Regular readers know that I think the liquidity trap is intriguing and certainly relevant right now, but more of a theoretical curiosity than a hugely important factor. Tyler Cowen makes much the same case in this post, which thinks through the zero lower bound argument by reviewing the importance of substitutability in other markets.
Cowen argues that adjustment can be slow for very close substitutes, but that it will happen - and many other factors are important than just the substitutability of cash and Treasuries for the adjustment process. That's all well and good, but the fact remains that the adjustment process is considerably slower for closer substitutes than it is for substitutes that are much less close. It is precisely the close substitutability of cash and Treasuries that makes all the other issues that Cowen talks about relevant right now, and that is the sense in which the liquidity trap is meaningful. Cowen uses the example of the close substitutability of grapes and pluots to talk about the liquidity trap, and he says that substitutability alone does not explain the adjustment. His appetite, for example, is also a factor. I would only add that we're only even talking about "appetite" as a factor because what is introduced is more food (pluots). If Cowen's house guest had brought, say, a bottle of wine we might think of the wine and the grapes as complements rather than substitutes. "Appetite" in the sense of how much food you feel like eating is no longer a constraint at all, because it might be very nice to have wine and grapes together. The close substitutability of grapes and pluots is disconcerting precisely because it introduces the relevance of other constraints like appetite.
That's largely how I think about the liquidity trap. It makes things problematic that wouldn't be problematic under other circumstances. Other than that, it's hard to stretch this metaphor much farther. Grapes and pluots aren't media of exchange, stores of value, or opportunities for speculation, after all - so I'm not sure how much mileage Cowen thought he was going to get out of this. I suppose it works as an explanation for portfolio adjustment, which is what he claims he's talking about. But since when is the importance of the liquidity trap derived from balancing the composition of your portfolio between cash and bonds? That's not really the major point. The point is the demand for liquidity as well as the impact (or lack of impact) of monetary expansion on the interest rate.
I guess I'd offer one more interpretation to push this metaphor a little further. If you were Cowen's house guest and you knew about his grapes/pluots dilemma, it would probably make more sense for you to bring that bottle of wine that would complement grape consumption, rather than those pluots which would be close substitutes for grapes, right?
What could possible complement liquidity preference right now - what could encourage households and firms to work through their liquidity preference - rather than exascerbate it? Probably some additional aggregate demand, right?
Sunday, July 25, 2010
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Well, since keeping my paycheck in my wallet for five minutes/five days/five weeks/five months/five years instead of spending it immediately (and by immediately I mean instantaneously, in no longer than one Plank time) is of course by the standard Keynesian definitionless definition considered hoarding, we should immediately implement a universal policy of forcing all employers to spend their employee's paychecks upon issuance, thereby creating the maximum possible aggregate demand and preventing "leaky savings," an immediate cure to our depression! Now, I'm not going take the underhanded Austrian tack and ridiculously make the crude mischaracterization of Keynesianism by saying that it is irrelevant on what such money is spent; no, au contraire, all such spending will be channeled to paying people to dig holes and fill them back up again, the most productive line of work, thereby also solving our unemployment problem! All those who insist on remaining unemployed after this measure has gone into effect (since of course this measure, like those very unemployed, won't work) will of course, in the collective national interest, be summarily executed as punishment for what amounts to hoarding of present and future unearned income by not allowing such income to come into existence. Daniel, I await your kudos for my brilliant policy idea. Keynes would be proud...
ReplyDeleteIf I hoard onions, is that considered "leeky savings"? What would Keynes's thoughts be on the matter?
ReplyDeleteI'll give you kudos when you write it up and post it.
ReplyDeleteSeriously though - your conceptualization of "liquidity preference" is technically fine, but practically speaking it's useless. Where is your treatment of fluctuations in liquidity preference? Where is your treatment of the relationship between an increase in liquidity preference and a decrease in output from its potential?
You seem to be saying:
1. The minutest expression of liquidity preference causes depressions, and
2. Eliminating all liquidity preference will solve it.
How do you expect me to respond to that?
As for digging holes - I see that as a heuristic device, and if you want to convince me otherwise you can show me a policy proposal where Keynes actually suggested to the British government that as a macroeconomic policy they should hire people to dig holes and fill them up again. If you provide me with that I will relent.
I think "leeky onions" would work... except onions aren't a medium of exchange or a store of value... no matter.
ReplyDeleteI'm wondering, though - did Keynes come up with this "leaking" metaphor or did someone else? I honestly don't know. I don't have a particular problem with it, except that some people get really worked up about "hydraulic Keynesianism", which distracts from the principel that is supposed to be illustrated.
Heuristic devices are pretty useful things for getting you to think about issues from a different angle, until they fall in the hands of dumbass hair-trigger "gotcha" critics. Then a very useful heuristic device can turn into a real stumbling block.
Barbarossa -
ReplyDeleteWhat are your thoughts on the "close substitutes" issue and the liquidity trap?
lol. I know guys like you. You don't like to be challenged, since, you know, you're smarter than everyone else after all, nor do you have any substantive counterargument, so you call me a "dumbass" and then moot quasi-relevant concepts in the hopes that either a.) you can pick a topic with which you're quite comfortable and about which hopefully I am completely ignorant or b.) make the issue as complicated and tangential as possible in the hopes that such obfuscation will be for me a stumbling block. Man, what an intellect worthy of Keynes himself!
ReplyDelete"1. The minutest expression of liquidity preference causes depressions, and
ReplyDelete2. Eliminating all liquidity preference will solve it."
No, I'm implicitly ASKING exactly what expression of liquidity preference DOES cause depressions? And wouldn't, in your view, eliminating all such liquidity preference indeed solve it?:
"What could possible complement liquidity preference right now - what could encourage households and firms to work through their liquidity preference - rather than exascerbate it? Probably some additional aggregate demand, right?"
If I misinterpret you, please let me know.
How do you define "output potential" or "optimal output"? What about opportunity costs? What if such output is unachievable anyway or simply a waste of resources?
ReplyDeletelol. I know guys like you. You don't like to be challenged, since, you know, you're smarter than everyone else after all, nor do you have any substantive counterargument, so you call me a "dumbass" and then moot quasi-relevant concepts
ReplyDeleteWhat are you talking about? Daniel loves to be challenged. In any case, hasn't he offered you a pretty substantial response?
And when did he call you a dumbass? Or are you self-identifying with the "gotcha" tactics he mentions? In that case, I don't see why you're getting all bent out of shape. No need to wilt in the face of disagreement. Just talk with him about where your reasoning differs. Geez.
...like your two responses immediately preceding mine. Those could have done just fine in the absence of the pouting that I quoted.
ReplyDeleteBarbarossa -
ReplyDelete1. I'm fine being challenged - it happens all the time on here. In fact, I have a fairly unsympathetic readership on most issues, and it doesn't stop me from posting what I post.
2. I'm certainly not smarter than anyone else.
3. I never called you a dumbass. I did describe a certain response as a dumbass response. I'm not sure if you engage in that or not. I'm thinking of people who point to "hydraulic Keynesianism" simplifications in textbooks, call that what Keynes said, and summarily dismiss Keynes for it. That is a dumbass way of approaching Keynes. You don't seem to do that here - in fact you specifically say that you avoid the "underhanded" and "crude" mischaracterizations. You do use allusions to Keynes's heuristic devices in your "counter-argument", and you do make what I think is a bad, ineffective counter-argument, but you don't seem to be misunderstanding Keynes in the way that I'm criticizing some people for doing.
4. "make the issue as complicated and tangential as possible" - no, actually I was trying to get your thoughts on what my post was actually about. You clearly seem to have a reasonable (if sarcastic) understanding of liquidity preference, so I thought you might actually have something to say on my thoughts on Cowen.
5. "Man, what an intellect worthy of Keynes himself!" Again, I have to plead innocence of this - but thanks.
"As for digging holes - I see that as a heuristic device, and if you want to convince me otherwise you can show me a policy proposal where Keynes actually suggested to the British government that as a macroeconomic policy they should hire people to dig holes and fill them up again. If you provide me with that I will relent."
ReplyDeleteJust because it is a heuristic device doesn't also mean that Keynes wouldn't approve of its actual implementation or that it doesn't conform to Keynesian theory in general. The fact that it was never implemented or that he never proposed it is irrelevant, since probably even he suspected the ludicrousness of the idea, or at least suspected that even those in government were smart enough to realize such an idea was ludicrous, no matter its "theoretical justification." The point, too, is that other "stimulus" or "make-work" policies are of the same KIND as the digging-holes suggestion and just as useless and detrimental, just much less obviously so.
"If I misinterpret you, please let me know."
ReplyDeleteYou do not misinterpret my solution. The misinterpretation (I think) is twofold:
1. You present liquidity preference as an on-off switch. The slightest hoarding is horrific, according to Keynesians. This removes the progressive relationship between liquidity preference and output from the discussion, and
2. Instead of reducing excessive or unnecessary liquidity preference (which is the Keynesian view), you present the demand augmentation argument as an argument for eliminating every last infintessimal drop of what could technically be called "liquidity preference".
In other words, as with your initial definition of "hoarding" - you're technically fine but you obliterate any useful scaling of the question.
"How do you define "output potential" or "optimal output"? What about opportunity costs? What if such output is unachievable anyway or simply a waste of resources?"
ReplyDeleteIf we think of a free market unencumbered by excessive liquidity preference we can assume that market forces arbitrate those opportunity costs. So a growth trend that we fall short of can be projected from an output growth trend fairly reasonably.
Now - will these opportunity costs be important in government-directed stimulus? Well of course - that's obvious. That's going to affect the size of the multiplier and it's going to be influenced by all the problems with state allocation that we've known about for centuries.
One reason to worry less about this is that there are a lot of externalities and pulic investments out there that aren't being made that we can make without substantial opportunity cost consequences. This often isn't a socialist calculation problem - this is a public investment issue. In other words, we're not generally speaking allocating the stuff that the market has an advantage in allocating.
"Heuristic devices are pretty useful things for getting you to think about issues from a different angle, until they fall in the hands of dumbass hair-trigger 'gotcha' critics." There. This is indisputable. You guys do this all the time on here. You overwhelmingly and obviously imply something insulting in general terms but that is CLEARLY APPLICABLE TO AND INTENDED FOR the specific person in question, leaving you plausible deniability, which you exploit to the utmost. In my satire I was clearly guilty of the crime committed by others which you bemoan, so how could you not have intended it as an insult directed at me, or at the very least, how could you not reasonably assume that I would take it as such? Look, I'm all for being friendly and civil, but you clearly called me a dumbass; there's no two ways about it. So simply fess up to stuff like this, discontinue doing it, and I'll be more than happy to be as polite as possible. And Daniel, it is clear to me, is extremely intelligent and extremely well-versed on virtually every topic on which he chooses to blog, but sometimes he gets a little too big for his britches, and in a way that rubs some (not just me) the wrong way. That's all.
ReplyDelete"And when did he call you a dumbass? Or are you self-identifying with the "gotcha" tactics he mentions?"
ReplyDeleteThe weirdest thing about this is, he made a point of telling us that he doesn't buy (or at least he isn't making) these crude mischaracterizations of Keynes.
This is an "if the shoe fits, wear it" situation. He informs us that the shoe does not fit him, gives no evidence that the shoe fits him, and then accuses me of trying to force the shoe on him!
Either he doesn't understand the concept of an "if the shoe fits" kinds of statements, or perhaps he's got a guilty conscience :)
Daniel, one word: SARCASM. It was perfectly clear that I WAS making the crude mischaracterization of Keynes since my sarcasm had already been established and since immediately subsequent to my denial was another "crude mischaracterization of Keynes" (as you basically admit). Do I give your intelligence too much credit? Generally, no, but in this case it seems so.
ReplyDeleteBarbarossa -
ReplyDeleteThe fact that you presented it with such dripping sarcasm and satire suggested to me just that: that you were satirizing Keynesianism rather than formally defining it. Which is why you didn't strike me as a dumbass at all - perhaps a smartass ;-)
Now, clearly I'm calling some people a "dumbass" for this.
Is that inappropriate of me? I don't know... maybe. Simply "ignorant", "blustery", and "oblivious" might be more accurate than dumbass. But I don't know, when there's enough material out there on what a guy said and one doesn't make any effort to understand it and instead takes a first week of econ 101 summary as the man's entire theoretical framework... I don't know... it's kind of a dumbass thing to say.
Maybe I should be more sensitive - but one thing I can assure you of: you seemed very critical, but aware of nuances of the Keynesian approach. I may consider you "wrong" for that, but I would never consider you a "dumbass" for that.
Most critics of Keynes that comment on here seem to me to have a pretty decent, working sense of what he was trying to say. Some understandings are more sophisticated than others, but very few take the blatantly, willfully ignorant "dumbass" approach I mention here.
I'm sorry, but you blithely sweep under the rug the socialist calculation problem, something which I was about to comment on until you dismissed it. So you're telling me now that the socialist calculation problem DOESN'T apply? Part of the point of liquidity preference is that the market is attempting itself to calculate, and any intervention will either thwart that or otherwise distort such calculations. Again, how does the government know how and what to stimulate?
ReplyDelete"It was perfectly clear that I WAS making the crude mischaracterization of Keynes since my sarcasm had already been established and since immediately subsequent to my denial was another "crude mischaracterization of Keynes" (as you basically admit)."
ReplyDeletePRECISELY. The fact that you recognized it (through your use of irony) as a crude mischaracterization suggested to me you didn't take it to be an "accurate characterization"
"I'm sorry, but you blithely sweep under the rug the socialist calculation problem, something which I was about to comment on until you dismissed it."
ReplyDeleteI've written a lot on this, which might cause me to slip into glossing over things I should clarify more. Let me clarify.
The socialist calculation problem points out that central authorities can't efficiently allocate goods because they don't have recourse to the price mechanism and the incentives implicit in property rights. For the most part, though, stimulus is spent on things for which there is no recourse to this stuff anyway - for public or private actors. Socialist calculations are problematic from an allocation standpoint. They don't really speak to an aggregate output question, as far as I can tell.
None of this is to say that the state has any perfect knowledge of appropriate aggregate output levels - I never claimed that. Insofar as that is a "socialist calculation problem", then the problem still applies. The point is, the state is in no worse a position than the market on this point - and in the most common forms of stimulus (public investment type stuff), the state is in no worse a position than markets either.
In other words - a Keynesian planner isn't facing the same problems that a central planner at Gosplan faces. Keynesian planners don't make allocation decisions, which is the heart of the SCD problem. To the extent that they do, it's on public investments and benefit payments - not exactly the sort of thing that the SCD would suggest the market has an advantage in allocating anyway.
"Part of the point of liquidity preference is that the market is attempting itself to calculate, and any intervention will either thwart that or otherwise distort such calculations."
ReplyDeleteI'm not so sure about this - could you elaborate?
I see liquidity preference as having more to do with human fear and uncertainty and the fact that we're mortals enmeshed in uni-directional time. I don't think it really has much of anything to do with calculations.
Granted - liquidity preference enters into other calculations, but it is no more a calculation itself than any other preference is. The difference is, other preferences are "legitimate" in ways we may think that liquidity preference may not be.
"If we think of a free market unencumbered by excessive liquidity preference we can assume that market forces arbitrate those opportunity costs. So a growth trend that we fall short of can be projected from an output growth trend fairly reasonably." Again, the assumption (which I would like you to explain) that liquidity preference is an "encumbrance" (which obviously implies that you consider it a cause and not a symptom). But what you're also saying is that, from a NECESSARILY incomplete and unknowably relevant set of statistical data, we can derive an equation that gives the optimal growth rate, which we can then target through stimulus. EVEN IF you could theoretically achieve this, and EVEN IF you could theoretically perfectly implement it, the fact of the matter is that this "underlying growth equation" for the market is itself CONSTANTLY CHANGING, not simply as a growth percentage, but as the very KIND of function "driving" it. Ultimately, let's go back to Hayek: Because RELEVANT CAUSAL FACTORS that aren't quantifiable are disregarded, and then quantifiable factors (however imperfectly accounted for) are exclusively considered, and then formulations and policy prescriptions are then derived from such data, such policies and their underlying assumptions and conclusions MUST NECESSARILY be both imperfect and, well, wrong. Like that whole thing about blind men touching different parts of an elephant.
ReplyDeleteAgain, define "legitimate" preferences and where one draws (or could know to draw) the line. That's part of my whole point.
ReplyDelete"I see liquidity preference as having more to do with human fear and uncertainty and the fact that we're mortals enmeshed in uni-directional time. I don't think it really has much of anything to do with calculations." Fear and uncertainty are part and parcel of calculation. If there were no fear or uncertainty, calculation would be perfect and easy, or rather, unnecessary. Do not fear and uncertainty also plague, to some degree, smart entrepreneurs in good times?
How is Keynesianism not central planning? Federal Reserve: check. Arbitrary government borrowing/spending (forced onto the market): check.
ReplyDeleteAs for "legitimate" - note I crammed that clause with not one but two "may"s because, as you point out, it's a pretty vague point.
ReplyDeleteBoth fear of the unknown and love of widgets are psychological to a certain extent. Who's to contradict them, right? To that extent I agree with you - liquidity preference may be considered "legitimate". But just as a kid's fear of the dark is unwarranted, presumably some of the fear and uncertainty we exhibit is unwarranted. That's the only point. Where do we draw the line? How the hell would I know? I'll worry more about that question when macroeconomic management becomes so sophisticated and energetic that it begins to threaten the very practice of precautionary savings.
"(which obviously implies that you consider it a cause and not a symptom)."
Actually it's probably both - Hayek's secondary depression and all that.
"such policies and their underlying assumptions and conclusions MUST NECESSARILY be both imperfect and, well, wrong."
Well sure - you'll find no argument from me on that. I regularly post on here about the problems with macroeconomic econometrics - feel free to look back at what I've written on it. I'd personally rather be roughly right than precisely wrong, though.
"How is Keynesianism not central planning?"
ReplyDeleteUmmm... I never said it wasn't.
It is central planning, of a sort. What I said was that Keynesian planners are not central planners in the sense that central planners at Gosplan are.
Gosplan planners made decisions about production and allocation that the market was unequivocally better at making.
Keynesian planners, to the extent that they exist, make decisions that the market cannot make on its own, and which the planners themselves obviously make imperfectly. They don't address decisions that the market clearly is better at making.
OK - a well spent lunch break, but I have to get back to work.
ReplyDelete"Keynesian planners don't make allocation decisions, which is the heart of the SCD problem. To the extent that they do, it's on public investments and benefit payments - not exactly the sort of thing that the SCD would suggest the market has an advantage in allocating anyway."
ReplyDeleteHow is public "investment" NOT an allocation decision? Or redistributive benefits payments? If "public investment" has no market signals, how can it be considered "investment"? Like Mises said, it's a "shot in the dark." And why doesn't the market have an advantage in these so-called "public investments" and "benefits payments"?
"The point is, the state is in no worse a position than the market on this point - and in the most common forms of stimulus (public investment type stuff), the state is in no worse a position than markets either."
How is the state in no worse a position? I know I'm asking a lot of questions, but I think the burden of proof is on you to prove your assertions. Is it in no worse a position because it can calculate better?
"The socialist calculation problem points out that central authorities can't efficiently allocate goods because they don't have recourse to the price mechanism and the incentives implicit in property rights. For the most part, though, stimulus is spent on things for which there is no recourse to this stuff anyway - for public or private actors. Socialist calculations are problematic from an allocation standpoint. They don't really speak to an aggregate output question, as far as I can tell." How is this NOT all linked? And if it's not an allocation problem, why wouldn't digging ditches help?
"How is public "investment" NOT an allocation decision?"
ReplyDeleteOK, now this is veering into dumbass territory :)
I said in this case it IS an allocation decision. My point, though, is that it is not an allocation decision where SCD suggests the market is all that much better equipped at dealing with.
Unlike Gosplan, which got its hands in precisely the decisions that that the market was best at dealing with.
Click on my "externalities" tag or my "calculation vs. incentives" tag and you'll see my case for why the SCD logic suggests that there are some goods where the government isn't at a disadvantage and (barring standard public choice concerns) may even have an advantage in supplying.
This is not the same as saying traditional central planning works or that the Hayek position in the SCD was wrong. Hayek was absolutely right - the logic is just often misapplied, in my view.
What we need is Hayek's insights, directed to problems by Pigou, caveated and qualified by Coase.
P.S. - the smile indicates that "dumbass territory" was meant playfully - don't worry.
ReplyDelete"But just as a kid's fear of the dark is unwarranted, presumably some of the fear and uncertainty we exhibit is unwarranted. That's the only point. Where do we draw the line? How the hell would I know? I'll worry more about that question when macroeconomic management becomes so sophisticated and energetic that it begins to threaten the very practice of precautionary savings." The kid is being "irrational" only in a relative sense, since we have more certainty about the dark as adults than the kid does. But that's the point. That's assuming that the government is the adult and wouldn't be just like the kid, or even worse. And again, we're assuming such stimulus and what have you will have no distorting/disrupting effect on the market. The stimulus doesn't exist in a vacuum. It can (and does) affect the market in such a way as to be self-defeating. It's a Chinese finger trap (obviously not an argument, just trying to find, even for myself, good--or not so good--analogies to use). Yeah, I should stop farting around and look for a job. But this ain't over, no Sir.
ReplyDelete"And again, we're assuming such stimulus and what have you will have no distorting/disrupting effect on the market."
ReplyDeleteWe are most definitely not assuming this.
No, I got your point, if overemphasizing another, although I still think that you can't compartmentalize quite so easily. And I simply don't buy the existence of things in which the government can have a knowable advantage, but I will admit that I am far from expert on externalities and public goods, two things which have often cast a little doubt on some of my other assumptions, so I will defer to your expertise and read your posts on the matter and perhaps respond later. Again, "suggesting" that government is "not at a disadvantage" and "may" be at an advantage is wording that I think supports my point, since it seems at best that government can be just as good as the market (rendering it unnecessary), with a dubious outside chance that it could be better, and a more than outside chance that it could be worse. There's no doubt that the government "could" do something better and DID do something better historically than the market, from the point of view of an omniscient being, but from the point of view of the rest of us fallible creatures of limited knowledge, "best" is left up to the second-best optimizer (next to the omniscient guy), the market. And of course, there's the assumption that the government will spend it precisely on these things. Anyway, I could be way off the market, so I'll read your stuff.
ReplyDelete