The Old Which Way Is Up Problem in Economics

February 27, 2016

Many people have contempt for economists. It is remarkable they don’t have more. Economists can’t even agree on answers to the most basic questions, like is an economy suffering from too little demand or too much demand. If that sounds confusing, this is like a weatherperson telling us that we don’t know whether to expect severe drought or record floods.

Today’s example is Japan. The NYT had a front page story about its declining population. Unlike many pieces on falling populations, this one at least pointed out the positives aspects, such as less crowded cities and less strain on infrastructure. But after making this point, the piece tells readers:

“The real problem, experts say, is less the size of the familiar ‘population pyramid’ but its shape — in Japan’s case, it has changed. Because the low birthrate means each generation is smaller than the last, it has flipped on its head, with a bulging cohort of older Japanese at the top supported by a narrow base of young people.

“One-quarter of Japanese are now over 65, and that percentage is expected to reach 40 percent by 2060. Pension and health care costs are growing even as the workers needed to pay for them become scarcer.”

Okay, this is a story of inadequate supply. The argument is that Japan’s large number of retirees will be making demands on its economy that its dwindling group of workers will be unable to meet.

That’s an interesting story, but anyone who has followed the debates on economic policy in Japan for the last three years knows that the government has been desperately struggling to increase demand. Prime Minister Abe has been pushing both monetary and fiscal stimulus with the hope of getting more spending to spur growth. In other words, Abe is concerned that Japan doesn’t have enough old people with pensions and health care demands to keep the economy fully employed.

Now this is pretty goddamn incredible. It is possible for an economy to face problem of too little demand. That was the story in the depression and I would argue facing most of the world today.

It is also possible for an economy to face a problem of excess demand, as is being described in this article. This is a situation where it lacks the resources needed to meet the demand it is generating. That typically manifests itself in high and rising inflation (clearly not the story in Japan today.) 

It is not possible for a country to have both too much aggregate demand and too little aggregate demand at the same time. Maybe the NYT editors should sit down with those covering Japan and figure out which story fits the country’s economy. Until they can decide, maybe they should refrain from reporting on a country’s economy that they obviously do not understand.

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