People who don’t know what “demand” is, aren’t likely to see demand as the solution

Karl Smith finds this peculiar comment in a Raghu Ragan FT article:

However, the past build-up of debt in now depressed areas may suggest that demand was too high relative to incomes. If so, demand, without the dangerous stimulant of borrowing, will stay weak. Policy should instead help workers move where there are suitable jobs – for instance, by helping them offload their homes and the associated debt without the stigma of default.

Smith can’t figure out what this means either.  Here’s Karl’s interpretation:

So first, when we use demand in the macroeconomic sense, income is simply the equilibrium value of demand at a given price level. It makes no sense to say that demand is too high relative to income.

We might mean that the local area was running a persistent current account deficit. So for example on total the people of Las Vegas were importing more than they were exporting. Las Vegas experienced perhaps the most severe crash of any major US metropolitan area. To undue this balance they need to run a current account surplus. That is they need to export more than they import.

Perhaps, but then his solution (people should work less in the region that has the CA deficit) would make no sense at all.  I really don’t know what Rajan means here, if I had to guess I think he’d claim the people of the problem regions like Vegas and Spain were not producing too much in total, but rather were producing too much of one good (like houses) and too little of other goods.  Then he might argue that in the short run it’s easier for the surplus labor to exit Vegas and Spain and work in a more prosperous area.  That would be a defensible argument, but of course it would have nothing to do with “demand” having been too high relative to income.  And even if output was too high in aggregate (say too many people had moved to Vegas), that would suggest both output and income were too high, not that demand was too high relative to income.

And as Karl points out, Rajan’s also confused about the re-allocation argument.  Here’s Rajan:

This is probably the more pertinent case in several industrial countries, such as the US and Spain.   Increasing employment in a sustainable way today could more than pay for itself if people who would otherwise drop out of the workforce earn incomes.

The key question then is whether more government spending can make a real difference to the most severe employment problems. Here the case for a general stimulus becomes less compelling. In the US, demand is weakest in communities where a boom and bust in house prices has left an overhang of household debt. Lower local demand has hit employment in industries such as retail and restaurants. A general increase in government spending may be too blunt – greater demand in New York is not going to help families eat out in Las Vegas (and hence create more restaurant jobs there). Targeted household debt write-offs in Las Vegas could be a better use of stimulus dollars.

Notice the non-sequitur, from a lack of jobs to the claim that the “key question” is whether we need more government spending.  If there’s not enough jobs (due to a demand shortfall) we need more monetary stimulus.  That oversight is forgivable for Spain, as they lack their own currency.  But the US?  Why would we employ fiscal stimulus, when monetary stimulus doesn’t run up any debts?  And the Vegas/New York comparison makes no sense.  Both regions have high unemployment. But even if they didn’t, regional differences should play no role in aggregate demand policies.  The Fed and the ECB can and should tailor their policy for the entire region.  Obviously both the US and the eurozone have a demand shortfall.  Recently the problem’s been getting slightly better in the US, and slightly worse in the eurozone.  But both could use more monetary stimulus.

Indeed the US needs more monetary stimulus even if AD is currently right on target.  How can that be?  Because we are still doing fiscal stimulus, e.g. the payroll tax cut.  So at a minimum you’d want to do more monetary stimulus until we reached a demand level where Congress felt it could remove fiscal stimulus.  People used to sort of blanch when I talked about the Fed “sabotaging” fiscal stimulus, but Bernanke all but admitted that this is exactly what the Fed is currently doing:

1.  Bernanke says the Fed can do more.

2.  Bernanke says the Fed chooses not to do more, as they think the expected future path of AD is adequate.

3.  Congress continues to hold down payroll taxes because they think the expected future path of AD (without fiscal stimulus) is not adequate.

That’s sabotage folks; there is no other word for it.

I apologize for the snarky post title.  But think about how hard we work to get our undergrads to distinguish between shifts in demand and changes in quantity demanded.  So it’s quite dismaying when a famous economist talks about too much “demand” in a context where he pretty clearly meant something entirely different.  It’s hard to have an intelligent debate if each participant comes to the discussion with their own private language.

PS.  It’s also possible Rajan meant “consumption” when he said “demand.”  That would be a strange use of the term ‘demand,’ and of course the main problem in Vegas and Spain was too much investment, not too much consumption.

PPS.  If anyone (including Rajan) can provide a sensible definition of what he meant by ‘demand’ then I’ll provide an abject apology.


Tags:

 
 
 

26 Responses to “People who don’t know what “demand” is, aren’t likely to see demand as the solution”

  1. Gravatar of KRG KRG
    25. May 2012 at 06:38

    “Why would we employ fiscal stimulus, when monetary stimulus doesn’t run up any debts?”

    Doesn’t monetary stimulus essentially amount to giving banks more funds to loan out or making it cheaper for them to make loans? How does that work without actively requiring the creation of more debt?

  2. Gravatar of Morgan Warstler Morgan Warstler
    25. May 2012 at 06:40

    “Increasing employment in a sustainable way today could more than pay for itself if people who would otherwise drop out of the workforce earn incomes.”

    In this sentence, he means the people who don’t have jobs work for WHATEVER PRICE they are worth.

    He might know of my Guaranteed Income plan to Auction the Unemployed, but he’d support it.

    So when he gets to “The key question then is whether more government spending can make a real difference to the most severe employment problems.”

    It is not a non-sequitor, he’s just saying ” make people work without government spending.”

    Market clearing is ALWAYS fastest where auctions and information are made use of.
    ——

    Scott, I read Rajan as saying this:

    “Ok boys, let’s get down to brass tacks and start talking terms of surrender.

    ‘The bad Keynesians are going to LOSE lots of high paying public service jobs, and the unemployed are going to have to work for less money, more folks are gong to get out of the wagon.”

    “BUT, in return for throwing the bad Keynesians under the bus, the Good Keynesians we have two consolation prizes:

    1. we can stop worrying about debt to do tax cuts.
    2. we can do Monetary stimulus.

    On the displaced workers it is the same thing – MAKE THEM LOSE THEIR FORECLOSED HOMES, MAKE THEM MOVE, fix their credit.

    That’s an interesting idea for another day – using credit improvement to force mobility.

    Could you offer Greeks that move to Germany the promise of SMB loans after they toil for three years. Basically 40 acres and mule for indentured servitude.

    ——

    The point is it reads to me like Rajan is showing Karl what Karl can get if he actually lets go of Obama being President.

    This is a very round about logic, but I think it is basically valid.

    His tone says these are the things we can discuss (ending Austerity), but we’re going to discuss it in ways that shrink the state.

    See here from WSJ:

    http://online.wsj.com/article/SB10001424052702304707604577423720925560872.html

    —–

    Scott, you’d win lots more common ground if focused for a while on WHY and HOW NDGPLT shrinks the state.

  3. Gravatar of JCE JCE
    25. May 2012 at 06:43

    “So first, when we use demand in the macroeconomic sense, income is simply the equilibrium value of demand at a given price level. It makes no sense to say that demand is too high relative to income.”

    i’m sorry i don’t get it. could you please elaborate on the explanation??

  4. Gravatar of Peter N Peter N
    25. May 2012 at 07:34

    I think Rajan would reject monetary stimulus on the same grounds as fiscal stimulus – that it isn’t sufficiently targeted. the implication is that any general stimulus sufficient to solve the local problems would be too expensive and risk overstimulating areas that don’t need it.

    “A general increase in government spending may be too blunt – greater demand in New York is not going to help families eat out in Las Vegas (and hence create more restaurant jobs there). Targeted household debt write-offs in Las Vegas could be a better use of stimulus dollars.”

    This may or may not be right, but it needs refutation by analysis. You can’t just dismiss it out of hand. Targeted debt relief could be very quick to work (but maybe not so quick to deliver) and also probably quite cost effective. It would help resolve the banks’ expectation deadening debt uncertainties (e.g. BOAs death of a thousand lawsuits), though by now the banks may have deepened the hole by their arrogance and stupidity so much that it has a life of it’s own (robo-signing, foreclosure fraud…).

    What we may really need is the equivalent of the S&L resolution trust corporation.

    We got the RTC, because there was a consensus that the banks were insolvent and a significant part of their managements were crooked. No consensus – no RTC.

    Monetary policy may be the only effective thing current politics will allow.

  5. Gravatar of Bill Woolsey Bill Woolsey
    25. May 2012 at 07:40

    The quantity of money is the amount of money that exists. The demand for money is the amount of money people want to hold. Monetary policy works by changing the quantity of money relative to what people want to hold.

    Because most money is in the form of checkable deposits at banks, and banks have a balance sheet where liabilities (and equity) are matched by assets, when there is a change in the quantity of money, there must be some other change on the bank balance sheet. An increase in the quantity of money can be matched by an increase in bank loans.

    However, it could also be matched by a decrease in nonmonetary bank deposits, like Certificates of Deposits, or else by holdings of bonds. While a bank holding more bonds is lending in a sense, it isn’t’ the same thing as bank loans and it doesn’t increase total debt–at least not directly.

    Of course, open market operations directly have the Fed buy up debt, usually government debt. Again, this is lending in a sense, though it isn’t necessarily new loans.

    Now, when the Fed and the banks buy government bonds, it is possible that those selling the government bonds take the money and use it to buy newly issued bonds. In that case, the monetary policy has motivated an increase in debt, but not through bank lending.

    However, it is possible that those who sold the bonds might use the funds to purchase consumer or capital goods. In which case, there is no increase in debt due to exchange in the quantity of money.

    While the direct effect of the central bank buying bonds and the banks buying bonds is to raise their prices and reduce their yields, it is possible that others currently holding bonds might sell more than the Fed is buying, so that the net effect is lower bond prices and higher bond yields. If those selling those bonds do so to fund purchases of consumer and capital goods, we can have a situation where interest rates rise and spending on output rises as well.

    Finally, it is possible that all of this occurs in a situation where the retirement of old bonds is greater than the issue of new bonds. Debt can be going down. If those recieve the bonds as debts are repaid purchase capital or consumer goods, this can result in more spending on output.

    To the degree those selling bonds or receiving repayment of bonds purchase capital goods, then their net worth rises. Wealth can rise in aggregate, while debt falls, and spending rises.

    The notion that more money must mean more debt, and those borrowing the money spend more on output is false. It is possible, but the _must_ is wrong.

    I don’t want to say that people shouldn’t borrow more if they want, but if people don’t want to borrow but rather pay down their debts, this is perfectly consisent with a monetary policy that keeps nominal GDP growing on target.

  6. Gravatar of ssumner ssumner
    25. May 2012 at 07:55

    KRG, You asked:

    “Doesn’t monetary stimulus essentially amount to giving banks more funds to loan out or making it cheaper for them to make loans?”

    No. Also see Bill’s response.

    Morgan, Not everyone thinks like you.

    JCE, Demand = NGDP = gross national income. It’s the famous “circular flow of the economy” discussed in principles textbooks.

    Peter N, You said;

    “I think Rajan would reject monetary stimulus on the same grounds as fiscal stimulus – that it isn’t sufficiently targeted. the implication is that any general stimulus sufficient to solve the local problems would be too expensive and risk overstimulating areas that don’t need it.”

    Yes, I did address this intepretation. But it makes no sense, as you must have a monetary policy. It makes no sense to talk about “whether we will use monetary policy or not.” The only question is what monetary policy is appropriate. I certainly agree that monetary policy can’t address regional problems, but surely we also have an aggregate AD shortfall. If Rajan doesn’t think we have an aggregate shortfall then he should say so, and not talk about regional problems, which are completely irrelevant to monetary policy. BTW, elsewhere he does say he thinks the US has an aggregate problem, he lumps us in with Spain.

    I don’t have strong views on banking reform, but nothing done there will help significantly until the Fed delivers faster NGDP growth.

    Bill, Good explanation.

  7. Gravatar of Don Geddis Don Geddis
    25. May 2012 at 07:58

    Raghu Ragan wrote: “The past build-up of debt in now depressed areas may suggest that demand was too high relative to incomes. If so, demand, without the dangerous stimulant of borrowing, will stay weak.”

    Scott suggests: “It’s also possible Rajan meant “consumption” when he said “demand.” That would be a strange use of the term ‘demand,’ and of course the main problem in Vegas and Spain was too much investment, not too much consumption.”

    May I suggest that you’re trying to find technical macroeconomic definitions, and Raghu is simply writing to non-economic lay people?

    I would interpret Raghu’s statement as: “People earn cash income at their jobs. They go buy stuff like food, cars, and houses. This is (consumer) “demand”. Sometimes they borrow more money to spend immediately, and local businesses see the amount of cash seeking their food, cars, and houses has gone up, as it’s the sum of the worker’s incomes plus this new borrowing. Hence, “more demand”. If those workers borrowed too much, and can’t pay back the loans, then recent “demand” for food, cars, and houses was unsustainably high, due to excess borrowing. People were trying to buy more stuff than they can really afford, and so now the economy is shrinking back to what they can sustainably afford based only on their actual cash incomes.”

    Doesn’t that story match Raghu’s words? Now of course it confuses consumption vs. investment, it confuses mere end consumer demand with total demand, it confuses the closed-economy nature that every debtor must have a creditor, etc.

    But if you DON’T have a real macro model in mind, and think only about households that are spending more than they can afford (via excess borrowing) … doesn’t that provide an interpretation of Raghu’s article?

  8. Gravatar of J.V. Dubois J.V. Dubois
    25. May 2012 at 08:06

    I think what Raghu wanted to say is some form of something I call an “inequality theory of recessions”. People have low incomes but they want to spend more (on capital and consumption goods). So they borrow and spend. This is what is probably hiding behind a very strange statement that the demand is high relative to the incomes. So now when the debt level is unsustainable, they should go somewhere else where they can earn enough to pay the debt down. In Raghu’s story the this mythical land of plenty (opportunities) is played by New York.
    .
    So in short, he is twisting the keynesian language to tell his pet structural reallocation story. Only he does not realize that there is no land of plenty. It is just a regional version of the topic he said all the time – that it is the whole west that is over-indebted and that the land of plenty is the developing world. That for some businesses refuses to serve billions of new potential customers who crave new things like accumulator refrigerators and such and a global government overseeing this structural change of the world industry.

    PS: I really like the idea of sabotaged fiscal policy. This plays very well to the explanation of prolonged demand slumps like those in Japan. It starts by monetary policy tightening that is responded by loosening fiscal until monetary policy tightens again in a vicious cycle. If you do it long enough, you start to have aggregate supply issues. And I think that you are right – advocates of fiscal stimulus can harm the economy. They may calibrate their models for an occasion when CB is “unable or unwilling to loosen” and they see it as doing “nothing”. But what if monetary policy is at the same time very willing to tighten? That is by no means “doing nothing” in my eyes.

  9. Gravatar of Saturos Saturos
    25. May 2012 at 10:10

    Scott, you said,

    JCE, Demand = NGDP = gross national income.

    Not necessarily: http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/01/ad-as-y-output-gaps-cuba-monopolistic-competition-and-recalculation.html

    Bill Woolsey, thanks for your expositions, maybe someday more people will understand that money and credit are not the same thing.

  10. Gravatar of Mark A. Sadowski Mark A. Sadowski
    25. May 2012 at 11:15

    “However, the past build-up of debt in now depressed areas may suggest that demand was too high relative to incomes.”

    That’s just Steve Keen’s Walras-Schumpeter-Minsky proposition that aggregate demand equals income plus the change in debt. (Yes, Keen relishes in inventing his own ideosyncratic economic definitions just so he can watch other economists scratch their heads in bewilderment.) See page 8:

    http://ineteconomics.org/sites/inet.civicactions.net/files/keen-steve-berlin-paper.pdf

    I didn’t realize until now that Rajan studied Keensian economics at the University of Western Sydney. Now, the absolute gibberish he has been writing lately makes a little more sense.

  11. Gravatar of Andrew Andrew
    25. May 2012 at 11:32

    I will freely admit that I don’t know what “demand” is but am willing to give Scott’s advice a try.

  12. Gravatar of Major_Freedom Major_Freedom
    25. May 2012 at 12:22

    ssumner:

    Notice the non-sequitur, from a lack of jobs to the claim that the “key question” is whether we need more government spending.

    Notice how you immediately knee jerked against Rajan for daring to suggest a recalculation argument, and then you non-sequitured into:

    If there’s not enough jobs (due to a demand shortfall) we need more monetary stimulus.

    He didn’t say that statement in parentheses. YOU are introducing the claim that a unemployment can be cured by money printing.

    Rajan is saying it makes no sense for “aggregate demand” to be increased nationally if there are specific problems in Nevada that can be better cured by localized debt write offs. He is saying more monetary demand brought about by the government is too blunt an instrument. He is saying it won’t do any good to those in Nevada if demand in New York rises.

    You are again, for the millionth time, presuming that increasing “aggregate demand” somehow means the same thing as demand increasing in every city, county, and state together in a nice smooth fashion. Monetary and fiscal policy don’t work that way. Money creation from the banking system for example doesn’t enter everyone’s bank accounts at the same time and therefore it doesn’t affect all goods equally either. It enters specific points of the economy, like New York. So even though you believe you’re helping those in Nevada by calling for money printing in New York, Rajan is saying they’d be better off not with higher demand there, but with localized debt write offs.

    That oversight is forgivable for Spain, as they lack their own currency. But the US?

    He wasn’t talking about the US. He was talking about Nevada.

    Why would we employ fiscal stimulus, when monetary stimulus doesn’t run up any debts?

    Holy cow. Why do you keep making this error? “Monetary stimulus” does in fact run up debts! The Fed increases the money supply by way of increasing bank reserves, correct? Well, money that stays in the banks doesn’t affect “aggregate demand”, which means money has to leave the banks, which is necessary in order for “aggregate demand” to rise! And what form does that money take? It takes the form of debt of course! The money the Fed prints ends up being used directly and indirectly by the banks to create new loans. It’s not used to increase the final consumer demand for everything, directly even though that’s the ultimate end from increasing credit expansion is. You have it backwards. Yes, monetary stimulus does increase the demand for consumer goods, but it does so by way of increasing debt first, which is then spent and respent. So when you are asking for “monetary stimulus”, you are in fact asking for more debt in the economy.

    It would be like me sending checks to a fish and chips restaurant, and then acting all surprised when the demand for raw fish and potatoes rises, and then, incredibly, saying to those who say this will affect raw fish and potato demand, that they are wrong, because it will really affect the demand for everything in the entire economy, except raw fish and potatoes.

    And the Vegas/New York comparison makes no sense. Both regions have high unemployment.

    He was making an analogy. You’re taking it too literally. There are differences in unemployment in various cities around the country, correct? He is saying it makes no sense to ask for general stimulus when there are more localized problems. There is not high unemployment everywhere. There are relatively high employment areas, and relatively low unemployment areas. AGGREGATE demand policies doesn’t address these problems. That’s what Rajan is saying.

    But even if they didn’t, regional differences should play no role in aggregate demand policies. The Fed and the ECB can and should tailor their policy for the entire region.

    That’s exactly his criticism of general stimulus policies! Wow.

    Obviously both the US and the eurozone have a demand shortfall.

    That’s not obvious at all, because it’s false. We don’t have a demand shortfall, we have a coordination shortfall. More monetary stimulus, which we have seen is the same thing as asking for more debt to enter the economy, will just postpone the correction of these problems, and in addition, create NEW problems of their own.

    Recently the problem’s been getting slightly better in the US, and slightly worse in the eurozone. But both could use more monetary stimulus.

    Like a crack addict who can’t see the problem.

    Indeed the US needs more monetary stimulus even if AD is currently right on target. How can that be? Because we are still doing fiscal stimulus, e.g. the payroll tax cut. So at a minimum you’d want to do more monetary stimulus until we reached a demand level where Congress felt it could remove fiscal stimulus.

    Tax cuts and tax increases don’t affect aggregate demand, because the money the government taxes, is spent by government, and the money the government does not tax, is spent by the populace. If there are any changes in aggregate demand that accompany tax changes, it has to do with the demand for money changing, not taxation.

    PS. It’s also possible Rajan meant “consumption” when he said “demand.” That would be a strange use of the term ‘demand,’ and of course the main problem in Vegas and Spain was too much investment, not too much consumption.

    Too much consumption actually accompanies too much investment. Cheap credit stimulates capital intensive investments as well as consumption. It stretches the economy into two directions.

    PPS. If anyone (including Rajan) can provide a sensible definition of what he meant by ‘demand’ then I’ll provide an abject apology.

    I think he meant monetary demand, because he compared demand with incomes, which are monetary.

  13. Gravatar of ssumner ssumner
    25. May 2012 at 12:31

    Don, You said;

    “I would interpret Raghu’s statement as: “People earn cash income at their jobs. They go buy stuff like food, cars, and houses. This is (consumer) “demand”. Sometimes they borrow more money to spend immediately, and local businesses see the amount of cash seeking their food, cars, and houses has gone up, as it’s the sum of the worker’s incomes plus this new borrowing. Hence, “more demand”. If those workers borrowed too much, and can’t pay back the loans, then recent “demand” for food, cars, and houses was unsustainably high, due to excess borrowing. People were trying to buy more stuff than they can really afford, and so now the economy is shrinking back to what they can sustainably afford based only on their actual cash incomes.””

    It depends on whether they are borrowing from inside the country, or outside the country. If they borrow from inside the country, then for every person spending more than their income, there is someone else spending less. And if they borrow from outside, then you have the CA deficit. But I already addressed that issue–it would provide no reason for people to work less.

    It’s possible that you are right about his reasoning, but that sort of bad reasoning is exactly what we try to get our principles students to avoid. One needs to think rigorously in macro. There’s no logical reason why people should take long vacations (unemployment) just because they’ve been borrowing and spending too much in the recent past. They should work harder. Misusing vague terms like ‘demand’ and ‘spending’ is likely to lead to bad reasoning.

    Saturos, I’ll accept that, although partly it’s a question of semantics.

    Mark, Ironic, the “Keensians” have taken over the University of Chicago.

  14. Gravatar of Donald Pretari Donald Pretari
    25. May 2012 at 13:05

    I’m not someone who generally gets personal, but many of the points I read from some opponents of QE plus a Reinforcing Stimulus sound to me like Nostrums: “You’re just robbing Peter to pay Paul.” “What goes up, must come down.” Etc.

  15. Gravatar of KRG KRG
    25. May 2012 at 14:51

    Bill,
    If I sell you a bond that I have issued how is that any different, except for of a reversal of language, than saying that you have made a loan to me? Bonds are a form of loan, and thus debt. Saying that buying more bonds reduces their yield is no different than saying the interest rates on the loans has been lowered. Bonds are debt; if monetary policy doesn’t have enough public sector bonds to worth with, it ends up needing to require the creation of enough private bonds (and thus private debt) to bridge the gap.

  16. Gravatar of Greg Ransom Greg Ransom
    25. May 2012 at 15:24

    I.e. equating “demand” with demand in micro is a crock:

    “Demand = NGDP = gross national income. It’s the famous “circular flow of the economy” discussed in principles textbooks.”

  17. Gravatar of Greg Ransom Greg Ransom
    25. May 2012 at 15:32

    Don Geddis nails it. If you are writing for a general audience why be trapped with the conceptually problematic technical terms of a failed fake “science”?

  18. Gravatar of Tom Tom
    25. May 2012 at 17:52

    Scott, I’m really doubly disappointed in your lack of understanding — which Don G explains well — and then your assertions which are unconvincing.
    Don explains Rajan : folk in LV had incomes, but spent/invested those incomes plus too much borrowing.
    It was an unsustainable amount of borrowing, and thus “too much demand”.
    You are so unconvincing when you claim:
    If they borrow from inside the country, then for every person spending more than their income, there is someone else spending less. This is just false. It’s possible that, with printed money dropped from helocopters (or other QE), every single person in the USA spent more than their income.
    But it’s not necessary that it be every person, merely that the total spent, the “demand” as most people understand it, is greater than the total disposable income.

    And most folk are pretty sure that’s what happened in the bubble — too many people spent too much borrowed money.
    Spent/ invested/ consumed/ speculated in housing, especially.
    Had house prices continued to go up for the next 20 years like they had gone up in the prior 20, there would be no “crisis” now.

    But whether the excess demand is funded thru domestic money, or foreign, the borrowers still borrowed too much.
    … because they were investing in housing, expecting prices to rise, and instead they dropped, making their speculations loss-making.

    A major wealth-loss, leading to a desire in many to save more so as to have a desired life cycle amount.

    So they should still do more monetary easing.

  19. Gravatar of Browsing Catharsis – 05.26.12 « Increasing Marginal Utility Browsing Catharsis – 05.26.12 « Increasing Marginal Utility
    26. May 2012 at 04:06

    […] Rajan doesn’t understand the concept of demand. I mean, have you read his book? He says some sorta public choice-y things, but that’s outweighed by all the nonsense economics he spouts. I don’t say that as an Austrian, either. Share this:EmailPrintStumbleUponLike this:LikeBe the first to like this post. links ← links […]

  20. Gravatar of Peter N Peter N
    26. May 2012 at 04:18

    Tom,

    The unwinding is even worse, because debt isn’t necessarily repaid. There’s also default, where the lender’s loss is only matched with borrowers value of forgiveness of debt.

    The result of severe debt unwinding is very contractionary, but it can sometimes affect only financial assets and real estate, not goods tracked by the CPI or measured as part of GDP. This seems to give the problem a cloak of invisibility for most economists.

    So one persons gain isn’t another’s loss, and more important one persons loss isn’t another person’s gain.

    There are dangers to using GDP as a proxy for spending. It isn’t a very good one.

    Japan post crash has had negligible CPI deflation, but enormous uncorrected (20 years and counting) deflation in equities and real estate.

  21. Gravatar of Phil Phil
    26. May 2012 at 04:45

    It seems to me that there is a tension between the micro and macro models. In a macro model of a closed economic system it is fairly clear that the total level of debt doesn’t matter to any macro quantities. On the other hand, it is fairly clear in micro economics that it is possible to become ‘balance sheet constrained’.

    I think the result of this will be a persistent deflationary pressure. Paying down debt reduces the broad money aggregates, and I suspect we are going through a once in a lifetime change in debt tolerance preferences by both companies and individuals, it will be extremely difficult to put ngdp back on track if everyone is using the money to pay off debt. Of course, the critique of this is to say that real interest rates must go hugely negative to counter this change in preferences, but it seems unlikely that banks will be prepared to lend too much at a real loss, as inflation expectations might change drastically to the upside when the deleveraging changes, and this could wipe them out. This is a classic example of how a macro model can ‘break’. Whatever inflation path/ngdp you pick for the future, the economy can respond in an appropriate way, and sure some are better than others, but if you do not know what the future holds, there is massive danger in all options.

    Of course, there needs to be a lack of productive opportunities for this to be the case. If the economy was undergoing massive technological advancement, there would be demand for capital that would offset the deleveraging. On the other hand, people being people, they probably would not deleverage until it is forced on them by a crisis, which will always happen at a time when the economy isn’t undergoing large productivity gains through technological advancement,

    If I have a point it’s this: I think the dynamics of individual deleveraging are not fully captured in macro models, because I do not think individuals approaches to these things are wholly rational. I also think its wrong to ignore the role of innovation as a background to these financial crises, I do not believe we could be here except that we are in a slow period of innovation, and this is suppressing demand for capital.

  22. Gravatar of Bill Woolsey Bill Woolsey
    26. May 2012 at 07:08

    Money and credit still confused.

    If the quantity of nonmonetary bank liabilities should fall to zero, and the quantity of monetary bank liabilities become equal to the total amount of nonmonetary debt, then, any further increase in the quantity of money would result in more debt in total.

    The U.S. is no where near this situation and it hasn’t been (ever?)

    Writing as if monetary policy _is_ the same thing as increasing debt because in some unrealistic scenario it would be, is mistaken.

    As for the other “excessive debt,” claims above, these are also flawed.

    Default reduces how much money the creditor can receive, while reducing how much the debtor must pay. There remains an exact match.

    If banks reduce nonmonetary liabilities and increase monetary liabilities, this increases the quantity of money with no change in bank credit.

    If banks purchase already existing bonds and expand monetary liabilities, this increases bank credit, but there is no increase in total debt. Investors other than banks hold fewer bonds, (which is a decrease in the supply of credit by them.) Banks hold more bonds, (which is an increase in the supply of credit by banks.) Total debt and the total supply of credit is unchanged.

    If, at the same time, some firms are paying off some of their debts, then total debt is falling. If the banks purchase more of the remaining bonds, then the quantity of money increased, bank credit increased, but total credit decreased. Total credit decreased because of a decrease in demand for credit.

    Now, if banks are purchasing bonds, then ceteris paribus, this lowers interest rates. However, this doesn’t mean that interest rates necessarily decrease. It is possible that other investors holding bonds might sell more than the banks buy, so that interest rates rise.

    It is possible that firms pay down some of their debts, reducing the demand for credit, that banks purchase bonds, raising the supply of credit by banks, but that those currently holding bonds sell more bonds than the banks buy and the amount paid off, so that the net effect is that interest rates rise.

    The quantity of money can rise, and interest rates rise.

    Ceteris paribus, interest rates rise, spending on consumer goods and capital goods fall.

    But, it is possible for spending on consumer goods and capital goods to rise, and the higher interest rates simply dampen the increase.

    One of those things that might cause spending on consumer goods and capital goods to rise is expectations of increased spending on output. To the decrease this increases real output and income in the future, it motivates an incerase in consumption and investment now. To the decrease it raises prices, it creates an incentive to increase consumption and investment now.

    How is this consistent with falling debt and rising interest rates? Those who are receiving payment as bonds are paid off, and those who are selling bonds (creating the net effect of higher interest rates) use the funds to purchase consumer and capital goods.

    An increase in the quantity of money beyond the amount people want to hold generates increased spending on output at some point in the future.

    So, it is possible for an increase in the quantity of money to increasing spending on output now while total debt falls and interest rates rise.

    The notion that monetary policy must work by lowering interest rates and increasing total debt is false.

    Nothing in this argument should suggest that it is impossible that an increase in the quantity of money would result in lower interest and increased debt. It could.

    Anyway, where do those blinded by the credit view go wrong? The assumption is that when bonds are repaid, those receiving the payment hold more money. The assumption is that when people sell bonds, they hold more money. Of course, they could do that. But not necessarily.

    I think most market monetarist see the first best option for recovery is this scenario where total debt falls, interest rates rise, spending on capital goods rise, and production and employment grow with little or no increase in the inflation rate.

    However, what we propose is a specific target for an initial value of nominal GDP in the near future (a 7% to 11% year from today,) and then a defined growth path from that point (5% or 3%.) But this is not a one shot deal. We propose a regime with a target nominal GDP staying on that defined growth path.

    The notion that this requires constant growth in debt is false. Even nominal debt could fall quite a bit from current levels. Of course, in the very long run, it is almost certain than nominal debt must be higher, but not as a ratio to nominal income.

  23. Gravatar of 123 123
    26. May 2012 at 09:21

    Scott, Bill,
    since I like the debt – jobs analogy so much ( both being sticky long term relationships ), I am tempted to write a comment along the lines of “money and jobs still confused”…

  24. Gravatar of dwb dwb
    27. May 2012 at 05:55

    Here’s more proof that demand is not structurally depressed:

    New home construction is rising fast in Las Vegas.

    http://www.vegasinc.com/news/2012/may/26/long-time-coming-homebuilders-are-busy-again-las-v/

  25. Gravatar of ssumner ssumner
    27. May 2012 at 08:12

    Donald, Yes, I see that sort of argument sometimes.

    Greg, I agree with your first comment. Regarding your second, Rajan’s comment makes no sense under any plausible definition of demand.

    Tom, Let’s start with the S=I tautology for a closed economy. If people invested too much in housing, then that means they saved too much. Do you agree? And no, dropping money from helicopters does not in any way violate that tautology.

    Rajan acts like AD proponents want to boost demand relative to income. But we consider demand and income to be the same thing, so it would be just as accurate to say we want higher income.

    If you want to argue demand is “consumption,” which seems to be the implication of your comment, then Rajan makes no sense, because the problem wasn’t too much consumption it was too much borrowing. If you want to claim the problem was too much borrowing, that plays no role in unemployment.

    Later you seem to suggest people both consumed too much and invested too much. In a closed economy model that means they worked too hard. But what possible basis is there for assuming people were working too hard? And if you go to an open economy model, then you are talking about a CA deficit. But the solution to that problem is not for people to work less, indeed they should probably work more.

    I don’t see any interpretation of Rajan’s argument that makes any sense. Macro has very precise terms that need to be used in precise ways, otherwise people are just talking gibberish.

    You said;

    “And most folk are pretty sure that’s what happened in the bubble “” too many people spent too much borrowed money.
    Spent/ invested/ consumed/ speculated in housing, especially.”

    This sentence perfectly encapsulates why “most folks” really need to take a few courses in macroeconomics, so they aren’t talking nonsense.

    Peter N, You said;

    “There are dangers to using GDP as a proxy for spending. It isn’t a very good one.

    Japan post crash has had negligible CPI deflation, but enormous uncorrected (20 years and counting) deflation in equities and real estate.”

    It depends what you are interested in. If it’s transactions, then yes, GDP is lousy. If it’s the sort of spending that creates jobs, then transactions are lousy and you definitely do want to look at GDP. Rajan seems interested in explaining unemployment, hence needs to focus on GDP.

    Phil, There is never a lack of productive opportunities as long as NGDP is on track and we all aren’t living the lifestyle of Hollywood millionaires. And the real factors you discuss do not determine NGDP, it is monetary policy that determines NGDP. Zimbabwe’s bad economic policies removed most good investment opportunities, but the government produced record levels of NGDP growth. They are two very different issues.

    Bill, Finally a voice of reason.

    dwb, I sure hope Greg Ransom doesn’t see that link, it would explode his entire worldview.

  26. Gravatar of "…you want to do more monetary stimulus until we’ve reached a demand level where Congress feels it can remove fiscal stimulus. People used to blanch when I talked about the Fed ’sabotaging’ fiscal stimulus, but Bernanke all bu "…you want to do more monetary stimulus until we’ve reached a demand level where Congress feels it can remove fiscal stimulus. People used to blanch when I talked about the Fed ’sabotaging’ fiscal stimulus, but Bernanke all bu
    29. May 2012 at 23:00

    […] Source […]

Leave a Reply