Tuesday, April 8, 2014

Larry Summers' Inverse Say's Law: Lack of Demand Creates Lack of Supply

From the Center on Budget and Policy Priorities Off the Charts blog:
Summers: Lack of Demand Creates Lack of Supply
Former Treasury Secretary Larry Summers, speaking last week at the launch of CBPP’s and Senior Fellow Jared Bernstein’s year-long project on full employment, highlighted three economic ideas with important implications for the United States.  One is “inverse Say’s Law”:
Jean-Baptiste Say, the patron saint of Chicago economists, enunciated the doctrine in the 19th century that supply creates its own demand. That in a sense, unemployment or output gaps were an impossibility because, after all, if you produce things then you’d have to create income in the process of producing them and then the people who got the income would spend the income and so how could you really have a problem, argued Say.

It was [John Maynard] Keynes’ great contribution to explain that [Say’s Law] was wrong, that in a world where the demand could be for money and for financial assets, there could be a systematic shortfall in demand.

Here’s inverse Say’s Law: Lack of demand creates over time lack of supply….  Figure 1 of our paper… tells a remarkable story and a profoundly troubling story. We are now in the United States in round numbers 10 percent below what we thought the economy’s capacity would be today in 2007. Of that 10 percent, we regard approximately half as being a continuing shortfall relative to the economy’s potential and we regard half as being lost potential. These are the estimates of the Congressional Budget Office; you’d get very substantially similar numbers from the IMF, from the Fed, from the OECD, from almost anybody you asked.
I want to focus on that second half. We have lost 5 percent of capacity that we otherwise would have had. Let me describe that 5 percent in some other ways. It is $800 billion. It is more than $2,500 for every American, more than $10,000 for every family of four….

Study after study has confirmed what Jared highlighted in his remarks; a stronger, more high pressure economy disproportionately benefits those who are last to be hired. It has a disproportionate impact on the employment of disadvantaged groups. It has a disproportionate impact on the wages of disadvantaged workers. It has a disproportionate impact on the income of disadvantaged families....MORE
HT: MoneyBeat