*Keynes and critics

[admin]

The core Keynesian innovation has been to explain that an economy can be stuck in a crisis because of lack of demand, but there have been those that argue that this isn't possible in principle. The latter, implicitly or explicitly invoke some form of Say's law, arguing that supply creates its own demand.

For instance, here is an Austrian perspective:

Say’s ideas were used to settle a debate between the British economists David Ricardo and Thomas Malthus who believed recessions were caused by a general glut. The concept of a glut for a single good is easy enough to understand: there is more supply on the market than demand at the offered price. A glut can be alleviated by a fall in the price of that good. The producers of the good may take a loss if the market price is below their costs, but the market can always clear at some price.

The idea of a general glut is that all markets for all goods are in surplus. And for some reason, prices are unable to fix the problem.

Say's Law And The Permanent Recession | Zero Hedge

[admin]

Here is Econobrowser with a hypothetical if the Great Recession wasn't caused by a lack of demand:

If a collapse in aggregate demand is not at fault, then was an aggregate supply shift? A quick-and-dirty evaluation using some back-of-the-envelope calculations

In 2008Q4, GDP fell at an annualized rate of 8.9%; it fell another 5.6% going into 2009Q1. One interpretation is that aggregate demand collapsed. An alternative interpretation is that supply fell; in this view, aggregate demand management policies would have no effect, or even be counterproductive. In this light, I thought it of interest to consider what must be true in order for the supply side view to be correct.

Interpreting the Great Recession in a Classical Framework | Econbrowser

[admin]

Here is Econobrowser with a hypothetical if the Great Recession wasn't caused by a lack of demand:

If a collapse in aggregate demand is not at fault, then was an aggregate supply shift? A quick-and-dirty evaluation using some back-of-the-envelope calculations

In 2008Q4, GDP fell at an annualized rate of 8.9%; it fell another 5.6% going into 2009Q1. One interpretation is that aggregate demand collapsed. An alternative interpretation is that supply fell; in this view, aggregate demand management policies would have no effect, or even be counterproductive. In this light, I thought it of interest to consider what must be true in order for the supply side view to be correct.

Interpreting the Great Recession in a Classical Framework | Econbrowser

If output is completely supply determined, then one has to think about the fact that the change in output must be attributable to either the change in total factor productivity, TFP (&Phi, the capital stock (K), or the labor stock (N).

Using a Cobb-Douglas production function, Econobrowser arrives at:

Either multifactor productivity declined by 3.7%, the effective labor stock fell by 6.2%, or the capital stock declined by 9.3% (all calculations assume labor share is 0.6, capital share is 0.4).

The two competing frameworks preduct diffferent things in terms of some economic variables:

1. Prices rise in the supply framework, decline (or decelerate) in the demand framework. Since prices declined sharply, this is consistent with the demand framework
2. TFP ["using John Fernald’s utilization adjusted estimate of total factor productivity, one finds that productivity rose 2.5% over the corresponding period (discussed in this post)."] Consistent with a demand framework, not a supply framework.
3. Neither is a big sudden decline in the capital stock very likely
4. Or a big sudden decline in labor.

So data make a supply shock rather implausible.

[ArtM72]

How does this interpret when looking at the possibility that the money supply itself in 2008 was the issue and not those goods and services which (at least in my ignorance) are considered in the traditional economic models?

A rapid drop in available funds (loss of supply) didn't result in an increase in demand so much as it created a further loss of supply as the credit markets went on lock down. Not until liquidity was restored to the market (which has taken years as banks couldn't deleverage overnight) did demand resume as evidenced by the regrowth of the economy. A pretty clear case of shortage begetting shortage.

Bless the Fed and those that have been in the position to actively support its actions.

[admin]

How does this interpret when looking at the possibility that the money supply itself in 2008 was the issue and not those goods and services which (at least in my ignorance) are considered in the traditional economic models? A rapid drop in available funds (loss of supply) didn't result in an increase in demand so much as it created a further loss of supply as the credit markets went on lock down. Not until liquidity was restored to the market (which has taken years as banks couldn't deleverage overnight) did demand resume as evidenced by the regrowth of the economy. A pretty clear case of shortage begetting shortage. Bless the Fed and those that have been in the position to actively support its actions.

Yes, there was a 'credit crunch', yes, there was and it was having a real impact. Banks weren't even lending other banks anymore, for a while, the whole credit system screeched to a grinding halt. After the Fed had restored some semblance of order in the credit markets, credit was still considerably tighter than before 2008, as banks were amongst those which wanted to repair their balance sheets and delever.

And yes, that did have negative effect on the economy, there are always parties dependent on credit, and when they couldn't roll-over old credit lines, they had to tighten their belts (or go out of business altogether or rescind their house, stuff like that).

But credit demand was also weak, exactly because households, hit by a $9 trillion decline in house values and a sudden decline in employment, tightened their belts considerably (which worsened the recession, needless to say).

All this points to a demand side problem as the main culprit, not a supply side problem, needless to say.