

How Depressions Work - ph0rque
http://www.aaronsw.com/weblog/depressions

======
tptacek
Isn't this just a point-for-point paraphrase of a Paul Krugman article, about
the same co-op? He didn't even _cite_ Krugman, or the journal article Krugman
cited for the same story.

~~~
aaronsw
Oops, I meant to add footnotes. Sweeney and Sweeney is here:

[http://cda.morris.umn.edu/~kildegac/Courses/M&B/Sweeney%...](http://cda.morris.umn.edu/~kildegac/Courses/M&B/Sweeney%20&%20Sweeney.pdf)

It's an awesome paper.

~~~
tptacek
It is an awesome paper, but it doesn't appear to be your primary source ---
which you haven't yet cited (it's "Babysitting the Economy", Krugman in Slate
from '98, about the Asian crisis).

For example, unlike Krugman, the original paper doesn't state that the co-op
is mostly lawmakers and lawyers (only that lawyers drafted the bylaws); unlike
your post and Krugman's article, the paper also doesn't talk about
legislation.

More importantly, the paper's thesis isn't Krugman's thesis, or yours. The
paper seems to be making the point that the implicit economies that develop
from social interactions are often destined to flail because people don't
recognize them _as_ economies, and insist on applying moral reasoning to
technical problems.

But your thesis --- and Krugman's --- is different. Obviously, we recognize
The Economy as _an_ economy. So what Krugman is saying is that this story
illustrates something about _how to resolve a depression_.

Which it very well might. It's not like I'm going to question Krugman on it.

(You did cite Krugman's anthology book, which I haven't read but might contain
this article).

~~~
jacobolus
> _might contain this article_

Pretty sure it does. The story seems familiar.

------
rsheridan6
Deja vu: <http://www.slate.com/id/1937/>

------
mixmax
If you cut away all the economist talk and get down to the core of the problem
it's very very simple: For the last 8 years America has been spending more
than it has made. Production is not up to world standards, just look at the
auto industry.

Bailing out companies and fiscal stimulus of one sort or another won't save
you from the basic and indeniable problem: You're broke.

There's only one way out of that: Spend less and work more.

------
cool-RR
In the "scrip" economy, couldn't they just let the value of the scrip change
organically? If scrips are getting too precious, you can tell your babysitter
that he'll be getting one scrip per two hours instead of one hour. If scrips
are indeed that rare, he'll accept it, and the scrip-time ratio will naturally
reflect the scarcity of scrips. Since this thing does happen with Dollars, I
reckon his analogy is bad, and adding more Dollars won't solve the problem.

~~~
mhartl
You've got it. I made the same point a few weeks ago:
<http://news.ycombinator.com/item?id=421617>. It doesn't seem like rocket
science, but maybe it is; the vast majority of economists, including Nobelists
like Krugman, just don't seem to get it.

~~~
bokonist
I made almost the exact same comment you made:
[http://www.reddit.com/r/Economics/comments/6oba0/its_ten_yea...](http://www.reddit.com/r/Economics/comments/6oba0/its_ten_years_old_but_its_still_probably_the_best/c04fkgp)

~~~
mhartl
Great minds think alike. And so do ours. ;-)

------
Retric
That's one facet another is how deflation and loans mix. In effect deflation
increases interest rates just as inflation decreases them. If you owe 1$ @ 5%
over a year with 50% deflation you now owe 2.1 times the value of what you
bought. Once deflation starts people start trying to pay back their debt
because their effective interest rate increased. Which decreases the money
supply and causes even more deflation. This cycle can quickly get extremely
nasty with most people defaulting.

The free market dampener is people refinancing at slightly lower rates, but
this this hits a wall. Negative interest rates never happens, because why lend
money when you can just keep it. And even mild deflation is hard to deal with
because loans have risk so you can't lower loans below the rate of risk.

------
dominik
"Keynes suggested stuffing bills into bottles and burying them down
mineshafts."

Can someone explain how such an action would _help_ the economy?

~~~
there
to get at the money, one would have to employ people and buy equipment.

~~~
mechanical_fish
Yep, that's it.

It would be nice if these people did something useful, but Keynes' point was
that this is an _optional feature_ which should not be allowed to detract from
the main goal.

~~~
dominik
The main goal being getting money circulating again?

But why should that be a main goal? Why have money changing hands for the sake
of changing hands? Isn't money just a medium of exchange -- a go-between, a
currency -- used to convert one type of good into another? We don't just want
money to circulate, we want money to circulate purposefully -- in transactions
on the free market.

I still don't see how burying money and having miners dig it up helps
anything. It doesn't create value. Those miners could do other, more
productive things instead.

~~~
mechanical_fish
_Isn't money just a medium of exchange...used to convert one type of good into
another?_

I'm tempted to answer "no". Money has properties -- the very ones that
prompted its design -- that make an exchange of money quite different from an
exchange of goods or services.

The important property for this discussion is: an exchange of services doesn't
offer you a reliable medium of _savings_. If I offer to shingle your house in
exchange for you shoveling my snow, but it's January and I can't shingle the
house until May, we're stuck. You can shovel the snow first and have me _owe_
you the shingling, but what if I flee the state, or injure myself? Or what if
May comes around and you have decided that you'd rather have the lawn redone
than the shingles replaced? I don't know lawns! I only do shingles!

But money solves this problem because you can put it in the bank (or a piggy
bank, for that matter) and decide later what to trade it for and with whom.

Which leads directly to the problem we're worried about: deflation. Right now
is a very bad time to hire someone to reshingle my house for $75 an hour,
because in six months another 3-5 million people will be out of work and there
will be a lot more unemployed people with building skills, some of whom might
be willing to reshingle my house for $50 an hour. But, of course, at that
point I might be out of work myself, and $50 might seem like a lot of money,
but no problem, because if I wait _another_ six months the price might be down
to $25 an hour...

In a depression people hoard their money, because there isn't a lot coming in
and because it's worth more the longer you wait. That's the phenomenon which
Keynesian stimulus seeks to prevent. You have to offer folks $50 an hour (or
whatever) to do _anything_ \-- twiddle their thumbs, if necessary -- to keep
money flowing into and through the system and to fight the universal tendency
toward deflationary deadlock: The situation where everyone sits on their cash
and their labor, waiting.

(Since the 1930s, we've prevented our economy from falling into this terrible
state by using monetary policy. But you can't use monetary policy to maintain
equilibrium once the real interest rate is zero. Which it apparently now is.)

Unfortunately, a depression is one of those nonlinear, non-equilibrium, black-
swan situations that relatively few living Americans have experienced, and
we're seeing the very real danger that people will refuse to recognize the
possibility this time until it's too late. You have to _anticipate_ these
things, because economies have a lot of momentum.

~~~
dominik
A _medium_ of exchange, not an exchange itself. A medium: "a means or
instrumentality for storing or communicating information." Money enables the
storage and communication of information about exchanges, as posited by your
example.

As for deflation: Isn't there a cost to not reshingling your house? You don't
have a reshingled house, something you presumably want. You shouldn't just
look at the price of labor, you also have to look at the value of what the
labor does: the house, reshingled. Compare that to the cost of reshingling the
house. (Opportunity cost, in so many words).

I still fail to see the point of offering folks money to do something
pointless, nor how it helps stop deflationary deadlock. If there's a deadlock
then they'll just sit on that money as before, no?

I'm not sure I understand the deflationary deadlock -- you posit a situation
where everyone sits on their cash and their labor, waiting -- waiting for
what? Eventually someone is going to stop waiting and start working,
eventually the gap between _desired state_ and _existing state_ will loom
larger than the value of sitting on that money. In the house-shingling
example, eventually you will value someone shingling your house for $X/hr
today more than you will value having a not-reshingled house until the price
drops to $Y/hr in Z days. When that point comes, you'll stop sitting on your
money and hire someone to reshingle your house. Wouldn't a series of such
events unlock the deflationary deadlock as the market reaches the new price
point?

------
bokonist
_This isn’t rocket science. Keynes suggested stuffing bills into bottles and
burying them down mineshafts; Milton Friedman once proposed tossing cash out
of helicopters. But as long as the government is spending money, we might as
well spend it on something useful. And thus, fiscal stimulus._

I agree with printing money to halt the deflation. But this should not be done
through government projects. If the money is spent via government projects,
then you still get massive frictional unemployment as businesses shut down and
and everyone has to find new jobs working for the government. Second,
government spending has a ratchet effect. Government programs never die.
Finally, I believe individuals know how to spend their money the best. Should
money be spent on a high speed train from Boston to Washington, or should it
be spent on healthcare? Just print money and give it to individuals and let
each person decide.

~~~
swombat
As I recall, an article I read recently outlined a few key principles for such
a monetary deployment (which Lawrence Summers apparently supported until he
became part of the administration):

1) Must be able to start very soon

2) Must have a clear horizon (i.e. a project with a final deadline, so that it
doesn't keep costing money forever)

3) Must be useful

One example it gave of the best way to spend that money would be actually to
_repair_ existing roads. That's usually very easy to do right away, provides
immediate short term benefits, and reduces your long term costs (unlike
building roads, which increases them, as you then have to maintain all these
new roads).

~~~
bokonist
The point of monetary deployment should be balance sheet repair. Only when
people's balance sheet's are repaired can normal spending resume and the
layoffs stop. The point of an intervention now should not be to get the
unemployment rate back down to 4%, but to prevent it from going to 15%.
Therefore, the thing to do is to repair balance sheets by printing money. If
you only give money to people repairing roads then consumer spending still
drops off a cliff, and millions of people still lose their jobs.

------
stevedekorte
A long response to Krugman's scrip example can be found here:

<http://www.amconmag.com/article/2009/jan/12/00031/>

------
hardik
"The moralists insist it’s irresponsible for us to just print more money."

Actually economists, not moralists, are against this; because excessive
pumping of money in they system in this way will cause hyper-inflation.
Classical (and rather extreme) example of why printing money should be kept
under check: Zimbabwe.

~~~
sethg
Everyone agrees that _excessive_ pumping of money into the system will cause
inflation. The problem is figuring how how much is, in fact, excessive. And in
a recession, you can't just say "let's err on the side of conservatism and not
pump anything in" because there's the risk of deflation on the other side.

"We stand today at a crossroads: One path leads to despair and utter
hopelessness. The other leads to total extinction. Let us hope we have the
wisdom to make the right choice." —Woody Allen

~~~
hardik
Well, the fact that interest rates are nearing zero does indicate how must is
_not_ enough.

------
richcollins
Yep, looks like it was a lack of money in circulation that caused the problem:

[http://research.stlouisfed.org/fred2/fredgraph?chart_type=li...](http://research.stlouisfed.org/fred2/fredgraph?chart_type=line&s%5B1%5D%5Bid%5D=AMBNS&s%5B1%5D%5Btransformation%5D=pc1)

~~~
baguasquirrel
The velocity of money has dropped. I don't have the charts on hand, but you're
citing that chart and making the wrong conclusions.

------
petercooper
Aha.. I've seen the "interest rates can't go below zero" claim again. Is this
really so? I've read it a lot, but surely a negative interest rate is possible
by being paid interest to borrow money?

A negative interest rate, therefore, would be a bit like a formalized
"helicopter drop". If the interest rate of a loan were tied to the nominal
interest rate in some way, you wouldn't have millions borrowing as much as
possible because the rates could well shift back in the other direction before
long.

~~~
vitaminj
Some economists have proposed imposing a tax on cash holdings, which would
theoretically push nominal interest rates negative... this would really give
people an incentive to hold assets instead of cash.

[http://blogs.ft.com/wolfforum/2008/11/the-case-for-
negative-...](http://blogs.ft.com/wolfforum/2008/11/the-case-for-negative-
interest-rates-now/)

------
johnrob
Inflation is one way to solve a debt crisis. What ends up sacrificed is the
reputation of the currency (dollar in this case). Our spending power as a
nation will decline when the rest of the world demands more dollars for their
goods.

I have wondered lately if this is why we are keeping our car companies alive:
Massive inflation could make them cheaper than foreign cars.

~~~
cchooper
He's proposing an expansion of the money supply, not inflation. It will only
lead to inflation if the money is not withdrawn quickly enough as the economy
recovers.

~~~
johnrob
It's all relative. Expanding the money supply has an inflationary effect, even
if the absolute effect is simply to slow deflation (which is still relative
inflation).

~~~
cchooper
Changes in the money supply do not appear to be correlated with short term
inflation at all, so it's not certain that short term expansion will produce
any effect.

~~~
hardik
But short term expansion will surely not be enough to quell the crisis. Also,
the point that other commentators have made on falling value of the currency
stands valid. At the moment, America is facing twin problems of slowing
economy and mounting debt; whose classical "cure" point to different
directions.

------
johnrob
How will this help us pay the 45 trillion dollars of combined public and
private debt? Keep in mind our GDP is 13 trillion.

~~~
sethg
The Keynesian prescription, AIUI, actually has two sides: the government
should run a deficit (when necessary) during a recession _and run a surplus
during a recovery_.

It's a damn shame that the Bush Administration didn't follow the second half
of this advice for the past eight years, but that's no reason to ignore the
first half now.

------
kingkongrevenge
This is just a muddled explanation of monetarism, which is pretty well clearly
nonsense at this point. No macroeconomic developments of the last 100 years
confirm it.

> We’re not being punished for our exuberance

We're being "punished" for massive malinvestment. Wealth was poured into
assets and ventures that could never achieve positive returns. A
recession/depression is the process of liquidating malinvestments and
redeploying wealth and labor to economically profitable ventures.

The malinvestment happens partly from mass psychology and mostly because of
artificially manipulated interest rates. The natural market interest rate
reflects the amount of wealth available for investment (capital). When people
have saved a lot and there's a lot of wealth stored up, interest rates are
low. When interest rates are _artificially_ held low, investors and business
people get the mistaken impression there's much more stored wealth in the
society than there actually is. Then eventually many business plans come to
tears at roughly the same time, as it becomes apparent there isn't the wealth
to drive demand for the ventures. This is a recession.

~~~
jorgeortiz85
_A recession/depression is the process of liquidating malinvestments and
redeploying wealth and labor to economically profitable ventures._

If what you say were true, then we wouldn't be suffering from unemployment.
We'd suffer from massive writedowns in our wealth (as we realize our
malinvestments) but labor would be redeployed to new ventures. Effectively,
we'd be working our assess off harder than before, but receiving a lower
quality of life in return.

In reality, however, the economy is not at full employment. If we malinvested
before (effectively did useless work), that should be a sunk cost. We wouldn't
receive the future benefits we expected from that work, but that wouldn't
preclude us from continuing to work. Malinvestment is not a reason for
unemployment.

No, we're in a liquidity trap. Option A is monetary policy. That has been
tried and exhausted. Option B is fiscal policy. Bring out the helicopters!

~~~
gojomo
_we wouldn't be suffering from unemployment... labor would be redeployed to
new ventures_

Yes, but redeployment takes time -- especially when everyone looks around and
sees all their assumptions about what profits different activities will return
are wrong, and need to be recalibrated. That research -- which happens
tentatively, experimentally at first -- means some capital/labor sits on the
sidelines while the necessary information is collected or created.

Redeploying labor immediately at the first things you can think of might keep
people busy but can worsen the wealth destruction, if those activities wind up
being of net zero or negative benefit. (By tying up workers on make-work, they
could also slow the rediscovery and restaffing of valuable projects.)

~~~
parenthesis
_redeployment takes time_

Those who have lost their jobs don't necessarily have the right skills for the
more economically productive jobs that hopefully get created. Also, they don't
necessarily live in the right places.

~~~
ricree
Not to mention that many who are in the right place and could profitably use
new people are not sure of that fact, so they lack the confidence to bring in
as many new people as they might otherwise.

------
tphyahoo
An alternative explanation:

<http://www.whereisthemoney.org>

You shouldn't just print money if it supports theft via nontransparent
government accounting, impoverishes the many, and enriches the few.

Then you are just Zimbabwe 2.0.

Fix the accounting systems first, please.

