A Brief Reply to Tyler Cowen

My apologies for disappearing for several days; this is what happens when your teaching load bunches up on you.  Anyway, on to TC.

For those who may still care about this (and I realize the lifespan of topics in the blogosphere that people care about is measured in hours), I thought I noticed a Marginal Revolution post that exhibited elementary confusions about the income-expenditure identity in macroeconomics—as did Paul Krugman.  The link to Cowen’s original post is here.  I responded with this, Krugman with this, and Cowen with this.

Briefly:

1. Cowen followed the snip from Krugman with four paragraphs about how corporate money doesn’t just sit there but goes back into the economy, as if this called Krugman’s concern about the corporate cash hoard into question.  This is what Krugman and I were pointing to.  Someone who understands that income and expenditure (in a closed system) are identical, two ways of looking at the same transactions, doesn’t worry about demonstrating that money has to go somewhere.  It’s not about “going”.

2. It is true that, in his fifth paragraph, Cowen raises the issue of consumer spending.  If the other four paragraphs had never existed and he had written only #5, he would have a perfectly valid complaint.

3. Now that he mentions that paragraph and the chart that accompanies it, however, it is fair to point out that the data say exactly the opposite of what he says they do.  After four tough years retail sales have returned to where they were before the collapse.  At the moment they are growing slightly faster than the pace of the economy as a whole, but not much.  In this they reflect our overall problem: the economy is growing in fits and starts but making hardly any progress in closing the output gap.

4. I’m sorry that Cowen has taken offense at my point about macroeconomic thinking being hard, even for professional economists.  It is hard.  If you go looking for comments by economists that exhibit muddle you will find plenty of examples.  In the classroom I will think that I have just explained the system logic of macro in a perfectly lucid way to my students, and they will come back at me with papers and exams that show that my efforts at communication have failed.  And there are times when I too have to stop and think, even sometimes draw little pictures to remind myself what is going on.  As I’ve written elsewhere, the fundamental problem is that macroeconomics deals in both equations and identities, and they don’t mean the same thing, even though the mathematical manipulation is the same.  Our brains work readily in equation mode, where x determines y, and not in identity mode where x is y.