I don’t think this captures the essence of macro economic theories. In my view, the key insight is that you must think about the money balances people hold (carefully distinguishing money from wealth here), how trade affects that balance and how they attempt to optimize it.
In particular with sticky prices, the ‘hot potato effect’ becomes important. You might also hear it called, ‘monetary disequilibrium’, ‘excess cash balances mechanism’ and probably some other things as well. The Keynesian concept of the “Paradox Of Thrift” is related, though less well developed. I’ve written more about it here.
consider an economy initially at equilibrium with a fixed quantity of money and prices that adjust to changes only after some time (sticky prices). Some people in the economy decide they want to hold higher money balances than they had in the past:
When people hold less money than they would like, they try to increase their holdings of money in two ways: 1) try to reduce their spending 2) try to increase their income. The quantity of money is fixed, so if one person holds a higher nominal quantity of money than before, all others must hold a lower quantity of money than before in aggregate. Prices are fixed, so this is also true for the real quantity of money. When one person reduces their spending, they reduce the income of others in the economy. Unless those others desire to hold less money than before, they now hold less money than they would like. Now those others also try to increase their money holdings by the same means. This is a vicious circle and aggregate spending and incomes decline. The circle ends when people no longer want to reduce their their spending to achieve higher money balances.
There are two effects which determine how far this process proceeds. 1) The quantity that people want to hold is positively related to the quantity people expect to spend, so as people expect to spend less they will need to hold somewhat less money. 2) As people reduce their spending, those reductions become more painful, so will be more reluctant to trade off consumption for increased money balances.
Do you know of a good explanation for why the Federal Reserve’s efforts to inject more money into the US economy since 2008 has not quickly brought it back to near full employment?
1) The Fed has made it clear that the injections are temporary and will be removed if the economy improves. Standard theory says that increases in the money supply expected to be temporary basically have no effect on inflation or (they lead people to want to hold more money). If you double the money supply but promise to reverse this in a year, the result is not huge inflation now till a year from now and then huge deflation, but no inflation (lots of people think about inflation as a differential equation, but this will lead you astray).
2) Near the start of the crisis in 2008, the Fed started paying interest on reserves which encourages banks to hold excess reserves, of which they hold a huuuuuuuuuuge amount. The interest rate is quite small, but this can have a huge effect this rate is above what banks can get elsewhere (risk adjusted). The appropriate interest on reserves could also easily be negative.
Also, the uncertainty about when the injections will be removed keep investors on the sidelines. People don’t like uncertainty, and will often wait it out.
Why would anyone assume that everyone (in the US and other wealthy nations in particular) is economically viable as an employee at prevailing wage rates?
Add in increasing regulatory and financial burdens to employers. Add in an economy increasingly based on information, where information coordination is more and more a relevant and limiting factor. Add in technology rapidly making people with meager skills obsolete.
Even without the add ins, management and coordination have financial costs and opportunity costs that a worker’s productivity may not overcome.
In case you’re interested, I have a short mathematical model of monetary disequilibrium, which is something I haven’t been able to find anywhere else. The people who seem to understand this aspect of macroeconomics clearly tend to incorrectly think that math is useless.
I don’t think this captures the essence of macro economic theories. In my view, the key insight is that you must think about the money balances people hold (carefully distinguishing money from wealth here), how trade affects that balance and how they attempt to optimize it.
In particular with sticky prices, the ‘hot potato effect’ becomes important. You might also hear it called, ‘monetary disequilibrium’, ‘excess cash balances mechanism’ and probably some other things as well. The Keynesian concept of the “Paradox Of Thrift” is related, though less well developed. I’ve written more about it here.
consider an economy initially at equilibrium with a fixed quantity of money and prices that adjust to changes only after some time (sticky prices). Some people in the economy decide they want to hold higher money balances than they had in the past:
When people hold less money than they would like, they try to increase their holdings of money in two ways: 1) try to reduce their spending 2) try to increase their income. The quantity of money is fixed, so if one person holds a higher nominal quantity of money than before, all others must hold a lower quantity of money than before in aggregate. Prices are fixed, so this is also true for the real quantity of money. When one person reduces their spending, they reduce the income of others in the economy. Unless those others desire to hold less money than before, they now hold less money than they would like. Now those others also try to increase their money holdings by the same means. This is a vicious circle and aggregate spending and incomes decline. The circle ends when people no longer want to reduce their their spending to achieve higher money balances.
There are two effects which determine how far this process proceeds. 1) The quantity that people want to hold is positively related to the quantity people expect to spend, so as people expect to spend less they will need to hold somewhat less money. 2) As people reduce their spending, those reductions become more painful, so will be more reluctant to trade off consumption for increased money balances.
Do you know of a good explanation for why the Federal Reserve’s efforts to inject more money into the US economy since 2008 has not quickly brought it back to near full employment?
Yes, there are two big reasons:
1) The Fed has made it clear that the injections are temporary and will be removed if the economy improves. Standard theory says that increases in the money supply expected to be temporary basically have no effect on inflation or (they lead people to want to hold more money). If you double the money supply but promise to reverse this in a year, the result is not huge inflation now till a year from now and then huge deflation, but no inflation (lots of people think about inflation as a differential equation, but this will lead you astray).
2) Near the start of the crisis in 2008, the Fed started paying interest on reserves which encourages banks to hold excess reserves, of which they hold a huuuuuuuuuuge amount. The interest rate is quite small, but this can have a huge effect this rate is above what banks can get elsewhere (risk adjusted). The appropriate interest on reserves could also easily be negative.
Also, the uncertainty about when the injections will be removed keep investors on the sidelines. People don’t like uncertainty, and will often wait it out.
Why would anyone assume that everyone (in the US and other wealthy nations in particular) is economically viable as an employee at prevailing wage rates?
Add in increasing regulatory and financial burdens to employers. Add in an economy increasingly based on information, where information coordination is more and more a relevant and limiting factor. Add in technology rapidly making people with meager skills obsolete.
Even without the add ins, management and coordination have financial costs and opportunity costs that a worker’s productivity may not overcome.
Thanks! That helps.
In case you’re interested, I have a short mathematical model of monetary disequilibrium, which is something I haven’t been able to find anywhere else. The people who seem to understand this aspect of macroeconomics clearly tend to incorrectly think that math is useless.