June 23, 2002
Things That Make Me Go, "Huh?!?"

I am reading more and more things these days in which the last paragraph or the next to last paragraph subverts the argument completely--demonstrates convincingly that the author knew all along that his main thesis was wrong, or at least radically incomplete.

For example, I was reading a piece by Lawrence Kudlow in National Review Online. It rang the changes on Kudlow's standard notes: (1) That those who worry about demand being insufficient are fools. (2) Praise of the early nineteenth-century French economist Jean-Baptiste Say. (3) What nonsense it is to say that aggregate demand can be lower than aggregate supply because ""business creates production, production creates jobs, and wages for jobs create income. And when producers take time off to become consumers, they use their incomes to spend on goods and services." (4) Praise of Ronald Reagan for worrying not about demand but supply (with, somehow, not a mention of how the Reagan deficits reduced investment and proved, over a decade and a half, a much bigger drag on the growth of America's productive potential than high tax rates had been). (5) How Jean-Baptiste Say would "laugh at demand-side economists" who fear that uncertain consumer confidence may lead to stagnant consumer spending and slow growth this year. (6) The assertion that "gains in the supply of production will soon lead to increases in the volume of consumption."

But then, in the next paragraph, comes the whammy: "In addition, the Fed is feeding more cash into the economic pipeline, removing the deflationary constraint on production."

What is this "deflationary constraint on production" that the Federal Reserve is removing? It is the possibility that low liquidity--too small a money supply--may keep firms from buying capital equipment and consumers from buying goods and services, and so push aggregate demand below aggregate supply. We do not need to worry that aggregate demand is too low because the Federal Reserve is watching over us. Thus, when push comes to shove, Kudlow believes--at some level--that aggregate demand is not automatically kept in balance with aggregate supply by the dazzling theoretical clarity of Say's Law, but by something else.

What is this something else? According to Kudlow, it is the Federal Reserve. For if Kudlow truly believed the gospel of Say's Law that he preaches in his first eleven paragraphs, he wouldn't care whether or not the Federal Reserve was feeding cash into the economic pipeline. But in paragraph twelve he becomes a heretic to his own doctrine. And he tells us--correctly--why aggregate demand has stayed so closely in balance with aggregate supply over the past fifteen years. It is the competence of the Federal Reserve as it attempts to match the level of aggregate demand to aggregate supply, fine-tuning aggregate demand neither too high (for that would cause accelerating inflation) nor too low (for that would cause high unemployment).

Posted by DeLong at June 23, 2002 05:31 PM

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I think one of the most notable things about this article is that Kudlow can't marshall any economists less than 119 years old to support him. Smith, Say, and Schumpeter were all brilliant economists, but a reader might be aroused to skepticism upon noticing that no one in the past fifty years or so has backed Kudlownomics. Of course, if he wanted, he could cite Edward Prescott as the latest messiah of supply-siderism (though if I understand correctly, he asserted (does Prescott still believe that business cycles are caused by technological factors, or has he abandoned that as an embarassing fiasco?) that recessions were real, but that they were caused by uneven technological progress *and* they were optimal responses to such factors...).

Still, the part about the Fed's expansionary monetary policy helping the economy is good, I think. It shows that Kudlow is in touch with reality at least to a certain degree. If his explanation for the 1982 recession is the accumulation of regulatory wickedness from Johnson to Carter, and he mysteriously forgot about the 1991 and 2001 recessions, it's nonetheless an optimistic sign that he acknowledges that changes in the money supply can have an affect other than distorting incentives through inflation...

Posted by: Julian Elson on June 24, 2002 09:34 AM
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