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

Saturday, September 1, 2012

The Problem is NOT a Lack of Demand

This just in from Mark Thoma: The Problem is a Lack of Demand. According to Mark,
The chair of Bush's Council of Economic Advisors, Ed Lazear, says that the unemployment problem is not structural, it's due to lack of demand:  
and then he goes on to cite a WSJ report: Jackson Hole Paper: True Cause of High Unemployment is Basic Economic Weakness.

Hmm, where to start?

I cannot find Lazear's paper at the moment, so I'm not exactly sure what he said or did not say. I'm pretty sure, however, that he did NOT say the "the problem is a lack of demand." Take a look at this interview with Lazear at Jackson Hole.

OK, so he does say that the problem with the U.S. labor market is not "structural." But then, what is the problem? He ascribes it to general "economic weakness"---which is a far cry, I think, from attributing the problem to a "lack of demand." The "lack of private sector demand" theories generally imply a role for monetary and fiscal stimulus. But here is what Lazear says in his interview:
...I don't think that there's a lot of evidence that this (fiscal stimulus) is going to work. The evidence is that the stuff that works is the long-run stuff. That means low and effective taxes. It means a good trade policy...and most important it means getting the fiscal situation under control...
So, you see what happened here. Lazear says that the problem is not structural, that it is the product of general economic weakness. The WSJ reporter, who has likely only ever been exposed to a macroeconomic principles course, has no other way to categorize what might be ailing the economy, apart from a "lack of demand." And so that's what he writes, which is understandable. But I don't think Mark should have made the same mistake. Mark's headline might have been more accurately stated as: Lazear: The Problem is Not Structural.

As for the title of this post, what I mean by it is as follows. Imagine that we all agree that a depression is characterized by a "lack of demand." The current demand for domestic investment spending, for example, still seems weak relative to how it typically rebounds following a recession; see here. But while we might share this view, and even use the same language to describe it, we may at the same time have very different opinions about what is causing the "lack of demand." Economists know that different causes generally imply different policy solutions. And the problem of identifying these different causes remains as difficult as ever (I explore alternative hypotheses herehere, and here, for example. Other interpretations are possible too, and I think we should keep our minds open to them.)

Happy Labor Day weekend! (And a happy Labour Day to my compatriots in Canada.) 


  1. It seems to me that we could go a long way on discovering what to do, if we first described what needed to be done.

    To use a metaphor, when one does a space launch to the moon there are at least two calculations---escape velocity and then the energy required to get to one moon and back.

    If one assumes that there are no structural changes and that we could return to the near past, a rough calculation of the amount of demand we would need in the next year can be calculated, something like X x Y, where X is the number of unemployed and Y is their average annual compensation. It also seems to me that if the result is large enough its mere magnitude will tell us whether we need to print money or not. In sum, if you multiply by $45.8k, the per capita GDP of Minnesota, times 15 million the number is so big isn't the only path use of Bureau of Currency printing press? My math is that we would need $687 in new billions

    Now to live in an inflation fearing world like Cochrane one has to have some microfoundation for getting $687 billion in new bank loans plus sufficient additional loans to cause inflation.

    What an I missing?

    There is just no other known source of the amount of money needed.

    1. It seems to me that we could go a long way on discovering what to do, if we first described what needed to be done.

      How can we describe what needs to be done if we do not fully understand the nature of the problem that needs to be solved?

      Implicit in your post is that the problem is the X number of unemployed. To me, the X number of unemployed is a symptom of a deeper, yet to be fully understood, problem. True, the state could just hire these X people and label them "government employees." Indeed, doing so would contribute immediately to the *measured* GDP, as the value-added of government workers is measured by their wage bill. Does anyone really believe, however, that such a policy will fix the root problem? Heck, why not just make everyone government workers?

    2. David,

      I fully agree that X number of unemployed is a symptom of a deeper problem (albeit I understand what that is, which I will get to in a moment). However, you seem to agree with my math and so let us see what we have learned from my model.

      What we have learned is that the problem is so big that it is beyond---in Keynesian time (in the long run we are all dead)---solution except by the government. In a nutshell the calculation shows Keynes was right: that, if there is a solution, it can only be government.

      It doesn't tell us what gov't should do (I didn't say everyone a gov't employee, you did) but it makes clear that, if there are any solutions, they have to come from gov't.

      That is a very useful exercise in that we can now pitch all the Hayekian, Rand BS, etc., out. The "market" is never, ever going to solve the present problem. We can show that with my very simple model.

      Now, my two cents is that because Keynes was an economist first, unlike Hamilton, he got one thing badly wrong in the general theory (or maybe with Hitler in the air he had the good sense to keep his mouth shut).

      Keynes GT makes a leap of faith. From the truth that only gov't can be the solution, he leaps to Gov't spending as the solution. He doesn't, contrary to Hamilton, ask, How are the weaknesses in the form and structure of Gov't contributing to our problem?

      That, my friends, is why Hamilton, not Keynes should be our guide. He looked at America under the Articles of Confederation and saw that this will never work. If one looks, as a Hamilton, at the weakness, form, and structure of our gov't today, it is plain it no longer works and its weakness, form, and structure is our problem (we need a stronger, far more democratic central government, while also moving power from the Legislature to the Executive) (can you imagine the madness of running a large corporation if all executives and officers had to be approved by the BOD?)

      David, if a new Moses came down tomorrow with the answers you seek on a tablet, a group of senators would, for narrow political advantage, block us from adopting the changes and policies required.

      We are where we are because our gov't can no longer govern effectively. A similar moment in history was Rome, before Julius Caesar crossed over the Rubicon to greatness beyond anyone who has walked this planet in your or my lifetimes. The weakness of the Roman gov't created a vacuum that let the larger than life characters of Caesar and Pompey and many others roam freely.

      My friend, if you want answers, put down your calculator and pick up great history, great political science, and great literature. Start with the Bible and that little passage on vision.

    3. David, I'm not an economist, but I teach students to watch out for logical fallacies: you have two in the following passage.

      "True, the state could just hire these X people and label them "government employees." Indeed, doing so would contribute immediately to the *measured* GDP, as the value-added of government workers is measured by their wage bill. Does anyone really believe, however, that such a policy will fix the root problem? Heck, why not just make everyone government workers?"

      "X wouldn't fix the root problem" is a false dichotomy--that's an argument for never doing anything about anything, because no course of action is perfect.

      "Why not make everyone govt. workers?" is a straw man argument: obviously a stupid idea. But what about a solution that has worked well in past, namely using government financing to undertake massive infrastructure projects that are desperately needed?

      We can borrow money almost for free right now, and fix 8000 unsafe bridges, make public buildings energy efficient, improve transportation and communications networks. We need all those, and the infusion of demand might give this faltering economy the boost it needs to restore confidence, after which the recovery might have enough juice to be self-sustaining.

      Then we can turn to the structural problems of our antiquated government structure, as AH rightly suggests--but not until then.

    4. Kevin, I appreciate your comments. My reply below.

      "X wouldn't fix the root problem" is a false dichotomy--that's an argument for never doing anything about anything, because no course of action is perfect.

      I'm not sure what you are talking about...a false dichotomy?

      In any case, I did not mean "fix"...I meant "improve"...perfection was not what I meant.

      "Give a man a fish and he is fed for a day. Teach a man to fish, and he is fed for a lifetime." I say hiring unemployed workers just for the sake of reducing unemployment is like the former. Retraining them is like the latter.

      What makes hiring everyone on the government a stupid idea, Kevin? What is the optimal division of labor across the private and public sectors? My "straw man" statement was designed to stimulate that question. You calling it a "straw man" in no way detracts from the usefulness of the statement.

      As for your concluding remarks, let me refer you to an earlier post of mine (I essentially agree with you):

    5. David,

      What you frame is entirely a political issue.

      When we do nothing about unemployment, the unemployed bear 100% of the loss.

      If we borrowed enough money to give them all a job, we gain some increase in production.

      If we were really smart, we would have already built the ultimate wonder of the world (e.g., the Great Pyramids or Great Wall raise by a factor of X, as close to infinity as possible). These investments, no doubt, were entirely written off at the time they were made and did nothing but raise taxes and inflation. However, for their respective societies they have turned out to be priceless.

      To the extent we don't gain an increase in production, the debt will have to be written off, either through higher taxes or inflation or both.

      For example, we spent billions in WWII on Navy ships and airplanes, raising debt to 150% of GDP, and then promptly wrote such off when the war ended. The planes were scrapped (you can hardly find a B-17, today) and the ships moth-balled. We were left with the debt which we have been paying ever since, either with taxes or inflation. This writing off of military hardware without a return on our investment has continued for 60 years.

      Now in WWII we were politically willing to take on the debt and the write-off. Today, the John Cochranes of the world are not about to risk either higher taxes or inflation for an increase production. It really is that simple.

  2. I take it that this is the paper (via MT's commenters):

  3. I would also note that Arin Dube has sent a very enlightening email to Mark Toma on theses issues

    And that another follower of Hamilton has in the comments written:

    Alex Hamilton said...

    Bernanke CAN DO SOMETHING!!!!!!!

    Bernanke can follow the example of central bankers all over the world, in Israel, Switzerland, Korea and dozens of other countries.

    He can begin purchasing foreign currency and foreign bonds. He should announce targets for dollar depreciation on an annual basis (eg: the dollar needs to depreciate by 80% over the next eight years, at a rate of 10% a year against a basket of East Asian currencies)

    If it can bring 2% unemployment to Singapore, 3% in Korea and 3% in China, why should the US play the role of foolish sucker? DEVALUE THE DOLLAR!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

    Although the Chinese don't allow foreigners to buy Chinese government debt, the Fed can begin stockpiling RMB notes by simply announcing that anyone who shows up in DC with Chinese currency can get a better exchange rate than the official Chinese rate (eg $1 = 4 RMB rather than 6). Arbitrage profits will drive trillions of RMB notes into the Fed Reserves vaults, plus because the RMB is going to displace the dollar as the world's reserve currency, these RMB assets will increase in value. The US kills 2 birds with one stone: we get an appreciating asset, and build up foreign currency reserves to help us prepare for the not-so-distant day when the US is a normal country.

  4. You decide - but the abstract seems clear Lazear believes it's demand not structural forces keeping back employment growth. Link to the full paper, below.

    Embargoed until presentation time of 9:00 a.m. Mountain Daylight Time, Saturday, September 1, 2012

    The United States Labor Market: Status Quo or A New Normal?

    Edward P. Lazear, Graduate School of Business and Hoover Institution, Stanford University
    James R. Spletzer, U.S. Census Bureau

    The recession of 2007-09 witnessed high rates of unemployment that have been slow to recede. This has led many to conclude that structural changes have occurred in the labor market and that the economy will not return to the low rates of unemployment that prevailed in the recent past. Is this true? The question is important because central banks may be able to reduce unemployment that is cyclic in nature, but not that which is structural. An analysis of labor market data suggests that there are no structural changes that can explain movements in unemployment rates over recent years. Neither industrial nor demographic shifts nor a mismatch of skills with job vacancies is behind the increased rates of unemployment. Although mismatch increased during the recession, it retreated at the same rate. The patterns observed are consistent with unemployment being caused by cyclic phenomena that are more pronounced during the current recession than in prior recessions.

    1. Thanks for this Bob. I did a quick search of the paper for "lack of demand" but could not find any reference.

      But as I say in my post, he could be thinking of a "lack of demand" in a different way than the standard Keynesian way; i.e., as uncertainty-constrained investment, tax-constrained investment, etc. My link to his interview suggests to me that he was not speaking of "deficient demand" in the Keynesian sense.

  5. And, to follow the above, here's (WSJ Fed reporter) Jon Hilsenrath on Lazear: "High unemployment now is the result of a lack of economic demand, he said, not structural factors like households being unable to move to find new jobs."

    1. Mark,

      I was unable to read the article you linked to (I don't have a subscription to the WSJ from my home computer.).

      But I trust that Lazear was quoted correctly, even if he did not say anything about a lack of demand (in the Keynesian sene) in his paper (did he?).

      In any case, maybe I'm making to fine a distinction here (between "Keynesian" notions of deficient demand, and other interpretations.) If Lazear said "lack of demand" he said "lack of demand" and you were no incorrect to attribute that to him. Mea culpa! And my apologies.'ll have to agree with the title of my post, no? The problem is NOT a lack of demand. The problem is in identifying the SOURCE of that lack of demand.

    2. David offers the obstacle that, "The problem is in identifying the SOURCE of that lack of demand."

      Does a doctor have to know you broke you leg in a car accident or from a fall in order to be able to fix it?

      Or, does a doctor just have to know that your leg is broken?

      What if we know the source and couldn't do anything about it?

      For example, what if we knew that the lack of demand is caused by (1) oil having gone up in price by a factor of 50; (2) globalization; and (3) too low of taxes on the rich, such that we are causing Dugger's FAC discounting?

      What should be we do if we knew these three factors were the source of the problem but couldn't do anything about them?

      BTW, I believe they are the source of the problem, and that everyone has known such since the 1970s, as per Noah's recent post that the economy has been broken since the 1970s. But if you admit such you immediately get attacked from the rich and the right. Romney just repeated the twin lies of American Exceptionalism (not if the economy is broken) and American's deserve prosperity (not if the economy is broken) and ... well I will hold my tongue about economists and incentive caused bias this morning.

    3. John, I really hope you get hit by a car today. Just wanted you to know that.

  6. The Lazear & Spletzer article is convincing that so far, there's been no permanent "structural" change in the causes of unemployment, but it's also quite evident that there have been sectoral changes that people have confused with structural effects. "the manufacturing industry is responsible for one-third of the recessionary increase in the index, with Education and Health Services, Government, and Construction being responsible for a combined 63 percent of the recessionary increase in the index". These four areas got much worse during the recession than the other areas, but they also seem to be rebounding faster, up to a limit that they don't want to talk about.

    Permanently shrinking government spending will permanently limit the amount of rebound that can be obtained from the government sector. Democrats want to have deficit-funded social spending forever, while Republicans want to have deficit-funded military spending forever. Keynesians talk about temporary stimulus spending, but after "temporary" is over, you're no better than before. Investing in America by the government can have permanent effects, but that means picking winners and losers, and government is very bad at identifying losers. Investing in anything and everything means investing in losers as well as winners. Even if those losers are chosen by private capital, the taxpayer still bears the cost.

    Failing to regenerate a housing bubble will permanently limit the amount of rebound that can be obtained from the construction sector.

    Continuing to allow the outsourcing of manufacturing to the rest of the world will permanently limit the amount of rebound that can be obtained from the industrial sector.

    There's little evidence that I know of that education and healthcare can take up all that slack and return the US to the levels of unemployment that we previously expected. Superinflationary cost increases for healthcare and education suggest that the total amount of GDP dedicated to those industries is increasing, but the data that L&S show indicate that they are also chronically undersupplied with qualified job applicants, and so their GDP growth will not be matched by corresponding job growth.

    In all of these cases, it's very hard to see what a central bank could do to fix them. A rising tide will lift all boats, but the ones with leaky hulls still don't float as robustly.

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  8. "what about a solution that has worked well in past, namely using government financing to undertake massive infrastructure projects that are desperately needed"

    See this piece: "Survival of the unfittest: why the worst infrastructure gets built—and what we can do about it",

    Oxford economist published in peer-reviewed journal. Not from the GOP.

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