In the medium-run, supply- and demand-side stagnation stories are very similar

Paul Krugman argues the contrary here.  But let’s say there was a supply slowdown starting in 1999 or so, as reflected in wage and jobs data, masked a bit by the real estate bubble of 2004-2006 and with some of the productivity figures inflated for domestic purposes due to outsourcing.

If there is less produced, there are eventually perceived negative wealth effects.  What happens to demand?  It goes down, in this case with a lag because of credit.  Yes, it is a big mistake to assume Say’s Law always holds but it is an even bigger mistake to think it never holds.  Supply slowdowns are bad for demand, and they likely are bad for credit creation too, which hurts demand further yet.

There is no contradiction in a model where both aggregate demand and aggregate supply curves shift in unfavorable directions!  And in the medium run, each of these shifts pushes the other curve around too.

Let’s not forget that economies have real wage and price stickiness in addition to nominal stickiness.  That is another channel through which negative supply shocks can hurt aggregate demand and throw people out of work.

Krugman is worried about policy implications:

If labor force growth and productivity growth are falling, the indicated response is (a) see if there are ways to increase efficiency and (b) if there aren’t, live within your reduced means. A growth slowdown from the supply side is, roughly speaking, a reason to look favorably on structural reform and austerity.

But if we have a persistent shortfall in demand, what we need is measures to boost spending — higher inflation, maybe sustained spending on public works (and less concern about debt because interest rates will be low for a long time).

It’s not either/or.  Circa 2008-2009, we should have had a higher inflation or ngdp target.  We could do structural reform too, whatever you might think that means, obviously opinions will differ.  We could build productive infrastructure, boosting both supply and demand, and with little risk of default on the debt.  And yes, we might wish to cut some other government expenditures in the process (farm subsidies anyone?), with looser money to pick up the slack.  What we shouldn’t do is all that Keynesian ditch digging.  Even if you agree with the argument for it (and I don’t), it so hurts the reputation of legitimate government investment that we shouldn’t be going near it.  There are many, many other better things to do, including giving our government a reputation for careful project selection looking forward.

Simple textbook economics indicates that the AD-AS distinction makes the most sense in the short run.  Of course hysteresis is a mechanism by which low AD can over time translate into low AS as well, but the causation runs both ways, don’t forget that.


Very good post Tyler.

If debt to gdp was 30%, I'd be willing to talk about all these no-brainer, can't miss, zero boondoggle sir type infrastructure projects a certain type is always nattering about.

But it's not. Debt is more than 100% of gdp. And the demographic crunch is just around the corner. And we actually do spend a staggering amount in infrastructure already.

You got AD issues- take it to the Fed.

Would it be a boondoggle to replace the bridge that you use to get to work after it fails and a boondoggle only if replaced before it fails, or would you argue for no bridge replacement in order to force you to privately build a bridge so you and your neighbors can get to work?

If your water stops because of a water main break, would restoring your water service be a boondoggle, or its only a boondoggle if it restores water to those living on the other side of the tracks?

Quoting the communist? Economist from June 28, 2014:
"America saw two great booms in infrastructure spending in the past century, the first during the Great Depression, when the Pulaski skyway was built, and the second in the 1950s and 60s, when most of the interstate highway system was. Since then, public infrastructure spending as a share of GDP has declined to about half the European level. America is one of the most car-dependent nations on earth, yet it spends about as large a share of GDP on roads as Sweden, where public transport is pretty good (see chart). The federal government scrimps on airports and sewage pipes so it can pay for pensions and health care."

Or from the socialist Business Insider:
"Well, there it is, the collapse in infrastructure spending that everyone is talking about. It's from BSA Research
[chart showing drop from $325B from 2001-2004, $300B 2004-2010, to under $250B and falling]
The chart was first spotted by Cardiff Garcia at FT Alphaville.

Yves Smith at Naked Capitalism is also writing about it.

The key thing, as Yves notes, is that the chart includes state and local infrastructure spending, which explains why they were was such a furious collapse right after the bust, as state and local governments furiously slashed spending.

The tragedy of course is that with inflation non-existent and a huge surplus of excess labor, this would have made an incredibly good time to spend like crazy on infrastructure, fixing everything and putting people to work.

But there wasn't the political will at the Federal Government (which had the capability to do it), and we've wasted all these years.

Read more:

$100B drop in infrastructure spending is the loss of two million $50K engineering, manufacturing, and construction jobs since the 90s.

mulp, you make some good points here. The sad thing is that governments in the U.S. will rake in $5.7 trillion this year and can't find room in there to keep infrastructure spending up. Pretty sure the answer isn't more taxes or deficits though.

So is the causality between negative supply shift and negative demand shift contingent on a wealth effect? Or is there some other mechanism at play?

another possible channel is expectations about income or growth. a supply shock that is perceived as temporary should have little spill over to demand, but if firms and households perceive a supply shock to be persistent (even if that is a misperception) the impact on demand could be larger. think especially about demand for consumer durables or investment goods which are used for some time.

Right, expectations of future income pv'd back reduce perceived wealth/purchasing power today for people who can and want to consumption-smooth.
All that means is that a supply-side shock can trigger a demand side slump far bigger than the initial shock. And demand-side policy would still be effective in stabilizing GDP, even if at a lower level than we would have expected before the supply shock hit.Sounds like standard Keynesian stuff to me.

None of this is really supported by theory. In a New Keynesian model, at times of inadequate demand, supply side policies don't merely not help, they actually worsen the contraction of GDP by reducing aggregate demand even further. Hence, the NK model has an unambiguous implication: boost demand first, then supply.

Great post and I don't disagree with it, but I think in reality it's too clever by a half. I suspect almost nobody in the actual policymaking world is this subtle and nuanced in their thinking. Republicans push for tax cuts because it suits their purposes anyway and they also don't understand how the business cycle actually works. It's not that they think there's a subtle interaction between supply and demand; it's that they don't understand that recessions are demand-side problems.

Elephant in the room that TC missed (or I am not reading TC right):

For those new to or confused by the term, secular stagnation is the claim that underlying changes in the economy, such as slowing growth in the working-age population, have made episodes like the past five years in Europe and the US, and the last 20 years in Japan, likely to happen often. That is, we will often find ourselves facing persistent shortfalls of demand, which can’t be overcome even with near-zero interest rates.

Secular stagnation is not the same thing as the argument, associated in particular with Bob Gordon (who’s also in the book), that the growth of economic potential is slowing, although slowing potential might contribute to secular stagnation by reducing investment demand. It’s a demand-side, not a supply-side concept. And it has some seriously unconventional implications for policy.

Very bizarre definition by Krugman. I think he's wrong about Gordon; economic potential is simply a linear extrapolation of the past, not secular stagnation which is Gordon's argument?

Anyway TC should address this issue.

Demographics alone already indicate that economic potential is not simply a linear extrapolation of the past.

This is what I refer to, and I think Krugman has it wrong about Gordon and about the definition of potential GDP. Does Gordon deny that demographics point to a slowing of productivity? If he does, then Krugman is right, but if not, then no. TC should address this issue. ("Potential output in macroeconomics corresponds to one point on the production possibilities frontier (or curve) for a society as a whole seen in introductory economics, reflecting natural, technological, and institutional constraints.... The difference between potential output and actual output is referred to as the output or GDP gap, which may closely track measures of industrial capacity utilization.")

" Does Gordon deny that demographics point to a slowing of productivity"

He does not.

I don’t see how a "a real estate bubble" (I guess this means producing more housing services than in retrospect was profit maximizing) "mask" a decline in the capacity of the economy to produce stuff? But OK the disappointment of real-estate investors leads them to consume less and save more; THEIR demand goes down, but it’s the job of the financial system to make sure that when some people start wanting to save more investment rises. The Fed’s job is to enforce Say’s law. (Whether that can be done with a Taylor rule, or NGDP level targeting or negative interest rates on e-money is another discussion.) And government makes the Fed’s job more difficult if in response to a fall in interest rates it does not start executing projects whose net present values become positive at the lower interest rates or – what’s worse adopts “austerity.”

Yes, it’s not either/or. Supply side policy is no substitute for a fall in demand but it’s not a very sensible response to a fall in productive capacity, either. If the Fed is doing its job, it’s always a good time to cut wasteful expenditures and eliminate bad policies.

Krugman's argument makes sense only if you assume that the Fed will not or cannot perform it's job, a job possible made more difficult by fiscal "austerity" (policies to decrease demand). Unfortunately, on the basis of the mistakes made in 2008-14,that hypothetical cannot be ruled out in the future and so his argument works in practice if not in theory.

How does a real estate bubble mask a slowdown in supply?

Because Real Estate and Finance was such booming in 2001, that is where all the most productive moved to. The huge outsourcing laid off a lot of productive workers who became Mortgage Writers or Real Estate Agents.

For the anti-government crowd, the real estate boom increased state government tax receipts and they hired too many employees from 2001 - 2007 which slowed down the supply of the private sector. (Notice the private payrolls during Bush took~ 6 years to reach the level of 2000.) Since 2009, public employees is a large net job negative, and that is way Obama's Nixon/China line will be "Only Obama could have let the drop of public employees."

What I find fascinating is how the two most productive economies in the Post War period, Japan 1980s and the US 1995 -2000, would devolve into this secular stagnation? (And what economy was more productive than the Roaring Twenties US economy?) It just seems the economies that the most productive and hard working, the bigger the bust.

What Krugman means when he refers to policy implications is that the western developed world is not competitive any more, and to make it competitive requires removing layers of know nothings that benefit from inaction, legacy cost structures and layers of rent seekers who do well by dividing up a stagnant pie.

During the housing boom drywall was being imported from China. A heavy, very low cost good. Where was the capacity to manufacture it locally? Where were the roadblocks to doing so? Lack of resources? China was importing them as well. Energy? China was buying up energy production facilities all over the world. What was adding costs to make it prohibitive to manufacture it locally? And yes, the economic term comparative advantage means that someone else is better than you at doing something and will get the work and the money.

Government in North America and Europe costs anywhere from 40-70% of GDP. If the US dropped theirs to 33-35% there would be no secular stagnation.

I sort of doubt THAT is what Krugman was talking about, but "removing layers of know nothings that benefit from inaction, legacy cost structures and layers of rent seekers who do well by dividing up a stagnant pie" is always a good idea, whatever the state of aggregate demand.

But that is what 'austerity' looks like. What has Krugman said about the State employees that were laid off as a result of collapsing revenues?

What HAS Krugman said about laying off state employees because of collapsing revenues?

I'd say if they are laid off because of collapsing revenues and not because they were not contributing to some useful state function, laying them off was a mistake. (Of course the fact that revenues were collapsing is probably a result of the Fed not doing its job, but that's another matter.) If they were not contributing to some useful state function they should have been laid off before there was a recession so they could be employed in something that is useful.

"Fed not doing its job" here makes sense only if the Fed's job is to bury bad decisions in huge stacks of worthless paper.

Magical thinking.

"What we shouldn’t do is all that Keynesian ditch digging." I'm not sure who supports that, not even Krugman. It's a straw man. "Of course hysteresis is a mechanism by which low AD can over time translate into low AS as well, but the causation runs both ways, don’t forget that." It certainly does, and Krugman would be the first to acknowledge that it does. It's unfortunate that, in an otherwise balanced post on AS-AD, Cowen has to throw in the straw man. I can appreciate why he does it, but it's still unfortunate.

Wasn't the implicit and explicit policies that encouraged and subsidized home ownership, along with financial innovation that increased the demand for housing, which incited a flurry of activity in that market from financial services to construction workers, production of the materials, a buildup of government services and costs in infrastructure; leading to a collapse and near obliteration of the financial system requiring vigorous filling in the ditch by TARP, the stimulus and the Fed QE program. Is it not a very large ditch digging and filling in operation pursued to generate economic activity?

Keynesian ditch digging is a pejorative phrase that encompasses non productive and wasteful activities done to encourage economic growth. Lots of that going on.

"Keynesian ditch digging is a pejorative phrase that encompasses non productive and wasteful activities done to encourage economic growth. Lots of that going on" I'm not sure there is a lot of that going on, but "wasteful and non-productive activities" are always bad whatever the state of aggregate demand. The state of dis-aggregated demand will, however, determine whether a particular activity is wasteful and non-productive. If the specific diggers and the specific shovels are really otherwise unemployed and the specific ditch reduces the risk of flooding a bit, this specific "ditch digging" is not a "wasteful and unproductive activity."

Is preparing for an imaginary Martian invasion anything like Keynesian ditch-digging? Whose idea was that?

It's not a straw man. At a certain point (someone else can surely provide a link), Paul Krugman and others decided that if the Fed wasn't boosting demand by enough, then the better-than-nothing option would be to engage in fiscal stimulus. We're no longer in an emergency situation, so the focus should return to monetary stimulus, not fiscal stimulus.

The impression Paul Krugman gives us is that we are still in a we-need-fiscal-stimulus-if-the-Fed-won't-do-its-job kind of situation. We're not. It's fair game to keep talking about monetary stimulus, and yes it's fair game to discuss reducing government debt-financed fiscal expenditures.

We do not need, never did need, fiscal expenditures on things with zero value -- holes dug in order to be refilled. We do need and did need investment in projects whose NPV have become positive because of a fall in borrowing rates. If this is "fiscal stimulus" then bring it on. If and when we return to full enough employment for interest rates to rise, fewer projects will pass the positive NPV rule and "fiscal stimulus" should be dialed back. That is the kind of austerity that makes sense. The public sector should just act over the business cycle like a rational non-credit constrained income maximizer.

Sure, if everyone agreed that the NPV were positive, then have at it.

Of course, for every proposed project, there is widespread disagreement about its efficacy. And since this is Marginal Revolution, I can describe this as "mood affiliation" and everyone will know what I mean. ;)

This is clearly a hysteresis/STeve Keen model.

I don’t see how a "a real estate bubble" (I guess this means producing more housing services than in retrospect was profit maximizing) "mask" a decline in the capacity of the economy to produce stuff? But OK the disappointment of real-estate investors leads them to consume less and save more; THEIR demand goes down, but it’s the job of the financial system to make sure that when some people start wanting to save more investment rises. The Fed’s job is to enforce Say’s law. (Whether that can be done with a Taylor rule, or NGDP level targeting or negative interest rates on e-money is another discussion.) And government makes the Fed’s job more difficult if in response to a fall in interest rates it does not start executing projects whose net present values become positive at the lower interest rates or – what’s worse adopts “austerity.”

Yes, it’s not either/or. Supply side policy is no substitute for a fall in demand but it’s not a very sensible response to a fall in productive capacity, either. If the Fed is doing its job, it’s always a good time to cut wasteful expenditures and eliminate bad policies.

The word austerity has popped up a lot in recent years. Meanwhile, we have added $7 trillion to the national debt since 2008. keep using that word. i don't think it means what you think it means.

I mean by "austerity" fiscal measures to reduce demand in response to recession, an increase in unemployed resources. It is the opposite of increasing public investment on projects whose expected net present values become positive when evaluated at the cost of borrowing and (if feasible) the shadow prices of the resources to be employed in the project.

Right. Here on earth, however, austerity means living within a budget, maybe even reducing debt. American households understand what austerity means. American businesses understand what austerity means. The American government does not understand what austerity means.

You seem to assume that "austerity" should mean the same for households and governments. That does not hold if the the two do not face the same borrowing constraint. If the borrowing rate falls during a recession, the government should increase its expenditures (financed by debt) to invest in projects whose NPVs become positive. The household cannot do this.

You keep talking about a recession. Keynesians always defend profligacy as a temporary measure to deal with a recession. But, as you demonstrate, the time to tighten the belt is... never. The recession ended four years ago, and the deficit is just now edging under 3% of GDP.

Governments aren't households. Obviously. No household has a credit card with a $20 trillion credit limit.

But this doesn't mean governments are exempt from the rules of economics. It means they can tick along for longer before blowing up spectacularly. See Greece, e.g.

I think the problem with your definition of austerity is that it's begging the question. Why do you think we have an AD shortfall? Because of severe austerity. Why do you say we have austerity despite higher deficits as a percent of GDP? Because deficits as a percent of full-capacity GDP has fallen. How do you know full-capacity GDP is so much higher? Because we have an AD shortfall.

Whether you think a recession is a demand or supply driven will affect your opinion about the right, non-austere, levels of spending. If you think pre-2007 trend is where you should be, and we're only lower because of AD shortfall, the you're going to say that governments should make up for the shortfall in trend. If you think that 2007 peaks represent an unsustainable bubble and that we're actually poorer than we thought, then governments should shrink accordingly. If the "right" level of government spending is 40% GDP, and half of the real economic capacity burns to the ground, then government should shrink proportionally with the economy.

I agree. What we do not need is for government to adjust its levels of expenditures according to the size or first derivative of the deficit. Where differences in views about AD/AS shortfall enter is in estimating what the appropriate shadow price for the "unemployed" potential ditch digger is and her MVP in digging the ditch. Both affect the NPV of the ditch project.

If all economic cycles were driven by AS, then matching government expenditures to revenue would be exactly the right algorithm. Counter-cyclical deficits would have no stabilization benefits, so you'd want public expenditures to remain proportional to overall economic activity. Hence one's view towards fiscal policy is very much informed by how much of overall cyclical variance they attribute to AS vs. AD shocks.

On the flip-side there very much is a public choice cost to deviating from simple budget heuristics (e.g. capping deficits as a percent of GDP). Public sector workers form a concentrated political interest. Political equilibrium would suggest that counter-cyclical spending is above efficient levels. That serves as a net transfer away from private sector workers. (It's not shocking to find that in nearly every developed economy public sector voters heavily favor the Keynesian party). If deficit levels were set by independent central banks, rather than political legislatures, that would probably co-opt a lot of conservatives into supporting fiscal stimulus.

We could build productive infrastructure, boosting both supply and demand, and with little risk of default on the debt. - See more at:



Or imagine an extraterrestrial attack.

These people are nuts. And in control. And we wonder why there is stagnation.

Re: Say's Law, it's basically right but poorly worded. The supply of goods and services is equal to the demand for goods and services, plus or minus inventory changes (and on a national level, plus or minus the current account deficit). Domestic-to-domestic credit expansion can only boost demand by also boosting supply.

That follows simply from the fact that you ultimately pay with what you produce. The exchange rates are the market values. Objections such as "what if I produce something nobody wants?" miss the point - the answer is nothing, the market value of that stuff is zero and irrelevant to supply and demand, which are always measured in market value terms.

So there is no mistake whatsoever in assuming that Say's Law always holds, so long as you properly understand its meaning, its one exception (inventory moves) and that since it is a global law it has limited application at the national level (corollaries of Say's Law that hold true at the global level tend to be negated at the national level by the outlet of current account balance moves).

Even so-called "real" values are really just the market values of some other time, and "PPP" values are just the market values of some other place. That for example is why real growth numbers are distorted by overproduction. They continues to value the overproduced goods at their past, prior-to-overproduction values.

This article is also muddled by the confusion throughout between contraction and growth slowdown. You seem to hop back and forth between the two even within sentences. Choose one and stick to it. I would suggest you stick to growth slowdown, since that and not contraction is the reality since 1999.

It's not surprising that you ultimately you come down agreeing with Krugman because ultimately you are a believer that public authorities should try to stimulate supply through the sovereign/central bank credit channel. NGDP targeting wouldn't work without constant fine adjustment of fiscal or quasi-fiscal stimulus. In practice NGDP targeting would be to the left of Krugman, roughly on par with MMT.

Next semester, after Cowen's course on Say's Law, the Mercatus Center will also be offering seminars on how to affix a horseshoe and a stirring debate on witchcraft punishments: burn at the stake or cast away to sea? Contact your town crier for more!

"But if we have a persistent shortfall in demand, what we need is measures to boost spending," says Krugman.

Well, Krugman's sure got that old-time Keynesian religion.

But even if "measures to boost spending" did at least temporarily increase aggregate demand, if much of that demand is for imported manufactured goods and commodities, that doesn't do much for employment at home, does it?

(Yes, I know: supposedly all the dollars used to buy imported stuff will come back home. But when they do, they don't come back to buy goods and services, they come back to buy government debt.)

Keynesianism only works if governments are truly counter-cyclical. That almost never happens.

In 2005-2006 when property tax revenues were exploding, local governments should have been pocketing the surpluses in rainy day funds. They could have then spent those savings in the down years.

What actually happened was that the US savings rate hit an all time low at the height of the property bubble and the cost of local/state governments also hit an all time high.

Then when the recession hit, consumers started saving more and local governments slashed spending.

Government spending doesn't smooth out the business cycle, it exaserbates it.

In other words, if it is Keynesian. :)

That's why the Chicago Plan of 1933 advocates QE ( Permanent ) plus a Reinforcing Stimulus. The QE addresses, mainly, the supply side, while the stimulus addresses, mainly, the demand side, although each does the other, as well. If you agree that it is not wise to increase taxes or cut jobs proactively in an economic downturn, then govt will have to borrow money, since tax receipts will go down, while spending first remains steady, so as not to destroy employment, and then grows to help people weather the bad economic times. The purpose of the QE is to raise future inflation expectations, while keeping current interests rates low. Future inflation incentivizes riskier investment, the kind of investment that produces returns that can outgrow inflation, as well as being the kind of investment that can add serious jobs and profits. Current low yields are meant as a disincentive, as they pay almost nothing. Of course, future inflation also incentivizes current spending.

The stimulus, govt borrowing, also incentives investment through its effect of adding to future inflation expectations.It is in this sense, and this only, that, as I interpret Keynes, you can spend the borrowed money on anything. The borrowing is what reinforces the inflation expectations of the QE. You should then spend the money on cash for the needy, a dated coupon, tax credits for investment, tax credits to help employers retain employees, a double-sided payroll tax holiday, sales tax holidays for the states, infrastructure, etc., or, optimally, some combination of these choices. The stimulus increases current spending, as well as reinforcing future inflation expectations, and incentivizing investment. As Prof. Cowen says, for any number of reasons, you want the most effective spending you can envisage, and part of the decision should be purely pragmatic. To the extent that QE works, the less govt will need to borrow.

As the economy gets better, tax receipts will rise and payouts to the needy, etc., should go down, allowing the debt to be decreased. If this doesn't happen, that doesn't argue against this plan being the most sensible response to an economic downturn. It means big government has more to do with other things than sensible economics for the whole economy. It is true that you will have to pay close attention to future inflation, but, if you follow this plan, future inflation expectations will change from concerns about the borrowing to being about a growing economy. Still, you will need to pay attention to inflation.

It is also true that there will be some losers in this plan, but the intent is to focus on the whole economy, not specific aspects of it, unless they help us grow the economy. Optimally, QE and the stimulus should be coordinated. In my view, and, more importantly, others views, like Frank Knight, Henry Simons, and Irving Fisher, this is what worked in 1933, and would have kept working but for some poor decisions. The Chicago Plan also advocated other steps to create a healthier economy, most of which are still sensible. This plan put forward by Milton Friedman sums them up:

'Reinforcing Stimulus?' Care to put some numbers around that? Because, since 2008, the federal government has spent $7 trillion more than it has collected in taxes. Unfortunately, this unprecedented deficit spending is generally bemoaned as 'austerity'.

Brian, I can't do that, since the QE I support didn't happen. Also, I agree with Dean Baker that raw numbers should always be put in context, like percentages of the budget, etc. Austerity, in my view, means a govt paying down debt by cutting help to the people who need it, for example. In other words, taking money away from the people least responsible for a govt getting into debt. It doesn't have to do with how much the govt spends or borrows. I do get your point, but, as Burke said, in "A letter to a Noble Lord.":

"Whatever I did at that time, so far as it regarded order and economy, is stable and eternal; as all principles must be. A particular order of things may be altered; order itself cannot lose its value. As to other particulars, they are variable by time and by circumstances. Laws of regulation are not fundamental laws. The public exigencies are the masters of all such laws. They rule the laws, and are not to be ruled by them. They who exercise the legislative power at the time must judge.
It may be new to his Grace, but I beg leave to tell him, that mere parsimony is not economy. It is separable in theory from it; and in fact it may, or it may not, be a part of economy, according to circumstances. Expense, and great expense, may be an essential part in true economy. If parsimony were to be considered as one of the kinds of that virtue, there is however another and a higher economy. Economy is a distributive virtue, and consists not in saving, but in selection. Parsimony requires no providence, no sagacity, no powers of combination, no comparison, no judgment. Mere instinct, and that not an instinct of the noblest kind, may produce this false economy in perfection. The other economy has larger views. It demands a discriminating judgment, and a firm, sagacious mind."

Great quote, and I do get your point too. But there is this weird, almost universal assumption that fiscal policy over the past seven years has been 'austere' rather than 'accommodative' because it's been ever so slightly less reckless than the policy that preceded it. I'm pretty sure that Burke, if he were here today, would agree with me. Our circumstances, after all, are wildly different from what obtained in late 18th century Britain.

"Circumstances give in reality to every political principle its distinguishing color and discriminating effect. The circumstances are what render every civil and political scheme beneficial or noxious to mankind."

Since I favor Monetary Policy before Fiscal, I agree, especially in the sense that I would hope that QE, rightly done, would significantly lower govt borrowing costs to get out of this mess.

Question for the Keynesians: Let's say I have a supply sector that produces nothing but tables, but consumers have all the tables they want and really want chairs. Since nothing is available that consumers want, they stop spending. Do I have a supply side problem or a demand side problem?

If it's a demand-side problem, how much fiscal stimulus is necessary in order to 'fix the economy'?

The Austrian argument would be that years of bubbles, stimuli, regulations and other market distortions have caused a misallocation of productive resources. We're investing in things that people don't want, so demand is down. So long as people aren't having their demands met by the supply side, fiscal policy isn't going to help much, other than to cause even more distortions.

Follow-up question to the above: As a Keynesian looking at aggregate data, how would you know whether demand is down because of the standard Keynesian reasons (fear, no cash, whatever), vs demand being down because people can't find what they want, or don't like what they are being offered?

What would it take for a Keynesian to look at the low demand and conclude that the problem was a mismatch between supply and demand, rather than just low aggregate demand because of non-supply reasons?

An unrelated question: What if demand was low because people are afraid that all the QE and stimulus and deficit spending was going to lead to a weak economy in the future, and therefore they are rationally saving their money? If demand is caused by worries generated by fiscal stimulus, how much fiscal stimulus do you need to overcome it? I know, a trick question. But at some point, even Keynesians have to be willing to acknowledge that when debt or fear of debt is the problem or part of the problem, borrowing and spending will not help.

The same question could be asked if the drop in demand is being cause by fears of the projected fiscal crunch when the boomers retire and move from being productive assets to liabilities, economically speaking. All those retirement promises are coming due, health care costs are going to explode, etc.

Given that likely future, doesn't it make sense to hunker down and not spend quite so much? If so, how does stimulus help - especially with money borrowed from the same future that is going to have a problem paying for all those retirement and health care bills? Why wouldn't consumers simply save even more if they saw the deficit increase dramatically?

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