We’re broke, therefore we should be booming

I see lots of discussion in the press about how the housing bubble made Americans poorer, and that this explains the low level of AD.  Yet the conclusion doesn’t follow from the premise.

Every bone in my body tells me the conventional view is correct.  We built too many houses and got too deeply in debt.  Now we need to spend less, and that means we need to produce less (as trade is too small a share of GDP to make up the gap.)  Intuitively this seems true, but it’s actually false.  To see why, consider the following parable:

A pioneer family in the American Midwest has run into trouble.  Locusts ate their wheat crop, and now they can’t pay back the local moneylender for the loan they used to get started in farming.  He threatens to burn down their house if they don’t repay within another 12 months.  What do they do?  I’d argue they need to tighten their belts and consume less.  They also need to work much harder.  But in a closed economy (they are self-sufficient) how can this be?  They consume what they produce.  No, they consume part of what they produce.  They need to consume less consumer goods.  Since they are self-sufficient, money plays no role (and that means, THANK GOD, no NGDP shocks.)  They need to “spend” less on clothing and pots, by spending less time making clothing and pots.  And they need to spend more time clearing another 40 acres of land, by cutting down trees.  They need to actually work harder, and plant twice as many crops as the year before.

You may not like the exports of wheat that are implicit in this example.  Then assume the problem is poverty caused by locusts eating one half of their crops.  Now they need to clear twice as much land to feed themselves, knowing the locusts will eat half of whatever they produce.  Either way, they need to invest more.  In an open economy they also made need to export more (depending on the situation in other “countries.”)

What’s true of the pioneer family is also true of the modern US economy.  We need to tighten our belts by saving and investing more.  But the Keynesians are wrong in assuming that more saving means less GDP.  We need to have the Fed stabilize NGDP growth, so that more saving means more investment (and exports.)

A more sophisticated argument accepts this analysis as a long run proposition, but rejects it’s applicability for the US in 2008.  People like Tyler Cowen and Arnold Kling might argue that a modern sophisticated economy can’t easily switch from producing one type of good to producing another.  During the re-allocation of resources, and retraining of workers, there may be a good deal of unemployment.  I accept this in principle, but believe the effect is so tiny as to not have important cyclical implications.

Perhaps the most famous example of the US finding itself producing the wrong set of goods occurred in late 1941.  We had been producing lots of cars and other consumer products in our factories (the economy had mostly recovered from the Depression by December 1941.)  And suddenly in late 1941 we realized that we needed to entirely stop producing any cars, and start producing tanks, airplanes, etc.  And even worse, we had to do so with a largely untrained workforce, as a large share of our regular workforce was drafted into the military, and replaced by housewives, unskilled rural workers, etc.

So if re-allocation led to recession and high unemployment, then 1942 should have been the mother of all recessions.  Obviously it wasn’t.  And the reason is also obvious—NGDP rose sharply.  Some might argue that we knew the new products we needed in 1942, but not in 2008.  But I can’t see why that would be.  The price system gives us the signals telling us what to produce, even without the sort of central planning we had in 1942.  Keep NGDP growing at a steady rate, and booms will burst out in non-housing sectors.  I said booms, not bubbles.  This re-allocation is efficient, just like clearing land was efficient.

Another objection is that the Fed can’t prevent a fall in wealth from decreasing NGDP.  So even if reallocation is not a problem, falling AD is.  We had a near perfect laboratory test of this hypothesis in 1987.  But first a bit of history.  In 1929 there was a big stock market crash, and consumer spending fell sharply in 1930.  This led many Keynesians to hypothesize that the stock crash actually caused the fall in AD during 1930.  We now know that hypothesis is false, thanks to Alan Greenspan.  This is because the 1987 crash was almost identical is size to 1929; if you overlay the two graphs for September/October, they line up almost perfectly.  And because Greenspan kept NGDP growing at a steady rate, there was no collapse in consumer spending, and not even the teeniest slowdown in economic growth.  Thus 1988 and 1989 were the two most prosperous years of the entire decade.  Even the first half of 1990 saw very low unemployment.  So the Keynesians were wrong about the Great Contraction.

Many people will send in comments to the effect that 1987 was different due to blah, blah, blah.  And 1942 is not a good example of reallocation due to blah, blah, blah.  Maybe you are right.  But it won’t affect my views, because no one can point to a counterexample, that would disprove my “NGDP drives the cycle” hypothesis.

Someone needs to find a counterexample to the two following “it’s funnies”:

1.  It’s funny that big drops in wealth never seem to result in recessions, unless the Fed lets NGDP growth slow sharply.

2.  It’s funny that major episodes of re-allocation never seem to result in recessions, unless the Fed lets NGDP growth slow sharply.

For me, those two claims are the bottom line.  We know what classical economics says should happen; I say it will happen if NGDP growth is stable.  A commenter named Skip linked to an interview with Bob Lucas.  Skip made the following observation:

In his interview when asked about his thoughts on Real Business Cycle theory he essentially says that he thinks RBC theory is basically right WHEN MONETARY POLICY IS GOOD.

Yep.

PS.  Here’s the link Skip provided:

http://media.bloomberg.com/bb/avfile/Economics/On_Economy/vv9VRoc8DQl8.mp3

PPS.  This exercise has made me a bit more accepting of the Keynesian argument that it’s time for lots more infrastructure.  I was initially skeptical, as I assumed that good monetary policy would raise real rates back up to normal.  Now I think they’d only go part way back to normal, at least for a while.  Of course I’d hope we follow the Swedish lead and have the private sector build and operate as much of that infrastructure as possible.  (So don’t worry Morgan, I’m not going soft.)


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54 Responses to “We’re broke, therefore we should be booming”

  1. Gravatar of Morgan Warstler Morgan Warstler
    26. July 2011 at 05:09

    Man, we’re so close!

    1. It’s funny that big drops in wealth never seem to result in recessions, unless the Fed lets NGDP growth slow sharply.

    …. which they SHOULD DO, if a Democrat is in office AND is trying to spend money on his base.

    2. It’s funny that major episodes of re-allocation never seem to result in recessions, unless the Fed lets NGDP growth slow sharply.

    …. which they SHOULD DO, if a Democrat is in office AND is trying to spend money on his base.

    ——-

    This helps us better inform a decision on infrastructure spending:

    “Of course I’d hope we follow the Swedish lead and have the private sector build and operate as much of that infrastructure as possible.”

    The one difference here Scott, is that we SHOULD NOT do infrastructure UNLESS it is done the “Swedish way,” which lets a Democrat be in office, but NOT spend money on his base.

    There is a larger game afoot than macro-economic policy.

    And Scott, when I first got here, you made the one point I think you have to admit now was wrong:

    You looked at the GD and told me that since it lead to more big social safety net, to bigger government, we should do whatever we could to not have another deep and binding recession.

    You should be awed by the Tea Party. Our grandparents generation simply wasn’t smart enough to fight through the fear.

    The disappointing thing would be if we as a culture had NOT learned, if we had not grown since the 1930’s.

    And the lesson took a serious cultural hack, it came in 1980 when Reagan started spending all the money.

    —–

    And it is Obama’s fault today for not learning the lessons of history.

    He KNEW FULL WELL what would work… he just had to come in and be Bill Clinton, he just had to come in a do it the Swedish way.

  2. Gravatar of tom tom
    26. July 2011 at 05:32

    “So if re-allocation led to recession and high unemployment, then 1942 should have been the mother of all recessions. Obviously it wasn’t. And the reason is also obvious””NGDP rose sharply.”

    1942 didn’t have high UE but in terms of individual quality of life it was very bad. As a random individual you had ~8% chance of being forced into the armed services (10 million conscripts out of a population of 131 million) and ~ 0.33% of dying during the war. GDP numbers don’t even try to capture the real life experience difference of going from living at home to living in a military setting under conditions of war despite the fact that virtually everyone prefers one to the other by a huge margin.

    For those who were not drafted there was still massive shortages of consumer goods. Oil, rubber and milk (to name a few) were difficult to obtain and new products like cars and refrigerators virtually non-existent.

    Basically calling 1942 not a recession because GDP numbers didn’t collapse and UE was low is like saying the USSR had a booming economy for decades because everyone had a state assigned job and GDP numbers were high. When you look at the underlying assumptions of the numbers it is clear that they had nothing to do with voluntary purchases of individuals which is the basis for assuming that price and value to the consumer are related.

  3. Gravatar of Tomasz Wegrzanowski Tomasz Wegrzanowski
    26. July 2011 at 05:34

    What do you make of recent UK experience of very high inflation and zero RGDP growth? I’ve only heard some hand-waving that UK must have some “real” problems unlike every other country.

    Between significantly above-target inflation and very cheap pound UK is having as much monetary stimulus as is plausible. Why is it not enough?

    Would slightly lower NGDP mean less inflation (back to target) or negative RGDP growth and why?

  4. Gravatar of Lewis Lewis
    26. July 2011 at 05:43

    “We built too many houses and got too deeply in debt.”
    The “we” isn’t all of America, however. Someone is holding that debt. I would bet most of the households deeply indebted are middle class and below. So, in addition to higher investment, some of the higher NGDP would probably show up as higher spending by high income households–spending that would let middle and lower income households undo their leverage. The best outcome is that debt holders make lots of awesome investments, building private roads and such like the SR91 lanes in California. But a likely outcome is they will direct some of their extra spending to get massages, hand-distressed furniture, and dog walking services or something. Maybe I’m wrong.

  5. Gravatar of Lee Kelly Lee Kelly
    26. July 2011 at 05:46

    It’s funny that so many economists seem desperate to find another explanation. Why? This is, by far, the simplest, easiest to test, and hardest to vary explanation of this recession the business cycles generally. This should be the default. Why isn’t it?

  6. Gravatar of tom tom
    26. July 2011 at 05:58

    “You may not like the exports of wheat that are implicit in this example. Then assume the problem is poverty caused by locusts eating one half of their crops. Now they need to clear twice as much land to feed themselves, knowing the locusts will eat half of whatever they produce. Either way, they need to invest more. In an open economy they also made need to export more (depending on the situation in other “countries.”)”

    This is wrong. Clearing 2x as much land is a death sentence to a subsistence farmer in response to a crisis such as locusts. Clearing twice as much land could hypothetically lead to 2x as much harvest (1/2 of which is then eaten by locusts) which results in “stable” NGDP. The cost of farming 2x as much land is ~ 2x as much and so real GDP is still 1/2 either way if land and labor is homogeneous. Because land and labor aren’t homogeneous (land farther from your home or farther from a water supply requires more effort to farm and labor productivity decreases sharply after a certain # of hours worked each day) the real cost of doubling the size of the farm is much much greater than 2x.

    Any cultural anthropologist will tell you that in times of stresses like these lead not to doubling the farming effort but to massive cuts in consumption and the rise of witch hunts that have evolved to reduce the lowest marginal product workers (generally elderly women and single mothers).

  7. Gravatar of Lee Kelly Lee Kelly
    26. July 2011 at 06:01

    Thomasz,

    The U.K. does have a real problem: it’s called “the government.” The Labour party increased government spending to more than half of GDP, and that understates the level of centralised command of resources, since the economy is also heavily burdened with regulation. That is, bureaucrats can direct the allocation of resources while the accountants register it as “private spending.” I would conjecture this has a lot to do with the U.K.’s poor recovery despite riding NGDP.

  8. Gravatar of Lee Kelly Lee Kelly
    26. July 2011 at 06:05

    Another way to make this whole argument is that we need to enforce Say’s law with NGDP targeting.

  9. Gravatar of flow5 flow5
    26. July 2011 at 06:18

    “We need to have the Fed stabilize NGDP growth” You would still have had a housing boom/bust. It would just have been postponed.

  10. Gravatar of Scott Sumner Scott Sumner
    26. July 2011 at 06:20

    Morgan, You said;

    “And Scott, when I first got here, you made the one point I think you have to admit now was wrong:

    You looked at the GD and told me that since it lead to more big social safety net, to bigger government, we should do whatever we could to not have another deep and binding recession.”

    Short-term I was right (UAW bailout, extended UI-both done by Bush.) But I admit that long term it looks like I was wrong. Obama’s problem is he got in too early. In 1929-33 we had 4 years of Hoover, and the voters were ready to let FDR do anything.

    Interestingly, regarding foreign countries I admitted I was wrong early on. In mid-2009 I had several posts pointing out that a number of elections were producing gains for the right in other countries.

    Tom, I think you misunderstood the point of my post. I’m not saying everything would be great if we had full employment, we still have all that economic waste caused by too many houses being produced, and having to shift over to producing something else. My point is that we should not have high unemployment. If 1942 saw high unemployment, living conditions would have been even worse than they were. Unemployment solves nothing.

    Tomasz, If true, it’s a no brainer. The problem is supply-side. But I have trouble finding NGDP data for Britain. What was NGDP growth in the second quarter?

    Lewis, Interesting issue but unrelated to monetary policy. All the Fed can do is produce the right amount of NGDP. It’s up to the private economy plus government to allocate that spending in a rational way. If there are market failures, you start thinking about optimal responses–but none of those responses involve monetary policy.

    Lee, Good question.

    Tom#2, It was just a hypothetical–if you don’t like my assumptions, make up your own more realistic ones.

    Lee, I agree about Say’s Law.

  11. Gravatar of Scott Sumner Scott Sumner
    26. July 2011 at 06:22

    flow5, As long as NGDP is on target, housing booms/busts don’t hurt the economy very much. In any case, the Fed can’t targeting individual sectors, only NGDP. Regulation needs to deal with any market failure in housing.

  12. Gravatar of tom tom
    26. July 2011 at 06:34

    “I think you misunderstood the point of my post. . .If 1942 saw high unemployment, living conditions would have been even worse than they were. Unemployment solves nothing.”

    You misunderstand the point of the reply. High UE might not solve anything but false low UE- the kind forced by government conscription- also doesn’t solve anything. Living standards during WW2 were comparable (and by some estimates worse) to the worst years of the great depression in terms of the quantity and quality of consumer goods available. The GDP numbers mask this because of the governments assumption that because the cost of building 1 tank = cost of building 4-5 cars (I forget the ratio) then the economic value of 1 tank = 4-5 cars.

  13. Gravatar of tom tom
    26. July 2011 at 06:39

    “Tom#2, It was just a hypothetical-if you don’t like my assumptions, make up your own more realistic ones.”

    I have no problem with your hypothetical- it is actually an excellent one for demonstrating how dangerous NGDP stabilization can be. In your example the farmers could stabilize NGDP but only by decreasing RGDP. I personally take the approach that a recession is a period in which the average expected return on investment is negative which fits in very nicely with your above example.

  14. Gravatar of Britmouse Britmouse
    26. July 2011 at 06:48

    Prof Sumner, it looks like we are not getting a UK NGDP figure for Q2 until October (!) because the stats guys are busy doing the National Accounts in the mean time; normally it would come in a month’s time.

  15. Gravatar of Lewis Lewis
    26. July 2011 at 06:59

    Scott,
    I’m not complaining about higher consumption from high earners. I just think it’s helpful to visualize what higher aggregate demand would mean in concrete terms. I don’t have a problem with their spending. They earned it.

  16. Gravatar of Morgan Warstler Morgan Warstler
    26. July 2011 at 07:09

    Lee, that’s a really nice way to say it:

    “Another way to make this whole argument is that we need to enforce Say’s law with NGDP targeting.”

    Which brings me to a request Scott…

    You spent all that time talking MMT, which I think we can all agree is the a pure manifestation of DeKrugman’s id splayed wide open.

    Meanwhile I really think Natural Money deserves a full post from you – as pure monetary theory I find it pretty compelling:

    http://www.naturalmoney.org/introduction.html

  17. Gravatar of David Pearson David Pearson
    26. July 2011 at 07:19

    Scott,

    House prices, not volumes, are the important variable. Think of the abrupt, unforeseen decline in prices as significantly impacting Klingian “Patterns of Sustainable Specialization and Trade.”

    The home equity withdrawal accomplished during the 2002-2007 period was unprecedented. Entrepreneurs come to rely on home equity financing as the main source of start-up capital for new firms (a “pattern” of organizing resources). Then, this source completely dries up. Creditors have no way to effectively channel funds to the small business sector. The result is the failure of net new firm creation to recover; along with this failure, employment stagnates.

    Another PSST-like narrative: consumers come to rely on home equity extraction as “liquid savings”. They draw down other sources of those same savings to compensate for the emergence of a new one. When those home equity “liquid savings” evaporate, consumers are forced to build up the alternative sources once again. This shows up as “excess demand for safe assets” on the part of households: the new “home equity” pattern of household finance is replaced by the old “money in the bank” one.

    A third PSST narrative: the vast majority of households face stagnant wages. They supplement their spending through credit; they get the credit from a tiny minority of households with low consumption propensities (another “pattern”). The debtor households pour spending into discretionary consumer services — think “strip mall”. House prices fall and the source of credit dries up; the first thing households cut back on is those services, which in turn hurts employment. Creditors with low consumption propensities do not compensate for that low spending as they receive back funds from de-levering consumers, and neither does anyone they want to lend to. The result: small businesses (which comprise this sector) suffer disproportionately, as does, again, employment.

    Would raising the general price level help the above PSST changes?

  18. Gravatar of Scott Sumner Scott Sumner
    26. July 2011 at 07:24

    Tom, I don’t disagree with you on 1942, as long as you accept that it has no bearing on my argument. I happen to think defeating Hitler was useful, and that the expenditure were productive. But if I’m wrong, that doesn’t change the fact that reallocation doesn’t lead to high unemployment. That was my only point. I wasn’t saying that re-allocation always goes into socially useful sectors–when the government is involved it’s often wasteful.

    Britmouse. Wow! That is just bizarre. NGDP is much easier to calculate than RGDP, indeed you can’t even calculate RGDP without first calculating NGDP. Aren’t there complaints in Britain? Their statistical office must be a real mess. That means they have no GDP deflator as well. But then how do you calculate RGDP?

    Lewis, OK

    Morgan, There will be no posts on Natural Money.

  19. Gravatar of spencer spencer
    26. July 2011 at 07:27

    In 1943-44 real civilian GDP — real GDP less military spending —
    fell 18% and 15%, respectively.

    So civilian real GDP had a decline comparable to the 1929-33 recession.

  20. Gravatar of Scott Sumner Scott Sumner
    26. July 2011 at 07:33

    David; You said;

    “Would raising the general price level help the above PSST changes?”

    No, but raising NGDP would help a lot. You said people spend less because their wages are low. Wrong, it’s because their incomes are low. If we have more NGDP then we have more income, and people will spend more. In addition, asset prices will go up, making it easier for entrepreneurs to borrow in order to finance new investments.

    If people have more trouble getting credit, the the economy should re-allocate into sectors that don’t require credit. But I’m not convinced that good borrowers aren’t able to get credit. And of course higher NGDP growth would reduce the real cost of credit.

    I don’t see how your argument relates to my post. It seems to me that you are simply repeating the re-allocation argument, that it is hard to move resources into the new industries that need to grow. I claimed their is empirical evidence that this is false (1942) and there is no empirical evidence that it is true (no cases of reallocation leading to recession w/o falling NGDP growth.)

  21. Gravatar of Scott Sumner Scott Sumner
    26. July 2011 at 07:34

    Spencer, Good point, and that shows how re-allocation can preserve jobs, even if consumption plummets (as I assumed in my example.)

  22. Gravatar of Joe Joe
    26. July 2011 at 07:44

    Professor Sumner,

    If we implemented your monetary ideas, could we get rid of deposit insurance and all the ensuing bank regulation?

  23. Gravatar of David Pearson David Pearson
    26. July 2011 at 08:28

    Scott,

    “…no cases of reallocation leading to recession w/o falling NGDP growth.”

    Is there a case of any significant recession occurring without falling NGDP growth?

    A theoretical, successful NGDP targeting regime leaves only two possible outcomes: 1) recessions can only occur with accelerating inflation; or 2) recessions cannot occur. Since the empirical evidence shows scant support for 1), 2) follows.

    The problem with this logic is what happens over the course of cycle. If the Fed pushes up NGDP despite structural obstacles, it will end up with ever more growth in P and less in Y. This combination also makes it ever more politically possible to restrain the growth in P. The result is a secular trend towards high, variable inflation and low, variable growth. There are many examples of this occurring.

  24. Gravatar of David Pearson David Pearson
    26. July 2011 at 08:30

    Sorry, I meant “ever more politically IMpossible to restrain the growth in P.”

  25. Gravatar of tom tom
    26. July 2011 at 08:31

    “Tom, I don’t disagree with you on 1942, as long as you accept that it has no bearing on my argument. I happen to think defeating Hitler was useful, and that the expenditure were productive. But if I’m wrong, that doesn’t change the fact that reallocation doesn’t lead to high unemployment. That was my only point. I wasn’t saying that re-allocation always goes into socially useful sectors-when the government is involved it’s often wasteful.”

    Perhaps we are just talking across each other but I don’t think anyone who proposes aspects of recalculation would disagree with you that it doesn’t have to increase UE. Their position though would be that the effects of forcing down UE (via government intervention) during a recalculation period would be to lower real living standards at the same time.

    You said

    “So if re-allocation led to recession and high unemployment, then 1942 should have been the mother of all recessions. Obviously it wasn’t. And the reason is also obvious””NGDP rose sharply.”

    From the viewpoint of standard of living from 1942-1945 there was a massive recession- that was my point. From the viewpoint of UE and GDP there was not- since the basic purpose of GDP and UE numbers are an attempt to describe standard of living it is clear that we discard the GDP and UE numbers and hold onto the standard of living assessment when there is disagreement and not the other way around.

  26. Gravatar of Anthony DeRobertis Anthony DeRobertis
    26. July 2011 at 08:44

    Scott,

    I think this is where to find UK data: http://www.statistics.gov.uk/statbase/Product.asp?vlnk=406 which is only RGDP. The NGDP figures apparently are here http://www.statistics.gov.uk/statbase/Product.asp?vlnk=818 but Q2 data won’t be released for a while. http://www.statistics.gov.uk/STATBASE/Product.asp?vlnk=1129 may give data sooner (though currently only shows an earlier estimate for 2011Q1)

  27. Gravatar of Benjamin Cole Benjamin Cole
    26. July 2011 at 08:48

    If I was not an atheist, I would write, “God Bless Scott Sumner.”

    Yes! If you find yourself overindebted, you need to increase output! In fact, for a national economy, it probably is always a good idea to increase output.

    I can’t stand the lunacy that suggests we need to “cut back.”

    Worse, our fatories have not been bombed, plague has not wiped out our crops. You mean we are supposed to reduce output due to an invisible thing called “debt”? Oh, that makes sense.

    Imagine explaining to a visitor from Mars, “You see, our roads are still there, our farms are fine, our factories still operable, and the workforce as skilled as it was two years ago. But due to debt–blips on a computer screen–we have to shut all of this down now, and have a Great Depression. Some will commit suicide, others will forego families, yet others will turn to prostitution. But we have the debt, you see.”

  28. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    26. July 2011 at 09:23

    Scott, you might want to change your example to 1945-46, as government spending declined drastically and millions of military were released into the civilian labor force.

    It was a pretty smooth transition from a centrally planned to market ordered economy. Nicely depicted in ‘The Best Years of Our Lives’.

  29. Gravatar of Cliff Cliff
    26. July 2011 at 10:08

    One issue with the grow NGDP strategy is that it necessarily means inflation – but this conflicts with what Says’ law provides should happen when an economy is faced with a glut and overcapacity. I think modern advocates of Say’s law want to see market forces working quickly – via price adjustment – to abolish both gluts and shortage. Of course, this can not happen if the Fed is focused on just pushing NGDP higher.

  30. Gravatar of maximillienne maximillienne
    26. July 2011 at 10:12

    your beat and most important post.

    the mechanics, instantly create a department of infrastructure funded by the fed
    don’t worry about borrowing the money, the fed simply funds the dept for as many private contacts it wants too take on until the ngdp target is on track

  31. Gravatar of Cliff Cliff
    26. July 2011 at 10:52

    At least one company (Ford) has lost at some of its profit margin and overall profitability was nominally flat despite greater sales. Ford’s gains in sales, pricing and incentives were almost entirely wiped out by increased commodity, material and warranty/freight costs, while increases in manufacturing, engineering, advertising and overhead structural costs more than compensated for volume and mix improvements.

    Thus, it is unlikely management will be able to increase wages in this environment.

    http://www.thetruthaboutcars.com/2011/07/ford-profitability-slides-earns-2-4b-anyway/

  32. Gravatar of lat lat
    26. July 2011 at 11:50

    Professor Sumner,

    If you have the time, I’m not quite clear on something here:

    “Some might argue that we knew the new products we needed in 1942, but not in 2008. But I can’t see why that would be. The price system gives us the signals telling us what to produce, even without the sort of central planning we had in 1942.”

    I realize this isn’t necessarily the point of your post, but what if the price system isn’t operating properly due to federal/regulatory interventions (ie. mortgage interest deduction, efforts to prop up housing/prevent foreclosures, etc.)? I’m having difficulty putting it into words, but I feel like the war build-up was intervention on a grand scale that seems different from government efforts today. I could be wrong, but it seems that many prices today aren’t providing accurate signals.

    Also, I could be getting confused on the differences between “the price level”, “AD”, and “NGDP”, but wouldn’t keeping NGDP growth constant have an effect on prices that could distort the signals prices are intended to give? I might just not know enough monetary econ, but I’m having difficulty separating Fed interventions such as NGDP targeting from prices.

    Thanks for taking the time, I know I’m not the only one that appreciates the time you spend on comments here.

  33. Gravatar of Citizen AllenM Citizen AllenM
    26. July 2011 at 12:06

    Ahhh, finally we get to the heart of the problem. The ability to liquidate our way to prosperity has been proven nil.

    I see so many finally beginning to understand the only solution to the problem is a growing economy, with the only part of the solution totally ignored by the freshwater economists is wages have to stabilize, and then begin to grow. When you have continuous layoff cycles, massive underemployment and large unemployment official and unofficial, talking about the returns to capital constitutes economic failure in their eyes.

    Wages must rise, employment must rise, or you end up in a crippled economy like Japan, facing zero growth prospects, limping on an export model that has managed to sustain the status quo for nearly two decades of decay and stagnation.

    One would note that the forced savings of WW2 provided the fuel for the restart of the consumer economy, and without that forced savings, the economy would have sputtered back into recession, if not depression.

    The irony of facing an artificial fiscal austerity, when government absolutely needs to maintain the minimal safety net simply wastes resources through the need to somehow provide bare minimal necessities to the 30% of the workforce that are currently suffering the direct impact of this economy.

    Further, because of the massive deficit in trade, compounded by the massive transfer of funds to maintain and operate the overseas military commitments further drains funds from the domestic economy. These massive leakages are only funded through the federal deficit, and the use of the new paper in the international reserve system. Yet another critical flashpoint in our international position is the possible downgrading of our paper, and attempted liqiudation of that paper.

    In short, having starved the beast for funding through suboptimal and inadequate taxation, the conservative option is to impose further domestic austerity to allow corporate job creation overseas.

    Sheer idiocy.

    We are swimming in paper capital, and yet we have massive unemployment.

    The balance between capital and labor will be restored, either through taxation and transfer payments removing the advantage of capital over labor, or destruction of both idle capital and idle labor.

    Further driving of the system into the austerity corner, with the targeting of Social Security and Medicare will simply ensure the expected reaction by Scott will be even more reactionary than what we have seen already.

    I would suggest reading a few of Huey Long’s speeches to see the power of corn pone socialism up close, and then determine if you want to see those policies implemented.

    In short, austerity is failing, job creation to offset government job losses is failing, and we sit here and wonder at the decisions of capital to further attempt to impoverish labor (remove the minimum wage? Folly!), and expect savings to somehow miraculously appear?

    Screw the folly of savings. Money is coming out of our ears. Corporate America is sitting on more funds than they can use, because demand is moribund, and labor’s share of national income has fallen so far, that it can’t get up.

  34. Gravatar of Citizen AllenM Citizen AllenM
    26. July 2011 at 12:21

    Just to make it explicit, this NYT article shows how the down esclator works: http://www.nytimes.com/2011/07/26/business/help-wanted-ads-exclude-the-long-term-jobless.html

    People exhausting unemployment, and finding no safety net beyond friends and family.

    That helps demand, doesn’t it?

  35. Gravatar of Charlie Charlie
    26. July 2011 at 13:52

    http://www.measuringworth.com has nominal GDP for the UK by year.

    2007 – 2010 in trillions.

    1.399
    1.448
    1.396
    1.454

  36. Gravatar of Martin Martin
    26. July 2011 at 14:06

    @Joe, I was actually thinking the same thing, but I believe that this question was (implicitly) answered in a previous post: https://www.themoneyillusion.com/?p=10022

    “But in the end Bernanke has to acknowledge that the major contractionary effect worked through falling NGDP. If the Fed doesn’t allow NGDP to fall in half, there is no Great Depression.”

    And from the comment section:
    “My second response is that if the Fed hadn’t let NGDP collapse in 1929-33, there would have been no banking crisis anyway.”

    If the Central Bank can keep NGDP on target then you have ‘no’ systemic banking crises and vice-versa if you have a bank-run and you keep NGDP on target, the fall in deposits is offset by whatever the CB does to keep NGDP on target.

    There seems to be therefore little justification for deposit insurance, unless of course deposit insurance is a less costly alternative (incl. efficiency).

    Am I correct in reading you this way Scott?

  37. Gravatar of Richard W Richard W
    26. July 2011 at 15:28

    Lee Kelly
    26. July 2011 at 06:01

    ” The U.K. does have a real problem: it’s called “the government.” The Labour party increased government spending to more than half of GDP, and that understates the level of centralised command of resources, since the economy is also heavily burdened with regulation. ”

    It is always useful to look at some objective evidence when the regulation meme comes up. The World Bank have an ease of doing business index.

    ” A high ranking on the ease of doing business index means the regulatory environment is more conducive to the starting and operation of a local firm. ”

    1/ Singapore
    2/ Hong Kong SAR, China
    3/ New Zealand
    4/ United Kingdom
    5/ United States
    6/ Denmark
    7/ Canada
    8/ Norway
    9/ Ireland
    10/Australia

    http://www.doingbusiness.org/rankings

    Scott Sumner
    26. July 2011 at 06:20

    ” The problem is supply-side. ”

    If the problems are all supply-side, how do explain unemployment not rising anywhere near what was forecast. The fall in employment has been modest considering the decline in output. Moreover, the private sector has generated 500,000 new jobs over the last 12 months even with low RGDP, at the same time as the public sector has shed jobs in a workforce of 30m. Why is unemployment not higher if low RGDP growth is a supply-side problem?

  38. Gravatar of Rien Huizer Rien Huizer
    26. July 2011 at 17:13

    Scott,

    I suspect locusts have been eating your blog crop, forcing you to double (redouble?) your output.

    Why not upgrade locusts to consumers, rather than their consumption deduct from output? Locusts are living beings and they have the right to a decent existence. How could they be different from pensioners like me wasting their time playing golf?

  39. Gravatar of We’re broke, therefore we should be booming « Economics Info We’re broke, therefore we should be booming « Economics Info
    26. July 2011 at 23:01

    […] Source […]

  40. Gravatar of Lorenzo from Oz Lorenzo from Oz
    27. July 2011 at 00:25

    There will be no posts on Natural Money. ROFL. I agree, a man has to have standards, life is too short and various other appropriate cliches 🙂

  41. Gravatar of Doc Merlin Doc Merlin
    27. July 2011 at 02:00

    @Scott:
    One thing you have wrong w.r.t. savings. You say that increasing NGDP when its too low via monetary stimulus would increase the savings rate. This isn’t so; increasing NGDP via monetary stimulus decreases savings rate.

    “1. It’s funny that big drops in wealth never seem to result in recessions, unless the Fed lets NGDP growth slow sharply.”

    Agreed!

    “2. It’s funny that major episodes of re-allocation never seem to result in recessions, unless the Fed lets NGDP growth slow sharply.”

    I’m not sure the fed is agile enough to actually target NGDP on the time scales you suggest. It would very often fail to accurately forecast NGDP growth correctly (as it does now), and still have serious recessions. If these two statements are correct, your only possible solution is a Fed who’s hands were tied and just worked based on some sort of prediction market. And I doubt even that would work because of the Lucas Critique. I very strongly suspect that if NGDP growth was finally fixed, after a short while it would cease to be an important macroeconomic variable and inflation rate would become far more important.

    @ Citizen AllenM
    “Wages must rise, employment must rise, or you end up in a crippled economy like Japan, facing zero growth prospects, limping on an export model that has managed to sustain the status quo for nearly two decades of decay and stagnation.”
    Nonsense, Japan is full of zombies corporations (this is what repeated bailouts do), is facing demographic collapse, and has one of the highest debt to GDP ratios of any country on the planet. Deflationary currency isn’t the problem. Many countries have operated in deflationary environments and done macro-economically quite well (I can think several of the top of my head.) At the heart of it, you fail to understand the heart of Scott’s argument: according to him it is adverse shocks in NGDP that cause recession. This is completely different than the view you seem to be espousing.

  42. Gravatar of sdfc sdfc
    27. July 2011 at 02:06

    The Fed should just target NGDP? Snap your fingers and there it is.

    As for 1987 v 2008. It’s a bit easier for a CB to stimulate an economy where private sector debt outstanding is ~120% of GDP as opposed to 175% of GDP.

  43. Gravatar of Cliff Cliff
    27. July 2011 at 04:47

    Actually, I don’t think Japan’s ever had an unemployment rate above 5% since the start of its “lost” period.

    Also, if the rationale of QE2 was that a “wealth effect” would benefit the economy, when should we expect to see that? Today’s durable goods numbers seems very weak.

  44. Gravatar of Scott Sumner Scott Sumner
    27. July 2011 at 07:25

    Joe; You asked;

    “If we implemented your monetary ideas, could we get rid of deposit insurance and all the ensuing bank regulation?”

    David; You asked;

    “Is there a case of any significant recession occurring without falling NGDP growth?”

    In foreign countries the answer is obviously yes (Zimbabwe.) In the US I think there might be some mild recessions without a slowdown, but am not sure. Perhaps the first half of 1974? Maybe someone can check, it’s an interesting question. I’d say no significant recessions, which is the claim in my post.

    You said;

    “The problem with this logic is what happens over the course of cycle. If the Fed pushes up NGDP despite structural obstacles, it will end up with ever more growth in P and less in Y.”

    I don’t follow. Yes, inflation would be countercyclical, but that’s precisely what you want. You’d have stable trend inflation, which seems reasonable, not ever increasing inflation like 1965-81.

    I’d hope that the media stopped focusing on inflation, but that’s probably too much to ask.

    Tom, You said;

    “Perhaps we are just talking across each other but I don’t think anyone who proposes aspects of recalculation would disagree with you that it doesn’t have to increase UE. Their position though would be that the effects of forcing down UE (via government intervention) during a recalculation period would be to lower real living standards at the same time.”

    I agree, I favor a stable monetary policy, and let UE go wherever the free market takes it.

    I agree that standards of living fall when there has been misallocation, and that was one point of my post. You wouldn’t expect lower standards of living to be associated with higher unemployment, however. Impoverished people should work harder.

    Anthony, That’s really bizarre, and confirms what Britmouse said. Why aren’t there more complaints in the UK? That seems disgraceful.

    Benjamin, Good points.

    Patrick, That’s a good point, I’ll try to remember to use that next time. And that’s also a reallocation that led to better lives, which addresses the complaint some commenters made above. But wasn’t the movie title meant to be ironic?

    Cliff, You said;

    “One issue with the grow NGDP strategy is that it necessarily means inflation”

    This confuses two issues. Should we target NGDP, and at what rate. Some like Woolsey favor a rate that leads to stable prices over time. George Selgin favors mild deflation, through a slightly different technique. I’m not tied to the 5% figure, I just didn’t think we should institute a sudden tight money policy in the midst of a financial panic, given that debts are denominated in nominal terms. Even economists that favored deflation agreed with me on that point.

    Maximillienne, I’m confused by your comment. Why? Shouldn’t the private sector allocate resources?

    Cliff, I agree about wages.

    lat, You might want to Google some of my older posts that advocate NGDP targeting, it reduces distortions of the price system.

    It is true that we have government distortions, but monetary policy can’t solve that problem. At best, we try to keep nominal spending growth stable.

    Citizen, You said;

    “I would suggest reading a few of Huey Long’s speeches to see the power of corn pone socialism up close, and then determine if you want to see those policies implemented.”

    I’ve already made that determination. And the answer is no.

    Charlie, Thanks for the UK data.

    Martin, Yes, we wouldn’t need deposit insurance.

    Richard, Size of government and ease of starting business are two completely different issues. There are countries with huge governments and very low regulation (such as Denmark.)

    You took my quotation completely out of context. I never said the problem in the UK was supply side. I said if AD growth is on target then the problem is supply side. I don’t have NGDP figures for the second quarter, so I can’t comment. My hunch is that Britain has both supply and demand side problems.

    Rien, Good point about you and locusts. 🙂

    Lorenzo, We think alike.

    Doc Merlin. You said;

    “One thing you have wrong w.r.t. savings. You say that increasing NGDP when its too low via monetary stimulus would increase the savings rate. This isn’t so; increasing NGDP via monetary stimulus decreases savings rate.”

    The easiest way to understand this is to imagine a closed economy. Investment tends to be very procyclical. Since saving equals investment, it also tends to be procyclical. And NGDP is highly correlated with RGDP. So saving is highly correlated with NGDP. So an expansionary policy (higher NGDP) tends to increase saving.

    Level targeting takes care of most of the policy lag problem.

    sdfc, You said;

    “As for 1987 v 2008. It’s a bit easier for a CB to stimulate an economy where private sector debt outstanding is ~120% of GDP as opposed to 175% of GDP.”

    Not if they do NGDP targeting, level targeting.

    Cliff, QE2 boosted the economy a bit late last year (U fell from 9.8% to 8.8%), but it’s too little too late (and the wrong technique.) I never focused on the wealth effect, although others do.

    Yes, Japanese unemployment is normally quite low, although their data is somewhat different from ours. The output data may give a better indication of the Japanese cycle.

  45. Gravatar of Richard W Richard W
    27. July 2011 at 14:12

    Scott Sumner
    27. July 2011 at 07:25

    ” Richard, Size of government and ease of starting business are two completely different issues. There are countries with huge governments and very low regulation (such as Denmark.) ”

    Indeed. I agree with you about the size of government and want the UK government to be smaller and do less. The World Bank index is actually ease of doing business not just starting a business.

    This OECD product market regulation paper from 2009 is a good example of regulation. There is no evidence in that paper that the UK is more overburdened with regulation vis-a-vis your example of Denmark. Most regulations that people complain about usually come from the EU. so they also apply to Denmark.
    http://www.oecd.org/dataoecd/29/41/42779045.pdf

  46. Gravatar of sdfc sdfc
    28. July 2011 at 00:41

    Scott

    Thanks for getting back to me. It is a mighty effort to try and answer all the responses.

    How does central bank target NGDP other than by influencing the financial decisions of households and business?

    Is there a paper of something you or someone else has written which fleshes out the subject?

  47. Gravatar of Hondo69 Hondo69
    28. July 2011 at 03:17

    It always strikes me as odd when economists pull out examples from the past and say, “hey, this worked in 1992, or 1942”, or whatever year.

    Read the Wall Street Journal, watch economists on TV, or read their blogs and it’s the same old story. The can’t make heads or tails of the economy and don’t understand why their models simply don’t fit into today’s world. But they’re making the mistake of not comparing apples and apples. The old models will not work today unless you factor in the extent of government regulation into each equation.

    Plug in a factor called “regulation rate” and the old algorithms start spitting out numbers that make much more sense in today’s economy.

    Now you have a fighting chance of really examining any given problem. Say you are researching the “tortilla riots” in Mexico and can’t quite get the economic numbers to jive. All of a sudden you factor in ethanol subsides of corn in the US and the answer appears before your very eyes.

  48. Gravatar of Scott Sumner Scott Sumner
    28. July 2011 at 05:52

    Richard, I’m not sure I entirely agree about the UK and Denmark, but it would be hard to debate without more info. Do those studies account for the relatively inefficient government provision of services in the UK (health, education, transport.)

    But I’m willing to agree that the countries aren’t all that far apart, as you know their per capita GDPs (PPP) are also relatively close–I think Denmark is a bit higher.

    sdfc, I have lots of posts on NGDP targeting.

    The trick is to think in nominal terms, not real terms. The public usually likes to hold a fairly small percentage of their income as non-interest bearing assets (cash) so if the government injects more case into the economy, the public tries to get rid of it, and incomes rise (i.e. NGDP rises.) That’s less true when rates are zero. In that case the Fed promises to raise the money supply in the future, when rates are no longer zero. That promise creates higher inflation and higher NGDP growth expectations, which tends to increase spending at the given zero interest rate. There’s much more that could be said, such as negative interest rates on excess reserves, but that’s a start.

    Hondo69, Some industries are much more regulated than in the past, and some are much less regulated. I doubt that has any bearing on the argument in this post.

  49. Gravatar of Doc Merlin Doc Merlin
    28. July 2011 at 07:15

    @Scott:
    “The easiest way to understand this is to imagine a closed economy. Investment tends to be very procyclical. Since saving equals investment, it also tends to be procyclical. And NGDP is highly correlated with RGDP. So saving is highly correlated with NGDP. So an expansionary policy (higher NGDP) tends to increase saving.”

    This is only true if the fed isn’t trying to goose NGDP. If the fed is trying to goose NGDP, they necessarily drive down interest rates from equilibrium which decreases incentive to save and increases expenditure on capital improvements. ‘I’ goes up, because people shift money from debt assets (like bonds) to equity assets (like stocks), as emh would predict, but actual savings rate doesn’t change. In this case I is just measuring a shift of one type of savings to another.

  50. Gravatar of sdfc sdfc
    29. July 2011 at 01:33

    Scott

    I’m a latecomer sorry I missed your earlier posts.

    I do think in nominal terms, which is why I think the level of private sector debt outstanding is important.

    I would have no argument with what you have written only you seem to assume away those liabilities. Monetary policy struggles when financial conditions are poor. I would have thought that when financial conditions are poor enough to warrant near zero interest rates government spending is most effective. (and no I’m not an MMTologist).

    I agree they should lower the interest rate paid on excess reserves. A negative rate is an interesting proposition.

  51. Gravatar of W. Peden W. Peden
    29. July 2011 at 02:16

    sdfc,

    “I do think in nominal terms, which is why I think the level of private sector debt outstanding is important.”

    Of course it is, in one sense or other. In what way do you think it is important?

  52. Gravatar of sdfc sdfc
    29. July 2011 at 03:56

    W Peden

    Because cash flow is important. Particularly when you are carrying a large amount of debt.

  53. Gravatar of W. Peden W. Peden
    29. July 2011 at 04:52

    sdfc,

    So it’s important at the level of the individual economic agent. Why is it important for a country as a whole?

  54. Gravatar of Scott Sumner Scott Sumner
    29. July 2011 at 10:25

    Doc Merlin, How can I go up and S go down if S=I?

    sdfc, In my view monetary stimulus is far more effective than fiscal stimulus at zero rates. That’s one reason I prefer monetary stimulus. Another is that fiscal stimulus is very costly (increased national debt, future tax burden on the economy.)

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