On the topic of aggregate demand, he writes,
When people say that they see shifts in aggregate demand, they mean that they see changes in the match between wants and resources. Thus in a more specific sort of model, high aggregate demand can be a good match. If this is what “aggregate demand” means, we could also call it “aggregate supply.”
That is from p. 87 of the 2010 edition of Exploring General Equilibrium. Basically, he sees a cyclical slowdown as a reflection of capital investments that were made with good intention but turned out to be wrong. In my terminology, people bet on certain patterns of specialization and trade, and those turned out not to be sustainable patterns.
On the Great Depression, he writes,
Firms made investments during the 1920s based on their beliefs about what tastes and technology would be, along many dimensions, during the 1930s. These beliefs turned out to be very wrong, so the investments were not worth much and ability to produce what people wanted was low…
But monetary forces played a big role too…many countries experienced sharp deflation, which drove their nominal interest rates down. Normally, very low nominal interest rates mean a big demand for currency [but] some countries stopped supplying currency passively. This meant a serious breakdown in financial markets.
…the deflations forced short-term nominal interest rates to zero in some countries, and would have made these rates negative were it not for the effective floor at zero. This caused disequilibrium in real asset markets. The real interest rate was forced above its natural level. It was a kind of “currency trap.”
Longer-term nominal interest rates did not fall to zero, because they reflected the chance that the nominal short rate would bounce back to positive levels. But they were artificially high, so longer-term real rates were artificially high, even more so than short-term real rates.
Some notes:
1. He does not believe in AD, but he thinks that the ZLB mattered in the Great Depression. He thinks that the artificially high real interest rates accentuated the mismatches between previous investments and prevailing wants. He does not give any examples. But imagine that you are a farmer, and you invested in farm machinery, and now crop prices are falling. Are you going to throw more money at your investment by buying seeds and fertilizer? Will the bank lend you the money to do so? If growing crops is no longer profitable, then the value of your investment in farm machinery is looking bad.
2. He is saying that just because you observe positive long-term interest rates, that does not mean that the ZLB is unimportant.
3. What about the U.S. in the last five years? On the one hand, we have seen low short-term interest rates. On the other hand, we have not had deflation, so the short-term real interest rate has been low rather than high. Has the long-term real interest rate been artificially high because of the ZLB?
4. In explaining unemployment, I would be inclined to focus more on mismatches involving human capital. In the 1930s, men who had been farm laborers and tenant farmers were thrown out of work by tractors, trucking (which made it possible to shift production away from relatively poor farmland close to cities to better farmland farther away), refrigeration, and so on. Also, workers whose human capital was in cigar rolling or lightbulb glass-blowing found themselves obsolete. In hindsight, these guys should have stayed in school instead of dropping out without completing high school. But as it was, there were too many of them relative to the technology of the 1930s, which ultimately called for a work force with at least a high school education.
Today, I would say that, in hindsight, more people should either have acquired computer skills or prepared for life providing elder care or otherwise engaged in personal services.
Two questions:
(1) Does a breakdown in ‘patterns of sustainable specialisation and trade’ result in falling total expenditure? If so, then why?
(2) Does the fall in aggregate expenditure mitigate or exacerbate the breakdown of ‘patterns of sustainable specialisation and trade’?
My problem is this: I’m inclined to agree with your patterns-of-sustainable-specialisation-and-trade story. Indeed, it seems to me a straightforward application of insights about the division of labour, market discovery, the coordination of plans across time, and so on. I’ve believed since the beginning of the Great Recession that world economies have major structural problems, and they cannot be solved by monetary policy or ham-fisted government intervention.
However, I’ve nonetheless been a proponent of some type of nominal GDP targeting for a while, because I see no good explanation of why total expenditures should be depressed so far below their precrash trend–which I interpret as a massive disequilibrium in the supply and demand for money. In fact, it seems to me that little progress can be made toward establishing new ‘patterns of sustainable specialisation and trade’ until monetary problems are resolved, because the money is the language of market coordination, and it remains broken. There are still, years after the crash, persistent signs of a shortage of money. I don’t expect it to be a panacea, but it has to be the first priority and, given our monetary institutions, it something government (or the Federal Reserve) can help to fix.
I guess what I’m saying is that unless one adopt the view that no structural problems exist in the economy, or they’re so negligible to be undetectable, then there is no conflict between the shortfall-in-aggregate-demand explaanation of the crash and the patterns-of-sustainable-specialisation-and-trade explanation of the slow recovery.
GDP measures goods and services trade in the market. so a breakdown in PSST means lower GDP.
Interesting blog post today. Thank you
“Providing elder care” is definitely a growth field. But most of the jobs in it are low skilled and low paid. There are a small number of higher paid jobs, upper management and nurses, and a larger, lower paid cohort.
Is it mere coincidence, or a real pattern, that both the great depression and the great recession had:
1. Dubious financial structures that blew up. (Funky margin and unsound banks and banking system in one, funky mortgages and … unsound banks in the other…)
2. Structural/pattern/allocation issues that were painfully revealed – in both cases related to apparent surges in technology. (You can think of it as “electricity” for the ’30s and “computers” for the great recession.)
Extra Credit – are the dubious financial arrangements a cause of, a result of, or basically independent of the pent up structural changes driven by technology?