Hutt’s insight was to interpret Say’s Law differently from the way in which most previous writers, including Keynes, had interpreted it, by focusing on “supply failures” rather than “demand failures” as the cause of total output and income falling short of the full-employment level. Every failure of supply, in other words every failure to achieve market equilibrium, means that the total effective supply in that market is less than it would have been had the market cleared. So a failure of supply (a failure to reach the maximum output of a particular product or service, given the outputs of all other products and services) implies a restriction of demand, because all the factors engaged in producing the product whose effective supply is less than its market-clearing level are generating less demand for other products than if they were producing the market-clearing level of output for that product. Similarly, if workers don’t accept employment at market-clearing wages, their failure to supply involves a failure to demand other products. Thus, failures to supply can be cumulative, because any failure of supply induces corresponding failures of demand, which, unless there are further pricing adjustments to clear other affected markets, trigger further failures of demand. And clearly the price adjustments required to clear any given market will be greater when other markets are not clearing than when they are clearing.
I had a few tangential comments on that post, but nothing worth repeating. Invoking Hutt, David ponders the possibility that we are currently in a "pessimistic expectations equilibrium." Here he is:
The key point is that if workers expect to be able to find employment at higher wages than they will in fact be offered, the aggregate supply curve of labor will intersect the aggregate demand curve for labor at a wage rate that is higher, and a quantity that is lower, than the equilibrium in which expectations about future wages were correct. From the point of view of Hutt, there is a supply failure because the aggregate supply of labor is less than the hypothetical equilibrium supply under correct wage expectations. But there is no restriction on market pricing, just incorrect expectations of future wages. Expectations need not be rigid, but in a cumulative process, wage expectations may not adjust as fast as wages are falling. Though Keynes, himself, did not discuss the possibility explicitly, it is also possible that there could be multiple equilibria corresponding to different sets of expectations (e.g., optimistic or pessimistic). If the economy reaches a pessimistic equilibrium, unemployment could stabilize at levels that are permanently higher than those that would prevail under an optimistic set of expectations.In a later post, he goes on to clarify the idea of a pessimistic expectations equilibrium:
As Hayek showed in his 1937 article, a sufficient condition for disequilibrium is that expectations be divergent. If expectations diverge, then the plans constructed on those plans cannot be mutually consistent, so that some, perhaps all, plans will not be executed, and some, possibly all, economic agents will regret some prior decisions that they took. Especially after a large shock, I see no reason to be surprised that expectations diverge or even that, as a group, workers are slower to change expectations than employers. I may have been somewhat imprecise in referring to a “pessimistic-expectations” equilibrium, because what I am thinking of is an inconsistency between the pessimism of entrepreneurs about future prices and the expectations of workers about wages, not a situation in which all agents are equally pessimistic.David's invocation of Hutt makes use of a "supply failure" explanation for our current recession. Namely, a divergence or inconsistency in expectations between different groups of people is causing them to supply less than they otherwise would, and therefore demand less, with this effect cascading through the economy so as to cause a broad slowdown. The crux then is not an excess demand for money per se, as most market monetarists would have it, but inconsistent expectations. Which isn't to say that David doesn't think that the problem can't be solved via monetary methods like QE. Nor did Hutt, for that matter, who wrote that: "Unanticipated inflation is a way, albeit a very crude way, of mitigating incipient depression."
In his Rehabilitation, Hutt described the idea of supply not entering the market as "withholding", and cumulative withholdings as leading to downturns. The very same inconsistent expectations that David Glasner describes in his posts serve as one of Hutt's reasons for why producers might withhold:
Such withholdings, whether initiatory or induced, may occur... through the price asked being higher than is consistent with the cost and price expectations of the community as a whole or with their predictions of the future of the market rate of interest.and
Well, admittedly, a worker's skills and muscle power do not become "purchasing power" (or barter power!) if they are priced (or valued) above the market-clearing level; and in this case that means inconsistently with prospective yields from investment in them; or, expressed somewhat differently, if they are not priced in conformity with the community's predicted ability to acquire the output, which includes the case in which they are priced inconsistently with price expectations.The idea that a worker's expectations concerning the deserved price of their labour might not be match with the price expectations of the community reminds me a bit of Arnold Kling's "recalculation". The way Kling puts it, the economy is characterized by complex patterns of specialization and trade. If these are not sustainable, new patterns must be recalculated, and this takes time. It would seem to me that people's plans and expectations constitute one component of the existing pattern of specialization and trade, and when the economy is moving between patterns, it would make sense to see different sets of people with widely differing and inconsistent expectations. The Huttian supply-side cumulative process so aptly described by David Glasner would turn a simple recalculation into a broad recession.
This also reminds me of an old post by Kling on which I brought up Hutt. At the time, Kling was not entirely conducive to the analogy I drew between himself and Hutt, the cause of recessions according to Kling being not mere errors of pricing but a much more complex array of factors. Nevertheless, I still see both theories as being in the same realm - mistaken and/or not fully-formed expectations and plans leading to much larger coordination problems.
Furthermore, Hutt thought along the same lines as Kling. Kling dislikes monetary theories of recessions, noting here that:
There is a fundamental methodological error in macroeconomics that leads to saying that if there is no excess demand for money then there can be no excess supply of goods. I think that the methodological error comes from ignoring the heterogeneity of goods, labor, and capital. The methodological error goes back to Joe, the representative agent, working at the GDP factory.
Under the fundamental methodological error, the only way to break Say's Law (supply creates its own demand) is for people to want to hold on to money as a store of value. Instead, I have been arguing that there can be all sorts of excess demands and supplies for different types of output that are not derived from excess demand for money. The idea that many markets can be out of equilibrium for reasons having nothing to do with the supply and demand for money as a store of value should be very obvious, once you think about it. What is remarkable is how much of the formal macro literature starts by assuming away those non-monetary reasons for disequilibrium. My contention is that the traditional emphasis on money as a source of disequilibrium reflects this misleading approach to doing macroeconomics, rather than the real world.
Hutt made the exact same criticism of purely monetary theories of recessions. In Hutt's world, recessions are not monetary phenomena, and are capable of appearing in either monetary or barter economies:
The use of money can be held only to facilitate, never frustrate, the process of asking market-clearing exchange values, i.e., values which permit a better (a fuller) utilization of productive capacity. But Leijonhufvud's stress on the medium of exchange seems to reinforce his assumption that, under hypothetical barter, the problems created by the power to withhold productive capacity would be non-existent. There seems to be no reason, however, why barter should release incentives for the asking of market clearing values. Unless we assume perfect value flexibility in an imaginary barter economy of assumed equal complexity, all the phenomena encountered under imperfect price flexibility will have to be assumed to influence adversely the incentives to co-ordinated activity. Under such assumptions, there will be no mitigation of the remoteness between a worker in one industry and a worker in another, or between entrepreneurs in one industry and those in others.
I would be curious to know what Arnold and David think about each other's views of business cycles and the current recession.