Scott Sumner  

Economics is symmetrical

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Many economic models are symmetrical. If higher business costs lead to higher prices, then lower business costs lead to lower prices. Thus if higher raw tobacco prices lead to higher cigarette prices, then lower tobacco prices lead to lower cigarette prices. This simple concept actually confuses students. They get the part about higher prices, but are skeptical that firms will lower prices to consumers just because costs fall. They think firms are selfish. What they don't get is that firms will lower prices precisely because they are selfish.

I think it's helpful to think in terms of specific numbers, not higher and lower. Thus consider the profit-maximizing price for cigarettes if:

1. Tobacco costs $10/pound P = _______
2. Tobacco costs $12/pound P = _______

Now consider the prices that would be written into each blank space. Which one is higher? That's it. Just asking the question this way pretty much suggests the model is symmetric.

Some people accept the fact that the Fed offset the recent fiscal austerity in 2013. After all, Paul Krugman suggested 2013 was a test of monetary offset, and GDP growth sped up significantly in 2013 (using Q4 to Q4 data.) Furthermore, Fed officials cited the need to offset fiscal austerity when they adopted in more aggressive forward guidance and QE3. I'm continually surprised, however, by the fact that some commenters see the relationship as being asymmetrical. They say that tighter fiscal policy will lead to easy monetary policy, but not vice versa. I suppose anything is possible, but the Fed would have to have a truly bizarre objective function to behave in such a fashion. Here's Matt O'Brien:

Government spending, though, can flood the economy with money, raising prices in the process. So the Fed, in turn, would either raise rates to offset this spending it doesn't want, or wouldn't cut rates like it otherwise would have.

Either way, the Fed's actions would keep the economy from being any bigger with more government spending than it would be without it.

But this calculus changes when there's a recession, especially if interest rates are at zero. In that case, the Fed wouldn't want to neutralize stimulus spending. So GDP would grow at least as much as spending does -- what economists call a multiplier of one -- and maybe more since there could be spillover effects.

I wonder if people get confused by the language. O'Brien says the Fed "wouldn't want to neutralize stimulus spending." OK, but if there was no fiscal stimulus would the Fed do more? If not, why not?

I think people also get confused by the concept of a "neutral" monetary policy, where the Fed is "doing nothing." Then from the neutral position the Fed can "do something," like expansionary and contractionary policy. The same confusion applies to fiscal policy. In fact, there is no benchmark, just more or less expansionary/contractionary fiscal policies. And if tighter fiscal makes the Fed do more, then refraining from tighter fiscal (i.e. stimulus) will make them do less than otherwise.

R.D. over at Free Exchange gets the nuances exactly right:

Here it would be prudent to mix in a bit of realistic policy. Take the euro area. Inflation is just 0.3% and the area is already awash with unemployed workers. Add to that the fact that France is missing its deficit target but--as Charlemagne reports this week--will come under pressure to put that right quickly. This means austerity. Italy, at risk of a sovereign downgrade, will feel it too. Finally add a bit of political economy. Suppose that France and Italy use political capital getting some breathing space for fiscal policy, and end up being profligate in the eyes of Germany and the Netherlands. That puts the hawkish German and Dutch view in the ascendancy when it comes to monetary policy. You end up with both fiscal and monetary policy being relatively tight.
As the fiscal authorities do more, the ECB will do less. However the opposite is not true, a change to a more expansionary monetary policy will not be offset by fiscal austerity. That's why only the ECB can generate faster nominal GDP growth in Europe.

Is there any other way to generate growth in the eurozone? I suppose they could make Martin Feldstein dictator of Europe. Let him work his supply-side magic. But that's perhaps even less likely than the ECB finally seeing the light.

In the US it's not at all clear that fiscal and monetary policymakers even agree on the goals of policy. Just a few months ago the Obama administration argued that the unemployment crisis was so severe that we needed an emergency unemployment insurance program that extended benefits to 73 weeks, far more than during the worst of the previous recessions. At the Fed however, things are quite different. Here's James Bullard, a moderate who is considered a swing voter:

In his comments to reporters, Mr. Bullard said "I think there's a risk" in holding off on rate hikes until the middle of the year. "We should act on good news. We've got a pretty good performing economy. We should be willing to remove some accommodation," and it would be better to get this process started and not wait too long, he said.
The debate is over whether to raise rates in the spring or the summer, not whether to raise them at all. (And recall that a promise to tighten next year means policy is tightened right now--the expectations channel.) A "pretty good economy" doesn't need an emergency unemployment insurance program. It's not just that Obama and the Fed aren't on the same page; they aren't even in the same library. The Fed would never sabotage fiscal stimulus? Sure, they'd never say they were doing so. They'd probably never believe they were doing so. But yes, they most certainly would do so, as we saw in 2009.

HT: TravisV

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COMMENTS (27 to date)
Shane L writes:

Here in Ireland we are seemingly experiencing rather fast economic growth again, average estimates are for around 5% GDP/GNP growth this year. Unemployment is still high but it has been coming down steadily and property prices are beginning to rise - quickly - once more. With much of the rest of the Eurozone seeming to sputter there's some concern that Ireland is actually experiencing a risky rush of cheap credit. (Ireland's economy is quite exposed to Britain and USA, with their respective monetary policies, as well as the Eurozone.) There is fear that the ECB will base its policies on the stagnant big continental economies, making them inappropriate for a quick-growing peripheral Ireland and possibly leading to another boom and bust.

I'm not an economist and I struggle to understand monetary policy but I'd be curious to hear what Scott or others think about it.

Robert Simmons writes:

Perhaps instead of saying the Fed offsets stimulus it would be better to say stimulus pre-empts the Fed? Maybe that would get the idea across?

Ken from Ohio writes:

A couple of quibbles

Lower production costs result in lower end product price only when there is market competition. Otherwise, the producer keeps the price the same and simply enjoys higher profits.

Second, the ECB is constrained by specific Eurozone rules that prevent its ability to do QE style monetary easing. For instance the ECB is forbidden from functioning as a bailout mechanism for the purchase of sovereign debt. And so even though the ECB as an institution may see the light it is politically and legally restrained in terms of the actions it can take.

Scott Sumner writes:

Shane, It would be a big mistake to rely on monetary policy to address problems of excessive debt. Instead, that should be addressed though improved financial system regulation. Of course Ireland made a huge mistake in bailing out its big banks (or if you prefer foreign countries made a big mistake in forcing Ireland to bail out these banks.) That action made their financial system more unstable in the long run, as it encourages more risk taking.

Robert, Perhaps, but I like the term "offset," as it implies neutralize.

Ken, I think they can do QE under current rules, but even if I am wrong they have far more powerful tools that they can use.

I'm afraid you are wrong about production costs. When marginal production costs rise (like my tobacco example) even a monopoly producer will want to raise prices. The only case where production cost would not affect price is if fixed costs rose for a monopoly supplier.

Ken from Ohio writes:

A little more on the ECB

The Eurozone rules governing the ECB, compel it to follow a single mandate-inflation targeting. This single mandate was created within the context that the Eurozone is an OCA (optimal currency area) such that a single monetary policy serves the needs of the entire area.

The Eurozone inflation rate of 0.3% is within the inflation target requirements of the ECB. And this low inflation may serve prosperous countries like Germany just fine. But countries like Italy and Spain need monetary expansion.

So which country does the ECB accommodate?

To me, this dilemma illustrates the failure of the OCA concept as applied to the Eurozone, and also demonstrates how the ECB is politically and legally restrained from pursuing an aggressive policy of monetary expansion

Ken from Ohio writes:

Another quibble on ths issue of production costs.

I concur that a monopoly producer would raise its product price when face with higher production costs. It would be less aggressive about raising its price if the production cost was limited to a fixed ( as opposed to a marginal) cost.

The question is if the monopoly producer would lower its price when faced with lower (either fixed or marginal) production costs. I think not.

But then again. I could be wrong. Standard Oil lowered its kerosene price even though it was essentially a kerosene monopoly

TheATeam writes:
I concur that a monopoly producer would raise its product price when face with higher production costs. It would be less aggressive about raising its price if the production cost was limited to a fixed ( as opposed to a marginal) cost.

The question is if the monopoly producer would lower its price when faced with lower (either fixed or marginal) production costs. I think not.

Ken from Ohio, you seem to have completely missed the point of Scott's tobacco example. If you can articulate why a profit-maximizing, monopolist cigarette manufacturer raises its prices when the cost of tobacco rises from $10 to $12/lb, it should be obvious why that same profit-maximizing, monopolist must lower its cigarette prices if the cost of tobacco falls back to $10/lb.

Marcus Nunes writes:

Scott, Long ago Krugman was a monetarist:
"To me, at least, the idea that changes in demand will normally be offset by Fed policy–so that they will, on average, have no effect on employment–seems both simple and entirely reasonable."

Scott Sumner writes:

Ken, You are wrong in claiming that 0.3% inflation is within their target range. It isn't. However that does point to a problem---the target range is very poorly defined.

The inflation rates in individual countries don't matter.

I think you missed the whole point on the symmetry discussion.

Kevin Erdmann writes:

Scott, you're giving a large concession by allowing that extended UI is even stimulative, especially now. Obama doesn't even know where the library is.

Shane, I think it's important to avoid thinking of debt as consumer debt, which is a small portion of total debt. Most debt involves trading risk exposure among asset owners. So, increasing debt might be a sign of more owners avoiding marginal volatility in asset cash flows. This might still be a signal of coming problems, but this would be because asset traders have foresight. A flattening yield curve would describe this sort of sentiment. But, to the extent that debt is increasing in real estate (would that it were in the us) this almost certainly is a return to a functional equilibrium.

Andrew_FL writes:

Scott, you're arguing that economic theories/models should be symmetrical with people who believe that prices are more sticky downward than upward. Do you see why it's obvious they aren't going to think you have a profound point?

ed writes:

"We test and confirm that retail gasoline prices respond more quickly to increases than to decreases in crude oil prices."

Do Gasoline Prices Respond Asymmetrically to Crude Oil Price Changes?
Severin Borenstein, A. Colin Cameron and Richard Gilbert
The Quarterly Journal of Economics
Vol. 112, No. 1 (Feb., 1997)

ed writes:

To expand on my previous comment: If we can find asymmetry in price responses in the retail market for gasoline, a market with a single undifferentiated product and a simple linear price that is POSTED IN GIANT NUMBERS right in front of the retail establishment, we should probably expect that there are even larger asymmetries in other, more opaque markets. I think your students may actually be on to something.

KD writes:


Despite being a regular lurker, I'm afraid none of Scott's (nor Brian's nor David's nor Art's!) wisdom has permeated my dense skull:

Ken from Ohio, you seem to have completely missed the point of Scott's tobacco example. If you can articulate why a profit-maximizing, monopolist cigarette manufacturer raises its prices when the cost of tobacco rises from $10 to $12/lb, it should be obvious why that same profit-maximizing, monopolist must lower its cigarette prices if the cost of tobacco falls back to $10/lb.

If the producer is a monopoly AND the cost of production isn't in the public domain, i.e., cost of production is mostly obscured or opaque, then Ken from Ohio poses a valid question.

Of course, Scott could implcitly be referring to a (relatively free!) market in which costs are freely available in the public domain - then yes, point obviously made.

Andrew_FL writes:

ed, gasoline prices respond to changes in the supply of and the demand for gasoline, not to oil prices per se. At best what you've shown is that under different cost pressures, producers of gasoline adjust supply to different degrees.

fralupo writes:


the problem is that Dr. Sumner gave an example where the market price of a good was supposed to go up if the cost of producing it went up and, symmetrically, would go down if the cost of producing it went down. The case of gasoline is an example where empirically that doesn't happen. Notably wages are probably another price that isn't as quick to fall as they are to rise.

I think symmetry works better as a model for prices that a revised frequently and with lots of volume or haggling. Something like the stock market. Where one side gets to choose the price and is expected to change it a few times a week at most you're probably not going to see it going one way as frequently as the other.

Andrew_FL writes:

fralupo, you can't say the cost of production went up or down, only that one of the factor prices involved in the production of gasoline went up or down-the price of crude oil.

There are ways to keep your cost of production down when one of your factor prices goes up, you know.

fralupo writes:


fralupo, you can't say the cost of production went up or down, only that one of the factor prices involved in the production of gasoline went up or down-the price of crude oil.

The gas station doesn't care whether prices went up because it costs more to get petroleum out of the ground or because speculators raised the price or any other factor. They don't get a "not an actual change our production price, just an extra markup we get to charge the market" discount from their supplier.

There are ways to keep your cost of production down when one of your factor prices goes up, you know.

So you're saying the production function used for producing product x always comes out with the same total cost, no matter the factor-price is for input y? I guess that can happen sometimes, especially for inputs that have many unrelated substitutes in the market. Does that sound like what a service station can do with petroleum or what a cigarette company can do with tobacco? That doesn't seem likely to me.

Andrew_FL writes:

fralupo, I didn't say that it always comes out the same, I was merely explaining why the relationship between the price of oil and of gasoline need not be a consistent linear function. Sometimes producers of gasoline will have the flexibility to substitute factors to mitigate an oil price increase, sometimes they won't. Sometimes other factor prices will increase when oil prices decrease other times they will not.

My point here is basically that ed would have a better point if the *only* factor of production involved in the production of gasoline were oil. As it is, it's clearly not, and if he wants to claim he's demonstrated an asymmetry, he needs to control for the other factors of gasoline production.

On your comment on my first statement, you're right I guess but it has nothing to do with what I said, or what ed was claiming, which was specifically about only one reason why gasoline producers might charge gas stations more to sell their product. The price of crude oil going up.

Gasoline is produced from oil. I wasn't talking about the factors driving up oil prices-they aren't relevant, we can take the oil price as a given for the factor prices of the gasoline producer.

Adjustment of labor prices to supply and demand is an issue of a different kind. Wages being sticky downward in the face of a shift of demand for labor, is not analogous because it deals directly with the issue of the price being determined by supply and demand. This argument is over whether a shift in one of the prices of one of the factors of production for gasoline, must always result proportionally in a change in the price of gasoline-whether it would depends not only on the supply curve for gasoline necessarily shifting consistently in response to a change in a single factor of production, but also on the elasticity of both supply and demand for gasoline.

I realize Scott kind of brought this on by talking about the shift of a single factor of production for cigarettes (tobacco) should lead to consistent, symmetrical adjustment of the price of cigarettes. I kind of feel he's made a mistake here, but a rhetorical one, not a theoretical one: He has failed to state he is speaking of ceteris paribus results. Obviously that condition does not hold in the real world, which makes the "empirical test" of the claim misplaced.

fralupo writes:

I see. I think there are multiple conversations going on and maybe we're responding to arguments the other isn't making.

I'm not saying that a shift in input price from y to y+z should change the market price of the good by a*z or some other linear transformation. I'm saying that for a "symmetric" price change going from the price based on y to y+z (whatever that amount ends up being) should be equal and opposite to the price change from y+z to y.

The example of gas stations not lowering their prices when oil goes down by some amount but quickly raising their prices when oil goes up by that same amount shows that "symmetry" may be a bad way of thinking about this.

Andrew_FL writes:

fralupo, I think I should be clear, that I'm not opposed in principle to the possibility an asymmetry is going on there. I just think I'd need more evidence to conclude that's true in this case.

Really though, aren't we both getting sidetracked by the analogy? What reason is there to assume showing one asymmetry, in microeconomics, necessarily says anything one way or the other about the symmetry of macroeconomic reactions to policies?

Anyway, all I was saying was, it could still be true that the reaction, ceteris paribus of price a to factor price y increasing to y+z, is equal and opposite to to the reaction going back from y+z to y, even if we don't observe that happening when y increases to y+z and back down to y in the real world. We'd need to show that all the other relevant variables stayed the same.

If that could be shown, I'd be happy to concede that you'd demonstrated an asymmetry of that kind exists.

Controlling for the variables is relevant to the question of why this apparent asymmetry exists in practice. Is it because Scott's reasoning is wrong, and economics isn't symmetric, or is it because the situations are not strictly comparable, in which case his reasoning stands?

Even then it's not clear to me the asymmetry has macroeconomic implications that should impair Scott's reasoning by analogy. You'd have a stronger case just straight arguing for sticky downward prices that aren't sticky upwards.

Robert Simmons writes:

Scott, I agree, but it doesn't matter what makes sense to me or you, it matters what others hear and gets through. Not sure if my suggestion is the answer, but we need to find a better way to communicate the idea.

BC writes:

"I suppose anything is possible, but the Fed would have to have a truly bizarre objective function to behave in such a fashion."

Essentially, Scott is correct. Arguing against monetary offset is essentially arguing that the Fed is irrational in that it has different targets for inflation or NGDP, depending on its perception of fiscal policy. Thus, one needs to adjust fiscal policy to get the Fed to target the right inflation or NGDP (rather than just, you know, giving the Fed the mandate to target the right inflation or NGDP).

I think there are two reasons why the argument against monetary offset is not usually stated this way. (1) Asserting that the Fed has a fiscal-dependent target often seems "bizarre" to the point of being implausible. For example, in O'Brien's formulation cited by Scott, the Fed is assumed to have a low NGDP target (only) during recessions that it raises only as fiscal spending rises above its pre-recession levels. Why would the Fed behave that way? (2) Many people, not just Scott's students, are confused by the framing issues he mentions. Thus, they don't even realize that they are accusing the Fed of being irrational (having inconsistent inflation or NGDP preferences) because they don't recognize the irrationality themselves.

Scott Sumner writes:

Marcus, Yes, although he'd call himself a "new Keynesian" which is a pseudo monetarist set of ideas.

Kevin, No, I wasn't suggesting it is stimulative. Just that it's more likely to be seen as "needed" when unemployment is at emergency levels. But not for stimulus reasons.

Andrew, Yes, in the short run they may be sticky, I accept that. But they are probably sticky both ways. In the long run they rise or fall.

ed, Wait, didn't that study find that lower crude prices cause gasoline prices to fall? That's what I hear students deny.

KD, I think you missed the point. The point is that it's in the interest of the producer to lower the price when the costs decline.

Everyone, I've done posts arguing that wages are stickier in the downward direction than upward, due to money illusion. My point in this post was more modest, to expose sloppy thinking about asymmetry. The arguments that I sometimes see from my students, and which appear in these comments, is 100% wrong. Full stop. That argument is that firms are less likely to cut prices than raise them because they are greedy. But even in the case of monopoly, if higher costs result in a higher profit-maximizing price then lower costs result in a lower profit maximizing price. No real world empirical studies can change that fact. On the other hand real world studies might show irrational behavior among firms. I specifically said in my post that this is "possible" but would imply "irrational" behavior on the part of the Fed.

Of course it's possible that gas stations are slightly irrational in the very short run, but the argument I run up against is that they'd never lower their prices when costs fell, because they are greedy.

Nathan W writes:

I think symmetrical is an excellent word to explain how these models work.

It draws attention to the "natural" simplicity, while I think tugging in the back of the mind that probably in the real world things are not quite so symmetric (often very much not so, and even the simplest models of risk are attuned to this).

In terms of passing on costs, let me provide some Canadian perspective. When costs go up due to exchange fluctuations, firms pass this on immediately even if their stock was purchased at a lower price. If costs go down, they try to exploit the gains for as long as possible. Not so much so for Amazon and Walmart, but Amazon and Walmart don't sell the quality and type of everything I want/need. Perhaps this is personal bias, but that would result precisely from the asymmetry of being more sensitive in the bad way of paying "too much" than sensitive in the good way for me as a consumer paying "too little".

Jon writes:

Yep, businesses cut prices when costs go down. Were it otherwise we'd quickly ratchet to infinite prices just from any perturbation upward.

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