Category: Equitablog

Lars Syll reminds me of a snarky passage I have never approved of from Hyman Minsky:

Hyman Minsky: Minsky on the IS-LM obfuscation: “The glib assumption made by Professor Hicks in his exposition of Keynes’s contribution that there is a simple, negatively sloped function, reflecting the productivity of increments to the stock of capital, that relates investment to the interest rate is a caricature of Keynes’s theory of investment… which relates the pace of investment not only to prospective yields but also to ongoing financial behavior…. The conclusion to our argument is that the missing step in the standard Keynesian theory was the explicit consideration of capitalist finance within a cyclical and speculative context… then the full power of the revolutionary insights and the alternative frame of analysis that Keynes developed becomes evident…. The greatness of The General Theory was that Keynes visualized [the imperfections of the monetary-financial system] as systematic rather than accidental or perhaps incidental attributes of capitalism…. Only a theory that was explicitly cyclical and overtly financial was capable of being useful…”

I have always thought that this and similar were both short-sighted and unfair. Short-sighted, in that it is not Hicks who would be Minsky’s long-run intellectual adversary but rather Freidman, Lucas, and Hayek, and so building bridges to the Hicksians ought to be a very high priority. Unfair, in that if you want to lead someone from classical pre-Keynesian macro to Minskyism, you start by saying:

• Classical pre-Keynesian macro has a vertical LM curve and a stable IS curve.
• Minskyite macro has a relatively flat LM curve and a wildly unstable IS curve driven by expectations, leverage, positive-feedback and the rest.

You can then drop the (dynamic) Minskyite apparatus into the determinants of the current (static) location of the IS curve, and you have a theory. As Charles Kindleberger liked to put it, more eloquently and clearly than Minsky ever did:

Charles Kindleberger: Anatomy of a Typical Financial Crisis: We start with the model of the late Hyman Minsky, a man with a reputation among monetary theorists for being particularly pessimistic, even lugubrious, in his emphasis on the fragility of the monetary system and its propensity to disaster. Although Minsky was a monetary theorist rather than an economic historian, his model lends itself effectively to the interpretation of economic and financial history. Indeed, in its emphasis on the instability of the credit system, it is a lineal descendant of a model, set out with personal variations, by a host of classical economists including John Stuart Mill, Alfred Marshall, Knut Wicksell, and Irving Fisher. Like Fisher, Minsky attached great importance to the role of debt structures in causing financial difficulties, and especially debt contracted to leverage the acquisition of speculative assets for subsequent resale.

According to Minsky, events leading up to a crisis start with a “displacement,” some exogenous, outside shock to the macroeconomic system. The nature of this displacement varies from one speculative boom to another. It may be the outbreak or end of a war, a bumper harvest or crop failure, the widespread adoption of an invention with pervasive effects–canals, railroads, the automobile–some political event or surprising financial success, or debt conversion that precipitously lowers interest rates. An unanticipated change of monetary policy might constitute such a displacement and some economists who think markets have it right and governments wrong blame “policy-switching” for some financial instability.

But whatever the source of the displacement, if it is sufficiently large and pervasive, it will alter the economic outlook by changing profit opportunities in at least one important sector of the economy. Displacement brings opportunities for profit in some new or existing lines and closes out others. As a result, business firms and individuals with savings or credit seek to take advantage of the former and retreat from the latter. If the new opportunities dominate those that lose, investment and production pick up. A boom is under way.

In Minsky’s model, the boom is fed by an expansion of bank credit that enlarges the total money supply. Banks typically can expand money, whether by the issue of bank’s notes under earlier institutional arrangements or by lending in the form of addictions to bank deposits. Bank credit is, or at least has been, notoriously unstable, and the Minsky model rests squarely on that fact. This feature of the Minsky model is incorporated in what follows, but we go further. Before banks had evolved, and afterward, additional means of payment to fuel a speculative mania were available in the virtually infinitely expansible nature of personal credit. For a given banking system at a given time, monetary means of payment may be expanded not only within the existing system of banks but also by the formation of new banks, the development of new credit instruments, and the expansion of personal credit outside of banks. Crucial questions of policy turn on how to control all these avenues of monetary expansion. But even if the instability of old and potential new banks were corrected, instability of personal credit would remain to provide means of payment to finance the boom, given a sufficiently throughgoing stimulus.

Let us assume, then, that the urge to speculate is present and transmuted into effective demand for goods or financial assets. After a time, increased demand presses against the capacity to produce goods or the supply of existing financial assets. Prices increase, giving rise to new profit opportunities and attracting still further firms and investors. Positive feedback develops, as new investment leads to increases in income that stimulate further investment and further income increases. At this stage we may well get what Minsky called “euphoria.” Speculation for price increases is added to investment for production and sale. If this process builds up, the result is often, though not inevitably, what Adam Smith and his contemporaries called “overtrading.”

Now, “overtrading” is by no means a clear concept. It may involve pure speculation for a price rise, an overestimate of prospective returns, or excessive “gearing.” Pure speculation, of course involves buying for resale rather than use in the case of comodities or for resale rather than income in the case of financial assets. Overestimation of profits comes from euphoria, affects firms engaged in the production and distributive processes, and requires no explanation. Excessive gearing arises from cash requirements that are low relative both to the prevailing price of a good or asset and to possible changes in its price. It means buying on margin, or by installments, under circumstances in which one can sell the asset and transfer with it the obligation to make future payments.

As firms or households see others making profits from speculative purchases and resales, they tend to follow: “Monkey see, monkey do.” In my talks about financial crisis over the last decades, I have polished one line that always gets a nervous laugh:

There is nothing so disturbing to one’s well-being and judgment as to see a friend get rich.

When the number of firms and households indulging in these practices grows large, bringing in segments of the population that are normally aloof from such ventures, speculation for profit leads away from normal, rational behavior to what has been described as “manias” or “bubbles.” The word mania emphasizes the irrationality; bubble foreshadows the bursting. In the technical language of some economists, a bubble is any deviation from “fundamentals,” whether up or down, leading to the possibility and even the reality of negative bubbles, which rather gets away from the thrust of the metaphor. More often small price variations about fundamental values (as prices) are called “noise.” In this book, a bubble is an upward price movement over an extended range that then implodes. An extended negative bubble is a crash.

As we shall see in the next chapter the object of speculation may vary widely from one mania or bubble to the next. It may involve primary products, especially those imported from afar (where the exact conditions of supply and demand are not known in detail), or goods manufactured for export to distant markets, domestic and foreign securities of various kinds, contracts to buy or sell goods or securities, land in the country or city, houses, office buildings, shopping centers, condominiums, foreign exchange. At a late stage, speculation tends to detach itself from really valuable objects and turn to delusive ones. A larger and larger group of people seeks to become rich without a real understanding of the processes involved. Not surprisingly, swindlers and catchpenny schemes flourish.

Although Minsky’s model is limited to single country, overtrading has historically tended to spread from one country to another. The conduits are many. Internationally traded commodities and assets that go up in price in one market will rise in others through arbitrage. The foreign-trade multiplier communicates income changes in a given country to others through increased or decreased imports. Capital flows constitute a third link. Money flows of gold, silver (under gold standard or bimetallism), or foreign exchange are a fourth. And there are purely psychological connections, as when investor euphoria or pessimism in one country infects investors in others. The declines in prices on October 24 and 29, 1929, and October 19, 1987, were practically instantaneous in all financial markets (except Japan), far faster than can be accounted for by arbitrage, income changes, capital flows, or money movements.

Observe with respect the money movements that in an ideal world, a gain of specie for one country would be matched by a corresponding loss for another, and the resulting expansion in the first case would be offset by the contraction in the second. In the real world, however, while the boom in the first country may gain speed from the increase in the supply of reserves, or “high-powered money,” it may also rise in the second, despite the loss in monetary reserves, as investors respond to rising prices and profits abroad by joining in the speculative chase. In other words, the potential contraction from the shrinkage on the monetary side may be overwhelmed by the increase in speculative interest and the rise in demand. For the two countries together, in any event, the credit system is stretched tighter.

As the speculative boom continues, interest rates, velocity of circulation, and prices all continue to mount. At some stage, a few insiders decide to take their profits and sell out. At the top of the market there is hesitation, as new recruits to speculation are balanced by insiders who withdraw. Prices begin to level off. There may then ensue an uneasy period of “financial distress.” The term comes from corporate finance, where a firm is said to be in financial distress when it must contemplate the possibility, perhaps only a remote one, that it will not be able to meet its liabilities.

For an economy as a whole, the equivalent is the awareness on the part of a considerable segment of the speculating community that a rush for liquidity–to get out of other assets and into money–may develop, with disastrous consequences for the prices of goods and securities, and leaving some speculative borrowers unable to pay off their loans. As distress persists, speculators realize, gradually or suddenly, that the market cannot go higher. It is time to withdraw. The race out of real or long-term financial assets and into money may turn into a stampede.

T>he specific signal that precipitates the crisis may be the failure of a bank or firm stretched too tight, the revelation of a swindle or defalcation by someone who sought to escape distress by dishonest means, or a fall in the price of the primary object of speculation as it, at first alone, is seen to be overpriced. In any case, the rush is on. Prices decline. Bankruptcies increase. Liquidation sometimes is orderly but may degenerate into panic as the realization spreads that there is only so much money, not enough to enable everyone to sell out at the top.

The word for this state–again, not from Minsky–is revulsion. Revulsion against commodities or securities leads banks to cease lending on the collateral of such assets. In the early nineteenth century this condition was known as discredit. Overtrading, revulsion, discredit—-all these terms have a musty, old-fashion flavor. They are imprecise, but they do convey a graphic picture.

Revulsion and discredit may go so far as to lead to panic (or as the Germans put it, Torschlusspanik. “door-shut-panic”), with people crowding to get through the door before it slams shut. The panic feeds on itself, as did the speculation, until one or more of three things happen:

1. prices fall so low that people are again tempted to move back into less liquid assets;

2. trade is cut off by setting limits on price declines, shutting down exchanges, or otherwise closing trading; or

3. a lender of last resort succeeds in convincing the market that money will be made available in sufficient volume to meet the demand for cash.

Confidence may be restored even if a large volume of money is not issued against other assets; the mere knowledge that one can get money is frequently sufficient to moderate or eliminate the desire.

Whether there should be a lender of last resort is a matter of some debate. Those who oppose the function argue that it encourages speculation in the first place. Supporters worry more about the current crisis than about forestalling some future one. There is also a question of the place for an international lender of last resort. In domestic crises, government or the central bank (when there is one) has responsibility. At the international level, there is neither a world government nor any world bank adequately equipped to serve as a lender of last resort, although some would contend that the International Monetary Fund since Bretton Woods in 1944 is capable of discharging the role.

Dilemmas, debates, doubts, questions abound. We shall have more to say about these questions later on.

That the Minsky Cycle has its proper place as a–major–piece in the IS-LM mechanism is, I think, important. Right now one major current in the macroeconomic policy debate is the stream fed by the BIS’s insistence that curbing “speculation” requires that interest rates rise soon, and that this can be done without (much) damage to the real economy and that in fact such interest rate rises will effectively control “speculation”. This is, in its essentials, an insistence that the LM curve is (nearly) vertical (so that damage to the real economy will be small) and that fluctuations in the IS curve are (relatively) minor (so that small increases in interest rates will rebalance the economy. The most effective counters to this argument are Hicksian ones: that the LM curve is not steep but relatively flat, and that swings in the IS curve are potentially large and need to be managed by other tools that act to damp those swings directly rather than merely offset them via interest rate-driven movements along the IS curve.

And this is not an argument that Minskyites who do not know or do not use the Hicksian IS-LM can effectively make.

Henry Aaron, David Cutler, and Peter Orszag: Stop the Anti-Obamacare Shenanigans: “So far, opponents of the Affordable Care Act…

…have lost every major battle to repeal or invalidate it. Some of them are now urging the courts to interpret the health reform law in a way that would guarantee its failure…. Having failed to undo the individual mandate to buy health insurance, opponents now claim that, under the law, subsidies for low- and moderate-income Americans to buy insurance may be paid only in those states–currently 14–that have set up their own online insurance exchanges. This would torpedo a central goal of the law: the expansion of coverage. At first, those of us who support Obamacare thought these claims were a joke. On July 22, the federal appellate court in Richmond, Va., rejected one such claim, but the same day, astonishingly, the federal appellate court for the District of Columbia Circuit ruled, 2 to 1, in favor of the plaintiff in a similar case, Halbig v. Burwell…. Now the opponents of Obamacare are asking the Supreme Court to immediately hear an appeal of the Richmond decision…. The law specifically instructed the secretary of health and human services to create and manage the exchanges for states that chose that option. And when the law was passed, everyone involved in the law’s passage understood that this directive vested federal exchanges with the same mission and authority as state-mandated exchanges…. Whatever one thinks of the Affordable Care Act, it is absurd to argue that its drafters intended to make insurance unaffordable.

I must say that Republican governors and state-level legislators are already furious at John Roberts for how he forced them to alienate either their activist Tea Party base or their fund-raising medical base over Medicaid expansion. They would be even more furious if Roberts forced them to go through the same thing again–this time not over Medicaid expansion but over state exchange establishment.

Helene Jorgenson and Dean Baker think that ongoing labor-force and work-hour reductions are good things–people being freed from job lock by the availability of health insurance via ObamaCare:

Helene Jorgensen and Dean Baker: The Affordable Care Act: A Family Friendly Policy: “Table 3 gives a breakdown of the distribution of part-time employment by age, gender, and whether or not the household has children. As can be seen, women accounted for the entire rise in voluntary part-time employment, with an increase of 3.2 percent in 2014 compared with 2013. By contrast, voluntary part-time employment for men actually fell slightly.
Furthermore, it is younger workers, ages 16-35, who account for the bulk of the increase. The number of people in this age group voluntarily working part-time rose by 5.0 percent. By comparison it dropped by 5.2 percent for workers between the ages of 45-55. There were small rises of less than 1.0 percent for the other two age groups. The biggest increase in voluntary part-time is for young people with children. The percentage of employed young people with children working part-time increased 11.3 percent from 2013 to 2014. For young people with three or more children the percentage working part-time increased by 15.4 percent.”

Olivier Blanchard, inveighing against “ergodicity” and “linearity” as assumptions, sounds like some post-Keynesian from the 1980s. They were right then. He is right now:

Olivier Blanchard: Where Danger Lurks: “One has to go back to the so-called rational expectations revolution…

…What was new was the development of techniques to solve models under the assumption that people and firms did the best they could in assessing the future. (A glimpse into why this was technically hard: current decisions by people and firms depend on their whole expected future. But their whole expected future itself depends in part on current decisions.) These techniques… made sense only… [if] economic fluctuations were regular enough so that, by looking at the past, people and firms (and the econometricians)… could understand their nature and form expectations… and simple enough so that small shocks had small effects…. Thinking about macroeconomics was largely shaped by those assumptions….

The state of the… economic world provided little impetus for… question[ing]…. That small shocks could sometimes have large effects and, as a result, that things could turn really bad, was not completely ignored…. But such an outcome was thought to be a thing of the past that would not happen again, or at least not in advanced economies thanks to their sound economic policies…

That we will assume linearity and ergodicity as convenient to build models we can solve is a not unreasonable modeling strategy to carry you forward.

What is unreasonable is to presume that the place where that modeling strategy stops tells you about the world. Yet that is what a great many economists have done for two generations. Blanchard sees these modeling assumptions as one factor supporting the “Great Moderation” conclusions that:

bank runs… [were of little concern because] the introduction of bank deposit insurance had largely eliminated the problem…. Central banks could quickly provide liquidity…. Sudden stops—episodes when capital flows to a country dry up and all investors try to get out at once—could not be ignored either…. But they were thought to be an issue for emerging markets [only]…

and not for developed economies, in which central banks could print as much of the safe and liquid asset of hard-currency cash as the sudden stoppers desired. Thus, during the “Great Moderation”:

issues of liquidity… were not seen as central…. The probability that central banks would want to decrease nominal interest rates below zero and be unable to do so… was seen as very small…. In short, the notion that small shocks could have large adverse effects, or could result in long and persistent slumps, was not perceived as a major issue. We all knew that there were “dark corners”…. But we thought we were far away from those corners…. Japan sat unhappily in that picture…. But its situation was often interpreted as the result of misguided policies….

As I look back, it still seems to me that in some sense this train of thought ought to be correct.

Regulators understood the moral hazard created by deposit insurance. They also understood the other two moral hazard points of vulnerability: limited liability at the corporate level, and limited liability at the individual level created by richly-funded options-based compensation schemes. From that starting point it ought to have been straightforward to guard against systemic risk. Moreover, even should systemic risk not be properly guarded against, and even should it have macroeconomic consequences, policymakers were far from helpless. Fiscal Policy. Standard monetary policy. Non-standard monetary policy. Banking policy–both to recapitalize the banks and restart the credit channel and via loan guarantees to support a much larger volume of investment spending with the limited risk-bearing capacity the impaired credit channel could mobilize.

With prudent surveillance and proper attention to the hot-money funding sources of the shadow banks, appropriate regulation would have kept us from visiting a “dark corner” in the first place. With appropriate–expansionary–standard and non-standard monetary policy, fiscal policy, and banking-sector lender-of-last-resort and loan-resolution deleveraging and -guarantee policy, we would have quickly exited the “dark corner”. We did not.

Blanchard says:

The main lesson of the crisis is that we were much closer to those dark corners than we thought–and the corners were even darker than we had thought too…. In this environment, economic policy–especially monetary policy–has taken on an element of black magic….

Monetary policy does indeed have an element of black magic to it at the zero lower bound. But fiscal policy–at least for sovereigns possessing exorbitant privilege–does not: one borrows money and buys stuff, and if that causes expected currency depreciation and rising interest rates then monetary-policy loses its black-magic aspect. And loan-resolution deleveraging and loan-guarantee policies to fix and support an impaired credit channel remain available as well.

The most curious question is why these policy levers were not used: who would have thought back in 2007 that the net policy response to the biggest demand shock in the United States since at least the Great Depression would be to cut government spending as a share of GDP, leave housing finance in benign neglect, and keep monetary policy at a gauge that would lead to a 2014 PCE price level 4% lower than had been firmly anticipated back in 2007?

Blanchard says absolutely nothing about this puzzle, and leaves untouched the roles of the economic research, economic policy analysis, and economic policymaking communities in this failure of response.

What does he say? This: He calls for more aggressive prudential regulation and higher capital requirements:

The crisis has one obvious policy implication: Authorities should make it one of the major objectives of policy—macroeconomic, financial regulatory, or macroprudential—to stay further away from the dark corners. We are still too close…. If the financial system had been less opaque, if capital ratios had been higher, there might still have been a housing bust in the United States in 2007–08. But the effects would have been limited…. The reality of financial regulation is that new rules open new avenues for regulatory arbitrage…. Staying away from dark corners will require continuous effort, not one-shot regulation….

And he calls for not the 5%/year inflation target that Larry Summers and I mused about back in 1992 but for a 4%/year inflation target:

If nominal rates had been higher before the crisis, monetary policy’s margin to maneuver would have been larger. If inflation and nominal interest rates had been, say, 2 percentage points higher before the crisis, central banks would have been able to decrease real interest rates by 2 more percentage points before hitting the zero lower bound on nominal interest rates. These additional 2 percentage points are not negligible….

And he calls for an opening up of the economic-research community:

Turning from policy to research, the message should be to let a hundred flowers bloom…. But this answer skirts a harder question: How should we modify our benchmark models—the so-called dynamic stochastic general equilibrium (DSGE) models that we use, for example, at the IMF to think about alternative scenarios and to quantify the effects of policy decisions? The easy and uncontroversial part of the answer is that the DSGE models should be expanded to better recognize the role of the financial system—and this is happening. But should these models be able to describe how the economy behaves in the dark corners?

And then comes a turn in the argument I simply do not understand:

Let me offer a pragmatic answer. If macroeconomic policy and financial regulation are set in such a way as to maintain a healthy distance from dark corners, then our models that portray normal times may still be largely appropriate…

But… but… but… Macroeconomic policy and financial regulation are not set in such a way as to maintain a healthy distance from dark corners. We are still in a dark corner now. There is no sign of the 4% per year inflation target, the commitments to do what it takes via quantitative easing and rate guidance to attain it, or a fiscal policy that recognizes how the rules of the game are different for reserve currency printing sovereigns when r < n+g. Thus not only are we still in a dark corner, but there is every reason to believe that should we get out the sub-2% per year effective inflation targets of North Atlantic central banks and the inappropriate rhetoric and groupthink surrounding fiscal policy makes it highly likely that we will soon get back into yet another dark corner. Blanchard’s pragmatic answer is thus the most unpragmatic thing imaginable: the “if” test fails, and so the “then” part of the argument seems to me to be simply inoperative. Perhaps on another planet in which North Atlantic central banks and governments aggressively pursued 6% per year nominal GDP growth targets Blanchard’s answer would be “pragmatic”. But we are not on that planet, are we?

Moreover, even were we on Planet Pragmatic, it still seems to be wrong. Using current or any visible future DSGE models for forecasting and mainstream scenario planning makes no sense: the DSGE framework imposes restrictions on the allowable emergent properties of the aggregate time series that are routinely rejected at whatever level of frequentist statistical confidence that one cares to specify. The right road is that of Christopher Sims: that of forecasting and scenario planning using relatively instructured time-series methods that use rather than ignore the correlations in the recent historical data. And for policy evaluation? One should take the historical correlations and argue why reverse-causation and errors-in-variables lead them to underestimate or overestimate policy effects, and possibly get it right. One should not impose a structural DSGE model that identifies the effects of policies but certainly gets it wrong. Sims won that argument. Why do so few people recognize his victory?

Blanchard continues:

Another class of economic models, aimed at measuring systemic risk, can be used to give warning signals that we are getting too close to dark corners, and that steps must be taken to reduce risk and increase distance. Trying to create a model that integrates normal times and systemic risks may be beyond the profession’s conceptual and technical reach at this stage…

For the second task, the question is: whose models of tail risk based on what traditions get to count in the tail risks discussion?

And missing is the third task: understanding what Paul Krugman calls the “Dark Age of macroeconomics”, that jahiliyyah that descended on so much of the economic research, economic policy analysis, and economic policymaking communities starting in the fall of 2007, and in which the center of gravity of our economic policymakers still dwell.

A little more evidence to move you slightly, slightly toward the position that the unemployment rate is exaggerating the extent to which the economy has moved toward full employment…

Ryan Sweet and Adam Ozimek: U.S. Employment Outlook: Solving the Wage Puzzle: “The U.S. labor market has tightened…

…but wage growth remains mediocre at best. This appears counterintuitive: All else equal, falling rates of unemployment should prompt faster wage growth. Several potential explanations have been offered…. One is that the unemployment rate could be sending a false signal about the amount of slack in the job market. Another… blames pent-up wage deflation… firms could not cut nominal wages by as much as they wanted during the recession, and are thus reluctant to raise wages now…. Because the economies of U.S. states experienced different rates of recession and recovery, they offer a laboratory in which to test the pent-up wage deflation hypothesis….

In six states the unemployment rates are below NAIRU, while in four states it is 1.5 percentage points above full employment…. The pent-up wage deflation hypothesis predicts that wages will accelerate not steadily, but quickly once the tipping point is reached. While the data show some relationship between wages and the unemployment gap, the results show little evidence of an acceleration in wage growth as the economy approaches full employment. This suggests there is no pent-up wage deflation…. We believe the labor market still has considerable slack… includ[ing] workers unemployed longer than six months, those who left the workforce but will return once job opportunities appear, and part-timers who would prefer to work full time…. Because the unemployment rate is no longer an accurate measure of labor force, assumptions about the unemployment gap can produce incorrect expectations of when wages will accelerate…

Sam Wang: Is Nate Silver a little too excited about his model?: “Really, the GOP has an 25% chance (3-1 odds)…

…of getting 54 or more seats? I’d put it at more like 5%. Even 53 GOP seats is a fairly outside outcome. If a betting person were offered the chance to put up $3000 against Nate Silver’s $1000 on that outcome… that would be taking his money…

Nick Rowe has a nice, intuitive, monetarist take on the core of macroeconomics. But he keeps failing to convince me completely. And I keep failing to make my objections clear in a way that convinces him I have a point rather than simply being a Crazy-Old-Keynesian-Yelling-at-Clouds. Let me try it again:

The way Nick sees it, The key is money demand and money supply (at full employment). When money demand is greater than money supply, people try to cut their spending hello their income in order to build up cash balances. The problem, of course, is that one person spending is another person’s income. So everyone’s income falls until everyone’s income is so low that people in aggregate no longer wish to build up their cash balances right now. And there the economy sits, depressed, until something happens to balance money demand and money supply (at full employment).

This story of Nick Rowe’s is all well and good. But it has one big hole. It strongly suggests that when depressions happen all other assets go to discounts vis-a-vis cash: people are, in addition to trying to cut spending below income, hoping to dump other assets for cash as well. Yet some depressions happen when savings vehicles are not at a discount but at a premium vis-a-vis cash. And other depressions happen when not all but only safe savings vehicles are at a premium vis-a-vis cash.

This suggests that simply characterizing a general glut as a time of excess demand for cash is not exactly wrong but in some way inadequate and incomplete.

Let’s start over. Let’s start again, with Walras’s Law: the sum of planned excess demands for all commodities must sum to zero. And let’s start with a two-commodity economy in equilibrium: lattes and yoga lessons. Suppose there is a shift in preferences so that people want to drink more lattes and take fewer yoga lessons. What happens? On the market day after the shift, the latte-pullers and yoga teachers show up to their jobs. The latte-pullers discover a zoo: more demand than they can possibly meet. Some ration by raising their price. Others ration by rationing. Some customers buy at the price they expected. Some buy at an unexpectedly high price. Some do not get to buy.

The yoga market, by contrast, is slack: some fill up their capacity by cutting their prices, and some wind up with small classes and few classes and sit idle some of the time. In the following days, weeks, and months, the markets for lattes and yoga lessons adjust. Yoga teachers exit the market, retrain as baristas, and start pulling lattes.

On the boom side, the fact the market for lattes is not characterized by long-term fixed-price contracts means that the rationing is quickly ironed out: the price of lattes rises to balance supply and demand, and then gradually falls as retrained yoga instructors show up and add to supply. On the slump side, earnings of yoga instructors are meager and prices of yoga lessons are low until the excess suppliers have exited. Depending on the market structure, there may or may not be something that looks like “involuntary unemployment”.

And as long as the worker migration from yoga instructor to barista is in progress, there will be macroeconomic consequences. The high earnings of the baristas are unlikely to be exactly large enough to offset the low earnings of the yoga instructors,  But that is a second-order consequence: the first-order process is the excess demand for lattes balanced by the excess supply of yoga lessons and the necessary process of structural adjustment thus triggered.

OK. Now let us add a third commodity: gold. And let us rerun the scenario, but this time with a shift in demand from yoga to gold: The story would seem to be the same: a structural depression in the yoga lesson industry and a structural boom in the gold mining industry. To the extent that it is more difficult to retrain yoga instructors as gold miners the process of adjustment takes longer. To the extent that gold is a durable good that does not wear out The shift of labor into gold-mining to meet the demand has to be followed by a shift back into yoga once the additional stock demand is satisfied info and returns to its previous level. To the extent that human psychology leads yoga instructors to have a mental block against cutting the prices they charge in gold terms, the disequilibrium sectoral depression and yoga has higher prices, lower quantities, and something that looks very much like “involuntary unemployment”. To the extent that gold is not only a commodity for which there is a stock demand but also a unit of account, a fall in the gold price and quantity of yoga lessons may lead to a wave of costly and pointless bankruptcies that will have other macroeconomic effects. But the fact that the demand for the stock of gold is a demand for a medium of exchange does not seem to be of the essence–the things that make this a macroeconomic problem rather than a sectoral depression, disequilibrium, and structural adjustment problem are (a) downward price stickiness and (b) the unit of account-bankruptcy-credit-channel complex.

OK. Now eliminate the gold: replace it with fiat paper money issued by a central bank. And the shock is that something happens that increases demand for the fiat cash. The story seems to be somewhat different. Instead of the process of meeting the demand for gold being lengthy and painful as labor makes its way from yoga studio to gold mine, there is no high-value alternative for displaced unemployed yoga instructors to  shift to. In the presence of yoga lesson price rigidity, there is no market adjustment of the quantity of money. The central bank has to choose to follow the right monetary policy to avoid grinding deflation, or not.

Now let us remove fiat money, but add banks that make loans and accept interest-bearing deposits–they can invest their extra deposits in fruit trees if they wind up with positive deposits. The shock this time is a jump in demand for savings vehicles–for interest-paying deposits. When the shock hits, the interest rate falls–buying a share of a fruit tree becomes more expensive–and we have a depression in the yoga sector and a boom in the fruit-tree planting sector: it looks a lot like the gold-mining boom.

How exactly does the specificity of a “monetary economy” manifest itself in these potted examples? There seems to me to be a continuum between sectoral adjustment (with macroeconomic consequences) in the cashless yoga-latte economy to sectoral adjustment (with macroeconomic consequences) in the yoga-latte with monetary gold economy (in which the demand for gold comes not because it is shiny and pretty but because it was money) to pure macroeconomic distress in the yoga-latte with fiat money economy to pure macroeconomic distress in the cashless yoga-latte-fruit trees economy.

I put this aside at the time because the CEA’s analysis seemed to me to be likely to be wrong in two areas:

1. Their short-run Keynesian multipliers looked low to me for large states, and for states surrounded by other non-expanding states.

2. In a long-run model in which we assume “full” or “normal” employment, increased federal government spending does not add to national GDP, but where the federal government dollars are spent redistributes economic activity around the country: Texas, Kansas, Missouri, Virginia, Louisiana, and company lose; and California, Oregon, Colorado, Illinois, New York, and Massachusetts gain; to the tune of a Moretti-style regional multiplier by which $1 of extra federal spending acts as do $1 of regional exports and so attract enough labor, capital, and enterprise to boost state-level economic product by $1.

But I never wrote up my long comment on the CEA’s report, and so it is time to declare commenting bankruptcy on this one…

Council of Economic Advisers: Missed Opportunities: The Consequences of State Decisions Not to Expand Medicaid: “In addition to their effects on insurance coverage, access to health care, and health and well‐being…

…States’ decisions to expand Medicaid will also have immediate macroeconomic benefits by drawing additional Federal funding into State economies…. Over the next few years, while the recovery from the 2007‐2009 recession remains 24 incomplete and slack remains in the economy, this increase in demand will boost overall employment and economic activity…. Much of the additional Federal funding will fund additional medical care for newly enrolled Medicaid enrollees, increasing overall demand for medical goods and services. For dollars entering the economy this way, CEA uses a GDP multiplier of 1.5…. Federal funding will protect enrollees from high out‐of‐pocket medical costs…. For dollars entering the economy this way, CEA uses a GDP multiplier of 1.5…. For reductions in uncompensated care costs borne by State and local governments, CEA uses a multiplier of 1.1…. For other reductions in uncompensated care costs, CEA uses a GDP multiplier of 0.8….

Gruber and Yelowitz (1999) provide some evidence that past Medicaid expansions have indeed reduced precautionary saving. Because the macroeconomic estimates presented in this report do not account for effects of Medicaid expansions on precautionary saving, they are somewhat conservative…