What We Talk About When We Don't Talk About Demand

There sure are a lot of ways to not say aggregate demand.

Here's the estimable Joseph Stiglitz, not saying aggregate demand in Vanity Fair:

The parallels between the story of the origin of the Great Depression and that of our Long Slump are strong. Back then we were moving from agriculture to manufacturing. Today we are moving from manufacturing to a service economy. The decline in manufacturing jobs has been dramatic—from about a third of the workforce 60 years ago to less than a tenth of it today. ... There are two reasons for the decline. One is greater productivity—the same dynamic that revolutionized agriculture and forced a majority of American farmers to look for work elsewhere. The other is globalization... (As Greenwald has pointed out, most of the job loss in the 1990s was related to productivity increases, not to globalization.) Whatever the specific cause, the inevitable result is precisely the same as it was 80 years ago: a decline in income and jobs. The millions of jobless former factory workers once employed in cities such as Youngstown and Birmingham and Gary and Detroit are the modern-day equivalent of the Depression’s doomed farmers.

This sounds reasonable, but is it? Nick Rowe doesn't think so. Let's leave aside globalization for another post -- as Stieglitz says, it's less important anyway. It's certainly true that manufacturing employment has fallen steeply, even while the US -- despite what you sometimes here -- continues to produce plenty of manufactured goods. But does it make sense to say that the rise in manufacturing productivity be responsible for mass unemployment in the country as a whole?

There's certainly an argument in principle for the existence of technological unemployment, caused by rapid productivity growth. Lance Taylor has a good discussion in chapter 5 of his superb new book Maynard's Revenge (and a more technical version in Reconstructing Macroeconomics.) The idea is that with the real wage fixed, an increase in labor productivity will have two effects. First, it reduces the amount of labor required to produce a given level of output, and second, it redistributes income from labor to capital. Insofar as the marginal propensity to consume out of profit income is lower than the marginal propensity to consume out of wage income, this redistribution tends to reduce consumption demand. But insofar as investment demand is driven by profitability, it tends to increase investment demand. There's no a priori reason to think that one of these effects is stronger than the other. If the former is stronger -- if demand is wage-led -- then yes, productivity increases will tend to lower demand. But if the latter is stronger -- if demand is profit-led -- then productivity increases will tend to raise demand, though perhaps not by enough to offset the reduced labor input required for a given level of output. For what it's worth, Taylor thinks the US economy has profit-led demand, but not necessarily enough so to avoid a Luddite outcome.

Taylor is a structuralist. (The label I think I'm going to start wearing myself.) You would be unlikely to find this story in the mainstream because technological unemployment is impossible if wages equal the marginal product of labor, and because it requires that output to be normally, and not just exceptionally, demand-constrained.

It's a good story but I have trouble seeing it having much to do with the current situation. Because, where's the productivity acceleration? Underlying hourly labor productivity growth just keeps bumping along at 2 percent and change a year. Over the whole postwar period, it averages 2.3 percent. Over the past twenty years, 2.2 percent. Over the past decade, 2.3 percent. Where's the technological revolution?

Just do the math. If underlying productivity rises at 2 percent a year, and demand constraints cause output to stay flat for four years [1], then we would expect employment to fall by 8 percent. In other words, lack of demand explains the whole fall in employment. [2] There's no need to bring in structural shifts or anything else happening on the supply side. A fall in demand, plus a stable rate of productivity increase, gets you exactly what we've seen.

It's important to understand why demand fell, but from a policy standpoint, no actually it isn't. As the saying goes, you don't refill a flat tire through the hole. The important point is that we don't need to know anything about the composition of output to understand why unemployment is so high, because the relationship between the level of output and employment is no different than it's always been.

But isn't it true that since the end of the recession we've seen a recovery in output but no recovery in employment? Yes, it is. So doesn't that suggest there's something different happening in the labor market this time? No, it doesn't. Here's why.

There's a well-established empirical relationship in macroeconomics called Okun's law, which says that, roughly, a one percentage point change in output relative to potential changes employment by one a third to a half a percentage point. There are two straightforward reasons for this: first, a significant fraction of employment is overhead labor, which firms need an equal amount of whether their current production levels are high or low. And second, if hiring and training employees is costly, firms will be reluctant to lay off workers in the face of declines in output that are believe to be temporary. For both these reasons (and directly contrary to the predictions of a "sticky wages" theory of recessions) employment invariably falls by less than output in recessions. Let's look at some pictures.

These graphs show the quarter by quarter annualized change in output (vertical axis) and employment (horizontal axis) over recent US business cycles. The diagonal line is the regression line for the postwar period as a whole; as you would expect, it passes through zero employment growth around two percent output growth, corresponding to the long-run rate of labor productivity growth.

1960 recession

1969 recession

1980 and 1981 recessions

1990 recession

2001 recession

2007 recession

What you see is that in every case, there's the same clockwise motion. The initial phase of the recession (1960:2 to 1961:1, 1969:1 to 1970:4, etc.) is below the line, meaning growth has fallen more than employment. This is the period when firms are reducing output but not reducing employment proportionately. Then there's a vertical upward movement at the left, when growth is accelerating and employment is not; this is the period when, because of their excess staffing at the bottom of the recession, firms are able to increase output without much new hiring. Finally there's a movement toward the right as labor hoards are exhausted and overhead employment starts to increase, which brings the economy back to the long-term relationship between employment and output. [3] As the figures show, this cycle is found in every recession; it's the inevitable outcome when an economy experiences negative demand shocks and employment is costly to adjust. (It's a bit harder to see in the 1980-1981 graph because of the double-dip recession of 1980-1981; the first cycle is only halfway finished in 1981:2 when the second cycle begins.)

There's nothing exceptional, in these pictures, about the most recent recession. Indeed, the accumulated deviations to the right of the long-term trend (i.e., higher employment than one would expect based on output) are somewhat greater than the accumulated deviations to the left of it. Nothing exceptional, that is, except how big it is, and how far it lies to the lower-left. In terms of the labor market, in other words, the Great Recession was qualitatively no different from other postwar recessions; it was just much deeper.

I understand the intellectual temptation to look for a more interesting story. And of course there are obviously structural explanations for why demand fell so far in 2007, and why conventional remedies have been relatively ineffective in boosting it. (Tho I suspect those explanations have more to do with the absence of major technological change, than an excess of it.) But if you want to know the proximate reason why unemployment is so high today, there's a recession on still looks like a sufficiently good working hypothesis.


[1] Real GDP is currently less than 0.1 percent above its level at the end of 2007.

[2] Actually employment is down by only about 5 percent, suggesting that if anything we need a structural story for why it hasn't fallen more. But there's no real mystery here, productivity growth is not really independent of demand conditions and always decelerates in recessions.

[3] Changes in hours worked per employee are also part of the story, in both downturn and recovery.

Is the Euro the Problem?

What's wrong in Europe?

Krugman is saying, again, that it's the inability to adjust exchange rates. He quotes Kevin O'Rourke:

The world nowadays looks very much like the theoretical world that economists have traditionally used to examine the costs and benefits of monetary unions. The eurozone members’ loss of ability to devalue their exchange rates is a major cost. Governments’ efforts to promote wage cuts, or to engineer them by driving their countries into recession, cannot substitute for exchange-rate devaluation. Placing the entire burden of adjustment on deficit countries is a recipe for disaster.

 In other words, it's a problem of relative prices. Wages are too high in Greece, Spain and Ireland, so those countries face unemployment; wages are too high in Germany, so it's experiencing an inflationary boom; and wages are just right in France, so it's chugging along at full capacity.

Wait, what?

Of course that's not what's going on at all.

There are a lot of ways not to talk about aggregate demand.

The Mind of the Master Class

In comments, Arin says,

my view of the world is that there were (at least) two distinct phases ... First was the emergence of a market for corporate control through hostile takeovers in the 1980s, which may have changed managerial incentives to basically ward off such possibilities. However, it didn't lead to greater power of shareholders over management ... consolidation and mergers over time ended up actually increasing managerial prerogatives. However, it was of course a very different type of management ... one whose incentives were quite aligned with short term capital gains which were also potentially helpful to ward off challenge for control... So yes, the market for corporate control changed the world - but ironically it changed it by passing more rents to managers, not less.

I don't know that I agree -- or at least, it depends what you mean by managerial prerogatives. Relative to workers, to consumers, to society at large? Sure. Relative to shareholders? I'm not so sure. But let's say Arin is right. I don't think it fundamentally changes the story. What I'm talking about isn't fundamentally a conflict between two different groups of people, but between two functions. Capital, as we know, is a process, value in a movement of self-expansion: M-C-C'-M'. The question is whether capital as a sociological entity, as something that act on its own interests, is conscious of itself more in the C moments or in the M moments. Do the people who exercise political power on behalf of capital think of themselves more as managers of a production process, or as stewards of a pool of money? The point is that sometime around 1980, we saw a transition from the former to the latter. Whether that took the form of an empowering of the money-stewards at the expense of the production-managers, or of everyone in power thinking more like a money-steward, is less important.

I heard a story the other day that nicely illustrates this. Back in the Clinton era, a friend of a friend was on a commission to discuss health care reform, the token labor guy with a bunch of business executives. So, he asked, why don't the Big Three automakers and other old industrial firms support some kind of national health insurance? Just look at the costs, look at how much you could save if you focus on making cars instead of being a health insurer. Well yes, the auto executives at the meeting replied, you make a good point. But you know, our big focus right now is on reducing the capital gains tax. Let's deal with that first, and then we can talk about health insurance.

If you're an executive in neoliberal America, you're an owner of financial assets first and foremost, and responsible for the long-term interests of the firm you manage second, third or not at all.

Netflix Disgorges the Cash

For a great example of what I've been talking about, check out this Dealbreaker post on how Netflix spent the past two years buying back its own stock, and then just this past Monday turned around and announced that it was selling stock again. Matt Levine:

NFLX bought 3.5 million shares of stock at an average price of $117 in 2010-2011, at a total cost of $410 million, and paid for it by issuing 5.2 million shares of stock at an average price of $77 in November 2011, for total proceeds of $400 million – minus $3 million that we pay to Morgan Stanley and JPMorgan to place the deal. So 1.7 million extra shares outstanding for net proceeds of negative $13mm or so. 

The comical thing about this from the point of view of the financial press is the buy-high, sell-low side of it. And of course whoever was on the other side of Netflix's share repurchases this past summer, when the stock was at four times its current value, must be laughing right now. But as Levine says, this is what the system is set up to do:

Most companies are rewarded for squeezing every last penny out of EPS [earnings per share] – in executive bonuses, sure, but also in stock price more broadly. It’s what investors want. ... So with Netflix: when things are good and it’s rolling in cash, it pushes up its price by buying. When things are bad and it needs cash, it pushes down its price by selling. And its incentives are neatly aligned to do so: when things are good, it needs one more penny of EPS; when things are terrible – hell, who cares about dilution when you’re unprofitable anyway? (It’s a good thing!)

Another way of looking at this, tho, is that buying its own shares high and selling them low is exactly how a firm should behave if shareholders really are the residual claimants, operationally and not just in principle. In the textbook this doesn't really come out, since "shareholder as residual claimant" is just a first-order condition imposed on some linear equations. But if you take it seriously as a claim that shareholders own every incremental dollar that the firm earns or raises, and that management is a not just the solution to an Euler equation but a distinct group of people who may have their own views on the interests of the firm, then shareholders should want businesses to behave just like Netflix -- pay out more when more is coming in, and then ask them for some back when more needs to go out. Can't be a residual claimant if you don't claim your residuals.

Now, financing investment is going to be more costly when it involves selling and repurchasing shares, compared to if you'd just kept the savings-investment nexus inside the firm in the first place. And these transactions were also disastrous for the firm's long-term shareholders -- in effect, they transferred $400 million from people who continued holding the stock to those who sold in 2010 and 2011. So in this case, a system designed to maximize shareholder value didn't even deliver that. Shareholders would have done better with management who said, Screw the shareholders, we're going to build the best, biggest online movie rental company we can. If you own our stock just sit back, shut up, and trust that you'll get your payoff eventually.

As the man says, "When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done."

On Other Blogs, Other Wonders

1. Are Banks Necessary?

Ashwin at Macroeconomic Resilience had a very interesting post last month arguing that the fundamental function of banks -- maturity transformation -- is no longer required. Historically, the reason banks existed was to bridge the gap between ultimate lenders' desire for liquid, money-like assets and borrowers' need to fund long-lived capital goods with similarly long-term liabilities. Banks intermediate by borrowing short and lending long; in some sense, that's what defines them. But as Ashwin argues, today, on the one hand, we have pools of longer-term savings for which liquidity is not so important, at least in principle, in the form of insurance and pension funds, which are large enough to meet all of businesses' and households' financing needs; while on the other hand the continued desire for liquid assets can be met by lending directly to the government which -- as long as it controls its own currency -- can't be illiquid and so doesn't have to worry about maturity mismatch. It's a very smart argument; my only quibble is that Ashwin interprets it as an argument for allowing banks to fail, while it looks to me like an argument for not having them in the first place.

Another way of reaching the same conclusion, in line with recent posts here, is that you can avoid much of the need for maturity transformation, and the other costs of intermediation, including the rentiers' vig, if business investment is financed by the business's own saving.  In comments to the Macroeconomic Resilience post, Anders (I don't think the same Anders who comments here) points to some provocative comments by Izabella Kaminska in a Financial Times roundtable:

An FT view from the top conference, with Martin Wolf moderating. He said an interesting thing re. all the cash on the balance sheets of American corporates. That for many US corporates, banks have become completely redundant, they just don’t need them. ... The rise of the corporate treasury, investing wisely on its own behalf. Banks have failed at the one job they were supposed to do well, which was credit intermediation... No wonder banks have sought ever more exotic creative financing options .. their traditional business is dying. They’re not lending, can’t lend. So corporates are inadvertently acting by piling up cash reserves to solve that problem.... [You] see lots of examples of Corporates who don’t trust banks. … it’s amazing to think that we have come this far in the last two years… to a point where people like Larry Fink are suggesting banks are pointless.

This is part of the story of Japan's Lost Decade that Krugman doesn't talk about much, but that Richard Koo puts right at the heart of the story: By the mid 1980s, Japanese corporations could finance almost all of their investment needs internally, but the now-redundant banking system didn't shrink, but found a reason for continued existence in financing real estate speculation. Banks may be pointless, but that doesn't mean they'll go away on their own.

2. Are Copyrights Necessary?

I'm surprised there hasn't been more discussion in the blogosphere of this new working paper by Joel Waldfogel on copyright and new music production. (Summary here.) Has Yglesias even mentioned it? It's totally his thing: an empirical study of whether file-sharing has reduced the amount of good music being produced, where "good" is measured by radio airplay, and various critics' best-of lists. Which, whatever, but you've got to measure it somehow, right? And, oh yeah, the answer is No:

We find no evidence that changes since Napster have affected the quantity of new recorded music or artists coming to market. ... While many producers of recorded music have been made worse off by changes in technology, there is no evidence that the volume of high-quality music, or consumers, have suffered.

Information wants to be free.



3. It's an Honor Just to Be Nominated

Hey, look, someone at everyone's favorite site for d-bags with PhDs, econjobrumors.com, has started a thread on the worst economics blogs. And the first blog suggested is ... this one. "Krugnuts times 11," he says. I think that'll be the new tagline.

Anti-Mankiw

Elsewhere on the World Wide Web: Some UMass comrades have revived the internet tradition of the grudge blog with this interesting new blog, with the Stakhanovite goal of refuting (tho thankfully not fisking) every post Greg Mankiw makes. It's an ambitious goal, especially since the average wordcount ratio of an anti post to its underlying Mankiw post is running around 50:1. But they're managing so far. You should read it. And if anyone wants to take a swing at the pinata, I think they may still be looking for new contributors.

So why aren't I contributing? Mainly because time is scarce and I am very lazy, so blogging-wise I'm tapped out just keeping up a trickle of content here. But also, to be honest, because I have some qualms about the anti-ness of the left in economics generally. Anti-Mankiw is a great project, and I have nothing but admiration for the students who walked out of Mankiw's class. But there's a certain assumption here that we on the left have a well-developed alternative economics, which the Mankiws of the world are ignoring or suppressing. If only that were true.

Right now I'm teaching macro, and I’m presenting basically the same material as everyone else. ISLM, AS/AD, and their open economy equivalents. How come? Well, partly because I feel a certain professional duty. Students signed up for a course in intermediate macroeconomics, not in J.W. Mason Thought. (That will be next semester.) But mainly because it’s the path of least resistance. I don’t know any good textbook that presents the fundamentals of macroeconomics from a genuinely Keynesian or radical perspective. And working up a course by myself would be vastly more work, and I don't think I could do it justice. A downward sloping AD curve, let's say, is absurd. There's no real economy on earth in which the main effect of deflation is to stimulate demand via a real balance or "Keynes" effect. It pains me to even put it on the board. But what's the counterhegemonic model of inflation I should be teaching in its place?

It’s not just me. I know a number of people who are unapologetic Marxists in their own work, yet when they teach undergraduate macroeconomics, they use Blanchard or some similarly conventional text. It’s a structural problem. I don’t mean to defend Mankiw, but in some ways I think those of us on the left of the profession are more to blame for the state of undergraduate economics education. We spend too much time on critiques of the mainstream, and not nearly enough developing a systematic alternative. Some people criticize radical economists for just talking to each other, but personally I think we don’t talk to each other nearly enough.

The anti-Mankiw that's needed, it seems to me, isn't a critique, but an alternative; as long as we're arguing with him, he still gets to decide what we're talking about. That's one reason I prefer to spend my time debating people like Krugman, DeLong, John Quiggin, and Nick Rowe, who I respect and learn from even when I don't agree with them. (Another reason is that attention is a precious resource and I prefer giving the bit I get to allocate to people and ideas that deserve it.)

It’s true that the ideological policing in economics is very tight—but mainly at the top end, and even there mostly not at the level of undergraduate teaching. As far as I can tell, most places nobody cares what you do in the classroom; there’s already plenty of space for alternatives at schools that aren't Harvard. But people mostly aren’t using that space. In my experience, even when people want to bring a “radical” perspective to undergraduate econ, that means presenting the mainstream models and then dissecting  them, which preserves the mainstream view as the default or starting point, when it doesn't just leaves students confused. "Radical" economics almost never seems to mean simply teaching economics the way we radicals think it should be taught.

So yes, Occupy Mankiw, by all means. But maybe we should also think more about the classrooms we’re already occupying. Or as a graffito that should be familiar to the male fraction of anti-Mankiw says:

Start your own hit band or stop bitching

EDIT: If anyone reading this wants to suggest good models or resources for what an undergrad economics course ought to look like, I'd be thrilled to hear them.

FURTHER EDIT: Lots of suggestions. I need to walk back a little: There are more good alternatives to Mankiw  & co. than you'd guess reading this post. But the key point is still, we need to move past critique and develop our own positive views. As long we're responding to him, he's setting the terms of the conversation. Read about, say,  Paul Sweezy in the 1940s -- he was so admired not because he had such a cutting critique, but because he so clearly and confidently offered an alternative. (And because he was so charming and good-looking, but that sort of goes with it, I think.) We'll be getting somewhere when, instead of rushing to rebut everything Mankiw says, we can say, "Oh, is that guy still writing? Well, forget about him -- here's the good stuff."

So, the good stuff.

I should have mentioned two excellent macro texts that, while they are too advanced for the students I'm teaching now, really comprehensively describe the state of the art alternative approaches to macro: Michl and Foley's Growth and Distribution and Lance Taylor's Reconstructing Macroeconomics. If, like me, you;re more more interested in short-term dynamics than growth models, you might get a little more out of the Taylor book, but both are very good.

In comments, NKlein suggests Godley and Lavoie's Monetary Economics: An Integrated Approach, which I know other people recommend but I'm afraid I haven't read (tho it's on my Kindle), and mentions that Randy Wray and Bill Mitchell are working on a new textbook. I believe Wray currently teaches undergraduate macro at Kansas City using Keynes' General Theory as the primary textbook, which is not a terrible idea (tho it would probably depend on the students.)

A lot of people like Understanding Capitalism, by Sam Bowles, Richard Edwards and Frank Roosevelt. Sam's microeconomics textbook is also supposed to be good, if, god forbid, you have to teach that. (But the orthodox-heterodox divide doesn't really exist in micro, I don't think.)

Meanwhile, over on anti-Mankiw itself, Garth suggested -- more or less simultaneously with this post -- Steve Cohn's Reintroducing Macroeconomics, and linked to a long list of heterodox texts. I'm only familiar with a few of the books on the list, altho most of the ones I do know are grab-bags of critical essays, which is not quite what I'm looking for. But clearly there's a lot out there.

The Capitalist Wants an Exit

Like a gratifyingly large proportion of posts here, Disgorge the Cash! got a bunch of great comments. In one of the last ones, Glenn makes a number of interesting points, some of which I agree with, some which I don't. Among other things, he asks why, if businesses really have good investment projects available, rational investors would demand that they pay out their cashflow instead. Isn't it more logical to suppose that payouts are rising because investment opportunities are scarcer, rather than, as the posts suggests, that firms are investing less because they are being compelled to pay out more?

One standard answer would be information asymmetries. If firms have private information about the quality of their investment opportunities, it may be more efficient to have capital-allocation decisions made within firms rather than by outside lenders. The cost of being unable to shift capital between firms may be less than the cost of the adverse selection that comes with information asymmetries. That's one answer. But here I want to talk about a different one.

Capital in general, and finance in particular, places a very high value on liquidity. But if wealth owners insist on the freedom to reallocate their holdings at a moment's notice, and need the promise of very high returns to let them be bound up in something illiquid, then investment in the aggregate will be inefficiently low. As Keynes famously wrote,

Of all the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of "liquid" securities. It forgets there is no such thing as liquidity of investment for the community as a whole.

Or as Tom Geoghegan recalls, from the last days of the old regime in the late 1970s,

Once a friend of mine from Harvard Business School came to visit, and I took him to South Works, just to see it.

"Wow," he said. "I've never seen so much capital just lying on the ground. At B School we used to laugh at how conservative these big steel companies are, but then you could come out and see all this capital, just lying on the ground..."

Capitalists, in general, do not like to see their capital just lying on the ground. They prefer it to be abstract, intangible, liquid.

There's no question that the shareholder revolution of the 1980s had a strong distributional component. Rentiers thought that workers were getting to much of "their" money. But if we're looking specifically at the conflict between shareholders and management -- as much a conflict between worldviews as between distinct groups of people -- then I think "the fetish of liquidity" is central.

As Keynes understood, liquidity is what stock markets are for. What they're not for, is raising funds for investment. That wasn't why they were invented (the publicly traded corporation is a relatively recent innovation), and it's not what they've been used for. Apart from a few years in the 1920s and a few more in the late 1990s, stock issues have never been an important source of investment finance for firms.

Let's talk about Groupon. Huge IPO, raised $700 million, the biggest offering in years. So, those people who bought shares, they're getting ownership of the company in return for providing it much needed funds for expansion, right?

Except that "Groupon has been shouting until it’s blue in the face that it doesn’t need the IPO cash, that it’s fine on the cash front, that the IPO is just a way of going public, and is not really about the money-raising at all." Cashflow is more than enough to finance all their foreseeable expansion plans. So why go public at all, then?

Because their existing investors want cash, that's why. Pre-IPO, Groupon was already notorious for using venture capitalist funds to cash out earlier investors.

Groupon is a very innovative company, and this is one of its most important innovations — the idea that the founder can and even should be able to cash out to the tune of millions of dollars very early on in the company’s lifecycle, while it is still raising new VC funds.... Historically, VC rounds have been about providing capital to companies which need it; in Groupon’s case, they’re more about finding a way to cash out early investors

But the venture capitalists need to be cashed out in their turn. After CEO Andrew Mason turned down offers from Yahoo and then Google to purchase the company, his VC bankers became increasingly antsy about being stuck owning a business, even a business selling something intangible as internet coupons, rather than safe pure money. Thus the IPO:

The board — and Groupon's investors — had a message for Mason, though. Someday, he was going to have to either accept an offer like that one he had just turned down, or take this company public.

One investor recounts the conversation: "We said, okay Andrew, you took venture capital, and remember venture capitalists want an exit.  It doesn't have to be tomorrow but you always have to be thoughtful when a company comes to buy your company, because it's not just you, it's your employees, options, investors and alike."

That's what Wall Street is for: to give capitalists their exit.

The problem finance solves is not how to allocate society's scarce savings between competing investment opportunities. In modern conditions, it's the opportunities that are scarce, not the savings. (Savings glut, anyone?) The problem is how to separate the rents that come from control of a strategic social coordination problem from the social ties and obligations that go with it. The true capitalist doesn't want to make steel or restaurant deals or jumbo jets or search engines. He wants to make money. That's been true right from the beginning. It's why we have stock markets in the first place.

Historically the publicly-owned corporation came into being to allow owners (or more typically, their heirs) to delink their fortunes from particular firms or industries, and not as a way of raising capital.

In her definitive history of the wave of mergers that first established publicly-traded corporations (outside of railroads), Naomis Lamoreaux is emphatic that raising funds for investment was not an important motivation for adopting the new ownership form. In contemporary accounts of the merger wave, she says, "Access to capital is not mentioned." And in the hearings by the U.S. Industrial Commission on the mergers,  "None of the manufacturers mentioned access to capital markets as a reason for consolidation." Rather, the motivation for the new ownership form was a desire by the new capitalist elite to separate their wealth and status from the fortunes of any particular firm or industry:

after the founder's death or retirement, ownership dispersed among heirs "who often were interested only in receiving income" from the company rather than running it. Where the founder was able to consolidate family control, as in Ford or Rockefeller,

the shift to public ownership was substantially delayed.

The same point is developed by historians Thomas Navin and Marian Sears:

A pattern of ownership somewhat like that in the cotton textile industry of New England might eventually have come to prevail: ownership might have spread, but to a limited degree; shares might have become available to outsiders, but to a restricted extent. It was the merger movement that accelerated the process and intensified it - to a smaller extent in the earlier period, 1890-1893, to a major degree in the later period, 1898-1902. As a result of the merger movement, far more people parted with their ownership in family businesses than would otherwise have done so; and doubtless far more men of substance (nonindustrialists with investable capital) put their funds into industry than would otherwise have chosen that type of investment. ...

[As to] why individual stockholders saw an advantage in surrendering their ownership in a single enterprise in favor of participation in a combined venture ..., one of the strong motivations apparently was an opportunity to liquidate part of their investment, coupled with the opportunity to remain part owners. At least this was a theme that was played on when stockholders were asked to join in a merger. The argument may have been used that mergers brought an easing of competition and an opportunity for enhanced earnings in the future. But the trump card was immediate liquidity.

The comparison with New England is interesting. Indeed, in the first half of the 19th century a very different kind of capitalism developed there, dynastic not anonymous, based on acknowledging the social ties embodied in a productive enterprise rather, than trying to minimize them. But historically the preference for money has more often won out. This was even more true in the early days of capitalism, in the 17th century. Braudel:

it was in the sphere of circulation, trade and marketing that capitalism was most at home; even if it sometimes made more than fleeting incursions on to the territory of production.

Production, he continues, was "foreign territory" for capitalists, which they only entered reluctantly, always taking the first chance to return to the familiar ground of finance and long-distance trade. Of course this changed dramatically with the Industrial Revolution. But there's an important sense in which it's still, or once again, true.

Are Wages Too High?

Here's a good one for the right-for-the-wrong-reasons file.

David Glasner is one of an increasing number of Fed critics who would like to see a higher inflation target. Today, he takes aim at a Wall Street Journal editorial that claims that the real victims of cheaper money wouldn't be, you know, people who own money -- creditors -- as one might think, but working people. Higher inflation just means lower real wages, says the Journal. Crocodile tears, says Glasner -- since when does the Journal care about wage workers? So far, so good, says me.

"What makes this argument so disreputable,"he goes on,

is not just the obviously insincere pretense of concern for the welfare of the working class, but the dishonest implication that employment in a recession or depression can be increased without an, at least temporary, reduction in real wages. Rising unemployment during a contraction implies that real wages are, in some sense, too high, so that a falling real wage tends to be a characteristic of any recovery, at least in its early stages. The only question is whether the falling real wage is brought about through prices rising faster than wages or by wages falling faster than prices. If the Wall Street Journal and other opponents of rising prices don’t want prices to erode real wages, they are ipso facto in favor of falling money wages.

And here we have taken a serious wrong turn.

Glasner is certainly not alone in thinking that rising prices are associated with falling real wages, and vice versa. And he's also got plenty of company in his belief that since the wage is equal to the marginal product of labor, and marginal products should decline, in the short run higher employment implies a lower real wage. But is he right? Is it true that if employment is to rise, "the only question" is whether wages fall directly or via inflation? Is it true that unemployment necessarily means that wages are too high?

Empirically, it seems questionable. Let's look at unemployment and wages in the past few decades in the United States. The graph below shows the real hourly wage on the x-axis and the unemployment rate on the y-axis. The red dots show the two years after the peak of unemployment in each of the past five recessions. If reducing unemployment always required lower real wages, the red dots should consistently make upward sloping lines. The real picture, though, is more complicated.

As we can see, the early 2000s recovery and, arguably, the early 1980s recovery were associated with falling real wages. but in the early 1990s, employment recovered with constant real wages -- that's what the vertical line over on the left means. And in the two recessions of the 1970s, the recoveries combined falling unemployment with strongly rising real wages. If we look at other advanced countries, it's this last pattern we see most often. (I show some examples after the fold.) So while rising employment is sometimes accompanied by a falling real wage, it is clearly not true that, as Glasner claims, it necessarily must be.

This is an important question to get straight. There seems to be a certain convergence happening between progressive-liberal economists and neo-monetarists like Glasner on the desirability of higher inflation in general and nominal GDP targeting in particular. There's something to be said for this; inflation is the course of least resistance to cancel the debts. But we in the party of movement can't support this idea or make it part of a broader popular economic program if it's really a stalking horse for lower wages.

Fortunately, the macroeconomic benefits of a rising price level don't depend on a falling real wage.

"Ten People Acting Together Can Make a Hundred Thousand Tremble Separately"

Suresh's excellent post on the Occupy Wall Street movement reminded me of Hannah Arendt's On Revolution. It's a funny book; I don't know if it's much read today. One of its innovations, or eccentricities, is to place the American Revolution not just in the revolutionary tradition, but right at its center. Another is the focus on the idea of "public happiness" -- the idea that there's a distinct kind of wellbeing that comes from participation in collective decisionmaking. And most relevant to the current conversation, is its emphasis on the role of local councils -- non-elected but representative -- in every revolutionary situation, from 18th century New England town meetings to the soviets of 1918. These have independently developed, she argues, the"federal principle" -- the idea that democratic politics consists not in selecting leaders who then exercise power on behalf of the public, but rather of local bodies delegating specific tasks to more centralized bodies.

The connection to the Occupy movement is perhaps obvious, though Arendt isn't one of the writers people usually associate with this kind of politics. Her insistence that broad participation in public life is an end in itself, even the highest end, is a nice corrective to people who are impatient with the inward-looking nature -- meetings about meetings! -- of a lot of conversations around OWS. And the General Assembly structure looks different when you imagine them as proto-soviets. Of course the US today isn't anywhere close to a revolutionary situation, and one can't imagine General Assemblies exercising dual power. Or more precisely, there's no way anything like that will happen; people are imagining it, that's the point. Maybe the best evidence that Arendt is onto something important is that her book, written in the 1960s mostly about the politics of the 1780s, has distinct echoes not just of OWS, but of popular movements around the world, like the idea of "delegation" rather than "representation" coming out of Venezuela and Bolivia. 

I think the connection is interesting enough,it's worth putting some long quotes from On Revolution here. Which requires us to deploy the new-to-Slackwire technology of the fold. So, after it, Arendt.

Demands, Democratization, and OWS

In formal political economy, Acemoglu and Robinson have a famous theory of democratization, which might illuminate the splits inside OWS. Non-democracies are characterized by elite control of the policy making process. Occasionally, non-elites are able to solve their collective action problems and temporarily threaten the elites with rebellion. Elites can respond to this threat by repressing, temporarily reforming, or democratizing. When a movement is weak, it can be easily repressed. If it is a bit stronger but not overwhelmingly powerful, elites might alter a few policies here and there, but not change the identity of who gets to decide future policies. Because politics is fickle and promises aren't worth anything unless they are institutionalized, the temporary policy changes won by a political movement aren't going to last unless the identity of the people deciding policy in the future changes. A sad example of a regime's worthless promises is the 1381 Wat Tyler peasant rebellion, where the king promised amnesty to the anti-landlord rebels, only to have them hanged once they put down their arms. Zuccotti square is our pitchfork, and we shouldn't put it down for non-credible promises from our elites. But what is a credible promise? What could we demand that would last and work well after we've gone back to normal life (in my case referee reports and regressions)?

In Acemoglu and Robinson, when protesting citizens have enough political power, they demand and win democracy instead of just redistribution. In this way, democracy is a commitment device, ensuring that non-elites get to decide policies even after they have demobilized from the streets. If one admits that de jure U.S. politics, while democratic in form, has certain parts of it (e.g. monetary policy, financial regulation, tax policy) captured by elites regardless of the politician in power, then this democratization model becomes pretty applicable. Perhaps it took Obama's election and subsequent ineffectiveness to really communicate the extent of elite capture of U.S. politics, although the evidence has been accumulating for decades. In any case, many of the folks in Zuccotti square think that electoral politics is completely run by the rich, and so it takes street politics to force reform. The problem is, as in Acemoglu and Robinson, that mobilization is generally temporary: you don't get people protesting on the streets for years. A lasting victory would depend on converting this mobilization into institutions and durable policy gains.

The claim that OWS is partially a democratization movement has been made by Hardt and Negri. I think they are right, because from the inside it exhibits the fractures that all democratization movements face. Social democrats want the movement to cash in the temporarily political energy for economic policies to generate economic growth right now. I understand this, as political power via the street mobilization and media is fleeting and there is a worry that we will lose it before we actually secure anything at all. But the radicals claim a bigger, better demand: "real" democracy. The ability to set policy is worth much more than any particular policy, and democracy is the institutional setup that gives everybody the ability to participate in setting policy.

So radicals want the movement to continue to try and build political power so that we can demand not just financial transactions taxes or even a jobs program, but all that and the ability to have a say over all kinds of other decisions, from incarceration to the environment. This is why the overarching concern for the anarchists is to build the organizational architecture of the occupation, growing its semiotic and spatial reach. This makes the whirring of activity around Zuccotti square an amplifier for all the popular economic justice struggles, from Sotheby's workers to anti-foreclosure activism to movements to democratize the Fed. I like the metaphor of OWS as a wildlife garden for a left political ecology, which is attracting and cultivating a biosphere of demands, grievances, ideologies and cultural practices to evolve a stronger left. This is also why we are sometimes accused of having a "grab bag" of disconnected issues: its because one of the promises of the movement is power for the majority over all kinds of decisions, instead of making demands from the incompetent and decadent elites that currently make those decisions. Its part of the idea that this is just the beginning; we have a long winter and a longer struggle ahead, and need to use this moment to set ourselves up for building more political power in the medium run. So we're not going to coalesce and harden into "demands", but instead continue to nurture a culture of a thousand different demands and recruit people and develop a hegemonic agenda (that we don't have yet!). But the promise of that power and hegemony is grander: democratic control over policy making writ large. Occupy Everything, until we get all our demands and we don't have to make any more.

Disgorge the Cash!

It's well known that some basic parameters of the economy changed around 1980, in a mutation that's often called neoliberalism or financialization. Here's one piece of that shift that doesn't get talked about much, but might be relevant to our current predicament.

Source: Flow of Funds

The blue line shows the after-tax profits of nonfinancial corporations. The dotted red line shows dividend payments by those same corporations, and the solid red line shows total payout to shareholders, that is dividends plus net share repurchases. All three are expressed as a share of trend GDP. The thing to look at it is the relationship between the blue line and the solid red one.

In the pre-neoliberal era, up until 1980 or so, nonfinancial businesses paid out about 40 percent of their profits to shareholders. But in most of the years since 1980, they've paid out more than all of them. In 2006, for example, nonfinancial corporations had after-tax earnings of $800 billion, and paid out $365 billion in dividends and $565 in net stock repurchases. In 2007, earnings were $750 billion, dividends were $480 billion, and net stock repurchases were $790 billion. (Yes, net stock repurchases exceeded after-tax profits.) In 2008 it was $600, $470, and $340 billion. And so on. [1]

It was a common trope in accounts of the housing bubble that greedy or shortsighted homeowners were extracting equity from their houses with second mortgages or cash-out refinancings to pay for extra consumption. What nobody mentioned was that the rentier class had been doing this longer, and on a much larger scale, to the country's productive enterprises. At the top of every boom in the neoliberal era, there's been a massive round of stock buybacks, which you could think of as shareholders cashing out their bubble wealth. It's a bit like the homeowners "using their houses as ATMs" during the 2000s. The difference, of course, is that if you took too much equity out of your house in the bubble, you're the one stuck with the mortgage payments today. Whereas when shareholders use businesses as ATMs, those businesses' workers and customers get to share the pain.

One way of thinking about this increase in the share of profits flowing out of the firm, is in terms of changing relations between managers and the owning class. The managerial capitalism of Galbraith or Berle and Means, with firms pursuing a variety of objectives and "owners" just one constituency among many, really existed, but only in the decades after World War II. That, anyway, is the argument of Dumenil and Levy's Crisis of Neoliberalism. In the postwar period,

corporations were managed with concerns, such as investment and technical change, significantly distinct from the creation of "shareholder value." Managers enjoyed relative freedom to act vis-a-vis owners, with a considerable share of profits retained within the firm for the purpose of investment. ... Neoliberalism put an end to this autonomy because it implied a containment of capitalist interests, and established a new compromise at the top of the social hierarchies... during the 1980s, the disciplinary aspect of the new relationship between the capitalist and the managerial classes was dominant... after 2000, managers had become a pillar of Finance. 

When I've heard Dumenil talk about this development, he calls the new configuration at the top a "loving marriage"; the book says, less evocatively, that today

income patterns suggest that a process of "hybridization" or merger is underway. ... The boundary between high-ranking managers and the capitalist classes is blurred.

The key thing is that at one point, large businesses really were run by people who, while autocratic within the firm and often vicious in defense of their privileges, really did identify with the particular businesses they managed and focused their energy on their survival and growth, and even on the sheer disinterested desire to do their kind of business well. You can find a few businesses that are still run like this -- I've been meaning to write a post on Steve Jobs -- but by far the dominant ethos among managers today is that a business exists only to enrich its shareholders, including, of course, senior managers themselves. Which they have done very successfully, as the graph above (or a look at the world outside) shows.

In terms of the specific process by which this cam about, the best guide is chapter 6 of Doug Henwood's Wall Street (available for free download here.) [2] As Doug makes clear, the increased payouts to shareholders didn't just happen. They're the result of a conscious, deliberate effort by owners of financial assets to reassert their claims on corporate income, using the carrot of high pay and stock for mangers and the stick of hostile takeovers for those who didn't come through. Here's Michael Jensen spelling out the problem from finance's point of view:

Conflicts of interest between shareholders and managers over payout policies are especially severe when the organization generates substantial cashflow. The problem is how to motivate managers to disgorge the cash rather than investing it at below the cost of capital or wasting it on organization inefficiencies [by which Jensen seems to have mostly meant high wages].

Peter Rona, also quoted in Wall Street, expresses the same thought but in a decidedly less finance-friendly way: Shareholders "take pretty much the same view of the corporation as a praying mantis does of her mate."

You don't see the overt Jensen-type arguments as much now that management at most firms is happy to disgorge all of its cash and then some. But they're not gone. A while back I saw a column in the business press -- wish I could remember where -- expressing outrage at Apple's huge cash reserves. Because they should be investing that in new technology, or expanding production and hiring people? Of course not. It's outrageous because that's the shareholders' money, and why isn't Apple handing it over immediately. More than that, why doesn't Apple issue a bunch of bonds, as much as the market will take, and pay the proceeds out to the shareholders too? From the point of view of the creatures on Wall Street, a company that prioritizes its long-term growth and survival is stealing from them.

UPDATE: Ah, here's the piece I was thinking of: Forget iPad, it's time for iGetsomemoneyback. From right before the iPad launch, it's a gem of the rentier mindset, complete with mockery of Apple for investing in this silly tablet thing instead of just handing all its money to Wall Street.

Why is Apple hoarding its cash? A company spokesman explains: "We have maintained our cash and strong balance sheet to preserve the flexibility to make strategic investments and/or acquisitions." ... Steve Jobs really doesn't need an acquisitions warchest of around $30 billion ... He should start handing back this money to stockholders through dividends. ... The money belongs to stockholders: Give. Indeed Jobs should go further. Apple should -- gasp -- start borrowing, and hand that money back, too.

Disgorge the cash!


SECOND UPDATE: Welcome to visitors from Dealbreaker, Felix Salmon and Powerline. If you like this, other posts here you might like include Selfish Masters, Selfless Servants; The Financial Crisis and the Recession; What Do Bosses Want?; and in sort of a different vein, Satisfaction.

[1] There's something very odd going on in the fourth quarter of 2005: According to the Flow of Funds, dividend payments by nonfinancial firms dropped to essentially zero. The shortfall was made up in the preceding and following quarters. I suspect there must be some tax change involved. Does anybody (Bruce Wilder, maybe) have any idea what it is?

[2] John Smithin's Macroeconomic Policy and the Future of Capitalism is also very good on this; it's subtitle ("the revenge of the rentiers") gives a better flavor of the argument than the bland title.

This Is What Democracy Looks Like

I haven't Occupied Wall Street, have you?

The protests are great -- more anger, please! -- but I don't have any particular insight into them. And those of us without first-hand knowledge should probably defer to those who do. Except, I want to think critically about one common criticism of the protests: that they lack a clear statement of what they're about.

It's not clear how much this is really true. But still, one can say, isn't there something circular about the idea of "Occupy Wall Street"? It's not identified as a movement against bank bailouts or foreclosures, or for jobs or free elections or socialism. It's a movement to, well, occupy Wall Street -- a protest to hold a protest.

I think there's an important sense in which this is true. And in which it's always true -- in which, indeed, it's the whole point.

If you've ever been to one of these things, you know that the most successful chants are the self-referential ones, like "Whose streets/Our streets!" and "This is what democracy look like." (Or "We're here, we're queer" and "We shall not be moved.") Whatever the ostensible reason for the protest, the real content is always simply We Are Here.

This is most obvious, and most powerful, when the participants are people who are not supposed to be political agents or be seen in public at all: The early civil rights and gay rights protests, undocumented immigrants today. The message is, We exist. Think of the Memphis sanitation workers strike, with its signs reading, "I AM A MAN." But it also works if the "here" is a setting that is not supposed to be political. The flipside, as everyone knows, is that a protest of recognized citizens at a place and time designated by the authorities is politically meaningless.

Most of us very seldom experience ourselves as political agents, in the sense of being active participants in the collective decision-making of our community. For better or worse, most of the time we delegate collective decision-making to specialists who represent us more or less faithfully, as the case may be. The only reason for protest -- for any kind of mass politics -- is that this system has broken down. The message of any protest is: There is a political subject, a We, that is not being represented. This, in the broadest possible way, is what the "99%" rhetoric is saying, and why it resonates. At some point, if a when movements like this are successful, some new more legitimate form of representation will be established, as people form new collective identities and new norms of collective action. But it's foolish to criticize an assertion of the failure of representation for not itself being an effective representative, with a specific set of demands and a strategy to carry them out.

It's a long time since I read any Habermas, but he has a passage somewhere about how politics is necessarily an open-ended discussion, a process for deciding a question that could in principle be resolved in many ways. So anything that becomes routine, that becomes part of the regular process of social reproduction, is no longer political. You can find a similar argument in Hannah Arendt, and Luciano Canfora makes it very powerfully. Democracy, he says, isn't a form of government, like in civics class and Civilization. It's something that happens, occasionally and intermittently. Any mechanism can be captured; you can't institutionalize rule by the non-rich, as long as there are rich. To assert ourselves we have to heckle from the sidelines, or once in a while storm the field.

With a legitimate system of political representation, the question is what we should do and how to do it. Without one, we first have to establish that "we" exist.


UPDATE: Once you start looking for this stuff, it's amazing how consistent it is. Pull up a photo of the protests at random, and there's at least even odds you'll see a sign with some self-referential message: "I am a human being, not a commodity," "We are the 99%", etc. Here's a particularly nice example:

"We" are made up of the people here with signs. Exactly.


UPDATE 2: Matt Stoller, who's actually spent time there, says the same thing: 

What do the people at #OccupyWallStreet actually want? What are their demands? For many people, this is THE question. So let me answer it. What they want, is to do exactly what they are doing. They want to occupy Wall Street. They have built a campsite full of life, where power is exercised according to their voices. It’s a small space, it’s a relatively modest group of people at any one time, and the resources they command are few. But they are practicing the politics of place, the politics of building a truly public space. They are explicitly rejecting the politics of narrow media, the politics of the shopping mall. To understand #OccupyWallStreet, you have to get that it is not a media object or a march. It is first and foremost, a church of dissent, a space made sacred by a community. ... There's no way to agree or disagree with a church or a carnival.

Quasi-Monetarism: A Second Opinion

(Anush Kapadia, who knows this stuff much better than me, writes in with some comments on the last few posts. I accept this as a friendly amendment, and don't disagree with any of it. I agree with particular enthusiasm with the points that we should be talking about liquidity, not money; that the the link between any quantifiable money stock and real activity had broken down by the early 1980s if not before (my point was only that it wasn't entirely obvious until the great financial crisis); that to make sense of this stuff you need a concrete, institutionally grounded account of the financial system; and that for that, a very good place to start is Perry Mehrling's work.)

Some cavils:

The meaningfulness of monetary aggregates depends on the configuration of the credit system. In a world of tight banking regulations, the monetarist assumption that "there's a stable relationship between outside money and inside money" worked fine precisely because regulations made it so. Once those regulations break down, the relationship between outside and and inside money transforms. As the mainstream understands, "the rapid pace of financial innovation in the United States has been an important reason for the instability of the relationships between monetary aggregates and other macroeconomic variables" (Bernanke, "Monetary Aggregates and Monetary Policy at the Federal Reserve: A Historical Perspective," FRB 2006).

Thus your claim that "Between 1990 and 2008, this [monetarist] story isn't glaringly incompatible with the evidence" is not entirely true. Post-deregulation, money demand ("velocity") became quite unmeasurable, breaking the link between the two sides of the quantity equation. "Behavior" had already changed significantly by the late 1960s, i.e. just as the monetarists were gaining the upper hand in the battle of ideas. (Note that the Fed eventually stopped measuring M3; but not everyone did: http://www.shadowstats.com/charts/monetary-base-money-supply).

Eventually, in response to this breakdown, the Fed quits its ill-conceived monetarist experiment and targets price rather quantity, specifically the Fed Funds rate. Thus "changing the stock of base money" has not been "the instrument of central banks, at least in theory, since the early 20th century." Since the empirical and theoretical tractability of "the money supply" gave way, monetary control moved to the price of central-bank refinance, i.e. "the price of liquidity." [1]

Price-based control works by acting on the leverage capacity of the balance sheets "downstream," most immediately those in the primary dealer system. (Mehrling, New Lombard Street). Modulation of this capacity is effected through changes in the price of refinance---the bailout price---for these dealers, thereby changing their bid-ask spread. So changes in the prices of the assets in which they make markets are a key transmission mechanism to changes in interest rates.

The effect interest rates have on investment and/or consumer demand itself depends on the configuration of the credit system, i.e. how investment and consumption are financed. The price of credit might not be as important as its quantity for investment, but the former might be very important for consumption and thus aggregate demand.

So you can get a recession thanks to insufficient aggregate demand if you have a credit system that ties consumption to finance. The reason is the same as that which enables what Mehrling calls "monetary policy without sticky prices," i.e. the leverage capacity of (in this case, consuming) balance sheets. If people are stuffed with debt, their "excess demand for money" basically represents a demand for liquidity to pay down their debts. Extra income will go first and foremost towards deleveraging rather than consumption; this of course is Richard Koo's Minsky-flavored lesson from Japan.

Given the current configuration of the system, a coordination problem of the kind referred to would mean that those with spare lending capacity can't find those with spare borrowing capacity. Yet in sectoral terms, its only households that are truly overleveraged: government is only political so and business are relatively okay. The problem is to get the big balance sheet with the spare capacity online again; of course, that is a political problem.[2] Boosting liquidity qua "the money supply" will simply pass through to paying down debts before it starts to affect consumption and thereby investment. In short, we might be some time, especially if we abstract away from the institutional configuration of the credit system.

[1] This signaled a return to pre-WWI "banking school" methods employed by the Bank of England, modulo differences in the respective credit systems: commercial paper for the trade-credit-based English system and government paper for the postwar US system. The Fed in our own period seems to be feeling its way to dealing in paper other than the government's (QE I), something that is appropriate given the importance of non-government debt in the present system.

[2] Incidentally, Morris Copeland's analogy of the credit system as an electric grid works much better than Fisher's "currency school" vision of money as a liquid. See http://www.nber.org/books/cope52-1.

What's the Matter with (Quasi-)Monetarism?

Let's start from the top.

What is monetarism? As I see it, it's a set of three claims. (1) There is a stable relationship between base money and the economically-relevant stock of money. [1] That is, there's a stable relationship between outside money and inside money. (2) There is a stable velocity of money, so we can interpret the equation of exchange MV = PY (or MV = PT) as a behavioral relationship and not just an accounting identity. Since the first claim says that M is set exogenously by the monetary authority, causality in the equation runs from left to right. And (3), the LM aggregate supply curve is shaped like a backward L, so that changes in PY show up entire in Y when the economy is below capacity, and entirely in changes in P when it is at capacity.

In other words, (1) the central bank can control the supply of money; (2) the supply of money determines the level of nominal output; and (3) there is a single strictly optimal level of nominal output, without any tradeoffs. The implication is that monetary policy should be guided by a simple rule, that the money supply should grow at a fixed rate equal to (what we think is) the growth rate of potential output. Which is indeed, exactly what Friedman and other monetarists said.

You can relax (3) if you want -- most monetarists would probably agree that in practice, disinflation is going to involve a period of depressed output. (Altho on the other hand, I'm pretty sure that when monetarism was officially adopted as the doctrine of the bank of England under Thatcher, it was claimed that slowing the growth of the money supply would control inflation without affecting growth at all. And the hedge-monetarism you run into today, that insists the huge growth in base money over the past few years could show up as hyperinflation without warning, seems to be implicitly assuming a backward-L shaped LM AS curve as well.) But basically, that's the monetarist package.

So what's wrong with this story? Here's what:

The red line is base money, the blue line is broad money (M2), and the green line is nominal GDP. The monetarist story is that red moves blue, and blue moves green. Between 1990 and 2008, this story isn't glaringly incompatible with the evidence. But since then? It's clear that the money multiplier, as we normally talk about it, no longer has any economic reality. There might still be tools out there to control the money supply. But changing the stock of base money -- the instrument of central banks, at least in theory, since the early 20th century -- is no longer one of them. Monetary policy as we knew it is dead. The divergence between the blue and green lines is less dramatic in this graph, but if anything it's even more damning. While output and prices lurched downward in the great Recession, the money supply just kept chugging along. Milton Friedman's idea that stable growth of the money supply is a sufficient condition for stable growth of nominal GDP looks pretty definitively refuted.

So that's monetarism, and what's the matter with it. How about quasi-monetarism? What's the difference from the unprefixed kind?

Some people would say, There is no difference. Quasi-monetarist is just what we call a New Keynesian who's taken off his Keynes mask and admitted he was a Friedmanite all along. And let's be honest, that's sort of true. But it's like one of those episodes in religious history where at some point the disciples have to acknowledge that, ok, the prophecies don't seem to have exactly worked out. Which means we have to figure out what they really meant.

In this case, the core commitment is the idea that if PY is too low (we're experiencing a recession and/or deflation) that means M is too low; if PY is too high (we're experiencing inflation) that means M is too high. In other words, when we talk about insufficient aggregate demand, what we're really talking about is just excess demand for money. And therefore, when we talk about policies to boost demand, we're really just talking about policies to boost the money stock. (Nick Rowe, as usual, is admirably straightforward on this point.) But how to reconcile this with the graph above? You just have to replace some material entities with spiritual ones: The true M, or V, or both, is not visible to mortal eyes. Let's say that velocity is exogenous but not stable. Then there is still a unique path of M that would guarantee both full employment and stable prices, but it can't be characterized as a simple growth rate as Friedman hoped. Alternatively, maybe the problem is that the monetary authority can only control M clumsily, and can't directly observe how far off it is. (This is the DeLong version of quasi-monetarism. The assets that count as M are always changing.) Then, there may still be the One True Growth Rate of M just as Friedman promised, but the monetary authority can't reliably implement it. Or sublunary M and V could both depart from their platonic ideals. In any case, the answer is clear: Since it's hard to get MV right, your rule should be to target a steady growth rate of PY (nominal GDP). Which is, indeed, exactly what the quasi-monetarists say. [2]

So what's the alternative? I've been arguing that one alternative is to think of recessions as coordination failures, which could happen even in an economy without money. I'm honestly not sure if that's going to turn out to be a productive direction to go in, or not. But in terms of the monetarist framework, the alternative is clear. Say that V is not only unstable, but endogenous. Specifically, say that it varies inversely with M. In this case, it remains true -- as it must; it's an accounting identity -- that MV = PY. But nonetheless there is nothing you can do to M, that will affect P or Y. (This situation, by the way, is what Keynes meant by a liquidity trap. It wasn't about the zero lower bound.)

This, I think, is what we actually observe, not just right now, but in general. "The" interest rate is the price of liquidity, that is, the price of money. [3] And what kinds of activity are sensitive to interest rates? Well, uh ... none of them. None, anyway, except for housing. When an economic unit is deciding on the division of its income between currently-produced goods and services vs. money, the price at which they exchange just doesn't seem to be much of a consideration. (Again, except -- and it's an important exception -- when the decision takes the form of purchasing housing services from either an existing home, or a new one.) Which means that changes in M don't have any good channel to produce changes in P or Y. In general, increases or decreases in M will just result in pro rata decreases or increases in V. Yes, it may be formally true that insufficient demand for goods equals excess demand for money; but it doesn't matter if there's no well-defined money demand function. A traditional Keynesian expenditure function (Z = A + cY) cannot be usefully simplified, as the quasi-monetarists would like, by thinking of it as a problem of maximizing the flow of consumption subject to some real balance constraint.

So, monetarism made some strong predictions. Quasi-monetarism admits that those predictions don't hold up, but argues that the monetarist model is still the right one, we just can't observe the variables in it as directly as early monetarists hoped. On some level, they may be right! But at some point, when the model gets too loosely coupled with reality, you'll want to stop using it. Even if, in some sense, it isn't wrong.

Which is all to say that, even if I can't find a way to disprove it analytically, I just can't accept the idea that the question of aggregate demand can be usefully reduced to the question of the supply of money.



[1] The simplest form of the first claim would be that the money multiplier is equal to one: Outside money is all the money there is. Something like this was supposed to be true under the gold standard, tho as the great Robert Triffin points out, it wasn't really. Over at Windyanabasis, rsj claims that Krugman, a closet quasi-monetarist, implicitly makes this assumption.

[2] In practice, despite the tone of this post, I'm not entirely sure they're wrong. More generally, Nick Rowe's clear and thorough posts on this set of questions are essential reading.

[3] I've learned from  Bob Pollin never to write that phrase without the quotes. There are lots of interest rates, and it matters.

Are Recessions All About Money: Quasi-Monetarists and Babysitting Co-ops

Today Paul Krugman takes up the question of the post below, are recessions all about (excess demand for) money? The post is in response to an interesting criticism by Henry Kaspar of what Kaspar calls "quasi-monetarists," a useful term. Let me rephrase Kaspar's summary of the quasi-monetarist position [1]:

1. Logically, insufficient demand for goods implies excess demand for money, and vice versa.
2. Causally, excess demand for money (i.e. an increase in liquidity preference or a fall in the money supply) is what leads to insufficient demand for goods.
3. The solution is for the monetary authority to increase the supply of money.

Quasi-monetarists say that 2 is true and 3 follows from it. Kaspar says that 2 doesn't imply 3, and anyway both are false. And Krugman says that 3 is false because of the zero lower bound, and it doesn't matter if 2 is true, since asking for "the" cause of the crisis is a fool's errand. But everyone agrees on 1.

Me, though, I have doubts.

Krugman:

An overall shortfall of demand, in which people just don’t want to buy enough goods to maintain full employment, can only happen in a monetary economy; it’s correct to say that what’s happening in such a situation is that people are trying to hoard money instead (which is the moral of the story of the baby-sitting coop). And this problem can ordinarily be solved by simply providing more money.

For those who don't know it, Krugman's baby-sitting co-op story is about a group that let members "sell" baby-sitting services to each other in return for tokens, which they could redeem later when they needed baby-sitting themselves. The problem was, too many people wanted to save up tokens, meaning nobody would use them to buy baby-sitting and the system was falling apart. Then someone realizes the answer is to increase the number of tokens, and the whole system runs smoothly again. It's a great story, one of the rare cases where Keynesian conclusions can be drawn by analogizing the macroeconomy to everyday experience. But I'm not convinced that the fact that demand constraints can arise from money-hoarding, means that they always necessarily do.

Let's think of the baby-sitting co-op again, but now as a barter economy. Every baby-sitting contract involves two households [2] committing to baby-sit for each other (on different nights, obviously). Unlike in Krugman's case, there's no scrip; the only way to consume baby-sitting services is to simultaneously agree to produce them at a given date. Can there be a problem of aggregate demand in this barter economy. Krugman says no; there are plenty of passages where Keynes seems to say no too. But I say, sure, why not?

Let's assume that participants in the co-op decide each period whether or not to submit an offer, consisting of the nights they'd like to go out and the nights they're available to baby-sit. Whether or not a transaction takes place depends, of course, on whether some other participant has submitted an offer with corresponding nights to baby-sit and go out. Let's call the expected probability of an offer succeeding p. However, there's a cost to submitting an offer: because it takes time, because it's inconvenient, or just because, as Janet Malcolm says, it isn't pleasant for a grown man or woman to ask for something when there's a possibility of being refused. Call the cost c. And, the net benefit from fulfilling a contract -- that is, the enjoyment of going out baby-free less the annoyance of a night babysitting -- we'll call U.

So someone will make an offer only when U > c/p. (If say, there is a fifty-fifty chance that an offer will result in a deal, then the benefit from a contract must be at least twice the cost of an offer, since on average you will make two offers for eve contract.) But the problem is, p depends on the behavior of other participants. The more people who are making offers, the greater the chance that any given offer will encounter a matching one and a deal will take place.

It's easy to show that this system can have multiple, demand-determined equilibria, even though it is a pure barter economy. Let's call p* the true probability of an offer succeeding; p* isn't known to the participants, who instead form p by some kind of backward-looking expectations looking at the proportion of their own offers that have succeeded or failed recently. Let's assume for simplicity that p* is simply equal to the proportion of participants who make offers in any given week. Let's set c = 2. And let's say that every week, participants are interested in a sitter one night. In half those weeks, they really want it (U = 6) and in the other half, they'd kind of like it (U = 3). If everybody makes offers only when they really need a sitter, then p = 0.5, meaning half the contracts are fulfilled, giving an expected utility per offer of 2. Since the expected utility from making an offer on a night you only kind of want a sitter is - 1, nobody tries to make offers for those nights, and the equilibrium is stable. On the other hand, if people make offers on both the must-go-out and could-go-out nights, then p = 1, so all the offers have positive expected utility. That equilibrium is stable too. In the first equilibrium, total output is 1 util per participant per week, in the second it's 2.5.

Now suppose you are stuck in the low equilibrium. How can you get to the high one? Not by increasing the supply of money -- there's no money in the system. And not by changing prices -- the price of a night of baby-sitting, in units of nights of baby-sitting, can't be anything but one. But suppose half the population decided they really wanted to go out every week. Now p* rises to 3/4, and over time, as people observe more of their offers succeeding, p rises toward 3/4 as well. And once p crosses 2/3, offers on the kind-of-want-to-go-out nights have positive expected utility, so people start making offers for those nights as well, so p* rises further, toward one. At that point, even if the underlying demand functions go back to their original form, with a must-go-out night only every other week, the new high-output equilibrium will be stable.

As with any model, of course, the formal properties are less interesting in themselves than for what they illuminate in the real world. Is the Krugman token-shortage model or my pure coordination failure model a better heuristic for understanding recessions in the real world? That's a hard question!

Hopefully I'll offer some arguments on that question soon. But I do want to make one logical point first, the same as in the last post but perhaps clearer now. The statement "if there is insufficient demand for currently produced goods, there must excess be demand for money" may look quite similar to the statement "if current output is limited by demand, there must be excess demand for money." But they're really quite different; and while the first must be true in some sense, the second, as my hypothetical babysitting co-op shows, is not true at all. As Bruce Wilder suggests in comments, the first version is relevant to acute crises, while the second may be more relevant to prolonged periods of depressed output. But I don't think either Krugman, Kaspar or the quasi-monetarists make the distinction clearly.


EDIT: Thanks to anonymous commenter for a couple typo corrections, one of them important. Crowd-sourced editing is the best.

Also, you could think of my babysitting example as similar to a Keynesian Cross, which we normally think of as the accounting identity that expenditure equals output, Z = Y, plus the behavioral equation for expenditure, Z = A + cY, except here with A = 0 and c = 1. In that case any level of output is an equilibrium. This is quasi-monetarist Nick Rowe's idea, but he seems to be OK with my interpretation of it.

FURTHER EDIT: Nick Rowe has a very thoughtful response here. And my new favorite econ blogger, the mysterious rsj, has a very good discussion of these same questions here. Hopefully there'll be some responses here to both, soonish.



[1] Something about typing this sentence reminds me unavoidably of Lucky Jim. This what neglected topic? This strangely what topic? Summary of the quasi-what?

[2] Can't help being bugged a little by the way Krugman always refers to the participants as "couples," even if they mostly were. There are all kinds of families!