The orthodox recovery of faith?

In May 2010 I wrote a post with the title "the orthodox loss of faith". Please read it (or re-read it). It's a short post, and it would take me as long to repeat what I said there. And I can't recapture today how pessimistic I felt just over two years ago.

If "orthodox" means "that which we teach our grad students", then Michael Woodford is as orthodox as they come. Two weeks ago Michael Woodford said that monetary policy can be used and should be used to increase Aggregate Demand, notwithstanding the Zero Lower Bound. And today the US Fed announced a "QE3", with a very different communications policy, which goes at least part of the way towards doing what Michael Woodford (and others) would want the Fed to do.

Does this mean that the orthodox have recovered their faith? If so why? And, more importantly, why did they ever lose it in the first place? What new empirical or theoretical findings could explain why beliefs seemed to change, and then change back again?

I don't have a good answer to that question.

But I do have one rather disquieting thought. It is a commonplace to note that the business cycle seems to be reflected in waves of optimism and pessimism. Might those same waves of optimism and pessimism extend to macroeconomists' beliefs in the efficacy of monetary policy? (And how come Scott Sumner seems to be immune?)

Oh, never mind. We're winning!

Comments

[Ian Lippert]

I still don't get how this market monetarism is a good thing. They are ecstatic that they are being recognized but if this doesn't work their recognition will be extremely short lived. Where is the evidence that changed the minds of the orthodox? No offense to the blogosphere but it's kind of scary if a consensus was created out of thin air so to speak. The blogosphere should be the place where economists throw around crazy ideas but the peer reviewed journals should still be the place where the heavy lifting gets done, where theory is put to the test, and where economists establish their credentials before they have their theories put into policy.

What happens when we eventually have full blown NGDP targeting and still have high unemployment? Are we really going to allow a consensus of blogosphere economists convince that all we need is to double NGDP from 5% to 10%? You guys better be right about this because if the orthodox economists are right and we relive the 70s/80s the blogosphere economists take as much of the responsibility as they currently are taking of the credit.

[W. Peden]

Ian Lippert,

"Are we really going to allow a consensus of blogosphere economists convince that all we need is to double NGDP from 5% to 10%?"

Not if Market Monetarists have their way.

[Saturos]

Praise be to Scott! And thank you, Nick, for being such a goddamn Bodhisattva! Your wisdom has literally changed the world!

[Lord]

I am sure they do. Scott is a true believer. Most have some measure of doubt; it comes from being a scientist. It does appear we will have a test, but are you prepared to out live your theories?

[Martin]

Nick,

"Does this mean that the orthodox have recovered their faith? If so why? And, more importantly, why did they ever lose it in the first place? What new empirical or theoretical findings could explain why beliefs seemed to change, and then change back again?"

Good question. Reminded me of Walter Lewin's course on mechanics where to demonstrate the conservation of energy he puts his face in the path of a wrecking ball. That's what you call faith. http://www.youtube.com/watch?v=mhIOylZMg6Q

I guess they lost it because they never believed what they wrote in the first place; to be selected in the top of the profession you don't have to believe what you write, you just have to demonstrate that you can tell new and clever stories without actually believing said stories.

[Ritwik]

Nick

The Fed is buying 40% of all new mortgages that will be originated. 40%! If that's communications policy in your world, then yes, you're winning.

I don't mean to be snarky or uncharitable - I like you guys! But I've seen a veritable orgy of optimism and congratulation since yesterday. And though my priors must bias me, for the life of me I can't figure out what is Bernanke saying or doing that differs substantially from how non-market monetarists have understood him in the past, or marks a move towards market monetarism.

Here's how I parsed the FOMC statement:

1) Ben Bernanke has decided to, roughly, find and hit the NAIRU. The probability that he and others assigned to the divine coincidence has become lower over time.

2) Ben Bernanke has re-affirmed his long-standing faith that monetary policy works through asset markets and wealth effects. He believes the Greenspan put was integral to the 'great moderation'. He sees no reason to take a different road.

3) Ben Bernanke and others have confirmed, in stronger terms than ever, that they believe housing IS the business cycle in contemporary US. They're not even fidgeting about it. They want to stimulate residential construction and home buying, and to this end they will buy agency originated mortgages. Thus the Fed has confirmed what many have long suspected - their preferred method of stabilization is keeping the economy in a Keynesian 'quasi-boom', except the boom itself is not Keynesian (business investment and sustained wage inflation) but Greenspan-ian (residential construction and increase in asset price / GDP ratio).

4) Ben Bernanke has confirmed, in keeping with Adam Posen and others, that he believes that a truly effective OMO buys risk capital, not treasury debt. The Tobin & Kiyotaki conception of OMOs.

Is my parsing incorrect? Am I still missing the divine prophecy for the concrete steppes?

If you're satisfied claiming victory from the open-ended-ness of QE, sure. But I fail to see how that explains the FOMC statement's focus on unemployment and mortgages.

[Nick Rowe]

Ian: "They are ecstatic that they are being recognized but if this doesn't work their recognition will be extremely short lived."

I'm not "ecstatic". We aren't really being recognised much at all. David Beckworth was briefly mentioned in a footnote by Michael Woodford, but that was it. And as Ritwik notes, the Fed policy only goes part of the way towards what we want. Will it "work"? I don't know. And I don't know precisely because Bernanke did not give a precise target for what "work" would mean. It was an *open-ended* and *conditional commitment* to *keep on buying MBS* until X happened. But X was not a number for the level path of NGDP. X was a loosey-goosey statement about unemployment and inflation.

"No offense to the blogosphere but it's kind of scary if a consensus was created out of thin air so to speak. The blogosphere should be the place where economists throw around crazy ideas but the peer reviewed journals should still be the place where the heavy lifting gets done, where theory is put to the test, and where economists establish their credentials before they have their theories put into policy."

I tend to agree. But it's probably better if the consensus is created by economist bloggers than by journalists who majored in English. But I really don't know how influential the blogosphere has been. And what I'm suggesting in this post is that it wasn't the blogosphere that won the argument. There wasn't even an argument. They just stopped being pessimistic and became more optimistic again. Which is an even scarier thought than the idea that they changed their minds because economics bloggers persuaded them.

"What happens when we eventually have full blown NGDP targeting and still have high unemployment?"

Then all of us who argued that the problem was Aggregate Demand will be wrong, and the people who said that high unemployment is structural will be right. And inflation will be a couple of percentage points higher than it would have been if we had listened to the people who said it's structural. The downside risk of not raising NGDP, if we are right and the structuralists are wrong, would be much greater, both in probability and cost. And raising NGDP in no way precludes doing "structuralist" policies at the same time (if anyone can think of any good ones that might be politically doable).

[Nick Rowe]

Martin: "I guess they lost it because they never believed what they wrote in the first place; to be selected in the top of the profession you don't have to believe what you write, you just have to demonstrate that you can tell new and clever stories without actually believing said stories."

In a way that's correct. And in a way that's how it should be. I did an old post on that subject years ago (but I can't find it now). The gist of it was: suppose some economists believe in RBC theory but I don't. But I happen to have some new theoretical insight, or some new empirical evidence, that develops and/or supports RBC theory. Should I publish? Yes, I should. (We shouldn't suppress evidence.)

But at the root there is an underlying question of what monetary policy really really is. And I think what has made it possible to flip back and forth about whether monetary policy can work at the ZLB is that we don't have a clear understanding of that question. And every so often I write another post about "strategy space" and stuff like that banging my head against that wall trying to get to the root of the question.

[Bill Woolsey]

Nick:

What if we have full blown nominal GDP level targeting, and nominal GDP continues on its previous growth path?

And then, suppose we get interest rates on reserves negative to a point where currency demand increases a bit.

And the entire national debt (and agency debt) belongs to the Fed.

And nominal GDP continues along on the lower growth path?

The no increase in real GDP, no decrease in unemployment, just an increase in inflation, is only one avenue for failure, and really, it is the failure of nominal GDP targeting, negative interest rates on reserves, and heroic open market operations that are more relevant to your discussion here.

[Nick Rowe]

Ritwik:

To me, the key is the open-ended conditional commitment, communicated as such. What's missing is a clear (numerical) statement of the target. And Bernanke still talked about lowering long term interest rates, when success means they will probably rise. And buying MBS is more open-ended than buying TBills, but the yield on MBS still has the wrong units to serve as an intermediate target/communications device.

If this policy "works" (or is seen as having "worked") then Market Monetarism will disappear. The orthodox will say "But we have always been Market Monetarists; and have been so since long before Scott Sumner started blogging". Which will be 90% true. The temporary loss of faith will be glossed over, as a mere part of the zeitgeist.

Which is why we need to build the theoretical foundations better. Strategy space, hot potatoes, and all those stupid posts I write about social construction of monetary policy.

[Nick Rowe]

Bill: and the Fed carries out its promise to buy up the whole stock market, and the whole capital stock of the economy? Then we enter the world of Friedman's Optimum Quantity of Money.

[Ian Lippert]

Nick, you might have one of the more tempered views amongst the MMers but you had Tyler Cowen literally congradulating Sumner on his "heroic" blogging efforts. As if he has single handedly saved the global economy.

I am sure if this blows up the blogosphere will be filled with the MMers downplaying their involvement. I would just like clarification that this is or is not an implementation that is closer to MM than the fed was implementing before. Because when this is all over I want a reassessment of MM in view of the results of this experiment and if MMers are going to own this policy announcement I would like them to own the results of this experiment ex ante like true scientists, meaning they lay out the possible outcomes of their experiment so that we can fairly asses how the theory stacked up to the experiment.

[Nick Rowe]

Ian: "I would just like clarification that this is or is not an implementation that is closer to MM than the fed was implementing before."

This is closer to MM than what the Fed was doing before. *How much* closer is a harder question to answer. Is it *close enough* is harder still. My gut says "50%" in answer to both questions. Which is not a very useful answer.

Yep. But it cuts both ways. Suppose it does "work" beautifully. People can still say "The economy would have recovered anyway, because of XYZ, and the recovery had nothing to do with the Fed". And it will be impossible to disprove them. You can rarely prove or disprove much from a single observation.

I'm watching markets to try to figure it out. And I'm watching how the news is interpreted to try to figure it out. My hunch is that if stock prices rise relative to (safe) bond prices over the next few days, that will be a good omen. I wish I could put some numbers on that. I wish we had a better measure of expected future NGDP.

Scott's blogging efforts have been heroic. Not all heroes win.

[Phil Koop]

The Fed is buying 40% of all new mortgages that will be originated. 40%!

OK, but he was already buying 24%. And the "open-ended" commitment is for a dollar amount, not a percentage, so if the result is to stimulate more mortgage issuance - "housing IS the business cycle" - then the percentage will fall. And if the alternatives are to buy 24% for 10 years of depression against 40% for 3 years of recovery, he would actually be buying fewer in total.

[JKH]

Nick,

“We aren't really being recognised much at all.”

You deserve some kind of award for intellectual honesty.

I think the important idea here was what Woodford referred to as “history dependent” – in this case, that mortgage purchases will continue past the point where the economy begins to “recover”.

And it’s like stealth level targeting of something – which seems to be unemployment.

The open ended characteristic is a consequence of that sort of “history dependent” targeting – you can’t really have a “history dependent” target without open ended strategy.

Bernanke rejects formulaic targeting in favor of qualitative targeting. That’s why he rejects NGDP targeting (and he does reject it). It’s the formulaic characteristic more than the NGDP objective that he objects to, I think. This seems to me to be an anti-Friedman type of attitude.

I’m not familiar enough with the history – should market monetarists believe that Woodford developed his “history dependent” idea independently, concurrently, or as a result of market monetarist thinking?

In any event, Woodford seems to be an interest rate guy rather than a monetary base guy, which I think must be depressing for you.

Somebody should unpack all this and write the “Six Degrees of Separation” version of it.

“X was a loosey-goosey statement about unemployment and inflation.”

I don’t think NGDP targeting will ever be adopted on a formulaic basis, because the concept in the long run embeds too much inflation risk as an independent component. Bernanke wants more flexibility than that. I think that happens to people when they’re in charge.

[phil]

Nick, sorry I'm a rube. How exactly does targeting NGDP result in higher aggregate demand?

[Ritwik]

Phil

I agree. I'm just saying this is not primarily a communications thing going on here. Ben Bernanke has a specific vision of the business cycle, and is taking a concrete step to act on that vision. The good thing is that he is talking about buying out new issuance, which acts on consumers with higher marginal propensities to spend, rather than simply swapping Treasuries with MBS, which is good but has lower propensity.

[Nick Rowe]

Phil: "And if the alternatives are to buy 24% for 10 years of depression against 40% for 3 years of recovery, he would actually be buying fewer in total."

If the policy worked perfectly, he would actually be buying none of anything in total. Rather, he would be selling a lot of everything. The Fed's balance sheet is twice(?) as big as it would be, if NGDP were confidently expected to grow at a reasonable pace. It's a *conditional* commitment. Chuck makes the threat about what he *would* do *if* the economy *doesn't* do what he tells it to do.

It's open in duration, which is good, and important. It makes it conditional-permanent. I wish it were open in magnitude and scope too. "However much of however wide a range of assets for however long as E(NGDP) remains below the target level path." That's what a real bazooka sounds like, with a proper target.

JKH: I agree a lot with your comment.

The "history dependent" bit (like keeping interest rates "too low for too long") is, in some sense, roughly equivalent to having a level path target for the Price level or NGDP.

"I’m not familiar enough with the history – should market monetarists believe that Woodford developed his “history dependent” idea independently, concurrently, or as a result of market monetarist thinking?"

MMs didn't invent it. It's been around, in various forms, for 30 years (and long before that, if you read the literature with interpretive hindsight). Various New Keynesian economists have been pushing it over the last few years as a cure for the ZLB. So has Paul Krugman, if you read him the right way.

Scott Sumner has said quite a few times that he's saying the same thing as New Keynesians like Lars Svennson(sp?).

"In any event, Woodford seems to be an interest rate guy rather than a monetary base guy, which I think must be depressing for you."

Bingo! Which is what my goldpunk post was about. But he's not just "an" interest rate guy; he is *the* interest rate guy. Which is why his paper, in moving ever so slightly away from interest rates, was (very slightly) cheering to me.

"I don’t think NGDP targeting will ever be adopted on a formulaic basis, because the concept in the long run embeds too much inflation risk as an independent component."

Maybe. But remember that one could have made the same sort of argument against inflation targeting, because the concept in the short run embeds too much RGDP risk in the short run.

[Nick Rowe]

JKH: "The open ended characteristic is a consequence of that sort of “history dependent” targeting – you can’t really have a “history dependent” target without open ended strategy."

I don't think you can have *any* target without some sort of open-ended commitment for letting all other things move to wherever they need to to hit that target.

[Ryan]

I often write about a concept I call the "cognitive time-horizon," which is a person's ability to think in terms of long-range cause and effect. By "long-range," I mean as long as possible. The longer-range a person can think, the more highly refined a person's cognitive time-horizon.

Clearly, Keynes was not much interested in the long run (since "we'd all be dead"). Over time, that ambivalence toward the long-run evolved into a set of economic assumptions about the long run.

It becomes possible to disregard a large set of economic distortions caused by certain economic policies when one maintains the convenience of a simplifying set of assumptions. For example, if I assume I'm going to be alive tomorrow, then by assumption I have very little disincentive not to do dangerous things like drinking and driving or whatever. These kinds of assumptions can be helpful when clarifying short-run economic relationships, but we should always remember that they are nothing more than simplifying assumptions.

And if a whole body of literature makes the same set of simplifying assumptions, that is not really the same thing as a unanimous view that reality absolutely must conform to those assumptions.

So, when things go haywire and we see massive asset bubbles that cause major waves throughout the global financial systems, we are jarred into remembering that our simplifying assumptions were just that. But if enough time goes by without a significant change in circumstances, then we will start to see current trends as being more like long-run trends. Our resistance to change will also make us reluctant to generate new explanatory theories.

The consensus was worth questioning, but was always too entrenched to be dealt a major blow. Meet the new boss, same as the old boss.

[Nick Rowe]

phil: "Nick, sorry I'm a rube. How exactly does targeting NGDP result in higher aggregate demand?"

I'm not quite sure what you are asking, so I'm going to give three answers:

1. "Aggregate Demand" is a curve, not a number. Put the price level P on the vertical axis. Put real GDP (Y) on the horizontal axis. NGDP is P.Y, and it gives a rough approximation of the position of any downward-sloping curve drawn in P,Y space. If the central bank targets NGDP, then that curve becomes a rectangular hyperbola, and NGDP gives an exact measure of the position of that curve. We want a higher level of NGDP, which means we want the Fed to shift that curve up/right.

2. The current level of Aggregate demand depends very much on expected future NGDP. If people expect NGDP to increase a lot, then they must (mathematically) expect either higher real growth or higher inflation. And either way they would want to buy more stuff now.

3. Read my old concrete steppes post.

[Ian Lippert]

"1. NGDP is P.Y, and it gives a rough approximation of the position of any downward-sloping curve drawn in P,Y space. If the central bank targets NGDP, then that curve becomes a rectangular hyperbola, and NGDP gives an exact measure of the position of that curve. We want a higher level of NGDP, which means we want the Fed to shift that curve up/right."

Could you expand on this a bit or link a post to it. Are you saying that NGDP is the PY line tangent to this curve? Why does the curve become a rectangular hyperbola? It means that there is one optimal point of P and Y correct? How does that curve get shifed up (I assume you address this in your third point, concrete steppes?

"2. The current level of Aggregate demand depends very much on expected future NGDP. If people expect NGDP to increase a lot, then they must (mathematically) expect either higher real growth or higher inflation. And either way they would want to buy more stuff now."

What happens if people expect an increase in future NGDP but cannot respond to it? Either by people expecting higher real growth but make investments that dont pay off if the growth doesnt come or if people have no further interest in going into debt (or reducing their savings) in the face of the threat of inflation?

Where do you place the stagflation of the 80s into your theory? Isnt it possible for the phillips curve to break down again and why do you think it broke down in the first place?

[Nick Rowe]

Ian: on a bit of graph paper, draw the curve represented by the equation: y.x=some constant. That's the rectangular hyperbola I'm talking about.

"What happens if people expect an increase in future NGDP but cannot respond to it?"

They can. One person's spending is another person's income. Read my old post here.

[Reverend Moon]

Because the Chuck Norris effect is based upon expectations and conditioning, the effect disappears if the population is told that their expectations are unrealistic, or that the Chuck Norris intervention is ineffective. A conditioned money demand reduction can be totally removed when Chuck Norris=asset swap is explained.[45]

-Modified Wikipedia entry about the placebo effect

[Patrick]

Ian: I'm confused. Why does the Phillips curve matter for NGDP targeting? Unemployment isn't the target. Come to think of it, it's no different than inflation targetting. In either case if the Phillips curve goes wonky on you, you have to live with the new U you get at the target. No?

[Ian Lippert]

Nick, so you think that threatening to take people's income away through inflation will force them to Increase their rate of spending thereby increasing income? I don't really understand how you can hold this belief and at the same time discuss says law in your link.

People must produce something that someone demands before they are accepted into the monetary trading network. It's this access that creates wealth for the individual that is distributed to them in the form of a job. But production not only requires a properly functioning money market it requires the savings that are required for the investment to produce. I don't see how you can disincentivize savings on the one hand and keep people producing things that keep them in the monetary system, ie employed.

[Ian Lippert]

Ignore that last part about say, I just realized that the say you were talking about was the one that said that in aggregate supply creates its own demand. Which I also disagree with (and wasn't what say wrote) but I understand your point.

[Ian Lippert]

@patrick, I was just wondering what Nicks view on stagflation were. It seems like market monetarists are a flavor of. The Phillips curve and I was just Wondering if nick thinks its possible that increasing NGDP targeting could create inflation and unemployment. I was just assuming that the point of increasing inflation was to decrease unemployment, isn't that what the Phillips curve is?

[marris]

> I was just wondering what Nicks view on stagflation were.

Nick can answer this for himself, but my reading of the "market monterist literature" is that stagflation *can* happen, but that is *not* what is happening *now*. What is happening now is the result of the Fed not targeting the correct nominal aggregate measure (NGDP).

Further, from what Nick has posted in the past, I think there is some theory (Friedman's?) that the stagflation in the 1970s was the result of the Fed targeting a real aggregate measure (unemployment?).

[Determinant]

Ritwik posted:

3) Ben Bernanke and others have confirmed, in stronger terms than ever, that they believe housing IS the business cycle in contemporary US. They're not even fidgeting about it. They want to stimulate residential construction and home buying, and to this end they will buy agency originated mortgages. Thus the Fed has confirmed what many have long suspected - their preferred method of stabilization is keeping the economy in a Keynesian 'quasi-boom', except the boom itself is not Keynesian (business investment and sustained wage inflation) but Greenspan-ian (residential construction and increase in asset price / GDP ratio).

So the US economy is supposed to be a one-trick pony? Monetary policy is just a variation of real estate policy and will not really address what most people do at work, that is anything that isn't real estate?

Does anyone else find that incredibly disturbing? It makes a mockery of aggregation, at least classic Keynesianism could aggregate the entire business sector into Aggregate Supply, which conveniently diversified away the particular risks of any one business model.

We just had a classic Depression crash in 2008 and I *thought* we learned that there are structural and practical limits to how many people can have a home under a mortgage scheme; the fact that perhaps renting IS for some people in fact better just went out the window.

It's also a recipe for a chronic Trade Deficit as it lets the broad productive sector whither, instead focusing on the consumption of housing.

Screw the Faith. Stagflation means we are in an Aggregate Supply Contraction, what we are in right now is an Aggregate Demand Depression. If Market Monetarism can't accept this idea then I have no time for Market Monetarism.

There are worse things than price inflation.

[rsj]

Oh, never mind. We're winning!

Who is "we" and what are you winning?

[W. Peden]

Determinant,

I agree that I don't like any asset being selected as such as what the CB should buy. It should purchase on the basis of independent risk assessment and with no primary dealer system, as George Selgin has advocated as a basic reform of the Fed.

[phil]

Isn't this NGDP targeting a bit like trickle-down? i.e. make the wealthiest wealthier in the hope that they might spend more and perhaps hire some people?

[OhMy]

rsj,

Yep, after missing the crisis of the century the orthodox economists are winning. https://www.youtube.com/watch?v=pipTwjwrQYQ

Everybody else is losing.

[PeterN]

I'm not so sure you're winning as far as solving our economic problems. Now if you are talking about keeping some of the worst lunatics from taking over the asylum, then you're winning, and it's a significant victory.

However we still have a hollowing out of the economy:

"Specifically, we examine employment trends in 366 detailed occupations. We formed three equal groups, each representing a third of U.S. employment in 2008: lower-wage occupations with median hourly wages from $7.69 to $13.83; mid-wage occupations with median hourly wages from $13.84 to $21.13; and higher-wage occupations with median hourly wages from $21.14 to $54.55 (all in 2012 dollars).
We then tracked net employment changes in these three groups over time, as shown in Figure 1. The red bars show net losses in employment during the recession (2008 Q1 to 2010 Q1). The orange bars show net growth in employment during the recovery (2010 Q1 to 2012 Q1).1 The pattern is striking.
During the Great Recession, employment losses occurred across the board, but were concentrated in mid-wage occupations. By contrast, in the recovery to date, employment growth has been concentrated in lower-wage occupations, which grew 2.7 times as fast as mid-wage and higher-wage occupations:2
 Lower-wage occupations constituted 21 percent of recession job losses, but fully 58 percent of recovery growth.
 Mid-wage occupations constituted 60 percent of recession job losses, but only 22 percent of recovery growth.
 Higher-wage occupations constituted 19 percent of recession job losses, and 20 percent of recovery growth."

http://www.nelp.org/page/-/Job_Creation/LowWageRecovery2012.pdf?nocdn=1

The sectors with the intermediate jobs - manufacturing, construction and financial services are all getting hit.

Normally the requirement that production = consumption sets relatively tight bounds on the labor's share of the profits simply because you can't have a consumer economy without consumers who have earnings to spend.

The result is that when a sector's productivity increases faster than overall economic growth, employment in other less productive sectors expands. Fewer steelworkers -> more (and more highly payed) dog groomers (not tradeable, not automatible).

This works fine unless the process can be short circuited. This can happen when capitalists take a larger share of consumption in their role consumers, or when capital and production are exported. Then direct earnings from labor's share of production remain overseas, and only the repatriated profits come back. Some of these will, of course be spent on goods made in the US, but there's a net reduction in labor's share of total income.

This process may reduce the cost of consumer goods in the US, which is a compensating benefit, but with a reduced share of income, labor gets a reduced share of the benefits (and the benefits need be no more durable than the goods are). The burden of proof rests on those who claim the overall result is net positive for labor.

Henry Ford said that he payed his workers enough so they could buy the products they made. Perhaps he knew something we seem to have forgotten.

As the old saying goes, we can't all live by taking in each others washing.

This isn't necessarily the result of a evil conspiracy (though I'm sure there must be at least an evil conspirator or two lurking somewhere). This might be part of the problem:

"Another sign of the difficulty small firms are having in accessing capital: the number of publicly traded companies in the United States continues to fall, according to new data supplied by Grant Thornton. At the end of February, there were 5,091 companies listed on major U.S. exchanges, a 2% drop from 5,179 companies at the end of 2009 and a 42% decline from the peak of 8,823 in 1997. (The numbers include foreign firms listing in the United States.) "U.S. listings have decreased every single year since 1997 with no rebound at all," says Edward Kim, capital markets senior adviser to Grant Thornton."

http://www.cfo.com/article.cfm/14563859

It's these small companies becoming big companies that create jobs. Mature large companies don't, nor do struggling young ones.

[Nick Rowe]

Peter N: "As the old saying goes, we can't all live by taking in each others washing."

I think that old saying is totally wrong. All an economy ever consists of is people taking in each others washing. You cut my hair, I teach your kids. And so on.

"Henry Ford said that he payed his workers enough so they could buy the products they made."

That's an old Keynesian myth. He actually said he paid a higher than market wage for efficiency wage reasons, because he wanted best quality workers who would always show up and not hold up the production line because they really wanted to keep their jobs. Can somebody find the Austrian blogger who documented all this very carefully, about a year ago IIRC?

"Normally the requirement that production = consumption sets relatively tight bounds on the labor's share of the profits simply because you can't have a consumer economy without consumers who have earnings to spend."

No it doesn't. Capitalists are consumers too. Investment demand is demand too.

[W. Peden]

Nick Rowe,

Re: Ford, it's not quite what you want, but here's an article that says much the same thing-

http://blogs.telegraph.co.uk/finance/timworstall/100016570/lefty-myths-of-our-time-why-henry-fords-pay-rise-for-workers-undermines-the-living-wage-campaign/

"There's nothing wrong with this appeal to misty history, except for the fact that the entire idea is pure mind-gargling nonsense."

[Nick Rowe]

W Peden: thanks! Good find. The Keynesian version of the Henry Ford story never made sense to me. He could just have given every worker a free car, if that's what he wanted to do. Much better than giving them extra money and *hope* they would spend it on his cars. But the efficiency wage story makes perfect sense, because a few workers not showing up or quitting would be very costly if they shut down the whole production line.

[W. Peden]

Nick Rowe,

Quite apart from the fact that Ford's workers didn't have to buy his cars, it would make no sense to do so unless he was paying them wages that reflected their productivity. If I go out, collect berries, and make a pot of jam, then give you $5 and sell you the jam for $5, then I've got a fundamentally flawed business model. So even if Ford was just giving his workers car vouchers, it would be a bad model insofar as he was paying them anything more than their contribution to the profitability of the business.

One thing that article doesn't mention is that Ford was a ruthless draconian boss who sent out inspectors into his workers' homes to make sure they weren't engaged in heavy drinking and other unproductive habits. Ford paid well because he had realised that mass production requires fundamentally different habits of work from (for example) farm labour. In particular, capital intensive production does not work optimally with low-quality workers and no labour retention.

Ironically, the long-run consequences of this business model and industralism generally has been to undermine the power of would-be Fords: modern workers don't have to worry about inspectors going into their homes, because they can take their skills elsewhere. Nevertheless, mandatory drug testing can be seen as a continuation of the Fordist model and it's only viable insofar as employees are compensated for the invasion of their privacy.

[Ian Lippert]

"Henry Ford said that he payed his workers enough so they could buy the products they made."

Isnt this just a rewording of the Say's Law that you linked me earlier in this post? Regardless of whether ford said this or not, in aggregate, supply creates its own demand because capitalists pay their employees who use their wages to buy the product of the capitalists.

Your criticism of the Ford myth contradicts your belief in Say's law and leads me to believe that I am misunderstanding something about your thought process. Is the whole point of NGPD targeting to get people to play hot potatoe with their dollars before they are devalued, increasing spending and thereby increasing income?

[Ian Lippert]

Nick, I guess its this part I am having problems understanding:

"It is money, and only money, that makes Say's Law false. If, in aggregate, we wish to hold more money than we currently hold, we will plan to spend less than our income. If, in aggregate, we wish to hold less money than we currently hold, we will plan to spend more than our income. An excess demand for bonds won't falsify Say. If there's an excess demand for bonds we can't buy more bonds, because the quantity of bonds is supply-determined. And if we can't buy more bonds, we have to spend our income ouselves. Or hold more money.

If the desired stock of money were identically equal to the actual stock of money, at all levels of income, then the Old Keynesian Cross model would have an indeterminate equilibrium. Any level of income between zero and "full employment" would be an equilibrium. At any level of income, demand would equal income, and income would equal demand. And so an infinitesimally small increase in the supply of money, or decrease in the demand for money, would be enough to create a self-perpetuating increase in demand, increase in income, further increase in demand, to get the economy to expand to where the supply constraint stops any further expansion. Or where inflation reduces the real value of the money supply, or leads the central bank to take away the punchbowl."

I am going to take a more serious read of this and get back to you, but if you have any helpful clarifications that would be useful

[W. Peden]

Ian Lippert,

At best, Say's Law is true at the level of the macroeconomy rather than a particular industrial enterprise. And it's also only true when dividends/rents are factored in as well as labour costs.

Say's Law entails that there cannot be a general glut in a barter economy since products would be paid for wit products. "Supply creates its own demand" is an awful way to render it.

[Determinant]

No it doesn't. Capitalists are consumers too. Investment demand is demand too.

That's fallacious reasoning. Henry Ford could not consume all of his own cars. With the degree of specialization present in an industrial/technological economy, producers need a broad consumer base to create demand through unmet utility needs for their products. If Louis Firestone bought all of Henry Ford's cars sure, money would change hands, but Mr. Firestone would have almost no utility for his fifth car and beyond. But a car in every family's garage satisfies utility much, much more.

Second, we've got Fed problems.

First, while going through an entertaining NPR series on Toxie, a toxic asset purchased by the producers of NPR's Planet Money so they could profile the source of the crisis, they discovered that due to a foreclosure in Maiden Lane I, some of the junk the Fed bought from Bear Stearns, the Fed now owns the Crossroads Shopping Mall in Oklahoma.

http://www.npr.org/blogs/money/2010/04/the_tuesday_podcast_the_fed_wa.html

This is not central banking.

On the Fed problems, the GAO did a study into loan destinations (a para-audit), as directed by the Dodd-Frank Act. Yes, Ron Paul signed on, as did quite a few lefties. Preliminary results on Sen. Bernie Sanders' website: http://www.sanders.senate.gov/newsroom/news/?id=9e2a4ea8-6e73-4be2-a753-62060dcbb3c3

The conflict-of-interest problems are going to be a problem.

[Peter N]

I can't find a primary source for Ford's saying he payed his workers enough to buy his cars, however it's quite likely he said it or something close to it. This doesn't mean it was necessarily his reason for doing it at the time. This seems to have been to have a more reliable work force and keep out the IWW. It also allowed him more control of his work force. People will accept more control to keep a job that pays twice what they would get elsewhere.

However it's clear he said things very similar to the famous quote.

This is from a 1926 interview with Ford by Samuel Crowther, twelve years after the famous pay raise, the quote supposedly justifies.

"The industry of this country could not long exist if factories generally went back to the ten hour day, because the people would not have the time to consume the goods produced. For instance, a workman would have little use for an automobile if he had to be in the shops from dawn until dusk. And that would react in countless directions, for the automobile, by enabling people to get about quickly and easily, gives them a chance to find out what is going on in the world-which leads them to a larger life that requires more food, more and better goods, more books, more music -- more of everything. The benefits of travel are not confined to those who can take an expensive foreign trip. There is more to learn in this country than there is abroad."

http://www.worklessparty.org/timework/ford.htm

I think this is close enough. Crowther was apparently a Ford ghostwriter, which, while it makes it less likely to be an exact quote, makes it more likely to be what Ford intended to say. There's similar stuff in his autobiography, but this is the closest that I could find to the famous "quote".

I'm taking the word of the website that posted this that it's a faithful copy, but the syntax and style are very close to other Ford writings.

It is, after all, as mentioned above, a bastard child of Say's law, and mass production does imply mass consumption.

It's clear that the intent was not to imply that each individual worker was likely to go out and buy a Ford car, but to advocate an industrial policy that would produce the mass consumers needed for the coming mass production.

The opposite plan would be to make luxury cars to sell to the rich and have many fewer workers, which was the common plan around 1910.

[Peter N]

"I think that old saying is totally wrong. All an economy ever consists of is people taking in each others washing. You cut my hair, I teach your kids. And so on."

You miss the point, I think. Taking in washing is a parasitic occupation. It can only exist if someone who produces goods or performs a service directly necessary to such production has washing to take in. You can't have an entire economy of dog groomers. They are only payed well when their consumption is needed to balance production of consumer goods. Otherwise the overall Boley ratio will fall, which it has.

"Capitalists are consumers too" is in no way equivalent to "Investment demand is demand too."

Capitalists buy consumption goods as consumers and production goods as producers, which is my point. If capitalists can consume their own production, they don't need other consumers. This is an economic model that is both viable and common. It just has certain drawbacks that would make it an unfortunate model for this country to adopt.

[Ian Lippert]

@peden, over the summer I read metzlers book on Keynes. His argument of says law was that when people produces things they create the demand that purchases those things. This seems to be along the lines of nicks argument in the blog posts he has linked to. While ford wouldn't be able to literally crate the demand to purchase his cars the theme of the myth falls along the same lines as says law as metzlers version.

Your version sounds like the Austrian view of says law and is closer to what say actually wrote. As I've been told before on this blog that version isn't really used anymore.

[rsj]

He actually said he paid a higher than market wage for efficiency wage reasons, because he wanted best quality workers who would always show up and not hold up the production line because they really wanted to keep their jobs.

That is a myth. Ford paid more because the cost to him of worker turnover was getting too high. He did not pay more for efficiency wage reasons -- e.g. to avoid shirking. He paid more because he demanded extremely repetitive and dangerous work that no one wanted to do for a prolonged period of time.

It was simple labor supply and demand and he was having a hard time finding workers willing to work in assembly lines.

[Nick Rowe]

rsj: reducing shirking is one efficiency wage model. Reducing turnover is a second efficiency wage model. Making sure the workers are well-fed and more productive is a third efficiency wage model.

Peter N: "Taking in washing is a parasitic occupation. It can only exist if someone who produces goods or performs a service directly necessary to such production has washing to take in."

That is a very old fallacy. And I Googled "Boley ratio", and got nothing. (Probably just as well).

[rsj]

reducing shirking is one efficiency wage model. Reducing turnover is a second efficiency wage model. Making sure the workers are well-fed and more productive is a third efficiency wage model.

So how are efficient wages different from regular labor supply and demand? What is the new insight? My understanding was that supervisory costs made it difficult to be sure that you were hiring a good worker or a bad worker.

But if you are offering generally unpleasant work and need to pay higher wages as a result, then that is supply-demand, right?

[Nick Rowe]

rsj: "My understanding was that supervisory costs made it difficult to be sure that you were hiring a good worker or a bad worker."

That's a fourth efficiency wage model, with unobserved worker quality.

On the turnover version: if you have a line-up of workers wanting jobs, but you don't cut wages because turnover would increase (even though workers who quit could be replaced from the line-up), and turnover is costly to the firm, that's the efficiency wage version.

[Nick Rowe]

rsj: "But if you are offering generally unpleasant work and need to pay higher wages as a result, then that is supply-demand, right?"

Yes. "Compensating differentials".

[rsj]

Nick, I don't think you got my point. The disutility of repetitive work increases with the amount of time that you have to do it. Workers most definitely were not lining up to Ford's factories to work there for 2 years. They were lining up to work there for 6 weeks. But he needed people to work for 2 years -- to reduce turnover -- so he had to raise the wage up until people were willing to stick to a repetitive and dangerous job even as the disutility of doing that job increased.

[Peter N]

Should be Bowley ratio - the ratio that is conserved in Bowley's law.

From Wikipedia:

"Bowley's law is an observation in econometrics that the proportion of Gross National Product from labor is constant.[1] It is named for Arthur Bowley, the statistician who first observed it. It was first observed based on economic data in Britain from the late 19th and early 20th centuries.[2] Bowley's Law has long been both an empirical and theoretical point of contention between rival theories of macroeconomic (functional) distribution.[3]"

I referred to it in this post here on 3AUG12

http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/08/can-we-understand-agent-based-models.html?
cid=6a00d83451688169e20167690a6ed3970b#comment-6a00d83451688169e20167690a6ed3970b

drawing attention to this post of the same day

http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/08/can-we-understand-agent-based-models.html?cid=6a00d83451688169e2017616fac9a5970c#comment-6a00d83451688169e2017616fac9a5970c

where Geoff Willis is plugging a very interesting paper of his on a sort of Thermodynamic model of the economy

http://www.econodynamics.org/sitebuildercontent/sitebuilderfiles/bullets

The question is why does Bowley's law work?

Thhe important point, however, is that the recovery is not restoring the pre-recovery wage spectrum. There's a hole in the middle.

as above:
" Lower-wage occupations constituted 21 percent of recession job losses, but fully 58 percent of recovery growth.
 Mid-wage occupations constituted 60 percent of recession job losses, but only 22 percent of recovery growth.
 Higher-wage occupations constituted 19 percent of recession job losses, and 20 percent of recovery growth."

Then there's this

"Firm startups account for only 3 percent of employment but almost 20 percent of gross job creation," the authors write. "[T]he fastest growing continuing firms are young firms under the age of five," the authors conclude.

In this study, which relies on data from the Census Bureau, the authors confirm that smaller companies created more jobs than larger companies during 1992-2005. But the importance of firm size depends very much on the assumptions one makes about the base year of the analysis, the number of employees used to define "small", and other factors. The real driver of disproportionate job growth, they find, is not small companies, but young companies. It is the startup firms that generate the surge of jobs that earlier research attributed to small companies."

http://www.nber.org/digest/feb11/w16300.html

and the fact I cited above that

"U.S. [stock market] listings have decreased every single year since 1997 with no rebound at all"

I believe there's a relationship. The decline in middle paying jobs began in 2000. We're not forming near as many of the sorts of companies that would have provided the missing jobs.