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I think the spelling is hysteresis.

Brett: Damn! Thanks! Will edit.


People all eat about the same amount if measured in calories. On the other hand, between persons, there is a tremendous difference in the quality of food consumed.

People need at least some shelter. Between persons, there is a tremendous difference in the quality of the shelter.

People certainly enjoy transportation. Between persons, the quality varies from walking (on your own two feet) to chauffeured cars and better.

If you have more things, you need more room to store them.

Now we come to taxes. In general, the better the quality and the bigger the quantity, the more the tax. Let the rich pay for the poor.

With this general scheme in mind, when we have "deficient demand", what are we really talking about? Has there been a collective decrease in expectations? Has there been a genuine oversupply of quality and quantity, causing over-migration of people into unaffordable tax realms?

If either of these two maladies are the cause of deficient demand, we could see lingering effects that we might define as hysteresis.

Roger: an AD deficiency is none of those things. It means that the stock of money is too small, or is circulating too slowly, to buy and sell all the things that people want to buy and sell. A good metaphor would be a shortage of plastic shopping bags, where everyone is hoarding shopping bags, and you can't sell anything without giving the buyer a bag to put it in.

Is it relevant that Alpha was "targeting" 2% inflation? Would it not be important if over the cycle an average 2% inflation had been achieved?

Nick - thanks for a thought-provoking post. Part of the problem is that "deficient" implies a shortfall relative to some desired state, but it is not obvious what that desired state is. Some "optimal growth rate" of the economy, presumably, but how do we define that? Maybe the 2% inflation is serving as a kind of proxy for the desired state in Simon's post. Whether that is a useful proxy or not is a different question.

John: thanks. I think that's right. Though I would maybe add "feasible/sustainable" (or something) to your "desired state" (though that's presumably implied).

Thaomas: I found your comment in the spam filter, which explains why it was delayed. Sorry about that.

Well, I assumed that both Alpha and Beta had been targeting 2% inflation to try to make the model relevant to what Simon says in that sentence I quoted near the end of the post. And I expect it depends on whether they are targeting 2% for every year, or only over the cycle.

Interesting but useless since you omit factors to simplify. As usual we do not include all of the events history so the prediction is flawed. The good news is you cannot know them all anyway so I put it in category of sort of a hobby.

@Nick Rowe:

> What is it that makes the "memory" of the recent recession in the Alpha economy different from the "memory" of the later development of the Beta economy?

Nothing, but we don't expect the Beta economy to remain behind forever. Developing countries are supposed to experience catch-up growth precisely because they're ostensibly more fertile places for investment.

This is also more than just a pure thought experiment. Since the last recession, the US has seen stagnant and declining capital intensity per hour worked, whereas the previous trend was notably positive.

The deficiency alleged by Wren-Lewis (as applied to the US, I haven't looked at UK statistics) is an ongoing deficiency, characterized by continuing low investment rates. Even if an economically-leading country can't "make up" for a period of foregone investment, that doesn't explain why it would continue to have low investment rates even after the aggregate demand deficiency is allegedly fixed.

Majro: if we embed my "model" within a Solow Growth model, which has catch-up, then yes; without the recession in Alpha, Beta would still have caught up (asymptotically) with Alpha eventually. But with the recession in Alpha, it catches up immediately.

It's puzzling why investment would be lower in Alpha than in the counterfactual conditional Beta after Alpha is back to "full employment" (just like Beta). One possible reason is AD uncertainty. Investors in Alpha, having just lived through a recession, are less confident that it won't happen again. (I think I did a post on something like this once). But I'm not sure that creating an AD boom would be the best way to restore their confidence.

A helicopter drops bales of money down people's chimneys at night. This should cause inflation, right? What's the mechanism? Everyone who received extra cash feels wealthier and plans to buy more at current prices. If agg demand equaled potential supply, the increased demand for goods should force prices to rise so quantity demanded equals potential supply again. What if we conducted a helicopter operation and prices failed to rise? Wouldn't that mean real GDP is rising and therefore we were/are suffering from deficient AD?

louis: suppose an increase in AD did increase RGDP in the Alpha economy, and we therefore say that AD was deficient. Wouldn't it also have the same effect in the Beta economy, and wouldn't we therefore say that AD was deficient in the Beta economy too, even though (by assumption) it never had a recession?

I think the alpha and beta setup is flawed, because it presupposes hysteresis. A's economy is smaller than it could have been by virtue of having invested less in land. If instead of a recession, an asteroid hit A and destroyed some land, we would have the same outcome. There's no reason to suppose an increase in NDGP would mean an increase in RGDP in that scenario. It would be a wonder if it did.
Better to use an example that better captures the dynamic Wren-Lewis set out, perhaps with differences in relative use of the factors of production.

louis: I thought my example *was* capturing the dynamic that Simon set out? The fall in wages during the recession results in a more labour-intensive production method, compared to what would have happened otherwise.

If you extend the model slightly to include public debt, you may get the memory needed.

Households in the Alpha economy may have accumulated greater savings (consisting of either land or public debt). When the recession strikes, the level of land comes into line with that of the Beta economy, so with higher savings the public debt is higher. An increase in AD in Alpha may then have more scope to divert savings from public debt to land.

Nick E: I need to think about that one. It's plausible (I think) that debt could be higher in Alpha. Not sure if the rest follows.

Maybe I'm not getting it, but Simon seems to be talking about a suboptimal switch to a more labor intensive mode. Ie economy could produce more output with a more land intensive mix. In your example there's no reason to believe that's the case... And if it is the case, the condition preceded the recession and is not a result of it.

louis: the economy can't switch to a more land-intensive mix unless it increases investment to produce more land. And if the Alpha economy can do that (as a response to increased AD) why couldn't the Beta economy do the same?

Reread both posts and I see more of where you are coming from. The assumption Simon made was that labor was utilized but capital was slack. You would see that as part of the recession and a sign AD is still under utilized. He goes further and says measures of utilizstion will be less accurate as time goes on, including for reason that we could be underinvesting in capital due to weak demand. Your example would be closer to his case if after the recession A and B had same GDP but B was investing more in capital than A. I see though that calling this deficient AD feels a little uncomfortable.

louis: yep. (Though it's not obvious why investment would be lower in Alpha than in counterfactual Beta, unless it's the increased uncertainty about future AD from the experience of the recent recession.)

> Though it's not obvious why investment would be lower in Alpha than in counterfactual Beta, unless it's the increased uncertainty about future AD from the experience of the recent recession

Investment would be expected to be lower in absolute terms from a less capital-intensive economy. If population growth is exogenous and constant in the two economies (say 1%), if Alpha has a stock of $100 land per person-year of labour and Beta has a stock of $200 land per person-year of labour, then a constant and equal growth rate for the two economies requires that Alpha invest $1/person in land while Beta invests $2/person.

If the central bank of Alpha credibly promised that aggregate demand would "make up" for the recession and return to the pre-recession expected trajectory, then Alpha would invest something more than $1/person in land and would at least partially recover its capital intensity, with the exact rates depending on the price-flexibility of capital (with inflexible investment resulting in more inflation and less real-terms capital formation).

Wren-Lewis's argument is then that capital is underutilized and is effectively very elastic, so an increase in aggregate demand will result in increases to real investment and output in much the same way that AD increases will result in more labour utilization if unemployment is high.

As an addendum to the previous, the difference between post-recession Alpha and Beta is that during the recession Alpha left some easy investment "on the table," whereas Beta did not. For some time, Alpha can make use of these missed opportunities.

Back to the land example, imagine if land investment required expensively raising land from the sea and inexpensively tilling that land. Immediately post-recession (by prescription) Alpha and Beta had the same level of employment and the same amount of tilled land, but Alpha would have had more raised but untilled land.

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