ZH: Larry Summers Comes Clean Ahead Of J-Hole, Admits Central Planners Are Impotent

https://www.zerohedge.com/news/2019-08-22/larry-summers-comes-clean-ahead-j-hole-admits-central-planners-are-impotent

This article represents a watershed moment.

Economist Steve Keen makes essentially the same observations in his book, “Debunking Economics,” first published in 2001. For President Obama’s former chief economist to confirm them is a big deal.

Keen and Summers agree that the classical aggregate demand curve has no predictable shape. Keen showed that as a matter of pure logic of neo-classical economics, demand can form the shape of a downward sloping curve, and upward sloping one, or an S-shaped one, downward at one point, upward at another. Theoretically, the Law of Demand cannot exist in the form in which it is usually taught.

Summers approximates Keen in his tweet, ” It is even plausible that in some cases interest rate cuts may reduce aggregate demand: because of target saving behavior, reversal rate effects on fin. intermediaries, option effects on irreversible investment, and the arithmetic effect of lower rates on gov’t deficits. “

The economic lesson for laymen to take is that demand is not a motive force in an economy. It is only an observation, a measurement of sales volume. It has none of the pneumatic qualities of water in a pipe.

Thus should economic policy makers humble themselves.

12 thoughts on “ZH: Larry Summers Comes Clean Ahead Of J-Hole, Admits Central Planners Are Impotent

    1. Summers has been consistent on this issue and is not alone in recognizing the limited power of the FED and others to thwart economic “turns” of any kind. His comments here highlight how ridiculous trump’s comments are blaming the FED during the tariff-based slow down.

      However, I do give him credit for helping Obama make good decisions that prevented the Recession from becoming a Depression…

      Liked by 1 person

    2. RE: “I got lost on the downward-upward curves.”

      Maybe this will help.

      The Law of Demand (one half of the supply-and-demand principle) holds that the price at which a product sells rises with more demand for that product and declines with less demand. This seemingly intuitive observation is typically represented by a downward sloping line (high demand/high price on the upper left, low demand/low/price on the lower right.

      Logical problems begin to emerge when you try to account for multiple products which may in themselves be of different value (or utility) to the buyer, or which are subject to substitution effects, or may be subject to variations in the buyer’s wealth or spending power (which can be independent of the buyer’s desires).

      When these and similar factors are plotted in graph form you end up with a three-dimensional representation: Mountains and valleys instead of simple curves. Depending on how you slice the three-dimensional terrain to get at the particular demand line you are interested in, it may slope up, or down, or first one way, then the other.

      Again, the basic take-away is that demand itself doesn’t create the picture. It is merely embedded in it.

      Liked by 1 person

      1. Interesting explanation. Well done. And thank you.

        Now (this goes back to your original post, and if I misunderstood something I blame it on the humidity), isn’t the discussion about the effect the FED has on the economy? And while it may or may not be accurate, the PERCEPTION that an interest rate change, up or down, has a direct effect on decision maker’s attitudes.

        Also Trump lives and breaths the FED (negatively lately) and the stock market (Positively because he APPEARS to see that as a bellwether on the economy). While both are indicators, it is ultimately the decision maker’s (POTUS, Congress) policy decision that drive things.

        No one can really control the demand side of the S/D system. Marketers try to push us one way or the other, but it ultimately the consumers decision on what they need (I believe that is what you were getting at JOhn)

        Unless I’m suffering from heat stroke and completely missed the boat on this.

        Like

      2. RE: “isn’t the discussion about the effect the FED has on the economy?”

        Yes it is, you are correct. The Fed, however, controls the money supply in our system. They create new money to fund federal deficit spending and they set the interest rate that controls how much banks can charge for making loans of their own, which is the process by which banks create new money. Deficit spending and low interest rates (quantitative easing) are two ways in which the Fed directly expands the total volume of money.

        Economists used to assume that creating more money stimulated economic activity specifically by creating demand. With more money in circulation, more buyers would buy more things. This is the assumption that Summers is now questioning.

        It is surprising that he should do so, since as Obama’s chief economist, Summers justified the bank bailout and subsequent massive federal spending programs as good “demand side” economics.

        Now that Trump is the deficit spender in chief, and QE is still the norm, Summers has begun to wonder whether the Fed’s money-creation stimulus which he championed really worked as advertised. It appears that more money doesn’t necessarily create more demand.

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        1. You raise a point of semantical interest. It doesn’t change my explanation to Mr. Green in any way. The mechanics are the same whether the explanation speaks of the “money supply” or the “monetary base.” They are effectively the same thing, albeit with some technically subtle differences.

          Similarly, Summers and Krugman are making the same claim. Summers emphasizes the Investment/Savings (IS) ratio, Krugman the status of regulated bank reserves. They are equivalent measurements albeit, again, with subtle technical differences.

          The key point is that the Fed’s ability to control aggregate demand either for stimulus or for austerity does not appear to be what economists have long assumed it was. Thinking in terms of the volume of money in circulation is an easy way to grasp that reality.

          Liked by 1 person

          1. “economists have long assumed”

            SOME economists have, and MOST economists assume a great deal to make their points.

            My point was on a more practical basis relative to control of the money supply which was the issue you brought up. Yes, the “mechanics” are what they are, their effectiveness (or lack thereof) remains what matters and will bite us in the butt if the lack of economic coherence continues…

            Liked by 1 person

  1. This is what Hayek called “The Fatal Conceit”

    Central planners think they hold the levers that control the economy, but most of those levers don’t do what they think they do and some of them don’t do anything at all.

    They do not know what they do not know.

    Yet they still believe they are in control.

    Like

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