« The gizmo theory of the recession | Main | Why the distribution of reality is skewed and so newspapers are biased towards bad news »


Feed You can follow this conversation by subscribing to the comment feed for this post.

I think that Caplan addresses the ambiguous nature of wage cuts. They could result in higher aggregate income if enough work is created by the lower wage. I am not sure about his conclusions because I do not have enough knowledge to truly evaluate them, but they do seem to follow some logical path. I am a firm believer in Say's Law, so I would be very interested in hearing some valid criticism of it.

Peter A: "They could result in higher aggregate income if enough work is created by the lower wage."

Which is exactly where he's wrong. He's assuming the conclusion.

Put "Say's Law" in the search box on the right.

I didn't get into much of the rest of Caplan's post, which you cover here - but I couldn't even get past the first paragraph without thinking he's wrong: http://factsandotherstubbornthings.blogspot.com/2011/12/caplan-on-wages-and-labor.html

Nick Rowe
I read some of the things you have written about Say's Law. I guess I have always assumed that prices are flexible enough to eventually clear all markets. Walrasian equilibrium has a strong hold on my thought processes. I am obviously not as well read on this subject as the majority of commenters. Thanks for pointing me in the right direction.

Peter A -
Markets may indeed clear - a balance between goods offered for sale and goods demanded may indeed by struck. But there's no guarantee that that balance will be struck at a full employment level, which is what we are really concerned about.

Of course, because of the very monetary issues that Nick has written a lot about, in the short term (aka - the time span we experience life in) monetary economies can propagate disequilibria into general gluts.

The idea that the economy is constrained by demand is the most preposterous thing I have ever read on an economics blog. There is absolutely, positively no possibility of reconciling that statement with the fundamental theorem of economic science: The economy consists of unlimited wants and limited resources.

But because all Keynesian/Monetarists believe in polylogism ("Micro is not the same as macro") we can expect nothing less. We as a species are therefore doomed to want fewer things in aggregate than we do on an individual basis. Figure that one out.

No wonder Peter Boettke repeatedly asserts that consistently applying the most basic economic theories is one of the most intellectually demanding things an economist can do.

Ryan: it *ought* to be a preposterous thing to say, but it isn't. Because we live in a monetary exchange economy, not a barter economy, and demand for goods is totally ineffective unless it's backed by a willingness to supply money in exchange for the goods you demand. An excess demand for the medium of exchange screws up all the other signals that people would otherwise send about wanting more goods.

Ryan: this is why Nick evoked that Say's Law. Try to think about it - do you think that there could be overhang of supply on a particular market? If the answer is yes, do you think that there can be overhang of supply on the market of newly created consumption goods? And this is where Mr. Say says no. He says, that people participate in economic activity meaning they create goods only as far as they want to to obtain other goods from other people. But this has been proven as wrong, and the reason is the existence of money. One can truly desire to work and produce - but not in exchange of the product of other people, but just to obtain the medium of exchange. If this behaviour prevails on aggregate, all participants have to fail because one's expenditure is another's income. The solution is to generate enough nominal demand so that they can satisfy their need and move on without any damage to real economy.

What JV said.

I'm not sure you're right that this is the same Stiglitz mistake or that it is a micro-macro mistake. I think it's actually a reflection of the key difference between how you see a monetary recession and how, say, Scott Sumner sees one. Let's say you thought the only nominal problem was sticky wages. That is, that demand-recessions are really about relative price distortions disrupting the market for labor amid deviation from a nominal income trend. From this perspective even though Sumner or maybe some NKs might describe a recession as about AD, it really can be equally described as about AS once it reaches some kind of quasi-equilibrium of excess unemployment. It seems like you could have what is essentially an AS fix to this problem so long as that fix didn't cause a secondary AD problem.

So if we're in one of these recessions, then what would determine whether lowering wages would clear the labor market and thus bring output back to potential where demand=output? I think the answer is how lowering wages would interact with Fed policy. That is, would lowering wages somehow cause the Fed to engage in a policy that subsequently puts pressure on nominal variables such that the lower-but-still sticky wages are again rendered too-high? This kind of reaction function doesn't seem impossible to imagine, but it does seem unlikely. I think it seems okay for Caplan to assume that the Fed would not counteract the AS benefits of this new policy (far more so than allowing Stiglitz to assume that the natural interest rate was negative 10% of whatever in 1929).

In Krugman's model lower wages seem to lead to deflation, which implicitly assumes some kind of reaction function from the CB which allows a departure from its pre-wage change inflation target. Then he makes the somewhat odd claim that deflation won't work in a liquidity trap (because it is really a form of increasing real money balances and monetary easing of that sort is worthless at the zero bound). He also argues that this deflation (which again is dependent on some sort of CB reaction function) would cause debt-deflation problems.

On the other hand, I think you see monetary recessions , including the aftermath, as about more than just sticky wages (am I right?), but about a continuing shortfall in the supply of the medium of exchange relative to demand for all things (i.e. not just labor but goods and services, perhaps with some price distortions thrown in). In this world Caplan's argument does seem misguided, but I don't think this is the world he is assuming.


Income = expenditure.

The "overhang of supply" to which you're referring can only be generated if someone pays for it. I can only accumulate "the medium of exchange for the medium of exchange's own sake" if someone is willing to pay me the medium of exchange. Whatever I happen to be saving in the short run is actually the money that someone else is spending on me over the same time period.

The argument is circular. What you're doing is holding one side of the same transaction constant. My wages "don't count as AD," but my income does. How is that possible?

One explanation might be that wages are "I" and my income is "C" whenever I spend it. Since "I" doesn't change but "C" goes down, then we've experienced an AD shock. But 0.97 of every dollar I keep in the bank ends up as "I" via the stock and bond markets. Is my savings then paying for my own salary? Another circular argument...

Another way to look at this is that if "money is just another good," then demand for money is also part of AD. Excluding it from the calculation understates AD makes it look like AD is a real problem. But imagine a situation in which society's demand for Obama T-shirts suddenly EXPLODED and everyone wanted to accumulate literally hundreds of them. The demand for everything else would contract, but we would never count this as an AD shock because people would be spending one good that doesn't count as AD (the medium of exchange) for another good that does. That's independent of what such demand would do to the commodities or pharmaceuticals markets or whatever.

The problem is the framework. The problem is that the AD concept allows us all the circular reasoning we need to make virtually any theoretical claim we want. That might not initially look like a problem, but when we get to the point when we are contradicting the fundamental tenets of economic science, we must finally admit that there is a problem.

"consistently applying the most basic economic theories is one of the most intellectually demanding things an economist can do"

Just because it's "intellectually demanding" doesn't mean the conclusions are true. I'm sure the study of alchemy is intellectually demanding.

I’ve noticed hot air and nonsense coming from Stiglitz more than once.

Ryan: money is different from other goods in one important way. If you want to say in terms of goods, if you for example wish to save in form of 1000 Obama T-Shirts, the only way to this is to go out and buy those T-Shirts. If Obama T-shirts are sold out because everybody wants 1000 of them, then your desire to buy them will be left unsatisfied, even if you have a lot of money in your pocket. But you may still use the money to buy and "save" in something else. Money however is special. Money can be stored not only by actively purchasing them (e.g. increasing your hours worked and exchanging your labor for money), but money can be saved by not buyng. This is not possible with Obama T-shirts. You will not get your hands on any obama T-shirt by not spending your money prepared for their purchase. That is, individually there is nothing that can prevent anyone from "saving" medium of exchange by buying less.

Then there is your belief, that every dollar you do not spend will be used for purchase if bonds or stocks. Really? And how should this happen? We assume that everyone wants to save, so why would anyone want to sell their stocks or why would government issue any bonds? For someone to sell stocks or bonds they hold in exchange for your labor (if that is the source of income) means dissaving. "Investment" in terms of purchasing new productive capacity and hiring new people to do stuff also means dissaving by the company that is doing it. They are using money earned by selling stocks to purchase labor and machines. So yes - in a world where there is not an aggregate desire to save in terms of money, and where every desire to save is mirrored by someone's else desire to dissave we do not face the risk of the general glut. But this is not the world we are living now.

Stiglitz and Rowe are walking along on a crowded sidewalk when Stiglitz exclaims, "Look! A twenty-dollar bill!"

"Ridiculous," Rowe replies, "If there was a twenty-dollar bill lying on the sidewalk somebody would have already picked it up."

Stiglitz and Rowe are marooned on a desert island. A case of canned food washes up...

JV - In your first point, you are basically saying that money is special because it can be manipulated by a central authority. You're right, but the justification for this belief is the advent of fiat, floating currency. It's another circular argument. "We need money manipulators because money needs manipulating." What happens when I step outside the argument is that it no longer makes sense.

In response to your second point, I was referring to the function of banks and the reserve requirement. Basically, if you're not going to invest your savings directly, the bank does it with your reserves. You rightly point out that this is "dissavings," and I agree.

But we don't live in a world where every government, bank, individual, and importer unanimously declares that they will hoard currency and stuff it under a mattress. The scenario you're suggesting we live in is one in which the "surplus demand" that went away in the AD shock is currently residing in our checking accounts collectively.

How does that jive with the fact that personal and government debt are both at historically very high levels? It basically doesn't. What you perceive to be a hoarding of dollars is really a mass-deleveraging. It's not "savings," because the money we are talking about was actually consumed in previous time periods.

But given that reserve requirements exist, where did all that leverage come from? Isn't there only one, unique kind of entity that has the power to create leverage out of thin air, and isn't that entity called a central bank?

Once we go that far, ACBT kicks in (or PSST if you prefer). The monetarist/Keynesian approach traps us in an endlessly circular debate about how to conduct our GDP accounting. We're chasing out tails. Looking outside the AD paradigm, we suddenly see the whole answer.

Or at least, that's how it appears to me.

My interpretation of Caplan is that he assumes final goods prices are more or less prefectly flexible and that wages are the only sticky prices.

When aggregate demand falls, then the price level falls appropriately, but wages don't. Real wages rise, and firms optimize, and hire less labor, produce less, and so, prices fall too little for real expenditure to match productive capacity.

If wages fall, then prices fall too. And that raises real expenditure, production, and employment.

The story is simplest if you just assume that the initial drop in nominal expenditure is given, and that nominal expenditure on output now stays at that new, lower level. Lower wages allow lower prices, which raises real expenditure to potential output.

But you can instead go with the nominal quantity of money staying the same and real balances rise. Wages fall enough, prices fall enough, real balances rise enough, real expenditure rises back to full employment output.

But why does Caplan bring up stuff like labor demand elasticity and spending out of profit? I guess that all looks bad for my argument.

In some kind of long run, I suppose that even with real output lower, we could see a shift in production technology to more labor intensive processes. In effect, potential output will fall.

Quantity of money drops, price floors on all final goods, real expenditure and real output falls. Surplus of labor. Nominal and real wages drop, eventually. Firms shift to more labor intensive production processes. Full employment of labor. What about capital and saving? Well, the business class fails to replace some of the existing capital goods and instead produces lots of yachts and mansions. When the capital stock is at the lower level (using all of those less capital intensive processes) we settle to a new equilibrium. The workers have a smaller share of a smaller pie. The capitals have a bigger share of a smaller pie.

OK? Full employment due to lower real wages without raising real expenditure on output.

Not a scenario that I (or Caplan, I imagine) finds attractive.

But you can imagine that from a micro perspective, these isoquant effects would be important. And that we macro/money theorists kind of blow over all of that might be irritating.

Ryan: "The "overhang of supply" to which you're referring can only be generated if someone pays for it."

Displaying my usual inability to understand the basics. Confused about the role of time, and stocks versus flows, in this discussion.

Nick, I think this relates directly to the idea of "notional" supply and demand that you and I have discussed, and that you've suggested is missing from economic discussion. I've been trying very hard to wrap my brain around it.

What does (overhang of) "supply" mean at a given instant in time, as represented by a S/D diagram in a particular state?

o The currently available inventory at that moment (wholesale and retail)? A stock.

o Producers' future ability to create the good? (A flow, necessarily specified over a period -- not an instant.)

o Producers' future willingness to produce/provide the good at a given price? (Again, a future flow necessarily specified over a period of time.)

Wikipedia: "supply is the amount of some product producers are willing and able to sell at a given price all other factors being held constant"

1. Doesn't this mean the quantity that producers "*will be* willing and able to sell" over a given period extending into the future? (During which period the S/D diagram will constantly change from instant to instant?)

2. In the context of an S/D diagram depicting a particular "supply" at a particular instant in time, what does "all other factors being held constant" mean? How could they not be held constant in that instant?

Are they talking about "supply" at a given instant, or the flow of "supply" in the future?

Again, notional (i.e. potential future) supply and demand seems to be the key concept here, but that thinking doesn't seem to be incorporated in the discussion. How am I not getting this?

Education much appreciated as always.

Bingo! I think Steve Roth has nailed it. William Thornton was talking about this little problem back in the 1860s.

"Thornton played a greater part in the history of economic thought. His first edition of On Labour was a blistering critique of the laws of supply and demand and served to mobilise the major players in the burgeoning neo-classical movement - Jevons, Edgeworth, Jenkin and Marshall - to reply with mathematical responses to the debate."

Suppose the quantity of money falls and there are price floors on all products. Real expenditure falls and real output falls. Firms hire less labor. There is a surplus of labor. Eventually, money and real wages fall.

Now, the firms switch to more labor intensive technology. The quantity of labor demanded rises. The workers consume less bread. The owners of the firm build more mansions and yachts.

During the transition, the owners of the firms get an extra large amount of yachts and mansions, as the old capital goods are being replace by newer, less productive ones.

The productive capacity of the economy has fallen to the given output, and it fully employs all the workers. If the quantity of labor falls due to the lower real wage, the shift in factor shares would be less, but the decrease in total output larger.

I don't think Caplan favors anything like this. But I think his micro-intuition is bothered that these effects are ignored by money-macro types like me and you.

Really, he is just assuming that sticky wages are the problem and product prices are pretty much perfectly flexible. The quantity of money falls, nominal spending falls, the price level falls, but wages don't. Real wages rise and the firms do a micro optimization so that real output falls. The price level is lower, but not enough for real expenditure to match productive capacity.

If nominal wages fall, the price level falls, real money balances rise, real expenditure on output rises, production rises, and employment rises.

Caplan understands that process and that is what he has in mind. He might just be assuming that the flow of nominal expenditure on output decreases and then stays constant as prices and wages fall, so that real expenditures fall. But if you pressed, you would get a real balance effect on the quantity of money.

oops.. output was given. If the lower real wages reduce the quantity of labor supplied, then the shift to more labor intensive production methods would the smaller. Still, the capital stock declines.


We don't live in a barter economy, we live in a monetary economy. In a monetary economy where all goods are sold for money and money is the only thing that can purchase goods. So each good to good transaction is really two transactions: a goods for money sale and a money for goods purchase.

In this world money acts like a noose or chokepoint on the goods market, the stock of money is finite and determines whether the market for each good can clear or not. If the stock of money is reduced (easy, we have confidence-based money through the banking system plus the variations introduced by deliberate banking policy) a certain amount of goods-to-goods transactions will not clear because of lack of money. You will retort prices should fall, to which I respond that in an economy with confidence-based money and intertemporal contracts price decreases will further contract the money supply and cause defaults.

A "general glut" is an excess of goods and a shortage of money. It is a social creation, a product of the rules gone amok to be sure, but the phenomenon exists. An economy can be choked by money.

Ryan: " ... "surplus demand" that went away in the AD shock is currently residing in our checking accounts collectively. ... How does that jive with the fact that personal and government debt are both at historically very high levels"

Try this:


The basic idea is that debtors get overstretched, have to pull back, and creditors don't make-up the resulting shortfall in AD. Recession results.

Also, Nick had a post a couple of years ago about patient vs. impatient people and debt. It was a thought experiment about China IIRC, but I think it applies.

Finally, keep in mind that for every debtor there is a creditor. For the world as a whole, net debt is 0. I think Canadian mostly owe money to other Canadians. So what is 'too much debt'? Well, it's meaningless. The issue is the distribution of debt: who owes how much to whom and under what circumstances will defaults cascade etc ...

Are you referring to "just assume we have a can opener?"

Here's a quote from Bill Vickrey on Say's Law: The supply-side notion that "supply creates its own demand," a maxim often cited as "Say's law" simply fails whenever part of the income derived from the production of the supply is shunted aside as savings, without an effective mechanism to insure that the corresponding resources will be utilized for capital creation. Actually, if an entrepreneur obtains an extension of credit from a bank, possibly facilitated by expansion of the reserves provided by the Federal Reserve System, and utilizes it to hire unemployed workers to lay bricks and mortar, then if this is done prudently the capital created is additional wealth that will be directly or indirectly owned by someone. This increase in wealth is ipso facto someone's savings. Instead of Say's law, we should have "capital creation generates its own savings." Saving, unless done by the one responsible for the creation of the capital, is neither a prerequisite nor a stimulus to capital creation. What, say (no pun intended), you?

Nanute: Yes. Or... just assume we have a "law" of supply and demand...

"Nine-tenths of the confusion and obscurity in which the doctrine of price has hitherto been involved has arisen from searching after the unsearchable, from seeking for some invariable rule for inevitable variations, from straining after precision where to be precise is necessarily to be wrong. Supply and demand are commonly spoken of as if they together formed some nicely fitting, well-balanced, self-adjusting piece of machinery, whose component parts could not alter their mutual relations without evolving, as the product of every change, a price exactly corresponding with that particular change. Price, and more especially the price of labor, is scarcely ever mentioned without provoking a reference to the 'inexorable' the ' immutable,' the 'eternal' laws by which it is governed; to laws which, according to my friend Professor Fawcett, ' are as certain in their operation as those which control physical nature.' It is no small gain to have discovered that no such despotic laws do or can exist; that, inasmuch as the sole function of scientific law is to predict the invariable recurrence of the same effect from the same causes, and as there can be no invariability where as in the case of price one of the most efficient causes is that ever-changing chameleon, human character or disposition, price cannot possibly be subjected to law." -- William Thomas Thornton, "A New Theory of Supply and Demand," Fortnightly Review, 1866.


In your "insufficient AD" view of the current state of affairs, do you think that we are experiencing an increase in the demand for money (relative to other goods), or a decrease in the supply of (M2-ish) money as credit markets dry up, or some mix of the two?

Is the goal of fiscal spending to jack up the M2-ish measure by increasing the amount of base money?

Or am I misreading this analysis?

If one needs to assume sticky prices for Say's Law to fail, and one assumes that wages are the only prices that are sticky, what can one say about the necessary wage adjustments to return to an equilibrium consistent with Say's Law? Or, alternatively, what is nonsensical about my question?

Ken: the difference between first-best and second-best can be quite large. The New Keynesians point out that nominal rigidity can be characterized as a collective action problem - it is in the interest of everyone to change prices and wages, but not in the interest of any given individual to do so. The social and private good is worse off if only a few people adjust. By the same logic, one should be cautious about partial wage adjustment. It only "works" insofar as you trigger an ensuing price adjustment toward general equilibrium. If not you just make one group of people worse off and another better off (i.e., a distributional effect).

"It would be good if prices were at the point were at the point where markets clear" is not the same as "it would be good if prices were closer to the point where markets clear", so to speak. Improvement is not monotonic in price adjustment.

Thanks David. So some set of wage adjustments would lead to a full-employment equilibrium if all other prices are flexible I suppose? This is the confusing part for relative beginners (like myself). I'm understanding that sticky prices is a necessary condition for potential monetary disequilibrium (or maybe I am misunderstanding this), but few seem to believe that "unsticking" prices would be helpful. Like Caplan (who knows orders of magnitude more than I do), I'm confused as to why wage adjustments is never considered even a potential part of the solution.

For one thing, real wages in past recessions appear to be acyclical (i.e., poorly correlated with non-trend changes in national output), which contradicts the hypothesis that business cycles are due to excessively high or low real wages. We would expect real wages to be anticyclical (i.e., being too high during recessions, etc.). So there is disagreement over whether "excessively high real wages" is even the problem.

For another, where wages (and price) are accepted to be slow to adjust, there are generally also known to be at least some real reasons why this might be so: morale, actual costs of negotiation, actual costs of arranging different payments, etc. Real rigidities can be significant.

The other extreme of the NK position suggests that long-term real wages are in fact flexible in practice (because long-term employment tends to be longer than the business cycle, so rational employers and employees adjust for the long-term) and so focusing on short-term real wages is illusory. The problem is then argued to be in sticky prices (which are rigid for whatever hypothesized reason).

Thanks David. This is helpful. I wonder if Nick at some point would comment in the context of one of his fantastic simplified models.

Fantastically unbelievable, or fantastically illuminating? ;)

Ryan said: "The idea that the economy is constrained by demand is the most preposterous thing I have ever read on an economics blog. There is absolutely, positively no possibility of reconciling that statement with the fundamental theorem of economic science: The economy consists of unlimited wants and limited resources."

I'm going to add to the preposterous of that.


"The customers of most companies, Hanauer points out, are ultimately the gigantic middle class — the hundreds of millions of Americans who currently take home a much smaller share of the national income than they did 30 years ago, before tax policy aimed at helping rich people get richer created an extreme of income and wealth inequality not seen since the 1920s.

The middle class has been pummeled, in part, by tax policies that reward "the 1%" at the expense of everyone else.(It has also been pummeled by globalization and technology improvements, which are largely outside of any one country's control.)
But, wait, aren't the huge pots of gold taken home by "the 1%" supposed to "trickle down" to the middle class and thus benefit everyone? Isn't that the way it's supposed to work?

Yes, that's the way it's supposed to work.

Unfortunately, that's not the way it actually works.

And Hanauer explains why.

Hanauer takes home more than $10 million a year of income. On this income, he says, he pays an 11% tax rate. (Presumably, most of the income is dividends and long-term capital gains, which carry a tax rate of 15%. And then he probably has some tax shelters that knock the rate down the rest of the way).

With the more than $9 million a year Hanauer keeps, he buys lots of stuff. But, importantly, he doesn't buy as much stuff as would be bought if that $9 million were instead earned by 9,000 Americans each taking home an extra $1,000 a year.

Why not?

Because, despite Hanauer's impressive lifestyle — his family owns a plane — most of the $9+ million just goes straight into the bank (where it either sits and earns interest or gets invested in companies that ultimately need strong demand to sell products and create jobs). For a specific example, Hanauer points out that his family owns 3 cars, not the 3,000 that might be bought if his $9+ million were taken home by a few thousand families.

If that $9+ million had gone to 9,000 families instead of Hanauer, it would almost certainly have been pumped right back into the economy via consumption (i.e., demand). And, in so doing, it would have created more jobs.

Hanauer estimates that, if most American families were taking home the same share of the national income that they were taking home 30 years ago, every family would have another $10,000 of disposable income to spend.

That, Hanauer points out, would have a huge impact on demand — and, thereby job creation.

It's time we stopped mouthing the fiction that "rich people create the jobs."

Rich people don't create the jobs.

Our economy creates jobs.

We're all in this together. And until we return to more reasonable tax policies that help the 99% instead of just the 1%, our economy is going to go nowhere."

I keep trying to say the problems of the U.S. economy are wealth/income inequality, too much currency denominated debt, and going from mostly supply constrained to demand constrained.

Peter A said: "I am a firm believer in Say's Law, so I would be very interested in hearing some valid criticism of it."

currency denominated debt

Ryan said: "Income = expenditure."

income in the present may not equal expenditure in the present because of currency denominated debt

Peter A said: "They could result in higher aggregate income if enough work is created by the lower wage."

I believe that assumes supply constraints due to labor shortages. That may not be true if the economy has gone from mostly supply constrained to mostly demand constrained so the number of hours of work does not increase.

dlr said: "On the other hand, I think you see monetary recessions , including the aftermath, as about more than just sticky wages (am I right?), but about a continuing shortfall in the supply of the medium of exchange relative to demand for all things (i.e. not just labor but goods and services, perhaps with some price distortions thrown in)."

Add financial asset prices in there too. Next, how does the amount of medium of exchange both rise and fall?

Ryan said: "But given that reserve requirements exist, where did all that leverage come from? Isn't there only one, unique kind of entity that has the power to create leverage out of thin air, and isn't that entity called a central bank?"

What about commercial banks and hedge funds? I equate leverage to mean currency denominated debt.

Ryan said: "But 0.97 of every dollar I keep in the bank ends up as "I" via the stock and bond markets."

Could you define keep in the bank?

Heck, even the Sandwichman believes in a soft version of Say's Law. And a soft version of the Coase theorem... Also if wishes were horses I believe that beggars would indeed ride.

But I wouldn't stake my livelihood on axioms that are only true if a whole bunch of other restrictive assumptions are also true. Consider the following propositions, for example:

1. The interests of the poor should have the highest priority (after all, what would become of the rich if there were no poor people to till their grounds, and pay their rent?);

2. There is not so great a difference between the real interests of the rich and the poor;

3. Trade is a large and difficult subject that requires deep thought, long study, extensive reading and large experience to form a true judgment;

4. Machines distinguish men in society from men in a savage state. There are many examples showing how machines invariably benefit people;

5. All improvements at first produce some difficulty but many receive the benefit while only a few suffer, probably not much and hopefully not for long (they should be grateful for the opportunity to make a sacrifice for their fellow man);

6. Trade will find its own level. Those thrown out of their old employments will find or learn new ones. Those who get a disproportionate gain will soon find many rivals and lose their temporary advantage;

7. There is a disposition among people to be unduly alarmed by new discoveries;

8. Even if machines (or globalization or the hypertrophy of the finance sector) are evils they are necessary evils. We might as well make the best of them;

9. This would be a prosperous time for the poor, if only they weren't so inclined to carry their money to the alehouse;

10. Anyone who disagrees with the above truths is a irreligious, conscienceless scoundrel; and (drumroll),

11. That "there is only a certain quantity of labour to be performed" is a false principle.

The above propositions are not a random collection but a mostly faithful (if occasionally sarcastic) enumeration of Dorning Rasbotham's main points in his 1780 pamphlet, Thoughts on the Use of Machines in the Cotton Manufacture, whose unique contribution and enduring legacy consists of point #11, which has come to be known as the... now, what was the name of that fallacy?

Patrick said: "Finally, keep in mind that for every debtor there is a creditor. For the world as a whole, net debt is 0. I think Canadian mostly owe money to other Canadians. So what is 'too much debt'? Well, it's meaningless. The issue is the distribution of debt: who owes how much to whom and under what circumstances will defaults cascade etc ..."

If more and more currency denominated debt does not produce price inflation (or is used to prevent price deflation), does that mean there is probably a distribution of debt problem and/or one of the major economic entities is experiencing negative real earnings growth?

Ken said: "So some set of wage adjustments would lead to a full-employment equilibrium if all other prices are flexible I suppose?"

If wages adjust downwards, will the economy get more debt defaults?

Ryan: "The economy consists of unlimited wants and limited resources."

Sure. The problem ultimately is that we are not optimizing present consumption. We are performing an intertemporal global consumption optimization over totally unknown future states of the economy. if we knew those future states or we could hedge them perfectly then the result of that optimization would be unique. But since we don't, and since those states depend critically on the optimization calculations of every other agent the optimal individual strategy is extremely uncertain. Under those circumstances it may be entirely rational for each individual to decide to reduce consumption and attempt to defer it till later, *especially* if they know that others may attempt to do the same thing thereby causing a drop in output. Output can't drop? Of course it can. We just all have to cut consumption, right? And given that it *can* drop then if you suspect that other people suspect that it might drop, then it becomes *rational* for you to reduce consumption and save. It's a classic coordination failure known as the Stag Hunt (I learned this from Nick a long time ago).

With expenditure way below trend and unemployment at 9%, how can one believe that the US is supply constrained? And if it is not therefore demand constrained, what is the problem? (Attempts to claim some sudden and persistent mismatch in prices and skills is to blame will have to explain how that did not magically happen down here in Australia.)

Those denying demand constraint seem to be in the situation of:
Person A: look, an unemployed person!
Person B: nonsense, wants are unlimited, therefore there is a job for him, he is just choosing to be unemployed.

Lorenzo: "how can one believe that the US is supply constrained"

Yes. And The Great Vacation just happened to immediately follow the greatest financial collapse and mass market panic in 80 years. Was it just so much fun to watch the spectacle on CNBC that no one wanted to go to work anymore? Or did we panic cause we suddenly foresaw the imminent collapse in output capacity that would result in the shedding of nearly a million American jobs per month a mere 3 months later. If there was no market failure that means we all *wanted* this and so I guess we must be happier now. Seriously?

Lorenzo from Oz,

I don't think that 9% unemployment tells you anything (the natural rate has fluctuated anywhere between nearly 0% to over 10% in various countries and at various times) but expenditure being so far below trend does indicate demand-constraint. That's not to say that supply-side problems don't exist, but rather that they aren't the principal cause of the phenomenon.

I agree the economy can be choked by an oversupply of money; I disagree with the AD framework.

You're assuming away the intertemporal nature of debt. Savings is foregone present consumption or increased future assumption. Debt is the opposite - debt is foregone future consumption and increased current consumption. It is possible for everyone to simultaneously take on debt. The result is a future period of reduced consumption. The AD framework calls this "a demand shock," but it's not. There was an unsustainable increase of consumption in past periods. No one is going to "take up the slack." The money is gone. Society ate its capital.

@Too Much Fed:
I was using the "income=expenditure" statement to demonstrate the circular reasoning of the AD framework. I'm not certain we disagree.

0.97 was a reference to reserve requirements. If I keep $100 in the bank, the bank will choose to make money off $97 of it unless I withdraw my funds.

You're not detecting the part of the story that I'm suggesting is circular. You're also calling something an "output drop" when I think it is better termed "prior periods of unsustainable levels of spending." So long as debt is accessible, it is possible to increase present spending at the expense of future spending. When we finally reach "the future" it will look like a decrease in spending, but what it really is is nothing more than the predictable lull associated with the "boom" of the previous period(s). Max out your favorite credit card, and you'll see what I mean. When you finally have to pay it off, you'll see that you're not actually "saving" at all. Your consumption goes down not because you're experiencing a demand shock but because you already spent your money. There is a big difference between debt-financed consumption and a decrease in demand. Keynesians and Monetarists call it all the same thing. This is the whole problem that's blinding them.

Nick, you’re simply missing a crucial part of Stiglitz’s argument:

Farmers then (like workers now) borrowed heavily to sustain living standards and production. Because neither the farmers nor their bankers anticipated the steepness of the price declines, a credit crunch quickly ensued. Farmers simply couldn’t pay back what they owed. The financial sector was swept into the vortex of declining farm incomes. [My emphasis]
The cities weren’t spared—far from it. As rural incomes fell, farmers had less and less money to buy goods produced in factories. Manufacturers had to lay off workers, which further diminished demand for agricultural produce, driving down prices even more. Before long, this vicious circle affected the entire national economy.

I’m not saying that he’s right, but let’s not pretend that he’s making some crass Caplanesque mistake. The problem he is highlighting is the difficulty of restoring equilibrium once bankruptcy costs enter the picture. It’s not enough to say that every debtor’s liability is someone else’s asset. If creditors make large provisions for loan losses their valuation of their own net worth falls, without raising that of the debtors.

I am also sceptical about Stglitz's idea,although we definitely need to think about frictions in the economy which prevent adjustment. I think that the difficulty of switching jobs is exaggerated. During WWII, many factories were quickly staffed largely by women who had probably never held a wrench before. This happened very fast once the necessary stimulus in the form of war-time deficit spending was applied.

I have my own simple way of looking at slumps like the current one. Perhaps it's simple minded,too, but it seems to fit the depression, the current U.S. situation, and Japan's lost decade. It also fits the end of the depression in WWII, and China's escape from the world slump in 2008-09.

If some part of the economy suddenly starts buying less stuff, it will obviously create unemployment unless some other sector starts buying more stuff. In a normal recession, the central bank gets the housing sector to buy more stuff by dropping interest rates, and the problem is solved. The problem in the U.S. today is that interest rates are at the bottom, and the housing sector still won't buy enough stuff for various reasons. The cure would be for the government to use deficit spending to buy enough stuff to return employment to normal levels. That is being prevented by politics and stupidity.

It worked in WWII, as Stiglitz points out. It also worked, more recently, in China in 2008-09, when what was shaping up to be a disaster precipitated by declining exports turned magically into a boom following a 15%-of-GDP stimulus. It will be interesting to see if the Tsunami disaster in Japan might, just possibly, force that government to provide the stimulus that should have been provided many years ago.

Ryan: We're talking past each other. I agree with your underlying intuition but the argument you are making is wrong. Assuming away time? Nope. The K&E paper is an inter-temporal maximizing model. Read it. It's not *that* hard to get the general gist of it if you know a little math and read carefully. And Nick has done many posts about debt. You might want to read those too.

That's pretty condescending, amigo. But I'm glad you think I'll be able to comprehend the paper with a little concentration on my part. Thanks for the vote of confidence.

Of course you agree with my intuition (we are talking about economic laws whether they are universally recognized or not), but there is an important epistemological difference you are ignoring, which is the thrust of my point. You may be glossing over this because epistemological debates sometimes look a lot like semantic debates. There is also a tendency for AD-adherents to say, "No, no, you're confused, you just don't get it," and proceed under the assumption that if people just understood AD a little better, it would all make sense.

I'm telling you: I get it and I still disagree. You don't have to agree with me, but let's not pretend it's a disagreement based on ignorance and paper over the problem with AD-favorable research. If I'm wrong, either engage me on the issue or don't. I could just as easily send you a boatload of links to theses that make my point, but I'm under the assumption that we are engaging each other rather than just referring each other to our own favorite research.

Nick, I think you missed this one. Bryan simply referring to the standard model in all the textbooks that we teach out of. AD shifts left, unemployment rises. Then wages adjust lower and SRAS shifts right to bring us back to the natural rate. The self-correcting mechanism. It's what distinguishes the old and new Keynesian models. I really don't see any problem with Bryan's analysis (although I of course think monetary stimulus gets us back to full employment much quicker, so I'd rather not rely on wage cuts.)

Krugman makes an argument than wage cuts might reduce AD, but that's certainly not the textbook model, and certainly Bryan's model can't be compared to Stiglitz.

Ryan: What would you call the ensuing collapse it if the Fed suddenly raised rates to, lets say, 20%. Since nobody lost the desire or ability to work (and since prices are collapsing) it's obviously not a supply shock. And I'm assuming this scenario allows us to rule out prior over-consumption? Which leaves...???

Wow. Scott Sumner and Nick Rowe disagree on something as fundamental (or, more precisely, "fundamental-seeming to a relative beginner") as this.

My ultimate concern is the overlap with economic theory and political reality. My common sense suggests that the lack of bottom-line wage flexibility (which should include all of the legally-mandated costs of employing someone) combined with government incentives NOT to work is a huge component of our unemployment situation. This could be solved by more money and/or lower nominal wages/benefits/anti-work-subsidies.

Meanwhile, back in the world of simplified theoretical models (which I believe could be important), leading economists can't seem to agree whether wage flexibility could move us to equilibrium. To be clear, I think we should start by agreeing on the solution in a world without debt. I totally agree that debt is critical in the real world -- in fact it is the missing piece in many prominent arguments. However, we can't even seem to agree in a debt-free world! Let's start there.

For me Caplan and Sumner (I'm not equating them) make intuitive sense on these issues, but Krugman and Rowe (I'm not equating them) seem to disparage or minimize the theoretical utility of wage adjustments. Regardless, this issue seems to be absolutely fundamental.

Of course, the weakest link in this chain of confusion is me, so I appreciate their patience!


Did you notice my comment above? I think I anticipated your response (and even the Krugman reference). Do you also buy the distinction I made between how someone who doesn't see the nominal problem as being mostly about sticky wages in particular (which I believe describes Nick) might see a mistake embedded in Caplan's argument?

Patrick: "Finally, keep in mind that for every debtor there is a creditor. For the world as a whole, net debt is 0. I think Canadian mostly owe money to other Canadians. So what is 'too much debt'? Well, it's meaningless. The issue is the distribution of debt: who owes how much to whom and under what circumstances will defaults cascade etc ..."

I think this once again shows a gross misunderstanding of the nature of private debts. Private debts, as they are measured in our economic statistics, are not of the "I borrowed 1000$ from Patrick": type. Private debts are TO financial institutions via mortgages, credit cards, car loans and the like. Everyone in the world (with an income) can be indebted to a bank at the same time. Now some people, (like myself)could if they had to, liquidate their savings, pay off all debts and still have something left over. Most people could not. If you are saying that the amount left over, of those who would have some left over, is equal to the amount lacking in those who would be lacking I would say that may be true, but its also somewhat trivial.

Here is what I see as the real crux of this "private" debt problem. We are granted worthy of servicing a nominal level of debt by a bank based on how much income we have AND by the nominal level of our savings. Also the nominal level of that which we may use as collateral. WIth our mortgages (probably the most significant factor in our private debt scenario), the house itself is part of the collateral and part of our net worth. This house is subject to great changes in value (as we've learned) and when it falls significantly it is not an example of "my loss in value means a reciprocal increase in someone elses value". No! When my house value collapses, I am in significantly greater debt ( I owe 100,000 on something worth only 50,000 maybe) AND the banks position is significantly worse. They might "get" the house but the fall in value leads to a deterioration in their balance sheet as well. Its a lose lose lose scenario. Everyones position is made worse nominally.

Im continually amazed by the number of smart people who think that banking is just a middleman for me to loan my excess to Patrick. Its not anything close to that. Banks are outside, just like the govt is and we can ALL be made worse off relative to the banks and it will be to everyones demise when this is so.

Scott: you have a downward-sloping AD curve in mind. But that is precisely the assumption that a Keynesian (e.g. Paul Krugman) would question. Why does a fall in P cause the aggregate quantity of output demanded to rise? (E.g. a Canadian New Keynesian would answer: "because a fall in P, relative to the Bank of Canada's 2% target, would mean that the BoC would cut real and nominal interest rates, so output demanded would rise."). Whether or not a fall in W leads to an increase in Y depends on the monetary policy being followed by the central bank.. If the central bank really is targeting NGDP, then sure. If the central bank were following some really stupid monetary policy (targeting a rate of interest?) then it wouldn't. But you *have to* talk about monetary policy to address this question. You can't just talk about downward-sloping labour demand curves because of diminishing MPL.

Kevin: IIRC, Stiglitz said that the financial stuff was *not* a crucial part of his argument, and more of a side-effect.

As I interpret Ryan, the choice of some to hoard money is a market decision, the decision to opt out of the market. That those with money want nothing other than money and those without have nothing anyone with money wants is not a failure but the market working. Exchange declines because only money has value, those with money won't part with it, and those without any have none to exchange. Wants may be unlimited, but only for money, or only by those with nothing of value to exchange for it.

Ryan: really not my intention. The point was "if I can understand it, anyone can 'cause I'm not that smart". Look, I think you're wrong and I think Nick and PK and others have more compelling arguments that might convince you if you gave them an honest hearing. But who am I? Just a guy wasting time on economics blogs. There are some very smart people who agree that AD isn't the issue. John Cochrane, for example. I think he's totally wrong but again he's the Chicago Prof and I am just a wage slave nobody shooting my mouth off.

"IIRC, Stiglitz said that the financial stuff was *not* a crucial part of his argument, and more of a side-effect."

I've looked again and I can't find this. Maybe you're thinking of remarks like this: "The banking crisis undoubtedly compounded all these problems, and extended and deepened the downturn. But any analysis of financial disruption has to begin with what started off the chain reaction." If that's what you have in mind I don't think it fits your interpretation.

Kevin: This bit of Stiglitz, for example:

"For the past several years, Bruce Greenwald and I have been engaged in research on an alternative theory of the Depression—and an alternative analysis of what is ailing the economy today. This explanation sees the financial crisis of the 1930s as a consequence not so much of a financial implosion but of the economy’s underlying weakness. The breakdown of the banking system didn’t culminate until 1933, long after the Depression began and long after unemployment had started to soar. By 1931 unemployment was already around 16 percent, and it reached 23 percent in 1932. Shantytown “Hoovervilles” were springing up everywhere. The underlying cause was a structural change in the real economy: the widespread decline in agricultural prices and incomes, caused by what is ordinarily a “good thing”—greater productivity."


Yes, the story is: rising productivity -> optimism -> borrowing -> falling agricultural prices and incomes -> bankruptcies -> slump in demand.

I don't know whether that story will convince economic historians but I can't see any theoretical howler there, as you seem to.

As someone who works for a company that makes lab equipment (think CSI on a budget) Stiglitzs theory makes a lot of sense
I really think economists who want to understand this should get the computer program Solidworks, and go through it, and then go to any small company that makes things out of plastic, and talk to them about solidworks, and protomold, rapidprototyping, and CNC machining, and Trinet for HR.
I know some famous economists quipped that you can see computers everywhere but in the statistics, but that is, finally, changing.
what makes it work is the personal discomfort of firing an employee; you may not be aware of this, but firing someone is very, very, very unpleasant.
So, when times are good (<2008) you might have a number of employees who, from a strict ROI perspective, are not really doing that much, but for psychological health reasons, it is worse to fire them then keep them on.
Comes the crunch; its fire 'em or loose your house, at which point the psychic pain tips.

Ezra: I'm a computer geek by training and trade, so I'm sympathetic to your view but I'm still not convinced.

On the micro level you're assuming that the result of investment is always unemployment. I think markets can adjust in other ways. Say, for example, the elasticity of demand is such that lowering the price a little increases demand a lot. The increased productivity might result increased employment.

Now take all markets and add them up. It isn't clear, to me at least, what the end result will be. Higher employment? Maybe. Sure looks like that's what happened in the 1990's.

As for the Stiglitz's alternate explanation for the depression ... Of course he's an accomplished economist and smart guy and I'm not, but I just don't buy it. In the US in the '30s it just wasn't that hard for people to shift from the farm to the factory. Ok, they might not have liked it all that much, and it probably caused all sorts of heartache and woe, but a farm worker and a factory worker are reasonably close substitutes. Fast forward to the present and I'm less skeptical. It seem plausible to me that we could run into problems because what the economy 'wants' is people with PhDs in math, engineering and computer science, but all it has are mere mortals like me with a B.Sc. And lawyers. Lots of lawyers. And FWIW, I don't think this is the major problem we are experiencing currently.

Following up on Scotts remarks. What Bryan says is wrong but I read it as intentionally wrong. The issue is that the says law failure is about money demand; that is, it is a nominal story.

The old Keysenians were obsessed with telling a story about a shortfall in real output--that's their demand deficiency. That's why Keysenian policies are always structured around multiplier assumptions.

Keynes may have punchered says law in the general theory; but the next 70 years were spent in the wilderness preaching a policy prescription whose only attachment to disproving days law was in the need to claim recessions were always self correcting.

Bryan's tongue in check mockery was thus pointing at a quite right observation: the problem isn't about real output at all, if it were we could cut wages an recover. No the problem is nominal and because it's nominal cutting the flow of income by allowing deflation only makes quenching the demand for money harder because if the implied real rate on money rising or even going positive.

"What would you call the ensuing collapse it if the Fed suddenly raised rates to, lets say, 20%."

Whether or not setting the rates at 20% would result in a "collapse" depends entirely on market conditions. It wouldn't be pleasant, but it would only trigger a collapse if the market rate were substantially >20%.

Because 20% is well above the competitive rate, I think a more likely scenario is that private lenders with very large reserves would be willing to offer more competitive loans to the financial sector at a rate of X%, where X<20.

Or perhaps it would be enough of an impetus to get people using currencies more competitively.

This is all speculation based on a very unlikely scenario, though.

Ryan: "I think a more likely scenario is that private lenders with very large reserves would be willing to offer more competitive loans to the financial sector at a rate of X%, where X<20."

The Fed doesn't bring the interbank rate to 20% by *lending* to the financial sector! It gets it there by *borrowing* from the financial sector. And if somebody wants to lend to the financial sector at 10% so the banks can turn around and dump the money at the Fed at 20%, I'm sure the banks would find that quite thrilling. It's pure arb. But it doesn't work that way. If the CB wants a 20% interbank rate it gets it, and every rate in the economy will set off expectations of *that* rate *plus* credit risk *plus* risk premium *plus* costs. And yes, the economy will *PUKE*. And fast. Even the RBC types will acknowledge that.

"It wouldn't be pleasant, but it would only trigger a collapse if the market rate were substantially >20%."

Based on what?! Are you kidding me?

"Yes, sir, the new rate on your mortgage is 26%. But not to worry. Monetary super-neutrality requires the necessary nominal adjustments. So obviously price and wage inflation will rise by 20%. But whatever you do, *DON'T* *CUT* *YOUR* *SPENDING*. Cause if everybody did that in the belief that maybe their nominal income wont rise by 20%/year then prices might *FALL* instead. We recommend, instead, that you go to your employer and demand a raise. Have a nice day."

"This is all speculation based on a very unlikely scenario, though."

But the answers we give and the conclusions we reach have very real consequences for the scenario in which we find ourselves.


I have never agreed with you so much for so consistent a period.

BDL responds:


dlr, Yup, That's a good comment.

Nick, You started by saying that Paul, Brad and Mark needed to call out Bryan. (Which as you know means they will call him a moron.) And now you say this is because Bryan assumes the AD curve slopes downward, like it does in all textbooks (including I'd guess Krugman's). Is that his big mistake? I am aware of Krugman's bizarre theory that it slopes upward, but I read your post as claiming that Bryan made some elementary error, when it seems you are actually accusing him of not buying into Krugman's avant garde theory of upward sloping AD. That's a completely different class of "error" from Stiglitz, so I still don't think they should be lumped together.

Or maybe I'm still missing your point.

BTW, Didn't you once argue that inflation targeting central banks produce a horizontal AD curve? And doesn't that also get Bryan's results?

Scott: Bryan is arguing against the Keynesians, but trying to do so without talking about money, monetary policy, and the shape of the AD curve. If you are a Keynesian who believes the AD curve is vertical (or even upward-sloping) in a liquidity trap, and who believes the US is now in a liquidity trap (if you are PK, in other words) the whole of Bryan's argument is based on an implicit assumption that you are wrong.

Try this thought-experiment: suppose, just suppose that the Fed were really daft, and had a real interest rate target, so the AD curve is vertical. And suppose the Fed targeted a real interest rate above the natural rate, so there were deficient AD. Would nominal wage cuts help? No. That's how the world looks to many Keynesians.

'At this point, Keynesians could just bite the bullet: "Wages must fall!" But in my experience they don't - and I don't think they're going to start now. The reason, I'm afraid, is politics. Keynesians lean left. They don't want to say, "Wages must fall!" They don't want to think it. "Wages must fall!" sounds reactionary - a thinly-veiled reproach to centuries of anti-capitalist intellectuals and militant unions.'

Erm, no, it's not political. Keynes explicitly assumes flexible wages in chapter 19 of TGT and comes to the conclusion that sticky wages are good because they prop up AD, due to workers higher MPC.

As I am fond of pointing out, if real wages cause unemployment, then why has the period of stagnant real wages (1980+) coincided with high unemployment whilst the 'golden age' of rising real wages coincided with low unemployment?


I did not say an economy could drown in money, though that can happen, but more critically an economy can be choked by a lack of money. A fall in the money supply means that an economy can fall into a depression. A fall in money, particularly broad money is like tightening the noose.

Second, you can think of savings, possible consumption and investment together with production as a second-order differential equation, just like a resistor/inductor/capacitor circuit or a mass/damper/spring system. In a second order system there is a fundamental frequency where production will equal consumption. At all other frequencies either savings or investment will act as additional resistance and reduce actual consumption. In a second order system both savings and investment can act as the limiting case relative to consumption.

It is rather frustrating to me to see economists argue that a perfectly good second order system is actually a first order system. Sorry guys, too much simplification there.

Nick, I interpreted Bryan's point 3 as a response to Krugman's upward sloping AD curve argument. It seems to me that Caplan basically said he didn't buy the argument that lower wages will reduce AD (and I agree.) And if that argument is not correct, then lower wages would spur recovery. How did you interpret his point three?

I suppose our disagreement hinges on how much the unconventional slope of the AD curve has become conventional Keynesian dogma. Also whether Caplan was making a general argument, or a liquidity trap argument. I sort of assumed it was a general argument. I don't see Keynesians calling for wage cuts during non-liquidity trap recessions either.

On the other hand even I don't call for wage cuts during recessions, mostly because I don't think it's very likely to occur, but perhaps partly because I assume people will misinterpret me as calling for lower INCOMES of workers.

And here's something for Krugman to think about. In August 2010 when core inflation had fallen to 0.6% in America he did a post calling for strong monetary stimulus to boost inflation expectations. The Fed did QE2 soon after and core inflation is now up to 2.2%. So the Fed did what Krugman wanted and it seemed to "work" (for inflation not NGDP.) So would Krugman still argue that the Fed stops inflation targeting once rates hit zero? Haven't recent events shown that's not true? But if they are inflation targeting then Caplan's right.

Scott: "I suppose our disagreement hinges on how much the unconventional slope of the AD curve has become conventional Keynesian dogma. Also whether Caplan was making a general argument, or a liquidity trap argument. I sort of assumed it was a general argument. I don't see Keynesians calling for wage cuts during non-liquidity trap recessions either."

Fair point. I would say that if inflation is at or above target, and the central bank has room to manouver, and you believe unemployment is too high, and if you believe that there is an excess supply of labour, then you should be calling for wage cuts.

I made a similar point in this old post:


But a Keynesian who argued that we are in a liquidity trap right now, and that the Fed had no room to manouver, could consistently argue against wage cuts right now.

W Peden: Thanks. Glad to know that you agree.

Nick, Scott: I'd guess Stiglitz doesn't feel any great need to justify that the Fed wasn't doing a particularly solid job of stabilizing demand in 1929. It pretty well goes without say. In which case all you need to do is tell a good story about why the natural rate declined. Which he does.

As far as the current situation goes, he clearly states that he thinks the fed failed during the bubble and there is no question that he now considers us to be in a liquidity trap. So, no, he doesn't believe in the Fed maintaining constant equilibrium and validity of Say's law, and he says so quite explicitly. But if you really want to know what he believes you should read the Stiglitz J of European Economics Association paper that was already linked to by a commenter in the other thread rather than judging him by a Vanity Fair article that obviously will neglect a lot of technical details. It's a really great paper.

W.Peden: I don't think that 9% unemployment tells you anything (the natural rate has fluctuated anywhere between nearly 0% to over 10% in various countries and at various times) Wow. My only specifically economic policy job was in labour market policy, so labour market issues push my buttons. But dismissing a dramatic surge in unemployment as uninformative is startling.

A sudden surge in unemployment tells me an economy likely has a cyclical issue. (There is the possibility of some dramatic structural change, but that is unlikely and should be easy to spot: it is not in any way a presumptive hypothesis.) A persistently high level of unemployment regardless of economic fluctuations tells me an economy has structural problems in its labour markets. Either way, high levels of unemployment are a pretty strong indicator that an economy is well below capacity.

Lorenzo from Oz,

I agree that a rapid CHANGE in unemployment indicates a lot. I also agree that a persistent 9% unemployment rate indicates structural problems. By "tell you anything", I mean tell you anything about demand; obviously a 9% unemployment rate always tells you SOMETHING.

What do you mean by "well below capacity"?

Nick, Thanks for clarifying that. I plan another post on Stiglitz.

K: thanks for that link. Hmmm. maybe Stiglitz's problem is that he just did a really bad job of explaining himself in the Vanity Fair piece. Because in that paper he does talk about differing marginal propensities.

W.Peden: well, that is clarifying, thanks. By "well below capacity" I mean that output could be increased with minimal investment in capital, so, in an important sense, the economy is operating at a significant distance from its (short run) supply constraint.

As for "not telling us anything about demand": perhaps not on its own but, short of some clear supply shock, a sudden increase in unemployment creates a presumption of demand issues.

Lars Christensen even provides a nice graph to chart the demand shock the Fed imposed on the US economy in 2008 by its sudden (if "passive") shift to a deflationary monetary policy.

Down here in Australia, we have a central bank that does us the courtesy of telling us explicitly what its target is. That is better. Particularly for unemployment. From down here in Australia (a first world economy, really it is) talk of sudden shifts in sklll needs just sound like very parochial crap.

Thanks Lorenzo for mentioning it...I hope that Nick agree that I got it right with AD...and demand inflation.

Thanks so much for this article and comments. If this is an example of "professional" economist's logic and critical thinking, I now know why things are so f*cked up.

Ryan said:

"@Too Much Fed:
I was using the "income=expenditure" statement to demonstrate the circular reasoning of the AD framework. I'm not certain we disagree."

We'd have to expand on some points to find out.

And, "0.97 was a reference to reserve requirements. If I keep $100 in the bank, the bank will choose to make money off $97 of it unless I withdraw my funds."

That sounds like some form of the demand deposit and reserve requirement form of debt creation. I don't believe that is how banking works. Would you be willing to listen to another "story" of how debt is created?

Sorry, it took so long to reply.

The comments to this entry are closed.

Search this site

  • Google

Blog powered by Typepad