Suppose there is an increase in desired saving, and the monetary and fiscal authorities do nothing. What happens?
That's the most important practical question in macroeconomics over the last few years. And it's also a really stupid question. And understanding why it's a really stupid question, and changing the way that question is asked -- not just in academia, but in the real world -- is the most important practical task of macroeconomic theory today.
Let's start with "saving". In macroeconomics, "saving" is defined as "not spending part of your disposable income on newly-produced consumption goods and services". It's a purely negative definition. And it invites the supplementary question: "OK, so if you are not spending it on newly-produced consumption goods and services, what are you doing with your disposable income instead?".
But few macroeconomists would ever ask that question. Which is unfortunate, because the answer to that question matters a lot. For example, suppose you were a Keynesian of some sort. Your immediate instinct would be to answer my original question by saying that an increase in desired saving, if the monetary and fiscal authorities do nothing, would cause a recession. But if you stopped and asked the supplementary question, and I answered "they decide to buy newly-produced investment goods instead of newly-produced consumption goods", you would stop talking about a recession.
Did you, the reader, stop and ask that supplementary question -- about what people wanted to do instead? I bet few of you did. But now I've asked it for you, what were you implicitly assuming about that supplementary question when you answered the original question? Were you implicitly assuming they wanted to buy antique furniture, or land, or bonds, or money, or what? And I bet most of you have to stop and think about what you were implicitly assuming, and stop and think whether it would matter whether it were antique furniture, or land, or bonds, or money, or what.
What this means is that I rigged the original question in order to elicit a particular answer from you. I think it's called "push-polling", when political pollsters do it. But it doesn't have to be deliberate. And it is something we can do to ourselves. We ask ourselves a question in a certain way, and the way we ask it affects the way we think about it and answer it.
For example, if you say that the average Canadian owes $45,000, you think one way. If you say the average Canadian is owed $45,000, you think another way. But in a closed economy, or one with no net foreign debt, debits equal credits, so the two are the same.
"Saving" is a "doing nothing" concept. When we save, we are doing nothing with our income. When desired saving increases, people want to do even more nothing. But there are 1,001 different ways of doing "nothing". And it matters which one you do.
Talking about monetary and fiscal authorities "doing nothing" is just as problematic. Does it mean holding a rate of interest fixed? Holding the money supply fixed? Holding the exchange rate fixed? Holding the price of gold fixed? Holding the inflation target fixed? Holding the NGDP target fixed? Or what? Different economists will make different assumptions (implicit or explicit) about what it means to hold monetary policy fixed. Because they have different views on what it is that monetary authorities do. So what one economist thinks of as the central bank doing nothing, another will think of as the central bank doing something.
It's like in those "trolley problems". The difference between "doing something" and "letting something happen" might not seem that important, but it changes the way most of us think about moral problems, and what we ought to do, or not do.
Now, if it were only economists who got confused about different ways of framing questions, it wouldn't matter that much. Eventually, after a lot of arguing at cross purposes, we would get it sorted out. We would become more precise about the question being asked. And perhaps go on to argue about whose implicit assumptions about what people want to do with their savings instead, and what it is that monetary and fiscal policies are holding constant, make most sense. But it's not that simple. Because it's not just economists whose answers depend on how the question is framed. It's real people too.
Expectations matter. I mean real people's expectations matter. Economics is about those real people. "What is the effect of X?" depends in part upon how X changes people's expectations, and that in turn will depend, not on how economists frame the question, but on how real people frame the question. How will real people think about the event X? What will real people be holding constant when they revise their expectation after learning X?
Economists, in part, need to be ethnomethodologists. We need to think about how people construct their own economic models, and how they think about "doing nothing". But, like anthropologists, we need to stand apart from the natives' own way of viewing their world. We don't have to believe it ourselves to recognise that they believe it. And sometimes we need to be missionaries, and suggest that other ways of viewing the world might lead to better outcomes.
If people think about monetary policy as setting an interest rate, then if they see that interest rate fall to zero they will think that monetary policy is powerless to loosen further. But if people think about monetary policy as setting the price of gold, and the price of gold is still finite, they will think that monetary policy can loosen further. And the effects of monetary policy depend in very large part upon what people expect those effects to be, because monetary policy is not just about what the central bank does today but what it is expected to do in the future.
If people think about monetary policy as setting an interest rate, then "promising a higher future price level" means the central bank will have to do something in the future. It will have to deliberately set future interest rates too low for too long. But if people think of monetary policy as setting the price of gold, then the central bank can simply raise the price of gold today, and hold it there. It need do nothing in the future.
Roosevelt could promise a higher future price level without having to promise to do something in the future. People automatically assumed he would do nothing. By "doing nothing" they understood "not lowering the price of gold back down again".
To misquote A J Ayer, an economist who says there is no confidence fairy is not an atheist. He is a fellow metaphysician with a rival fairy of his own.
It is probably not feasible today to attempt the social re-construction of the gold standard reality. And it wasn't a very good reality in any case. But it does show, by example, that today's social reality is not the only possible reality.
"But central banks really do, do, do set a rate of interest" is said by people who have swallowed the pill proffered and swallowed by the central bankers themselves, and by the rest of the population. That's how the natives at the central bank describe what they are doing, and most economic anthropologists have decided it's simpler to take the natives' self-description as a statement about concrete reality. It's not that there's a blue and red pill, one false and one true; but there are many pills, and each can re-create its own reality. But you can do different things in each of those different realities, because each reality has its own definition of "doing nothing".
Or, switching metaphors to my generation's, the pills that maternal central banks have given you now can't do anything at all. So maybe they should switch pills.
This was supposed to be a post on David Beckworth and Paul Krugman on balance sheet recessions. Half the population is in debt to the other half. Then something happens and the debtors can't continue to borrow and dissave. Nobody will lend to them, so they are borrowing-constrained. So they consume less. Aggregate savings rises, and the central bank has already pushed the rate of interest down to 0%, so can do nothing. So there's a recession, unless the fiscal authorities do something.
"The debtors stop borrowing from the creditors". "The creditors stop lending to the debtors". Those are two different ways of framing the same event. The first sounds like it would lead to an increase in aggregate savings, as the dissavers stop borrowing. The second sounds like it would lead to a decrease in aggregate savings, as the savers stop lending. What are the savers going to do instead, if they can't save by lending to the debtors? They can't just do nothing?
What can monetary policy do to solve the problem, if there is one? Has it already done as much as it can do, and can do nothing more? Would we believe it if it promised to do something in future? If people thought of monetary policy in a different way, then there could be something it could do now, without having to promise to do something in the future. Roosevelt did it. And the only difference between then and now is how people think about what central banks do, and how they do nothing. The change in perceptions about what "doing nothing" means has meant that Roosevelt's concrete policy lever now looks like a confidence fairy.