Are Recessions Possible?

The obvious answer seems to be 'yes.' The more difficult question is 'how?' WARNING: what follows is a more technical musing than I usually post here. I'll try to keep it as close to the principles level of accessibility as possible, but I won't be offended if those of you who are less economically interested skip this one.

The problem is that, at the macroeconomic level, there is an accounting identity that says INCOME=EXPENDITURE.  All of the income in an economy in a given period has to be spent on something.  All your income, after all, is just somebody else's spending, and all your spending is somebody else's income.  Every seller in one market is a buyer in another, and every buyer in one market is a seller in another (and yes, this even holds when some people live off other people's money, although it gets more complicated to sort out how).

This leads to something called Say's law, which basically says that if there are more sellers than buyers in one market (such as in the labor market when we have unemployment), there has to be some other market where there are more buyers than sellers, a shortage.  It's the only way for the accounting identity to be true, and it's true by definition.

So how can we have a recession, where it seems there are more sellers than buyers everywhere?  I've been thinking about this recently because of some recent discussion at EconLog (here, here, and here, for examples) about that very question. Scott Sumner and Nick Rowe argue that the excess demand has to be for money.  People want to hang on to (not to spend, but to have in their pockets) more of the good we use in exchange than they can get their hands on.  Brad DeLong and Paul Krugman, on the other hand, think there is excess demand for "safe assets," essentially places investors can store their value without any real risk that they'll walk away with less than when they started. Money is OK at this, but not great; a better option is typically government bonds, particularly when our faith in the quality of supposedly safe private firms is shaken.

Arnold Kling of EconLog, on the other hand, thinks we are in the middle of what he calls a recalculation, in which people find themselves working on things no longer in demand (more sellers than buyers) and don't yet know where the demand has gone. To my understanding, his story is basically that the recession, as we usually talk about it, is a myth. We don't have more sellers than buyers everywhere; it's just easy to see where we have more sellers than buyers, but it takes more time to figure out which markets have more buyers than sellers.

Well, the thing about markets is that when there's a shortage, it's a chance for some business to raise its prices and still sell more, thus making a ton of money. Sellers who want to make money (and don't they all?) in order to consume things they like (and don't we all?) will leave the market where there are too many sellers and enter the market where there aren't enough. Shortages and surpluses should always be rather brief.  Sumner and Rowe have an answer for this: the money market isn't normal, there's a single supplier of money, the Fed (and there are good reasons to have a single supplier as I've discussed in this series). DeLong and Krugman have a similar defense: the best safe assets are supplied by the government, and are thus influenced more by political pressure than market pressure.

What I haven't seen from the Recalculation Story (or, to use Kling's latest phrase, Patterns of Sustainable Specialization and Trade) is an explanation for why market adjustments are so slow. He has talked before about why economic busts happen much more quickly than booms, but that's not really what I'm after. What I want to know is why is the information that we have excess supply in many, many markets so easily obtained by everyone (this is what creates the unemployment in his story, after all), but information about where supply isn't keeping up with demand is so very hard for entrepreneurs to obtain. 

Is it that entrepreneurs have to borrow money to chase demand quickly, but it's hard to borrow during recessions? Is it that information transmits most quickly out of markets with many established firms (and if so, why)? Is it government intervention, particularly temporary attempts to undo the shift in demand?  I just really don't get what in Kling's view is holding entrepreneurs back, and make no mistake, if we don't have something holding entrepreneurs back, then recessions are just not possible.

Bad #6!  Let that entrepreneur go!