Keynes described the phenomenon where there’s an almost insatiable desire to save with the natural result of declining consumption and investment (demand). This is a specific type of recession, or depression, and the recuperative cures are clearly laid out by Keynes in his work The General Theory of employment, interest and money.
Here’s a quick post over at macromarketmusings that shows our economic position and it exactly describes what Keynes so perceptively explained would be the case.
Friday, July 8, 2011The demand for money and money-like assets remains elevated as indicated in the figure below. This means nominal spending remains depressed. Until this changes we shouldn’t be surprised by employment reports like the one we got today.Update: Here is the household sector’s money and money-like assets as a percent of total household assets plotted against the same civilian-employment population ratio. The money and money-like assets include the following: cash, checking account funds, time and saving account funds, money market funds, and treasury securities.
In the short term Keynes said the government will have to spend in proportion to the decline in demand caused by the increase in savings. Going into the recession demand declined by $1.4 trillion annually but the amount of government spending that was directed at increasing demand was, net, about $300 billion annually. Most of the spending went to efforts at shoring up insolvent bank balance sheets. From Dean Baker at the Center for Economic and Policy Research here.
People who have the hubris to know arithmetic would also point out to Brooks that the “huge” stimulus did not fail because they knew from the onset that it was nowhere near large enough. The annual stimulus was around $300 billion in each of 2009 and 2010. The loss in annual demand from the collapse of the housing bubble was around $1.4 trillion. Followers of arithmetic know that $1.4 trillion is considerably larger than $300 billion, therefore they did not expect the stimulus to be anywhere near sufficient to boost the economy back to full employment.
Economist Paul Krugman points out that this type of situation can render traditional monetary policies less effective–the so-called ‘pushing on a string’ problem. The Federal Reserve finds itself in this type of situation. The Fed has flooded capital markets with liquidity and dropped short term interest rates effectively to zero. Yet the private economy remains sluggish still, almost three years later. Krugman says fiscal policy, not more monetary easing, is what’s needed. That could mean anything from specific tax cuts (something we’re doing in spades right now but with not enough forthcoming in the way of new jobs) to large infrastructure projects (something I think would be more effective, taxes in my opinion have at best secondary effects on economies).
OK, David Brooks has what amounts to a reply. I don’t want to get into a tit for tat. But I do want to take on the claim that believing that simple actions can bring big improvements in the economy amounts to belief in magic.
The key point here is the difference between raising the economy’s long-run growth rate, which is very hard, and increasing demand when the economy is operating below potential, which isn’t hard at all.
Look: under normal conditions, when interest rates are well above zero and there’s room for conventional monetary policy to operate, we actually take it for granted that the Fed can produce dramatic acceleration of short-run growth. When Paul Volcker decided in 1982 that the economy had suffered enough, he loosened the reins — and it was Morning in America.
Now, of course,the Fed funds rate is already zero, so Bernanke can’t just slash the rate. But the same logic through which looser monetary policy can produce a rapid economic turnaround now applies to fiscal expansion.
Stroking your chin and saying, well, I don’t believe in magical solutions because experience shows that raising growth is hard sounds serious, but it’s actually silly. It’s like saying that it’s really hard to extend the human lifespan, so it’s foolish to believe that an infection can be quickly cured with a dose of antibiotics.
But haven’t we tried a huge fiscal expansion? No, we haven’t. The ratio of spending to GDP is up because GDP has fallen and safety net programs like unemployment insurance and Medicaid are covering more people — that is, what we’re looking at isn’t stimulus, it’s the consequences of the slump.
The point is that realizing that there’s a lot you can do to reverse a short-term slump isn’t magical thinking — it’s what basic macroeconomics, what we learned through hard thinking and hard experience, tells us. Rejecting all that may sound judicious, but it’s actually an act of intellectual amnesia.
And in another Krugman, New York Times op-ed piece, he explains this in a little more detail.
Our failure to create jobs is a choice, not a necessity — a choice rationalized by an ever-shifting set of excuses.
Excuse No. 1: Just around the corner, there’s a rainbow in the sky.
Remember “green shoots”? Remember the “summer of recovery”? Policy makers keep declaring that the economy is on the mend — and Lucy keeps snatching the football away. Yet these delusions of recovery have been an excuse for doing nothing as the jobs crisis festers.
Excuse No. 2: Fear the bond market.
Two years ago The Wall Street Journal declared that interest rates on United States debt would soon soar unless Washington stopped trying to fight the economic slump. Ever since, warnings about the imminent attack of the “bond vigilantes” have been used to attack any spending on job creation.
But basic economics said that rates would stay low as long as the economy was depressed — and basic economics was right. The interest rate on 10-year bonds was 3.7 percent when The Wall Street Journal issued that warning; at the end of last week it was 3.03 percent.
How have the usual suspects responded? By inventing their own reality. Last week, Representative Paul Ryan, the man behind the G.O.P. plan to dismantle Medicare, declared that we must slash government spending to “take pressure off the interest rates” — the same pressure, I suppose, that has pushed those rates to near-record lows.
Excuse No. 3: It’s the workers’ fault.
Unemployment soared during the financial crisis and its aftermath. So it seems bizarre to argue that the real problem lies with the workers — that the millions of Americans who were working four years ago but aren’t working now somehow lack the skills the economy needs.
Yet that’s what you hear from many pundits these days: high unemployment is “structural,” they say, and requires long-term solutions (which means, in practice, doing nothing).
Well, if there really was a mismatch between the workers we have and the workers we need, workers who do have the right skills, and are therefore able to find jobs, should be getting big wage increases. They aren’t. In fact, average wages actually fell last month.
Excuse No. 4: We tried to stimulate the economy, and it didn’t work.
Everybody knows that President Obama tried to stimulate the economy with a huge increase in government spending, and that it didn’t work. But what everyone knows is wrong.
Think about it: Where are the big public works projects? Where are the armies of government workers? There are actually half a million fewer government employees now than there were when Mr. Obama took office.
So what happened to the stimulus? Much of it consisted of tax cuts, not spending. Most of the rest consisted either of aid to distressed families or aid to hard-pressed state and local governments. This aid may have mitigated the slump, but it wasn’t the kind of job-creation program we could and should have had. This isn’t 20-20 hindsight: some of us warned from the beginning that tax cuts would be ineffective and that the proposed spending was woefully inadequate. And so it proved.
It’s also worth noting that in another area where government could make a big difference — help for troubled homeowners — almost nothing has been done. The Obama administration’s program of mortgage relief has gone nowhere: of $46 billion allotted to help families stay in their homes, less than $2 billion has actually been spent.
So let’s summarize: The economy isn’t fixing itself. Nor are there real obstacles to government action: both the bond vigilantes and structural unemployment exist only in the imaginations of pundits. And if stimulus seems to have failed, it’s because it was never actually tried.
Listening to what supposedly serious people say about the economy, you’d think the problem was “no, we can’t.” But the reality is “no, we won’t.” And every pundit who reinforces that destructive passivity is part of the problem.
Beezer here. Krugman has a speech available he made at a conference on Keynes. In it he describes his interpretation of what Keynes wrote about depression economics and why not understanding Keynes (he’s not taught much at economics schools today) means we’re repeating all the same mistakes we made going into the Great Depression. Keynes identified fallacies in classic economics that come to the fore in financially caused recession, or depression. Krugman maintains modern economists were never taught Keynes and as a result are falling today for the same fallacies. Unfortunately, this includes all Republicans, and most unfortunately it appears Obama too.