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Circular Flow of Income theory

I'm obviously in a camp that doesn't think the standard economic theory is completely correct. And before you dismiss that, my camp includes plenty of Ph.D.s that studied standard economics and then came to the MMT camp, plus those Ph.D.s that started out there. So it has some validity.

My intention was not to drown your claims but to be precise about how economists work out the relationship between real variables and nominal variables.*If you're going to make the case that it is wrong, the first thing to do is to be very clear about it is you criticize.

And I don't think of DSGE models as exactly correct, as much as I think they are useful tools to organize arguments. I know that Lawrence Christiano, Martin Eichenbaum, and Paul Krugman have expressed this kind of view in the past. John Cochrane also has a similar view and it's the opinion all macroeconomists under which I studied share.

That said, your explanations might as well be written in German for all the help they are to a layman. You need to dumb it way down on this forum.

Let me try it again.

The most fundamental concepts in economics are preferences and option costs. Here, the important bit concerns option costs. The idea is that when you can't have your bread and eat it too, so one must be sacrificed to obtain the other. That which you sacrifice is the option cost. Now, in a context where you have prices, this means that what will matter are price ratios: the rate at which the market allows you to sacrifice, say, little American flags for some beer on every July 4th is what matters.

This feature is not a bug, but a fundamental feature of economic theory. It's everywhere, including in our most sophisticated models and because it's the ratio of prices that matters, you get the core of what makes money neutral in some models: if you multiply all prices by 10, no ratio has changed (because you multiply the numerator and denominator of each ratio by 10), hence, if nothing else has changed, the behavior of people is the same. The way you work around this is obvious: you want some, but not all prices to be multiplied by 10 so that some ratios change and the behavior of people therefore also changes, even if nothing else happened. That's what price stickiness does in New Keynesian models: it creates drag in average price adjustments (sometimes also in wage adjustments) that have consequences on real variables like output, consumption, investment, etc.

So, to respond to a comment you made previously, money doesn't come first in this view. What is fundamental is how many hours I need to work to buy a bag of oranges and prices are just instruments that convey this information, even if I gave above an explanation as to how this information might be distorted by delays in pricing adjustments. You don't care about dollars, except through what dollars can get you if you prefer. That's the point of view of contemporary economics, though I left out some subtleties, hopefully to make more accessible.

Right now in Jackson Hole, Krugman and Summers are coming to some very MMT-like conclusions, but without acknowledging MMT itself or any of the MMT academics that have been saying the same things, and publishing papers, for years. They are bending into pretzels trying to validate Krugman's IS/LM ideas, instead of simply questioning whether it's valid at all. Mostly, I believe, because they have too much to lose by admitting that they have been wrong for years.

This will shock you, but the arguments made by Krugman and Summers are not esoteric. Krugman's Wonderland analogy, his arguments about the ineffectiveness of monetary policy at the zero lower bound, about how unconventional monetary policies should play out, about the power of fiscal policy during a zero lower bound spell, etc. ALL of that without a single exception comes out of a New Keynesian DSGE model. Krugman uses the IS/LM diagrams to get his point across to a lay audience, but the point can be even more forcefully be made in a New Keynesian model.
 
This is not true either. These are accounting identities, not expenditures as the FRED article notes. Furthermore, there is a stock of savings that can (and is) drawn upon to make purchases.

Not in an aggregate sense. You may draw $5 out of your savings and spend it, but somebody else is putting away $6.

Economic growth is more than deficit spending, which is what you're trying to make the case for throughout these exchanges... i.e. that the Treasury should forego issuing bonds and just print their expenditures on demand. I for one oppose this type of system, because it incorrectly assumes that government is the driver of innovation and growth.

You misunderstand what I am saying. I am saying that economic growth requires an increase in aggregate demand year over year, and that requires in increase in income year over year, which requires some combination of increased credit and/or deficit spending. Because the money has to come first. Any real-world increase in production is going to require more labor and more materials, and nobody works, or gives you materials, for free.

It could be paid for by net exports, but we don't do that. And it could be paid for by net "dis-saving," but we don't do that, either. So we are left with increased credit and federal deficit spending.

As for your point about issuing bonds, there is no difference between a dollar and a zero interest bond. We are getting to that point where it is silly to argue that the direct issue of currency would be inflationary, but zero-yield bonds would not be. Anyway, that's a side issue.


Again, you're improperly understanding what the NIPA identities are telling you. Output is consumed on the basis of production, not income.

That sounds like a "money is neutral" position.

People can go into debt,

That's credit.

Same applies with government.

And that's deficit spending.

pull from savings,

But in the aggregate, they don't.

substitute, etc... in order to meet their consumption and investment goals in the absence of the necessary income.

We are saying the same thing here.


No it does not! I cannot understand why you're refusing to acknowledge this simple point: imports do not reduce GDP.

Repeat after me... imports do not reduce GDP.

Not in the year that you are measuring, maybe. But over time, I stand by my reasoning.

What does reduce GDP in times of recession? Reduced demand for domestic production, for whatever reason. Production goes down, and our income goes down. So our potential demand (from that income) must go down as well.

You would get the same demand-lowering effect if everybody decided to save 20% of their income. And trade deficits are just savings by foreign parties - Chinese workers earn dollars, then don't spend them.
 
You misunderstand what I am saying. I am saying that economic growth requires an increase in aggregate demand year over year, and that requires in increase in income year over year, which requires some combination of increased credit and/or deficit spending. Because the money has to come first. Any real-world increase in production is going to require more labor and more materials, and nobody works, or gives you materials, for free.

First of all, nobody wants money. They want what money buys.

Second of all, it's not because you increase the supply of money that people can suddenly magically produce more. More money doesn't make anyone more productive by even one iota. You just have exactly the same real situations with the same real constraints, except with more money. The only force countering an immediate increase in price is the presence of sticky prices and that fades over time. The best argument you will have is that in a draught, handing out money in a system with pricing that takes time to update itself might lead the economy to push closer to its potential, but that is not an infinitely lived situation.

Third of all, deficit spending cannot be an eternal constant either. At some point, that debt needs to be paid back, so there absolutely is a level -- perhaps a very high level, but some level nonetheless -- beyond which it is no longer possible to sustain that scheme.
 
First of all, nobody wants money. They want what money buys.

But they do get paid in money. And at some level, people do want money more than what it can buy; savings are proof of that.

Second of all, it's not because you increase the supply of money that people can suddenly magically produce more. More money doesn't make anyone more productive by even one iota. You just have exactly the same real situations with the same real constraints, except with more money. The only force countering an immediate increase in price is the presence of sticky prices and that fades over time. The best argument you will have is that in a draught, handing out money in a system with pricing that takes time to update itself might lead the economy to push closer to its potential, but that is not an infinitely lived situation.

Then explain to me how an economy increases aggregate demand year over year without an increase in either credit or deficit spending. Would you work overtime for free?

Ford isn't constrained by the lack of available labor, or the lack of parts. Ford produces as many cars as they forecast they can sell. They are only constrained by demand. At least, on realistic points on the curve. I'm not claiming that they can make an infinite number of cars. But they can certainly produce more than they do now, if the demand was there.

Third of all, deficit spending cannot be an eternal constant either. At some point, that debt needs to be paid back, so there absolutely is a level -- perhaps a very high level, but some level nonetheless -- beyond which it is no longer possible to sustain that scheme.

The government has no operational need to extinguish its liabilities.

If there is a limit on the number of govt. liabilities that can exist as savings in a healthy economy, and you think something bad would happen at that level, I'm willing to listen. But if you are going to make the argument that an infinitely high number of dollars would be inflationary, therefore all points on the curve leading up to that are bad, I'm not going to buy it.
 
But they do get paid in money. And at some level, people do want money more than what it can buy; savings are proof of that.

Savings is consumption tomorrow. Money is just one type of good against which we chose to measure all others.

Ford isn't constrained by the lack of available labor, or the lack of parts. Ford produces as many cars as they forecast they can sell. They are only constrained by demand. At least, on realistic points on the curve. I'm not claiming that they can make an infinite number of cars. But they can certainly produce more than they do now, if the demand was there.

This might surprise you, but the New Keynesian models I talked about earlier imposes 3 constraints on businesses: technology, demand and some kind of pricing rigidity. Yet, if you try to match the statistical patterns in the data with this kind of model, you find that innovations to overall productivity are a major driver of business cycle fluctuations. Often, innovations to productivity and to the marginal efficiency of investment (how easy it is to transform savings into productive capital) are the only two drivers of long term economic growth, besides population growth. All of this in spite of the fact that changes in deficit and credit conditions are often present in those models.

The reason is as follows: in the long run, the economy is pressing against the production possibility curve. Why? Because businesses are thought to, at least to a first approximation, to do their best. So, once the effect of nominal rigidity has faded, you need the ability of the economy to produce more of everything to increase, or else, all consumers can do is change the point they pick along the same curve. That's the theoretical reasoning -- which I doubt you will buy in any event.

However, irrespective of this, you have quite a big empirical problem. Notwithstanding the military buildup of the late 1930s and 1940s, the net federal budget position as a share of GDP was considerably smaller and more often positive in the 1950s and 1960s than in all subsequent periods. So, you have on average much less buildup of debt in the decades when the average growth rates were higher and much more buildup of debt in the decades when the average growth rates were lower. This story is true also of European countries and Canada. The growth rates were much higher earlier than later in the 20th century and most of the welfare programs responsible for major spending hikes and subsequent deficits were put in place in the second half of the 20th century.

So, it's a problem: the government starts spending borrowed money a lot more in proportions of total production in the same periods which shows slower growth of that production. In a typical macroeconomic model, this has a very obvious explanation. The government is, at least in the long run, diverting resources away from the private sector when it borrows. You only get the kind of dynamic you have in mind (depressed aggregate demand leads to slower growth) in very specific contexts in those models and it's always temporary: eating up some slack by borrowing and spending what consumers or businesses will not spend works only if a sort of paradox of thrift emerges and it never lasts eternally. You can agree or disagree with the methodology. The point is that your claim would work only temporarily in very specific circumstances if those models are right and these models do offer and obvious way to rationalize the fact you have high real growth in the 1950s with somewhat balanced budgets and low real growth rates today with rather proportionally large deficits.
 
The government has no operational need to extinguish its liabilities. If there is a limit on the number of govt. liabilities that can exist as savings in a healthy economy, and you think something bad would happen at that level, I'm willing to listen.

Say the government issues zero-coupon bonds. The engagement by the government is to repay face value at a predetermined date to the holder of each bond. The way it works is that the government sells those bonds to commercial banks. The interest would be implicitly defined here as the gap between the amount they got by selling the bonds and the total face values of those bonds. The banks turn around and sell the bonds to various types of investors. Institutional investors could include pension funds and hedge funds, for example. Ultimately, those guys are just managing the wealth of ordinary Joes.

You understand that, ultimately, what we are describing is a transfer of funds now from individuals and businesses to the government? Alright. The other point is that the wealth of those ordinary Joes can take various forms: cash, bonds, stocks, corporate paper, even physical things like machinery in non-incorporated businesses or buildings. All of this can eventually be traced to be funding some productive activity or the consumption of someone else. Some multiple of cash deposits are used to issue loans, bonds and corporate papers are loans to governments and businesses, and obviously physical capital of all kinds can be used in production.

What I am getting at here is that there exists a direct relationship between savings and investment from a bird's eye view. Absent other side effects, the government borrowing IS taken right out of those savings NOW. It may very well be the case that what the government does with it, on net balance, creates enough of a hike in production that savings do not ultimately fall and even increase (it's what happens at the Zero Lower Bound in many NK DSGE models). However, we must not forget the point that (1) the funds the government borrows are ultimately the funds of someone else and (2) those funds actually represent stuff, resources. That the government may roll over its debt by issuing new instruments when the time comes to pay back bondholders does not change what I just said. Right here, right now, the funds come from somewhere and that place happens to be your pockets. It's an important point because what it says is that borrowing, like taxing, ultimately substitutes one set of decision-maker for another. If you bought corporate paper or corporate bonds, instead, a business would be choosing what to buy. Likewise, if you prefer cash, a bank would lend the money to someone else and they would decide how to spend it.

That's one reason why economists tend not to like it when deficits pile up: in most of our models, most of the time, it creates drag and we have every reason to suspect funds in the hands of bureaucrats do not tend to be very well used.
 
Not in an aggregate sense. You may draw $5 out of your savings and spend it, but somebody else is putting away $6.

I'll just use data to make my point... can you do the same?

fredgraph.png


I am saying that economic growth requires an increase in aggregate demand year over year, and that requires in increase in income year over year, which requires some combination of increased credit and/or deficit spending. Because the money has to come first. Any real-world increase in production is going to require more labor and more materials, and nobody works, or gives you materials, for free.

Government deficits are not the pinnacle source of aggregate demand. What is most desirable is for the private sector to drive AD, and when market failure curtails growth, government steps in to bridge the gap.

That sounds like a "money is neutral" position.

It's not.

But in the aggregate, they don't.

The data tells another story. Savings trajects upward because, for the most part, the economy trajects upward.

Not in the year that you are measuring, maybe. But over time, I stand by my reasoning.

Again, the data tells a different story. Imports and output move together:

fredgraph.png


What does reduce GDP in times of recession?

Businesses reduce investment (and at the same time cut (labor) costs).

Reduced demand for domestic production, for whatever reason.

This is incorrect. It's typically investment that stalls or falls in sync with costs firms are willing to take on in order to derive profit. We see investment fall first, then consumption declines (if it does in a measurement sense).

You would get the same demand-lowering effect if everybody decided to save 20% of their income. And trade deficits are just savings by foreign parties - Chinese workers earn dollars, then don't spend them.

JFC... imports do not reduce GDP. You're simply incorrect and refuse to acknowledge this fact. Are there situations we can construct where imports do reduce growth? Sure. But the data we have tells us a much different story. We had this same discussion 6 years ago, and you're still trying to make the data fit your theory as opposed to deriving a theory that's driven by the data.
 
I'll just use data to make my point... can you do the same?

fredgraph.jpg
fredgraph (1).jpg

Your graph is of the % change from the previous year, so of course it's going to go up, down, and negative. But my point has always been that there is net savings every year. Point being that we never use our savings to grow. We use credit.

Government deficits are not the pinnacle source of aggregate demand. What is most desirable is for the private sector to drive AD, and when market failure curtails growth, government steps in to bridge the gap.

Right, the main source of demand is past income - money that goes through the cycle. Then you add in increased credit. Then you add in deficit spending. Then you subtract savings, both foreign and domestic.

It would be great if the private sector could hold up its end of the bargain as you describe, but we lose too much to savings.
 
Your graph is of the % change from the previous year, so of course it's going to go up, down, and negative.

It's not percentage change, but is annualized change in current dollars.
 
Savings is consumption tomorrow. Money is just one type of good against which we chose to measure all others.

Money is more than just another commodity. We can't just immediately come up with more apples if there is a jump in demand, but we can come up with more money on the spot.

Savings might mean consumption tomorrow for an individual, but in the aggregate, we always net save. So savings today really just means lost consumption for today that won't be made up in the future.

This might surprise you, but the New Keynesian models I talked about earlier imposes 3 constraints on businesses: technology, demand and some kind of pricing rigidity. Yet, if you try to match the statistical patterns in the data with this kind of model, you find that innovations to overall productivity are a major driver of business cycle fluctuations. Often, innovations to productivity and to the marginal efficiency of investment (how easy it is to transform savings into productive capital) are the only two drivers of long term economic growth, besides population growth. All of this in spite of the fact that changes in deficit and credit conditions are often present in those models.

The reason is as follows: in the long run, the economy is pressing against the production possibility curve. Why? Because businesses are thought to, at least to a first approximation, to do their best. So, once the effect of nominal rigidity has faded, you need the ability of the economy to produce more of everything to increase, or else, all consumers can do is change the point they pick along the same curve. That's the theoretical reasoning -- which I doubt you will buy in any event.

I'm not saying that increases in productivity have nothing to do with growth. I'm just saying that you won't realize growth without money up front to pay for it. Nothing comes for free - not tech innovations, not better machines, and not increases in labor.

However, irrespective of this, you have quite a big empirical problem....

...The point is that your claim would work only temporarily in very specific circumstances if those models are right and these models do offer and obvious way to rationalize the fact you have high real growth in the 1950s with somewhat balanced budgets and low real growth rates today with rather proportionally large deficits.

What this sounds like to me is that you look at a graph of deficit spending vs. growth, notice that deficit spending seems to go up as economies slow down, therefore you are assuming deficit spending to be the cause of the slow growth.

I would counter by saying that a depressed economy means lower tax revenues, which, combined with fairly steady government spending, gives you increased deficits (and debt).

I would also counter that your models would suggest that austerity is the best way out of a recession, but that didn't work for Europe.

And finally, I would counter that you can't just look at the years that fit your theory well to prove your point. The Depression counts, and WWII counts. Did deficit spending cause the Depression, or was it a cascade of failing private debt? And did we get out of the recession when the government stopped diverting resources away from the private sector, or did we get out of it when we finally stopped waiting for the private sector to "come around" and increase investment in the face of a still-depressed economy?

*******************

The post WWII era does not hurt my case. (I used to have a bookmarked chart with yearly C, I, netG, X, and M for the whole 20th century, but it's on an old computer somewhere). Due to the G.I. Bill, we had tremendous jumps in consumption and investment that took the place of wartime deficit spending. That came from credit, not savings. We also used to run trade surpluses.

We ran a surplus in 47, 48, and 49. Recession in 48-49. Surplus in 56-57. Recession in 1957. That all makes perfect sense to MMT, because a surplus is money being pulled out of the active economy. To us, the government is just another customer, one with really, really good credit. Credit so good that we are happy to hold their debt instruments as rock-solid assets, and replace them with more debt instruments when they mature.
 
Money is more than just another commodity. We can't just immediately come up with more apples if there is a jump in demand, but we can come up with more money on the spot.

You can print more money. The point is that this eventually will turn up as increased prices because what matters, in the long run, is the capacity to bring things to the market.

Savings might mean consumption tomorrow for an individual, but in the aggregate, we always net save. So savings today really just means lost consumption for today that won't be made up in the future.

You missed part of what I said. Of course, you always have net savings. Investment derives from savings in the aggregate.

What this sounds like to me is that you look at a graph of deficit spending vs. growth, notice that deficit spending seems to go up as economies slow down, therefore you are assuming deficit spending to be the cause of the slow growth.

No, I said that you have to come up with a good reason for what we see. The implied correlation above has the wrong sign given your view that deficits tend to drive economic growth.

I would counter by saying that a depressed economy means lower tax revenues, which, combined with fairly steady government spending, gives you increased deficits (and debt).

In the United States just as in Europe, you have several-fold increases in government expenditures related to welfare programs in the latter half of the 20th century. It's true that the growth rates could not keep up, but it's not "fairly steady spending," unless you make your cut somewhere after the Great Society and War on Poverty program of the Johnson administration in the US, for example.

Moreover, you talked about deficit spending. That can happen through combinations of tax cuts and spending hikes of all sorts unless you really meant just spending.

I would also counter that your models would suggest that austerity is the best way out of a recession, but that didn't work for Europe.

There is a difference between long term and short term growth. Over sufficiently short spans of time, you can get pretty large multipliers on deficit spending in reasonable DSGE models that would still agree with my comments about long term growth. Over the span of a few quarters to a few years, a timely bout of deficit spending can do a lot. It's a point of controversy, but it is defensible.

And finally, I would counter that you can't just look at the years that fit your theory well to prove your point. The Depression counts, and WWII counts. Did deficit spending cause the Depression, or was it a cascade of failing private debt? And did we get out of the recession when the government stopped diverting resources away from the private sector, or did we get out of it when we finally stopped waiting for the private sector to "come around" and increase investment in the face of a still-depressed economy?

Usually, we set aside the period prior to 1947 for lack of quarterly data, but it is true that we would ideally prefer to take the whole data. It wouldn't look better for you, however, because if you all the way back to the 19th century, we do have old estimates that we can use at a yearly frequency, I believe, for the US and possibly also for England. Average growth rates were quite high until the Depression and things did fall back in place when the US entered WWII. Until the 1960s, you wouldn't have heavy government budgets outside of wartime, hence the point remains: the correlation would be negative.
 
You missed part of what I said. Of course, you always have net savings. Investment derives from savings in the aggregate.

This is something I have always wanted to understand.

To me, a sensible definition of savings is money that I don't use to consume or invest. How do you get real Investment from my savings? What is the real-life mechanism?
 
I'm not understanding what you're trying to say.

You missed part of what I said. Of course, you always have net savings. Investment derives from savings in the aggregate.

Consider the possibility that you have it backwards...

It begins with what’s called “the paradox of thrift” in the economics textbooks, which goes something like this: In our economy, spending must equal all income, including profits, for the output of the economy to get sold. (Think about that for a moment to make sure you’ve got it before moving on.) If anyone attempts to save by spending less than his income, at least one other person must make up for that by spending more than his own income, or else the output of the economy won’t get sold.

Unsold output means excess inventories, and the low sales means production and employment cuts, and thus less total income. And that shortfall of income is equal to the amount not spent by the person trying to save. Think of it as the person who’s trying to save (by not spending his income) losing his job, and then not getting any income, because his employer can’t sell all the output.

So the paradox is, “decisions to save by not spending income result in less income and no new net savings.” Likewise, decisions to spend more than one’s income by going into debt cause incomes to rise and can drive real investment and savings. Consider this extreme example to make the point. Suppose everyone ordered a new pluggable hybrid car from our domestic auto industry. Because the industry can’t currently produce that many cars, they would hire us, and borrow to pay us to first build the new factories to meet the new demand. That means we’d all be working on new plants and equipment - capital goods - and getting paid. But there would not yet be anything to buy, so we would necessarily be “saving” our money for the day the new cars roll off the new assembly lines. The decision to spend on new cars in this case results in less spending and more savings. And funds spent on the production of the capital goods, which constitute real investment, leads to an equal amount of savings.

I like to say it this way: “Savings is the accounting record of investment.”

Warren Mosler https://moslereconomics.com/wp-content/powerpoints/7DIF.pdf

**************

I'm working my way through Wiki's Macroeconomics wikibook right now, but I'm having a hard time taking it seriously. But I'm trying.
 
Consider the possibility that you have it backward.

I see what you mean, but that might be a poor choice of word on my part. I meant that savings equal investment. What is not consumed today is transferred tomorrow. Ultimately, the flow of resources that a country can use to acquire more physical and human capital (that is, what it can invest) is funded by what people do not consume out of what has been produced.

I'm working my way through Wiki's Macroeconomics wiki book right now, but I'm having a hard time taking it seriously. But I'm trying.

The first thing you have to realize is that no matter how you approach a complicated problem, you're bound to turn some corners round. In the final analysis, what matters is whether you missed out on something important enough that your theory ends up being impractical. Contemporary economics turns some interesting corners round, but it doesn't always matter all that much and it forces you to think about things no one else talks about.
 
This is something I have always wanted to understand. To me, a sensible definition of savings is money that I don't use to consume or invest. How do you get real Investment from my savings? What is the real-life mechanism?

The fact that savings equal investments is just a definition. It's just one way to chop up the data.

Macroeconomics is heavily concerned with national accounts. Our definitions track rather closely the data we are trying to understand. Exclude international trade for simplicity and you get that Y = C + I + G. This says there are 3 uses for resources: it can be consumed, it can be used for investment (in the sense of acquiring physical capital) or the government spends it. Where are the savings? Well, Y - C - G = I = S. Why? Because S := Y - C - G. Savings from a bird's eye view is what wasn't consumed or used by the government.

Just be careful, however, how you relate NIPA data to economic models. Given how we define the problem of a household, we basically conflate durable goods and gross private investment. We call all of that investment. Consumption is then restricted to be the expenditures on nondurable goods and on services.
 
Government deficits are not the pinnacle source of aggregate demand. What is most desirable is for the private sector to drive AD, and when market failure curtails growth, the government steps in to bridge the gap.

In our best models (e.g., Ascari, Phaneuf and Sims (2019)), the bulk of business cycle variations are tied to two types of technological changes -- one relates to the transformation of investments into working capital and the other to total factor productivity. Monetary and fiscal shocks, in comparison, explain almost nothing of what you see in the data with regards to business cycles.

This point raised incredulity in the early 1980s when Kydland and Prescott came up with the idea of appending new types of random changes to what essentially was a model of long term growth, creating the first real DSGE model. Yet, you just cannot go around that. In fact, the paper I linked is a rare paper where something else than changes in total factor productivity dominates business cycles without the model implying completely ludicrous behavior for the data. The whole point of the paper is, in fact, to show that what the paper does is actually possible -- the Barro-King curse was a conjecture made in the 1980s that was not overturned until, well, now.

That shows how solid is this point.
 
Circular flow of income - Wikipedia

GDP = C (consumption) + I (investment) + G (government spending) + (X - M) (net exports, positive or negative)

Production = national income = potential demand.

If you have a $15 trillion economy, the national income is $15 trillion. ...
JohnfrmClevelan, if our GDP would be $15 trillion, and a trade deficit of $500 billion = $0.5 trillion, our nation would have spent $15.5 trillion and produced $15 trillion.

If our GDP would be $15 trillion, and a trade surplus of $500 billion, our nation would have spent $14.5 trillion and produced $15 trillion.

For every given value of of a nation's spending, trade surplus nations' increased, and trade deficit nations' reduced their nation's GDP. USA's chronic annual trade deficits indicate we purchased a greater value of products than we produced. Due to those annual trade deficits, our nation's numbers of jobs and aggregate payroll amounts were then less than otherwise.

It's that simple. But additonally, it's contended that because all production is not entirely reflected within the prices of products, balance of trade understates trade surpluses contributions, or trade deficits reductions of their nation's GDP.
Respectfully, Supposn
 
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First, apologies up front, I've read this entire thread to this post (post #36). That said I don't want to pass this post without a response before I forget what's in my head or I can't find it later.....

If this has been addressed, again, my apologies.

You can print more money. The point is that this eventually will turn up as increased prices because what matters, in the long run, is the capacity to bring things to the market.

Yes and no and sort of....

Creating money by policy causes inflation, right. I mean, we have an inflation target. This, in turn, does increase prices, that's also true, but what you're leaving out is that salaries are cost and therefore will increase over time. Thus, price increases only matter (at the 10,000-foot view) in relation to the cost of work. If the cost of work (salaries) increases at the same or faster rate than prices, that is, IMO, a good thing. And indeed the cost of wages have, over the last 100 years or so increases 5 times faster than prices.

All that said you are 100% correct to suggest that what really matters is capacity output.

However, I think the capacity can be split into two categories. There is;

1) Unused current capacity

2) Unrealized potential capacity (which would be the amount capacity could increase via increased efficiency, use of existing untapped resources and existing untapped labor.

Now, there are lots of other nuances I'm going to skip for the sake of brevity and if you care to debate them, I'm game, but let's try to keep this at a high level for now.


You missed part of what I said. Of course, you always have net savings. Investment derives from savings in the aggregate.

This is a common misconception, but I think it can be explained fairly easily.

Investment funds savings, it is not derived from it.

Let's walk through this.

Couple #1 is older their kids have moved out and they want to sell their home and downsize.

Couple #2 has just married and wants to buy a home together...

Couple #2 applies and is approved for a bank loan. The funds are created when the bank expands it's balance sheet and deposits Couple #2's promissory note and the newly created bank credit are transferred to Couple #1's account.

Couple #2's investment becomes Couple #1's savings.

Couple #2 spends the next 30 years extinguishing the principle created when they took the loan. The bank keeps interest as gross profit.

Now, if you believe that banks lend savings, then there is your mistake, however, before I put words in your mouth, I'll wait for a response.



No, I said that you have to come up with a good reason for what we see. The implied correlation above has the wrong sign given your view that deficits tend to drive economic growth.

I would say that assuming Ceteris paribus, deficits increase demand will increase. However, if private sector borrowing decreases more than deficits increase, it's possible that aggregate demand could still decline. But the point is, demand is higher with deficit spending than without.


Usually, we set aside the period prior to 1947 for lack of quarterly data, but it is true that we would ideally prefer to take the whole data. It wouldn't look better for you, however, because if you all the way back to the 19th century, we do have old estimates that we can use at a yearly frequency, I believe, for the US and possibly also for England. Average growth rates were quite high until the Depression and things did fall back in place when the US entered WWII. Until the 1960s, you wouldn't have heavy government budgets outside of wartime, hence the point remains: the correlation would be negative.

As an interesting asside....

1920-1930: U. S. Federal Debt reduced 36%. Depression began 1929.

The government removed money from the economy for 10 years, resulting in a massive depression.

Sure, the correlation does not prove the cause, but if we look back, every period where the government runs a net surplus.

So let's go back were there other periods where the government ran a sustained surplus and what was the result?

1804-1812: U. S. Federal Debt reduced 48%. Depression began 1807.
1817-1821: U. S. Federal Debt reduced 29%. Depression began 1819.
1823-1836: U. S. Federal Debt reduced 99%. Depression began 1837.
1852-1857: U. S. Federal Debt reduced 59%. Depression began 1857.
1867-1873: U. S. Federal Debt reduced 27%. Depression began 1873.
1880-1893: U. S. Federal Debt reduced 57%. Depression began 1893.

Proof? Perhaps not, but it does lend significant evidence.
 
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For every given value of of a nation's spending, trade surplus nations' increased, and trade deficit nations' reduced their nation's GDP. USA's chronic annual trade deficits indicate we purchased a greater value of products than we produced. Due to those annual trade deficits, our nation's numbers of jobs and aggregate payroll amounts were then less than otherwise.

For the nth time... this is undeniably false. This fallacy is addressed in this very thread.
 
For the nth time... this is undeniably false. This fallacy is addressed in this very thread.

I've read the thread, but I still take issue with the claim.

Nations save in US dollars. Savings reduces demand. Reduced demand reduces GDP (all other things being equal). The amount of savings (in context) is measured by foreign reserves. Today foreign reserves sit at about $10 trillion with, according to the sources I've read, 60% of those being in US dollars.

So please explain to me (using examples if possible), how when a US dollar that is captured by foreign interest and deposited in a bank (yes US dollars never leave the US, but they are still saved) does not reduce demand and by extension GDP unless the government or private sector borrow dollars to replace them.
 
So please explain to me (using examples if possible), how when a US dollar that is captured by foreign interest and deposited in a bank (yes US dollars never leave the US, but they are still saved) does not reduce demand and by extension GDP unless the government or private sector borrow dollars to replace them.

Imported goods are consumed or used for investment (durable goods). All the NIPA equation does with imports is subtract them from domestic production to yield a net-zero. Hence, imports are not a detriment to domestic production, because the transaction is mutually beneficial. Instead of investing in the manufacturing of textiles and non-durable die casting, U.S. producers can focus on higher-level goods like cloud infrastructure, weapons systems, and electrical generation equipment. Furthermore, trade also creates an income effect. Instead of paying prices for products whose production is originated in an area with a higher standard of living (higher labor/property/input costs), people and businesses can consume these goods and have additional income left for consumption/investment.

You do realize that consumption or investment due to foreign produced goods/services is still economic activity? Trade deficits allow the country to consume above it's productive capacity.
 
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Creating money by policy causes inflation, right. I mean, we have an inflation target. This, in turn, does increase prices, that's also true, but what you're leaving out is that salaries are cost and therefore will increase over time. Thus, price increases only matter (at the 10,000-foot view) in relation to the cost of work. If the cost of work (salaries) increases at the same or faster rate than prices, that is, IMO, a good thing. And indeed the cost of wages have, over the last 100 years or so increases 5 times faster than prices.

First of all, I am not leaving out wages. I meant that all prices would increase more rapidly over time.

Second of all, this is absolutely not a good thing. Inflation is costly, especially because of nominal wage rigidities. The idea is that wages in the labor market do not adjust immediately when changes occur. Only some wages get adjusted immediately; others will have to wait. When you have a higher average inflation rate, the adjustments are bigger when they are made which in turn means that at any given point in time the dispersion of prices is bigger. That worsening price dispersion is the cost of inflation. It is costly because it messes up relative prices across inputs, as well as across labor types: when those relative prices do not reflect real costs and real preferences, they lead to inefficient outcomes.

We used to think that those costs were small and mostly related to increased dispersion in the prices of the goods market. It's why people like Krugman were talking about rising the inflation target to 4%, for example. It turns out, however, that if you work through the maddeningly complicated algebra without making a certain simplifying assumption, the resulting costs are much larger than we thought and are mostly related to sticky wages. In other words, to the best of our knowledge, you're wrong. Higher inflation rates lead to distortion because of sticky wages that happen to be very costly.

Investment funds savings, it is not derived from it.

That is just the wording I choose. Investment equals savings is an accounting identity in macroeconomic models.
 
First of all, I am not leaving out wages. I meant that all prices would increase more rapidly over time.

Ok, so let me state that, in theory, that accelerating prices relative to wages does cause short term disruption and in some cases destruction, but I think there is a case to be made that it can also lead to long term growth. For example, in the latter part of the first decade of the 2000's energy prices rose. Increasing prices create opportunity *IF* there is space to expand (labor and real resources) and improve (e.g technology).

The idea that inflation is by default bad is simply wrong. I think it depends on several variables. When oil and gas prices increased that reduced the barriers to entry in energy. It opened the doors to exploit (for better or worse) energy that was always available but, historically speaking, too costly to exploit. But it was the initial cost that was the hardest to bear, which is why when real energy prices fell back to what they were in the late 2000's most companies were able not only to stay in business (even though the energy they were going after were more expensive to exploit) but they have flourished because the initial start-up costs were paid with money earned during the period of higher inflation.

Today prices are lower AND we have the benefit of all the jobs and infrastructure that didn't exist before prices increased.

That said, I know that one industry is not how we measure inflation. It is the aggregate of all prices, though, as an aside, I would argue that energy is the single most influential single input when determining inflation.

Second of all, this is absolutely not a good thing.

Without trying to sound like I'm being argumentative, good in this context is pretty subjective. When you say good or bad, you have to share with me what you think the goal of econ policy should be in the context of this convo.

Inflation is costly, especially because of nominal wage rigidities. The idea is that wages in the labor market do not adjust immediately when changes occur. Only some wages get adjusted immediately; others will have to wait.

Here we agree 100%. So either we can try to slow the rate of inflation or we can support policies that lead to less rigidity in wages or perhaps a little of both. I think wage rigidity has a lot to do with the current structure of our system and a lack of cultural awareness about the effects of unbridled capitalism.

That said and sort of as a side note, our nation has moved toward ever-greater efficiency. Today the average worker is 2.5 times more efficient than in 1980. That means it takes 2.5x fewer people to do the same amount of work as it did in 1980. That fact alone puts an enormous amount of pressure on labor as people fight to compete for jobs, but then add to that the fact that there are 100 million more people, about 30% more people than there were in 1980 putting even more pressure on the system.

I would argue inflation is exactly what we need in the environment we have. The trouble is, labor lacks the power to take a large enough share of the pie and those with power are working not only to maintain that system but increase the disparity. This is why you can't measure all of this stuff using equations. Behavioral economics is the X, the unknown, the wildcard that classical econ cannot or does not IMO, account for.



cont....
 
{cont from above...]

When you have a higher average inflation rate, the adjustments are bigger when they are made which in turn means that at any given point in time the dispersion of prices is bigger. That worsening price dispersion is the cost of inflation. It is costly because it messes up relative prices across inputs, as well as across labor types: when those relative prices do not reflect real costs and real preferences, they lead to inefficient outcomes.

Here I agree again, but efficiency and inefficiency measured against what? Productive output or social mobility. I don't mean to sound like someone who only cares about people at the cost of corporations or the "wealthy", but I think that the scales are being tipped in a direction that favors efficiency at the cost of human welfare. I think we need to strive for a balance and I don't think neoclassical economics considers this at all.

We used to think that those costs were small and mostly related to increased dispersion in the prices of the goods market. It's why people like Krugman were talking about raising the inflation target to 4%, for example. It turns out, however, that if you work through the maddeningly complicated algebra without making a certain simplifying assumption, the resulting costs are much larger than we thought and are mostly related to sticky wages. In other words, to the best of our knowledge, you're wrong. Higher inflation rates lead to distortion because of sticky wages that happen to be very costly.

I've spent a LONG time studying econ. That said I realize there are large gaps in what I know. You obviously have knowledge that I do not and I conceded that I could learn a lot from someone who, based on some of your posts here, like you. That said, I think that there is also something that people like JohnfC and I have to add to this conversation. Believe me, I would take great pleasure in meeting with groups of people, like your self, in person and hashing this stuff out to fill gaps in my knowledge.

I for one would like to thank you and Kush for taking the time to have this conversation.

That is just the wording I choose. Investment equals savings is an accounting identity in macroeconomic models.

Sure, I understand the identities involved, but it matters how we think the order of operations works here. I mean, it REALLY matters.

Do people have money to borrow because other people save it, or do people have savings because people have the capacity to borrow?

I think this is fundamental to the way our system works. The government's role is to ensure that it's debt level is on par with the economies potential capacity for growth taking care to ensure that growth is financed at a sustainable rate in the private sector (something I'd argue is wayyyyy out of whack and a big part of the problem we have today). The rest needs to come from government deficit spending. Of course, it's not that simple, there are 1000 ways to do what I said right and a billion ways to do it wrong.

With respect,
 
Imported goods are consumed or used for investment (durable goods).

So what you are saying, if I'm understanding, is that there is a real benefit that does not get measured in the identity?

If this is what you mean, I completely agree, but I think there is more to it...I'll addresses this as I continue.

All the NIPA equation does with imports is subtract them from domestic production to yield a net-zero. Hence, imports are not a detriment to domestic production, because the transaction is mutually beneficial.

Yeah, I understand the identity and how it's calculated, but I'm not sure how it can be said that based on how it's calculated that it's not a detriment to domestic production. You seem to be saying there is an offset, which I don't deny, but I think there is something else you're leaving out.


Instead of investing in the manufacturing of textiles and non-durable die casting, U.S. producers can focus on higher-level goods like cloud infrastructure, weapons systems, and electrical generation equipment.

Agree 100%. I've been saying for years that our focus on output should be on par with our capacity to produce goods and services that other places in the world find challenging. We have a combination of factors like large population, rule of law, an excellent secondary education system, certain cultural values, excellent infrastructure and the capacity to improve it, and so on and so on....

That said, don't misunderstand my position (and I think I speak for JFC too). I'm not lamenting the trade imbalance. I absolutely think it works in our favor. But I think that imports result in the export of our dollar, trillions of dollars of which are saved by foreign interests. Deficit spending/ debt is money that replaces the money that's currently "leaked" out of our economy.

Of course, people in the private sector can also create credit money, the problem with private sector debt is that there are very real limits the private sector will run into that will cause a reduction in consumption and all of the effects that go with it.

Furthermore, trade also creates an income effect. Instead of paying prices for products whose production is originated in an area with a higher standard of living (higher labor/property/input costs), people and businesses can consume these goods and have additional income left for consumption/investment.

That's great and I agree, the problem is that a lot of investment these days isn't productive. Speculating on real estate or energy removes as much money as it adds and does very little relative to the volume of money that moves through those markets to put people to work. Investment should be broken into subcategories IMO as not all investment is of the same quality.

You do realize that consumption or investment due to foreign-produced goods/services are still economic activity? Trade deficits allow the country to consume above its productive capacity.

Again, I agree 100% I don't object to imports at all. I just think that imports create a fiscal problem that if misunderstood will cause an accounting problem that could be totally avoided if only we understood the nature of our currency.

Finishing up....Thanks for taking the time to comment on this. I find it useful and interesting.

-Cheers
 
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