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Originally Posted by Iriemon
When I wrote: "This, however, assumes that the money saved is invested in a way the business can actually use it" I meant it is not being used to purchase goods and services.
If a person is saving, they are still producing, agreed. But here is the fundamental point you do not address: they are not purchasing products from others, in the agregate that decreased demand is what causes the layoffs and closing. And when people do not produce, there is a loss of wealth, and creation of fear.
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I understood exactly what you meant, and that part of my post addressed precisely that. My response to this also pertains to what you've written below, so I will just put that below as well.
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But the second shift isn't necessarily so, because the shift isn't necessarily to investment, but to non-invested savings (hording). This causes production decrease, which is missing in your equation. Production does not remain constant in a recession. It decrease. It is not therefore a simple matter of a shift from consumption to savings, but a decrease in the total wealth produced. It's not simply and accounting transfer, there is a real loss. You acknowledge this in other areas by acknowledg
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It is necessarily so, which is what I'm trying to explain. So called "hording" isn't saving at all, and nor is it a reduction in consumption. It's a reduction in the quantity of money in circulation. Ceteris paribus, it does not affect output or total consumption. It lowers the quantity of money in circulation, and so prices decrease, and the decrease in price makes other people in the economy other than the hoarder purchase the goods and services that he forgoes by hoarding his money. It does not cause a reduction in consumption, and it does not cause a reduction in production.
There are reasons why production decreases in a recession, but this is not one.
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Your last two sentences seem suggest that credit expansion creates a boom and contraction is a recession -- thus in a boom the money supply should be tightened and in a recession, eased to counteract the these effects. Which is generally what the Fed tries to do. And what you cannot do with a gold standard.
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Actually, you just shouldn't mess with the money supply to begin with and you shouldn't use the government to enable a fractional reserve banking system, which is a way that the money supply is increased (by having deposits be greater than reserves, and thus having a
money multiplier greater than 1). You wouldn't have cyclical business fluctuations at all. Rather than messing something up first and then trying to patch it back together, just don't mess it up in the first place. This is why a gold standard is preferable to a central bank.
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The business reaction to a drop in demand is not to simply cut prices. You acknolwedge that, for what you call "malinvestments". But there are also cuts in production and people are laid off, even for businesses that are not "malinvested" but see lower demand simply because of the overreaction of panic and fear. It is not just malinvested businesses that go down. Business that were fine would go down because their credit is cut off and because folks aren't buying their products.
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First of all, nearly all businesses are malinvested in to some extent. Credit expansion is an expansion of all credit beyond what is desirable through the normal determinations of savings/investments and the natural interest rate. It affects all businesses that make use of credit, which is essentially all of them. However, due to many different factors, some are more highly affected by artificial credit expansion than others.
And secondly, the overall drop in demand for
today's consumer goods is matched by an increase in real savings, or investment, which we've been through before. And "panic and fear" are only factors if you have presupposed the myth that "lower demand means disaster."
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Empirically false. Millions of white collar workers aren't being laid off because of the minimum wage. They were let go because there was no demand for their products and/or services.
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Understand the reasoning before you try to add in empirical observations. Unemployment is caused when workers have to shift there jobs, but that is temporary. When the government implements these kinds of policies, that temporary unemployment becomes more permanent. Empirically, there is unemployment of white collar workers. That is transitional unemployment, not structural.
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On a macro level? Saving creates the availability of capital which businesses need for expansion. But that is of little help in the near term.
But you never addressed my points. You argue that deflation is no worse that inflation, or you even seem to imply it is better.
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I am, actually, implying that deflation is better. And here's why: in the natural progression of an economy, certain resources are put towards the production of today's goods and services and certain resources are put towards increasing future production. As a result, the amount the economy can produce steadily increases. If the money supply stays the same and doesn't artificially distort economic activity, you get a natural rate of deflation, determined by the natural rate of economic growth, which is determined by the level of investment in the economy.
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However, deflations is not the same as inflation, and it impacts different groups, which you do not address.
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That is actually a relatively inconsequential issue. Such impacts occur only where there is an
unexpected change in inflation/deflation in the economy. Otherwise, both lenders and borrowers set their nominal interest rates based on the level of inflation/deflation [i = r + π, where pi is the rate of inflation (positive) or deflation (negative), r is the real interest rate, and i is the nominal interest rate. Fisher equation.]
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Inflation helps borrowers and encourages both consumption and investment savings. Why? Because when you buy a house with a 30 year mortgage, your salary goes up with inflation and the cost of the mortage, relatively, decreases. You don't save money under the mattress, you invest it because you need to stay ahead of inflation. That increases production and investment.
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And we have already seen why the "money under the mattress" arguments are bogus.
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Who gets hurt? The lenders. But the lenders are financial institutions that can offset the loss of inflation by hedging with investments.
Deflation hurts borrowers, discourages borrowing and consumption, and encourages non-investment savings.
Who gets hurt when salaries go down? Borrowers -- folks that owe on mortgages. But unlike banks, they generally do not have the means to leverage their loans with offsetting investments. And since in a deflation investments decrease too, hedging is less practical. Result? Defaults on loans.
Are you going to buy a house with a 30 year mortgage knowing that your salary is going to decrease every year? It is an invitation to defaults. Its partly what is happening now. So you don't buy a house. And are you going to invest in the stock market watching your investment decrease every year because of deflation? Of course not. Your best bet is to hide whatever you can save in cash under the mattress. Which many did in the GD.
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All of these statements are made with the misunderstanding clarified above.
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With deflation, the means of exchange increases in relative value to goods and services, creating a storage value for the means of exchange greater than investment in goods and services. This discourages consumption, discourgages investment, and therefore hurts production and the economy.
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Deflation encourages investment. If you were to draw out a supply and demand model for savings and investments, in which saving is comparable to supply and investment to demand and in which the price is the interest rate and the quantity the quantity of funds loaned in the economy, then it is easy to see that an increase in supply (savings) results in an increase in
quantity of money invested.
And if we had a gold standard, we would not be artificially messing with this process, and it would proceed at a natural interest rate determined by the average time preference of the economy, and so the best possible relationship between the production of consumer-goods and investment-goods would be determined along with a natural interest rate.
05-16-2009, 07:46 AM
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