The Wisdom of David Laidler

Michael Woodford’s paper for the Jackson Hole Symposium on Monetary Policy wasn’t the only important paper on monetary economics to be posted on the internet last month. David Laidler, perhaps the world’s greatest expert on the history of monetary theory and macroeconomics since the time of Adam Smith, has written an important paper with the somewhat cryptic title, “Two Crises, Two Ideas, and One Question.” Most people will figure out pretty quickly which two crises Laidler is referring to, but you will have to read the paper in order to figure out which two ideas and which question, Laidler has on his mind. Actually, you won’t have to read the paper if you keep reading this post, because I am about to tell you. The two ideas are what Laidler calls the “Fisher relation” between real and nominal interest rates, and the idea of a lender of last resort. The question is whether a market economy is inherently stable or unstable.

How does one weave these threads into a coherent narrative? Well, to really understand that you really will just have to read Laidler’s paper, but this snippet from the introduction will give you some sense of what he is up to.

These two particular ideas are especially interesting, because in the 1960s and ’70s, between our two crises, they feature prominently in the Monetarist reassessment of the Great Depression, which helped to establish the dominance in macroeconomic thought of the view that, far from being a manifestation of deep flaws in the very structure of the market economy, as it had at first been taken to be, this crisis was the consequence of serious policy errors visited upon an otherwise robustly self-stabilizing system. The crisis that began in 2007 has re-opened this question.

The Monetarist counterargument to the Keynesian view that the market economy is inherently subject to wide fluctuations and has no strong tendency toward full employment was that the Great Depression was caused primarily by a policy shock, the failure of the Fed to fulfill its duty to act as a lender of last resort during the US financial crisis of 1930-31. Originally, the Fisher relation did not figure prominently in this argument, but it eventually came to dominate Monetarism and the post-Monetarist/New Keynesian orthodoxy in which the job of monetary policy was viewed as setting a nominal interest rate (via a Taylor rule) that would be consistent with expectations of an almost negligible rate of inflation of about 2%.

This comfortable state of affairs – Monetarism without money is how Laidler describes it — in which an inherently stable economy would glide along its long-run growth path with low inflation, only rarely interrupted by short, shallow recessions, was unpleasantly overturned by the housing bubble and the subsequent financial crisis, producing the steepest downturn since 1937-38. That downturn has posed a challenge to Monetarist orthodoxy inasmuch as the sudden collapse, more or less out of nowhere in 2008, seemed to suggest that the market economy is indeed subject to a profound instability, as the Keynesians of old used to maintain. In the Great Depression, Monetarists could argue, it was all, or almost all, the fault of the Federal Reserve for not taking prompt action to save failing banks and for not expanding the money supply sufficiently to avoid deflation. But in 2008, the Fed provided massive support to banks, and even to non-banks like AIG, to prevent a financial meltdown, and then embarked on an aggressive program of open-market purchases that prevented an incipient deflation from taking hold.

As a result, self-identifying Monetarists have split into two camps. I will call one camp the Market Monetarists, with whom I identify even though I am much less of a fan of Milton Friedman, the father of Monetarism, than most Market Monetarists, and, borrowing terminology adopted in the last twenty years or so by political conservatives in the US to distinguish between old-fashioned conservatives and neoconservatives, I will call the old-style Monetarists, paleo-Monetarists. The paelo-Monetarists are those like Alan Meltzer, the late Anna Schwartz, Thomas Humphrey, and John Taylor (a late-comer to Monetarism who has learned quite well how to talk to the Monetarist talk). For the paleo-Monetarists, in the absence of deflation, the extension of Fed support to non-banking institutions and the massive expansion of the Fed’s balance sheet cannot be justified. But this poses a dilemma for them. If there is no deflation, why is an inherently stable economy not recovering? It seems to me that it is this conundrum which has led paleo-Monetarists into taking the dubious position that the extreme weakness of the economic recovery is a consequence of fiscal and monetary-policy uncertainty, the passage of interventionist legislation like the Affordable Health Care Act and the Dodd-Frank Bill, and the imposition of various other forms of interventionist regulations by the Obama administration.

Market Monetarists, on the other hand, have all along looked to monetary policy as the ultimate cause of both the downturn in 2008 and the lack of a recovery subsequently. So, on this interpretation, what separates paleo-Monetarists from Market Monetarists is whether you need outright deflation in order to precipitate a serious malfunction in a market economy, or whether something less drastic can suffice. Paleo-Monetarists agree that Japan in the 1990s and even early in the 2000s was suffering from a deflationary monetary policy, a policy requiring extraordinary measures to counteract. But the annual rate of deflation in Japan was never more than about 1% a year, a far cry from the 10% annual rate of deflation in the US between late 1929 and early 1933. Paleo-Monetarists must therefore explain why there is a radical difference between 1% inflation and 1% deflation. Market Monetarists also have a problem in explaining why a positive rate of inflation, albeit less than the 2% rate that is generally preferred, is not adequate to sustain a real recovery from starting more than four years after the original downturn. Or, if you prefer, the question could be restated as why a 3 to 4% rate of increase in NGDP is not adequate to sustain a real recovery, especially given the assumption, shared by paleo-Monetarists and Market Monetarists, that a market economy is generally stable and tends to move toward a full-employment equilibrium.

Here is where I think Laidler’s focus on the Fisher relation is critically important, though Laidler doesn’t explicitly address the argument that I am about to make. This argument, which I originally made in my paper “The Fisher Effect under Deflationary Expectations,” and have repeated in several subsequent blog posts (e.g., here) is that there is no specific rate of deflation that necessarily results in a contracting economy. There is plenty of historical experience, as George Selgin and others have demonstrated, that deflation is consistent with strong economic growth and full employment. In a certain sense, deflation can be a healthy manifestation of growth, allowing that growth, i.e., increasing productivity of some or all factors of production, to be translated into falling output prices. However, deflation is only healthy in an economy that is growing because of productivity gains. If productivity is flagging, there is no space for healthy (productivity-driven) deflation.

The Fisher relation between the nominal interest rate, the real interest rate and the expected rate of deflation basically tells us how much room there is for healthy deflation. If we take the real interest rate as given, that rate constitutes the upper bound on healthy deflation. Why, because deflation greater than real rate of interest implies a nominal rate of interest less than zero. But the nominal rate of interest has a lower bound at zero. So what happens if the expected rate of deflation is greater than the real rate of interest? Fisher doesn’t tell us, because in equilibrium it isn’t possible for the rate of deflation to exceed the real rate of interest. But that doesn’t mean that there can’t be a disequilibrium in which the expected rate of deflation is greater than the real rate of interest. We (or I) can’t exactly model that disequilibrium process, but whatever it is, it’s ugly. Really ugly. Most investment stops, the rate of return on cash (i.e., expected rate of deflation) being greater than the rate of return on real capital. Because the expected yield on holding cash exceeds the expected yield on holding real capital, holders of real capital try to sell their assets for cash. The only problem is that no one wants to buy real capital with cash. The result is a collapse of asset values. At some point, asset values having fallen, and the stock of real capital having worn out without being replaced, a new equilibrium may be reached at which the real rate will again exceed the expected rate of deflation. But that is an optimistic scenario, because the adjustment process of falling asset values and a declining stock of real capital may itself feed pessimistic expectations about the future value of real capital so that there literally might not be a floor to the downward spiral, at least not unless there is some exogenous force that can reverse the downward spiral, e.g., by changing price-level expectations.  Given the riskiness of allowing the rate of deflation to come too close to the real interest rate, it seems prudent to keep deflation below the real rate of interest by a couple of points, so that the nominal interest rate doesn’t fall below 2%.

But notice that this cumulative downward process doesn’t really require actual deflation. The same process could take place even if the expected rate of inflation were positive in an economy with a negative real interest rate. Real interest rates have been steadily falling for over a year, and are now negative even at maturities up to 10 years. What that suggests is that ceiling on tolerable deflation is negative. Negative deflation is the same as inflation, which means that there is a lower bound to tolerable inflation.  When the economy is operating in an environment of very low or negative real rates of interest, the economy can’t recover unless the rate of inflation is above the lower bound of tolerable inflation. We are not in the critical situation that we were in four years ago, when the expected yield on cash was greater than the expected yield on real capital, but it is a close call. Why are businesses, despite high earnings, holding so much cash rather than using it to purchase real capital assets? My interpretation is that with real interest rates negative, businesses do not see a sufficient number of profitable investment projects to invest in. Raising the expected price level would increase the number of investment projects that appear profitable, thereby inducing additional investment spending, finally inducing businesses to draw down, rather than add to, their cash holdings.

So it seems to me that paleo-Monetarists have been misled by a false criterion, one not implied by the Fisher relation that has become central to Monetarist and Post-Monetarist policy orthodoxy. The mere fact that we have not had deflation since 2009 does not mean that monetary policy has not been contractionary, or, at any rate, insufficiently expansionary. So someone committed to the proposition that a market economy is inherently stable is not obliged, as the paleo-Monetarists seem to think, to take the position that monetary policy could not have been responsible for the failure of the feeble recovery since 2009 to bring us back to full employment. Whether it even makes sense to think about an economy as being inherently stable or unstable is a whole other question that I will leave for another day.

HT:  Lars Christensen

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24 Responses to “The Wisdom of David Laidler”


  1. 1 JCE September 11, 2012 at 7:11 pm

    great post david!! then again, your posts are consistently good and enlightening. keep up the good work!

  2. 2 Ritwik September 11, 2012 at 8:12 pm

    David

    I always find reading Laidler enjoyable. The best historian of macro thought, apart from perhaps Dimand.

    Having said that :

    1) Shouldn’t Clark Warburton be the father of monetarism? As in fist combining a monetary theory of the business cycle along with monetary diseuilbrium.

    2) Real interest rates are not negative. If there were only two categories of assets – ‘money’ and ‘bonds’ – in the global hierarchy of money, the 10 year treasury bond is arguably more money than bond. Cost of capital for businesses – yield on risky long ‘bonds’ – remains highly positive.

    3) The marginal efficiency of capital may indeed be very low. But your mental model seems to be to equate this with the cost of capital. This is not reconcilable with a Wicksellian S-I disequilibrium. The only way you can create a recession in such a model is to go the whole nominal hog and chuck interest rates out of the window, i.e talk about monetary disequilibrium and low expected spending/sales overall, rather than corporate cash balances and low investment due to rates.

    4) The paleo and market monetarist distinction is not just about inflation/ deflation. It’s about real interest rates. The paleo-monetarist conviction was that deflation, i.e rising real rates caused the recession. It’s reconcilable with a Keynesian-Wicksellian neutral rate(MEC) < market rate model, albeit it emphasizes the rise in the market rate rather than the Keynesian emphasis on the fall in the MEC. The market monetarist model would predict declining real rates (not just declining nominal rates) in a recession. It's an upward sloping FF/IS curve model.

    Having said all that, I completely agree that the real rate of return on 'money' has to decline for there to be a chance at escaping the downturn, whether through negative nominal rates or expected inflation. How to go about creating that inflation is where I differ from the market monetarist pov, of course.

  3. 3 Ritwik September 11, 2012 at 8:17 pm

    Sorry, having made much of the distinction between ‘money’ and ‘bonds’, I used ‘real rates’ to differentiate between the kinds of monetarists without specifying that I meant real rates on bonds.

  4. 4 Greg Ransom September 11, 2012 at 9:37 pm

    Why not identify Hayek & Mises as the first monetarists? It is well known that Hayek and Mises combined a monetary theory of the business cycle along with monetary disequlibrium.

    “Shouldn’t Clark Warburton be the father of monetarism? As in fist combining a monetary theory of the business cycle along with monetary diseuilbrium.”

  5. 5 Nick Rowe September 12, 2012 at 2:41 am

    “Whether it even makes sense to think about an economy as being inherently stable or unstable is a whole other question that I will leave for another day.”

    Because I can’t wait: take an economy that would be stable under one monetary regime, it seems to me it is always possible to think up another monetary regime under which it would be unstable. So I don’t think it makes sense to talk about whether an economy is inherently stable or unstable independent of the monetary regime.

  6. 6 Bill Woolsey September 12, 2012 at 4:52 am

    Laider looked to be very Austrian here.

    The damange was done in the run up to the crisis.

    While I have no problem with stating that money growth or consumer prices fail to signal the difficulty, my preferred measure, the nominal GDP growth path signalled little problem. A bump up during the dot com boom. A fall below trend after. A very slow recovery to trend. The a gradual shortfall, then collapse.

    I see no reason to doubt that the problem is a failure to even try to get nominal GDP back to the trend level. That is, growth rate targeting, in particular, inflation targeting is the source of the problem. And the problem is post crisis.

  7. 7 Ritwik September 12, 2012 at 6:13 am

    Bill

    I’d say Laidler was Wicksellian (or as he calls it, Robertsonian) rather than Austrian. This is not surprising – one of his closest intellectual mates is Axel Leiojnhufvud, who gave the original non-Walrasian, Wicksellian interpretation of Keynes.

    To quote from pg 11:

    “I have elsewhere (e.g Laidler
    2011) suggested that the collapse of the US housing bubble (and similar
    bubbles elsewhere in Spain, Ireland and the UK) has a rather Austrian,
    perhaps better Robertsonian, appearance to it, implying a pre-crisis
    dislocation in the inter-temporal allocation of resources that Monetarism,
    with or without money, simply does not encompass”

    That, in a nutshell, is my disagreement with monetarist theories of the business cycle, of all hues. Big recessions seem to be more about failures of inter-temporal coordination (Wicksellian) than about atemporal exchange (monetarist). Money matters of course, but especially when it starts becoming the conduit for inter-temporal decision making (wealth preservation).

  8. 8 david stinson September 12, 2012 at 7:35 am

    @ Bill Woolsey:

    ” Laidler looked to be very Austrian here.”

    He has exhibited such sympathies before.

  9. 9 Greg Ransom September 12, 2012 at 10:05 am

    This is what I don’t understand, Bill.

    Today the rate of NGDP growth is roughly tracking the same rate of NGDP growth as before the bust/recession.

    What if the economy did that for 50 years or 60 years, but but remained as it is today, below a line produce by placing a ruler on the old pre-2007 NGDP grown path?

    What is your story which tells us that this would leave us with a weak economy and recognizing that “the problem is a failure to even try to get nominal GDP back to the trend level.”

    And if not in the 50 – 60 years down the road story, why so in the case of the 5 – 6 years down the road story?

    What’s the story? I don’t get it. Can prices remain sticky & in disequilibrium for 50 to 60 years? Why not? And if not, why so over 5 – 6 years — or 8 – 9 years, which we will very rapidly approach.

    Bill writes,

    “I see no reason to doubt that the problem is a failure to even try to get nominal GDP back to the trend level.”

  10. 10 Greg Ransom September 12, 2012 at 10:11 am

    Hayekian macro is nothing more than an attempt to get the money and production goods parts of Wicksell in competent shape.

    The “normal science” task of working out Wicksell’s production goods theory into a marginalist frame was yet to be done, and similarly the normal science of the disaggregated/marginalism of money/credit/liquid asset values had yet to be done. This is the task that Hayek & Mises worked on in different dimensions.

    It’s just a punt — and bad science — to be a “Wicksellian” with a broken/incomplete/false production goods picture & a broken/incomplete/false money/credit/liquid asset values picture.

  11. 11 Saturos September 12, 2012 at 10:45 am

    A number of points here:

    I agree that the lack of explanation for how long it takes to adjust is the weakest part of Market Monetarism. But even Keynesians do not have a really believable explanation for why nominal shocks cause real fluctuations. The best evidence we have to go by is that markets still clearly want more NGDP. The best explanation I can offer is that the economy is being held back by uncertainty, not of fiscal but of monetary policy. Essentially each new Fed announcement which does not commit to a new level path for NGDP is effectively equivalent to a fresh NGDP shock. Wage-price expectations do not have a new expected path to coordinate around. Also, as Matt Yglesias just reminded us, wages can be really sticky. The one thing Keynesians and Monetarists can agree on though is that such stickiness cannot last forever. Recall that even Keynes held that the economy would self-correct eventually – in the long run, when we are all dead. Of course, for Keynes “we” meant his own generation, which was the last for him. Apart from the lack of forward-lookingness this typifies, it means that we do have a surefire way to reset wages – wait until all the occupants have left (say 30 years) their current posts. So if we ever had to test it historically…

    Regarding deflation exceeding the real rate, why should that lead to a long gradual decline in the capital stock? Why shouldn’t the resulting unmet excess demand for money at the nominal ZLB lead to instantaneous (or near enough) deflation, until the expected rate no longer exceeded the real one? Then we are back to stickiness causing the problems. Indeed stickiness due to money illusion should mean that even disinflation should force some of the distribution of required wage changes into negative territory, meeting resistance. If we accept that the expected path of average nominal wages is what constrains the economy, it becomes obvious that NGDP must follow that level path to keep the economy steady. Also, I think David is making a mistake here: ” My interpretation is that with real interest rates negative, businesses do not see a sufficient number of profitable investment projects to invest in.” He is reasoning from a price change (or level). Real rates are low because of the lack of demand for investment, because low growth is expected, because monetary policy is expected to fail. More generally this means you can’t explain the harm of disinflation by positing negative real rates, because as Scott would say those rates reflect the harm that’s already been done (in no small part because of economists doing too much reasoning from interest rates.)

  12. 12 David Glasner September 12, 2012 at 8:27 pm

    JCE, Thanks so much for your kind words.

    Ritwik,I agree that Bob Dimand is a superb scholar,

    About Clark Warburton, I don’t know his work that well, but he clearly was very influential. But I would say that he became influential mainly because he Friedman cited him very favorably.

    I agree that it is tricky to identify the asset whose yield we should look to as the rate of interest

    Why do you assume that I am wedded to a Wicksellian S – I framework? I prefer a capital market (stock) equilibrium condition to a S – I (flow) equilibrium condition.

    Interesting point about paleo and market monetarism. It did not occur to me before; I will have to think about it.

    So remind me, how would you go about creating inflation?

    Greg, If Hayek and Mises are Monetarists, why wouldn’t Wicksell have preceded them?

    Nick, I was thinking of a different distinction between stability and instability, namely the notion that an economy is either moving toward or away from equilibrium and that it can only move in one direction. I think there are multiple expectation-dependent equilibria and an economy may sometimes move toward and sometimes away from an equilibrium. But I agree with you that the nature of the regime may have important effects on the tendency to move toward or away from equilibrium and on the type of equilibrium in the direction of which an economy is moving.

    Bill, I agree with Ritwik that Austrian may not be the best term to use in describing Laidler, but you are right to draw attention to the similarities.

    Ritwik, Do you think that the Great Depression was about anything other than deflation? The 1920-21 depression? The 1937-38 downturn? The 1981-82 recession?

    david, You are right, he has. As Ritwik points out, this may have something to do with the influence of Axel Leijonhufvud.

    Greg, Can you identify what exactly is broken in the Wicksellian theory? Can you also provide the Hayekian argument that explains why an economy in disequilibrium will find its way back to equilibrium?

  13. 13 Ritwik September 12, 2012 at 11:42 pm

    David

    Interesting point about flow disequilibrium vs stock disequilibrium – I tend to think that the two are isomorphic because :

    1) In the aggregate, the properties of marginal capital are the same as average capital. The production process is an integrated whole, and when firms invest, they are basically creating more of themselves, or buying time. Thus flow disequilibrium is isomorphic with stock disequilibrium.

    2) Keynes showed that the adjustment process of an S/I disequilibrium can be through aggregate income rather than interest rates. Thus flows equalize and unrealized plans show up only through stock disequilibrium.

    So yes, rather than saying Wicksellian S-I disequilibrium, I could say Wicksellian cost of capital vs. rate of return on capital disequilibrium. This capital market disequilibrium is essential in the Wicksell-Keynes-Hayek tradition, but not reconcilable with the Earl Thompson/ market monetarist model.

    My understanding of domestic inflation in developed economies is that money-financed fiscal transfers/ tax cuts are required. LSAPs boost aggregate wealth but reduce the marginal propensity to spend (consume or invest) out of that wealth as they are disproportionately *grabbed* by existing wealth-owners. Comunications are good, and NGDP targets are good, but I am a ‘people of the concrete steppes.’ :)

    I do tend to agree with MMs that currency depreciation can partially save the day. But i would also do this through direct purchases of foerign assets rather than SNB style pegs.

    As for the big recessions, I really should reserve comment as my knowledge of specific recessions is feeble. About the great depression, my default position is to think in terms of the gold demand, i.e. high real rates. So I agree with the paleo-monetarists, but like I said, the paleo-monetarist (at least of the gold demand variety) model is reconcilable with a Keynesian-Wicksellian model. But this recession seems to me to be more Keynesian than any. My main clue is the secular upward trend in corporate cash balances, which suggests secularly declining MECs.

  14. 14 John September 13, 2012 at 8:27 am

    The question is whether a market economy is inherently stable or unstable.

    David, how can you claim to talk about economics without taking on this most basic of issues, which frames everything, and which you refuse to write?

    It is the equivalent of putting on Hamlet without the Prince of Denmark, the ultimate game of fence sitting.

    Seriously, it is black or white. If a market economy is is inherently stable, and it is, especially financial markets, then what is economics? It is as Munger said, The Psychology of Human Misjudgment. Your models, charts, assumptions, all mean nothing, and they should. Where in your model is Vision and what weight do you give to Vision?

  15. 15 John September 13, 2012 at 11:20 am

    BTW

    Hayek was all wrong on markets. Now, would you drop the Hayek and Hawtrey stuff and get to work

    http://www.columbia.edu/~rs328/Hayek.pdf

  16. 16 Blue Aurora September 13, 2012 at 4:22 pm

    When are you going to publish “The Fisher Effect Under Deflationary Expectations”, David Glasner? Do you plan on submitting it to any journal?

    Also, when is your paper on Hawtrey and Cassel’s prescience going to be submitted to a journal?

  17. 17 David Glasner September 14, 2012 at 9:36 am

    Ritwik, You may be right that flow equilibrium and stock equilibrium are isomorphic, but that requires demonstration. In the meantime, following Earl Thompson, I think it is preferable to carry out the analysis in terms of the stock equilibrium which is governed by a more reliable set of theoretical tools than the flow equilibrium where are tools are less reliable.

    What do you mean by this statement?

    “This capital market disequilibrium is essential in the Wicksell-Keynes-Hayek tradition, but not reconcilable with the Earl Thompson/ market monetarist model.”

    I agree that simple pegs are not enough, because they can easily lead simply to an accumulation of foreign reserves in the central bank which is unsustainable. I also agree that MECs are declining, but I have no strong view about why other than that the depth of the 2008 downturn and the policy response have been deeply unsettling. That is obviously not a theory very much more persuasive than the policy uncertainty theory that I like to ridicule, but for the time being, at least, I have nothing better, and I sam sticking with it.

    John, I am afraid that I am going to disappoint your expectations. Economies are sometimes stable and sometimes not. When economies are near equilibrium they tend to stay there, but if they are shocked sufficiently severely they don’t easily get back on their equilibrium path.

    Hayek got a lot wrong, but he got even more right. Sorry to be such a two-armed economist. Thanks for your link, which I will try to have a look at.

    Blue Aurora, I am hoping to begin a major revision and extension of the data analysis in the Fisher effect paper and then submit to some as yet undetermined journal I hope by year’s end. The Hawtrey-Cassel paper is almost ready for submission. I hope we will send it out almost any day now. Thanks for your interest.

  18. 18 Blue Aurora September 14, 2012 at 10:34 am

    Regarding the Hawtrey-Cassel paper – can I make suggestions for journals? I think that they would go well in other journals besides History of Political Economy…do you think that you would submit to one of the following journals?

    1.) History of Economics Review
    2.) History of Economic Thought and Policy
    3.) History of Economic Ideas

    The first journal is based in Australia, and the latter two are based in Italy. I think that the Hawtrey-Cassel paper would fit best in History of Economic Thought and Policy, as the Hawtrey-Cassel paper fits both history of economics and seems to have policy implications.

    Finally, would it be possible for me to e-mail you, David Glasner? I’d like to engage in some correspondence.

  19. 19 John September 15, 2012 at 6:32 pm

    You argue, “when economies are near equilibrium they tend to stay there”

    Seems like Miles puts up a fundamentally discrediting post

    Why I am a Macroeconomist: Increasing Returns and Unemployment

    http://blog.supplysideliberal.com/post/31546639371/why-i-am-a-macroeconomist-increasing-returns-and

    Fascinating theory—would love to see the proof. For starters, what law or rule of economics defines how long “staying there” is sufficient for us to declare such a property?

    Seems to me this is nothing but personal bias as revealed by Kahneman

    My counter argument runs something like:

    Since 1970, I have not seen anything like near equilibrium in the United States economy. Noah has pointed out it has been broken for all that time. We have had, what 18 months of a federal surplus? And, I don’t believe one year where unemployment was below 3%

  20. 20 Ritwik September 16, 2012 at 4:42 am

    David

    Absolutely agree that the equivalence of the stock disequilibrium and flow disequilibrium has to be demonstrated – I interpret the capital theory of the later Hicks (and the occasional rumination of Leijonhufvud and Tobin on this topic) as attempting to show something very similar. Also agree that till such equivalence is demonstrated, an FF curve is the way to go, not an IS curve.

    What I mean by the statement you quoted is that I think there are two broadly convincing types of theories of recessions (also booms, actually) –

    1) ‘Wicksellian’ : these are theories of issues with inter-temporal coordination. Capital markets carry out this coordination, so these are necessarily theories of capital market disequilibrium. In this class of theories, as long as there is a way of deferring present spending to the future in a generic manner without making specific future purchase decisions, recessions can arise. ‘Money’ or purely nominal factors are not needed to explain recessions, but monetary factors in the determination of interest rates can obviously complicate the inter-temporal coordination problem. Most obvious example are Keynesian theories, especially as interpreted by Leijonhufvud.

    2) ‘Nominal’: these are theories of issues with atemporal, same-period exchange. Monetary disequilibrium/ market monetarist theories fall in this category. There’s no capital market disequilibrium, or at least it’s not needed to explain the recession. Recessions are frustrations of trade plans, rather than frustrations of inter-temporal plans. Purely nominal things such as money supply, money illusion and sticky nominal wage expectations can explain the recession. Thompson’s FF/LM model is obviously consistent with all such criteria – ‘the’ rate of interest, whatever it is, is not critical to explaining recessions in this model.

    I see Hawtrey and perhaps Laidler as being halfway between, or equally comfortable with either class of theories.

    I think declining MECs have a lot to do with one or more of the following :

    1) Uncertainty arising from globalization and the response of the developing economies (Raghuram Rajan’s contention)

    2) The great stagnation (Tyler Cowen).

    3) We live in a post-scarcity world (The Keynes-Skidelsky-FT Alphaville contention)

    4) Cronyism and significant barriers to entry have led to an excess accumulation of risk-averse capital by incumbents (the ‘Neo-Schumpeterian’ contention)

    5) Monetary policy that has been overly sensitive to asset prices and makes financial systems operate at ‘peak liquidity’ has made business owners demand even higher asset prices before they invest any further. (shifting the LM curve out also pushes the IS curve down).

  21. 21 David Glasner September 19, 2012 at 7:58 pm

    Blue Aurora, Thanks for your suggestions, we will consider those.

    John, There’s no proof for my predispositions. That’s just how I look at the world. I don’t find your view particularly compelling. I don’t think that most economists consider 3% unemployment a realistic or desirable criterion for full employment. This is on the level of cosmology in physics. There are only the slightest shreds of evidence available to test our conjectures about the evolution of economic systems.

    Ritwik, Thanks for your clarifications, but I would need to see this spelled out in more detail. I agree that the intertemporal element is very important. But capital theory is very difficult and hard to integrate into a macroeconomic model except in the very simplest form. Have you written this up anywhere? If not, you should.

  22. 22 Blue Aurora September 20, 2012 at 8:09 am

    You’re welcome, David Glasner. Did you get my e-mail?


  1. 1 David Laidler: “Two Crises, Two Ideas and One Question” « The Market Monetarist Trackback on September 11, 2012 at 10:21 pm
  2. 2 Links for 09-12-2012 | FavStocks Trackback on September 12, 2012 at 1:28 am

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About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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