Its On! A Holy War Over Say's Law

     In the world of economics this is a guerrilla war. Sumner goes after Krugman for knocking Say's Law:

     "Yesterday I wrote:

But if and when Krugman does draw some policy implications from the “sinkhole” of corporate saving, he’s way too savvy to ignore the saving/investment identity. He’ll talk about income distribution, propensities to save, and dysfunctional monetary policy. Or at least imply those assumptions.

Looks like we can assume Mr. Krugman doesn’t read my blog, as his newest post is a step backward, invoking the tired old myth that conservatives just don’t get why Say’s Law is a fallacy. But let’s start with the post that got Krugman’s attention:

Ah, but why are these investment opportunities lacking? Could one of the reasons be that too high a fraction of national income is being funneled into corporate profits, rather than households inclined to spend it? What Cowen has trouble with is seeing all the pieces simultaneously in true macro fashion. The problem is not that corporate money can’t find its way to ultimate investment, but that too much corporate money itself reduces the pull of final demand on the level of investment. The upshot isn’t that money disappears into cupboards, but that national income is lower than it would otherwise be.
I’m sympathetic with Cowen’s struggle: I see the same difficulties in my economics classes every year. Students can usually see only one or two linkages at a time; it is really hard to see the whole thing as one simultaneous entity.

     "OK, Dorman’s an immature jerk, so are lots of other economists. But what’s wrong with his argument? Everything. What he calls ”true macro fashion” is the old Keynesianism of John Maynard Keynes. The man that developed a macro model for a constrained monetary policy (i.e. the gold standard), but never really understood what made the model tick. By the 1990s the view that savings is good was back in the saddle, a key part of New Keynesian macroeconomics. When the Fed targets inflation at 2%, attempts to save more will not reduce aggregate demand. Now it’s true that the Fed fell short of its inflation target in 2009, but ever since then they’ve been pretty close. In today’s environment one common definition of Say’s Law holds (at least approximately) true for changes in AS and AD. Aggregate supply really does drive demand. Attempts to save more will not depress aggregate demand. (BTW, an alternative definition of Say’s Law—demand shortfalls cannot exist—does not hold true today.)"

     http://www.themoneyillusion.com/?p=19358#comment-226905

     Note Sumner's explanation of Keynes' "Paradox of Thrift": it was plausibly true for the old gold standard system-as there was a limited gold supply. However, with the end of the gold standard, Keynes' idea is a pure fallacy. This is really at the locus of the debate between Krugman, Dorman, and Noah Smith on the one hand and Sumner and Tyler Cowen on the other. According to Noah, public finance theory expects a orporations to do one of two things with retained earnings: take the money and reinvest back into the business or pay it out of dividends. However, since the 90s, corporations have come to pay out dividends far less often:

    "Standard corporate finance theory says that companies try to generate returns for shareholders in one of two ways. Either 1) the company reinvests its earnings in the business (i.e. "business investment"), raising the company's value and allowing shareholders to reap a capital gain, or 2) it pays its earnings to shareholders as dividends. Now, since the 1990s, we've gotten used to thinking of companies as rarely paying dividends. But the reason for that was that there were (or at least, companies thought there were) many important growth opportunities to be had; companies took their earnings and reinvested them."

     http://noahpinionblog.blogspot.com/2013/02/the-corporate-cash-puzzle.html

      Cowen sees the fact that companies like Apple are doing neither but instead putting them in Treasuries, etc. is not a problem. Or if it is a problem it's because of his own coinage: a "Great Stagnation."

      For conservatives like Sumner and Cowen, saving is always a good thing and the idea of the "Paradox of Thrift" is anathema. Sumner always claims that Keynes confused "excess savings"-an impossiblity for him-with hoarding. Cowen argues that if corporate money is being parked in securities, this is not hoarding and is not a drain on the economy but actually a net gain:

     "Tyler Cowen responds to Krugman’s “sinkhole” claim:

That seems to be Krugman’s argument here, and here, excerpt:
“So corporations are taking a much bigger slice of total income — and are showing little inclination either to redistribute that slice back to investors or to invest it in new equipment, software, etc.. Instead, they’re accumulating piles of cash.”

I am confused by this argument. I would understand it (though not quite accept it) if corporations were stashing currency in the cupboard. Instead, it seems that large corporations invest the money as quickly as possible. It can be put in the bank and then lent out. It can purchase commercial paper, which boosts investment.
Maybe you are less impressed if say Apple buys T-Bills, but still the funds are recirculated quickly to other investors.
 

       http://www.themoneyillusion.com/?p=19311

       Sumner though-I've always argued he's a good game theorist whether you like him or not thinks Cowen leaves conservatives exposed with this:

       "I don’t much like either post. Tyler seems to believe that high levels of corporate saving do not cause depressed levels of AD. I have no complaints with that broader claim. But you can’t really make that argument by pointing to the fact that funds saved get recycled into investments. Yes, increases in realized saving lead to increases in realized investment, at the aggregate level. But if and when Krugman does draw some policy implications from the “sinkhole” of corporate saving, he’s way too savvy to ignore the saving/investment identity. He’ll talk about income distribution, propensities to save, and dysfunctional monetary policy. Or at least imply those assumptions."

        As we saw above, Sumner in the next post declared 'I guess I was wrong' and that Krugman supposedly made that exact fallacy of 'ignoring the saving/investment' identity. The reason Say's Law is such a Holy War in economics is that there's so much at stake. Here there's some quibbling over history:

       "Now here’s Krugman:

When John Maynard Keynes wrote The General Theory, three generations ago, he structured his argument as a refutation of what he called “classical economics”, and in particular of Say’s Law, the proposition that income must be spent and hence that there can never be an overall deficiency of demand. Ever since, historians of thought have argued about whether this was a fair characterization of what the classical economists, or at any rate his own intellectual opponents, really believed.
Not being an intellectual historian myself, I won’t venture an opinion on that subject.

      "You don’t need to be an economic historian. Wicksell, Marshall, Pigou, Cassel, Hawtrey, Fisher, etc, all had business cycle explanations that involved what we would call “demand shocks,” even if they didn’t all use that term. Fisher invented the Phillips Curve in 1923. Keynes was inaccurately describing the standard business cycle model of the 1920s, and it’s hard to see how it wasn’t intentional, at least at some level. He personally knew some of these people. Maybe that’s why he didn’t quote them directly."

       http://www.themoneyillusion.com/?p=19358#comment-226905

       Ok, now we have some vintage Sumner! Accusing Keynes of deliberately lying. To digress a little on the history of it, Wicksell, Marhsall and company weren't "Classical" economists-though Keynes himself referred to them as such but Neoclassical. Not all the names Sumner mentions necessarily go seamlessly together: you can certainly argue that Fisher was quite different after the Great Crash and he had the impetus for his "Money Illusion" book.

      Part of what this argument is gets to something that remains contested: the actual nature of Say's Law. This idea goes back to Ricardo but what's really important is that it remains with us today. Whether or not these economists believed there could be a demand shortfall depends how you parse the definition of it.

      What's really objectionable for Sumner in Krugman going after Say's Law is that it is the foundation of the entire modern supply side edifice of which Sumner is a major resident.

       He has to protect Say's Law. Here's how he does it. Again, you have to give him credit-it's quite ingenious. He doesn't so much prove it's true as prove that it's very hard to make it false-if we believe him. For Say's Law to not be true 4 things have to hold.

       "I’m sure if you add enough epicycles you could construct some sort of bizarre convoluted theory that makes Krugman correct. Let’s see how it might work:

       1. The fact that corporations have big cash hoards, shows that they’ve increased their MPS. This is by no means a sure thing, as total saving often falls when the MPS increases.

       2. Of course corporations don’t really have income, their owners have income. So now lets assume that the owners don’t “see through the veil.” The owners don’t realize that corporate income is their income. So now the big corporate profits don’t lead to more consumption.

     3. Next we’ll assume that the increase in corporate saving reduces the velocity of circulation. Not a sure thing—it depends on the counterfactual.

     4. Next we’ll assume that Bernanke’s Fed passively allows NGDP and inflation to decline, and doesn’t offset this with additional QE, or promises of future monetary easing.
If all four of those things happen, then Say’s Law might not hold.

     "We need to teach our macro students two key concepts: Say’s Law, and the need for NGDP targeting in a world of sticky wages. Flush the rest of Keynesianism down the toilet."

      Sumner argues that Krugman uses the Zero Bound as a get out of jail free card:

       "Krugman thinks the zero bound is a get out of jail free card for any sort of Keynesian counterintuitive cleverness. But it’s not. We are in an AS/AD world where the Fed is essentially keeping P level (on a plus 2% trend.) In that world AS drives output. There can be demand shortfalls (indeed there is right now), but this has nothing to do with the Keynesian critique of Say’s Law. Any attempt to supply more really does create more demand—from this point forward. Saving doesn’t depress demand. The problem is that inflation is the wrong target—they should stabilize NGDP growth."

       Ironic, isn't it? One can well argue that it's Sumner who sees his NGDP targeting as the ultimate get out of jail free card.

       With stakes like these you can see why it's such a Holy War.