Arnold Kling  

Krugman vs. Blanchard on the State of Macro

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The Median Economist Speaks on... Capitalism and the Jews...

Paul Krugman writes, contra Olivier Blanchard, that


The state of macro, in short, is not good.

I agree with his diagnosis. But his prescription, to return to some sort of old-time Keynesian religion, is too vague. It would be precise if one could speak of the old-time Keynesian religion, but unfortunately schisms erupted from the very beginning in the 1930's and have continued to this day. Economists are no more ready to agree on what is Keynesian than Iraqis are ready to agree on what is the true Islam.

It is odd that Krugman wrote this for the New York Times. It belongs in the new American Economic Association journal Macroeconomics. An imaginative editor would open up the pages of such a journal to heterodox points of view. But, come to think of it, that journal is edited by Blanchard. Never mind.

Krugman trots out his baby-sitting co-op story, which is roughly equivalent to my hydraulic macro fable (he wrote his fable before I wrote mine). However, Krugman does what I suggest not to do, which is make a big deal out of the problem of money as a store of value (the baby-sitting coupons on his story).

The odd thing about the baby-sitting co-op is that there is no possibility of investment. There is nothing you can do today that will increase production of baby-sitting services tomorrow. Because there is no investment, there is no possible place for savings to go. So saving is contractionary. But why should that pathological situation carry over into an economy in which there are real capital investments available?

In the real world, if you want to have consumption for next year, there are things that are produced today that can give it to you. Buying a car can give you transportation services for next year. Buying frozen food can give you food for next year. Buying a house can give you shelter next year. Investing in securities can provide funds to firms that purchase capital equipment that will yield consumable goods next year.

What I propose is that instead of thinking that saving exceeds investment in some aggregate sense, we consider that the market is in the midst of a great recalculation, due to the fact that suddenly there is a misalignment between production plans and consumption plans. Two years ago, builders were expecting consumers to absorb 2 million new homes a year. Today, they know that's not happening. Consumers would like to increase future consumption of something other than housing services. The recalculation problem starts with the fact that nobody is quite sure what consumers would like this future consumption to be. Health care services? Fancier smart phones? Devices enabled by nanotech or biotech that has not yet been perfected?

Along the way, all sorts of changes in wages and prices will take place. These will send signals that will lead people away from some occupations and toward others. But the process is going to take years, and meanwhile there will be idle resources. Government might be smart enough to employ the idle resources for a while and then release them when the market is ready. But I don't think that Congress designed the stimulus package with that in mind.


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CATEGORIES: Macroeconomics



COMMENTS (44 to date)
Troy Camplin writes:

Hey, Krugman is right about something. Of course, as usual, when he's right, he's almost always wrong. He's right that the state of macroeconomics is not good. But like the government with the current depression, he proposes more of what caused the problems as the solution to the problem. If we could remove Keyneseanism in its entirety from all economic thinking, that would go a long way to solving the vast majority of the problems in economics. At the very least, one should just assume the opposite of whatever Keynes says, and it's almost certain to be true. Keynes is the reason macro is in bad shape. More Keynes is like throwing leeches as a hemophiliac.

Greg Ransom writes:

This "odd thing" is the thing at the heart of Keynes econ that Hayek and Garrison have been calling attention to for 70 years -- in Keynes there is no choice between more or less
time in production and more or less output. See Garrison's Hayek vs Keynes Powerpoint. REAL output gains from increased savings require greater output for the sacrifice of greater time -- something Keynes never "got" and something ever absent from Keynesian economics.

Arnold wrote:

"The odd thing about the baby-sitting co-op is that there is no possibility of investment. There is nothing you can do today that will increase production of baby-sitting services tomorrow. Because there is no investment, there is no possible place for savings to go. So saving is contractionary. But why should that pathological situation carry over into an economy in which there are real capital investments available?"

fundamentalist writes:

Nice analysis! Of course, Austrian complaints of Keynesian econ are similar: Keynes refused to admit capital or time into his model. He prentended that we exist in a state of equilibrium in which capital and time don't matter.

I hope that mainstream econ doesn't go Austrian on us. That would make it much more difficult for me to make money on the stock market.

Boonton writes:
What I propose is that instead of thinking that saving exceeds investment in some aggregate sense, we consider that the market is in the midst of a great recalculation, due to the fact that suddenly there is a misalignment between production plans and consumption plans. Two years ago, builders were expecting consumers to absorb 2 million new homes a year. Today, they know that's not happening. Consumers would like to increase future consumption of something other than housing services. The recalculation problem starts with the fact that nobody is quite sure what consumers would like this future consumption to be. Health care services? Fancier smart phones? Devices enabled by nanotech or biotech that has not yet been perfected?


To echo deLong's objection, why does the entire economy have to suffer a massive amount of unemployment to get a few thousand carpenters out of Nevada and into something else? More to the point, this explains why homebuilding would suffer unemployment but what about everything else? Since there's uncertainity about where this unknown spending is going to end up wouldn't firms respond by either hiring workers (in case their industry is the lucky one to get the consumption) or at least holding firm in case they have to suddenly ramp up production?

Arnold Kling writes:

Boonton,
Read Leamer's book on how central housing can be to the economy. If you don't buy a new house, you are less likely to buy a new refrigerator, a new washing machine, etc. If your housing wealth is stagnant or declining, that affects how you approach replacing your car, choosing your vacation, and so on. Lots of industries get disrupted by a housing bust.

Boonton writes:

Point taken but I notice you've switched from active to passive. At first you put forth that the recession is due to a collective decision by consumers to change their style of consumption (either in terms of the make up (less housing, more ipods) or timewise (less consumption today, more tomorrow)). Now consumers seem to be passive victims as their income falls because, say, the refrigerator salesman has fewer new home buyers to sell too, the hotel manager sees fewer families on vacation etc.

In the active mode it seems like the change in consumption decisions should not be so sudden....housing is a major investment, why would people's preferences about it turn on a dime so quickly? In the passive mode it sounds like a dressed up version of Keynes where individuals may be acting rationally but the economy as a whole becomes irrational.

Niko writes:

A quick note on the nature of blogs. It's so interesting to see intellectuals develop their own thoughts through the history of their postings.

I like this post because it shows that even professors can grow in their thoughts.

Matthew C. writes:

Karl Denninger, Mike Shedlock and many other bloggers who correctly predicted the financial crisis / market crash say that this is a crisis of indebtedness. That the whole "asset class inflation" paid for by increasing debt loads which has driven up prices (and corporate earnings) has finally hit the wall, and that the future economy will feature far less indebtedness at all levels. And they claim that essentially none of this indebtedness problem has been resolved yet, and that a sustainable economic recovery will require it.

I do not see this being discussed much among academic economists, but I find a lot of merit in this analysis.

fundamentalist writes:

Matthew, that view is similar to the Austrian theory of business cycles. I think you'll find academics who subscribe to Austrian econ talking more about debt and its consequences.

David Welker writes:
Consumers would like to increase future consumption of something other than housing services. The recalculation problem starts with the fact that nobody is quite sure what consumers would like this future consumption to be. Health care services? Fancier smart phones? Devices enabled by nanotech or biotech that has not yet been perfected?

Do you not think you have to prove the first sentence I quoted? Do you think you can just assume it? Isn't that the stereotype about economists. They think they are under no obligation to prove anything, but can just assume it. How do you know that consumers would like to consume something other than housing services? How do you know they aren't just scared that such investments would decrease in value?

Also, you seem to fail to differentiate between the bundle of things people are buying when they buy a house. They are buying (1) shelter, (2) access to schools of a particular quality, (3) proximity to other individuals within a particular community, (4) tax incentives, and (5) an investment capable of a positive or negative return. To name just a few things. One could, I suppose, collapse this diverse bundle of things into one thing and call it "housing services." I think that would be intellectually bankrupt, because it distorts the story that is told. In particular, the story isn't primarily that people find other goods suddenly more desirable relative to quality housing. The story is primarily that people are fearful of owning houses as an investment. The story isn't that suddenly people have a growing desire for health care, smart phones, and devices that have yet to be invented that has surged and displaced the desire for houses.

[Btw, no one WANTS healthcare -- most people would prefer to have no need for treatment -- this isn't a good that people want, it is a good they need. And that is part of the problem with the story libertarians tell. Saying that individuals consume "too much" healthcare presumes that people desire healthcare more than they need it. Most people I know don't exactly enjoy going to the doctor. I personally avoid the doctor even though I have really great health insurance. And that is another thing that you probably abstract away: the very real difference between desire for those things you need and desire for those things you do not need. But it is an important distinction. Even though my "consumption" of health services is heavily subsidized, I still avoid consuming it. This is not like fancy vacations, which fill people with desire for that which they do not need and where demand will probably act differently in response to subsidies. And before you say that subsidies do the same thing to demand in both cases and say that subsidies increase demand in both cases, I will point out that "increase" is an abstraction and you are missing extremely important nuances. Subsidies do not increase MY demand for health services. There may be an aggregate increase in both cases, but the nature of that increase is different and that difference is very important. Consuming health services costs not only money, but also the time and discomfort for the patient. Therefore, there is less need to ration care through market or other mechanisms. Also, from a moral perspective, there is a difference between depriving people through market mechanisms or otherwise of goods they desire because they need them and goods they desire but do not really need. Somehow, this is all lost in your abstractions.]

Anyway, it seems to me that economists, and especially libertarian economists, are people who prefer abstractions over actual reality. You prefer to talk about the market for "housing services" because that is more abstract than separating the bundle of things that you get from home ownership into its constituent parts. And THAT is the biggest single flaw in libertarian thinking. Abstraction, when not appropriately handled, distorts the stories you tell and disconnects those stories from actual reality. Rather than clarity, such abstractions result in obfuscation.

As a result, you come up with implausible stories about a sudden surges in desire for health care and smart phones and devices that haven't been invented yet and no one knows about displacing people's desire to live in comfortable housing. Yeah, right. That story is possible, but simply not plausible.

Yancey Ward writes:

David Welker,

Perhaps Kling should have stated it this way:

"Consumers would like to increase future consumption of something other than housing services at present prices."

Boonton writes:

I'm not feeling this theory here. OK if consumers want less housing consumption I can see mortgage brokers, real estate agents, construction workers, all taking a big hit in jobs. OK, I can see appliance manufacturing and appliance retail jobs (see Home Depot) also taking a big hit.

But everything is taking a hit and "housing is big and connected to everything" just doesn't seem sufficient. Everything is connected. A big cut in one type of consumption implies a big jump in another type. If the replacement consumption is to take place in the future then that means a big jump in savings (hey why a liquidity problem with banks then? I'm sure financial firms would love more e-trade accounts and 401K contributions).

Likewise if this is just 'recalculation' then what of all the gov't stimulus both monetary and fiscal? Where's the market building in massive inflationary expectations?

David Welker writes:

Yancey Ward,

I know your trying to address my argument. But you have failed to do so.

The brevity of your response also illustrates my argument against excessive abstraction. You really believe, in my view absurdly, that your simplistic addition to Kling's argument actually addresses anything I said.

Abstraction, when misused as you are unintentionally misusing it, might act as a nice little magic wand to wave away the complexity of the real world. I think there is something comforting about thinking you have THE ANSWER for complexity in the world via the mechanism of abstraction. Unfortunately, that view, while perhaps psychologically comforting, does not comport with the truth.

Your point about prices actually is very unhelpful, in fact. Prices are lower. If everything was equal, demand for quality housing should be higher than ever. But things are obviously not equal.

However, the explanation for the drop in demand for quality housing is both obviously and DEFINITELY not a sudden and new desire to consume more on healthcare, smart phones, and yet to be invented technological devices.

As you can see, excessive abstraction leads otherwise smart people like Arnold Kling to come to theories or explanations that do not even approach plausiblity, much less probability, as explanations of the real world.

Drewfus writes:

Boonton writes:
"...why does the entire economy have to suffer a massive amount of unemployment to get a few thousand carpenters out of Nevada and into something else?"

Empirically, does there appear to be a choice? Currently there is a massive deficit and a ZIRP. Even so, unemployment is rising rapidly! Investment is still falling!

Why makes you think the suffering is avoidable?

Drewfus writes:

David Welker, you make some good points, but...

"Btw, no one WANTS healthcare -- most people would prefer to have no need for treatment -- this isn't a good that people want, it is a good they need."

...aren't you making the same mistake you accuse Arnold of - namely, how do you know that consumers see health services exclusively as a necessary evil, and not in any way desirable in their own right? By projecting your own subjective opinion onto everyone?

Also, the 'bundling' of consumption goods and sevices that are strongly associated with housing into the abstraction of 'housing services' might indicate that the demand for housing is likely to be quite stable and price inelastic, ceteris paribus, since the combined consumption of housing plus related goods and services is a massive chunk of total consumption. There just isn't enough 'other stuff' to take up the 'slack'. So if housing prices are falling, it must be due, not to the relative desirability of housing services to other goods and services changing, but a financing problem. Excessive debt and higher lending standards are the obvious culprits.

On the hand, your charge that economists make too many assumptions is justified (but not that this is particular to Libertarians). I would 'arrogantly' suggest that every econ blog post should start with a graph (or two), and go from there.

MD writes:

David Welker:
"You prefer to talk about the market for "housing services" because that is more abstract than separating the bundle of things that you get from home ownership into its constituent parts."

It's ironic that you rail into Kling for his supposed reliance on "abstraction" and then proceed to illustrate this precisely backwards. To clarify, the concrete and actual here is to pay for this "bundle of things" at once, to imagine what consumers would pay for each of the separate services derived from housing separately is a dreaded abstraction; people don't actually pay for these things separately and in many cases could not even if they wished to. Abstraction is a basic cognitive function. Even if you had pointed to an actual abstraction made by Kling, that in itself would be no indictment; there is nothing necessarily wrong about it. Given your poor illustration, all your ranting about "abstraction" from the other side comes across as mere crankery.

"...you come up with implausible stories about a sudden surges in desire for health care and smart phones and devices that haven't been invented yet"

In the part of Kling's post to which you're referring he used question marks, presumably to indicate the speculative nature of his statements. Work on your reading comprehension.

Kling states: "Two years ago, builders were expecting consumers to absorb 2 million new homes a year. Today, they know that's not happening. Consumers would like to increase future consumption of something other than housing services."

You seem to take issue with these statements in particular, but I find nothing controversial about them at all. Demand for housing has fallen dramatically. Hence, his statement that consumers would consume something other than housing is following from the simple observation that they aren't consuming housing. Of course, they could save (and so consume later) too, but that doesn't negate the fact that they aren't consuming housing now. Arnold's point seems to be just that we don't know where, when, or for what that demand will reappear, connecting to his larger theme of 'recalculation' - that it will take time for the resources in one sector to shift to another unforeseen one.

In any case, I found the blustery confidence in your response to Yancey rude, considering the flaws in your own post.

David Welker writes:

MD,

It is highly interesting to me that you criticize my reading comprehension, when your own reading comprehension is quite deficient.

I did not criticize all abstraction. I criticized the misuse of abstraction and the preference for abstraction and simplicity over the concrete complexity that constitutes reality. Abstraction is useful, but a generalized preference for abstraction is foolish.

In other words, I am not criticizing the use of hammers (i.e. abstraction). I am criticizing hammers when a screw driver is the more appropriate tool.

So, I am criticizing abstraction as Kling foolishing goes about it. He wants to talk about "housing services" because that is a simplistic abstraction and wants to avoid the constituent parts, which actually exist and are much more useful for the analysis he wishes to engage in.

Your point about how the constituent parts are really abstractions, because no one ever consumes these parts individually is seriously confused. People do in fact interact with these things individually and in a concrete way.

When someone consumes a house, they do concretely record a tax deduction on their 1040 and pay less taxes, which has a concrete effect on their bank account. When people sell their house, they either sell it for a profit or a loss, again, with a concrete effect on their bank account. These are real transactions, not merely abstractions.

So yes, reducing these real world concrete things to the term "housing services" is a simplified abstraction. Your view otherwise is clearly and obviously wrong.

Even if you had pointed to an actual abstraction made by Kling, that in itself would be no indictment; there is nothing necessarily wrong about it. Given your poor illustration, all your ranting about "abstraction" from the other side comes across as mere crankery.

As shown above, the term "housing services" is clearly more abstract than an examination of the constituent parts. You already have pie on your face. But then you engage in an ad hominen to top it off. Nice job.

In the part of Kling's post to which you're referring he used question marks, presumably to indicate the speculative nature of his statements. Work on your reading comprehension.

The problem with Kling's speculation is that it not even plausible. And the serious intellectual flaw that leads him to this implausible speculation is his confused used of abstractions.

There is nothing wrong with educated guesses. But such guesses should at least be plausible. Otherwise, what does Kling's knowledge as an economist who is supposed to know something as opposed to an ignorant bum off the street buy us exactly?

So, as you can see, the problem here is not my reading comprehension. The problem is that I, unlike you, have standards.

You seem to take issue with these statements in particular, but I find nothing controversial about them at all. Demand for housing has fallen dramatically. Hence, his statement that consumers would consume something other than housing is following from the simple observation that they aren't consuming housing.

Here is what Kling said:

Consumers would like to increase future consumption of something other than housing services.

Based on standard English, this is a story about shifting consumer preferences. As if people who used to like vanilla ice cream woke up one day and discovered that chocolate ice cream was so much better. But, changing consumer preference clearly has very little explanatory power in explaining our current situation. The story that this is all about a sudden increase in demand for healthcare, smart phones, and yet to be invented devices is clearly and obviously WAY off.

Under another interpretation, less in line with standard English, Kling is asserting that decreased demand for housing will result in increased demand for other things.

However, decreased consumption of "housing services" could be substituted by nothing, rather than increased consumption of anything else. That is, we could have a situation where real unemployment exists which then decreases consumption of not only so-called "housing services," but all goods and services produced by the economy.

Once again, we have a critical statement, namely that decreased consumption of housing services will result in increased consumption of something else, that is assumed, when it really needs to be proven.

Under any interpretation, this statement is foolish and clearly the product of poor reasoning.

In any case, I found the blustery confidence in your response to Yancey rude, considering the flaws in your own post.

I apologize for being confident. Some of us just can't help ourselves. We are just naturally well endowed with self-confidence. I hope you will forgive me.

More substantively, Yancey Ward did not say anything that actually addressed the points I was making. I simply pointed out that fact, in a, as you say, confident manner. I also used the opportunity to connect her failure to my larger theme. The fact that Yancey Ward, with her simplistic reference to price, actually thought she was addressing my argument, goes to show the flawed thinking that comes from excessive and poor use of abstraction.

David Welker writes:
...aren't you making the same mistake you accuse Arnold of - namely, how do you know that consumers see health services exclusively as a necessary evil, and not in any way desirable in their own right? By projecting your own subjective opinion onto everyone?

I do not pretend to have perfect knowledge of every person's motivations. However, I do know a lot of people, and most of them do not exactly look forward to visits to the doctor's office with glee.

Furthermore, there are clearly significant non-pecuniary costs of doctor visits in terms of costs and discomfort. It is not much of a stretch to suppose that those non-pecuniary costs matter.

I would 'arrogantly' suggest that every econ blog post should start with a graph (or two), and go from there.

This is not so much an arrogant perspective as an extremely foolish perspective. Graphs are a method of communication, nothing more. To say that we should always start with graphs is to say that which is important can always be most effectively communicated with graphs. But that is clearly false.

It seems to me that you have foolishly transformed what could be a positive, that is, the ability to communicate with graphs, and turned it into a negative, that is, the inability to communicate and discuss topics not best communicated with graphs.

It appears to me that you have some sort of irrational graph fetish. As such, I would not really trust you to give a good definition of "rational" since your graph fetish is anything but.

Drewfus writes:

David,
regarding what you said in relation to my question about the desirability or otherwise of receiving health treatments, i'm taking that as a 'yes'.

"To say that we should always start with graphs is to say that which is important can always be most effectively communicated with graphs. But that is clearly false."

Wrong. One does not imply the other. What your asserting would only be true if i'd advocated that blog posts both started and ended with graphs, and that no other form of communication, by comparison, was worthwhile. No, i do not hold that mad view.

By advocating the use of graphs to 'kick-off' blog posts, i'm simply indicating that real-world data is likely to be a more productive way to initiate thinking on a topic than arbitary assumptions and subjective 'facts'. You have railed against Arnolds' over-reliance on assumptions, and with that point of view i've suggested a partial alternative. Of course i don't think that graphs are the be all and end all, or that i seriously believe that the 'graph first' approach is universally applicable. However good graphs are clear, factual, succinct and high-resolution. I like graphs. They are certainly more valuable to debate than paragraphs of rambling, self-confident attacks on others that involve substituting your definition of valid abstractions for theirs. Why do you bother?

I'm sorry to end on a sour note, but my first reference to you in this post was positive, an effort you seem to have gone out of you way not to return.

MD writes:

David Welker:
"It is highly interesting to me that you criticize my reading comprehension, when your own reading comprehension is quite deficient.

I did not criticize all abstraction. I criticized the misuse of abstraction and the preference for abstraction and simplicity over the concrete complexity that constitutes reality. Abstraction is useful, but a generalized preference for abstraction is foolish."

Right. However, as I already pointed out, your illustration of Kling's failure to abstract properly was a pile of rubbish, nor have you demonstrated that he has a generalized preference for abstraction.

"When someone consumes a house, they do concretely record a tax deduction on their 1040 and pay less taxes, which has a concrete effect on their bank account. When people sell their house, they either sell it for a profit or a loss, again, with a concrete effect on their bank account. These are real transactions, not merely abstractions.

So yes, reducing these real world concrete things to the term "housing services" is a simplified abstraction. Your view otherwise is clearly and obviously wrong."

This is sophistry. I do not deny that each of these aspects of enjoyment of housing exist, and neither has Kling. Nor was that even implied by his original post; that you interpreted it that way is, again, a failure on your part - you're introducing your own assumptions. The fact remains that these when someone chooses to buy or to not buy a house, the house is in fact the concrete thing and, as a I mentioned already, the other aspects are not necessarily separable at all. In fact, the point stands.

You claim that this is a faulty abstraction, but that is bizarre; there is no abstraction involved. You said that "Also, you seem to fail to differentiate between the bundle of things people are buying when they buy a house. [...] One could, I suppose, collapse this diverse bundle of things into one thing and call it "housing services." I think that would be intellectually bankrupt, because it distorts the story that is told." Clearly you think that an analysis of the separate reasons we desire housing is important, but you fail to realize that that is not mutually exclusive with Kling's statement. You have shown no such distortion, and your statement that it is "intellectually bankrupt" to discuss buying or selling a house without mentioning these separate reasons is an absurd exaggeration.


"The story that this is all about a sudden increase in demand for healthcare, smart phones, and yet to be invented devices is clearly and obviously WAY off."

This statement reveals fully that you still don't understand. Kling is clearly not saying that these things caused the drop in demand for housing. That you persist in this erroneous interpretation is testament to your ability to follow the discussion. He merely suggests them as possible areas to which consumption may shift. This was already pointed out to you...

Sulla writes:

This always struck me as fascinating. On one side you have people saying that most of the mainstream economists are more in favor of government intervention than not, and now you read Krugman who says the opposite: that economists put too much faith in the market.

As far as graphs go, they can be nicely manipulated as well.

Floccina writes:

In response to the ideas in Krugman's article could one conclude that we need a mechanism to make and contract the money supply without using debt? So how about this:

Each American would be given shares in the federal reserve. Those shares can be sold on the stock market. This newly publicly traded federal reserve should become a bank that in times of decreasing money, supply-due to a contraction in the desire to borrow or lend, would buy up all kinds of assets (Stocks, bond, REITs, buildings, Oil, etc. ) with an intent to make money, that it would hold and earn income for the stock holders? It would pay out the earnings in dividends to shareholders. That this citizen owned Federal Reserve bank should target holding 30% capital as the Scottish free banks did. In response to a rise in inflation due to an increase in lending it could then sell off some of the assets that it owns. Hopefully the euro and other world currencies would provide competition and keep it in line.

What you would have would be a money backed in assets.

This is my lame attempt to solve the problem that a reduction in debt leads to a contraction in money supply and makes debtors poorer.

Why should we be poorer when we have the same assets and productive capacity as before this began.

Boonton writes:

Drewfus

Empirically, does there appear to be a choice? Currently there is a massive deficit and a ZIRP. Even so, unemployment is rising rapidly! Investment is still falling!

If the financial crises of 2008 was roughly similiar to the stock market crash of 1929 then unemployment should have been heading up to 20% or more with even larger declines in GDP. That appears not to be happening.

You might be correct, some suffering is unavoidable hence even with more stimulus we still would have to endure some unemployment. I don't disagree there but what we are talking about here is a narrative of whatever macro theory we think explains what has happened. Krugman's argument is that the neoclassical narrative doesn't seem very convincing. Kling's "people just got tired of having nice homes" leaves a lot to be desired IMO.


David
Based on standard English, this is a story about shifting consumer preferences. As if people who used to like vanilla ice cream woke up one day and discovered that chocolate ice cream was so much better. But, changing consumer preference clearly has very little explanatory power in explaining our current situation. The story that this is all about a sudden increase in demand for healthcare, smart phones, and yet to be invented devices is clearly and obviously WAY off.

Well one problem here is that houses are assets. If you think in ten years there's going to be wonderful consumption goods invented and available in the market, buying a house today makes sense......just sell it in ten years and buy the goods you want. In the meantime you're building your assets for tomorrow.

Kling's argument seems to be that we are consuming less 'housing services'. OK. So let's say I'm living in a two bedroom apt. in NYC paying through the nose. I think in ten years I want to buy the wonderful new cars that will be on the market. I decide to reduce my 'housing consumption' by moving to a one bedroom apt. and putting the lower rent into a savings account. If I was a homeowner I might slack off on needed repairs (hit to Home Depot)....if I was really going to be dramatic I might sell my house and buy a smaller one.

I'm sorry but this looks a lot like Keynes 'animal spirits' idea to me. Except in Keynes system investors and consumers get spooked into thinking diaster is around the corner. They immediately retreat from consumption spending and pull back their investments into the safest options possible. The result is that they create the diaster they are seeking to protect themselves from as a massive rescession destroys the income they are trying to build a savings cushion out of.

Kling has invented a positive spin on this. Consumers suddenly think consumption tomorrow is going to be much greater than it is today. They pull back their consumption spending today (why buy the Playstation 3 if Playstation 4 is going to be super-duper-awesome?). BUT Kling only hits one side of the nail. If consumers think consumption tomorrow is worth so much that they are going to kill themselves saving up for it then why the investment collapse? Clearly investment returns tomorrow will be fantastic as consumers start spending their money on whatever mysterious fantastic product they expect to be on the shelves.

Kling's answer is that no one knows what it is consumers want. They know they are going to spend their money on something fantastic in the future but the investment side of the economy doesn't know what that is so it doesn't know if it should put money into cell phones, video games, air planes, electric cars etc. So it just parks the saved cash under the mattres. But if this was the case why wouldn't a diversified portfolio be the answer? The consumption collapse in spending should be matched by a boom in R&D investment spending looking for that killer consumption product. Where is it?

8 writes:

What caused the great miscalculation? The prices were wrong.

Now we have the great recalculation. But what if it is just another miscalculation?

Obama & Dems think they know what consumers want: to spend another 5% of GDP on healthcare. Frank, Uncle Ben & Turbo think they want toxic assets, cars, and houses. Their success will lay the ground for another big recalculation.

And when I listen to the market, I hear the cry of the bears, "We have not yet begun to recalculate!"

I agree with fundamentalist, don't let the Austrians run things, otherwise the only way to get rich will be through hard work and savings.

JP Koning writes:

"However, Krugman does what I suggest not to do, which is make a big deal out of the problem of money as a store of value"

Arnold, after following the link mentioned next to the above quote, I still can't understand why we should avoid thinking about money as a store of value. Can you flesh this out?

David Welker writes:

Here is my last comment, and it is addressed to Drewfus.

I appreciate your attempts to be positive.

That said, you have to admit that your goal of presenting real world data at the beginning of a conversation could be achieved with devices other than graphs. Furthermore, graphs are not always the most optimal means of communicating data -- it depends on the data.

In addition, I would disagree with the idea that all discussions should start with real world data or even include real world data. It depends on the purpose of the discussion.

Another point, your statement, which you have retracted that one should always start with graphs was an extreme one. I was not trying to be negative, but I actually thought you meant precisely what you said. So I responded accordingly. I think it is pretty crazy to assert, except in a tongue in cheek manner, that all discussions should proceed in one particular manner. That is precisely the sort of overarching abstraction I would tend to rail against.

A final point. You appear to think that my discussion of abstraction is a waste of time. That it is all about dueling abstractions. After all, we are stuck with abstraction, if only to enable efficient communication if nothing else. You are missing the point. I am not saying, in a very abstract way, that one abstraction is always superior to another. Instead, I am saying that one really needs to put more thought into what abstractions one uses. Economists in particular tend to gravitate towards particular abstractions without much thought. This is unfortunate, because it seriously biases the conversation and needs to a systematic neglect of certain important topics.

And to end on a positive note. I like graphs too. A picture can convey a lot quickly.

David Welker writes:

One more comment, just for the heck of it.

MD:

This is sophistry. I do not deny that each of these aspects of enjoyment of housing exist, and neither has Kling. Nor was that even implied by his original post; that you interpreted it that way is, again, a failure on your part - you're introducing your own assumptions.

I did not assume that either your or Kling denied these other aspects of housing exist. Instead, what I asserted was that these other aspects were not discussed, but instead unhelpfully "abstracted" to the concept of "housing services."

The fact remains that these when someone chooses to buy or to not buy a house, the house is in fact the concrete thing and, as a I mentioned already, the other aspects are not necessarily separable at all. In fact, the point stands.

Just because you cannot buy a house without getting the whole bundle does not mean that the individual things do not exist as concrete things. If you buy a new car, and the dealership insists that the transaction must include both an engine and a steering wheel, the engine and the steering wheel are existent and concrete things.

It would be an abstraction to refer to a thing called a "car" without reference to engines and steering wheels. Sometimes such abstractions will be useful for the sake of efficient communication. Sometimes such abstractions will obscure.

You claim that this is a faulty abstraction, but that is bizarre; there is no abstraction involved.

First, the claim was not that the abstraction was "faulty" as in logically invalid. The claim is that the abstraction is very unhelpful and obscures more than it enlightens.

Second, if you do not believe there is an abstraction involved, then you clearly do not understand the concept of abstraction. If I talk about a car without talking about engines, steering wheels, and bolts, then I am engaged in abstraction. Likewise, if I talk about "housing services" without talking about tax deductions, neighborhoods, investment value, shelter, construction material, nails, and splinters, then I am engaged in abstraction.

I would say that the process of abstraction is pretty much constant. The issue is whether or not one is being thoughtful about that process.

This statement reveals fully that you still don't understand. Kling is clearly not saying that these things caused the drop in demand for housing. That you persist in this erroneous interpretation is testament to your ability to follow the discussion. He merely suggests them as possible areas to which consumption may shift. This was already pointed out to you...

First, this is mostly ad hominen attack. Second, to return the ad hominen, if you had the reading comprehension skills that you claim I lack, you would know that I have already addressed this possible meaning and found it lacking. As I have already pointed out, the problem is there is an assumption of increase consumption of SOMETHING other than housing services IN THE FUTURE. Which ignores the possibility of decreased consumption of all goods and services. And also ignore the possibility, that in the FUTURE, consumers will want increased housing services after all.

I will admit that this was not my first interpretation and upon reflection do find your interpretation more plausible. But this only partially matters to my argument. The relevance of my point about faulty choice in abstraction is not well illustrated here. (That point is nonetheless quite valid.) However, the point about assuming that which should be proven still holds.


money in market instead of econ gradschool writes:

Got to laugh. Macro was not the problem and did not fail. Austrians knew the game. And all schools have some relevancy.

It was a politicized US Federal Reserve under Greenspan who owed the Republicans for his existence. He lost papa Bush his 2nd term and had to come through for younger Bush's 2nd term this time. He held the rates too low for too long to make sure, and Bernanke gave him savings glut cover (along with his printing press speech, that is why heli-Ben got appointed in the first place). Come on. Some of Greenspan's comments about housing, ARMS, markets, and such were just cover to keep it going.

No prominent economist will ever criticize the Fed outright because then there would be no hope of getting a position in government later on.

It was the people not the macro economics development. And Greenspan paid his dues to the GOP!

El Presidente writes:

But why should that pathological situation carry over into an economy in which there are real capital investments available?

Because the return on those investments is driven by demand at least as much as supply and demand is a function of income. That's the whole point of Krugman's position; to strike a balance. Saving is hoarding to the extent that the return for investing (the purchase of the incomes of others) does not overcome the perceived risk, and consumption is less efficient when the utility of luxuries is perceived to be greater than the utility of investments. When distribution is polarized, purchasing power is consolidated and average creditworthiness declines, so investment requires higher return to compensate for added risk or to overcome increasing opportunity costs. Absent changes in currency valuation, this is not resolved in any meaningful way by any half-measures short of redistribution. It can be controlled (fiscal policy) or uncontrolled (deflation), but it must happen to restore balance. I know hydraulic is quaint, but it is accurate because of the goal we have chosen: maximizing real output. I'm always open to picking a new goal, but I think I'm in the minority.

When the Fed loses control of the money supply then loses traction in an attempt to reestablish control, there are really only two options left, and only one of them actually works. I am reminded of the idiom, "It's as plain as the nose on your face." The point being, the nose is on _your_ face and it takes _somebody else_ to see it. We're all that way to one degree or another. Until we are comfortable with this, and until we accept that Ricardo's insights on rents were just as important as and integral to his insights on trade, we will continue to lack the balance we need to stand upright and walk out of this mess. We won't find equilibrium with half of a model (supply-side), nor with two thirds (Cobb-Douglas).

If we want to disparage the variety of opinions people have on Keynesian economics as evidence that it's not worth pursuing, we shouldn't spare that criticism when considering Neoclassicals. Getting hung-up on which religion to choose misses the point of having any in the first place: to pursue truth, not to own it. If you don't want to adopt Keynesian religion, fine. Set down the rest of your baggage too. It's harder to walk a straight line with a bag in your right hand but none in your left.

The lesson we take from this should be: don't chase the mastodon into the tar pit; it's really hard to get out. I'm certain we figured that out once, but it's been a while. I'm in Los Angeles, so I have the advantage of being able to review the diagram from time to time.

Steve Cohen writes:

So, Let's see. Economists dismiss common sense. They ignore philosophy, psychology, sociology, history and political science--any of which could have saved them from their silly errors. They don't have the decency to respond to those non-professional economists and social critics who got it right, while they got it wrong. They behave like smarty-pants middle schoolers who are good at math--though not good enough to be real mathematicians. In short, smug, arrogant and wrong. Pathetic. Like so many other authorities in contemporary America.

MD writes:

"I will admit that this was not my first interpretation and upon reflection do find your interpretation more plausible. But this only partially matters to my argument."

Well, if only you were able to display this kind of humility before, instead of so "well endowed with self-confidence", we might have been able to avoid this whole episode.

David Welker writes:

[Comment removed for rudeness, Sep. 4. Followup: On Sep. 5., in two separate emails, Mr. Welker has requested that we do not email him any further, including with regard to the possibility of discussing reinstating him in accord with our offer to discuss matters with him after he overstepped the bounds of EconLog policy. We have welcomed his comments, and we now respect his request. There are several comments that follow that were posted in the interim.--Econlib Ed.]

Drewfus writes:

Booton writes:
"If the financial crises of 2008 was roughly similiar to the stock market crash of 1929 then unemployment should have been heading up to 20% or more with even larger declines in GDP. That appears not to be happening."

Obviously governments and their advisors have benefited greatly from the scare campaign that compared the 2008 crisis to the beggining of the great depression. Almost totally unjustified, in my opinion. The GD occured in an era when large wage deflations were common, exchange rates were fixed, and fiscal and monetary policy was erratic.

However, the tactic of putting the scare of the GD into the publics mind, was a clever manipulation of general expectations. Now almost any outcome looks good. So the government and the fed "saved us from another depression". Don't fall for it. These are politicians, if anyone needs reminding. Of course they exploited the situation.

I asked re the loss of jobs/idle resources:
"Empirically, does there appear to be a choice?"

Boonton replied:
"You might be correct, some suffering is unavoidable hence even with more stimulus we still would have to endure some unemployment. I don't disagree there but what we are talking about here is a narrative of whatever macro theory we think explains what has happened. Krugman's argument is that the neoclassical narrative doesn't seem very convincing."

The question really was a question! There was no implied answer :-)
Speaking of Krugman - same again. So the downturn has now slowed. Must have been that stimulus that Krugman campaigned so strongly for, right? What else could it have been? But again, why compare 2009 to 1930? Why not 1983? It is just too convenient, and ironically, IMO, Friedman's now dominant monetary mistakes/bank failure theory of the GD has paved the way for massive government intervention, most of which he probably wouldn't have favoured.

Boonton writes:

Obviously governments and their advisors have benefited greatly from the scare campaign that compared the 2008 crisis to the beggining of the great depression. Almost totally unjustified, in my opinion. The GD occured in an era when large wage deflations were common, exchange rates were fixed, and fiscal and monetary policy was erratic.

In other words you're carrying Keynes's water. Exchange rates are no longer fixed because the post WWI attempt to return to the gold standard resulted in wage deflations that are no longer acceptable. The attempt by Europe & the US to maintain fixed exchange rates likewise fell apart. 'Fiscal and monetary policy was erratic' is code for 'stimulus was not used as the standard response to severe recessions/depressions'. You're essentially saying its a 'scare campaign' to say we would have had a GD. But you're also saying we aren't having a GD because we have policies today that we didn't during the GD.

So the government and the fed "saved us from another depression". Don't fall for it. These are politicians, if anyone needs reminding. Of course they exploited the situation.

You seem to have a lot of faith in politicians. You seem to think that they knew the unemployment rate was going to go up to 9% so they tell us without various policies it would have been 15%. I think your faith is misplaced, the primary impression I got from both central bank politicians as well as regular ones in 2008 was perplexed confusion over what was happening and what to do about it.

But OK so if these policies were not implemented what would have happened? Are you saying we would have peaked at 7% unemployment? Where's your evidence.

True to assert something worked is to assert a counter-factual. To say that soap and hand washing has saved millions is to assert that if we didn't use soap millions would die from bacterial infections. But to assert something hasn't worked is also to assert a counter-factual. To claim the stimulus is on net bad is to assert things would have or would be better if it wasn't done. You can't tar politicians for asserting a counter-factual as support and then assert one yourself.

Speaking of Krugman - same again. So the downturn has now slowed. Must have been that stimulus that Krugman campaigned so strongly for, right? What else could it have been? But again, why compare 2009 to 1930? Why not 1983?

Well one important difference is that 1983 was an engineered recession to 'squeeze' inflation out of the economy. 2008 appeared to begin with a sudden collapse in asset values followed by a liquidity crises as financial institutions whose balance sheets were heavy in those assets suddenly were faced with short term debt coming due and serious doubt that the market would allow them to turn it over as they had done in the past. This appears to echo a similiar crises financial firms had in 1929 as loans they had made to brokers to purchase stock were suddenly deemed questionable after the stock market crash. (Another echo is the 'open secret' of the bubble prior. Throughout the 2000's people were chattering about the 'housing bubble' as it continued to expand. Likewise, the 20's were dominated with talk about the 'stock market bubble' and whether the Fed should try to pop it....granted you never step in the same river twice, 1929 is not exactly 2008 but there does seem to be a good argument for considering it a model....a better argument than, say the early 1980's).

Drewfus writes:

David Welker writes:
"A final point. You appear to think that my discussion of abstraction is a waste of time. That it is all about dueling abstractions. After all, we are stuck with abstraction, if only to enable efficient communication if nothing else. You are missing the point. I am not saying, in a very abstract way, that one abstraction is always superior to another. Instead, I am saying that one really needs to put more thought into what abstractions one uses. Economists in particular tend to gravitate towards particular abstractions without much thought. This is unfortunate, because it seriously biases the conversation and needs to a systematic neglect of certain important topics."

I admit that i cannot comprehend why the changing patterns of demand are likely to be misundertood by abstracting housing and housing related goods and services into a more abstract category. What is the is problem? Too much congnitive load?

As i see it, the difficulty in understanding the changing patterns of demand is partly due to incomplete theories of demand at the micro level. There is a conflation of 'demand' with 'desirability'. Now which of those terms is synonymous with 'utility'?

The utility concept as the sole explanation for demand overlooks finance issues like debt, borrowing capacity, investment quality and strategy, lending standards, etc. Notional constraints and real constraints, but not budget constraints.

So the shift away from housing and associated markets to other sectors, represents not *only* a change in utility functions for housing services (abstracted or not) vis-a-vie other stuff like health services, but the consequence of numerous other financial factors unrelated to changing desires. The bottom line is that 'utility' as a concept underlying demand functions is EBNE - Excellent But Not Enough.

Microeconomics has developed ideas about substitute and complimentary goods, that is, how the demand for some goods is affected by the demand for certain others. That is fine. However there does not seem to be any concept of consumption as a structured activity. For example, the demand for lounges is surely highly dependent on the demand for housing, but one wouldn't say the reverse is true. A lounge compliments a house, but does a house compliment a lounge?

Micro seems to treat consumption as a series of choices from a smorgasboard - a flat landscape where goods and services can relate one-to-one, but not one-to-many or many-to-many. There is choice but no depth to the purchasing decisions. But real world demand is 'structured', just as the supply-side of the economy is.

Additionally to substitute and complimentary goods, there are also what i would describe as 'host goods' or 'prerequisite goods' - goods that act as containers for other goods. Demand flows one-way, rather than two-way as for complimentary goods. It's a derived demand.

Obviously housing would be the best example of this, but so would for example, computers, as they relate to software, although software titles could see changes in demand unrelated to hardware sales, so hardware-software might be somewhere in between 'host' and 'complimentary' status.

Drewfus writes:

Boonton,
i am not really interested in discussing the current situation from a Keynesian perspective. As far as i'm concerned, Keynes was simply another of the cranks that the depression made popular, albiet a sophisticated one, who unfortunately got very lucky.

In dismissing Keynes, it is sufficient in my view to point out that neither i, nor anyone i know, nor anyone i have heard of has found it necessary to purchase a safe deposit box over the period of the ZIRP, on the basis that interest rates have not been sufficiently enticing to persuade them to continue to "part with their liquidity".

Given that the whole Keynesian apparatus rests on the absurd 'liquidity preference' theory of interest rates, i simply do not believe that Keynesian thinking is relevant. Not now, not ever.

Boonton writes:

Ohhh ok, well if each of us gets to simply declare a theory invalid then I should get a turn too. I'd like to declare Maxwell's equations for magnetism invalid. Kindly adjust your life accordingly.

Boonton writes:

Drewfus,

I'm sorry if I'm curt but you asked two questions of substance:

1. How do we know the claims we were heading into another GD were overblown?

2. Why is 1983 not a better model for this recession than 1929?

My response to both questions might be shaped by a Keynesian perspective but I think they are applicable no matter what your POV.

To #1 the answer is we don't just was we can't know if claims that things would have been better or just about the same if various policies were not done is true. Theory may give us tools to argue the question but it is probably going to remain an argument.

To #2 numerous important facts have been listed that show a similarity to 1929 but not to 1983. You are free to show that other facts should also be considered to challenge that similarity or show 2008 looks more like 1983 but simply declare Keynesian discussion is off limits does not advance an argument.

Drewfus writes:

1929-33 is commonly regarded as the period of the Great Depression. My PoV is that financial year 1929-30 was a recession, and was due to a credit boom going bust and quite similar therefore to 2008-9. Financial years 1930-33 were a depression, and this was due to something else entirely.

Now there was a recent posting and debate over at The Austrian Economists blog about the impact of nominal wage cuts on the depression economy;

http://austrianeconomists.typepad.com/weblog/2009/08/hoover-and-the-great-depression-redux.html

It's an interesting read. Again my PoV is that it seems to be more than just a coincidence that all the pre-WW2 depressions were accompanied by large and general wage deflations. In the U.S. i believe that in the 1930-32 period, the manufacturing wage was cut by over 20%, and the non-manufacturing wage (mostly farming i guess) was cut by around 40%.

So simply, why is the current recession not like the depression? Because its only like (in some ways) the recession that directly proceeded the depression - it is not like the depression because since WW2 we have had much greater resistance to wage cuts - wages are much 'stickier' downward. This prevents the vicious cycle of declining aggregate demand and rising real debts, from occuring. So far at least!

Remember that the firm is a goal driven entity. The primary goal is a specific rate of return on investment. If this rate of returned can be maintained during an economic downturn by obtaining reductions in wages, then the goal of the firm is maintained. Disequilbrium - wrt its rate of return target - becomes equilibrium. Problem is, if every firm acts in the same manner there is a negative impact on aggregate demand.

Btw, this is why the policy of recapitalizing banks is daft. They are out of equilibrium before TARP and whatever else was done for them, then after these policies are activated the equilibrium is restored. Therefore no tendency to change/move. Therefore no extra lending. Therefore recession continues.

One always has to look at economics issues from the PoV of the firm.

Ignacio writes:

I read Professor's Krugman piece and, even though I am not an economist, I have a few questions.

Was Prof. Krugman arguing against a strawman in his description of neoclassical economists? It appeared that every time he described any of the positions of neoclassic economists, he described the most extreme version (e.g., strong form of ECMH) even when, as far as I understand, no serious thinker defends such positions.

Another issue is that, as valid as his criticisms may be, what is Professor Krugman offering? I mean, we do not normally discard a theory because it is imperfect; we discard it when we find a theory that provides a better explanation. As imperfect as neoclassical economics is, does Keynesianism offer a better solution?

Finally, Prof. Krugman describes how the market got it wrong and therefore how we should not believe it to be infallible. So, according to him, who should we trust instead? Should we turn into a command economy? Or should we empower the government to intervene when they detect a bubble? It appears to me that this may be too risky; as far as I know, it continues to be true that economists have successfully predicted 6 of the past 3 recessions.

Boonton writes:

Drewfus

It's an interesting read. Again my PoV is that it seems to be more than just a coincidence that all the pre-WW2 depressions were accompanied by large and general wage deflations. In the U.S. i believe that in the 1930-32 period, the manufacturing wage was cut by over 20%, and the non-manufacturing wage (mostly farming i guess) was cut by around 40%.

I think you're overlooking the role the Gold Standard played here from about 1870 until the end of the 20's. Britain, for example, was willing to maintain high interest rates during a period of 20% unemployment just to preserve their gold reserves and keep the pound from becomming delinked to gold. Labor did not have the vote that it did post the GD. Even in the US, its dedication to the Gold Standard was in doubt due to the populist silver movement. Our forefathers were willing to force prices and wages to adjust in the system for the same reason they were willing to fight massive wars where drafted men by the tens of thousands were killed....because they weren't really democratically accountable.

At the beginning of the GD, though, countries did try to maintain the gold standard for as long as they could but what worked in the old days stopped working. Before when a country's gold fell, speculators assumed it would be brought back into balance and purchased its currency. In the late 20's, when a country's reserves fell speculators assumed it was only a matter of time before devaluation was unavoidable. They sold the currency in exchange for gold thereby making it harder and harder to maintain the standard.

Pre-1870 I have a hypothesis and you can tell me what you think of it..... I think the large portion of the population employed in agriculture makes the economic statistics and theories unworkable when comparing to a modern age. Agriculture provides, IMO, more opportunities to 'check out' of the formal capitalist system and work in barter (a chicken for a doctor's visit, labor in exchange for room and board). When depressions hit it was easier for wages to drop because the population had more opportunities to 'check out' of urban life and return to the 'off the books' agricultural economy.

Of course economic theory still applies. But half or more than half the picture is hidden from us. We can see wage income falling but we can't track 'off the books' transactions. In other words, I suspect when you look at GNP of 1920, 1940, 1990 etc. you are seeing a pretty good picture of the economy at that point in history. When you look at estimates of GNP for, say, 1840, you are looking only at a minority of the economic activity that is happening. It's more like looking at an industrial sector today.

After the Civil War, agriculture was still important but the world of finance won out. Even if lots of 'off the books transactions still happened, farmers became dependent on the formal economy. Money and accounts were needed to handle mortgages for land and seasonal loans for seed and fertilizer. Futures markets likewise connected the economy of the ground with the economy of the steel mill. The man who once worked in the factory couldn't just return home to work in the fields for a bit. Factory work was too involved and agricultural skills were lost. Likewise the farmer couldn't just work with cows and pigs but had a mortgage note to worry about.

Drewfus writes:

Make that *two* major differences between now and then!

I will have to brush up on the history before i comment fully, but some thoughts...

"Britain, for example, was willing to maintain high interest rates during a period of 20% unemployment just to preserve their gold reserves and keep the pound from becomming delinked to gold."

The British Great Depression was really 1920-33. During this time Keynes' became more and more desperate that the authorities 'do something', in contrast to the 'treasury view' (as understood). My guess is that lead him to more and more radical and elaborate ideas, in an attempt to get his point through, with plenty of help from his Cambridge friends. In the end i think it all went way too far.

But whatever, between a credit boom and the gold standard and wage deflation, i reckon we can work out the GD without him! What do you think?

"At the beginning of the GD, though, countries did try to maintain the gold standard for as long as they could but what worked in the old days stopped working. Before when a country's gold fell, speculators assumed it would be brought back into balance and purchased its currency. In the late 20's, when a country's reserves fell speculators assumed it was only a matter of time before devaluation was unavoidable. They sold the currency in exchange for gold thereby making it harder and harder to maintain the standard."

They can't all be struggling with reserves and wanting to deflate at the same time.

"When depressions hit it was easier for wages to drop because the population had more opportunities to 'check out' of urban life and return to the 'off the books' agricultural economy."

No doubt the informal/black economy was much more significant back then. Yes. But this would presumably be a reason for believing that wage cuts might have been even greater than historical records suggest, and therefore gives even more support to the wage deflation theory.

Boonton writes:

But we don't really know if they had wage cuts. The informal economy today (we can't call that part of the economy 'black' because back then it wasn't illegal) usually works with money. If I make $20K a year under the table that can still be estimated and put into GDP calculations (granted capturing it is a challenge for econometrics).

But if I work 'for room and board' capturing that can't be done unless you reduce that to a dollar figure. But if a huge portion of people are doing this then how do you convert that do a dollar figure. Simply looking at the price of food and lodging isn't very helpful. Those prices are for those people who are using cash (such as tourists traveling).

What this means is that what seems to be a wage deflation during some periods in the 1800's might have just been a decline in wages in one particular sector of the economy. For all we know wages in the other sector might have been rising or steady.

My hypothesis is that what used to be a minority sector of the economy, the formal money using sector, has grown so large that it has dominated what we measure as the economy.

Boonton writes:

The British Great Depression was really 1920-33. During this time Keynes' became more and more desperate that the authorities 'do something', in contrast to the 'treasury view' (as understood). My guess is that lead him to more and more radical and elaborate ideas, in an attempt to get his point through, with plenty of help from his Cambridge friends. In the end i think it all went way too far.

Actually Keynes's views at this time were hardly all that radical. The UK wanted to return to the pre-WWI gold standard exchange rates. Pre-WWI the UK dominated trade and finance. WWI damaged that, in addition other countries were becoming more powerful in the world of trade and finance. For example, if the UK provided capital (via loans) to the 'developing world', it would loose gold. But since the UK was also a provider of capital, it would bring the gold back. {The example I've read is imagine a loan to develop a port. The country would buy cranes, well who was a leading provider of cranes, why UK based companies} In this way the 'gold standard' had a lot of cushioning to keep it from hurting. The war broke the system, though. The US ended up with a huge share of gold. France, because it choose to go back to the gold standard at a lower rate, ended up with surging exports that collected a lot of the remaining gold. The insistance by France that Germany pay reparations coupled with the US's demand that the allies pay back their loans from the US made it impossible to work out a sensible return to the old system.

The UK wanted to restore prices and exchange rates to the pre-WWI levels. Keynes felt the pound needed to be devalued. The 20's were wasted for the UK trying to squeeze prices and wages down just a bit more to achieve its goal. There was very little that was radical here, even Churchill admitted in the end that Keynes was right and the gold worshippers had lead him in the wrong direction.

I will have to brush up on the history before i comment fully, but some thoughts...

Two books I've gone through on the topic are Lords of Finance which is a new book that made a splash a while ago. The other is Globalizing Capital by Barry Eichengreen which I got from going through Brad De Long's Amazon.com recommendations (I wanted to hit the library for the holiday and needed some ideas). I think 1900-1932 or so is a very fascinating era of history that has been overlooked because of the attention WWII gets.

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