Facebook Twitter LinkedIn

Very few people understand economic theories such as supply and demand, the quantity theory of money, comparative advantage, AS/AD, etc. As a result, if journalists explained things using these economic concepts, their readers would be hopelessly confused. Thus even the elite news media tends to rely on some version of what Paul Krugman once called “Pop Internationalism.” It’s hard to blame them, but unfortunately this analytical apparatus uses economic terms in a very different way from how economists use the terms. So while their readers can follow the articles, I cannot. Here’s an example of pop macroeconomics from the Wall Street Journal:

The global economy is awash as never before in commodities like oil, cotton and iron ore, but also with capital and labor””a glut that presents several challenges as policy makers struggle to stoke demand. “What we’re looking at is a low-growth, low-inflation, low-rate environment,” said Megan Greene, chief economist of John Hancock Asset Management, who added that the global economy could spend the next decade “working this off.” The current state of plenty is confounding on many fronts. The surfeit of commodities depresses prices and stokes concerns of deflation. Global wealth””estimated by Credit Suisse at around $263 trillion, more than double the $117 trillion in 2000″”represents a vast supply of savings and capital, helping to hold down interest rates, undermining the power of monetary policy. And the surplus of workers depresses wages. Meanwhile, public indebtedness in the U.S., Japan and Europe limits governments’ capacity to fuel growth through public expenditure. That leaves central banks to supply economies with as much liquidity as possible, even though recent rounds of easing haven’t returned these economies anywhere close to their previous growth paths. “The classic notion is that you cannot have a condition of oversupply,” said Daniel Alpert, an investment banker and author of a book, “The Age of Oversupply,” on what all this abundance means. “The science of economics is all based on shortages.”

I’m not quite sure what the WSJ means by “glut” or “stokes demand” or “oversupply” or “vast supply of savings and capital” or “surplus” or “abundance” or “surfeit of commodities” or “working this off” or “shortage.” Yes, some of these terms are also used by economists. For instance, we use the term ‘shortage’ to refer to a situation where quantity supplied exceeds falls short of quantity demanded. But obviously “the science of economics” is not “all based on shortages.” The authors obviously mean something entirely different. Wealth also has a clear meaning in economics, but it is not something that “represents a vast supply of savings and capital, helping to hold down interest rates.”

When they say, “stokes demand” I’d guess they mean boost AD. But if so, why would a “glut” of commodities make it more difficult to boost AD? And exactly what does a “glut” of commodities mean? Does it mean a surplus, reflecting a price above equilibrium? Then why doesn’t the price fall? Commodities usually trade in auction-style markets. And what is “oversupply? Is it increased supply, or a surplus? If the “classic” model says you can’t have oversupply, then what’s wrong with the classic model? We are not told.

Producers have their own share of the blame. In a lower commodity price environment, producers typically are reluctant to cut production in an effort to maintain their market shares. In some cases, producers even increase their output to make up for the revenue losses due to lower prices, exacerbating the problem of oversupply. “Generally, this creates a feedback cycle where prices fall further because of the supply glut,” said Dane Davis, a commodity analyst with Barclays.

If the price were artificially held above equilibrium, then it would not fall. If it falls, then presumably price is determined by the forces of supply and demand. In that case a “supply glut” presumably means an increase in supply. But the most notable thing about the world economy in recent years is the extremely slow pace of increase in the aggregate supply curve. Thus even during a period of falling unemployment in the US (2009-15), real GDP growth has been quite slow, and the trend rate of growth (the rate LRAS shifts right) is even slower. It’s even worse in Britain, the eurozone, and Japan.

Even if governments have the capacity for more fiscal stimulus, few have the political will to unleash it. That has left central banks to step into the void. The Federal Reserve and Bank of England have both expanded their balance sheets to nearly 25% of annual gross domestic product from around 6% in 2008. The European Central Bank’s has climbed to 23% from 14% and the Bank of Japan to nearly 66% from 22%. In more normal times, this would have been sufficient to get economies rolling again,

This is a rather odd way of making the point. Yes, an increase in the monetary base is usually associated with a rise in AD. But it is not the case that an increase in the base/GDP ratio is normally associated with higher AD, in fact just the opposite. Higher base/GDP ratios are usually associated with monetary policies that stop economies from “rolling again.”

Here’s how I’d look at the global picture:

1. The data suggests that global productivity growth is slowing, as is global growth in the labor force. The global AS curve is still shifting right, but more slowly. The Wicksellian equilibrium real interest rate is falling.

2. In some areas (particularly the eurozone) AD is too low because money was far too tight around 2011-12, leading to high unemployment.

I’m not sure what all the “glut” discussion adds to this. But maybe that’s because I’m an economist who doesn’t live in the real world. Or at least that’s what my commenters keep telling me.

HT: Ken Duda

Facebook Twitter LinkedIn

Tags:

This entry was posted on April 28th, 2015 and is filed under Heterodox macro. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.



