John Papola is most famous for his Keynes-Hayek Rap but has now added to his Econstories series with the Deck the Halls with Macro Follies video dealing with Say’s Law which came out just before Christmas.
Yesterday I posted an excerpt from an article by John under the heading “Say’s Law going mainstream”. Pedro, in the comments, made an observation to which there was a reply from John himself. Both the comment and John’s response are found below. First the comment:
From the article:
As economic historian Robert Higgs’ pioneering work on the Great Depression suggests, increased uncertainty can depress job growth even in the face of booming consumption. As recent years have demonstrated, consumer demand that appears to be driven by temporary or unsustainable policies is unlikely to induce businesses to hire.
I’m not arguing against the importance of the supply side for recovery, but I think that the system is more interdependent than the article conveys. Uncertainty (and other factors) can lead to demand shocks as well as supply shocks and both will have implications for production and growth. A supply shock is also, of course, a demand shock and the classic keynsian demand shock is liquidity preference. I don’t think anyone would want to say there is no such thing as liquidity preference and that it has no macro effects.
The second part of the para I’ve quoted is a business version of the permanent income hypothesis and I think it is true. Pump priming is therefore very unlikely to start or sustain a recovery. However, when there is a big demand shock I think some spending can act as a parachute.
And here is John’s response which is deeply interesting, very subtle and to the point.
A ‘demand shock’ is, in my view, solely defined as an unmet/excess demand for money. This is not solved by inducing people to consume real output. It is solved by increasing the supply of what is demanded: money. John Stuart Mill understood this, and so do I. Even in monetary disequilibrium, consumption is still not a means to grow the real economy. Demand shocks are not the cause of recession, either. I have yet to find a single economist who could point me to a demand shock which came out of nowhere. Every one is the response to real problems of structural failure. This past one was a response to the house bust. Trillions wasted in non-value-adding production of houses. The bust began in 2006. The money demand shock didn’t happen until AFTER that, in response to the events that followed as a result of that bust in the financial system. Our Fed made matters worse by failing to meet money demand, resulting in a collapse of nominal spending. David Hume, John Stuart Mill and Friedrich Hayek would all say this made a bad situation worse. I agree.
So this article is both compatible with a monetarist and monetary equilibrium approach AND independent of those concerns. Consumption without production leaves society with less. ‘Derived demand’ is a fallacy. And I hope that my notes about the business cycle data make this clear. In the USA, comparing the levels of real growth, employment, private investment and private consumption make clear that record-high consumption can occur along side stagnant or falling employment and growth. Heck, 2012Q4 is a perfect example.
Production is funded by savings, not sales. I know this from experience making payroll for my company. The revenue not distributed to pay for past production is saved for future production to the extent that it is not distributed to the owners. That’s the point of my narrative.
I hope this helps clarify the position and point.