I Don't Think This Is the Best Way to Put It... - 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, RealityBased, and Even-Handed Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; delong@econ.berkeley.edu.
Economics 210a Weblog Archives DeLong Hot on Google DeLong Hot on Google Blogsearch September 03, 2010
I Don't Think This Is the Best Way to Put It... Paul Krugman writes: Paradoxes Of Deleveraging And Releveraging: Whenever the issue of fiscal stimulus comes up, you can count on someone chiming in to say, “Only a moron could believe that the answer to a problem created by too much debt is to create even more debt.” It sounds plausible — but it misses the key point: there’s a fallacy of composition here... There is nothing wrong with what Paul says. But I think it is incomplete, and that there is a better way of getting to the right conclusion. The problem was created by too much risky debt and not enough safe debt. The result is that right now there is an excess demand for safe assets--like U.S. government securities. Because businesses and households want to hold more safe assets at full employment than exist, they are trying to cut back on their spending on currentlyproduced goods and services in order to build up their stocks of safe assets. As a group, when they try to do this they fail: building up the economy's stock of safe assets requires that somebody do something to create them. But as they try their cutbacks in spending on currently-produced goods and services produces the fall in production, income, and employment that has led us to our current situation. The best ways to get us out of this? (a) Have the government put people to work, and (b) have the government create more safe assets--more Treasury bonds--for people to hold. The first puts people to work. The second gives businesses and households more safe assets to hold so that they will be happy with their safe asset portfolios. Thus they will then stop trying to accumulate more safe assets, they will spend their incomes, and that will put more people back to work too.
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If our big problem were too much debt we would not be here, in depression. Too much debt generates inflation. The things that generate depression are shortages of financial assets, and excess demand for some class of financial assets then produces, by Walras's Law, excess supply of currently-produced goods and services. We had a "shortage of liquid cash money" recession in 1982; we had a "shortage of long-duration bonds" recession in 2002, and now we are having a "shortage of safe assets" recession. Brad DeLong on September 03, 2010 at 08:30 AM in Economics, Economics: Federal Reserve, Economics: Finance, Economics: Fiscal Policy, Economics: Macro, Obama Administration | Permalink Favorite
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Comments kdedeLC said... Sounds an awful lot like a recent lecture I heard.... Reply September 03, 2010 at 09:02 AM A said... "The problem was created by too much risky debt and not enough safe debt." Worse than that - a lot of the risky debt was bought by people who thought they were buying safe debt. Hence there is a massive overhang... Reply September 03, 2010 at 09:22 AM walt said in reply to kdedeLC... When I first arrived at Berkeley in the fall of 1964, the big event soon became the Free Speech Movement. I wonder if this fall it will be Econ 1, DeLong's "cast of thousands." Informal assignment for the students: find the locations of the nearest branches of BofA, Citi, Chase etc. Later in the semester, at the end of a class, you may feel like taking mass strolls to them. It's what Saul Alinsky and Mario Savio would have done. Reply September 03, 2010 at 09:23 AM Neal said... "Safe asset" shortage for households and businesses??? That's where the problem comes from??? With the rates today, there is no significant difference between holding Treasurys, cash, money market funds, insured certificates of deposit, or cash in an insured savings account in the scale of money holding that almost every individual and business in this country falls under. There is no shortage of "safe" places to put money (and get
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virtually no return). Its a plain asset/income shortage. We should be so lucky as to have a population that have excess assets/income to be squirreled away in "safe assets". Reply September 03, 2010 at 09:33 AM Omega Centauri said... I don't think I guite get it. Households (maybe businesses also, but thats not needed for this argument) want more safe assets. But, safe assets are not to be found, so they save more even though their is no perceived safe parking place for the money. One way to react to the perceived problem that your money and investents may not be safe is to spend it now, rather than risk losing it on a poor investment. I think you are implying that the desire to have "safe" assets means they either accumulate more not-so-safe assets, or perhaps just stuff their mattresses with cash. Theres a link to human psychology here that just isn't obvious to someone who hasn't been exposed to the proper micro arguments. Reply September 03, 2010 at 09:35 AM WoodyinNYC said... I don't get the whole argument either. There's some slip between households and Treasurys in my mind -- obviously I'm no economist! But I don't know any households holding Treasury bonds or trying to get more of them. Is it just me? I do see this connection: Households that I know have mortgages, car loans, credit cards. (If they've got college loans too, forgetabout it, they're doomed.) The asset value of the house has declined a good bit, wiping out their sense of financial security from that source. They can even be underwater with the mortgage. They look around, the safest surest "asset" they can get is "reduced debt". So they cut back spending and start paying down the revolving credit on their pocketful of credit cards. Good for them, but bad for the retailers and the mall owners etc. Those car loans, remember how they used to get a shiny new car every two or three years? Not this time. With the greatly improved reliability of cars, SUVs, pickups in recent years, they can put off buying a new one even after that car loan is paid in full. Good for them, but bad for dealers, Detroit and the transplants. Then with the money that used to go to car loans and credit card payments, maybe then they can shovel extra payments into that hell hole of a mortgage, trying to pay down the remaining principal until they can get above water. Good for them, but still bad for the retailers, the importers, the malls, the car dealers, and their employees. So paying down the debts, which has to be done, is good for individual households -until they become victims of the unemployment resulting from their reduced spending. Which gets us back to jobs, or the lack thereof, which is (a) on the list of problems Prof DeLong thinks the government must address. That part anyone can understand. Reply September 03, 2010 at 10:19 AM Gerard MacDonell said... I prefer Krugman's economy. Delong's distinction between risky and riskless debt seems a valid and useful one. I think it helps complete the argument. But when he offers it here as a correction to Krugman's construction, he offers comfort to a common misperception: that the cure can never involve a bit of the disease. In fact, the solution to problems caused by insufficient thrift in the past can indeed be http://delong.typepad.com/sdj/2010/09/i-dont-think-this-is-the-best-way-to-put-it.html
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policies that are designed to drive down (ex ante) national saving now. Delong offers nothing against this, in fairness. But Krugman's take challenges the prevailing ignorance more directly and cleanly. It is preferable in that regard. Reply September 03, 2010 at 10:24 AM Jim said... Why not go all the way and admit that the level of public debt is meaningless? Unlike private debt, society cannot owe something to itself. Why not spend through the printing press when we have massive unused resources? The political problem is that the contradictory position that a) we should deficit spend and b) deficits matter and can be dangerous is not sellable. It never has been. Center-left economists need to get outside the box, dust off Abba Lerner and the early Keynesians, and back the idea that the very notion of public debt is a meaningless confusion that only assures the continuation of right wing policies. Jim commentsongpe.wordpress.com Reply September 03, 2010 at 11:56 AM Min said... "If our big problem were too much debt we would not be here, in depression. Too much debt generates inflation." Well said! :) Reply September 03, 2010 at 12:15 PM Roman Berry said... Channeling Alan Simpson: Whaddaya mean more safe assets like US Treasury securities? Them things ain't safe assets. Them thing's just IOUs. Reply September 03, 2010 at 12:52 PM Foster Boondoggle said... I don't see that there's a "problem" of a shortage of safe assets. Yes, Treasury yields are at record lows. But there's no shortage of them - just a shortage of future returns... And to the extent that the low yields reflect some kind of shortage, doesn't Quantitative Easing increase that shortage? The problem with QE at this point is that it doesn't seem to work without fiscal policy biased towards increasing the deficit. If you take the banks out of the picture, QE amounts to the Fed buying the Treasury's debt. Both put their pieces of paper (or numbers in a computer) in their pockets and nothing else changes. If you add the banks to the picture, you just change that straight line into a triangle - the banks buy the Treasury's bonds & the Fed buys those from the banks. Again, nothing changes. Unless the Fed starts doing QE with risky assets, I don't see how monetary policy can get us anywhere. Which means 2+ more years of stagnation or worse, unless we get pulled out by Chinese consumers or some other external force. Reply September 03, 2010 at 01:39 PM jcb said... I'm not sure what you mean by a "safe asset." Do you just mean government bonds? In that case, selling a lot more of them would create deflation. Is there any asset so safe that it will guarantee a return above the rate of inflation or deflation? Do you mean assets that are fairly priced, for which risk is adequately advertised, and with commensurate return? In that case, it's the aim of acquiring any asset. And the
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definition becomes virtually tautological. This seems to be a debate between Richard Koo (channeled by PK) and J.S. Mill and Hyman Minsky (channeled by BD). I prefer Koo's balance sheet depression ("The Holy Grail of Macroeconomics") because it provides a better account of the relationship between public and private expenditure and GDP, supported by a great deal of empirical evidence from Japan and the U.S. And also because he provides a better situational account of economic motivation -sometimes fearful and cautious (paying down debt), sometimes optimistic (investing and profit maximizing). But he seems to focus entirely on corporations (that earn profits to pay down debt from where?), and not on consumers who need incomes to support effective demand (and are often at the receiving end of corporate cost-cutting). Hence, the overwhelming need for a jobs policy to support incomes, not tax cuts which will hasten debt repayment at the expense of effective demand. As "Neal" (above) said. And "Woody." The flight to safe assets is motivated by fear; when people are optimistic, they want profitable assets. Contra Mill, acquiring large stocks of money (or safe assets) is precautionary hoarding (for future consumption) or fear-induced (because no other asset seems safe). Money and government bonds are not assets like any other. They are also a financial refuge, not to be confused with a goal of economic policy -- although safer assets would assuredly be the byproduct of that policy. Reply September 03, 2010 at 02:43 PM scathew said... I think if you're taking econ yours is more succinct and fits better into the "science" of the issue. Paul's however I think is aimed at showing the problem in real human terms - it is a "political" document. That is, if I was talking to economics students I'd use yours, if I was talking to politicians or trying to sway lay people, I'd use his. Reply September 03, 2010 at 04:36 PM scathew said... BTW - I'm sorry but Obama sux. As channeled by Gibs: "Some big, new stimulus plan is not in the offing." Reply September 03, 2010 at 04:44 PM Full Employment Hawk said... "The result is that right now there is an excess demand for safe assets--like U.S. government securities. Because businesses and households want to hold more safe assets at full employment than exist, they are trying to cut back on their spending on currently-produced goods and services in order to build up their stocks of safe assets." The fallacy in this argument is that unlike the product and labor markets, where prices are sticky so that an excess supply or demand can persist for an extended period of time, prices in the bond market are highly flexible. If people want to hold more safe assets than exist, AT THE INITIAL PRICE OF THE SAFE ASSETS, the price of the safe assests are bid up until the quantity supplied and demanded are equal, so that there is no excess demand for safe assets that creates an excess supply for commodities. Reply September 03, 2010 at 05:51 PM Brad DeLong said in reply to Full Employment Hawk... So you are saying that we are at full employment right now?
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Yours, Brad DeLong Reply September 03, 2010 at 06:07 PM Full Employment Hawk said in reply to Brad DeLong... Absolutely not. What I am saying is that the excess supply in the commodity market is not being caused by an excess demand in the bond market. Prices in the bond market adjust almost instantaneously to eliminate any excess demand there so there is no excess demand there long enough to create an excess supply in the commodity market. The excess supply in the commodity market exists IN SPITE OF, INSTEAD OF BECAUSE OF the fact that there is no excess demand in the bond market. As Clower showed in his 1965 article "The Keynesian-Counter-Revolution," and was shown in the disequilibrium literature that followed from it: When transactions can take place and be finalized in one or more markets when they do not clear, Walras' Law does not hold. In other words, the sum of the excess demand in the bond and commodity market do not add up to zero. You have zero excess demand in the bond market and a positive excess supply in the commodity market. A good exposition of this approach is found in Hershel Grossman's paper "Money, Intest, and Prices in Market Disequilbrium" JPE Sept.-Oct. 1971, pp. 943-61. For a while this spawned a very promising literature on Disequilibrium Theory, which unfortunately was killed off by the New Classical Economics before it was able to get firmly established. So instead of having macro models that explicitly take the effects of non-market-clearing transactions into account, with cyclical unemployment being involuntary because the labor market is not clearing, we have Panglossian models in which all markets are instantaneously clearing and all unemployment is voluntary. Reply September 03, 2010 at 07:21 PM Full Employment Hawk said in reply to Full Employment Hawk... One minor tweak in the above reply "When transactions can take place and be finalize" should be "When transactions take place and are finalized" i.e. no auctioneer and no recontracting to prevent transactions from being finalized at non-market-clearing prices. Reply September 03, 2010 at 07:25 PM Sora said... I think your argument would be strengthened by walking the discussion away from the analogy of public debt to household debt. Most people seem to treat government securities like credit card debt. It seems to be a big turn-off that you are arguing that the best thing to do in hard times is get more credit cards rather than cut unnecessary spending. Of course, you might also want to make a distinction between prudent spending and wasteful pork. Unfortunately, the analogy to the 1940s falls apart, because what people really supported was military spending to win the war. People aren't nearly so supportive of road projects and the census. Reply September 03, 2010 at 09:21 PM Full Employment Hawk said... "than cut unnecessary spending" during hard times. Cutting any kind of spending at a time when the economy is depressed increases unemployment. Even pork puts unemployed workers to work. Even paying people to dig holes in the ground and fill them back up puts unemployed workers to work.
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Obviously it is better if the spending to put people to work is on things that increase the economy's potential output, like investment in infrastructure, but when it comes to putting people to work, even intrinsically wasteful spending will do the job. Reply September 04, 2010 at 04:45 AM Full Employment Hawk said in reply to Brad DeLong... If you publish your text using this approach, many others are going to point out that since the bond market is a flexible price market, the price of bonds will quickly adjust to clear it, so that there will be no excess demand in the bond market long enough to cause an excess supply in the commodity market. I'm only the FIRST one to have caught this. When this happens, remember I was the first one to point it out. I'm not trying to be rude. But this is an important point you need to consider. Reply September 04, 2010 at 11:03 AM yoyo said... No, you're mistaking stocks and flows. The creation of debt causes inflation, not the existence of debt. Reply September 04, 2010 at 12:31 PM Comments on this post are closed.
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and Friends
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