Is there a general glut?

Matt Yglesias writes:

We right now have the capacity to produce more–much more–than has ever been produced before in the history of the planet. There are dozens of supply-side policies that could be improved in every country on earth, but that’s not a new fact about the world. What’s new is the lack of demand, the willingness of the key leaders in Tokyo, Frankfurt, Washington, Berlin, and now it seems London as well to tolerate stagnation and disinflation in the face of some of the most exciting fundamental new opportunities for human economic betterment ever.

You can take that quotation as a stand-in for the more general Keynesian AD views about the current recession.

First, I am fully on board with Scott Sumner-like ideas to boost AD through monetary policy, as is Yglesias and are many other Keynesians.  There is no practical disagreement, but it remains an open question how effective such measures (or a bigger stimulus) would be. 

Consider a simple model, in which uncertainty goes up, first because of the U.S. financial crisis, now because of Greece and the Euro and the open questions about Spain and how well Europe can cooperate.  I'm not saying that's the only or even the prime cause of what's going on, it's simply an illustrative story.

With higher uncertainty, investors pull back, wait, and exercise option value.  Aggregate supply declines, as does employment.  As a result, aggregate demand declines too, and that includes real aggregate demand, not just nominal aggregate demand.  Until the underlying uncertainty is resolved, the economy remains in the doldrums.

Note that there is still a case for fiscal policy, based on the idea of intertemporal substitution.  With some labor unemployed, a sufficiently finely targeted fiscal policy can build a new road at lower social cost than before, by drawing upon unemployed resources.  But even if that fiscal policy is a good idea, it won't drive recovery, at least not for plausible values of the multiplier.

There is also still a case for countercyclical monetary policy.  As real AS and real AD are falling (see above), there is also downward pressure on nominal variables.  Aggressive monetary policy, or for that matter the velocity-accelerating aspect of fiscal policy, can limit the negatives of this process and check the second-order fall in employment.

I'm all for countercylical AD management, noting that for other reasons I prefer monetary to fiscal policy in most cases and even if you don't agree with me there it suffices to note that the monetary authority moves last in any case.

That all said, the countercyclical monetary policy won't drive recovery either, or set the world right again, it just limits the damage.  We still have to wait for the uncertainty to be cleared up. 

Reading the Keynesian bloggers, one gets the feeling that it is only an inexplicable weakness, cowardice, stupidity, whatever, that stops policies to drive a more robust recovery.  The Keynesians have no good theory of why their advice isn't being followed, except perhaps that the Democrats are struck with some kind of "Republican stupidity" virus.  (This is also an awkward point for Sumner, who seems to suggest that Bernanke has forgotten his earlier writings on monetary economics.)  The thing is, that same virus seems to be sweeping the world, including a lot of parties on the Left.

Romer, Geithner, Summers, know all the same economics that Krugman and DeLong and Thoma do.  If a bigger AD stimulus would set so many things right, they'd gladly lay tons of political capital on the line to see it through and proclaim triumph at the end of the road.

Except they expect it would bring only a marginal improvement.  And for that marginal improvement they have only a marginal desire to:

1. Raise the long-term national debt (if it's fiscal stimulus)

2. Put their reputations behind policies which might backfire or irritate Congress,

3. Put additional pressure on the independence of the Fed (if it's more aggressive monetary policy)

4. Wreck the current term spread of interest rates, which is a) making the short-term debt easy to finance, and b) restoring major banks to profitability rather quickly.

I still think they should try to do it — through more aggressive monetary policy — but it's a judgment call and that's why they are more or less staying put.

In general you should be suspicious of explanations which take the form of "if only the good people would all band together and get tough." 


" it seems London..."

Well, London is cutting government spending because London has to cut government spending. It had the worst, or one of the worst, government deficits this year; a small government debt had turned into one which looked to exceed 100% of GDP in a few more years. No one was going to lend to a government like that. It was either "austerity" or collapse.

I just don't get what the Keynesian advice is in such a case. To keep on spending and bring about the collapse?

We're now several years into this crisis and now have experience with several stimulus packages (eg. remember the stimulus package under Bush?). What does the balance of empirical evidence say so far? A significant number of macro models suggest the effects of fiscal stimulus to be, because of crowd out, modest to non-existence and/or extremely short lived. Have these models or the Old Keynesian models with high multipliers been more consistent with current evidence?

What do people think of Keynes’ ‘paradox of poverty among plenty’as an explanation of stagnation? That is, given the limits to a community’s propensity to consume the greater extent of productive capacity the harder it is for new investment to bridge the gap between total consumption and effective demand.

Or, maybe, there is a bit of a 'meta' question here. If a theory is brilliant in describing that which should be done, but the likelihood of it ever getting used is - effectively - zero, then
a) Does the theory matter?
b) *Should* the theory matter?

(b) is probably 'yes', i.e., we can hunt around for other ways to implement said theory. But if (for arguments sake), the probability pretty much remains zero, then the answer to (a) is probably 'No'.

The obvious context is politics/macro - we can talk about monetary policy, stimulii, etc till we are blue in the face, but the bottom line is that in this current environment, It Just Wont Happen...

I guess I'm just pessimistic today...

With higher uncertainty, investors pull back, wait, and exercise option value. Aggregate supply declines, as does employment. As a result, aggregate demand declines too, and that includes real aggregate demand, not just nominal aggregate demand. Until the underlying uncertainty is resolved, the economy remains in the doldrums.

What if one of the chief drivers of uncertainty is a general sense that things are going off the rails with massive increases in government debt? If people are responding that way to growing deficits, then additional stimulus might exacerbate the situation by producing additional pullback by consumers and industry that more than swamps the new stimulus effects. Conversely, a government promising to get spending and deficits under control might have the effect of increasing confidence, reducing uncertainty and ending the pullback.

The problem with 'animal spirits' theorizing may be that the 'animals' have their own economic theories (however naive), are watching their economic 'masters' behavior, and seem to be getting more spooked the longer they watch.

I keep hearing about this lack of demand. How do they know what demand should be? Just that it should be what it used to be? However, if you can have low demand, can you have high demand? Is it possible that we had an excess of demand and now is just a reversion to the mean? Is that possible? At all?

So, the bottom line of the post:

The only reason reasonable options cannot be taken is that past tax cut induced deficits have taken away reasonable options, and we are only left with monetary policy and a slow recovery.


@ Thomas,

Rational expectations didn't do too well during the cycle. People shouldn't have sold their stock and we shouldn't have had a near depression.

Talking of making things worse--it doesn't have to be liberal economists who tinker and create time inconsistency--hey, we can make it worse if we try.

Let's balance the budget.

The bigger Macroeconomics question is why are we reasoning from "capacity"?

Think of it this way. Let's say you had a giant buggy-whip-making machine and suddenly buggy-whips become obsolete and demand collapses practically overnight because of the automobile.

Now, what do you have in this machine that can only make something nobody wants (or what they only want now at a price so low that the machine can only be operated at a marginal loss)?

Do you have "Industrial Capacity"? Or do you have Scrap? You have scrap. What errors in our economic-policy reasoning about "insufficient aggregate demand" will result from the confusion of the later for the former?

This means that the permanent demand shift has also caused a kind of supply shock.

The buggy-whip machines must now be subtracted from your ledger for "capacity", added to the inventory of "scrap", melted down and turned into different, more useful machines. The "inter-temporal" period of transition will likely be painful, but it that really avoidable by the government placing a lot of pointless orders for buggy-whips.

It's kind of the equivalent of an unexpected "depreciation shock" in the Solow model. Machines which ordinarily last 10 years surprising only "lasted" a year or two. Though they still stand there and look like capital - they're not - they're now useless and the capital stock has been significantly diminished if people are intellectually honest about the accounting.

Now, the same is true of any process or setup - the output for which is no longer demanded at feasible prices. Just because you have a lot of devices set up in sequence that - if put in motion - could be called a "giant-gas-guzzling-luxury-SUV metal stamping facility" and though it seems you have this idled industrial capacity just sitting there, waiting to be used, that doesn't actually mean it's "capacity".

It's capacity if the drop in orders and partial-idling seems temporary and likely to return. It's no longer capacity if the whole thing has become obsolete and needs to be effectively shuttered and torn down or reconstituted. I suppose some dilapidated housing stock in the more crime-ridden blighted areas of Detroit might also qualify as "false capacity" - if no one can or will ever live in those houses at any price - it's not "housing stock" - it's pre-demolition stock.

Employees that require specific training, licenses, thousands-of-hours-of-experience, etc... are also part of the same phenomenon - it seems to me. A skilled construction foreman essentially has a lot of valuable human capital that suddenly depreciates into nothing (scrap skill) when it becomes clear that there's been a massive over-building which won't clear for a decade. A person becomes unemployed, but the skill that person had - his human capital - disappears from "human capacity".

Sudden-physical-and-human-capital-depreciation shock is probably similar to what happens to a country after a war or major natural disaster - like the Haiti Earthquake. I wonder if what makes this recession different from the others is that it's less like a temporary-idling-until-recovery and more like a permanent capacity-depreciation-disaster.

This seems mostly correct, though I think the reticence of the Obama administration has more to do with the political cost of more stimulus qua stimulus, than whether they think it'll work or not. I'd also point out they really lowballed how bad the economy would get, so they're to say the least not perfect.

The one thing I'd like you to address, Tyler, is the contractionary effect of state budget cuts on the economy and whether the effect they have on AD is worth mitigating those cuts via federal govn't support.

As for the effect of stimulus as raised by mgunn, here's the CBO on Obama's: - the short answer is that in a deep recession like this fiscal policy does have a positive effect and the real question is at what point does government spending pull back to avoid crowding out private investment. I don't think we have a realistic answer to that.

Indy makes some very good points I hadn't really thought about and am now going to ponder.

That's awfully convenient to say we have excess unemployment because it's higher than you want it to be. But how do you know we have "excess unemployment?"

When unemployment was below the theoretical minimum, I never saw anyone say we have "excess employment." Maybe we did, eh?

Demand shortfall is NEVER the problem. Demand is always unlimited. Prices need to be allowed to adjust.

Monetary policy does not "limit the damage," it increases the damage by prolonging the period of adjustment. Just ask Japan.

A commenter above asked:

why are people buying so much government debt?

Why indeed.

the drilling moratorium is about to cause a major hit to one of the few major industries that has yet gotten through this downturn relatively unscathed. put on your seatbelts boys and girls: texas has just lost its forcefield.

Bill, you are missing my point. Look at what the Keynesians are advocating- that we produce more government debt that has to be bought by someone.

"Until the underlying uncertainty is resolved, the economy remains in the doldrums."
This is blog is just amazing. First Bryan Caplan thinking it possible and desirable to raise himself.
Now Cowen...

So we have to wait it out, perhaps do a rain dance and pray to the gods that the uncertainty will dissipate itself.

Meanwhile, "we" have to live with a U6 at--I think--over 15%. A psychiatrist tells me that his case load is exploding.

Grant Cowen's point that traditional fiscal and monetary policies can't do much, and may not even be worth the political capital. The Krugman radicalization could even backfire. Grant all that. That could be true.

But at what point does one throw up his hands and counsel patience to those of whose suffering one evinces no sympathy?

I agree with Noah. This is where we need the flood of price and wage cuts. Prices may be sticky and the best way to "fix" things is to help prices become unstuck - wipe out union wage contracts and do NOTHING to shore up house prices.

House prices became unstuck in the worst markets and sales are beginning to rebound. There's a lot of pain in there, but necessary and deserved pain. All the right people are getting hurt. It's only a shame we can't reach into the wallets of people who hit and ran.

State and local governments are FINALLY beginning to cut back employment and wages, even for the public sector unions. Thank God for this crisis!

Employing countercyclical policy does little good when governments were procyclical in creating the crisis. Where are the rainy day funds?

Tax revenues are highly volatile due mainly to progressive taxation. Politicians never met a dime of revenue they didn't want to spend. Draw a model of cyclical revenues becoming more volatile over time. Then draw an expenditure model where spending rises with revenues and is slow to retreat. Look at how quickly deficits and debt grow!

Bush's deficits righted a lot of wrongs: eight years of military cuts, onerous taxes, active terrorism around the globe, insane foreign regimes, and resolution of Clinton Era spending that was backloaded in the budget. He didn't inherit a surplus. He inherited problems that weren't paid for.

Bush and Clinton created this housing crisis with their wide array of government subsidies and incentives. State and local governments are credited with the assist. When government has the OBJECTIVE of putting more people into homes and supports that in the tax code, with government programs and with large government agencies, why are people surprised there are price and quantity distortions?

You can burn down a forest overnight but you can't regrow it overnight. There is NO policy to fix this mess except for government to step out of the way and stop causing further damage.

Why are we stuck in this insane notion that government can solve economic problems? Government IS the problem.

Look at what is going on in Washington.

Health Care manipulation with cooked books.

Financial regulation that is complex and ripe for unintended consequences.

Energy policy that will increase energy costs, which almost always leads to a downturn.

We are creating structural barriers to economic success with a Congress and an Administration that hates markets, because markets do not consistently produce the distribution of goods that they consider equitable.

From Judge Posner
"We have an alarming public debt, swollen by unfunded spending programs in both the Bush and Obama Administrations (the new health care reform is, realistically understood, unfunded) and by the decline in tax revenues as a result of the economic downturn. But as long as the U.S. dollar remains the dominant international reserve currency (which means that it is used in many transactions in which there is no U.S. party), the demand by foreign central banks for the dollar will remain very high and the resulting volume of U.S. money held abroad will enable us to continue borrowing abroad at low or at least moderate interest rates.

But if we continue running huge deficits, continue being unable politically either to cut spending significantly or raise taxes significantly, continue adding huge new spending progams, continue increasing the ratio of elderly to young, continue raising the minimum wage and promoting unionism, turn protectionist, resist immigration, and become even more deeply involved in military operations, we too may eventually go the way of Europe, even the way of Greece. Nowhere is it written that the United States can never decline."

And from Gary Becker

"To manage effectively a growing federal government debt, it is essential that the growth in entitlements be reduced, in part by raising the age of retirement and of access to Medicare. It is also crucial that government policies encourage more rapid economic growth of the American economy. Unfortunately, this is not true of many policies proposed or implemented during the past 18 months. These include, among many others, higher income taxes on corporations and on persons with bigger incomes, government regulation of pay, especially the pay of executives, health care “reform† that will raise, not lower, government spending on healthcare, special subsidies to various unproven green technologies, so-called job creation bills that create few jobs per dollar spent, and more aggressive anti-trust actions against successful companies, such as Google. These and other policies will reduce US economic growth at a time when faster growth is more necessary than ever.

"Government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it. "
Ronald Reagan

People are being rational. Higher taxes are coming. Greater regulation is coming, Serious structural damage is being done to the economy.

And Krugman today ignores the structural changes. As if temporary boosts in government spending to stimulate the economy is anything like the huge expansion of government obligations that Washington is undertaking.

Krugman who wants to raise taxes during a recession (on the "rich") and continue structural changes in the economy that involve huge permanent increases in expenditures. The same Krugman who argues that the social spending in Europe didn't hurt their economy.

The significant percentage of the baby boom generation is seeing a hugh drop in retirement savings. The value of their homes have fallen. They are being told that they will see fewer government benefits (unless they are poor) with more regulations. The Obama administration talks of them as vile people who have money that rightly belongs to the government. And you wonder why people want to hold onto what little they still have? Why uncertainty and fear have increased.

Remember this is a Congress and an Administration that pushed through health care changes regardless of what the public said. They just wanted to build their Trojan Horse to create the structure and let the political games really begin.

A government that rewards connected financial firms, that is busy rewarding friends and punishing enemies, yet incompetent to stop an oil leak. That is our government today. Unable to stop the huge explosion of government expenditures

Dan C, this post is for you.

Government deficit spending is necessary for the world to function. It isn't up for debate or opinion. It is fact. I am 100% sure of it.

It is accounting. If you accept:

GDP = Consumption + Investment + Government Spending + (X - I)

and as far as I know it is the definition of GDP so it must be true, then this must also be true

Private Sector Fiscal Balance + Government Fiscal Balance + Current Account Balance = 0

Then we know for the entire world, the Current account balance = 0 so

Private Savings = Government Deficit

Net Private Sector U.S. Dollar Savings = our government Deficit to the penny.

We should be cutting taxes like crazy right now - the world has a huge unmet demand for U.S. dollars.

But this equation even has greater significance. Ricardian Equivalence cannot be true because of accounting. Note that if we balance the budget, there is no potential for savings to happen.

As a result, what happens? Demand for money goes up, and demand for goods goes down. In other words, we'll have a demand deficit if we don't spend enough to match the demand for savings. Just like we do now.

Now, the U.S. Dollar is the worlds reserve currency! There is a huge amount of demand for USD all across the world. If you doubt this, pull out a $20 bill anywhere not in the G-10. You'll have undivided attention.

If we cut spending now - like Europe is in the process of doing, we're going to have a depression. In fact, the Surpluses of the 90's were reason the 00's were so bad. We didnt have enough money to meet the demand for savings.

What is worse, the uncertainty of financial failure or the certainty of it? Certainty is overrated.

Yancey, Kindleberger's book on financial crises--a classic--and Mr. E's comment explain the economics of this pretty well.

What you do not want to be doing is becoming a Ms. Merkel. Germany and some of the EU members are creating a real risk for everyone. It's really risky if you are an international bank--or a domestic bank that loaned in Europe--as they set about creating a contractionary phase. Oh, well, at least our interest rates will be low as people flee to the dollar. It will make our export situation worse, though.

You can also think of public debt another way: that banks were overleveraged, that they need liquid assets, and US debt is quite a liquid asset.

Now, if you want to adopt countercyclical tax policies--raising taxes when things heat up--count me in; but I suspect we will throw fat on the fire with a tax cut when that time comes around.

Read Kindleberger's book. It's really good.

. . . banning of financial remediation. I meant intermediation.

Investors also "calculate", you know. It's not like the trader is sitting in front of his computer trying to gauge the precise psychological fear of the numbers he sees.

When investors look at sovereign debt, they not only have a feeling in their gut about it, they also have a feeling in their mathematically oriented brain that the government numbers are complete nonsense and the media is just cheer leading for their boss, the President.

Tyler Cowen: I still think they should try to do it -- through more aggressive monetary policy -- but it's a judgment call and that's why they are more or less staying put.

You failed to list the tax hike option which has been shown to work well with monetary policy. Tax hikes funding added government investment with monetary expansion worked from 1933 through 1937 to create the fastest increase in employment of all the expansions since by a huge margin. Tax hikes from 1983 onward reversed the job losses caused by increased government spending on military combined with tax cuts which drove up the costs of credit at a time when monetary policy was limiting growth after Carter appointed Volcker. Tax hikes in 1990 and 1993 with easy monetary policy fueled the longest expansion in US history, marred by the pump and dump promoting capital gains tax cuts in 1997 which drove asset price inflation in the NASDAQ which produced the expected malinvestment in such bad ideas as

Note that the past decade has been one of easy money and tax cuts and massive promotion of pump and dump and malinvestment, with much of the malinvestment being in Iraq and Afghanistan nation building done badly and generally for the profits of US corporations. But that malinvestment, along with malinvestment of aid after Katrina did boost the economy to reverse the negative impact of the tax cuts which promoted gluts which led to private sector malinvestment.

Federal taxes this past decade have been lower than at anytime since the recession in Truman's second term, but the better decade for comparison is the 20s. That was a period of tax cuts, easy money from gold flowing into the US, gluts of many things, and lots of asset price inflation. The 20s and the 00s have ended much the same way. The easy money of FDR's breaking of the gold contract wasn't sufficient; it took the tax hikes and government investment to get the economy growing. FDR was too conservative to really push investment until the needs of war provided the incentive FDR needed to really invest heavily. FDR nationalized most of the economy after 1939, leaving the denationalization to Truman and Eisenhower. But FDR invested heavily during that time, and the US came out of the world the leading industrial economy for more than just the fact the others had been destroyed by bombing.

But massive investment is hard for profit seekers, and hard for government if not paid for with taxes.

Investment is needed and taxes need to hiked to pay for it. Or to drive the private sector to invest - a carbon tax or stiff cap and trade system would be a real boost to the economy and sure to eliminate the gluts.

Kindleberger and John Kenneth Galbraith both a total waste of time. How anybody can take them seriously is amazing.

Mr Ed, have an apple and read a basic macro econ text. Mishkin or Mankiw would be good place to start.

I don't have a desire to debate with someone who lacks minimal experience, sorry

Overpaid American, & European, workers.
That's why the coming recession recovery will be so slow, and the recession will last so long.

Continued technological & organizational advancement in private firms; that's why the coming recovery will take off so quickly, after housing bottoms.

Increased regulation and an anti-success, anti-capitalist press/ elite intelligentsia. Slow recovery.

Increased demand from the growing middle classes in China & India (2/5s of the world right there)-fast recovery.

The biggest issue above is the overpaid US worker. Why should new job-creators create jobs in America? If they can do it elsewhere, they'll try.

Mankiw uses Ricardian Equivalence all the time. I've read lots of his stuff. And RE is based on not knowing accounting.

Maybe you should look up national income accounting and go over it carefully. Economists usually skip over this stuff pretty fast because they don't want to soil their hands with adding and subtracting when they can use other fancy math to confuse people.

And I really, really doubt that you have more experience than I do. You might have a bit more formal trainin', but I've talked with dozens of economists that really don't understand that Stiglitz threw a bomb right into the heart of neo-classical economics. They don't realize to this day that his paper wasn't just about a few cases of loosening assumptions. It doesn't seem like you do.

And almost no economists study the accounting relationships very closely for ways they might shed insight into macro theory - they just assume the accounting adds up for them, when it clearly does not.

Private Sector Fiscal Balance + Government fiscal Balance + rest of world Fiscal balance = 0 by accounting. Cry, stamp your feet, dismiss me, shout, call me a horse and tell me to eat an apple - it doesn't change this relationship. You are going to see it again and again over the next decade. It's your economics that are wrong.

And this relationship simplifies even further to:

Private Savings = Government Deficit

in any single currency.

This means Ricardian equivalence is and must be false. Not all borrowing should be repaid. And since RE is a foundational part of the neo-classical theory of the business cycle, the deficit hawks are in big, big trouble. Note that because of this equation, some government spending shouldn't even be borrowed, it should just be spent.

It might take longer than I estimated for you all to go through the algebra. It seems beyond your capacity.

Never had a big interest in Macro beyond some issues related to finance, currency trading, etc. Recent events led me to return to core macro issues, various related issues and blogs.

I assume Bill is in his seventies to still support a Pax Americana view of the world/ It was popular for a period after WWII

Mr. E,

What's this nonsense?

Let's start with your first assumption that GDP is the correct statistic for "how the world runs."

mulp said

Tax hikes funding added government investment with monetary expansion worked from 1933 through 1937 to create the fastest increase in employment of all the expansions since by a huge margin.

The easy money of FDR's breaking of the gold contract wasn't sufficient; it took the tax hikes and government investment to get the economy growing.... FDR nationalized most of the economy after 1939...

Are arguing that those policies, not the US entrance into WW 2, ended the depression?

If government spending made economies work Greece and California would not be the fiscal disasters they are.

Mr E.:

Your argument sounds like a macroeconomic version of C. H. Douglas.

*** Certainty of Uncertainty ***

It is certain that we need to deal with Social Security, Federal civilian and military retirement, state and local pension funds, the Pension Benefit Guaranty Corporation, Medicare, Medicaid, state and Federal retiree health benefits, private health insurance, the tax code, Federal, state and local spending, unemployment, underwater mortgages, Fannie, Freddie,, bank failures, the FDIC, and the Federal debt.

It is also certain that governments, at all levels, have outspent and outpromised the ability of the tax-producing sector to create. Their budgets, including pension and retiree health care costs, can’t be funded.

Until we acknowledge those problems openly and start formulating actual solutions, we will cotinue of function in a world with total uncertainty as increasingly desparate people at all levels try to put off the painful choices that must be made.

John Bailey

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