Macroeconomics without Supply

by on December 29, 2008 at 7:35 am in Economics | Permalink

Paul Krugman writes:

…if you believe that a surge in private spending would raise employment – and even the critics agree on that – it’s very hard to explain why a surge of public spending wouldn’t have the same effect.

Brad DeLong writes:

But surely we believe that if the U.S. government were to follow the Countrywide plan–to send its representatives out onto the streets to have them walk up to people and say: "Here’s $500,000. You can have it if you go buy a house"–then that would drive a recovery, right?

What’s interesting about these statements is not so much whether they are right or wrong (let’s just say that it depends) but that Krugman and DeLong are so immersed in the Keynesian viewpoint that they cannot even see any other way of looking at the issue. Thus "even the critics" and "but surely we believe," as if no other view were conceivable.

Well if the only frame you can see is the "spending increases employment" frame then whether the spending is private or public may seem like a niggle. But many of the critics of mass fiscal stimulus have an alternative frame in mind, namely, that "employment increases spending."

Frame the issue this way and it becomes clear that the choice between private employment and public employment as a driver of spending is crucial.  Moreover, when we remember that employment drives spending we focus attention on the real allocation of labor and capital across sectors of the economy, on internal and external fiscal balance, on investment as well as on consumption and on time paths of development. The "spending drives employment" frame misses all this.

fusion December 29, 2008 at 7:45 am

It’s easy to see how to increase spending (and therefore employment). How are we to increase employment in the short-run without increasing spending?

Mike December 29, 2008 at 7:52 am

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Ron Hardin December 29, 2008 at 8:20 am

Why do you want economic employment at all?

It’s not to keep people busy and off the streets.

It’s because the standard of living of the nation rises, and that all depends entirely on disagreements over value.

Namely, I trade something I value less than you for something you value less than me. We disagree about what they’re worth. The result of that disagreement is that we can both profit; and the result of such voluntary trades over the nation is a rise in the nation’s standard of living.

Voluntary means not any old trade, but only ones that occur voluntarily, namely those where there’s this mutually profitable disagreement over value.

One of the chief enablers of disagreement over value is the division of labor. People specialize and turn out lots of their product easily; other people value them much more highly.

Division of labor takes capital, which means extra money, to supply the power equipment for the division of labor.

And capital isn’t moving.

Stan December 29, 2008 at 8:46 am

I’m on the left myself, but I’d be willing to accept Tyler Cowen’s views on the proper way for the government to address a recession if he supported them using a coherent argument rather than ex cathedra announcements. To me, the New Deal experience is conclusive: 1) FDR employed a modest degree of fiscal stimulus in the period 1933-1937 and achieved modestly good results in employment and GNP; 2) encouraged by this, he reverted to Calvin Coolidge economics in 1937 and wound up with a steep recession; 3) starting in 1939, a combination of British and French purchases of military equipment followed by massive US government military expenditures ended the Depression.

If this experience doesn’t suggest that fiscal stimulus works, why doesn’t it? My feeling is that the government should run a surplus in good times and a deficit in bad times to provide negative feedbacks to both bubbles and busts. If I’m wrong, tell me why. And please, Professor Cowen, avoid moralistic arguments about how awful it is to run deficits in your answer.

Naadir Jeewa December 29, 2008 at 9:27 am

Looks like Gordon Brown is hedging is bets and is emphasising both fiscal stimulus and employment-though I’m not sure how rapidly dropping benefits and pushing people into a dwindling job market is going to help.

DanC December 29, 2008 at 9:29 am

Public spending is about increasing political power while private investing is about the efficient allocation of limited resources. Public spending is about politicians forcing the allocation of resources in a manner that free markets would not allocate resources. Public sector spending has a lower multiplier then the private sector spending.

So I disagree with Cowen and Krugman. I don’t care if spending drives employment or if employment drives spending. Both statements can be true given various conditions. But the key issue is how do we allocate resources so that we can encourage long term growth.

Government allocation of resources has never been shown to be superior to the private sector allocation of resources. Efforts by Social Democrats, such as President Elect Obama, have not worked, will not work.

Spending driven by the public sector will create downstream and upstream problems in the economy. Wasteful government spending today will quickly become a severe burden on potential growth tomorrow. And the prospect that we must pay for this wasteful spending will not only be a burden on future generations but the regulatory and structural changes that such massive new spending will become an immediate burden on long term growth potential. Potential private sector employment will be reduced as more resources are allocated to the public sector.

Krugman favors increases in the public sector. He just uses the current economic troubles to argue for what he wants to do regardless of the state of the economy

Anderson December 29, 2008 at 9:53 am

Frame the issue this way and it becomes clear that the choice between private employment and public employment as a driver of spending is crucial.

This is the part I need explained to my puny non-economist brain, I guess. Why does it matter whether I’m spending my private paycheck or my government paycheck? Are government workers not really employed?

I can see that the gov’t paycheck comes from tax dollars, but private paychecks come out of the public’s wallets too. Is there some assumption here that money spent on gov’t services is “wasted”? Depends on the services, doesn’t it? Is money spent on private goods and services just assumed to be money well spent?

erichwwk December 29, 2008 at 10:13 am

I continue to be amazed at how far the economics profession has digressed from reality. Lost in the discussion is why we work in the first place. It seems that consumption and employment have both become an end, rather than a means to an end.

Andrew December 29, 2008 at 10:32 am

Also, what if the public spending comes out of private spending? Then the question is “which is better?”

Is this downturn the same as any other? It seems not, consumer spending drops have lagged.

In Joseph Ellis book “Ahead of the Curve”, he put spending drops at the front of the downturn. What caused the spending drops? Spending bubbles caused by inflation and spending cuts caused by Fed tightening. This is just another installment of the pros who know, not doctrinaire Austrians.

the buggy professor December 29, 2008 at 11:53 am

Tyler:

1) As usual, you show yourself to be an uncommonly flexible libertarian economist . . . willing, in various ways, to countenance some monetary stimuli to our economy and even some fiscal stimuli too — especially if targeting local and state governments. All that is commendable, no other word for it — and particularly amid a system-wide financial meltdown and global crisis that hasn’t materialized until this year since the gloomy 1930s’ Great Depression.

2) There are some ambiguities — maybe even peculiarities — in your policy positions though.

* You emphasize “real” causes of the current recession, with an emphasis on sectoral changes. This reflects real business cycle theory, of course; and that theory — embraced as the main explanation of the ups and downs in short-term manner of long-term economic growth . . . the latter, of course, due strictly to supply-side factors: 1) growth in the capital stock, 2) growth in the labor force (plus improvements in labor-quality), and 3) improved knowledge, whether embodied in machines or in better understanding of managing business firms and marketing their products.

* Real business cycle theory, though, revives the pre-Friedman, pre-monetarist classical and neo-classical views about money: it’s strictly neutral in its ability to influence GDP, rather only changes in the price-level of the economy.

Presumably you don’t buy that orthodox view. Good. But then it’s strange, isn’t it, to find Robert Lucas endorsing a financial bailout of a huge sort to restore “liquidity” to the financial system, isn’t it? I mean, how could money injections influence “real” sectoral and other changes?

* In real business cycle theory, after all, the causes of short-term ups and downs are found in 1) changes in productivity across economic sectors, driven by technological shocks; or 2) marked shifted in consumer preferences (which cover both shifts in what consumers prefer to buy and their willingness to go into debt or not for consumption); or 3) resource problems, such as the unexpected and surging price of oil in 1973 and against in 1979. Or maybe — forgotten by most economists, it seems — by a big war.

* So how, if money is neutral, how could either fiscal or monetary stimuli influence such factors? If anything, in real business cycle theory, such efforts are likely to backfire and delay the return of the economy’s growth to its long-term potential-trend, right?

……

3) Against this background, the link to Robert Lucas is all the more surprising. After all, it’s is work on rational-expectations that shows how changes in the money supply — or presumably in interest rates caused by the Fed Reserve — can work only if the public is “surprised”. Who these days has been surprised by the continued efforts of the Federal Reserve for more than three months now to bring short-term interest rates down close to zero, along with the use of quantitative easing?

Lucas is on record, it’s true, for saying recently that in “a fox hole, we’re all Keynesians?”. Does your endorsement of monetary expansion mean that you reject real business cycle theory and rational-expectations views of economic agents in favor of Keynesianism too . . . or, more likely, Friedmanite quantity-theory monetarism?

—(For the posters in this thread who aren’t familiar with rational-expectations in its full-blooded form, it argues that all economic-agents — including workers, consumers, business managers, savers, and investors — understand the economy’s causal workings just as well as the models of Nobel prize-winning economists. And supply and demand, therefore, except for real shocks, are always in equilibrium.

—It does leave you wondering 1) which economic models and theories they test rational-expectations theorists mean? and 2) whether, in periods of surging uncertainties about the economy and financial markets, economic-agents aren’t as confused as the controversies among economists indicate that they don’t agree on which models and theories are the right ones now too . . . except maybe on faith or doctrinal biases.

…..

4) You have asked for concrete evidence about the impact of fiscal stimuli in the New Deal era — or in Nazi Germany at the same time — and rightly so. Here, in the work of a J.P. Morgan specialist, is a link to a graph that shows a very close trend-correlation between the size of Federal deficits and unemployment levels between 1930 and 1950 for the U.S. economy.

The trend-correlation looks very close and way beyond any random effects, no?

……

Michael Gordon, AKA, the buggy professor

Jean-Jacques Rosa December 29, 2008 at 12:25 pm

There is a slight difference between private and public spending: the former does not increase taxes, and thus does not increase the tax wedge and deadweight loss.

R. Stanton Scott December 29, 2008 at 12:58 pm

Since I apparently do not share Mr. Stepp’s enthusiasm for Rothbard’s anarchistic capitalism, I wonder if I could ask him to take another stab at explaining why it matters whether spending precedes employment or vice versa. Mr. Crusoe, after all, is neither spending nor employed, so his example makes very little sense without further discussion. Stepp’s non-sequiturs about economists studying accounting do not make his point clearer.

Perhaps he means to say that Crusoe’s home-made fishing net would catch him more fish than one given him by government. If so, he should offer some empirical evidence supporting this assertion, and help the rest of us master his understanding of “how an economy actually works.”

Bill Stepp December 29, 2008 at 1:31 pm

Mr. Crusoe, after all, is neither spending nor employed, so his example makes very little sense without further discussion. Stepp’s non-sequiturs about economists studying accounting do not make his point clearer.

Crusoe is employed, as in self-employed. So are lots of small business owners. Everything Crusoe does from consuming berries or fish to storing some food (i.e. saving) to making a fishing net (investing) is a one-person counterpart of what he would do in a more advanced economy. He has no need for money because he doesn’t live in an economy where it were necessary, but as soon as Friday comes on the scene, he could spend some berries in exchange for apples or fish supplied by Friday. The basic economic ideas are the same, and the economic problem still confronts him thanks to the scarcity of resources. He has to save and invest in order to increase his productivity and his income. Of course he could get his income, G, the way the State does and just steal some fish from Friday. Then maybe he could give some of it to Jones, who is unemployed because he’s a deadbeat, keeping some vig for himself naturally.
You can figure out for yourself what the–reaching for the laughtrack button–”Keynesian multiplier” is here. (Hint: it ain’t 1.4 or 1.8.)

Studying business and accounting certainly is an aid to understanding why Keynesianism is a non-starter.
Even better would be working in a business.

Grant December 29, 2008 at 1:50 pm

Bill Stepp,

I do not believe Robinson Crusoe stories are helpful to understanding Keynes. Keynes believed that money is “different” in that Say’s law does not apply to it. Specifically, he believed an increasing demand for money (savings) wouldn’t spur investment because it must also represent a drop in demand for other goods and services. There are a number of critiques of this viewpoint, but to understand it I believe you need an economy with money, i.e. not a Crusoe story.

Brian Slesinsky December 29, 2008 at 1:58 pm

Speaking of weird, do you really think the people facing foreclosure don’t want a house? Do you really think there are 40% fewer people who would like to have a new car today than a year ago? If there were a shortage of production, why are the stores full of the same sort of merchandise that sold well a year ago at higher prices?

A hint: it’s not all about you.

Yancey Ward December 29, 2008 at 2:56 pm

I would ask him on his site, but he is sure to delete my question without comment, so I will post it here:

Does DeLong really believe giving everyone $500,000 dollars would spur economic recovery? Does Krugman?

Oil Shock December 29, 2008 at 5:36 pm

Mike Huben says…which came first, the chicken or the egg.

Chicken laid the egg. Eggs don’t lay chickens. Is that clear?

Lord December 29, 2008 at 5:59 pm

And surely government employment increases spending, so what is dispute? Public will spend differently than private naturally enough, but there is a need for both. Public can take advantage of this opportunity to spend when private seeks to avoid doing so. That is a responsible use for government. Public and private are not adversaries dividing a fixed pie but two combining to increase it, or at least should be.

Craig December 29, 2008 at 9:37 pm

“I can see that the gov’t paycheck comes from tax dollars, but private paychecks come out of the public’s wallets too. Is there some assumption here that money spent on gov’t services is “wasted”? ”

Money spent on government services is not necessarily “wasted” (though sometimes, of course, it is), but it won’t result in new wealth creation. What you call “private paychecks” are paid by customers who gain economic value from their purchases. They also create gain (profit, increase in wealth, value-added, etc.) for the businesses they bought from.

Think of an ancient tribe that fishes and hunts for its living.

They need a chief to resolve disputes and they pay him a portion of their hunt. His position is necessary, but costs them some of their wealth. Meanwhile, they trade another portion of their catch to the tribe across the river for the excellent baskets it makes.

The baskets enable them to hunt and fish longer because they can carry more salmon and antelope meat with them. Their productivity has increased and their wealth along with it. Of course they need the old chief, but no one pretends that he makes them a profit and, thus, they keep him on tight rations. Always a good plan with government anywhere.

Hal December 30, 2008 at 10:13 am

I’d like to know where Alex thinks the private spending/employment is going to come from. As the economy is seizing up, the amount of private spending has fallen off a cliff. Likewise with employment. Thus, we spiral down until we apparently reach the libertarian ideal where we’re back to the stone age.

Really, if the private sector isn’t spending nor are they employing, it’s rather hard to see Alex’s point. There is only one spender/employer of last resort. And it is the time of last resort, unless Alex has some magic employment/spending ponies he has stashed away in the private sector. And if he does, I think that us poor progressive spenders would love to hear about them.

Bob Murphy December 30, 2008 at 10:57 am

Stan wrote:

To me, the New Deal experience is conclusive: 1) FDR employed a modest degree of fiscal stimulus in the period 1933-1937 and achieved modestly good results in employment and GNP; 2) encouraged by this, he reverted to Calvin Coolidge economics in 1937 and wound up with a steep recession;

Not sure if you’re still reading Stan, but if so, can you clarify the 2nd point? Calvin Coolidge (with Treas. Sec. Mellon) slashed income tax rates, making Reagan look like a wuss. I need to double check but I think there were huge budget surpluses too in the later years of his tenure.

Is that what FDR did in 1937?

Anderson December 30, 2008 at 11:07 am

What you call “private paychecks” are paid by customers who gain economic value from their purchases.

Yes, but taxpayers gain economic value from bridges and roads. Tires wear out slower on better roads, etc.

Your “old chief” metaphor is illustrative of — nothing personal here, I see it a lot — a contempt for government that I don’t think is deserved, given the huge contribution of the modern state to our standard of living.

Here’s the rub. WHATEVER a consumer buys is said to have value, no matter how stupid a purchase, because that’s just what “value” is defined as — stuff people want.

But somehow, when it comes to taxes imposed by that consumer’s democratic representatives, whatever’s bought with that money becomes “waste” and lacks “value.”

I don’t accept that. If consumers don’t think they’re getting value for their tax dollars, they’ll vote for lower taxes. The history of the last 40 years strongly suggests that most consumers think they *are* getting value for their tax dollars.

Exalting the Almighty Consumer as the final arbiter of value, while treating tax payments and government spending with contempt, sounds like a contradiction embraced on ideological grounds. I would be happy to be corrected on this, of course.

Bill Stepp December 30, 2008 at 5:00 pm

Crusoe economics is quite helpful, I would argue even necessary, in understanding economics. Just compare a text such as Rothbard’s Man, Economy, and State, with Samuelson or any of its numerous clones. I studied Samuelson first, but didn’t begin to understand economics until reading the Austrians, Rothbard in particular. (That said, you have to read George Selgin’s book on money and banking in place of Rothbard’s discussion of those subjects for a better understanding of them.)

To repeat what I said earlier, I didn’t bring up Crusoe to criticize Keynes so much as to make a simple point about production and income. Production must be done to consume anything. Indeed, when Crusoe gathers berries, he is engaged in production, just as much as any modern farmer is.

But I would suggest that if you believe that “the mere circumstance of creation of one product immediately opens a vent for other products,” you should try opening a slide rule factory.

Should I laugh now or wait for the punchline?

Re: Say’s law, it says that
if n-1 markets are in equilibrium, then the nth market must be too. Not much insight there, and it’s not necessary to defend his law against Keynes to criticize the Keynesisn apparatus or to argue that in a free market (which means no central bank, and a free banking system) there can be no systematic unemployment, certainly nothing like a double-digit rate or something like existed in the Great Depression.
If I recall correctly, Rothbard doesn’t even mention Say in his textbook.
In the modern world, mass unemployment is a result of central bank interference with money and banking. To put it more broadly and in a way that would encompass panics and depressions before central banks existed, these phenomena are caused by legal restrictions on the private supply of money, to use Selgin’s apt term.
I would refer you to his work and to that of other free banking economists, such as Lawrence H. White.

Mass unemployment in the modern world is caused by the discoordination of markets, which stems from malinvestments made by entrepreneurs when the loan rate of interest is pushed below the natural rate by a central bank. When the loan rate increases to reflect economic reality, the malinvestments are revealed in capital losses and the unemployment of capital and labor.

Re: public goods, etc., Tyler Cowen already refuted the idea of public goods in a 1985 paper, and there are other refutations floating around, e.g., Joseph Kalt in the Cato Journal (198?), and E.C. Pasour in the J. of Libertarian Studies, I don’t remember the date.

Also, re: government as anything other than a criminal gang, see Rothbard, Egalitarianism as a Revolt Against Nature and Other Essays, especially, “The Anatomy of the State” (available online), “The Fallacy of the Public Sector,” and “War, Peace, and the State.”

Anderson December 30, 2008 at 8:24 pm

Also, re: government as anything other than a criminal gang

O-kay … when we need an imaginary solution to real-world problems, we will look you up.

Meanwhile, in a world with governments, laws, and responsibilities, we need to figure out what to do.

Bill Woolsey December 31, 2008 at 8:47 am

Stepp:

I think that the reason that the n-1 markets are in surplus is because the n-1 market, base money, is in shortage. Because of the nature of base money, it is difficult to be determine by examining base money. But, there appears to be evidence that nominal expenditures are falling accross the economy.

I will grant that prices can be found that balance supply and demnad, but adjusting the real supply of base money to the demand could require a quite large decrease in the price level.

The market signal that everyone gets is fewer sales at current prices.
Usually, that is a signal to cut production and employment, freeing
resources to produce other, more useful things. In this situation, it
is a signal to reduce your offer prices. And to bid less for all the resources you use. And because the demands for their alternative uses
are also falling, those should be taken. But, usually, firms that are willing to pay less for resources, should get less, and the resources should go to alternative uses. Is it any surprise that an increase in the demand for base money is disruptive and leads to less production and employment?

Generally, bankruptcy and default provide an opportuntity to take resources out of the hands of those who are using the resources in
relatively less valuable ways. Resources are freed to produce other things. However, if the reason of the default is because of an increase in real indebtedness because the real supply of base money needs to rise, then all of the bankrupcy effort is a waste. There
“should” be just a transfer of wealth because of these bad bet by debtors, with output unaffected. How well does that work out in practice? (Leaving aside the “benefit” of people betting with every
nominal contract on the real value of base money.)

Further, between the period in which the price level is high and it is low, real interest rates are driven by the needed delfation, not
intertemporal coordination. This, of course, is due to the zero lower bound on nominal interest rates. If the needed deflation drives the nominal interest rate to zero, then, the price signals for intertemporal coordination are smothered.

My view is that if the monetary base were gold, then all of these problems would continue to exist. But, it isn’t gold. It is Federal
Reserve liabilies–currency and deposits. Why suffer through this
sort of disruption?

Mogens January 2, 2009 at 5:19 pm

The public should invest in infrastructure and other items too big for private investment.
In Denmark we talk about kick-starting the economy (if it becomes nessesary) with an earlier start of investments in new trains, better public transportation, information highways (allthough almost everybodý has broadband connections at home and at the job), updating schools, hospitals ect.
Our present unemployment rate is 1.7%, but it is expected to rise to about 3% in the coming year; mostly in construction.
so now is the time for public spending, when private construction falls.
Of course we don’t have a large public debt and we had for mantý years had a surplus on the public budgets.
That makes it a lot easier to make that kind of macroeconomic management.

Menger January 5, 2009 at 12:40 pm

I’d like to see somebody make a good case why it would matter which came first.

Easy.

Which comes first – the money or the spending?

If you can’t figure that out, you’re a Keynesian.

Menger January 5, 2009 at 1:27 pm

Which happens to be the first since the early 1930s that includes a system-wide financial meltdown on a global scale.

Your mistake is pretending that that government stimulus hasn’t been going non-stop at ever-increasing levels since the end of WWII. Today, federal per capita spending is HIGHER than at it’s peak in WWII.

Read figure 1. http://research.stlouisfed.org/publications/review/06/01/GarrettRhine.pdf

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