Home > Uncategorized > Selgin on Good and Bad Deflation

Selgin on Good and Bad Deflation

George Selgin recently did an interview with RT  (about half way through the clip) in which he discusses deflation and why, in his view, sometimes it is good and sometimes it is bad.  I have several issues with this treatment of deflation.

Cause and effect

Selgin’s claim is that deflation is good when it is due to an increase in productivity but bad when it is due to a decrease in demand.  There are a few problems with this.  The first is that this seems to confuse the causes of inflation with the effect of inflation.

If we assume a simple free-market economy, then when productivity increases and the quantity of money stays the same, then one would expect the price level to fall in order to bring the economy into equilibrium.  In this case, the falling prices are a sign of increasing productivity which is good.  Similarly, one could argue that, given the increased quantity of goods and services and lower relative quantity of money, the fall in prices is itself good because it brings markets into equilibrium.

However, what is causing the fall in “demand” in Selgin’s mind?  I admit I don’t know but let’s imagine the converse of what I described above, namely that production remains constant and the quantity of money falls for some reason.  In this case, again the price level must fall in order to bring markets into equilibrium.  Is this bad now?

Aggregate Demand

The natural question which arises from this theory is what would cause a shortfall in aggregate demand?  Presumably Selgin believes in some form of Say’s law (supply begets its own demand in aggregate).  So how is it that there can be a reduction in “demand” which is caused by some real phenomenon not related to productivity that drives an undesirable deflation?  Is this some kind of “animal spirits” argument?  That doesn’t seem like Selgin’s M.O. though I am only casually familiar with him.

The reality is that “aggregate demand” is an inherently monetary concept.  In a money-neutral economy, there would be no such thing as aggregate demand and prices would adjust up and down to bring the market into equilibrium and this would always be good (at least it would always be Pareto optimal).  If there is such a thing as an aggregate demand shortfall it is a purely monetary phenomenon.  This is true whether productivity is rising or falling.  So why would it be bad in one case and good in the other?

Knock-on Effects

The reason “mainstream” economists think deflation is bad is not that falling prices themselves are inherently bad but that falling prices cause some kind “knock-on” effects in the real economy that rising prices do not cause.  Most of them explain these in terms of sticky prices or wages, I explain them with debt contracts but either way, there is something bad that happens if prices fall short of what people were expecting.

Selgin, on the other hand, seems to believe that there are knock-on effects of falling prices when productivity is not rising but not when it is.  I have heard many people make this kind of argument but I have yet to hear one of them explain how this is possible.

Profit Inflation

Selgin argues that, for some reason, when productivity is increasing, inflation causes the prices of end products to increase without causing the prices of inputs to increase causing (real) profits to increase.  Again, this makes no sense to me and I don’t know how he comes to this conclusion.  To me it looks like he is applying the concept of inflation selectively here.  It is hard to see how an increase in the money supply would not lift the prices of inputs along with outputs.

Debt Contracts

Selgin touches on debt contracts but he does so in an inconsistent way.  He says that when deflation is because of increases in productivity both parties benefit but when you have the bad kind of inflation he says this.

“If you’re a lender, you get back dollars that are worth more, even at times when productivity hasn’t reduced prices so your gain comes at the expense of your creditors.”

That is a contradiction.  If there is deflation (you are getting back dollars that are worth more) by definition prices are reduced.  It makes no difference to you or your creditor why they are reduced.  The important thing is whether the deflation was anticipated.  If both sides anticipated it, then both benefit from the exchange.  If the deflation is unanticipated, then the debtor may be made worse off.  This does not depend on the reason for the deflation.

Of course, an unexpected inflation has the opposite effect (benefitting creditors and harming debtors) and this could simply be chalked up to a risk that both parties willingly undertake but what Selgin (and seemingly everyone else) fails to notice is that debt contracts are not just a thing that exists between two private parties in a free economy, they are the very thing which create the money which drives the inflation/deflation.  This means that the economy as a whole is always in the position of net debtors vis a vis the banking system.  This is why I argue that deflation is bad.

Of course, if deflation is caused by a productivity increase, it is possible that everyone ends up better off because there is more stuff to go around, but this tells us nothing about deflation, it only tells us about productivity increases.

It’s monetary systems that matters

Selgin explains that there have been times in history when deflation was good and times when it was bad.  I agree.  But the difference between those times was not that in the good times productivity was increasing and the bad times demand was decreasing (though that is the case).  The difference is that the monetary systems in place were different.

In the times when deflation was accompanied by increasing productivity, there were commodity standards.  This means that the price level is just the price of gold or silver or what have you in relation to other goods.  So naturally, if you have the productivity of other goods relative to gold or silver increase, you see the price level falling and it is a sign of something good (the productivity increase).

But in more modern cases (like in the thirties) the quantity of money, and therefore the price level, has been detached from the price of any commodity like gold (although only partially in the thirties).  In these cases “aggregate demand” and the price level as well as expectations of the same, are determined by central bank policy.  This is the case regardless of what is happening to productivity.

In this system, what we have in the cases of bad deflation is a shortfall in “demand” caused by tighter than expected monetary conditions.  But if we had increasing productivity and this caused deflation, it would be the result of the same thing and it would have similarly negative effects.  There is no way to conceive of a demand shortfall that is not a monetary phenomenon. 

The logic behind this view of the price level seems to be based on some notion that there is a “natural” or proper rate of change in the price level and that that rate of change is related to the value of something like gold even though the value of money is no longer linked to anything like that.  So people like Selgin think that when productivity increases, prices should decrease (and vise versa) because that is what would happen if we were on a gold standard and for some reason that is what people expect to happen so when something else happens it is disruptive.

But the monetary system is not based on the price (and therefore the relative supply) of a real good, it is based on credit.  The demand for credit is based on expectations about the price level in the future.  Those expectations are based on expectations about the future stance of monetary policy.  Monetary policy is determined by the central bank and the central bank tells us that it is trying to cause a certain amount of inflation.  So people, for better or worse, expect prices to rise when productivity increases and rise when productivity falls.  When this doesn’t happen, it is disruptive and the disruption is not balanced in the sense that some people gain and some lose.  Because people are net creditors, when inflation comes in below expectations, people are net losers.

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Categories: Uncategorized
  1. John S
    March 16, 2014 at 11:21 am

    In truth, I’ve found Selgin’s comments on “false/illusory profits” to be somewhat confusing[1]. But at the same time, I haven’t yet read his theoretical work on the “productivity norm” (which he is careful to stress that he didn’t invent), namely “Less Than Zero.” Perhaps you’ll find some of the answers you’re looking for there (or by commenting on freebanking dot org; he responds fairly often, though to his discredit he can sometimes have a short fuse).

    http://mises.org/books/less_than_zero_selgin.pdf

    David Beckworth (Selgin’s former student) also partly seems to adhere to the productivity norm idea (it features prominently in “Boom and Bust Banking”):

    http://macromarketmusings.blogspot.com/2007/09/mark-toma-points-us-to-knzn-who-is.html

    (Honestly, this is above my current pay grade in terms of macro understanding. I’ll have to read Less Than Zero first.)

    [1] Re: biz cycles, I think Selgin at least partly adheres to some modified version of ABCT which in which central-bank created asset price booms, rather than Hayekian “capital lengthening,” are the key factor. However, to my knowledge, he hasn’t explicitly spelled out a full-fledged “business cycle theory” per se.

    • John S
      March 16, 2014 at 11:22 am

      how is it that there can be a reduction in “demand” which is caused by some real phenomenon not related to productivity that drives an undesirable deflation? Is this some kind of “animal spirits” argument?

      The reality is that “aggregate demand” is an inherently monetary concept.

      AFAIK, by “demand shock” Selgin is referring to monetary shortages allowed by central-banks, the quintessential example of which is the violent contraction in the money supply allowed by the Fed in the early 30’s (the post 2008 NGDP growth slowdown could also be seen as a smaller example). So I don’t think he’s referring to real factors causing deflation; instead, he means monetary contraction due to bad central bank policy (not a free banking scenario).

      Here’s a related comment from Selgin (his drowning/dehydration analogy):
      http://uneasymoney.com/2012/10/10/on-the-unsustainability-of-austrian-business-cycle-theory-or-how-i-discovered-that-ludwig-von-mises-actually-rejected-his-own-theory/#comment-10251

      • Free Radical
        March 16, 2014 at 6:16 pm

        but that’s basically my point. Deflation is a monetary phenomenon all the time. It is always caused by the quantity of money relative to goods and services. That is true regardless of the growth of productivity.

      • Free Radical
        March 16, 2014 at 6:58 pm

        For the record, since admittedly, I’m not exactly sure what Selgin has in mind here, I sort of took the approach of “arguing” certain points which I don’t necessarily think he disagrees with but which I think are central to my point (incidentally, looking back at this post, I feel like it is not one of my most clear explanations). So I believe that Selgin believes that a demand shock is caused by monetary factors but my point is that you can’t draw a distinction between a monetary policy that causes prices to unexpectedly fall when productivity is not rising and one which causes prices to unexpectedly fall when productivity is rising.

        My point is that these AD shocks are caused by credit contraction and the credit contraction is caused by unexpectedly falling prices (cause and effect here are not necessarily that distinct but there is at least an association). So when you promise inflation and fail to deliver it, you weaken the financial position of debtors (which is most people) which causes credit to contract which is the “demand shock.” This problem is not fixed by increasing productivity. It would be fixed by an entirely different monetary system which had forseeable deflation when productivity increased, but you have to be careful to not conflate that with the CB suddenly letting the price level fall because of productivity increases.

    • Free Radical
      March 16, 2014 at 7:04 pm

      I think the “false/illusory profits” stuff may come from ABCT somehow, I am only casually familiar with it but I often find it makes claims like that which I find odd. It seems to suspend market forces in certain cases and not others and the distinction often seems arbitrary to me. The blog post you linked to in the other comment sort of touches on this too when he points out that consumptions goods becoming scarce aught to increase their price and regulate their consumption. Of course, if people see all of this coming, then nothing makes sense because they would save more in anticipation of the increasing prices…

      But if one believes in some version of this, then it is probably possible to argue that the structure of production somehow causes the disparity between productive inputs and output.

    • Free Radical
      March 16, 2014 at 7:54 pm

      P.S. One thing I do know Selgin well enough to be aware of is his short fuse haha.

  2. J Thomas
    March 16, 2014 at 12:45 pm

    “If we assume a simple free-market economy, then when productivity increases and the quantity of money stays the same, then one would expect the price level to fall in order to barring the economy into equilibrium.”

    This is a really minor picky thing, but when you say “productivity” do you mean “production”? To me those are different things.

    Anyway, in theory a rise in production is not always a good thing. Imagine that everybody in the economy gets stoned and wildly optimistic, and they all try to double production and they succeed. Then it’s “I know your family has been eating one loaf of bread a day, and now we want to sell you two loaves a day.” “You’ve been happy to drink two six-packs every day? Now you can buy four six-packs a day!” “You’re a family of four with two teenagers and three cars? We’re here to sell you another three cars.” But people really only want one car apiece, one loaf of bread, and two six-packs. Prices fall and that’s a sign to producers to cut back production. Not a good or bad thing in itself, but the signal to change direction. Don’t produce stuff that people don’t want.

    Now try this one: Lots of producers automate their work and lay off people. But now they find they are producing too much. People who have money are not buying their products unless they cut the prices. They cut production, the weakest competitors drop out and cut production completely, and the companies which have not yet automated are under pressure to lay off more employees. “Aggregate demand” is the stuff that people who have money will buy at a given price level. The more people who don’t have money, the more people who can’t buy. And you can’t expect the people who still have jobs to drink twice as much beer to make up for the people who can no longer afford it.

    Somehow it seems better to me when the economy provides more stuff that people want and prices drop, than when the economy provides stuff that people don’t want and prices drop, or when the economy provides stuff that people can’t afford and prices drop. But the economy (meaning each individual producer) gets the message that prices are down and it’s time to cut production in each case. The price signal is only a signal, and it can come in situations we think are good or bad.

    “Alternatively, we might imagine that the money supply stays constant but productivity falls. Again, we would expect the price level to fall to bring the market into equilibrium.”

    I think you said that backward. Money supply constant, production falls. Inflation. It fits what you’re saying that way too, despite the typo. Rising prices are a signal, but what they signal depends on other things. If suppliers *can* make more, they can probably sell it. But what caused production to fall in the first place? Maybe for some reason they can’t in fact make more at a decent price.

    • Free Radical
      March 16, 2014 at 7:17 pm

      I meant productivity but I don’t think it makes much difference.

      Your first paragraph is a lot of nonsense. You have a profoundly non-economic sense of “want.” “People only really want one car apiece.” That makes no sense, the number of cars people “want” certainly depends on what they have to give up to get additional cars. “Don’t produce stuff that people don’t want.” Obviously, that would be bad for business and that is why we don’t expect people to do it systematically. The fact that you can imagine people acting in ways that make no sense is not an economic argument of any kind.

      The next two are also nonsense….

      You’re right, I said it backward, thanks!

      • J Thomas
        March 17, 2014 at 9:07 pm

        “Your first paragraph is a lot of nonsense. You have a profoundly non-economic sense of “want.” “People only really want one car apiece.” That makes no sense, the number of cars people “want” certainly depends on what they have to give up to get additional cars.”

        You can only drive one car at a time, unless you are extremely talented. Most people will not buy twice as many cars as they can drive, at full price. This is something I have observed, I’m not making it up from theory.

        You can’t in general expect to sell twice as many cars at the same price. If you make too much stuff, prices fall and that’s called deflation. When farmers on average produce a bumper crop (because of good weather etc) their unit price goes down because supply has gone up more than demand.

        Would you tell me why this seems like nonsense to you, if it still does?

        “The next two are also nonsense….”

        I challenge you to say why. Demand is what gets bought by people who can afford it. If half the people suddenly lack money, while the other half has more, the people with money will probably not drink twice as much beer as they used to. Twice as rich does not usually mean twice as drunk.

      • Free Radical
        March 18, 2014 at 1:22 am

        I don’t want to be a jerk here, I appreciate your comments in general, but sometimes you start down a path that indicates a fundamental misunderstanding about the way economics operates (not just a particular logical error but a completely different kind of logic) and trying to explain exactly what is wrong with it would amount to trying to condense at least a semester of economic methodology into a comment on a blog so I try to avoid getting into it. But since I like you, I will try to get you started.

        I think you probably have a correct idea in mind (your third paragraph here is basically right) but in the process of explaining it, I think you accidentally make a lot of erroneous statements. For instance “most people will not buy twice as many cars as they can drive.” That is simultaneously not true and not the point. Jay Leno has way more cars than he can drive at one time. When I was growing up, my parents had two cars and sometimes three, though they could have survived with one if the price of cars were high enough. I know many people who own more cars than they can drive at once. But more importantly, this is not the point. The appropriate way of measuring demand for most goods is average units per some unit of time, so like “cars per year.” If you buy a new car every year, you are buying twice as many than if you buy one ever two years. This is also not the point.

        The main point is that the quantity of a good people “need” is a meaningless concept. People “demand” some quantity of a good and the quantity they demand depends on the prices. Basically all of economics is based on this notion in some way. This means that if you are reasoning along lines like “people need a certain amount and then they won’t buy any more” then you are almost always making a mistake (in some cases demand may be highly inelastic but that is a special case that can only be understood once you get that there is no such thing as “need.”) My old prof used to say “there’s no such thing as ‘need,’ some people just have a highly inelastic demand for an appendectomy.”

        Again, I think you may comprehend this on some level, you have an interesting knack of following up problematic statements with conclusions that actually make sense (you actually have a lot of interesting characteristics as blog commentators go, and this is a compliment).

  3. J Thomas
    March 16, 2014 at 1:18 pm

    “The natural question which arises from this theory is what would cause a shortfall in aggregate demand? Presumably Selgin believes in some form of Say’s law (supply begets its own demand in aggregate). So how is it that there can be a reduction in “demand” which is caused by some real phenomenon not related to productivity that drives an undesirable deflation?”

    Say’s law is true if you agree that the value of each product is what it will sell for, and products which cannot be sold are not products at all but merely trash. Then if you make something that you cannot sell except below cost, or that you cannot sell at all, it does not mean there is oversupply but only that you have made a mistake and you should learn to do better. If a large fraction of labor goes into things that cannot be sold above cost, similarly there have been many mistakes but no oversupply. If you define it correctly Say’s law cannot ever be wrong.

    But a correct definition is useless. Definitions that lead to interesting results give us versions of Say’s law which are not true.

    “So how is it that there can be a reduction in “demand” which is caused by some real phenomenon not related to productivity that drives an undesirable deflation?”

    If there is just as much money available, but it’s held by people who do not buy while people who want stuff don’t have money to buy with, then you can get a reduction in “demand”. The stuff that the newly-poor people would have bought, which the people who now have money do not want, will get cheaper until the people who make it adjust their production enough.

    Another way to say it is that if we have the same quantity of money but for some reason its velocity is reduced, that can cause deflation.

    “…the goal of good monetary policy is to try to make Say’s Law true.” Nick Rowe

    • Free Radical
      March 16, 2014 at 7:22 pm

      I actually don’t know to what degree Selgin believes in a version of Say’s law but basically, any deviation from it has got to be a monetary phenomenon. That is my point. The monetary phenomenon which potentially causes it to be violated is the same when productivity is increasing as when it is not.

      • J Thomas
        March 17, 2014 at 8:57 pm

        “The monetary phenomenon which potentially causes it to be violated is the same when productivity is increasing as when it is not.”

        You can call it the same thing. But when production increases and money velocity does not, the guys who control monetary phenomena have to add the right amount of money to the system to prevent deflation.

        When production does not increase but somebody’s hoarding money, then it’s harder to spread money around to people who are scared and want to save — they’ll have a tendency to save the money instead of spend it, and having more money that they don’t spend doesn’t reduce the deflation.

        It doesn’t look the same to me, although the desired result is the same.

      • Free Radical
        March 18, 2014 at 1:01 am

        “But when production increases and money velocity does not, the guys who control monetary phenomena have to add the right amount of money to the system to prevent deflation.”

        Yes….

        “When production does not increase but somebody’s hoarding money, then it’s harder to spread money around to people who are scared and want to save — they’ll have a tendency to save the money instead of spend it, and having more money that they don’t spend doesn’t reduce the deflation.”

        Yes, if people, for some reason, suddenly decide to “hoard” money, this will cause a drop in prices other things equal. But this is not a theory if it doesn’t explain why people would do that. As is, it is just more of the “let’s assume that people suddenly start acting in a certain way even though there is no reason for them to do that” reasoning which I am trying to break you of.

  4. J Thomas
    March 16, 2014 at 1:26 pm

    “Selgin argues that, for some reason, when productivity is increasing, inflation causes the prices of end products to increase without causing the prices of inputs to increase causing (real) profits to increase. Again, this makes no sense to me and I don’t know how he comes to this conclusion.”

    If you buy your inputs before you sell your outputs, then it could work. During the time it takes you to turn inputs into outputs and sell them, prices rise and if you can then increase your price to match inflation, you win a little that way. You win more the longer it takes you to produce.

    I think that’s the argument. Buy at today’s prices, sell at tomorrow’s prices. The shorter your turnaround the less good it does you.

    During deflation it hurts you. You buy expensive inputs and then you have to sell cheap. If it gets too bad then you’d have been better off to just keep the money and avoid the bother and the risks of producting a product.

    • Free Radical
      March 16, 2014 at 7:23 pm

      If that is the argument, I think it is silly.

      • J Thomas
        March 17, 2014 at 8:54 pm

        “If that is the argument, I think it is silly.”

        If that’s the argument it can at least be somewhat true. It’s the only way I see to make it true. Otherwise you need prices of end products to increase while prices of inputs don’t increase, and it doesn’t work at all.

        Except, that in inflationary times, some sellers *can* increase prices better than others. In general, the more competition the harder it is to raise prices when you see inflation coming, and the less competition the easier it is. So employees generally can’t demand raises though a few star employees can. Employers who have only a few competitors can raise prices easier than those who have more. Companies with lots of customers and not many competitors should do well, and that tends to be true for final sellers of consumer goods.

  5. J Thomas
    March 16, 2014 at 1:46 pm

    “The important thing is whether the deflation was anticipated. If both sides anticipated it, then both benefit from the exchange. If the deflation is unanticipated, then the creditor may be made worse off. This does not depend on the reason for the deflation.”

    The interest the debtor pays is bad for the debtor and good for the creditor. Unexpected inflation or deflation can make it worse for one and correspondingly better for the other. Maybe to the point that one of them would not have made the deal if he’d known.

    “This means that the economy as a whole is always in the position of net creditors vis a vis the banking system. This is why I argue that deflation is bad.”

    If the bank owes you money and then the money is worth more, that’s good for you and bad for the bank. Did you say it backward again? The economy as a whole is always net debtors?

    So when the money supply contracts because banks decide to lend less, then assuming people mostly manage to pay off their debts the amount of money owned free and clear by the bank is a larger percentage of all the money than usual. At that point the bank has its paid interest, but everybody else has less money.

    So if I owned a bank, I would want to time my big purchases to recessions. Buy my mansions and yachts etc when the economy is slow and prices are down but *my* wealth is high. Then after I’ve spent the unaccustomed amounts, then I’d want the economy to recover so I could go back to making more money fast.

    • Free Radical
      March 16, 2014 at 7:24 pm

      You got me twice! I always get to lazy to proofread on the weekends…

  6. J Thomas
    March 16, 2014 at 1:48 pm

    “Monetary policy is determined by the central bank and the central bank tells us that it is trying to cause a certain amount of inflation. So people, for better or worse, expect prices to rise when productivity increases and rise when productivity falls. When this doesn’t happen, it is disruptive and the disruption is not balanced in the sense that some people gain and some lose. Because people are net creditors, when inflation comes in below expectations, people are net losers.”

    Yes! Again, people are net debtors, and everything you said makes sense.

    • Free Radical
      March 16, 2014 at 7:18 pm

      Thanks Thomas! 🙂

  7. John S
    March 17, 2014 at 2:16 pm

    OK, I just read Less Than Zero and I will comment on certain parts of your post in relation to it. Anyway I had been meaning to read it for a while, so I’m glad your post spurred me to do it.

    • Free Radical
      March 17, 2014 at 9:09 pm

      Don’t see your comments, assume they are forthcoming. I am going to post a brief follow-up so some points in this discussion may pass each other in transit so to speak.

  8. J Thomas
    March 18, 2014 at 9:38 am

    Free Radical :
    I don’t want to be a jerk here, I appreciate your comments in general, but sometimes you start down a path that indicates a fundamental misunderstanding about the way economics operates (not just a particular logical error but a completely different kind of logic) and trying to explain exactly what is wrong with it would amount to trying to condense at least a semester of economic methodology into a comment on a blog so I try to avoid getting into it. But since I like you, I will try to get you started.
    I think you probably have a correct idea in mind (your third paragraph here is basically right) but in the process of explaining it, I think you accidentally make a lot of erroneous statements. For instance “most people will not buy twice as many cars as they can drive.” That is simultaneously not true and not the point. Jay Leno has way more cars than he can drive at one time. When I was growing up, my parents had two cars and sometimes three, though they could have survived with one if the price of cars were high enough. I know many people who own more cars than they can drive at once. But more importantly, this is not the point. The appropriate way of measuring demand for most goods is average units per some unit of time, so like “cars per year.” If you buy a new car every year, you are buying twice as many than if you buy one ever two years. This is also not the point.
    The main point is that the quantity of a good people “need” is a meaningless concept. People “demand” some quantity of a good and the quantity they demand depends on the prices.

    It sounds like I said something with the wrong emphasis. Of course people will buy some quantity of a good, and the quantity they will buy depends on the price the sellers will agree to and also on the money the people have available.

    I claim that if you were to suddenly double your income, you would not buy twice as much of the same things as you did before. You might buy a car that cost twice as much, you would probably not buy two cars that are like the one car you would otherwise buy. You might develop a taste for lobster, you would not buy two chickens when before you would buy one. You might start to learn which single-malts you like, you will not drink twice as much Pabst Blue Ribbon.

    Basically all of economics is based on this notion in some way. This means that if you are reasoning along lines like “people need a certain amount and then they won’t buy any more” then you are almost always making a mistake (in some cases demand may be highly inelastic but that is a special case that can only be understood once you get that there is no such thing as “need.”) My old prof used to say “there’s no such thing as ‘need,’ some people just have a highly inelastic demand for an appendectomy.”

    Doesn’t it seem like the higher the income people have, the more of it they put into savings or investment, and the smaller the fraction of it they put into consumption? In general. It doesn’t seem to be true of people who win lotteries. As a general rule, when somebody’s a bit richer than you, they tend to spend just enough to show they can afford more than you. Not proportional to income. Doesn’t that seem true in your experience?

    Bigger variance in income goes along with less aggregate consumer demand compared to less variance in income, because the poor people can’t afford as much and the rich people save more rather than consume that much more. Do you disagree?

    Again, I think you may comprehend this on some level, you have an interesting knack of following up problematic statements with conclusions that actually make sense (you actually have a lot of interesting characteristics as blog commentators go, and this is a compliment).

    When I get outside my professional specialties it’s easy to say the wrong thing. Once discussing a computer programming issue with a bunch of computer science students, we were looking at something in a programming language that tended to be inefficient. There was a better way to do it which programmers tended not to use because it didn’t fit their mindset, and instead they used a construction the language supplied which didn’t work as well. I suggested that perhaps the compiler could be written to substitute the better approach for the worse one. Let the compiler optimise it. And I got something like 50 responses explaining that real computer scientists knew that optimising compilers are impossible, that there is no way to make a compiler which can correct all programming errors. I knew that, I just wanted to correct this one. But something about the way I said it made people think I wanted the compiler to correct everything and optimise away every possible problem.

    I guess this sort of thing is inevitable. I probably underestimate you. In my eyes, free markets are good because they provide a feedback loop that allows them to self-correct. But then I hear people say something like “Free markets can never fail because they have a feedback loop so they self-correct!”.

    People who design feedback systems find that they fail lots of ways. They can’t react well to events that happen too fast. They can overshoot and then oscillate. Usually feedback loops fall into limit cycles which cycle around an equilibrium point and do not approach it, in the absence of external shocks. Designing useful feedback systems is a black art, and there’s no particular reason to think that a design which people settled into with a few hundred years of unconscious experimentation would be particularly good. I tend to assume that you believe that free markets must inevitably give good results as a sort of religious belief, without evidence. But probably your thinking is not that simple.

    • Free Radical
      March 19, 2014 at 3:13 am

      First of all, your first comments here are entirely sensible but I don’t remember what that has to do with what we were talking about. It is probably worth mentioning that it is possible for the distribution of income to affect the net demand for loans but remember that it is the net demand that matters. If one private (non-bank) party lends money to another, it does not change the money supply and I assume that this goes on so that everyone has the same marginal value of money and then banks increase the quantity and lower the price (interest rate) and MV for everyone.

      Now, more importantly, on free markets:

      You said in a previous comment something to the effect that you didn’t think I had proven that free markets are perfect all the time and I resisted the urge to argue with all of your criticisms because I think you are approaching the question from the wrong angle. I think free markets are good because I think freedom is morally just. This is an inherently normative judgment. People often act like it is radical (thus the “free radical” business) but I think that’s odd. If I went and told you that being a house slave in colonial times was better than being a free laborer because you got to live in a nice house, you were well-fed, you had “job security,” etc. almost everyone would find that opinion shocking because people have a moral repulsion to slavery that is not overcome by these kind of base material considerations. But still when it comes to “free markets” which is just another word for “freedom,” we act like the case for free markets rests entirely on an economic argument that they would be perfectly efficient and the moment someone proposes some theory suggesting that it is possible that free markets might not achieve such perfection in some situation, we rush to put shackles on people (figuratively speaking). This strikes me as madness.

      Nonetheless, on some level, the indulgence in moral ideals like freedom is a luxury that does require some degree of material subsistence and people will be willing to give up varying degrees of freedom if they thought the material benefits were likely to be large enough. (Usually we are asked to sacrifice other peoples’ freedom but that is another problem all together.) So it is worth considering how well free markets work relative to other systems but I will never claim that nothing bad ever happens in a free market. I think this is the wrong burden of proof. I am quite confident that free markets would work pretty well. I actually think, in total, they would work a lot better than any alternative economically speaking (though that is difficult to disentangle from any normative bias). This belief is not a religious belief it is based on a lot of careful consideration of economics by myself and countless others before me.

      But I don’t think we should have to prove that freedom is perfect before we advocate for it. The burden of proof should be on the adversaries of freedom. We should ask ourselves if we are thoroughly convinced that too much freedom will lead to such a catastrophe that we are willing to give it up. Because there is a normative belief here you can call it “like a religious belief” if you want but you can’t come to any kind of conclusion about “good” and “bad” without relying on some normative judgment.

      But to call it “without evidence” I think is crazy. I don’t even know how to begin with this. It’s almost unbelievable to me that, given the relative success of free markets and the countless economic and humanitarian disasters we have seen result from heavy-handed government control, that anyone could possibly believe that the “evidence” is against free markets even without all of the theoretical analysis suggesting that we shouldn’t expect it to be.

      • J Thomas
        March 19, 2014 at 12:30 pm

        “I think free markets are good because I think freedom is morally just.”

        I like freedom too. What bothers me is that in practice freedom has very little to do with free markets.

        It’s like if somebody said “I don’t like slavery, I like freedom” and from there it turned into “So everything that isn’t slavery is good.” Imagine a society where everybody has jobs working for the government. At any time you can quit your job and then look for another job working for the government, and pick the one you like best out of the two or three (or one) the government offers you. That is not slavery because you have the right to quit your job and look for another one. But I don’t like it even though it isn’t slavery.

        It isn’t true that everything which isn’t slavery is good. If you find yourself arguing that everything which isn’t government intervention is good, you will probably be wrong in some cases.

        When two markets compete directly, usually one of them wins and the other folds. To survive, they must somehow avoid direct competition. They can serve different geographical markets, if it’s inconvenient for people in one area to use the other market. They can be open at different times of day. They can sell different products. Etc. It often turns out that when you want a particular product you are limited to one market. You don’t have complete freedom. (That’s less true with the internet, you can buy from all over the world if you don’t mind paying shipping.)

        Each market has rules. The rules vary from market to market. You mostly don’t have the freedom to find a market whose rules you like, you must use the market you have or do without. Free markets are not particularly about freedom, except in the sense that by definition they avoid government inteference.

        I am not arguing in favor of government interference. (If we find that in certain limited circumstances government intervention is useful then I’ll go with the data, but I don’t claim to have any such data now.)

        If you want to argue that government action is bad in every possible case then I say you are going beyond the data, but I’m ready to listen to arguments about it. (It’s possible that we can prevent free people from enslaving others easier without government than we do it with government, for example. I dunno. So far as I know it’s never happened.) I consider this sort of argument vague and not particularly interesting.

        If you like markets, let’s look at which kinds of free markets you like better and which kinds you like worse. There’s a lot of variety and some are surely better than others. I bet you’ll have something more interesting to say than “Everything except government is good.”.

      • Free Radical
        March 20, 2014 at 7:45 pm

        There are so many problems with this reasoning.

        1. “It isn’t true that everything which isn’t slavery is good. If you find yourself arguing that everything which isn’t government intervention is good, you will probably be wrong in some cases.”

        This is the main one. It is not possible for a normative judgment (what is “good” or “bad”) to be true or false. My point is that freedom is inherently “good.” Other things are good and bad also and it is possible that some of those things may come into conflict with freedom so it is worth considering them. But you seem to have some independent notion of what is “good” which I suspect you haven’t clearly flushed out and you are then trying to apply that vague notion, whatever it is, to free markets in order to determine whether they are “good” or not. Whatever that notion is, you should clearly identify it and you should state your criticisms in relation to it rather than taking “good” to be some positive statement that can be falsified.

        2. in practice freedom has very little to do with free markets.

        This is just completely wrong. I don’t know how you are coming to this conclusion but most likely, if you are imagining some definition of “free markets” that has nothing to do with freedom, it is the wrong definition (by which I mean not the one I am using) and that is the root of all your misunderstanding.

        3. Your government jobs disaster.

        Inserting a little bit of supposed freedom into a system that runs entirely on coercion doesn’t make it free. If the government controls all jobs and sets the wages, where does it get the money (representing real goods) to pay those wages? And how does it prevent other jobs from existing? And how are the prices of the goods which are produced by those government jobs determined?

        4. “It isn’t true that everything which isn’t slavery is good.”

        I never said anything like that.

        5. When two markets compete directly, usually one of them wins and the other folds.

        This betrays a complete ignorance of how markets function. (And even what a “market” is, markets don’t compete with one another…)

        6. “I am not arguing in favor of government interference. (If we find that in certain limited circumstances government intervention is useful then I’ll go with the data. . .)”

        Yes you are and this approach depends entirely on your definition of “useful” which is no less “religious” than my affinity for freedom (see #1).

        7. “If you want to argue that government action is bad in every possible case then I say you are going beyond the data”

        That’s not what I’m saying at all, that is what I tried to explain to you before when you said you didn’t know why I brought up anarchy. Free markets are not anarchy but that is what you always resort to arguing against for some reason. You have to have “government action” to protect freedom but there is a clear line between that and all of the other interventions I am arguing against.

        8. “varieties” of free markets.

        No, “free market” means something specific and what it means is always the same and I pretty much always think it is good (obviously, there are some particular issues that have to be addressed that are different in various cases). Your problem is that you don’t seem to have any idea what “free market” means, and that is why you are making all kinds of totally misguided arguments.

  9. J Thomas
    March 18, 2014 at 12:25 pm

    Free Radical :
    “But when production increases and money velocity does not, the guys who control monetary phenomena have to add the right amount of money to the system to prevent deflation.”
    Yes….
    “When production does not increase but somebody’s hoarding money, then it’s harder to spread money around to people who are scared and want to save — they’ll have a tendency to save the money instead of spend it, and having more money that they don’t spend doesn’t reduce the deflation.”
    Yes, if people, for some reason, suddenly decide to “hoard” money, this will cause a drop in prices other things equal. But this is not a theory if it doesn’t explain why people would do that. As is, it is just more of the “let’s assume that people suddenly start acting in a certain way even though there is no reason for them to do that” reasoning which I am trying to break you of.

    For example, if investors believe that they may have suffered big losses but they won’t know until more information is available, they tend to get more cautious. You don’t want to start big new projects when you are undercapitalized. If a bank offers you favorable loans when you aren’t sure you could pay off the loans, it’s cause for concern.

    Oil shocks can do this. If oil prices threaten to go up fast, and oil availability is in question, that’s a reason to delay spending.

    Stock market crashes can sometimes do it. If people who felt rich before suddenly feel poor, they are likely to invest less and possibly consume less. The idea that other people are doing that may make some investments seem less likely to pay off — when the people who spend less will not buy as much from you.

    Bank crises can do it. If your business expansion depends on a line of credit, and you aren’t sure your bank will actually extend you that credit because your bank might be in trouble, then you hesitate to commit.

    If you have consumer debt and you aren’t sure your job is safe, then it makes sense to spend less and pay down debt. If you get fired and wind up with a bad credit rating that makes it harder to get the next job.

    If you want to invest but you see only bad investment opportunities, you are likely to hold onto your money or possibly try to put it into inflation hedges. Bad investments are worse than no investments.

    There are various reasons that people might decide to spend less. In general, if you have to put up collateral for loans and you don’t believe you can repay the loans when they come due, you are likely to think you are better off not to take the loans. Check whether you can get a better price selling your assets than using them as collateral and getting a bad credit rating and maybe having to declare bankruptcy.

    It’s hard to get people to borrow when they think the future will be worse than the present.

    But let’s consider the other side of it. When spending is down, in theory prices should fall. Businesses compete and keep selling as long as they can get more than the variable price. People don’t spend as much, prices should fall. But what I observe is prices don’t fall, instead production falls — they make less stuff and try to sell it at the same price. It isn’t what I’d expect from a competitive free market. Why do you think that happens?

  10. J Thomas
    March 21, 2014 at 12:57 am

    Free Radical :
    It is not possible for a normative judgment (what is “good” or “bad”) to be true or false. My point is that freedom is inherently “good.”

    OK. You have not shown that “free markets” will maximize freedom. By the name it seems obvious, just like when you hear the name “Democratic People’s Republic of Korea” it’s only natural to think they’re a democracy. Approving of freedom does not necessarily mean you must approve of all free markets. Markets vary a lot and some give more freedom than others.

    But you seem to have some independent notion of what is “good” which I suspect you haven’t clearly flushed out and you are then trying to apply that vague notion, whatever it is, to free markets in order to determine whether they are “good” or not. Whatever that notion is, you should clearly identify it and you should state your criticisms in relation to it rather than taking “good” to be some positive statement that can be falsified.

    My claim is that there may be contradictions between “freedom” and “free markets”, and my other goals don’t relate to that. But I’ll describe them.

    My highest priority is the survival of human and human-related species. We should try to avoid things that are likely to lead to extinction.

    My second priority is the survival of ecosystems that are likely to be useful to humans, which at the moment consists of all ecosystems that have survived a reasonably long time. When we learn how to design genomes and ecosystems, we can mine those for useful genes and species, and also study of those genomes will tell us a lot about past climate etc. We should try to do some habitat preservation.

    My third priority is human welfare. We should try to maintain environments where humans can thrive. This is only common sense.

    My fourth priority is human freedom. People should be able to do pretty much whatever they want provided they aren’t too destructive of human species, environments, or individual other humans.

    In practice I tend to be pretty much undecided about what’s likely to cause things like human extinctions, so while it’s my first priority I tend not to do much about it.

    2. in practice freedom has very little to do with free markets.
    This is just completely wrong. I don’t know how you are coming to this conclusion but most likely, if you are imagining some definition of “free markets” that has nothing to do with freedom, it is the wrong definition (by which I mean not the one I am using) and that is the root of all your misunderstanding.

    OK. If your definition of “free markets” has nothing to do with the details of how markets work, then it won’t get in my way when I consider ways that actual markets do not maximize freedom and often fail to maximize the traded wealth of participants. To the extent that actual deeply flawed markets can be replaced by better markets, freedom is served and abstract free markets are served and I hope you will join me in working for that.

    3. Your government jobs disaster.
    Inserting a little bit of supposed freedom into a system that runs entirely on coercion doesn’t make it free.

    But it does make it “not slavery”. Analogously, if we had something that was “not government” which was not very free, the absence of government would not make it free. It’s possible to get plenty of coercion without government. Also, I don’t consider people free when they are enslaved by habits that prevent them from thinking freely.

    4. “It isn’t true that everything which isn’t slavery is good.”
    I never said anything like that.

    We’re agreed we like freedom. When I asked you what it took to be a free market you said that government interference makes it not be a free market. If everything that doesn’t have government interference is a free market, we can find lots of examples that aren’t very free. So it sounded to me like you were saying something very much like “everything which isn’t slavery is good” except it was “everything that isn’t government interference is good”. It’s freedom that we want, not just to minimize government.

    5. When two markets compete directly, usually one of them wins and the other folds.
    This betrays a complete ignorance of how markets function. (And even what a “market” is, markets don’t compete with one another…)

    I’m sorry. You betray an almost complete ignorance of how markets function. I’ll look for some beginning texts to recommend to you. Here’s a lead-in.

    https://en.wikipedia.org/wiki/Market_maker

    6. “I am not arguing in favor of government interference. (If we find that in certain limited circumstances government intervention is useful then I’ll go with the data. . .)”
    Yes you are and this approach depends entirely on your definition of “useful” which is no less “religious” than my affinity for freedom (see #1).

    Of course it depends on what I think is useful, and if the issue comes up we can discuss whether it looks useful to you also. I haven’t seen data that convinces me yet, but I’m willing to accept the possibility it might happen.

    You have to have “government action” to protect freedom but there is a clear line between that and all of the other interventions I am arguing against.

    If we need government to protect freedom, then we need a way to persuade government to act to protect freedom and not act to destroy freedom. This may be difficult but it’s very much worth doing.

    8. “varieties” of free markets.
    No, “free market” means something specific and what it means is always the same and I pretty much always think it is good (obviously, there are some particular issues that have to be addressed that are different in various cases). Your problem is that you don’t seem to have any idea what “free market” means, and that is why you are making all kinds of totally misguided arguments.

    Do you agree that there are a big variety of markets? And that that variety often has nothing to do with government? I don’t see why you would deny this, unless you have never actually studied markets.

    • Free Radical
      March 22, 2014 at 8:10 pm

      “You have not shown that “free markets” will maximize freedom.”

      Again, you don’t seem to understand what a free market is. Or maybe you have some strange definition of “freedom.” That is actually pretty likely considering your occasional tendency to make Marxist arguments. Either way, I think that your thinking is way off target. “Maximizing freedom” is basically the definition of a free market (within a context of legal property rights.) If you are asking whether a free market maximizes freedom you have the wrong definition for one or the other (or likely both).

      “OK. If your definition of “free markets” has nothing to do with the details of how markets work, then it won’t get in my way when I consider ways that actual markets do not maximize freedom and often fail to maximize the traded wealth of participants. To the extent that actual deeply flawed markets can be replaced by better markets, freedom is served and abstract free markets are served and I hope you will join me in working for that.”

      No this is nonsense. Of course the definition of free markets has to do with the details of how markets work but the definition of “freedom” is independent of market outcomes. I think your logic on this is too twisted for me to be able to recover it and it saps a lot of energy when I try. If freedom is number four on your list of priorities, you are probably never going to support free markets (even if you eventually figure out what it means) because someone will always come along with some argument that they are bad for the environment or something and you will be inclined to accept those arguments and use them to try and restrict the behavior of others. This is an unfortunate symptom of the human condition which I find very frustrating but there’s only so much I can do to fight it and I can’t do anything for you as long as you are operating under this kind of logical framework. If you think I am completely ignorant of how markets work then I don’t think there’s any point in continuing to talk to me…?

      • J Thomas
        March 23, 2014 at 1:03 am

        “That is actually pretty likely considering your occasional tendency to make Marxist arguments.”

        I haven’t noticed myself making any marxist arguments. But I don’t know much about marxism, so I could be doing it by accident. How much do you know about marxism?

        “If freedom is number four on your list of priorities, you are probably never going to support free markets (even if you eventually figure out what it means) because someone will always come along with some argument that they are bad for the environment or something and you will be inclined to accept those arguments and use them to try and restrict the behavior of others.”

        No, I’m not particularly inclined to accept that sort of argument without a whole lot of evidence. Also, when it does turn into an issue we can look for ways to minimize restrictions on freedom. Kind of like we discourage people from unnecessarily shooting each other while we minimize restrictions on gun ownership. If a particular example comes up where we’re likely to do something that makes us go extinct unless we manage to stop ourselves, you and I can discuss it. Currently my prime example is nuclear weapons, which is entirely a government thing.

        “If you think I am completely ignorant of how markets work then I don’t think there’s any point in continuing to talk to me…?”

        Not so! You previously had a collection of doctrinaire beliefs that did not match up to reality, and you learned better. You threw out the beliefs that you saw did not match reality, and you kept the ideals about what was valuable. It’s a rare person who does that.

        So I tend to believe that if you see ways that existing markets should be improved (by your standard of what’s good) you will look at it and start to spread improved methods. On the other hand you might find ways to interpret the variety of existing markets as all being optimal, and you might express it so clearly that I get convinced.

        Did you read about the variety of market makers? In some circumstances market makers perform a service to people who want to buy and sell. In some other circumstances they extract a price to perform disservices. Some markets have a single market-maker who has a monopoly on doing that job. Others let anybody do it who can. The London Stock Exchange usually has two! market makers for a single stock. There is a tremendous variety for different markets.

      • Free Radical
        March 24, 2014 at 7:41 pm

        “Not so! You previously had a collection of doctrinaire beliefs that did not match up to reality, and you learned better. You threw out the beliefs that you saw did not match reality, and you kept the ideals about what was valuable. It’s a rare person who does that. ”

        I agree with that completely and I might add that you seem to have the same proclivity which I appreciate.

        I know a bit about Marxism but am not an expert. The first comment you posted here had a distinctly Marxist air about it. I’m not accusing you of being a Marxist, there are just a lot of corrupt notions about markets and economics which have become deeply entrenched in much of society that I attribute to that way of thinking.

        I didn’t read your links about market makers but that is essentially what my actual education is in. The point is that you are using the word “market” to mean something different from what economists usually mean. When you think of a “market” you think of a service provided by some entity. This is different from the abstract concept of a market as a collection of actors engaged in the exchange of some goods or services. For instance, I would say that there is a market for market-makers in which they compete for the privilege of “making a market.” This market may not be perfectly competitive but my arguments for individual liberty do not hinge on assuming that every market is perfectly competitive.

  11. J Thomas
    March 24, 2014 at 11:25 pm

    “The point is that you are using the word “market” to mean something different from what economists usually mean. When you think of a “market” you think of a service provided by some entity. This is different from the abstract concept of a market as a collection of actors engaged in the exchange of some goods or services.”

    In the abstract, whenever two people agree to a trade they both think they are better off. So it’s an improvement over what they had before, unless one of them is wrong and is not better off after all.

    Actual markets can have various things I regard as systematic imperfections that let some people benefit at others’ expense. I don’t see why it should be that way. The result is systematic distortion of the economy. I don’t like it when government distorts the economy toward inefficiencies, why would I like it when private individuals do it?

    “For instance, I would say that there is a market for market-makers in which they compete for the privilege of “making a market.””

    In many actual markets, the market-maker is officially given a monopoly for that. He can keep his book of limit orders secret. All trades are trades with him, buyers and sellers buy from him and sell to him. The existence of the market provides benefits, and he gets to collect a toll. Why should he get to do that? Because the market was originally designed to benefit him.

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