Arnold Kling  

Worrying About Demand

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Robert J. Samuelson writes,


First, the economy is bound to lose the stimulus of rising consumer debt.

...Second, the benefits from defeating double-digit inflation are fading.


His argument is that without the boost to consumer demand from increased borrowing and lower interest rates, the economy will stagnate.

I find myself unable to get worked up worrying about "the consumer." As I wrote in my book, I think that investment is affected by stock market bubbles and panics, such as occurred in 1997-2001. In fact, the swing in stock market values was so strong that I believe it also did affect consumer wealth and spending. I think that progress and displacement mean that employment is always churning, and sometimes the transition out of declining sectors and into expanding sectors is less than smoothe. But I have come to believe it's really misleading to think of consumer spending as the "engine of growth."

The engine of growth is the accumulation and application of knowledge. If those activities are proceeding, then the economy will thrive.

For Discussion. Can a case be made that weak consumer demand will cause the economy to slump?


Comments and Sharing


CATEGORIES: Macroeconomics



COMMENTS (12 to date)
Sharn Cedar writes:

The point you are missing in your analysis is that the US economy has "globalized" to the extent there is no US economy anymore, because the currecny and trading area is international. So "consumer demand" must be considered as a global phenomenon, it isn't isolated to US. What is "consumer demand" like in China today? You miss the picture if you don't measure that as well. Its like trying to analyze the old US economy by just looking at one state, say Minnesota.

Case in point: massive inflation is going on right now, in ... China and India, ie in the US dollar economy. Massive inflation. Destructive, damaging, bad inflation. But the US keeps stimulating. How come? For example, give my corporation $50 billion as a present (like the decrepit fool Bush just did). It will imediately flow to China and India, without hesitation. The money won't land in the US territory. So it pumps up Chinese inflation, but doesn't stimulate "jobs or growth" in Amercia. And thus the decrepit morons that are presiding over our self-destruction continue to "stimulate", and measure things like consumer demand and inflation within borders that don't mean anything.

Are you folks just stupid, or pretending to be ignorant so you can destroy our country?

Lawrance George Lux writes:

Q
A weak Consumer demand will not percisely cause a slump in the Economy, it will cause a Products matrix shift. This shift has greater impact on the High-Enders( high-Wage and Profits-Takers). There is still much to fear from weak Consumer demand, and high Consumer debt is the greatest Products matrix shift producer. lgl

Deb Frisch writes:

I think it's both, Sharn. It's scary and depressing to read AK or Steven Landsburg - guys who are good at clarifying the logic (sic) underlying economic theory (sic).

Deb Frisch writes:

Arnold Kling can't get it up to care about the plight of the American consumer.

Film at 11.

Dewey Munson writes:

Back to basics.

Will someone explain how Demand can be isolated from Supply (Production)?

Not only that,they are necessarily EQUAL and therefore cycles are caused by temporary inequalities correcting to produce this equality.

"The Economy" is actually a complex of economies, Family economy, Local economy,State economy,National economy etc.

It seems (to me)that most commentary is broad-brush and affects all economies at once without considering individual characteristics of each.

Meanwhile, every day Capitalism is efficiently detecting the inequalities and struggling between exploitaion and correction.

Demand? Capitalism at present fails to see that increasing Prices (Profit) and decreasing wages (Layoffs) is counterproductive in increasing Demand (Sales).

Producers and Consumers are one and the same.

Hi, Dewey.

You asked a lot of great questions all at once. Let's start with this one:

Will someone explain how Demand can be isolated from Supply (Production)?
Not only that,they are necessarily EQUAL....

In equilibrium, they are indeed equal. It's the kind of conundrum that has puzzled the scientific community for three hundred years or more, but one that is now not hard to sort out by stepping back a bit. While we only get to observe the resulting equilibrium, we can both envision and measure circumstances in which only supply or only demand changes. Those circumstances let us isolate, begin to understand, and ultimately predict changes in the equilibrium, at least to some extent.

A few articles you might turn to for some background in the economics of sorting out supply from demand are:

Demand:
http://www.econlib.org/library/Enc/Demand.html
Supply:
http://www.econlib.org/library/Enc/Supply.html
Some historical quotes, graphs, etc., from Pigou, Marshall, and other sources on Demand, Supply, and Equilibrium, at various levels:
http://www.econlib.org/cgi-bin/search.pl?query=demand+supply+equilibrium&book=pgEW+marP+Encyclopedia+llCy+mlP&x=0&y=0&andor=and&sensitive=no

It's sometimes helpful to think of some other scientific analogies about equilibrium.

For example: If you could only observe the line of a beach--an equilibrium between the supply of water by the sea and the 'demand' for it by the land--you'd be hard-pressed to understand or predict changes in that equilibrium tide line. But, just as earth scientists have been able by careful consideration to explore the underlying shifts of the earth's crust that produce both eventual rises in land masses as well as the shocking encroachment of tsunamis, economists are also able to sort out some of the separate influences from the various underlying forces behind changes in economic supply and demand. The conditions that create changes in supply differ in identifiable ways from those creating changes in the opposing force of demand--timing, frequency, location, government regulation changes, our common sense understandings of which changes are behind which shocks; and therein lies our ability to study enough historical events to sort each force out. It's no more confusing in economics than in geology; but also no easier.

Michael writes:

To Deb and Sharn and the rest of your ilk,


I am growing weary of your misinformed vitriol. You are doing a tremendous disservice to yourselves and the many people falling prey to your demagoguery.

To start with:

"The point you are missing in your analysis is that the US economy has "globalized" to the extent there is no US economy anymore, because the currecny and trading area is international. So "consumer demand" must be considered as a global phenomenon, it isn't isolated to US. What is "consumer demand" like in China today? You miss the picture if you don't measure that as well. Its like trying to analyze the old US economy by just looking at one state, say Minnesota.

Case in point: massive inflation is going on right now, in ... China and India, ie in the US dollar economy. Massive inflation. Destructive, damaging, bad inflation. But the US keeps stimulating. How come? For example, give my corporation $50 billion as a present (like the decrepit fool Bush just did). It will imediately flow to China and India, without hesitation. The money won't land in the US territory. So it pumps up Chinese inflation, but doesn't stimulate "jobs or growth" in Amercia. And thus the decrepit morons that are presiding over our self-destruction continue to "stimulate", and measure things like consumer demand and inflation within borders that don't mean anything.

Are you folks just stupid, or pretending to be ignorant so you can destroy our country?"

Yet another mature quote.

Can you answer these questions? I think it is a bit lazy to throw your opinions out there as if they are facts and hope that all of the readers assume you are right. So, let's be serious about things so a serious discussion can take place.

1. How much of the American economy depends in non-American consumption?

2. Would "the decrepit fool" be able to give your company $50 billion if the government weren't as enormous as it is today?

3. Please describe the "present" to all of us and please detail the economic reasoning behind your comment that "it will immediately flow to Inida and China ... " and tell all of us how none of it will stimulate jobs or growth here.


Now, I think Deb is really showing her class these days.

Landsburg and Arnold and others like them do not beat people up with economic theory - they try to help people understand the economic WAY OF THINKING - a very different concept. Read one of their books and show me a place where some elaborate esoteric theory is presented and defended. Your attacks on them come off as being childish.

I hope for your sake that Arnold is wrong when he writes,

"The engine of growth is the accumulation and application of knowledge. If those activities are proceeding, then the economy will thrive"

...because you will be suffering through the long depression that you are predicting will happen anyway.

I just read this from Deb,

"So if you think Bush's economic policy is crazy, don't blame it on Republicans. Blame it on the tenured economics professors who dress up right wing rhetoric in economic mumbo jumbo and pass it off as "science."

... and how is someone that TEACHES a class on decision-making any different? I bet you THINK of that as science too.

I do think Bush's economic policy is ludicrous. I also happen to be an Economist (untenured of course). I don't think many of the blogs you spew your ignorance on are moderated by "right wing economists trying to pass mumbo jumbo off as science." Are you too foolish to know the difference between a classical liberal and a contemporary conservative? Many people are. Furthermore, the vast majority of tenured economics professors, last I checked, tend to have political leanings similar to yours. How can you then feel confident in your ridiculous claims?

I don't understand the usefulness of the following quote:

"Are you folks just stupid, or pretending to be ignorant so you can destroy our country?"

If you have no interest in contributing to the important dialogue that is trying to take place on blogs like this, please warn me at the beginning of your post so I don't have to continue wasting my time with replies like this.

Deb Frisch writes:

Michael:

I just read this from Deb,

"So if you think Bush's economic policy is crazy, don't blame it on Republicans. Blame it on the tenured economics professors who dress up right wing rhetoric in economic mumbo jumbo and pass it off as "science."

... and how is someone that TEACHES a class on decision-making any different? I bet you THINK of that as science too.
---
First, let me say I appreciate your taking the time to understand my position and respond to it thoughtfully and passionately. I was kind of pissy and snippy in this thread and you responded seriously. So thank you.

Second, even though I like and respect many economists (George Loewenstein, Linda Babcock, Laura Razzolini, Richard Thaler, Bill Harbaugh, Mark Machina) and understand that many of them are liberal, I truly believe that economics has a built-in right wing bias.

The vast majority of economic theory is based on the assumption that people (and therefore markets) are rational. This is an empirical assumption that turns out to be false (see Allais, Ellsberg, Kahneman, Tversky.) Mainstream economics is a faith-based science.

Almost every post at this web site has a market-worshipping flavor to it. It's ironic, scary and oxymoronic that the defenders of "rational choice theory" are disdainful of the empirical data showing the theory is false.

I have more to say on why I have such a negative view of the dismal science but I'll stop here.

Michael writes:

Hi Deb,

I too get depressed about the world often. I'd like you to know however that the reason I decided to get my Economics PhD and that I find it so stimulating is that I was introduced to the work of Kahneman and Tversky and Allais and others and it really struck a chord with me. For goodness sake, I teach my students about rational behavior when I don't even practice it myself! I think the strict adherents to a rational choice view of the world need to clarify their positions - my feeling is that when thinking about the absolute basics of economics, people (on average) exhibit "rational" behavior. For instance, when the price of cars goes up ceteris paribus, people desire to purchase fewer cars. I think that ANY economist that tries to defend rationality in the limits of human behavior is nuts - and there is an entire field of behavioral economics and information economics that is arising exactly for this reason.

Now, I could learn something from you right now because I think I am naive about people's definitions of right-wing and left-wing, liberal or conservative, etc ... so let me tell you a little about myself and then try and help me understand where I fit into the world views as you see them ...

1. I am a staunch environmentalist (moreso because I grew up in the concrete jungle, but also because I am one of those guys that gets intrinsic value from knowing that a polar bear is cathcing fish in the Artic, although I will never see one in person). I give lots of my money to organizations who poltiics and economics I don't agree with but who I think support the same ideals as I do as far as preservation, open space, habitat protection, clean water, etc.

2. I am horrified at the fact that so many people in America (and globally of course) are poor.

... you can see where the rest of this list is going.

Now, I agree with you that there is lots of empirical support (actually lots of experimental support) for your claim about rational choice being violated in many situations. However, I don't believe that you can derive from these findings the conclusion that many seem to - that free-markets (really free ones, not semi-free)are "worse" than alternative systems. I think it's a bit like throwing the baby out with the bathwater.

What is your view of the following,

"The welfare system currently has enormous incentive problems built into it, coupled with an enormous administrative burden as well as an enormous direct tax burden on American citizens - which we know distorts outcomes. Suppose now that someone devised a system that would DOUBLE the amount of annual income received by American welfare recipients today at the same time as reducing the forced tax burden on many Americans AND not having the new "welfare" system to have any work or other contingencies built into it. Further, this system will be coupled with an aggressive effort to clean the environment." "Oh yeah, the policy can be designed to be extremely progressive too."

Sounds good, right? Now, how would you feel about it if I said the government would have only minimal involvement? If much of this program would be left to the markets to work?

Would you call me a market evangelical? I would hope not - I am just trying to think of a BETTER way to help our poor and preserve our environment than what we are doing today. My proposal simply happens to have a market flavor to it. There is a role for all Americans and their governments to have a say in how this works too, it just leaves all agents with more freedom than they have under our current system.

Intrigued?

Thanks for your thoughtful post - I hope to continue the conversation!

Deb Frisch writes:

Michael: my feeling is that when thinking about the absolute basics of economics, people (on average) exhibit "rational" behavior.

I disagree with this. I don’t think the irrationalities demonstrated by decision psychologists cancel out in the aggregate or disappear in the market.

[I prefer the term decision psychologist to behavioral economist since it doesn’t purge the psychology. I dislike the term neuroeconomics for the same reason. These are transparent, sleazy attempts by economics to deny their overlap with psychology. Maybe some day George Loewenstein, Sigmund Freud’s (great?) grandson will write about economists’ denial of the increasing relevance of psychology to the dismal science.]

>For instance, when the price of cars goes up ceteris paribus, people desire to purchase fewer cars.

Well, some people think price is a signal of quality of status. I’m sure there are examples where an increase in price increases desirability. It’s a generalization that’s usually true, but not always true.

>I think that ANY economist that tries to defend rationality in the limits of human behavior is nuts - and there is an entire field of behavioral economics and information economics that is arising exactly for this reason.

The problem is that economists think that by awarding Danny K. the fauxbel prize, they’ve acknowledged behavioral economics. But the real test is whether it’s required – is it as important as “micro” and “macro?” Is it in the same league as the optional econ courses (labor economics, agricultural, whatever).

You could argue that it should be as required as micro and macro. But I bet it’s not offered by the majority of universities in the US. And when it is offered, it’s not considered a core course. It's hypocritical and disrespectful for academic economists to award the BS prize to Danny but then not take "behavioral economics" seriously.

>I am a staunch environmentalist (moreso because I grew up in the concrete jungle, but also because I am one of those guys that gets intrinsic value from knowing that a polar bear is cathcing fish in the Artic, although I will never see one in person).

I like folks who get intrinsic value from knowing the bear’s got enough salmon more than I like folks who don’t. Personally, I find this way of thinking too human-centric. When we do the cost-benefit analysis, we should include animals. So the reason to include the bear’s utility isn’t that some people care about bears. It’s because ethical economists include costs and benefits to all affected living creatures, not just the human ones. This is Peter Singer’s view, essentially.

>Are free-markets (really free ones, not semi-free) "worse" than alternative systems?

I don’t know what a really free market is. I have never seen one. The question is whether the semi-free ones the US shoves down the rest of the world’s throats is better than alternative systems.

There is a HUGE gap between US policy and what a really free market would look like. We’ve got steel tariffs and bans on imported drugs and barriers to entry of foreign workers. We’ve got legal nicotine and illegal marijuana. What we have is a joke, in many ways. Corporate interests and a little bit of free market.
I’d love to see an economist speak out against the tenure system. I’d love to see an economist argue that the National Science Foundation should open the competition for the $25 million it spends every year on economic research to foreign competition. Economists are against minimum wage but for tenure. For outsourcing but against opening competition for grant money.

In general, economists are extremely hypocritical – speaking out against cost-ineffectiveness that hurts corporations and remaining silent about cost-ineffectiveness that helps corporations.

[To be fair, economists have way more potential to be hypocrites since economics applies to almost everything.]

I think of economics as part science and part cheerleading for corporate America.

I don’t have strong feelings about the welfare system. You might be right that the same goals could be achieved better in the market. I'd be in favor of reparations + market-based solution instead of the current welfare system, probably.

On the other hand, I’m sure that government supplied health care would be better than the kooky system we have today – corporations and universities get tax breaks for providing health care to employees. Taking from the poor to give to the rich, not to mention a host of other economic stupidities.

Do you think the status quo in health care is preferable to universal health care?

If we are to continue this conversation, I’d like to know who you really are. If you prefer to remain anonymous on this list, that’s your business. But please email me off list so I know who you are. I prefer symmetrical information, given Akerlof and Yellen’s work on the downside of being on the wrong side of the asymmetry.

Michael writes:

Deb,

I can't seem to find your e-mail address on your webpage.

I need to teach all day today, but will happily send you an e-mail this evening.

Erik Kubec writes:

I think a case can be made. Simply, 2/3 of the economy is 'consumer goods.' So this is a signifcant portion of overall GDP. Hence, a decrease in 2/3 of economy would likely lead to a decrease in GDP. This is fairly simple.

Your argument I believe is that the "engine of growth" = "knowledge and application of knowledge", or that there is some mechanisim by which "knowledge and application of knowledge" = increasing GDP.

I would argue that historically "knowledge and application of knowledge" have been the impetus of growth: Look at the USA in the 1850's-1870's and the railroad industry. Look at the 80's through today and the PC industry. Further examples could be found in the mechanization of farming. Look at FDR's "New Deal" Monuments (not social security) but damns, roads, etc. Look at the Cold War and the exansion of the military industrial complex.

However, aside from new knowledge and the applicaton of that knowledge, there is one thing all of these examples share: credit. Or more specifically, new credit and the application of new credit. The "New Deal" was mostly a marriage of the application of new physical knowledge (ie. concrete construction) and the application of new financing, or credit (borrow money against the future in a Keynesian manner to stimulate growth and GDP and jobs). The railroad boom also was backed by new financing methods that would allow for the type of investment that could build a railroad across a country. The Tech Boom of the 90's was underwritten by some degerre in a new form of credit between employee and employer in the stock option.

However, everyone of these booms eventually busted or ceased. At the point that say railroad companies were going bust in the latter half of the 19th century, one could argue that "knowledge and the application of knowledge" was at its peak, with regard to railroad knowledge. ie, industry new more about railroads and how to build and finance them in 1890 than they did in 1850. Yet there was a recession in 1890 or there about.

So knowledge and the application of knowledge is not in and of itself the thing that drives growth. , although it plays a critical part in the cyclical expansion (kondreitiv cycles) of economies. Likewise, consumer spending is not in and of itself important. It is important because of its relationship to credit. Or rather, without credit, there would be little consumer spending. Cheap and easy credit means full malls, busy home-builders, and happy car-salesmen. Take away credit, consumer sales drops.

This is the danger to the economy as I see it. The American consumer has had so much credit thanks to the Fed and those Japanese Mints that pump out large volumes of Yen with which to buy Treasuries. The housing boom (bubble?) has enabled even more spending and credit expansion. If you like Soros' theory of reflexivity (that things are valued based upon, well how they are valued) you can see a dangerous credit bubble in housing. People are lent money based on their house value. More money to buy houses. More money chasing same houses means higher house values. Higher house values means banks lend people more money. Until this unstainable process pops.

-e

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