Bryan Caplan  

Rebranding Additive Shocks

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A year ago, I wrote a little-known post called "Additive Shocks."  A week ago, Sumner made my point with more panache:

...I don't know about you, but I don't recall reading; "Severe AD shocks are really, really bad, except when the economy is also suffering from some other structural problem.  Then they're just dandy!"

As an analogy, suppose you had pneumonia, and then someone stabbed you in the gut.  You show up at the hospital, and the doctor says "there's no need to patch up that knife wound, your real problem is pneumonia."  I think you'd look for another doctor.  A severe AD shock causes lots of unemployment; that's true whether you start from full employment, or whether you already have lots of unemployment from structural problems.

So when economists react to the sharpest fall in NGDP since 1938 by announcing that the economy really needs tighter money, I'm inclined to react as if a doctor ordered leeches for someone already bleeding from a knife wound.  I'm going to look for another economist.
I wonder if Arnold would like to suggest an alternate medical analogy.


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COMMENTS (6 to date)
Charles R. Williams writes:

The patient has diarrhea and vomiting. it is essential to keep the patient hydrated. it is counter-productive to force-feed eggs, sausages, raisin bran and coffee to maintain caloric intake.

A policy of force-feeding money to keep AD on track can have damaging side effects as it did during the run up in housing. Will it speed the structural adjustments for the fed to create more money? Maybe and maybe not.

fundamentalist writes:

The correct analogy needs to show some kind of failure to diagnose the problem. A "shock" is not a diagnosis of a problem. That would be like someone feeling really bad, going to a doctor and the doctor says, "yep, you have a severe shock to your system. Let's give you chemo-therapy and massive doses of radiation."

Before you prescribe a remedy, you should diagnose the problem correctly. Just saying there was an AD shock is not enough. What caused the shock? If we know what caused the shock we can know how to treat it.

andy writes:

"So when economists react to the sharpest fall in NGDP since 1938 by announcing that the economy really needs tighter money, I'm inclined to react as if a doctor ordered leeches for someone already bleeding from a knife wound. I'm going to look for another economist."

Assuming these things are linear. They are NOT. I.e. if you do too much 'easing', you'll get hyperinflation. Which is arguably ordering leeches for an already bleeding patient..

The question is: where is the equilibrium? Will we move towards equilibrium or out of equilibrium by tightening money?

I still consider the AD story pretty stupid; it boils down to: (1) people stopped spending money (i.e. we got negative AD shock).. (which isn't even true, consumption is actually quite stable in recessions...whatever).. which caused recession. (2) Therefore if the state starts spending money instead, the problem will be solved.

Now even if I concede point (1) is 'negative' for the economy (as opposed to shooting the messenger, as the Austrians would argue), point (2) absolutely doesn't follow.

Steve Miller writes:

I think critics of that view could say the question is not whether you ignore one problem or another but whether you use steroids or antibiotics to treat a patient. Do you help the immune system or suppress it? It depends on the illness, so proper diagnosis is very important. The anti-stimulus, anti-inflation argument is that you're proposing giving more steroids to an infected patient, and what's needed is to allow that patient's immune system to work. It's important if you hold this view that you believe markets really do have some sort of supply-and-demand self-correcting properties. Those who don't believe markets are self-correcting will naturally assume that either the patient is having an allergic reaction or will die anyway, and dose up the steroids.

RPLong writes:

That's the first I've seen Caplan's additive shocks post. My knee-jerk reaction is to point out that if Sumner is in charge of the Fed, then the mud pie industry probably sprung up as a result of the perpetual 5% money supply increase.

When people get coerced into spending their hard-earned money, they will even invest in mud pies, so long as mud pies yield a bigger investment than (-5%). In truth, we would never have produced mud pies in the first place, had our central bankers presented us with any option other than "spend now or lose 5% every year, forever."

Bob Layson writes:

The first shock was the shock of finding that a great deal of ongoing investment (much in housing) was malinvestment. Since there is no gain in reinforcing failure entrepreneurs chose to abandon such projects and lay workers off.

The second shock was to the investors in such malinvesments and/or those who gave them loans.
Then falling asset prices and marking-to-market led to a rush to get liquid and a further collapse in prices.

Finally, to top it all, the politicos said 'we have to stop a financial meltdown' and 'the fundamentals of the real economy are fine' whilst engaging in the most dramatic and unprecedented interventions. This so spooked those whose jobs were safe that discretionary spending collapsed and savings shot up. This in turn produced redundency in jobs now unsafe.

The recession did not occur because consumers stopped spending but because some investors had to stop paying workers and suppliers.

As for recovery, Say's law tells us that increased demand is increased supply and supplies will increase when redundent assets are priced to return, in a new position, to prospectively profitable production. The statesman can however much prolong this necessary process by regulation, taxation, monetary meddling and paying the redundent to sit tight and wait for the recovery that state spending will bring.

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