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Inherent Assumptions

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July 19, 2010 – Comments (9)

 

I was reading an article today entitled Learn to Love Our Massive Deficit which made some inherent assumptions I'm not sure I'm entirely comfortable with.  You know, the kind of assumption that is not actually stated, but must be true for the argument itself to be true.  The kind of assumption that, if it were expressed outright, one might or might not agree with, but that gets 'buried' or lost in the shuffle.

Here's the paragraph that caught my eye:

But wait. There is a counter-argument made by another very smart group of people. They argue that balancing the budget right now would be exactly the wrong thing to do! Our fundamental global economic problem is a lack of demand. We're not spending enough to keep our manufacturing plants running, our shops busy, our restaurants full -- which is why unemployment is still lingering near 10 percent. Cutting government spending, which is a substitute for private consumption and investment right now, would make the situation worse. So would any tax increase, since it takes money out of consumers' pockets.

Let's take them one at a time.

Our fundamental global economic problem is a lack of demand.

This is one I've heard or read in the media time and time again.  The inherent assumption?  That our global economic problem isn't oversupply.

I'm not so sure that's an assumption I'm personally willing to make.  All we know for sure is that the supply/demand equation has changed.  That we know.  Is it because demand fell?  Maybe.  Or maybe, due to a lot of factors, we created too much supply.  You know, things like all too easy credit and the creation of mortgage backed securities that I've read had at least a little something to do with the housing downturn that seemed to kick off the party.  Think we that we had artificially high demand for housing, which caused homebuilders to overbuild, created a supply glut, and then when the artificial stimulus evaporated, the house of cards collapsed?  Maybe?

Is it that we don't have enough demand now?  Or is it that we had too much demand then?  So the argument is that when we encounter an over-inflated bubble economy and the bubble bursts, what we should do is try to reinflate the bubble and put everyone back to work because lack of demand is the problem?

There's another inherent assumption here I'm not much of a fan of too:

Cutting government spending, which is a substitute for private consumption and investment right now, would make the situation worse.

Whether cutting government spending would make things worse or not isn't where I'm going (though that is an assumption that I'm sure could be legitmately challenged -- even if one agrees with it, there's still room for valid argument).  Government spending is a substitute for private consumption right now?  That's the part I'm not so sure about.  All that goverment spending comes from somewhere.  I think I have a paycheck stub, or a store receipt, or a bunch of other documements floating around that show that I pay taxes and fund that govermnment spending.  Even if the government spends borrowed money, I'll be taxed at a later date to repay the loan.  Maybe I look at it too simply and a real economist (unlike the armchair variety I am, or like to think myself sometimes) will tell me how wrong I am, but, since the money the government spends ultimately comes from me, whatever the government spends, I can't.  I guess it's a 'substitute' in that sense, but the inherent assumption here is that if the government didn't spend it and instead let me keep it, I wouldn't spend it at all.

Maybe that's true.  Maybe I'd put it in the bank.

Oh, wait, that ususally means the bank would turn around and lend it to someone who would spend it.

Hrm...  well, I guess all these banks shoring up their balance sheets and refusing to lend money is the flaw in that line of reasoning....  or is it?

Maybe I'm wrong, but, based on my personal experience I see banks lending money -- but only to more highly qualified borrowers than they used to.  You know, the same kind of borrower that could borrow money in the old days before teaser rates, no doc loans, and mortgage backed securities.  So... the 'evil' banks aren't lending enough of that money back out?  Maybe, but just like our 'lack of demand' argument, maybe the problem isn't that they're not lending enough out now, but that they were lending out too much before.

Just... maybe.

Then again, the crux of this article was about how deficits, at least for now, are a good thing.  Maybe they are.  That's not my point.  My bone to pick here is with inherent assumptions.  The kind of assumptions that have plenty of room for debate, but that often get taken as a 'given' in so many arguments.

Of course I don't expect inherent assumptions to go away anytime soon.  I think it's rather human to make them -- I'm certain I have.  So maybe I shouldn't be overly critical.  I do think, however, that the better job we do at turning inherent assumptions into explicit ones that can be verified, challenged, or examined, the better we'll do at forming economic policy that meets our objectives.

Regards,

Russell (a.k.a. TMFEldrehad)

9 Comments – Post Your Own

#1) On July 19, 2010 at 4:14 PM, angusthermopylae (38.68) wrote:

Very nice title--inherent assumptions usually lead to unintended consequences...something I'm alway wary of.

David Days

Grad student, farmer, PI, pilot, software developer, blacksmith.

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#2) On July 19, 2010 at 4:18 PM, davejh23 (< 20) wrote:

"Is it that we don't have enough demand now?  Or is it that we had too much demand then?  So the argument is that when we encounter an over-inflated bubble economy and the bubble bursts, what we should do is try to reinflate the bubble and put everyone back to work because lack of demand is the problem?"

It was a bubble that grew U.S. GDP to $14 trillion.  The gov't seems to think that, as consumer spending falls, federal spending needs to make up the difference...to keep U.S. GDP running around $14 trillion.  However, as you mention, maybe we had too much demand...maybe demand was fueled by conditions that never should have existed and will never exist again.  U.S. GDP shouldn't have reached $14 trillion so soon, so why spend trillions in borrowed money to hold onto an imaginary number...I believe projections for trillion dollar deficits over each of the next 10 years prove that this is precisely what we're doing...playing make-believe.  What if millions of jobs that we've lost aren't coming back?...should we extend unemployment benefits to 520 weeks?...more?  A depressionary 10%+ decline in GDP would be painful, but we would have an economy that reflects reality.

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#3) On July 19, 2010 at 6:31 PM, MegaEurope (< 20) wrote:

"Our fundamental global economic problem is a lack of demand."

vs.

"Our fundamental global economic problem is a glut of supply."

I think it is more about mismatch between the things supplied and the things demanded (and who gets them.)

After all, prices can adjust to match supply with equivalent demand.  But if you demand a hamburger, even a free hot dog is not going to fully satisfy you.

Unemployment is partly a result of mismatches by sector, geography, etc. between corporations that want to expand and capable unemployed people.

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#4) On July 19, 2010 at 6:48 PM, MegaEurope (< 20) wrote:

As far as the second assumption I'm not sure I understand your reasoning, Russell.

Are you saying that people completely factor government spending in to their current spending/saving habits in anticipation of paying future taxes?  I think that effect is small - nowhere near enough to make government spending "not count".

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#5) On July 19, 2010 at 7:20 PM, TMFEldrehad (99.99) wrote:

"Our fundamental global economic problem is a lack of demand."

vs.

"Our fundamental global economic problem is a glut of supply."

Six of one, a half-dozen of the other.  Agreed.

Are you saying that people completely factor government spending in to their current spending/saving habits in anticipation of paying future taxes?  I think that effect is small - nowhere near enough to make government spending "not count".

The unspoken asssumption I was challenging was that if the government didn't spend the money, nobody else would.  I'm not so sure I believe it.

 

 

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#6) On July 19, 2010 at 9:49 PM, MegaEurope (< 20) wrote:

"Six of one, a half-dozen of the other.  Agreed."

That wasn't my point, in fact I don't think those statements mean the same thing.  My point was that macroeconomic statements like that are overly reductive.  In the real world there are many more degrees of freedom besides quantity - i.e. what, where, when.  If it was just about quantity, economic problems would not be very difficult.

 

As far as the second assumption, I think your opinion would be right in a closed system at a specific time.  But once you expand the variables, it is obvious that government actions influence production and consumption of specific things, over time, within an individual area.

The theory that adding or removing government deficit spending will not affect production was tested in 1937:

And it was tested in 1941-1946:

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#7) On July 20, 2010 at 3:00 PM, EnigmaDude (89.37) wrote:

I agree with MegaEurope, which is not to discount your point in this blog at all.  There are a lot of inherent assumptions just in the statement about "global economic demand". 

There are many levels of consumption and many macro-economic variables that factor into the supply/demand equation. If only an increase or reduction in govt spending were the solution then we would not even be having a debate!

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#8) On July 20, 2010 at 3:27 PM, TDRH (99.65) wrote:

The issue is not a lack of demand, but a lack of qualified demand.    The key point you mention is: 

"things like all too easy credit and the creation of mortgage backed securities that I've read had at least a little something to do with the housing downturn that seemed to kick off the party."

Stimulus to drive "Consumption" is only delaying a standard of living adjustment that is necessary in a country where we actually produce very little.   Providing rebates  temporarily stabilized housing prices, but the natural correction has continued. 

The question we have to ask ourselves is when will the international investment community require the US to pay for the risk involved with their debt? 

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#9) On July 20, 2010 at 6:57 PM, TMFEldrehad (99.99) wrote:

Stimulus to drive "Consumption" is only delaying a standard of living adjustment that is necessary in a country where we actually produce very little.

Now, whether we produce enough in the U.S. to justify how much we spend (or borrow) as a country is an altogether different question (and probably where the comment above was headed), but to argue that the U.S. produces very little isn't true.

The U.S. has the highest manufacturing output of any nation on the globe.  I found a few different sources on per capita manufacturing output and while the U.S. ranked differently depending on the source, it never ranked out of the top 20 (and sat as high as #4).

Of course, that's just manufacturing output -- services add value too, and in my view count as 'production', just of a different type.

Granted, we may not produce enough to justify the debt we, as a nation, are taking on (which was probably your main point), but I don't think the U.S. produces 'very little'.

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