Comment Cards 09

Below are responses to some good questions that students have written on their comment cards during this semester's macroeconomics classes.

1. You said that the more people are out of work the less inflation exists. But the post-war years proved the opposite. Then, there were five million Germans out of work and the inflation was the highest it had ever been. So, how is this possible?

R: The Germans were out of work because their industrial structure was destroyed and the allies demanded that they make good on their war reparations (i.e., payment to the allies for their war expenses). The Weimer Republic couldn't raise revenue by taxing their citizens because they had very low incomes so they resorted to the printing press. The Germans printed so much money that what few commodities were available exploded in price. The resulting discontent among the German people proved a boon to recruitment in the nazi party. Normally, if markets are allowed to work, a rise in unemployment will lower wages which will reduce product prices (deflation) because consumers (aka workers) will not be able to buy as much as before the deep recession.

2. Can you explain the concept "just in time" production more specifically?

R: A business has traditionally had an inventory (often a warehouse) of spare parts, inputs, finished goods etc. These inventories cost money in the sense that the company had to pay to buy them and pay to build and maintain or lease the storage facilities. That money is money not making profits for the firm. In today's technologically advanced business systems, firms constantly monitor their input needs and keep orders perfectly in synchrony with those needs. In other words, the parts, inputs, and production of finished goods arrive or are produced "just in time" to be used or sold.

3.  Say's Law (J.B. Say -- 1820s) that supply creates its own demand was shown incorrect through Keynes' theory of production.

R: Keynes argued that Say was wrong in that over production of goods would result in workers being laid off, causing incomes to fall and causing demand for output to fall, once again causing producers to cut back production and lay off more workers in a downward spiral. Keynes and others also said that wages don't act as an equilibrating force (sticky wages) because workers resist cuts in wages. Conservatives have argued that labor unions are the reason for this sticky wage condition. Historically, however, periods of strong labor unions have been periods of the strongest economic growth. When Salvador Allende won election in Chile (before he was assassinated in a CIA sponsored co-op) he doubled the minimum wage and consumer demand exploded, causing a rapid rise in production of goods and services and general prosperity. It also produced a more equal distribution of incomes which didn't thrill the ruling class who were behind the co-op plot that brought General Pinochet to power and generated a decade of repression and death squad atrocities. Alan Greenspan, our former Federal Reserve Chair, and Milton Friedman were unofficial economic consultants to the Pinochet regime.

Say was right in a fundamental sense. For every dollar of product produced and sold there is a dollar of income received, so theoretically a dollar's worth of produced commodities has a dollar in consumer's or businesses' hands to match it. That doesn't mean it will be spent to buy that good however. Consumers will occasionally sit on their wallets and purses as they are doing now. And if low prices don't entice them into the stores (you can get amazing deals on airfares and hotel rooms right now) then the price system has failed in its equilibrating function (supply = demand).

4. A number of people have asked about the official definition of poverty.

R: When President Lyndon Johnson undertook the war on poverty (why this fascination with going to war on everything?) he was presented with three methods of determining the poverty income threshold. He chose the lowest one. It was based on the value of a basket of food items required to provide a family of four with just the required caloric intake and then multiplied by three (which at the time was the percentage of a family's budget used for food purchases). First, it required a very skilled shopper to even meet that standard and secondly over time the percentage of a family's budget comprised of food began to fall to around twenty-five percent. Medical care, housing and education began to outpace increases in the price of food. The income that officially made a family of four fall into poverty was therefore (and still is) a gross underestimate. Today, that income is around $20,000.

5. I don't see how aggregate demand can ever be equal to aggregate supply. Goods will always be sitting on shelves. During crises can't government use taxes collected on business during prosperous times to put the businesses back on their feet?

R: It's true that technically it would be unusual if general equilibrium was right on the money but the desired position is one in which aggregate demand leads aggregate supply just enough to encourage businesses to expand and hire more workers, keeping the system growing. It has been said that capitalism must grow or die. If the surplus (that caused by under-consumption) is not somehow put back into the income-consumption stream then a downturn is inevitable. The government certainly can use taxes raised during periods of prosperity to forestall an economic downturn. But guess who doesn't like business taxes and guess who put the last administration in office for eight years when corporate profits taxes reached the lowest levels in fifty years.

6. How does the Phillips Curve work exactly? Is it true that with unemployment there is more deflation?

R: A.W. Phillips found it to be true for a period of about twenty years in Great Britain. The relationship is easy to explain --- if workers are thrown out of work, they reduce their consumption and producers are forced to react in two ways: lay off more workers and/or cut prices. They often do both. That gives substance to Phillips findings. However, during the 1970s several things occurred to throw that system out of whack. The oil embargo of the early seventies, the collapse of the Bretton Woods Agreement in which all currencies were pegged to the dollar, and the end of what one of my professors called the Social Structure of Accumulation (David Gordon) in which there was relative peace between workers and managment and between citizens and capital (Americans really did believe what was good for G.M. was good for America) created the beginning of what Gordon and others called the wasteland or the deindustrialization of America. The result was both a decline in relative prosperity for Americans and a devaluation of the dollar and a rise in the cost of living relative to median American family incomes.

7. Are there examples of American workers over-throwing corporate leaders in a revolution?

R: We have had periods of revolutionary unrest in which there were pitched battles between corporate armies (Pinkertons etc) and striking workers. Some of the unions at the turn of the nineteenth century were particularly militant and intent on over-throwing capitalism, for example the Industrial Workers of the World (the Wobblies). These unions were overwhelmed by unions that had less revolutionary goals -- the eight-hour day, a minimum wage and maximum hours laws which they finally got in 1936 with the Fair Labor Standards Act (which explicitly excluded farm workers who today are paid so low that we have to bring in foreign labor to harvest our crops). (Marc Linder "The Autocratically Workplace; Philip Foner The History of the labor Movement in the United States) Americans are not by nature revolutionary in part because they firmly believe that no matter how unequal the distribution of wealth and income they could someday strike it rich. Interestingly the gathering crowds outside the AIG executive's homes in Connecticut sure look like a hint of unrest regarding the fairness of the system. Notice, the homes were surrounded by private security forces and local police.

8. Why is it that when the rich people spend on everyday items it doesn't add to the economy? Why do most wealthy citizens re-supply wealth for each other and not for the nation?

R: I think your question regards why upper income groups' incomes don't provide a net stimulus to the economy. Of course, a dollar spent by a millionaire is just as stimulative as a dollar spent by a poor person. The problem is that the rich don't spend all their incomes and the poor always spend everything they earn, so the more unequal the distribution of income the lower the percentage of national income going toward consumer spending. Savings (unspent income) will rise as inequality increases. That hasn't posed a problem in recent years because low and moderate income folks were more than willing to spend everything they had and then some, fueling the biggest increase in consumption relative to income in memory.  All that ended with the collapse of the housing bubble, the rise in housing foreclosures, and the increasing transparency of the flawed financial products Wall Street was peddling to the Chinese and others of our foreign debtors. The wealth accumulation which was increasingly based on speculative securities' swaps could no longer sustain the global circuit of finance capital. If, as your question hints, the wealthy had used their wealth to invest in companies that produced products and earned profits the old-fashioned way then at the very least when the downturn came there would be physical assets available when the recovery began. One wonders now what the physical infrastructure will look like that will pull us out of this recession. David Ricardo referred to "buying cheap and selling dear" as profit by alienation --- someone makes money at the expense of someone else. It's like the joke about the two jewelers with shops across the street from one another. One day Smith goes into Jones' shop and buys a broach. That night Jones' husband says, "Smith only bought that broach because she knew it was worth more, you buy it right back from her tomorrow." So, Jones buys it back and then Smith returns and buys it back again. This goes on for awhile until one day Smith sells the broach to a rich Chinese man. Jones screams at her, "You idiot. Didn't you realize how good we had it. We were making money hand over fist!"

9.  If general prices fall as aggregate demand falls does the minimum wage fall?

R: No. In fact, maintaining wage levels is one way in which the system can be salvaged. Spending declines have a floor, albeit a mighty meager floor. Sticky wages during an economic downturn can be a good thing.

10.  What significance does gold provide during times like today? Is it the only secure investment?

R: We seem to be facing a good old liquidity trap in which no amount of money will increase spending or lending. To protect one's wealth against the possibility that a government treasury will try to spend its way out of the recession via the printing press, wealth-holders will want to stay as far away from cash as possible. A fall in the value of the dollar will mean the value of one's assets if entirely in cash will collapse accordingly. Gold is a hedge against hyperinflation. We're not there yet.

11. Why is it said that the economy will stabilize at full employment?

R: Classical economists believed markets were completely self-equilibrating. If that's so then the labor market will also achieve equilibrium through the fluctuation of wages as demand for labor falls or rises. Marx believed the capitalist class would always strive to maintain a reserve army of the unemployed to keep wages low, i.e., there would likely never be a fully-employed labor force if capital had anything to do with it. It was a matter of power. If there is a large number of workers without jobs it's very difficult to ask your boss for a raise. She has the upper hand.

12. What is the significance of nominal GDP as opposed to real GDP?

R: Nominal GDP is measured in today's prices. So, if you buy five haircuts for $20 each this year then nominal GDP would include $100 for those haircuts. But if haircut prices rose by $5 from last year (and it's the base year) then real GDP is only $15 x 5 = $75. In other words, real GDP discounts production for changes in prices.