Yellen wants to understand effective demand
Janet Yellen gave a speech where she posed 4 questions to economists in general seeking answers… The first question she asked was this…
“The Influence of Demand on Aggregate Supply
The first question I would like to pose concerns the distinction between aggregate supply and aggregate demand: Are there circumstances in which changes in aggregate demand can have an appreciable, persistent effect on aggregate supply?
“Prior to the Great Recession, most economists would probably have answered this question with a qualified “no.” They would have broadly agreed with Robert Solow that economic output over the longer term is primarily driven by supply–the amount of output of goods and services the economy is capable of producing, given its labor and capital resources and existing technologies. Aggregate demand, in contrast, was seen as explaining shorter-term fluctuations around the mostly exogenous supply-determined longer-run trend.”
Janet Yellen is really asking for research into effective demand. She sees a weakness in aggregate demand affecting aggregate supply… or potential output. That is effective demand, but she cannot even use the term effective demand because economists do not understand it.
I have been researching effective demand for 4 years. I have seen really a complete lack of understanding of what effective demand is among economists. It surprises me that Janet Yellen would be calling for research on its dynamics.
She does not really understand effective demand yet though. She goes on in her speech about hysteresis which is a short-term shock which produces a long-run affect. Effective demand is not a short-run shock. It is based on the relative strength of labor share to profit share. A lower labor share sets a lower limit upon potential output. And the drop in labor share is not short-term. It has been constant for years since the crisis.
I have models that can be built on by other researchers. It truly is important for economics to finally understand and define effective demand.
“Effective demand is not a short-run shock. It is based on the relative strength of labor share to profit share. A lower labor share sets a lower limit upon potential output. And the drop in labor share is not short-term. It has been constant for years since the crisis.”
With, I hope, appropriate respect for the need for deep economic research and analysis, is this not obvious to any reasonably sentient human?
Lambert
send Yellen your paper.
Do you have her email?
I’ve got to say I’m rather disturbed that Yellen struggles with this concept. Manufacturers do not make products for which they do not see a demand. And as we move more and more to a service economy, production CANNOT precede demand. A barber cannot produce a haircut until a customer walks into his shop.
This is elementary micro-economics.
Warren:
DeSoto had a Yuge demand and it was made? Companies make product they “think” there is a market for. Production does precede demand every year when different models come out. Most recently UF and PF car models are being discontinued because the demand did not materialize. I guess Chrysler was wrong in its forecast of demand. The cost? $millions to inventory being stocked at the Tiers.
Warren, In communications with Nick Rowe, he said that there is no difference between capital income and labor income affecting the economy. They both get moved through the economy. I tried many ways to get him to see a difference, but he could not.
As Yellen says, “Prior to the Great Recession, most economists would probably have answered this question with a qualified “no.” They would have broadly agreed with Robert Solow that economic output over the longer term is primarily driven by supply.”
Economists do not see the power of labor income demand… I agree with your barber analogy.
But there is a mindset among economists that keep them from understanding effective demand. But they are beginning to realize that it exists somehow but not quite getting it yet.
Edward
no. but her post office address is published.
Warren
I think the post mentioned a distinction between short term (mostly micro?) and long term (mostly macro). I am disposed to agree with you and with Lambert to the extent i understand him, but we need to pay attention to the distinctions.
Run, I think we are in violent agreement again. Again, perhaps I did not phrase that as concisely as I could have. Let me try again:
Manufacturers do not make products for which they do not think there will be a demand.
That is the contrapositive of your statement, “Companies make product they ‘think’ there is a market for.”
Certainly, companies do occasionally err in their forecasts.
Edward, I too, once saw no difference between capital income and labor income in it’s effect on the economy. As I see them now, however, they differ in their velocity. Labor income is generally spent as soon as it is received. Indeed, with the proliferation of what I consider the greatest economic evils of the modern age, credit cards, much labor income is spent long before it is received.
The difference between capital and labor income spending is that labor income spending is the end spending. It is the spending the completes the process that required the capital spending.
Run’s auto industry example. Sure, business’ spend on projected sales. But, eventually, that capital spending gets cut because the end of that process was not a sale of the car.
The only way capital income might be considered the same as labor income in the over all picture of an economy is if labor is receiving the productivity gains equally to what goes to capital. That stopped in the early 70’s.
I think this effective demand is what the current post by New Deal Dem here at AB is struggling with. Are we or are we not in a recession. Truth is, for a large part of the labor force, there has been no recovery and what recovery has shown up in the stats is do to the adaptations companies have made to look profitable. On a global scale, our growth was just an exception via QE. That is, a company can look bad on it’s US sales, but may be profitable overall do to the size of their global sales, no one particular country. I believe Walmart is an example of such.
But, China is struggling in that the worlds largest consumer market has not recovered to even what was the 90’s which was the tech boom that China manufacturing rose on.
How we look at growth is an oddity too. Seems as long as we’re growing we will ignore that there is a continual decline in the % until growth goes negative. Oh Noooooooooo! as Mr. Bill would say.
Hi Daniel,
Thank you for your good comments… I would add another difference between capital and labor income. The owners of capital have to decide how much to pay labor according to how much profit they want for themselves. The act of paying labor more or less changes the relative value of capital vs labor, which then changes the optimization level of utilizing capital in the economy. The utilization of capital then affects output and potential output… which is what Yellen seems to want to understand.
“The difference between capital and labor income spending is that labor income spending is the end spending.”
Capital spending can also be end spending. (By “capital spending” we mean the spending of income earned by return on capital, and by “labor spending” we mean the spending of income earned by labor.)
Consider a retiree. He is not working. His income is entirely from his personal investments and from his “investment” in Social Security. That income is capital income, but is “end spending.”
Similarly, a man in the accumulation phase, who is investing in his 401(k), IRA, and Social Security. That portion of his labor income which he invests is NOT end spending.
Warren, I disagree.
Capital spending creates more capital. Even investing for a laborer is not end spending as it is creating more capital ultimately for personal consumption.
It is personal consumption that is mostly what labor income is and thus end spending. That a person goes on to spend again does not mean the cycle is continuous.
Buying the car is the end of the line for spending both capital and labor. Buying the lollipop and using it as intended is the end of the line for capital spending.
It does no good to build up capital, to only build more capital. In fact, I believe that that is all we have been doing under the Milton ideas of how an economy works.
Money/dollars devoted to end spending, consumption by the human population in the pursuit of sustaining one’s life I think will be found to have a natural range of ratio to money devoted to capital activity. Get outside that and we get what we have.
As we have put finance/banking on equal footing and even above production I believe we have been trying to make the idea that capital should be ahead of end spending. It’s the trickle down idea put in terms of labor vs capital.
I have shown here at AB in the past that there appears to be a range in which share of income works best. That is not much below 10% to the top 1% and not over 15%. Definitely at over 15%, the 99% go into debt spending, no savings. I have also shown that for the top 1% their income has double faster than the growth of the economy.
How long can the system work when people are pocketing money faster than the machine can make it? Obviously longer than I thought was possible, but then I underestimated the creativity of those believing capital is king and thus the schemes to keep it going.
“Capital spending creates more capital.”
OK — I think we are operating under different definitions of “capital spending.” What’s yours?
“I have shown here at AB in the past that there appears to be a range in which share of income works best.”
By what metric?
“I have also shown that for the top 1% their income has double faster than the growth of the economy.”
Could you rephrase that, please?
“How long can the system work when people are pocketing money faster than the machine can make it?”
I have seen no evidence that that is actually happening.
Warren, you can start with these two here:
http://angrybearblog.strategydemo.com/2008/12/income-distribution-and-gdp-it-matters.html
http://angrybearblog.strategydemo.com/2007/12/its-big-one-honey-i-know-it.html
OK — I read all three (including http://angrybearblog.strategydemo.com/2007/12/in-beginning-there-was-income.html). I’m afraid they got me no closer to the answers to my questions.
First, what is your definition of “capital spending”?
Second, what evidence do you have that “people are pocketing money faster than the machine can make it”?