And We Are Live at the Financial Times... - Grasping Reality with Both Hands
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Grasping Reality with Both Hands The Semi-Daily Journal of Economist J. Bradford DeLong: Fair, Balanced, Reality-Based, and Even-Handed Department of Economics, U.C. Berkeley #3880, Berkeley, CA 947203880; 925 708 0467; delong@econ.berkeley.edu.
Economics 210a Weblog Archives DeLong Hot on Google DeLong Hot on Google Blogsearch July 19, 2010
And We Are Live at the Financial Times... It is far too soon to end expansion... My original draft: In 1829 the thenyoung economist John Stuart Mill put his finger on how it could be that there could be excess supply of everything in the economy--of pretty much all currently produced goods and services and pretty much all kinds of workers. Previous economists had asserted a "metaphysical necessity" that excess supply of one commodity be matched by excess demand for another: that if there were unemployed cobblers then there were desperate consumers frantically looking for more seamstresses, and thus that the http://delong.typepad.com/sdj/2010/07/and-we-are-live-at-the-financial-times.html
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economy's problems were never those of a general shortage of demand but of structural adjustment instead. These previous economists, John Stuart Mill was the first to point out, had forgotten about the financial sector. If there was an excess demand for some set of financial assets, then there could be an excess supply of everything else--what they used to call a "general glut," and what we now call a depression. But what is the financial excess demand, exactly? Friedmanite monetarist dogma says that the key financial excess demand is always and everywhere for money--and you can always cure depression by bringing the money supply up so that there would no longer be excess demand for money. Hicksian doctrine says the key financial excess demand is almost invariably a demand for bonds--for vehicles to transport purchasing power in the form of savings from the present into the future--and you can almost invariably cure the depression by (i) raising business confidence so that they would issue more bonds and build capacity or (ii) getting the government to borrow and spend and so boost the supply of bonds. The Minskyites have a different take. The Minskyites say that the monetarists and the Hicksians (usually called Keynesians, much to the distress of many who actually knew Keynes) are sometimes right but definitely wrong when the chips are down and a big depression is the result of a financial crisis. Then the key financial excess demand is for high-quality assets: safe financial places in which you could park your wealth and still be confident it would be there when you returned. After a panic, Hyman Minsky and his (few) allies argued, boosting the money stock would fail. Cash is a high-quality asset, true, but even big proportional boosts to the economy's cash supply are small potatoes in the total stock of assets and would not do much to satisfy the key financial excess demand. Trying to boost investment would not work either, for there was no excess demand for the risky claims to future wealth that are private bonds. The right cure, Minsky and his allies argued, was the government as "lender of last resort": increase the supply of safe high-quality assets that the private sector can hold by every means possible: printing cash, creating reserve deposits, printing up safe high-quality government bonds and using the proceeds to buy goods and services, printing up safe high-quality government bonds and then swapping them out into the private market in return for risky assets. When the government prints up cash and swaps it out for government bonds, we call that expansionary monetary policy. When the http://delong.typepad.com/sdj/2010/07/and-we-are-live-at-the-financial-times.html
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government prints up bonds and uses them to buy goods and services, we call that expansionary fiscal policy. When it prints up cash and bonds and swaps them for risky private financial assets or guarantees private assets we call that banking policy. All of these, the Minskyites say, have their place and should be pursued now--not as Friedmanite monetarism or Hicksian fiscalism, but instead as ways to boost the supply of high-quality financial assets that are in such extraordinary demand now. But what happens should a government's printing press print more bonds than investors think it will dare to raise future taxes to pay off? What happens when a government's debts are no longer regarded as safe? Then policies of monetary or fiscal expansion or of banking sector asset swaps and guarantees do not boost but reduce the supply of safe high-quality assets: they move government paper out of the "safe" and into the "risky" category. We saw this in Austria in 1931 and in East Asia in 1997-8 and in Greece right now. Then not expansion but rather austerity to restore confidence in the safety and quality of government liabilities is the best a government can do to attempt to relieve depression--that and cry for help from outside. Here we have the crux: Right now Greece and Ireland and Spain and Portugal and Italy need to be austere. But Germany and Britain and America and Japan do not. With their debts valued by the market at heights I had never thought to see in my lifetime, the best thing that they can do to relieve the global depression is to engage in coordinated global expansion: expansionary fiscal policy, expansionary monetary policy, and expansionary banking policy are all called for on a titanic scale. But, the members of the Pain Caucus say, how will we know when we have reached the limits of expansion? How will we know when we need to stop because the next hundred billion tranche of debt will permanently and irreversibly crack market confidence in dollar or sterling or deutschmark or yen assets? Will shrink rather than increase the supply of high-quality financial assets the world market today so desperately wants? And send us spiraling down? Trust me, we will know when the time comes to stop expansion. Financial markets will tell us. And not by whispering in a still, small voice. Trust me, we will know, and right now we are still very, very far from that point indeed. http://delong.typepad.com/sdj/2010/07/and-we-are-live-at-the-financial-times.html
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940 words: July 15, 2010 Brad DeLong on July 19, 2010 at 03:10 PM in Economics, Economics: Federal Reserve, Economics: Finance, Economics: Fiscal Policy, Economics: Great Depression, Economics: History, Economics: Macro, History, Obama Administration | Permalink Favorite
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Comments dd said... "many whom actually knew Keynes"? Reply July 19, 2010 at 04:10 PM Steve Bannister said... I am usually loathe to criticize the historians. I almost always learn something useful from them. And, interestingly, their ideology is almost independent of their usefulness. Ferguson demolishes that general relationship and trust. He is either an idiot, or an a**hole, or both. Now, these are highly technical terms, gleaned and internalized with great mathematical difficulty and study in several economic history classes from people I have come to fully trust and completely respect. So much for the marginal theory of factor compensation. Brad. Get a raise, rescue the theory! Well, maybe not that far. But, jeez, get a raise!
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Reply July 19, 2010 at 05:22 PM Nick R said... Brilliant piece.....but what about "sudden stop?" Or should we just go for it the way Japan has for the past 20 years? Nick R. Kyoto Reply July 19, 2010 at 11:02 PM Anon said... I would still let the Bush income tax cuts expire. Reply July 20, 2010 at 03:07 AM enric said... Sorry DeLong... you are worng on one (or two or three) accounts (countries)... Spain and Italy and Portugal (and Ireland by the way) do not need austerity.... what Italy, Spain, Portugal and even Germany (though they do not know it) need is a 3% core inflation. I have never read a serious argument claiming that expectation of inflation in a liquidity trap is not the best solution. Krugman said it once... and Krugman is (almost?) always right. We need inflation, we need printing money, we need to monetize all debt until we reach the inflation target...In your framework it eliminates the desire for safety assets towards cash money. In Europe you have a bonus it reduces private and public debt. And of course, there is Greece... which basically needs a default and a program so that the Greek masters pay taxes (not an austerity program on the low-income earners). Sincerely yours.
Reply July 20, 2010 at 04:38 AM bakho said... Excellent piece. Is a discussion of the adverse effects of wealth inequality missing? Is there not a mis-match between resources and unmet demand? Those with the most unmet demand (both individuals and countries) lack money and resources. All they have to trade is labor which is in excess supply. Those with excess supply have little unmet demand, but have resources and money.
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The structural problem is to create new unmet demand among those who have excess money and to provide money to those who have current unmet demand (Ex: Thoma's deficit neutral stimulus). Reply July 20, 2010 at 07:03 AM Andy Harless said... I don't understand the Minsky argument as you present it. Provided that both safe and risky assets are presumed to exist in reasonable quantities, there is a reason to issue more safe assets, because portfolio balance effects will then increase the demand for risky assets. But if all the safe assets become unsafe, ins't that just tough noogies for the people who want to own them? People can't go to Mars to buy safe assets. If the safe assets don't exist on Earth, they'll have to own risky assets instead. And moreover, if all the American safe assets become unsafe, but there are still safe assets abroad, doesn't that just mean that the value of the dollar will decline and produce enough export demand to solve the domestic glut? The only reason to maintain confidence in domestic safe assets is out of international altruism. Reply July 20, 2010 at 07:43 AM Roland Buck said... This is a very clever hypothesis, but it has a fatal flaw: To have an excess demand in any market, the price of the good involved has to be sticky, so that it does not change quickly in the face of the excess demand. If the price adjustment is instantaneous, no excess demand will be observed at all, and if it is fast, the excess demand does not last long enough to cause an extended period of excess supply in other markets, like for output and labor. Markets for financial assets are highly flexible upward. (They are also highly flexible downward unless there is credit rationing, which involves sticky prices.) Therefore if there is an incipiant excess demand for bonds, the price of bonds will adjust upward almost instantaneously so an excess demand for bonds will not last long enough to cause an extended period of excess supply in the commodity and labor markets. Therefore this cannot explain long periods of recessions and high unemployment. The same thing is true with the market for safe assets. Again, their price will shoot upward quickly so that an excess demand for them will not last long enough to cause an extended period of excess supply in the product or labor market. The case of an excess demand for money is more complex because there http://delong.typepad.com/sdj/2010/07/and-we-are-live-at-the-financial-times.html
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is no explicit money market in the sense of a particular trading post in which money is traded. The "money market" is simply the mirror image of all other markets in which money is used as a medium of exchange. If there is an excess demand for money the excess demand will quickly be eliminated by the sale of financial assets in the bond market. This will cause an excess supply in the bond market, which, unless there is credit rationing, will also be eliminated very quickly, so that the excess demand for money is very quickly eliminated though the sale of bonds so that there will not be an excess demand for money that lasts long enough to cause an extended period of excess supply in the commodity and labor markets. Therefore this type of reasoning does not stand up to critical analysis. Reply July 20, 2010 at 11:35 AM Roland Buck said... Clower's dual-decision hypothesis and the non-market-clearing literature that developed from it (now, unfortunately largely forgotten, a great loss for macroeconomics) show that if prices are sticky in the product and labor market, you can have excess supplies in both of these markets without any excess demand in any other markets, so that Walras' Law does not hold. Suppose that, for some reason, households consume less of their income than before. Therefore the demand for output in the product market drops. With prices sticky, this does not cause an immediate drop in the price for output. Instead, there is an excess supply in the product market. Firms respond to this excess supply by producing less than they would if they could sell all they wanted at the existing prices. Therefore they demand fewer workers. This produces an excess supply in the labor market. With wages sticky this excess supply is not eliminated. With workers earning less than if they could sell all the labor they would like to, they buy fewer goods in the product market further increasing the excess supply in this market, causing firms to produce still less. Therefore we get a Keynesian mulitiplier. Note that we have excess supply in both the product and labor markets with no excess demands in any other markets. Therefore Walras' Law does not hold. This phenomenon occurs if there are sticky prices and transactions can take place and be finalized when markets do not clear. Reply July 20, 2010 at 11:52 AM kharris said... I realize that, once the right wing in US politics makes an expression http://delong.typepad.com/sdj/2010/07/and-we-are-live-at-the-financial-times.html
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fashionable, centrist Democrats will mindlessly adopt the expression, too. What on earth does a "still, small voice" have to do with interest rates? Reply July 20, 2010 at 11:53 AM Kevin Donoghue said... Roland Buck at 11:52 seems to be explaining where Roland Buck at 11:35 goes wrong: an excess demand for a safe asset can be eliminated by a reduction in income, rather than an increase in price. Keynes (GT Ch 17) toyed with the idea that excess demand for land and other inelastically-supplied real assets could result in a slump. Reply July 20, 2010 at 12:27 PM Roland Buck said in reply to Kevin Donoghue... There is no contradiction. The difference is whether prices in a PARTICULAR MARKET are flexible or sticky. With markets where prices adjust quickly, price adjustement quickly eliminates any incipient excess demands and supplies IN THAT PARTICULAR MARKET. (With perfect flexible price adjustment the excess demand never actually affects quantity at all.) Markets for bonds and other traded finacial assets are highly flexible upwards (and also downward if there is no credit rationing). So excess demands in these market quickly get eliminated by adjustents in the price of the financial assets. Therefore no significant excess demand in these markets arises that can cause large, long, excess demands in the product and output markets. This is what happens in the 11:35 message. When prices are sticky and rapid price adjustments cannot do this quantity adjustements take place. This is what happens in the 11:52 message. Prices in product and labor markets are sticky. Therefore price adjustments do not eliminate the excess supplies. The excess supply in the product market causes the excess supply in the labor market, which, in turn reinforces the excess supply in the product market, giving us a Keynesian multiplier. Both the product and labor market are in exess supply while no market is in excess demand. Walras' Law does not hold Reply July 20, 2010 at 04:23 PM Roland Buck said in reply to Roland Buck... That should be "that can cause large, long, excess SUPPLIES in the product and output markets." Reply July 20, 2010 at 04:27 PM Sondre said... The thing I found most interesting about this article was seeing into a http://delong.typepad.com/sdj/2010/07/and-we-are-live-at-the-financial-times.html
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keynsian mind, the supply an option for "postponing into the future". I personally think this has little to do with reality (well, look at Japan for analogy), but that's another matter. Secondly I found it very interesting that this "austerity vs stimulus" debate had 4 people on one side and 1 on the other. "Columnsspace for austerity-bashing-debate" would be more fitting. Oh, and another thing. I truly enjoyed your last comment, "believe me, you'll know". Because as with Greece, when financial markets tell you how badly you've messed up - it's already too late. Reply July 21, 2010 at 04:55 AM Comments on this post are closed.
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Rauchway and Friends John Holbo and Friends
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