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"In short, why has the argument that while there may be macroeconomic problems, there are only microeconomic explanations and solutions fallen on deaf ears among so many economists and economic students?"

I would argue that it is because the argument is fundamentally inaccurate. And this is a serious response to what I do acknowledge is an "actually serious" question that you've posed. The anti-aggregation bias is grounded in a fear of committing an ecological fallacy - inaccurately inferring something about constituent parts based on observations of the whole. That's a very valid fallacy to be concerned about, and it's something that macroeconomists should always be on guard against.

But it's not the only fallacy out there. There are fallacies of composition too, and this is what I think we often see committed by people with an instinctive bias against aggregation. This is what you and Steve and others have to always be on guard against.

I think you have to be careful in assuming that because someone doesn't think there are "only microeconomic explanations" they are somehow unreceptive to the microeconomic explanations that do clearly exist. Jerry O'Driscoll seemed to make this leap of faith in a recent post about Larry Summers on ThinkMarkets as well (although I could very well be misinterpreting him). The fact that macroeconomic processes are preoccupying some of us right now should not be mistakenly interpreted as an abandonment of the microeconomic concerns. Take this recent concern about unemployment insurance. I'd be a fool to deny the fact that unemployment insurance, holding all else constant, reduces the incentive to find a job. That's definitely on my radar. But with current hiring behavior it's hardly my biggest concern right now. In places like Europe, where there are substantial separation costs, hiring behavior may indeed be tied to these microeconomic concerns. But I'm not sure how one could make the case that deficient hiring here is driven by mircoeconomics or the safety net. And I'm not sure how one could make the case that here in the U.S. job search intensity is a bigger concern for unemployment than the hiring rate.

"What Precisely is Aggregate Demand Failure and How Would You Know It If You Saw It?"

My best (generous) interpretation is: low consumer confidence. I don't believe in "animal spirits" (I have never been highly religious) so I tend to look for underlying causes. As an example, a report on a recent survey of small businesses summed the following way:

__Owner optimism remains stuck at recession levels. The proximate cause is very weak consumer spending, better than a year ago, but that was pretty bad. ... But the other major concern is the level of uncertainty being created by government, the usual source of uncertainty for the economy. The “turbulence” created when Congress is in session is often debilitating, this year being one of the worst. Themes including “tax more,” “tax the rich even more,” “VAT taxes,” higher energy costs due to Cap and Trade, mandates and taxes for health care, threats of “stimulus II,” incomprehensible deficits, and a huge pool of liquidity created by the Federal Reserve Bank that threatens price stability and higher interest rates. The list goes on and on. There is not much to look forward to here and good reason to “keep your powder dry.” Uncertainly is the enemy of the real economy as well as financial markets.__

So: the __proximate__ cause is low consumer spending - small businesses report "nobody is shopping, so my profits are low" - a fall off in aggregate demand - but what are the underlying causes?

Consumers may worry that taxes are going up, and so they may be holding onto their money instead of spending it. Businesses may worry that taxes, regulations etc, are getting worse, so they may not feel they can afford to drop prices even more to pull in more customers, they may not be investing, expanding, etc. Prices may be high due to inflationary policy and this may be curbing demand as well, etc.


"Why is this mainline of economic thinking response so out of favor with the current mainstream of economic theory and policy? "

This is the eternal question for Austrians - I think it is rooted in the history of the discipline, which took a turn after the MR, which itself coincided with a social movement favoring socialism, when "rational" social and economic direction (by elites or by 'democratic' means) was the fashion. Mainstream contemporary models developed in a highly path-dependent process within a highly centralized and elitist academic environment, so the scientific community is not ready to question the core models.

"I'm not sure how one could make the case that deficient hiring here is driven by mircoeconomics or the safety net." - Daniel Kuehn

Low hiring may not be due to the safety net (alone at least) but this is a far cry from saying that it is not due to things happening at the micro-level: such as the expectation of tax increases (as cited by the small business survey), the difficulty in competing with firms that are receiving subsidies or bailouts, and for some firms and industries regulatory or price-control measures, etc.

These would be the micro-level issues starting at time t and going forward -- but there were also issues at time t minus the bubble, when inflationary policies drove investment into housing and certain kinds of financial instruments; and the policies that the macroeconomists argue are necessary to deal with the macro-issues may have long term "micro" based effects, such as further investment in areas where there is insufficient demand for those particular products, etc.

Personally, I think the micro/macro distinction is a major cause of misdirected research, and confusion. But, this may be because I never took a really good class in Keynesian economics, and I just don't get it. So, I am curious Daniel: what do you think is the cause of deficient hiring -- not the proximate cause, but the real underlying cause. What caused the bubble? What caused the crash? Why is there insufficient hiring now, and what should be done about it? Thanks.

Daniel-
Do you find that there is any sort of tension between looking at the economy in terms of high levels of aggregation and the type of relative price adjustments Pete is talking about?

It seems to me that once you hit a certain amount of aggregation you're going to have to end up denying- or at least ignoring- microeconomic explanations to be consistent.

What do you think?

Deficient aggregate demand--aggregate demand less than productive capacity = excess demand for money--a quantity of money less than the demand to hold money = a market interest rate greater than the natural interest rate--saving greater than investment.

How do you know that aggregate demand is deficient? If cash expenditures have fallen below their trend growth path, and the levels of prices and wages have not fallen in proportion, then the presumption should be that aggregate demand is too low, that there is an excess demand for money, and that the market interest rate is above the natural interest rate.

Never, never, never look at market interest rates and the quantity of money and compare them with historically "normal" levels.

If some aggregate measure of production has fallen, and in the particular markets where it has fallen, there are shortages and higher prices, then deficient aggregate demand is probably not the problem.

If aggregate production has fallen and in the markets where output fell there were surpluses (that is, production was cut because it couldn't be sold,) but that there are other markets where demand, production, prices, employment are all rising. Further, the rate of expansion in production is being limited by bottlenecks of various sorts. Complains about finding workers with specific skills, prices of key materials rising and the like, then there is a difficult judgement call. How significant are these expanding industries relative to the contraction ones. Is the unobservable excess demand in these markets greater than the reduction in output?

If there are no such markets with increased demand, and every market is in surplus, then it is clear. There is obviously an excess demand for money generating the problem.

My "solution" to the problem is to keep aggregate cash expenditures on a stable growth path. If somehow rising prices creates an excess demand for money--too bad. The prices should rise.

If the productive capacity of the economy is depressed for some reason, then the price level will rise.

I don't believe there is a market process by which a drop in productive capacity automatically results in a decrease in cash expenditures so that we can say, sure, nominal and real expenditres have dropped on the whole, but that simply reflects a reduction in the productive capacity of the economy.

A drop in productive capacity, even if it is due to a change in the composition of demand will tend to cause higher prices. And that tendency should not be combated.

On the other hand, having changes in the general level of prices and wages in order to bring the real quantity of money to the demand to hold money and the market interest rate to adjust the natural interest rate results in pointless disruption when the nominal quantity of money can be adjusted instead.

oops!

If somehow "market power" is used to boost prices or wages, so that stable growth of cash expenditures results in excessively low aggregate demand, then nothing should be done. Prices should fall, and wages should fall, though rising more slowly will rapidly do the trick.

Of course, if there is really a monopolization, so that productive capacity is reduced and prices increased, then this is presumably a bad thing, but nominal expenditure should continue to grow on target.

liberty -
I think tax policy expectations are clearly a part of the concern, but the recent April survey of small businesses that I've seen emphasized consumer demand as the primary concern of small businesses (also mentioning taxes less prominently, of course). I would expect that small businesses would be disproportionately concerned about taxes (relative to larger businesses), so if consumer demand is reported as the primary obstacle to hiring for them I think we can only expect it to be considered a greater obstacle for larger employers (it's important not to take small businesses as the exclusive barometer for American business).

I agree with you on your bubble logic in the second paragraph.

You ask quite a question at the end. I can provide impressions and cautious answers, but I'd leave firmer answers to others - particularly to others in the future who have had more time to review. I think a major cause of the unsustainable boom was the global capital imbalances that fueled the bubble. Low interest rates in the early 2000s probably had something to do with it as well, but I think this point is unfortunately too heavily emphasized to the exclusion of other factors. Again my _impression_ is that the lack of financial regulatory balance on the upside and on the downside lead to a bubble. Before you accuse me of being a trigger-happy regulator, I'll point out that this imbalance in regulation is highlighted by both Russ Roberts and Joe Stiglitz. But I think you're making an unjustified distinction between "proximate" and "underlying" causes. I imagine you wouldn't consider debt-deflation cycles, wage-price dynamics, collapses in confidence, etc. as being "proximate". I'd submit those as well and argue that they're worth highlighting as unique causes in their own right.

Samuel -
I guess it depends on what you mean by "a tension". Certainly if I were to take an exclusively aggregated perspective or an exclusively disaggregated perspective, they could and would come to different conclusions on many questions and that - uninterrogated - might be seen by some as a "tension". But the point is you need to interrogate those apparent tensions and understand whether one line of argument is committing an ecological fallacy or the other is committing a fallacy of composition.

To me, that's like asking whether there is "tension" between cosmologist and a molecular physicist. Or (because I think economics/physics comparisons are bad), whether there is "tension" between organic chemistry and biology - or for that matter psychology and sociology. On a superficial level, of course tensions emerge. Good science arbitrates between those tensions. You don't have to throw what we know about capital accumulation out the window to claim that under certain circumstances the paradox of thrift is a real concern.

Pete,

Well, maybe this is simple-minded, but if one sees GDP fall and employment fall, and one cannot identify some obvious supply-side cause, such as the current volcanic eruption in Iceland, which may well trigger a double dip of the recession, then it is probably due to a shortfall in aggregate demand, which can come from a variety of well-known sources. Of course supply-side shocks, such as an oil price shock, often will show up initially or fundamentally as relative price shocks, but when one invokes something like minimum wages that have barely changed as a cause for a sudden surge of unemployment, this is not credible, even if too high minimum wages might be at least partly to blame for chronically high unemployment.

An interesting character here in my mind is John Stuart Mill, who is not particularly liked by either Austrians (traitor! traitor!) or by Keynesians (classical! classical!). From the Keynesian side he is disliked as one of the foremost defenders of Say's Law, following his father's influence, who I think may have even been the one who coined the term, "Say's Law." He clearly supported it, at least in some sort of longer run, and openly and loudly dismissed Malthusian-Sismondian arguments for the possibility of aggregate gluts (at least in the long run).

However, he was clearly open to the idea of recessions (the term not in use then) being due to shortfalls of aggregate demand, even if he did not formulate it that way. And, to my eyes, his model of macro fluctuations looks highly Keynesian/Minskyan, although I would say that if a Hayekian really wanted to, s/he could put a Hayekian spin or interpretation on it. Furthermore, Mill's view looks very appropriate to the current situation.

Essentially, it is a model of endogenous financial fragility. Mill very much accepted the idea of bubbles, and he saw many possible causes for them, with his view being that they usually started from an initial shock to mirco supply-demand fundamentals, but that then psychological factors would kick in, abetted by a loosening of credit standards (here the Hayekians can leap in), with a price bubble forming. When it eventually crashes, it takes down financial intermediaries that got too deep into financing it. This collapse of financial intermediaries then dries up lending, with real capital investment falling. This then is the source of the fall in aggregate demand that pushes the economoy into a recession until things gradually work themselves out. And for Keynes indeed the usual culprit was a collapse of investment, with the collapse of animal spirits possibly being triggered by the collapse of a speculative bubble somewhere in the economy.

Just a quick note to largely second Bill W's analysis. And note that "deficient aggregate demand" is possible, in his account, only when there is an excess demand for money. That is EDM = excess supply of goods. I would rather refer to this situation as an "excess demand for money" than a deficiency in AD given some of the problematic connotations AD has acquired over the years, but the substance is the same.

Note further that this is not a denial of Say's Law. Any decent and fair-minded reading of Say himself (so Keynes' silly misrepresentation is out) makes it very clear that Say allowed for gluts and shortages *IF there was too much or too little money.* No serious understanding of Say's Law denies the possibility of gluts or shortages (i.e. believes AS always equals AD). For Say, and for the monetary disequilibrium crowd and the Austrians, gluts and shortages (systemic, economy-wide ones as opposed to individual markets) have to have monetary disequilibria as their cause.

An "aggregate demand failure" can only occur in a monetary economy. Hayek made a big point of this, even though he never used the phrase "aggregate demand." When a surplus or shortage of the medium of exchange develops, available resources are not properly accounted for by the price system. Relative prices may or may not need to adjust, depending on whether there are structural distortions.

Steve - it's a reasonable point, and one that Brad DeLong has made in the past as well. But I think we have to admit that a substantial contingent of fair-minded people don't have this understanding of Say's Law. For example, my understanding was that Mises presented Say as providing precisely what you say he didn't: a refutation of the idea of a general glut. Mises wrote: "Whenever business was bad, the average merchant had two explanations at hand: the evil was caused by a scarcity of money and by general overproduction. Adam Smith, in a famous passage in The Wealth of Nations, exploded the first of these myths. Say devoted himself to a refutation of the second."

It's important when thinking about what Keynes wrote on Say's Law to distinguish between thinking about it as a thorough review of Say's Law (which it really wasn't) and a treatment of a classical mindset grounded in Say's Law that served more as a heuristic device (which I think it was). I haven't read Say in depth, but the selections of Say that I have read that have been pointed out to me leads me to be sympathetic to your interpretation and DeLong's interpretation. However - the fact that in their more sober moments the Classics were capable of acknowledging this prospect doesn't change the fact that general gluts were woefully underemphasized in the Classical tradition.

Steve,

Well, maybe this is some monetary disequilibrium, but some of the examples Say himself provides for how "his" law might be violated involve fiscal effects, such as tax avoidance. One of his prime examples was people hiding their (excess?) money and not spending it because they wanted their houses and properties not to look too valuable, thereby avoiding confiscatory taxes under the Ottoman Empire.

It's nice to see such a great agreement between the hard-core Keynesians and soft-core Problem Coordinationists here. :)

However, Steve's reformulation of the problem also leaves much to be desired, just as "aggregate demand failure" mantra does. Namely - how can we recognize an "excessive demand for money" when we see the one? Falling general price level? If so, why then only a falling price level would suggest excessive demand and not say, stable, or that at the level increasing less than 2% annually?

As for "general gluts", I am afraid that our Keyensian friend is basically right: crackpot Mises really believed, just like crackpots Smith, Ricardo, Hume, Say and Mill did, that the notion of a general overproduction is a nonsense, and that only thing that is possible in a market economy is a change in the exchange ratio between the various goods, not an "overproduction".

But, nobody serious and respectable today does listen these crazies anymore, since the great genius JM Keynes, enlightened by the "great Prophet" Silvio Gessel and their glorious 17th century Mercantilist predecessors already refuted those drunken Say's Law phantasmagories of Classical and Austrian economics.

Hayek interpreted Say's Law as equilibrium reasoning. There can be an excess demand and supply in particular markets, but price changes will move markets back into equilibrium.

Only the existence of money can break that rigid linkage and introduces demand for goods where there is no counterbalancing supply of goods. From that, Hayek developed his analysis of economic fluctuations.

For good reason, Hayek did not reason in terms of aggregate demand. It was inherent to his theory that an increase in supply of money relative to demand distorts interest rates -- intertemporal pricing and allocation. There is no general excess demand for goods (or excess supply of money), but different demand changes in different markets.

Mises and Hayek were in agreement on this analysis. Mises would later say there is no such thing as neutral money; a money that was neutral would not be money at all.

Both Mises and Hayek relied heavily on the classical economists for the origin of this analysis. Hayek in particular cited Mill authoritatively on the important proposition that the demand for commodities is not the demand for labor. New Keynesianism collapses if Mill was correct on that point.

It is generally accepted that Say denied the possibility of general gluts (general oversupply of goods). He acknowledged there could oversupply in some markets and undersupply in others; that was the essence of his equilibrating mechanism. It is not even clear that Say was the first to articulate the principle. Arguably, Adam Smith was first.

Here I'm going to rely on Thomas Sowell, who did the original research on this issue. In the 4th edition of his book, Say recanted his denial of the possibility of a general glut. That edition has never been translated into English. Reissues of Say in English are of the 3rd edition.

The classicals were accutely aware of recessions and cycles, booms and busts. They wrote often on the subject in pamphlets and newspapers. They used what we would call disequilibrium analysis and often invoked changes in the demand for money. They had no need of instruction on the issue. They offered analysis relevant today, as, for example, Henry Thornton's Paper Money.

My pithy take on all this is that are macroeconomic phenenomena, but only microeconomic analysis of the phenomena.

Jerry,

I don't have a copy in my office, and I do not remember which edition I saw in our library (all beat up), but there were at least two chapters in which he presented several examples of how general gluts might arise, at least for periods of time, although he did not spend much time on those examples, and in other places in that copy/edition he stated strong versions of "his" law, despite having offered caveats in other places. But then, he is hardly the only economist to have pulled off such stunts, if just to confuse everybody coming later.

I think Jerry is spot on here, and I actually think it is _this_ analysis that Steve is groping for, and which gets lost when aggregate demand (supply) concepts get employed. Jerry's point about price changes and different demand changes in different markets is what I was trying to suggest by my reference to the Say and Malthus exchange on a _general_ glut.

On the problem with aggregates, I recommend that all look at Hayek's review of Keynes's A Treatise on Money, and then also his discussion of aggregate statistical analysis in Counter-Revolution.

So to Daniel, Bill, Steve, and Barkley, I remained unpersuaded that aggregate concepts do much of anything to improve our understanding of an economic system. I realize just how "crazy" that might seem, but it is unclear to me what we are actually talking about and whether these ideas have any _economic meaning_ to the actors within an economy. I guess I am part of the old school that believes that there is monetary theory, there are questions concerning inflation, unemployment, and fiscal policy, but there is only as far as the discipline of economics is concerned only microeconomics. And to Nikolaj --- that leads to a focus on the coordination problem; nothing soft-core about that, just not fringe crazy and instead part of the mainline of economic thinking from Smith and Hume, to Say and Bastiat, to Mises and Hayek.

Well Pete, I'm going to stick to my guns a bit here.

In the case of an EDM, I would argue that we really do have an *excess supply of goods* in the aggregate. The interest rate effects of an EDM are different from those of an ESM in that I don't believe they pull at the two ends of the triangle in the way Roger describes with inflation. In contrast, EDM pulls the middle up - namely investment is greater than savings in the form of unintentended inventory accumulations. This is the excess supply of goods.

Of course they need not be exactly *equal* across all markets as the "non-spent" money will not be distributed equally. But the excess supply of goods evidenced by the inventory accumulations are *general* in the sense that they (absent any other interventions that distort by sector - like the housing market) will affect the entire economy as MV falls.

As I said, I don't think the term "aggregate demand" is useful here for a whole bunch of reasons, but I do think the idea of a general glut isn't silly and as Barkley said, it's in Say once he admits the role that money can play.

Jerry is quite right about the effects of inflation being a different ends of the Hayekian triangle and thus not "a general shortage." But I think the deflationary case is not precisely parallel.

Let's also be careful not to take "general" to mean "equal." General simply means that there exists ESG in most/every market, not that there can't be differences in the degree to which each market is affected.

I should add: I plead agnostic on the issue of the 4th edition of Say. That's an interesting addition to the debate.

dear prf Beottke.

I am 100% in agreement with you and Jerry on this. My jocking comparison of hardcore Keynesians and soft-core "Problem Coordinationist" was not intended to refer to your post (I agree, as I said, completely with the main thrust of your argument) but to Steve's far-reaching agreement with the commentators advancing obvious Keynesianism here, and to his (their) rejection of your argument which represents a typical mainstream "Austrian" theorizing. I am sorry if that was not obvious.

One other point:

I'm not arguing that what is happening *right now* is a general glut/EDM situation. I was simply pointing out that such a thing is possible. Our problems right now are of the sort Pete and Jerry are talking about: the need to reallocate among parts of the economy through a Great Recalculation thanks to interventions preventing such a process in the wake of an Austrian type cycle.

If I may be permitted to quote from an "authority" on the issue of aggregate demand and supply analysis, an individual who in the 1930s and 1940s was considered probably THE most well read and knowledgeable individual on monetary theory in several languages.

This is Arthur W. Marget, from volume 2 of his "The Theory of Prices" (1942), in his critical comments on Keynes' method of doing macro analysis (pp. 541 & 544):

"It is a fundamental methodological proposition of 'modern' versions of the 'general' Theory of Value that all categories with respect to 'supply' and 'demand' must be unequivocally related to categories which present themselves to the minds of those 'economizing' individuals (or individual business firms) whose calculations make the 'supplies' and 'demands' realized in the market what they are . . .

"[T]he type of problem raised by the necessity for establishing a relation between these 'microeconomic' decisions and these 'macroeconomic' processes is not solved by the arbitrary introduction of an 'aggregate supply functon' and an 'aggregate demand function' for industry as a whole, in deficance of the fact that neither of these 'functions' deals with elements which enter directly into the calculations of the individual entrepreneurs whose 'microeconomic' decisions and actions make 'macroeconomic' processes what they are. On the contrary, it must be said, of such an attempt at 'solution,' that it misconceives entirely the true nature of the relation between microeconomic analysis and macroeconomic analysis . . ."

Richard Ebeling

Gosh, call me a naive macro guy, but this all seems much more complicated than it need be. Why not simply think of aggregate demand in nominal terms, letting it stand for the total _expenditures_ (Py). In that case it's easy enough to envision a stable situation in which that flow retains a stable value over time, allowing aggregate firm revenues to cover aggregate expenditures. Since MV=Py, the flow may be reduced either by monetary contraction or by a decline in velocity. Unless P adjusts immediately to compensate, the "excess demand" for money must impinge on sales or output or both. Nor is this possibility at all inconsistent with Say's law, properly understood (and as Jerry appears to understand it): as George Poulett Scope indicated in a chapter heading to his 1833 Principles of Political Economy, "A General Glut of Goods presupposed a general Want of Money." A "general want of money" can occur; hence a general glut of goods is itself possible.

Plain ol' textbook monetarism, which is what all this is, may be faulted for plenty of things. But inconsistency with orthodox microeconomics isn't one of them.

Assuming that "relative prices" includes the prices of money, i.e. the rate of exchange between money and other goods, then deficient aggregate demand merely means that money is too expensive.

Richard,

Nothing in Marget's quote is, to my mind, at odds with my argument. Under the conditions of an excess demand for money, all kinds of individual microeconomic decisions can add up to an excess supply of goods. It's for Marget's reasons that I explicitly said in my first comment that I would not use the terminology of "aggregate demand failure" because of the problems with the term "aggregate demand." Nothing in Marget's quote in and of itself denies the possibility of a general glut that emerges from a whole series of microeconomic decisions when desired money balances are greater than what the current supply can accommodate.

So if other folks want to continue to use the adjective Keynesian as an epithet for me go right ahead, but I'll stand with Marget if that's okay.

What George said.

And careful George or the really smart people here will call your "textbook monetarism" a form of Keynesianism just to show you how smart they are and how confused you are.

Steve:

My use of the quote from Marget was not necessary directed at you. Nor did Marget -- knowledgeable as he was about virtually all of the history of monetary thought -- deny the potential for a general "glut."

The questions are: (a) what has occurred in and between markets that has caused this "imbalance" and discoordination across much of the economy? (b) what is preventing appropriate adjustment or adaptation to the relevant situation as it now exists that would restore balance and coordination? (c) what, if any, policies would assist in restoring this balance and coordination across the market?

Marget's point, and I think others such as Hayek, for example, was that these questions cannot be successfully answered unless the investigation focuses on the microeconomic relationships through which all market interactions occur. And this, surely, requires us to understand where and why the structure of relative prices and wages, and various resource allocations across markets, are not making the necessary adjustments and adaptations to restore that balance.

I am, therefore, not persuaded by statement such as George Selgin's that "it's all so easy" if we just think and analyze it in terms of some version of the equation of exchange.

If we accept that there is no "aggregate demand" -- there are only the demands for specific goods -- then there is no such thing as trying to maintain "total" nominal expenditure.

The additional money introduced into the economy to compensate, for example, for a increase in the demand for money (decline in velocity) must be injected SOMEWHERE, it must impact on some specific demands and prices FIRST, and then ripple through the structure of relative demand and prices, so that at some point the macroeconomic level of nominal expenditures will appeared to have been restored or maintained.

However, you cannot just say, well, it has compensated for an excess demand for money. The market demand for money is merely the sum of the individual demands for money. Who has an excess demand for money and by how much compared to his preferred money holdings before the current situation cannot be known.

The individuals, businesses, borrowers, etc., to whom the injected money first goes may have nothing to do with these people. The injected money merely follows its own temporal-sequential path, leaving in its train its specific impact and influence on relative prices and wages, profit margins, and resource uses.

I do not see how this restores or corrects for the specific relative price and wage distortions, and resource misallocations that were the problem that a policy was supposed to find a "cure" for. You just overlay, possibly, another layer of relative price and resource distortions over the original ones that made people concerned about the initial macro problem.

And this was, of course, the perspective originally taken by Mises, Hayek, Machlup, Robbins, and even Pigou, in the early 1930s as the Depression was intensifying.

I know some of these individuals "recanted" in later years. For myself, I still find their original position the most persuasive and consistent with a micro-process approach to macro problems.

Richard Ebeling

Pete, a fall in aggregate demand is recessionary because there is a recessionary virtue in it whose nature is to cause the economy to become recessionary.

And an aggregate demand failure is characterized by the fact that GDP falls and unemployment rises -- and conversely the fall of GDP and the rise in unemployment is explained by an aggregate demand failure. In other words, aggregate demand failure is explained by a shortfall in aggregate demand.

Compare Moliere, "dormative effect"

Richard,

I know you weren't directing it at me, and my response was more to make that clear to others.

Question for you though: I understand your argument about the problems with responding to a decline in velocity with an increase in the nominal money supply. My question is whether you think the problems are the same under central banking (where I will concede they are greater) and under a free banking system, where, I would argue, the responses in terms of an increase in the nominal money supply would match far more closely to where the decline in velocity is taking place.

If you think the problems are significantly lessened under free banking, then I think we're debating over "degrees" as I don't think (nor does George I feel fairly comfortable saying) that changes in the nominal MS under central banking will do the job anywhere near as well as free banking would.

If you think such problems are (nearly) equivalent under free banking, then:

a. Would you still support a free banking system under which such responses in M would take place to changes in V?

b. If not, what set of institutions would you prefer?

c. Do you believe that the downward pressure on prices exerted by the excess demand for money is sufficiently harmless so as to suggest that a fixed nominal money supply is the preferred choice for either central banking or some private system?

I have a piece in tomorrow's Wall Street Journal that addresses the issue of distorted pricing. But I carry Hayek beyond pricing to accounting statements and representations in financial transactions. It's titled "An Economy of Liars."

http://online.wsj.com/article/SB10001424052748704508904575192430373566758.html

For Pete: Much of economics is devoted to explaining the origins of "aggregate phenomena" in the actions of individuals. Changes in "aggregate demand" are an instance of one such phenomenon. Now, to in turn treat a change in AD as itself "causing," say, a (temporary) change in output isn't to insist on treating the change itself as an ultimate cause. It is simply a matter of it not always being necessary or worthwhile to refer to the individual actions. It is instead to be understood that, if one attributes a recession to a decline in AD, one really means to attribute it to those more fundamental ("microeconomic") causes of the decline in AD itself. Of course, one could try to avoid the shorthand; one could scrupulously avoid referring to intermediate aggregate phenomena as causal factors. But would doing so assist our understanding? Should we likewise insist that we stop speaking of "demand for pencils" and refer only to Joe's demand plus Frank's demand plus Sue's demand and so forth? If aggregation "helps" understanding of phenomena at the industry level (and, for that matter, at that of the firm), why shouldn't it sometimes prove helpful when considering economy-wide phenomena?

The more Romer/Summers/Obama muck up the economy the more people want to hoard money and abandon producing, the more Romer/Summers/Obama feel compelled to muck up the economy, the more people want to hoard money and abandon producing -- the problem that Pete is having is that "aggregate demad failure" is a viciously self-fulfilling and refractively defined circle, it comes defined as "not enough Keynes" -- and the more Keynes you get the more aggregate demand failure you get.

As Popper would put it, anything and everything that happens is taken as evidence in favor of the theory -- failure of aggregate demand is defined as not enough Keynes, and every refutation of Keynes is taken as evidence that more Keynes is needed ...

I should add that words begin to loose their meaning and purchase on the world when there is no state of the world to which you can't ascribe the term -- i.e. if the problem of "failure of aggregate demand" means "not enough Keynes" and no matter how much "more Keynes" you get still results in "failure of aggregate demand" it comes to be that there is no state of the world that isn't describe by the phrase "failure of aggregate demand".

I wrote:

"The more Romer/Summers/Obama muck up the economy the more people want to hoard money and abandon producing, the more Romer/Summers/Obama feel compelled to muck up the economy, the more people want to hoard money and abandon producing -- the problem that Pete is having is that "aggregate demand failure" is a viciously self-fulfilling and refractively defined circle, it comes defined as "not enough Keynes" -- and the more Keynes you get the more aggregate demand failure you get.

As Popper would put it, anything and everything that happens is taken as evidence in favor of the theory -- failure of aggregate demand is defined as not enough Keynes, and every refutation of Keynes is taken as evidence that more Keynes is needed ... "

In the last 10 years, the financial structure of the economy has become unsustainable.

In 2007 a return to normalcy has begun, it has been called deleveraging, and it has an output and employment effect that have nothing to do with aggregate demand. It's the adjustment to a lower level of debt, intermediation, risk and maturity transformation.

Lending possibilities have been reduced by this process, as analyzed on a higher level of abstraction (i.e., with a loose interpretation) by Strigl in Capital and Production.

One may object that deleveraging is a nominal issue, but it is not: lower risk taking, lower level of debts, lower access to credit, lower availability of long-term funds and higher counterparty risk are real phenomena.

This alone explains a lot even without Austrian capital theory. If we add a 2 million new unemployed in construction, 0.3 million new unemployed in automotive and other evident forms of malinvestment (of 2.3 millions jobs lost in industry, 1.8 were in durables) being revealed by the crisis, we explain some 50% of unemployment.

Considering that most of new unemployed are low-skilled, I would argue that minimum wages, which have increased, may have played a role, too.

However, even without minimum wages, a rise in unemployment would have resulted, unless one argues that a construction worker can become immediately and costlessly a productive oil driller or photovoltaic producer.

Dearth of resources have hit also non-overxpanded sectors, of course mainly in durables.

Aggregate demand analysis is not required to explain the slump, and aggregate demand policies will provide with funds those who need to relinquish these funds to other markets. Which is surely positive in the short run for unemployment and output, but not in the long run.

In Japan, billions of yen has kept a steady flow of resources from leaving construction markets, impeding the slump. There has been no scarcity of standard policies, both fiscal and monetary, and to no avail for the economy. Monetary easiness has only protracted malinvestment, which might have liquidated in a couple of years without government intervention. Japan is the real issue here, because it is similar to the US: a long boom with a lot of financial overexpansion, ineffective policies for a decent length of time and a steady flow of funds to already overextended markets.

The Great Depression, instead, it's not an issue: we don't have Hoover or Roosevelt, so a 25% unemployment for a decade is not possible: it has never happened, and in fact it wouldn't have happened without the White House intervention.

PS Employment by sector:

ftp://ftp.bls.gov/pub/suppl/empsit.ceseeb1.txt
http://www.bls.gov/webapps/legacy/cesbtab1.htm

Fiddledeedee, Greg. Aggregate demand does sometimes fail, and you don't have to be a Keynesian to say it.

"For Say, and for the monetary disequilibrium crowd and the Austrians, gluts and shortages (systemic, economy-wide ones as opposed to individual markets) have to have monetary disequilibria as their cause."

I agree that the Keynesian story about AD and gluts and shortages is a mistaken focus on a proximate cause. The underlying cause in a market economy may either be monetary (a deficiency or excess in supply of money compared with demand) or have a monetary trigger (which created a bubble, led to a bust, and resulted in a recession).

However, it is interesting to note that generalized and local gluts and shortages were (and are) widespread in planned economies. I do not think that these are caused by monetary disequilibrium (it would be a very hard case to make given money's limited role in such economies). Although they are not monetary, they ARE relative price issues - which are very much like the "bust" situation in market economies, when the economy must deal with the fact that it has wasted resources in areas where it is not needed, and the coordination in the economy is lost: inputs for factories in need are missing because resources went elsewhere, and projects are unsustainable; etc.

The focus on "aggregate demand" is a focus on a proximate cause - it says nothing of the root cause. The root cause in market economies tends to be money, because it is the most powerful centralized tool for altering individual decisions in a private property economy. Yet, the actual cause is the mal-coordinated decisions in the economy - malinvestments, etc - and these theoretically can be altered any number of ways, including subsidization, nationalized firms with heavy funding, and so forth, the most extreme case being the fully planned economy.

__An "aggregate demand failure" can only occur in a monetary economy. Hayek made a big point of this, even though he never used the phrase "aggregate demand."__ - Lee Kelly

heh - given what I just posted, and this, I might have to look into the question my father posed to me when he heard of my (forthcoming) book on lessons from the Soviet experiment. My book is of course about things like competition, profit, behavior - "micro" stuff. My father, a post-Keynesian, heard "lessons from the Soviet experience" and suggested I look into aggregate demand problems (!)

Perhaps I will! :)

I still need an answer to this question, which I raised to Daniel Kuehn above: what is the role of aggregate demand other than as a proximate cause? Does a deficiency in aggregate demand itself have a causative role, or is it only an intermediate step? If the former, what does it do, and how does it do it? If the latter, what is the purpose of discussing it, and are you sure it does not create more confusion than it alleviates?

Steve says:
"In the case of an EDM, I would argue that we really do have an *excess supply of goods* in the aggregate. "

George Selgin comments, "Unless P adjusts immediately to compensate," and Richard Ebeling asks, "what is preventing appropriate adjustment or adaptation to the relevant situation as it now exists that would restore balance and coordination?"

If prices are __kept__ from falling when demand falls, then there will be a "problem" of deficient aggregate demand -- there will be a glut, inventories, a recession. For example, when companies are bailed out, subsidized, or nationalized, rather than failing when nobody wants to buy their goods--their prices are being propped up... or when wages are kept high through gov. empowered unions or labor regulations, etc.

Then, if we blame the proximate cause "aggregate demand failure" for the recession and unemployment, we may respond by increasing the money supply as Steve has suggested may be necessary. When more money is injected into the economy SOMEWHERE (as Richard reminded us), this does not "solve" the original "glut" so much as compound a problem probably originally caused by preventing free movement of prices.

Otherwise we'd be where George Selgin had us -- "Unless P adjusts immediately to compensate," -- nothing is ever immediate, but prices could adjust relatively quickly if they are allowed to be flexible.

And yes, Steve, there would be significantly fewer issues if free banks "injected" the money locally to those who wanted it -- I think the two issues magnify each other (or, you could postulate a "multiplier" effect, or something like the Leijonhufvud corridor).

If the demand for money was either caused or exacerbated by sticky prices then truly local response by free banks would leave issue mostly as one of some sticky prices - if prices are free to adjust then even a problem caused by central banking will soon smooth itself out. However if you have a central bank and sticky prices, you have a full blown mess -- they feed on each other (the way that Keynesians see them feed and blame "aggregate demand").

Prof. Ebeling:

"The market demand for money is merely the sum of the individual demands for money. Who has an excess demand for money and by how much compared to his preferred money holdings before the current situation cannot be known. The individuals, businesses, borrowers, etc., to whom the injected money first goes may have nothing to do with these people. The injected money merely follows its own temporal-sequential path, leaving in its train its specific impact and influence on relative prices and wages, profit margins, and resource uses. I do not see how this restores or corrects for the specific relative price and wage distortions, and resource misallocations that were the problem that a policy was supposed to find a "cure" for. You just overlay, possibly, another layer of relative price and resource distortions over the original ones that made people concerned about the initial macro problem. "

In my opinion this is the core of the problem which is being discussed.

Monetary equilibrium theory assumes that changes in the demand for money influences the supply of money - if money is created competitively - in a way that those who want to add to their cash balances receive the new money, and nothing else changes. In all the free banking literature I've read there is, in fact, little or no analysis of injection effects (the exception being Horwitz's book, which, however, I think would say that additional money supply goes to the additional demanders and that's the end of the story under free banking).

I have three issues with the argument:

(1) It is likely that additional demand for money comes from those who have malinvested and are close to liquidation: thus, increasing the supply of money postpones liquidation of malinvestment. This can be seen in Japan (Peek & Rosengren), where additional funds for banks were used to save their clients by perpetuating bad investments. I would say, thus, that the additional supply of money will at least in part contribute to the perpetuation of the problem.

(2) In MET analysis, as far as I know, injection effects are neglected. Of course, in orthodox Austrian setting they would rule the roost of the analysis. Point (1) shows why it is likely that injection effects will be relevant.

(3) In "The pure theory of capital" there is a complicated argument in the last three chapters regarding money, regarding the distinction between strictu sensu liquidity demand and the demand for money in a wider sense. If demand for liquidity is a mere preference for money holding, it is one thing, if it is comes out of the whole structure of production it is a completely different story. It appears that MET or Free Banking analysis are cast on the assumption that liquidity and investment choices are orthogonal, so that an increase in liquidity will satisfy those who want more liquidity but will not incentivize anyone to indulge in additional investments. However, a bank can mistake an increased demand for credit for an increased demand for money because investors which are planning new investments are also likely to planning some cash-building. To the extent that this happens, banks cannot simply discriminate between cash-building money demand and malinvestment-funding money demand by the "law of reflux": in case they fund malinvestment, they won't see the problem after a clearing arrangement (a week), but when they will attempt to complete the investment plans (which may took years).

In simpler words: malinvestment does not result in immediate reflux, unless the start of the new investment plans is never accompanied by cash-building. Interbank clearing does not communicate information regarding intertemporal equilibrium, only day-by-day monetary equilibrium.

Greg -
I have to agree with George. The same "vicious cycle" could be imagined for a non-interventionist position, or any other position. It's one of those unfalsifiable conspiracy theory throw-aways.

I'm also a little confused on why "not enough Keynesianism" is so outlandish for you. Yes, we've had large deficits at the federal level - but the federal government isn't the only game in town. If you look at total government spending - adding in states and localities - there has been barely any Keynesian stimulus to speak of. Maybe you disagree with the wisdom of fiscal policy, but you can't disagree with the plain fact that there is very little fiscal policy to speak of.

Austrians rightfully complain when people blame them for the crash. They rightfully argue that nobody has even tried anything like an Austrian solution. But the same goes for Keynesians. Just because an Austrian solution hasn't been tried doesn't mean that what we've been doing is Keyensianism. I suppose you could call it "tepid monetarism" with Keynesian federal policy neutralized by anti-Keynesian state and local policy.

This has all been very interesting, I agree with a lot of what has been said on both sides of the debate.

In the theories of the Steve Horwitz and George Selgin there is a close connection between aggregate demand and the excess demand/supply of money. So, for those folks debating a fall in aggregate demand or a rise in the demand for money is quite a similar thing. But, from the point of view of other theories it's not like that.

I discussed this with Scott Sumner once, he doesn't look at it the way Steve and George do. I think that Scott's way is the more accepted one. In his view "Aggregate Demand" means demand for GDP components, not all demand. In Monetarist terms there are two different equations involved here:

M = k1 P1 T

Where:
T = total goods exchanged against money
P1 = prices of all goods
k1 = "average demand for money" (in the classical sense)

As I understand it this is what Austrian economists generally mean by demand for money.

M = k2 P2 Y

Where:
Y = GDP output
P2 = prices of GDP goods
k2 = Average demand for money for GDP goods

There is a difference here because total goods T includes exchanges of capital and property, but Y doesn't.

This definition of the Aggregate Demand idea is Ricardian, it centres on employment and production, it puts trade on the sidelines. However, couching the problem in terms of demand for money puts more of an emphasis on trade.

For example, lets say there has been a recession and speculators are worried and are holding a lot of money. Then, their expectations of the future change and they spend their money on shares driving up stock prices. To Austrian economists this is a fall in the demand for money, which is a good sign. It would also be a good sign to Keynes himself I think. But, to Keynesians and Monetarists it isn't a rise in Aggregate Demand - not yet - it only becomes a rise in AD once it has affected GDP components.

Daniel,

Keynesian fiscal policy may also be neutralised by monetary policy. If the monetary authorities are not pursuing sufficiently expansionary policy, then any addition to aggregate demand created by fiscal policy will likely be offset by less aggressive monetary policy.

Unless the monetary authorities are using every means at their disposal to stimulate aggregate demand, fiscal policy will likely be neutralised. And although everyone makes a big noise about the zero-nominal bound, it seems that unless *all* interest rates are at zero, no such problem exists.

I agree with liberty and Richard Ebeling that there is a "money distribution problem" associated with reflation.

Unfortunately, I can't think of much to do about it. I think it's a real problem. On the one hand sticky prices and the need for entrepreneurial learning mean that a rise in the demand for money won't cause prices to fall straight away. On the other, if the demand for money is "satisfied" by issue of fiduciary media then it may not go to the right agents, and may perhaps support malinvestment.

I think though that the latter problem is simpler because it is similar to another problem: "usury". The justification for usury laws is that by banning lending above a certain rate society benefits. If you read the papers on the subject that support usury laws they generally assume that the banks must differentiate customers by the interest rate they will accept. In practice though this isn't true, banks have many more ways of knowing their customers than that. I think that the same is generally true of banks. They can (recent events notwithstanding) recognise quite well when they have made poor loans and respond to that.

Also, let's consider businesses that have "malinvested" and demand money. The free-banking system supplies them with that money. In this case the business is supplying a cheap loan to the bank. This is a positive externality. If it helps the business deal with its malinvestment the best way it can then it's all to the social good. So, I'm not very worried about "supporting malinvestment". If you think about it, this is only a big worry if behavioural economics is involved and entrepreneurs are emotionally attached to their investments.

Lee -
The problem I see with the zero lower bound is that once you start pushing all other interest rates to zero you start distorting the term structure of interest rates. Perhaps I'm thinking about this wrong, but that is why I still place a great deal of importance on the zero lower bound, and why I think the burden is on the Congress now, and not the Fed.

First, on Steve's question, do I consider compensatory injection "problem" the same under free banking as under central banking.

No, I do not see them as equivalent. But, at the same time I'm not sure if I would agree that we are only, then, discussing matters of "degree." (And as I think you know, Steve, I am an advocate of free banking, and I have written on the theme, too, and argued for its superiority over central banking.)

But the issue is, I think, a confusion of how we should interpret the change in the demand for money.

We need to distinguish, may I suggest, between a change in the demand for money as a "cause" as opposed to as a "symptom."

For example, suppose that some individuals in the market have a change in preferences such that they wish to consume less and save more, and the particular form in which they decide to do this (marginally) greater saving is decreasing their consumption spending and increasing their holding of an average cash balance. (Or a decrease in velocity.)

Under a free banking system, those private financial institutions in which the pattern of depositor withdrawals and reflux through the clearing mechanism declines due to their depositors choosing to hold (unspent) larger cash balances, may respond to this form of increased savings by expanding loans without deleterious effect on their reserves.

And if one accepts the fractional reserve form of free banking (as I know you do), then this is one way for the banking system (unintendedly) smoothing out what might otherwise be greater fluctuations in the purchasing power of the monetary unit (the "price level") due to any such changes in people's cash holding preferences.

But this is not the type of situation in which we find ourselves today. Here people are not changing their underlying preferences in the same way as my example, above.

They are responding, partly, to the uncertainties, confusions, and delays in adjustments to distortions resulting from misguided monetary (and related policies -- Fannie Mae and Freddie Mac, etc.) that resulted in misdirections of resources and labor, and capital malinvestments.

(And, by the way, this is the context in which John Stuart Mill in his famous essay "On the Influence of Production on Consumption" restated Say's Law by introducing and viewing money as a commodity that is demanded, and for which there may be temporarily an increased demand relative to other commodities in the wake of the confusions and imbalances of an economic crisis.)

What needs "fixing" in this case, I would argue, is not an increase in money for people to hold, but the necessary price and wage and resource adjustments that will restore the balance and coordination so people can be reemployed, once again have profitable investment opportunities, etc., that have market-based possibility and sustainability.

Those are the "real" factors beneath the monetary surface, and manipulating the amount of money in the economy does does nothing, per se, to bring the economy back into order along the lines I've suggested.

As I said in my earlier comment, this merely runs the risk of superimposing new misdirections of resources, labor and capital on top of the prior ones that are still waiting for correction.

In reply to George Selgin's comment about the use and level of aggregates. My argument is that any such aggregation should not in the process do what Hayek in his criticisms of "The Treatise on Money," said Keynes did: "Mr. Keynes' aggregates conceal the most fundamental mechanisms of exchange."

The "easy" approach that George suggested with his reference to elements in the equation of exchange, in my opinion, involves just such over aggregation. If the aggregates are so "aggregated" that the analysis submerges under the macro surface virtually any focus on or existence of scarcity, relative demand and price relationships, sectoral allocation patterns (and as the Austrians tend to emphasize intertemporal choices and resource and capital uses), then the aggregates have assumed away all the elements crucial for reasonable economic analysis.

The underlying supply and demand and structural price and wage relationships all disappear under the macroeconomic magnitudes. And, again, relying (I apologize) on "authority" once more, I'd just remind us of Hayek's comments in the opening pages of chapter one of "Prices and Production" on the misguided attention on "total" employment, output, the "price level" in general, which hides from view all the essential aspects of how changes in the money supply work their affect on an economy.

Richard Ebeling

Daniel,

I don't remember "stimulus" as being defined by "increasing the total level of government spending." In textbooks, etc., "stimulus" has always meant "increasing deficit spending." If the former was true, we should expect some stimulus effects by increasing both taxes and spending, which I don't think has ever, or should ever, have been on the table. Shifting this discussion to terms of aggregate demand (detached from monetary problems) instead of deficit spending is both kinda grasping at straws and has sent the Keynesian position back fifty years.

"What needs "fixing" in this case, I would argue, is not an increase in money for people to hold, but the necessary price and wage and resource adjustments that will restore the balance and coordination so people can be reemployed, once again have profitable investment opportunities, etc., that have market-based possibility and sustainability.

Those are the "real" factors beneath the monetary surface, and manipulating the amount of money in the economy does does nothing, per se, to bring the economy back into order along the lines I've suggested." - Richard Ebeling

Yes! This is the issue that I once tried to raise to Steve in a FEE session, but did not get across well. Even with free banking, if the cause of change in demand was triggered by earlier monetary or relative price manipulation, changing the supply of money could slow readjustment, or (if not a purely free market in banking) layer on more malinvestments - or "superimposing new misdirections of resources."

I am interested in Steve's reply.

George, I was making a joke -- I actually agree with both you and Steve on this.

But I was also telling a joke as a means for ironically hinting at the element truth in Boettke's discomfort with the statements of Romer and Summners

There _are_ pathologies in the causal picture imagined by Romer and Summers -- which I explained more directly in my second and third comments.

But so as not to be misunderstood, the problem is in Romer and Summers, not Selgin and Horwitz or "good economics" more generally.

George writes:

"Fiddledeedee, Greg. Aggregate demand does sometimes fail, and you don't have to be a Keynesian to say it."

Ryan M,

In traditional Keynesian macro the "balanced budget multiplier" is 1. That is, when the government tax a dollar and spend that dollar it leads to a multiplier of 1, not zero.

The New Keynesian view is different.

Daniel writes:

"Greg - I have to agree with George [...] I'm also a little confused on why "not enough Keynesianism" is so outlandish for you."

In _theory_ some sorts of "Keynesian" policy can help put M V closer in line with P Q (or however you want to write the math).

But more of what the government is currently doing won't ever do that THE REAL WORLD. Much of the "stimulus" is creating greater micro and macro discoordination and regime uncertainty, not less.

AND NOTE WELL -- most all these "Keynesian fixes" pre-date Keynes 1936, and where "modeled" by economists prior to Keynes' 1936 work, and some got the limited endorsement even by HAYEK himself (well prior to 1936).

It's a pathetic joke the way the word "Keynes" is thrown around by economists and policy makers.


I think that how free banking is done affect the problem liberty and Richard Ebeling are discussing a lot.

I think it's quite likely that in a free-banking system that each bank will specialise in providing services to particular markets. Many banks do this already. But, in a free-banking world there may be extra incentive to do it because it will make money demand easier to understand.

Consider if a particular bank specialises in a particular industry (or area) then it can gather good information about who to loan to and who not to loan to in a recession.

Richard wrote:

"What needs "fixing" in this case, I would argue, is not an increase in money for people to hold, but the necessary price and wage and resource adjustments that will restore the balance and coordination so people can be reemployed, once again have profitable investment opportunities, etc., that have market-based possibility and sustainability.

Those are the "real" factors beneath the monetary surface, and manipulating the amount of money in the economy does does nothing, per se, to bring the economy back into order along the lines I've suggested." - Richard Ebeling

I agree with you here Richard I think. The problem is always distinguishing between downturns caused by an insufficient money supply and downturns caused by necessary reallocations of resources in the wake of an unsustainable boom. I think we suffer from the latter at the moment, although Bill W. will disagree. At the very least, I think we suffer much MORE from the latter than any insufficiency of money.

What we need at the moment is to allow the necessary corrections to take place and try to ensure that the money does not impinge, either by excesses or deficiencies. That's very hard to do under central banking and when we're in a bust, we should, I would argue, err on the side of caution and assume these are real adjustments, not insufficiencies in MV.

Prof Ebeling:

"In reply to George Selgin's comment about the use and level of aggregates. My argument is that any such aggregation should not in the process do what Hayek in his criticisms of "The Treatise on Money," said Keynes did: "Mr. Keynes' aggregates conceal the most fundamental mechanisms of exchange."

The "easy" approach that George suggested with his reference to elements in the equation of exchange, in my opinion, involves just such over aggregation."

Exactly. And Hayek in "Prices and Production" says that "Neither aggregates not averages do act upon one another, and it will never be possible to establish necessary connections of cause and effect between them as we can between individual phenomena, prices etc. I WOULD EVEN GO SO FAR TO TO ASSERT THAT FROM THE VERY NATURE OF ECONOMIC THEORY, AVERAGES CAN NEVER FORM A LINK IN ITS REASONING" (PRICES AND PRODUCTION P.200).

So, it seems that Hayek not only questions the usefulness of aggregation, but REJECTS it utterly and completely, as a part of quasi-scientific disciopline called "macroeconomics"!

Greg -
First, I'm concerned with what goes on in the real world, not in theory. Theory is only useful insofar as it illuminates what happens in the real world. I don't know about "almost all these fixes" predating Keynes. It was still a relatively novel idea, although certainly not an idea original to Keynes. What Keynes offered was a comprehensive theory to justify it. Others had parts of that theory, and others had the intuition, but they never put it all together. Your "pathetic joke" ephithet is a little much, I think.

I'm a fan of Hayek, so I'm not quite sure why you're throwing that in my face either as some sort of contradiction to my point.

Ryan M -
Deficit spending is more effective, and that's how I generally think about fiscal stimulus as well - I'm sorry for the confusion if that was unclear. But I don't think we can restrict ourselves exclusively to deficit spending. If spending in general is reduced from baseline spending, that's still a reduction in aggregate demand. Why do we care about deficit spending? Because it's perceived as being some sort of use of "idle resources". It's a nice way of making use of excess savings that the private sector isn't making use of. That's the only reason why (taxing would soak up some excess savings and some private consumption). So yes, it's good to focus on deficit spending when we're talking about fiscal policy, but ultimately whether it's borrowed or collected in taxes has little to do with whether demand is boosted or not. Think about a very simple Keynesian cross. That completely eliminates any discussion of borrowing. Presumably it's all spend out of income (revenue). The dynamic is still the same.

Prof Ebeling:
"First, on Steve's question, do I consider compensatory injection "problem" the same under free banking as under central banking.

No, I do not see them as equivalent."

Why not? I asked that question to Steve 6 months ago and never got an answer apart from his personal beleif. Of course, the extent of "injectory" distortion of the relative price structure in free banking would be certainly less than in central banking, just like the boom i slikely to last shorter and be less severy. Nobody denies this quantitative difference.

However, where is the qualitative difference. When you try to make MV = PQ in central banking and in fractional reserve free banking, you are doing exactly the same thing - emitting the fiduciary media, i.e. "creating" (Machlup) the credit out of thin air that is injected into the economy. Apart from likely quantitative difference, where is the qualitative difference? Do you assume that credit inflation under free banking does not create the same kind of distortions as central banking "injections".

And to clarify: in order to make money neutral to production you don't have just to make MV=PQ. Even if free banking can do that, this is just the beginning of the problem, because the money must be delivered in such a qualitative way as to reach the hands of the entrepreneurs who really need them. That is to say, to end up in the projects that would be "over-corrected" without the monetary injection, and in the same time not to prevent necessary correction of other projects. A "secondary recession" is by no means a uniform "shortage of money" across the entire structure of production, but very specific distortion in prices and production patterns of individual entrepreneurs. Stabilizing MV is useless as a maxim of countercyclical monetary policy, as Hayek openly says in PP.

So I don't see the qualitative difference between free banking and central banking credit inflation still (except in the magnitude).

liberty's invocation of the issue of aggregate demand under command socialism brings up a curious point. Under the standard "normally functioning" command socialist economy such as the USSR between sy 1950 and 1985, there were conditions under which one could fairly clearly distinguish aggregate effects from micro effect. This was due both to the tendency to chronic aggregate shortage as well as a general fixity of nominal prices.

So, the degree of aggregate shortage could be measured by the average length of lines, whereas the degree of micro inefficiency could be measured by the relative imbalances in the lengths of lines for one good versus another.

Prof Ebeling:
"First, on Steve's question, do I consider compensatory injection "problem" the same under free banking as under central banking.

No, I do not see them as equivalent."

Why not? I asked that question to Steve 6 months ago and never got an answer apart from his personal belief. Of course, the extent of "injectory" distortion of the relative price structure in free banking would be certainly less than in central banking, just like the boom is likely to last shorter and be less severe. Nobody denies this quantitative difference.

However, where is the qualitative difference? When you try to make MV = PQ in the central banking regime and in fractional reserve free banking, you are doing exactly the same thing - emitting the fiduciary media, i.e. "creating" (Machlup) the credit out of thin air that is injected into the economy. Apart from likely quantitative difference, where is the qualitative difference? Do you assume that credit inflation under free banking does not create the same kind of distortions as central banking "injections".

And to clarify: in order to make money neutral to production you don't have just to make MV=PQ. Even if free banking can do that, this is just the beginning of the problem, because the money must be delivered in such a qualitative way as to reach the hands of the entrepreneurs who really need them. That is to say, to end up in the projects that would have been "over-corrected" without the monetary injection, and in the same time not to prevent necessary correction of other projects. A "secondary recession" is by no means a uniform "shortage of money" across the entire structure of production, but very specific distortion in prices and production patterns of individual entrepreneurs. Stabilizing MV is useless as a maxim of countercyclical monetary policy, as Hayek openly says in PP.

So I still don't see the argument for the qualitative difference between free banking and central banking. inflation (except in the magnitude).

No, it wasn't.

"It was still a relatively novel idea, although certainly not an idea original to Keynes."

Read Laidler, then get back to me.

Or a decent account pre-1933 economic policy thinking in America.

Daniel writes:

"Your "pathetic joke" ephithet is a little much".

"No, it wasn't."

Exactly, it was suggested by Malthus and no end of other people.

In his monumental 3-volume history of the Fed, Allan Meltzer found that the Fed repeatedly mistook permanent changes for transitory or cyclical changes. In terms of the discussion here, that finding presents a problem for what I'll call the activist AD camp.

An example. Suppose the growth of consumer spending falls below its trend growth rate. Is that a sign of deficient AD or a change in the composition of AD? How would one know? What should one do about it?

Such problems support the case for a rule rather than discretionary responses, even if one belongs to the pro-AD camp. My example is simply an illustration of the knowledge problem that Austrians and monetarists agree on.

For those inclined to activist responses in economic downturns, I suggest they study carefully the 1920-21 downturn. Friedman & Schwartz present the facts but have no explanation for why it played out the way it did.

"So yes, it's good to focus on deficit spending when we're talking about fiscal policy, but ultimately whether it's borrowed or collected in taxes has little to do with whether demand is boosted or not. Think about a very simple Keynesian cross. That completely eliminates any discussion of borrowing. Presumably it's all spend out of income (revenue). The dynamic is still the same." - Daniel Kuehn

I don't mean to sound ignorant here - I did learn my Keynesian Cross etc - but unless one assumes that the taxation (and expectations about taxation) will take a long time, in which case you are still positing deficit spending, how can government spending THAT DISPLACES private spending, by taking it away in taxes, possibly boost demand?


"liberty's invocation of the issue of aggregate demand under command socialism brings up a curious point. Under the standard "normally functioning" command socialist economy such as the USSR between sy 1950 and 1985, there were conditions under which one could fairly clearly distinguish aggregate effects from micro effect. This was due both to the tendency to chronic aggregate shortage as well as a general fixity of nominal prices.

So, the degree of aggregate shortage could be measured by the average length of lines, whereas the degree of micro inefficiency could be measured by the relative imbalances in the lengths of lines for one good versus another." - Barkley Rosser

Yes! This was my point in a way - you had the microimbalances created by relative price distortion, (which are the same 'malinvestments' you get with monetary policy), and you had rigid - sticky - prices (which prevents re-adjustment: this of course you had to the fullest extreme under planning). These two together created the same "aggregate demand" problems we see in market economies after a monetary-fueled boom and the prevention of readjustment via sticky prices. (And of course the Soviet experience had nothing to do with demand at all! Demand cannot even be expressed in a planned economy!*)

And yes, you could visibly see some of this, in the form of lines for consumer goods - overall shortage and relative shortages. You could not see all of the relative shortages due to malinvestment/distortion because much of that took place among intermediate goods, inputs and capital goods and raw materials, and all you'd see is a generalized shortage of consumer goods often because shortage inputs would affect many kinds of consumer goods. Plus substitution etc would affect what would finally show as surplus and shortage.


* There is a great joke about this:

A naïve young Russian passes by a store whose sign says, “Vegetables, Fruit.” As it is winter and he has not had fruit for some time, the young man joins the queue. But when he asks the clerk for fruit she tells him they never have any. Feeling foolish, the young man asks the store manager why it is that a fruit store sells no fruit. The manager tells him to wait and watch the queue a few minutes and he will understand. After observing numerous customers asking for potatoes or cabbage, the young man says to the store manager that he still doesn’t understand why the fruit store carries no fruit. “Have you heard anyone ask for fruit?” the store manager asks. “Obviously, there’s no demand.”

liberty: "I don't mean to sound ignorant here - I did learn my Keynesian Cross etc - but unless one assumes that the taxation (and expectations about taxation) will take a long time, in which case you are still positing deficit spending, how can government spending THAT DISPLACES private spending, by taking it away in taxes, possibly boost demand?"

Because the government isn't saving anything, but households would have done if they had retained the money taxed away from them. See the "balanced budget multiplier" entry here:
http://en.wikipedia.org/wiki/Balanced_budget#Balanced_Budget_Multiplier

Current - Thanks. Right, and investment isn't useful. It isn't as if in private hands that savings might have gone into a bank, which might have lent it to a business or invested in a business (yay to fractional reserve banking, right?), which might have used it to hire someone that very same day.

Investment that does not go to hiring workers (which Keynesians do like because they like when government hires people) would presumably go to purchasing raw materials and so forth for long term investment -- bricks to build a building. Now, when government buys bricks this is considered stimulus, why not when private businesses invest?

So, I am left thinking that "savings" is bad because savings != investment. But, unless we are stuffing money under our mattresses, savings == investment, more or less. Now, government will spend 100% while private people will (1) consume part, (2) save the rest, (3) invest most of that savings. There will be a fraction sitting as reserves, but is this fraction likely to be greater or smaller than the DWL of taxation plus the inefficiency of monopoly (public) spending compared with competitive market spending and investment? My guess, that fraction is significantly smaller.

Incidentally, I'm only citing the above to educate you about Keynesian economics. I think it's rubbish.

Current - yes, I know. I had just forgotten anyone used that 'propensity to consume' argument, because most models now assume savings are invested -- so most Keynesians jump to the deficit spending defense.

liberty,

Actually in the actually existing former Soviet Union, most people kept some sort of bag with them most of the time, and if they saw a line forming rapidly, they would be inclined to get into it, even without knowing what was supposedly being sold. The reason was that if it was something that could attract a rapidly forming line, it was something of more severe relative scarcity than most items, and even if they did not want it, they could probably barter trade it for something that they did want.

Oh Richard, I'm not falling for it: I know that you secretly agree with everything I've said but are only setting a trap to see whether you can make me change my position so as to be able to subject my modified view to truly unanswerable and withering criticisms.

Barkley,

There is truth to that - and this exacerbated shortages and hid actual demand even more from planners (who could otherwise have assumed that long lines meant all those people actually *wanted* the product). However, it is also true that there were shortages for many items *only* due to a lack of certain common inputs or transport etc, when the planned production would otherwise have (likely) equaled the demand for it. The final length of lines for consumer goods could not reflect the disproportion between supply and demand for those particular items, because substitution, desire for a good for trade/barter, lack of inputs or uncoordinated labor, capital, transport, intermediate goods, or other factors, etc, all could lead to shortage. Hence, the "signal" of long lines cannot precisely track the relative shortages of different consumption goods.

Current and Greg -
I'm not sure how I was unclear. I never denied that elements - important elements in fact - of these ideas came long before Keynes. I don't think Keynes ever claimed anything otherwise! But Malthus simply did not have the the comprehensive treatment of the problem that Keynes did. Lawrence Klein gives a good account of a whole string of proto-Keynesians, gives them their due, and fleshes out their short-comings.

Unless you're arguing that Keynesianism is inflationism or Keynesianism is building canals, this really was a novel (albeit, as I said, not exactly original) perspective. I don't understand the objection.


RE: "I don't mean to sound ignorant here - I did learn my Keynesian Cross etc - but unless one assumes that the taxation (and expectations about taxation) will take a long time, in which case you are still positing deficit spending, how can government spending THAT DISPLACES private spending, by taking it away in taxes, possibly boost demand?"

Because you can't assume that it ONLY displaces spending. It's going to displace some savings too, which is the whole virtue of the deficit spending that people usually remark on. I don't want to overstate this point. I primarily think in terms of deficit spending too. But we think that way because never think of the government acutally retrenching during a downturn. So, given that they are spending more regardless, we say that deficit spending is best. You can't assume there is no retrenchment at the state level. States are actually cutting budgets, and that matters.

RE: "Right, and investment isn't useful. It isn't as if in private hands that savings might have gone into a bank, which might have lent it to a business or invested in a business (yay to fractional reserve banking, right?), which might have used it to hire someone that very same day"

If investment demand were at all evident we wouldn't be having this discussion, liberty. You can dispute the argument, but please don't distort it. Of course investment is useful. That's the ideal here. You're treating an accounting identity like a behavioral law. It's not.

Daniel,

I'll take you word for it on the proto-Keynesians.

On the issue of spending though see the post I made at 9:58 AM that includes two sets of equations of exchange.

Which one are you thinking off? It looks to me that you are thinking of the GDP based one. I think that's a mistake, I think the total one is the relevant one.

To George Selgin:

I read that recent interview that you did in the "Daily Bell" and your preference not to label yourself an "Austrian."

But you have given yourself away with your comment to me. You are a "practicing praxeologist" applying the method of "ideal types" and "understanding" in an attempt to "read my mind" and anticipate my future actions.

Why, you, you -- Austrian, you!!!

Richard Ebeling

Ebeling 1, Selgin 0. ;)

Daniel, you're talking past me -- when I talk about "Keynesian policy" I very plainly _am_ talking about current policy efforts to "build canals" and manipulate the money supply, in order prop up demand.

And this idea is as old as the hills, and was VERY fashional in America in the _1920s_.

Daniel writes:

"Unless you're arguing that Keynesianism is inflationism or Keynesianism is building canals"

liberty,

Oh, you and your intermediate goods fixation! Dem's da perils of shturmovshchina.

As for proto-Keynesians, are they better or worse than crypto-Keyneians?

And regarding being a praxeologist, hopefully that is better than being a proctologist.

"If investment demand were at all evident we wouldn't be having this discussion, liberty. You can dispute the argument, but please don't distort it. Of course investment is useful. That's the ideal here. You're treating an accounting identity like a behavioral law. It's not."

How can it be evident when it's already been crowded out by massive government spending , and short-circuited by price-fixing policies which together have frozen the malinvestments of the boom?

If prices are allowed to fall, and failing businesses to fail, etc., why would you expect private investment to necessarily shrink up? When demand falls, if price is allowed to fall it will bottom out and begin to climb again - this is adjustment, or "equilibration" and occurs in all markets that are free to adjust.

This is well-agreed at the "micro" level, but "macroeconomists" aggregate in such a way as to misrepresent the "macro" market so that "aggregate supply" and "aggregate demand" replace the "macro" view of what has emerged from "micro" interactions such as these: prices in sectors that are failing need to fall, businesses need to fail, and when they do an adjustment can occur. This leads to a quick "recovery" from the "macro" ills.

This is why I have been focusing on the "micro" malinvestment and price causes of the "macro" phenomena.

Greg Ransom -
It seems to me that infrastructure investment alone isn't Keynesian. There are lots of reasons for investing in infrastructure - some Keynesian, some not. I'm not aware of Keynesian justifications for infrastructure projects before the 1930s. Perhaps you could enlighten me on an example. I'm getting the impression you think any proposal for government spending is a Keynesian proposal.

And I'm not sure where you're coming from on the inflation point. At best Keynes could be said to have thought that inflation was the lesser of two evils, and that domestic price stability was the ideal. He also suggested that there were occasions in which inflation could be more effective than nominal wage reductions (not in all cases - a lot of people twist his point on this to say that he thought nominal wage adjustments were never effective). I don't know where you get that he was an inflationist out of that.

It seems to me that Austrians are mistaken about the so-called "injection effects" of new money. Bill Woolsey recently blogged on this matter, and his arguments were very persuasive. The confusion seems to have led many Austrians to claim that all money creation must distort relative prices and cause unsustainable malinvestments, even when that money is created by private institutions to satisfy changing demands.

Although it is true that money creation almost always changes relative prices, it does not follow that such changes are necessarily distortionary. Monetary expansion in a free banking system does not lower "the" interest rate below "the" natural rate; instead resources must be saved by reductions in spending by bank customers. The change in relative prices is broadly equivalent to the change in relative prices caused by a rise in demand for bonds.

Lee,

I think Bill Woolsey's argument is quite dubious. I'm going to write a post over on his blog about it soon.

This is because you don't know the history.

Daniel wrote:

" I'm not aware of Keynesian justifications for infrastructure projects before the 1930s."

The talk of inflation is your own, Daniel.

I think it is because of the illusion that debt causes. It looks like monetary policy actually works when you have legal nominal rigidities. For example if you have a law fixing minimum wage at X an hour, then inflating the currency WILL decrease unemployment. This looks like you are raising AD when really you are lowering barriers in the labor supply.

I think this presentation is, if not completely relevant, at least interesting.

http://singularityu.org/videos/2010/04/john-mauldin-the-end-game/

Doc Merlin,

Certainly nominal rigidities would be lower without state interference. However, they wouldn't go away entirely. They enter naturally into the entrepreneurial process because action is required to change a price, while no action is required to keep it the same.

Restaurants changes prices hourly at one point during the hyperinflation in 1920s Germany ... the New Keynesian claim that price are rigid and price changes are sticky and price changes are costly must be put up next to the fact that Berliners very cheaply (using a typewriter) updated their posted prices on an _hourly_ basis.

This all depends on the fact that restaurants were in the mostly unregulated private economy and the law allowed them to arrange private contracts on private terms .. two conditions which are not met in much of the economy.

Another way of thinking about deficient aggregate demand is as a consequence of bad money.

All goods are in a kind of implicit competition to become a medium of exchange. Open any economics textbook and you can find a list of properties that good money should have. Good money was not consciously selected for these properties, but rather these properties were discovered in goods that had already evolved into money. The era of central banking and monetary monopolisation has turned this evolutionary process on its head--men now consciously decide what makes good money and then force it on the economy.

Any good that suffers from erratic changes in supply or demand does not make for good money, that should be clear. Less clear, is that erratic *relative* changes in supply and demand are what really matter, i.e. good money is neither a rapidly depreciating nor rapidly appreciating asset. Appreciation and depreciation create a friction which, in extreme cases, may stop the good functioning as money altogether.

Basically, deficient aggregate demand occurs when money repidly appreciates in value, i.e. when the monetary authorities, who we unfortunately rely on for money, fail to provide good money.

liberty:

"unless saving goes under the mattress"

Well, it really does't matter whether it literally goes under a mattress or not, but the process of accumulating additional money balances given the quantity of money is what causes an excess demand for money and an excess supply of goods and services.

I grant that an excess supply of goods in general is a simplification. There isn't such a thing as goods in general. The sum of the nominal value of the excess supplies of all things add up to a positive amount. The sum of the nominal value of the surpluses of goods with excess supplies is greater than the sum of nominal value of the shortages of the goods with excess demands, if there are any such goods.

I don't agree that there is no such thing as an excess demand for money. Of course, there is my excess demand, and yours, and so on. And the excess demands add up to more than zero. The excess demands for those with excess demands add up to more than the supplies of those with excess supplies if any.

In the market for pencils, the market price clears it if the excess demands of those with excess demands matches the excess supplies of those with excess supplies.

I guess I go with Patinkin. While relative prices clear particular markets, any level of money prices reflecting those ratios will be equally appropriate, unless having money prices too high or low creates an excess supply or demand for goods.

Like George, and unlike Steve, I don't see the problem of describing this in terms of aggregate demand and supply. I don't think I ever get so confused that I cannot conceive of the demand for consumer goods rising and the demand for capital goods falling. Or that it makes a difference if the demand for capital goods fell and the demand for government goods rises.

Bill,

I agree with your first three paragraphs. It is possible to show what you have written without resorting to aggregates, though several other assumptions are needed. This is shown in some of the papers on Say's Law such as:
http://mises.org/journals/qjae/pdf/qjae4_4_2.pdf

"Like George, and unlike Steve, I don't see the problem of describing this in terms of aggregate demand and supply. I don't think I ever get so confused that I cannot conceive of the demand for consumer goods rising and the demand for capital goods falling. Or that it makes a difference if the demand for capital goods fell and the demand for government goods rises. "

The problem that people are point to here is "what if the monetary injection doesn't go into the areas hit by the secondary recession".

Do you think that is a real problem?

"Well, it really does't matter whether it literally goes under a mattress or not, but the process of accumulating additional money balances given the quantity of money is what causes an excess demand for money and an excess supply of goods and services."
- Bill Woolsey

My point was not that there is not such thing as a change in demand for money. My point was in response to the idea that government can "stimulate" the economy by increasing taxes and then spending that money, because absent that tax the consumer would have spent only part of the money and saved the rest.

So, two scenarios: (a) Tommy gets his paycheck of $600 after taxes and spends $500 and saves $100. (b) Tommy gets his paycheck, after the new stimulus tax, of $500 and spends $450 and saves $50 (he still needs to save something), and government spends Tommy's other $100.

Daniel Kuehn made the case that this would indeed provide "stimulus" since saving is no good, only consumption. My argument is that when Tommy saved that $100, given profit incentive and fractional reserve banking, probably $90 of it was lent or invested anyway. So, in order to provide "stimulus" government would have to squeeze that last $10 for quite a lot, and given the DWL of taxation etc, it is unlikely this would be a net positive.

Daniel Kuehn replied that nobody is investing today, post-crash, and I replied that government has already done the tax/borrow/bailout so we can't know if $90 would have been lent or invested absent this intervention, except to the extent that theory tells us that in markets in general prices fall, and if allowed to fall, recover.

liberty,

Your argument isn't really against the concept of "change in the demand for money". You have allowed for it in discussing fractional reserve banking which is a method of responding to changes in the demand for money.

Greg, Doc Merlin,

I know that in some circumstances businesses have been able to change prices quickly. However, it's not as simple as you make it out to be.

Price setting is an entrepreneurial decision, though of-course it may be delegated to managers. There are two problems, firstly, the cost of making a price change and secondly the cost of making that entrepreneurial decision itself.

Catalogues are a good example of the first problem. Your restaurant example reflects one aspect of the second problem. When the staff of the restaurants made those changes it's likely they did so because the job had been delegated by the owners. That was natural in that case because it was obvious which way prices were going, in other situations this isn't so obvious.

Around small levels of price change there is certainly stickiness caused by both of these factors. Consider an auction for example (Joe Salerno often uses this example). At an Auction for a vase worth ~£3000 the auctioneer doesn't auction down to the last pound, he cuts off at some point because he doesn't want to waste the customer's time. Joe Salerno wrote on thinkmarkets a while ago about this stuff:

http://thinkmarkets.wordpress.com/2009/08/25/auction-markets-and-optimally-sticky-prices/

Current,

Correct. That is why I said "My point was not that there is not such thing as a change in demand for money."

Current - on the price changing issue:

I doubt anyone would argue that there are not any transaction costs ever in price changing -- but when it is important for prices to move these costs are relatively low, and can be got around. This was the point of the example of restaurants during a hyperinflation--they found a way to get around it.

There are many examples at the retail level of this, even without any inflation or other pressure to change prices. For example, Wal-Mart uses a digital inventory gadget they created to constantly monitor sales, profits and stocks, so that they can change prices moment to moment in each store. My local grocer does something similar each morning - checking prices charged by his supplier (which also change every day) and recalculates the price he will charge the customer.

Stores (such as clothing stores, electronics, department stores, etc etc) use sales in addition to price changes to get around what's been printed; contractors change their rates frequently, and price-discriminate -- one of the greatest advantages markets have over planning is in price flexibility.

Current:

If there is an increase in the demand for money and the quantity of money increases to avoid monetary disequilibrium, I think it is very unlikely that the people demanding more money will continue to spend exactly what they were before. No, they will spend less to accumulate more money.

As for those borrowing newly created money, I doubt they will spend that money exactly on the particular goods and services that those choosing to hold more money don't purchase.

But I don't see this as a problem. It isn't that the term "aggregate demand" means I don't cannot conceive of this.

For example, suppose that there was some crisis, and people chose to purchase rifles and freeze dried food rather than go out to nice restaurants and take long vacations.

The demand for some things rise, and the demand for other things fall.

It is my view that an increase in the demand for money cannot be the demand for some things fall, and the demand for nothing rises. Just because there is money standing in between, it is the same. The demand for the various things those demanding money sacrifice falls, and the demand for those borrowing the newly created money want to buy rises. Those who want more money "buy it" and those supplying more money finance the purchase of whatever they want.

If this is a temporary change, then building a bunch of specific capital goods to purchase things that those borrowing the money want to buy will be an entrepreneurial mistake. They shouldn't do that.

It is the same with the rifles and freeze dried food. If people stop going out to eat and going on vacations and start buying rifles and freeze dried food, and this is temporary, then building a bunch of specific rifle producing equipment and food drying gear would be a malinvestment.

On the other hand, if the change is permanent, then these changes should be made.

But if the increase in the demand for money was temporary, why would you think that the temporary deflation of prices and wages will result in a relative pattern of demands that reflects the recovery?

If there is some crisis and people want to take vacations, that is ok. And then people should work less.

The signal, no one wants to buy, so lower your prices, so the real quantity of money will rise, so a lower level of nominal expenditure will be consistent with the past level of real expenditure-- why isn't this just one more burden?

I think stable growth of nominal expenditures is the best environment for any real disruptions that may occur.

Oh.. by the way, I don't think there would be a secondary recession if it weren't for monetary institutions that result in nominal expenditure falling.

Monetary institutions that keep nominal expenditure growing will allow any malinvestments to be liquidated without there being a secondary recession.

This entire plan of that prices and wages should all fall 20% and then rise back again with the recovery, seems a bit crazy to me.

If the monetary institution required that they all drop 20% forever, that would be bad enough. But handling a temporary fluctuation in money demand by a large fluctuation in all prices?


Current -- know you are talking about the knowledge problem, which is HAYEKIAN macro, not New Keynesian macro (and the mainstream attempt to handle the knowledge problem is pathetic, so lets not go there).


"When the staff of the restaurants made those changes it's likely they did so because the job had been delegated by the owners. That was natural in that case because it was obvious which way prices were going, in other situations this isn't so obvious."

Greg,

That's what I said right from the start: "Certainly nominal rigidities would be lower without state interference. However, they wouldn't go away entirely. They enter naturally into the entrepreneurial process because action is required to change a price, while no action is required to keep it the same."

Bill,

I'm not arguing for deflation as a better policy, neither is Steve Horwitz.

The point though is that injecting money in still isn't perfect. You write: "If there is an increase in the demand for money and the quantity of money increases to avoid monetary disequilibrium, I think it is very unlikely that the people demanding more money will continue to spend exactly what they were before. No, they will spend less to accumulate more money.

As for those borrowing newly created money, I doubt they will spend that money exactly on the particular goods and services that those choosing to hold more money don't purchase."

I do see this as a problem, though not as bad as deflation. The investment plans that the group borrowing new money are embarking on are unlikely to be as robust as those of people investing in normal times.

However the injection of new money is done it will involve relative price changes. I can't see how that can't cause disruption.

Bill,

Also, if we can get this right then the primary recessions shouldn't be common. And, if the response to them is always competent then agents will no longer respond to recession with a hugely increased demand for money as they do now.

Businesses may worry that taxes, regulations etc, are getting worse, so they may not feel they can afford to drop prices even more to pull in more customers, they may not be investing, expanding, etc.

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