From the comments

“Lord” has a way with words:

The filp side of AD is unused capacity which is why it takes long to adjust, more of the same can be produced from productivity improvements alone and more investment is unnecessary. This means high profits for incumbents that are not competed away because everyone knows the encumbant can always undercut them if they had to. The combination of low inflation and productivity growth result in little to no progress in price adjustment. The entirety of growth must be borne by innovation which is small and slow, especially now. The wealth loss means debt liquidation will proceed for an extended period of time, doubly long since collateral values aren’t there to lower rates and risk premiums are greatly enhanced. Those are structural but ones that could be fixed monetarily with a sufficient money drop but probably not otherwise with conventional policy since there is little reason to borrow by anyone with the capacity to do so and little capacity to borrow by those with reason to. Game over.

Comments

What is "wealth loss"? Is wealth something objective or based on expectations? Isn't one's wealth a guesstimate of NPV instead of our current balance sheet? Is it impossible that five years from now the look-back analysis will say "We weren't as poor as we thought we were"?

Dirk,

Wealth loss is - at least for some - having positive and growing equity in one's primary residence and waking up in 2011 to find that you have negative and stable or even declining equity in the same home. While Krugman and others talk about expectations I don't see much about the effect of the change in the rate of change in equity growth. Back in the day when equity was growing at double digit rates [yes unsustainable double digit rates] income consisted of not just the check one took home from his or her employer, but the "reserve" sitting on the personal balance sheet that could be easily converted [highly liquid?] to cash when needed via home equity loan[s]. A key point is that not only had this nest egg BEEN growing for several years - but people thought there was no or very low probability of that changing - and the idea that it would go into reverse was unthinkable for a vast majority of people.

So while you may end up being right - in the FUTURE we may think "We weren't as poor as we thought we were" - it is also true that we KNOW that today most Americans don't think "We are well off as we thought we were".

Robert Higgs makes the opposite argument.
http://mises.org/daily/5641/Its-Not-about-Consumption

Darn, that was one hard-to-read paragraph. I just re-read it twice and still might have missed a point or two.......

PS. The ETS might love this one for their GRE / GMAT comprehension tests......

He didn't say "a GOOD way with words."

Not as easy to read as their more famous "Lord's Prayer" but I think it's a very readable, albeit extremely concise, paragraph.

Similarly, at full capacity one must make very inefficient moves to increase output.

This is another good opportunity to ask my favorite question, why is peak capacity the right capacity?

If I ran a business, I'd want the top end to be flexible and that might mean hiring additional labor instead of excess capital. But when there is a downturn those people I have to lay off are now "unemployed" even though they shouldn't have ever been thought of as part of the trend labor force. It wasn't long ago we were below the natural unemployment rate.

This is a good point. If you make a habit of running at full capacity, you can't respond when orders increase.

Yes, but this factory goes to 11.

"Full capacity" is a misnomer. The right target ought to be.maximum sustainable resource utilization. Demand can rise above this ideal level, but only in the short run, causing a brief economic expansion; in the long run, prices will increase and capacity utilization falls back to its long-run level. (This happens because imperfect competition is pervasive in a modern economy, so prices are never set at true marginal cost. In a boom, prices are unexpectedly pushed towards the competitive allocation, so we are better off for a while.)

This makes as much sense as all the liquidity trap arguments by Krugman. That is, it sounds plausible if you think the country is a static block. Maybe that is what Tyler meant with all the questions about the difference between short-term and long-term. Our population continues to grow. Inventories deplete and new products do come up all the time (even when they are not that innovative). So for how long this cycle could go on? 3 years sounds like a long time and there's got to be something that is either contributing to the cycle to prolong.

Very amusing.

Did you have to hold this gentleman up to ridicule?

I don't think that was Tyler's intention. I think Tyler agrees with him. :-(

A fair few smug, substanceless comments here. Nobody seems to have actually engaged his argument.

Such is the internet.

Not quite, as a lot can happen without productivity improvements to constrain investment. Suppose you have two production facilities and due to low demand, you idle one of the plants. If you sell the idle plant there is no excess capacity problem as someone else starts using the factory to produce to meet demand and not an AD problem.

If you keep the plant idle, you have real continuing costs (not sunk costs) for rent, interest payments on the debt used to finance the purchase or building of the idle factory, real estate taxes and other local municipality taxes and fees. Additionally, if you want to be able to use the idled facility at a later date you will have some continuing maintenance, security and other costs. These expenses are now borne by the producing factory and the lower level of product produced, lowering profitability. These additional fixed costs can quickly swing a profitable business to unprofitably and negative cashflow.

While the company will produce as long as marginal revenues exceed marginal costs, at marginal cost break-even, the company is disinvesting because it cannot afford the cost of the idle plant. In a competitive environment, including substitute producing competitors, the companies selling price will be forced to its marginal cost level or to the price of the lowest marginal cost producer.

Companies carry more non-reducible factory costs per unit production during economic slowdowns. It is the debt burden on a lower cash flow and on the reduction in value of formerly producing, now idle, assets that constrains companies from investing during recessions. The company's debt and fixed cost burden are now a larger share of its cashflow and assets.

During slowdowns, demand declines, cash flow declines, but some costs are now borne by the fewer products produced leading to lower profitability per unit product and overall, and lower investment without the need for any productivity increase to contribute to the lack of investment.

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