A big demand slump isn’t just an economic disaster; it’s also a prediction of an economic disaster. And that means it’s a prediction of policy failure. At least that’s the implication of the Woodfordian view of macro (which I accept.) Changes in current AD are mostly driven by changes in the future path of AD. Changes in near-term NGDP are mostly driven by changes in expected NGDP 1, 2, 5 and 10 years out in the future. Call it the term structure of NGDP. And those are driven by the future expected path of monetary policy.
And of course whenever we have crashes like 1920-21, 1929-30, 1937-38, 2008-09, we also tend to have asset market crashes. Asset markets aren’t perfect (1987) but when there’s a very big economic slump on the way they are pretty good at sniffing it out.
Unfortunately, this puts a huge emphasis on something that is unobservable, namely “expected NGDP 1, 2, 5 and 10 years out in the future.” Any time you have a theory that relies on such an unobservable, you drift further away from the realm of science and nearer to the realm of circularity.
In Sumner’s defense, he wants expectations for nominal GDP to be observable, by having tradable NGDP futures contracts. Even so, it is rare for any such contracts to go out more than a year ahead.
I’m more inclined to think that demand drops are the result of fears that the economy as currently structured is not able to handle a small dip in NGDP (e.g., overleveraged).
You can buy oil futures 8 years into the future.
To be fairer to Scott Sumner, he admits that NGDP-futures markets would have to be generously subsidized to provide enough incentive to produce good market information for the entire term structure instead of just a year.
Subsidized in a way that is information-neutral?
Yeah, this idea doesn’t make any sense.
Effem, that scenario might support Sumner’s argument. The society reaches such a levered state as a result of nominal expectations. Overleverage is the condition where those expectations are adjusted downwards.