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Philip George
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"This is a horrible research program." Understatement of the week.
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The inferiority complex with respect to DSGE is amazing. A good way to get over it is to understand that General Equilibrium theory and Marshallian demand analysis amount to the same thing. Marshallian demand analysis is not partial equilibrium analysis; it is just as general as "General Equilibrium" theory though this does not mean that either is general equilibrium. I have written about it in the link below. It's a very long read with lots of math. But it is mathy only to show that General Equilibrium math is rubbish. http://www.philipji.com/holes-in-general-equilibrium/
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Greenspan was not a coward. But it is not fair to say that he made a bad call either. If he made an error it was an error for which all of economics should take the blame, not he alone He simply did not have the theoretical infrastructure to make the right call. To begin with he did not have a proper measure of money. But even if he had one it is unlikely that he would have made the correct decision. The measure of money that I use shows money supply rising continuously for the period from 1995 to the end of 2005 with brief periods of levelling off (for instance, around the time of the 2001 recession). But this was not more steep than the rise from 1985 to October 1987. The difference was interest rates. The much lower interest rates during the early 2000s permitted an asset market boom. What brought about the crash of course was that money supply dipped slightly in 2006 and then was held rock steady from the beginning of 2006 to the end of 2009. In real terms this amounted to a severe squeeze.
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The problems of DSGE lie in GE. To attack DSGE you need to first point out the problems in General Equilibrium Theory. In http://www.philipji.com/holes-in-general-equilibrium/ (which is a work in progress) I show that the principal claim of GE, viz. that it represents an advance over Marshallian demand analysis, is without basis. DSGE is of course lost when it comes to understanding money. But even before that it fails to understand involuntary unemployment. I have shown that Keynes was right in saying that flexible wages cannot lower unemployment during severe recessions. The whole argument, which is basically "classical", can be seen at http://www.philipji.com/involuntary-unemployment/
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1. "It is misleading to think of the demand for money." That is correct. People complain that food is going waste although there is so much unfulfilled demand (people starving, etc). But of course when economists talk of demand for food they mean the willingness and capability to exchange food for money. Therefore, the demand for money would mean the willingness and capability to exchange money for money, which makes no sense for all. Imagine a couple of decades wasted during the sixties and seventies when tomes were written about "the demand for money". 2. "If individuals want to save in the form of money, they won't collectively be able to if the stock of money does not increase." Completely incorrect. In order to save more in the form of money all individuals need to do is cut consumption. This automatically means less money is used as a medium of exchange and more money is converted into asset. Money in M1 deposits (barring, importantly, precautionary balances) is medium of exchange. Money in non-M1 M2 deposits is an asset. One can be transformed into the other. My book "Macroeconomics Redefined" http://www.amazon.com/dp/B00ZX9O5XQ has more details. This also means that the velocity of money has nothing to do with time. It is a ratio of two stocks, which is why the velocity of money is an exact function of interest rates. See http://www.philipji.com/item/2014-04-02/the-velocity-of-money-is-a-function-of-interest-rates
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The problems of classical macroeconomics have their roots in classical microeconomics. Who would guess, for instance, that the linear demand curve for a single market actually assumes constant aggregate demand? But it does. So the classical argument that involuntary unemployment is impossible is actually a circular argument. There is only one demand curve that does not assume constant aggregate demand, and that is the rectangular hyperbola. An analysis taking the rectangular hyperbola as the general form of the demand curve yields involuntary unemployment as a natural result. See http://www.philipji.com/involuntary-unemployment for the complete argument Be prepared to abandon some fundamental assumptions.
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I compared YoY changes in the labor participation rate with YoY changes in real median household income (as a proxy for wages). The relationship appears to be a close one. Apparently, the idea of opportunity cost is a major part of the explanation for changes in the labor participation rate. See http://www.philipji.com/item/2016-04-16/what-explains-changes-in-the-labour-participation-rate
As a homework assignment your students might want to figure out what is wrong with the following post that argues the Keynesian multiplier is negative during recessions. It involves only elementary arithmetic. http://www.philipji.com/item/2015-06-20/the-keynesian-multiplier-is-negative-during-recessions By the way, Joe Stiglitz had something to say about negative rates yesterday on Project Syndicate: https://www.project-syndicate.org/commentary/negative-rates-flawed-economic-model-by-joseph-e--stiglitz-2016-04
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If the mistakes on both sides are corrected Keynesianism and Monetarism are indeed the same thing. From a common sense point of view this follows from the fact that to get $1 of aggregate demand you need to spend $1 of money. This can be seen by comparing the graph of YoY changes in Corrected Money Supply (my measure) on http://www.philipji.com/item/2016-03-05/a-major-crash-is-on-the-cards-this-year with the graph of YoY change in Real Personal Consumption Expenditure at https://research.stlouisfed.org/fred2/graph/?g=48Dx Both graphs indicate that by the end of this year we are in for a major market crash followed by a recession.
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The paper explores the effect inequality has on real interest rates. It seems to me that it is very low interest rates that have exacerbated inequality. See https://research.stlouisfed.org/fred2/graph/?g=46rB In the 1950s and 1960s labor share of income was high despite lows interest rates. But this was because in those days very few people (if any) were being paid in stock options. Now low interest rates boost the financial industry because it makes cheap leverage possible. So it increases both wealth and income inequality. See also http://www.philipji.com/item/2016-04-05/who-benefits-from-low-interest-rates
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You are completely right in reiterating that the demand curve for loans is always downward sloping. So why does the graph of Industrial and Commercial Loans vs the Effective Federal Funds Rate seem to point in the opposite direction? See https://research.stlouisfed.org/fred2/graph/fredgraph.png?g=3I8H It clearly shows that whenever the Fed raises interest rates from close to zero levels the quantum of industrial and commercial loans goes up, not down. The reason is that in your entire argument you have ignored the supply side of the equation. Very low interest rates make it possible for players in the financial asset markets to earn high returns by using high leverage. When interest rates are raised leverage becomes expensive and returns fall drastically. So financial companies are forced to look at alternative places to deploy their money. This is why loans to the real side of the economy increase when rates are raised from very low levels. I wrote about this five years ago at http://www.philipji.com/item/2011-07-24/why-banks-do-not-lend-at-near-zero-interest-rates At that time I was still groping for the correct model of money which I have since written about in my book "Macroeconomics Redefined" http://www.amazon.com/dp/B00ZX9O5XQ Incidentally, the book predicts a massive crash by the end of this year.
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"However, this relationship struggles to explain the 1995-96 and 2012-15 periods, with the latter being one of stable global growth and steep commodity price declines in both 2012 and 2015." You might want to take a look at another variable which is Corrected Money Supply for the US. A graph can be seen at http://www.philipji.com/item/2016-03-05/a-major-crash-is-on-the-cards-this-year. For your convenience I have uploaded a graph for the period from 1990 to 2016 which is at http://www.philipji.com/CMS-1990-2016-libertystreeteconomics.png This agrees much better with commodity prices for 1995-96 and 2012-15. I also venture to predict that because Corrected Money Supply Growth is approaching the 0% level, commodity prices will either continue to be low or there will be a major crash.
The Fed has increased rates a little and hints at more increases this year. The ECB has reduced rates and promised to keep them low for very long. It would be interesting to see where inflation rises more.
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This carries on the error of a previous chapter where Keynes hazards a guess that the failure to invest is because firms have set aside depreciation allowances much higher than the actual depreciation required. Two gargantuan omissions stand out in The General Theory. The first is the absence of any mention of the 1929 stock market collapse (a blunder continued by modern Keynesians who see no pattern in the fact that the Great Depression, the Great Recession and Japan's Lost Decade were all preceded by massive asset market collapses). The second is the total absence of any reference to banks and bank failures. After the coming market crash it is to be hoped that the ideas of The General Theory will be given a decent burial while retaining the Keynesian method which is substantially correct.
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"We are barking up the wrong tree: there is something we have missed, and the models that we think are good first-order approximations to reality are not, in fact, so." Questioning is the first step towards progress.
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Duy, The scenario five and Yellen testimony links in your post are not working.
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"In sum, a key factor in keeping the US economy on the rails is acknowledging that tightening financial conditions via the dollar obviates the need to tightening conditions via monetary policy." But monetary conditions have been tightening since January 2014 as the graph on http://www.philipji.com/item/2015-12-05/the-fed-is-set-to-squeeze-during-a-monetary-contraction shows. The fall in commodity and equity prices is only a reflection of that. The Fed is doing exactly what it did the last time around. It first created asset bubbles and then burst them by contracting money. The YoY growth rate of money supply (my measure) was around 2.4% on 1 December 2015 (before the Fed raised the Funds rate). It is probably close to zero at present. If another QE is not carried out, I expect a massive crash in one or more asset markets before the end of the year. I don't see too many economists predicting this. Of course after it happens many of them will claim to have seen it coming.
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When I look at your graph of share prices and production index, it seems apparent that the bottom of the share price line precedes the bottom of the production index. (You can see it in 2008-09 as well as in 2012-13) The reason is that asset market crashes cause recessions. Surely it is not an accident that the Great Depression, Japan's Lost Decade, and the Great Recession all followed huge asset market crashes. The arrow of causation is simple. Huge asset market crashes cause huge contractions in net worth of a large part of the population. They respond by cutting consumption in a bid to recoup the net worth. In turn companies respond by cutting output. The larger the crash, the larger the cut in consumption and the more prolonged the cut. In the 2008-09 crash, for instance, the median US family lost 18 years of net worth. It would have to double its saving rate for 18 years in order to regain the lost net worth. That is why recoveries following asset market crashes are so long-drawn-out. If you see the graph on http://www.philipji.com/item/2015-10-04/us-recessions-and-recoveries-over-55-years you will see an almost vertical drop in real consumption at roughly the start of every recession.
The Great Depression, Japan's "Lost Decade" and the Great Recession all followed an extended period of very loose monetary policy. The Fed's QEs (and current monetary contraction) will soon be causing the next great market crash followed by a recession that will probably turn out to be worse than the Great Recession. But Prof DeLong is right. According to the Keynesian model, loose monetary policy cannot cause higher asset prices. That is because Keynesian economics (like Friedman's monetarism) goes by the portfolio theory of money. Money is just one of many financial assets. So if demand for money is high it follows that demand for other financial assets must be low. And if demand for those financial assets is low, how can their price go up? This theory obviously violates practical experience. And yet it is a truth universally acknowledged that we cannot see the world except through the lens of our theories. In the right theory, where money is a medium of exchange and not an asset, more money results in higher demand for real goods and services as well as for financial assets. Lower interest rates automatically skews the demand in favour of financial assets. That is what has been happening. The simple model which predicts the next crash as well as the reason for the failure of central banks and governments to boost economic growth since 2008 can be found in my book "Macroeconomics Redefined" http://www.amazon.com/dp/B00ZX9O5XQ But for people weaned on IS-LM diagrams, liquidity preference and an erroneous conception of money, it is difficult to let go of phlogiston and epicycle theories. We can only hope that another severe recession will finally put an end to discredited theories. But the experience of the past seven years does not fill one with optimism. Perhaps Max Planck was right: "A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it."
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How many recessions does it take to change economists' models?
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For information on sweeps see https://research.stlouisfed.org/aggreg/swdata.html Data are available in the link saying Excel format
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Corrected Money Supply = M1 - 12 months personal saving + sweeps. For the rationale behind it you will have to read my book "Macroeconomics Redefined"
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Not at all. As the graph shows, the Great Recession was accompanied by a drop in money supply.
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The Volcker recessions were different from the Great Recession. In those recessions there was no major asset market crash. So consumers did not lose any part of their accumulated saving. As soon as the Fed loosened the taps and firms got access to money the economy swiftly got back to normal. Recoveries following asset market crashes are necessarily long-drawn-out because consumers raise their saving rate for an extended period to recover their lost net worth. The Japanese experience was different. In the Japanese asset market crashes consumers lost very little. The big losers were firms who found themselves very short of money to carry on business. They might have borrowed from banks but banks too had lost money in a big way. Unlike in the US, Japanese consumers cut their saving rate which has moved from very high levels to nearly zero. The Fed did do a lot to counter the contraction in 2009-10. That is why the Great Recession did not become a depression. The expansion thereafter only served to create asset bubbles that are now in the process of being popped.
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I will be very happy if you can point out anything wrong in the arithmetic of http://www.philipji.com/item/2015-06-20/the-keynesian-multiplier-is-negative-during-recessions The book itself points out the important role of banks and other lending institutions. In textbooks banks intermediate between saving and investment. This would be about 5% of GDP. In reality bank lending amounts to about 60% of GDP.
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