Macro Miscommunication: How Keynesians and the Right Misunderstand Each Other

Not sure where should I place myself, but I never quite understood what – actually – is ‘aggregate demand’. The same with the ‘circular flow’ model which seems to me a little pointless. I always found using the ‘P’ (price level) at the model level very unsystematic (P is by definition a number generated by the ‘Ministry of Statistics’; it’s as if you put ‘index of economic liberty’ into mathematic models; I have never seen a consistent definition of P that wouldn’t rely on ‘Ministry of Statistics).

And, finally, I am not sure what ‘would work’ should mean in this case. Maybe that’s because nobody said what is actually ‘broken’.

If I heard in private sector ‘let’s spend a billion of dollars on something and the problems will go away’, I would bet, that the company will not solve any problem this way. Yet, that’s more or less what Keynessians say.

As for the wage rigidity: I did search for the studies and I am confused:
– most of the studies study behaviour of firms in normal economic conditions. In a crisis many firms behave differently and you did actually see many firms cutting significantly;
– the studies often conclude that the wage rigidity applies to different groups differently; you have a lot of self-employed where it obviously does not apply; it mostly doesn’t apply to recently-hired people and it applies more to senior positions;

Given these findings, I would say that there is a huge group of people to whom the wage rigidity does not apply; people can move between the groups. Why should such a rigidity cause large-scale unemployment? It shouldn’t be that hard to arbitrage it away..

I don’t think you need crazy monetary policy or crazy government spending to pull out of a down turn. What you need is to clear the market as quickly as possible. When a firm goes bankrupt, no wealth is lost–it merely changes hands. When a house is lost to foreclosure the same situation occurs. No wealth is lost in the foreclosure; the house just changes hands. Where wealth is lost, is in lost productivity and accelerated depreciation during the time it takes to change hands. Productive assets derive their value from production. If they are not producing, their value is lost for the time they are shut down. The accelerated depreciation comes from the fact that assets in limbo are not guarded and maintained. Think of the house with fish in the swimming pool and squatters inside. There is nobody to fix the leaky roof which destroys the house. The key to getting out of an economic fix has nothing to do with Keynes or monetary policy. What you need to get the markets cleared as fast as possible. It’s like pulling off a bandage. The faster you do it, the less painful it will be. What governments do during downturns is to try and prevent this painful process from occurring at all. All they accomplish is dragging out the pain and destroying wealth.

Decades in the biz or not, I think you’re wrong about what “right-wing non-economists” think. We actually think printing money increases prices (inflation), not demand. Moreover, most of us think printing money is a substitute for increasing taxes.

Since printing money (inflation) transfers resources from private actors to the government and its cronies (e.g., big banker execs) it decreases demand overall because of deadweight loss and transaction costs. (Of course we understand that government workers and government cronies may demand more luxuries, but their gains come at the expense of normal people who are left with fewer resources so they demand less).

You are correct, however, that we think QE won’t work because increased spending of inflated fiat money will not lead to increased employment or output. We think QE will merely push up prices and transfer productive resources to government workers and cronies, who will blow said resources on luxuries– or at the least awful, buy assets to be mismanaged by themselves instead of being put to their highest and best uses by private actors. Since inflation, like taxation, comes with deadweight loss etc., we think QE will result in less employment and output.

Cushman:

Firms fail all the time without there being a recession.

You are making an error in assuming that a recession is the same thing as a single firm failing. As soon as the firm is reoganized then it can start again. Or something like that.

Well, really, what happens when particular firms fail, usually, is that they permanently shrink in size–use fewer resources and produce less product. Resources, including labor, are shifted to expanding areas of the economy. This is an economy that is prospering. This is _normal_.

A situation when may sectors of the economy are shrinking, freeing up resources, but few if any sectors are growing–needing the additional resources–is a recession.

The problem is that spending in total is too low. However, the only way that can exist is if the demand to hold money is greater than the quantity of money.

One solution is for the price level (including wages) to fall enough so that the real quanity of money equals the amount people want to hold. At the same time, real expenditures on goods and services will rise to match the productive capacity of the economy. That _means_ that the demands for some goods and services will rise faster than the demands for other goods and services fall. That is, that the resources freed up in shinking industries will be needed to produce goods in the growing industries.

The other solution is for the nominal quantity of money to rise enough so that it equals the demand to hold money, and so money expenditures grow. The demand for some goods can still fall, some firms can go bankrupt, some workers laid off, but the whole point is to free up the resources to produce other goods and services, those for which spending rises, those which people want to buy the most.

Or, of course, there is a third possibility. People could just choose to hold less money. And that, I think, is what you are implicitly assuming. People are holding more money for now, and then, once we work out these problems that are like bankruptcy by a single firm, then people will choose to hold less money, and so spending will recover. We just need to wait for this adjustment.

Your error is to fail to see that the adjustments that are needed is a shift in resources, including labor, between industries. And that there is no need to wait for a time before starting the adjustment. Let’s just pause, and have many poeple do nothing, and then, after a while, we can start expanding something else.

The market process at a given quantity of money is the lower price level. That works slowly, and the alternative is what you call “crazy” monetary policies.

In {P,Y} space printing money is a bit like relabeling the divisions along the P axis. The AD curve doesn’t go anywhere, really.

Of course that’s too simple, because we don’t just give everyone the same proportion of new money like with a stock split. We give some people more and others less. Aggregate demand stays about the same (maybe shifting a little because of deadweight loss, etc.) but if we could disaggregate it we would see many shifts in demand by various actors.

(Inflation tends to transfer real goods from private actors to government/crony actors, from employees to employers, and from creditors/savers to debtors; e.g., from depositors to banks. Tax “bracket creep” exacerbates the first effect.)

Although money acts, in the short run, as “the most liquid commodity” (medium of exchange, etc.), in the long run, fiat money is just a rubber ruler for measuring the relative values of real goods and services, its length constantly distorted by central-bank machinations.

So many people so desperately wish money to be a “real” commodity so they can save “money” rather than stockpile goods or make investments,* that many of them simply delude themselves that what they wish is true. Then they assume changes in money supply right out of their analyses of changes in price levels. In fact, only relative prices (that is, among various goods and services) are very meaningful in a fiat-money economy, though we mustn’t neglect people’s money holdings at any given time.

The worst are the pretenders-to-wisdom like Paul Krugman, who really seems to think that newly printed money has some intrinsic value which can be traded for new real goods and services. Of course he is delusional; printing money can change the distribution of goods and services but not the quantity, except to the modest extent that some people (foolishly, wrongly) feel richer when they have more quatloos of less value so they inadvertently (spend their savings/eat their seed corn) in an Austrian fashion producing a temporary boom.

*Of course bank-account/money-market balances are “investments” but many people don’t understand that very clearly and thanks to the government such accounts pay virtually no interest/dividends at the moment. For good reasons, such investments wouldn’t pay much even without government manipulation.

The right-wingers are wrong to think that printing money increases demand. The Fed issues $100, and gets a $100 bond from the public. Nobody’s net worth is changed, so there’s no change in demand for goods.

The Keynesians are wrong because, well, where to begin? For starters, they think the government can make us richer by burying bottles of cash in coal mines.

Lee Kelly:

You have to ask why that money was issued in the first place and why people chose to spend it, rather than, say, returning it to the Fed or letting it sit in a drawer.

If a certain community used nothing but 1 oz. silver coins, and if, for some reason, someone minted 100 new coins, then somewhere in the economy, 100 coins would be melted back to bullion or stamped into spoons, forks, candlesticks, etc. Nothing would happen to the number of coins spent at the grocery store, and nothing would happen to the price of groceries. That’s the Law of Reflux in action. The reflux works even more easily for paper money, since paper can easily reflux to the issuer without the expense of melting silver.

Mike Sproul,

M*V = P*Y = AD

All else being equal, AD rises when the Fed increases M. To hold AD constant, you implicitly assume that V falls in proportion, but that implies the bonds sold were perfect substitutes for cash. This is false. Even short-term notes with near 0 interest rates are not perfect substitutes, but just closer substitutes. Long-term bonds with higher interest rates are certainly not perfect substitutes. While sellers may hold some of the money received from the Fed purchase, it is highly unlikely that all will go unspent.

Since the dollar is a fiat paper currency, it cannot be melted for a precious metal, and it cannot be redeemed at the Fed for any valuable asset. There is no reflux of notes to the Fed that forces it to contract its issuance. The Fed can issue as many, or as few, of its notes as it likes, and aside fluctuations in money demand, has almost complete authority over the level of AD.

Lee Kelly:

You give a fine description of the operation of the Law of Reflux for silver coins. If there is increased need for silver coins in trade, then bullion will be stamped into coins, and there will be a small rise in the price of silver. A fall in the need for silver coins will have the reverse effect. But of course this means that if someone just minted 100 coins on a whim, then that many coins would reflux to bullion, and the price of groceries would not change.

But let’s focus more on paper money. Suppose a free-banking world where people trade with dollar bills, each redeemable by its issuer for either 1 oz. of silver or for other goods (land) with a market value of 1 oz. of silver. When business picks up and people need more dollars, they sign over title to 1 oz. worth of land to the issuer of dollars. If business slows, and people need fewer dollars, they bring their dollars back to the issuer and get back their land titles. Would you agree that in this case, the issuance and reflux of dollars would happen with only negligible effect on the value of land, silver, and dollars?

(I also have plenty to say about MV=PY, and about fiat money, but I’ll keep it short for now.)

Lee Kelly,

The typical story of the recession espoused by libertarians and conservatives has an interesting implication: unemployment has risen because that is the most efficient use of labour.

Indeed, that’s my view. With one minor adjustment: it’s the most efficient use of labor given the web of minimum wages, taxes, regulations, etc. etc. that make labor far more expensive to ‘purchase’ than might otherwise be the case.

For many if not most unemployed people, you can fairly ask: what, exactly, would it be worth paying them minimum wage + benefits + paperwork + etc. to do? Send emails to each other? No. The answer in many cases is: ‘not very much’. (If you had a better answer, you’d implement it and make money. But you don’t so you don’t; no one does.)

As for whether unemployment is ‘too high’ to be well explained by this factor, that’s not obvious. Says who?