Yesterday I wrote:
But if and when Krugman does draw some policy implications from the “sinkhole” of corporate saving, he’s way too savvy to ignore the saving/investment identity. He’ll talk about income distribution, propensities to save, and dysfunctional monetary policy. Or at least imply those assumptions.
Looks like we can assume Mr. Krugman doesn’t read my blog, as his newest post is a step backward, invoking the tired old myth that conservatives just don’t get why Say’s Law is a fallacy. But let’s start with the post that got Krugman’s attention:
Ah, but why are these investment opportunities lacking? Could one of the reasons be that too high a fraction of national income is being funneled into corporate profits, rather than households inclined to spend it? What Cowen has trouble with is seeing all the pieces simultaneously in true macro fashion. The problem is not that corporate money can’t find its way to ultimate investment, but that too much corporate money itself reduces the pull of final demand on the level of investment. The upshot isn’t that money disappears into cupboards, but that national income is lower than it would otherwise be.
I’m sympathetic with Cowen’s struggle: I see the same difficulties in my economics classes every year. Students can usually see only one or two linkages at a time; it is really hard to see the whole thing as one simultaneous entity.
OK, Dorman’s an immature jerk, so are lots of other economists. But what’s wrong with his argument? Everything. What he calls ”true macro fashion” is the old Keynesianism of John Maynard Keynes. The man that developed a macro model for a constrained monetary policy (i.e. the gold standard), but never really understood what made the model tick. By the 1990s the view that savings is good was back in the saddle, a key part of New Keynesian macroeconomics. When the Fed targets inflation at 2%, attempts to save more will not reduce aggregate demand. Now it’s true that the Fed fell short of its inflation target in 2009, but ever since then they’ve been pretty close. In today’s environment one common definition of Say’s Law holds (at least approximately) true for changes in AS and AD. Aggregate supply really does drive demand. Attempts to save more will not depress aggregate demand. (BTW, an alternative definition of Say’s Law—demand shortfalls cannot exist—does not hold true today.)
Now here’s Krugman:
When John Maynard Keynes wrote The General Theory, three generations ago, he structured his argument as a refutation of what he called “classical economics”, and in particular of Say’s Law, the proposition that income must be spent and hence that there can never be an overall deficiency of demand. Ever since, historians of thought have argued about whether this was a fair characterization of what the classical economists, or at any rate his own intellectual opponents, really believed.
Not being an intellectual historian myself, I won’t venture an opinion on that subject.
You don’t need to be an economic historian. Wicksell, Marshall, Pigou, Cassel, Hawtrey, Fisher, etc, all had business cycle explanations that involved what we would call “demand shocks,” even if they didn’t all use that term. Fisher invented the Phillips Curve in 1923. Keynes was inaccurately describing the standard business cycle model of the 1920s, and it’s hard to see how it wasn’t intentional, at least at some level. He personally knew some of these people. Maybe that’s why he didn’t quote them directly. Krugman continues:
What I will say, however, is that Say’s Law (Say’s false law? Say’s fallacy?) is something that opponents of Keynesian economics consistently invoke to this day, falling into exactly the same fallacies Keynes identified back in 1936.
Cowen can’t see why corporate hoarding is a problem. Like Riedl and Cochrane, he concedes that there might be some problem if corporations literally piled up stacks of green paper; but he argues that it’s completely different if they put the money in a bank, which will lend it out, or use it to buy securities, which can be used to finance someone else’s spending.
There is a problem here, but not the one Krugman assumes. These people are mostly trying to fight back against Keynesianism on its own terms, and for the most part aren’t particularly persuasive. The problem is not their conclusions; it’s their method. Let’s start with the question of whether hoarding is only a problem if it involves little pieces of green paper. That’s true if the stock of cash is held fixed by the central bank, or grows along a predetermined path. In that case, for deflation to occur there really does need to be an increase in the real demand for cash—aka money hoarding. This is the standard conservative critique of Keynesianism. But it’s not a particularly effective argument. If the stock of pieces of little green paper really were fixed (as was approximately true under the gold standard–albeit not exactly) then the Keynesians would have good reason to worry about any shock that made people want to hoard more cash. For instance, an increased propensity to save would lower interest rates, increasing the attractiveness of hoarding non-interest-bearing pieces of green paper. A depression might ensue.
So I don’t much like either side of the debate. Krugman’s wrong that deflation doesn’t require the hoarding of cash. Assuming we hold the stock of cash (i.e. the base) fixed it does. But the conservatives are wrong if they assume that an increased propensity to save won’t cause people to want to hoard more cash. Even if the saving initially takes the form of non-cash accumulation, an increased desire to save will reduce interest rates, which will induce other people (and banks) to hoard more cash.
Now one might argue that Krugman is sort of saying the same thing in a different way from his opponents:
But of course there isn’t any difference. If you put money in a bank, the bank might just accumulate excess reserves. If you buy securities from someone else, the seller might put the cash in his mattress, or put it in a bank that just adds it to its reserves, etc., etc.. The point is that buying goods and services is one thing, adding directly to aggregate demand; buying assets isn’t at all the same thing, especially when we’re at the zero lower bound.
He’s a smart guy, unlike the other Cowen-basher he does at least understand that the zero bound is essential to the modern “Say’s Law fallacy” argument. However it’s poorly framed, as the aggregate problem is not too much saving, it’s too much money hoarding. But let’s put that aside as a difference in interpretation. Krugman slips badly in two other areas:
1. Early in the crisis Krugman adopted a simple Keynesian model that had some important predictions. He likes to talk about the ways in which he’s been right—and there are some important successes. But he glosses over a key failure. After the deflation of 2009 the Fed has returned to 2% inflation targeting. Krugman didn’t expect that, because the old Keynesian model can’t account for that. In a world of 2% inflation targeting Say’s Law holds, at least in one sense. Krugman and the other old-style Keynesians want to apply a gold standard era Keynesianism to a world where Bernanke runs the Fed. I just doesn’t fit. (And dear God–is Noah Smith now in that group of old-style Keynesians? I see someone with that name in Dorman’s comment section, praising his silly post. Despite all the grammatical errors! Hopefully it’s not the Noah Smith. The one that made fun of my grammatical error.)
Krugman thinks the zero bound is a get out of jail free card for any sort of Keynesian counterintuitive cleverness. But it’s not. We are in an AS/AD world where the Fed is essentially keeping P level (on a plus 2% trend.) In that world AS drives output. There can be demand shortfalls (indeed there is right now), but this has nothing to do with the Keynesian critique of Say’s Law. Any attempt to supply more really does create more demand—from this point forward. Saving doesn’t depress demand. The problem is that inflation is the wrong target—they should stabilize NGDP growth.
2. Krugman’s second mistake is to “reason from a quantity.” The Keynesian model suggests that an increase in the marginal propensity to save might cause lower NGDP. But this prediction does not have anything to do with realized saving. Indeed (in the Keynesian model) in equilibrium an increase in the propensity to save will generally lower realized saving and investment, even as a share of GDP. Both variables are very procyclical. Thus looking at the quantity of saving tells us nothing about what is causing a recession. Yet Krugman seems to think that those corporate cash hoards are some sort of smoking gun, implicating them in the demand shortfall. Note, he specifically absolves corporations of the charge of investing too little. It’s a claim they save too much. But too much saving doesn’t cause recessions, even in the Keynesian model.
Perhaps he wishes to claim that the saving hoards show that corporations have reduced their MPC. But corporations don’t consume, people consume. OK, so the owners of corporations consume less than the average guy. Here’s Krugman on that theory:
First, Joe offers a version of the “underconsumption” hypothesis, basically that the rich spend too little of their income. This hypothesis has a long history — but it also has well-known theoretical and empirical problems.
It’s true that at any given point in time the rich have much higher savings rates than the poor. Since Milton Friedman, however, we’ve known that this fact is to an important degree a sort of statistical illusion. Consumer spending tends to reflect expected income over an extended period. If you take a sample of people with high incomes, you will disproportionally include people who are having an especially good year, and will therefore be saving a lot; correspondingly, a sample of people with low incomes will include many having a particularly bad year, and hence living off savings. So the cross-sectional evidence on saving doesn’t tell you that a sustained higher concentration of incomes at the top will lead to higher savings; it really tells you nothing at all about what will happen.
So maybe he’s got some theory that the rich people don’t actually realize that they own the corporations. They don’t realize how much wealth they are accumulating with these high corporate profits. Fair enough, but we’re a long way from “Say’s Law fallacy” now, aren’t we?
I’m sure if you add enough epicycles you could construct some sort of bizarre convoluted theory that makes Krugman correct. Let’s see how it might work:
1. The fact that corporations have big cash hoards, shows that they’ve increased their MPS. This is by no means a sure thing, as total saving often falls when the MPS increases.
2. Of course corporations don’t really have income, their owners have income. So now lets assume that the owners don’t “see through the veil.” The owners don’t realize that corporate income is their income. So now the big corporate profits don’t lead to more consumption.
3. Next we’ll assume that the increase in corporate saving reduces the velocity of circulation. Not a sure thing—it depends on the counterfactual.
4. Next we’ll assume that Bernanke’s Fed passively allows NGDP and inflation to decline, and doesn’t offset this with additional QE, or promises of future monetary easing.
If all four of those things happen, then Say’s Law might not hold.
We need to teach our macro students two key concepts: Say’s Law, and the need for NGDP targeting in a world of sticky wages. Flush the rest of Keynesianism down the toilet.
PS. You might wonder why Krugman didn’t quote those passages of Cowen’s post that showed he didn’t understand Say’s Law. Recall that Keynes is Krugman’s hero. Would Keynes have quoted Cowen?