Write the argumentation essay The General Glut Controversy 207 years on
The general glut controversy is an ancient feud. It arises from a seemingly absurd question: “Can there be too much of everything?” Until the 1930s the respectable answer was “No”; from the mid 1930s to the 1970s it was mostly “Yes”; then “No” again during the 1980s and 1990s; the early 2000s was “Maybe”; and after 2007 to the present time again “Yes”.
The question is subtle, misunderstood by almost everyone, and of profound importance to many questions of economic policy. Most recently the debate over „stimulus‟ was implicitly a debate over gluts, though few realised it.
I propose to give a simple account of the glut question, and I expect to fail.
Consider a two person, two good exchange economy. This is what it sounds like: there are two people (we will call them Alice and Bob) who produce two goods (apples and bananas). Alice and Bob exchange apples and bananas at some ratio and choose levels of production to maximise their happiness as they see it.
In this scenario there might at some point be a surplus of apples or bananas: Alice might produce more apples than Bob is willing to buy at the prevailing exchange ratio.
For one reason or other Alice does not sell the apples at a discount (accept fewer bananas for each apple). She either stores the apples or lets them waste. In this case there is a “glut” of apples.
There is a glut of apples but also, and equivalently, there is a shortage of bananas. This follows since there are only two uses for apples: eating them or exchanging them for bananas. Bob did not produce enough bananas to exchange at the prevailing ratio.
It is important that this occurs at the prevailing apple/banana exchange ratio. We assume that prices do not adjust to balance demand and supply, at least in the short run.
In this example it is very clear that a surplus of one good is identically a shortage of another. The same logic would hold if we introduced Carol to produce Cumquats, Dorian to produce dates, and Edward to produce eggplants: there might be a glut in a particular good but it would imply a shortage in others. Overall, gluts and shortages balance out. There cannot be too much of everything; there can only be too much of some things and too little of others. There are no general gluts.
There are a number of equivalent ways to make this statement: “Aggregate demand equals aggregate supply at all price levels”, “There cannot be a deficiency in aggregate demand”, “There cannot be involuntary unemployment.”
Now we introduce money and things change a little. Say that it becomes convenient for Alice and Bob (and Carol and Dorian) to use money for their transactions. Money is a good that has no value except in exchange. The same is true of most wedding gifts. People exchange goods for money and then later exchange money for goods.
Good. So what effect does money have?
There still cannot be a general glut, but there can be a surplus in all goods (apples and bananas) relative to money. At some point Alice might want to hold on to a larger amount of money – to save more. If less money is produced than Alice desires at a certain level of prices then there is a glut of goods (and a shortage of money).
This can be bad for a number of reasons. If Alice hoards money she will not purchase bananas. Bob will not be able to sell his bananas so he will reduce production. He also now has less money to buy apples, so Alice will sell fewer apples. And so it goes. This is known as the paradox of thrift: By saving Alice reduces demand for goods and causes a reduction in output (a recession).
There are two main „market‟ solutions to this problem. One is to wait for the value of money to adjust (money needs to be worth more against goods). If this happens the problem goes away; money costs more and so Alice will hold less money and more bananas.
The second solution is for Alice to lend her savings to Bob so he can afford to buy apples from her. She might just as well sell him the apples on credit. If she does lend money to Bob she actually creates money in a certain sense because the loan itself can be used as money. (Bob writes “I owe Alice $10” on a piece of paper and Alice uses the piece of paper to purchase dates from Dorian. Meanwhile Bob uses the money to purchase apples from Alice.)
There are also two main non-market solutions. One is to take the money from Alice and spend it on bananas. Then Bob never needs to reduce his production and will have enough money to buy apples from Alice. This is called „fiscal policy‟.
The other solution is to increase the amount of money. The new money can either be spent directly by a third party (let‟s call him Gerald) or lent on favourable terms to Bob to buy from Alice. This is called „monetary policy‟.
Which solution is best? It depends.
It depends mostly on how quickly the market mechanisms work. Alice would probably be wise to lend her savings to Bob. She could be convinced to lend at a sufficiently high rate of interest, and things would start getting better. Even if she didn‟t it might not be so bad. The price of money would naturally increase (the price of goods would go down). This is „deflation‟.
On the other hand these mechanisms might not work. Alice might be fearful of Bob‟s creditworthiness and so not lend to him (apples or money). The increase in the price of money (deflation) might also create some uneasiness. The price adjustment process will be tricky because it is difficult for Alice and Bob to distinguish between a broad price decrease against money – which does not affect the correct level of production – and a change in the relative price of apples and bananas – which does.
If Alice lends to Bob money at a high interest rate that can be bad too. The rate of interest determines the demand for loans. If production is already depressed an increased interest rate will make things worse, at least in the short run.
On the other hand the non-market solutions also have problems. If we take money from Alice to spend on Bob‟s bananas she won‟t have that money to spend on Cumquats, or to lend to Edward to finance his new eggplant farm. Maybe these were better uses of her money. Similarly, pushing up the price of bananas means Bob will spend more time producing bananas at the expense of his other activities. Maybe he will buy some land from Carol to expand his banana farm. We might end up with lots of bananas and little else. This unfortunate side effect of fiscal policy is called „crowding out‟ – Bob‟s increased banana production comes at the expense of production and consumption of other things.
Increasing the amount of money also has problems. Ideally the increase would not affect relative prices: everything would just get cheaper and the goods glut would be solved by a manufactured glut of Write the argumentation essay money. But more likely the prices of some goods will increase before others, particularly if the new money is not distributed proportionally to everyone. Creating new money devalues old money. The increase in money is costly for Alice, who will find her savings can be exchanged for fewer bananas than before.
We have expanded our example to a fairly general setting. There are many goods and people, production, a credit market, a government (Gerald), a factor market (for land), a central bank. In our story sticky prices for bananas and a precautionary money demand from Alice caused a recession. It‟s debatable whether this was a general glut. If you count money as part of the economy it isn‟t, if you don‟t then it is.
There are four possible responses in this situation: (1) the market expands the money supply organically (Alice supplies credit), (2) the market reprices money in terms of goods (money becomes more expensive, goods cheaper), (3) the money supply is increased, or (4) money is taken from Alice and used to buy Bob‟s bananas.
Back to reality
This story is not too different to Keynes‟s motivating example for his General Theory. He argued that at the start of the 1930s British wages had failed to adjust downwards, in part due to strong labour unions. This meant that workers could not profitably be hired at the prevailing wages. These involuntarily unemployed workers earned no money and so were unable to consume goods produced by other firms who then had to fire their workers and so forth. This was in Keynes‟s view a central cause of the Great Depression.
Keynes‟s solution for this situation was twofold. First, the government should print money to create inflation. Inflation reduces the real (inflation adjusted) wages and induces firms to hire more workers. The cause of the problem is wages not adjusting correctly (price stickiness) and the solution is for the government to change the price by decreasing the value of money relative to goods and services (inflation).
Second, the government should hire the unemployed workers. The type of work is not particularly relevant; the point is to get money into worker‟s pockets so they could spend again.
Keynes combined the two solutions in an ingenious scheme: he proposed that the government print money and bury it in a secret location. A mining industry would develop to discover the buried treasure, hiring the unemployed and increasing the money supply in the process.
Keynes was very influential at the time and his recommendations were introduced (though lamentably never burying the money supply underground). The recovery was slow, but it happened eventually. In America, Roosevelt‟s New Deal programs began in 1933 (Hoover was already running substantial budget deficits from 1929) and the recovery in
employment came in 1939. A new generation of Keynesian economists and politicians were quick to take the credit and the first golden era of Keynesian demand management had begun. |
