Two great posts are up by Paul Krugman and Nick Rowe on the problem people have accepting that we have a demand problem.
Krugman starts, and marvels that the very idea that we could have an effective demand problem is so repugnant to people. The post is mostly just expressions of dismay, but he mentions a few interesting things. First, the baby-sitting co-op experience. This is a fascinating little episode and if you're not familiar with it you should click through the link. It's a microcosmic example of a monetary disequilibrium, demand side depression. George Mason University does lots of experimental tests of microeconomic phenomenon and the market process. I wish they'd do macroeconomic experiments like this one - perhaps with free bankers and a central banker? The other interesting point that Krugman raises is that the Monetarist advocates of a monetary disequilibrium theory are really - in the eyes of the intellectual vandals jettisoning demand-side thinking - just as bad as Keynes. I think this is basically right. One thing that he does not seem to be aware of is that by the same token there are monetary-disequilibrium Austrians out there too that offer an important in-road that simply isn't available in the RBC or New Classical side of the demand-skeptic camp.
Nick Rowe follows up by highlighting "short-side thinking". What position would you rather be in right now - in the market to buy a product, or in the market to sell a product? In the market to buy a product, clearly. Rowe points out that there's obviously a limit to this. At some point, the tables turn and you start to get pressure on prices. Nick points out that because of the obviousness of "short-side thinking", what's really amazing is that anyone doubts the primacy of the demand side.
But there are good reasons to doubt - and the doubt has to do with the distinction between the long run and the short run. In the long run, secular growth is determined by the supply side: by capital accumulation and technological progress. But in the short run demand is largely the concern. I'll also refer people to a post from November by Peter Dorman that does a great job laying the microfoundations for these demand-side problems. He also references a prominent critic of socialist calculation, Janos Kornai. That's right - the logic of one of the most famous critics of socialism also leads to the expectation that market economies will be plagued by effective demand problems.
Tuesday, January 25, 2011
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This is classic ignorant Krugman.
ReplyDelete1. He never makes any mention of prices. The amount of hours - 1 - that each ticket was worth were PEGGED? The flexibility of prices is THE reason that changes in preferences - whether monetary or non-monetary - can be reflected by the activity of traders.
What so interesting is that Krugman doesn't even make mention of this aspect. Is he not aware of the importance of prices? That this is one of the main arguments of his opponents seems to go completely over his head.
2. What's so funny is that Krugman recognizes, without realizing it, the importance of prices. He suggest that some sort of Central Bank should be established that would serve as a more effective rationing device to curtail hoarding. Couples could borrow tickets in times of need and pay back the principal plus a premium when not in need.
This is standard AD, centralized decision-making, drivel. It is recognized that there needs to be a mechanism that properly the matches decisions of individuals, but the conclusion drawn is that that mechanism needs to be centrally designed and administered - the market simply can't handle hoarding. This is completely ignorant of all information problems - the nature of which are rarely brought up. If they are, then their importance is delegated to the back of the line.
This whole mode of reasoning would be like suggesting that natural selection is not effective enough at adapting species to new environments and that therefore some planning board should specifically modify various species according to some "rationally based" analysis. Anyone with any sense would consider this crazy. Its TOO COMPLEX to be planned - only more problems would result. Of course, advocates don't see the analogy with the economy.
3. This informational problem is touched, if only for a brief moment. It's importance is thrown to the waste side. Krugmans says, "Eventually, of course, the co-op issued too much scrip, leading to different problems ..." That's the extent to which he considers "AD tweaking" a problem - it's just a little snag in the overall operation. Of course, this one of the fundamental problems associated with any planning. How are the additional scrips to be distributed? What premium should the "Central Bank" places on tickets? What is the loss function used to weight the benefit against the costs? All advocates implicitly assume that the benefits obviously outweigh the consequences. We can't have "excess" capacity"!!!!
4. From reading Krugman's take, I found a couple of aspects about the experiment particularly strange. I only glanced at the actual paper - the plan is to read it tonight - but just from that, the conclusions that were drawn by the authors seem fundamentally different from Krugman's. For one thing, the pegging of prices is of fundamental importance, as recognized by the authors. And for another, there were various administrative problems. In other words, using this as an analogy for a market is suspect at best.
5. What I find most comical about the paper, or at least Krugman's interpretation, is that it in fact demonstrates the superiority of the market. Here we have group of people who want to plan, from the top down, a system of babysitting. The rules did not evolve naturally, nor the currency. There was no process of evolution involved. The system was a product of legislative decree. And naturally, a myriad of unforeseeable consequences, the result of a very complex process, resulted. F.A. Hayek is rolling in his grave - this is what he had been preaching against for latter part of his life!
All in all, I found this incredibly disheartening. I've rarely agreed with Krugman's views but I at least thought that he was capable of objectively assessing phenomena. This completely demonstrates the opposite.
Note that my post is about the '98 co-op article, not the AD post.
ReplyDeleteCan we critique people without calling them ignorant???
ReplyDelete1. Price was pegged, but remember there is one good in this market. Any fall in prices would have been tantamount to devaluation. I'm not sure how bad this is as a basic illustration. Would have prefered a few more goods with flexible prices? Of course. I think Krugman would prefer such an experiment too. We didn't have control over a baby-sitter co-op in the seventies. It's still instructive. But the fact that there's only one good, plus the cash, cuts down the problem considerably. You still ahve the fundamental overidentification problem that drives Keynesian monetary disequilibrium thinking. And don't be foolish - of course he understands prices. I'm forced to steeply discount the value of your comment when you ask questions like that.
2. Yes, it's not a perfect experimental test of a Keynesian central bank vs. free banking. It's an interesting illustration of the difference between a Keynesian central bank and a fixed supply of money. Your planning/natural selection analogy is absurd. Nobody is planning the allocation of any good. The allocative decisions are entirely market based. Demand management is simply not allocative planning. Stop pretending they're one and the same.
3. I think he is refering to inflation here. This is what the original article and accompanying comments refer to as well.
4. Different... how? They address two other issues that Krugman doesn't in his shorter, more accessible Slate article with the specific subject of a liquidity trap: namely, inflation and price controls. I understand that they cover more than Krugman. I'm struggling to understand where they differ from Krugman.
5. I'm not sure how you draw that conclusion. It compares two types of monetary economies. We can presume (although this doesn't demonstrate) that a monetary economy is more efficient than a non-monetary economy. I hope that's not controversial. Nothing here demonstrates that the monetary economies described are better or worse than, say, a free banking system. The co-op ran into a depression. It was still more prosperous than a non-monetary baby sitting co-op. That's the whole point. Also, a naturally evolved rule or currency isn't just sitting on your doorstep one morning. Social institutions like this evolve precisely the way the baby-sitter co-op did: free people trying things out. Don't drag Hayek down by juxtaposing the great economist with that.
1. The economy consisted of two goods. 1.) The scrip or "claims to babysitting" and 2.) babysitting itself. If there were truly only one good, what choice would need to be made? What basis would there be for trade? In the co-op the individual faces the choice between maintaining his claim or exchanging for babysitting. This is why pegging the price has such disastrous consequences. I guess I can see why you've confused it with a one-good economy, but in most standard economic models one of the goods is the numeraire - in this case that's the claim itself.
ReplyDeleteI have no doubt that Krugman knows what a price is. But do I think he comprehends it's importance? Not even close, as evidenced by the article, among other things. That he didn't make mention of the problem is obvious evidence for that conclusion. Where have I gone wrong?
2. First, if you think demand management doesn't have allocative effects, you're living in a dream world. May I ask how you carry out such a task so as to leave the relative properties unchanged? Moreover, in so far as there at least some allocative effects, something I imagine you agree with, on what basis can you rationally argue that the benefits out-weigh the costs? And I don't count something like, "well it's obvious that the gain obtained from utilizing "idle" resources outweigh the "minimal" loss from allocative effects." Nor will I be very convinced by any of the back-of-the-envelope, silly calculations. Do you know of an appropriate measure for the allocative loss? I do not, as it would by practically impossible to obtain one. Yet the zeal with which you seem convinced of it's minimal size seems to imply some sort of reasonable measure - on both ends. Can you inform me of this statistic? We're dealing with remarkably complex phenomena here. Anything on the basis of "feeling", which the substance of your argument seems to in part be based, has no weight with me.
I should also point at that even if we make the absurd assumption that demand management could raise spending in a manner which wouldn't distort allocations - there would still be a different type of allocation distortion that would result. Say that spending is uniformly lowered on all goods, e.g. from hoarding by individuals. This is equivalent to a reduction of the rate of money flow against the goods of all businessman. Since the rate at which various firms produce output is not uniform, different firms will be affected in different ways. Firms whose output is replenished very regularly, e.g. a grocery store, will lose a relatively much larger amount than a firm whose output only tends to mature much less frequently. The grocery store will experience enlarged inventories and so forth. This will result in released resources in the form of labor and intermediate goods. Firms with relatively longer production periods will absorb the resources as the fall in their price was such that it is still greater than the now reduced costs. Simply put, a reduction in spending tends to result in the individual stages of production becoming more "roundabout". This sort of process was called the "Ricardo Effect" by Hayek in "Profits, Interest, and Investment" - he provides a table to illustrate it in detail. In conclusion, spending by government will distort the real structure no matter how it is administered.
3. Inflation and shortages. My point was that you never know how much scrip - i.e. it's an informational problem.
4. I have not read the article in full yet. My comment was on the basis of the beginning of the authors "comment" to their own paper, in which they immediately acknowledged the problems caused by a constitutional peg of the scrip. No such problem was discussed by Krugman.
5. My point was not that experimentation as such is not a vital part of institutional evolution - of course it is. It was that Krugman's point rested on the idea that, as an experiment, it contained certain features which allowed for legitimate conclusions to be made with respect to a market system mediated by money. That the co-op was developed on the basis of untried rules and price pegs, and then tweaked in a central manner, completely disqualifies it as an object that can be compared to a modern market economy. A modern market economy is the product of many years of institutional evolution. It is therefore silly to make the comparison, especially when the failures of the system were a consequence of precisely those things which the modern market has solved. And don't be silly by invoking someone you demonstrate little familiarity with.
ReplyDeleteFor some reason it didn't seem to register the post.
ReplyDelete1. The economy consisted of two goods. 1.) The scrip or "claims to babysitting" and 2.) babysitting itself. If there were truly only one good, what choice would need to be made? What basis would there be for trade? In the co-op the individual faces the choice between maintaining his claim or exchanging for babysitting. This is why pegging the price has such disastrous consequences. I guess I can see why you've confused it with a one-good economy, but in most standard economic models one of the goods is the numeraire - in this case that's the claim itself.
I have no doubt that Krugman knows what a price is. But do I think he comprehends it's importance? Not even close, as evidenced by the article, among other things. That he didn't make mention of the problem is obvious evidence for that conclusion. Where have I gone wrong?
2. First, if you think demand management doesn't have allocative effects, you're living in a dream world. May I ask how you carry out such a task as to leave such properties unchanged? Moreover, in so far as there at least some allocative effects, something I imagine you agree with, on what basis can you rationally argue that the benefits out-weigh the costs? And I don't count something like, "well it's obvious that the gain obtained from utilizing "idle" resources outweigh the "minimal" allocative effects." Nor will I be very convinced by some back-of-the-envelope calculation. Do you know of an appropriate measure for the allocative loss? I do not, as it would by practically impossible to obtain one. Yet the zeal with which you seem convinced of it's minimal size seems to imply some sort of reasonable measure - on both ends. Can you inform me of this statistic? We're dealing with remarkably complex phenomena here. Anything on the basis of "feeling", which the substance of your argument seems to in part be based, has no weight with me.
I should also point out at that even if we make the absurd assumption that demand management could raise spending in a manner which wouldn't distort allocations - there would still be a different type of allocation distortion that would result. Say that spending is uniformly lowered on all goods, e.g. from hoarding by individuals. This is equivalent to a reduction of the rate of money flow against the goods of all businessman. Since the rate at which various firms produce output is not uniform, different firms will be affected in different ways. Firms whose output is replenished very regularly, e.g. a grocery store, will lose a relatively much larger amount than a firm whose output only tends to mature much less frequently. The grocery store will experience enlarged inventories and so forth. This will result in released resources in the form of labor and intermediate goods. Firms with relatively longer production periods will absorb the resources as the fall in their price will be such that it is greater than the now reduced costs. Simply put, a reduction in spending tends to result in the individual stages of production becoming more "roundabout". This sort of process was called the "Ricardo Effect" by Hayek in "Profits, Interest, and Investment" - he provides a table to illustrate it in detail. In conclusion, spending by government will distort the real structure no matter how it is administered.
3. Inflation AND shortages. My point was that you never know HOW MUCH scrip - i.e. it's an informational problem.
4. I have not read the article in full yet. My comment was on the basis of the beginning of the authors comment, in which they immediately acknowledged the problems caused by a constitutional peg of the scrip. No such problem was discussed by Krugman.
EdP - its not a confusion. If you want to call the scrip a "good" then clearly it's a two good economy. No confusion - just different terminology.
ReplyDeleteFirst, if you think demand management doesn't have allocative effects, you're living in a dream world.
When did I say that? What I said is that demand management isn't allocative planning. That is the job of the market. Certainly it has allocative effects. Sometimes the allocative effects are deliberate (ie - demand management in a form that specifically benefits low income populations or well connected banks). But it's entirely different from the task that the price mechanism is accomplishing. Krugman didn't mention the price mechanism because he's not talking about allocative efficiency. You're focusing on that because you're conflating the two, and because you're stumbling on the fact that a baby-sitting group isn't the best economci experiment.
Your zeal seems to work off the opposite assumption - the allocative inefficiencies outweigh the aggregate inefficiencies. Do you have any reason for thinking that? We are seeing pretty good signs of aggregate inefficiency. Can you point to any signs of substantial allocative inefficiency??? You don't seem interested in sharing them if you do. And if there is allocative inefficiency (of which I've been provided no evidence), on what side do those inefficiencies err??? They err on the side of benefiting working families and public investments. You're not going to find me losing a lot of sleep over that.
The best way to get the most efficient market allocation is to have the market operating and the price mechanism functioning at full employment.
"Inflation AND shortages. My point was that you never know HOW MUCH scrip - i.e. it's an informational problem."
Of course it is - who said it wasn't? The point is, some informational problems can be corrected by the price mechanism. There is no reason to expect this would. And we have signs for "how much" is too much. There is an information problem but that doesn't mean its an information problem the market is able to solve and it doesn't mean we're flying completely blind.