I Don't Fully Buy Stiglitz's Argument That Our Macro Problems Have Deep Structural Roots. But I Do See Its Coherence
Truth is, I don't understand all the hating on the Vanity Fair Stiglitz piece, "A Banking System is Supposed to Serve Society, Not the Other Way Around".
Perhaps I am giving Joe too charitable a reading. But I really do not see a serious analytical problem. Not that I buy the argument--I don't think that our macro problems today have deep important structural roots in the decline of manufacturing due to its rapid productivity growth, and I don't think that a massive governmental borrow-and-spend program is the only way out (but Stiglitz may be right in his claim that it would be the best way out).
However, even though I do not fully buy it I do think I understand the argument. And I do not think it is incoherent.
As I understand the Greenwald-Stiglitz hypothesis--about the Great Depression as applied to agriculture and about today as applied to manufacturing--it goes like this:
Rapid technological progress in a very large economic sector (agriculture then, manufacturing now) leads to oversupply and steep declines in the sector's prices. Poorer producers have less income. They come under pressure to cut back their spending. Others--consumers--are now richer because they are paying less for their food (or their manufactures), but their propensity to spend is lower than that of the stressed farmers or ex-manufacturing workers.
Moreover, the oversupply of agricultural commodities (or manufactured goods) means that only an idiot would invest at their normal pace in those sectors. To the shortfall in consumption spending is added a shortfall in investment spending as well.
Thus we have systematic pressures pushing spending down below economy-wide income. These aren't going to go away until the declining sector (agriculture then, manufacturing now) is no longer large enough to be macroeconomically significant.
Macroeconomic balance requires that the economy generate offsetting pressures pushing spending up. What might they be?
For a while, those receiving the income that farmers (or ex-manufacturing workers) have lost and those who use to invest in the declining sectors can lend it to the farmers (or ex-manufacturing workers) so that they can keep up with the Joneses. But lending more and more to poorer and poorer debtors is, like lawn darts, only all fun-and-games until somebody loses an eye.
An alternative possibility is to switch investment away from the farm value-chain complex (or the manufacturing value-chain complex) to something else. But what? Nobody really knows. The future is uncertain. Other investments are clearly riskier then funneling money into the old channels of boosting the capital of the farm value-chain complex (or the manufacturing value-chain complex) had been. Given the extra risks, this pressure can only manifest itself if the cost of capital falls. But here we hit the zero lower bound on interest rates. And we are off to the secular liquidity-trap races. This won't work either.
Now at this point I disagree with Greenwald-Stiglitz. I see three plausible ways to fix the unemployment-generating aggregate demand shortfall:
(a) This could be fixed by expectations of inflation that push you sustainable real cost of capital down below zero far enough that savings no longer exceeds planned investment at full employment. (But normal monetary ease it does not produce expectations of secular inflation won't do anything useful.)
(b) This could be fixed by government loan- or bank-guarantee programs that transfer the risk of new and untried investments away from entrepreneurs and investors onto taxpayers, so that even without expected inflation planned investment at full employment no longer falls short of saving when the cost of capital is at the zero nominal lower bound. so that you don't need a cost of capital less then be expected rate of deflation. It can be fixed by the government running up debt and buying stuff.
(c) This could be fixed by having the government borrow and spend on a large scale.
Stiglitz, however, doesn't see either the "expected inflation" or the "loan- and bank-guarantee" roads as possible. Stiglitz's conclusions:
Two conclusions…. The first is that the economy will not bounce back on its own, at least not in a time frame that matters to ordinary people. Yes, all those foreclosed homes will eventually find someone to live in them, or be torn down. Prices will at some point stabilize and even start to rise. Americans will also adjust to a lower standard of living—not just living within their means but living beneath their means as they struggle to pay off a mountain of debt. But the damage will be enormous. America’s conception of itself as a land of opportunity is already badly eroded. Unemployed young people are alienated. It will be harder and harder to get some large proportion of them onto a productive track. They will be scarred for life by what is happening today. Drive through the industrial river valleys of the Midwest or the small towns of the Plains or the factory hubs of the South, and you will see a picture of irreversible decay.
Monetary policy is not going to help us out of this mess…. [A]nyone who believes that monetary policy is going to resuscitate the economy will be sorely disappointed. That idea is a distraction, and a dangerous one.
What we need to do instead is embark on a massive investment program—as we did, virtually by accident, 80 years ago—that will increase our productivity for years to come, and will also increase employment now. This public investment, and the resultant restoration in G.D.P., increases the returns to private investment. Public investments could be directed at improving the quality of life and real productivity—unlike the private-sector investments in financial innovations, which turned out to be more akin to financial weapons of mass destruction.
I think that if I asked him Stiglitz would say that (a)--zero interest rates and expected inflation--would help if you could get there, but that you cannot get there through monetary policy. Only if people expect full employment will there be enough inflation to sustain a full employment equilibrium. And since they don't expect full employment there isn't enough expected inflation no matter how easy monetary policy is. I think he would say that (b) might work in the sense of restoring full employment in the short run, but it would be an unfair upward redistribution of wealth from taxpayers to financiers, and moreover would not help resolve the underlying structural problems that created the shortfall between savings and planned investment at full employment in the first place.
Stiglitz does say that (c) is best:
The private sector by itself won’t, and can’t, undertake structural transformation of the magnitude needed—even if the Fed were to keep interest rates at zero for years to come. The only way it will happen is through a government stimulus designed not to preserve the old economy but to focus instead on creating a new one… out of manufacturing and into services that people want—into productive activities that increase living standards, not those that increase risk and inequality…. Education…. [B]asic research. Government investment in earlier decades—for instance, to develop the Internet and biotechnology—helped fuel economic growth…. Meanwhile, the states could certainly use federal help in closing budget shortfalls…. [C]leaner and more efficient energy production…. [O]ur decaying infrastructure, from roads and railroads to levees and power plants, is a prime target for profitable investment.
And once we have both restored full employment and accelerated the structural transformation needed then we can return to normality. But in order to get there:
we must fix the financial system. As noted, the implosion of the financial sector may not have been the underlying cause of our current crisis—but it has made it worse, and it’s an obstacle to long-term recovery…. What’s needed is to get banks out of the dangerous business of speculating and back into the boring business of lending. But we have not fixed the financial system. Rather, we have poured money into the banks…. We have, in a phrase, confused ends with means. A banking system is supposed to serve society, not the other way around…
I'm not sure that I buy Stiglitz's argument that massive government borrow-and-spend is the only, or even the best, way out of our current mess. And I agree that Stiglitz's piece could have used a couple more paragraphs about life at the zero nominal interest rate lower bound explaining why Stiglitz thinks the belief "that monetary policy is going to resuscitate the economy will be sorely disappointed. That idea is a distraction, and a dangerous one".
Perhaps I have seen so much really bad macroeconomics over the past four years that I now suffer from the soft bigotry of low expectations. But this does not seem to me to be, as Nick Rowe calls it:
really bad macroeconomics. God it's depressing. If you want to talk about a deficiency of aggregate demand, and why Say's Law sometimes fails, you really do need to talk about monetary exchange economies and an excess demand for money at the aggregate level. You can't just do partial equilibrium analysis and cobble it all together.
So then why does Nick have such an adverse reaction to Stiglitz?
I think it is because Stiglitz is at bottom a Wicksellian and Rowe is a Fisherian. A Wicksellian is a believer that the key equation in macro is the flow-of-funds equation S = I + (G-T), savings S equals planned investment I plus government borrowing (G-T), and that the money market exists to feed the flow-of-funds an interest rate that has a (limited) influence on planned investment I. A Fisherian is a believer that the key equation in macro is the money market's quantity theory equation PY = MV(i), and that the flow-of-funds exists to feed the quantity theory an interest rate that has a (limited) influence on velocity V.
Thus they have a hard time communicating. From the Fisherian viewpoint, the Wicksellians are talking nonsense because they spend their time on things that have a minor impact on velocity while ignoring the obvious shortage of money. From the Wicksellian viewpoint, the Fisherians are talking nonsense by ignoring the obvious fact that movements in money induce offsetting effects in velocity unless they somehow alter the savings-investment balance.
And it is we Hicksians, of course, synthesize both positions into a single unified and coherent whole…