Chapman’s autobiography:
Nick: yes Ford’s story is partly about efficiency wage, a totally micro concern. But it also was about fear of concentrating wealth-income in such a way that that the mass demand needed for his mass production could’t be realised, a partly macro worry.
Ford’s story was an analogy and public relations spin. To criticize its literal “falsehood” is to miss the point, which highlights A truth despite its deviation from The Truth.
Stiglitz is Intro Macro wrong. Income = output = expenditure wrong. Like watching someone get muddled over the Keynesian Cross. He just doesn’t get macro.
I think this is too harsh. I think Stiglitz understands Intro Macro – he just thinks that those kinds of high-level accounting identities obscure the important factors in explaining something like the Great Depression. There’s a longer paper he wrote that spells out his thinking in more detail: “Rethinking Macroeconomics: What Failed and How to Repair It,” Journal of the European Economic Association, 9(4), pp. 591-645.
http://onlinelibrary.wiley.com/doi/10.1111/j.1542-4774.2011.01030.x/full
Here’s a relevant quote:
“But more generally, distribution matters: if prices of agricultural goods fall rapidly, farmers reduce their spending by more than urban workers and rentiers increase their spending. Aggregate demand thus falls. More generally, with both supply and demand concave functions of firm equity, there are real, and potentially large, consequences to such redistributions.”
o. nate:
In other words, Stiglitz doesn’t think macro arises onlt because of money but because of frictions an sdelayed reactions?
Nick: “K: Yes. Think about it. Ever heard of people earning very high incomes from selling their labour? Watch TV sometime.”
Ok, sure. I’m quite familiar with that kind of labour. I guess I lumped it more together with Land (rent collecting), though of course it’s not 100% like that (I suppose Steve Jobs is the canonical counterexample).
Oh, maybe all true. BUT “non-gizmo producers now have an extra $1 million to spare which they can spend on something else:” people aren’t spending that money because they are being hit in so many other ways and are frightened.
“You just can’t do macro like that. . . The fall in the price of gizmos, for a given quantity of gizmos sold, and for given prices of non-gizmos, reduces the real incomes of gizmo producers, but increases the real incomes of non-gizmo producers by an equal amount.”
Um….suppose you have an open economy? one that exports lots of gizmos? so that the fall in P_Gizmo is a bad terms of trade shock? or put another way, suppose the benefits of cheaper gizmos mostly accrue to foreigners?
What you’re describing as a nonsense sounds like a textbook case of immiserizing growth; Harry Johnson and Bhagwati worked it out in general equilibrium before you or I were born, Nick. Now, you can argue that it is very unlikely or unrealistic, if you like. But it is very, very logical.
(Exercise for the grad students: suppose the gizmo-exporting country now has a large foreign debt denominated in foreign currency. Explain whether the change in the country’s wealth is now larger or smaller.)
Simon: but the standard terms of trade effect says that the manufacturing sector will have higher real income. Stiglitz says the manufacturing sector has lower real income. He doesn’t mention exports or foreign debt. His is a closed economy analysis, as far as I can see.
All of this blackboard economics is making me very sad. Do any of these ideas make any sense if we do back of the envelope calculations over their magnitudes?
Chris: well, my back of the envelope calculation would give me a rough magnitude of 0!
Let’s work backwards. Suppose you wanted a 30% decline in GDP. Divide it by the Keynesian multiplier, say 3, to get a required 10% decline in autonomous expenditure. Now suppose farm income is say 30% of GDP, and it declines by 50%, and the difference between farmers’ and non-farmers’ mpc is (say) 0.666. That should do it. No, I don’t believe those numbers.
Nick;
Damn. Now you’re forcing me to read Stiglitz’s article. I’m still working my way through, but I have a hard time thinking of the early 2000s experience that Stiglitz highlights in a closed economy setting.
“The American standard of living was sustained only by rising debt—debt so large that the U.S. savings rate had dropped to near zero.”
“The fact is the economy in the years before the current crisis was fundamentally weak, with the bubble, and the unsustainable consumption to which it gave rise, acting as life support.”
He’s talking about a zero savings rate but not a lack of investment. We both know the reason for that; persistent and large capita inflows a.k.a. current account deficits and mounting foreign indebtedness.
When you say Stiglitz is making a closed-economy argument, is that because of what Stiglitz says? or is that your assumption?
Simon: Make sure to read the JEEA paper if you really want to know what he is talking about. It’s full of ideas and far more clearly laid out (to an economist) than the Vanity Fair piece.
Simon: “When you say Stiglitz is making a closed-economy argument, is that because of what Stiglitz says? or is that your assumption?”
Because, IIRC, he never mentions anything to do with foreigners, exports, imports, capital flows, etc.
K is right.
But the link I gave doesn’t work. here it is.
In other words, Stiglitz doesn’t think macro arises onlt because of money but because of frictions an sdelayed reactions?
I don’t want to put words in Stiglitz’s mouth. He can explain himself better than I can, so I’d recommend reading the full paper. But if you want my very short summary, he basically highlights the importance of things like credit, expectations, and firm equity in amplifying shocks.
Do you think you might be taking Stiglitz too literally, like he doesn’t literally mean monetary measures can’t help at all. He just means that the big root of this is a huge structural shift, and if you don’t address it, don’t speed the transition, then you’ll just keep getting this drip, drip, drip, over decades.
It’s like monetary policy helped in the 2000’s, but you had to keep doing it for years and years. You didn’t really address the cause of the constant drip, drip, drip. You didn’t actually re-surface your roof, you just kept bailing with buckets. Sure it had an effect, it kept your house from molding and rotting, but it would be a lot better to really get the roof in good shape.
Certainly I strongly prefer Stiglitz’s solutions. These are really high return investments of the kind the pure free market will grossly underprovide due to externalities, asymmetric information, coordination problems,…
Growth economists Charles I. Jones of Stanford and John C. Williams of the San Francisco Fed wrote in a 1998 QJE paper:
Is there too much or too little research and development (R&D? In this paper we bridge the gap between the recent growth literature and the empirical productivity literature. We derive in a growth model the relationship between the social rate of return to R&D and the coefficient estimates of the empirical literature and show that these estimates represent a lower bound. Furthermore, our analytic framework provides a direct mapping from the rate of return to the degree of underinvestment in research. Conservative estimates suggest that optimal R&D investment is at least two to four times actual investment [emphasis added].
– Vol. 113, No. 4 (Nov., 1998), pp. 1119-1135
the monks chase each others assumed tails/tales
two words
open and closed
two nominal quantities
output value debt service value
final ponder
credit is rationed like spots in the columbia college freshman class
not like oranges at the korean fruit and veg stand on broadway and 111 st
price of orange <=> price of money
nope interest is not the price of credit
like orange prices
unless the fuit and veg guy decides if you are qualified to buy her oranges
stig is trying to tell the chattering literate class a story
a vague underlying parallel between great D and great R
its a just so story
that is not a logic boxed story like our dear nick
sunny abbot of this monastic establishment
TV stats. I hope they are correct, and Nick finds them useful.
http://financiallyfit.yahoo.com/finance/article-113820-11722-1-now-is-a-great-time-to-buy-a-television
TV Prices Fall, Squeezing Most Makers and Sellers
“There were roughly 32 million television sets sold in North America in 2004, for an average cost of $400, Mr. Gagnon said. The average size of a television was 27 inches. Today, 44 million sets are sold a year in North America, with an average cost of $460 and an average size of 38 inches.
Consumers buy a new television set every seven years or so, and an average household owns 2.8 TVs, he said. While those numbers would suggest a bonanza for television manufacturers, Mr. Gagnon said the larger, more sophisticated sets were expensive to manufacture and cut into manufacturers’ profit margins.
To help reduce costs, manufacturers invested heavily in sophisticated new factories or retrofitted old ones that were capable of cranking out more televisions at lower cost. The problem is that the factories became operational about the time the recession hit, creating a glut of televisions and forcing prices down.
A strong yen, relative to the dollar, has further hurt Japanese manufacturers like Sony and Panasonic, while Korean manufacturers like Samsung have benefited from a weak won.”
And, “”Everybody is fighting for a limited amount of consumer dollars,” said Gregg Richard, president of PC Richard and Son, which has 66 electronics and appliance stores. “We are selling more TVs, more units, at lower retail prices.”
It does not help that consumers are reluctant to pay much more for the latest features, like 3-D and Internet connectivity. Instead, they are likely to wait patiently for a few months until the price inevitably comes down.
“People used to pay additional to get a Sony Trinitron,” said Riddhi Patel, director of television systems at IHS iSuppli, a market research firm. “But the industry has trained the consumer that any time there is a new technology, if they wait six months the price will come down.”
Paul Gagnon, director of North America TV research for DisplaySearch, which tracks the market, noted that a 60-inch LCD television by Sharp was now selling for as little as $799 — about half of what it was selling just a year ago. “Absolutely amazing,” he said.
The slump is a hangover of sorts for an industry that binged on years of double-digit growth, as consumers rushed to replace old television sets with flashy new models with new features like high definition and flat screens.”
And, “It’s a great time to buy a television, and Ram Lall, a television salesman, isn’t happy about it. In a basement showroom of J&R, the huge electronics store in Lower Manhattan, Mr. Lall says the days of making big money from televisions are in the past. Pointing to a top-of-the line, 55-inch Sony television, Mr. Lall said it would have sold for $6,000 a few years ago. The current price? $2,599.
“We are making less money because the company is forcing us to slash prices,” Mr. Lall said, standing amid rows of flickering television sets.
Televisions have become so inexpensive that the profits have largely been squeezed out of them, a result of a huge increase in manufacturing capacity that has led to an oversupply and continued downward pressure on prices from low-cost manufacturers and online retailers.
The near fire-sale prices are great for consumers, who can now buy a television for a fraction of what one cost just a few years ago.
But what is good news for consumers has been a nightmare for manufacturers of TVs and retailers that sell them. The earnings of mainstay television manufacturers like Panasonic, Toshiba and Sony have been hammered. Sony, for instance, is overhauling its television operations because of what one executive said recently was a “grave sense of crisis that we have continued to post losses in TVs.” Even newer and more nimble competitors like Samsung and LG have struggled to make much money on TVs, if any.
Seeking to stanch its losses, Sony on Monday said it would end its flat-panel joint venture with Samsung, which was set up in 2004 to capture the boom in televisions with liquid-crystal displays. Samsung, based in South Korea, will pay about $940 million for Tokyo-based Sony’s 50 percent stake; Sony aims to save on manufacturing costs while still buying panels from Samsung.
For retailers, the picture is not much better. This month, Best Buy reported a 29 percent drop in net income for the third quarter, in part because the retail chain had slashed prices on televisions and other electronics.
Perhaps even more ominously for the long term, the future of televisions appears to be more about what content they can provide, like Netflix and iTunes, than new hardware features like flat screens or 3-D technology. It is an area where television manufacturers have struggled with little success to get an edge, even as Apple and Google vow to upend the industry.”
test
spam filter, someone?
TMF: sorry. Found it in spam filter.
Thanks, Nick!
I’m trying to figure out if the average cost of $400 to average cost of $460 is costs or ASP’s (average selling prices).