Anatomy of the Global Economy
Economics for Parrots
J. Bradford DeLong
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BERKELEY – It is said that the early nineteenth-century British economist J.R. McCulloch originated the old joke that the only training a parrot needs to be a passable political economist is one phrase: “supply and demand, supply and demand.” Last week, US Federal Reserve Chairman Ben Bernanke said that McCulloch’s economics – the economics of supply and demand – was in no way discredited by the financial crisis, and was still extraordinarily useful.
It’s hard to disagree with Bernanke’s sentiment: economics would be useful if economists were, indeed, likeMcCulloch’s parrots – i.e., if they actually looked at supply and demand. But I think that much of economics has been discredited by the manifest failure of many economists to be as smart as McCulloch’s parrots were.
Consider the claims – rampant nowadays in the US – that further government attempts to alleviate unemployment will fail, because America’s current high unemployment is “structural”: a failure of economic calculation has left the country with the wrong productive resources to satisfy household and business demand. The problem, advocates of this view claim, is a shortage of productive supply rather than a shortage of aggregate demand.
But it should be easy – at least for an average parrot – to tell whether a fall in sales is due to a shortage of supply or a shortage of demand. If a fall in sales is due to a shortage of demand while there is ample supply, then, as quantities fall relative to trend, prices will fall as well. If, on the other hand, the fall in sales is due to a shortage of supply while there is ample demand, then prices will rise as quantities fall.
Which do we see now? There are no places in the US economy where wages or product prices are rising more rapidly than expected. There are no places where a shortage of qualified labor or of available capacity is sufficiently great to induce managers to pay more than they have been used to paying for good hands or useful machines.
McCulloch’s parrot would call this conclusive. The coexistence of high unemployment with falling inflation and no bottleneck-driven price or wage spikes tells us that “structural” supply-side explanations of America’s current high unemployment are vastly overblown.
Or consider the claims – also rampant these days – that further government attempts to increase demand, whether through monetary policy to alleviate a liquidity squeeze, banking policy to increase risk tolerance, or fiscal policy to provide a much-needed savings vehicle, will similarly fail. These measures, too, are supposedly doomed because they all involve increasing governments’ liabilities, and financial markets are at a tipping point with respect to sovereign debt. If governments that have already tapped-out their debt-bearing capacity now issued more debt or money or guarantees, they would deal a mortal blow to confidence.
Once again, an adequately trained parrot, unlike many economists nowadays, would ask whether the economic problems that current levels of government debt are causing reflect too much public debt supplied by governments or too much public debt demanded by the private sector. If the problem were that supply is too great, then new emissions of government debt would be accompanied by low prices – that is, by high interest rates. If the problem were that demand is too great, then new emissions of government debt would be accompanied by high prices – that is, by low interest rates.
Guess which one the US and many other countries have? For a parrot, that’s a no-brainer: the public-debt problem is not that governments have issued so much debt that investors have lost confidence, but that governments have issued too little debt given the enormous private-sector demand for safe places to park wealth. The problem, the parrot would say, is that households and businesses are still trying to build up their stocks of safe, high-quality assets, and are switching expenditures from buying currently-produced goods and services to increasing their shares of an inadequate supply of government liabilities.
When economic historians examine the Great Recession, their overwhelming consensus is likely to be that its depth and duration reflected governments’ refusal to try to do more, not that they tried to do too much. They will agree with the parrots that falling inflation showed that the macroeconomic problem was insufficient demand for currently produced goods and services, and that the low level of interest rates on safe, high-quality government liabilities showed that the supply of safe assets – whether money provided by the central bank, guarantees provided by banking policy, or government debt provided through deficit spending – was too low.
The question that will be a mystery to them is why so many economists of our day did not know how to say: “supply and demand, supply and demand.”
J. Bradford DeLong, a former US Assistant Secretary of the Treasury, is Professor of Economics at the University of California at Berkeley and a Research Associate at the National Bureau for Economic Research.
Copyright: Project Syndicate, 2010.
www.project-syndicate.org
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denim 08:07 01 Oct 10
"...the supply of safe assets – whether money provided by the central bank, guarantees provided by banking policy, or government debt provided through deficit spending – was too low."
So the Supply Sider politico-economists are controlling the supply of that commodity that is called wealth by some of us.
ReobertInAz 05:08 03 Oct 10
In a similar line of thought, would McCulloch’s parrot decide that the income stagnation at the lower income levels is due to a lack of demand for low skill labor, or an essentially unlimited supply of (illegally in sourced) low skill labor?
Joulie 09:52 08 Oct 10
Bonjour,
C'est une logique tout à fait erronée, juste un exemple : si les taux d'intérêts sur la dette publique sont très faible, ce n'est pas comme l'auteur le soutien, que l'offre d'actifs sûrs est trop faible mais plutôt que les investisseurs ont préféré déplacer leurs capitaux, par peur et de façon excessive, des marchés actions, notamment, vers les obligations d'Etats.
Bien cordialement,
benoit.
JerryLapell 04:17 12 Oct 10
"There are no places in the US economy where wages or product prices are rising more rapidly than expected."
I don't know about you, but the cost of food, getting a good quality education at any level, decent health care, and even decent house contractor work continue to rise far more rapidly than I expected.
I must live in a different world than DeLong. I don't find this piece persuasive at all.
There really is structural unemployment because there really is a tremendous amount of wasted human potential in this country, human potential which could be studying ways to improve the quality of the American food supply, educating, providing medical treatment and services, and fixing leaky pipes.
Come on, professor -- you can do better than this!
denim 01:54 12 Oct 10
To admit to structural unemployment as anything but utter nonsense is to say that man can never go to the moon and back the first time because it has never been a college credit course.
RvanGinderen 05:04 19 Oct 10
What botters me is the conclusion that the government must issue more bonds (hence, increase their deficit), because interest rates are so low and there is a shortage of supply of bonds, while completely ignoring the fact that bond yields and rates a so low, because the Fed is manipulating the bond market. This manipulation causes rates to remain low, which is exactly the intention of the Fed. Without Fed intervention, Treasury rates would be much, much higher.
So what if it appears later on that interest paid on government debt rises once the Fed moves out of the bond market? Obviously, this will not just happen.
All in all, the actual cost of borrowing should be considered. And moreover: one can just NOT conclude that there is a shortage of supply of Treasuries, while it is the Fed that is buying up a huge pile of Treasuries.
Read more on http://economicious.blogspot.com/2010/10/demand-and-supply-forces-how-fed-tries.html
humantide 04:54 21 Oct 10
This is where theory bamboozles commonsense. Academic alchemy. It also assumes that the participants in the market are rational as opposed to emotional, which better explains the "Popular delusion and madness of crowds".
US Treasuries may be considered safe because it is thought that the US government would never default. That may be true but if the US Treasury continues to issue at the present rate it is highly questionable that what the lender will receive back will have anything near the buying power of the money lent at the time of issue. It completely amazes me that anyone could consider such debt safe in a world of massive deficits, very high unemployment, an unwillingness to borrow or spend by private business and a new eagerness to save. The problem with academics is that they have no real understanding of the driver of economics which is people. There may be a herdlike rush for the perceived "safety" of US government debt but the real story is that the money supply is declining. It is being forced down by people cutting back on credit card expenditure and lowering borrowings. People are beginning to save again but being paid a pittance for it. On the one hand they are rational because they know that they cannot sustain such high debt loads but on the other hand they are supporting the government in its relentless borrowing expansion. De Long's assertion that the public has not lost confidence in the government because of its massive debt issuance is belied by the behaviour of markets - if they did have confidence they would be borrowing hand over fist and banks would be lending hand over fist. hat is clearly not happening. Instead we have a cosy arrangement between large financial institutions and the Fed to appear to be creating or "printing" money wholesale and yet money supply is falling. The Fed is a bank and knows full well that it has done its dash. It has swopped billions of "good" Treasury debt for god knows what but definitely the toxic variety that banks could not wait to be relieved of. It is not often mentioned that the member banks of the Federal Reserve System are obliged to make good any losses that the Fed entails. The trouble is that the Fed is so secretive about the "assets" it holds and anyway it does not have to mark to market so the con job is complete - until it fails. In the meantime they do thier best to massge some confidence into the public, trying not to let on that they are just as alarmed as the public. If they were really serious about stimulating the economy they would close down the IRS and send out large cheques to everyone instead of this farrago of the Fed buying up debt and the banks depositing the funds back with the Fed to create the illusion of money creation. Sheer common sense tells me that you cannot remove the problem of massive debt by borrowing more. The only cure is cold turkey.
lleeoonn 02:15 26 Nov 10
The smart people like Mr. Delong see the big picture and explain things simply, clearly, and rationally. The parrots of Congress, the Tea Party, et al, only complain about the 'debt' without seeing or understanding the bigger picture.
RvanGinderen 06:58 26 Nov 10
To me, the bigger picture is that the U.S. and other Western nations (most notably Japan) have such huge debts, that will never be repaid. Once investors wake up and realise that bond yields are so low because the central bankers manipulate these bond yields, and that future liabilities are enormous (a.o. due to ageing) such that the current debt will never be repaid, yields WILL rise. If governments engage in more fiscal stimulus now, they therefore WILL face rapidly rising costs of financing their debts, so soon this WILL run out of hand. For a clear example, look at Greece, Ireland, and more to come. The fact that the debt of Japan is still manageable is because of the high savings ratio of the Japanese and because the largest part of the Japanese government debt is financed by domestic savers. Now that the savings ratio has dropped to virtually zero, Japan will have to start searching for foreign investors crazy enough to buy their bonds. When every government would have a debt like Japan, competition among countries to sell their government bonds will be very large, and therefore, yields will rise.
Enough reasons, therefore, why yields WILL rise. Fiscal spending now only enlarges this future problem. Okay, not if this spending generates so much growth that by doing this, the debt will be easier to repay later on. The problem is that I don't see this happening. Government spending is just not efficient. Let the market recover and find its way to the most productive uses of capital.
bluebear 05:22 01 Oct 10
To do their jobs, in addition to “supply and demand, supply and demand,” the modern economic parrots should start practicing to say “global economy, global economy.”
The best thing that the dogmatic population of the mature generation of economists, by modeling the U.S. economy as standing by itself and wrongly predicting its behaviors and hence wrongly steering it by giving one-sided advice to the administration, should do to help the economy might be to consider retirement.
The emerging generation of economists needs to observe and think to create new models and not just to learn only from history because the textbooks are outdated.
What if the current “structural” unemployment is not an issue of intranational skills gap, but an issue of disparity in international real labor costs per unit productivity?
More aggregate demand stimulus packages by more monetization of debts while consumer confidence is overly conservative might create proportionally little jobs in the U.S. and more jobs in other countries relative to the cost of imposing massive inflation taxes on the U.S. Depending on how desperate we are, arguably more stimulus should help somewhat in the short term, but it may be too costly in the long run as it will further damage the credibility of the dollar and of U.S. economic leadership standing.
One way to suck the wealth and jobs back to the U.S., before too late, may be to apply to China, Germany, and other export-lopsided fast rising countries revised versions of the trade policies that the U.S. imposed to Japan in recent history. With protection, the average U.S. consumer pays more but more will go back to his paychecks because everyone is a consumer as well as a producer. Getting big paychecks while buying things dirt cheap was nice but not a sustainable cycle: During that exuberant period, the U.S. has cashed out massive portions of both its technological advantage and its monetary-controls credibility earned by geopolitical luck and by hard work and scarification of earlier generations.