Tuesday, April 20, 2010

Questions about Aggregate Demand

Both Pete Boettke and Scott Sumner have mulling over the idea of changes to aggregate demand. As a result, both have asked good questions on this issue. First, Pete poses the following question:
What precisely is aggregate demand failure and how would you know if you saw it?
There were a large number of responses to his question in the comment section of his blog and of those I like best what Bill Woolsey had to say:
Deficient aggregate demand--aggregate demand less than productive capacity = excess demand for money--a quantity of money less than the demand to hold money = a market interest rate greater than the natural interest rate--saving greater than investment.

How do you know that aggregate demand is deficient? If cash expenditures have fallen below their trend growth path, and the levels of prices and wages have not fallen in proportion, then the presumption should be that aggregate demand is too low, that there is an excess demand for money, and that the market interest rate is above the natural interest rate.

Never, never, never look at market interest rates and the quantity of money and compare them with historically "normal" levels.

So does the data show any of the characteristics Bill outlines above? The answer is yes, as can be seen here and here. Next, Scott Sumner is wondering whether there is a better way to describe changes in aggregate demand:

I’ve constantly complained that there is no word in the English language for nominal shocks, i.e. unexpected increases and decreases in NGDP... So we need terms for changes in M*V, which is the sort of nominal variable the Fed should be trying to stabilize.
Here is my reply to Sumner in his comment section:

Awhile back we talked about reframing the nominal income targeting approach by saying the Fed should stabilize total cash spending. That is so intuitive and should be understood by most folks.

Consequently, in terms of what is a nominal spending shock we can simply say “There has been a sudden collapse in total cash spending” for a negative AD. Alternatively, we can say “Total cash spending is increasing at an unsustainable pace” for a positive AD shock.

Of course there is always Leland Yeager's take on this issue.


  1. David: The link to Pete Boettke doesn't work.

    My answer (or at least, one answer): an increased use of barter would be a symptom of a shortage of AD, which means an excess demand for the medium of exchange, a la Yeager.

  2. Nick,

    Right. A money that is not functioning as a medium of exchange is bad money. In other words, deficient aggregate demand is a consequence of bad money!

  3. Nick,

    The link is fixed. And yes, I like Yeager too.

  4. Good posting and comments. This issue is becoming a lot clearer to me.

    Don the libertarian Democrat

  5. This is my discovery. Aggregate monetary demand is our means-of-payment money times its rate of turnover (M*vt). Money is the measure of liquidity & the transactions velocity is bank deposit turnover.

    It is the equivalent of "total cash spending" or bank debits (there isn't an historical database on hand to hand currency transactions, the black market, etc.)

    Contrary to economic theory, & Nobel laureate, Dr. Milton Friedman, monetary lags are not “long and variable”. The lags for monetary flows (MVt), i.e. the proxies for (1) real-growth, and for (2) inflation indices, are fixed in length. However, the FED's target?, nominal gdp?, varies widely.

    The monetary savings of the public are reflected in the velocity of deposits, not their volume.

    Seeing is believing.

  6. Inevitably, as reserve requirements are completely eliminated, this will come to light. The member banking system is just a posting machine.

  7. In capitalism human consumption is the goal. Keynes, Say's Law, output gaps, etc. are mis-directed.

    In the Keynesian System, S = I by definition. In the national income accounting system, S = I + (G-T).

    The Keynesian's ignore that the "utilization of bank credit to finance real investment or government deficits does not constitute a utilization of savings, since bank financing is accomplished throught thr creation of new money...never are the commercial banks intermediaries in the savings-investment process".

    Savings impounded within the commercial banking system are a leakage.

    It is obvious that if full employment is the objective, then the US will have to nationalize the commercial banking system, and get these banks out of the savings business.

  8. 2010 -- monetary flows
    inflation / real-growth
    jan.....0.53....0.25 top
    mar....0.55....0.09 (+1)….(+1)
    apr.....0.52....0.13 (+5)….(+3)
    may....0.46....0.05 (+5)….(+4)

    those numbers inside of ( ) indicate the change from the "trading desk's", original path (the FED constantly fine tunes their short-term forecasts).

    This is quick countervailing accommodation by the FED.

    & monetary inflation is increasing at a faster rate-of-change than real-growth (the recipe for stagflation -- business stagnation acccompanied by inflation).


    To counter what Greenspan described as “irrational exuberance” (at the height of the stock market bubble), Greenspan initiated a "tight" monetary policy (for 31 out of 34 months). A “tight” money policy is one where the rate-of-change in monetary flows (our means-of-payment money times its rate of turnover) is no greater than 2-3% above the rate-of-change in the real output of goods & services.

    Greenspan then wildly reversed his “tight” money policy (at that point Greenspan was well behind the employment curve), and reverted to a very "easy" monetary policy -- for 41 consecutive months (despite 17 raises in the FFR---every single rate increase was “behind the curve”).

    Alan Greenspan’s profligacy ended with Ben Bernanke’s appointment to the Chairman of the Federal Reserve in February 2006. Coinciding with Bernanke’s instatement, the FOMC reversed Greenspan’s extremely “easy” money policy, and initiated a “tight” money policy (one aimed at reducing chronic inflation).

    At that point, correcting the Central Bank’s past excesses, required that the “trading desk” drain (or reduce the rate of expansion), in the existing volume of legal reserves (thereby reducing the growth rate of the money stock, thereby money flows, or aggregate monetary demand/nominal-gdp).

    From Feb. 2006 until July 2008, the FOMC pursued a consistently tighter money policy. In fact, the rate-of-change in the volume of legal reserves (one proxy for inflation), fell for 29 consecutive months (out of a possible 29, or more than sufficient to wring inflation out of the economy).

    For the last 20 successive months (since Sept. 2008), the FOMC switched from its “tight” monetary policy, to the extraordinarily “easy” monetary policy in force at present. Easy money is here defined as a growth rate of aggregate monetary demand (money times velocity) in excess of the growth rate of product, and service output.