You might check out
Saturday's
episode of Weekend All Things Considered on NPR. It is a good example
of how a popular discussion of economics can easily miss what is right
under its nose, solely because it lacks an adequate informative
argument. One way to understand a thesis statement is as an answer to
the question: "What is the reality of X"? That's a different question
from "tell me what you think about X" or "what are the facts about X"?
There was nothing necessarily inaccurate, factually speaking, about what
they were saying on this broadcast. It is their argument, their answer
to the reality question, that ends up creating a highly misleading
picture.
What we need is a different informative
argument, that is, a different way of framing what is important about
this issue. And with that, I present to you my own brief informative
argument:
At one point in the NPR broadcast, the
reporter says something to the effect of "why aren't economists
providing us with answers about how to get out of the crisis"? But we
know from our readings that they are--it's simply that the people asking
such questions don't seem actually to want to hear the answers; they
just want to keep asking the question. The reporters were continually
framing monetary policy in terms of affecting interest rates, but they
also noted that even in normal times, this is not a very good account of
how to understand what the Fed does.
Of course, you
already know that the statement "economists don't really understand why
using interest rates works in ordinary times" is inaccurate. Our
monetarists would already argue that it works because the Fed is
actually increasing NGDP, and that interest rates are a secondary effect
not really worth paying attention to. Our Keynesians would argue that
it works because it changes inflation. Our moderate Marxists (think Joan
Robinson) would argue, in a way that is not dissimilar to the
Keynesians, that it reduces the hoarding of financial assets and money,
and that in turn constitutes a sign to the capitalists that they will
miss out on profiting from the coming boom if they don't start investing
and hiring. Our radical Marxists would argue that the real problem is
the use of money, and so instead of reducing the hoarding of money, they
would say we should just move to a barter economy. The last
prescription is a bit absurd, but notice that in terms of its
explanation of the crisis, it is actually more accurate than the
standard "the Fed only has one tool--raising and lowering interest
rates" type of explanation. And unlike the interest rate story, all of
the other arguments actually apply to the current situation, when
interest rates on safe investments are already quite low.
The
problem with the interest rate story is that the Fed's real goal is to
lower the price of money, not to lower the price of borrowing money
(credit). The first is akin to buying a house, the second is akin to renting one--the two are different markets which have a connection to each other, but it is not hard and fast (right now, rental prices for houses and apartments are shooting up even as home prices are continuing to fall). To achieve the goal of lowering the price of money, the Fed tries to get more money into
circulation. But they cannot just give it away, as they would quickly
lose all control over the supply and therefore the price of money. They
need a way to signal that they can withdraw the newly created money at a
moment's notice if the price of money starts dropping too quickly (more
on this below). So what they do is buy government bonds, in effect
making a loan to a very safe borrower--the government. That means that
there is almost no risk that they won't be able to sell the bonds to
someone else in the future at around the same price, and thus maintain
control over the supply of money.
In normal times, buying
government bonds increases the supply of safe credit, which in turn
lowers its price. However, the most important effect of this is to
increase the supply of money in circulation and to lower its price as
safe borrowers begin to borrow more and thus to spend more. In effect,
people are now "selling" a lot more money, thus lowering its price. In
the current situation, however, loaning money to safe borrowers like the
government does not lead to a growth in the supply of money in
circulation. As we see in the case of the government, they are already
taking advantage of low rates by borrowing a great deal, and thus are
reluctant to borrow much more. This is because the price of safe credit
is already extremely low, and cannot go much lower. Crucially, it cannot
go negative--although who knows if the Congress would approve new
borrowing even if the rate went negative (indeed, the inflation adjusted
returns on some forms of government debt is already slightly
negative). So there is already more than enough credit available for
safe borrowers, and indeed those who lend out money to them are just holding on to dollars as a store of value, not as something that they could loan out to borrowers who want to spend or invest.
One part of the problem is that the bad economy
makes it so that there are far fewer safe borrowers, and so a very big
increase in the amount of money loaned to safe borrowers leads to a very
small increase in the supply of money in circulation. This is the
phenomenon of hoarding--what the Keynesians call "the liquidity trap"
and monetarists call "an excess demand for money." At this point, the
interest story makes even less sense, because the real problem is that
safe borrowers are not spending. First of all, there are far fewer of
them due to the bad economy caused by the high price of money. Secondly,
those few genuine safe borrowers know that the economy is bad because
of the high price of money (which is different from the price of
borrowing money--credit) and so they are reluctant to take on more debt,
in case the price of money starts increasing again. If they knew that
the price of money would fall, they would probably reconsider their
decision. However, they need to hear this directly from the government.
The Fed needs to come straight out and tell everyone that they want to
lower the price of money. They are not saying this. The result is that
high unemployment continues, because the price of money is not dropping.
We know that a recession is actually a pretty simple
process. Money is a commodity not unlike gas. Gas is a necessity for
almost all market transactions. Money is a necessity for all economic
transactions. If suddenly the price of both goes way up (as happened in
2008), then people will have a hard time conducting business. That will
put many people out of business. A recession happens.
The
hard part of understanding this simple phenomenon is to imagine a
notion like "the price of money." The price of a necessary commodity
like gas is easy to measure: in terms of money. But how then do we
measure the "price" of money? Well, we want to measure whether it is
becoming easier or harder to turn one's labor into money. Monetarists
measure this using NGDP growth rates. Keynesians measure this with the
concept of inflation. Moderate Marxists use the concepts of unemployment and real incomes--whether or not people can find jobs and whether they can buy more things with their salaries after deducting the costs of servicing their debts.
Now obviously, we would want the
price of gas to be as low as can be. There's no limit to how low we
would want it to go. The reason for this is that sudden increases in
prices of necessary goods not accompanied by sudden increases in wages
mean that we have fewer resources at our disposal to buy things with.
Rising prices but stagnant wages = :(
The same is
basically true of money, with an additional caveat. In the case of gas,
big increases in price are generally bad, and big decreases are
generally good. Money, however, serves a very different function, and
thus changes in its price work somewhat differently. It is still
generally true that prices going down is better than prices going up.
However, the strange thing is that even small increases in its price are
very, very bad, while small decreases are good. However, big decreases
can also be pretty bad, although perhaps not as bad as big increases.
The reason for this odd asymmetry can be traced back to Hobbes and
social contract theory. The function of money is to bring a kind of
sovereign order to economic interaction. It allows us to measure the
value of goods and services, and it allows us to make contracts, such as
employment contracts, using a common measure of value. But there are
many instances in which we don't build inflation into a contract.
One
example is a mortgage. When we take out a loan, we have to pay back a
fixed amount of money over time, and this is not adjusted for inflation
or deflation. If deflation occurs--if the price of money rises--then, in
a sense, the home buyer now must sell his money to the bank at the
original price (a home of a certain size and value) even though it is
now worth more (i.e., would buy a bigger or nicer house). This may seem
selfish; however, the home buyer turns around and acts in just the same
fashion. Because the money the worker owes is worth more, she wants to
ensure that her employer does not lower her wages. In effect, she wants
to keep the employer selling her money at the cheaper price; or to put
it another way, she wants to keep the employer paying more for her
labor, not in fixed dollar terms, but in inflation adjusted terms. This
is because informal employment contracts generally do not adjust for the
price of money--for inflation. If every worker would agree to sell his
or her labor for money at the original price, there would be no problem.
But because the worker is being squeezed by the bank and the credit
card company, she cannot do this. So in turn, the employer has to choose
which employees to keep on the payroll. They have to fire some workers.
One result is an increase in productivity, as suddenly one worker is
doing the job of all the fired employees. This is exactly what happened
during the recent slump. And this is why even small increases in the
price of money, i.e. deflation, is very, very bad.
Small
decreases in the price of money, however, don't have this effect. If
prices in general are going up, employers can simply charge more, and
use this to pay their workers more, while their debts actually stay the
same--so their real (inflation adjusted) income actually goes up. If
prices in general are going down, then employers have to charge less,
but they cannot pay less on debts that aren't inflation indexed, and
they cannot pay less to workers, because the workers in turn are stuck
in the same situation, unable to renegotiate their debts. So they lay
people off, which then leads to another round of the same problem. This
is why slight unexpected increases in inflation have a positive effect.
Most people are debtors rather than creditors, so most people experience
an increase in real wages during mild inflation because their debt
burdens go down as their wages or incomes go up. The only downside is
that there may be a slight lag between when prices rise and when a
worker or business can increase their wages or prices. But this will
eventually be made up by lowering debt burdens. With deflation, not only
do businesses have to lower prices, but their debt burden goes up, and
to make matters worse, they have a hard time lowering their employees
salaries. In general, then, as with gas or other commodities, it is good
for the price of money to go down and bad for it to go up. The only
exception were if the price of money were dropping so fast that we could
not count on it to retain the vast majority of its value in the very
short run, say within the period of a few months, a few weeks, or even
in extreme cases, a few days or hours (hyperinflation). This would be
bad, because people would be reluctant to accept money, and we would
return to some of the inefficiencies of a barter economy. It would
become harder to save and to invest, and people would start to be hurt
more and more by the lag between the increase in the prices they pay and
the wages they receive. As long as that lag does not present a significant risk, then inflation is running at an acceptable level.
As you can see, there is no real mystery about
recessions. Economists can explain them to those who will listen. And
the explanation is simple. Recessions have to do with the price of a
specific asset of prime importance--money. The ideal case is for the
price of money, this one very special asset that alone has the property
of being necessary to conduct any economic transaction whatsoever, to be
falling at a steady and predictable rate. If it increases in value,
businesses may pay lower prices, but they will also have less money to
pay back their debts and pay their workers. As a result, real incomes go
down. On the whole more people are losing than gaining, and this is
detrimental to the overall health of the economy. This leads to a
pessimistic outlook, which in turn further depresses spending and
therefore prices. In the case of increases in prices, employers can pass
on price increases to balance out their own increasing costs while
their debt burdens stay the same. As a result, real incomes go up. Thus
individuals and businesses have more money, and they also do not have to
pay more to service their debt, which balances out the fact that they
may have to pay higher prices. On the whole, more people are gaining
rather than losing, and as most feel they have a slight advantage in
this situation, they feel more confident, which in turn leads to more
economic activity.
In monetarist terms: recessions occur because of a fall in NGDP, which leads to falling real incomes.
In Keynesian terms: recessions occur because of deflation, which increases debt burdens and lowers real incomes.
In
Marxist terms (also similar to Keynesian terms): recessions occur
because the creditor class attempts to benefit at the expense of the
debtor class, which harms the overall economy.
In my terms: recessions happen because people have the wrong thesis statements about economic policy.
