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  Bare-Bones GEM Stabilization Theory

  By James Annable | Mar 22, 2019

  Heterogeneous Demand Disturbances

  In generalized-exchange macroeconomics, featuring microfounded meaningful wage rigidity and the rational suppression of labor-price recontracting, a broad variety of adverse shocks are centrally promulgated by nominal demand disturbances (DD). Stationary demand disturbances are the most common DD class. SDD are associated with garden-variety business cycles. They are inherently self-correcting, helped along by automatic stabilizers augmented by central-bank “lean-against-the-wind” intervention.

  The second propagation category, much less frequent but extraordinarily costly and important, is nonstationary demand disturbances. NDD features contracting total spending that overwhelms automatic stabilizers and orthodox central-bank intervention. If not contravened, extreme instability induces collapsing asset prices, output, and profits, rapidly cumulating forced job and income loss, impaired lending by and funding for financial institutions, debt default, nominal wealth destruction, gathering price deflation, and cataclysmic depression. Given NDD, prevention of depression requires very aggressive and broadly targeted total-spending management.

  The stabilization theory that follows builds on fundamental demand-disturbance heterogeneity. It draws on contributions by Roger Farmer, Nancy Stokey, Eugene Fama, and the GEM Project.

  Demand-Disturbance Mechanics

  Confidence. Farmer (2010b, p.18) revives the argument that confidence exerts a “separate, independent” influence on spending behavior. His specific contribution is that investor/lender confidence is rooted in a positive feedback relationship with mark-to-market financial asset prices and, as a result, is most effectively calibrated as an increasing, nonlinear function of those prices. In short, Farmer posits asset prices to be an effective proxy for the varied determinants of investor/lender confidence that have been identified in market behavior. This is not a new idea. The intertwined reduced-form nature of the stock market and overall confidence has been noted by many economists. From Alan Greenspan (2009) during the worst of the Great Recession: “… a significant driver of stock prices is the innate human  propensity to swing between euphoria and fear, which, while heavily influenced by economic events, has a life of its own. In my experience, such episodes are often not mere forecasts of future business activity, but major...

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