Sunday, May 20, 2012

Metaphorically Speaking


Robert Schiller opens his New York Times column today on a promising note, pointing out the power that metaphors have over our thinking about economics.  A particularly nefarious motif is “belt-tightening”, conjuring up the idea that running an economy is like managing the finances of a family.  When family income falls, under normal circumstances a proper response is to cut spending too: live within your means.  It’s a  misleading guide to macroeconomics, however, since it takes the outside world, the place where our money comes from, as given and looks only at how we can respond to it.

Unfortunately, Schiller’s alternative, while fine for some purposes, also misses the point.  He suggests “a winter on the family farm”, where, while when the land is covered in snow, it makes sense to invest time in repairing old equipment, investing in new methods, and so on.  He’s right of course, except that his metaphor also sidesteps macro.  It too takes “winter” as an exogenous force and fails to illuminate how economic winters are created by the behavior of the farmers themselves.

I’ve been looking for the right metaphor, and I don’t have it yet, but I do have a story.  It is the farm family version of the baby sitting coop, sort of.  Apparently we all have peasant roots and respond better to yarns about hardscrabble agriculturalists than yuppies looking for a place to park their babies.

It goes like this: there is a far-off land with just two farmers and their families.  One grows wheat, the other raises cows for milking.  Each produces for itself and sells the rest to the other farmer.  One day, the dairy farmer decides to try out a low-carb diet and reduces her family’s wheat purchase.  The wheat farmer’s income drops, and his family holds an emergency meeting to figure out what to do about it.  “Our income is down,” he says, “and we have no alternative but to tighten our belt.  This means we have to cut down on milk.”  And so they do.  But then income falls over at the dairy farm, and they too hold a meeting, and the result is even less wheat buying.  And so it goes, around and around, until neither family has any income at all, and everyone’s diet is terrible.

Yes, I have left out prices, and there is nothing about expectations.  It’s just a story, and the point is to make as vivid as possible the core macroeconomic insight that spending is income—that they are two sides of exactly the same thing.  Every dollar or euro the government spends is income for someone, and if income is dropping and the government responds by cutting its spending, that dries up the flow of income even more.

Nothing profound here, and I’m sure most readers are asking, why bother?  The answer is that none of us has time to book up on every subject of importance, and we need metaphors and simple stories to help us get through the rest.  That’s how it is for most people and economics.  How can we create potent little macroeconomic memes and send them out into the world where they can do some good?

18 comments:

kh said...

I like to think of the economy as a large vehicle stuck in a ditch. Due to accident or carelessness or whatever it gut stuck there and now it has troble getting out under its own power. The solution is obvious: apply an outside force for a limited amount of time (i.e. have a tractor pull it out). After it has been pulled out it should be able to get around under its own power.

kh

Peter Dorman said...

I see what you're trying to do, but it still doesn't capture how the income-expenditure identity changes the role of government. The government doesn't send a tractor; by spending more it makes the ditch shallower so you can drive yourself out.

It just sounds weird with this metaphor, no?

kh said...

I'm not sure it's necessary to include the income-expenditure identity in a simple metaphor. The government (the tractor) produces a forward force that the economy (the truck or whatever) is unable to supply.

One point to be made is of course that the expenditure is temporary (the tractor is not supposed to tow the truck indefinitely).

An alternative analogy could be that conditions are icy and the government is putting sand under the rear wheels of the truck, but I prefer the tractor analogy.

Brenda Rosser said...

Re: It goes like this: there is a far-off land with just two farmers and their families. One grows wheat, the other raises cows for milking. Each produces for itself and sells the rest to the other farmer. One day, the dairy farmer decides to try out a low-carb diet and reduces her family’s wheat purchase. The wheat farmer’s income drops, and his family holds an emergency meeting to figure out what to do about it. “Our income is down,” he says, “and we have no alternative but to tighten our belt. This means we have to cut down on milk.” And so they do. But then income falls over at the dairy farm, and they too hold a meeting, and the result is even less wheat buying. And so it goes, around and around, until neither family has any income at all, and everyone’s diet is terrible....SPENDING IS INCOME"

How about 'don't put all your eggs in one basket'? Don't just do one thing. Don't rely on one market. Don't rely for your subsistence entirely on 'the market place'.

Whilst spending leads to income for someone else, neither is guaranteed to generate real wealth, nor any form of collateral. Therein may lie the real (long term) cause of the global financial crisis.

At any moment in time the long-term has arrived.

Don Levit said...

Brenda:
You make an excellent point, in regards to consumption versus investment.
Consumption is for the short term, while, investing, ideally, provides much longer-term benefits.
I have a chart from mybudget 360.com which shows from the Federal Reserve, the growth in Total Credit Market Debt Owed TCMDO) and GDP growth since 1970.
In 1970, the 2 were about the same.
Since then, in 2010, TCMDO is over $50 trillion, while the GDP is $15 trillion.
Looks like we are getting much less bang for the buck.
Don Levit

Barkley Rosser said...

Robert "Shiller," not "Schiller," please, Peter, even though I know you are hanging out in the land of the poet whose name is spelled in the latter way...

Peter Dorman said...

Oops. Ein Fingerfehler.

bseconomist said...

This is more like a metaphor for the RBC model! The "shock" that has hit the economy is a preference shock and real production is unchanged. In the macro stats for this econommy, the TFP would be lower because people are less inclined to eat either of them.

What you really need here is a chain of causation that leads to falling production and hence being poorer. The two families here will not be obviously poorer to non-economists.

Good try though.

Brenda Rosser said...

Re: "Consumption is for the short term, while, investing, ideally, provides much longer-term benefits..."

Don, I wouldn't assume that 'investment' leads to longer-term benefits. Whilst that may be the economic aim of 'investment' the outcome is often very different.

(For example): China has been on a growth path that necessitates its national consumption of crude oil (imported) equating to half of world production by 2020. That's not going to happen. What investment, however, can make up for the energy deficit it is about to experience?

Brenda Rosser said...

...not that I assume that you're assuming...sigh

I'm merely thinking out loud...cryin' out loud!

Don Levit said...

Brenda:
Good points.
All generalities are false, even the prior statement!
Don Levit

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