Why is aggregate demand so confusing?

It’s possible that I’m the one that’s confused.  But since it’s my blog, I’ll write the post as if others are confused.

Picture the AS/AD diagram.  Now shift AS to the right, due to population growth, capital accumulation, resource discovery, or technological developments.  What happens to AD?  I guess it depends what you mean by “AD.”  I’d say nothing happens, although the quantity demanded rises at a lower price level.  When I read others I often get the impression they have in mind some sort of “real AD” concept, which would drain AD of all meaning.  After all, if it’s quantity demanded, then any and all changes in output are changes in aggregate demand.   This would allow no debate as to whether recessions were caused by AD shocks, as a recession is defined as a significant fall in output.  It becomes a tautology!   Yet I get the feeling reading people like Stiglitz that he views AD is a real concept, not a nominal concept.

Or consider an increase in AD when the economy is at capacity.  The textbooks say you just get inflation in that case.  But if you used a “real AD” concept, then there would have been no increase in AD in the first place.  That’s right, even in Zimbabwe AD did not rise, because output didn’t rise.

Why does this confusion exist?  Perhaps because we have two radically different ways of thinking about AD; the monetary approach (M*V) which is obviously a nominal concept, and the Keynesian approach (C+I+G+NX) , which could be visualized in either nominal or real terms.  Most people are Keynesians, and think in terms of actual purchases of goods and services.  To take a micro analogy, most people views the terms ‘consumer purchases’ and the term ‘demand’ as being synonymous.   Even though purchases are also sales, and could just as well be termed “quantity supplied.”    (Remember those graphs of “oil demand” over the next 50 years?)  When I read popular writers on macroeconomics I see them break the economy down into sectors, and talk about things like “December demand for US made cars,” what they really mean is “quantity demanded.”

The deeper problem is that the Keynesian and monetarist worldviews are nearly incommensurable.  It’s very hard to mentally toggle back and forth between the two approaches, because they are so radically different.

When I read the following quotation from Tyler Cowen, I initially wondered whether he was confusing AD with real quantity demanded:

Weak job creation remains at the heart of America’s unemployment problem.  Accepting this hypothesis does not require the rejection of Keynesian economics; for instance you can think of weak job and start-up creation as one reason why AD is not recovering so well on its own, with causation running both ways of course.

(BTW, commenters should not complain that his first sentence is tautological, he’s talking about gross job creation, not net job creation.)

I see economic dynamism, creative destruction, as something that affects AS, not AD.  Yet in the very next line he shows that he’s not confused.  Like me, he views AD as a nominal concept:

Remember “” monetary velocity is endogenous to perceived gains from trade.

But I’m still not happy, because I don’t agree with his implicit assumption that velocity shocks affect AD.  They do under Friedman’s 4% money growth rule, and they do under a gold standard.  But velocity shocks have no impact on AD under the following monetary regimes:

1.  Inflation targeting.

2.  NGDP targeting.

3.  A Taylor Rule.

4.  A hybrid policy where the central bank does just enough QE to prevent inflation from falling below 1%, but no more.

I’m not quite sure what sort of regime we have today, but my hunch is that it’s closer to the 4 items on that list, then it is to either a 4% money rule or a gold standard.  If I had to guess I’d assume Tyler might have made the following error:

1.  He developed a real theory of unemployment (no problem there.)

2.  Saw market monetarists looking over his shoulder, or perhaps felt uncomfortable with empirical evidence that AD matters too, and decided that the theory was in some way compatible with AD theories of the recession.  But I don’t think you can do that.  An AD theory must be 100% nominal.  That means it must move the monetary policy process front and center into any explanation.

This doesn’t mean that real shocks can’t matter.  For instance, I speculated that in 2008 and 2011 the oil price shocks made monetary policy more contractionary, which reduced AD.  In both cases the Fed saw high headline inflation rates, and became squeamish about monetary stimulus.  In both cases they tightened enough to reduce NGDP growth, even as inflation was still above target.  The slower NGDP growth slowed the economy.  It’s possible that a similar explanation could be developed with Tyler’s job creation story.  But I don’t think it’s enough to tack on a “velocity might fall” explanation.  To me, that seems too much like someone working out a real theory of AD, and then assuming nominal AD must move in the right way to make it work.  As when Keynesians convince themselves that fiscal policy must affect AD, and then offhandedly suggest that velocity will move in the right direction to make it happen.  Maybe so, but the theory needs to be developed in terms of actual central bank practice, i.e. changes in M*V, not just a add on assumption about velocity.

PS.  A whole different issue is the question of how nominal AD shocks get translated into real changes in quantity demanded (those December car sales.)  For that you need wage/price stickiness, and Tyler Cowen has a new post that discusses fascinating evidence on wage stickiness in rural India (where you might expect wages to be flexible.)

PPS.  Here’s how I’d make the argument if a gun was pointed at my head.  A more dynamic job creation process would somehow raise the Wicksellian equilibrium real interest rate.  This would allow the Fed to do less of the “unconventional monetary stimulus” that is it squeamish about doing, and more conventional stimulus, for any given inflation rate.  Do I believe that?  I’m not sure.


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33 Responses to “Why is aggregate demand so confusing?”

  1. Gravatar of StatsGuy StatsGuy
    15. December 2011 at 07:49

    “I see economic dynamism, creative destruction, as something that affects AS, not AD.”

    That is a failure of the nominal model which requires a strong version of money illusion to support. Here is why:

    If I believe that the economy is benefiting from a renewed wave of economic dynamism (and, hence, will benefit from large future supply increases), then I am more secure in consuming current resources.

    This holds with or without nominal GDP targeting. If everyone holds the very strong believe that future supply will be drastically reduced (e.g. peak oil), they will try to “save” in order to preserve future consumption. This savings may take the form of diversification into non-monetary hedges (like commodities). Some of this could be functional (increasing the price of oil to reduce present consumption), but some could be non-functional (speculative in the bad sense of the word, to the point where speculation itself excessively impacts input prices and inflation). That statement is not a violation of the EMH because no one really knows what is purely speculative and what isn’t.

    As such, AD is not a purely monetary phenomena in so far as we CANNOT achieve any level of desired AD merely by application of monetary policy (when you devalue the money, some of it gets spent but some gets diverted into alternate savings, and if people start to think the stimulus is destructive in real terms the real effect could overcome the nominal effect and lead to a reduction in AD – of course, we’re nowhere close to this). The point is: there is a real component to creating AD as well. So maybe market monetarists should face up to the REAL EFFECTS OF monetary stimulus, and accept the reality this implies:

    — It lowers real wages
    — It depreciates the currency, and hence makes exports cheaper and imports more costly
    — It reduces real debt burdens
    — It reduces the consumption power (and expected consumption power) of savings

    ALL OF THESE are primarily distributional. ALL OF THEM. If you are arguing for monetary stimulus, then you are arguing that POLICIES WHICH ARE PRIMARILY (RE)DISTRIBUTIONAL CAN AND DO HAVE POSITIVE IMPACT ON ECONOMIC AGGREGATES.

    And you wonder why you piss off conservatives?

    One of the fundamental tenets (or, if you prefer, lies) of conservative economics is that distributional policies are always bad, and that the status quo is somehow “neutral” in its distributional consequences and therefore “pure” – vis a vis the ‘state of nature’ myth.

    You, sir, are not a conservative, but you still hate the “D” word.

  2. Gravatar of ssumner ssumner
    15. December 2011 at 08:11

    Statsguy, You said;

    “So maybe market monetarists should face up to the REAL EFFECTS OF monetary stimulus, and accept the reality this implies:

    – It lowers real wages
    – It depreciates the currency, and hence makes exports cheaper and imports more costly
    – It reduces real debt burdens
    – It reduces the consumption power (and expected consumption power) of savings”

    Umm, maybe market monetarists have already faced up to those facts, and done 100s of blog posts making those exact arguments. So we agree.

    I pretty sure you misunderstood my argument, as I don’t see how your comment relates to it. Obviously monetarists agree that nominal shocks have all sorts of real effects.

    BTW, I’m fine with the “D” word, but not fine with commenters telling me that monetary stimulus hurts people like me (high savers) when I know for a fact it helps me.

    You said;

    “If I believe that the economy is benefiting from a renewed wave of economic dynamism (and, hence, will benefit from large future supply increases), then I am more secure in consuming current resources.”

    This is a common misconception about AD. The decision to consume more has no impact on AD, as AD isn’t C, it’s C+I. So if you consume more you save less, and since S=I you invest less. AD is unchanged. Of course attempts to save more might throw monetary policy off course (off its Taylor Rule/inflation target/NGDP target). But that’s another argument–an argument about monetary policy.

    You said;

    “One of the fundamental tenets (or, if you prefer, lies) of conservative economics is that distributional policies are always bad, and that the status quo is somehow “neutral” in its distributional consequences and therefore “pure” – vis a vis the ‘state of nature’ myth.”

    That would be an idiotic argument, and certainly wouldn’t be accepted by conservatives like Friedman and Hayek, so I’m not sure who you are talking about.

  3. Gravatar of Cy Cy
    15. December 2011 at 08:34

    Is population growth a bad example in your second paragraph? I know next to nothing about AS/AD, but I would expect a doubling of population in most models to double AS *and* AD, leaving prices the same and output doubled? I can see how resource discovery and technological developments wouldn’t change AD (although they would change price/output along AD.)

  4. Gravatar of anon anon
    15. December 2011 at 08:45

    “This holds with or without nominal GDP targeting. If everyone holds the very strong believe that future supply will be drastically reduced (e.g. peak oil), they will try to “save” in order to preserve future consumption.”

    Suppose that people choose to “save” by buying land, an asset in fixed supply. Clearly, any transaction in the land market involves both a buyer (who will give money out and reduce her consumption) and a seller (who will receive money and increase her own consumption). It’s a wash.

    What about other effects? If the price of land fails to rise, because of price stickiness, quantity demanded might increase over quantity supplied. So some notional demand will be shut out of the market. But then agents will re-optimize taking the quantity constraint into account, and that demand will spill over into real consumption and investment.

  5. Gravatar of ssumner ssumner
    15. December 2011 at 09:06

    Cy, You are thinking of quantity demanded. Yes, more people will definitely increase the quantity demanded, the amount of stuff people produce and buy. But it won’t directly shift the AD curve, unless the central banks wants it to shift the AD curve (which they might, if they are targeting inflation, for instance.) But not if they are targeting NGDP.

  6. Gravatar of John hall John hall
    15. December 2011 at 09:10

    Good post. I was at an economics conference earlier in the month and at lunch a few of us discussed the recent payroll tax cut legislation. I had made the comment that basically everyone favored employer-sided cuts to a guy who’s kind of a big-wig at the CEA, which he responded by saying that corporations already have a lot of cash on their balance sheets (a fair point in levels, but not as a percent) and would be unlikely to hire more. He also mentioned that there are employer-side effects for small firms, but for the sake of simplicity I’ll ignore that.

    Within the context of AD/AS, that seems to be an argument that an employee-sided payroll tax cut would shift AD more than an employer-sided one (I wouldn’t want to put words in his mouth, but I’m just trying to translate the above into AD/AS-speak). I’m really not sure what empirical evidence or theoretical reasoning there is that one would shift the AD curve better than the other. Nevertheless, if the central bank is doing its job (according to you), it would offset any adjustment to AD regardless of the tax cut. However, I failed to mention the point you made in an earlier post that the employer-sided payroll cut would also shift SRAS. As far as I can tell, the reason to prefer an employer-sided cut must be that it would shift the SRAS curve more than the employee-sided cut. I’m not sure I can prove it (perhaps a post on SRAS is necessary?), but it seems to be the argument you made earlier when discussing your preference for employer rather than employee.

  7. Gravatar of Bill Woolsey Bill Woolsey
    15. December 2011 at 09:20

    Scott:

    Think about “long and variable lags.”

    Changes in some type of real expenditure directly impacts the aggregate. And then, the response of monetary policy will only have an impact after some long and variable lag.

  8. Gravatar of W. Peden W. Peden
    15. December 2011 at 09:24

    How many definitions of nominal output are there? There’s the various reworkings of Fisher’s transactions quantity theory of money to define income velocity; the Keynesian witch’s brew definition of income as final expenditure; the incomes approach that combines NDP and NDIA; the NDP minus approach… Is that it?

    Even more off-topic: even if the M*V = PY approach (i.e. an incomes approach) might be better in terms of measurement and assessing short-term connections between M and PY, doesn’t M*V = PT have advantages for understanding financial stability? If PT and PY diverge over a significant period of time and there are correlations within that time between asset prices and growth of broad money, then that seems to suggest that money still matters for financial stability despite income velocity being unstable. That seems to have been exactly what we have seen since 1980 and perhaps explains why we have experienced greater financial instability despite extend periods of nominal income stability.

  9. Gravatar of jj jj
    15. December 2011 at 09:29

    Wouldn’t velocity shocks affect AD if we’re in a regime where below 1% inflation the central bank does QE, above 2% inflation the central bank tightens, and we’re currently floating between 1% and 2%? Because to me, that sounds like an accurate description of today’s situation.

  10. Gravatar of Cy Cy
    15. December 2011 at 09:30

    I think what you’re saying then is that by holding the money supply constant, the central bank is basically holding P*y (the two axes of the AS curve) constant (with a bunch of wiggle room via velocity increases and financial hacks.) If we “doubled the economy” that would not only be population growth, but also a doubling of the money supply, which is what my simple description missed?

  11. Gravatar of Donald A. Coffin Donald A. Coffin
    15. December 2011 at 09:41

    The same confusion, you know, actually exists in micro. The problem is that when one writes a demand curve with quantity as a function of price and a vector of other variables (X):

    Q = f(P, X)

    Then Q changes when P changes or when some component of X changes. How do we describe this, as a change in demand, or as something else? After all, that *function* is the demand *function*, and, whether P or X changes, the value of the *function* has changed.

    So I have quit talking about “changes in demand” and “changes in quantity demanded,” whether “demand” refers to the demand for an individual product or AD. I talk about “a shift in the demand curve” and “a movement along the demand curve.” So in the case you begin with (an increase in productive capacity, or AS), I would talk about a movement down along an existing AD curve.

    I know this is non-standard, but I think it makes things clearer to think about, anyway. Or at least it makes thngs clearer for me.

  12. Gravatar of Brian Brian
    15. December 2011 at 10:52

    @Statsguy

    I don’t undertand how currency depreciation would effect the price of imports and exports. Wouldn’t the exchange rate change to offset the depreciation? Wouldn’t $100 Canadian buy the same here whether it was converted to $100 or $120 American?

  13. Gravatar of marcus nunes marcus nunes
    15. December 2011 at 11:13

    Scott
    You are elaborating on the 6th post you wrote, back in February 2009. A few months ago I suggested that post should make your “all favorite” (or something to that effect) list:
    https://www.themoneyillusion.com/?p=274

  14. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    15. December 2011 at 11:18

    Scott, I had pretty much the same reaction to Stats Guy’s argument as you did. Maybe if he’d dropped the ‘always’ from: ‘One of the fundamental tenets (or, if you prefer, lies) of conservative economics is that distributional policies are always bad….’, it might be less idiotic.

    Also, the paper by Supreet Kaur that Tyler Cowen links to

    http://www.people.fas.harvard.edu/~kaur/papers/Kaur_JMP_WageRigidity.pdf

    is pretty informative:

    ————quote————-
    While nominal wages rise robustly in response to positive shocks, they do not fall during droughts
    on average. Second, transitory positive shocks cause a persistent increase in wages. When a positive
    shock in one year is followed by a non-positive shock in the following year, wages do not adjust back
    down””they remain higher than they would have been in the absence of the lagged positive shock.

    Third, particularly consistent with nominal rigidity, inflation moderates these wage distortions.

    When inflation is higher, droughts are more likely to result in lower wages. In addition, transitory
    positive shocks are less likely to have persistent wage effects. For example, when inflation is above
    6%, positive shocks have no impact on future wages. Since local rainfall is uncorrelated with inflation
    levels, these tests have a causal interpretation.
    3
    The findings support the hypothesis that inflation
    “greases the wheels” of the labor market….
    ————–endquote————

  15. Gravatar of David David
    15. December 2011 at 12:49

    Scott,

    “Aggregate Demand” is is a theoretical object that should be defined within the context of an explicit (preferably mathematical) model. It is a confusing object precisely for the same reason that many economic statements are confusing: people are either unwilling or unable to state propositions formally and explicitly. And I can’t say that your “picture and AS/AD curve” helps very much in this regard.

    David

  16. Gravatar of Morgan Warstler Morgan Warstler
    15. December 2011 at 12:53

    Stats

    Jesus, at least by osmosis you should get smarter, you words do after all sit on the same page as mine.

    What Scott espouses, over say last 20 tears, DIMINISHES Democrats.

    These are facts:

    1. over the last twenty years there would be LESS gvt. spending.

    2. there would be less inflation… harder money.

    3. there would be less wage growth… particularly with public employees.

    Finally, you totally miss the yang, the ying is printed money now, the yang is pissing on booms.

  17. Gravatar of Mike Sax Mike Sax
    15. December 2011 at 13:05

    Why is aggregate demand so confusing?

    “the Keynesian and monetarist worldviews are nearly incommensurable. It’s very hard to mentally toggle back and forth between the two approaches, because they are so radically different”

    If this is true then I guess that’s the answer. In Rorty’s terms we are engaging in “language games” that while superfically similar are in fact wholly incommensurate.

  18. Gravatar of ssumner ssumner
    15. December 2011 at 15:47

    John Hall, You are right. The ONLY argument for a payroll tax cut is the argument that it boosts AS. No effect on AD.

    Bill, I don’t buy the long and variable lags argument. The newest models suggest that current AD is strongly impacted by future expected AD. If so, then temporary “AD” shocks have little effect. And of course Tyler was making a long term argument, not something that played out over a few months.

    W. Peden, I think there is only one definition of nominal output (NGDP = NGDI). Expenditure is something different, and transactions (Fisher) is completely unrelated, indeed more than 100 time larger than NGDP.

    jj, You can make all sorts of assumptions. But it’s just as easy for me to make one where higher velocity reduces NGDP, as where higher velocity raises NGDP. I think the most sensible baseline assumption is no effect; the NGDP growth rate we have had over recent years is the one the Fed wants, or at least all they are willing to produce with unconventional policies. Check out my “God of the gaps” posts.

    Cy, I’m not saying they hold M constant, then Tyler would be right. I’m saying they are holding NGDP constant (M*V) or something similar like inflation. In that case he’s wrong.

    Donald, That’s a valid way of using terms.

    Marcus, I thought about that one when I was writing the post.

    Patrick, Yes, and the response of wages to inflation provides powerful support for – – – the title of my blog.

    David, I did just what you suggest. A rectangular hyperbola is a constant P*Y. I’m pretty sure I learned about hyperbolas in math class, not history, so I’m pretty sure I provided a specific mathematical model, just as you asked for. If you have a better one, let’s see it, and tell my why it’s better. What insights does it give us that a hyperbola lacks?

    Mike Sax, Yup.

  19. Gravatar of StatsGuy StatsGuy
    15. December 2011 at 16:39

    @ Brain

    Not if you’re buying American imports with Canadian dollars.

    @ Scott

    You are not saving primarily in cash; and you are failing to differentiate between savers and investors. A saver may be an investor, but not necessarily. A bank is not a saver, but is often an investor. So perhaps I should have said “fixed rate instrument savers”.

  20. Gravatar of Brian Brian
    16. December 2011 at 07:16

    If you are paying with Canadian Dollars, why does the value of the American dollar matter?

  21. Gravatar of Jason Jason
    16. December 2011 at 11:06

    “The deeper problem is that the Keynesian and monetarist worldviews are nearly incommensurable. It’s very hard to mentally toggle back and forth between the two approaches, because they are so radically different.”

    I imagine this is a bit like the Copernican vs Ptolemaic theories in the early days of science. Not going to say which macroeconomic theory is which because I don’t think it is settled. One theory worked better for accurate calculations (Ptolemaic), whereas another worked better for intuitive reasoning (Copernican, but it was actually less accurate for awhile after his book was published). One turned out to be “more correct” in a later over-arching theory (Newtonian) because it was simpler, but calculating the paths of the planets in a non-inertial reference frame centered on a stationary earth is complex but not impossible. In fact, the Ptolemaic assumption is the natural assumption for e.g. weather and ballistics and we introduce Centripetal and Coriolis forces.

    My opinion here, but I think finding a theory that reduces to both a monetarist theory and a Keynesian theory in various limits or under specific constraints may be a key to understanding macroeconomics and more focus should be in that direction (unless it has already been done! I haven’t been able to find anything). Both theories appear to save the phenomena in particular regimes so the “correct” macroeconomic theory should reduce to each in particular limits.

    There is a great quote from Wittgenstein (don’t know if it is apocryphal) about the obviousness of things after the fact. In the future an economic Wittgenstein might say something like “But what would economics have looked like if it wasn’t AD”.

    The quote is excerpted from Dawkins The God Delusion (only because it was a relatively compact re-telling for cut/paste):

    “Tell me,” the great twentieth-century philosopher Ludwig Wittgenstein once asked a friend, “why do people always say it was natural for man to assume that the sun went around the Earth rather than that the Earth was rotating?” His friend replied, “Well, obviously because it just looks as though the Sun is going around the Earth.” Wittgenstein responded, “Well, what would it have looked like if it had looked as though the Earth was rotating?”

  22. Gravatar of ssumner ssumner
    16. December 2011 at 12:16

    Statsguy, I never confuse saving and money hoarding, which are two unrelated concepts. Money hoarding reduces NGDP, saving boosts investment.

    But in any case, I don’t see how any of this relates to my post.

    Jason, I love that final Wittgenstein quotation. Now I need to think of a blog post that works it in.

  23. Gravatar of W. Peden W. Peden
    16. December 2011 at 12:23

    The quotation is apocryphal, as far as I know, but it does fix into a lot of Wittgenstein’s work in the Philosophical Investigations (especially Part II) and in the Blue & Brown Books. The reason that Wittgenstein is interested in swastikas and duckrabbits and cartoon faces in those books is to illustrate how much more complex our concept of “seeing X” is than the standard passive-observer model in much of philosopher, since “seeing X as Y” is very complex and not describable with just a passive observer. You have to give X some attention to see it as Y e.g. you have to really pay attention to the (apparent) movements of the Sun in order to realise that it is actually the Earth that is moving.

  24. Gravatar of W. Peden W. Peden
    16. December 2011 at 12:25

    Aha! It turns out it’s not Wittgenstein, it’s Tom Stoppard. From the play “Jumpers”.

  25. Gravatar of James Oswald James Oswald
    16. December 2011 at 13:49

    I took Tyler’s IO class a couple semesters ago and he mentioned that he believes that “When Scott Sumner says you are wrong, you are wrong. He’s not always right, but if he tells someone they are wrong, they are”. So, there is a high probability you will convince him.

  26. Gravatar of What Recession? What Recession?
    16. December 2011 at 16:51

    […] reading this post of Scott Sumner’s I suddenly came up with an example that illustrates what bugs me about the description of the […]

  27. Gravatar of ssumner ssumner
    17. December 2011 at 08:45

    W. Peden, I investigated, but couldn’t find an answer.

    James, Thanks for that anecdote. Here’s my reply to Tyler Cowen:

    “You’re wrong.”

  28. Gravatar of John Papola John Papola
    17. December 2011 at 13:16

    Scott,

    I groped through a related question to this post in a comment on your Delong/Stiglitz post before seeing this one.

    It seems to me that the Keynesian view of aggregate demand trips over the idea that the inverse of an increased demand for money is a decrease for “goods in general” or a “general glut”. This seems logical… and false. There is no such thing as a general glut of goods in reality. When people increase their demand for money, which is a real good, they do so by not buying other specific real goods or by failing to put their money into capital markets and thus preventing others from buying specific goods. That this ultimately gets summarized such that the total demand is lower, that summary is not a thing. It’s not real. It’s a summary.

    So, if Y = C+I+G and C or I go down because demand for money went up, it’s simply ex-post accounting to say that Y went down. Again, Y isn’t a thing. There is no market for Y. There are no bidders for Y. No price for Y that emerges out of bidding.

    But money is a thing. There are real demanders for money in particular, and they forego particular things in order to attain it.

    I believe it’s in this leap from the demand for money to the notion of a deficient demand for “goods in general” where keynesianism (and mainstream macro) all falls apart. Because once you have some idea of “goods in general”, it ceases to matter what gets demanded in you stimulus plan. You can just dig ditches and fill them back in and it all adds to the summary of Y.

    But if you reject that leap and stay with the suppy and demand for money, it becomes clear that there are particular people demanding cash and that paying unrelated distant people to dig ditches is unlikely to change their demand. Talk of velocity via various so-called “propensities” falls in the same over-aggregated problems.

    I think it’s this central and subtle idea that also leads so many Keynesians to spend so much time talking about consumption even though Keynes seemed to be far more concerned with investment spending and decisions and the animal spirits. Here, Mill comes in to remind us that the demand for commodities is not the demand for labor. Consumer spending is a very different thing from production and, in particular, new entrepreneurial activity which seems to be where most new job opportunities come from.

    Maybe I’m totally confused and tripping over myself here. Does any of this make sense?

  29. Gravatar of ssumner ssumner
    18. December 2011 at 08:25

    John, Some of it makes sense, but I don’t think that’s a useful way of thinking about things. To me it’s all about nominal shocks. We know for a fact that nominal shocks don’t matter when wages and prices are flexible (1000 to 1 currency reforms have no real effects.) And we know nominal shocks do matter when wages are sticky. So it’s all about modeling and preventing nominal shocks. And for that you focus on money.

  30. Gravatar of John Papola John Papola
    18. December 2011 at 11:37

    I understand that your approach focuses on nominal shocks. What I’m trying to get at is where your view and the keynesian view diverge and why they arrive at such a bizarre set of a assertions regarding government spending and so-called “fiscal policy”.

    Do you think I’m getting at something in that regard? This notion that (for shorthand) mass ditch-digging can function similarly to increasing the supply of money to meet demand seems to be the heart of the question. This is what you seem to be exploring in this post, isn’t it? Where does the Y=C+I+G view take their analysis versus the MV=PT view? How does their view lead them to claim that war and tsunamis can be “stimulus”? In short, how does an approach which on the surface can sound pretty similar to yours, with the focus on “aggregate demand”, veer off into what I can only regard as pure bedlam.

  31. Gravatar of ssumner ssumner
    19. December 2011 at 14:40

    John, Keynesian economics is basically “bad monetary policy economics” They assume the Fed isn’t targeting NGDP, and then consider how various shocks might interact with various bad monetary policies.

  32. Gravatar of dwb dwb
    19. December 2011 at 14:45

    John, Keynesian economics is basically “bad monetary policy economics” They assume the Fed isn’t targeting NGDP, and then consider how various shocks might interact with various bad monetary policies.

    best line I’ve heard in weeks. nice.

  33. Gravatar of ssumner ssumner
    20. December 2011 at 10:11

    dwb, Thanks, I was inspired to do a post.

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