Larry Summers is beginning to see Effective Demand
Larry Summers wrote a post yesterday about the hollowing out of the middle class and how that has lowered consumption and led to secular stagnation. He says that this effect must be taken into account for policy.
Well I sit here after 4 years of building models of Effective Demand using labor share… My models have performed accurately.The drop in labor share reflects the hollowing out of the middle class. The data for labor share allows precise models to be built for secular stagnation. Larry Summers is absolutely right when he paints a basic picture of policy implications…
“What is the policy implication? Principally, it is the macroeconomic importance of supporting middle class incomes. This can be done in a range of ways from promoting workers right to collectively bargain to raising spending on infrastructure to making the tax system more progressive. These are hardly new ideas. And I supported them before seeing this new research. But there is now another powerful argument in terms of mitigating secular stagnation in their favor.”
Larry Summers sees new research, but I have seen 4 years of economists not understanding effective demand. So when I see Larry Summers’ post, I again see how far behind economics is in truly understanding the dynamics of effective demand. He notices a connection between labor income and economic potential, but has no model to define it yet. I have a models of effective demand that work and that can be built upon.
From my models, the effects and limits of effective demand are definable and forecastable in terms of labor and capital utilization and more such as interest rate policy. My models show that the effect on natural real rates from a drop in effective demand can be measured.
Larry Summers has not said it yet, but corporate after-tax profit rates will have to drop.
Also, my models show that the Fed missed a whole interest rate cycle and they do not even know it yet. They still think the cycle is just beginning. That shows how much an understanding of effective demand is lacking. It is a serious issue.
Larry Summers does not have precise models yet for effective demand, but he has opened the door to knowing.
What is “effective demand”, in contrast to “ineffective demand” or plain old “demand”?
Keynes defined effective demand as a limit on expected profits by entrepreneurs. At the effective demand limit, profits are maximized and utilization of resources starts to be cut. My models predicted in 2013 that the profit cycle would peak in late 2014. And they did. There is an effective limit upon the biz cycle from demand. That is effective demand.
Have you written a paper and tried to get published or at least circulated among heterodox economists like Dean Baker, John Quiggin, Steve Keen, James Galbraith, Barkley Rosser, Peter Dorman, etc.? From reading Roger Farmer’s blog, I see some similarity with your ideas and his, since you both escape the “neo-Fischer” conundrum of how to raise nominal interest rates without putting the economy in recession by boosting Fiscal demand.
Hi Sherparick. All first time commenters go to moderation. Approved both of yours and this won’t happen again. Welcome
Hi Sherparick,
I only have my blog where I post the development of my models.
You are obviously paying attention to the issues and who is doing what.
After my initial post I read your Angry Bear colleague Robert Waldman’s suggestion that Krugman, Romer, Kocherlakota, etc. getogether and create a new economics journal for a new macro-economics of the post DSGE wrong turn.
Also, this is Farmer’s latest blog post, hitting some of the same themes that you do. http://www.rogerfarmer.com/rogerfarmerblog/2016/9/27/the-liquidity-trap-and-how-to-escape-it-time-for-a-new-approach
There is a difference between me and Farmer… labor share has to be raised. He does not state that. He looks to Fiscal Policy…
But if labor share stays the same, then any money circulating through the economy from fiscal stimulus falls into the same low labor share rut, with stimulus money going more to capital than should be… in the end the problem is not solved.
Labor must have a stronger voice. Labor share must rise, which implies lower corporate profit rates… which will lead to corporate incentives to raise prices… but that has to be done together with a normal interest rate cycle, where creative destruction is normal. The economy lacks important creative destruction with such low nominal rates.
Edward,
Here is an Ezra Klein interview with Larry Summers in 14 January 2014:
https://www.washingtonpost.com/news/wonk/wp/2014/01/14/larry-summers-on-why-the-economy-is-broken-and-how-to-fix-it/
And here is a question from Ezra Klein and the answer from Larry Summers in that interview:
————————————————— Start —————————————————
“EK: How do you measure that? That is to say, how do you distinguish an economy that can’t generate enough demand from one that simply hasn’t generated enough demand quite yet?
LS: No one can be sure. I’ve spoken of secular stagnation as a contingency that has to be planned for rather than a certainty that has to be assumed. No one would be more pleased than I if the economy suddenly hit escape velocity and grew at four percent for the next several years while remaining stable financially. We are now 10 percent below where we thought the economy would be now in 2007, as the economy has performed surprisingly poorly in the past four years. There’s been close to no progress in regaining potential measured relative to the judgments made at the time in 2007. There’s been only very, very limited progress — even adjusting for demography — in restoring the fraction of the adult population that is working (the employment ratio to previous levels).
One of the reasons for my concern was that before the financial crisis, when we had the mother of all bubbles in the housing market, that was enough to propel growth to perhaps adequate levels, but not enough to produce any kind of overheating as measured by wage and price inflation or as measured by unemployment relative to traditional low points. Imagine the economy between 2003 and 2007 without the consequences of housing bubbles and overly easy credit. Housing investment would have been two to three percent of GDP lower, and consumption expenditure would have been considerably lower, as well, resulting in very inadequate performance.”
————————————————— End —————————————————
So in this interview, we see the first inkling that Larry Summers’s view of the world is changing and why it is changing. He recognizes that something was very wrong before the Great Recession.
In the 29 September 2016 post which you cite, we see Larry Summers recruiting an IMF working paper which he says shows that declines in middle class incomes have reduced consumer spending by 3% or $400 billion annually.
And he includes this:
“This level of reduction in spending is huge. For example, it exceeds by a significant margin the impact in any year of the Obama stimulus program. Alone it would be enough to account for a significant reduction in neutral real interest rates. If consumers were spending 3 percent more, there would be scope to maintain full employment at interest rates much closer to normal. And there would be much less of a problem of monetary policy’s inability to respond to the next recession.”
Now he has put the pieces together. Our problems predate the Great Recession and if consumers were spending 3% more then we would be closer to full employment at normal interest rates. And the bonus would be that monetary policy could be used to respond to the next recession!
But can he persuade other mainstream economists to accept his argument? There has been a lot of noise in the discussions of our continuing economic problems. By noise I mean all the trashing around looking for any economic explanation that would allow the ‘powers that be’ to continue their supply side economics.
His recommended solutions would be ‘dead on arrival’ (DOA) in the Republican controlled US Congress. But if tariffs were increased enough, some US corporations would move production back into the United States. That would increase labor share by raising employment and thus increase consumer spending. But this idea is also DOA in the US Congress unless Donald Trump is elected. And it might be DOA anyway.
I think that you are right that corporate after-tax profit rates will have to drop. (Unless some production is moved back to the US.)
So I expect this tragedy to continue to play out for another decade or two.
JimH,
Thank you for your well thought out comment.
Be careful of Trump saying that he would raise tariffs and that labor share would rise as a result. Remember he is in favor of a weak minimum wage of $8 to $10.
https://www.washingtonpost.com/news/fact-checker/wp/2016/08/03/a-guide-to-all-of-donald-trumps-flip-flops-on-the-minimum-wage/
His views on minimum wage do not speak well to raising labor share.
Then if he wins and raises tariffs, then firms will have more incentive to cheat around the tariffs as has been done by Chinese firms for years. And corruption would increase under Trump. The people who work for him and he himself will micromanage everything in their own favor. That is how this type of government works in Latin America. I have lived in Latin America. I know what type of classist, elitist, racist, selfish person Trump is. He wants to amass a personal wealth to rival all others in the world while degrading other cultures and races. Not good.
You really believe you are ahead of Larry Summers on macro economics?
Hubris
arrogance, conceit,pomposity, superciliousness, superiority, cockiness
He seems to just now be realizing the impact of low labor share… yet all he can say is that there is a 3% drop in consumption. That is a weak blunt model to have.
So yes, I am ahead of him. I have taken labor share to pinpoint the peak of the profit rate cycle. I have taken labor share to diagnose interest rate policy. I have taken labor share for a model of inflation.
So yes again, I am ahead of him. He does not see as deeply as I see into the dynamics of labor share. He does not have a model to explain more. All you get is a 3% drop leading to less consumption… That is the beginning of any model, but he does not give any more model than that. That is sad for economics.
Bruce? Project much? You calling out anyone on superciliousness is like, I don’t know, Julius Caesar calling out someone on ambition? Midas on covetousness?
EL – I ask if you think you are smarter than Larry Summers on economics and you respond:
“I am ahead of him”
Well, you’ve got balls.
The CV for Summers:
http://siepr.stanford.edu/sites/default/files/people/cv/5257-summers-cv.pdf
Summers screwed the pooch on the original stimulus plan by bending to politics (as he saw it) and side lining actual economics. Something he largely admits now.
And an overreliance on CVs is what got Obama into so much trouble to start with. For the most part he put WAY too much credence in folks from Chicago School of Business (Goolsbee) and Harvard and Harvard’s Kennedy School of Government (Summers, Liebman, Cutler) in picking his initial econ team that he went soft (tax cuts) rather than hard (infrastructure spending) in balancing the stimulus. As a result banks got their bailouts, big business started on their ongoing project of stocking up cash in the back room, and the multipliers that were supposed to result from reinvestment largely didn’t happen. Much of this from listening to Larry while sidelining folks like Christina Romer. For example this from Wiki: https://en.wikipedia.org/wiki/Christina_Romer
“In late 2008, Romer along with fellow economic advisors Larry Summers and Peter R. Orszag presented then-President-elect Barack Obama with recommendations for a stimulus package.[18] Romer calculated that a $1.8-trillion package was necessary to fill the output gap, but Summers rejected the proposal and opted not to include it in the memo fearing that a trillion-dollar package would not pass through Congress.[19] The Obama administration ultimately passed an $800-billion package.”
Thanks, Edward. Is that maximization of TOTAL profits, or profit per widget?
EL – All of your analysis and conclusion are driven by after tax corporate profits as measured by FRED. I say there are many flaws to this data series. If you understood corporate finance you would know that companies are constantly manipulating earnings.
A very large example of this is the $2.1 Trillion of earnings that US companies have chosen to keep offshore in order to avoid or delay US taxes. I do hope you are familiar with this?
Those earnings are not included in your data set as the taxes, have not yet been paid, So we have 150% of annual corporate earnings that has been fudged over the past eight years.
Does your model adjust for this well documented aspect of modern corporate finance?
Would you like some more examples of how your data set is flawed?