Request for feedback on critique of AD-AS model.

[Neodoxy]

Albert,

You’re making some very dangerous errors here.

First of all, I haven’t changed my argument, my argument is the same as it was with my first post, it’s just not the argument or worldview you’re used to seeing. You’re not trying to herd cats or catch a jellyfish, you’re trying to see a mouse when you’re really looking at a dog. Secondly the way that you’re looking at things is a black and white view of the world where there is a neat box of “austrianism” and “Keynesianism”. Not only is this viewpoint inaccurate, but it’s restrictive to your intellectual growth and a real understanding of the world. Economic schools are not entirely contradictory, both Keynesianism and Austrianism agree, for instance, that an increase in the supply of loanable funds will (usually) decrease the interest rate. Some aspects of the schools, Austrianism’s methodological individualism and Keynesian aggregation, are contradictory, but this doesn’t mean that every insight and aspect of these things are mutually exclusive. Austrianism, while skeptical of Keynesian animal spirits, nowhere contradicts that some investors will use inaccurate and superfluous information in making investment decisions, indeed this viewpoint can be wholly integrated into AE, but it can never eclipse the fact that most entrepreneurs and investors employ decent reasoning skills when investing and are reasonably capable at their work.

The neo-classical synthesis, the greatest economic paradigm shift that has ever occurred, came about by fusing Austrian, classical, and a variety of other insights into a single school. You can be an Austrian and still appreciate and find some truth in the work of Milton Friedman, and so I think it’s clear that saying Austrianism and Keynesianism are necessarily exclusive in every way is not only closed minded, but it may also cause one to lose track of some valuable insights that might otherwise have been gleaned.

“I believe saving contributes to the economy. I dispute that it takes it out of circulation. As I see it Austrians believe it is not possible to take money out of circulation by saving.”

Here’s the chain of causality (and yes, this is pure Austrian taken straight out of Rothbard if it makes you happy):

At any point and time there is a ratio between investment and consumption, as individuals choose to consume more this decreases the amount of money that is invested and shifts the productive structure towards a shorter and a less capital intensive shape. In the long run this causes capital consumption and decreases living standards, shrinking the overall productive capacity of the economy, but in the short run consumers are able to reap the bounty of old capital accumulation through consuming this capital and instead of accumulating or “sustaining” the capital supply, all production can be used to produce current goods. If the opposite occurs and people invest more then they sacrifice a portion of their living standards in the short run, and the production structure becomes more focused on producing things in the future, the structure becomes longer and more capital intensive. In the long run this causes the productive capacity of the economy to grow and living standards increase.

With this in mind we can make up arbitrary numbers for the consumption to investment ratio to exemplify this point. If we start of with a consumption to investment ratio of 50:50, where half of all dollars are being used in consumption and half are being used in investment, then we see that when consumption increases by 5 then we get 55:45. The economy now favors consumption more than it did. When hoarding occurs and money is taken out of circulation, the money actually being used in the economy (if it is taken out evenly) will look like 47.5:47.5. This necessitates that deflation occur within the economy and, after prices adjust, the economy will look the same in real terms as it did before. If it comes disproportionately out of consumption, however, 50:45, then deflation as a whole must occur since the monetary unit is now worth less than it previously was, but when prices adjust downwards, we see that investment is now favored, not as heavily as if consumers had moved money from consumption to investment, but real money available for investment is still there.

Thusly we see that putting money out of circulation, either by decreasing the money supply or by hoarding money (plain savings) causes deflation. Anything other than this viewpoint contradicts the quantity theory of money. I think you might be confused as to what “in circulation” means. “In circulation” is an admittedly arbitrary term meaning when money is being actively used to purchase things. There is, of course, a time lag between when the money is saved and when prices fall, but if the money supply was constant now, and you shoved half the money supply under your mattress, I doubt that prices wouldn’t adjust downwards given a few years of half the purchasing ability of the economy. Nonetheless, it’s obvious that there’s nothing contradictory about the view that plain savings cause deflation and the idea that plain savings is good for the economy.

1. I have read Rothbard’s theoretical chapters in “America’s Great Depression” and his chapters on the business cycle in “Man, Economy, and State”. Therefore I have no reason to believe that the pamphlet in question will help me to understand the Rothbardian or the Austrian position.

2. Mises and Rothbard both agree that the phenomenon occurs and they both embrace it.

[sacvet]

No, Neo, thanks for keeping up the chat.

Like I said before I find most of what you say well thought out and useful. Many of our arguments are the same thing seen from a different angle.

I am not saying you are WRONG, I do not say that you changed your argument, I just cannot argue if we use different criteria.

I agree ALL economists have to use some arguments and some assumptions in common.

Nobody is totally wrong on everything (and for that matter totally right on everything either) It is an evolving discipline. But there are certain narrow areas like ABCT and Hoarding … where some factions go 180 degrees opposite each other. It is very important to examine this because depending on where you sit, the solutions are miles apart. And it is impossible to be on the north pole and the southpole at the same time.

And my point is we cannot compare opinions if we play out of opposite rulebooks.

Otherwise what repeatedly happens is we read the same paragraph and interpret it opposite because we use different definitions. Until we can find some common definitions we agree on, the conversation goes nowhere.

So with respect let me try and show you where I come from in your terms

So from Human Action chapter XVII LvM

Every piece of money is owned by one of the members of the market economy. The transfer of money from the control of one actor into that of another is temporally immediate and continuous. There is no fraction of time in between in which the money is not a part of an individual’s or a firm’s cash holding, but just in “circulation.”[2] It is unsound to distinguish between circulating and idle money. It is no less faulty to distinguish between circulating money and hoarded money. What is called hoarding is a height of cash holding which — according to the personal opinion of an observer — exceeds what is deemed normal and adequate. However, hoarding is cash holding. Hoarded money is still money and it serves in the hoards the same purposes which it serves in cash holdings called normal. He who hoards money believes that some special conditions make it expedient to accumulate a cash holding which exceeds the amount he himself would keep under different conditions, or other people keep, or an economist censuring his action considers appropriate. That he acts in this way influences the configuration of the demand for money in the same way in which every “normal” demand influences it.

from

What has Government Done To Our Money- Rothbard

9. The Problem of “Hoarding”
   What’s wrong with people who hoard up gold in their cellar and don’t let it circulate in the
   economy? Nothing. All it means is that the demand for money (to hold) increases, so prices of
   goods will fall, purchasing power rises. No benefit or loss to society occurs.
   Moreover, it is not irrational to hoard money. Money is not only useful in a present
   exchange but also in an expected and preferred future exchange and so hoarding confers that benefit
   to the owner. People keep cash balances because of uncertainty of the future: 1. if we knew exactly
   how much money we were gonna use, then there is no need for cash balances, 2. if we expect
   money to become worth more, we’d want to stock up on it now.
   Total cash balance is always equal to total supply since all money must be owned. If there
   was no uncertainty nobody would be willing to hold cash, price of money would fall and thus of
   other goods will rise infinitely causing monetary breakdown. This also means that the idea of
   money ‘circulating’ is a misleading metaphor. The only thing that takes place is transfers from one
   cash balance to another’s.
   Unlike changes in the supply of money, changes in the demand for money do confer social
   benefits, for they satisfy a public desire for either a higher or lower proportion of cash balances to
   the work done by cash How can an increase in demand for money be satisfied if changes in supply
   stays the same? If people value cash balances more highly, then demand for money increases and
   prices of goods fall, so the same total sum of cash balances confers a higher “real” balance, i.e.
   higher in proportion to the prices of goods.

I think you identified a key sticking point. We define “circulation” differently

Let’s get consensus on that and then reevaluate our arguments in baby steps

It looks to me that you define “the economy” as that portion that is used on consumer goods, and you define money that is used in that realm as “circulating”.

and therefore you believe money taken out to hoard or save is now “out of circulation.” and will shrink the money supply and cause prices to fall or the value of money to rise within this “consumer goods” field. We use a similar quantity theory of money.

If I accept your definitions then your argument is sound- I just try to tell you I define it differently.

I define the economy (which I call the MARKET economy) as the whole darn shebang. It includes your version which is buying and selling of consumer goods (I call that the consumer goods economy), it includes money in checking accounts, savings accounts and money in investment.

So in my world it is impossible to take it out of circulation unless you burn it. I have no use for the term “in circulation” in my world all money is always in circulation.. some circulate slow, some circulate fast.

When you hoard or you save or you invest (synonyms in my world) you move it from the one area to another. it is a re allocation within the larger market economy. It is moving it from your left pocket to your right pocket.It is not out of circulation it just serves a different purpose.

So when money is taken out of consumption(what you call circulation) as your example describes, it does cause deflation locally in those areas that are narrowly directly affected (I don’t see the economy as a large wholistic single entity but many small ones) I think you believe correctly it will cause some unemployment in those particular areas- I grant you that.

Some other areas of the consumption economy are left untouched.

But because it is not burned it is “invested” somewhere else in my definition of “the economy” where it has an opposite effect. It causes immediate employment in the investment industry and it causes future employment as in your capital goods quote from Rothbard above It might cause a lengthening of the production cycle but on net, it does not contribute to unemployment.To me it is all a wash overall.

from your post:

"If the opposite occurs and people invest more then they sacrifice a portion of their living standards in the short run, and the production structure becomes more focused on producing things in the future, the structure becomes longer and more capital intensive. In the long run this causes the productive capacity of the economy to grow and living standards increase."

Any disagreements?

[Neodoxy]

Albert,

Our views allign much more harmoniously than I thought they did. It appears that we only have one area of disagreement which I will get to below. However, I feel inclined to tell you why I define my terms the way that I do:

The economy: A continuous process of production and exchange in response to man’s values that relate to the physical world

The money supply: All money that exists within the market economy

Circulation: The process of spending money. Money can be said to be out of circulation after not being spent for an arbitrary period of time that causes a fall in demand.

While these definitions may not be perfect, I see that it is valuable to distinguish between money that is in and out of circulation because it helps to indicate shifts in the value of money caused by non-governmental means that may otherwise be overlooked. My analysis is far easier if I say “money is circulating”, rather than explaining what I mean every time. I also don’t deny that hoards serve a purpose in the economy, although I do believe it to be a collective goods problem (it makes sense for everyone to hoard, but if there was less hoarding there would be less of a need for hoarding because fewer people would be laid off).

As for our the only real thing I saw that I disagreed with was this:

“it does not contribute to unemployment.To me it is all a wash overall.”

This is only true if prices are flexible. The demand falls for a large variety of goods (I agree that some are unaffected). The amount of money circulating is not enough to pay back labor that is employed in current quantities. All prices must fall to match the new price level. Where prices do not fall unemployment results. If prices were perfectly flexible then this phenomenon would not cause unemployment. Since they aren’t, it must. This is where I sympathize with Keynes, although as I’ve stated, I don’t think that this as originally as “Keynesian” a position as it might at first seem. This does not mean that the Keynesian prescription of stimulus and inflation will solve the problem (or even if it were to solve “this problem” it does not mean that it doesn’t create other, more severe problems). A significant increase in plain savings must result in a significant fall in wages, whether this only be large fall in a small number of areas or a small fall in many.

This is quite a good discussion. You should post here more often.

[sacvet]

Good we found some common ground. Now understanding that you do not necessarily want the government to do a Keynesian stimulus but you still have issues about unemployment in certain areas,

We can narrow the discussion to:

1. Does savings cause net unemployment

2. What to do about it

We cannot answer 2 till we agree on 1

I think you and I are the only two reading this thread anymore. Lets start a new thread about "Does saving or “hoarding” lead to unemployment?

Maybe more people will participate

[Smiling_Dave]

I think you and I are the only two reading this thread anymore.

You never know. Yesterday I saw that 2 members of the forum were online, but over 8,000 other people were lurking. Think of us as a TV show. There a few actors, but a huge viewing audience.

[Neodoxy]

Albert,

Frankly I think that anyone interested in this discussion on these forums would be taking part. As far as I can tell there are only a handful of people on these forums who are really all that interested in talking about more advanced economic issues. What I’ve been really surprised about is that gravy hasn’t taken part in this thread thusfar, since he’s usually keen on these sorts of issues.

Anyway, my thesis here for a while has that any significant decrease in aggregate expenditure (for the sake of argument we’ll just say that all savings come from consumption) necessitates a fall in wages. Since wages cannot be perfectly flexible, some unemployment will result. Recessions are a particularly bad time for this to happen since this increases unemployment and further decreases demand and increases uncertainty.

[sacvet]

Because you make Keynesian statements that I probably don’t get I am going to insist you justify them. (also because I cannot always tell which Keynesian thoughts you agree and disagree with.)

The first three thoughts I want to pick apart are:

1.How can you prove that “savings” by individual actors are “significant” enough to actually influence the economy as a whole

(by your own definition you said we leave out the impact of fractional reserve banks for now to narrow down on that part of the recovery not controlled by government, also you cannot use this current recession as an example of significance (unless you give me actual numbers) because the banks expanded the mortgage industry by trillions upon trillions of dollars - that WAS significant in causing massive unemployment, what numbers do you have for personal savings in comparison)

2.“significant decrease in aggregate expenditure necessitates a fall in wages”

3."Since wages cannot be perfectly flexible, some unemployment will result"

So in

1. my question is clear

2. Prove to me that significant decrease in expenditure ALWAYS necessitates an overall fall in wages. You already know I am going to argue that private savings might be negligible compared to the effect of banks contracting, because banks have the hidden power of compounding credit expansion)

The economy is HUGE. Contractions, like those caused by savings NEVER hit the whole economy all at once. It hits certain sectors worse while other sectors might be booming. Especially in crony capitalism, these advantages are usually channeled to the government’s favorite businesses (the banks right now) After a lag period why do they not just get employed elsewhere? I already conceded in previous posts that savings in a specific sector probably affects that sector but not the others the “aggregate economy” is too huge I think we both agree it would be terrible to try and prop up those sectors against the wishes of the market. Or have you lost faith in the ability of the market to choose its own winners?

There have been contractions in sectors as long as free makets have existed- nothing wrong with that - the market always adjusts.

Its a similar argument as Hazlet refutes when he took on the anti industrialists who claimed that machines were taking away jobs- why don’t they create new jobs in the building, servicing and managing of machines?(Like in the old hand knitted sweater industry in England, when the horseless carraige was invented it was devastating to the horse drawn carraige industry but it created the automobile industry, when the refigerator was invented it killed the ice vendors overnight, but “on aggregate” it washed out … if it was interfered with by bailing out or propping up the old sectors, it would have increased uncertainty and punished the new industries)

3. WHY can wages not be perfectly flexible? Surely a worker would rather take lower pay in a recession than be out of work?