Say Law follies

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.

In the past I’ve caught Brian Riedl and John Cochrane doing it; now Peter Dorman finds Tyler Cowen in their company.

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?


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66 Responses to “Say Law follies”

  1. Gravatar of TravisV TravisV
    11. February 2013 at 19:18

    I have to say, it is very frustrating when my Austrian buddies characterize Monetarist arguments as “Keynesian.” Prof. Sumner has shown that they are not at all the same thing……

  2. Gravatar of TallDave TallDave
    11. February 2013 at 19:23

    Good points, very illuminative, thanks for sharing.

    BTW, an alternative definition of Say’s Law—demand shortfalls cannot exist—does not hold true today.

    Sorry, a little tangential, but this has been bothering me lately. It seems intuitively obvious you can’t really have such a thing as a “demand shortfall” since consumption is always limited by what can be produced, which is why less productive countries have lower consumption — shouldn’t a “demand shortfall” really be considered a misallocation of production? Aside from temporary shocks, talking about demand that way seems too much like a theory that considers rain as an effect of wet streets. Maybe there’s a better theoretical underpinning for “demand shortfalls” than I’ve seen?

  3. Gravatar of ChargerCarl ChargerCarl
    11. February 2013 at 19:40

    Scott, you said:

    “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.”

    I’m confused. Canada didn’t see any deflation or, as far as I know, any deviation from 2% inflation, yet they’re suffering from what appears to be depressed AD.

  4. Gravatar of ssumner ssumner
    11. February 2013 at 19:50

    Thanks Travis.

    Talldave, Demand is the wrong term, it should be called a “nominal shock.” That makes it clear how sticky wages could lead to less quantity supplied and less quantity demanded.

    Chargercarl, You said;

    I’m confused. Canada didn’t see any deflation or, as far as I know, any deviation from 2% inflation, yet they’re suffering from what appears to be depressed AD.”

    And so are we. We have a demand shortfall today, because inflation is the wrong target. Even if inflation is 2%, it doesn’t keep employment at the natural rate.

  5. Gravatar of Alexei Sadeski Alexei Sadeski
    11. February 2013 at 20:12

    Reading Krugman provides conclusive proof that high school never ends.

  6. Gravatar of Ron Ronson Ron Ronson
    11. February 2013 at 20:20

    Had Krugman said that business was holding piles of cash rather than investing I think he may have had a point even taking inflation targeting into account.

    Reduced investment would depress demand for labor, and with sticky wages this would lead to employment below the natural rate. There is no guarantee that IT or even NGDPT would increase the money supply enough to address this. I guess wage-level targeting might but that would lead to both NGDP and inflation being at indeterminate levels.

  7. Gravatar of Saturos Saturos
    11. February 2013 at 21:11

    “But let’s put that aside as a difference in interpretation.”

    See, I don’t think we should. I think the problem starts right there.

    Rewrite all the syllabi. Don’t talk about “aggregate demand” and “aggregate supply”. There is the total flow of output, being produced by diverse firms which are owned by and employ diverse households. These people want to swap what they make with each other to maximize utility. If there is no money, then Say’s Law is obviously true. More precisely Walras’ Law is true, if we imagine everything getting traded at one giant swap meet. But since people are not stupid, and recalibrate unsatisfied demands, Say’s Law is also true.

    With the introduction of money to make wide exchange actually possible, we now have the economy split into n markets. But each of these markets is still a bilateral exchange system, as before, with two commodities bartered against each other in each. Money (cash, demand deposits, whatever) on one side, output (bread/piano lessons/jumbo jets) on the other.

    It is obvious that Say’s Law only fails when the aggregate inflow of money (a [quasi-]physical commodity) to households is not equal to the aggregate outflow. I.e., there is a change in the circular flow of (*money*!) income.

    The problem is that after we draw the picture on the board in the first lesson, with goods arrows going one way round the circle, and then money arrows the other way, the students completely forget the money arrows subsequently, under the discouragement of their teachers. Money is eventually reintroduced as an asset in a portfolio-balance decision, but without recalling its omnipresent market-clearing role.

    Even brilliant Keynesians like Krugman are dissonant here – he sometimes explicitly admits that money is central to the whole thing, but then having dealt with the possibility of shortfalls of spending (the flow supply of money for goods) he reverts to Keynesian thinking. Whereas sane people should easily see that, *really*, the whole question of spending on output, gluts, inflation, is all about the exchange of the flow of money with the flow of goods. Which immediately leads you to supply and demand for money. Thinking about the supply and demand for money lets you determine the flow supply of money – rising demand for money stocks leads to falling supply of money flows, just like the slides Scott and David presented in Washington. So how can Keynesians sensibly talk about stimulus and spending without continuing to think about demand for holding money, and the supply to spend it? Instead they go back to ignoring money as soon as they have satisfied themselves that they have put down the “deniers”. I call that cognitive dissonance.

    Now, it’s possible that even if a monetary exchange-based picture is what intuitively corresponds to reality, some other more bizarre abstract “real expenditures” approach (confusing the desire to buy goods with the money flows available to pay for them) may work better as a model. But do Keynesians really have a great track record in outpredicting monetarists? *cough* 1970′s *cough.

    I think perhaps the big obstacle is that it seems *too simple* to people who do get the picture. Why have we had centuries of crises, if it was that simple all along? Well that’s another question, but just think that as Scott points out Irving Fisher had basically this model in the 20′s, and basically suffered a public relations disaster in ’29, without in fact being refuted by events – in fact, since he was the father of the recovery, he was if anything vindicated. Since then the profession went on a wild goose chase for more “sophisticated models” when in fact they didn’t need any. Which makes perfect sense to me – since the basics of market clearing can be explained to school-children quite simply, it’s hard to believe that it should take that much more exposition to explain why markets often fail to clear in aggregate, again with a story which corresponds pretty straightforwardly to observed market reality.

    This explains the whole root of mainstream economists’ refusal to take MM seriously. They continue to take the “gears and levers” approach to visualizing and then modelling the macroeconomy, This also accounts for how economists could possibly have ever thought that stabilizing the growth rate of prices (!), instead of the level of aggregate spending/money flow (inverse value of money, whatever) would lead to stability. It’s all gears and levers to them. They don’t have a picture in their heads of what is physically going on when people are losing their jobs. You can’t talk about people saving instead of spending, they’re not opposites – obviously you mean “holding MoE” instead of “spending MoE”. You can’t say “consumer demand isn’t high enough to employ people”, which so many people think of as “people ought to want to buy more stuff”. What you mean is, workers are unemployed instead of trading with each other as before because the nominal flow of medium of exchange is too thin to meet the nominal rates at which they require to be paid, at the same volume of work hired. Everything else is illogical. And Keynesians are still illogical today when they accept and distance themselves from this clear picture as it suits them.

    And yes, what Alexei said.

  8. Gravatar of TravisV TravisV
    11. February 2013 at 22:45

    Could someone please explain how I can subscribe to Marcus Nunes’s blog via Google Reader? It’s not clear to me how that’s possible since I don’t see “RSS” or “feed” on this page: http://thefaintofheart.wordpress.com thanks!

  9. Gravatar of Suvy Suvy
    11. February 2013 at 23:06

    I’d also like to clear up some things that are clear misinterpretations of the Keynesian theory and the paradox of thrift. The standard interpretation of Keynes assumes that savings are turned into investment; however, this model is not a good interpretation of Keynes and is flat out wrong(Keynes was “radically opposed”–in his own words–to this view that was put forth by John Hicks).

    The biggest misunderstanding of the Keynesian model is that savings are turned into investment. What Keynes actually says is that investment are turned into savings, that investment is financed by a financial sector/banking system, and that the supply of savings has no affect on the amount of investment that takes place. None of these important facts are ever included in any “Keynesian” model I’ve seen except for Minsky.

    The paradox of thrift is not actually about people saving money and taking it out of circulation; it’s about what happens when you have falling investment combined with falling aggregate demand. If you have falling investment, savings must fall because investment is turned into savings. On top of this, if the amount invested is not counterbalanced by the corresponding amount of consumption, and thus aggregate demand collapses. If this causes people to cut back on their consumption and investment is already falling, aggregate demand will continue to fall farther. This process will continue and the total amount of savings will actually be less than if new money is injected into the circular flow of an economy. That is the paradox of thrift. It has nothing to do with savings not being invested; it has to do with investment falling which causes savings to fall and if consumption falls too, then you have an economy with major problems. That’s the Keynesian view of the paradox of thrift.

  10. Gravatar of Suvy Suvy
    11. February 2013 at 23:22

    Also, there’s a very simple way to debunk Say’s Law. Almost every single investor(investors are businessmen) hold a good amount of money in cash. This is because it doesn’t make any sense to sell assets in order to buy a new asset that is at a bargain all of a sudden, especially when the assets are illiquid. If I run a firm and all of the assets that I trade/own are illiquid, it doesn’t make any sense to have 0% cash. I always want to hold cash in case another opportunity comes up, because if I had to sell an illiquid asset, it’s very expensive to do so at a particular time on an immediate need for cash. This is a scenario that played out quite a bit in 2007-2008 where firms like hedge funds were basically behaving like banks–borrowing short term and buying long-term illiquid assets. Those same firms had runs and some of them had to close. When you run a firm that holds a lot of illiquid assets, it always makes sense to have some cash on hand and it can certainly make sense to hoard cash regardless of inflation(unless inflation is at absurdly high levels like 20% or so).

    Say’s view was that it never makes sense for a “rational” businessman to hoard cash. However, I would argue that it almost always makes sense for a rational businessman to hoard cash, especially in uncertain economic times and in financial panics and in industries that can be very vulnerable to runs.

    Let’s take a simple example, suppose that I run a firm that primarily trades in illiquid assets and I usually hold 10% in cash. Now, I see an asset that is cheap so I take half of the 10% and buy that asset; now I hold 5% in cash. However, since I am vulnerable to a run and my assets are illiquid, it makes perfect sense for me to take the income that I earn off my assets and to “hoard” the income until I have 10% in cash like I usually do. Even if inflation is at 5%, it still makes sense because cash gives me security and protection against certain events. In the event of a financial panic, I might get scared because so many of my assets are illiquid that I may want 20% in cash to protect against some sort of a run against my firm.

  11. Gravatar of Suvy Suvy
    11. February 2013 at 23:27

    I think the idea of Say’s Law is completely out of touch with reality. Cash hoarding, as Keynes talks about it, isn’t irrational just because cash is a bad investment. Cash hoarding also allows you to have more cash on hand later. This means that I can use cash to buy cheap assets or to possibly protect against some sort of a run. Cash in a liquid asset that can be exchanged for anything. That single point, in and of itself, makes having a certain amount of cash on hand very valuable. That preference for cash(liquidity preference) may go up if there’s a banking panic and it may go down in other periods of financial stability.

  12. Gravatar of TravisV TravisV
    11. February 2013 at 23:37

    Question:

    I’ve heard David Beckworth and others argue in the past that rapid NGDP growth above 5% in 2005 and 2006 was a major contributor to the housing bubble.

    If that’s true, then……why didn’t we have any similar crazy asset bubbles during the 1970′s (when NGDP grew much more rapidly)?

  13. Gravatar of bret bret
    12. February 2013 at 02:13

    Hi Scott, great post as usual. I was wondering if you could help me out with one of your points which I’m trying to understand. You say that:

    “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. ”

    Now I didn’t understand this at first, but now think this might be what your saying: Keynesian counterintuitive cleverness only works if the central bank is constrained by the zero lower bound and hence can’t achieve its target. However, we are observing the central bank roughly hitting its targets (i.e. P growing at 2%). Hence the central bank isn’t really constrained (because unconventional policy works?). Hence Keynesian counterintuitive cleverness doesn’t apply (because the central bank would adjust the scope of QE to offset things).

    Is this what you meant? It sounds reasonable, but imho doesn’t it require the assumption that QE really does work? I thought that the jury was still out on that one?

    Thanks!

  14. Gravatar of bret bret
    12. February 2013 at 02:15

    Apologies, there is a horrible misuse of “your” instead of “you’re” in my previous comment. I hope the moderator doesn’t get too angry.

  15. Gravatar of Saturos Saturos
    12. February 2013 at 02:25

    OK Scott, here’s some good links. This one’s about how the Nikkei jumped on remarks by a Treasury official that the US supported yen depreciation:
    http://www.cnbc.com/id/100451834?utm_source=dlvr.it&utm_medium=twitter

    And this one is Jeremy Warner in the Telegraph despairing that nobody knows what’s up with the UK economy: http://www.telegraph.co.uk/finance/comment/jeremy-warner/9863483/No-one-really-understands-whats-going-on-in-our-economy.html

  16. Gravatar of Saturos Saturos
    12. February 2013 at 02:27

    And this one is Barry Eichengreen on the future of economics education: http://www.project-syndicate.org/commentary/how-economics-will-change-in-the-next-20-years-by-barry-eichengreen

    Travis, I normally subscribe to blogs using my Google Chrome extension, which gives me an icon to click in my address bar whenever there’s an RSS feed to subscribe to. But you can also go to your Google Reader page and use the “Subscribe” box in the sidebar, just type in the name of the blog you want to subscribe to, eg. “Historinhas”.

  17. Gravatar of Becky Hargrove Becky Hargrove
    12. February 2013 at 03:21

    Disbelief in Say’s Law is little more than a lazy response to commenters such as Sasha on your jobs bleg, who are just expected to “get in line” behind the rest.

  18. Gravatar of Say Law follies | Fifth Estate Say Law follies | Fifth Estate
    12. February 2013 at 03:26

    [...] See full story on themoneyillusion.com [...]

  19. Gravatar of TallDave TallDave
    12. February 2013 at 05:21

    Demand is the wrong term, it should be called a “nominal shock.”

    Thanks Scott, that seems to make more sense, I’ll have to think about that.

  20. Gravatar of ssumner ssumner
    12. February 2013 at 05:42

    Saturos, Great Comment. BTW, I also noticed that Japan story–quite interesting.

    Suvy, You said;

    “The paradox of thrift is not actually about people saving money and taking it out of circulation; it’s about what happens when you have falling investment combined with falling aggregate demand. If you have falling investment, savings must fall because investment is turned into savings. On top of this, if the amount invested is not counterbalanced by the corresponding amount of consumption, and thus aggregate demand collapses. If this causes people to cut back on their consumption and investment is already falling, aggregate demand will continue to fall farther. This process will continue and the total amount of savings will actually be less than if new money is injected into the circular flow of an economy. That is the paradox of thrift.”

    So there’s no paradox of thrift in the paradox of thrift. Okay . . . .

    TravisV, Very good point about the 1970s.

    Bret, No, it doesn’t require QE to work. The only needed assumption is that the Fed is capable of controlling the expected rate of inflation.

    In any case, the school is not out on QE, it raises the expected rate of inflation in TIPS markets—the evidence is overwhelming.

  21. Gravatar of Niklas Blanchard Niklas Blanchard
    12. February 2013 at 05:54

    TravisV: All WordPress blogs’ RSS feeds are located at *sitename*.wordpress.com/feed/.

  22. Gravatar of Geoff Geoff
    12. February 2013 at 06:06

    Say’s Law just holds that supply **constitutes** demand.

    It does not hold that supply **causes** demand, as if an increase in the supply of good X or goods X, Y and Z, will cause a profitable nominal demand for good X, or goods X, Y and Z.

    Even anti-Keynesians are accepting Keynes’ false interpretation of Say’s Law.

    Say was just responding to a prevailing myth around his time that there can be such a thing as more real wealth in the aggregate than what people want or desire in the aggregate. There is no such thing as this.

    For those periods of time when there are depressions, or aggregate increases in the desire to hold money, or aggregate build ups of inventory, and so on, these do not in any way refute or invalidate Say’s Law. Say’s Law still holds. That which is supplied still **constitutes** that which is demanded.

    Furthermore, and related, the “aggregate” overabundance of goods is actually a partial relative overabundance, with a corresponding, **UNOBSERVED**, partial relative underabundance of goods.

    Someone on a deserted island is observed to reject every single electronics device that washes up on shore. Seems there is a general oversupply of wealth here. Or is there? A little thinking of counter-factuals and we can imagine a very significant unobserved partial relative undersupply of wealth, such as food, water, medicine, shelter, toothbrushes, soap, and so on.

    The reason so many people believe the Great Depression invalidates Say’s Law is because they are only considering what they can see, and ignoring what they cannot see but is required in order to have a correct understanding of Say’s Law.

  23. Gravatar of Geoff Geoff
    12. February 2013 at 06:26

    I think this is related and useful:

    Say’s Law is a concept that does not exclude a person’s mind and their plans. It is not a purely empirical concept. It is more philosophical.

    It is not surprising that empirically minded economists who believe there exists constant relations between external economic objects divorced from the mind, approach Say’s Law in the same empirical manner and conclude that its alleged claim of a constant relation between external objects (e.g. supply of goods and demand for goods) sometimes holds and sometimes doesn’t hold. They believe Say’s Law is purely empirical.

    In order to understand classical economics, and Say’s Law, indeed to understand most economics prior to around the 1950s, is to always keep in mind…the mind itself.

    Economics around this time was more psychological and less empirical. It asked and answered questions of the human condition in a world of scarcity. The foundation of classical economics is best explained as philosophical self-reflection, not statistical empirical analysis as in physics.

    It’s a mistake to approach Say’s Law using statistical empirical analysis as the standard. For the law includes non-empirical, i.e. psychological/mental/intentional, categories in addition to external objects.

    One can argue it is not fashionable to include the mind in “modern” economics, but if the intention is to understand classical economics, then self-reflection is a must.

  24. Gravatar of Suvy Suvy
    12. February 2013 at 06:31

    “So there’s no paradox of thrift in the paradox of thrift. Okay . . . .”

    The paradox of thrift is that falling consumption when you have falling investment reduces aggregate demand, and thus means that you save less in the future. There is less saving, but the falling savings comes from falling investment and falling consumption means people are attempting to save more. It has nothing to do with the fact that there is savings that are invested. That is a misinterpretation of the Keynesian theory that Keynes himself distanced himself from(it was Hick’s interpretation).

    The paradox of thrift is this simple, if you have falling investment creating falling AD and people try to cut back consumption(try to save more), in the aggregate, people actually save less.

  25. Gravatar of Suvy Suvy
    12. February 2013 at 06:50

    “If all four of those things happen, then Say’s Law might not hold.”

    Say’s Law never actually holds for the reasons I stated above. Especially when dealing with firms that are subject to runs and firms that trade highly illiquid assets. Cash is a liquid asset that I can use to buy things; it holds a lot of flexibility, therefore, hoarding cash can make perfect sense, especially in poor economic climates where liquidity preferences are high.

    Also, any version of Keynes saying that savings is turned into investment is flat out wrong. In the Keynesian theory, investment is turned into savings. Keynes expounds on this in both The General Theory and in his papers after The General Theory.

    “The investment market can become congested because there is a shortage of cash. It can never become congested when there is a shortage of savings.”–J.M. Keynes

    “Surely nothing is more certain than that the credit or “finance” required by ex-ante investment is not mainly supplied by ex-ante saving.”–J.M. Keynes

    By the way, Keynes also says that investment is what gets turned into savings in chapter 4 and chapter 7 of The General Theory as well.

  26. Gravatar of Suvy Suvy
    12. February 2013 at 06:53

    “Recall that Keynes is Krugman’s hero.”

    No he’s not. Krugman’s hero is John Hicks. Krugman’s ideas are about as classical as they come; Paul Krugman is no Keynesian and misses the most important parts of the Keynesian theory.

  27. Gravatar of Saturos Saturos
    12. February 2013 at 07:12

    Suvy, Krugman has literally written paeans to Keynes. I think you mean Hicks is Brad DeLong’s hero. Yes I know what you’re saying, you think Keynes’ ideas proper were quite different from the neoclassical synthesis they were shoehorned into, and Krugman is in the latter tradition (as he knows).

  28. Gravatar of Suvy Suvy
    12. February 2013 at 07:27

    “Suvy, Krugman has literally written paeans to Keynes. I think you mean Hicks is Brad DeLong’s hero. Yes I know what you’re saying, you think Keynes’ ideas proper were quite different from the neoclassical synthesis they were shoehorned into, and Krugman is in the latter tradition (as he knows).”

    The problem is that the New Keynesian miss the most important aspects of the Keynesian theory. In fact, Skidelsky actually says that the most accurate interpretation of Keynes is held by Minsky, which is very different from the interpretation held by Krugman.

    Why Krugman isn’t a Keynesian:
    1. Krugman has no financial sector that finances investment in his model of macro
    2. Krugman thinks that savings are turned into investment
    3. Krugman still things IS/LM is worth a salt and thinks it’s Keynes’ model when Keynes was “radically opposed” to it
    4. Krugman completely misunderstands liquidity preference from a Keynesian perspective.
    5. Keynesian economics is built on principles laid out in Keynesian probability theory, which Krugman has no understanding of
    6. I can go on all day

    If anyone ever wants to know what a real Keynesian sounds like, I’d recommend them to read John Maynard Keynes by Hyman Minsky. In my eyes, not only is that an accurate representation of Keynes’ work, but it is the best model of a capitalist economy that I have ever seen. It’s not very long, but it is very concise and radical.

  29. Gravatar of TravisV TravisV
    12. February 2013 at 08:19

    More from Ryan Avent:

    “The wisdom of Scott Sumner”

    http://www.economist.com/blogs/freeexchange/2013/02/monetary-policy-0

  30. Gravatar of TravisV TravisV
    12. February 2013 at 08:30

    Another question:

    If Krugman doesn’t read Sumner’s blog, what does he read? If he’s ignoring Sumner’s arguments, he must also be ignoring Ryan Avent and Yglesias.

    Does Krugman read nothing but DeLong and Thoma these days?

    Anyway, here’s an old post where Krugman discusses what he reads:

    http://krugman.blogs.nytimes.com/2011/03/08/what-i-read

    I bet he’s ignoring Yglesias now……

    But Krugman is still WAY better than Stiglitz!

  31. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    12. February 2013 at 08:57

    ‘Krugman thinks the zero bound is a get out of jail free card for any sort of Keynesian counterintuitive cleverness.’

    Wish I’d coined that phrase. But, I think Geoff is making a good point. Let’s first define what we mean by ‘Say’s Law’.

    Using George Stigler’s ‘Supply is (implicit)demand.’, it seems obvious that flexible prices are needed for it to hold.

    And that is not where Krugman wants to go. Because a lot of policies that he favors contribute to inflexibility of prices.

  32. Gravatar of a.concerned.reader a.concerned.reader
    12. February 2013 at 09:00

    Scott asserts, “Any attempt to supply more really does create more demand—from this point forward.”

    In the Ozarks,we have an unlimited supply of rocks.

    Scott, will be see you there on Saturday, picking up your fair share of the demand created by this supply.

    This leads me to the Iron Rule of the Ozarks: Scarcity creates demand

  33. Gravatar of Geoff Geoff
    12. February 2013 at 09:07

    Saturos:

    You wrote:

    1. “If there is no money, then Say’s Law is obviously true.

    2. “It is obvious that Say’s Law only fails when the aggregate inflow of money (a [quasi-] physical commodity) to households is not equal to the aggregate outflow. I.e., there is a change in the circular flow of (*money*!) income.”

    3. “This explains the whole root of mainstream economists’ refusal to take MM seriously. They continue to take the “gears and levers” approach to visualizing and then modelling the macroeconomy”

    4. “since the basics of market clearing can be explained to school-children quite simply, it’s hard to believe that it should take that much more exposition to explain why markets often fail to clear in aggregate…”

    5. “It’s all gears and levers to them. They don’t have a picture in their heads of what is physically going on when people are losing their jobs. You can’t talk about people saving instead of spending, they’re not opposites – obviously you mean “holding MoE” instead of “spending MoE”. You can’t say “consumer demand isn’t high enough to employ people”, which so many people think of as “people ought to want to buy more stuff”. What you mean is, workers are unemployed instead of trading with each other as before because the nominal flow of medium of exchange is too thin to meet the nominal rates at which they require to be paid, at the same volume of work hired.

    Each of the comments in bold are untenable.

    (1) Say’s Law is not only obviously, i.e. always?, true in barter economies only. It always and everywhere true. It just states that supply is what constitutes demand. The demand for goods in the aggregate, is constituted by supply in the aggregate. It does NOT hold that an increase in supply causes an increase in demand for that same supply, nor does it hold that an increase in supply causes a nominally profitable demand for that supply. Even during the deepest part of a depression, with massive quantities of inventory piling up, and long line ups at the unemployment office, Say’s Law still holds. Whatever demand for goods exists in the aggregate, is still constituted by supply in the aggregate.

    (2) Two problems. One, Say’s Law does not “fail” when aggregate inflows of money fail to match aggregate outflows of money. It could only fail if demand for goods in the aggregate is constituted by something other than supply in the aggregate…meaning it will never fail. Two, and closer to the claim that you have made, it is nonsensical to speak of “aggregate inflows of money” and “aggregate outflows of money”. There is no such thing as these concepts. The economy is not a machine in a lab, which is understood from outside of it, abstracted away from it, from some scientist’s, or bird’s, (God’s?) eye view from without, after which you believe you can make sense of “money flowing into the system” and “money flowing out of the system.” (It is even problematic to use the phrase “flow” in the first place, but we’ll get to that later). Every single money expenditure or “money outflow” made by one “household” is equivalently a receipt of money or “money inflow” from another “household.” Money “flows” are really just another way of saying “Money spent is money earned.”, or, “Every party that earns money necessarily implies the existence of another party that spends that money.” It is impossible for there to be inflows or outflows of money that are greater than or less than outflows or inflows of money. In short, you are committing the fallacy of composition, by taking the fact that a particular single household could potentially earn more or less money than it spends, and then claiming the same thing can take place for the economy as a whole. But in the economy as a whole, all such “money flows” are offsetting. In the aggregate, money spent is money earned is always true.

    (3) Perhaps it takes an “outsider’s” perspective to make this obvious, but MM is no less a “gears and levers” approach to the economy as is Keynesianism. You just want to change the rate at which gears and levers are to move, so that you can get an allegedly more favorable outcome from “the machine”. Instead of putting in 30 Watts, you want to put in 30*k Watts, or whatever. Just like Keynesians will be left “denying” problems exist with monetary policy if price inflation is on target, so too will MMs be left “denying” problems exist with monetary policy if NGDP is on target.

    (4) Markets never fail to clear in the aggregate. Portions of the market is what can fail to clear. There has never been in the history of mankind, and there probably will never be in the future either, a time where everything that is supplied, fails to find a single buyer. What we observe are portions of the market failing to clear. I suspect the reason you perceive of aggregate failures of market clearance is because you are only considering of what is seen, not what is not seen. You see piles of inventory, you see unemployed people, and so on, but you aren’t considering the unobserved concepts that are necessary to understanding how the market never fails to clear. You’re not considering all the unobserved goods and services that never got a chance to be produced and offered because the resources were instead used up in the production of that which you observe the inventory piling up! What you are observing during periods of depression and inventory buildup are periods of observable partial relative overproduction of goods with a corresponding unobservable partial relative underproduction of goods. The reason this unobserved component is crucial is because the whole argument of market clearance is based on the very real existence of the human desire for practically unlimited amounts of additional wealth in general. This desire can only ever be met at infinite abundance of everything, which is to say practically never. Depressions are just what we call periods of what are in fact periods of particularly acute partial relative overproduction and partial relative underproduction. They are NOT periods where total supply is too great relative to total demand. This is the case even if the money supply drops by half, and half the workforce is laid off and consumption is halved. This scenario is one where too many resources were put into presently available consumer goods, and not enough were put into goods available for future consumption. Remember, while consumers have a practically unlimited desire for more wealth in general, they are constrained by time and resources, and must allocate goods production and consumption over time.

    (5) Prices are a function of money expenditures, not vice versa. I own my labor. If I offered my labor for $10 million an hour, but nobody took my offer, then this does not mean that there is insufficient money in existence. It means that my asking price is relatively too high compared to other labor in the market. I am asking for a partial relative overprice, and there is a corresponding partial relative underprice for other labor (as compared to my asking price). If I withhold reducing my asking price, then this is not a failure of markets, either in the aggregate or in portion. It would mean I am no longer a part of market activity, and hence no longer a part of the colloquial “market”. Sure, I could keep telling you “I would very much like to sell my labor at $10 million an hour, and I will keep looking, so consider me a part of the market”, and I could very well even believe in my mind that I might be able to get that price, but my failure to find a profitable employment for my asking price doesn’t mean gold miners “failed” to produce enough gold, or that the Fed “failed” to print enough paper notes. Now, what is true for me is also true for two people like me. If two people ask for relatively too high prices, it still doesn’t mean a failure of gold miners or central bankers. If three people ask for relatively too high prices, still no failure of others to supply them with their desired money. Even if 10 million or 100 or 200 million people ask for relatively too high prices, there still is no failure of others to supply them with that desired money.

    Final note: While you may believe that you are arriving at the conclusion that MM is the best alternative via some complex deductive or inductive reasoning that does not presuppose MM is the best, but you’re really not. You are STARTING with the claim that “the job” of the money issuers is to supply everyone else with whatever profitable prices they desire (which is a function of relative demand for money holding), constrained to nothing but what YOU believe is justified in terms of the sum of all prices paid over a period of time (subjectively determined NGDP target rate of growth), and if there are STILL unsold goods and labor at the prices asked, THEN you switch gears and believe that because you got the NGDP target you want, the problems must therefore be partial relative overpricing and underpricing, rather than money issuers who are providing “insufficient MoE”.

  34. Gravatar of Saturos Saturos
    12. February 2013 at 09:16

    Yes, the Ryan Avent article is wonderful, check it out.

    Geoff, excess supply of some goods is not necessarily matched by excess demand for others in a monetary exchange economy (unless you count money). You can have continually rising inventories and decline in factor-capacity utilization without any shortages elsewhere. That’s what we have right now. Job lossess are occurring in all sectors, and are not being matched by equal job openings or positive hiring pressure elsewhere. This is a general glut.

    I agree with Hayek, who said that the least interventionist monetary policy is to stabilize the aggregate flow of money.

  35. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    12. February 2013 at 09:23

    That Ryan Avent piece recommended above is definitely worth reading;

    http://www.economist.com/blogs/freeexchange/2013/02/monetary-policy-0

    ————quote————
    Now maybe slower growth in both the 1990s and the 2000s is the price one is forced to pay to avoid a deep recession in 2008-9. But the longer the horizon over which growth is kept in check, the worse the calculus looks for the pre-emptive approach. As I mentioned on Friday, financial stability is a means to an end rather than an end in itself. The desired end is maximised social welfare, and as unpleasant as the Great Recession was, it’s not clear that its prevention by two decades of slower growth would have been preferable. Or rather, to me at least, it’s clear that it wouldn’t have been.

    Keep in mind that modern economic history is chock-a-block with episodes of overheating in one credit market or another. Depressions, by contrast, are quite rare. What’s more, in the two deep downturns of the past century too-tight monetary policy is broadly suspected as as key culprit.
    —————endquote————

  36. Gravatar of Vivian Darkbloom Vivian Darkbloom
    12. February 2013 at 10:05

    “BACK in December, Scott Sumner mused:

    People form their views of politics and economics when they are young, and are given the reins of power when in their late fifties.”

    That sounds like a self-serving statement, or is it prophesy?. How old did you say you are, Scott?

    Is think I hear Scott crying “Giddyup”? (some also spell it “Giddyap”). Insert that smiley face here….

  37. Gravatar of Geoff Geoff
    12. February 2013 at 10:22

    My views of politics and economics now are vastly different than what they were when I was young. I had to unlearn so many things but thankfully my teachers and parents instilled in me the importance of self-reliance, critical thinking, and curiosity for learning new things with a persistence in understanding it. That allowed me to not have to depend on their particular beliefs as if they were true because they were grown ups, but rather to question their “reign of power.”

    I still question authority to this day, and I can’t imagine how horrible just contemplating how the alternative would be (because I wouldn’t know anyway, but I do now, so…).

  38. Gravatar of Josh Josh
    12. February 2013 at 10:30

    My Krugman-to-Sumner Translator, which may be malfunctioning, translates Krugman this way:

    “Saving” = NGDP shock
    “Say’s Law” = NGDP shocks don’t matter

    Am I totally wrong? I feel like Krugman is a closet Sumnerite.

  39. Gravatar of Geoff Geoff
    12. February 2013 at 11:02

    Saturos:

    “Geoff, excess supply of some goods is not necessarily matched by excess demand for others in a monetary exchange economy (unless you count money).”

    Correct, but partial relative overproduction and partial relative underproduction does not require there to be an excess nominal demand for observable goods other than the partial relative overproduced goods.

    Partial relative underproduction of unobserved goods do not have an excess nominal demand for them because they cannot have any nominal demand for them, as they don’t physically exist, due to the fact that the physical resources went into the production of the goods in partial relative overproduction.

    “You can have continually rising inventories and decline in factor-capacity utilization without any shortages elsewhere.”

    This is the crucial part that requires more than simple observations of what has historically been produced. There are in fact shortages of goods, you just can’t see them because they never got a chance to be produced, since resources were instead redirected into that which is piling up in inventory that Say’s Law treats as partial relative overproduction.

    “That’s what we have right now. Job lossess are occurring in all sectors, and are not being matched by equal job openings or positive hiring pressure elsewhere. This is a general glut.”

    Job losses can only occur in sectors that have already had resources and labor allocated to them, so right away you’re excluding partial relative underproduction from consideration.

    Job losses cannot occur in the sectors that have not had any resources or any labor allocated to them, on the basis that the resources and labor instead were allocated into other (what is to be understood as the partial relative over allocation) sectors instead (while the unobservable sectors that COULD have been expanded, but were not, are the partial relative underexpanded sectors).

    This is no such thing as a “general glut” of goods. What we have is a partial glut, with a corresponding UNOBSERVED partial relative under-glut, which, as mentioned, that never got a chance to be expanded because of the partial glut’s resource redirection of resources and labor.

    Moreover, it is not true, if it ever was true, that every sector is losing jobs, at least recently. Recently there has been job growth in a number of sectors, so even if one were to incorrectly infer that overall unemployment increased means general glut, we’re not in a general glut according to that criteria either.

    “I agree with Hayek, who said that the least interventionist monetary policy is to stabilize the aggregate flow of money.”

    I guess you don’t agree with the Hayek who also said that we should abolish central banking and have competitive money instead. I guess the game is to pick and choose self-serving quotes from highly touted economists and pretend your position is strengthened by it. I for one am not impressed by that. Not sure about others who might find that convincing.

    At various points in their careers, both Hayek and Milton Friedman argued central banking should be abolished. Where are the repeated mentions of these quotes on this blog? Crickets.

  40. Gravatar of Geoff Geoff
    12. February 2013 at 11:14

    Saturos:

    Also, since when did “stabilize” mean “keeps growing indefinitely at a subjectively determined rate”?

    Price inflation economists also use the word “stabilize” when referring to actual continually rising values.

    If it’s “stable growth” you meant, then 100% growth rate should be as stabilizing as 5% growth rate, unless you want to add further caveats to the meaning of “stability” until it’s just another way of saying “what I am personally psychologically stable with.”

    ………………

    Did anyone else read Krugman’s post here:

    http://krugman.blogs.nytimes.com/2013/02/04/money-wealth-and-models/

    Where he effectively, and likely unintentionally, threw “ongoing” monetary policy under the bus?

    “One quite common statement among the Austrianish horde is something along the lines of “It’s ridiculous to imagine, as Krugman does, that you can create real wealth by printing more pieces of paper.”

    Well, it may be ridiculous, but it’s also true, under certain conditions — namely, when the economy is suffering from inadequate demand. And you don’t have to use highly abstruse reasoning to see this, either; all you need to do is think in terms of some kind of model, not necessarily of the mathematical kind.”

    “The haters love to claim that people like me view more demand, more money printing, as the solution to all problems. But of course that’s not true. Aggregate demand won’t solve a problem of low productivity, or inadequate productive capacity, or for that matter extreme inequality due to technology or market power. But it can solve certain problems, which happen to be the problems we have now.”

    These quotes basically contradict constant, persistent, money printing that is necessary for there to be a constant, persistent growth in the price level or NGDP, which is the same thing as saying it contradicts ongoing OMOs by central banks. Since Krugman believes economic growth requires constantly growing prices (and sometimes he believes it needs constantly growing NGDP), and since constantly growing prices and NGDP require ongoing central bank money printing, not just money printing during certain times, like depression times, it follows that Krugman’s worldview of central banking contradicts Krugman’s worldview of central banking. Ha.

  41. Gravatar of Brian Donohue Brian Donohue
    12. February 2013 at 11:52

    “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.”

    Scott, can you provide a brief explanation as to why lower interest rates will induce people to hoard more cash?

    Snarky and cryptic is fine…expected even.

  42. Gravatar of dtoh dtoh
    12. February 2013 at 12:41

    Scott,
    I think you’re making this way to complicated. PK made a simple point that Say’s Law doesn’t hold if an increase in the amount of financial assets held by corporations simply results in an increase in ER. He’s right about that. The issue is how likely that is to happen.

    The problem with PK’s argument is when he says this is likely to happen, “especially when we’re at the zero lower bound.” “Especially” is a misnomer because we’ve never seen an increase in ER above the ZLB.

    If PK had said this is likely to happen “only” at the ZLB, he would have been less incorrect.

    PK’s problem as I have said before is that he views the interest rate mechanism in nominal terms. If he properly viewed it in real terms, “ZLB” would disappear from his lexicon.

  43. Gravatar of JimP JimP
    12. February 2013 at 12:59

    Lets go guys – print it and spend it.

    Martin Wolf

    http://www.ft.com/intl/cms/s/0/9bcf0eea-6f98-11e2-b906-00144feab49a.html#axzz2KQ71okOU

    It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” This comment of Mark Twain applies with great force to policy on money and banking. Some are sure that the troubled western economies suffer from a surfeit of money. Meanwhile, orthodox policy makers believe that the right way to revive economies is by forcing private spending back up. Almost everybody agrees that monetary financing of governments is lethal. These beliefs are all false.

    When arguing that monetary policy is already too loose, critics point to exceptionally low interest rates and the expansion of central bank balance sheets. Yet Milton Friedman himself, doyen of postwar monetary economists, argued that the quantity of money alone matters.

    Measures of broad money have stagnated since the crisis began, despite ultra-low interest rates and rapid growth in the balance sheets of central banks. Data on “divisia money” (a well-known way of aggregating the components of broad money), computed by the Center for Financial Stability in New York, show that broad money (M4) was 17 per cent below its 1967-2008 trend in December 2012. The US has suffered from famine, not surfeit.

  44. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    12. February 2013 at 13:03

    ‘…why lower interest rates will induce people to hoard more cash?’

    If you think of interest foregone as a penalty for hoarding cash, then reducing that penalty will make it more likely hoarding will occur.

  45. Gravatar of Ritwik Ritwik
    12. February 2013 at 13:06

    A. Keynes’s theory didn’t depend on the gold standard, but on the behavioural assertion that

    1) The MEC varies sub-optimally.
    2) If the MEC crashes by a wide margin, investors will not let rates of risky capital slide down enough before income itself adjusts and unemployment finds a new, sub-optimal equilibrium.

    B. Keynes quotes Fisher, Cassel, Pigou, Hawtrey et al at length.

    Apart from that, good post.

  46. Gravatar of Geoff Geoff
    12. February 2013 at 13:55

    Patrick Sullivan:

    “‘…why lower interest rates will induce people to hoard more cash?’

    If you think of interest foregone as a penalty for hoarding cash, then reducing that penalty will make it more likely hoarding will occur.”

    Agh! Why is it that so many people conflate real with nominal when it comes to interest rates and its relationship to “hoarding”?

    If the rate of saving and investment increases, then we can’t forget that productivity increases as well. A higher productivity means a higher real return on investment.

    Yes, nominal interest rates would be lower here, but a decline in the nominal rate of interest in this case would not necessarily imply a smaller “penalty” for holding money. It would be just as much of a penalty (and likely even more of a penalty, due to the fact that a single increase in saving generates an exponentially increasing productivity as more capital begets more capital in physical terms).

    Suppose not investing one’s money means one is forgoing 10% nominal interest on average, in an environment where the going real rate of return on capital averages 10%. If the nominal rate of interest falls to 5% on average because of more saving and investment, and the going real rate of return on capital rises to an average of 15% because of more productivity, then one is worse off holding cash in that environment of lower nominal interest rates as compared to the higher interest rate environment.

    It is foolish to the nth degree to believe that lower nominal interest rates necessarily makes lending money more similar to holding money such that more people hold money instead of investing it.

    Imagine considering investing in Zimbabwe where the nominal rate of return is 10000% but the real rate of return is 0.10%, versus in the US where the nominal rate of return is 10% and the real rate of return of 5%.

    Who would claim that because nominal interest rates are lower in the US, that one is forgoing less by not investing in the US, as compared to not investing in Zimbabwe?

    What matters is real return, not nominal return. It’s why every single ROI model corrects for inflation in some way. Investors want to know how much real bang they’re getting for their buck.

    If the real return is very low, then I can see people making a good case that holding money more and more becomes a “substitution good” for investment.

  47. Gravatar of Mark T Mark T
    12. February 2013 at 14:16

    I am no expert but one thing that jumps out at me on a simple minded level is that for years Krugman has advocated deficit spending on the basis that it has a multiplier > 1. Now suppose, as I think is generally the case, that corporate cash balances are actually principally invested in loans to the federal government (Tbills). So the money is being put to use in the way that Krugman advocates. Then a string of posts about “corproate cash hoarding” comes along. It makes absolutely no logical sense to me. It makes sense on a populist level, of course, and on a “keep giving Times Nation what they pay for” level. But not on any intellectually respectable level. And the Say’s Law post has to be one of the great red herrings of the year.

  48. Gravatar of Morgan Warstler Morgan Warstler
    12. February 2013 at 14:42

    Why would anyone scream about corporations socking away money?

    It goes into banks, who the Fed is paying not to loan it / buy other assets.

    Why wouldn’t everyone scream about Fed ending IOR instead?

  49. Gravatar of Geoff Geoff
    12. February 2013 at 15:06

    Morgan:

    “Why wouldn’t everyone scream about Fed ending IOR instead?”

    Because Marx never attacked IOR, but he did attack capitalists.

    Exploitation theory dominates the “conventional wisdom.”

  50. Gravatar of Doug M Doug M
    12. February 2013 at 15:54

    After 20 years in fincance, the definition of cash is one of the most slippery.

    Is cash paper currency? Is money in the bank cash? How about short CDs? Long CDs? T-Bills? German T-bills? Receivables?

    When we say “corporations are holding cash” it could be any of the above, and anything that can fairly easily be turned into cash.

    So, when economists talk about cash — what is cash? I understand it to be paper currency and reserves held at the Fed, but other money that may be part of the monetary aggregates are not cash.

    In which case corporations are holding very little cash.

  51. Gravatar of Benny Lava Benny Lava
    12. February 2013 at 16:06

    Ah yes, Scott repeats one of the fundamental fallacies if economics

    “Aggregate supply really does drive demand”

    Nope sorry you have it wrong. This is why the physical sciences laugh at the social sciences. You actually have an opportunity to correct this mistake and teach your Econ students the truth. If not we will sadly only make progress one funeral at a time.

  52. Gravatar of Morgan Warstler Morgan Warstler
    12. February 2013 at 17:20

    Geoff,

    yep.

    Benny,

    See Geoff.

    What I want to know though is why Scott doesn’t hit Krugman with this argument?

  53. Gravatar of Geoff Geoff
    12. February 2013 at 18:28

    Benny Lava:

    “Nope sorry you have it wrong. This is why the physical sciences laugh at the social sciences. You actually have an opportunity to correct this mistake and teach your Econ students the truth. If not we will sadly only make progress one funeral at a time.”

    Instead of (rather pompously) declaring someone is wrong without at least giving an explanation of why, perhaps you can explain, in your own words, why it is wrong.

    Just to warn you, I can guarantee to you that you will make a mistake in your explanation.

  54. Gravatar of Geoff Geoff
    12. February 2013 at 18:37

    Morgan:

    “What I want to know though is why Scott doesn’t hit Krugman with this argument?”

    My guess: Partly because MMs need Krugman for tactical reasons so that MM can pass through the liberal/progressive black gate of Mordor, partly because by criticizing Krugman’s views on when money printing is justified the pandora’s box would inadvertently be opened and MM’s Frodo and Sam might be exposed as non-Orcs.

  55. Gravatar of Morgan Warstler Morgan Warstler
    12. February 2013 at 20:25

    Geoff, I hope everyone else understands this. Important.

    Scott??

  56. Gravatar of DocMerlin DocMerlin
    12. February 2013 at 20:51

    @TravisV
    Because we DID have asset bubbles in the 70′s lots of them. Look at gold and silver prices for example.
    We didn’t have a housing bubble, however because the baby boomers were about to start buying their homes.

  57. Gravatar of Noah Smith Noah Smith
    12. February 2013 at 23:30

    Me?

    Make fun of a grammatical error??

    Now why would I go and do a thing like that…

  58. Gravatar of Morgan Warstler Morgan Warstler
    13. February 2013 at 06:38

    Over at Monetary Realism, it’s becoming clear the issue really is IOR

    http://monetaryrealism.com/krugman-on-says-law/?replytocom=15591#respond

    There all kinds of blind assertions that the reserves are here to stay and negative IOR cant even be modelled or considered.

    This is NOT a discussion about Corporations cash hoarding, the entire Krugman line is meaningless.

    And with a poof, there is nothing there.

    Scott, please explain WHY the smartest response on PK wasn’t:

    Dude, the Fed WANTS the banks hoarding reserves, and keeping S from equalling I.

  59. Gravatar of Becky Hargrove Becky Hargrove
    13. February 2013 at 07:05

    There are many ways to pass through the black gate that have nothing to do with Krugman, which everyday people (as well as women) could relate to. All in good time.

  60. Gravatar of ssumner ssumner
    13. February 2013 at 08:18

    Suvy, You are moving closer to my view of the paradox of thrift–keep moving.

    Vivian, Come to think about it . . . I’m in my late 50s.

    Josh, With such incommensurable languages, it’s hard to know for sure.

    Brian, The nominal interest rate is the opportunity cost of holding cash. Studies show that, ceterias paribus, higher nominal interest rates lead to a lower demand for cash as a share of GDP. (Or higher V if you prefer.)

    dtoh, I read Krugman as suggesting that higher corporate saving isn’t just a potential problem in theory, but is a problem in America circa 2013. Maybe I’ve misread him.

    Ritwik, He certainly doesn’t quote them claiming demand shocks don’t matter, which was the Krugman point I was responding to. I realize that Keynes did not understand that he had a gold standard model, but that’s essentially what makes it tick–constrained monetary policy. Otherwise he would have been a new Keynesian, calling for a 2% inflation target, or even 4%, to avoid liquidity traps. Instead he called for fiscal stimulus, even as Fisher called for dollar depreciation in late 1933. By late 1933 Keynes was with the conservatives, opposing further dollar devaluation, but favoring fiscal stimulus (unlike the conservatives.) The same three way split we have today.

    Morgan, Yes, IOR is also a problem.

    Noah, I guess you like me better than Dorman, because you only spend time helping me to improve my grammer, while you allow Dorman to wallow in ignorance. :)

  61. Gravatar of Nadav Nadav
    13. February 2013 at 09:12

    “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.”

    There is evidence that this is actually happening. The public companies with the largest cash hoards trade at historically low P/E ratios, even though they continue to grow earnings at above-average rates. The perception seems to be that investors are not valuing the cash at face value because they consider it “trapped” on the other side of the veil, earning low rates, and that it must be unlocked via dividends, share repurchases, or financial engineering (see David Einhorn’s fight against Apple).

  62. Gravatar of B. H. Soetoro B. H. Soetoro
    13. February 2013 at 15:53

    Krugman is not an economist any longer. He is a tool used to sell advertising dollars, so he merely writes what uninformed leftists wish to believe.

  63. Gravatar of Saturos Saturos
    14. February 2013 at 22:29

    Izabella Kaminska weighs in with her uniquely backward take on Say’s Law, concluding by announcing a crisis of abundance: http://ftalphaville.ft.com/2013/02/13/1384802/on-cash-hoarding/?

  64. Gravatar of ssumner ssumner
    18. February 2013 at 07:39

    Nadav, Of course taxes on dividends have risen sharply, which may have some effect as well.

  65. Gravatar of Steve Roth Steve Roth
    21. February 2013 at 08:17

    I can’t resist pointing out:

    Scott Sumner, here: “the aggregate problem is not too much saving, it’s too much money hoarding.”

    Scott Sumner, September, 2011: “I have no idea what you mean by hoarding financial capital.”

    I actually don’t find the term “hoarding” (of money/capital) to be very useful or coherent. “Not spending” on the individual level or “velocity decline” on the aggregate seem more conceptually tractable and useful.

    But the direct contradiction above makes it hard for me to parse what Scott really thinks.

  66. Gravatar of Consuming Our Way to Prosperity is Macro Folly – PBS : INVEST WEB Consuming Our Way to Prosperity is Macro Folly – PBS : INVEST WEB
    6. March 2013 at 21:13

    [...] and celebrates consumption. Mr. Livingston’s book, as well as recent commentaries by Paul Krugman and other Keynesian economists demonstrate that after two centuries the debate over what grows the [...]

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