I recently came across the following passage reading an old article written by one of the economic greats. It is Joseph Schumpeter in an article titled “The Explanation of the Business Cycle” and published in Economica in December 1927.
Those economists who really count do not differ so much as most people believe; they start from much the same premises; problems present themselves to them in much the same light. . . .
The problem of the business cycle is a case in point. It presented itself to the classic period and their immediate successors in the aspect of the striking fact of recurring ‘crises’. Two results were speedily established. The one, negative only but of the greatest ‘diagnostic’ importance, was that there can be no such thing as a general glut.
That is, it was unanimously agreed at the highest level amongst economists that demand deficiency is never a correct explanation for recession and therefore recovery can never be driven from the demand side of the economy. This is a principle – now long gone from economic theory because of Keynes – known within the trade as Say’s Law.
The world’s economies are floundering because this principle, understood by all in the 1920s, is now understood by virtually no one. The result is that we now continuously try to drive recovery from the demand side and are on each occasion astonished to find that it does not work.
I take nothing from the great Schumpeter, who was apparently the greatest economist, the greatest horseman and the greatest lover in the Austro-Hungarian Empire.
He is however out of date. The business cycle is a macro concept. It is totally swamped bt micro matters.
There is no business cycle in micro-economics. Simply an ever rising tide of restictions and prohibitions.
There is simply a decline.
Rodney
22 Jul 12 at 11:46 am
What about demographics?
.
22 Jul 12 at 11:48 am
And it’s not going to change quickly either – the global education system has been Fabianised and this has to be reversed before anything can be expected to change. And it has to be a walloping severe depression as well – a veritable dark age – for the fact to penetrate the stygian depths of the Keynesian minds.
Global starvation has the useful function of focussing people’s minds on what is relevant.
Louis Hissink
22 Jul 12 at 11:48 am
It is true there cannot be a general glut, in the sense that one cannot experience excess supply in every market. Excess supply in one market (eg labour) must be matched by excess demand in another (eg money). This is in accordance with Say’s Law, Stephen, so you cannot disagree. The real question is why does this disequilibrium arise and what can and should be done about it.
It arises because of nominal wage rigidity – an empirical fact – prevailing in situations in which shocks occur that require real wages to be cut. The solution (apart from fostering as much wage flexibility as possible) is to supply (and promise to supply) as much money as required to meet a target level of nominal GDP sufficient to facilitate the real wage cuts required to balance the labour market. This simple act will itself curb money demand and require less additional money to be supplied to meet the objective. I implore you, Stephen, to properly open your mind to the work of the market monetarists. Of course it is important to cut or eliminate wasteful government spending and taxes. We here all agree with that. But understand that the answer to stagnation lies beyond simply cutting waste or removing market distortions.
Sleetmute
22 Jul 12 at 12:28 pm
Mute,
What about the machinations of normal commercial lending?
M3 growth generally drives M1 growth. I’m sure the market can adjust quite well if we aren’t subsidising banks with moral hazard to outrageous capitalisation ratios.
.
22 Jul 12 at 12:33 pm
I’m not quite sure what you mean dot. Anecdotally, we hear about the US undergoing significant deleveraging at a time when the money base has expanded dramatically. The problem is that velocity has moved inversely to the money base. This is because the central bank has not made clear that it will do whatever it takes to get NGDP back towards its pre-2008 trendline. NGDP targeting would provide the credibility lacking in the Fed’s and ECB’s actions that should stop the decline in velocity we have observed.
Sleetmute
22 Jul 12 at 1:13 pm
Under ‘normal circumstances’, of course.
In a free market a quasi central bank would issue currency up to the point where the marginal write offs in its loan book matched the marginal arbitrage profits from issuance.
Which pretty much matches NGDP targeting where inflation is implicitly targeted to an average of zero.
.
22 Jul 12 at 2:59 pm
Sleetmute, this is fine as far as it goes, but how do you explain the shocks? Are they exogenous, like a meteor strike, or are the shocks endogenous to the system? This is what the classical business cycle theorists of the past tried to determine. Using Ricardian terminology, what causes men to err in their productions? I can agree with the market monetarists that the money supply should be adjusted to offset a decline in velocity (increase in money demand) but I think that is merely treating symptoms rather than looking for the fundamental causes (which is reasonable for short periods)…This is why cutting wasteful government spending and removing market distortions are vital to repairing a busted economy – because this will ultimately lead to a replenishment of savings and therefore capital. Wasteful government spending just consumes more capital and market distortions will prevent entrepreneurs from discovering new and different opportunities.
Skuter
22 Jul 12 at 5:59 pm
sorry, but schumpeter was wrong about there being general agreement.
Thomas Humphrey wrote an excellent 250 year long literature survey of the rules versus discretion debate in the 1998 Richmond Fed Quarterly.
He wanted to know if macroeconomics was a progressive science in the sense that superior new ideas relentlessly supplanted inferior old ones.
Humphrey found that:
• Keynesian ideas about a lack of demand and their great many antecedents gain currency when unemployment was the main concern.
• Monetarist ideas tended to reign when price stability was the main problem.
Humphrey showed that stable policy rules are popular in good times to contain inflation, and when unemployment was rising, discretionary monetary policies returned to policy vogue.
The policy debate keeps recycling because
1. people forget the lessons of the past and
2. For better or worse, politicians and the public have tended to believe that central banks, the focus of his studies, have the power to boost output, employment, and growth permanently.
Humphrey concluded that doctrinal historian knows that much of what passes for novelty and originality in monetary theory and policy is ancient teachings dressed up in modern guises.
Haberler, Jacob Viner and frank knight also all pointed out in their reviews of the General Theory that it lacked originality, and presented old ideas often incorrectly in confusing new vocabularies that made the book difficult to read.
Jim Rose
22 Jul 12 at 6:00 pm
Its time for someone 2 be completely and utterly honest and the core level in this whole debate.
1) Keynes was a Homosexual
2) We have been ruled for the last 150 years by female monarchs.
Heterosexual men know from a very very young age that they have to produce, they have to be strong, productive, responsibile, conservative and useful, in a social context they have to live by Says law or they are shut out.
This is not the experience of Homosexual men (like Keynes) or Women.
This is the core reason why the world is fucked – no one with any experience of being useful or productive has run anything for a very very long time.
Peaceout to H’mos and women, the reality is you just dont understand
Max
22 Jul 12 at 6:12 pm
What about the high income levels of “gay” suburbs like the inner east and inner west in greater Sydney?
.
22 Jul 12 at 6:16 pm
Keynes was bisexual. How does that fit the theory?
Rodney
22 Jul 12 at 6:23 pm
Might be useful to study Keynes at Harvard first – always helpful to get some primary sources. Keynes was also a self confessed bolshevik apparently.
Louis Hissink
22 Jul 12 at 6:42 pm
1) In all the suburbs they represent less have half of the overall population.
2) They mostly work as rent seeking tax eaters or in the color and movement industries – they dont actually make anything of enduring value and their economic success is also largely as a result of not having to support a wife and family.
3) Keynes had sexual optionality, he didn’t HAVE to live by Says law, he could choose to. Heterosexual men do not have that choice.
4) Keynes wife was probably a “beard”
Max
22 Jul 12 at 6:49 pm
Thanks for your link Louis.
Just as men can never understand being pregnant and giving birth.
H’mos and women can never understand trudging to the same factory for 40 years all in the hope of providing for and lifting up their children.
We live in different worlds.
Max
22 Jul 12 at 7:10 pm
…but you can pontificate about both…riiight.
.
22 Jul 12 at 7:47 pm
We have been ruled for the last 150 years by female monarchs.
From 1901-1952 it was solely male monarchs. You might want to check your history. (Two of the three even had beards).
Quentin George
22 Jul 12 at 8:04 pm
Skuter, shocks can be real or nominal and may come from the demand or supply side. Of course you want to minimise shocks, but they are unavoidable – export commodity prices (eg iron ore), import commodity prices (eg oil) world demand (eg GFC).
Sleetmute
23 Jul 12 at 6:45 am
Just heard on the ABC News that the last recession Australia was in was 21 years ago.
Quoting some economic comentator from Deloite’s ?
Presumably based on irrefutable statistics?
Louis Hissink
23 Jul 12 at 7:06 am
Sleet, I would argue that while some shocks are exogenous, like the ones you have outlined, there are also endogenous shocks and so are some are avoidable. I would also add that Keynesian and Monetarist prescriptions to deal with exogenous shocks can disrupt the structure of production. That is, lines of business get established (scarce capital gets diverted into these sectors) that is not sustainable without continued government support or low interest rates. The pink batts program is the clearest example. Look at how the Government basically blew up a well functioning market – the stockpiles that were built up and the new entrants, some dodgy ones, that flooded into the sector. Monetary policy is not as direct as that but interest rates that do not reflect the amount of available savings will lead to projects being commenced that are ultimately not sustainable. As I said, I can understand short bursts of loose monetary policy to offset a decline in velocity of circulation, but it should be used sparingly…
Skuter
23 Jul 12 at 9:40 am
Sleet, here is a rather more articulate version of our little debate here:
http://uneasymoney.com/2012/07/22/to-qe-or-not-to-qe/
Skuter
23 Jul 12 at 10:10 am
Skuter, yes, I am with Glasner on that. Market Monetarism seeks to use the market to drive stabilisation policy. The central bank would use a prediction market to stabilise market expectations of NGDP growth. This should help minimise the prospects of the central bank amplifying shocks.
This is how Lars Christensen explains it:
Sleetmute
23 Jul 12 at 4:09 pm
OK Sleet, on this point we don’t disagree, but the focus on NGDP as the be all and end all leaves no room for changes in relative prices/wages.
The aspect to which I think the market monetarists pay insufficient attention is the changes in relative prices necessary to restore equilibrium. In other words, there needs to be more attention paid to ways of achieving not just downward flexibility in all wages and prices, but in some wages and prices relative to others. Monetary expansion will change relative prices, but not necessarily in a predictable way and it is this aspect that makes it potentially damaging. So much depends on how the money is injected into the system of course. That is why I don’t really think market monetarism has all the answers. Having said that, a failure to offset declining velocity of circulation will lead to needless suffering…
Skuter
23 Jul 12 at 4:47 pm
Skuter, I don’t think proponents of NGDP targeting claim it to be a substitute for different nominal wage growth in different industries according to the specific conditions prevailing in those industries. Just that they would (quite rightly) see this as outside the remit of macroeconomics. Scott Sumner for instance is a big advocate of supply-side reform.
Sleetmute
23 Jul 12 at 4:55 pm
Whereas in my view, you can’t separate the macro from the micro, as the micro has macro implications – in other words monetary disequilibrium is not just a macro story…I see the distinction between the two as flawed and one of the (many) damaging legacies of Keynes…
However, I do acknowledge that there are instances when monetary expansion will bring us back into what Leijonhufvud would have described as the ‘corridor’. When we are inside the corridor (i.e. not too far away from monetary equilibrium) changes in relative prices and wages can occur relatively smoothly, whereas if we are outside the corridor (i.e. all prices/wages are a long way from monetary equilibrium prices/wages), then changes in relative prices/wages are less important than adjusting the overall level of prices/wages. I suppose you could say that we need to get back towards the correct NGDP growth path before tackling misallocations of resources…the only thing is, will monetary expansion allow this to happen without distorting relative prices/wages further? Can it be controlled effectively and precisely enough? I definitely think the distortionary effects of fiscal policy are worse though…
Skuter
23 Jul 12 at 5:09 pm