Friday, December 24, 2010

More conversation with Papola

I thought this was worth reproducing - someone let me know if I could have said it better. Lee? You're always good at verbalizing the general glut point, although I know you cringe to do it in a fiscal policy context. Anyway, here it is:

John: "Do me a favor. Dig into my specific points/questions about aggregation in my last long post. You haven’t yet. You’ve just waved your hands by saying “keynesians recognize that slack is unevenly distributed”. That’s not an answer. I’m asking what I believe are reasonable and reasonably precise questions. That you agree with DeLong and Stiglitz suggest to me that my understanding of keynesianism is correct and that my criticism holds. Posting your blog that I’m spewing fallacies doesn’t do anything to point them out. You haven’t. I’m listening. Nothing would make me happier in life than to have keynesianism proven true. After all, both political parties are keynesian."

Me: I said "peddling" not "spewing" fallacies... that sounds a little nicer to me. Isn't it? I was referencing the "Keynesianism as consumptionism" fallacy and the assumption that we're operating at full employment (ie - no liquidity preference so no paradox of thrift). I feel pretty solid calling those "fallacies" and I have pointed to them explicitly a couple times now, so don't suggest I haven't pointed them out - I have.

OK - on aggregation - let me try and think of another way of phrasing my point.

We always experience uneven levels of depression, growth, market tightness, market looseness, inflation, and deflation. That is always with us - they are simply temporary disequilibria and price signals to direct scarce resources to their best use. They're a good thing in a market economy because the market uses the price signals from those imbalances to make economic activity more efficient. This is intertemporal as well - people save and borrow because the market allocates goods and services over time as well. What I'm saying is that in some situations, there is a general depression. There are still these heterogeneous differences as there always are, but everything is more depressed than it would have been under normal circumstances. This occurs when there is a reduction in effective demand - when people and firms don't want to save to set something aside for the future - they want to save to have a liquid asset. This isn't time preference this is liquidity preference, and it's something Austrians regularly ignore. You say your money is in the bank and isn't idle simply by virtue of the fact that it is paid interest. It isn't absolutely idle, you're right - but savings can be kept in more liquid and less liquid forms. More liquid assets are by definition kept less productive than less liquid assets.

So, the point of Keynesianism is that while liquidity preference may be rational in the sense that its understandable why people have it, it isn't socially functional. It's unnecessarily wasteful and it means that the market does not always efficiently use all factors of production. The task at hand is to turn that liquidity preference shock into actual income.

Restoring full employment in that sense has absolutely nothing to do with your concern about unevenly depressed sectors. The task isn't to say "what's especially low out there? - let's fill up that hole because its not doing so well". No. That defeats the whole purpose. We like those relative differences because those provide price signals that efficiently allocate means of production. That's not the way to think about fiscal policy. Think about fiscal policy as being much like monetary policy. People are demanding liquid assets, so they hold money or some other highly liquid asset, and it just sits there - depressing everything, not just specific sectors. Fiscal policy is the government saying "here, why don't you hold on to this bond - its very liquid, there's always a market for it, it'll satisfy your mattress-stuffing impulses, and I'm going to go credit worker and contractor accounts to do this "stimulus" stuff. People want to turn income into liquid assets and take it out of circulation. So the government says "I'll take that trade", and then puts it back into circulation. It's no different from monetary policy, which you were damn close to embracing on Cafe Hayek recently.

So that's why I say you're thinking about this from completely the wrong angle. You are thinking of it from the goods and services side of things, which is why it seems like a calculation problem to you. You need to be thinking about what's going on in the money and loanable funds markets - why your savings are in fact idle, and what fiscal policy does about it.

So see - the case I've made so far has nothing to do with these relative imbalances. Because I don't see the relative imbalances as a problem - I only care about general gluts. Market specific gluts are going to be worked out by the market. The task is to fix the problem that lead to the general glut.

Now, I did agree with you that these relative imbalances in different sectors are important because clearly fiscal policy is going to have an impact in various markets in ways that monetary policy simply isn't going to. You want to be smart about how you spend the money in that sense. If you spend $800 billion on Sponge-Bob Square Pants DVDs, macaroons, and snow-globes you're going to introduce some pretty bizarre price distortions. You'll still put idle cash back into circulation, which is why Brad DeLong says anything passes the cost-benefit test and why Keynes talked about burying bank notes and digging them up again. You will, in essence, solve the general glut problem but exascerbate the industry-specific gluts. I am not aware of a Keynesian that doesn't recognize this, John. Are you? The argument is that the general glut is by far and away the bigger problem at a time like this - period. If we solve the general glut and cause a few issues with relative price distortions, the argument is that the cost of those relative distortions is much, much lower than the benefit of solving the general glut. You can't accept this because from what I gather you don't even think general gluts are real.

So this is why I say anything works as long as you put money back into circulation, but relative prices still matter because of course you can introduce distortions. The thing is, there are a lot of public goods that we could be investing in. They are sub-optimally underinvested in right now so we can dump money on them and they would indeed change relative prices but they would improve the situation. We can dump money on research and education and it would adjust relative prices for the better because these are underpriced by the market. We could dump money on clean energy technology and it would indeed adjust relative prices, but for the better because this is underpriced by the market. We could increase NASA's budget five-fold and it would adjust relative prices for the better because space colonization is currently underpriced by the market. We could also just put a roof over people's head, food in their mouth's, and clothes on their back as a purely humanitarian act because people are deserving of the basic dignity of having their needs met. At full employment you have to weigh that against what you're taking money away from. Below full employment, I say "it solves the general glut and it serves a humanitarian motive outside economic calculation - win-win to me".

You have to be careful of course, because these can have bad distortionary effects too. You mentioned health care in an earlier post. Policies that drive demand for health care - mandates, tax breaks on health plans, etc. are not the way to spend stimulus money. Things that will lower costs like health care IT and grants for nurse training wouldn't be as bad.

But the point isn't to distribute money to every weak market. It's not "C, I, G, altogether adds to Y - keep that total growing and watch the economy fly". That's crude Keynesianism. That completely misses the point. The point is get money back into circulation, recognize that as your number one priority, but also recognize the distortionary effects your policy might have and try to avoid them the best you can.

Robert Skidelsky says it very well on your website [see his discussion starting at 12:53] - there is government waste and there is market waste. Governments absolutely waste when they try to allocate resources. Governments cannot do economic calculation, period. But in a general glut, markets are far more wasteful than governments. You have to just live with some government waste to solve the market's waste problem - and ideally you spend on positive externalities and public goods to minimize the level of government waste in the first place.

Keynes wrote: "To put the point concretely, I see no reason to suppose that the existing system seriously misemploys the factors of production which are in use. There are, of course, errors of foresight; but these would not be avoided by centralising decisions. When 9,000,000 men are employed out of 10,000,000 willing and able to work, there is no evidence that the labour of these 9,000,000 men is misdirected. The complaint against the present system is not that these 9,000,000 men ought to be employed on different tasks, but that tasks should be available for the remaining 1,000,000 men. It is in determining the volume, not the direction, of actual employment that the existing system has broken down."

I could not agree more.

If you still don't feel like I'm speaking to your point, you may want to look for answers elsewhere because I'm clearly not communicating this well. I feel like this has been asked and answered countless times by lots of Austrians before you, and maybe I'm just not addressing it right. Needless to say, if you still think I'm violating some assumption about economic calculation I'm miscommunicating something because I am fully on board with Hayek on economic calculation.

Note that Keynes never submitted a report to the Chancellor of the Exchequer saying "My dear chap, I strongly feel that we should bury banknotes and pay the unemployed to dig them up". Notice Stiglitz never castigated Congress for not including more ditch digging in the stimulus package.

Doesn't that say something to you? The whole reason for pointing out these completely crazy options is to try to highlight this fact that its not about "boosting consumption" or even "boosting investment" directly. A lot of people think of fiscal policy as the government spending when the market won't - as if the government is stepping in to do the economic calculation.

That completely misses the point, which is precisely why Keynes came up with such goofy examples. But he never seriously proposed such examples because even though the point wasn't to bolster certain goods and service markets, it clearly could have the effect of distorting those markets."

14 comments:

  1. "Robert Skidelsky says it very well on your website [see his discussion starting at 12:53] - there is government waste and there is market waste. Governments absolutely waste when they try to allocate resources. Governments cannot do economic calculation, period. But in a general glut, markets are far more wasteful than governments. "

    To me, this doesn't follow for your previous premises. There is a glut, and resources are not being allocated. This isn't waste. There is a difference between capital consumption and the existence of unused non-specific factors of production.

    One still has to prove that purposeful capital consumption is better than doing "nothing".

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  2. My (utterly ignorant) impression is that this "doing nothing" is really "doing recalculation," from what I remember of Alchian, and so gluts are a kind of economic activity. How is that factored into all of this?

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  3. I completely agree Jonathan, and that's what I was thinking the whole time.

    Daniel, I certainly understand the argument, and you make a lot of good points. Assuming there is a general glut (which you haven't really explained and I'm a bit confused on) and people are unnecessarily holding their money and prohibiting more "productive" employment, it would make sense to satiate their impulses for liquidity so as to free up their money for the necessary transactional purposes it serves in productive exchange. I think I get it.

    The question, as Jonathan put it, is why do you think it is better to "do something" rather than "do nothing?" If resources are idle, if they are not being employed, if they are being neglected, and depreciating, and whatever else - I think you should ask a deeper Why? Maybe, you'll answer that "such-and-such economic consequences have left people with a higher liquidity preference and so X, Y, and Z general glut conditions appear" - but then it is imperative to ask what those preceding conditions were.

    If they were, as the Austrians consistently claim, the depression end of the business cycle, then you should know that people's "liquidity preference" is due to falling profitability in capital goods sectors. Certain capital readjustments are necessary and there will be, if you read Hayek or my analysis, idle non-specific capital goods. There are a couple reasons for this. But energizing these idle resources will not help the readjustment of the structure of production, and here's the important part since the structure of production is a manifestation of consumer desires, it will not be in the best interests of the consuming body to delay, interrupt, or frustrate the readjustment of the structure of production as "putting idle resources back to work" would.

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  4. Regarding the general glut concept, I think it's an issue of nominal demand. If there is a fall in the supply of money by 10%, but prices don't immediately adjust, some goods won't be affordable and they will remain unused. I don't see it as an issue of "true" overproduction, because ultimately prices will adjust. Do we have a "general nominal glut" today? I don't think a liquidity trap and that are the same thing.

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  5. These are all good thoughts - I'm going to respond with another full post on them tomorrow morning - merry Christmas everyone. Keep an ear out for reindeer.

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  6. I'm still planning on addressing this stuff at some point - just haven't had the time to think about it.

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  7. Daniel,

    First, you should know that I posted an apology on the econlib comments. Our debate got needlessly heated and while we both pushed each other’s buttons, I went too far in a few places and that’s not productive.

    Now, to try one more time at the substance here….

    You say this:
    "everything is more depressed than it would have been under normal circumstances”

    and then this:
    "People are demanding liquid assets, so they hold money or some other highly liquid asset, and it just sits there - depressing everything, not just specific sectors.”

    I say this statement is both demonstrably false and it lies at the heart of the tautology that is the “general glut”. I tried to get at this point by stressing that we are currently facing shortages and rising prices in a number large sectors (Healthcare, Energy, Education). That these sectors are also heavily intervened by government supports other points about the injection effects of monetary policy on relative prices… but lets leave that to the side.

    “Everything" is not depressed. Making this general, absolute claim is what is both breaking your argument and breaks the concept of a general glut. Again, I don’t see how one can claim that these sectors are more depressed “than they would have been”. That is impossible to know. What we do know is that they face shortages now and that increase spending in these sectors would result primarily in even more inflation.

    Increased spending (a shift in the demand curve) has two impacts in a market. A price effect and a supply response. The supply response comes if there is an increase in profit. For that to happen, there must be an increase in price without an increase in the cost of production. We can’t know ex ante how much or in what proportions these effects will manifest. It depends on the availability of production resources for expansion and the capacity utilization.

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  8. (cont…)


    Right now, our healthcare system can reasonably said to be operating at full capacity with excess demand not being met by increased supply. There is little indication that increased supply of medical providers is easy to draw on to meet that increased demand. So we have a shortage. Now, we can get into the details of healthcare shortages, medicare price controls and spending waste, but that will take us afield.

    I simply don’t understand how we can talk about “everything” being depressed when 1/7th of our economy is experiencing this kind of shortage and price inflation. I don’t how “it would have been worse” or “it would have been better” is an answer.

    Back to the broader idea. I recognize that people have a “liquidity preference” as well as a time preference for their consumption. Again, what I don’t understand is how you can determine from the top down which areas of the economy are seeing slack due to temporary liquidity shocks versus real preference changes.

    I don’t think you or any other Keynesian I regularly follow give much (or any) play to inter-temporal effects either.

    Housing and auto demand collapsed in part because of short-term overconsumption of those goods stoked by bad policy and faulty price signals. Consumption is not investment. Housing and Auto consumption does not improve our productive capacity. So (and these specific numbers aren’t real) 20 years worth of housing was purchased in 10 years and paid for by 20 years worth of debt.

    Well, we’re in the second half of that intertemporal process where we need to live with the houses we’ve bought and pay off our debt. If I borrow to consume, I do not increase my productive capacity or the productive capacity of the economy. I am not in a better position to buy more, I am in fact in a worse position due to my debt servicing. Now my lender may be in a better position to spend more… except that the malinvestments have produced waste and excessive losses, which has consumed my interest payments into a hole of toxic assets.

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  9. (cont…)
    So, yes, we are poorer for having dumped trillions of real resources into durable goods that people didn’t actually want at cost-covering prices.

    All of these effects are sectoral and relative price related. Aggregate spending is not causal. It is a reflection of effective production. What we’ve had is malinvestment leading to ineffective production. Production of goods people don’t want at real market prices. So the prices must fall.

    Something you haven’t mentioned at all is how important sticky prices and wages are to the keynesian framework. The claim that is central to Keynesianism is that output falls faster than prices and wages because of institutional rigidities and therefore we need to maintain aggregate demand to prevent prices from falling. But where is the evidence that prices fall slower than fiscal policy can re-inflate prices? If they fall faster, the point is moot and the framework breaks down. And that still doesn’t answer the aggregation problem. Which prices and wages? Again, pushing up spending in healthcare where we are already at full capacity doesn’t seem to offer any solution to unemployed construction and auto workers.

    Simply restating “everything is depressed” doesn’t answer any of these questions. That’s why I got frustrated. “Everything is depressed” is simply saying “there’s a general glut” in another way. It’s tautological. Everything is depressed because there is a general glut because everything is depressed. But “everything” isn’t depressed. Some things are depressed and others aren’t. Keynesians have no answer for how a fiscal policy administrator can determine which depressed items are due to preference changes versus temporary liquidity (hoarding). People don’t increase their cash and cut back on all consumption equally. Their preferences impact what they choose not to buy.

    All of this aggregation criticism applies equally to the so-called “price level”.

    If we can dig into this together, I don’t know where to go from here.

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  10. (This was dropped for some reason. It’s part I of these comments)

    Daniel,

    First, you should know that I posted an apology on the econlib comments. Our debate got needlessly heated and while we both pushed each other’s buttons, I went too far in a few places and that’s not productive.

    Now, to try one more time at the substance here….

    You say this:
    "everything is more depressed than it would have been under normal circumstances”

    and then this:
    "People are demanding liquid assets, so they hold money or some other highly liquid asset, and it just sits there - depressing everything, not just specific sectors.”

    I say this statement is both demonstrably false and it lies at the heart of the tautology that is the “general glut”. I tried to get at this point by stressing that we are currently facing shortages and rising prices in a number large sectors (Healthcare, Energy, Education). That these sectors are also heavily intervened by government supports other points about the injection effects of monetary policy on relative prices… but lets leave that to the side.

    “Everything" is not depressed. Making this general, absolute claim is what is both breaking your argument and breaks the concept of a general glut. Again, I don’t see how one can claim that these sectors are more depressed “than they would have been”. That is impossible to know. What we do know is that they face shortages now and that increase spending in these sectors would result primarily in even more inflation.

    Increased spending (a shift in the demand curve) has two impacts in a market. A price effect and a supply response. The supply response comes if there is an increase in profit. For that to happen, there must be an increase in price without an increase in the cost of production. We can’t know ex ante how much or in what proportions these effects will manifest. It depends on the availability of production resources for expansion and the capacity utilization.

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  11. All comments should be back - blogger identifies comments as spam from time to time - I've found no rhyme or reason to it, but the good thing is I'm able to recover them.

    I'd agree it got "needlessly heated", but it's an obvious pattern in certain people. I'm regularly either given the version of crude Keynesianism (or whatever other topic) that I'm expected to defend, or I'm told I haven't addressed things I've spoken to at length, or the views I do expressed are leveraged out into other views (Keynesian demand targeting turns into central planning, etc.). I'm happy to address any of these points as they come up because these are very dense things to think about. I need to regularly walk myself through them. But when I start to see a pattern, I'm just not interested John.

    I've provided substantial "substance" and I'll continue to provide it on this blog and elsewhere. I've got a lot of other things to work on - grad applications, a book chapter, and several encyclopedia entries (and that's in my own time, to say nothing of what I get paid for). Marginal costs have exceeded marginal benefits for me in this conversation.

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  12. I did see your apology on Econlib, btw. And I appreciate the sentiment as far as the "heatedness" of the discussion, and I can I'm not interested in - and sorry for - any "heatedness" on my part. But even a renewed cordiality doesn't change the fact that I was ultimately spinning my wheels.

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  13. Wheel Spinning indeed (though it actually was quite helpful to me in clarifying my own thinking).Still, we are at an impasse. Enjoy your New Year.

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