Various Keynesian and Monetarists stimulus programs have been tried and
failed since 2008 and the response of their advocates to their failure
is always "the level of stimulus didn't go far enough - lets have more
please".
What the advocates of these forms of stimulus have in
common is a belief that the recession is somehow caused by nominal
factors (not enough money) or confidence factors (future expectations
too low) rather than real factors. This seems inconsistent with the
facts. There was a large drop in RGDP in 2008 accompanied by a fall in
NGDP and levels of employment. Since then NGDP has risen more or less
in line with its long-term trends while employment has increased much
more slowly. If this was nominal wouldn't we have expected a more
significant recovery in employment as NGDP has increased substantially
since 2008 ?
To my mind this looks like something real happened
in 2008 from which we have not yet recovered - perhaps there was a
realization (doesn't really matter what it was for the purposes this
post) that year that something fundamental had changed that would
render a proportion of investment unprofitable ?
What would we have expected to see happen if this was the case.
-
A sudden drop in RGDP and employment as these unprofitable lines of
business were terminated accompanied by a fall in NGDP as effective
demand is reduced
- A reduced demand for labor that if not resulting in lower real wages would result in higher long-term unemployment
-
If effective demand has fallen but wages have not then there will be
less profitable investment opportunities. This will increase savings
and reduce borrowing and lead to a fall in IR potentially to zero and a
"liquidity trap" that will again cause NGDP to fall.
This chain of
events is consistent with what has happened. What then will be the
effect of an attempt of the monetary authorities to set expectations
that NGDP will increase at a higher rate in the future? It will depend
upon how businesses expect this increased money supply to affect
relative prices - in particular the wage level relative to the price
of final goods. In the best case scenario then this will cause real
wages to fall and allow investment to increase. Even here though the
effect will be via inflation which will affect different goods
differently and disrupt the price mechanism. Based on the experience
since 2008 though the increased money supply will cause real wages to
rise almost as much as final goods. We will get higher inflation
and only a marginal effect on employment. This is stagflation and
will quickly wipe out any beneficial effects of the marginal lower real
wages.
