Parrot Economics.

J. Bradford DeLong, an economist at UCal Berkeley and former Treasury official with Clinton, raises some economists on their own petard with an article entitled ‘Economics for Parrots’ published at Project Syndicate.

Economists know the rules of supply and demand but seem to have forgotten them recently, DeLong says.  The parrot analogy came from a quote by British economist J.R. McCulloch who said that the only training a parrot needs to be a passable political economist is one phrase: “supply and demand, supply and demand.”

“….economics would be useful if economists were, indeed, likeMcCulloch’s parrots – i.e., if they actually looked at supply and demand. But I think that much of economics has been discredited by the manifest failure of many economists to be as smart as McCulloch’s parrots were.

Consider the claims – rampant nowadays in the US – that further government attempts to alleviate unemployment will fail, because America’s current high unemployment is “structural”: a failure of economic calculation has left the country with the wrong productive resources to satisfy household and business demand. The problem, advocates of this view claim, is a shortage of productive supply rather than a shortage of aggregate demand.

But it should be easy – at least for an average parrot – to tell whether a fall in sales is due to a shortage of supply or a shortage of demand. If a fall in sales is due to a shortage of demand while there is ample supply, then, as quantities fall relative to trend, prices will fall as well. If, on the other hand, the fall in sales is due to a shortage of supply while there is ample demand, then prices will rise as quantities fall.

Which do we see now? There are no places in the US economy where wages or product prices are rising more rapidly than expected. There are no places where a shortage of qualified labor or of available capacity is sufficiently great to induce managers to pay more than they have been used to paying for good hands or useful machines.”

And DeLong says these economists are getting another policy response wrong because they, despite their claims to pay attention to supply and demand, apparently aren’t. 

“Or consider the claims – also rampant these days – that further government attempts to increase demand, whether through monetary policy to alleviate a liquidity squeeze, banking policy to increase risk tolerance, or fiscal policy to provide a much-needed savings vehicle, will similarly fail. These measures, too, are supposedly doomed because they all involve increasing governments’ liabilities, and financial markets are at a tipping point with respect to sovereign debt. If governments that have already tapped-out their debt-bearing capacity now issued more debt or money or guarantees, they would deal a mortal blow to confidence.

Once again, an adequately trained parrot, unlike many economists nowadays, would ask whether the economic problems that current levels of government debt are causing reflect too much public debt supplied by governments or too much public debt demanded by the private sector. If the problem were that supply is too great, then new emissions of government debt would be accompanied by low prices – that is, by high interest rates. If the problem were that demand is too great, then new emissions of government debt would be accompanied by high prices – that is, by low interest rates.

Guess which one the US and many other countries have? For a parrot, that’s a no-brainer: the public-debt problem is not that governments have issued so much debt that investors have lost confidence, but that governments have issued too little debt given the enormous private-sector demand for safe places to park wealth. The problem, the parrot would say, is that households and businesses are still trying to build up their stocks of safe, high-quality assets, and are switching expenditures from buying currently-produced goods and services to increasing their shares of an inadequate supply of government liabilities.”

DeLong wonders what future historians will ask when they look back on today’s debates over whether or not the federal government gave the American economy too much, or too little.

“When economic historians examine the Great Recession, their overwhelming consensus is likely to be that its depth and duration reflected governments’ refusal to try to do more, not that they tried to do too much. They will agree with the parrots that falling inflation showed that the macroeconomic problem was insufficient demand for currently produced goods and services, and that the low level of interest rates on safe, high-quality government liabilities showed that the supply of safe assets – whether money provided by the central bank, guarantees provided by banking policy, or government debt provided through deficit spending – was too low.

The question that will be a mystery to them is why so many economists of our day did not know how to say: “supply and demand, supply and demand.”

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11 Responses to “Parrot Economics.”

  1. the advisor Says:

    surely this has nothing to do with the current fed balance sheet buying tsy’s with interest payments or the expectation of further quantitative easing.

  2. Chris Herbert Says:

    The Fed has certainly been doing everything it can to artificially suppress interest rates.

    That said, I think the point is that the market for AAA government bonds seems to be far from satisfied. That’s why interest rates don’t go up. DeLong thinks this is a Minsky moment type of thing. That means that the demand for AAA savings instruments is not being satisfied, and that the demand for savings mirrors the lack of demand for product, capital investment, job creation yadda yadda yadda.

  3. Chris Herbert Says:

    Which, looked at in a slightly different way, we have two ‘output gaps.’

    One is the demand output gap, where productive capacity is idled due to a sudden drop in demand–measured more or less by a rise in unemployment.

    And two is the AAA savings instrument gap, where the demand for super safe credits is far above the production of same. An output gap here where demand has outstripped supply.

    They could be related because a shock to the financial system will create the second output gap, while the rise in unemployment and decline in demand–the first output gap–are also a result of the financial system shock.

    I do believe I know what created such a severe recession. That would be the ‘run’ on wholesale banking created when all the pros realized, at pretty much the same time, that the AAA mortgage backed securities on their balance sheets (really levered balanced sheet it turns out) were mostly crap. Froze that market totally. Almost collapsed the entire economy.

    Republicans figure the Dems did this because, well, don’t the Dems always do the bad stuff? Real complicated thinking like that.

  4. Chris Herbert Says:

    I think I’ve read that the subprime mortgage market was under a trillion dollars. In other words we could have paid the entire thing off for less than we’ve spent on bailouts and stimulus.

    Of course, much more than that market collapsed because it was an asset that we levered to the stratosphere. Courtesy of a wild west attitude towards finance.

  5. the advisor Says:

    you are missing the point. why is the demand there? If everyone expects the government to buy bonds, they’ll do it ahead of time. If they came out tomorrow and said they wouldn’t, who would buy then? Fewer people obv.

  6. Chris Herbert Says:

    What’s so obvious here? Be careful about that. So far the neo liberal economists have been precisely and consistently wrong on predicting what would happen in our current circumstance. Rates didn’t go up. Inflation is subdued, to say the least.

    Their models don’t seem to apply to our current liquidity trap. And that’s the point Krugman and others make. What works in one set of circumstances doesn’t in others.

    Anyway, of course the Fed announcing it’s going to buy long dated bonds will cause some investors to front run the move. Speculation that capital gains rates are going from 15% to 20% will cause some folks to take the gains prior to the increase. No argument there.

    But are these the only dynamics involved? No, in my opinion. The demand of savings for AAA securities is a dynamic that was there before any Fed announcement. Minsky argued this demand shift can cause recessions or depressions, because in the realm of economics such a shift affects the entire economy and has to be balanced by a deficit in demand. You know, the old ‘everything balances out’ type of bookeeping thing. Say’s law and all that.

    I’m not missing the point. I’m saying there’s more than one ‘point’ at work.

  7. the advisor Says:

    it pretty much is. Mutual funds have only seen inflows of about 1bln into LONG dated bond funds. On top of that, i think you fail to realize what people expect the fed to buy. 500bln of treasuries, expanding upon their current plan of reinvesting the interest (10-20bln a month) they are currently doing. 500 bln is a lot of skin. Occum’s razor dude.

  8. Beezer Says:

    That’s the stimulus part. The QE II deal. Buying up the long bonds injects money into the system of course, and at the current rates, is less costly than normal.

    Myself, I think the cost/benefit isn’t worth it. I think the monetary tools are pretty much wrung out in terms of their effectiveness. Which is why I favor direct stimulus into tangible public goods, or other economic activity like utility plants and transmission systems which have the additional attraction of being deficit neutral. Plus you can reasonably predict the job producing benefit from these types of projects.

  9. Beezer Says:

    The aggravation in all this is that Republicans would normally approve of such projects, but because they hew to the ‘two santas’ political dynamic in order to win power, they will hold the economy hostage as long as it takes for the populace to ‘give up’ and put a curse on both parties. So the Dems lose.

    This is a level of cynicism with which I am unfamiliar.

  10. the advisor Says:

    just to clarify:

    you are against lowering interest rates to help consumers delever by allowing them to refi at much lower rates than would be normal.

  11. Chris Herbert Says:

    At the current historically low rates, I just don’t think it makes that much difference. Japan has knocked its rates down to zero, for instance, but like the continued easing in the US its more about currency devaluation, in my opinion.

    Also, devaluation amounts to a pay cut at these rates, and that probably sterilizes any help re: deleveraging, which is based upon debt that hasn’t changed.

    I’d rather get folks to work earning a decent paycheck. That’s the underlying problem and it’s tough to mount the political will to pass programs that would help –other than more tax cuts. The tax cuts obsession essentially stops the country from utilizing government capital power to boost private business. And that’s a relatively new problem. It’s a relatively new economic philosophy in the history of the country.

    It used to be widely understood that government capital could be used to boost private economic activity. But no longer.

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