Saturday, July 30, 2011

Stagnation or Stagflation?

One way to make a Keynesian angry is to point out that stagflation -- a simultaneous increase in inflation AND unemployment -- is not possible under the Keynesian scheme. The Phillips Curve supposedly "proves" that the way to get unemployment down is to ramp up inflation.

In a recent blog post, "Stagnation Nation," Krugman laments the woeful GDP numbers and the fact that unemployment is going up, and he blames it on a lack of government spending. However, inflation also is increasing, no matter what Krugman claims.

Anyone who purchases food, fuel, and consumer items can tell that prices are going up, and Krugman can tout the government's CPI all he wants, but that does not change the fact that we are seeing a huge increase in commodity prices at the same time it becomes harder and harder to find work. Yes, yes, he claims that "volatility" is the answer to rising commodity prices, as though volatility explains why they are rising together. What we know is that commodity price changes tend to be more volatile than price changes for finished goods and labor, but that does not explain why commodity prices are going up.

I recall watching the late Richard Gill neatly try to explain stagflation in a scholastic film. His trick was to move the aggregate supply curve to the left and, Voila!, stagflation! But, it only was a trick and explained nothing and certainly did not explain production of goods in the USA during that time. No, the Keynesians have no way to explain stagflation, and so they either ignore it or try to explain it away, claiming higher oil prices are the key. (The cause of inflation, in their view, is...higher prices, a nice example of "begging the question.")

In the end, Krugman claims that governments should spend more, as though a government magically can produce resources out of nothing. And when someone points out that simple fact, he gets angry and resorts to insults or simply pulls another logical fallacy out of his Keynesian hat.

69 comments:

dchamil said...

Bravo, Professor A., for properly using "to beg the question." This is improperly used by many to mean "raising the question."

Lord Keynes said...

"stagflation -- a simultaneous increase in inflation AND unemployment -- is not possible under the Keynesian scheme."

You clearly have a poor understanding of the various types of Keynesian theory.

Stagflation was a theoretical problem for neoclassical synthesis Keynesians, with their flawed Hicksian IS-LM models (e.g., Hicks, Samuelson).

Keynes' General Theory, his Cambridge Keynesian students and colleages (e.g., Joan Robinson, Kaldor etc), and the Post Keynesian school that followed them never had any difficulty explaining stagflation and offering effective cures for it.

http://socialdemocracy21stcentury.blogspot.com/2011/06/stagflation-in-1970s-post-keynesian.html


"... Keynesians have no way to explain stagflation, and so they either ignore it or try to explain it away,"

Utter garbage, Anderson:

Kaldor, N. 1976. “Inflation and Recession in the World Economy,” Economic Journal 86 (December): 703–714.

From 1968–1971 there were the beginnings of inflationary pressures, in both wages and prices in many industrialised nations. Around 1968–1969, this was reflected in wage rises in Japan, France, Belgium and the Netherlands, and from 1969–1970 in Germany, Italy, Switzerland and the UK, which appear sto have caused by demands from unions for wage rises (Kaldor 1976: 224).

The prelude to stagflation was also marked by a sharp rise in commodity prices that occurred in the second half of 1972, which was caused by

(1) dismantling of the US buffer stock policy in the 1960s by PL 480 provisions and by reducing output through acreage restriction. Before this the US buffer stock policies had caused commodity price stability down to the late 1960s;

(2) the failure of the harvest in the old Soviet Union in 1972–1973 and the unexpectedly large purchases on world markets by the Soviet state.

(3) the uncertainty caused by the break up of the Bretton Woods system in 1971 as investors moved to commodities as a hedge against inflation;

(4) wage-price spirals and

(5) the first oil shock from October 1973-March 1974;

The years from 1975-1977 in the US were not stagflation: these were years of an expansion in the business cycle with disinflation (falling inflation rates), rising employment, and rising real output growth.

The second bout of stagflation came in 1979-1982, again caused by wage-price spirals and the second oil shock.

karaipuku said...

are you sure that you are part of any school of economics?
could you offer critique from perspective of common sense ?
are you sure that inflation is increasing?
is there a measure of inflation that you could agree on with professor krugman, or with anyone serious?
if you do not see inflation when it is there, or if you see it when it isn't there, even Australian school will be of little help. So please tell us
what was the inflation in 2000, 2001, 2002, etc.
according to your perspective

Mike M said...

LK your citation of "causes" are not the root causes. They are intermediate consequences ot the root causes. Accordingly you have not explained stagflation.

Anonymous said...

" Krugman can tout the government's CPI all he wants, but that does not change the fact that we are seeing a huge increase in commodity prices at the same time"

But you assert that inflation is due to monetary expansion versus volatility in global markets and increased DEMANDS for all commodities from China and India. Then explain why commodity prices have merely risen to their levels prior to the recession and why they have actually fallen in the past 6 months? http://www.indexmundi.com/commodities/

For stagflation you need to look at the entire bundle of goods one consumes, and not only commodities. People might be paying more for gas (but less than 6 months ago),but the price for shelter, apparel, or vehicles has not increased commensurately.

Mike M said...

Anonymous, given the credit market bust environment you must dintinguish and adjust for items that are discretionary and credit dependent vs. Non discretionary and not credit dependent.

Anonymous said...

Well, I'm not sure that shelter necessarily counts as discretionary.

You are simply looking for facts that are not there.

1) Food has inflated 3.7% since December 2010 at a declining rate and Energy has inflated 20.1% at a declining rate (turning to deflation in May and June).
2) Within those energy prices, the major uptick is in the price of fuel oil and gasoline, which have also deflated in recent months. Natural gas and electric bills have only inflated about 1%.
3) Commodities less fuel and food which might be more volatile than other commodities has only inflated 1.6%. That is less than the inflation in discretionary items like clothing or vehicles.

The evidence is just not there and people can cry foul as much as they want to about Core CPI and the recent uptick in food and energy prices (which brought those prices to pre-recession levels). The fact is that the predictions of hyper-inflation following monetary expansion have just not come to fruition. Could it be that when interest rates are at their lower bound, wages are flat, and consumer demand is still low?

Awaiting Bob Roddis' Cantillon Effect Response.

Bob Roddis said...

We don't need to worry about the MMTer crowd. They're just a bunch of commies.

http://mikenormaneconomics.blogspot.com/2011/07/marxian-david-ruccio-goes-mmt.html

aka "economics deniers".

I think the MMTers contribute something positive and important to the problem of the oblivious public. The public does not really comprehend that the government can create money out of thin air that is the sole purposeful cause of inflation. The MMTers take an absurd and obviously immoral position in support of unlimited funny money that is bound to horrify average people if they understood it and they shout it to the heavens. Go for it.

Mike M said...

Anon

Real estate is credit dependent. Look at a 10 HR chart of the CCI Your numbers are noise in the macro trend

Mike M said...

10 year

Bob Roddis said...

Could it be that when interest rates are at their lower bound, wages are flat, and consumer demand is still low?

With interest rates artificially low and collapsing wages held up by funny money, people would tend to be getting poorer. I'm not clear on how that self-evident reality translates into "low consumer demand" [duh] JUSTIFYING more debt and funny money.

Worse and worse poverty accompanies Cantillon effects as part of the joys of funny money dilution and unpayable debt.

Hyper inflation will come when it becomes clear that there isn't enough stuff in the universe to satisfy the unpayable government debt. Two people cannot shove the same piece of toast down their own throat at the same time (despite the protests of the MMTers).

Tel said...

One way to make a Keynesian angry is to point out that stagflation ...

And we love making Keynesians angry round here, one particular Keynesian especially so.

But hey, I actually agree with LK on one point. Yes a oil shock can push an economy into stagflation (or any supply shock in a critical commodity, such as stable foods, etc). let's run with that and see how it pans out...

So your economy is ticking over nicely and suddenly WHAM you find the key ingredient to a whole bunch of your production processes is in short supply. Prices go up as people grab this commodity that is becoming scarce. Production slows down because everyone is getting cautious, trying to make it last. Marginal cost per unit of production is increasing so therefore the most efficient production quantity decreases and firms should rationally ramp down production (until some alternative design that gets around the bottleneck can be found).

So does it help for government to spend on huge stimulus packages in an attempt to solve the supply shock problem? Well government spending will not make that scarce commodity any less scarce. It will not bring down the marginal costs of production. All it can do is increase retail prices, which in turn improves the profit motive for firms to ramp up production, which in turn puts more pressure on dwindling supplies, and up go the marginal costs of production even worse.

So if the observed cause of stagflation is a supply shortage in key commodities (e.g. oil) then Keynesian stimulus is the worst thing governments can do... guaranteed to be ineffective, and probably makes the problem worse.

Let's think of an analogy here: you are driving interstate and you see that you are low on gas. The engine starts to cough now and then but it might hold for a while. So the Keynesian stimulus theory says that you push hard on the accelerator because we know that always makes the engine go better... the rational approach is to go easy on the gas and try to nurse it to the next gas station.

Bob Roddis said...

Notice how the statists flash the “aggregate demand” card as trump implying that this somehow proves their arguments, cause, effect and result (“see, we told you it was caused by a lack of aggregate demand”).

EVERYONE agrees that in a recession average people are poorer than before and are unable to purchase the same amount of consumer goods as before during the boom. EVERYONE AGREES WITH THAT. That is not an issue in play.

But what caused that poverty and what the solution might be still remain at issue. Duh. Hello??!!!
The Keynesians simply announce that they are calling that situation a “lack of aggregate demand” as if that proves their theory. But that pronouncement proves nothing because everyone already agrees that people in general are poorer that they were before.

zackA89 said...
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zackA89 said...
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zackA89 said...

Bob this is how i explain it.

People stop spending because there is a recession, but the pull back in spending is not the cause of the recession. Consumers dont cause recessions by somehow being too dumb to realize they need to "demand" more stuff.

In other words, keynesians see the effects and consequences of a recession as being the cause of the recession.

The fall in AD is a consequence of the inevtiable end of the phony boom period where the malinvestments reveal themselves. Spending needs to fall and savings needs to increase as the production strucutre must reconfigure to match consumer preferences in light of the new reality.

FdaPopo said...

Does it not seem silly to measure inflation in terms of prices? Which prices do you chose and how do you weight them?

It seems every economist defines inflation differently. The definition that makes the most sense to me is: inflation is money plus credit. Thus, prices are influenced by inflation, but not the root cause.

Defined this way, we see the government was able to influence credit for a while after the bust, but eventually banks will stop lending and people will stop borrowing. Yes the money supply is also increasing but it is very small compared to the total of money+credit.

So it seems deflation may be the order of the day. In either case, the Keynesians are still wrong but I was wondering what your take is on the different definitions of deflation?

FdaPopo said...

Krugman: "growth well below the economy’s potential, so we’re actually losing ground in the effort to reduce the gap between what we should be producing and what we’re actually producing"

Wow, what do you guys think about this statement? Krugman must be a really really smart guy to actually know the "potential" of the economy and the exact amount of "what we should be producing".... I was wondering, what is the magical Keynesian formula that allows him to compute this number?

p.s... my mama always said "don't should on yourself"

William L. Anderson said...

None of the things that LK listed would cause stagflation. An "oil shock" would be disruptive, but to claim that it would cause system-wide inflation is to endorse the nonsense of the "cost-push" inflation theory. In fact, everything he lists in that "proof" list is nothing more than "cost-push," including the silly "wage-price spiral" explanation.

What LK says in that comment is that higher prices cause higher prices. I'm serious. The Keynesian causality mechanism nothing more than yet another application of circular reasoning.

Prices rise on a general level because of inflation; price increases are not a CAUSE of inflation, but rather an effect of it.

All of this reminds me of the Jake Blues character trying to explain to the woman played by Carrie Fisher in "The Blues Brothers" why he had jilted her at the altar. The reasons were mutually-exclusive, but nonetheless the character played by Fisher bought them.

However, when economists like Krugman insist on giving us a Jake Blues redux on inflation, we don't have to listen. They are just blowing smoke.

Lord Keynes said...

"An "oil shock" would be disruptive, but to claim that it would cause system-wide inflation ..."

Really?? A massive surge in the price of oil - a major factor input for commodity after ocmmodity - doesn't cause inflation when businesses mark up the prices of their product because the factor input costs have risen?

is to endorse the nonsense of the "cost-push" inflation theory.

In other words, you have no refutations to anything I've said.

William L. Anderson said...

Please explain the cause-and-effect. Money prices reflect the relationship between money are real goods. You are claiming that prices of real goods can rise in tandem by themselves without any influence of money.

Cost-push is a nonsense theory because it is based upon circular logic. In your view, price increases cause price increases.

Your view also is another rendition of the "Cost of Production" Theory of Value, which was pretty well refuted in 1871. You cannot have a Marginal Utility Theory AND a Cost of Production Theory operating simultaneously.

Lord Keynes said...

"You are claiming that prices of real goods can rise in tandem by themselves without any influence of money."

If the major producers of a cartel (OPEC) restrict supply of oil, then the price of oil surges.
That causes higher factor input bills for commodity producer after producer. Unless you seriously believe producers leave their prices unchanged when their factor input costs rise, you've got nothing. Also, the 1970s were a period of much stronger trade union power than today: trade unions had the power to force higher wages in reponse to inflation back then.

Your view also is another rendition of the "Cost of Production" Theory of Value, which was pretty well refuted in 1871.

Rubbish. You confuse value with price. While economic value is subjective, the price of many commodities (though not all) in modern industrial economies is set by the factor input costs plus the mark-up for profit. Do some basic reading in price theory.

And tell me: what viable business can set its normal, long run price below its factor input costs?
Care to name me one?
I suspect not.

You cannot have a Marginal Utility Theory AND a Cost of Production Theory operating simultaneously.

Again, that's utter nonsense. Economic value and price are 2 different things. You're conflating them.

Bob Roddis said...

People trade stuff for other stuff. If the price of one item goes up, it will require more stuff (or money) in trade. People will then have less stuff (or money) to trade for other things and demand for those other things will fall and suppliers will be forced to lower the price or take them off the market. With a stable supply of money, an average of all prices will remain stable regardless of a shortage of a single commodity, even if it is a vitally important one.

Lord Keynes said...

People will then have less stuff (or money) to trade for other things and demand for those other things will fall and suppliers will be forced to lower the price or take them off the market.

You're living in a fantasy world of perfectly flexible wages and prices - something that has never existed in the real world, and that won't even in exist in a Rothbardian anarcho-capitalist system.

"With a stable supply of money, an average of all prices will remain stable regardless of a shortage of a single commodity, even if it is a vitally important one."

We live in a world with an endogenous broad money stock:

“… the vast bulk of the money supply in modern economies is credit money which only comes into existence because it is demanded, to meet the needs of trade.

It is more likely, therefore, that it is not changes in the money supply driving prices but price (and output) changes driving the money supply .... Likewise, change in money preceding changes in prices cannot be taken to mean that money is causal since agents will demand money in advance of production to finance the higher cost of intermediate inputs.”
Phillip Anthony O’Hara, Encyclopedia of Political Economy: L–Z, p. 752.

Bob Roddis said...

LK - You're living in a fantasy world of perfectly omniscient and benevolent overseers and SWAT team thugs. Heck, according to LK, even a bunch of commie syndicalist collectives are going to need an omniscient overseer with SWAT teams because “Say’s law would not hold in a syndicalist economy” and “in such an economy, there would still be failures of aggregate demand”.

http://socialdemocracy21stcentury.blogspot.com/2011/07/chomsky-on-meaning-of-socialism.html

One can only spout such drivel by purposefully refusing to understand the nature of the real world and the knowledge limits of acting humans.

There is no "failure of aggregate demand" afflicting the human race. There is a proliferation of mass slaughter, war, genecide and massive institutional embezzlement in the form of funny money. Those are the problems facing mankind and most are funded and subsidized by Keynesianism.

Bob Roddis said...

Let’s not forget that multi-ethnic socialist democracies of the LK variety almost invariably lead to ethnic conflict, murder and grand national theft. Everyone tends to vote ethnic and largest group wins. Using the immoral theories of the progressives and Keynesians, the government owns everything and the largest ethnic group then owns the government, at which point we have the joy and marvel that is today’s Africa. More proof that rich progressive white people in the West actually hate brown and black people in the third world. Just look at what they have inflicted upon them.

Rabushka and Shepsle explain:

http://www.stanford.edu/~rabushka/politics%20in%20plural%20societies.pdf

Robert V said...

I have a theory that LK is actually Paul Krugman. His drivel here is as pointless as his drivel in the NYT.

burkll13 said...

no, LK is really "Deep Blue", that IBM computer that beat kasparov. He has a ton of information that he can recall quickly, but ZERO ability to comprehend the information that he can regurgitate.

Bob Roddis said...

Professor Anderson’s main blog focuses upon prosecutorial misconduct. Under the statist model, there is no incentive or knowledge feedback loop to help reign them in. They run wild.

http://williamlanderson.blogspot.com/

Just like LK’s elected SWAT-team guided overseers of “aggregate demand” management, they always demonstrate benevolence and wisdom. Right? Oh, you say it’s not the same thing? Really?

Tel said...

Quote from Bob:

People trade stuff for other stuff. If the price of one item goes up, it will require more stuff (or money) in trade. People will then have less stuff (or money) to trade for other things and demand for those other things will fall and suppliers will be forced to lower the price or take them off the market.

Sure, but let us suppose we have an island where 100 fresh coconuts are produced every day. At the same time, 100 silver coins are in circulation, and people trade at a price of one coin per coconut. Whoever feels energetic that day will gather a bag of coconuts, and sell them off for siver coins and then that person doesn't have to do any work until their coins run out and presumably someone else takes a turn.

So what happens when the trees die back and now the supply is only 10 fresh coconuts per day? You have just as many silver coins in people's hands but a lot less "stuff" to spend them on. It is now impossible to maintain a price of one coin per coconut because there just isn't enough "stuff" to satisfy the people who have coins.

Tel said...

Quote from Prof Anderson:

You cannot have a Marginal Utility Theory AND a Cost of Production Theory operating simultaneously.

However, using Marginal Utility Theory does not suddenly cause the costs of production to be ignored -- they are still built into the theory, just in a different way. Using the Theory of the Firm (which is relatively easy to demonstrate as a simulation BTW), the costs of production are represented by two curves: the Average Unit Cost curve (as a function of total production volume) and the Marginal Unit Cost curve (also function of total production).

A monopolist will optimise their production volume such that the Marginal Return equals the Marginal Unit Cost... and we call this "charging what the market will bear". A competitive market will push up production towards the point Average Unit Price equals Average Unit Cost, but no market is ever so very competitive that it gets all the way up to this point.

A supply shock moves the cost curves upwards, thus in every case it must reduce production volume and increase retail prices. Of course, as the supply shock ripples through the system, the level "what the market will bear" will also slowly shift, almost certainly also in an upwards direction.

See also:

http://lnx-bsp.net/news/2010/07/09/

http://lnx-bsp.net/news/2010/07/19/

Brady said...

People trade stuff for other stuff. If the price of one item goes up, it will require more stuff (or money) in trade. People will then have less stuff (or money) to trade for other things and demand for those other things will fall and suppliers will be forced to lower the price or take them off the market. With a stable supply of money, an average of all prices will remain stable regardless of a shortage of a single commodity, even if it is a vitally important one.

Well put!
As somebody who has been stalking around here for a while… LK - Your appeals to authority and lack of logical and independent thought are really disappointing. I’m sure you are a smart guy with a good education, but you cite Keynesian literature like a preacher cites his holy book; it is true because it says it is true. I assume that everybody here is well-versed on the economic literature and doesn't need a Keynesian textbook thrown at them as if it were the bible. Perhaps you are unaware that Keynesian theory is in fact a theory.
For the sake of academic honor, please make your own arguments as so many others on here have. Rob's quote above, while simple, is inescapably true. Admittedly, what he describes is not the "real" world we live in today. But who are you to say that such a world was not, or is not possible? Indeed, this is the very crux of the debate to begin with.

Brady said...

Given a stable money supply, how it is possible for the average price of goods to rise?

I would love for somebody to answer this question as plainly as I have asked it.

Tel said...

Given a stable money supply, how it is possible for the average price of goods to rise?

It's very simple, you have money and you have goods. So there is an exchange rate between money and goods, and we call that exchange rate the "price" of goods.

So suppose large amounts of new money flood into the system, now we have the same amount of goods, but a lot more money so the exchange rate swings and prices go up. That's an inflationay scenario... money gets printed, and inflation happens. All happy so far?

OK, so now suppose the amount of money in the system stays the same but the amount of goods available is drastically reduced (that is to say a physical problem is making it more difficult to produce goods). Now the exchange rate also swings because the ratio between money and goods in the system has changed... exactly like inflation, the prices go up, not because there is additional money, but because there is a shortage of goods for the same money.

Point is, if you get government printing additional money in an attempt to repair that physical problem that is causing the shortage of goods, they make matters worse. Printing additional money might temporarily hide the problem, it will not fix it.

JG said...

"Cost-push is a nonsense theory because it is based upon circular logic. In your view, price increases cause price increases."

A supply disruption causes oil prices to rise, which causes the prices of oil-intensive products to rise. How is this circular?

Bob Roddis said...

1. Stable money GENERALLY means stable prices.

2. For the exceptions, the worse thing to do is have the government print more money. The temporary distortions of high prices in some sectors are important and necessary price signals.

3. Concerns about ubiquitous "cost-push inflation" are still nonsense.

4. It's still preposterous to think that the people who are allegedly so dumb as to be unable to voluntary resolve the [non-existent] problems of "aggregate demand" are at the same time smart enough to elect benevolent and intelligent SWAT team leaders to guide them out of the [non] problem at the point of a gun using funny money and more debt. And, according to LK, this problem will even afflict commie socialist syndicalist utopias who will then vote for their SWAT team saviors. That's what this "debate" is ultimately all about.

jason h said...

"A supply disruption causes oil prices to rise, which causes the prices of oil-intensive products to rise. How is this circular?"

Prices responding to a supply shock is not inflation; it is textbook supply and demand.

The cost-push theory indicates that the price of a good will increase if the cost of producing said good increases. However, price is set by the buyers in a market and is independent of production cost.

A diamond studded platinum cell phone may cost $1 million dollars to produce - but the PRICE is $0 if no one is willing to buy.

Bob Roddis said...

Yglesias wants to know "When did Keynes [Keynesianism] live?" I say never, and further insist that average people have no idea that their betters think funny money dilution and government debt are actually CURES for economic problems. If average people could focus for more than 7 seconds to understand this, I think they would be appalled.

http://thinkprogress.org/yglesias/2011/08/01/283990/when-did-keynesian-economics-live/

JG said...

"However, price is set by the buyers in a market and is independent of production cost."

Maybe for consumer discretionary items like iPads and Coach hand-bags but not for energy, food, medical care of other necessities. For necessities like gasoline and food the price is set by production cost because the consumers have few substitutes and cannot go without.

When it comes to fuel, food, energy and countless other goods an services the cost-push theory holds true.

Lord Keynes said...

"1. Stable money GENERALLY means stable prices."

It does no such thing.

A fixed money supply or inelastic one means delfation in a growing economy.

Delfation is NOT price stability.

Deflation imposes a tax on producers and productive busineses taking out debt for investment, and reduces investment by giving a return on holding money without lending it.

Anonymous said...

"Deflation imposes a tax on producers and productive busineses taking out debt for investment, and reduces investment by giving a return on holding money without lending it."

Yet, we find that ,in real terms, the value of stocks trends upward during mild deflation or price stability, and tanks when inflation is high.

jason h said...

For necessities like gasoline and food the price is set by production cost because the consumers have few substitutes and cannot go without.

Where in the Law of Supply and Demand is the asterisk for "necessities"?

Price is always driven by buyers. For gasoline and fuel high demand and fierce competition drives the profit margins down resulting in the illusion of cost-push, but producers can only charge the maximum the market will bear, regardless of production costs.

jason h said...

Deflation imposes a tax on producers and productive [businesses] taking out debt for investment...

It's not a tax, but a premium paid for consuming resources now rather than later. (AKA interest, time value of money) It is a critical price to guide the market for long term investments.

and reduces investment by giving a return on holding money without lending it.

Great! Instead of allowing sustainable, profitable long-term investments, induce people to part with their cash (blowing up stock and housing bubbles and such) by stealing the value of their hard-earned savings.

How cruel to force people to labor in perpetuity because their savings continues to purchased less and less.

Tel said...

Having some mild deflation caused by a growing economy is one of those problems that isn't such a bad problem to have. Obviously investment must be doing OK in this scenario because the first premise was that the economy is growing!

Generally you can expect lower risk premiums on shares under such an environment because fewer companies go bust in a growing economy, and you can expect lower natural interest rates on loans because investors don't need to charge a premium to overcome their loss to inflation. That's presuming interest rates are allowed to form some sort of natural free market, rather than a manipulated market (like we have today).

Worst case I can think of is maybe you don't quite achieve the maximum possible growth... but people need time to adapt to growth anyhow, so it's arguable whether artificially pumping it will be beneficial to real people.

Brady said...

So suppose large amounts of new money flood into the system, now we have the same amount of goods, but a lot more money so the exchange rate swings and prices go up. That's an inflationay scenario... money gets printed, and inflation happens. All happy so far?


Not at all. By stable money supply I mean that the quantity of money doesn't change.

But you've made my point for me: Prices go up when you introduce new money.

It is quite simple to reason through the following:

1) If there is system with some amount of goods (add value), and I introduce new money, prices will necessarily rise (inflation).

2) If there is a system with some amount of goods, and I introduce new goods holding the money supply steady, prices will go down (deflation).

3) If there is a system with some amount of goods, and I introduce new goods and a corresponding amount of money, prices will remain stable.

4) If there is a system with some amount of goods, and I take out goods (remove value) but introduce new money, prices will rise sharply.

5) If there is a system with some amount of goods, and I take out goods and corresponding amount of money, prices will remain stable.

Given the need for debt financing to be possible, deflation is bad. So the trick is to keep the money supply in lockstep with the amount of value present in the economy.

Wouldn't you agree?

Now, consider a bubble like the one we had with real estate. The perceived value of assets in the system went up, and the money supply along with it (see #3).

Now, the market has decided that
the assets in the system are worth less, so what should we do? (hint: see #5)

But what are we doing? (hint: see #4)

JG said...

"Price is always driven by buyers. For gasoline and fuel high demand and fierce competition drives the profit margins down resulting in the illusion of cost-push, but producers can only charge the maximum the market will bear, regardless of production costs."

According to this logic consumers will stop eating food when the price of food rises above what they are willing to pay. Or stop heating their homes when the price of heating oil rises too high.

Of course, there is an ultimate limit to what consumers are able to pay. But supply shocks can and do push consumers to the edge of that limit to an extortionate extreme before that threshold is breached. That is why cost-push is valid and why your axiom of consumers being the arbiters of price is misleading at best.

Brady said...

According to this logic consumers will stop eating food when the price of food rises above what they are willing to pay. Or stop heating their homes when the price of heating oil rises too high.

That's exactly right. You disagree? But, chances are that your average joe is clever enough to seek out cheap alternatives before starving or freezing to death. They might eat ramen and bundle up, for example.

What makes Keynesians think they have some sort of special ability to know what the price of a commodity "ought" to be?

Prices are set by markets, and those who cannot afford those prices will need to find alternatives. Artificially depressing prices is folly as it invariably leads to shortages, hoarding, and rationing. Surely even a Keynesian can admit this simple truth of supply and demand?

boatman said...

dr. anderson, i see you have the same socialist trolls all good responsible sites have.

it is a badge of honor and you are a gentlemen and a scholar.

i salute you.

Lord Keynes said...

"But you've made my point for me: Prices go up when you introduce new money.

It is quite simple to reason through the following:

1) If there is system with some amount of goods (add value), and I introduce new money, prices will necessarily rise (inflation)."


You don't even understand the Austrian theory of price inflation:

“the essence of inflation is not a general rise in prices but an increase in the supply of money, which in turns sets in motion a general increase in the prices of goods and services .... While increases in money supply (i.e., inflation) are likely to be revealed in general price increases, this need not always be the case. Prices are determined by real and monetary factors. Consequently, it can occur that if the real factors are pulling things in an opposite direction to monetary factors, no visible change in prices might take place. In other words, while money growth is buoyant – i.e., inflation is high – prices might display low increases.”

Frank Shostak, “Defining Inflation,” Mises Daily, March 6, 2002.
http://mises.org/daily/908

That is easily confirmed in the real world: Japan actually had a zero inflation rate in 1996 and 2004 or a fall in average prices (price deflation) over a number of years in which they did QE, even though the money supply - both the money base and broad money stock - were still actually increasing in the these years.

Brady said...

You don't even understand the Austrian theory of price inflation:

“the essence of inflation is not a general rise in prices but an increase in the supply of money, which in turns sets in motion a general increase in the prices of goods and services .... While increases in money supply (i.e., inflation) are likely to be revealed in general price increases, this need not always be the case. Prices are determined by real and monetary factors. Consequently, it can occur that if the real factors are pulling things in an opposite direction to monetary factors, no visible change in prices might take place.


LK - Is your attention span really so small that you could not be bothered to read my entire post?

How is the situation described in your quote not EXACTLY what I describe in my post at points #3 and #5?

Here they are for you, again:

3) If there is a system with some amount of goods, and I introduce new goods and a corresponding amount of money, prices will remain stable.

5) If there is a system with some amount of goods, and I take out goods and corresponding amount of money, prices will remain stable.

Thank you for bringing up Japan by the way. Despite all the QE, Japan's economy has gone nowhere. I suppose the Keynesian explanation is that the there just wasnt enough QE, though right?

Lord Keynes said...

1) If there is system with some amount of goods (add value), and I introduce new money, prices will necessarily rise (inflation).

Even in this instance prices will not necessarily rise: there could be unused capacity or the ablity to import goods.

"I suppose the Keynesian explanation is that the there just wasnt enough QE, though right? "

QE is not a Keynesian policy - it's a monetarist one.

Brady said...

Even in this instance prices will not necessarily rise: there could be unused capacity or the ablity to import goods.

This would work essentially like my earlier point #3 as money and value are added to the economy simultaneously. So far, this sounds good!

But think about the assumptions that this strategy makes:

A) 100% of stimulus can be directed at "unused capacity or the ability to import goods"

B) 100% unused capacity targeted by the Keynesian overseer are unused but would still be valuable in the marketplace.

Given the politics of government spending, do you really believe these assumptions hold true in practice?

QE is not a Keynesian policy - it's a monetarist one.

Well that's good to hear.

JG said...

"But, chances are that your average joe is clever enough to seek out cheap alternatives before starving or freezing to death. They might eat ramen and bundle up, for example."

And what would the average joe do to power his vehicle when gasoline hits $10 a gallon? Invent his own substitute for gasoline? Take a bus that is also powered by gasoline? Walk 30 miles to work each day?

Listen, the whole point I'm trying to make is that suppliers can and do set prices just as much as consumers do. Not all demand is negotiable, not every good or service can be substituted. And for those goods/services producers have tremendous pricing power. To pretend otherwise is foolish and ignores the examples of history.

Reality does not conform to your neat little bite-sized axioms like "only consumers set prices". It sounds like you prefer theory to reality.

Brady said...

And what would the average joe do to power his vehicle when gasoline hits $10 a gallon? Invent his own substitute for gasoline? Take a bus that is also powered by gasoline? Walk 30 miles to work each day?

Pretty much. Taking the bus, buying a motor cycle, or riding your bike would each provide good solutions.

There are substitutes for driving the family car to work every day. Comsumers might not like them, but at some point they would rather take the bus than pay $X for gas. This is how the market works. It finds its own way.

But Brady, what if there ISNT a bus?? Well, that's the beauty of markets. Where theres unsatisfied demand, supply will be on the way.

Just because you cannot predict exactly how the market will overcome an obstacle doesn't mean that it will not. Government interference in prices only slows down the innovation/reconfiguration process.

Mike Cheel said...

@JG It sounds like you believe in entitlements. No one is entitled to drive a car, have electricity, have medical care or any of the other modern conveniences you are used to. If you can't pay your rent then you have to live on the street. If you can't pay for gas, you have to ride your bike or *gasp* walk. If you can't pay the doctor you had better hope for some charity.

You can't be a seller without having buyers.

JG said...

"Pretty much. Taking the bus, buying a motor cycle, or riding your bike would each provide good solutions."

Or, the far more likely outcome that we have witnessed time and again, the consumer will pay the extortion of the supplier and pay the higher price. Thereby proving the point that producers have pricing power and that cost-push is a valid concept.

JG said...

"You can't be a seller without having buyers."

No kidding. But the entire reason that we have anti-trust laws is because we acknowledge that producers can impose prices on consumers. Supply and demand is not a one-way street with consumers calling all the shots, producers have always found ways to manipulate prices through cartels (OPEC in the 1970's) or monopolies (Standard Oil in the 1800's) or market manipulations (Enron in 1990's in California electricity market).

You can go ahead and ignore or deny examples of this happening but I choose to be put reality over theory.

Mike M said...

JG said: “the consumer will pay the extortion of the supplier and pay the higher price. Thereby proving the point that producers have pricing power and that cost-push is a valid concept.”
NO! You assume that consumers are rats trapped in a maze with no exit. This may be true in a statist utopia but not a free market. Consumers will pay the higher prices at the expense of other items UNTIL the pain becomes too high and/or the market provides an attractive alternative. Your comment assumes everything else is static. It is not.

jason h said...

That is why cost-push is valid and why your axiom of consumers being the arbiters of price is misleading at best.

Hardly misleading. This is fundamental stuff. The same economic law determines consumers will pay $500 for an Ipad and $4 for a gallon of gas.

The notion that production cost determine price is a myth. Its why price controls cause shortages.

Say, a gasoline alternative cost $1/gal to produce, while gas costs $2/gal to produce. What will the price for fuel be?

jason h said...

Enron in 1990's in California electricity market

Thanks for this one! The regulated electricity market with price ceilings caused electricity shortages making it more profitable to allow rolling blackouts than to fire up a power plant.

Also, notice how none of the examples lasted very long as when monopolies/cartels artificially restrict supply to bid up the price they attract fierce competition. Unless of course that monopoly/cartel has gov't thugs to guarantee their monopoly.

Mike Cheel said...

"Enron in 1990's in California electricity market"

I will also point out that cities that provided their own electricity (such as Pasadena, CA which is where I lived at the time) didn't have this issue.

Brady said...

The fundamental flaw in the logic that JG and others like him make is that they believe they possess the ability and the right to decide where the laws of supply and demand are allowed to apply.

A quick look at history will show you that "necessities" have evolved over time.

We used horses for transporation until cars become more efficient.

We used wood for heat until natural gas become more efficient.

We used candles for light until electricity became more efficient.

Efficient here refers to that of of utility per unit of cost and thus includes more than just price/unit, but other things like safety and convenience.

If the price of these necessities were held artificially low, people would have had less incentive to switch. "Sure, electric light is convenient and safe, but it's just not worth the extra money."

This evolutionary process must be allowed to continue for there to be any hope of an increase in the standard of living. Indeed, this evolutionary process is what we call value creation is what fuels the economy, not money.

JG said...

"The fundamental flaw in the logic that JG and others like him make is that they believe they possess the ability and the right to decide where the laws of supply and demand are allowed to apply."

No. That is the false conclusion that you have projected onto my statements.

I claim no such ability to decide where the laws of supply and demand apply. I only point out the inconvenient fact that supply and demand are equal parts of the equation while you dogmatically insist that supply is a tail that gets wagged by the dog of demand.

When supply constraints occur on goods that have inflexible demand then prices go up. Every time I remind you of this with examples from real life you choose to ignore those examples and pretend they never happened. That is a common trait that many Austrians share, a preference for neat theories over messy reality.

Tel said...

4) If there is a system with some amount of goods, and I take out goods (remove value) but introduce new money, prices will rise sharply.

My estimate is that this is very close to what has been happening in the USA, except that so far price rises have only shown up in the commodities, and have not rippled through to manufactured items.

There has also been simultaneous debt deflation happening which is caused by people walking away from their mortgages, companies going bankrupt, banks writing off losses, etc. The debt deflation has cancelled out inflation in areas where people struggling with their mortgages can choose not to buy (i.e. all non-essential items are remaining price stable, because people simply stop buying those items).

To look at how commodities are throttling industry... it's not just oil. Look at copper over the last decade or two and the price increase has been very significant. Copper goes into every piece of machinery you care to name, and every building. Then there are silver, gold and platinum which are thought of as investor metals but they do have significant industrial uses. If you want to make mobile phones (and you want them small to fit in your hand) then you will need Tantalum. If you want to make high power magnets you will need Neodymium... and China is deliberately tightening world Neodymium supply, because they can and because it makes them money.

Brady said...

I claim no such ability to decide where the laws of supply and demand apply.

But you do. Let me show you how.

First lets take a look at the use of the word "extortion" earlier. Here it is:

the consumer will pay the extortion of the supplier and pay the higher price

Using the same meaning of extortion, please answer "Yes" or "No" to each of the following:

Do you believe there can be extortion in gasoline markets?

Do you believe there can be extortion in food markets?

Do you believe there can be extortion in the video game market?

Do you belive there can be extortion in the luxury yacht market?

If you didn't answer (or want to answer) each of these questions the same then you must admit you are making a distinction between where supply and demand ought to be able to operate.


On the other topic about suppliers setting prices. Take a deeper look at your logic. You posit that because the supplier can manipulate supply, he can set the price. If you believe this, then you must also believe that buyers can set demand by the exact same mechanism, in reverse. Would you agree with me if I told you that buyers set the supply?

JG said...

Your first segment is just silly. To compare goods that have no substitutes (food, gasoline) to goods that have many substitutes (yachts, video games) is disingenuous and assumes that consumers can delay consumption of food and transport as easily as they could delay consumption of entertainment and luxury items. They cannot and to assume otherwise is foolish.

Regarding you second segment: "You posit that because the supplier can manipulate supply, he can set the price. If you believe this, then you must also believe that buyers can set demand by the exact same mechanism, in reverse."

What I believe is that buyers can manipulate prices when they are few enough and large enough to dominate a market. The same is true for suppliers when they are few enough and large enough. Your argument seems to be that since a supplier cannot hold a gun to your head and force you to pay a price you don't want to pay that somehow the buyer is ultimately setting the price. However, that doesn't mean that suppliers are without pricing power. The fact that OPEC can and does control prices through supply restrictions is proof of this.

Brady said...

To compare goods that have no substitutes (food, gasoline) to goods that have many substitutes (yachts, video games) is disingenuous.

How so? Do supply and demand work differently for food and gasoline than they do for yachts and video games?

You just can't get by your subjective judgment that some goods need to be treated differently, can you?

The "no substitute" argument is ridiculous as I have already shown.

Alternatives for gasoline:
Take the bus
Walk
Ride your bike
Don't travel
Get a job closer to home

Alternatives for food:
Buy a cheaper form of food
Grow your own food
Hunt
Eat less and conserve energy

Just because a consumer doesn't prefer the alternatives doesn’t mean they are not there. The consumer willfully chooses to pay higher prices until, by his judgment, the cost is not worth the benefit at which point he will either switch to an alternative or stop consuming.

Your argument seems to be that since a supplier cannot hold a gun to your head and force you to pay a price you don't want to pay that somehow the buyer is ultimately setting the price. However, that doesn't mean that suppliers are without pricing power. The fact that OPEC can and does control prices through supply restrictions is proof of this.

That’s right. In the absence of coercion, the supplier cannot force the buy to pay anything. Period. End of story.

Pricing power and price setting are two VERY different things. I hope you can understand the difference.

JG said...

"Do supply and demand work differently for food and gasoline than they do for yachts and video games?"

Actually, they do. The concept of price stickiness applies differently to various goods and services depending on the nature of the goods/services in question. That's why the demand for gasoline changes so little when the price of gasoline sky-rockets while demand for other goods (that have more substitutes) react more sensitively to price changes.

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