EconomistMom.com
…because I’m an economist and a mom–that’s why!

EconomistMom.com

Ezra on the Not-Good-Enough Stimulus

October 10th, 2011 . by economistmom

ezrachart3-unemployment

(Graphic from the Washington Post comparing Obama Administration projections of unemployment rates with and without stimulus with what actually happened even with the stimulus.)

__________________________________________________

Here’s a really excellent article by Ezra Klein from Sunday’s Washington Post (lead story–and a majority share of–the Business section) on how the stimulus turned out to be–not a “failure”–but certainly “not good enough.”  Ezra explains the graph above:

The issue is the graph…It shows two blue lines sloping gently upward and then drifting back down. The darker line — “With recovery plan” — forecasts unemployment peaking at 8 percent in 2009 and falling back below 7 percent in late 2010.

Three years later, with the economy still in tatters, that line has formed the core of the case against the Obama administration’s economic policies. That line lets Republicans talk about “the failed stimulus.” That line that has discredited the White House’s economic policy.

But the other line — “Without recovery plan” — is more instructive. It shows unemployment peaking at 9 percent in 2010 and falling below 7 percent by the end of this year. That’s the line the administration used to scare Congress into passing the single largest economic recovery package in American history. That line is the nightmare scenario.

And yet this is the cold, hard fact of the past three years: The reality has been worse than the administration’s nightmare scenario. Even with the stimulus, unemployment shot past 10 percent in 2009.

Ezra points out that thoughtful critics of the stimulus don’t claim it didn’t help–just that it didn’t help as much as it could have:

Some partisans offer a simple explanation for the depth and severity of the recession: It’s the stimulus’s fault. If we had done nothing, they say, unemployment would never have reached 10 percent.

That notion doesn’t find much support even among Republican economists. Doug Holtz-Eakin is president of the right-leaning American Action Forum and served as Sen. John McCain’s top economic adviser during the 2008 presidential campaign. He’s no fan of the stimulus, but he has no patience with the idea that it made matters worse.

“The argument that the stimulus had zero impact and we shouldn’t have done it is intellectually dishonest or wrong,” he says. “If you throw a trillion dollars at the economy, it has an impact. I would have preferred to do it differently, but they needed to do something.”

A fairer assessment of the stimulus is that it did much more than its detractors admit, but much less than its advocates promised.

And most Democrats argue that it didn’t do enough because it wasn’t big enough:

Critics and defenders on the left make the same point: The stimulus was too small. The administration underestimated the size of the recession, so it follows that any policy to combat it would be too small. On top of that, it had to get that policy through Congress. So it went with $800 billion — what Romer thought the economy could get away with — rather than $1.2 trillion — what she thought it needed. Then the Senate watered the policy down to about $700 billion. Compare that with the $2.5 trillion hole we now know we needed to fill.

Ezra then explains the Administration’s logic–why the Administration really couldn’t hope for anything bigger (because of concerns about the debt), and how going as big as they were already going (in stimulus) means that eventually you have to spend money in less effective ways, after you use up the more effective ways:

Even if Congress had been more accommodating, there was a challenge to vastly increasing the size of the initial stimulus: The more you spend, the less effective each new dollar would become.

“We were trying to spend 10 times what had ever been spent in a year,” says Goolsbee, who chaired the Council of Economic Advisers until this year. “The tension was that the biggest bang for the buck comes from direct spending like infrastructure, but once you use up the big-ticket items, you eventually come to a point where the tax cuts are better bang for the buck than the 300 billionth infrastructure dollar.” And tax cuts, frankly, aren’t a very good bang for the buck.

Of course, the problem is that contrary to Austan Goolsbee’s description, policymakers did not line up the stimulus spending from most effective to least and pursue the most effective ones first.  Along the way they had to constantly sprinkle in lower economic “bang per buck”–but higher political “bang per buck”–spending, just to get the Republicans to go along.  How else can we explain how the Bush tax cuts for the rich became part of what was considered “stimulus” spending (in the lame duck session’s two-year deficit-financed extension of them), when those tax cuts have proven so ineffective at stimulating demand?

I’ve said this before–most recently here–that there’s lots of room for policymakers to do better in the future and to both more effectively stimulate the near-term economy and reduce the deficit, even right away, if they would consider swapping out the policies near the end of Goolsbee’s imaginary list for policies at the top.  (Here’s a “real” list, from CBO; see Table 1.)  But how can we clear out the influence of that “political bang per buck” list?  Who knows, but maybe the “Occupy ___” movement could become part of the answer.  If it turns out to be a “good enough” movement, that is.

33 Responses to “Ezra on the Not-Good-Enough Stimulus”

  1. comment number 1 by: SteveinCH

    Diane,

    I just looked at the CBO’s table 1, in particular the column labeled years of employment per million dollars of spending. Taking the midpoint of the ranges, there really are no good policy options. The best option which generates 12 years per million dollars (or $80,000 per job year) is payroll tax reduction for companies that increase payroll…not something we can spend hundreds of billions on. The next best option ($100,000 per job year) is paying more out in UI, aka giving money away.

    What I take away from the CBO report is that the best available policy, according to macroeconomists is giving money away. It’s not infrastructure ($140,000 per job year), not aid to states ($160,000) per job year, not anything actually in the Obama jobs bill. It’s just giving money away.

    That may be right but it’s a pretty bitter bill to swallow.

    More generally, the CBO, based on midpoint estimates, appears to be saying that there simply is no efficient way to provide stimulus, at least if jobs are your measure of success.

  2. comment number 2 by: Vivian Darkbloom

    What we have here are three lines: one line, the red line, represents reality; the two other blue lines represent hypotheticals, both based on the same flawed macro economic model. What I frankly don’t get is the logic being pushed here to claim that because the delta between these hypothetical blue lines shows the stimulus should have increased employment to a certain extent, it actually did, irrespective of what really happened. This is reminiscent of the shell game: here, the spectators are supposed to keep their eyes and minds on the blue lines and away from the red one.

    What the reality line suggests is that there was an abrupt, but brief drop in the rate of unemployment in early to mid-2009. This undoubtedly represented census hiring and not the stimulus per se. The graph suggests that unemployment actually peaked at about the same time the unemployment was predicted to peak *without* the stimulus and just a little bit later than it was supposed to have peaked *with* the stimulus. The prediction was that if *nothing* would be done employment would now be a full one percentage point lower than at its peak. That’s actually what happened *with* the stimulus.

    If, aside from mistaking the severity of the recession, the stimulus worked as it was promoted to work, would not the difference between the peak unemployment rate and the reduced unemployment rate be the same in reality as in the prediction.? The “with” and “without” blue lines show that the stimulus was to shave two full percentage points from the unemployment rate. But, if you take their prediction at face value but allow for a higher peak of unemployment, the reduction of unemployment of only 1 percent should have happened anyway.

    In the best case scenario (let’s be “thoughtful” here) , we could grant that the stimulus was responsible for the full 1 percentage point drop in unemployment between the peak and the trough. But, again, that’s one-half of what it was supposed to have done.

    And, how much credit for the decrease in unemployment shall we attribute to the monetary policy of the Federal Reserve, particularly the two “quantitative easing” programs that were carried out in the period of time charted by the graph? The fact is that we will probably never know. However, Martin Feldstein suggests it probably did significantly affect consumer spending. http://www.project-syndicate.org/commentary/feldstein33/English

    Ezra and Mom would like us to think that every job “created or saved” during this period of time was the direct result of the stimulus. While the Federal Reserve often works to counter the effects of fiscal policy, here they worked in tandem.. Why should we give all the credit even for modest results to a very poorly designed and executed stimulus program and nothing to the Federal Reserve?

    Romer and Berstein seem to have taken their inspiration from a Tom Wait’s lyric (“Money’s just something you throw off the back of a train”). Of course Waits is inspiring, but common sense suggests that if you throw $800 billion off the back of the train it is bound to have some temporary effect on GDP and employment, but that doesn’t mean you should do it, even (or particularly) if your political patrons are gathered just behind the caboose.

    The fact that any effect is only temporary is clearly demonstrated even by the Bernstein/Romer chart where the two blue lines meet again after only 4 years. What the graph does not show are the effects the stimulus (that is the deficit caused by it) would have on employment after the “with” and “without” lines meet. It’s not even funny how the chart is abruptly cut off at the point,; it’s just a sad commentary on how economics are spun to cater to politics. In reality, one would see the “with” line drop below the “without” line and that explains the rather arbitrary cutoff date.

    This was a clever attempt by Mr. Klein to spin what, even by his own graph and faulty logic, was a very bad government investment. And, whether it was a good “investment” should be the real measure of whether the stimulus “worked” or whether it “helps”. By my standards, at least, “investments” need to be judged by a longer period of time than 4 years. The evidence suggests this was a very bad short-term investment and a disastrous long-term one.

  3. comment number 3 by: AMTbuff

    I contend that when the government is running deficits of 10% of GDP, the best stimulus is to reduce future promised benefits by 10% of GDP each year. Lock in a formula that raises eligibility ages and reduces income thresholds sufficiently to offset the current year’s deficit. With this approach one can spend as much on stimulus as needed without convincing job-creators that we are about to become Argentina.

    Long-term retrenchment should have been a central feature of the stimulus from the beginning. Omitting it rendered any amount of stimulus impotent. This was a bipartisan error, since Bush’s plan in 2008 made the same mistake. Stimulus by tax cut without long-term fiscal reform would also have failed.

  4. comment number 4 by: Vivian Darkbloom

    “Long-term retrenchment should have been a central feature of the stimulus from the beginning. Omitting it rendered any amount of stimulus impotent. This was a bipartisan error, since Bush’s plan in 2008 made the same mistake. Stimulus by tax cut without long-term fiscal reform would also have failed.”

    That’s exactly right. And, don’t forget the work of Reinhart that predicts when public debt exceeds 90 percent of GDP, the stimulative effect of any further deficits is greatly diminished.

    One can, to some extent, excuse mistakes made with respect to a hastily packaged stimulus plan. One can also excuse the mistakes made in gauging the severity of the recession (despite timely warnings by Reinhart and Rogoff).

    What cannot be excused is that, in the face of all this, the administration did nothing to address the long-term debt and deficit problem or to make any attempt to offset the deficit caused by the stimulus by making offsetting long-term fiscal adjustments. Rather than focusing on the fiscal problem in the midst of the greatest contraction since the Great Depression, and the highest debt levels since WWII, the administration spent one and one-half years of public debate over an equally costly, ill-designed and highly partisan health care plan. The plan would cost, conservatively, $1 trillion over a 10 year period but would be offset by taxes of nearly the same amount.

    What would have happened if, instead of wasting all this time and energy on ACA, the administration had used its control of both houses to push through a long-term tax and entitlement reform that would have reduced long-term deficits by $1 trillion or had “gone big” to do much more?

    My guess is that the economy would be in much better shape and many more people would be employed and Obama would be coasting to a second term. *That* was the administration’s greatest blunder.

  5. comment number 5 by: Arne

    “don’t forget the work of Reinhart that predicts when public debt exceeds 90 percent of GDP, the stimulative effect of any further deficits is greatly diminished”

    Was it not about GDP growth rate, not about stimulus?

  6. comment number 6 by: Arne

    about GDP gorwth rate rather than about stimulus?

  7. comment number 7 by: Vivian Darkbloom

    It was about GDP growth rate and debt. If you borrow money to stimulate, you increase debt.

  8. comment number 8 by: Patrick R. Sullivan

    ‘My guess is that the economy would be in much better shape and many more people would be employed and Obama would be coasting to a second term. *That* was the administration’s greatest blunder.’

    Yes, never has a President so richly deserved his fate than ‘The One’. If he’d done nothing at all Obama would be better positioned for re-election.

  9. comment number 9 by: Gipper

    Let’s look at the microeconomic factors keeping unemployment rates high.

    1. 99 weeks of UI definitely makes the unemployed more choosy, and less likely to lower their reservation wage to respond to job offers.

    2. PPACA has permanently changed the cost structure of new hires. Businesses will more intensively use the labor they already employ. New hires only appear in sectors with high rates of return.

    An intelligent conservative critique of Obama and Keynesian economic policies in general is to look back to the lessons of the 1982 recession. We saw unemployment rates higher than today, but it was short-lived. There wasn’t a stimulus program. We just let the market forces work the correction.

    During the Great Depression we saw FDR screw up the private sector and thereby lengthen the recovery period into a decade. Obama is doing a similar dance number. This nonsense isn’t incorporated in CBO models which is why these models are doing a very poor job making any predictions.

    Anyone who says that running a 40% deficit is not a large stimulus program needs to have their head examined — and that includes Paul Krugman. Short of nationalizing large sectors of the economy and building pyramids, there’s nothing more the government can do. People aren’t employed just to get a paycheck. They’re supposed to do something useful in a market economy. Cuba has a low unemployment rate, but that’s not the direction we should be heading.

  10. comment number 10 by: Patrick R. Sullivan

    ‘…maybe the “Occupy ___” movement could become part of the answer. ‘

    There appear to be two kinds of people, those who recognize the reincarnation of Al Capp’s, Students Wildly Indignant about Nearly Everything, and those who don’t.

  11. comment number 11 by: Arne

    “Businesses will more intensively use the labor they already employ.”

    This is true of a recovering economy regardless of ACA, and since we have not yet reached the pre-recession level hours worked, it is clear that the lack of hiring is due to:

    3) not enough customers.

  12. comment number 12 by: Vivian Darkbloom

    So, if the lack of hiring is due to not enough customers and the not enough customers is due to the lack of demand, what is causing the lack of demand?

  13. comment number 13 by: Arne

    For the extra 4 percent who are unemployed lack of demand is obvious. For the rest it is from unwillingness to spend when reserves have dropped.

    Reserves here can be reduction in home equity, in retirement savings, or in confidence in having a job for the next 6 months. Whatever the cause, savings rates are up.

  14. comment number 14 by: Vivian Darkbloom

    Can you not bring yourself to say excessive debt—at all levels, public and private? Frankly, I don’t think people stop spending if the value of their homes goes down. But, they do stop spending when they’ve got mortgages (and home equity loans and credit card balances) to pay that exceed the value of those homes and their sources of credit dry up.

    So, the main cause is not “lack of demand”–that’s one of the effects. The main cause was, and is, excessive leverage that fueled past over-consumption.

  15. comment number 15 by: Arne

    I think we are agreeing about excessive private debt, since that is the same thing as low reserves, but how does the excessive public debt impact demand? Public spending is affected by revenue reduction, but it occurs without the increased savings we see in consumer spending.

  16. comment number 16 by: Vivian Darkbloom

    “I think we are agreeing about excessive private debt, since that is the same thing as low reserves, but how does the excessive public debt impact demand?”

    In two ways: First, excessive public debt necessarily implies higher future taxes to pay for that debt (or inflation, or both). Second, although we have not seen it yet (for entirely other reasons) the excessive public debt will entail higher future interest rates and, likely, a lower dollar. Didn’t a couple of guys just get a Nobel prize for their work on rational expectations?

    Don’t get me wrong, I’m not entirely against counter-cyclical government investment spending, with the emphasis please on countercyclical *and* investment. But, that is not what we’ve had here or what is proposed. First, we’ve started the public spending spree already deep in public debt, and the spending that has been done has been nothing but investment.

    The countercyclical remedies Keynes might have proposed did not envision public debt at the level it is now at as a starting point. To the extent he would have recommended fiscal rather than monetary stimulus I’m sure he envisioned a public debt-to-GDP ratio of well under 90 percent. Keynes was, after all, quite a fiscal conservative. And, this is completely consistent with the Reinhart’s observation about the drag excessive public debt has on GDP growth. We no longer have the luxury of merely stimulating current growth through increased public spending–we also have to pay for excessive prior public (and private) borrowing.

    At the very least, this gets us back to AMT’s earlier point that any “stimulus” proposal has to be accompanied by a medium and long-term plan to reduce the public debt to reasonable levels.

    The answer is likely that there is no answer except to pay for those lunches we’ve over-indulged on in the past. Best that we just face up to reality and work out a reasonable long-term payment plan.

  17. comment number 17 by: Gipper

    Arne,

    Lack of aggregate demand? Demand for what? Demand for AGGREGATE? Are you referring to the stuff used to make concrete?

    Keynesian notions of Aggregate Demand are what get us in big trouble making stupid policy decisions. It is a chimera. The idea that priming the pump or getting people to buy “stuff” is necessary to stimulate investment is an idea proferred by intellectuals who assume that economic agents are stupid.

    Keynesianism is the kind of thing people believe in when they get frustrated that they body of knowledge they have (microeconomics) cannot explain everything. Just because microeconomics is silent on many matters doesn’t make Keynesian Macroeconomics correct by default.

    It’s like saying, that because biologists cannot explain how life began, then that must mean that God exists. Keynesian macroeconomics is theology, pure and simple.

    Where was the “demand” for an I-phone when it was a figment of a developer’s imagination? Did someone need an order or stimulus from the US Govt. to go forward with that project? Things are being conceived of today, in the middle of a recession, that will flourish and make people wealthy in a few years.

    The problem is, frankly, macroeconomists. Their training, divorced from microeconomic rigor, leads them into a sea of econometric modelling and data mining detatched from a sensibility of the things that make economies work and stall.

    Working at the CBO is a good place to be if you want to be bereft of microeconomic reasoning.

  18. comment number 18 by: Rotton Ralph

    One of the problems is that the stimulus projects were politically selected to benefit Democratic favored groups, Teachers, Policeman, Union Construction workers, so we got much less long term bang for the buck. Contrast that with the FDR spending on school, bridges and dams. The spending was concentrated in Blue states, and to the extent it avoided laying off public workers it delayed that and resulted in a problem this year. My company benefitted from some of the spendingt and we found that the government overpayed for features that were not necessary.

    Also, it would be much more productive to allow non-union contractors to bid or to pay WPA type workers $20 per hour than hire union labor at $70. Would take a lot of pople off the UC rolls.

  19. comment number 19 by: Jim Glass

    An intelligent conservative critique of Obama and Keynesian economic policies in general is to look back to the lessons of the 1982 recession. We saw unemployment rates higher than today, but it was short-lived. There wasn’t a stimulus program. We just let the market forces work the correction.

    Unemployment reached 11% then as the direct result of Volcker rocketing short-term interest rates up over 17%. Unemployment then fell as a direct result of him them plunging rates downward nearly as fast.

    Neither of those events was any kind of laissez faire just letting market forces work.

    Anyone who says that running a 40% deficit is not a large stimulus program needs to have their head examined

    Well that’s true enough. If “deficit” is supposed to equal “fical stimulus”, then … what the heck? Who can complain about lack of it? Fiscal stimulus is grossly inefficient, corrupted distorted by politics, very costly for the national debt, slow-working at best, and there are credible theoretical grounds for doubting that it can work at all. All true … but none of these objections apply to monetary stimulus.

    Lack of aggregate demand? Demand for what? Demand for AGGREGATE? Are you referring to the stuff used to make concrete? Keynesian notions of Aggregate Demand are what get us in big trouble making stupid policy decisions. It is a chimera…

    Aggregate demand is every bit as much Milton Friedman Monetarist as Keynesian. There’s nothing particularly Keynesian about it at all, except for the politics. It goes back to David Hume.

    The law of supply-and-demand applies to money just as it does to everything else. When something makes the demand for money rise relative to that for everything else, we get a recession. The relative decline in demand for everything else compared to that for money is the decline in aggregate demand. Hume ID’d this long, long, before Keynes, and all the classicals knew it. (Recessions are always and everywhere a monetary phenomena.)

    The Fed caused the Great Depression (FDR only slowed the recovery) by letting nominal demand plunge when its job is to keep it stable — and it repeated the very same mistakes it made then, sometimes uncannily so, in getting this recession going.

    Fortunately, it had also learned some things since the 1930s, so when in the 4th Q of 2008 deflation hit at a 13% annual rate — a plunge in aggregate demand as not seen since the worst collapse days of the Great Depression — the Fed responded strongly with QE1, successfully stopped the deflation on the spot, and stabilized matters. That was the Fed controlling nominal demand in real time in real-life practice, no better example need ever be asked for.

    Unfortunately, the Fed stopped there. Although Bernanke has said explicitly, many times, that the Fed has plenty of ammunition left to spur the economy by spurring demand, it refuses to do anything signficant more (unless, as in Q4 ‘08, it thinks things are about to collapse). Why? Lots of intelligent discussion of that here.

  20. comment number 20 by: SteveinCH

    FWIW, I think Q4 2008 and today have very little to do with each other. In Q4 2008, corporate balance sheets (particularly financials) were the issue. QE1 was a good solve (though a costly one in my view) to that issue.

    Today, the issue is consumer balance sheets, in particular, the relationship between disposable income and debt service. Since most debt service is fixed long (mortgages) or not monetary policy driven (credit cards), QE3 wouldn’t really do much on the fundamental issue which is consumers feel poorer and more exposed. As a consequence, spending is stagnant as is growth since the two are strongly linked.

    Suffice it to say that neither fiscal stimulus nor monetary stimulus is likely to be of great help at this point. Monetary stimulus cannot change the consumer view of their balance sheet. Fiscal stimulus could provide more money to consumers but does so inefficiently and at the cost of the government’s balance sheet.

    No, in my view, the only thing we can do is decide on two questions.

    1. Is a different tradeoff between consumption and production appropriate in today’s global economy requiring more explicit focus on local production through protectionism?

    2. Is a different tradeoff between consumer or collective protection and job growth appropriate today meaning less regulation of business activities?

    Other than these two fundamental questions (neither of which I think I know the answer to), government can do little to affect the direction of the economy.

  21. comment number 21 by: Patrick R. Sullivan

    ‘… the spending that has been done has been nothing but investment.’

    I think you meant ‘nothing like investment’, Vivian?

    ‘…a different tradeoff between consumption and production…’

    There’s no such trade off. Production is FOR consumption. otherwise there’d be no production. You’re closer with your point number 2; the trade off is between production and consumption by private actors v. by political actors.

  22. comment number 22 by: Vivian Darkbloom

    “I think you meant ‘nothing like investment’, Vivian?”

    Yes, as TS said to Ezra (Pound) “il miglior fabbro”.

  23. comment number 23 by: Jim Glass

    FWIW, I think Q4 2008 and today have very little to do with each other. In Q4 2008, corporate balance sheets (particularly financials) were the issue.

    Corporate balance sheets had already been an issue for at least two years by then. The economy still grew. What happened in Q3 2008 was a *sudden drop in the price level* as hadn’t been seen since the 1950s, which in Q4 turned into a *plunge* of 13% at an annual rate, again, not seen since the worst collapse days of the Depression. That was a huge increase in the demand for money relative to everything else, the price of money going up (deflation) — a plunge in aggregate demand.

    The Fed caused the Great Depression by failing to respond to the big increase in the demand for money that happened back then with a corresponding increase in supply of money. As Bernanke said about all this, “We did it. We’re very sorry.”.

    The same thing was happening gradually through later 2007 and 2008, with the Fed again doing nothing in response — this time the excuse being the exploding price of oil (remember, *that* was the big problem everyone thought we had *then*) which was supposed to cause inflation, leading the Fed to sit “tight”. Then the deflationary plunge of Q4 2008 hit, Ben remembered what he’d said and responded with QE1 which did increase the money supply sort-of almost correspondingly.

    Be grateful he did, or we’d be in balance sheet hell amid a much worse economy today. A collapsing economy causes a lot more damange to balance sheets than bad balance sheets cause to the economy — 2008 may have been our 1929 but 2009 was not 1930. Balance sheets did not do well in 1930.

    Suffice it to say that neither fiscal stimulus nor monetary stimulus is likely to be of great help at this point. Monetary stimulus cannot change the consumer view of their balance sheet.

    Friedman would disagree, and did regarding every past example of this kind of situation from the Derpression to 2000s Japan.

    Friedman’s analysis in a nutshell: There is a given level of demand for money relative to everything else. If there are major under-utilized resources in the economy, then the demand for money is too high relative to its supply. If the central bank then increases the money supply by buying (whatever) the recipients of the new money (who made the sales to the CB, motivated by profit) now have larger money balances they want. So to reduce their money balances and increase their asset balances they spend the money buying (whatever). The corresponding parties who sold (whatever) receiving the passed-on money, now have larger money balances than they want, etc. Repeat.

    The result is increasing aggregate demand as the new money is passed on through purchases, with formerly under-utilized resources getting pulled into productive use. The economy strengthens.

    The effect on balance sheets: They improve. Increasing economic activity and a strengthening economy improve balance sheets. The improving balance sheets in turn further help the economy.

    This all happens *if* their are major under-utilized resources in the economy that are available for productive use. Then the result of the money stimulus is a very favorable ratio of a lot of economic growth to only a little more inflation. But *if not*, or if there are structural problems blocking growth, then the money stimulus creates a lot of inflation and only a little growth.

    What does the empirical evidence say about conditions today?

    [] With unemployment over 9%, the drop in employment bigger than the increase in unemployment, and the economy running more than 12% below trend, it sure *looks like* there are a whole lot of under-utilized resources available for use.

    [] Inflation over the last 36 months has been 1.1% at an annual rate, and the market is predicting inflation over the next *ten years* at only 1.37% annual rate. These are 60-year lows.

    With major under-utilized economic resources in sight everywhere and inflation at 60-year lows, methinks Friedman would say conditions today fit his presciption for money stimulus right on the money, so to speak.

  24. comment number 24 by: Gipper

    Jim,

    I think Milton Friedman’s Quantity Theory framework for interpreting, explaining, and predicting events is in tatters right now. A demand for money is a demand for future consumption goods. There is no demand for money qua money. Money is a veil. A means to an end.

    Keynes critique that was correct is that because we don’t have futures markets where consumers interact with producers to place their refrigerator order for delivery 8 years from today, that money is a problematic conveyor of the demand for future consumption and production.

    Money, bond and equity markets are the instruments used to coordinate the present and future, however imperfectly it may work.

    Recessions don’t result from obstinate consumers refusing to buy more stuff now. Recessions result a breakdown in the coordination process of intemporal markets. Who induced the breakdown? Govt. policies? Greedy Wall Street Bankers? The Chinese?

  25. comment number 25 by: ESS

    What do you think about the stimulus plan now in light that there is a push for LOWERING government spending to reduce the deficit?

  26. comment number 26 by: Jim Glass

    The Economist posted an interesting responseto Klein’s article…

    That leads us to Mr Klein’s second mistake, which is to accept too readily the contention that the Fed has reached the end of its ability to influence aggregate demand…

    Jim … A demand for money is a demand for future consumption goods. There is no demand for money qua money.

    Oh, I’m pretty sure Friedman, Krugman and Hayek would all disagree with that. Money serves a lot of functions and there is a demand for it for itself, due to its value in serving those functions, just exactly as there is demand for whatever else due to the value of whatever else’s function is.

    The price of everything is determined by supply and demand for it, measured in terms of money. That means money equally has a price determined by supply and demand for it, measured in terms of everything else — the rate at which other things are exchanged for it.

    What’s inflation? A decline in the price of money that results from the money supply increasing faster than demand for it. People grasp that easily, “inflation comes from too much money”. That’s just supply-and-demand determining the price of money. Weimar, Zimbabwe, created way too big a supply of money relative to demand, so they made the price of their money *plunge*. Deflation is the reverse, the price of money rising as demand for it rises relative to supply.

    The USA had serious deflation in the last half of 2008, the Fed gave the money supply big boost upward, ended it. Thankfully, else we’d be re-living 1931 about now.

    If that big increase in the demand for money, as we saw in 2008 and 1929-30, reflected only a big increase in demand for future consumption goods then it would predict a *booming* economy, not the Great Recession of today or the Depression of 1931-on.

    For the record, here’s Friedman on Japan:

    … the Bank of Japan’s argument is: “Oh well, we’ve got the interest rate down to zero, what more can we do?”

    It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.

  27. comment number 27 by: Gipper

    Jim,

    If the world were to end next week, the demand for money balances would evaporate. If money had some intrinsic value like any other consumption good with a supply and demand curve, then the demand for money balances would have no more reason to collapse than then demand for apples and oranges.

    Because the demand for money is a derived demand based on future consumption, it is circular logic to speak of a demand and supply curve of money. My apologies to von Mises, Hayek, and Friedman.

    If inflation were merely the decline in the price of money, then all goods would increase in price at the same rate. However, that isn’t the case. Price increases happen at the market level for particular goods and services at different rates because demand curves are being pushed outward by the nominal income effect induced by increases in the supply of money. However, this effect is uneven and doesn’t occur just in the sectors that are captured by CPI measurements.

    These nominal income effects on demand curves (as occured from 2002 - 2007) can be manifested in future consumption goods priced in asset markets — like housing, stocks, and bonds. Oila! We saw huge increases in the prices of housing and stock market shares, thanks to Greenspan’s loose monetary policy during this period, without significant current consumer good price increases measured by the CPI.

    When Bernanke pulled back on the reins a bit in 2006-2007, that led to the collapse of this demand for future consumption sectors.

    The solution is not to reinflate to restore the unsustainable asset market price vector. The solution is to allow markets to adjust to the unmolested intertemporal demand preferences of consumers. This will involve a lot of pain (as in 1982), but it will be quicker and decisive. Unlike this slow motion prolonged recession we’re in the midst of today.

  28. comment number 28 by: Patrick R. Sullivan

    If the world ended, just who do you propose for the demanders of apples and oranges?

  29. comment number 29 by: Gipper

    People would still want to eat them. The demand for apples and oranges wouldn’t evaporate. In contrast, everyone would be trying to get rid of their money.

    If money had its own value, and not a derived demand for future consumption of other goods, then according to Friedman, et. al., this shouldn’t happen. But with the imminent end of the world, optimal money balances would be zero.

    This example demonstrates the nexus between money and future consumption.

  30. comment number 30 by: Patrick R. Sullivan

    ‘The demand for apples and oranges wouldn’t evaporate. In contrast, everyone would be trying to get rid of their money.’

    Presumably by buying apples and oranges (but not green bananas). But, you are destroying your own argument in the process.

  31. comment number 31 by: gipp

    You could always barter for apples and oranges. you don’t need money. My argument is intact.

  32. comment number 32 by: Jim Glass

    If the world were to end next week, the demand for money balances would evaporate

    Ooops, you said the key word, “demand”. You are correct in saying there is demand for money. And the amount of demand can *change*, as your albeit extreme example shows.

    Now the question is, in light of the amount of demand and changes in it: what is the optimal amount of supply? The amount supplied relative to that demand **makes a difference** … Correct? Discuss.

    Because the demand for money is a derived demand based on future consumption, it is circular logic to speak of a demand and supply curve of money. My apologies to von Mises, Hayek, and Friedman.

    Hello? Because demand for X is set a given way, the supply of X makes no difference? And the supply of X relative to demand for it doesn’t set the price of X? That makes no logical sense at all. It’s not “the law of demand”.

    BTW, it was Friedman, Krugman and Hayek (I wouldn’t quote Mises on anything — although he certainly agreed on this point too). And when three Nobelists with such disparate views as them (plus all the textbooks) agree on a basic fundamental, I’d be very careful about checking my own logic before claiming it refutes theirs.

    How did Weimar get hyperinflation? Because the people of Germany suddenly decided they weren’t going to consume anything in the future? Then they had no demand for money, sending its price dropping to a millionth of before?

    Or was it because the government ran the printing presses to increase the quantity of money a million-fold? And thus, with the people having the same demand for money as before (intending to use it to buy the same amount of consumption) the million-fold increase in supply plunged the price of reichmark to one-millionth of before, as per supply-and-demand setting the price of money?

    Pick one of the above.

    C’mon, you know very well how Zimbabwe got its hyperinflation — by printing way too dang much money. How do you explain the Zimbawean hyperinflation, collapse of the price of its money, *other than* by supply and demand for money?

    I’m curious, how is it that the harm of creating too much money is so obvious to everyone (except MMTers) but the harm of creating too little is invisible — and often absolutely denied — by the very same people?

    If inflation were merely the decline in the price of money, then all goods would increase in price at the same rate. However, that isn’t the case.

    What goods didn’t rise with the general price level in Weimar and Zimbabwe? Or for that matter, in the USA during the double-digit inflation of the 1970s? Got a list of them?

    If inflation isn’t a decline in the price of money, what is it? What does cause it??

    Moreover…

    “Because the demand for money is a derived demand based on future consumption…”

    … is wrong. Future consumption is funded by *savings*. Demand for savings is set by intended deferred consumption. Money balances normally are only a tiny part of savings, the rest being investments (stocks, bonds, real estate, etc.) and deposits (in banks, money funds, etc. — and a kind of money under some definitions.)

    But money demand also is very much derived from need for liquidity. Money is an absolutely **unique good** in that it is immediately exchangable for anything. There is no other good like that. That creates a demand for money *as money*, for itself. Just as demand exists for cars and TV sets for the value of their unique traits, so there is demand for money due to the value of this unique trait. (A barter economy without money can exist — but name one that ever got out of the pre-industrial era. Try leading your own life on a barter basis without money with no drop in your standard of living. Do those things and you will have an argument that money doesn’t have value *as money*.)

    OK, now imagine something happens — say a major earthquake and tsunami (as just caused a recession in Japan) or a big stock market crash that takes some major banks down with it (such as in the USA in 1929) — that increases the demand for money *both* as savings and to meet liquidity needs.

    That is, both businesses and individuals — especially businesses — react to events with “Yikes, my investments just plunged in value and now look shaky going forward, so I’m going to move my savings from them into safe, secure money. And while my income unexpectedly now looks like it is going down, all my debts remain the same — so I *must raise cash* to stay liquid enough to cover them …”.

    Demand for money goes up, right? If you think that can’t happen just say so, and explain why not.

    But if it does happen, demand for money does go up, all the rest follows.

    []Absent an increase in its supply, the increases in demand for money increases its price — creating disinflation or deflation. This damages business balance sheets.

    Post-1929 there was 25% deflation. That meant that the real cost of interest payments on debt, lease payments, etc, increased 33% … and even as these debt payments were made, paying loans down, the balanced due on them **rose** 33% in real terms. Plus inventories aquired for sale at $1 saw their sake price drop to 75cents. What does all that do to balance sheets and P&L statements?

    It drives business that were perfectly sound when operating in an economy of stable prices and rates straight to bankruptcy.

    Businesses striving to stay afloat had an urgent need to raise liquidity yet further, so investment disappeared, and to slash employment so unemployment exploded, driving up among workers the need for liquidity and “safe” investments, while with deflation ultra-safe savings in money now paid a positive return in the mattress so who needed to save in risky banks? resulting in bank runs en masse, further slashing funds for investment, repeat and repeat, all driving the price of money up further and economic activity down further in a chain reaction.

    Such is the impact of unexpected *deflationary* change in the price of money — demand for it rocketing up relative to supply — much worse point-for-point than inflationary change in its price.

    OR…

    [] The increase in demand for money *is* matched by the central bank increasing its supply (as the 13%-rate deflation of Q4 2008 was stopped on a dime by the Fed with QE1). To the extent the increase in supply accurately corresponds to the increase in demand, the price level and rate environment remain stable. This lets the troubled segments of the economy that triggered the increase in demand for money straighten out their “malinvestments” without dragging down the whole rest of the economy with them.

    All the awful consequences of the deflation in the first option are avoided.

    Now if you really believe there is **no** price of money, so the inflations of Weimar and Zimbabwe and the USA in the 1970s **weren’t** caused by too much money supplied relative to demand for it … and the destructive deflations of 1920s and 1930s in the USA and around the world **weren’t** caused by too little money supplied relative to demand for it … please explain exactly what did cause those inflations and deflations.

    If those inflations and deflations weren’t changes in the price of money, I’d really like to know what they were.

    OTOH, If they were changes in the price of money, well then money does have a price set by supply and demand after all, which has a significant impact on the real economy, with consequences you don’t want to consider.

  33. comment number 33 by: gipp

    Jim,

    I’m definitely not an MMT guy. My past posts quoting Zimbabwe and Weimar attacking the MMT nutters proves that.

    You are attacking a lot of strawmen and making assumptions about my thinking that are not correct. Also, you minimize the theoretical problems economists have trying to develop a microfoundations for understanding the value of fiat money. Don Patinkin wrote an entire book trying to address the problem, and no one thinks he really solved it.

    Von Mises’ solution to the problem was an argument that all fiat money at some point started out as an inventory receipt for a commodity, usually gold, offered as collateral by someone, usually a government.

    Once that anchor to a valuation was established, and the unit of money was used as the numeraire in market transactions, then the guarantee of redeemability could be severed, yet the value of the money did not evaporate. Why? Because vendors continued to accept it.

    Money is demanded because suppliers of goods and services are willing to use it as the numeraire and to accept it in exchange. So you can think of the demand for money like the demand for usage of a language. It exists because other people use it and understand it.

    There really isn’t a marginal utility of money or of the English language in the same sense as apples and oranges. Therefore, the normal language and modeling of microeconomics really doesn’t apply to valuation of money like it does to ordinary consumption goods and services. Just because something has “value” doesn’t mean that we can apply the apparatus of microeconomic theory to “price” it.

    Of course the “supply” of money impacts price levels. But Milton Friedman scratched his head trying to figure out exactly what was THE measurement of the money supply. He backed into the definition by arguing that whatever measure best correlated with changes in the price level, that should be the measure of money supply. He liked M2.

    But when it comes to microeconomic price theory, prices in individual markets are affected by demand and supply in those separate markets. Prices in different markets are affected by changes in the supply of money to the extent that nominal income changes drive demand curves. Changes in the money supply work through the economy unevenly. The urge for macroeconomists to grasp for easy to measure aggregations doesn’t alter this fundamental truth.

    And the markets tracked by the CPI may not be affected by changes in the supply of money for many years. We’ve seen that since the 2008 quantitative easing, monetarists are stumped that inflation has not kicked in sooner. There isn’t a “price of money = 1 / (price level). There are only money prices in different markets, and with inflation, prices don’t uniformly increase. This fact alone is evidence that there isn’t a price of money determined by supply and demand for money. There are only prices of goods in terms of money set by supply and demand for goods.

    You and I have subtle disagreements about the nature of the “demand” for money, but in the main, I think we are in agreement about the long-run effects of changes in the supply of money.

    BTW, I never said that all future consumption demand is manifested by holdings of money balances. Financial assets are the main form of this. However, money would never be held in the first place unless it was used to purchase good in future periods.

    This is why Confederate money lost its value once its defeat was imminent. Even if the Confederate money supply was decreasing, there still would have been inflation and eventual abandonment of the currency. My framework can explain that phenomenon. The QuantityTheory framework cannot.