The Treasury View: Swimming pool version

Your story was taken from the Michael Lewis article about Iceland in Vanity Fair, too.

6: cutting taxes, of course.

I think what we’re supposed to be doing is shunting all that water into a pressurized bathtub and then drowning ourselves in it, in the name of freedom.

The professor matter-of-factly stated that he was trying to make the shallow end much deeper.

What amuses me most about this is, in this model, given there’s apparently no other water to be had, how is a human being supposed to grow the economy? Adopting the metaphor at face value, the only possible productive action I can think up is peeing in the pool.

This is the sort of intellectually awesome humor you find in Readers’ Digest, so that a bunch of uninformed small business right wingers can laugh it up in the dentist’s office at those damn hippie liberals and their crazy lack of grasp of common sense that right wingers supposedly swim in.

the only possible productive action I can think up is peeing in the pool.

That will only work if you didn’t first drink from it ;-)

Well if nothing the government does is going to make any difference overall, what’s the problem with raising taxes on the rich to 95% and giving the revenue to the poor? I think I’ve found my argument for radical redistributionism.

I guess it’s a criticism of the idea that we can all be made better off by shifting the level of money around in the economy, be that by borrowing it from the future, or by raising taxes and increasing government spending. If this is the idea it is aimed at, then I presume the original authors’ response to Zamfir’s criticism would be that if you work late tonight then you are producing something useful and thus metaphorically increasing the amount of water, unlike the stimulus bill, which is just shifting economic production around at considerable administrative cost according to this metaphor.

The macroeconomic theories that I know of that we can be made better off by shifting money around, as opposed to producing more real goods and services (please insert normal disclaimers re environmental quality etc) are somewhat counter-intuitive. That doesn’t mean that said theories are therefore automatically wrong of course, plenty of counter-intuitive theories have turned out to be right in the hard sciences, but it does mean that they’re very likely to be mocked or misunderstood by non-experts, for an example from the hard sciences see what pseudo-scientists can do to quantum mechanics.

For a moment, let’s assume that story is true (I’ve seen it now, by the way, at least 6 times). Presumably the professor in the story has earned a PhD in economics. And has a teaching job. And has kept that teaching job.

NowTHAT’s scary.

I acknowledge the many errors, minor and significant, practical and philosophical, with the comment I posted above.

The point of it was: it’s not that counter-intuitive to see why the government should spend during a recession, unless maybe you see “the government” as a family that is competing with yours for resources. Perhaps it’s that many people frame the government in a very counter-intuitive way: the government is the thing that takes my tax money away from me and does things with it that have nothing to do with me.

One of the things that the righties are real good at is spinning these nonsensical Just So Stories that “prove” their economic theories. I’m sure that we’ve all gotten some version of the “Ten People Go Into A Restaurant” story which, while stupid and wrong, can be fairly persuasive if you don’t think about it closely and suffer from traumatic brain injury.

The best we have on out side is probably Krugman’s Babysitting The Economy, which is hampered by being a bit long and actually correct.

One of the things that makes me support a strong stimulus plan more and more is the sheer number of really bad arguments I’ve seen against it. When Harvard and Chicago economists resort to howlers (not here, but elsewhere), I figure that they don’t actually have any good reason, and are just ‘banging on the table’.

Isn’t the best, quickest rebuttal of the Treasury View Brad DeLong’s very short story about Alice, Beverly, Carol, and Deborah (which I quote later) in his response to John Cochrane’s long blog post, which, though I think doesn’t explicitly represent the Treasury View, does so implicitly:

First, if money is not going to be printed, it has to come from somewhere. If the government borrows a dollar from you, that is a dollar that you do not spend, or that you do not lend to a company to spend on new investment. Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both. This is just accounting…

Someone please correct me if I’m wrong, but doesn’t the Treasure View, which is represented in the swimming pool analogy, basically say that fiscal stimulus can’t work because any economic activity it “creates”, it does so at the cost of reducing economic activity elsewhere?

Which seems commonsensically true; although the first objection that comes to mind is that the Federal Debt created by the Stimulus Bill is not debt to Americans, but mostly to foreigners, isn’t it?

But, that aside, DeLong and others point out that Cochrane’s claim that this is a simple accounting matter is built upon the assumption that the velocity of money is constant; and it’s not. Thus, Brad’s thought experiment:

Suppose that we have four agents: Alice, Beverly, Carol, and Deborah.

Suppose that Beverly has $500 in cash that she owes Carol, due in two months. Suppose that Alice and Carol are both unemployed and idle.

In one scenario in two months Beverly goes to Carol and pays her the $500. End of story.

In a second scenario Beverly says to Alice: “I have a house. Why don’t you build a deck–I will pay you $500 after the work is done. Here is the contract.” Alice takes the contract and goes to Carol. She shows the contract to Carol and says: “See. I will be good for the debt. Cook me meals so I will have the strength to build the deck–here’s another contract in which I promise to pay you $500 within 90 days if you cook for me.” Carol agrees.

Two months pass. Carol cooks and feeds Alice. Alice goes and builds the deck.

Alice then asks Beverly for payment. Beverly says: “Wait a minute.” She goes to Carol and says: “Here is the the $500 cash I owe you.” Beverly pays the money to Carol. Beverly then says: “But now could I borrow the cash back by offering you a long-term mortgage at an attractive interest rate secured with an interest in my newly more-valuable house?” Carol says: “Sure.” Beverly files an amended deed showing Carol’s mortgage lien with the town office. Carol gives Beverly back the $500. Beverly then goes to Alice and pays her the $500. Alice then goes to Carol and pays her the $500.

The net result? (a) Alice who would otherwise have been idle has been employed–has traded her labor for meals. (b) Carol who would otherwise have been idle has been employed–has traded her labor for a secured lien on Beverly’s house. (c) Beverly has taken out a mortgage on her house and in exchange has gotten a deck built. (d) Carol has the $500 cash that Beverly owed her in the first place.

Alice has more income and consumption expenditure than if she hadn’t taken Beverly’s job offer. Carol has more income and saving than if she hadn’t cooked for Alice and then invested her earnings with Beverly. Beverly has an extra capital asset (the deck) and an extra financial liability (the mortgage) than if she had never offered to hire Alice.

A deck has gotten built. Meals have been cooked and eaten. Two women have been employed. And all this has happened without printing any extra money.

Can anyone tell me if, from what I’ve written, I understand the fundamental argument going on here?

What’s great about this analogy is that the bottom of the pool, cast in concrete and completely immutable, represents the distribution of wealth, something that in the real world, has changed shape dramatically since 2000. I love the tacit assumption in this story that the stimulus is trying to redistribute wealth, and the problem is not that the goal is wrong but that it can’t possibly succeed. I wonder if this story is the result of someone’s thorough misunderstanding, or diabolical genius.

Also (please excuse the long and sequential comments), wouldn’t a good rebuttal of the swimming pool analogy include a reserve pool as part of, say, the filtration system, which backs up and lowers the level of the pool water?

I mean, we get back to the basic argument between the pre-Keynesians and the Keynesians about what a recession really is.

Per my understanding of Krugman’s old explanation, the business/boom-bust cycle view believes that booms are when you have a big misallocation of resources and recessions are the friction-filled periods when all this misallocation is corrected. This is commonsensical and is what I believed until I learned otherwise. I mean, obviously, bubbles are when resources are badly misallocated in a speculative manner. In the current situation, I imagine the misallocation would be the growth of the financial sector in conjunction with the building of homes that aren’t needed.

My intuitive objection to this view is that this amoung of misallocation can’t possible be equal to how much money and labor is being shifted around right now. I suppose the response would be that there’s a multiplying factor involved.

Anyway, the old view naturally believes that the misallocation needs to be corrected and any interference in this only drags out the pain (which, arguably, if it lowers the short-term pain, wouldn’t necessarily be a bad thing).

The Keynesian view is simply that the business cycle is something else, bubbles are what they are, but recessions are no more and no less periods of time when a large portion of the agents in an economy decide to save money rather than spend it.

(As an aside, you can nicely see an analogy here to the pre- and post-Enlightenment theories about nature: the pre-Keynesian view is an attempt to understand what’s happening with an essential “why?” basis to the explanation. The Keynesian view takes a step back, discards preconceptions, and simply describes a process without a built-in teleological bias.)

(And because of this, I have to say I am immediately convinced of the Keynesian view’s superiority, as someone with a history/philosophy of science background and an empiricist bias.)

With this in mind, the Treasury View is really just an argument designed to justify the pre-Keynesian view of recessions. It has built-in assumptions about the economy that it doesn’t own up to.

In contrast, the Keynesian view (as I’ve described it) has no assumptions. From what I’ve written alone, there’s no reason to assume that anything could be done about recessions. But there’s no reason to assume that it couldn’t, either.

The missing thing seems to me, in my limited and lay understanding, to be the velocity of money. What does it mean to say that a lot of people are saving? People biased by an accounting view (which probably is why so many business people are attracted to the Treasury View, aside from politics) would say that someone’s savings is another person’s debt. (This also conveniently elides a crucial factor involved in the credit crunch; specifically, that banks have varying amounts of reserve deposits which really is just money sitting in a vault—right now, banks are greatly increasing their reserve deposits so, in fact, the amount of money available for lending is decreasing dramatically.)

But once you include the velocity of money, you can see that savings can increase without lending also increasing. And if that’s true, then lending can increase without savings increasing. This is what the government is doing with stimulus: it’s pushing money around the economy much faster than it otherwise would be moving and thus counteracts the sudden increase in savings.

You could also talk about the psychology of this; but that strikes me as a bit regressive in scientistism terms.

Als0, however, even accounting for their short-term focus, doesn’t their argument seem to imply that short-term increases or decreases in taxation can’t actually make a difference in the “depth of the pool”? Something they certainly claim to not believe.

Terry Pratchett has some fun with physical hydraulic models in Making Money.

“In this context, the point that Brad is making is that the level of economic activity is not constant.”

If that’s his point, couldn’t he just say that a possible world is where no one works and where there is no economic activity, which is obviously different from the actual world?

Anyway, I want to know what happens to Alice when she’s a real estate agent and doesn’t know how to build a deck (or how to cook).

Being the ignoramus that I am, I am more convinced by the explanation of the boom-bust cycle in terms of misallocation of resources. Given two economies, one which allocates its resources effectively during period P (the ant) and one which does not (the grasshopper), there will presumably come a time when the ant’s economy outperforms the grasshopper’s. If that’s the case, how does one think this outperformance should manifest itself? Surely a less rapid increase in the wealth of the grasshopper’s economy. And presumably resources can be *so* badly misallocated that there is at some point a large decrease in the wealth of the grasshopper’s economy.

Now I think the US economy has really badly misallocated resources over a period of 25 years. Maybe there are economic policies which will diminish the bad effects; but if there are economic policies which could just remove them, then the efficient allocation of resources doesn’t matter in the first place, and we could all just party (which I don’t believe).

This would be a better story if they were taking water in dumptrucks from the town reservoir and dumping it onto people’s front lawns in order to create decorative ponds, and everything else was the same.

How can I structure what I know, with these pieces, to create a narrative

Please, let me try to help with this. Here’s my Argument Outline:

Main Point 1. The amount of water in the pool just represents the money supply. What we really care about in an economy is the amount of stuff and services we can buy with our money: the only reason a million dollars is so valuable is because someone could buy a lot of stuff with it. But what we really care about in an economy is the goods and services we buy. When more money flows into our hands, we can buy more and better things, and life is better; when less money flows into our hands, we can’t afford to buy as many things, and life is worse. The momentum of the water represents this flow of money to buy things: when we get paid for work, the money flows in, and when we pay for stuff, the money flows out. End with some kind of “surely this is obvious” statement.

Main Point 2. The more people who have money flowing through their hands, because of working and spending, the better the economy will be. So a good economy is like a Jacuzi: lots of money flows into your hands for the work you do, and you can spend that money. A bad economy is like a stinky pool that’s had standing water sitting in it for months: not much money is flowing, and lots of people end up unemployed.

Main Point 3. Demand naturally changes over time, and this causes slumps in business profit for different industries. Some industries depend on others, so a natural change in demand can cause many large industries to slump at the same time. This is all a natural result of markets, where demand is not constant.

Main Point 4. A multi-industry slump causes a downward spiral. During a general slump, a recession, it’s in each business’s self-interest to lay off employees, because they can’t afford them. However, this means that most businesses are firing people, who therefore no longer have any money to spend at these businesses. That means even less profit, which means a bigger slump, which means even more businesses will have to lay off employees. The end result is very high unemployment, which means very little money is changing hands, which means the economy’s in bad shape.

Main Point 5. What the economy needs in a slump is for someone to take the reins, buy a lot of stuff, invest in building a lot of stuff, and generate some momentum again. However, each business won’t do this, because they’re each making very little profit, so it’s in their own self-interest to fire people and reduce their costs. They each can’t afford to buy and build.

Main Point 6. What we need is somebody to step in and stand up for the public interest by buying goods and services from American businesses. Our government often sucks at standing up for our interests (this is a sop to conservative moderates), but it’s the government’s job. This is the main reason why put up with having a government: it’s supposed to provide our society with the services it needs, like roads and post offices and spending during a slump, when private industry won’t do it or can’t do it.

Main Point 7. The government doesn’t have to worry about profit, so it has no excuse for inaction. Therefore, the government should increase its spending, to generate some demand and momentum again. Once momentum picks up, businesses will be able to hire more people again, and we’re back to a growing economy.

Main Point 8. Supply side economics just looks at how much money’s in the pool. Demand side economics looks at whether that money is actually flowing into the hands of hardworking Americans: are enough hardworking people employed to keep the money flowing? (I hate that “hardworking Americans” phrase, but it’s not inherently a damaging frame, so I borrowed it.)

…

Notice I avoided, say, a discussion of teleology. I don’t think it’s reasonable to expect an “average person” to wade through the intricacies of the policy. The Everyman’s version of the Treasury View gets annihilated as soon as we remind people that what they really want from an economy is employment, dollars flowing in that they can spend.

Salient: Let’s say there’s a slump: businesses can’t or won’t run up their little deficits.

That’s the problematic bit. If businesses can’t or won’t run up their little deficits then savers, who were providing the deficits in the past, must be holding on to an equivalent amount of money they can’t lend to anyone. What happens to that money?

Admittedly a suprising number of non-economists don’t think like that, in that they don’t automatically wonder what happens to money that isn’t spent. Not knowing who wrote the swimming pool analogy in the first place makes reconstructing the thinking behind that story rather difficult – I might have entirely misunderstood what the authors were trying to get at.