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this reminds me of an idea I once pitched to my PhD supervisor, who told me to go away and think up another idea*

Define consumerism as the frequency with which people want to replace durable goods. What I have in mind is people who wear a T-shirt a few times then buy a new one, versus people who wear them for years. What are the effects of changes in the degree of consumerism?

I had been thinking that there may be level effects on output - consumer societies have higher levels of economic activity and higher output - but perhaps welfare neutrality (the degree of consumerism is a preference thing, so you get what you want in either high or low consumer societies). Possible implication that changes in preferences could cause output growth.

But there is a link with hoarding. Trying to accumulate cash entails holding on to those T-shirts a while longer. A sudden decrease in consumerism causes a recession, and presumably increases in consumerism causes booms? Hey, either I've just come up with a new theory of business cycles, or I've just re-stated something obvious people thought of years ago (or C: I'm talking nonsense).

(Although decreases in aggregate consumerism don't necessarily entail hoarding because you could switch to productive investment goods ... but why would you do that if you don't want the future consumer goods these investment goods will produce... and how does the quality and cost of producing more durable goods change things. Oh dear).

* be nice - if anybody out there thinks they could turn this idea into a paper, let me in on it! **
** or if anybody can point to the already existing people ... post a link.


“Why can't the firms just pay the workers in goods?” You’ve heard this answer before I’m sure: workers in the chemical industry really don’t relish being paid in sulphuric acid.

Now to the main point: imagine a model in which utility is a function of consumption, leisure and antiques (of which there is a fixed stock; the technology for making genuine Louis IV furniture does not exist and people will accept no fakes). In a full-employment Walrasian equilibrium the stock of antiques, measured in wage-units, is A*. The stock is worth that many hours of standard labour. For the sake of simplicity let’s assume the equilibrium is unique. If for some reason the wage is stuck above the full-employment level the result is a state of Keynesian unemployment, with zero excess demand for either antiques or produced goods. Yes, the excess supply of labour can perhaps be eliminated if W falls. Keynes didn’t deny that, but he also saw the possibility that falling wages might only make antiques even more desirable.

I know Clower says that Keynes was either anticipating Clower or else he was simply talking nonsense, but I don’t think he established that there really is no third possibility. Not that the labels matter – you and David Beckworth can describe yourselves as you see fit – but isn’t Clower usually called a Post-Walrasian? AFAICR he objects to being called a Keynesian.

I might be wrong, but I don't think the Fed has the authority to buy stocks, though I suppose between Treasury and the Fed one could buy and the other could print and it comes to the same thing.

Does the BoC have the authority to buy stocks?

Luis, here's an idea that I've been trying to pitch to Nick with no success*

My fledgling has just left the nest and set up her own apartment. Furnishing: table and chairs - free from L, moving overseas. Desk and chair - free from L, downsizing. Crockery - free from A, downsizing. Futon - free from M, downsizing. Sofa - scavenged for free from the sidewalk - the neighbours were downsizing. Endtables - one she took with her from home, a matching one bought for $5 at Value Village. Someone else was downsizing.

With an aging population, there will be more and more consumer durables chasing fewer and fewer people. Surely this explains why aging societies experience slow economic growth.

Nick, isn't this a different scenario from the antique furniture scenario as antique furniture is basically a produced good - take someone else's old stuff, buff it up, refinish it, and then hawk it as something special?

*you can have this idea for free, I don't know anything about macro so can't do anything with it.

NB if you really want a credible commitment to a higher price level, why not do a Caballero drop, buy a ton of govt bonds to finance teachers salaries and so forth, and then instead of talking about how you might drain the money from the system post-recovery, the Fed could just have itself a bond bonfire? Why wouldn't that work?

(I've polluted David Andolfatto's blog with my ignorance and now I'm doing it here - but still I don't understand)

Francis, I like it - see also the housing stock and shrinking populations (Germany)

Patrick, the Fed does not have the authority to buy stocks.

By buying antique furniture, one is buying the services of the persons who gathered, fixed, displayed, and advertised for sale the item. These services are newly created. It matters not a bit that no factory was involved.

This even applies to crappy used items purchased on craigslist. Someone is being paid for their services.

asp

It doesn't really matter that buying antiques (assets) involves a bit of production and services - even buying gold or shares involves paying dealers who have overheads etc. the point is merely that the paradox of thrift is about what happens when everybody tries to stop spending, not when everybody tries to start saving, because saving still involves spending (on assets).

Luis: if people decide to buy fewer new shirts per year, that is just a fall in the mpc, or a fall in labour supply (what's the point in working such long hours if you don't want new shorts?).

Kevin: it's precisely *because* they don't want paid in sulphuric acid that we live in a monetary exchange economy.

You lost me on your example. Is this a Walrasian non-monetary economy, with a central auctioneer? If there's a notional excess supply of labour there must, by Walras' Law, be an equal notional excess demand of something else.

Patrick, Adam: Yes, I keep forgetting the political constraints on monetary policy. But I still think it would be easier, politically, to get the Fed to buy stocks than to get House, Senate, and President to raise taxes and cut spending!

Frances and asp: suppose (say) 20% of the price of antiques is due to newly-produced services. Then an increased demand for antiques is still 80% an increase in savings.

Kevin: I didn't know that Clower rejected the label Keynesian. I've always thought of him as Keynesian. He's the one who made Keynesianism make sense.

Nick,

yes, a fall in mpc and labour supply. So I guess it's trivially true that lower 'consumerism' would cause output to fall but be welfare neutral, and that variations in 'consumerism' could explain cross country variation in output, changes in preference cause growth.

I don't know, maybe the fed could take equities on repo?

Say's Law is never wrong, even in monetary disequilibrium. It's analytic, and maybe tautological in some formulations (note: not all analytic statements have tautological forms). Does this make it non-empirical? Yes, but statements about the law and its relation to reality may be empirical. For example, does "consumption", as defined by Say's Law exist in the real world? If not, then Say's Law is still true in a purely logical sense, but doesn't describe our reality (like the theorems of Euclideam geometry?). In a peculiar way, tautologies and analytic statements can actually be false ... kinda, at least insofar as we are interested in using them to interpret reality. All interesting empirical statements can be rendered in a purely analytic form, though such a procedure doesn't enhance our empirical knowledge, because it merely shifts the type of questions we ask from "is it true?" to "is is true that these things exist?"

Say's Law appears to break during an excess demand for money, but it doesn't -- not really. At least, that is my take on the matter.

Nick. Brilliant discussion. The Japanese government tried buying stocks and I am not sure it worked. What about buying government debt and use the impact on inflation expectations (or price level expectations) as the measure of success. Too crude? Too uncertain? Would seem consistant with adressing both the fiscal constraint and the recession risk.

Here's a better solution: a competitive market for money.

An excess demand for one money would be a profit opportunity for competing money issuers. That is, when one money is frustrated in its role as a medium of exchange by appreciation, another money can step in and fill the excess demand with an alternative medium of exchange. Problem solved without any technocratic tinkering of the supply of base money; the "zero nominal bound" is jut not an issue; and no more using crystal balls to divine the Fed's true purpose.

Nick,

I am probably not understanding what you mean by a "shortage of safe nominal assets."

There are no illiquid markets or wide bid-ask spreads in broad asset classes (this would be evidence that, in aggregate, those that want to sell risk assets, can't). Households are spending at a reasonable rate (it was reported as 5.7% for August today). Households are not de-levering by paying down debt, its just that some minority is defaulting. Credit spreads in high yield, corporates, emerging markets, or muni bonds are indicative of a healthy risk appetite. Equity P/E's are not at historical lows, nor are dividend yields at historical highs. Consensus earnings growth estimates for the S&P 500 are a healthy 15% for 2011. Corporate, high yield and emerging bond issuance is literally booming. We just saw one of the largest equity placements in history (Petrobras). Covenants for LBO and CRE debt are getting much looser, and in some cases reaching practices last seen in early 2007. Finally, there seems to be an enormous appetite for commodities, and the CRB raw materials index is back to record highs (the CRB itself is held back only by lower oil than the peak).

Yes, real rates on term Treasuries are quite low. How much of this is an artifact of expected Fed buying? If deflation is the issue, then why are TIPS inflation spreads stubbornly positive, even while real rates are at zero? One would imagine, in the event of deflation fears, that the inflation spread would disappear before the term premium on 5yr bonds.


Nick: "Frances and asp: suppose (say) 20% of the price of antiques is due to newly-produced services. Then an increased demand for antiques is still 80% an increase in savings."

O.k., let's think of it from a micro perspective.

I have a nice little antique endtable that I picked up for $75.

Price of antiques increases.

My endtable is now worth $100. I've made $25.

Your argument is that this $25 is now being saved (I think - I tend to skim your posts because reading them carefully and trying to thoroughly understand them would take way too long).

However the endtable is producing a flow of services - imputed income that isn't measured in GDP.

Presumably that increase in the price of endtables reflects an increase in the value of those services produced by the endtable - why else would people want more of these?

So my consumption has increased also - the flow of imputed income that I'm getting from the endtable is now worth more.

It's just that these services aren't measured in GDP.

So is it a real world problem, or simply an artifact of imperfect measurement of economic well-being?

Nick,

If A saves and swaps money with B for antiques, and B spends that money on goods and services, there is no thrift at the micro level, because there is no net saving. B has spent what A saved, which means A and B net to zero saving and zero thrift and zero hoarding.

That doesn’t contradict the paradox of thrift, which assumes saving at the micro level. Whether it’s an individual unit or a joint unit shouldn’t matter. You’ve assumed joint behaviour on the part of A and B that contradicts the assumption of initial conditions underlying the paradox of thrift.

i.e. above, your implicit assumption is that B is dissaving, which contradicts the assumption of initial conditions for the paradox of thrift

Hoarding sounds active though it may be passive. Panic is usually used when it is active and lenders don't want to lend. I can't think of a good term for when it is passive and borrowers don't want to borrow.

Maybe slump. That is pretty much what we are in.

Nick,

It seems to me you have just defined away the paradox of thrift. Of course there is no paradox of thrift with antique furniture, because there is no net thrift. Somebody already owns the furniture, and for some individual to be thrifty by buying it, some other individual has to be un-thrifty by selling it.

One might state the paradox of thrift as, "When everyone tries to save at the same time, total savings declines." If someone is selling their furniture assets, they aren't trying to save, so furniture does not fit the premise wherein "everyone tries to save." To the extent that collective thrift is possible, there is a paradox of thrift. What you call "hoarding" is the only kind of "thrift" that is collectively possible. You haven't disproven the paradox of thrift; you've just renamed it. And you've argued that it can only happen with money as the thrift asset. I don't know that Keynes would have disagreed. But it's still thrift and it's still paradoxical.

Adam: I think repoing shares is allowed. Not sure.

Lee: There's the "accounting version" of Say's Law, which says that stuff bought = stuff sold. That's true tautologously. But the economists' version, which says that the value of stuff people want to buy is equal to the value of stuff people want to sell, is only true in equilibrium.

Pierre: Thanks! Maybe buying the TIPS spread to target expectations? (Or would that be selling the TIPS spread? my brain's not working).

I should not get up at 4.00am and start arguing with Paul Krugman!

Lee: My hunch is that we *do* see an increased supply of competitive monies during a recession. All the local hippy currencies, like LETS, seem to make a lot more sense when you can't buy or sell stuff any other way. But it doesn't seem to happen enough to make a big enough difference.

David: I took the idea from Brad DeLong. It doesn't mean an excess demand for safe assets at current prices and income. It just means that demand is too high and supply too low for macroeconomic equilibrium.

Frances: I'm not talking about the capital gain you get on antiques. I'm talking about the macro consequences of everyone trying to buy more antiques. Would it cause an excess supply of newly-produced goods and unemployment? And I'm saying it wouldn't, but that the standard Keynesian model says it would.

JKH: The paradox of thrift is about the effect of an increased *desire* to save at the *macro* level. Everyone wakes up one morning and decides they want to save more. And the standard (simple) Keynesian model says they will fail to actually save more (which is correct), but their failed attempts to do so will cause a recession (which is incorrect, unless they try to save in the form of money). Their income falls until they stop desiring to save more.

Andy: assume no investment, government, or foreigners, for simplicity.

Aggregate savings is of course impossible, by accounting identity. But the question is: will the aggregate *desire* to save cause a recession? I'm saying "no", (unless it's saving in the form of money).

Andy: and, (assume the supply of money is fixed, for simplicity) aggregate *actual* hoarding is also zero, by accounting identity. But the question is: will the aggregate *desire* to hoard cause a recession? I'm saying "yes".

What JKH said. Nick, could you expand on your furniture analogy for those of us who aren't economists? Because superficially, it seems wrong.

The reason is as follows. In your idealization, furniture is imperishable and its supply is completely inelastic. It can therefore serve as a unit of account and the premise is that we begin to use it that way. I have some money, and I can consume it by buying ordinary real goods or save it by buying antiques. But there is no net saving if the antique seller spends my money on real goods. Since the savings vehicle is antiques, that action is implied by the example.

Doesn't the same apply when I buy a bond? No! Suppose that I buy the bond with cash. The cash is in the form of a demand deposit; if I spent the money on an antique, another demand deposit would be created somewhere else when mine is destroyed. But when I buy a bond, the bank erases my deposit (its liability) and transfers ownership of the bond (its asset) to me; it merely shrinks its balance sheet. This is the mechanism by which demand for the safe bond might "spill over" into reduced supply of (deposit-) money.

Nick,

Two questions:

If reasonable, within-historical-norm levels of risk appetite and savings are producing a macroeconomic disequilibrium, what does that tell us?

And if we are to address a causal driver of disequilibrium, don't we need some evidence of causality (i.e., credit spreads are indicative of an unwillingness to take on risk, and these spreads are dampening investment and consumer spending below normal levels)?

Assuming that central bankers are allowed to buy stocks, why consider only select companies in the S&P? Why create an uneven playing field by giving these companies a lower cost of capital over other companies? Why not issue new money by funding new ventures instead?

Small business not listed in the stock market probably have better prospects for growing the economy, and returning better yields to government, no? If these businesses fail, the act still boosted money supply going around in the system, which is the intention anyway. Government getting into the public stock market only rigs the investing game more than it already is.

If I'm following Nick, I think part of the point is that nobody is making new antiques. Starting in equilibrium, if everyones suddenly refuses to sell their antiques it doesn't put plumbers, factory workers, or university professors out of work. But if everyone starts to hoard money it does because it means that in all markets (since money is present in all markets) there must be a surplus of goods.

That last comment was in reply to Phil.

I hope to get this into terms Nick will like.

If positive productivity growth and cheap labor lead to more goods and services available to purchase, which lowers price inflation (maybe even produce price deflation) and creates excess savers that lowers the velocity of the medium of exchange(s) [currency and demand deposits from currency denominated debt], should more currency be created or more demand deposits from currency denominated debt?

Luis Enrique said: "NB if you really want a credible commitment to a higher price level, why not do a Caballero drop, buy a ton of govt bonds to finance teachers salaries and so forth, and then instead of talking about how you might drain the money from the system post-recovery, the Fed could just have itself a bond bonfire? Why wouldn't that work?

(I've polluted David Andolfatto's blog with my ignorance and now I'm doing it here - but still I don't understand)"

Why not just mail $1,000 in currency to every citizen and legal immigrant in the USA?

Or, credit everyone's bank account $1,000 with a guarantee of 1 to 1 convertibility to currency?

“You lost me on your example. Is this a Walrasian non-monetary economy, with a central auctioneer? If there's a notional excess supply of labour there must, by Walras' Law, be an equal notional excess demand of something else.”

No, it’s not a Walrasian economy since a Walrasian household faces only one constraint. My representative household faces an additional constraint: it can’t sell more labour than the representative firm is prepared to hire at the going wage. So in general Walras’ Law doesn’t apply, at least in its usual form. (There may be some variant which applies to problems with rationing; if so I’d appreciate a pointer.) Of course, if the wage is just right jobs are not rationed; that’s the (unique) Walrasian equilibrium.

But we’ve been over this ground before and I have an uneasy feeling that if I spell out a non-Walrasian model you’ll say I have money up my sleeve, so to speak. So let’s keep it strictly Walrasian. Households maximise U(C,N,A) = v.logC+(1-v).logA+a.log(N0-N), where C is consumption, A is antiques held and N0 is all the hours a body could possibly work. The production function is logY=s.logN. The parameters are all in the interval (0,1). Let antiques be the numeraire, so W is the number of antiques an hour’s labour will buy. At full employment, in the unlikely event that my calculus is right: N = s.v.N0/(a+s.v). Notice that N depends on v. Preferences have consequences. If demand shifts in favour of antiques, employment will fall. W = A.[(v+a/s)/(1-v)]/N0. If demand shifts in favour of antiques, wages must fall in order to maintain full employment. There’s your paradox of thrift: if wages are sticky, an increased desire for the asset in which wage-contracts are denominated will result in unemployment.

As I see it, the crucial difference between Keynes’s view on this issue and Clower’s, is that for Clower money is the medium of exchange while for Keynes money is just the standard of value used when wage bargains are struck. If contracts were denominated in diamonds then a surge in demand for diamonds would create unemployment (except in South Africa obviously). I can’t remember where I first read that Clower objected to Keynes as being insufficiently Clowerian, but Google quotes David Colander as saying that “Clower cringes when called a Keynesian.”

"But that prediction makes no sense whatsoever. This is what would happen instead. The supply of antique furniture is fixed. Either the price of antique furntiture rises to equilibrate the market, or it does not. If it rises, then the quantity of antique furniture demanded falls back to its original level, and people decide to buy newly-produced furniture instead, so there's no recession. If it does not rise, then people will be unable to buy the antique furniture they want to buy, because nobody wants to sell. Unable to buy antique furniture, people have to buy newly-produced furniture instead, so there's no recession."

What about working gold into this, assuming that the supply of gold grows around .5% per year and price deflation is 2% a year or more?

"Keynesian macroeconomics makes no sense whatsoever in a barter economy. Unemployed workers want jobs, so they can buy goods? Firms won't hire them, because they can't sell goods? What's the problem? Why can't the firms just pay the workers in goods?"

There are some scenarios where this won't work. Suppose that firms are monopolistically competitive in the product market: they sell their products above marginal cost in order to recover fixed costs. Conversely, firms may be monopsonistic in factor markets; perhaps some factor exhibits increasing average returns, in which case that factor will not earn its marginal product. Then some exchanges which are profitable (at least ex post) will not occur, even in a barter market. In the short run, though, welfare may be improved by raising demand for the 'overpriced' products or supply of the 'underpaid' factors.

"But that prediction makes no sense whatsoever. This is what would happen instead. The supply of antique furniture is fixed. Either the price of antique furntiture rises to equilibrate the market, or it does not. If it rises, then the quantity of antique furniture demanded falls back to its original level,"

There are two problems here. One is that even though the physical quantity of furniture is fixed, a higher price means that a larger portion of the economy is now invested in furniture, rather than other kinds of capital. So real interest rates should increase and investment should fall.

The other problem has to do with the underlying reason for buying furniture. If the motive was precautionary "thrift", then the whole effort amounts to a cornering of the antique furniture market: the thrifty savers will fail to "bury the corpse" and cash in on their paper profits. Rational savers will anticipate this problem and refuse to join the attempted market corner, especially if they are late in the game and the price of the asset is high. Perhaps this is the true "paradox of thrift".

Nick,

Assume no investment &c.

Assume a time lag between when you commit to a consumption decision and when you learn your income.

Define "intended saving" as the difference between expected income and actual consumption.

If everyone increases their intended saving, there will be a recession.

What if they increase their intended saving by intending to buy more antiques? Given my definition, that question is meaningless. Either they're consuming less or they're not. Either their income expectations have changed or they haven't. I can imagine several cases, and in each one of them, either intended saving never rises, or there is a recession.

Suppose everyone comes up with a new plan to replace some of their consumption with antique purchases. Do they immediately start consuming less (before getting a quote for antiques to purchase)? In that case intended saving rises, and there is a recession. Do they wait to see what antiques they can buy before reducing their consumption, then discover that the price has risen and go back to their original plan instead? In that case intended saving never rises. Do they purchase the antiques and simultaneously reduce their consumption? In that case the antique dealer either consumes more with the proceeds (in which case aggregate intended saving doesn't rise) or "hoards" the proceed (in which case there is a recession).

Phil: you really need to make the distinction between quantity demanded and quantity bought. Between desired purchases of antiques and actual purchases of antiques. Between desired savings and actual savings.

In an economy without government, investment, or foreigners, (for simplicity) actual savings is always zero. People in aggregate cannot save. That's not controversial in economics. Just as people in aggregate cannot buy more antiques.

The standard paradox of thrift says that if people *desire/try/demand* to save more, the result will be a recession. The standard argument is that consumption demand will fall, and since income comes from producing and selling consumer goods, so sales, production and income will fall, and keep on falling until they stop *trying* to save.

I am saying that if they *desire/try/demand* to save in the form of antiques, the result will not be a recession. But if they *try/desire/demand* to save in the form of money, it will cause a recession.

Too much Fed

well, if your concern is a supposed inability to credibly commit to inflation, why not?

[sings] I would do anything for inflation, but I won't do that.

Kevin: I'm not sure I fully understand you. But let me make a couple of points that may (or may not) help:

1. In your model a decrease in v increases the Marginal Utility of antiques and reduces the MU of C. It leaves the MU of leisure unchanged. That means an increased preference for antiques changes the marginal rate of substitution between consumption and leisure, and thus shifts the labour supply curve to the left in real wage space (where real wage means the relative price of labour to consumption). So even if all prices are fully flexible, an increased desire for antiques will reduce the market-clearing level of employment. OK, but it's not what Keynesians are talking about.

2. What markets exist in your model? If there's no money, I assume it's a barter economy. There's a CN market, a CA market, and an AN market. Even if the price of antiques is stuck too low, so there's an excess demand for antiques in both the CA and AN market, that doesn't prevent the CN market from clearing, if the relative price of C and N can adjust.

AArgh! How do we turn off italics??

anon: agreed on monopolistic competition. But that's not what the paradox of thrift is about. If we move away from perfect competition, the LRAS curve will shift left, so we get lower equilibrium output and employment, and not all mutually advantageous trades are executed. But that's not an AD curve problem.

"There are two problems here. One is that even though the physical quantity of furniture is fixed, a higher price means that a larger portion of the economy is now invested in furniture, rather than other kinds of capital. So real interest rates should increase and investment should fall."

I was keeping investment out of the model (or holding it constant) to keep things simple. The simplest paradox of thrift model does the same thing. If we allow investment to vary with the rate of interest (or anything else) the paradox of thrift model breaks down anyway. For example, if an increase in desired savings causes r to fall so that investment rises enough to fully offset the increased desire to save, there's no recession. that's not controversial.

You lost me on the last paragraph.

Andy: OK. I think I get where you are going.

I am implicitly assuming they learn that they cannot buy antiques *before* they revise their expectations of income. For example, suppose they visit the antique market first, then the market for new furniture second. They plan to spend $100 at the antique market, and $100 less at the new furniture market. And they learn they can't spend anything at the antique market, so spend that $100 on new furniture instead.

You are saying (I think), suppose it's the other way around? They visit the new market first, and spend $100 less, then go to the antique market, and find they can't buy more, so go home with $100 more in their pocket than they had planned. Then that afternoon they learn that their income from sales of new goods is $100 less than they had expected. We get a recession. Right?

Here's my response: That recession cannot persist. They will eventually learn they cannot buy antiques. So they learn they are holding too much money for their now lowered level of income. So they spend some. So output returns to normal. Your recession can only persist as long as people are willing to hold too much money, relative to their income, in the hope there will be antiques for sale. Ultimately, your recession is caused by an excessive demand for money.

Luis Enrique said: "Too much Fed

well, if your concern is a supposed inability to credibly commit to inflation, why not?

[sings] I would do anything for inflation, but I won't do that."

Would you borrow enough with gov't currency denominated debt to send out checks to every citizen and legal resident for $1,000 each?

What are the differences between borrowing enough to send $1,000 to each person and actually printing currency with no bond to do it?

It seems to me there is one similarity. They both create more medium of exchange IN THE PRESENT.

Need to get the mechanism right.
http://www.ftportfolios.com/blogs/EconBlog/2010/9/27/the-myth-and-mistake-of-quantitative-easing

Remember how Canada's quantitative easing was sterilized so you termed it qualitative easing. Maybe the same in the states.

"You lost me on the last paragraph."

I might try to rephrase my concerns later, but the fact that "there is no investment" in your model makes it difficult, and it might be irrelevant to your basic point. The way I see it, any kind of intertemporal resource allocation _is_ investment, at least in some sense.

Along these lines, is "hoarding money" really any different from "loaning real resources to the government at 0% nominal interest"? [Yes, there is a money multiplier, so the banking system is also involved, etc. But let's suppose banks create no money to keep things simpler.] The monetary base is backed by government bonds, which represent claims to real resources; if the demand for money rises, either the price level drops (in which case the government gets more real resources for the same quantity of money) or the Fed creates more money and the price level stays on its planned path. Perhaps there is no paradox of hoarding, but merely a transfer from C to G--and possibly a price level shock, which of course creates severe frictions.

Under a gold standard, things would be rather different; hoarding money would involve current owners of gold rather than governments, and the desire to hoard money might have real effects on the supply of gold or its use in industry and jewelry. But the basic principle would be unchanged, AFAICT.

Nick and Andy. Andy's comment also crossed my mind, but I don't know enough about the Keynesian model to have a strong view. I've never liked analyses that revolved around differences between planned and actual saving, as I don't see that as the key issue. So let me come at this from another angle:

Suppose people try to save more, and want to accumulate future money, not antique furniture. So they put money into banks, corporate bonds, etc. This attempt to save more depresses interest rates, and causes AD to fall. But I see the transmission mechanism differently from Nick, although I completely agree that what seems like the paradox of thrift, is actually the paradox of hoarding. I don't think you need any disequilibrium models where planned and actual saving differ. Suppose people save more, and interest rates fall. The demand for base money will rise, even if it is not at all a close substitute for safe government bonds (and I don't think it is a close substitute.) Instead, all you need is the Baumol-Tobin transactions money demand model. Interest rates fall and hence people go to ATM machines less often to stock up. Instead of carrying enough cash to buy one week's worth of groceries, they carry enough cash to buy two weeks worth of groceries. If the Fed doesn't adjust the supply of money, NGDP falls in half. What looks like the paradox of thrift, is actually the paradox of cash hoarding. But I can get the result w/o any assumption of planned saving differing from actual saving, or of cash being a close substitute for T-bills.

I once argued that the Keynesian model was essentially a gold standard model. Normally if the demand for cash balances doubled, the Fed would accommodate that demand by doubling the supply of cash. The only case where they couldn't do that was under the gold standard, where gold reserves constrained the size of the base. The one example of a liquidity trap in the General Theory is a case where the Fed wasn't able to increase the money supply because there was a huge outflow of gold. Thus under the gold standard, the paradox of thrift is really the paradox of cash hoarding, and the paradox of cash hoarding is only a problem because cash must be backed with a finite supply of gold bullion.

BTW, great post.

Frances@10:17AM: "With an aging population, there will be more and more consumer durables chasing fewer and fewer people. Surely this explains why aging societies experience slow economic growth."

That is what I pointed out here. If that is the case, the problem is more *structural* than mere paradox of thrift or paradox of hoarding or whatever. And that structural problem could cause structural unemployment, as opposed to the structural problem Krugman has in mind here. However, maybe it isn't major problem in US yet. Some people (such as Dean Baker) say it isn't major problem even in Japan.

Good topic. I think, judging from the price of commodities, that the Fed's strategy is working in the reduction of the hoarding of cash...sort of. Maybe the fed thinks by QE and low policy rates they will chase cash out of hoarders' hands and into capital assets like equities and real estate, which will in turn help the economy expand. However, given the unsustainable debt levels, the chased money appears to be hoarding precious metals and basic commodities as safe havens from anticipated defaults and high inflation. It's kind of going to physical cash substitutes as a statement of even deeper pessimism than going to cash.

Don't you think the game is over for this kind of Keysian hopeful-ism? What if what we really need is big defaults to wipe clean the global balance sheet and set the groundwork for a genuine expansion, supported hopefully by a gold standard?

edeast: I had a quick read of that link you posted, but it didn't really make sense to me.

anon: agreed, any type of intertemporal resource allocation is investment.

If one individual saves, and there is no change in investment, then some other individual must dissave. There is no aggregate intertemporal resource allocatation, only an intertemporal resource reallocation across individuals.

So if all individuals *try* to save, and there is no change in investment, they will fail.

I'm arguing that if all individuals try to save in antiques, nothing happens (except the price of antiques may rise).

And if all individuals try to save in the form of money, and the supply of money is fixed, something will happen. If prices are fixed (in the short run) we get a recession. If prices are flexible, we get deflation, so people succeed in getting more real money (M/P), even though they fail to get more nominal money (M).

Scott: Yep. Andy's critique is a good one. The best I've had so far. But I think that ultimately Andy's critique comes down to saying that an excess demand for antiques will cause a recession because people demand an extra $100 cash that they carry in their pockets in the false hope they will find an antique with a "for sale" sign on it, so they can rush and buy it immediately.

How do we define "substitute"? If an increase in the price of bananas causes the demand for apples to increase, then bananas are a substitute for apples. Similarly, if an increase in the price of bonds (a fall in their yield) causes an increased demand for money, then bonds are a substitute for money. So, I think you are implicitly assuming that bonds are a substitute for money.

The trouble for us Keynesians is that we naturally think in ISLM terms, where there are 3 goods: newly-produced output; money; and "bonds", where bonds are everything else, and are a substitute for money. And it's awfully tempting for us to see the causal chain going this way: demand and supply of money determines the interest rate (LM); the interest rate determines the demand for output (IS). It's so hard for us to think though the causal chain the other way around: IS determines r, r determines Md, and Ms-Md determines Y. Of course, it's all simultaneous at the ISLM intersection. It's only when we consider weird cases, like antiques, or supposing buyers are rationed in markets for assets, that we are forced to think through the transmission mechanism.

himaginary: what's puzzling though is that retired people are supposed to be dissaving. The people who do the big saving are supposed to be those about to retire soon, because they have already paid for their kids, house, furniture, etc, and can now save like mad for a few years before they retire. It's the 55-65 group I would have thought would be the big savers. Still working and earning, but spending less.

Geoff: the rise in commodity prices is what we would expect to see from monetary easing. To me, it's a hopeful sign. If there weren't the threat of recession and deflation, those balance sheets would look a lot better. Plus, there's a way to repair balance sheets without default: debtors spend less, and creditors spend more.

Great post Nick.

You should mention Yeager with this stuff.

Scott, Nick's response is right. What does it mean to say that interest rates impact the transactions demand for money other than that bonds are a close substitute for money. While the rationing stories are usually not too relevant, I think it is the best way to understand zero bound phenomenon. There is a shortage of T-bills at price of one, and it clears by a shift in the demand to hold money. This is important because open market operations in T-bills take away T-bills, worsening the shortage, leading to a further spillover to money demand at the same time they create money. Not very effective.

I think Andy's confusion, and this is common, it to assume we are always talking about an "exogenous" money demand shock. Suddenly, tastes change and people what to hold more money. When, instead, they think of something else (say a change in saving) and as part of the process there is an increase in the demand for money, then they refuse to see that it is that step in the process that is causing the problem for aggregate nominal expenditures.

The actual arguments he made seem uninformed by basic supply and demand. Suppose investment demand is perfectly inelastic with respect to interest rates. Saving supply increases. The interest rate falls enough so that quantity of saving supplied drops enough so the amount saved remains the same. There was still an increase in the supply of saving.

Suppose the demand for peaches rises. The supply of peaches is perfectly inelastic. The price of peaches rise so that the quantity of peaches demanded falls enough, so that the equilibrium quantity of peaches is unchanged. There was still an increase in the demand for peaches.

Thanks Bill! Yes, I should have mentioned Yeager. But I don't know how to characterise him. Not really Keynesian, but I'm not sure I would call him monetarist either. He's even harder to pigeonhole than Clower. With Clower, at least you can say he was "Keynesian" in the sense of re-interpreting Keynes ("what Keynes should have meant, whether he meant it or not"). Even if Clower rejects the label.

In fact, what the hell do we call this whole approach?

Bill: " There is a shortage of T-bills at price of one, and it clears by a shift in the demand to hold money. This is important because open market operations in T-bills take away T-bills, worsening the shortage, leading to a further spillover to money demand at the same time they create money. Not very effective."

Funny thing is, this is almost identical to what Brad DeLong said:

Here's Brad:

"Could I make Nick Rowe happy by saying that there is too a "paradox of thrift," in this sense:

When there is an excess of (planned) savings over investment, savers will be unable to find enough bonds to satisfy their demand and will park the excess demand in liquid cash money instead, which they will hoard. They will thus diminish the supply of money available to meet the transactions demand for money and that imbalance creates the excess demand that breaks Say's Law. Thus even though the problem as an excess demand for money, standard open-market operations will not resolve it: they will increase the money supply, yes, but by diminishing the supply of other savings vehicles they will also increase the amount of the money stock not available for transactions purposes because it is being held as a savings (or a safety) vehicle

?

Does that make anything clear, or just deepen the darkness?"
Endquote from Brad.

Basically, when Brad DeLong really gets into why Say's Law is wrong, what he says is really the same as you and me. He even talks about velocity at times.

And don't let anyone know I said this, but I sometimes suspect him of "quasi-monetarist" tendencies.

P.S.

Suppose the demand to hold money rises. The quantity of money is unchanged. The purchasing power of money rises (or the price level falls) so that the amount of nominal money balances people choose to hold falls back to its initial level. The demand for money still rose.

Suppose the equilibrium process does not occur, and instead, the demand for money rose, and real income falls enough so that people are poorer and choose to hold less money. The amount of money they want to hold given the lower income, equals the existing quantity. Still, the demand for money rose.

Of course, I am just a supply and demand kind of guy, but it all makes sense to me thinking about "quasi" changes in supply or demand and changes in quantity supplied or demanded. Of course, there are multiple methods of adjustment to monetary disequilibrium==at the very least, interest rates on money, interest rates on other assets, real income, and the price level.

In some sense, I want to say the interest rate on money or the price level adjustments are the "right" ones, because interest rates have an intertemporal adjustment function and real income is the entire point of economy activity.

Nick,

I think Andy Harless is right in his comments, and that you’ve effectively just renamed the paradox of thrift. The paradox of thrift always equates to the hoarding of money in some sense, because it requires a failure/contraction in aggregate demand, which in a monetary economy is a failure of people to spend money, which must imply hoarding of money at some level compared to the previous level of activity. If the supply of money is fixed, a recession means a slowdown in the velocity of money, which must equate to hoarding at the margin. So I don’t think you’ve disproved the paradox of thrift in the full breadth of its logic at all.

Andy’s second comment points to a fallacy of composition and internal contradiction in your argument, explained by him in according to the deconstruction of the macro outcome into micro subsets and potential outcomes.

The key sentence is:

“In that case the antique dealer either consumes more with the proceeds (in which case aggregate intended saving doesn't rise) or "hoards" the proceed (in which case there is a recession).”

This is consistent with my earlier point. While the paradox of thrift is a macro phenomenon, the assumed micro composition of behaviours contributing to the macro paradox must be internally consistent as preconditions for the macro outcome. E.g. in a pure service economy, the desire to save will translate into a distribution of actual micro saving and actual micro dissaving that sum to a net saving of zero. The micro dissaving distribution is a reflection of the evolving contraction. When I said that the fallacy of composition assumes actual saving at the micro level, I certainly didn’t intend to mean that it doesn’t assume desired saving at the macro level.

Nick,

I also think there are two quite separate ideas being debated here:

a) The relationship between the paradox of thrift and the paradox of hoarding

b) The relationship between the central bank risk transformation function and the operational resilience of either paradox

By the central bank risk transformation function, I mean that the swapping of money for equity risk is likely to have a greater effect in combating the paradox than will the swapping of money for t bills. And the swapping of money for t bills will have a greater effect at higher rates than at the zero bound.

Yeager calls his approach "monetary disequilibrium."

At some point, Yeager was a "monetarist" and was very sympathetic to quantity of money rules. And he understood, Friedman, for example, of
having more or less the same understanding that he did.

Yeager always insists that there were pre-Keynesians who understood monetary disequilibrium quite well. But that there were others who were off. And, he was very critical of the liquidationists.

Yeager criticized Clower and Leijonhuved (yikes) for reinterpreting Keynes with a focus on monetary disequilibrium. There were plenty of pre-Keynesians who understood this better, and Keynes just created a mass of confusion--a diversion.

But, if the "new Keynesians" finally get it straight, then fine, we can be hold our noses and be "new Keynesians" regarless of these history of thought points. Of course, now that they are all focused on targeting the Federal Funds rate, and have become neo-Wicksellians, well, I guess that is out the window.

And Yeager has always been very critical of market clearing assumptions, and so new classical and real business cycle theories.

Anyway, "quasi" monetarist might be it.

The free banking Austrians say "monetary equilibrium" theory, and it does have a nice sound to it. They tend to favor mild deflation and are very worried about malinvestment, but I think they have the basics of monetary theory straight. Selgin edited a book of Yeager's essays.

Nick,
I have a post that argues that 2008 crisis was caused by a flight to liquidity, not by a flight to safety. The relative price of very safe but less liquid assets such as TIPS has crashed after Lehman, this indicates that monetary disequilibrium was the most important issue:

http://themoneydemand.blogspot.com/2010/10/brad-delong-and-flight-to-safety.html

Nick,

I read DeLong. I thought that he was right. And that Yeager explained this in 1956--explaining how the liquidity trap fit in with monetary disequilibrium. Your points

Nick, I think our differences may be mostly semantic, but my real point is that the "paradox of thrift" semantics are useful. What will happen if people get more thrifty? Unless there is some mechanism (such as an IS curve without a binding zero constraint) for channeling thrift into real demand for new products, the answer (assuming sticky prices) is that there will be a recession. Provided that there exists some asset (call it money) whose value does not rise in response to increased demand and which can still be obtained when it is in excess demand. People may try to buy other assets first, but eventually they will give up and keep their savings in the form of money. Because they can. (Or rather, because each of them can, although, collectively, they can't.)

I'm implicitly assuming that money is the only bubble asset, so maybe I should call it the paradox of undeluded thrift. There could also be a bubble in antique furniture, where people keep buying despite price increases because they don't realize that prices will eventually fall again. In that case they will overestimate their wealth and consume more (relative to their actual wealth/incomes) despite their thrift. In the absence of such a bubble, though, any increase in the value of another asset will make money more attractive, so people will eventually channel their thrift into money and cause a recession.

A couple of points, when you are disagreeing with Krugman and DeLong on the paradox of thrift v. paradox of hoarding, you all seem to be describing the same thing. Are you doing this just to keep on good terms with the Krugman phobes since Krugman is no longer a respectable economist (having gone all heterodox like Quiggin, Keene, Dean Baker, Jamie Galbraith, Minksy e.g. all the folks who have been right these last 10 years).

See DeLong's brief historical discussion of Say, J.S. Mill, and successors about how "money" changes everything in a financial crisis.

http://delong.typepad.com/sdj/2010/10/a-picky-historical-correction.html

Also, I just note that Keynes magnum opus was "A General Theory of Employment, Interest, and Money." See, it is right there in the title "Money."

I don't like the term hoarding because to me it implies intent, where the intent may be quite different. If antique sellers maintain larger cash balances waiting for the opportunity to buy antiques at a better price, they may be hoarding in the sense of maintaining high cash balances, but it is not high cash balances that they actually desire. It doesn't seem untoward to me to call this thrift.

Andy,

I think balling up bubble theory with an excess demand for money
is just confused. I can see why a popping bubble might lead to an increase in the demand to hold money, but expanding bubbles don't do that except through the effect on the difference between the yield on the asset and the yield on money. Higher price, lower yield, lower difference between the yield on the asset and money, increase in the demand to hold money. But this hardly requires that the increase in the asset price is a bubble.

Your notion that if an increased supply of saving doesn't cause reduced real output, then it wasn't really an increase in the supply of saving is confused.

Or, perhaps, the "semantics" is that I see the paradox of thrift as being a situation where a shift in the supply of saving to the right supposedly causes a reduction in income and output. The monetary disequilibrium theory is that this is only true if at some point in the process, the result is an increase in the demand to hold money that is not accommodated by an increase in the quantity of money.

If there is no excess demand for money in the process, then the usual impact occurs--the quantity of investment demanded rises and the quantity of savings supplied falls. In the end, the interest rate is lower and the amount saved and the amount invested are higher. Make investment demand perfectly inelastic, then the amount saved and invested don't change. It is just supply and demand.

If you start getting into negative nominal interest rates on some assets, and you assume that any increase in the nominal quantity of money can only occur if banks, or the central bank purchases those very same assets, then you have a problem.

But you have got to get used to thinking about negative nominal interest rates, and of course, negative real interest rates.

Sure, issuing zero nominal interest currency on demand is a problem if you need negative nominal interest rates. But isn't then obvious that the problem is that there is going to be an excess demand for this zero interest currency when market clearing nominal interest rates are negative?

By the way, it is false that central bank portfolios are made up of Treasury bills!!!!!! This is a story we Money and Banking economists have been telling, long after it was false. The government bond portfolio
of the Fed is made up securities of longer terms to maturity for the most part, nearly all of them with yields above zero.

If you assume the central bank is targeting an interest rate, and the increase in the supply of saving requires that particular interest to go negative (even though others may well be positive,) then there are problems with the central bank's rule. This could easily involve a decrease in the quantity of money as well as a failure of the quantity of money to rise enough to match some increase in demand. Why do you think we "quasi-monetarists" always gripe about interest rate targeting.

So, paradox of thrift-- occurs when market clearing nominal rates are zero, and so, there is an excess demand for zero interest currency. Or, it is caused by a central bank targeting the interest rate, causing an excess demand for money when they fail to reduce their target for the interest rate, perhaps because it has hit zero, resulting in an excess demand for money.

There is no excess demand for money, but people want to buy financial assets or antiques, and this creates an excess supply of currently produced goods. Impossible.

Shifts in saving and investment occur all the time. Interest rates are the prices that clear that market. If the interactions between interest rates and monetary institutions mean that changes in interest rates lead to excess supplies or demands for money, then the problem is with the monetary institutions, not changes in saving or investment behavior.

That is what monetary disequilibrium theory is about.

Frankly, trying to fix the economy so that the supply of saving never rises or the demand for investment never falls is a fools errand.

The "paradox of thrift" is a misnomer, because has nothing to do with thriftiness per se. The problem arises when the money supply is inelastic, prices are inelastic, and money demand unexpectedly increases. Since each of these conditions can be satisifed while aggregate saving is actually in decline, calling it the "paradox of thrift" just gives thriftiness a bad name. Although learned economists might understand that it is just a name, and that thriftiness is not actually the problem, do not expect laypeople, journalists, and politicians to understand these subtleties. (Moreover, it only ever seemed like a paradox because of the contorted manner in which it is traditionally expressed -- understood in terms of MET the so-called paradox is as sensible as "1 + 1 = 2".)

Fiscal policy works only insofar as it reduces money demand. That is, by offering a safe and liquid alternative to money, some part of the demand for money balances will be "mopped up" -- at least presuming the government does not merely increase its own money balances in proportion. But this seems like a very inefficient, unpredcitable, costly, and even foolish way to go about trying to restore monetary equilibrium.

Sorry I'm not keeping up with responding to all the comments. (Hey, you are all arguing well among yourselves anyway!)

Lee Kelly: "The "paradox of thrift" is a misnomer, because has nothing to do with thriftiness per se. The problem arises when the money supply is inelastic, prices are inelastic, and money demand unexpectedly increases. Since each of these conditions can be satisfied while aggregate saving is actually in decline, calling it the "paradox of thrift" just gives thriftiness a bad name."

Damn! Lee is right. An increase in desired savings in the form of an increased demand for money causes a recession. But whether desired savings actually increases or not is irrelevant. It's just that the normal story of the paradox of thrift (implicitly or explicitly) assumes that it's thrift in the form of money. What did Lady Joan Robinson say about incantations being very effective at killing sheep, if delivered with arsenic at the same time?

sherparick: "A couple of points, when you are disagreeing with Krugman and DeLong on the paradox of thrift v. paradox of hoarding, you all seem to be describing the same thing. Are you doing this just to keep on good terms with the Krugman phobes since Krugman is no longer a respectable economist (having gone all heterodox like Quiggin, Keene, Dean Baker, Jamie Galbraith, Minksy e.g. all the folks who have been right these last 10 years)."

Thrift and hording are different. There's a disagreement here, though with Brad DeLong it's more a difference of perspective.

Paul Krugman and Brad DeLong are both very respectable economists in my eyes. I don't think either is very heterodox at all. And, I agree with them much more than I disagree with them. (Though I rarely, if ever, do a post to say I agree with them. What's the point?)

Nick, thanks for the response. Reading the comments I get the sense that your post means different things to different people and I suspect my reading is a bit further off than most. But anyway:

“So even if all prices are fully flexible, an increased desire for antiques will reduce the market-clearing level of employment. OK, but it's not what Keynesians are talking about.”

Agreed, although Keynes himself did talk about it quite a bit. He saw the excessive demand of the Indian princes for barren treasure as a reason why the Indian economy had failed to develop satisfactorily. But that’s by the way and has to do with the Juncker ‘Fallacy’ rather than money.

"What markets exist in your model? If there's no money, I assume it's a barter economy. There's a CN market, a CA market, and an AN market. Even if the price of antiques is stuck too low, so there's an excess demand for antiques in both the CA and AN market, that doesn't prevent the CN market from clearing, if the relative price of C and N can adjust."

It’s an idealized barter economy. Your quoted statement isn’t quite true, surely? The relative price of C and N is just the real product wage. If the antique-wage is somehow prevented from adjusting then in general the real product wage won’t find its way to the full-employment equilibrium level. Obviously you know that and I don’t want to be nit-picking, but I do have trouble seeing how this barter model of yours actually works. It seems even more Panglossian than a simple micro textbook GE model, but I’m sure that’s not your intention.

I’m not under the illusion that I’m saying anything profound here: all I’m saying is that, even in a very simple static model with no money, you can have a paradox of thrift (of sorts anyway). All it takes is an inflexible price for the non-produced good in terms of labour. If I’m wrong about that then I’m in distinguished company. The ‘money’ in many Old Keynesian models is really nothing more than the Nth good in a GE system. Yet the Old Keynesians never had any problem using models like that to explain their paradox of thrift. Krugman still trots out the “World’s Smallest Macro Model” which Robert Hall taught him; you could substitute antiques for the ‘money’ in that model and it wouldn’t change a thing.

PS: re your latest: it was Voltaire, not Joan Robinson and she was never elevated to the peerage.

Kevin: "If I’m wrong about that then I’m in distinguished company."

Yes, to both! (Unless I've misunderstood you).

In a true barter economy, with n goods, there are (n)(n-1)/2 markets, and the same number of relative prices. If there are three goods there are three markets, and each market has a relative price of the two goods traded. If all three markets are in equilibrium, then arbitrage ensures all three relative prices must be mutually consistent, so there are only 2 degrees of freedom. This means we can arbitrarily make one good the numeraire, set its price equal to 1, and just have two prices.

But if one or more of those markets is not clearing, one or other side of the market (the "long" side) will be quantity-constrained, so arbitrage won't work. Suppose there is a law fixing the price of the non-produced good "M" in terms of labour in the LM market. There can be one price of output in the YM market, and a quite different price for output in the YL market, with no possibility for arbitrage via M.

But if M is money, i.e. barter is not allowed, then there are (n-1) markets, and the same number of relative prices. And it means there is no YL market. So the labour market can't clear, if you fix the price of L in terms of M.

I think I've explained that right.

Lee:

"The "paradox of thrift" is a misnomer, because has nothing to do with thriftiness per se. The problem arises when the money supply is inelastic, prices are inelastic, and money demand unexpectedly increases. Since each of these conditions can be satisifed while aggregate saving is actually in decline, calling it the "paradox of thrift" just gives thriftiness a bad name. Although learned economists might understand that it is just a name, and that thriftiness is not actually the problem, do not expect laypeople, journalists, and politicians to understand these subtleties"

Calling it something else gives thriftiness an unjustifiably good name. Empirically observed central bank reaction functions are such that, when interest rates are very low, they do not fully accommodate (or act to reverse) increases in money demand. In fact, they don't even come close. As a result, there exists, in practice, a paradox of thrift. Given the limited understanding of laypeople, journalists, and politicians, to deny the paradox of thrift is, in effect, to argue for socially suboptimal policy.

And central banks are not necessarily behaving unreasonably by failing to accommodate money demand. There are highly regarded arguments against allowing inflation rates to rise above 2%, and a 2% inflation rate may not be feasible (because the Wicksellian natural interest rate is less than negative 2%), or it may be feasible only with unacceptably high uncertainty, or the actions required to produce it may produce unacceptable future costs/risks. Or the ultra-low interest rates produced by accommodating money demand may lead the formation of asset bubbles.

Under these circumstances, thrift is demonstrably a bad thing and deserves to have a much worse reputation than it actually has among non-economists (and economists for that matter).

If you have mastered alchemy to the point where your incantations can actually produce arsenic, then I submit that the incantations themselves deserve much of the blame for the dead sheep, even if there were other potential ways of producing the arsenic, and even if lesser enchanters could not have brought forth the arsenic with their incantations.

Nick and Bill, I think you are confusing "substitutes" with "close substitutes," which is what I said. Obviously I was assuming that cash and bonds are substitutes, but so are bonds and wallets. After all, if you carry more cash you need bigger wallets. I don't know of any evidence that cash and bonds are close substitutes. That would imply a tiny change in the price of bonds would cause a massive change in the demand for currency. Is they any evidence for this? The demand for currency in America has changed very little in recent years, even as the yield on T-bills has fallen to near zero. How can they be close substitutes? Close substitutes means a small fall in the price of bonds (i.e. a small rise in rates) would cause the demand for cash to fall to near zero.

The problem with IS-LM is that it doesn't explain business cycles in an economy w/o bonds. If there is just cash and goods, and the supply of cash falls, the price of goods falls. Because wages are sticky, unemployment rises. If there are no bonds, how can that recession be explained with IS-LM? And if you add bonds, does the sticky wage mechanism suddenly stop causing recessions, and interest rates suddenly start causing recessions? If so, why? Indeed I think the same argument applies if we use your medium of exchange approach.

Kevin: a simpler thought experiment.

Assume the MRS between labour and consumption of the output good is independent of M for simplicity (seperable utility function). M is numeraire.

Start in equilibrium. Double W and P. There's now an excess demand for M. But W/P is unchanged. If there's a barter economy, so you can trade labour for output directly, the labour market still clears at the same level of employment. MRS(L,Y)=W/P=MPL(L). But there's excess demand for M in both the other markets. If it's a monetary economy, you can't trade L for Y directly, and since firms can't sell Y for M, they hire less L. Barro Grossman 1971.

Under certain empirically reasonable (for the present) conditions, an increase in the propensity to save results in a decrease in aggregate savings. That is thrift. That is a paradox. That is the paradox of thrift. The details of why it happens are a separate issue. I don't get how y'all are denying it.

Andy, it's painfully obvious you're right. However, don't expect anyone else to admit it because they never, ever, do.

Andy,

"Calling it something else gives thriftiness an unjustifiably good name."
W would calling the paradox of thrift something else give thriftiness an undeservedly good name? Besides the fact that it would be more accurate, since it really has nothing to do with aggregate saving, why would calling the paradox of thrift "an excess demand for money" give thriftiness a good name? That just makes not a jot of sense.

In any case, I believe thriftiness really does deserve a good name, and that the legacy of Keynes has been quite detrimental on this point. Any apparent problem with thriftiness in our current monetary and banking system is better understood as a problem with monetary policy. That is, given the monetary and banking order we have inherited, it is the responsibility of the central bank to ensure that the supply of money is adjusted to the demand to hold it. Without such assistance, financial intermediaries cannot smoothly redistribute purchasing power among savers and borrowers so as to coordinate the allocation of resources between consumption and production over time.

"Empirically observed central bank reaction functions are such that, when interest rates are very low, they do not fully accommodate (or act to reverse) increases in money demand. In fact, they don't even come close. As a result, there exists, in practice, a paradox of thrift. Given the limited understanding of laypeople, journalists, and politicians, to deny the paradox of thrift is, in effect, to argue for socially suboptimal policy."
To deny the paradox of thrift is not to deny that a real problem exists, but rather that it is too often misidentified because of misleading language and sloppy assumptions. An excess demand for money is the real problem and always was the real problem, and we'll all do much better to focus on that.
And central banks are not necessarily behaving unreasonably by failing to accommodate money demand. There are highly regarded arguments against allowing inflation rates to rise above 2%, and a 2% inflation rate may not be feasible (because the Wicksellian natural interest rate is less than negative 2%), or it may be feasible only with unacceptably high uncertainty, or the actions required to produce it may produce unacceptable future costs/risks. Or the ultra-low interest rates produced by accommodating money demand may lead the formation of asset bubbles.
Who said anything about 2% inflation? The best macroeconomic measure of monetary equilibrium is nominal spending. If it rises or falls sharply it normally implies an excess supply or demand for money. Think of "MV = PY".
Under these circumstances, thrift is demonstrably a bad thing and deserves to have a much worse reputation than it actually has among non-economists (and economists for that matter).
Or equivalently, contractionary monetary policy, without which the "paradox of thrift" cannot occur, deserves a bad name. I much prefer this formulation.

Thrift is bad because "reasonable" central bank policies mean thrift causes recession.

How about explaining that the reason for the recession is that the central bank, which monopolizes the issue of the monetary base, believes that accommodating the demand for money might cause other problems.

Then we can ask exactly what those problems might be and how likely they are to occur and whether those chances are worth taking.

Your approach is to instead blame households and firms for the problem. You all are just saving too much. And that way, the Fed doesn't have to explain why it is failing to supply the quantity of money demanded.

I know what central bankers like this approach. But it makes me ill.

Nick wrote:"Unable to buy antique furniture, people have to buy newly-produced furniture instead, so there's no recession."

Because there is no thrift and thus no paradox, right? Why still call it thrift when people buy newly-produced furniture instead?

'Attacking' Krugman on a distinction between between thrift and hoarding serves what purpose? Both are 'not-spending' on new goods and services, the latter chooses to hold financial assets and while the former chooses non-financial assets. Both will lead to recession.

Moving on, you do need a better distinction between monetary and fiscal policy.

Try....

Monetary policy involves spending FRN (federal reserve notes) on Tsy Secs (treasury securities). Fiscal policy involves spending FRN on new, non-financial assets (including labor which if not purchased goes wasted) and then removing the FRN from the economy with sales of new Tsy Secs.

If you want the gov/Fed to start spending FRN on new, private sector issued financial assets, call it fascism or something else (like corruption).

Having the Fed purchase the stocks of the S&P 500 just doesn't qualify as monetary policy. Besides, why would those purchases be anymore appealing to Middle America than bank bailouts, except they benefit the top 10% rather than the top 1%? I know you could come up with a better economic outcome than S&P 500 purchases.

Nick wrote: "Fiscal deficits, if they work, will have future costs."

The 'big' difference between you and Krugman?

Krugman will sometimes state fiscal deficits could have future benefits as well. When he is in a really good mood, he will say the future benefits of fiscal deficits tend to easily outweigh future costs especially in a liquidity trap.

Perhaps Nick is never in a good mood?

Nick, the discussion might have been clearer IMO if you’d started with the question – what is the intersection of monetary theory with the paradox of thrift – and then developed your conclusions. That way, you might have avoided the interpretation that you’ve simply renamed the paradox of thrift.

Seems to me the paradox of thrift is developed around a fiscal as opposed to a monetary framework – it describes the nature of a particular type of dynamic relationship between income and saving.

Your foray into antique transactions is a balance sheet adventure – not an income and saving one. That’s where the confusion of your logical argument begins for me. Money plays a role in either type of transaction – income (GDP, including fiscal policy) or balance sheet (asset transactions, including monetary policy). But the relevant role of money in the paradox of thrift is in the context of income and saving.

If T, under conditions M, causes R, what's to blame for R? T or M?

Andy's got a point though. It *is* paradoxical, that T causes notT, even if the mechanism only sometimes works and is via M. Most non-economists would not see that one coming.

Winslow R: If there are two policies, fiscal and monetary, that could achieve those same future benefits, but fiscal also has future costs, and monetary doesn't, that leans me in favour of monetary.

Canada is a bit different. I was much less worried about Canada's recent fiscal policy. I'm not sure it was really needed, but it could be defended as an insurance policy. We don't have the same "structural" debt and deficit problem. We bought a load of stuff we probably needed to buy sometime anyway, and last year seemed a good time to buy.

JKH: "Nick, the discussion might have been clearer IMO if you’d started with the question – what is the intersection of monetary theory with the paradox of thrift – and then developed your conclusions. That way, you might have avoided the interpretation that you’ve simply renamed the paradox of thrift."

Maybe.

"Your foray into antique transactions is a balance sheet adventure – not an income and saving one. That’s where the confusion of your logical argument begins for me."

I intended it as a income statement adventure. Balance sheets are stocks, income statements are flows, of $ per year. Saving is a flow. I was intending to mean a *flow* of desired expenditure on antiques, $ per year, and a flow of desired hoarding $ per year. It's a bit tricky because antiques are lumpy. But then so are new cars. But if we average over the whole economy, those lumps get smoothed out into a smooth flow.

Bill,

It's appropriate for an analysis of each party's actions to assume the likely reaction function of the other parties. This does not mean one excuses the actions of the other parties, just that one takes them into account. It works both ways: given the central bank's reaction function, there is a paradox of thrift; given the public's and fiscal authority's behavior, there is a non-paradox of tight money.

If we're going to talk in terms of deeper causes, the fact that the central bank "monopolizes the issue of the monetary base" is a good thing, given the likely alternatives. At least the Fed partially accommodates the demand for base money; gold mines wouldn't do that.

Nick,

It's not obvious to me that the net future costs of fiscal policy exceed those of monetary policy. Monetary policy could cause asset price instability, and the type of monetary policies that the Fed can legally pursue have potential fiscal costs, and we don't get any infrastructure investment or tax relief out of the bargain.

My objection to fiscal policy is that it's only a temporary solution, whereas monetary policy, if it is to be effective at all, probably has to be a permanent one. If I were a dictator, though, I would use both: monetary policy, if you like, as the ultimate solution to aggregate demand deficiency, and fiscal policy to reduce asset price instability.

I don't favor using "fiscal policy" to stabilize asset prices.

Creating a clear signal for taxpayer-voters about the cost of public goods should be the key goal of "fiscal policy."

Keeping money expenditures on target should be the goal of monetary policy of monetary institutions.

The role of interest rates should be to provide for intertemporal coordination. There is no particular reason to expect them to be "stable."

Of course, I suppose there are some people who favor having the government vary stores of wheat to stabilize wheat prices.


Bill: "Creating a clear signal for taxpayer-voters about the cost of public goods should be the key goal of "fiscal policy.""

Wandering off-topic, next to most of the big fiscal stimulus projects in Canada recently, there was a big sign saying how much was spent on the project. My immediate reaction was disdainful: it seemed they were just boasting "Look how much money we've spent for you!". But on second thoughts, it seemed like there was another way to interpret those signs. "This new road cost $x million; this is how we are spending your tax dollars; you decide if it's worth it". Sort of public accountability/auditing.

Actually, isn't there a big debate going on in the US right now that is related to this? Something about issuing taxpayers with itemised receipts? (I never bother to click past the headlines on the blog posts).

Something for Mayors like Bill to think about? ;-)

Nick,

"I intended it as an income statement adventure. Balance sheets are stocks, income statements are flows, of $ per year. Saving is a flow. I was intending to mean a *flow* of desired expenditure on antiques, $ per year, and a flow of desired hoarding $ per year."

You may have misinterpreted my point, which is that it can’t be an income statement adventure.

Yes, balance sheets are stocks and income statements are flows. But not all flows qualify for inclusion in the income statement. A complete measurement system must include balance sheets, income statements, and flow of funds statements.

Antique purchases belong in the flow of funds statement, not the income statement.

The correct flow of funds statement includes asset and liability transactions that are required by construction to bypass the income statement entirely. Among these are "old asset" transactions, such as the swap of money for antiques. Flow of funds transactions and income/expenditure transactions (and saving) can’t be consolidated simply because they are flows.

I suspect you may dismiss this as “just accounting”, as you’ve done on occasion before, but the fact is that it maps directly to the logical structure that explains the paradox of thrift, which is an income statement paradox.

JKH: I did misinterpret your point. I still don't fully get it though.

I think I must be talking about flow of funds. On the income statement, is there a distinction between flows of expenditures on the various types of assets? If not, if they are all lumped together into "savings", then i must be talking about flow of funds.

(Just remember though, there's a very important distinction here between the *desired* flow of funds and the *actual* flow of funds.)

Nick,

In the monetary system, income is (normally) paid in cash. Saving is a subset of income. So saving is paid in cash. In that sense, saving can be interpreted as the hoarding of cash as an income statement flow. And in that sense, if you wish, you are free to rename the paradox of thrift as the paradox of hoarding.

What happens next occurs on the flow of funds statement.

If the cash is left as is, the flow of funds statement reflects an increase in household net worth (saving) as a source of funds, and an increase in cash as the use of funds.

If the cash is swapped for antiques, the flow of funds statement reflects an increase in household net worth (saving) as the source of funds, and an increase in antiques as the use of funds.

In the first case, you can interpret the retention of cash as the hoarding of cash in the flow of funds. But this has nothing directly to do with the paradox of thrift, which is an income statement effect.

In the second case, you can interpret the swapping of cash as the dishoarding of cash in the flow of funds. But this has nothing directly to do with the paradox of thrift, which is an income statement event. And you must also allow for the fact that the antique seller has done the opposite transaction.

“Just remember though, there's a very important distinction here between the *desired* flow of funds and the *actual* flow of funds.”

I’m aware of that. But consider this question. In a pure service economy (for example), how likely is it that the paradox of thrift can operate without at least one entity actually saving from income. Therefore, to the degree that some micro units achieve actual saving, other units must be forced into dissaving. E.g. if an antique transaction actually took place, the buyer would have actually saved, but the seller might be forced into dissaving as a result of losing his job and income (because of the buyer’s saving), and being forced to spend more than his income. His spending would appear as a deficit on his income statement, assuming his gross income was now zero. His flow of funds would reflect the antique sale as the source of funds and his own deficit financing as the use of funds.

(Income statements and the flow of funds intersect through the equity account – saving is an increase in equity, which is a source of funds; negative saving (deficit) is a decrease in equity, which is a use of funds.)

(Damn. I’m trying to watch the Ryder Cup. But there’s some serious shanking going on here as well.)

Nick,

“On the income statement, is there a distinction between flows of expenditures on the various types of assets?”

This a somewhat self-referential classification, but the income statement would include revenues and expenses that in general would qualify as gross contributions to GDP type calculations. E.g. antiques would not be a GDP item and so would not be included as an expense if bought or as revenue if sold.

The flow of funds statement can include both GDP items (e.g. new investment goods as a use of funds) and non-GDP items (e.g. antiques as a use of funds).

That's how it would work for corporate statements, and there's every reason not to be inconsistent in simulating comparable household statements.

(May be over simplified)

Nick,

Debt and equity issuance are also included in the flow of funds as a source of funds. Unlike saving (= profits or surplus) which is also a source of funds, debt and equity issuance are not part of the income statement.

(Dividends from profits are a use of funds.)

So Nick, if the economy is cashless, but has bonds, then you're saying there is no paradox of thrift?

Take for example your back-scratching economy. Trade is either exchange of service, I scratch your back and you scratch mine, or one person receives a backscratch in return for a debt instrument that entitles the holder to one backscratch (from the issuer) the next day.

The catch is that the bonds are not bearer bonds, they aren't fungible, only the person the bond was issued to can collect the service so he can't sell it on the day he got it for a backscratch. This rules out the bonds being a medium of exchange.

Also, assume that nobody can give more than one backscratch per day, though you can receive more than one in a day. So an individual can, in principle, make the trade of consuming one less today for one more tomorrow but total output can't exceed the number of people in the economy (it can only be less).

Is there no paradox of thrift here?

"Antique purchases belong in the flow of funds statement, not the income statement."

I'm not sure that these accounting distinctions are relevant to the macroeconomic question. What distinguishes the income statement is its relationship to the business as a going concern rather than a pile of assets of in a box.

So when the CFO moves the company hoard out of tbills and into grandfather clocks that's not an income statement event. But so what? If the company were in the clock business, it would be a different matter.

That the same transaction means different things to different firms, means this whole discussion is confused.

This is how I understand it.

Income equals saving plus consumption. Saving is deferred consumption. Therefore, income equals consumption in the long run. All income is spent immediately, because income and spending are two sides of the same coin. In other words, it is impossible for aggregate spending to fall as a proportion of income. When someone saves by increasing their money holdings, they do not refrain from spending income, but instead they spend income on increasing money holdings.

But increasing money holdings is just one way of deferring consumption; to identify thriftiness with spending income on increasing money holdings is simply false. Since it is possible for an aggregate decline in savings to occur alongside an aggregate increase in money demand, calling macroeconomic problems associated with an excess demand for money a "paradox of thrift" is, at best, misleading.

This talk about the "reaction functions" of other parties is nonsense. It is not as though such "functions" are unchangable. So perhaps instead of trying to work around broken institutions (and blaming recessions on thrift), we should work to improve them. Just a thought.

Nick's assumption was that people spend income immediately on antiques instead of other non-monetary goods. Suggesting that people hold money in anticipation of buying antiques merely contradicts this assumption, because it means that people are not spending income immediately on antiques but are deferring the purchase of antiques by increasing their money balances.

Jon,

It matters.

The paradox of thrift is intended to explain GDP income and saving behaviour.

The sale of antiques does not generate income according to the capital cost of the antique – not unless you implicitly contort the definitions and the accounting so that the sale of money (for antiques) generates negative income - which is beyond nonsense.

Since the sale of antiques doesn’t generate income, it matters to the interpretation of the paradox of thrift.

“If the company were in the clock business, it would be a different matter.”

Not for a company in the business of building new clocks. It matters to an auctioneer or an antique shop, but only with reference to the business of earning what is effectively a broker’s commission or spread. The capital cost of the antique clock does not generate income and is not part of GDP and therefore is not directly relevant to the paradox of thrift.

Let me make this plain: paradox or not, THRIFT IS BAD!!!! In a barter economy, in which (for the sake of argument) there is no paradox of thrift, thrift is still bad, because it leads to asset price instability. And asset price instability is bad. (How can anyone who has lived through the past 15 years, or the past 25 years in Japan, deny this?)

In the simplest case, suppose an asset whose return is expected to grow (on average) at a fixed (but not precisely known) rate forever. If the risk-adjusted expected growth rate is close to the discount rate, the price of the asset will change dramatically in response to small shocks, including subjective shocks. Obviously the example is extreme, but the general principle is not merely a theoretical curiosity. We have, as I implied above, observed the adverse effect of a low discount rate on asset price stability and the real damage that that effect can wreak. The way to avoid it is to raise the discount rate, which is to say, to be less thrifty.

In principle, this is only a problem with "excessive" thrift -- that is, thrift that is reflected in a discount rate low enough to produce a damaging degree of instability. But excessive thrift is a wolf in sheep's clothing. One might think it impossible to accuse Americans of excessive thrift in 2005, when their saving rate was near zero. But one would be wrong. Their low saving rate was not due to a high discount rate (low thrift) but to an overestimation of their wealth. Why did they overestimate their wealth? Because they were confused by asset price instability. Why were asset prices unstable? Because of thrift. (Specifically mostly because of Asian thrift; but a little less thrift on the part of Americans would have improved matters, as Americans were not lacking in thrift but merely confused, and reduced thrift would have stabilized asset prices and reduced their confusion.)

People who say reaction functions are irrelevant remind me of a dance instructor I once had. He was teaching us how to do dips, and he said to the women in the class, "Ladies, you have absolutely nothing to worry about. If the gentleman drops you, it's entirely his fault."

Nick,

Going back to your post:

“Hoarding is a subset of thrift”

You must mean that hoarding is a proper subset of thrift. Otherwise, hoarding is the same thing as thrift, and you’ve only renamed thrift, which I don’t think was your intent.

So if hoarding is a proper subset of thrift, that means there are two types of thrift:

- Thrift that is hoarding
- Thrift that is not hoarding

Perhaps you feel you’ve already done this, but I’d like to see a side by side comparison of the two that shows what you intend by this difference – particularly as it reveals the one by comparison where thrift is not hoarding.

Nick wrote: " If there are two policies, fiscal and monetary, that could achieve those same future benefits, but fiscal also has future costs, and monetary doesn't, that leans me in favour of monetary."

I still don't understand your fiscal/monetary framework.

In your framework, is any action taken by the Fed considered 'monetary policy'?

Does Fed hiring of thousands of economists to do economic research qualify as monetary policy?

JKH: "So if hoarding is a proper subset of thrift, that means there are two types of thrift:

- Thrift that is hoarding
- Thrift that is not hoarding"

Suppose I earn $1,000 per month.

1. I spend $1,000 per month on newly produced goods and services - zero thrift, zero hoarding.

2. I spend nothing, and leave the whole $1,000 in currency. $1,000 thrift, $1,000 hoarding.

3. I spend $1,000 on antique furniture. $1,000 thrift. Zero hoarding.

Adam: "So Nick, if the economy is cashless, but has bonds, then you're saying there is no paradox of thrift?"

Yes, in the sense that an increase in desired savings cannot cause a recession. This is how I would think about it, if I've understood your cashless backscratching economy correctly.

Start in equilibrium. Then suddenly everyone wants to save in backscratch bonds. You go to another person, and offer to scratch his back in return for one bond. He refuses the deal, because he was about to offer you the same deal. Excess demand for bonds. Either the price of bonds rises (r falls) until they don't want to save, or it doesn't (for some reason) and the excess demand for bonds remains. But if you can't swap your labour for bonds, you swap it for a current backscratch as the next best alternative (it's better than sitting idle). So, no recession.

Winslow: if current or future money supply changes, it's monetary. If government spending and/or taxes change, it's fiscal. Yes, this is different from MMT definitions, but it's standard. Fed hiring economists with new money is both fiscal and monetary.

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