Tyler Cowen asks whether the downturn is "all about aggregate demand" as he cites restaurant and retail reports that don't look all that bad. Karl Smith makes a basic point that may end the discussion. He writes:
"Something I don’t have a macro-theoretical explanation for but have divined from experience is that people in general and managers in particular think of the market climate in terms of rates of change.
Business is doing well if business is doing better. Business is doing poorly if business is doing worse. This is irrespective of where they are compared to some baseline."
When the baseline is the bottom of a Great Recession, then yes - it does look like we've had growth. The question is, is that growth on track with long-term trends? The answer is not at all - it's still well below trend.
That may do it. But I'd be remiss if I didn't point out that restaurants and retail doesn't lead us out of a Keynesian recession like this one. Consumptionism is what they teach high schoolers when they learn about FDR and the 30s. We shouldn't fall into it here.
When firms make investments they are comparing an up front cost (or potentially a stream of costs) with a stream of uncertain benefits. One alternative opportunity to making that investment that they have is putting their money at interest - so the interest rate is an important opportunity cost for firms. When the intereset rate is too high because money demand is too high, or when expectations for future streams of income break discontinuously, you can get heavy volatility in investment - we call this "the business cycle". Often, monetary policy has sufficient flexibility to adjust the interest rate and recover full employment. Sometimes, it doesn't, either because there is a lower bound on monetary policy (ZIRP) or because money demand is so elastic monetary policy can't get traction (liquidity trap). It seems to me the latter is more serious but less likely than the former - but the discipline is still duking that out. Consumption plays much less of a role in all of this than a lot of people like to pretend it does. Keynes figured it was pretty stable and didn't talk about it too much. "Aggregate demand", for all intents and purposes, refers to (1.) investment demand, and (2.) change in consumption demand in response to the multiplier, or the movement of the Keynesian cross. Consumption doesn't lead recoveries (well - I suppose you could argue that reassessments of future consumption levels do - but that doesn't seem like it's being discussed here).
I talk more about Keynesianism vs. consumptionism here. They're related insofar as the cruder consumptionist theories did not presume full employment and so they predisposed people towards Keynesianism. You could say that consumptionists were in the right mindset to adopt Keynesianism. They were "wrong for the right reasons", and for that reason I actually do have a soft spot for underconsumptionists (and overproductionists, for that matter). But they didn't quite get it. This isn't to say that consumption increases are bad for the economy, of course. If they're exogenous that helps - if they're endogenous then it's a sign of at least some recovery. These changes simply don't get at the central point.
Sunday, May 8, 2011
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One alternative opportunity to making that investment that they have is putting their money at interest - so the interest rate is an important opportunity cost for firms.
ReplyDeleteI thought the interest rate was determined by cash balances - not saved capital.
When the intereset rate is too high because money demand is too high, or when expectations for future streams of income break discontinuously, you can get heavy volatility in investment - we call this "the business cycle".
1) Wait, now it's determined by money demand?
2) The business cycle is not about investment volatility. If that were true, we'd see one every time we go to war, face a natural disaster, invent something huge, etc. Unless you want to argue RBCT this is way off. You know that.
"Aggregate demand", for all intents and purposes, refers to (1.) investment demand, and (2.) change in consumption demand in response to the multiplier, or the movement of the Keynesian cross.
Do you see why this sounds silly? The whole theory of why an economy turns down is because 1)people aren't investing in enough machinery, or 2)people change their consumption patterns.
No mention of money or credit, no mention of inflation, fractional reserve banking, or lending. No mention of capital structure, no mention of time preferences... How can people take AD arguments seriously?
If all aggregate demand arguments boil down to "people aren't buying enough stuff," I'm sorry - that's a pedestrian observation masquerading as professional diagnosis.
re: "I thought the interest rate was determined by cash balances - not saved capital."
ReplyDelete1. Keynes thought yes, but that doesn't mean it isn't paid on savings. Come on Mattheus. 2. Hicks any many others, including that DeLong post I've shared with you a couple times now and most of the way I talk about it is that the interest rate is one price operating in two markets. We don't all take the past economists we admire as gospel truth.
re: "1) Wait, now it's determined by money demand?"
What do you mean "now" and why do you have the question mark at the end of that?
re: "2) The business cycle is not about investment volatility. If that were true, we'd see one every time we go to war, face a natural disaster, invent something huge, etc. Unless you want to argue RBCT this is way off. You know that."
This sentence does not make sense Mattheus. Why does the fact that "the business cycle" is essentially synonymous with "the cyclical volatility of investment" imply anything about war, disaster, or RBCT???? Care to elaborate on this insight of yours a little?
re: "No mention of money or credit"
HUH?!?!!? Do you read my posts or just start writing comments?
re: "no mention of inflation, fractional reserve banking, or lending. No mention of capital structure"
Right. These may not be entirely irrelevant in all cases and there are certainly interesting things to say about each of them - but one can present a reasonable explanation without them in this case.
re: "If all aggregate demand arguments boil down to "people aren't buying enough stuff," I'm sorry - that's a pedestrian observation masquerading as professional diagnosis."
Do you have any concept at all about why I write these posts about consumptionism vs. Keynesianism? If you think the argument boils down to "people aren't buying enough stuff" you don't seem to. The whole point of all these consumptionism posts is precisely to debunk the idea that "people aren't buying enough" is the argument that's being made. What do you expect me to say to this, Mattheus? I don't know if I should ignore it or take it as a defeat and a failure on my part that you would actually write that - that that is actually your understanding of what is being said. Is that really what you read into this post? Is that really what you read into this blog?