Another look at why both AD and AS matter

by on June 15, 2011 at 3:50 am in Economics, Uncategorized | Permalink

Often I read blog posts by other economists, using the AD-AS model.  The implicit assumption is that there is either too little AD, or too little AS, but the two problems do not and indeed cannot exist together.  If the economy is well-described by these two curves, that is indeed the implication: if AD is shifted in too far to the left, how can there be too little AS?

I suggest a slightly more complex model.  During the financial crisis the American economy took a big AD hit due to debt overhang, falling asset prices, unemployment, imperfect monetary policy, credit contraction, and several other factors.  After the peak of the crisis there were massive layoffs, largely because of these AD problems, toss in an increase in the risk premium and perhaps higher fixed costs of employing people.  A lot of the labor market problems from this hit still have not been cleaned up, and furthermore with lower net wealth many of these jobs are never coming back, with or without monetary stimulus.

Now fast forward.  These days, the layoffs are no longer so frantic, but the rate of new job creation is slow.  Some of the unemployed (not all) could find new work by moving to North Dakota or Australian mining communities, but few of them will do so, mostly for the obvious reasons.  They are waiting for good, new jobs in areas they are willing to live in.  But slow underlying rates of innovation mean slow job creation and so many of these unemployed continue to wait.  It also means a very low quit rate, which we have observed too, because employed workers can’t so easily step into new jobs.

The economy still has a problem with weak AD.  The economy also has an ongoing problem from weak AS.  Both are true, though you won’t see this if you think those two AD and AS curves sum up the whole picture.  Again, it is about the disaggregated aggregate demand.

Thinking even a little bit hard about the derivation of the AD curve (especially in “p space” rather than “p dot space”) should cure one of the tendency to take these models too literally.  Note also that most AD-As models are not integrated with growth theory, though the Modern Principles text with Alex is a big exception here.

Here is further simple proof, using seasonal data, that both blades of the scissors matter.  Via Matt Yglesias, here is a iscussion of how productivity growth in the recovery — if you could call it that — is lagging behind other U.S. business cycles.

1 Alt June 15, 2011 at 4:38 am

Dunno how many American unemployed could move to Australian mining communities. They’d have to come in on a 457 meaning getting sponsorship and having appropriately verifiable trade skills. You have that many diesel fitters and truck electricians with mines experience hanging about?

(Don’t be fooled by the mining company bleating, they don’t employ that many people overall. There are other bods coming in on 457s for constructions and some others industries, mostly Asian, and mostly illegally because their pay and conditions are substandard.)

If they are in their 30s with internationally recognised trade qualifications and several years experience or a degree and experience in a wanted field they might make it as a skilled immigrant, but it’s neither cheap nor quick. (You have to support yourself and pay your own medical expenses for some time.) I also am unsure that the people we want are the ones you don’t have jobs for.

I would genuinely be surprised if you had enough skilled people with suitable training and experience to get into Australia to make any kind of difference in your number of unemployed. I would also be surprised if there were jobs here for them, we have a lot of very educated taxi drivers, and a lot more unemployed than the official figuures show. (If only because the definition of “employed” is one hour of work in the last week.)

2 E. Barandiaran June 15, 2011 at 7:15 am

Just before this post on the U.S. economy, you posted one about the prospects of the Chinese economy. It’s amazing that you ignore the global market economy and prefer to discuss each country as a closed economy. Do you think that the prospects of both economies are not closely interrelated, as well as closely interrelated with those of the economies of other countries?

Before opening MR today, I read these two posts in the American Conservative on Keynes, one in defense of True Keynesianism and the other pointing to the deficiencies of the former:
http://www.amconmag.com/blog/why-not-keynes/
http://www.amconmag.com/blog/the-keynesian-failure/
I thought Galbraith’s attempt to rescue Keynes’ legacy was pathetic because the post was mainly a denunciation first of False Keynesians (the Obama’s Team) and then of non-keynesian macroeconomists for being slaves of Adam Smith and therefore incapable of understanding national accounting. Murphy’s reply was limited to the obvious weaknesses of Galbraith’s post.

Upon reading Galbraith and Murphy, I thought again about how little macroeconomics has progressed in the past 50 years. I remember when I was introduced to national accounting and macroeconomics in 1961. Indeed they were about “closed” economies and the focus was always a country, but for a small country like Argentina there was some need to make clear that international trade was included in both national accounting and macroeconomics. We learnt about the openness of the small economies in other courses –in particular International Trade and Business Cycles (largely the legacy of what Raul Prebisch had been teaching in the 1940s). All textbooks were about the “closed” economy, although in the 1970s we benefited from some interest in the macroeconomics of the small open economy (by then I was a professor in Chile and the first one to teach the “new” macroeconomics). The world economy has been changing rapidly for some time, but macroeconomics has been lagging well behind reality because it has not been able to escape the limits of national accounting and of an ill-founded aggregation of all sorts of goods, labor, and claims.

I don’t have time to repeat what I have said many times about the Chinese economy. Martin Wolff is wrong about China because he relies on Michael Pettis’s analysis (an application of standard macro to a country with a huge savings rate and other “Chinese” characteristics). And I don’t have time to repeat myself on the AD/AS analysis of a closed economy (btw, do you think that the world economy suffers from an AD or an AS or AD+AS deficit?).

3 Ken Rhodes June 15, 2011 at 9:03 am

I chuckled when I red “disaggregated aggregate demand.” I thought of Tip O’Neill’s title — “All politics is Local.”

4 dirk June 15, 2011 at 9:15 am

Do economists ever use 3D models?

5 Lord June 15, 2011 at 9:33 am

There is only one A in AD and AS and a shortage can only occur in one. This does not preclude shortages in both different Ds and Ss, but the same market can never be short in both at once. It is misleading to talk of shortages in both AD and AS as a result.

6 Bill June 15, 2011 at 9:48 am

There is a point about disaggregated aggregate demand that can be seen in demographic/economic regional studies, such as in the book Patchwork Nation, a demographic/economic picture of the US funded by Pew and PBS.

The book was published during the great recession, and tracks unemployment, spending, sources of income, educational level, etc. by zip code and clusters groups of counties, and then analyzes the cluster with respect to change in employment, volatility of income, average income level, etc. What was particualrly interesting were the counties whose growth relied on housing–in those counties, not only were there persons who became cash strapped after they moved in, but a large part of the county populations work force was tied to the housing sector–construction workers, real estate and mortgage bankers. Unviersity communities, selected tech communities with a cluster of specialized tech companies and jobs, were unaffected and growing. What they called Evangelical communities, with lower education, really took a hit because they had attracted low wage employers who were moving to even lower wage countries like China, and they were the communities with the largest Tea Party support. You get a sense of persons being really pressed on both sides.

7 TGGP June 15, 2011 at 9:50 am

Sometimes NYT blogs trip the view counter, so here is Mulligan’s blogspot post.

I agree with him that supply matters and should not be ignored just because there is a recession, but I have yet to hear him clearly state what he thinks the role of demand is in this and other recessions. He spends a lot of time trying to prove the rather binary question of supply mattering, rather than trying to quantify how much it matters, or how many points of unemployment we should attribute to which factors.

8 Scott Sumner June 15, 2011 at 10:13 am

You said:

“The implicit assumption is that there is either too little AD, or too little AS, but the two problems do not and indeed cannot exist together.”

I’d always thought I understood the AS/AD model, and that the two problems could co-exist. Both curves could shift left. Can someone explain why both problems cannot occur at the same time? What if all oil production in Saudi Arabia shuts down, and the Fed cuts the money supply by 90%. How does that look in a AS/AD model?

9 Silas Barta June 15, 2011 at 12:11 pm

The role of a full-time economist is to be able to provide plausible answers to such questions without having to ask the internet, Dr. Overpaid.

10 Patrick L June 15, 2011 at 12:17 pm

You’re absolutely right! Tyler’s brain did that thing where the bottom of the curve is Employment as a Percent, rather then a Quantity. When you put real numbers into the graph, it becomes obvious how both AS and AD can shift left; and how that will necessarily result in more unemployment relative to the total population. Any shift to the left along either curve results in lower production and lower employment.

11 Unburdened Water Spout June 15, 2011 at 10:30 am

AD and AS are simply not useful concepts — there is nothing that will shift one of these things without shifting the other. Stop misleading the public, they’re dumb enough as it is.

12 E. Barandiaran June 15, 2011 at 10:38 am

In relation to Tyler’s last sentence on lagging productivity growth, take note that President Obama is complaining that productivity is still growing too much. A letter from DB to BO:

Mr. Barack Obama
President of the Executive Branch
United States Government
Washington, DC

Dear Mr. Obama:

In your recent interview with NBC News you explained that your policies would promote more private-sector job creation were it not for (as you put it) “some structural issues with our economy where a lot of businesses have learned to become much more efficient with a lot fewer workers. You see it when you go to a bank and you use an ATM, you don’t go to a bank teller, or you go to the airport and you’re using a kiosk instead of checking in at the gate.”

With respect, sir, you’re complaining about the source of our prosperity: innovation and the increases it causes in worker productivity.

With no less justification – but with no more validity – any of your predecessors might have issued complaints similar to yours. Pres. Grant, for example, might have grumbled in 1873 about “some structural issues with our economy where a lot of businesses have learned to become much more efficient with a lot fewer workers. You see it when you go to a bank that uses a modern safe and so employs fewer armed guards than before, or when you travel on trains which, compared to stage coaches, transport many more passengers using fewer workers.”

Or Pres. Nixon might have groused in 1973 about such labor-saving innovation: “You see it when you step into an automatic elevator that doesn’t require an elevator operator, or when you observe that polio vaccination keeps people alive and active without the aid of nurses and all those workers who were once usefully employed making iron-lung machines, crutches, and wheelchairs.”

Do you, Pres. Obama, really wish to suggest that the innovations you blame for thwarting your fiscal policies are “structural issues” that ought to be corrected?

Sincerely,
Donald J. Boudreaux
Professor of Economics
George Mason University

13 Rich Berger June 15, 2011 at 11:23 am

Too bad Milton Friedman isn’t around to set Dear Leader straight:

“While traveling by car during one of his many overseas travels, Professor Milton Friedman spotted scores of road builders moving earth with shovels instead of modern machinery. When he asked why powerful equipment wasn’t used instead of so many laborers, his host told him it was to keep employment high in the construction industry. If they used tractors or modern road building equipment, fewer people would have jobs was his host’s logic

Then instead of shovels, why don’t you give them spoons and create even more jobs?” Friedman inquired.”

14 Bill June 15, 2011 at 12:09 pm

Let’s keep keep increasing investment tax credits and accelerated depreciation during a recession so we can displace more workers!

15 Rich Berger June 15, 2011 at 12:17 pm

Why be a piker, Bill? Why don’t you advocate a complete ban on investment? That should get the job machine humming. The only reason we are as wealthy as we are is because of investment.

16 Bill June 15, 2011 at 2:01 pm

Rich,
There is such a thing as a capital/labor ratio–believe it or not–and when you intervene in the market by goosing one–in this case capital–you cause a substitution of capital for labor. Now, if that occured during full employment, fine, or if it occured with your willingness to assist those who are displaced with your capital subsidy, fine. But, since neither case applies, my own view is that we should support labor–by increasing the value of labor, by investing in people (through education), rather than things, as we have a surplus of unemployed human assets and more than ample business capacity which is running at around 72% or so.

Come out in favor of developing human capital.

17 Bill June 15, 2011 at 2:06 pm

Rich,

You might also want to look at Mark Thoma’s piece on this at Economists View: http://economistsview.typepad.com/economistsview/

18 Rich Berger June 15, 2011 at 7:16 pm

Found this at Think Markets
http://thinkmarkets.wordpress.com/#!/entry/4620

I think it’s a great summary of the idiocy of the Obama stimulus.

19 Bill June 15, 2011 at 9:04 pm

Rich,
Really interesting page on a blog by an assistant prof who writes on an Austrian group website . Confirmation biases confirmed.

How about this article and the conclusions of a former Vice Chair of the Fed and Mark Zandy of Moody’s Analytics

In Study, 2 Economists Say Intervention Helped Avert a 2nd Depression

By SEWELL CHAN

Published: July 27, 2010

WASHINGTON — Like a mantra, officials from both the Bush and Obama administrations have trumpeted how the government’s sweeping interventions to prop up the economy since 2008 helped avert a second Depression.

Economix Blog: The Impact of Another Kind of Stimulus (July 27, 2010)

Now, two leading economists wielding complex quantitative models say that assertion can be empirically proved.

In a new paper, the economists argue that without the Wall Street bailout, the bank stress tests, the emergency lending and asset purchases by the Federal Reserve, and the Obama administration’s fiscal stimulus program, the nation’s gross domestic product would be about 6.5 percent lower this year.

In addition, there would be about 8.5 million fewer jobs, on top of the more than 8 million already lost; and the economy would be experiencing deflation, instead of low inflation.

The paper, by Alan S. Blinder, a Princeton professor and former vice chairman of the Fed, and Mark Zandi, chief economist at Moody’s Analytics, represents a first stab at comprehensively estimating the effects of the economic policy responses of the last few years.

“While the effectiveness of any individual element certainly can be debated, there is little doubt that in total, the policy response was highly effective,” they write.

Mr. Blinder and Mr. Zandi emphasize the sheer size of the fallout from the financial crisis. They estimate the total direct cost of the recession at $1.6 trillion, and the total budgetary cost, after adding in nearly $750 billion in lost revenue from the weaker economy, at $2.35 trillion, or about 16 percent of G.D.P.

By comparison, the savings and loan crisis cost about $350 billion in today’s dollars: $275 billion in direct cost and an additional $75 billion from the recession of 1990-91 — or about 6 percent of G.D.P. at the time.

But the new analysis might not be of immediate solace to officials in the Obama administration, who have been trying to promote the “summer of recovery” at events across the nation in the face of polls indicating persistent doubts about the impact of the $787 billion stimulus program.

For one thing, Mr. Blinder and Mr. Zandi find that the financial stabilization measures — the Troubled Asset Relief Program, as the bailout is known, along with the bank stress tests and the Fed’s actions — have had a relatively greater impact than the stimulus program.

If the fiscal stimulus alone had been enacted, and not the financial measures, they concluded, real G.D.P. would have fallen 5 percent last year, with 12 million jobs lost. But if only the financial measures had been enacted, and not the stimulus, real G.D.P. would have fallen nearly 4 percent, with 10 million jobs lost.

The combined effects of both sets of policies cannot be directly compared with the sum of each in isolation, they found, “because the policies tend to reinforce each other.”

Told about the findings, another leading economist was unconvinced.

“I’m very surprised that they find these big impacts,” said John B. Taylor, a Stanford professor and a senior fellow at the Hoover Institution. “It doesn’t correspond at all to my empirical work.”

Mr. Taylor said the Fed had successfully stabilized the commercial paper and money markets, but he argued that its purchases of $1.25 trillion in mortgage-backed securities have not been effective. And he said the Obama administration’s stimulus program has had “very little impact and not much to show for it except a legacy of higher debt.”

The disagreement underscored the extent to which econometric estimates are heavily reliant on underlying assumptions and models, but Mr. Blinder and Mr. Zandi said they hoped their analysis would withstand scrutiny by other scholars.

“When all is said and done, the financial and fiscal policies will have cost taxpayers a substantial sum, but not nearly as much as most had feared and not nearly as much as if policy makers had not acted at all,” they write.
In Study, 2 Economists Say Intervention Helped Avert a 2nd Depression

By SEWELL CHAN

Published: July 27, 2010

WASHINGTON — Like a mantra, officials from both the Bush and Obama administrations have trumpeted how the government’s sweeping interventions to prop up the economy since 2008 helped avert a second Depres

Economix Blog: The Impact of Another Kind of Stimulus (July 27, 2010)

Now, two leading economists wielding complex quantitative models say that assertion can be empirically proved.

In a new paper, the economists argue that without the Wall Street bailout, the bank stress tests, the emergency lending and asset purchases by the Federal Reserve, and the Obama administration’s fiscal stimulus program, the nation’s gross domestic product would be about 6.5 percent lower this year.

In addition, there would be about 8.5 million fewer jobs, on top of the more than 8 million already lost; and the economy would be experiencing deflation, instead of low inflation.

The paper, by Alan S. Blinder, a Princeton professor and former vice chairman of the Fed, and Mark Zandi, chief economist at Moody’s Analytics, represents a first stab at comprehensively estimating the effects of the economic policy responses of the last few years.

“While the effectiveness of any individual element certainly can be debated, there is little doubt that in total, the policy response was highly effective,” they write.

Mr. Blinder and Mr. Zandi emphasize the sheer size of the fallout from the financial crisis. They estimate the total direct cost of the recession at $1.6 trillion, and the total budgetary cost, after adding in nearly $750 billion in lost revenue from the weaker economy, at $2.35 trillion, or about 16 percent of G.D.P.

By comparison, the savings and loan crisis cost about $350 billion in today’s dollars: $275 billion in direct cost and an additional $75 billion from the recession of 1990-91 — or about 6 percent of G.D.P. at the time.

But the new analysis might not be of immediate solace to officials in the Obama administration, who have been trying to promote the “summer of recovery” at events across the nation in the face of polls indicating persistent doubts about the impact of the $787 billion stimulus program.

For one thing, Mr. Blinder and Mr. Zandi find that the financial stabilization measures — the Troubled Asset Relief Program, as the bailout is known, along with the bank stress tests and the Fed’s actions — have had a relatively greater impact than the stimulus program.

If the fiscal stimulus alone had been enacted, and not the financial measures, they concluded, real G.D.P. would have fallen 5 percent last year, with 12 million jobs lost. But if only the financial measures had been enacted, and not the stimulus, real G.D.P. would have fallen nearly 4 percent, with 10 million jobs lost.

The combined effects of both sets of policies cannot be directly compared with the sum of each in isolation, they found, “because the policies tend to reinforce each other.”

Told about the findings, another leading economist was unconvinced.

“I’m very surprised that they find these big impacts,” said John B. Taylor, a Stanford professor and a senior fellow at the Hoover Institution. “It doesn’t correspond at all to my empirical work.”

Mr. Taylor said the Fed had successfully stabilized the commercial paper and money markets, but he argued that its purchases of $1.25 trillion in mortgage-backed securities have not been effective. And he said the Obama administration’s stimulus program has had “very little impact and not much to show for it except a legacy of higher debt.”

The disagreement underscored the extent to which econometric estimates are heavily reliant on underlying assumptions and models, but Mr. Blinder and Mr. Zandi said they hoped their analysis would withstand scrutiny by other scholars.

“When all is said and done, the financial and fiscal policies will have cost taxpayers a substantial sum, but not nearly as much as most had feared and not nearly as much as if policy makers had not acted at all,” they write.
In Study, 2 Economists Say Intervention Helped Avert a 2nd Depression

By SEWELL CHAN

Published: July 27, 2010

Recommend
Twitter

E-Mail

Print

Reprints
Share

.

.

WASHINGTON — Like a mantra, officials from both the Bush and Obama administrations have trumpeted how the government’s sweeping interventions to prop up the economy since 2008 helped avert a second Depression.

Related

Economix Blog: The Impact of Another Kind of Stimulus (July 27, 2010)

Now, two leading economists wielding complex quantitative models say that assertion can be empirically proved.

In a new paper, the economists argue that without the Wall Street bailout, the bank stress tests, the emergency lending and asset purchases by the Federal Reserve, and the Obama administration’s fiscal stimulus program, the nation’s gross domestic product would be about 6.5 percent lower this year.

In addition, there would be about 8.5 million fewer jobs, on top of the more than 8 million already lost; and the economy would be experiencing deflation, instead of low inflation.

The paper, by Alan S. Blinder, a Princeton professor and former vice chairman of the Fed, and Mark Zandi, chief economist at Moody’s Analytics, represents a first stab at comprehensively estimating the effects of the economic policy responses of the last few years.

“While the effectiveness of any individual element certainly can be debated, there is little doubt that in total, the policy response was highly effective,” they write.

Mr. Blinder and Mr. Zandi emphasize the sheer size of the fallout from the financial crisis. They estimate the total direct cost of the recession at $1.6 trillion, and the total budgetary cost, after adding in nearly $750 billion in lost revenue from the weaker economy, at $2.35 trillion, or about 16 percent of G.D.P.

By comparison, the savings and loan crisis cost about $350 billion in today’s dollars: $275 billion in direct cost and an additional $75 billion from the recession of 1990-91 — or about 6 percent of G.D.P. at the time.

But the new analysis might not be of immediate solace to officials in the Obama administration, who have been trying to promote the “summer of recovery” at events across the nation in the face of polls indicating persistent doubts about the impact of the $787 billion stimulus program.

For one thing, Mr. Blinder and Mr. Zandi find that the financial stabilization measures — the Troubled Asset Relief Program, as the bailout is known, along with the bank stress tests and the Fed’s actions — have had a relatively greater impact than the stimulus program.

If the fiscal stimulus alone had been enacted, and not the financial measures, they concluded, real G.D.P. would have fallen 5 percent last year, with 12 million jobs lost. But if only the financial measures had been enacted, and not the stimulus, real G.D.P. would have fallen nearly 4 percent, with 10 million jobs lost.

The combined effects of both sets of policies cannot be directly compared with the sum of each in isolation, they found, “because the policies tend to reinforce each other.”

Told about the findings, another leading economist was unconvinced.

“I’m very surprised that they find these big impacts,” said John B. Taylor, a Stanford professor and a senior fellow at the Hoover Institution. “It doesn’t correspond at all to my empirical work.”

Mr. Taylor said the Fed had successfully stabilized the commercial paper and money markets, but he argued that its purchases of $1.25 trillion in mortgage-backed securities have not been effective. And he said the Obama administration’s stimulus program has had “very little impact and not much to show for it except a legacy of higher debt.”

The disagreement underscored the extent to which econometric estimates are heavily reliant on underlying assumptions and models, but Mr. Blinder and Mr. Zandi said they hoped their analysis would withstand scrutiny by other scholars.

“When all is said and done, the financial and fiscal policies will have cost taxpayers a substantial sum, but not nearly as much as most had feared and not nearly as much as if policy makers had not acted at all,” they write.

20 Bill June 15, 2011 at 9:56 pm

sorry it reprinted two extra times.

21 Rich Berger June 16, 2011 at 8:52 am

So what you are saying is that you dismiss a very clear, logical explanation of why the Porkulus was bound to fail and point me to a explanation that we have all heard many times. Doesn’t get any more credible with repetition. Oh Mama, I just didn’t know how bad it was or I would have gone for $3 Trillion.

In your opinion, what were the top three successful fiscal stimuli applied to the US economy?

22 allan June 15, 2011 at 5:23 pm

Yeah, and Friedman’s hosts are now building all of the heavy equipment, which soon Friedman’s countrymen will no longer be able to afford. Wonderful economist, that Friedman guy.

23 J Thomas June 15, 2011 at 5:59 pm

This calls out for a science fiction story.

Several engineers at several giant corporations independently develop machinery which can make every product without any human labor, cheaper than anyone who does use human labor. Due to the timing and the interlocked collection of patents, they can all legally do this.

They each get a big bonus, and one of them gets a big raise, before they are fired along with everybody else.

The CEO of the last corporation that has a CEO says they’ll be sorry, they need him. The chairman of his Board of Directors shakes his head sadly. “Sorry, Fred. You have no one to give orders to, nobody to negotiate with, and there are no decisions for you to make. I’d keep you if I could, but it just looks too bad.”

Productivity is way way up. Food is cheap, you can feed a family of 4 for a year on $20. Solar-powered automobiles cost $50 each. A palatial home costs $200 provided you own the land to put it on. (Rents are high, though.) For a penny you can get a thousand great machine-generated detective novels, or great american novels, or travelogues, or pop science books.

And the machines will generate for you half a dozen novel economic theories and argue their merits against traditional theories whenever you like — for free.

However, pretty quickly nobody who depends on finding work for their income has any money. There’s a little work for people who do services — massage, the sex industry, flattery — things where machines might achieve technical perfection but the human touch is still worth a lot. But how many owners are there compared to sex workers? A buyer’s market.

What works best is when you can sell rights or resources to the machines that produce everything. So there’s a holdout — human legislatures do not have to appoint machine judges. And human judges can refuse to accept machine lawyers. And so human lawyers can support themselves doing law. The more lawsuits among owners, the better. The slower and more tedious the trials, the better for the humans employed by the legal system. Until the various owners voluntarily switch to machine-run arbitration.

Well, but there are the criminal courts. A wage-earner accused of a crime can be held for less than $1/year by machine prisons, and who should complain if it takes 10 years for his case to come to court? At least in jail he gets fed every day. Lots of work for human lawyers that way.

So, once the entire laboring class and their dependents have been put in jail awaiting trial, or in prison after their sentencing, the economy reaches equilibrium.

I think there are unresolved issues here and I don’t know how to resolve them. But just as we think of pollution as a cost to society that businesses should avoid or pay for, maybe the same should be true of unemployment. Maybe we might figure that the government owes welfare payments to the whole population, for everybody. And when a business hires somebody for more than they would get on welfare then the government should give that money to the business that hired them. Because without that business creating that job, the government would still be out the welfare money.

And it only makes sense that businesses should not be responsible for their employees’ health care. Businesses in many other nations aren’t, and putting that burden on them helps to make our products uncompetitive on the world market — and in our own markets.

24 Steve C. June 15, 2011 at 10:42 am

I wonder if the high levels of private debt would have anything to do with a lack of demand.

But then, I’m not an economist so the idea the lots of people carrying lots of debt service (not to mention the collapse in home values and foreclosures) is probably explained away by some abstruse graph in some obscure text book.

25 dirk June 15, 2011 at 12:07 pm

You are correct. The point of the Fed boosting the money supply is to inflate aggregate income back to previous growth levels so people can more readily service their debt as well as consume more goods and services. This is also known as boosting AD (or shifting its abstruse curve right).

26 Steve C. June 15, 2011 at 12:30 pm

That may be the intent, but doesn’t appear to be the result. I’m reminded of the phrase “pushing on a string”.

27 J Thomas June 15, 2011 at 6:21 pm

Slightly less abstractly, the way the Fed might speed the economy by boosting aggregate income, is to inflate the money supply so that debts don’t count as much (unless they’re variable rate). So people who are currently in debt with no way out could get big raises to nearly match inflation, and they could then pay off their loans and still have enough money left over to spend and increase demand.

But the Fed’s first responsibility is to bankers. If the Fed increased inflation enough to remove the profit from existing loans, the various bankers and shadow bankers would complain vociferously. Some of them might hire assassins.

So the Fed chairman might talk about increasing inflation. It’s his job to say things at random to make it harder to predict what he will do. But I very much doubt he will actually raise inflation. It may happen if he can’t prevent it.

28 Bill June 15, 2011 at 3:31 pm

Yes, Steve, we have overleveraging of private debt from 2001 to 2008, and have a private debt hangover.

Private debt as a percent of GDP went from 62% in 2001 to 106% in 2008. Debt financing accounted for most of the growth from 2006 to 2008 (think of Home Equity loans); now that that bubble has burst, people have underwater housing and still have to pay the debt. Government debt as a percentage of GDP was then and has today remained fairly constant over the period, except for periods of contraction when countercyclical policies (unemployment, etc.) kick in.

29 Dale June 15, 2011 at 11:29 am

Admittedly I have always considered myself incompetent as a macroeconomist though I believe I know something about micro. I have simply never found AD/AS useful for understanding the macro economy. They offer fine ex post explanations of what happened but seem to be unable to be used in any predictive manner – of course, various individuals believe they can be used in that way, but they don’t agree with each other. We can’t pin down the slopes of either curve and they shift or don’t shift depending on factors that look a lot like psychological sunspots. Since the numbers involved are huge, the difference between one slope/shift and another can easily be the difference between full employment and a deep recession. A related problem is the “natural rate of unemployment” which has now mysteriously risen to over 7%. I can easily believe that it is higher than it used to be, but I find a sudden rise in the “natural” rate to be implausible.

I actually lost a teaching job because I refused to teach macro principles believing myself incompetent to do so. I still feel that way. Reading posts like this make me feel both more confident about that position as well as somewhat justified.

30 Silas Barta June 15, 2011 at 12:08 pm

You know, maybe — just maybe — AS and AD models complicate more than they simplify so you’re adding and unnecessary burden by trying to phrase every problem in these terms. You’re first hint about the validity of this possibility was probably when you found yourself saying, “We need to get people to [do X] more than they want to!” or “The economy will collapse if people don’t consume/invest in enough of the present opporunities!”

It’s bullshit, and should have been called such from the beginning.

(Yes, you can force-fit any valid explanation into an AS/AD framework, but not in a way that makes your model any simpler or insight-yielding.)

31 allan June 15, 2011 at 5:26 pm

Why can’t economists write in plain English?

32 J Thomas June 15, 2011 at 6:06 pm

Allan, when you write in plain english it takes longer. Complicated ideas that other people have developed and that can be used, wind up getting re-explained. In some ways, writing in plain english is like programming in assembly.

Also, when you write in plain english, ideas that get hidden by the simple labels for complex phenomena are more likely to pop out and embarrass you.

33 Bill June 15, 2011 at 6:30 pm

Re:

‘Why can’t economists write in plain English?”: Because if people could understand their English or their math, they would see what fools they can be.

Don’t pay any attention to that man behind the screen.

34 Danny Noonan June 15, 2011 at 6:58 pm

The economy still has a problem with weak AD.

If I might take a step back, what is the evidence for this claim. I understand that AD is weaker that it was in, say, 2007, but is AD actually “weak” given the current structure of our economy. I would think there is some decent evidence that the AD level in 2007 was unsustainable, no? What is the evidence that AD is less than it “should be” at this point?

Essentailly what I’m asking is, how do we know we are not working (through temporary stimulative measures) to re-inflate an AD balloon back to an unsustainable level. Because if we were doing that, it would seem like a bad idea.

35 Bill June 15, 2011 at 9:59 pm

The follow up to that observation would be to retool and retrain some workforce and at the same time sponsor jobs in areas where will have to invest in sometime in the future anyway, such as infrastructure, and then plan to reduce infrastructure work as the economy recovers.

36 TallDave June 16, 2011 at 9:49 am

Yes, the workforce needs to retrain — but the unique feature of this recession is how much it has eroded labor mobility, as it’s suddenly become difficult to sell homes. Additionally, the incentive to retrain (which is very painful) is also smaller relative to, say, 1950, when not working often meant going hungry, as oppose to today’s obesity crisis in the poor. It’s nice that everyone is well-fed, of course, but reduced incentives affect outcomes.

On infrastructure, beware the Japan trap. They overbuilt and ended up with little to show for it aside from massive debt. I believe the U.S. actually leads the world in paved miles per capita and generally in delivery of basic services for our rural/urban mix.

37 Minnesinger June 15, 2011 at 11:40 pm

Why don’t the MSM talking heads ever mention STOPPING Immigration during this downturn at least, and H1-Bs and all the rest. Make sense, but no will save you and it will all end in tears.

Then you have this when it came to Stimulus Jobs, I think America is gone and Ron and Rand Paul both know that:
Robert Reich, Obama’s economic adviser, and Charles Rangel, House Ways & Means Committee on Stimulus Jobs, how come Katie Couric, Brian Williams and Dianne Sawyer didn’t show this????
http://www.youtube.com/watch?v=nT1TkLgfinE

38 TallDave June 16, 2011 at 9:41 am

The notion we can “fix” AD is deeply flawed. As Tyler’s pointed out, the pre-recession AD was built on the assumption we were wealthier than we actually were. The current AD is more correct. The old AD isn’t coming back until we earn it with higher productivity.

39 Unburdened Water Spout June 16, 2011 at 9:58 am

Again, I point out that the notion of “aggregate demand” is just useless. And the idea that we have “too little” requires a benchmark — exactly what is the notion of the right amount? You guys (except Dale) are worthless.

40 Guy in the Veal Calf Office June 16, 2011 at 11:55 am

“Another look at why both AD and AS matter”

To whom? I’ve sat at the table (or steakhouse) with lobbyists, staffers, legislators, etc. and I’ve also attended jargon soaked niche conferences. To which does the AD/AS model belong? Does it change policy maker’s minds (like the Laffer Curve convinced a wholly democratic Congress & Prez to extend tax cuts) or can every policy proposal find an AD/AS variant to support its passage?

Also consider that when scientistic models get served to policy makers, the caveats and exceptions are scraps left in the kitchen, and only the intuitively true helping is eaten (e.g., climate models (alarmist or denialist)).

41 allan June 16, 2011 at 2:59 pm

AD-AS translation:

In 2008 a lot of people lost their jobs. They didn’t have money to buy stuff.

42 Jason June 20, 2011 at 10:33 pm

This is maddening.

The summer employment effect is *tiny* relative to the overall economy (0.03%, no really 0.0003), and by the looks of it, the Christmas effect is even smaller! The output gap is two orders of magnitude bigger!

“Oh, yes you’re pure AD theory captures this ~5% effect to some accuracy but is missing out on this order ~0.05% effect so it must be flawed and thus we need to look at an AD/AS theory.” This is literally what is being said when one cites Mulligan and says both sides of the scissors matter. I’d say better to base policy on a pure AD approach and get it 99% right with a simple remedy (monetary/fiscal stimulus/helicopter drops of money).

Economics isn’t that accurate, and with the strong influence of ideology I can’t even say I trust a complicated theory.

Comments on this entry are closed.

Previous post:

Next post: