Bryan Caplan  

Question for Recalculationists, Round 3

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Unless I've unfairly overlooked someone, it looks like no recalculationist answered my original question - namely, "By what percentage do real GDP and employment fall if nominal GDP unexpectedly declines by 5%?"  Arnold comes the closest.
In this example, I would have to say that a standard monetarist-Keynesian synthesis gives the correct answer.
Yes, the standard monetarist-Keynesian synthesis might have a standard range of responses.  However, I'm asking recalculationists to answer my question with the specific number they believe to be true.  Who will indulge me?


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COMMENTS (13 to date)
Gu Si Fang writes:

Easy! 3.787%

Vasile writes:

Brian, I'll rather argue, that is does not really matter.

Real GDP, nominal GDP are just proxies used to approximate general welfare.

GDP measures spending, and if due to a change in consumers preferences, be it too much debt or just an asceticism infatuation spending will fall than GDP will fall as well.

But that's OK, because consumers right now are considering that too much spending is bad for them.

Bill Woolsey writes:

Vasile:

Your argument is incoherent.

Too much debt? Too much spending?

You must be kidding.

If less production is the solution, then the problem _must_ be too many consumer goods and services, either now or in the future, and too little leisure (too much labor.) The proper response reduces the production of consumer goods and services and/or capital goods now, and expands the enjoyment of leisure. Less real GDP.

It is possible to have too little current consumption and too much future consumption. This would lead to increased demand for consumer goods and services today, and less demand in the future, and so less investment--spending on capital goods. Total production may fall if there is too little productive capacity for consumer goods today. In the long run, production will fall compared to what it would have been because of the decrease in the production of capital goods. But not now--except problems with the composition of productive capacity. This is a sort of "recalculation," but that is a poor word. It is what we call strucutural unemployment.

Too much debt? You ignore the creditors. If people borrow less, what do those who would have lent do with the money? If people repay debt, what do those who receive the repayments do with the money? If people go bankrupt, those who would have been paying on the debts don't. What do they do with the money?

Always with these stories that suggest less spending is "optimal" (or a problem, for that matter) that focus on saving, investment, or debt, there is an imbalance between the quantity of money and the demand to hold it in the background.

Too much spending? Spending is just a means to allocate resources. The problems must be as described above.

All of these stories are in the end about monetary disequilibrium. Less spending is about accumulating more money.

You assume that producing less somehow allows everyone to accumulate more money. That is what it comes down to. And it doesn't.

The fundamental proposition of monetary theory (which Caplan described a few months ago) is that the individual can accumulate money by cutting expenditures. But we cannot all do that at once. Either the price level falls so the real quantity of money rises, or the nominal quantity of money needs to rise.

If, instead, production falls, this is just a disruption of the production process, and it makes people poorer until they are satisfied with the existing quantity of money. The contraint of money is preventing people from optimally allocating between leisure and the production and consumpton of consumer goods and services now and in the future.

Yes, a shortage of money that leads to less production does provide for more leisure. Also, capital goods wear out less. But that isn't the intention. Reduced production is never an optimal response to too much saving, too much debt, or too little money.

Robinson Crusoe wants to be more liquid. Or he wants to deleverage. So he takes a nap. Explain that. If you cannot, then there is no way that the proper market response to excessive debt or an increaced demand to hold money is going to be to take time off.


Tyler Cowen writes:

It depends how much of the original change was caused by...recalculation. That is obvious, no?

q writes:

it depends on how many of the people aiding the recalculation of the economy lost their jobs because their employers were highly levered or took liquidity risk with short term funding instruments.

Carl The EconGuy writes:

How many sick days will an average person have if his/her temperature suddenly rises to 104 degrees?

Depends on what caused the rise, don't you think?

So don't go looking for a statistically significant correlation there across a large population, it's not likely to be meaningful. Instead, why not try for a more sensible diagnosis of the illness in each case? That way intervention can be tailored more meaningfully.

Ryan Vann writes:

Carl,

I think your question fairly portrays why the original question is a bit silly. Anyway, I'll make a tl;dr worthy post in a bit which partially takes your view into consideration.

fundamentalist writes:

It also depends on the ratio of gdp to ngdp. If they were identical, that is, no price inflation, then gdp might fall the full 5% in the very short run. If there was a lot if price inflation, say 10%, then gdp might not fall at all.

Ryan Vann writes:

I'm hesitant to say there is some formula that necessarily tells you exactly the numeric effect a 5% nominal drop will have. Seems to me, a 5% nominal drop is not the catalyst, but the result of certain conditions. Besides, if human activity could be narrowed down to such fine measurements and predictability, we probably would never see 5% drops in nominal GDP to begin with.

However, I'm sure someone could dredge up some historical relationships, and extrapolate from there.

Per usual, I'm not really sure if I understand what Mr. Woolsey is saying. If one sees the recession as a result of consumers cutting back on spending (primarily debt financed spending) one of two things likely happened, obligations reached a level whereby payments of debt neared or overtook income, or expectations of future earnings were reduced..

In the first scenario, there are a few things consumers are doing; they are trying to pay down debt, earn higher wages (perhaps returning to school) or flat out going through bankruptcy. All three solutions require a recalculation on both the firm and individual level. In the second scenario, there is really only one way to solve the underlying issue, and that is to invest in human capital (ie go back to school) this of course means tightening belts and reinforcing savings. In that regard, I do agree with Mr. Woolsey that the issue is primarily one of money, but that lack of money was a result of either insufficient human investment, or bad financial planning. In either case, recalculation is necessary, unless we assume extraneous events.

By extraneous events I euphemistically mean government action. It is entirely possible that the government could simply pay off debt obligations, thereby increasing consumer cash flows. Of course, this just transfers debt obligations from the private sector to the public sector, it also wouldn’t address the scenario of decreased expectations of future earnings. Individuals would still have to get training and reduce work hours in that scenario. A recalculation would still need to take place.

Lastly, there is the option of just waiting for prices to adjust (unfortunately debt obligations legally can not adjust, which means individuals still have to cope with budgetary constraints).

fundamentalist writes:

Suppose ngdp fell by 10% because the guv passed a law requiring all businesses, banks, etc. to move the decimal in all accounting systems one place to the left. Obviously, the monetary value of ngdp and gdp would fall by 10%, but would actual wealth fall? Not at all. Thus the illusion of money. Economics needs to focus less on gdp or ngdp and more on output per capita, which is a measure of wealth.

Greg Ransom writes:

Any non-incompetent economist would rightly say that the answer to your question is unknowable.

Only fake "scientists" would pretend that the answer to such a questions is knowable.

And note well.

Your question asks the relation between two socially constructed "measures" -- both of them measured using both "rubber" and imaginary yardsticks that don't exit in the real world and both of them measuring "stuff" that has no physically or materially fixed dimensions across time.

Vasile writes:

Bill Woolsey;

Your argument is incoherent. Too much debt? Too much spending? You must be kidding.

Well, no. It's your interpreation of my argument which is incoherent and over-assuming. Here's what I said: "But that's OK, because consumers right now are considering that too much spending is bad for them." Emphasis added.

Right now, people, prefer (to as greater degree) to hoard money instead of spending it. So prices as well as production of goods need to adapt to that change.

If less production is the solution ....

Well less houses seem to be a part of solution, and not because we cannot use more houses in abstracto, but because at the current prices houses cannot be produced with a profit.

So, it is not about less production, it's about the incapacity of economy to produce stuff which consumers are willing and ready to buy, about the need of production (and prices) to adapt to a change in consumer preferences which have chosen to delay some of their consumption to a future date.


Too much debt? You ignore the creditors. If people borrow less, what do those who would have lent do with the money?

Well, since the creditors are mostly the banks, why ask?


You assume that producing less somehow allows everyone to accumulate more money. That is what it comes down to.

You assume, that I assume that producing less... Well, you're wrong. Producing less will not do the trick, but falling prices can increase real money balances to a degree when people will stop freaking about their future, and the value of present consumption will rise again.

Are if you are assuming that printing money to buy goods which otherwise would stay unproduced is increasing general welfare... just say so.


If, instead, production falls, this is just a disruption of the production process, and it makes people poorer until they are satisfied with the existing quantity of money. The contraint of money is preventing people from optimally allocating between leisure and the production and consumption of consumer goods and services now and in the future.

Fallacy of aggregation (over production) reigns supreme in your analysis, dude. Some of those businesses need to fall. Continuation of some kind of production will make people poorer. Production of stuff which cannot be realized with a profit (without, I guess, a radical increase in the quantity of money) had already made people poorer. Well, no need to go into specifics. Production of stuff people do not want to buy (no matter for what reasons) had made people poorer. As well as production of stuff for producing stuff which people do not want to buy.

(And as matter of fact, a lot of those businesses fall even before the consumer preferences changes and are the primary cause of that newly found frugality.)


Robinson Crusoe wants to be more liquid. Or he wants to deleverage. So he takes a nap. Explain that. If you cannot, then there is no way that the proper market response to excessive debt or an increased demand to hold money is going to be to take time off.

Mr. Wooolsey, At some point, I may start collecting your red herrings.

There's absolutely no need for Robinson Crusoe to go more liquid, or to deleverage. But there may be a need for him reduce spending (more specifically, eating), either because of past entrepreneurial errors, foolish feasts with parrots, or just bad luck.

Norman writes:

Wait, are you challenging the recalculationists to come up with an econometric point estimate using zero data points? Or to do a DSGE simulation without a meaningful specification of the shocks beyond "people irrationally panic," which may or may not even be a coherent shock in their model? Come on, Bryan. We expect incoherent challenges from the likes of Paul Krugman, not you.

If you insist that your question is answerable, why don't you start by giving us the Sumnerian point estimate, or the Keynesian point estimate, or your own point estimate? With explanations, of course.

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