Home > The Economy > Why does aggregate demand collapse?

Why does aggregate demand collapse?

from  Asad Zaman and the WEA Pedagogy Blog

 

The Great Depression of 1929, and now the Great Recession following the Global Financial Crisis, poses several puzzles for economists. One is them is the sudden and severe drop in aggregate demand. This leads firms to curtail production, and therefore reduces demand for factors of production, most importantly labor. Why does aggregate demand fall, and why do not the price adjustment mechanisms restore equilibrium? The outstanding contribution of Atif Mian and Amir Sufi in House of Debt (see my Review & Summary) is to explain both why aggregate demand fell and also why the standard price adjustment mechanisms fail to restore equilibrium. The correct explanations have eluded famous economists like Keynes, Friedman, Lucas and many others. Only after understanding the reason for the shortfall in aggregate demand does it become possible to prescribe a remedy.

Keynes noted that Aggregate Demand fell in wake of the financial crisis and suggested that fiscal and monetary policy might restore it. It is the shortfall of aggregate demand which leads to unemployment. Standard macroeconomics then and now does not allow for a long run and persistent shortfall in aggregate demand. Theoretically, prices should fall in response, which would stimulate the demand. Increased demand would lead to increased production and ultimately restore full employment equilibrium. The Great Depression made it clear to all that this mechanism did not work as expected. The Great Recession following the Global Financial Crisis has reinforced this lesson. Unemployment persists at high levels, even though there had been no change in the productive capacity of the economy. Why did not the self regulating market restore equilibrium? A similar and related puzzle was the failure of demand and supply in the labor market. High unemployment should have led to falling wages, which should have eliminated unemployment. Again this was not observed to happen. Why?   read more

  1. paul davidson
    November 7, 2014 at 9:46 pm

    Sorry but you clearly confuse Samuelson’s terrible misinterpretation of Keynes for what Keynes actually said. Samuelson said, and I have provided quotes directly from Samuelson in an article to be published in the JPKE — Samuelson said he found the General Theory “unpalatable” and therefore merely assumed it was a walrasian system that was slow to adjust to an exogenous change in demand.

    Actually, I point out both in my textbook POST KEYNESIAN MACROECONOMIC THEORY and my trade volume THE KEYNES SOULTION: THE PATH TO GLOBAL ECONOMIC PROSPERITY the drop in aggregate demand depends on Saving finding a place in liquid assets and the “essential properties” [the quote of essential properties is directly from Keynes’s Chapter 17.. Especially footnote # 1 on p. 241 which specifically indicates that the “attribute of ‘liquidity’ is by no means ondependent of the presence of these two characteristics” — where the two characteristics are the two “essential properties” elaborated by Keynes in this chapter.]

    Why don’t you read my textbook and get your students to use it. Then you will understand what Keynes said EXACTLY — and why these properties are necessary to understand what has to be done in a closed economy — and why, in an open economy, there is need for an institution such as Keynes described in the Keynes Plan at Bretton Woods and which I have translated into a 21 century equivalent institipon which I call the International Monetary Clearing Unit or IMCU.

  2. November 8, 2014 at 1:44 am

    OK, Paul, I have put your textbook on my reading list. But it will take a while to get from amazon.

  3. November 8, 2014 at 1:36 pm

    From theory collapse to economic collapse
    Comment on Asad Zaman’s ‘Why does aggregate demand collapse?’

    First of all, I would like to support Paul Davidson’s advice: read his books!

    The litmus test for every economist is whether he takes the Walrasian approach seriously. Since the days when Keynes saw more clearly than his fellow economists that the ‘classical’ axioms had been refuted once and for all by the Great Depression this is self-disqualifying. There is no way back before Keynes.

    However, Keynesianism has to be developed further. It is not such a good idea to cling to the General Theory. Keynes started the overdue paradigm shift but he did not finalize it in a formally acceptable manner (2011).

    You ask two important questions, first about aggregate demand, second about the price mechanism. Both are, of course, interrelated but the crucial point is that the popular idea of the functioning of the price mechanism is mistaken. Loosely speaking: it is the profit mechanism that is decisive, not the price mechanism. Even if the adaptation of the product price and the wage rate for the business sector as a whole is perfectly flexible, this cannot turn the losses that result from insufficient aggregate demand into profit. Therefore, the price mechanism cannot prevent the self-dissolution of the economy.

    Hence it is the familiar story of supply-demand-equilibrium that has to be replaced by the correct price theory (2014a). The correct employment equation contains both aggregate demand and the interplay of the price mechanism (2014b, p. 9, eq. (22)).

    It is proverbial that the representative economist does not know how the economy works. Neither orthodox nor heterodox economists understand the two most important phenomena in the economic universe: profit and income. Because of this economists have nothing to offer in the way of a scientifically founded advice.

    “In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum, 1991, p. 30)

    Not to forget, before you tell students about the economy you need the true theory.

    Egmont Kakarot-Handtke

    References
    Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–15. URL http://ssrn.com/abstract=1966438.

    Kakarot-Handtke, E. (2014a). Economics for Economists. SSRN Working Paper Series, 2511741: 1–29. URL http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?
    per_id=1210665.

    Kakarot-Handtke, E. (2014b). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2489792.

    Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge, MA: MIT Press.

  4. November 8, 2014 at 9:48 pm

    The desire to save money, is related to the level of income. At the same time saving money can not be higher than the borrowing. Therefore, the income (= aggregate demand) is limited by the borrowing.

    It is not difficult to understand: If you want to rise the aggregate demand, the income of your economy, you need more deficit spending. Too much saving and too little debt is the cause of the crises. Usually the real interest rate is too high.

    Sorry for my bad English.

  5. November 9, 2014 at 7:01 am

    Macro is not my area, though given the extreme importance of the subject, I am currently engaged in trying to learn more about it. However, for both Paul Davidson and Egmont Kakarot-Handtke I have the following question: have you read House of Debt? The authors explain the drop in aggregate demand (which is the root cause of both the Great Depression and the Great Recession) by a causal mechanism which is new (to the best of my knowledge). This is simply that the assets of the class with a very high marginal propensity to consume out of income were wiped out in the financial crash preceding the depression. This is a DISTRIBUTIONAL argument — the same level of destruction of wealth visited upon the wealthy (as in the dotcom collapse) WOULD NOT have caused the recession, because the wealthy have low marginal propensity to consume. To the best of my knoweldge, no one has made this argument before. If this is the correct reason for the collapse of aggregate demand, then reading Davidson and Kakarot-Handke and Stigum will not lead to an understanding of the causes of the Great Depression of 1929 or the Great Recession of 2008.

    As far as Wolfgang Wadner is concerned, the idea that the solution to a crisis created by excessive debt is to create even more debt is explicitly attacked, with a wealth of empirical arguments by Sufi and Mian. So my advice to you is also to read House of Debt carefully, The central theme of this book is that the argument you are making leads to the kinds of policies which are currently being pursued, and WHICH HAVE FAILED to work, both in the USA and in the European context.

  6. November 9, 2014 at 9:05 am

    In your economy there are some people saving money and some other people are borrowing money. The people who save do not ask the people who borrow, how much money they shall lend. But at the end of each time the saving of money is quite equal the borrowing of money. If you want to explain it, you have to explain the business cycle:

    If the people want to save too much money, their income will shrink and they can not save the money they want. And the people who did not like to borrow more money will earn lower income, so they must borrow more money. It is the same mechanism, if the people want to borrow more money than they save: Their income will increase so they have to save more and to borrew less. That`s the business cycle.

    The root cause of both the Great Depression and the Great Recession has been the financial crash after the FED raised interest rates. After the stock market crash in 1929 all people, companies and governments tried to save more money and borrow less. But each time saving and borrowing have to be equal.

    You know – the aggregate demand had to fall until saving and borrowing got equal.

  7. Ton Notermans
    November 9, 2014 at 3:07 pm

    In a credit economy, i.e. in the real world, deflation plays a crucial role in the collapse of aggregate demand, I would say. It simultaneously reduces the incentives to consume, to borrow (rising real debt) and to lend (mounting default and reduced creditworthiness of potential borrowers). If one assumes, as Keynes correctly did in my view, that the nominal wage is the anchor of the price level, then escalating unemployment, possibly accompanied by policies to increase labour market flexibility, may imply that deflation becomes cumulative. In other words reliance on price flexibility to solve a crisis is something that may work in a neoclassical textbook with its absolute dichotomy of absolute and relative prices, but in the real world such price flexibility is the problem rather than the solution. As the Great Depression picked up steam, many businessmen (“ruinous competition”) and policy makers actually became convinced that deflation was the main problem. As a result, many of the early measure to combat the Great Depression were aimed at reducing nominal flexibility; e.g. currency devaluation to import a price level increase, attempts to put a floor under nominal wages etc..

    • November 9, 2014 at 8:57 pm

      Comment on Ton Notermans

      Of course you are right that deflation may become a problem. The crucial point is that the popular idea of the functioning of the price mechanism is mistaken. What is needed first is the correct price theory (2014a) which delivers the correct employment equation (2014b, p. 9, eq. (22)). Roughly speaking, if the product price (for the economy as a whole) falls faster than the wage rate the employment effect is positive under the condition that all other parameters remain unchanged. If the wage rate falls faster the employment effect is negative. On closer inspection it turns out that there are two types of deflation. As you rightly pointed out, there are also secondary effects on the real value of debt but this is a separate issue. Resume: neoclassical economics got the price mechanism wrong.

      Of course Wolfgang Waldner is also right. If the relation between saving and income increases the employment effect is negative.

      The combined price and demand effects are captured by the employment equation (2014b, p. 9, eq. (22)).

      Egmont Kakarot-Handtke

      References
      Kakarot-Handtke, E. (2014a). Economics for Economists. SSRN Working Paper Series, 2511741: 1–29. URL http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=1210665.

      Kakarot-Handtke, E. (2014b). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
      http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2489792.

  8. Norman L. Roth
    November 10, 2014 at 12:45 am

    Nov. 09 2014

    Please refer to:
    [1] Voluntary & Involuntary Declines in Labour Supplied, Feb. 08, 2014, Scroll down to Norman L. Roth & to #5 by Helene Clement Pitiot

    {2} Krugman gets it Right on Sticky Wages, Oct. 15, 2013,Scroll down to Norman L. Roth, ‘6:54 PM & Helene Clement Pitiot at 11:13 A.M.

    Egmont Handtke is quite correct in asserting that {1} “The representative economist does not
    know how the economy works”. ‘Even if the adaptation of product prices & wage rates are perfectly flexible, this cannot turn the losses that result from insufficient [aggregate] demand into profits”. {3} A better paradigm to explain the crucial role of profits in understanding how an economic system really works. . {Instead of the tendency of neo-Marxist ‘progressives’ to exorcise the subject of profits as the ultimate obscenity in human nature}. Even worse than interest on money ?

    Telos & Technos reflects a profound distrust of aggregative thinking to explain how a complex inter-active quasi-organic economy works. Similar to that of Hayek & Mises,
    The great Keynes’s “Effective demand” is aggregative thinking: Just as it’s Malthusian ancestor was. For this reason I chose to pursue ‘dehomogeonization’ [i.e disaggregation] & taxonomy to describe the role of the primal economic variables: As an antidote to the spurious ‘quantification’ & misleading manipulation of aggregative & qualitative variables, that have leeched so much out of the credibility of economics. e.g. Capital, aggregate consumption function, the unmitigated farce of ‘Total Factor Productivity, the consignment of technology to a residual operator, courtesy of Robert Solow & the unapologetic neoclassical-equilibrium -crazed crew. Not to mention the “Shock & restoration to equilibrium explains all” wankers.
    This led to concepts such as “the current conception of the standard of life” [Chapter 2] and a ‘model’ [don’t shoot me just yet] of how consumers change & adapt their tastes to new & obsolescent commodities & services.It’s a decision-making PROCESS that relates changes in real prices of commodities to changes in money wages. And I tried to make it as amenable to tests for falsification as possible. Not to mention the restoration of real time to economic thought via the concept of ‘Technological Time”…Chapter 3. In TELOS & TECHNOS, the events are the time.
    I believe that the basic concepts introduced in TELOS & TECHNOS would be the best possible fit with a liberated theory of profit & loss. Hint: Gestalt thinking is crucial in this regard. Rather than linear pseudo moralistic pontification & heated cique-mania. Thank you one & all for your patience.

    Norman L. Roth, Toronto Canada.
    Please GOOGLE: {1} Origins of Markets, Norman Roth {2} Economics of Technos, Roth
    [3] telos & technos [4] Norman Roth, Economic theory

  9. davetaylor1
    November 10, 2014 at 12:17 pm

    I too had problems with Asad’s interpretation Keynes in his pedagogy paper, but I am delighted how close Egmont comes to my own position in his first comment:

    “Keynes started the overdue paradigm shift [from interpreting human interactions as in physical interactions determined by mathematical “laws”, towards interpreting them as information exchanges within a cybernetic information feedback system]; but he did not finalise it in a formally acceptable manner”.

    I’ll merely ask the question, “acceptable to who”? and remind bloggers of Kenneth Boulding’s distinction between symbolic and iconic form in his little book “The Image”.
    Why is the generic topological form of a PID control servo not acceptable?

    I accept also Egmont’s explanation that it is the profit motive which is decisive, not the price mechanism. Way back in 1960, when electronic control technology was so crude all the components were distinct and thyratron tubes lit up so one could actually see what was happening, one had to have a standing error (P) to leave enough difference between setting and achievement to generate the required power output. Where it was necessary to eliminate this we generated an integral corrective (I) as a rolling average, exactly as Keynes did in response to “the standing army of the unemployed”. When profits start to fall producers and marketeers alike differentiate (D) their products and/or prices, the ease of the latter in corporate monopolies and wholesale stock markets unfortunately encourages second-order speculative profiteering detrimental to both producers and consumers. That is supposed to be controlled by a second-order chrematistic control system using interest rates to regulate observable levels of speculative debt, but at electronic speeds the cost of momentary or internal to corporation indebtedness has become negligible, requiring a change to something like the proposed Tobin tax.

    I also like Egmont’s thought-provoking reference in that first comment to “The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment”. It is surely a mistake to differentiate profit from a form of income, to identify savings with productive investment without subtracting stock market investment in second-hand debt, and to employ people instead of forming co-operative partnerships with them

  10. Norman L. rOth
    November 12, 2014 at 1:17 am

    Nov. 11 2014

    M. Egmont Handtke brings a certain epistemological /ontological inspiration into his definition of an [economic] “non-entity”. I wonder if “AGGREGATE DEMAND” may well be one of those ‘non-entities’. As well as the Marxian concept of “capital” as a quasi-solid substance that can be “accumulated”. [And even enjoy a certain “immortality” by the magic of automatic non-stop compound- interest “drive”. ] So entertainingly debunked by Philip Mirowski & the great Thorstein Veblen among others. But true believer Thomas Picketty won’t let go of substance-capital & the devil of compound interest.. He’s hardly alone. Jack London [1876-1916] an early, rather belligerent American socialist, more popular as an adventure writer, was similarly mesmerized by & inflamed by the phenomenon of compound interest. Doesn’t Picketty realize he believes in the economic equivalent of a ‘perpetual-motion machine’ ? Please read Chapter 5 [CAPITAL] of TELOS & TECHNOS for some common sense & clarification about this greatly abused & key concept of economic thought.

    The primal source of the ebb and flow of the income levels, which shore-up authentic purchasing power, is to be found in chapter 4 of TELOS & TECHNOS. Especially the part about the formation of degenerate income levels. And the Natural participation rate. It will be noticed that “aggregate demand” & “equilibrium” never set foot therein.
    I’m inclined to believe that the ‘profit motive’ and its roots in human nature, need far more “respect” and less punishment in the stockade of moralistic denunciation. And that the approach taken in Telos & Technos is the perfect analytical bedrock for it.

    Editors, Thanks again for your patience & indulgence.

    Norman L. Roth, Toronto Canada.

    Please GOOGLE {1} Norman Roth, Origins of Markets
    [2] Norman Roth, Economics of Technos [3] Norman Roth, Economic theory

    • November 14, 2014 at 9:34 am

      Comment on Norman L. Roth

      It is important to distinguish between political and theoretical economics. In political economics ‘anything goes’; in theoretical economics scientific standards are observed.

      The crucial point is: political economics is based on behavioral axioms (McKenzie, 2008) and this is not a solid enough foundation.

      “. . . if we wish to place economic science upon a solid basis, we must make it completely independent of psychological assumptions and philosophical hypotheses.” (Slutzky, quoted in Mirowski, 1995, p. 362)

      To start with behavioral assumptions like the profit motive invariably leads to a gossip model of the world. This is not to say that the profit motive is ‘unrealistic’. What is said is that second-guessing the agents is a pointless exercise.

      “… there has been no progress in developing laws of human behavior for the last twenty-five hundred years.” (Hausman, 1992, p. 320), (Rosenberg, 1980, pp. 2-3)

      Many economists tend to think that they are doing science while they never get above the level of yellow press gossiping about what the agents want or think or expect.

      The upshot is that no way leads from the understanding of how agents behave to the understanding of how the economic system behaves (2014).

      This fully explains the failure of behavior based approaches — including, of course, the Austrians.

      Egmont Kakarot-Handtke

      References
      Hausman, D. M. (1992). The Inexact and Separate Science of Economics. Cambridge:
      Cambridge University Press.

      Kakarot-Handtke, E. (2014). Objective Principles of Economics. SSRN Working Paper Series, 2418851: 1–19. URL http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2418851.

      McKenzie, L. W. (2008). General Equilibrium. In S. N. Durlauf, and L. E. Blume (Eds.), The New Palgrave Dictionary of Economics Online, pages 1–18. Palgrave Macmillan, 2nd edition. URL http://www.dictionaryofeconomics.com/article?id=pde2008_G000023.

      Mirowski, P. (1995). More Heat than Light. Cambridge: Cambridge University
      Press.

      Rosenberg, A. (1980). Sociobiology and the Preemption of Social Science. Oxford:
      Blackwell.

  11. Norman L. Roth
    November 14, 2014 at 4:50 pm

    Mr. Egmont Handtke,

    Please refer to: The ‘scientific’ attitude of modern economists—decidedly unscientific; from Lars Syll , Dec. 05 2013.
    Please scroll down to Dec.06 2013 ‘at 12:10 A.M. by Norman L. Roth. Therein you will find, at the very least, the direction of a solution to your dilemma.

    By the way, there is no ‘deus ex machina’ in the universe of economic events that could possibly lead to “laws” [like in physics ?] that would “place economic science on a solid basis..”completely independent of psychological assumptions and philosophical hypotheses”.
    What was Slutzky {???} inhaling when he pontificated such nonsense?

    Norman L. Roth, Toronto, Canada.

    Please GOOGLE: [1] Norman Roth, economist {2} Economics of Technos, Roth
    [3] Norman Roth, Origins of Markets [4] telos & technos

  12. Norman L. Roth
    April 10, 2015 at 11:33 pm

    April 10, 2015
    M. Egmont Handtke,

    Do you really believe that “There are structural ‘laws’ {in Economics} ? And they are ‘exact’ and ‘testable’ like any physical ‘laws’ ? And that considerations about human economic behaviour can somehow be avoided ? And that anybody who does this is being truly “scientific” ? Because “behavioural”, political and psychological content, leech the
    “scientific” credibility out of truly “scientific” economics ? Gott in Himmel ! Where have you been for the last century ?
    Read the epistemological & ontological material of {the mathematically gifted} Keynes . And about the Keynes-Ramsey disputation. And their openness to how human belief about the world around them, influences our economic behaviour. And Hayek, Mises, And MORE HEAT than LIGHT by the early Philip Mirowski. Also Ludwig Von Bertanaffly . There you will learn why Economics cannot be like the physical sciences. And that emergence, time-path dependence, gestalt process, Organic systems and the philosophy of time, cannot be avoided by any serious economic practitioner or thinker. You’ve staggered into the same positivist cul-de-sac that did -in neoclassical economics’ :Not to mention four generations of Monetarists. Regardless of their academic affiliations. This is easily accomplished by reading the back jacket of TELOS & TECHNOS.

    Norman L. Roth, Toronto Canada

    Please GOOGLE: [1] Roth, Economics of Technos [2] Norman L. Roth, Markets [3] Norman Roth, Economic theory [4] Norman L. Roth, Current Conception of the Standard of Life
    [5] Norman L. Roth, RWER

  13. Norman L. Roth,
    September 11, 2016 at 8:24 pm

    Sept. 11, 2014
    Please refer back to “DaveTaylor1 Nov.10, 2014 at 12:17 P.M.

    I do not understand why the author of the above, continues to repeat sanctimoniously about how a “PID Control servo”, or ‘chrematistic control systems’ and other forms of control programs applicable only to CLOSED -loop control systems, should be imposed forthwith,by some almighty, omniscient merciless “Big Nanny, She who must be obeyed” : On the ultimate in OPEN systems…interactive, complex, organic, path-dependent, non-ergodic, gestalt, emergence generating HUMAN ECONOMIES !
    I strongly advise you to familiarize yourself with the ideas of Ludwig Von Bertallanfy and other pioneers of complexity and open systems such as Roger Penrose.

    GOOGLE: {1} Norman L. Roth {2} Norman L. Roth, Technological Time {3}Norman L. Roth, economist {4} Norman L. Roth, Economics of work

  14. dave taylor
    September 12, 2016 at 1:44 pm

    Apologies to Norman if I appear sanctimonious to him (perhaps in light of my having run out of steam when trying to react to his own work).

    Let me try and clarify his misconception that PID and chrematistic control systems apply only to closed loop systems.

    The first point is that these are not perfect, so that in trying to improve them they develop. A physical control system, like the safety valve on a steam engine or pressure cooker, is only a proportional P control system, and while not perfect, in that static application it is sufficient. However, when what one is trying to control is speed or direction (i.e. a space-time quantity rather than physical attribute) of a process, control by means of physical processes is necessarily indirect (i.e. it requires an information-based servo subsystem), and may have to correct for instrumental errors as well as deviation from the ostensive aim.

    The slight physical deviation necessary to have something to correct will, if biased in one direction (as by a speedo reading slow or a compass not picking up sideways drift), accumulate positional error, requiring an integrated I feedback to correct it. This, I have argued, is what Keynes, prior to articulation of this theory, did more or less intuitively: compensating for persistently inadequate money flow by increasing investment (as against wage levels). Likewise, if the space-time required for the process is in danger of disappearing (e.g from an approaching road-block or on-coming vehicle) it becomes necessary to follow a different path, changing course with a differential D feedback.

    The problem with this now is that one has changed not the error but the aiming point, so the situation has changed, but not the need for control. If on occasion one neglects to reset the aim, the speedo or compass readings are thereafter relative to the new aim and not the old. If the new aim is to go faster rather than meet the economic need, and to direct more money into banking rather than necessary investment, the control system mediated by the information servo a chrematistic (money-making) one rather than an economic one. That in turn develops Proportionate control by means of share market prices, Integrated control by means of insurance and Differential control by means of derivatives (portfolio management), thereby changing the objective being controlled yet again from money making to the stability of the money supply. At the beginning of this new open cycle it is as yet uncontrolled.

    The second point is that the PID servo is not itself a control system imposed by “she who must be obeyed”. It is a method of correction of error in whatever, which is applicable by mature households in their everyday living just as it is in driving a boat or navigating a ship. What “she who should not have been obeyed” imposed on households and businesses to choose their own paths because by fraudulent ownership of property and debt they have been made legally subservient to banks and financial managers of corporations. Company law (in Anglo-Saxonia at least, as Robert Locke keeps pointing out) is thus contrary to the international Law of the Seas, whereby larger ships are required to give way to smaller ones, and are held responsible if they run them down.

    • dave taylor
      September 12, 2016 at 2:24 pm

      Correction in last para. ” What “she who should not have been obeyed” imposed on households and businesses [limited their ability] to choose their own paths, because by fraudulent ownership of property and debt they have been made legally subservient to banks and financial managers of corporations.

  15. dave taylor
    September 12, 2016 at 11:26 pm

    I see I am responding to a 2014 posting that I missed. Let me say that, despite Paul Davidson’s correction and Wolfgang Waldner’s comment, I very strongly agree with Asad’s summary of why aggregate demand fell and also why the standard price adjustment mechanisms fail to restore equilibrium.

    ” The millions of distressed homeowners have cut back on spending, which is the root cause of the recession… Instead of stimulating aggregate demand, deflation led to a reduction in aggregate demand, which led to further decreases in production, prices and wages. This vicious cycle was termed the debt-deflation cycle by Irving Fisher; as he put it in 1933, “I have . . . a strong conviction that these two economic maladies, the debt disease and the price-level disease, are, in the great booms and depressions, more important causes than all others put together.” Thus excessive [consumer] debt is the solution to the second puzzle of why the price adjustment mechanisms fail to work./ This analysis remains critically important today.”

    However, when one comes to motivation, this does not negate Egmont’s position in his first comment here: ” Loosely speaking: it is the profit mechanism that is decisive, not the price mechanism”.

    In terms of the three-level PID model I have just described, price is the control variable at the level of the economy, profit the control variable at the level of the chrematistic “shadow economy”, and monetary growth the stability control now being pursued by centralised banking. In Fisher’s analysis commodity price controls fail to work in the aggregate because because they are over-ridden by profit-pricing of monetary debt, and that is over-ridden when contral banks maintain aggregate profits by directly increasing money supply in the supposed interests of stability. But in the terminology of system theory Asad’s “vicious cycles” are called positive feedbacks, which exacerbate rather than controls errors. When each multiplies the effect of the previous one, the system behaviour bifurcates when(as now) the logarithmic dimensional sum reaches about 2.5. By about 2.7, as shown in chaos theory, it becomes chaotic.

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