10/21/10 7:57 PMI Don't Think This Is the Best Way to Put It... - Grasping Reality with Both Hands

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Grasping Reality with Both HandsThe Semi-Daily Journal of Economist J. Bradford DeLong: Fair, Balanced, Reality-Based, and Even-HandedDepartment of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 7080467; delong@econ.berkeley.edu.

Economics 210aWeblog ArchivesDeLong Hot on GoogleDeLong Hot on Google BlogsearchSeptember 03, 2010

I Don't Think This Is the Best Way to Put It...

Paul Krugman writes:

Paradoxes Of Deleveraging And Releveraging: Whenever the issue of fiscalstimulus comes up, you can count on someone chiming in to say, “Only a moroncould believe that the answer to a problem created by too much debt is to createeven more debt.” It sounds plausible — but it misses the key point: there’s afallacy of composition here...

There is nothing wrong with what Paul says. But I think it is incomplete, and that thereis a better way of getting to the right conclusion.

The problem was created by too much risky debt and not enough safe debt. The resultis that right now there is an excess demand for safe assets--like U.S. governmentsecurities. Because businesses and households want to hold more safe assets at fullemployment than exist, they are trying to cut back on their spending on currently-produced goods and services in order to build up their stocks of safe assets.

As a group, when they try to do this they fail: building up the economy's stock of safeassets requires that somebody do something to create them. But as they try theircutbacks in spending on currently-produced goods and services produces the fall inproduction, income, and employment that has led us to our current situation.

The best ways to get us out of this? (a) Have the government put people to work, and(b) have the government create more safe assets--more Treasury bonds--for people tohold. The first puts people to work. The second gives businesses and households moresafe assets to hold so that they will be happy with their safe asset portfolios. Thus theywill then stop trying to accumulate more safe assets, they will spend their incomes, andthat will put more people back to work too.

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If our big problem were too much debt we would not be here, in depression. Too muchdebt generates inflation. The things that generate depression are shortages of financialassets, and excess demand for some class of financial assets then produces, by Walras'sLaw, excess supply of currently-produced goods and services. We had a "shortage ofliquid cash money" recession in 1982; we had a "shortage of long-duration bonds"recession in 2002, and now we are having a "shortage of safe assets" recession.

Brad DeLong on September 03, 2010 at 08:30 AM in Economics, Economics: FederalReserve, Economics: Finance, Economics: Fiscal Policy, Economics: Macro, ObamaAdministration | Permalink

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kdedeLC said...Sounds an awful lot like a recent lecture I heard....

Reply September 03, 2010 at 09:02 AMA said..."The problem was created by too much risky debt and not enough safe debt."

Worse than that - a lot of the risky debt was bought by people who thought they werebuying safe debt. Hence there is a massive overhang...

Reply September 03, 2010 at 09:22 AMwalt said in reply to kdedeLC...When I first arrived at Berkeley in the fall of 1964, the big event soon became the FreeSpeech Movement. I wonder if this fall it will be Econ 1, DeLong's "cast of thousands."Informal assignment for the students: find the locations of the nearest branches ofBofA, Citi, Chase etc. Later in the semester, at the end of a class, you may feel liketaking mass strolls to them. It's what Saul Alinsky and Mario Savio would have done.

Reply September 03, 2010 at 09:23 AMNeal said..."Safe asset" shortage for households and businesses???

That's where the problem comes from???

With the rates today, there is no significant difference between holding Treasurys, cash,money market funds, insured certificates of deposit, or cash in an insured savingsaccount in the scale of money holding that almost every individual and business in thiscountry falls under. There is no shortage of "safe" places to put money (and get

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virtually no return).

Its a plain asset/income shortage.

We should be so lucky as to have a population that have excess assets/income to besquirreled away in "safe assets".

Reply September 03, 2010 at 09:33 AMOmega Centauri said...I don't think I guite get it. Households (maybe businesses also, but thats not neededfor this argument) want more safe assets. But, safe assets are not to be found, so theysave more even though their is no perceived safe parking place for the money. One wayto react to the perceived problem that your money and investents may not be safe is tospend it now, rather than risk losing it on a poor investment. I think you are implyingthat the desire to have "safe" assets means they either accumulate more not-so-safeassets, or perhaps just stuff their mattresses with cash. Theres a link to humanpsychology here that just isn't obvious to someone who hasn't been exposed to theproper micro arguments.

Reply September 03, 2010 at 09:35 AMWoodyinNYC said...I don't get the whole argument either. There's some slip between households andTreasurys in my mind -- obviously I'm no economist! But I don't know any householdsholding Treasury bonds or trying to get more of them. Is it just me?

I do see this connection: Households that I know have mortgages, car loans, creditcards. (If they've got college loans too, forgetabout it, they're doomed.) The asset valueof the house has declined a good bit, wiping out their sense of financial security fromthat source. They can even be underwater with the mortgage. They look around, thesafest surest "asset" they can get is "reduced debt". So they cut back spending and startpaying down the revolving credit on their pocketful of credit cards. Good for them, butbad for the retailers and the mall owners etc. Those car loans, remember how theyused to get a shiny new car every two or three years? Not this time. With the greatlyimproved reliability of cars, SUVs, pickups in recent years, they can put off buying anew one even after that car loan is paid in full. Good for them, but bad for dealers,Detroit and the transplants. Then with the money that used to go to car loans andcredit card payments, maybe then they can shovel extra payments into that hell hole ofa mortgage, trying to pay down the remaining principal until they can get above water.Good for them, but still bad for the retailers, the importers, the malls, the car dealers,and their employees.

So paying down the debts, which has to be done, is good for individual households --until they become victims of the unemployment resulting from their reduced spending.Which gets us back to jobs, or the lack thereof, which is (a) on the list of problems ProfDeLong thinks the government must address. That part anyone can understand.

Reply September 03, 2010 at 10:19 AMGerard MacDonell said...I prefer Krugman's economy.

Delong's distinction between risky and riskless debt seems a valid and useful one. Ithink it helps complete the argument. But when he offers it here as a correction toKrugman's construction, he offers comfort to a common misperception: that the curecan never involve a bit of the disease.

In fact, the solution to problems caused by insufficient thrift in the past can indeed be

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policies that are designed to drive down (ex ante) national saving now.

Delong offers nothing against this, in fairness. But Krugman's take challenges theprevailing ignorance more directly and cleanly. It is preferable in that regard.

Reply September 03, 2010 at 10:24 AMJim said...Why not go all the way and admit that the level of public debt is meaningless? Unlikeprivate debt, society cannot owe something to itself. Why not spend through theprinting press when we have massive unused resources? The political problem is thatthe contradictory position that a) we should deficit spend and b) deficits matter andcan be dangerous is not sellable. It never has been. Center-left economists need to getoutside the box, dust off Abba Lerner and the early Keynesians, and back the idea thatthe very notion of public debt is a meaningless confusion that only assures thecontinuation of right wing policies.

Jimcommentsongpe.wordpress.com

Reply September 03, 2010 at 11:56 AMMin said..."If our big problem were too much debt we would not be here, in depression. Toomuch debt generates inflation."

Well said! :)

Reply September 03, 2010 at 12:15 PMRoman Berry said...Channeling Alan Simpson: Whaddaya mean more safe assets like US Treasurysecurities? Them things ain't safe assets. Them thing's just IOUs.

Reply September 03, 2010 at 12:52 PMFoster Boondoggle said...I don't see that there's a "problem" of a shortage of safe assets. Yes, Treasury yields areat record lows. But there's no shortage of them - just a shortage of future returns...And to the extent that the low yields reflect some kind of shortage, doesn't QuantitativeEasing increase that shortage?

The problem with QE at this point is that it doesn't seem to work without fiscal policybiased towards increasing the deficit. If you take the banks out of the picture, QEamounts to the Fed buying the Treasury's debt. Both put their pieces of paper (ornumbers in a computer) in their pockets and nothing else changes. If you add thebanks to the picture, you just change that straight line into a triangle - the banks buythe Treasury's bonds & the Fed buys those from the banks. Again, nothing changes.

Unless the Fed starts doing QE with risky assets, I don't see how monetary policy canget us anywhere. Which means 2+ more years of stagnation or worse, unless we getpulled out by Chinese consumers or some other external force.

Reply September 03, 2010 at 01:39 PMjcb said...I'm not sure what you mean by a "safe asset." Do you just mean government bonds? Inthat case, selling a lot more of them would create deflation. Is there any asset so safethat it will guarantee a return above the rate of inflation or deflation?

Do you mean assets that are fairly priced, for which risk is adequately advertised, andwith commensurate return? In that case, it's the aim of acquiring any asset. And the

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definition becomes virtually tautological.

This seems to be a debate between Richard Koo (channeled by PK) and J.S. Mill andHyman Minsky (channeled by BD).

I prefer Koo's balance sheet depression ("The Holy Grail of Macroeconomics") becauseit provides a better account of the relationship between public and private expenditureand GDP, supported by a great deal of empirical evidence from Japan and the U.S. Andalso because he provides a better situational account of economic motivation --sometimes fearful and cautious (paying down debt), sometimes optimistic (investingand profit maximizing). But he seems to focus entirely on corporations (that earnprofits to pay down debt from where?), and not on consumers who need incomes tosupport effective demand (and are often at the receiving end of corporate cost-cutting).Hence, the overwhelming need for a jobs policy to support incomes, not tax cuts whichwill hasten debt repayment at the expense of effective demand. As "Neal" (above) said.And "Woody."

The flight to safe assets is motivated by fear; when people are optimistic, they wantprofitable assets. Contra Mill, acquiring large stocks of money (or safe assets) isprecautionary hoarding (for future consumption) or fear-induced (because no otherasset seems safe). Money and government bonds are not assets like any other. They arealso a financial refuge, not to be confused with a goal of economic policy -- althoughsafer assets would assuredly be the byproduct of that policy.

Reply September 03, 2010 at 02:43 PMscathew said...I think if you're taking econ yours is more succinct and fits better into the "science" ofthe issue. Paul's however I think is aimed at showing the problem in real human terms- it is a "political" document.

That is, if I was talking to economics students I'd use yours, if I was talking topoliticians or trying to sway lay people, I'd use his.

Reply September 03, 2010 at 04:36 PMscathew said...BTW - I'm sorry but Obama sux. As channeled by Gibs:

"Some big, new stimulus plan is not in the offing."

Reply September 03, 2010 at 04:44 PMFull Employment Hawk said..."The result is that right now there is an excess demand for safe assets--like U.S.government securities. Because businesses and households want to hold more safeassets at full employment than exist, they are trying to cut back on their spending oncurrently-produced goods and services in order to build up their stocks of safe assets."

The fallacy in this argument is that unlike the product and labor markets, where pricesare sticky so that an excess supply or demand can persist for an extended period oftime, prices in the bond market are highly flexible. If people want to hold more safeassets than exist, AT THE INITIAL PRICE OF THE SAFE ASSETS, the price of the safeassests are bid up until the quantity supplied and demanded are equal, so that there isno excess demand for safe assets that creates an excess supply for commodities.

Reply September 03, 2010 at 05:51 PMBrad DeLong said in reply to Full Employment Hawk...So you are saying that we are at full employment right now?

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Yours,

Brad DeLong

Reply September 03, 2010 at 06:07 PMFull Employment Hawk said in reply to Brad DeLong...Absolutely not. What I am saying is that the excess supply in the commodity market isnot being caused by an excess demand in the bond market. Prices in the bond marketadjust almost instantaneously to eliminate any excess demand there so there is noexcess demand there long enough to create an excess supply in the commodity market.The excess supply in the commodity market exists IN SPITE OF, INSTEAD OFBECAUSE OF the fact that there is no excess demand in the bond market. As Clowershowed in his 1965 article "The Keynesian-Counter-Revolution," and was shown in thedisequilibrium literature that followed from it: When transactions can take place andbe finalized in one or more markets when they do not clear, Walras' Law does nothold. In other words, the sum of the excess demand in the bond and commoditymarket do not add up to zero. You have zero excess demand in the bond market and apositive excess supply in the commodity market. A good exposition of this approach isfound in Hershel Grossman's paper "Money, Intest, and Prices in MarketDisequilbrium" JPE Sept.-Oct. 1971, pp. 943-61. For a while this spawned a verypromising literature on Disequilibrium Theory, which unfortunately was killed off bythe New Classical Economics before it was able to get firmly established. So instead ofhaving macro models that explicitly take the effects of non-market-clearingtransactions into account, with cyclical unemployment being involuntary because thelabor market is not clearing, we have Panglossian models in which all markets areinstantaneously clearing and all unemployment is voluntary.

Reply September 03, 2010 at 07:21 PMFull Employment Hawk said in reply to Full Employment Hawk...One minor tweak in the above reply

"When transactions can take place and be finalize" should be "When transactions takeplace and are finalized" i.e. no auctioneer and no recontracting to prevent transactionsfrom being finalized at non-market-clearing prices.

Reply September 03, 2010 at 07:25 PMSora said...I think your argument would be strengthened by walking the discussion away from theanalogy of public debt to household debt. Most people seem to treat governmentsecurities like credit card debt. It seems to be a big turn-off that you are arguing thatthe best thing to do in hard times is get more credit cards rather than cut unnecessaryspending.

Of course, you might also want to make a distinction between prudent spending andwasteful pork. Unfortunately, the analogy to the 1940s falls apart, because what peoplereally supported was military spending to win the war. People aren't nearly sosupportive of road projects and the census.

Reply September 03, 2010 at 09:21 PMFull Employment Hawk said..."than cut unnecessary spending" during hard times.

Cutting any kind of spending at a time when the economy is depressed increasesunemployment. Even pork puts unemployed workers to work. Even paying people todig holes in the ground and fill them back up puts unemployed workers to work.

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Me: Economists:

PaulKrugmanMark ThomaCowen andTabarrokChinn andHamiltonBrad Setser

Juicebox

Mafia:

Ezra KleinMatthewYglesiasSpencerAckermanDanaGoldsteinDanFroomkin

Moral

Philosophers:

Hilzoy andFriendsCrookedTimber ofHumanityMarkKleiman andFriendsEricRauchwayand FriendsJohn Holbo

Obviously it is better if the spending to put people to work is on things that increasethe economy's potential output, like investment in infrastructure, but when it comes toputting people to work, even intrinsically wasteful spending will do the job.

Reply September 04, 2010 at 04:45 AMFull Employment Hawk said in reply to Brad DeLong...If you publish your text using this approach, many others are going to point out thatsince the bond market is a flexible price market, the price of bonds will quickly adjustto clear it, so that there will be no excess demand in the bond market long enough tocause an excess supply in the commodity market. I'm only the FIRST one to havecaught this. When this happens, remember I was the first one to point it out.

I'm not trying to be rude. But this is an important point you need to consider.

Reply September 04, 2010 at 11:03 AMyoyo said...No, you're mistaking stocks and flows. The creation of debt causes inflation, not theexistence of debt.

Reply September 04, 2010 at 12:31 PMComments on this post are closed.

Economists Debate The Philosophy Behind British Budget CutsNPR (blog) - 12 hours agoBrad de Long, an economist at UC Berkeley, and a prolific blogger, is quoted in theTimes as mourning the dismissal of Keynes. ...Related Articles » « Previous Next »

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and Friends

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