Larry Summers’ Inverse Say’s Law sheds light on lack of Effective Demand…
By way of Mark Thoma, there is a new video of Larry Summers talking about Inverse Say’s Law. It is a wonderful video and one that could wake up the economics profession about Effective Demand. His views will not only challenge Fresh Water economists, but also Salt Water economists. (His talk starts at 9-minute mark.)
His idea of Inverse Say’s Law is that “lack of demand creates overtime lack of supply”. He is describing the situation when weak Effective Demand leads to higher unemployment and lower utilization of capital capacity. He is describing the work that I have been doing for over a year. He is describing what Keynes wrote in Chapter 3 of General Theory about Effective Demand.
Update for statement made during talk: “This might have been a theoretical notion some years ago… it is an empirical fact today.”
Most economists know that weak demand is a problem, but Mr. Summers is opening the door to the theory behind it. Like he says at the beginning of his talk, he will present 3 ideas that were not part of the economics tool kit, so to speak, 7 years ago. And I have been writing for over a year that Effective Demand is now low enough that it is having a noticeable effect on the traditional calculation of potential output and the natural rate of unemployment.
He talks about the $800 billion lost in potential. I have written before here on Angry Bear that this money has gone from the hands of labor consumers to the hands of capital income.
He says that going forward, the US will “suffer a demand constraint and to have its level of output and employment constrained by demand, rather than supply”. He is saying what I have been saying that weak Effective Demand means that potential output has fallen and that the natural rate of unemployment has risen, beyond what most economists perceive.
There are still some issues that will come to light about effective demand. For example, Christine Lagarde at the IMF is warning about low inflation. My veiw is that inflation will stay low in the US as long as effective demand stays low in terms of low labor share. I hear everyday that inflation will perk up again. I do not think it will. I am watching labor share. I still do not see it rising. Even if labor share does rise, you have to watch consumption by capital income to see if labor income will rise faster than capital consumption falls.
He goes on to imply that monetary policy is constrained by demand. This is old news to me. I have a model to show this, but I wonder what model he is using.
He concludes his talk with these words…
“Let us hope, that the focus of our macroeconomic policy discussion over the next 5 years shifts to a dominant emphasis on the crucial priority of generating sufficient demand to restore rapid and reasonable growth.”
In the answer portion of the video, he mentions how current monetary policy can bring back the asset bubble environment before the crisis. He mentions how low interest rates with low inflation have an unstable impact on asset prices. He says that it is better to raise demand, which points at consumption by the general population.
“It seems to me that a strategy of focusing dominantly on reducing real interest rates is a strategy of bringing back 2005…. it seems to me that the safer strategy is one that goes directly at demand at a given level of real interest rates.”
He kind of says what I have been saying. Yet I frame it specifically in terms of labor share, even though Mr. Summers does refer later in the video to the “inclusiveness” of growth. He is referring to the general population, who as I see it depend upon a reasonable labor share of income to be considered “included”.
As long as the Fed rate stays low in an environment that prefers non-productive investment by the wealthy over productive investment in the face of weak effective demand by labor, I am not in favor of easy monetary policy. However, if the Fed was to direct their funds at productive community investment with a complementary policy to raise labor share, then I would be in favor of easy monetary policy. As it is, the current policy does more long-term damage to the economy than good. He might call that damage financial instability, but he must recognize that the damage could go much deeper than that… Social instability.
This is a great day in economics to hear Larry Summers forming a debate around effective demand.
“But, but, but …… job creators!”
If people of Larry Summer’s stature start to talk about this, then something could get done a lot quicker than I ever thought. Maybe by 2018 instead of 2028.
The devil will be in the details of funding demand. And dealing with consumer’s current huge debt load.
But none of that even begins until the ‘powers that be’ recognize the source of the problem.
JimH,
I agree with you. This is a big step when Larry Summers points to demand as the cause of secular stagnation. Even Paul Krugman will certainly respond to this. What do you think he will say?
What about increasing demand by changing the feds counterparties in monetary policy? Instead of interacting with large corporates why not deal with the broader public which have a higher MPC? This can be done by providing reserve accounts to the broad public.
This “lack of demand creates over time a lack of supply (edited)” is something new? No sh*t Summers. What do you thing happened with Semi-Conductors in 2007/8?
There was more capacity than there was demand. So Infineon, ST, Onsemi, Intel, Renesas, NXP, etc. shut down production globally to match demand. In 2009 when automotive started ramping up, there was not enough capacity so they lengthened lead time from 16 weeks out to 42 weeks (which does absolutely nothing to improve delivery as it has NO effect on capacity).
The impact of lost demand is lost Labor and the lesser consequence of idle capital (L is purposely capitalized). If you want more demand, then you have to impact Labor as Labor spends money while Capital looks good and does nothing.
It took 1 full year to bring that capacity back on line for Fab (growing crystals) and Packaging (cutting them to size). We sat through weekly meeting with each supplier coercing, begging, and borrowing to get a couple of weeks supply to keep out production lines running for things such as key fobs.
This is nothing new that Summers stumbled upon. He is trying to get in front of the parade of common sense of what the demand driven of which the consumption economy consists. Don’t forget, it was he who stood in front of Congress and said Brooksley Born was throttling a market place because she was attempting to add transparently to derivatives (CDS, naked CDS, tranched MBS, etc) or investments which created profits for Capital sans Labor.
Summers channels Sandwichman!
The Sandwichman wrote back in January (Yasraeh’s Law), “I have described the lump-of-labor fallacy claim as ‘an inverted Say’s Law on steroids.'”
http://econospeak.blogspot.com/2014/04/larry-summers-crushes-lump-of-lobster.html
Larry Summers tweeted in February, “”The inverse of Say’s Law holds today: Lack of demand creates lack of potential supply.”
Sandwichman:
Not to take away from your thunder as you have been on the money long before I started reading you; but, this comment by Summers is just plain stupid. It is not even an awakening. This is just common sense.
Edward Lambert,
I don’t know what Paul Krugman will say, but I don’t think anyone can ignore Larry Summers’ speech. It may take others some time to absorb the details.
Larry Summers seems to be firmly in the lead in internalizing the lessons of the Great Recession with his speech on Secular Stagnation and now this speech “Lack of Demand Creates Lack of Supply”.
I listened to part of his speech and stopped to see if I could locate a transcript. (I could not.) The speech is apparently based on a paper. This speech was done on 2 April 2014 at an event for the Center on Budget and Policy Priorities. (Full Employment Policy Proposals) It is on YouTube with better resolution here:
If you find a transcript please post a link. I did go back to listen to the remainder. His responses to questions were interesting too.
His “Inverse Say’s Law” certainly got my immediate attention. LOL
run75441,
“Don’t forget, it was he who stood in front of Congress and said Brooksley Born was throttling a market place because she was attempting to add transparently to derivatives (CDS, naked CDS, tranched MBS, etc) or investments which created profits for Capital sans Labor.”
He, Alan Greenspan, Robert Rubin, and Arthur Levine.
We certainly would have been much better off if she had gotten her wish. How much of the housing bubble could have happened if the bankers had trouble hedging against their bundled home mortgage securities. Home mortgages made with very poor underwriting standards.
But the Great Recession would have happened anyway, only earlier, since the real problem was consumers’ wages stagnating. One refinance after another bought consumers some time, that was all.
Jim:
The real problem was profits on Capital sans Labor. This mechanism cause the stagnation of wages as jobs dropped off the face of this earth. Summers testified in front of Congress, not the others.
Apparently there were at least 4 hearings on the subject.
Look here “The Warning” starting at 33:00 to about 36:00:
http://video.pbs.org/video/1302794657/
I see everyone there but Robert Rubin, perhaps I was mistaken about him.
I think your opinion of Larry Summers is about as bad as my opinion of Alan Greenspan. (50:30 on this video).
Makes you wonder how much of life is just being present at the right time.
I just hope that Larry Summers can jump start a conversation about effective demand. Somehow he still has the stature.
JimH,
It’s good to go back and watch that video again. Thank you for posting the link to the video.
Edward Lambert,
This seems to be the paper that Larry Summers was referring to in his speech:
http://www.pathtofullemployment.org/wp-content/uploads/2014/04/delong_summers_ball.pdf
See 1:07:00 in the YouTube video of the Larry Summers speech for confirmation info.
Edward Lambert,
Larry Summers speech covered much more than the paper I referenced in the my last comment. (I still believe that this paper was the one he was referencing during his speech.)
This paper has no mention of Inverse Say’s Law, or effective demand. (There is a reference to aggregate demand.) It seems to be a defense of increased government spending or tax cuts during an economic downturn.
In my opinion, that may be a lesson for future Great Recessions but not for where we are now. The time and funds for that has been frittered away.
Jim H.
…increased government spending or tax cuts during an economic downturn…that may be a lesson for future Great Recessions but not for where we are now.
That was my first concern as I watched the video. Is he talking stimulus? If yes, then just what kind? Because, if he doesn’t mention a labor movement in some form or such words, then he’s not talking anything beyond what has been done for the politically advantaged.
We can spend via government, but if those expenditures don’t come tied to means designed to drive up wages by shifting the productivity gains, then ….
There are some false assumptions I’ve explained before. The Fed has done a brilliant job promoting economic growth, ceteris paribus.
The Fed deserves a lot of credit for QE (pun intended).
The Fed has nothing to do with lending standards set by Congress, and has to follow laws passed by Congress.
Asset booms and busts are only residuals of monetary policy, not to be confused with the production of goods & services.
Greenspan was likely the best Fed chairman the country ever had. For example, in the mid-’90s, Greenspan believed the data overestimated the potential for inflation. So, the Fed promoted faster growth, which turned out not to be inflationary.
The “$800 billion” a year of potential output didn’t go to the rich. It went to no one, because it wasn’t produced.
Supply and demand are both sides of the same coin. You can’t have one without the other. Consumers are also producers.
The U.S. has a demand problem, in part, because U.S. consumers bought foreign goods and foreigners bought U.S. Treasury bonds. Rather than those dollars being “refunded” to U.S. consumers, they were spent by the U.S. government.
And, all we got for an additional $5 trillion of federal debt over the past few years is a deep and long depression, where the U.S. continues to underproduce by about $1 trillion a year.
I just experienced an interesting phenomenon. I think that my skin crawled so violently that it created a compression wave that was actually audible to the human ear.
JimH,
Many thanks for the link to that paper. You are right. There is not a direct link between the paper and what Larry Summers said. He seems to be blazing another trail apart from the paper. Interesting strategy…
Daniel B,
I am with you. I wondered if he was simply going to support more fiscal stimulus, especially with Dean Baker and Jared there. But then he veered off course and basically said that the shortfall was somewhat permanent as long as demand stays weak.
Dean Baker tweeted me once that he did not agree that weak demand would lead to a permanent shortfall in output. So from my experience with Dean, he would not agree with the logic of Larry Summers. Actually I have not seen a reaction by Dean about what Summers said. I would presume that he does not agree with it, but he hasn’t said yet.
Interesting…
I always like it when people use the deficit to show something it does not have any direct relationship to since it is a big number.
This is a new use I haven’t seen before. Usually it is used to show how much “stimulus spending” we have done.
EMichael,
Personally, I do not look at the Federal Deficit. I focus on total government spending/borrowing, which includes state and local. Why do economists separate out the Federal? It does not make sense. Some taxes are best implemented at the local level, and some best at the Federal level. In reality, government functions at many levels as ONE government.
For example, in 4th quarter 2013, net borrowing to total tax receipts by the Federal government was 22.4%.
What do you think it was for state and local?… 12.6%
For the government as a whole, it was… 18.2%.
So the Federal deficit overstates the total government deficit.
This comes from the NIPA tables, section 3, tables 3.1, 3.2, 3.3
http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=3&isuri=1&903=86
I use the addenda numbers.
The financial sector would rather loan money to the government than have their clients pay taxes directly.
Edward, in a depression, government collects less taxes and spends more on the unemployed. So, state governments borrow from the federal government, e.g. for extended unemployment benefits.
On a personal note, the total taxes taken out of my paycheck is over 25%. And, then, there are many other taxes I pay for with what’s left over.
And, why pay more taxes than you have to, including the “financial sector.” When you pay about a 10% sales tax in California, do you say that’s too little and pay extra?
Hi PeakT,
The prime directive in economics is comparing the social costs and benefits to private social costs and benefits.
When people make their cases based on private costs and benefits, it is an error. One must look at the social costs and benefits of any issue.
Now a low Fed rate lowers private costs of capital and one might conclude that is good for society. But when there is little incentive for investment due to weak effective demand, that lower private cost of capital leads to higher private benefits for the rich and lower social benefits for the non-rich. I say the social gains in the long-term are negative with a low Fed rate.
And with taxes, lower taxes will require lower spending by government unless the government wants to borrow heavily. But that cuts into services provided and raises capital costs to the government. The financial sector enjoys private benefits from loaning money to the government, whereas taxes do not give private benefits to the financial sector. Government borrowing increases government debt. But the rich do not want to pay taxes, they prefer the private benefits of lending over what is better economically for society, which is to pay taxes and not make society indebted.
So as people choose not to pay taxes, services by government will be cut. That has a social cost, especially in an environment where labor share is shrinking and people have less of an ability to pay for social services like healthcare and education.
So when people make a case based on what is good privately for each individual, disregarding what is beneficial to society as a whole, they are breaking down the social fabric of an advanced country and leading it toward a third world dynamic.
I have traveled through many third world countries. I was even in the Chilean stock exchange when an earthquake hit. Their big board was there and many computers. No traders were there because they work in offices around the building through computers. The building swayed and creaked around me.
Now i did a study of the Chilean economy. There are rich and there are many poor. Believe me, you do not want that type of society for the US, unless you are rich and want to be rich at the expense of society.
run75441,
Comment: “This “lack of demand creates over time a lack of supply (edited)” is something new? No sh*t Summers. ”
Comment: “… but, this comment by Summers is just plain stupid. It is not even an awakening. This is just common sense. ”
First I agree with your statements completely. This is common sense. But the mainstream economics field has gotten itself so confused that they cannot accept it as true. I spent months trying to wrap my mind around this simple fact.
Apparently, Say’s Law is at the root of this mess. Originally Say’s Law probably made some sense, in some limited sense.
Read this: http://en.wikipedia.org/wiki/Say's_law
One part reads “It is worthwhile to remark that a product is no sooner created than it, from that instant, affords a market for other products to the full extent of its own value. When the producer has put the finishing hand to his product, he is most anxious to sell it immediately, lest its value should diminish in his hands. Nor is he less anxious to dispose of the money he may get for it; for the value of money is also perishable. But the only way of getting rid of money is in the purchase of some product or other. Thus the mere circumstance of creation of one product immediately opens a vent for other products. (J. B. Say, 1803: pp.138–9)[4]”
And this: “Keynes summarized Say’s law as “supply creates its own demand”, which is to say, the assumption “that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product” (from Chapter Two of his General Theory).”
This last paragraph seems to be when the wheels came off. Most economists seem to take “supply creates its own demand” as holy writ. And those with only a year or two of formal economics classes seem to be the worst. They are true believers.
It is as though you say 2 + 2 = 4 and they agree. Then you say so 2 * 2 must also equal 4 and they rebel. You say it is common sense but they won’t budge.
It is ridiculous but there it is. At some point, someone in the economic priesthood will have to step forward and say that Say’s Law doesn’t mean what Keynes said it meant or seem to say anyway. And I suspect it will provoke a fight with Keynes followers and a lot of smirks from Keynes detractors, so it is at least partially political.
I just didn’t want you to believe that I did not understand how ridiculous this actually was.
This may be confusing to some:
“It is as though you say 2 + 2 = 4 and they agree. Then you say so 2 * 2 must also equal 4 and they rebel. You say it is common sense but they won’t budge.”
This is better:
“It is as though you say 2 + 2 = 4 and they agree. Then you say so 2 x 2 must also equal 4 and they rebel. You say it is common sense but they won’t budge.”
Edward, you deserve a lot of credit that although I disagreed with some of your statements, you never deleted them, like some others here.
PeakT,
No doubt we have our differences, but I want to hear what you have to say and see how others respond.
SW
April 8, 2014 10:48 am
“I just experienced an interesting phenomenon. I think that my skin crawled so violently that it created a compression wave that was actually audible to the human ear.”
I’ll trade you that for my phenomenon that my hair hurts when I read something like you are referring to. Your skin stops crawling, my hair keeps hurting.
In the comments above I inferred that Arthur Levine had appeared before Congress in opposition to Brooksley Born’s attempt to regulate derivatives.
Actually it was Arthur Levitt. Sorry for causing the confusion.
In the video, at around 56 minutes, Summer’s makes the following statement…
“I would say there is a concept called repressed budget deficits… when you defer maintenance, don’t fund pension liabilities, underpay civil service, and let it atrophy, fail to engage in investments to replenish leadership, thats repressing the deficit and that is pushing a debt forward to the next generation, just as surely as borrowing money, with something called bonds, and I would say to you that the rate at which that debt accumulation long term debt.s is pretty far above the zero short term interest rate on paper debt, or the 2.7% interest rate.”
I may be challenged in my understanding of economics, but this was an “aha” moment for me. “Pay me now, or pay me later.”
I would think this, if framed properly, would be a powerful political message. Reframe the discussion from pushing forward a dollar debt to pushing forward a real physical deficiency in ability to deliver the products, services, and infrastructure we need to meet the future needs of everyone.