Structural demand deficiency

Macroeconomic swimming

A thought bubble from when I was in the pool. It retreads some basic ground for clarity’s sake. [fn1].

Consider a typical cyclical recession driven by uncertain expectations by agents. Demand is insufficient to meet capacity as consumers and investors are unwilling to spend. Consumers fear lower income in future (due to job loss or lower shifts) and try to save just in case. Investors don’t borrow any funds saved because there’s little prospect of a return when no-one is spending. Which means there’s also less prospect of future employment. Which means that people reduce spending and save as a precaution….and so on.

But of course there’s the paradox of thrift. Not everyone can save at the same time since any savings come out of someone else’s spending – spending that is not forthcoming when everyone is trying to save. So there simply isn’t enough spending to reach the capacity of the economy and reduce fears about unemployment and returns. Uncertainty that was sparked by a crisis or elsewhat becomes self fulfilling and there’s not enough demand to sustain demand. Here typical macro policy works to end the guessing game by either sparking or directly providing enough demand to keep demand going.

But does this uncertainty need to be purely situational based on what everyone else is doing at a given time, or can it be structural?

If there is insufficient or non-existent  unemployment benefits, then the precautionary motive to save is greater for everyone since one’s own savings will be all that will save one from destitution. If the structure of the job market (cultural or regulatory) makes the hiring of laid off workers unlikely, than one’s savings will need to last a lifetime, and everyone will try to save more. If health insurance is provided mainly through an employer, then fears of job loss are magnified by uncertainty about unexpected illness, and precautions have to be taken.

All these factors would exacerbate uncertainty in a slowdown and reinforce the self perpetuating mechanisms of a recession. In fact, if you were in a country with near non existent unemployment insurance, cultural factors that make firms unlikely to hire outside school leavers and where job loss can almost guarantee homelessness…you’d probably be in Japan.

This brings us to an interesting point. In this case the demand problems can have a structural element and may require a sort of microkeynesianism. This may not entail a permanent equilibrium under capacity, but it may mean that micro policies to address uncertainty are required when the uncertainty is more than just a giant guessing game. Even if the BOJ managed to pull off QE or spur some inflation, and even if fiscal policy hadn’t been hesitant, choked off prematurely or directed to the well connected instead of households – even if the “I won’t spend til you spend” game had been addressed through normal policy,  Japan may really need proper unemployment insurance. It’ll take a lot more than a simple upswing in activity to convince people to start spending again. Their savings are all that will keep them away from living in park and shunned by fellow citizens. The Japanese government can’t do anything about the hiring practices of corporations, but they can reduce uncertainty with a safety net to replace the security of lifetime employment.

I have had a relatively quick search of the literature since I don’t remember reading anything like this. There is a great deal of savings literature that uses natural experiments in unemployment insurance or health insurance to determine their effects on precautionary saving, but I haven’t seen it extrapolated to it’s macroeconomic implications. I might just be searching with the wrong terms – the concept seems too obvious not to have been dealt with after all – in which case someone can point me in the right direction. But even after a generation of purportedly making microfoundations for macro it could have just slipped through the cracks. RET economists have no idea what a recession is. New Keynesians were too eager to impress the RET kids to pay attention to the implications of real recessions. Post Keynesians who would otherwise be sympathetic may have simply instinctively turned away from anything involving microfoundations because of the example set by the two former groups. Meanwhile the economists studying savings just didn’t think about macro.

But there is a certain irony to it. In Marxian business cycle theory firms relied on uncertainty and the threat of unemployment to maintain discipline on the factory floor to produce goods to sell. It’d be turn up for Marx if they really need the welfare state to reduce this threat in order to make sure they can sell the good they’ve produced.

[fn1] and of course the fact that certain issues get obscured by a thicket of formalisation or emphasis on other elements like price stickiness and are then forgotten.

About Richard Tsukamasa Green

Richard Tsukamasa Green is an economist. Public employment means he can't post on policy much anymore. Also found at @RHTGreen on twitter.
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11 years ago

“Consider a typical cyclical recession driven by uncertain expectations by agents.”
Just what would that typical recession be? That too many people at once come to believe they’re holding funny money rather than real claims on production? And why would that be?
Cart horse!

James Farrell
James Farrell
11 years ago

Richard, I may be missing your point but I don’t really agree that ‘economists studying savings just didn’t think about macro.’ As you know, there was a huge literature on estimating consumption functions in the ’90s in particular, and — implicitly at least — most of the motivation was with regard to its implications for macro.

You may have come across this survey but, if not, much of the literature is surveyed here, (the full text is not available, but I might be able to get it for you), and for a more recent piece of work with an explicit macro orientation try this.

Gavin R. Putland
11 years ago

The article omits the words “tax” and “speculation” — as in “not enough tax on the spoils of speculation, hence too much tax on the rewards of production”.

If you tax the rewards of production, producers collectively cannot afford to buy their own products. Speculators won’t take up the slack, because they would rather buy tribute-rights than buy products. Government spending won’t take up the slack, because the benefit of that spending doesn’t compensate for the deadweight cost of the taxes that fund it — unless the spending is on desirable infrastructure, in which case the benefit takes the form of unlifts in land values, which are pocketed by the undertaxed speculators and not converted into demand for products. On a national scale, exports can’t take up the slack, because taxes on products are overwhelmingly on a production/origin base rather than a consumption/destination base, and consequently favour imports over exports. On a global scale, exports can’t take up the slack, because not all nations can be net exporters.

So the only way to buy the output of products is by an expansion of DEBT. When debt can’t expand any further, you get a recession. What eventually halts the expansion of debt is the bursting of debt-funded speculative bubbles which are encouraged by the under-taxation of speculation.

Solution: Tax speculation, not production.

11 years ago

Ah, so that’s another reason why Japan has languished in a 20 year recession.

If Australia replaced employer based superannuation with a lifetime superannuation scheme like the MySuper proposed by Cooper would it be easier for mature workers to gain employment? ie would workforce participation rate improve for the over 45s