Now, I do think one of the fundamental questions about extended slumps like the one we are in now is why can’t you build your way out. That is, why doesn’t investment in long lived structures soak up idle resources and return the economy to full employment.

And, further I think that this has to do in large part with the fact that structures are attached to the ground and so when the falling price of land offsets falling interest rates it becomes extremely difficult to finance new construction spending. Notably remodeling existing structures does not suffer from this problem and so rebounds nicely even in the midst of a liquidity trap.

All that having been said the proximate cause of the slump is a sharp decline in consumer spending from which we have not recovered. Don Boudreaux, as many others have, points to the rise in Real Personal Consumption Expenditures as evidence that this can’t be true.

And Don is partially right, Real PCE has rebounded.

FRED Graph

However, ironically Real PCE does not actually measure consumer spending. This is because to make the metric consistent it has to include implicit spending. Things like the rent that you pay to yourself. Things like the medical bills that Medicare and Medicaid pay on your behalf. Things like the spread between the profits that banks make and the interest that they pay to savers. Things like the deterioration of buildings and machines.

These are things that are not directly under the control of consumers, but go under PCE. If you are trying to build a consistent metric then you need to do it this way. Even bank profits make sense because the idea is that as a saver you are consuming some “bank services” or else you would have done the direct lending yourself.

Those things, however, are not fungible using cash. It doesn’t matter what is happening to the relative price of potatoes you can’t spend Medicare dollars on them. Thus the pool goods purchased with cash moves separately from the pool of goods either purchased on your behalf by the government or consumed implicitly.

We can look at the set of goods purchased with cash or cash equivalents with real retail sales.

FRED Graph

Here there hasn’t been full recovery. We are still bellow the 2007 peak and well below trend.

Even more importantly retails sales has fallen well below productivity growth. Thus our ability to create goods and services purchased by consumers is increasingly outstripping the actual goods and services that consumers are buying.

The straight forward explanations for this are either that people are optimally choosing to consume more leisure and fewer goods and services – that is, we are in the midst of a Great Vacation. Or, that something is preventing people from purchasing as many goods and services as our society is capable of producing.

Since, the former strikes us as so counter-intuitive, we fall back on explanations for the latter. This is the heart of demand constrained macro-economic analysis – what I think Don refers to as sophisticated Keynesianism.

As a final note I think Demand Constrained, rather than Demand Driven is the right way to frame this to help folks understand. We don’t want to give the impression that all you need for a prosperous economy is just want stuff bad enough.

No, fundamentally people have to be capable of producing more and better thins. This is a supply side phenomenon. However, at certain times, for reasons we don’t completely understand, people suddenly start buying fewer things than we are capable of producing.

We don’t think their desire for consumption has somehow become completely sated. This implies that there is some price at which they would want to buy more real goods and services. Yet, the market does not find that price.