Wednesday, February 11, 2009

The Monetary Policy Theory of Debt-Deflations

I believe recession-fighting monetary policy works very well in theory and practice in any one iteration.  By artificially depressing the real interest rate, increases in investment and consumption and decreases in the savings rate are forced.  This should come as no surprise: that is the entire purpose of stimulative monetary policy.  GDP and employment growth resume as a result.

But I propose that when this cycle is repeated in series, it will lead to structural oversupplies of credit and excess productive capacity.  This will force price and wage disinflation and decreases in the equilibrium real interest rate(important read) over the longer run.  Debt-deflationary spirals and instability become increasingly likely as high debt-to-GDP ratios and the zero bound inexorably are achieved.

Here are some graphs of supporting data.  We are particularly interested in the post-1982 numbers. Personal savings ratesreal interest rates, non-residential investment as a percentage of GDP, total credit outstanding to GDP, the effective federal funds rate, and consumption as a percentage of GDP.  It's helpful to review these as you step through the cycle below, and I apologize again for not being good with charts.

The Proposed Process

1.  During a boom, real interest rates and investment's share of GDP naturally increase.  Household income also increases.  This income is distributed between consumption and savings.  This distribution depends on the level of real interest rates: if they're high, more will be saved, and if they're low, more will be consumed.

2.  A shock hits the economy, and the business cycle turns down.  Investment registers a particularly sharp decline, and household income declines as well.  Consumption falls less significantly.  Disinflation occurs as slack emerges in capacity utilization.

3. To forestall a deepening recession, short-term interest rates are cut to forcibly depress real interest rates.  In Hayek's parlance, this constitutes forced saving.  There is an increase in investment beyond what is supported by economic equilibrium, with an associated increase in money supply growth to fund this investment.

Over-leveraged or under-productive enterprises that would normally have been destroyed find respite from the lowered interest rates too.  They are able to continue producing goods, adding to surplus output.

In the U.S., which has a low savings rate, decreased real interest rates will also increase consumption, because the lost interest income is outweighed by benefits of cheaper credit, goods, and the wealth effect.  Thus, consumption also rises in response to the lowered real interest rates, but not as sensitively.

4.  The economy emerges from recession into a fresh boom due primarily to the resurgence in investment, and due partly to increased consumption.  Real interest rates, employment, income, inflation, and investment begin to rise again as the business cycle is reignited successfully by monetary policy.

However, we find ourselves with excess money supply and investment lingering from the prior cycle.  The artificial overhang of productive capacity and debt outstanding lead to a lower equilibrium real interest rate during this recovery.  Thereby, inflation, policy rates, and the real rate of interest fail to recover to prior cyclical highs.

As a second order effect, the lower real interest rates induce households to consume more of their income and save less during this cycle.  The savings rate rises more slowly, or even continues to fall, while consumption rises more quickly.

Investment responds to this increased consumption by growing even faster.  Total credit outstanding surges to fund this expansion, while inflation fails to respond.

Then, another shock hits the economy.



After this cycle is repeated enough times, we are left with very high consumption, enormous productive capacity, very low savings rates, very low inflation, very low equilibrium real interest rates, and a very large money supply.  These conditions are perfect for a debt-deflationary spiral.

Debt Deflation

A debt-deflationary spiral finally occurs when the zero bound is reached.  This section of the story has already been written by Fisher.

Recovery

Fisher's policy solutions supporting his main recommendation -- "dude, you so do not want to go there" -- are impracticable. Bernanke and the U.S. economy have ably collaborated to demonstrate that in our present disaster.

First, interest rates cannot be cut low enough.  The real interest rate rises as the economy tries to force saving.  But at the same time equilibrium real interest rates may be very low, and perhaps even negative due to the overhang of productive capacity and credit, making the liquidity trap virtually impossible to escape from. Therefore, there are few appealing investments.  Consumers will not be credit-worthy either with declining income, high debt burdens, and job losses.  It becomes very difficult to force either investment or consumption through conventional monetary policy.

Quantitative easing, encouraged by Fisher, is also probably not going to succeed because it lacks any transmission mechanism to the real economy during a liquidity trap.  Money supply is rightly thought of as a dependent variable.  As such, heroic efforts to halt a deflationary spiral by forcible money creation and liquidity provision will fail unless the money is created at incredible pace.  This would probably cause unacceptable collateral damage.

My policy prescriptions are different.  First, defaults must destroy excess money and productive capacity.  This is a painful process that will temporarily exacerbate the debt-deflation spiral and result in increased unemployment, but it is inevitable.

Secondly, future monetary policy must be consistently more constrictive, forcing declines in investment and debt outstanding during expansions.  I think it's still a useful tool, but provisioning its use by inflation and employment alone is a recipe for our current disaster.

This will be my last post for awhile.  I've got a series of contiguous business trips for my real job from now to the end of March, and expression of this theory is the reason I started the blog.  The incredibly good commentary and your readership are extremely flattering and a little addictive.  I'll continue commenting elsewhere as long as I'm welcome regardless.  If you like my ideas, please promulgate them for me, as I'm not wont to do so myself.

18 comments:

Juan said...

NDK,

I believe you and I are on the same 'wave length' though from different perspectives.

In particular your understanding of the multi-cyclic nature of capital accumulation which, other than under exceptional circumstance such as the immediate post-WWII decades, I would add, places downward pressure on the nonfinancial rate of profit and correspondingly, public and private attempts to compensate for or overcome this, no matter that such attempts virtually guarantee that which they seek to prevent.

Thanks

think like a trader said...

Too bad to hear you may not to post in the near future. Wish you the best and thanks for sharing your thoughts.

When you have time, do you mind to picture a hypothetic scenario where the global trade is mostly halted for the final goods ( let's assume the trade for the material inputs are not affected)? I expect protectionism will reach its new high very soon and let's just have an intellectual mind game of what kind of world will be without international trade.

ndk said...

I believe you and I are on the same 'wave length' though from different perspectives.... places downward pressure on the nonfinancial rate of profit and correspondingly, public and private attempts to compensate for or overcome this, no matter that such attempts virtually guarantee that which they seek to prevent.

Juan, this is exactly right. I'm trying to connect monetary policy to the trans-cyclical capital accumulation you describe.

If monetary policy is relatively accommodative, with a low effective real interest rate, then capital will accumulate, the return on savings will decrease, and the equilibrium rate will drift downward. If monetary policy is relatively tight, with a high effective real interest rate, then capital will be destroyed, the return on savings will increase, and the equilibrium rate will drift upward.

Put succinctly, I believe that the equilibrium real rate of interest trends to the real rate of interest set by policy. Can anyone find this proposed elsewhere?

Basically, it seems we agree that a lot of capital -- both in money and actual capital stock -- will need to be destroyed to create more appealing investment opportunities.

Too bad to hear you may not to post in the near future. Wish you the best and thanks for sharing your thoughts.

Believe me, if I didn't have a legacy job, I'd do it a lot more often. Thanks for your well wishes, tlat.

When you have time, do you mind to picture a hypothetic scenario where the global trade is mostly halted for the final goods ( let's assume the trade for the material inputs are not affected)? I expect protectionism will reach its new high very soon and let's just have an intellectual mind game of what kind of world will be without international trade.

Sure, I'd be glad to if I have time. And you guys make it awfully hard not to find the time. :P

Detroit Dan said...

Makes sense to me. We do need national health insurance and a better overall safety net so that we can survive an occasional sluggish economy. Taking our medicine is good, but we don't want it to literally kill our citizens...

Anonymous said...

ndk,

Thank you for posting Fisher's piece on Debt Deflation on Yves' blog in the comments section, as well as your ideas!

mike

Anonymous said...

Very interesting theory. Please resume posting when you are back in April.

jult52

reason said...

Sorry I think there are several logical errors in this analysis.

Firstly, I don't think "excess capacity" means anything in a macro sense. You can have "excess capacity" in particular industries but not in the economy as whole. What you must argue here is that the growth in capacity is for some reason unbalanced, not that it is excessive.

(See
http://interfluidity.powerblogs.com/posts/1229192192.shtml )

I would have thought point 3 was just simply contradicted by the empirical evidence. During a contraction investment always falls. Investment is mostly influenced by long term interest rates, not short rates and these are not controlled by authorities but mostly by expectations. And as far as I am aware monetary authorities mostly follow the market rather than lead it during the recessionary phase.

In point 4.
You say "(H)owever, we find ourselves with excess money supply and investment lingering from the prior cycle." Why exactly? And excessive relative to what?Actually monetary policy tries to smooth the path of money supply growth and contraction to try to maintain steady nominal growth. The excess build up of debt has another source (speculative demand for money perhaps).

Now if you want to convince me of this logic - build a model of it, make it run and show that it matches in every respect what we see from real world economies like Steve Keen does. And even better, produce empirical evidence for your assumptions. Otherwise I thik you are just pulling this stuff from the top of your head and have no evidence at all for it.

And see this:
http://www.slate.com/id/9593

ndk said...

Firstly, I don't think "excess capacity" means anything in a macro sense. You can have "excess capacity" in particular industries but not in the economy as whole. What you must argue here is that the growth in capacity is for some reason unbalanced, not that it is excessive.

Why would you believe there can't be an excess of aggregate supply as compared to aggregate demand? Isn't that just reformulation of Say's Law? I'm pretty sure we have ample evidence that such a law doesn't hold.

I would have thought point 3 was just simply contradicted by the empirical evidence. During a contraction investment always falls. Investment is mostly influenced by long term interest rates, not short rates and these are not controlled by authorities but mostly by expectations.

The end of a recession in the period after 1982 is always marked by a sharp upturn in investment spending, following a sharp decline in policy rates. The correlation is very strong and noted by others. As Bernanke and Blinder stated:

The results are striking: the Federal funds rate is markedly superior to both monetary aggregates and to most other interest rates as a forecaster of the economy.

I believe point 3 to be strongly supported by empirical evidence.

And as far as I am aware monetary authorities mostly follow the market rather than lead it during the recessionary phase.... Actually monetary policy tries to smooth the path of money supply growth and contraction to try to maintain steady nominal growth.

I consider this a succinct statement of why monetary policy has been part of the problem. There is an extraordinary and understandable reluctance to limit investment and consumption in favor of developing savings. If there were less reluctance to instigate recessions, destroying excess capacity, such an excess of capacity would not develop.

Now if you want to convince me of this logic - build a model of it, make it run and show that it matches in every respect what we see from real world economies like Steve Keen does. And even better, produce empirical evidence for your assumptions.

I would love to do so more explicitly, but I unfortunately have a real job, and it's not economics, as fascinating as I find this all. I'll do my best to add as much evidence as possible to my posts, but sometimes the reader will have to fill in the gaps(or hire me so I can do it without losing my own job).

Thanks a lot for the valuable criticism, reason.

ndk said...

I should add that this is a testable hypothesis. If I'm correct, and there is a structural negative real rate of interest embedded in the US economy, monetary and fiscal policy will generally fail to produce any inflation or economic growth. They both rely on the ability of policy-makers to shock the natural real rate of interest higher, and I find no reason to believe they have that ability.

Qualitative easing may help to the extent it reduces interest rates below their natural levels, but it would have to be performed to a tremendous degree, and it would only further depress the natural real rate of interest in the economy.

Fiscal policy will also fail to solve the problem, because it would succeed only if the structural natural real rate of interest were positive. It may increase demand and employment temporarily, though I'm skeptical of even that from prior experiments.

The equilibrium real rate of interest will have to become positive again before economic growth returns. I suspect that a positive real rate of interest can only be achieved through destruction of the capital oversupply of the economy. This could be hastened by raising interest rates, with disastrous short-term consequences.

Anonymous said...

Mr. Kasriel in his Feb 9 (Northern Trust website-The Econtrarian)seems to argue this will all lead to a turnaround. Do your ideas differ in that he is assuming a ton of monetized stimulus-more than you are assuming-or that there may be a rebound (with higher prices) result but you think not a durable one? Or do your ideas ultimately reconcile or at least not conflict? The thing everyone seems to be asking, and that you all seem to be addressing is "will this all work?" and "where are we going?" so as an investor/trader non-economist I can't imagine a more relevant discussion. Thanks for your contributions.
Jon

ndk said...

It looks like the tendency of active monetary policy based on the Taylor Rule to lead to deflationary spirals was also observed in model behavior by Benhabib, Schmitt-Grohé, and Uribe. I suspect we've just watched it in action. The theoretical mechanism would be as I described.

Jon, sure. I'll do one more post on what negative equilibrium real interest rates mean for investment and the future of the economy.

Marlowe said...

ndk,

I'll add my thanks and appreciation. I look forward to the next piece on negative real rates, as well as anything else you post in future.

Important stuff.

Juan said...

I'm trying to connect monetary policy to the trans-cyclical capital accumulation you describe.
[...]
Put succinctly, I believe that the equilibrium real rate of interest trends to the real rate of interest set by policy.


Long time since I've read it but my recollection is that Marx, in the third volume of Capital, argued that avg. rate of industrial profit set a medium-long term cap on interest rates while, on the other hand, these rates were also determined by supply/demand relations for money capital or, better, loan capital.

OK, this was mid-19th c England and prior to govt use of counter-cyclic policies so the credit cycle behaved quite differently - expansions were accompanied by declining interest as a rising mass of industrial profit generated relatively more loan capital than was demanded by industry. Other hand, contractions tended to see a rising interest rate as the quantity of industrial profit distributed to loan capital diminished relative to demand for such, some of which can be thought of distress induced.

Or, during crises, it was not abnormal to see interest rates well in excess of avg rate of industrial profit that, nevertheless, was determinant over longer frames.

So FF to the post-WWII period and govts' use of monetary policies and the profit rate/interest rate relation acquired a different character with policy rates being reduced when the real econ entered a cyclic contraction,,,reductions that, consciously or not, have been reactions to what has been the drop in rate of industrial profit.

My first approximation then would be that counter-cyclic policies have contributed to the multi-cyclic nature of over-accumulation (need to look at both rate and mass of nonresidential investment), the erir should have trended downwards and that the present crisis may well include the destined arrival at absolute policy limits with which we experience a return to a mid 19th c 'future'.

reason said...

ndk
Firstly,
you haven't answered the point about excess capacity, it is not sensible. Are you saying we would be better off producing less? How does growth happen then? Surely, Say's law (not that I believe it) should want the economy to at balance at full employment? Did you follow the link to interfluidity?

Further, what you are saying is not sufficient to test your hypothesis because it doesn't look at alternative explainations and rule them out. And while you personally may not have the time to do such tests, there are a number of academic Austrian economists who do, but they reject the whole concept of empiricism (and so of science in my view).

You talk in point 3 about the downturn phase and then try to explain your answer in terms of the upswing. Make up your mind.

Lets just put it this way, imagine that investment swings up and down exogenously. Then imagine that the central banks act endogenously on the basis of investment volumes. How do you distinguish that possibility from your model?

Secondly, where is the foreign sector in all this? I happen to think the major explaination of low real interest rates is a disfunctional international financial system. The imbalanced trade flows are the key statistic which were pointing red for some time. Your investment story, is a just so story that doesn't explain all the facts. Leave your theory behind and think about what is really happening.

And learn about the theory of second best while you are at it.

Anonymous said...

I’ve followed the second link to find no reason there. Not for its critique but for taking on the wrong premise and presenting his attack as a final irrevocable victory. Bollocks.

As for the above NDK post I think of it as wrong-headed also.

I propose instead that falling real interest rates are the single most important cause of capital destruction.

This was true long before Keynes and it remains true after Friedman though a lot of politico-economic obscuring was perpetrated in-between.

Both Bernanke (monetary miss policy) and Krugman (fiscal miss policy) are two of deeply lost guys in the woods of this planet. Together they offered a smoke screen to hide their greater depression behind. The biggest mistake was Ben’s - to lower the nominal interest rates back before election (when Paul won his award) - instead of rising them up though this produced a nice side effect of a desired election outcome e.g. for debt holders’ hostile take over of the (by then already failed) state.

Now they’ll be prolonging this crisis indefinitely by implementing (by completely taken out of historical as well as today’s context – bankrupt) ideas. The only “macro economic” (remember the source) question remaining is how far they can push the new president to swallow his near-future diving good will (approval ratings) before the other tools in the kit get used.

I do hope I am wrong.

ndk said...

Yes, I absolutely believe in over-investment. Of course it's better to produce more goods when there is sufficient demand, but if demand fails to respond, margins will be hit. Here's an academic treatment and analysis of over-investment in Japan. Tobin's q has been quite low there for a long time, and I suspect it will become low here too.

This was a simple description of a fairly closed economy. In the real world, I think the international aspect you cite is very significant, and that much of the overinvestment is overseas. Similar monetary policy theory has been employed globally. As the Fed forced investment in the US economy despite rapid capacity and export growth overseas, this investment shrank away from sectors exposed to cheap imports. Residential fixed investment is one such category.

Again, I apologize for the lack of formality in my formulation. I don't have the time nor capacity to do it right.

john c. halasz said...

NDK:

I found this post a confusing hodge-podge of ideas from differing theoretical sources.

I'll deal with the Austrians first. Production is not a temporally prolonged process. It's true that it involves vertically integrated supply chains or stages and must be inter-sectorally balanced between industries/businesses, but that is always an on-going and constantly adjusting process. Nor is the supply of savings and hence "equilibrium" interest rate a matter of the time-preferences of individuals. There will always be a large mass of such individuals with differing "time-preferences" and savings rates, on the one hand, and on the other, savings rates will be crucially effected by current incomes from the on-going production of the economy. Nor is it the case that savings must precede investment, which is merely a short-run accounting identity in NIPA accounts. Rather, long-run, it's investment that produces savings, in the sense of technical improvements in capital stocks that reduce costs, raise productivity, and increase the real distributable surplus-product. Which, in turn, is why credit is endogenous to the production/business cycle, since it is required to get it going. Hence there is no Austrian "natural" rate of interest "out there" somewhere, which depends on "value" being incarnated in some sort of "hard money" commodity such as gold, which must be saved "prior" to production. If, indeed, there were such a "hard money" requirement underpinning all provision of credit, then production would be difficult to get going and the level of output would be deficient, severely below potential, and hence the savings/surpluses accruing to innovative productive investment would be long deferred in being realized. Hence returns of real capital investment would be so low and long-dated that it would generate little further supply of available savings, and, indeed, force the "natural" rate of interest up. There is a considerable amount of archaic thinking in Austrian economics, and its belief in perfectly self-regulating markets, -(and in the reduction of the sphere of production to markets, since the constraints of production systems are not the same as those on market exchanges, and those constraints may be mediated by markets, "outsourced", as with the Austrian account, but just as well may have alternate arrangements, as with vertically integrated industrial oligopolies, or Japanese "keiretsu" arrangements)-, whereby the failures of markets are simply due to markets never being "free" enough, due to evils of government interventions, (on behalf of the hoi polloi), amounts to converting a functional account of "free" markets into an ideological fantasy of reactionary utopianism.

But, leaving the Austrians -deservedly- behind, I don’t think what happens in production/business cycles can be usefully understood solely from the standpoint of a monetary economics and in terms of the effect of interest rates, as all-determining. Let’s look at some of your numbered points:

“1. During a boom, real interest rates and investment's share of GDP naturally increase. Household income also increases. This income is distributed between consumption and savings. This distribution depends on the level of real interest rates: if they're high, more will be saved, and if they're low, more will be consumed.”

There is no mention here of corporate savings, and the account of household savings depends on a substitution effect, with no income effect. And the assumption the real interest rates and investment/GDP start mid-boom, and is not simply “natural”, but an effect of the boom and its slowing.

“2. A shock hits the economy, and the business cycle turns down. Investment registers a particularly sharp decline, and household income declines as well. Consumption falls less significantly. Disinflation occurs as slack emerges in capacity utilization.”

The shock is entirely exogenous? That’s RBC theory. And whereas it’s true that investment would be more volatile than consumption, (partly because of the availablity of credit to households), it’s the decline in wage-based household demand that spurs disinflation, results in excess capacity.

“3. To forestall a deepening recession, short-term interest rates are cut to forcibly depress real interest rates. In Hayek's parlance, this constitutes forced saving. There is an increase in investment beyond what is supported by economic equilibrium, with an associated increase in money supply growth to fund this investment.

Over-leveraged or under-productive enterprises that would normally have been destroyed find respite from the lowered interest rates too. They are able to continue producing goods, adding to surplus output.”

What “equilibrium level”? Isn’t that precisely what has collapsed? There is an increase in investment solely due to interest rates? And what is the significance you’re attaching to the “money supply”? Is this monetarism? (See the Steve Keen post you cite). “Over-leveraged or under-productive” enterprises are destroyed or not solely by the recession and the interest rate? It’s likely that the competitive damage done to the most marginal concerns occurred before the recession, and if they aren’t driven-out by the recession, they’re all the more likely to be driven-out by the competitive pressures of the recovery. It’s true that lower interest rates raise the price of repurchase for a concern’s debt, even if it lowers the price/cost of new re-financing debt. But that, of itself, does not amount to, nor account for, the destruction of the “value” of capital. And lowered interest rates (or other stimulus measures) have a larger effect in “saving” still viable concerns, which merely are suffering from the more-or-less temporary short-fall in adequate demand, compared to which your liquidationist argument is trivial. (Actually, in “New Keynesian” accounts of monetary policy, the main effect of cuts in short rates is to steepen the yield curve and thus increase or restore the NIM of banks, which ration credit, to help them weather the recession, and one of the primary channels of such cuts to the real economy is through housing, whose decline is concurrent with the recession, both through its effect on re-fi and on construction employment, which gives a large hint at why such policy can’t be effective now). And why exactly is it that the least productive concerns are contributing to excess output, rather than the most?


4. The economy emerges from recession into a fresh boom due primarily to the resurgence in investment, and due partly to increased consumption. Real interest rates, employment, income, inflation, and investment begin to rise again as the business cycle is reignited successfully by monetary policy.

However, we find ourselves with excess money supply and investment lingering from the prior cycle. The artificial overhang of productive capacity and debt outstanding lead to a lower equilibrium real interest rate during this recovery. Thereby, inflation, policy rates, and the real rate of interest fail to recover to prior cyclical highs.

As a second order effect, the lower real interest rates induce households to consume more of their income and save less during this cycle. The savings rate rises more slowly, or even continues to fall, while consumption rises more quickly.

Investment responds to this increased consumption by growing even faster. Total credit outstanding surges to fund this expansion, while inflation fails to respond.”

This might be taken as a post-hoc description of the last cycle in the naughties. But then it misses the absence of much corporate real investment, the stagnant wages and low employment recovery, and the fact that over-consumption was largely a function of asset inflation, wealth-effect dis-savings, which, er, was not widely shared by the wage-earning class. And neither “excess money supply”, nor “the artificial overhang of productive capacity” would account for those aspects. “Reason” above is right: you should look to China et alia abroad for the export of deflation and the liquidation of domestic productive investment, for an explanation. But, of course, all of that was officially sanctioned domestic policy, not something foisted on the domestic policy-makers and elites. Likewise, the “forced savings” were not a result of domestic interest rates, (though the asset inflation partly was), but rather occurred through exchange-rate policies and MNC labor-arbitrage abroad. (In China, in particular, though wages have risen, the wage-share of GDP has fallen from 40% to 35%, while the household savings rate has held constant, hence the excess savings supply for export was largely due to PBoC, SAFE, And SOEs). Hence, “investment responds to this increased consumption by growing even faster. Total credit outstanding surges to fund this expansion, while inflation fails to respond”, scarcely constitutes a real explanation, unless you’re describing the likes of China. In fact, you should look to the declining wage-share in global output, both domesticly and abroad, rather than to “investment overhang” for the beginnings of an explanation, since excess production capacity is relative to under-consumption, i.e. lack of real aggregate effective demand, and the financial asset inflation induced by low interest rates is simply the obverse of low rates of profit from real productive investment.

As far as I can tell, your account of the economy is an entirely monetary one, and hangs solely on the notion that interest rates, especially short ones, determine investment “at the margins”, in neo-classical fashion. But consider that much core industrial investment is long-run, high-cost, and uncertain fixed investment in capital stocks, which may last through several production/business cycles. (It takes 4-5 years to build an oil refinery and 20 years to amortize its cost). Interest rates could only effect replacement costs for such capital stocks or additional, incremental investments in them, but not the “value” of such total stocks. In fact, the primary determinants of real fixed capital investment are the sensed presence of adequate effective demand, the available horizon of untapped technical possibilities, and the pressure of wage-costs, (which cycles back onto the level of wage-based real effective demand, contrary pressures). And, of course, such real productive investment must be realized through revenues from the sale of output, which, in turn, determines the “value” of such capital stocks. Now consider what happens in the course of the production/business cycle in “real economy” terms. Productivity-enhancing/cost-reducing innovative investments in real capital stocks lower unit production and output costs/prices, increase potential output, and raise the real distributable surplus-product, first of all, in terms of increased profit-returns to such investment. A particular sector might undergo such an innovative boom in real investment, which then has spill-over effects on other sectors, insofar as the level of real effective demand is raised. Further, since technology tends to come in inter-locking complexes, other sectors might undergoing technical spill-over effects, sparking further innovation/investment booms. And the generally high level of effective demand would also spark incremental improvements, due simply to the high level of activity, in business organization and production methods, through the learn-by-doing principle, across many sectors. But note the follow-on effects of a productivity- enhancing boom. Initially, there are high profits, but labor is dis-employed and shifted to more labor-intensive, lower-surplus sectors. And older competing capital stocks are driven-out, resulting in a destruction in the total capital stock. And high profits are recycled into further such investment, but, at some point, with diminishing incremental returns. In fact, the perception of high profits and the need to recycle such profits into further investment to maintain the “value” of total capital stocks results both further real investments and the bidding up of financial “asset” claims to the revenue from the realization of such investments, (which lowers the monetary costs of such real investment). In the meantime, losses accrue to the destruction of older capital stocks, competitively driven-out, (and thus to the “value” of the total capital stock), and wages, partly redeployed to lower surplus sectors, due to both the asymmetry and the lag in distributions between wages and profits, rise less than the growth in productivity, resulting in a gradual decline in wage-based real effective demand. Hence, the real rate-of-profit on real capital investment begins to imperceptibly decline. Both the technical limits and the availability of wage-based demand begin to dry up investment opportunities, (and note that real investment needs to be realized through revenues from output, to maintain the profitability and “value” of capital stocks, so the rate of technical change will be limited by the need to realize such investments before they can be liquidated). But the need to recycle realized profits into further investment to maintain the “value” of capital and the experience of prior returns from such realizations will result in a tendency to prolong the real investment boom into speculation on financial “assets”, continuing to bid up their prices, even as real profits are in decline, thus prolonging the boom into a bubble, and by further shifting income and wealth upward, however temporarily, resulting is “wealth-effect” based consumption demand and further real dis-savings. But such inflation in the prices of financial “assets”, which is already an expression of lower real returns, can’t last, and results in a bust, in which both profits and the “value” of capital stocks collapse. And please note, it is the wage-earning class that is subject to a triple-whammy in the business cycle: 1) they are partly dis-employed and consigned to lower surplus sectors of employment through producivity-enhancing investment, even as their wages lag the total increase in potential output; 2) their savings-rate is inherently lower and thus they largely do not participate in the boom in profits and asset-inflation, wealth-effect consumption; and 3) in the bust, they have the least savings/wealth to tide them over and suffer first and most from unemployment. In the bust, real capital stocks are liquidated and financial assets deflated until such point as the “value” of remaining capital stocks and the rate of return on financial investment, (which is itself derived from the realization of real investment), are “restored”, i.e. reset at a new level at which they can begin to absorb excess unemployment. But it is hard to regard such a bust as a “healthy” cure. For one, those who gained least from the boom suffer/pay the highest real cost for the bust. For another, it is the very success of real productive capital investment in raising real output potential that has led in the boom to the fall in the rate-of-profit and the devaluation of capital, not simply “investment overhang”. That may well be paradoxical, but it is rooted in the asymmetry in the distribution of income and wealth inherent in a private profit-driven system. So interventions to “correct” for the bust having a contradictory quality. Redistributions of income and wealth are required to restore the rate-of-profit and motivate renewed demand-based investment. On the other hand, a high-profit/low-wage economy is stagnant, lacking any motive-force for renewed investment in productive capital stocks. Which is to say, that the “value” of capital would be maintained only by its relative lack of productivity. Capital stocks then might appear nominally more valuable, through the “negative Wicksell price-effect”, but that’s really just another recipe for collapse.

The only thing to add to this account of the real production/business cycle, in which both falling profits and expanding-credit are endogenous components and not mere “exogenous” shocks, is that economies have now gone global, through the globalization of both finance and production supply-chains, under the aegis of “free trade”. And the most advanced technical means are now being employed to seek out the lowest wage-costs, and boost the rate-of-profit, thus decreasing the global wage-share in output. But then one might pause to consider whether the Pentagon/Wall Street/MNC dollar-kiting scheme is not really aimed at “productive” ends, but rather amounts to an imperial scheme to extract rents off of the real productive economy, both domesticly and financially, from the household and SME sectors, and globally, from the RoW.

Anonymous said...

that hope (of being wrong) is fast deleveraging:

http://www.bloomberg.com/apps/news?pid=20601087&sid=aKm0M7RHXDoQ&refer=home