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It's the demand, stupid


Christina Romer remembers the first time she really had to walk Barack Obama through the scope of the mounting recession. "As I was briefing the President-Elect by phone, I found myself saying, 'I am so sorry, the numbers are horrible.' The President-Elect replied, 'It's not your fault. Yet.' "

We've passed "yet," and now the numbers are, if not the administration's fault, then certainly its responsibility. And the numbers remain horrible. Unacceptable, even. But in her speech at Princeton -- which she originally wanted to title "It's the aggregate demand, stupid" -- Romer makes very clear that one of the things the administration is having to fight against is the political system's willingness to simply accept high unemployment and let horrible become the new normal.

My first and most fundamental point is that when it comes to the economy, we are very far from normal. The unemployment rate is currently 9.7 percent. I find it depressing that some observers talk about unemployment remaining high for an extended period with resignation, rather than with a sense of urgency to find news ways to address the problem. Behind this fatalism, there seems to be a view that perhaps the high unemployment reflects structural changes or other factors not easily amenable to correction. High unemployment in this view is simply "the new normal." I disagree.

Basically, there are two sides to this debate: One is that the meltdown either exposed or created an economy where the level of unemployment is simply much higher. That is to say, it's not just the recession pushing unemployment up, but the new reality of a post-high consumption, post-housing boom, or post-something else America.

Romer's view is different: "This rise in long-term unemployment is readily explained by the prolonged collapse in aggregate demand." She sees five factors pushing down demand: Tight credit markets, state and local budget problems, burnt-out consumers, subdued foreign demand, and the Federal Reserve's inability to stimulate the economy by further cutting interest rates.

The neat thing about a demand-side explanation is that policy can help. Demand, after all, is another way of saying "someone spending money to buy things." The economy doesn't much notice if that someone is a household, a business, or the government, So if households and businesses are too weak to play that role right now, the government can, and should, step in and create the demand that will get the economy moving again. Romer suggests a couple of policies in addition to those currently in place, with the most promising being further aid to state and local governments and a lot of money to jump-start lending to small businesses.

The question isn't whether those policies will work to ease the recession and move us toward recovery. They will. If states don't have to lay off teachers, those teachers don't have to stop buying groceries, which means those grocers don't have to fire their employees, and so on. The question, rather, is whether we actually want to do something about unemployment, or whether we'd prefer to just complain about it.

Graph credit: Calculated Risk.

By Ezra Klein  |  April 19, 2010; 10:09 AM ET
Categories:  Economy  
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"Some observers" makes me crack up. I love that she's not even bothering to disguise the fact that she's calling out Bernanke.

Posted by: dal20402 | April 19, 2010 10:15 AM | Report abuse

It's important that this debate is highlighted, because into the void will seep exaggerations of the costs of international trade (and downplaying of its benefits), which could lead to bad policy.

Posted by: jduptonma | April 19, 2010 10:17 AM | Report abuse

One problem seems to be poison in the well of federal spending: state and local governments are, in increasing numbers, afraid to accept federal assistance due to longer-term social policy strings attached to such funding. Rather than being a potentially beneficial economic policy option, federal stimulus funding has become a social policy gun to the heads of states, local governments, and small businesses: if such non-federal entities refuse to accept the federal social policy (thereby setting aside their own social views), the funding trigger is pulled and the non-federal entities fail.

For better or worse, the Administration is asking most non-federal entities to decide if their strongly-held moral views are worth their economic lives. When backed into such corners, I'd guess that many folks react negatively... even those who take the money will remember the coercion.

Posted by: rmgregory | April 19, 2010 10:25 AM | Report abuse

Idk, everyone that I know is trying to decouple from all that junk. We are trying to keep the crap moving out the door and not let any new crap in. Like some are saying about jobs, my sense is some of that demand is never coming back.

You would think China with its aging population would be purchasing medical stuff from us. Or purchasing the latest pollution control technology to help alleviate their environmental catastrophe. Or we could make solar shingles that everyone on earth would want to have on their roofs.

There are other ways to stimulate demand rather than just rely on people shopping. That's the GWB shop or the terrists will win approach. We can do better than that.

Posted by: luko | April 19, 2010 10:40 AM | Report abuse

"For better or worse, the Administration is asking most non-federal entities to decide if their strongly-held moral views are worth their economic lives. When backed into such corners, I'd guess that many folks react negatively... even those who take the money will remember the coercion."

and people wonder why many don't like federal subsidy of faith-based initiatives or those that claim that religious-based charities can provide an adequate safety net.

Posted by: sarijoul | April 19, 2010 10:41 AM | Report abuse

wait wasn't it the Dems that pushed the idea of "they were against the stimulus but took the money" concept? I seem to remember Pelosi railing Cantor et all for that. I even remember some nice bashing done by Olbermann and Maddow too.

Are we now agreeing that the politicizing of using stimulus money is bad and that we're all in this together no matter who you voted for in the last election?

Posted by: visionbrkr | April 19, 2010 10:48 AM | Report abuse

Absolutely correct. The majority of our elites don't care about unemployment. Obama is a major disappointment. He has done too little to address the unemployment problem and try to jumpstart new sectors of the economy. The Republicans though, are far worse. Republican trickle down policies are a recipe for complete disaster and Republicans are making it more difficult for the government to do what needs to be done. People who are anti-government should just stay home for the good of the American people and not foul up the government process.

Posted by: bakho | April 19, 2010 10:55 AM | Report abuse

Aggregate Demand right now is on par with levels from Jan 2006. So assume we can support employment levels of Jan 2006. By the standard calculation of 150,000 new jobs a month just to keep up with population growth, but only enough demand to suppot 2006 levels, that's a loss of over 7.5m jobs just due to lagging demand. That fits neatly with the actual data.

Posted by: Quant | April 19, 2010 11:16 AM | Report abuse

Throwing good money after bad into the bottomless pit of state pension funds (which is what "aid to states" really means) will not support demand. It's just a political payoff.

Posted by: tomtildrum | April 19, 2010 11:16 AM | Report abuse

"The economy doesn't much notice if that someone is a household, a business, or the government, So if households and businesses are too weak to play that role right now, the government can, and should, step in and create the demand that will get the economy moving again. "

That first use of "economy" probably instead should read "GDP accounting" -- over time, it does matter what sector is doing the spending, and of course the aim of the government doing some spending in the first place is to get the private sector back into the game so that the government can get off the field.

Posted by: bdballard | April 19, 2010 11:17 AM | Report abuse

It's all of it. Some part of demand is never coming back because it was built on a credit bubble. The part attributable to state and local gov't cutbacks could be helped with stimulus money. But ultimately we can't make up all of the demand. In an era of less, we need to reduce income inequality. How many people could be hired for the price of one bloated Wall Street bonus?

Besides the really rich (top 1%), who have literally made out like bandits in the last 15 years, the other big source of gov't savings is the military. If we want to be competitive with countries with low military budgets, we have to reduce our overseas commitments in an orderly fashion as soon as possible.

Posted by: Mimikatz | April 19, 2010 11:33 AM | Report abuse

Its the cashflow, stupid.

While I agree that demand is the problem, what suppresses demand? Lack of cash, specifically low cash flow. Consumer wages have been essentially flat for the last decade. What economic 'growth' did occur during that decade came largely from borrowing - whether at the consumer level, or in the financial industry (which saw its share of GDP grow).

So, to me, the demand problem is a result of a net reduction (after inflation) of cash in the hands of consumers. To regain sound economic footing, we need to not just improve the employment/unemployment numbers, but get some wage inflation into the equation too - and increase consumers' cash flow.

Posted by: bsimon1 | April 19, 2010 11:41 AM | Report abuse

It's partly demand, but not entirely. Some of the downturn is certainly economic recalcuation.

Housing demand simply isn't going to return to 2005 levels any time in the near future. I suppose we could throw the kitchen sink at everything to reinflate the bubble, but that will ultimately prove to be pointless.

So let's say you have a factory worker who was laid off in 2001 - in 2002, he got a job in construction, and we employed until he lost his job in 2008 due to the downturn. His job has been structurally eliminated - it won't be back with the next cycle. His factory job is still gone too, and he needs to figure out what the next job will be. Meanwhile, this person's demand for things like cars is going to remain supressed, so part of the drop in auto sales is also in a way structural.

Mimikatz, by the standards of the stimulus (assuming $800bn for 3mm jobs), eliminating the bloated wall street bonuses could create 75,000 jobs - there was only $20 billion in bonuses paid. Of course, taking all of Wall Street's bonuses will do little other than turbocharge the financial sector in freer economies - Sinagapore and Hong Kong perhaps.

Posted by: justin84 | April 19, 2010 12:02 PM | Report abuse


but it'll make the MimiKatz' of the world feel better so let's go ahead and do it anyway.

that being said while she's at it with the "sharing of military spending" worldwide why not add in the sharing of medical prescription spending so that our prescription costs go down dramatically and the rest of the world goes up slightly to make up for our subsidization of the world's prescription costs.

Anybody willing to ask the rest of the world to pay for their fair share and any chance their response is anything publishable?

Posted by: visionbrkr | April 19, 2010 12:10 PM | Report abuse

In any case, the demand portion of the decline should be addressed with monetary policy.

If you think about fiscal stimulus programs, the dollars involved have to come from somewhere. Fiscal stimulus is only successful in terms of generating GDP growth if it can increase the velocity of money, or reduce the demand for money balances. It's entirely possible that the alternative use of the dollar would have been better. So while we can see the teacher can continue buying groceries with stimulus funds, we might not see that the investor who parked his cash in treasuries might have instead bought equities, increasing spending via the wealth effect. Given the general inability of the government to understand and process local information as well as individuals, more times than not the money is best left with them.

Fiscal policy is more likely to increase demand if the dollar is created rather than borrowed or taxed away, although this will create some inflation as well. In all probability, fiscal policy is unnecessary once you stop thinking of monetary policy in terms of interest rates and liquidity traps.

On demand management, we should task the Fed with one responsibility - to keep nominal GDP growing at a slow and steady pace. In addition to avoiding deflation during downturns, a burst of inflation during a downturn will reduce real wages and thereby increase employment.

Posted by: justin84 | April 19, 2010 12:17 PM | Report abuse


Agree on the military spending (and in vision's case, drug costs). Of course, slashing military spending would be countercyclical fiscal poicy wouldn't it? Lockheed would have to lay off staff who wouldn't be able to buy groceries etc. That's not saying I'm not for it - it's just hard to cut the military while arguing for fiscal stimulus from a Keynesian perspective.

I'd imagine that if we cut military spending to $350 billion, we could have a military that's nearly as strong as what we currently have. Nothing creates a drive for efficiency like a lack of resources.

Take the F-35. We're buying around 2,400 of these guys for $83 million each (I'm going to say yeah right but we'll see if the price gets down there). The RQ-9 Predator is about $10 million. You could switch the buy to 1,400 F-35 and 1,000 RQ-9, and save ~$73 billion, provided the economies of scale for the F-35 are largely realized at 1,400 airframes. The RQ-9s have somewhat smaller payloads than F-35s, but can use JDAMs and hellfires and can loiter for a long time. They are also cheaper to operate and don't require pilots. Maybe drop $100 million/yr in data security to make sure their feeds aren't intercepted, and you've largely have similar capabilities - we don't need anything better right now in our current conflicts.

So despite this large cost savings, the U.S. will still have nearly 1,700 fifth generation stealth fighters in its fleet once all purchases are made, so it's not as if these cuts will be that severe in terms of relative power.

Posted by: justin84 | April 19, 2010 12:50 PM | Report abuse

Sounds like somebody is looking for a new bubble.

Posted by: jc263field | April 19, 2010 1:11 PM | Report abuse

A great deal of military spending is salary for employees--the troops, brass and civilian employees. But a lot is also hardware, contractors and foreign suppliers/contractors. We could reduce the latter without much affectinbg jobs at home and train a civil force for disaster relief. Also, why is the military seen as a legitimate jobs program for certain industries, but infrastructure spending, which actually creates useable goods and improves the flow of goods isn't?

On those opposing reducing inequality, what if there is no one left to buy the stuff? Low wages are killing the golden goose of consumer demand. Plus people may be learing that they can do ok with less. And the more inequality, the less stability in a society and the less well off everyone is. There are studies that show this. We all do better when there are more expansionary and redistributive policies in effect; that's why the Dems are actually better for the stock marklet than the GOP. Multi-millionaires and billionaires don't spend money at the same rate as the lower 95% and stash more offshore. So they actually contribute less to reviving the economy.

Posted by: Mimikatz | April 19, 2010 2:20 PM | Report abuse


Increasing inequality doesn't mean wealth is destroyed.

If you have a worker who makes $50,000/yr and a worker who makes $550,000/yr, and then that distribution changes to $40,000/yr and $560,000/yr, respectively, you've still got $600,000 in total aggregate income. So while the low wage worker buys less, the high wage worker buys more. Or the high wage worker invests the extra $10,000 in a startup, and increases productive capacity in the United States. Or the high wage worker buys German equities, which ceteris parabus reduces the U.S. current account deficit.

Making do with less isn't necessarily a a bad thing either. I think most people agree the U.S. savings rate is too low.

It's also not at all clear that inequality creates instability and makes everyone worse off per se.

Singapore is a richer country than the United States, with income per capita about 10% higher ($50k/yr vs $46k/yr). It is also more unequal, with a Gini coefficient of 48.1, vs 45.0 for the United States.

This isn't to say that from a values perspective inequality isn't a problem, it's just not a problem in terms of economic efficiency.

Posted by: justin84 | April 19, 2010 4:36 PM | Report abuse

One of the side effects of fundamentally remaking the American economy is that uncertainty is the bane of investment. No one knows the actual effects of the health care bill, no one knows what's going to be the next bill pushed through the congress, no one knows how the vast amount of spending is going to affect interest rates and economy as a whole.

So, business is very careful about committing to expansion, adding staff, etc. Profits aren't bad because there is still demand, but we're all trying to get by as long as we can without hiring until we see what's going to happen.

Posted by: WilliamShipley | April 19, 2010 7:10 PM | Report abuse

Two comments:

1. We're also pretty burnt out by getting ripped off. Why save for anything when white collar criminals can waltz off with your stash?

2. Freddie Mac has a limit on real estate investors-4 mortgages total. This is a government limit on small business credit availability.

Posted by: lroberts1 | April 19, 2010 8:44 PM | Report abuse

"wait wasn't it the Dems that pushed the idea of "they were against the stimulus but took the money" concept? I seem to remember Pelosi railing Cantor et all for that. I even remember some nice bashing done by Olbermann and Maddow too."

I think that what got "bashed" was the hypocrisy of Republican politicians who opposed the ARRA later showing up at photo op ribbon-cutting events with giant cardboard checks and taking local political credit for bringing home the very funds that they had voted NOT to allocate. That's not "politicizing," that's just pointing out rank hypocrisy.

"If you have a worker who makes $50,000/yr and a worker who makes $550,000/yr, and then that distribution changes to $40,000/yr and $560,000/yr, respectively, you've still got $600,000 in total aggregate income. So while the low wage worker buys less, the high wage worker buys more."

If you have 10 workers that all make $50,000/yr and 1 worker who makes $500,000/yr, the 10 will do far more to create demand in the economy than the single rich individual, whose consumer spending will not be ten times as much as the $50k indivduals.

Reducing income inequality and growing our middle class again is sound economic policy.

Posted by: Patrick_M | April 19, 2010 10:49 PM | Report abuse

Unfortunately, national aggregate demand is useless measure. People that want the government to be more powerful and spend more money love the concept, because it gives them an excuse to do that and spend money to curry political power. Just think for a minute that demand in the US has a lot to do with the economy of other countries. Such a simplistic notion as AD has no use in the overall planning and strategy of the economy. We can't use that as a goal.

Ezra says, "Tight credit markets, state and local budget problems, burnt-out consumers, subdued foreign demand, and the Federal Reserve's inability to stimulate the economy by further cutting interest rates."

We do not have tight credit markets, unless you are talking about iBanks and making leveraged buyouts. Corporate bond rates are still low. Consumers aren't "burnt-out", they were just spending fake winnings from the housing casino for five years, so our numbers were artificially inflated. We're just adjusting to the new normal. It is not the responsibility of the Federal Reserve to pump the economy to make the numbers look right for the benefit of our dear leaders. Bush was faking it for years. Now it's Obama's turn. We lost illusory wealth. We're not getting it back, despite the best efforts of our government and Realtors.

Sadly, we need lower wages and more people working. We're in a global market now. Stop looking at the world only to the edge of borders. High unemployment isn't the new normal- a growing global supply of workers and the infrastructure to move goods and services around the world (how many US tax returns were prepared in India this year?) means prices are falling. We have a sticky wage problem- so what do we do? Raise the minimum wage. Ouch. Wrong direction.

Since we can't move wages down, for reasons of the fallacious illogic (loss aversion, etc.) of our species, we're getting very close to the point where the only fiscal strategy is dollar inflation. Sure, your wages will nominally go up, but a made in China iPod will cost $1000. Of course, the Chinese know this is very bad for them and are pegging their currency so that the value of their Treasuries isn't wiped out. It's going to be interesting times...

Posted by: staticvars | April 20, 2010 12:14 AM | Report abuse


nice try. There were plenty of liberal websites and the Olbermann's and Maddow's of the world had plenty of shows where they bashed individual Republicans for just showing up.

I specifically remember a story that listed Republicans and chastised them for simply showing up.

now if they did "promote" this ala the cardboard check and act like they were behind it they absolutely deserve scorn for it but don't make it seem like the Dems and liberal media were innocent in this. They weren't.

Posted by: visionbrkr | April 20, 2010 7:49 AM | Report abuse

"If you have 10 workers that all make $50,000/yr and 1 worker who makes $500,000/yr, the 10 will do far more to create demand in the economy than the single rich individual, whose consumer spending will not be ten times as much as the $50k indivduals."

Actually, the rich individuals contribution to demand will be precisely 10 times that of the other workers. If the $500,000/yr worker saves $100,000 in a bank, then the bank can loan out that $100,000 for someone who wants to start a business, increasing investment demand and thus aggregate demand. If the government taxes that rich person $100,000 and doesn't tax the others, then aggregate demand is still unaffected because presumably the government is purchasing goods and services with that money. The rich person doesn't have to spend money on groceries for it to be put to use.

What if the rich guy puts $100,000 in the mattress? In the long run, unless he just enjoys having money in the mattress, it will eventually be spent, and so on average the demand from the rich guy will be $500,000/yr, and the demand from everyone else will be $50,000/yr.

Of course, there might be some short-term dislocation if the rich guy goes from spending $500,000 to $400,000, but if prices and wages are allowed to adjust, the same total real production can be returned to relatively quickly.

Posted by: justin84 | April 20, 2010 10:16 AM | Report abuse


There is no "if" about the fact that on numerous occasions Republicans bragged publicly about stimulus funds spent in their Districts (funds that they tried to block), and that they were (rightly) called out for it by commentators like Maddow and Olbermann. Here's an example of that commentary:

If you have any links to liberal media bashing Republicans "for simply showing up," please share one or two, because I am puzzled what "chastised them for simply showing up" even means. I recall criticism for opposing the stimulus, and for bragging about it after they voted against it, but I don't remember anyone being criticized for "showing up." I must have missed that.


If you really think that a rich person depositing $100k into an account at JP Morgan Chase will result in stimulating the same level of demand in the economy as giving 10 lower middle income American families an additional $10k in purchasing power, I give up. If you are convinced Chase will immediately loan out that rich fellow's $100k to a start-up or small business, you have not been reading the papers for the past few years. But even if the banks were turning deposits into business loans at the rate they ought to, that is not as stimulative to demand as the "trickle up" consumer spending that occurs when employment rates and discretionary income are on the rise with a growing middle class.

As wealth is concentrated into fewer hands, more money stays out of circulation, and demand is impeded. You want to keep the money in motion in the economy at the consumer level if you want to stimulate demand. A healthy and growing middle class promotes growing demand for goods and services, and thereby stimulates economic growth.

Posted by: Patrick_M | April 20, 2010 5:41 PM | Report abuse


Let's say JPM doesn't make a new loan because it is capital constrained. In that case, the deposit helps JPM in the process of building up capital. After all, some of the government spending was just to dump money into capital constrained banks. If the money was more equally distributed, it might still end up in banks - being capital constrained, JPM would simply offer higher CD rates to attract depositors from the middle class. What if demand for loans was low, instead of JPM being capital constrained? Well, then JPM could would offer lower rates on its loans, as it would prefer to put money to work all else being equal, which benefits those who end up taking out the money in loans (say the other 10 people who all want a $10,000 loan to purchase a car).

In any case, I was speaking to the generic comment that inequality per se reduces aggregate demand. It doesn't. If the rich have a higher propensity to save (and invest), that suggests inequality should lead to greater investment spending and greater long run economic growth. What if there are no good investment opportunities? Well, then the rich can themselves buy more consumer goods. Or the rich can buy stock, increasing the wealth of everyone who owns stock by bidding up the price, and driving consumption growth in that manner.

If it's hard to believe, look at Singapore. Singapore is more unequal than the U.S., is richer, and is seeing a whole lot of aggregate demand growth right now.

Posted by: justin84 | April 20, 2010 6:57 PM | Report abuse


Your horse is very tired of being placed behind your cart.

Demand begins with the consumers, not with bank deposits. Credit remains tight, although the banks have healthy balance sheets again. There is more than one reason for tight credit (including the fact that deposit banks are now allowed to play with depositors' money in such "innovative" ways). But logic dictates that banks will become more inclined to lend again not when your hypothetical rich man deposits an additional $100k, but when the bankers observe a revitalized demand and a brighter business climate, making lending to businesses and individuals safer and more profitable.

And the idea that a rich person's purchase of a stock certificate does anything at all to lift demand is absurd, as is demonstrated by the disconnect going on right now between the resurgence of the Dow Jones average during the Obama Administration and the still anemic demand weighing down the American economy.

Wealth is something people "accumulate;" demand is what happens when people are exchanging their income for goods and services. Once you hit a certain income level, anything above tends to go toward accumulation, and not towards the purchases that comprise demand. A high price for a share of stock means only a high demand for that stock, and a rising stock market only means that more money is being tied up in the purchase of paper stock certificates by investors, rather than being cashed out for use in other ways. I'm all for a healthy stock market, but it has nothing to do with stimulating aggregate demand.

The structure of the economy in Singapore is unique in many ways, and the fact that Singapore may have greater income inequality and stronger demand at this time than the USA does not make Singapore's society an apt model filled with valuable lessons for the USA. For every Singapore, there are many dozens of "banana republics" with high income disparity and terrible economies with weak demand. Here in the goold old USA, we have been shrinking our middle class for 30 years now, and it hasn't worked out well.

Higher employment and higher wages would directly result in higher consumer spending and greater demand. It also makes for more stable communities, and a better educated next generation of workers and entrepreneurs. Staying on the now well-worn path of ever-widening income disparity and a continually shrinking middle class will not make America more prosperous, whatever you (and the army of Randroids) may believe about the magical economic powers of the wealthy.

Posted by: Patrick_M | April 20, 2010 9:07 PM | Report abuse

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