There's been a lot written lately on why the Pigou effect (i.e., increase in output and employment caused by an increase in consumption due to a rise in the real balances of wealth) isn't a foolproof way around the problem of the zero lower bound. It reminded me of these lines by James Tobin....Fictional Reserve Barking
James Tobin on why deflation isn't a cure for unemployment
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Why lower prices do not necessarily stimulate demand, and why it is likely they won't in Fisher debt-deflation.
Of course deflation is not good. So why do the MMT folk support a money system whereby purchasing power is lent into existence since what is lent must be repaid and with interest?
ReplyDeleteOn the other hand there are two money forms that are SPENT into existence so there is no necessary repayment hence no necessary deflation. These are fiat and common stock.
Tobin omits far and away the biggest private sector asset which rises in value given falling prices, and that’s government debt. Not that I’m arguing that the Pigou effect is of any practical importance. Reason is that prices just don’t fall in recessions to any great extent, if at all.
ReplyDeleteFictional Reserve Barking says “There's been a lot written lately on why the Pigou effect…” Presumably he’s referring to this recent post by an Oxford economics prof:
http://mainlymacro.blogspot.co.uk/2013/08/why-pigou-effect-does-not-get-you-out.html
The prof (Simon Wren-Lewis) argued that while the Pigou effect (given falling prices) would raise private sector net financial assets, it wouldn’t for a variety of reasons raise demand. He then went on to argue that for similar reasons, increasing PSNFA via a helicopter drop would also not raise demand. Most MMTers would disagree with the latter. Certainly I did, so I left a lengthy comment after the prof’s post.
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ReplyDeleteProfessor Tobin rightly pointed out the example of the Great Depression as an instance of the irrelevance of the so-called Pigou effect:
ReplyDelete"...the direct effect of the price level on demand is not an equilibrating mechanism of any practical importance. Certainly, the big deflation during the Great Depression did no good."
Let's recall what happened then: in 1929 - in the two months following the October 30 crash - prices fell 2%; and then they went on falling - by 9% in 1930, 10% in 1931, 5% in 1932.
With that massive deflation (whose sheer scale would be unthinkable in present day economies), did aggregate demand and employment recover as a result of the Pigou effect?
No.
So maybe the time has come (80 years later!) to face the facts and simply stop wasting any more time debating that imaginary "effect".
And, like, do fiscal stimulus instead.
Ralph, Tobin draws attention to government debt in the second paragraph (and he doesn't think it is of much importance in terms of Pigou effect, as you rightly mentioned):
ReplyDelete"...There is a small excess of privately owned credits over private debts, the monetary issues and near-money obligations of the central government. But this net credit may not be sufficient to offset the likelihood that increased private debt burdens deter spending more than the corresponding gains in the purchasing power of creditors encourage it."
Good point about the helicopter drop to Wren-Lewis