{ "cells": [ { "cell_type": "markdown", "metadata": {}, "source": [ "# What and Why Business Cycles?\n", "\n", "### Why Care About the \"Business Cycle\"?\n", "\n", "Why should the so-called \"business cycle\" be of primary or even of significant interest to anyone? \n", "\n", "The 2008-2009 \"Great Recession\" was the largest business-cycle downturn in 70 years. Something like 900 billion dollars of annual output—useful commodities, useful goods and services—that the American economy could have produced in a typical year simply vanished from possibility. And it looks as though the American economy is, as a result of that \"Great Recession\", on a permanently lower growth path by some 600 billion of annual output—a reduction in the efficiency of labor of some 3 percent relative to a counterfactual in which the \"Great Recession\" had not happened. But even the bigger number is only four years' worth of long-run economic growth: the growth process did 17 times as much good for the American standard of living and level of productivity in the years since the last \"Great\" downturn than the \"Great Recession\" did harm.\n", "\n", "So why spend one-half of our macroeconomics course on it? Why not spend 16/17 of the semester on growth, and just one weeek—or less than one week—on the \"business cycle\"? Yes, the \"Great Recession\" was bad. Yes, it is unfortunate to have been born in 1996 rather than in 2000. Why not make as big a deal of the second, proportionately, as of the first?\n", "\n", "One big reason is that the government can materially and powerfully affect the state of the business cycle, while the government can only tangentially and marginally affect the path of economic growth. As far as its impact on any individual's life chances is concerned, failures of current business-cycle policy—of stabilization policy—are likely to be more important than failures of growth policy. Yes, past failures or successes of growth policy have a mighty influence on our current prosperity for ill or good, but that is all past. Yes, current failures or successes of growth policy have a mighty influence on the future, but that is in the future. It is current business cycle policy that has the biggest influence on current prosperity.\n", "\n", "Thus what happens in the course of the business cycle shapes everyone's life. A rise in inflation is sure to enrich debtors (people who have borrowed) and impoverish creditors (people who have lent money to others). An expanding economy will make real incomes rise. A deep recession will increase unemployment and make those who lose their jobs have a hard time finding others. Your bargaining power vis-a-vis your employer (or, on the other side of the table, your bargaining power vis-a-vis your employees) depends on the phase of the business cycle.\n", "\n", "Though you cannot control the macroeconomy, you can understand how it affects your opportunities. To some degree, forewarned is forearmed: Whether or not you understand your opportunities may depend on how much attention you\n", "pay in this course. The macroeconomy is not destiny: Some people do very well in their jobs and businesses in a recession, and many do badly in a boom. Nevertheless, it is a powerful influence on individual well-being. To paraphrase Russian revolutionary Leon Trotsky, you may not be interested in the macroeconomy, but the macroeconomy is interested in you.\n", "\n", " \n", "\n", "### The Business Cycle as a Market Failure\n", "\n", "Business cycle policy has a big influence on current prosperity because it raises the possibility of correcting a major market failure.\n", "\n", "Believers in the market economy have a big problem with the business cycle. \n", "\n", "We economists think of the economy as a societal calculating machine. It is supposed to grind out human happiness as it gives us signals in the form of market prices and financial rewards to indcue us to do things that are profitable for us and utility enhancing for the country as a whole. Yes, there are externalities and monopoly and imperfect competition and so forth. Yes, there is the distribution of income and wealth: the economy cares about your demands and wishes only if it is effective, which means that it cares about your demand only if you have the wealth to back it up. The economy may well be a societal calculating machine, but it is one in which the happiness of the rich counts much more than the happiness of the poor. Given those caveats—corrected for externalities and other microeconomic failures, conditional on the distribution of income and wealth corresponding to what is useful to society and what individuals and families deserve, and so forth—we economists want to see the economy as calculating and enforcing a near-optimal arrangement of economic activity. \n", "\n", "\"Lecture\n", "\n", "History does not show a steady, stable, smooth upward trend toward higher production and employment. Production can easily rise several percentage points above the long-run trend or fall 5 percentage points or more below\n", "the trend. Unemployment can fall so low that businesses become desperate for workers and will spend much time and money training them. Or it can rise to more than 10 percent of the labor force in a deep recession, as it did in 1982 and again in 2009. These business cycles simply do not fit: the market cannot then be near-optimal. The business cycle is thus another market failure, and one that is very large indeed: something that can, in a year in which the state of the business cycle is wrong, rob 5 percent of the workers in their economy of their normal employment is not something that can be shrugged off.\n", "\n", "But, if so, why does the market's arrangement of economic activity grind out an unemployment rate of 10 percent in one year and 4 percent in another year? Here we have a case in which sometimes in some years the market economy is doing a much better job than others, and the question is: why? Figuring out figuring this why is complicated and it's complicated in large part because of what I call the bullshit factor, which goes back to economist John Stuart Mill writing in the 1830s: \n", "\n", ">What was affirmed by Cicero of all things with which philosophy is conversant, may be asserted without scruple of the subject of currency—there is no opinion so absurd as not to have been maintained by some person of reputation. There even appears to be on this subject a peculiar tenacity of error – a perpetual principle of resuscitation in slain absurdity…\n", "\n", "I do not understand fully why economics has such a \"perpetual principle of resuscitation in slain absurdity\". But is does. And it makes life difficult for us economists. I will try to point out examples as we go along.\n", "\n", " \n", "\n", "### Competent Economic Policy Can Curb the Business Cycle\n", "\n", "That the business cycle is a major and signicant economy-wide market failure would be of less importance were it not taht it is something competent governments can do something about. Today's governments have powerful abilities to smooth out the business cycle by diminishing the depth of recessions and depressions. Good macroeconomic policy can make almost everyone's life better; bad macroeconomic policy can make almost everyone's life much worse. Picy makers' reliance on the gold standard as the international monetary system during the Great Depression was the source of macroeconomic catastrophe and human misery. Thus the stakes that are at risk in the study and the application of the lessons from study of the business cycle are high.\n", "\n", "Business-cycle fluctuations are felt not only in production and employment but also in the overall level of prices. Booms usually bring inflation, or rising prices. Recessions bring either a slowdown in the rate of inflation, or disinflation as it is called, or an absolute decline in the price level, called deflation.\n", "\n", "Note that output falls relative to its growth trend and unemployment rises relative to its growth trend at the same time. These two variables move together. There is thus only one dimension of variation in output relative to trend potential and in employment and unemployment—not two. For most of the time in the United States since World War II, the unemployment rate has been tightly coupled with the rate of growth of real GDP in a relationship called Okun’s Law, named after Johnson administration economic advisor Arthur Okun. From any one year to the next, the very simple equation:\n", "\n", "> $ {\\Delta}{\\%}Y - {\\Delta}{\\%}Y* = -2.5({\\Delta}{\\%}u) $\n", "\n", "fits the data well. A 1-percentage-point fall in the unemployment rate is associated with an extra 2.5 percentage-point growth in real GDP relative to potential output. For example, in a year in which potential output grew 2 percent and the unemployment rate fell by 1 percentage point, real GDP would grow by fully 4.5 percent.\n", "Because of Okun’s law, if you know what is happening to real GDP relative to potential output, you have a good idea of what is happening to the unemployment rate, and vice versa.\n", "\n", "Interest rates, the level of the stock market, and other economic variables also rise and fall with the principal fluctuations of the business cycle. We will deal with those variables in their proper place.\n", "\n", " \n", "\n", "### The Circular Flow of Economic Activity and \"Say's Law\"\n", "\n", "Back at the start of the nineteenth century a market economy where almost everybody specialized in one particular kind of job was a new thing. For most of human history most people had spent most of their time working to provide for their own households: growing their own food, weaving and sewing their own clothes, building their own houses, with purchases and sales in the market restricted to a relatively small part of total economic activity. But starting in the eighteenth century economic growth brought us to a place where, in northwestern Europe at least, for the first time most of what was produced was not consumed by the household that had made it, but was then sold in the marketplace and the money earned used to buy things that others had made.\n", "\n", "This market economy disturbed a great many people. “What if it all went wrong?” we might think of them as asking:\n", "\n", ">Could we wind up with a situation in which the yoga instructors were offering too many lessons on achieving inner peace that the potters couldn’t buy, and the potters had made too much pots that the baristas couldn’t buy, and that the baristas had made too many cups of coffee that the yoga instructors could not buy—so everyone was unable to satisfy their needs because they could not sell what they had produced, and because they could not sell what they had made they could not afford to buy what others had made?\"\n", "\n", "It was French economist Jean-Baptiste Say who first proposed an answer back in 1803. \n", "\n", "Say had been special assistant to Tom Paine’s friend and France’s Girondist Party Secretary of the Treasury Etienne Claviere. Secretary of the Treasury Claviere was then purged, arrested, and imprisoned by Maximilien Robespierre’s Mountain Party. Etienne Claviere committed suicide in prison the night before his scheduled execution. Somehow Say escaped the purge of the Girondists with his liberty and, more im- portant, his life. Say decided, probably wisely, to retire from politics and government. He become a theoretical economist. Ten years later in 1803 he published his first economics book, his _Treatise on Political Economy_. And thereafter he churned out more and more volumes.\n", "\n", "In his 1803 _Treatise_ Say dealt with the possibility of a “general glut,” of deficient aggregate demand. He concluded that there could be no such thing: \n", "\n", ">To say that sales are dull, owing to the scarcity of money, is to mistake the means for the cause; an error…. [Money] appears to vulgar apprehensions the most important of commodities, and the end and object of all transactions, whereas it is only the medium. Sales cannot be said to be dull because money is scarce, but because other products are so. There is always money enough to conduct the circulation and mutual interchange of other values, when those values really exist. Should the increase of traffic require more money to facilitate it, the want is easily supplied…. Merchants know well enough how to find substitutes for the product serving as the medium of exchange or money... (Say (1803): _A Treatise on Political Economy_, Book I, Chapter XV)\n", "\n", "Say claimed that such a “general glut” was inconceivable, for every seller was also a purchaser. In a market economy, Say argued, every transaction has two sides. Nobody sells\n", "without intending to buy. Thus purchasing power flows throughout the economy in a circle, as: \n", "\n", "* Businesses produce and sell because they then intend to spend the money they earn hiring workers and rentoing capital.\n", "\n", "* What they pay workers and capitalists in wages, salaries, rent, income, and dividends becomes their household incomes. \n", "\n", "* But workers and capitalists only sell and rent their hours and their resources to businesses because they then intend to spend the money they earn buying goods and services. \n", "\n", "* And those goods and services that they buy—well, those are the goods and services that the businesses make. \n", "\n", "* So businesses sell final products to households and buy factor services from households, \n", "\n", "* And households buy final products from and sell factor services to businesses.\n", "\n", "Households take their incomes and divide them up into three parts: some they spend\n", "buying goods and services from businesses, some they use to pay taxes, and some they save and deposit in financial intermediaries—banks, mutual funds, 401(k) account holders, brokerages, et cetera. The federal, state, and local governments take their taxes, return some to\n", "households as transfer payments, add to net taxes their government borrowing, and spend buying goods and services. Financial intermediaries received the private savings from households and the net investment by foreigners, and use that to fund investment to expand capacity by businesses.\n", "\n", "Where do foreigners get the dollars that they use to invest in America? They get them by selling us more in imports than they buy in exports. Dollar bills are not of much use outside the United States—so they take them and invest them in the United States.\n", "\n", "Thus Jean-Baptiste Say in 1803 was _partially_ right. Every transaction does have two sides. For every buyer there is a seller. Everyone’s cost is somebody else’s income. And purchasing power does proceed throughout the economy, greasing a flow of production, sales, income, and purchases that in the U.S. economy now amounts to $20 trillion worth of commodities every year. Most of the time the circular flow of economic activity works, and works relatively well. \n", "\n", " \n", "\n", "### Disrupting the Circular Flow\n", "\n", "But Say was also partially wrong. As Galileo is supposed to have said: _\"Eppur si muove\"_—and yet it moves, even though doctrine says that it does not. \n", "\n", "Say's case seems strong. Every act of spending is somebody else's income. Nobody makes and sells without intending to buy. And yet...\n", "\n", "At the end of 2006 in the United States total national income and product was equal to 13.06 trillion dollars at an annual rate. It had then been growing at an average rate of a hair above 3 percent per year. People thus expected it to stand at 14.3 trillion dollars per year as of the end of 2009. But it did not. The flow of production at the end of 2009 was a mere 13.1 trillion dollars per year—fully 8.5 percent lower than what three years before we had all expected it to reach. More than 8 percent of the flow of production of useful goods and services that we ought to have been producing and could have been producing at the end of 2009 was not there. It had vanished completely—into thin air.\n", "\n", "This would have surprised the Jean-Baptiste Say of 1803. It would not, in fact, have surprised an older Jean-Baptiste Say—the Jean-Baptiste Say of 1829. After watching the financial crisis of 1825 and the subsequent economic depression of 1825-6 in England, Say had a very different, and more accurate, view.\n", "\n", " \n", "\n", "### Economists and the Possibility of a “General Glut”\n", "\n", "Normally, whenever there is deficient demand for some commodity—and hence a glut of it on the market—there is excess demand for and hence a shortage of another one. That was what Jean-Baptiste Say was the first to point out. Aggregate demand had to match supply, he wrote, because the only thing that could generate demand was supply and the only thing that could genrate supply was demand:\n", "\n", ">it is production which opens a demand for products.... Yonder farmer... can buy none at all [of your woollens] if his crops fail altogether. Neither can you buy his wool nor his [wheat] yourself, unless you contrive to [first sell] woollens or some other article.... The silver coin you will have received for the sale of your own products and then use to buy those of other people will in the next moment do the same thing for other contracting parties, and so from one to another to infinity.... You will have bought, and everybody will have bought, what you want or desire, each doing so with the value of his own respective products sold and transformed into money for that instant only. Otherwise, how could it be possible that there should now be bought and sold in France five or six times as many commodities as in the miserable reign of King Charles VI? Is it not obvious that five or six times as many commodities must be produced now [as then]. And that they must have served to purchase each other?\n", "\n", "This is the circular flow principle of the previous lecture. Households earn money—and they then spend it: it doesn't do them any good if they don't spend it on anything, and \"spending\" includes buying a bond or putting it into a bank. Businesses receive what households spend, and they then use that money to (a) hire workers, (b) buy things, or (c) distribute to their shareholders as profits: it doesn't do them any good if they in turn do not spend or distribute it. But the spending of businesses hiring workers and the distribution of profits are the incomes of households.\n", "\n", "Thus, Say argued in 1803, we did not have to worry about a lack of aggregate demand. Con- sider a simple toy model of a three-sector economy—agriculture, industry, and service sectors, and since this is Berkeley let's talk about baristas, potters, and yoga instructors. We thus have baristas who make lattes, potters who make ceramics, and yoga instructors who teach lessons. Can there be a situation in which baristas have brewed more cups of coffee than potters wish to buy who have made more ceramics than yoga instructors want to buy who are offering more yoga lessons than baristas want to take? Say in 1803 said no. \n", "\n", "Others have picked up his—wrong—argument ever since. \n", "\n", " \n", "\n", "### Must Excess Supply Here _Really_ Mean Excess Demand There?\n", "\n", "Say’s argument does have at its core the truth that is the circular flow of economic activity. Everybody’s expenditure is somebody else’s income, and everybody’s income is somebody else’s expenditure. You cannot earn the money that you will yourself then spend unless you can sell what you are making. And they cannot buy what you have to sell unless you have bought what they are selling. That circular flow seems at first glance to rule out any possibility of a “general glut”—of a general economy-wide excess of supply. Say in 1803 certainly thought that it did so.\n", "\n", "But by the end of his career, in his last book, his 1829 _Cours Complet d’Economie Politique_ Pratique, Say was singing a very different tune. Describing the British economy’s crash and depression of 1825-6 he admitted not only the possibility but the reality of such a “general glut”:\n", "\n", ">As [the price of] every type of merchandise had sunk below its costs of production, a mul- titude of workers were without work. Many bankruptcies were declared among mer- chants and among bankers, who having placed more bills in circulation than their per- sonal wealth could cover, could no longer find guarantees to cover their issues beyond the undertakings of individuals, many of whom had themselves become bankrupt...\n", "\n", "And Say’s 1829 analysis of how the British economy had then gotten itself so wedged sounds remarkably modern:\n", "\n", ">The Bank [of England]... obliged to buy gold back... to limit its losses... forced the re- turn of its banknotes... ceased to put new notes into circulation... was then obliged to cease to discount commercial bills. Provincial banks were in consequence obliged to fol- low the same course, and commerce found itself deprived at a stroke of the advances... to create new businesses, or to give a lease of life to the old.... Businessmen... obliged to meet [the bills they had issued]... each was forced to use up all the resources at his dis- posal. They sold goods for half what they had cost. Business assets could not be sold at any price...\n", "\n", "But how can it be that the price of everything “had sunk below its cost of production” if everyone’s expenditure is somebody else’s income, and thus everybody’s cost is somebody else’s purchasing power? The circular flow principle seems to rule it out.\n", "\n", " \n", "\n", "### Why Say's Law Is False\n", "\n", "It was an economist a generation younger than Jean-Baptiste Say who put his finger on the reason: moral philosopher, libertarian, colonial bureaucrat, feminist, public intellectual, and economist John Stuart Mill put his finger on the answer in a piece he wrote in 1829:\n", "\n", ">Those who have... affirmed that there was an excess of all commodities, never pretended... money was one of these.... Persons... at that particular time... [fearing] being called upon to meet sudden demands [for payment], liked better to possess money than any other commodity. Money, consequently, was in request, and all other commodities comparative disrepute... the result is, that all [other] commodities fall in price, or become unsaleable...\n", "\n", "We don’t just buy those goods and services that are then currently being produced. We don’t just sell the current flow of services from the labor, the machines and buildings, and the natural resources we own. We add to the current flow of our incomes by selling our assets. We spend our purchasing power not just on the goods and services currently being produced but on financial assets as well.\n", "\n", "Thus it is perfectly possible for there to be an excess supply of goods and services—for the current flow of aggregate demand for goods and services to be less than the cost of the goods and services currently being produced—if there is an excess demand for assets. Depressions come, and we need a non-full-employment economics, a depression economics, to analyze, when there is an excess demand for one or more of three particular kinds of financial assets:\n", "\n", "1. “Liquid” assets, assets that can be readily and easily used to pay for things, which assets we usually call “money”.\n", "2. High-quality assets, assets that are generally regarded as safe ways to store up purchasing power so that it will still be there intact to be used later on—like U.S. Treasury bonds.\n", "3. Long-duration assets, assets that allow us to take some of the money we are earning now and move it back in time away from us into the future.\n", "\n", "Whenever there is full employment and yet the population as a whole wants to hold more of any of these types of assets than exist, people try to switch their spending away from spending on currently-produced goods and services and towards accumulating these assets. And that puts downward pressure on employment and production.\n", "\n", "That is the important insight. let us see if we can make it—the mechanism of how the economy falls into a depression—clearer:\n", "\n", "Consider, first, a normal shift in demand: Berkeleyites decide that they want to spend somewhat less on lattes that make them jumpy, irritable, and stressed. Berkeleyites decide they want to spend somewhat more on yoga lessons in order to seek inner peace. Baristas find that they have brewed more lattes than they can sell. Some cut their prices and see their incomes fall, some cut back on hours, some find themselves unable to buy the shade-grown beans for their next round of pro- duction and are unemployed.\n", "\n", "Yoga instructors find demand booming.\n", "\n", "They schedule extra classes.\n", "\n", "They work late into the night chanting “om mani padme hum” to satisfy demand.\n", "\n", "They raise their prices.\n", "\n", "They take on extra apprentices to help them carry the load.\n", "\n", "Prices fall in the coffee industry. Prices rise in the fitness industry. Excess supply of coffee and ba- ristas comes with excess demand for yoga lessons and yoga instructors.\n", "In a short time the economy adjusts.\n", "\n", "Labor exits the coffee industry and enters the yoga industry. And in a short while the economy has rebalanced with fewer baristas and more yoga instructors, the structure of production has shifted to accommodate the shift in demand, and there is no more excess unemployment.\n", "\n", "But now consider, instead, what Jean-Baptiste Say and John Stuart Mill were talking about in 1829:\n", "\n", "Consumers decide that they want to spend somewhat less on lattes purchased from baristas and to hold more cash in their wallets instead. Instead of spending normally, everybody decides to keep at least one 20 dollar bill in reserve at all times. Those with less than 20 dollars simply stop spending—until somebody buys some of what they have made and they have more than 20 dollars in their pockets.\n", "\n", "What happens?\n", "\n", "Well, what happens in the coffee industry is the same thing that happened when there was a shift in demand from caffeine to inner peace. Baristas find that they have brewed more lattes than they can sell. Some cut their prices and see their incomes fall, some cut back on hours, some find themselves unable to buy the beans for their next round of production and are unemployed. Inventories of unsold beans and cold coffee pile up. Entrepreneurs looking at their growing piles of unsold inventory cut back on hours and production even more.\n", "\n", "But there is no countervailing increase in spending, employment, and hours for yoga instructors. \n", "\n", "Things then snowball. The unemployed baristas now have no incomes. They cannot afford to buy as many pots or as many yoga lessons or, indeed, as much of the coffee made by other baris- tas. Inventories of unsold goods keep rising, and so employers cut back production and employ- ment even more. Thus there is a second-round fall in demand which renders even more people unemployed—and not just weavers this time. And then there is a third round. And so on...\n", "\n", "Moreover, everybody sees rising unemployment and falling incomes around them. Can you imagine a better signal to make you decide to try to hold onto more cash? Instead of cutting back on spending on coffee when you have less than 20 dollars in your pocket, people start cutting back on all spending when they have less than 40 dollars in their pocket. And the more the prices at which you can sell your goods falls and the higher unemployment climbs, the more desperate people are to pile up more cash in their wallets.\n", "\n", "In a normal full-employment market adjustment—a fall in the demand for lattes and a rise in the demand for inner peace—the workers fired from the coffee industry would rapidly be hired into the yoga instructor industry. But this is not a normal market adjustment: this is _depression economics_.\n", "\n", "How far down does production and employment decline when the economy gets itself into a de- pression economics state? How high does unemployment rise? Well, employers keep cutting back employment—and thus keep cutting back their workers’ incomes—until they are no longer pro- ducing more than they can sell and inventories are stable rather than rising. And households keep trying to build up their cash balances until their incomes have fallen so low that they do not think that they dare economize any further to try to boost their cash.\n", "\n", "How far is that? To determine how far that is, we need to build another, different economic model—a macroeconomic business-cycle model.\n", "\n", " \n", "\n", "### SUMMARY\n", "\n", "Ever since at least 1825 we have had macroeconomic downturns: relatively sudden and substan- tial falls in production and employment, the effects of which persist for years before production returns to trend and employment returns to normal levels. These downturns are not the result of any collective “forgetting” of technological or organizational knowledge. They are not the result of some sudden change in preferences to work less and enjoy leisure more. They are not the re- sult of some sudden obsolescence of any significant part of the economy’s capital stock. They are not the result of the sudden emergence of a mismatch between the skills of the labor force and the requirements of producing the goods and services households and businesses d mand—although they can themselves generate such long-run “structural” employment mismatches. And they are not—for the most part—the result of confusion between the value of wages workers can earn and what they think the value of their wages is.\n", "\n", "Instead, such downturns are the result of a generalized deficiency of demand for goods and services. People collectively want to buy less of the goods and services currently being produced than they want to make.\n", "\n", "This generalized deficiency, this “general glut” requires some explanation: As Jean-Baptiste Say put it back in 1803, nobody makes unless they intend to use or sell, and nobody sells unless they intend to buy. It is perfectly understandable how there can be excess supply of any particular good—how people can plan to buy more houses or washing machines or grapefruits than are currently being made. But excess supply of one good must be balanced by excess demand for another, right? And so labor and machines and buildings and organizations and finance will relatively quickly flow out of those industries where too much is being made and into those industries where too little is being made, right? This would seem to be guaranteed by the circular flow prin- ciple: the idea that everybody’s sales are somebody else’s purchases, that every dollar earned by businesses in sales is passed on to somebody as income, and that every dollar of income winds up as somebody’s purchases.\n", "\n", "What Say’s 1803 argument missed was that people seek not just to buy currently-produced goods or services but also to build up or draw down their stocks of assets—in particular, their stocks of liquid money assets, their stocks of long-duration bond-like assets, and their stocks of safe high-quality assets. Whenever there is planned excess demand for money, for savings vehicles, or for safe assets, there will be a generalized excess supply of currently-produced goods and services—and a downturn in production and employment will follow, as businesses respond to the piling-up of unsold goods and services by firing workers and cutting back production.\n", "\n", " \n", "\n", "#### Test Your Knowledge\n", "\n", "1. Which early nineteenth-century classical economist—Malthus, Mill, or Say—changed his position on the possibility of “general gluts” over his life, and how did he change it?\n", "2. Why did that classical economist change his mind?\n", "3. WhatdoesbreakSay’sLaw—whyisn’titthecasethatexcesssupplyofsomecurrently-\n", "produced goods and services always is offset by excess demand for some others?\n", "4. What kinds of financial excess demand produce “general gluts”—produce economic down-\n", "turns and high unemployment rates?\n", "\n", " " ] }, { "cell_type": "markdown", "metadata": {}, "source": [ "\n", "\n", "## Catch Our Breath\n", "\n", "* Ask me two questions…\n", "* Make two comments…\n", "* Further reading…\n", "\n", "
\n", "\n", "----\n", "\n", "Lecture Support: \n", "\n", " \n", "\n", "----\n", "\n", " " ] }, { "cell_type": "markdown", "metadata": {}, "source": [ "### Appendix: A Caveat—This Is Not a Consensus Framework\n", "\n", "Before we build up our approach, however, a digression and a warning:\n", "\n", "Our aggregate demand-based total-spending-shortfall framework for understanding business cycles is not a consensus framework. \n", "\n", "The total-spending-shortfall approach is law within this course. It has been the dominant thread in economists’ understanding of economic downturns since at least 1829. But does not command the attention of all economists. I count at least five other theories, all of which have at least some adherents today.\n", "\n", "Why is this the case? Why aren’t economists able to reach even a rough consensus about their discipline. This is especially true in macroeconomics much more than in microeconomics. This has always been the case. As an economist we have seen before, John Stuart Mill, wrote early in the nineteenth century:\n", "\n", ">What was affirmed by Cicero of all things with which philosophy is conversant, may be asserted without scruple of the subject of currency—that there is no opinion so absurd as not to have been maintained by some person of reputation. There even appears to be on this subject a peculiar tenacity of error—a perpetual principle of resuscitation in slain absurdity...\n", "\n", "The sects that deny that total-spending-shortfalls are at the root of economic downturns are, by my count at least, five. These all are attached to a view that these business cycles are in some sense, good or necessary—that even though they look bad they are not, for things apparently bad happen for a reason, and are really good. This is an intrusion of Panglossian theology into economics: \"The market giveth. The market taketh away. Blessed be the name of the market!\" I find it hard to understand these as anything other than an attempt to willfully deny empirical reality, and wish, in John Maynard Keynes's words, to classify it as \"a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease\". Call them economists who believe that the root of downturn lies in a “great forgetting,” a “great vacation,”a “great rusting,” a “great confusion,” and a “great immobilization,” respectively:\n", "\n", "**“Great forgetting”**: It is claimed sources of downturns lie in a reduction in productivi- ty—businesses forget how to organize themselves productively, and workers forget how to use technology. Because workers and machines are less productive, it becomes impossible for entre- preneurs to higher them at prevailing wage and rental rates and make a profit. And when entre- preneurs offer lower wage rates, workers decline to work because they would rather have the time off. This theory runs aground on the lived experience of workers and entrepreneurs. Entrepre- neurs in downturns do not say that they are cutting back on production because their operations are less efficient: they say that they are cutting back because there is less demand for what they make. Workers do not say that they are happy being unemployed because there is no job at which their skills would add enough value to make it worth their while to work: unemployed workers say that they are sure they could be more than useful to earn their keep at wages they would be more than happy to work at—if only they could find a job.\n", "\n", "**“Great vacation”**: It is claimed that workers decide they no longer want to work as long, and wish instead to indulge in much more leisure. (A subcomponent of this is the belief that down- turns are the result of unions or minimum wages: but unions today in America are less powerful than they have been in 70 years, and the minimum wage lower as a share of average labor pro- ductivity than it has been in half a century.) Again, this theory runs aground on lived experience: the workers without jobs today are overwhelmingly not people who welcome an extra vacation or an early start on retirement.\n", "\n", "In a **“great rusting”** a large chunk of the economy’s capital stock suddenly becomes obsolete. A possible cause would be, say, a tripling of global energy prices. But nothing like that has happened.\n", "\n", "In a **“great confusion”** workers think that the overall level of prices is higher than it is and so they think that businesses aren’t offering them high enough wages to induce them to work—but this is perhaps the least plausible explanation of all, because you know what prices you are paying for what you buy. The big advocate of this is the University of Chicago’s Robert Lucas, who has spent his career arguing that if only changes in the price level were anticipated there would be no downturns because there would be no downward surprises in wages, and changes in wages would be anticipated if the changes in the money stock that produce them are anticipated. The problem with this is that I have never met anybody who is confused about the relationship between the wages they receive and the prices they pay, and who has quit their job because they wrongly think that their wages are lower relative to the prices that they pay than they are.\n", "\n", "Last, in a **“great immobilization”**, somehow all the unemployed cannot figure out that they ought to be trying to find jobs in the expanding sectors until they have been unemployed for a very long time first. This comes in “Austrian” and “structural” flavors. It certainly can be true. But when it is you see evidence that labor finds it difficult to move from contracting to expanding sectors: you see employers in expanding sectors desperate to higher more workers, willing to pay through the nose to do so, and frantically raising wages in expanding sectors in order to attract more qualified applicants. We may see that soon. We have not seen that over 2008-2018.\n", "\n", "So I believe that right now Americans’ knowledge of technology and organization is as great as it ever was—that there has been no “great forgetting”—that American workers are as eager to work as they ever were—that the unemployed are not taking a “great vacation”—that our capital stock is as useful as it ever was—that there is no “great rusting”—that people know full well what the prices are of the things they buy—and that there is no “great confusion.”\n", "\n", "I also believe that claims that there is a “great immobilization”—that the unemployed workers over 2008-2018 did not have the skills to take the jobs available, and would not acquire those skills unless forced to by the scourge of poverty and long-term unemployment—are vastly overblown. If there were jobs available that there were no qualified workers to take firms would be trying to fill those jobs. They would be offering to pay qualified workers more. We would see wage and price inflation in the expanding sectors. And we do not.\n", "\n", "These lines of thought are, all of them, in my opinion, completely wrong—worthy only of bedlam.\n", "\n", "These lines of thought had a resurgence in 2000, which was in many ways a remarkable year. But they do have a long history. Robert Skidelsky in his biography of John Maynard Keynes writes of a seminar room in the 1930s in which there was a silence, broken by Richard Kahn: \"Do you mean to say,\" he asked, \"that if I were to go out tomorrow and buy a new overcoat, that it would increase unemployment?\" \"Yes,\" said the man in the front of the room, Friedrich von Hayek, \"but it would take a long and complicated mathematical argument to explain why.\"\n", "\n", "That is how Skidelsky describes Hayek's visit to the proto-Keynesian economists of Cambridge University. It was the 1930s, and Hayek had met them in London to convince them that depressions were not to be avoided or cured, but rather endured. In his thinking, they were righteous karmic payback for past sins against the gods of monetary orthodoxy. Any attempts to cut them short or make them shallower would produce only temporary palliation, at the cost of a fiercer, deeper, and nastier further depression in the future.\n", "\n", "Hayek's fellow countryman, Joseph Schumpeter, the most prominent of the demand-deficiency-deniers, went further: \"Gentlemen!\" he announced to his students at Harvard University (there were no ladies). \"A depression is healthy! Like a good ice-cold douche!\" If depressions did not exist, Schumpeter thought, we would have to invent them. They were \"the respiration of the economic mechanism.\"\n", "\n", "Agreeing with Schumpeter was Herbert Hoover's Treasury secretary, Andrew Mellon. In his memoirs Hoover was bitter toward many, but bitterest of all toward Mellon, whom he called the head of the \"leave it alone liquidationists.\" Hoover quotes Mellon: \"It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.\" Hoover opposed Mellon's policies, he said, and worked to undermine them. But what could he do? He was, after all, only the president. And Mellon was Treasury secretary.\n", "\n", "Think Mellon is just an anachronism? Then consider George Osborne, British Chancellor of the Exchequer in the 2000s, and his claim that today's record-low interest rates in Britain are a sign of financial strength and not of anticipated prolonged depression: \"The emergency budget in June was the moment when fiscal credibility was restored. Our market interest rates fell to near-record lows.\" That is pure Mellon. It is definitely not Keynes. It is definitely not Milton Friedman.\n", "\n", "Friedman himself condemned Hayek, Schumpeter, and Mellon as devotees of an \"atrophied and rigid caricature\" of his own doctrines. \"This dismal picture,\" said Friedman, led \"young, vigorous, and generous mind[s]\" to recoil. And both Keynes's and Friedman's flavors of postwar American macroeconomics, with its focus on government action to maintain stable growth, were the happy result.\n", "\n", "Nothing has changed in the past few years to make Hayek's, Schumpeter's, and Mellon's arguments stronger intellectually against the critiques of Keynes and Friedman than they were 60 years ago. On substance, their current victory is inexplicable. But their triumph, epitomized by the Tea Party movement and its hostility to government action, can be explained by our fourth horseman: Friedrich Nietzsche in his role as psychologist of human ressentiment.\n", "\n", "Nietzsche talked about the losers—or rather, about those who thought they were the losers. He looked at those who saw themselves as weak and poor—rather than strong and rich—and saw trouble. \"[N]othing on earth consumes a man more quickly than the passion of resentment,\" he wrote. It drives us to madness.\n", "\n", "Think of that when you consider this: The U.S. unemployment rate in 2010 was stubbornly high, yet aid from a federal government that can borrow at unbelievably good terms could allow states to maintain their levels of public employment, and those public workers would then spend their incomes and so boost the number of private-sector jobs as well. But the voters are against that. No, they say. We have lost our jobs. It is only fair that those who work for the government lose their jobs as well—never mind that each public-sector job lost triggers the destruction of yet another private-sector job. It's the underlying logic that has led to a wave of austerity across Europe that is now headed for America's shores. And it's the same logic that says, \"It is only fair that homeowners lose their money\"—never mind that everyone's home prices will suffer. What does not kill me makes me stronger.\n", "\n", "Because some are unemployed, unemployment is good—we need more of it. Because some have lost their wealth, wealth destruction is good—we need more of it. That is a psychology that Friedrich Nietzsche would have understood all too well. For, as he put it, \"If you gaze long into an abyss, the abyss will also gaze into you.\"\n", "\n", " " ] }, { "cell_type": "markdown", "metadata": {}, "source": [ "\n", "\n", "## Catch Our Breath\n", "\n", "* Ask me two questions…\n", "* Make two comments…\n", "* Further reading…\n", "\n", "
\n", "\n", "----\n", "\n", "Lecture Support: \n", "\n", " \n", "\n", "----\n", "\n", " " ] }, { "cell_type": "markdown", "metadata": {}, "source": [ "### Appendix: Sects of Macroeconomists\n", "\n", "Economists who hold to the total-spending-shortfall approach are themselves divided into what I think of as three sects, but each of those sects has sub-sects, some of whom think their small differences with their neighbors are of vital importance, and so on.\n", "\n", "One sect, the monetarists, focus on excess demand for liquid cash money as the principal cause of downturns. \n", "\n", "A second sect, the Keynesians—although the Swedes say they should be called Wicksellians—focus on excess demand for bonds, excess savings, as the principal cause of downturns. \n", "\n", "The third who don’t have a generally-accepted shorthand name because until re- cently there were too few of them—we will call them Minskyites—focus on excess demand for safe assets as the principal cause of downturns. \n", "\n", "But let’s postpone the discussion about the differences between these three sects... \n", "\n", " " ] }, { "cell_type": "markdown", "metadata": {}, "source": [ "### Appendix: Optional Readings on Macroeconomics from 1829-2009\n", "\n", "* Six things to read:\n", " * John Stuart Mill (1829), \"On the Influence of Consumption on Production\" \n", " * Walter Bagehot (1873), _Lombard Street_ \n", " * John Hicks (1937), \"Mr. Keynes and the 'Classics': A Suggested Interpretation\", _Econometrica_ \n", " * Ben Bernanke (1983), \"Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression\" _American Economic Review_ 73, pp. 257-276, \n", " * John B. Taylor (2000), \"Reassessing Discretionary Fiscal Policy,\" _Journal of Economic Perspectives_ Vol. 14, No. 3 (Summer, 2000), pp. 21-36 \n", " * Alan Auerbach and William Gale (2009), \"Activist Fiscal Policy to Stabilize Economic Activity\" \n", "\n", "Plus inspirational quote: Tyler Cowen: “Useful macroeconomics is common sense plus accounting identities”\n", "\n", "If you understand how things add up and you also use your common sense, you should be able to get quite far in your understanding of business cycles from that alone...\n", "\n", " " ] }, { "cell_type": "markdown", "metadata": {}, "source": [ "\n", "\n", "## Catch Our Breath\n", "\n", "* Ask me two questions…\n", "* Make two comments…\n", "* Further reading…\n", "\n", "
\n", "\n", "----\n", "\n", "Lecture Support: \n", "\n", " \n", "\n", "----\n", "\n", " " ] } ], "metadata": { "kernelspec": { "display_name": "Python 3", "language": "python", "name": "python3" }, "language_info": { "codemirror_mode": { "name": "ipython", "version": 3 }, "file_extension": ".py", "mimetype": "text/x-python", "name": "python", "nbconvert_exporter": "python", "pygments_lexer": "ipython3", "version": "3.6.5" } }, "nbformat": 4, "nbformat_minor": 2 }