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Quote of the Week

If reflation can now so easily and quickly reverse the deadly down-swing of deflation after nearly four years, when it was gathering increased momentum, it would have been still easier, and at any time, to have stopped it earlier. In fact, under President Hoover, recovery was apparently well started by the Federal Reserve open-market purchases, which revived prices and business from May to September 1932. The efforts were not kept up and recovery was stopped by various circumstances, including the political “campaign of fear.”

—    Irving Fisher, “The Debt–Deflation Theory of Great Depressions,” Econometrica 1, 4 (1933), p. 347.

Secular Stagnation and Capital Goods’ Prices

In the opening to a recent post, J.P. Koning gives a very good overview of Paul Krugman’s and Larry Summer’s secular stagnation theory,

According to Krugman, if the natural rate of interest has become persistently negative—i.e. new capital projects are expected to yield a negative return—then investors will look to existing durable assets like gold or land that yield no less than a 0% return. The prices of these goods will be bid upwards, bubble-like. Or, as Summers puts it, if the return on capital is below the economy’s growth rate, then intrinsically valueless ponzi assets may be recruited as stores of value to bridge the distance between an individual’s present and the future. (Krugman and Summers’s ideas are a bit hard to follow, but Nick Rowe has a bunch of helpful posts on these ideas).

This is how I interpret the above: a negative natural rate of interest makes investment in capital projects unattractive, leading investors to invest in commodities, rather than in productive capital goods.

In my experience, if you think you have a “gotcha” you probably don’t and you’re probably wrong. But, it seems to me that the pro-cyclical behavior of intermediate goods contradicts Krugman’s and Summer’s prediction,

I’m using “intermediate materials” and not “capital equipment” — and, admittedly, the PPICPE is more ambiguous —, but I think the intermediate materials index does a better job capturing the range of inputs firms use to make physical investments. Capital equipment tracks machinery, but intermediate materials is more inclusive,

Commodities that have been processed but require further processing before they are ready for sale to the final demand user. This includes goods such as flour, cotton yarn, steel mill products, and lumber. This also includes items that are physically complete but that are purchased by business firms as inputs for their operations, such as diesel fuels, paper boxes, and fertilizers.

The behavior of input prices seems to be better explained by a business cycle theory that predicts procyclical movements in inputs for physical investment projects, rather than theories that assume physical investment is comparatively unattractive.