Believe those who are seeking the truth. Doubt those who find it. Andre Gide


Thursday, July 15, 2010

A Comment on: Lincoln, McClellan, and Stimulus

Paul Krugman writes:

There’s now a lot of talk about the fact that U.S. corporations are sitting on a lot of cash, but not spending it. I don’t find that particularly puzzling: with huge excess capacity, why invest in building even more capacity. But almost everyone seems to agree that if we could somehow get businesses to spend some of that cash, it would create jobs.


Which then raises the question: how can you believe that, and not also believe that if the U.S. government were to borrow some of the cash corporations aren’t spending, and spend it on, say, public works, this would also create jobs? (Brad DeLong has tried to make this argument repeatedly).
...
I have never seen a coherent objection to this line of argument.


Let me take a crack at this.

The key question, in my view, concerns the reason(s) for why firms appear reluctant to undertake new capital projects. If I understand the Krugman and DeLong worldview correctly, firms are reluctant to spend because they fear that future demand for their products will fail to show up. Their collective fear somehow becomes a self-fulfilling prophesy. Because firms fail to invest, they fail to hire workers, and hence, workers fail to generate income--the income that would have been necessary to purchase the added future production. Something like this (I welcome clarifications).

There may be an element of truth to this. But there may be other reasons underlying the collapse in investment spending. And, as usual, different interpretations may lead to very different policy implications.

There is no question that firms appear "fearful" of investing. The question, I think, is whether this fear is rooted in fundamentals, or whether it is simply a byproduct of market psychology. I see several good fundamental reasons for being afraid to invest.

First, there has been a massive overinvestment in residential capital (largely a byproduct of government policy) and this needs to be worked off. The same likely holds true for other forms of business capital. In short, it is simply not a good time to invest. Additional investment may employ more people, but this is just throwing good money after bad (some people gain in the short-run, but society loses on net).

Second, in addition to being scaled back, employed resources need to be reallocated to their most productive uses. Workers may have to change locations or professions (or both), idle capital needs to be matched with new owner/operators, etc. This is a process that takes time. It is not clear why the government should have to interfere with this adjustment process (it should, if anything, encourage it).

Third, there is currently a high degree of uncertainty over the path of future government policies. I am not sure that I, as an employer, would want to make the commitment to hire a new worker not knowing what the future payroll tax will be, or what health care costs may be. The Krugman and DeLong tonic seems to be that government spending is needed because the government--unlike the business sector--is not afraid of the effect of its future policies on the business sector's income/balance sheet statements. Hmm...OK (I think).

Note that I am not necessarily against the idea of new public works in the current environment (in fact, I think one could make a very good case for it).  I think that proper NPV calculations should be used to judge whether individual government projects should go forward or not (just like any other investment project). Instead of carefully worked out NPV calculations for specific projects, Krugman and DeLong want to cite studies of huge fiscal spending multipliers which assure that any government spending will have huge returns to society (not just those employed in the works). Is this simply the product of wishful (and lazy) thinking? Let's get serious, people.

Krugman and DeLong write as if they think that the goal of society is simply to create jobs. I am reminded of  a news column I read from the Soviet news agency (Tass), written in 1957, which stated (in translation): "The unemployment in the USSR is currently zero percent, as it has been for the last two decades." I am not sure that shipping idle workers to Siberia and forcing them to stuff cotton balls in empty aspirin bottles was the best use of that economy's workforce, but it certainly had the effect of miminizing unemployment. Clearly, there is more to the resource allocation problem than simply creating jobs.

I have never seen a coherent objection to this line of argument.

17 comments:

  1. Good comments. The first and third points you raise are probably critical for understanding the current situation. The third in particular may explain the current high profit/low investment phenomenon. In this regard, it is always useful to find out what business-owners have to say. Here's a good example: http://www.coyoteblog.com/coyote_blog/2010/07/same-here.html

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  2. David,

    I agree with your points here. Moderate cash hoarding did start prior to the recession, though. It seems that operating risk (volatility of quarterly operating profits) had started to pick up prior to the housing bubble bursting. Now, of course, cash balances are a great deal higher. I think point #3 is key. As Bob Higgs would call it, regime uncertainty.

    Also, it's interesting that all your discussion about the adjustments that need to be made after the boom busts are basically the Mises/Hayek story. The question, I guess, is why do people not learn these lessons?

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  4. The question posed by Krugman is not whether businesses have good reasons for being fearful of investing. (As he says, it's not particularly puzzling.) The question is, how can you believe that private-sector spending will boost GDP and not believe that public-sector spending will do so? I'm not saying you hold those seemingly contradictory beliefs, but lots of commentators do. Krugman's question is addressed to them. Your answer might be interesting too, but this post is unresponsive.

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  5. I see your point, but I think you stretch it a little bit when you say that the krugman-delong point of view -- that any spending can be beneficial -- is a product of wishful and lazy thinking. Although you might not agree with it or see it the same way as krugman-delong do, there is an extensive amount of research an evidence regarding spending multipliers, so its not like these guys are pulling things out of thin air. In fact, I would guess that the evidence and research concerning general fiscal multipliers is far more extensive and persuasive than whatever evidence there is for the real-factors arguments you give. Although the stories of skills-mismatch and uncertainty over tax and regulatory policy are alluring, I think the evidence for these arguments is far weaker than their appeal is.

    There is more to it than simply creating jobs, but creating jobs is certainly a big part of it. Work cannot be stockpiled, so each day we lose real output when people are unemployed. This is not to mention the enormous societal costs of unemployment, something which is well documented in the non-economics literature. We don't want peveryone stuffing cotton into aspirin bottles, but at the same time we don't want the skill atrophy and the higher crime, alcoholism, family breakup, and suicide rates associated with unemployment either. If the NPV calculations you suggest incorporate all of these real effects of unemployment, then I am all for such a measure.

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  6. DS,

    I hope David doesn't mind that I make some responses here.

    The fiscal multiplier literature is filled to the brim with papers find multipliers everywhere from insignificantly different from zero all the way up to 3x spending. Research design is very important here, and so is capturing the surrounding economic conditions. Also, the source of fiscal stimulus (borrowing v. tax v. seignorage) is not typically modeled, from the papers I've seen. Moreover, many papers show the importance of "tax stimulus," or permanent reductions in marginal tax rates. Actually, the Romers have one out or forthcoming in the AER on this issue. Very interesting work. But anyway, the "science," if you will, is far from settled. Despite declarations from the pulpit.

    As for why business investment is dissimilar to government spending, well, the source of funds is of primary interest. Businesses have two sources: internal and external. Internal is stockpiled retained earnings, usually held as cash, and short-term and long-term investments. External money is raised either through debt or equity issuance. In order to place their securities, they have to convince people that returns will be sufficiently high for the risk borne. In other words, all business investment has carefully thought through the opportunity cost issue, and the investors have done likewise. So it's a voluntary tradeoff that I expect will garner some returns in the future. Short-term pain, long-term gain.

    Government spending has only one source of funds: external. Had the government been running surpluses for some time now and built up a savings account, then they might have internal money - although this is politically unfeasible. Now, fiscal stimulus is typically financed through borrowing. But note this reverses the order of business investing: the government wants to ease short-term pain by moving it into the long-term. Now, if debt and deficit levels were low enough to see an easy pay off in the future, I would imagine that this would not be much of an issue. But that isn't the case.

    So, the character of spending differs not only because of the decision making process, but because of the source of funds. This is an important issue, in my estimation, because it affects our expectations regarding future costs for all households and businesses in the country.

    I understand your concerns regarding unemployment. I see that a good case for government spending to ease transitions - job training, short-term help for those whose jobs have been phased out, never to return, and the like. But the stimulus concocted by the feds isn't about that. If you see Veronique de Rugy's research at the Mercatus Center, you'll see that politics has more to do with receipt of stimulus moneys than need. So even if fiscal multipliers had historically been greater than one, that wouldn't necessarily apply here because of how the stimulus moneys have been deployed.

    Finally, if government spending locks people into place and prevents the painful readjustment or prolongs the delaying period, it will be even more costly in the long run for those families it was designed to help. Maybe somebody who started framing houses during the boom shouldn't be a house framer anymore. To the extent unemployment benefits keep that person from finding other work, this is a net cost, not a net benefit. I know people like to be comfortable and not change to much. But it is not the world we live in.

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  7. Fernando: thanks, very interesting.

    Kevin: technically, you are correct. But you know as well as I where Krugman is headed with this line of enquiry, and it was this more substantive issue I wanted to address.

    DS: I am told that unemployment, as a concept, did not exist prior to the 19th century (evidently, Adam Smith never mentioned the phenomenon). The social ills you document have been with humankind since well before there were unemployed people. So it is not clear that policies directed to the unemployed are desirable per se. It might be better to target a broader class of people, including the working poor.

    Prof J: thanks for the brilliant assist!

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  8. Interesting post but if I may address some points.


    " If I understand the Krugman and DeLong worldview correctly, firms are reluctant to spend because they fear that future demand for their products will fail to show up."

    There is no PRESENT demand for their products so its completely rational to wonder where the future demand will come from.

    "First, there has been a massive overinvestment in residential capital (largely a byproduct of government policy) and this needs to be worked off."

    Please, there are plenty of reasons why people invested in houses; everyone needs a place to live, lots of people have invested their lives in selling houses and building houses....... and these would have been present with or without govt policies


    "The same likely holds true for other forms of business capital. In short, it is simply not a good time to invest"

    Depends, its a great time to invest in alternative energy solutions and improved mass transportation.


    " Additional investment may employ more people, but this is just throwing good money after bad (some people gain in the short-run, but society loses on net)."

    This is a specious argument. Every investment decision, even privately made ones can have the same tradeoffs. Private decisions can be throwing good money after bad as well.



    "Second, in addition to being scaled back, employed resources need to be reallocated to their most productive uses. Workers may have to change locations or professions (or both), idle capital needs to be matched with new owner/operators, etc. This is a process that takes time. It is not clear why the government should have to interfere with this adjustment process (it should, if anything, encourage it)"

    Why do employed resources need to be "scaled back"? Reallocated to new productive uses yes I agree but the scaling back? Why is that necessary. And yes the process takes time and its been over two years. How long must we wait for private interests to step up?

    "Third, there is currently a high degree of uncertainty over the path of future government policies. I am not sure that I, as an employer, would want to make the commitment to hire a new worker not knowing what the future payroll tax will be, or what health care costs may be."

    There is always uncertainty, if not your fooling yourself. Health care costs? Have they ever been KNOWN with more certainty than today?


    "Krugman and DeLong write as if they think that the goal of society is simply to create jobs."

    Ummmmmm as long as $US are required to pay taxes and purchase goods and as long as the USgovt has the will and way to enforce legal tender laws and tax collection, and as long the only way to get $US is to work, then yes the goal of the society (of which govt is a part) is to create jobs.

    " I am reminded of a news column I read from the Soviet news agency (Tass), written in 1957, which stated (in translation): "The unemployment in the USSR is currently zero percent, as it has been for the last two decades." I am not sure that shipping idle workers to Siberia and forcing them to stuff cotton balls in empty aspirin bottles was the best use of that economy's workforce, but it certainly had the effect of miminizing unemployment. Clearly, there is more to the resource allocation problem than simply creating jobs."


    No one here is advocating a Soviet style system, so please, no need to go there. You are correct that there is more to resource allocation than creating jobs .......and there is more to economics than money, but try to get someone to be productive without money. Tell me how to allocate resources without work tell me how to do work without creating a job. And not all jobs, even in the private sector are about resource allocation.

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  9. GBGasser: Good comments. Let me address a few of them here.

    What I meant was that the present demand for investment depends on the forecasted demand for future output. In any case, I'm not sure that I have their argument down precisely. Partly, this is because they are not in a habit of formalizing their thoughts (and when they do, the underlying friction is a sticky nominal price, which I hardly find compelling).

    Yep, I agree, there are plenty of reasons why people invested in houses. Not sure that they were great reasons (they could have rented instead). And while government subsidies, both direct and indirect, may not be the entire story, I believe they played a significant role. I admit, however, that I can't quantify it.

    Scaling back is necessary to remedy the overproduction. When I was a construction worker, I was laid off in the recession of 1981. Even back then I could see that too many homes had been built too quickly (in Vancouver at the time). How long must we wait? Until private interests see positive NPV projects worth exploiting. There is no God-rule which states that there must always be a constant level of investment. Is there?

    I disagree with you: it is not the job of society to create jobs. The job of society is to create an environment where people are free to pursue their interests, for the benefit of themselves, their families, their friends, and society at large. Among other things, this may mean staying home with the kids or going to school. Who are we to judge what is best for individuals?

    I didn't mean to imply that anyone was advocating a Soviet style system (even if Obama is appointing a new Czars every day). The point was simply to drive home the fact we should not confuse the employment rate (or unemployment rate) with any sensible measure of social welfare. The level and distribution of (broadly defined) consumption is a better measure. Focussing on unemployment is misleading. Among other things, it hides the plight of the working poor.

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  10. GBGasser:

    See here for how the government skewed housing incentives: http://mercatus.org/publication/gambling-other-peoples-money

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  11. Thanks for the response David

    I guess my real point about the govt and housing is this; Its very easy to blame govt policy but very hard to pick any one policy that one can say "If we didnt have this..... ". Govts influence on the housing market was not opaque, all the incentives were known and of all people, those who contend that markets adjust to all known information efficiently (not sure that's you, but most of those yelling the loudest about the govt influence are of this mindset) are being disingenuous. When the "market" misses the mark, it is not by default the govts fault, but this is the easy fallback for too many and I'm not convinced. I think this is lazy.

    I'm not sure why scaling back is a necessary response to over production? This over production only emerged after demand was killed with all the layoffs. Now in the housing sector yes, but economy wide, in aggregate, scaling back is not the right response.
    All scaling back is going to accomplish is more income loss, more defaults, more bank failures.....

    "I disagree with you: it is not the job of society to create jobs. The job of society is to create an environment where people are free to pursue their interests, for the benefit of themselves, their families, their friends, and society at large."


    Let me rephrase this. I think anyone who wishes to work should have a job provided somewhere. If the private sector has no need the public sector needs to step in. Denying access to the currency which you require for tax payment and which is necessary to access all goods and services in your currency area should be considered a violation of a fundamental right.

    "we should not confuse the employment rate (or unemployment rate) with any sensible measure of social welfare. The level and distribution of (broadly defined) consumption is a better measure. Focussing on unemployment is misleading. Among other things, it hides the plight of the working poor.

    It is not the sole measure of social welfare to be sure and I agree about overall unemployment being misleading but involuntary unemployment is NOT misleading. When that is too high there is trouble.

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  12. How did my identity change between the two posts? Strange

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  13. Hi Greg:

    Well, I suppose that we'll have to agree to disagree on a couple of matters.

    You are right that it is difficult to pinpoint any one government policy. And I am by no means suggesting that the private sector should be absolved.

    "I think that anyone who wishes to work should have a job provided somewhere...Denying [this to people] should be considered a violation of a fundamental right."

    Now here's one place where we see things very differently. My own view is that, first of all, anyone who wants to work (and I mean, really want to work), already has many job opportunities available out there -- somewhere. They may not be the greatest paying jobs in the world, but they are jobs -- something to get your foot in the door, the way my old man did when he immigrated to Canada from Italy as a poor, illiterate, and uneducated peasant. I cannot believe the opportunities today are any less they were in 1955.

    Second, since when is it a fundamental right to be granted a job? When the Pilgrims landed at Plymouth Rock, did they immediately demand job rights? Is it written in the Constitution? And whose rights in society might be violated if the government taxes some to finance the job for another? It's a tricky question.

    As for involuntary unemployment, I'm not exactly sure what you mean. Unemployment is not involuntary in the sense that everyone is free to work at odd jobs or drop out of the labor force. On the other hand, unemployment may be a state chosen by a person following an involuntary change in personal circumstances. I think that this is what you mean. And I agree that it would be desirable for policy, if it is to do anything, to facilitate the transistion out of unemployment. So I guess we don't disagree on everything! :)

    PS. And by the way, don't forget about involuntary employment (those who are compelled by personal circumstances to work, rather than spending time at home, for example, looking after the kids).

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  14. Thanks again David for an interesting discussion

    I still have a couple more responses and questions?

    " My own view is that, first of all, anyone who wants to work (and I mean, really want to work), already has many job opportunities available out there -- somewhere."

    To what do you attribute this view? There are something like 6 applicants for every available job(private sector) according to the latest stats.

    "They may not be the greatest paying jobs in the world, but they are jobs -- something to get your foot in the door, the way my old man did when he immigrated to Canada from Italy as a poor, illiterate, and uneducated peasant. I cannot believe the opportunities today are any less they were in 1955."


    Why do you find that hard to believe? Many businesses are getting by with fewer employees. The problem is that in an effort to keep stock prices boosted companies have viewed employees more as costs and less as assets. Bottom lines are staying as businesses cut costs but does any one really believe that this can continue? Will cutting the labor force to zero put profits at infinity? The whole business model is totally fucked up. Why even embark on unsustainable paths. What I think gets missed by too many businesses is that your employee is someone elses customer and his employee is your customer. A cutting labor cost strategy is classic fallacy of composition that cannot work economy wide.

    "Second, since when is it a fundamental right to be granted a job? When the Pilgrims landed at Plymouth Rock, did they immediately demand job rights? Is it written in the Constitution? And whose rights in society might be violated if the government taxes some to finance the job for another? It's a tricky question."


    SInce when is it a fundamental right to own property? It was granted via political process to make it so, but there is nothing "fundamental" about it.

    The pilgrims came to a land that was not under a single currency either. Money then was not what it is today. I'm not sure "what the pilgrims demanded" is the right metric.

    I'm not arguing that a job is a constitutional or a god given right (whatever the heck a god given right is), I'm simply arguing that it makes good sense for a consumer economy to not have large swings in purchasing power in aggregate. This is why unemployment insurance acts as a floor under aggregate demand. Do you think we would have had more bank failures, more unemployment, more defaults and more social unrest if everyone who lost jobs the last two years went from whatever income they were receiving to zero?

    I would suggest you consider the idea that in fact the govt never has to tax one person to finance a job for someone else. That is a fallacy that has been perpetuated for decades. Its not a zero sum game in that manner.

    Involuntary unemployment just means people who wish to work but cant find it . There are lots of those now.

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  15. Greg:

    I think that I understand where you're coming from now (at least a little bit better). Maybe we are not as far apart as I imagined. Let's continue with the discussion (it would be great to do this over beer one day). Let me first provide a few answers to your question, and then try for reconciliation.

    To what do I attribute my view that jobs are not scarce? Mainly, my own experience working as a young lad at odd jobs followed by a fairly lengthy spell in the construction sector. My reading of history (4000BC - 1800AD) is another source. It is clear that our ancestors were wanting *leisure*, not labor. Work has never been scarce.

    Of course, what may be scarce are jobs that pay high wages and are, at the same time, a fun way to pass time (like my job). High paying auto sector jobs may be scarce...sure. But this is not the same thing as saying that there are no jobs.

    Now, I don't want you to get angry at what I'm about to say (so brace yourself). Your definition of involuntary unemployment is lousy. I just finished saying that jobs are not scarce. This does not, of course, imply that the unemployed should take up these lousy jobs. Nor does it imply that there is no role for government policy. Nevertheless, to say that you are involuntarily unemployed because (say) as a high-school drop-out you cannot find a job that pays $20/hour plus benefits is rather lame. And indeed, I find the notion of involuntary *employment* potentially more useful (these are people who wish to leisure, but cannot afford to). If you are interested, I discuss these issues in greater detail in my paper "Unemployment and Economic Welfare."

    Note: I do not think that we are just arguing semantics here. I think that we have to get our thinking right here, if we are going to design policies that truly help the unemployed (and employed, and nonparticipants) smooth consumption over difficult periods in their life.

    Now, let's get down to brass tacks. You said:

    "What I think gets missed by too many businesses is that your employee is someone elses customer and his employee is your customer. A cutting labor cost strategy is classic fallacy of composition that cannot work economy wide."

    Perhaps. You appear to have a multiple equilib rium model (based on an externality of some sort) in mind. I have written down mathematical models with this property. The question, of course, is whether the mechanism highlighted in your proposition is the one working in reality. You seem to believe strongly that it is. I caution you, however -- there is more than one plausible way to interpret the phenomenon you describe. In Long and Plosser's classic (1983) real business cycle model, for example, sectoral shocks feedback throughout the economy via intersectoral linkages. In that model, a bad shock to one sector of the economy can lead to widespread contraction via feedback effects, but the allocation remains Pareto optimal. (This is just one example, there are certainly others).

    To sum up, you may be right, or you may be wrong. I don't know. I don't even know what aggregate demand is. I don't necessarily share your view that large cycles should be avoided (perhaps they are a natural and inseparable byproduct of economic growth a la Schumpeter). But perhaps you and I might agree that those hit hardest in recessionary times deserve some government support (even if it to some extent crowds out private support and charity). Temporary government jobs -- sure, building infrastructure, cleaning streets, whatever. My own preference would be that any such government program be delivered at the local or state level (rather than the federal level).

    Whew...that was a long response, and I could have said much more! I'll hand it off to you now.

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  16. Some interesting points, thats for sure!

    I think its quite right that what we have ALL always wanted is leisure. Problem is, leisure is the most expensive commodity out there. I'm not doing my blogging on my work time and I couldnt afford to blog if I didnt work. The thing is in todays world where everything is priced, literally everything, one must work to get the money to buy anything at all so income is a necessity and no one really supports income without some sacrifice of leisure time.

    The one weakness with this view though is that it gets taken too far and leads some to view unemployment as the simple freeloading state of not having to work. You are correct that work is not scarce but paid work is. Much can be done but much that could be (needs to be) done is not profitable in the view of the private sector.

    Listen, you wont make me mad not liking my definition of involuntary unemployment. I said nowhere about a 20$/hr job with bennies, however too many are unable to service their debt load on the unemployment payments they are getting(until the party of NO steps in) and cannot move to somewhere where a job might be for them. Much of this cannot be simply attributed to poor personal choices. We are all part of a system of which we individually have little control over but there are those especially in the economic world who do control the financial lives of others. Some are freer than others so to speak. All this is said simply to say that those who have been laid off, the longer they go not spending at the levels they used to, are dragging the rest of us down too. We are in an economic boat together. We will make ALL our lives better (have more vibrant businesses to choose from etc) if we can help get more of the currently "under consuming" people back to closer to their previous levels. That is ALL aggregate demand is. GDP IS aggregate demand.


    Look, I cant call my thinking based on any type of multiple equilibrium model or any such thing. I honestly avoid mainstream academic economic models. As soon as they start assuming "rational expectations" and "efficient markets" they've lost all credibility in my view. I dont want to offend you either but I think "Pareto efficient" is one of those sciency sounding things that too many economists stole from engineering and physics and honestly I think it is lacking as an analytical tool in economics. It assumes a zero sum situation which often times is not true. Furthermore its simply a fancy way of saying everything has trade offs..... to which I say....... ......DUHHHHHH!!

    I'm not sure why you cant see a good reason to avoid what we had the last two years. Down cycles are one thing, mass economic disruption because balance sheets got out of whack is another. There never really has to be balance sheet recessions. Goods can become scarce, supply lines can be disrupted for various reasons, products can become obsolete, but given the nature of modern money and knowing that in truth we can never "run out of money" we should never have these kinds of funding problems.

    I agree that states and local authorities should handle jobs but it can be funded federally.

    I'm ready for a beer.....

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  17. Well said, Greg. Except for one thing: I thought that GDP was aggregate supply. ;)

    Enjoy that beer!

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