## Saturday, August 12, 2017

### Defining Aggregate Demand Deficiency

Nick Rowe defines Aggregate Demand Deficiency: "It means that the stock of money is too small, or is circulating too slowly, to buy and sell all the things that people want to buy and sell."

It sounds like Nick is saying the velocity of circulation of money is not influenced by the decisions of spenders. I would say it is the decisions of spenders that determine the velocity of circulation.

Suppose Nick accepts the view that spenders determine the velocity of circulation. How does that fit into his definition?

"There are too few spenders, or they are spending too slowly, to buy and sell all the things that people want to buy and sell."

But "people" are the spenders.

"People are spending too slowly to buy all the things that they want to buy."

So it seems people are confused, wanting to buy things but not wanting to spend the money.

Most of us are familiar with that problem, I think. And if we want something but decide not to spend the money, demand is reduced because of our decision. Our wants and desires only count as demand if we actually spend the money.

Nick Rowe's definition again: The stock of money is too small, or is circulating too slowly, to buy all the things that we want to buy.

"Want to buy" is not quite right. Everybody wants a coach and six, Adam Smith said. Everybody wants a Corvette. But not everybody gets one. All of that "wanting" is not demand.

Okay, so maybe 1000 people were actually going to buy Corvettes but it turns out that only 750 of them can afford to buy one. There is a demand shortfall of 250 Corvettes, 1000 minus 750. The million people who "want" Corvettes do not come into the calculation at all.

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That definition again: An "aggregate demand deficiency" happens when money is circulating too slowly to buy all the things that people want to buy.

But of course we can always just go out and borrow the money, and buy whatever we want. But maybe we don't want to borrow enough to get that new Corvette. Or maybe our bank is telling us we don't want to borrow that much.

An aggregate demand deficiency might happen because we are borrowing less. And that's not really the same as "the stock of money is too small, or is circulating too slowly". It is, and it isn't. Borrowing money is a way to make the quantity of money bigger (if you count bank money as money) or it is a way to make the velocity of circulation increase (if you don't). But borrowing money has other effects also: It makes our debt bigger. It makes our debt service bigger. It reduces our "after debt service" income. It reduces the money we'll have in the future for spending to buy all the things that we want to buy.

In the long run, borrowing money creates an aggregate demand deficiency. The U.S. economy slowed after 1973? Aggregate demand deficiency since 1966. But we ignored it and kept borrowing anyway, borrowing more and more, because policy paved the way for that. And then, after 2007, we didn't keep borrowing anymore. And suddenly the stock of money was too small and we had ourselves an aggregate demand deficiency we couldn't ignore. As a consequence of borrowing and of the effects of too much borrowing for too long a time.

We borrowed too much, early on (in the 1950s and '60s). It became a problem in the 1970s. They fixed the problem in the 1980s and '90s by making it possible for us to borrow even more. But they solved the wrong problem. The problem was not that we couldn't borrow all that we wanted. The problem was the growing cost of the growing debt. They tried to solve the problem by encouraging us to add even more to our debt.

Borrow more we did. Add to our debt, we did. Debt grew faster and faster. But the overall cost of that debt grew also. And paying the debt service took money away from "aggregate demand" and created an "aggregate demand deficiency". And the economy grew slowly because of it.

But all that ended after 2007, when people suddenly realized their debt was a problem. And people started borrowing less and paying back more. And the economy suddenly tanked.

So here is the big picture: In the early years we have too much borrowing (but not a lot of debt) so aggregate demand is high and economic growth is good. In the middle years we have too much borrowing (and too much debt) so we have an aggregate demand shortfall that slows the economy despite all the borrowing. And in the later years we have no borrowing (and still too much debt) and the economy tanks.

So there is a little more to the story than "the stock of money is too small, or is circulating too slowly". There is also the cost of finance.