More on Corporate Liquidity Preference

The other day I approvingly mentioned Arnold Kling's interpretation of corporate profits that was puzzling Tyler Cowen, and I added that the profit rates are also consistent with corporate liquidity preference, an important dimension of Roger Farmer's recent book.

Today Matt Yglesias, drawing from Ezra Klein, Cowen, and Barry Ritholz, presents a very intereseting graph demonstrating that the trend towards corporate liquidity has been going on for well over two decades. It would have been nice to see this as a percent of non-financial corporate revenue, or with some sort of denominator, but I'm guessing the same general trend holds. Here it is:

Yglesias writes, "As an economics question, this now becomes more interesting. But as an explanatory factor for today’s economic problems, it becomes a good deal less interesting.". I wouldn't give up quite that easily.

Keynes presents a secular and a "cyclical" (or more accurately "crisis") explanation of unemployment. I've actually primarily seen Keynes as a secular unemployment theorist, but Garrison has opened me up to the idea that to a certain extent he was both.

Liquidity preference explains the secular unemployment, so in that sense this trend isn't all that upsetting to the vision of The General Theory. What explained sudden crises was:

(1.) A decline in investment demand, which Keynes believed to be largely interest inelasatic, and
(2.) Perhaps the second-order liquidity preference effects that would result from a crisis.

One thing I've been keeping track of in Garrison is all the places where he modifies Keynes, either because he thinks he's wrong or because he needs to make a modification to be able to express Keynes in the Hayekian model he presents. For example, he does away with a separate treatment of liquidity preference entirely, as Hicks had presented Keynes (Garrison makes the case Hicks was unfaithful in the first place), because Hayek doesn't treat liquidity preference separately. For the sake of comparability, it's axed (although then brought back in, but only through the loanable funds market). He does a lot of little revisions like this throughout the book.

Another such revision Garrison makes is to the response of the interest rate to a decline the demand for investment. Keynes says that when income is reduced, savings will also be reduced - so you have a decline in investment demand (the demand for loanable funds) coupled with a decline in the supply of loanable funds, so that in fact the interest rate isn't reduced appreciably by the decline in demand. Garrison insists that the supply of loanable funds won't be reduced with the demand for loanable funds, because the market will (inexplicable) stay on its PPF. No output decline means no decline in the supply of loanable funds.

So Garrison waves his hands and *poof*, the supply of loanable funds stays put and the interest rate does in fact get reduced. The reduced interest rate has distributional and structural effects that Garrison then expounds on.

What does any of this have to do with the Yglesias post?

Well when Garrison models Keynesian secular unemployment (liquidity preference) and Keynesian cyclical unemployment (animal spirits/investment demand) separately, the change in the interest rate that he ensures with his revisions and assumptions introduce some corrections into the Keynesian model which, under Keynes, did not correct itself.

However - secular and cyclical unemployment can't be compartmentalized or experienced separately in real life as they are in Garrison's book.

Garrison demonstrates that a decline in animal spirits is self-correcting because there is no shift in the supply of loanable funds. However, if a backdrop of increasing liquidity preference since 1985 (as shown by Yglesias et al.) reduces the supply of loanable funds and increases the interest rate steadily over time, then a shock to investment demand suddenly becomes more dangerous, and starts resembling Keynes's original rendition more than Garrison's revision of Keynes.

Put another way - under certain conditions it's clearly conceivable that the self-correcting tendancies of markets could have no problem dealing with a shock to investment demand. However - under conditions of increased and increasing liquidity preference, those self-correcting tendancies can short-circuit and be more problematic.

Note also that every recession since this corporate liquidity buildup began has been characterized by "jobless recoveries" where hiring doesn't pick up.

And who ties corporate liquidity preference to weak hiring? Again, Roger Farmer.

Damn, I need to get his book.