The big issues in macroeconomics: unemployment

@John Quiggin

The big problem with the the sticky wage story is that it implicitly assumes a unique general equilibrium with an associated distribution of real wages. But in reality, there’s a lot of room for political processes/class struggle to influence wages and unemployment is part of that struggle (the “reserve army of labor”)

Does it? I thought most Keynesians included situations like “wage-price spiral” inflation, where you have rising prices and pressure for rising wages (often abetted by labor unions) both feeding each other and creating inflation.

@ponce, from observation: yes, obviously yes.

I don’t really disagree with this, as a description of the state of the field. But it could be a bit clearer on a couple points.

First issue, is unemployment a labor-market phenomenon? In the NK story, it isn’t — all factors are underutilized in a recession. The NK story does not assign the relative price of labor (the real wage) an important role with fluctuations and makes no strong predictions about the cyclical behavior of wages. If nominal wages are stickier than than the nominal price of the basket of wage goods, real wages will be countercyclical; if nominal wages are more flexible than the wage-good basket, real wages will be procyclical. Which of these cases holds has no implications for the validity of the NK story.

Second, the nature of the “demand shocks” could be more clearly specified. In the NK model, a shortfall of demand for currently produced goods and services (a recession) necessarily implies excess demand for some nonproduced asset, since by Walras’ law the sumof excess demands must be zero. The nonproduced asset for which there is excess demand is assumed to be money, altho what exactly constitutes “money” varies. Demand constraints are always, as a matter of logical necessity, the result of either a rise in the demand for money or a fall in the supply. (In this important sense New Keynesianism is equivalent to monetarism, as I believe many NKs would agree.) A “demand shock” just means a rise in the demand for money. Economic units reduce expenditure on currently produced goods and services in order to increase their holdings of money. “Money,” again, could include a more or less broad range of assets. The important thing is that it cannot be produced by the private sector. An increase in the demand for money ought to lead to a rise in its price, i.e. deflation, but sticky prices (again, not wages any more than any other price) precent this from happening. So we get an output gap instead.

This is why NKs generally — again, like monetarists — believe in the omnipotence of central banks. If a shortfall of demand for currently produced output is logically equivalent to excess demand for some moneylike asset, and if the central bank controls the supply of such assets, then it is impossible for appropriate central bank policy to fail to close any output gap. This faith has not been shaken, any more than on the other side — note DeLong’s belief that it is literally impossible (<a href="“it has vanished from the spread of possible future worlds”) for there to still be a large output gap in three years if the Fed sticks to its current policies. Or just look at the use of a central bank policy rule as the third equation in reduced-form NK models.

So yes, there is a clear alternative to the RBC type models. You may not like it, but it is the universal explanation for business cycles among respectable New Keynesian economists.

Note that, as someone else pointed out in another thread, the NK story also has problems with the global nature of the recession, since it implies similar errors simultaneously among central banks all over the world.

Err…civilian employment :)

Michael, being at 98% of peak pre-recession employment isn’t bad.

In fact, I think it’s an A+.

There’s a compared-to-what counterfactual in there, namely, how much higher might employment be, assuming (say, as per Krugman) the stimulus had been bigger?

Economics is FULL of compared-to-whats. Every single benefit-cost analysis involves a compared-to-what. The Stern Review involved major compared-to-whats. Counterfactuals, baselines, business-as-usuals, what-ifs.

You can’t offer up an “A+” unless you have some comparison point in mind.

“The low rate of US unemployment in the 1990s and (to a lesser extent) 2000s was indeed taken as a vindication of this prediction.”

I would also speculate that homeless people are not counted in the survey and that homelessness is higher in USA than in Europe (no data to back it up, just my impression).

http://research.stlouisfed.org/fred2/series/LNU01300001?cid=32443

I find the above graph pretty interesting – decade after decade, in both good times and bad, men “choose” or are “forced” to labor less. If you look at the women’s rate of participation, it seems to have peaked in 2000. http://research.stlouisfed.org/fred2/series/LNU01300002

and finally:
http://research.stlouisfed.org/fred2/series/CIVPART

It seems the halcyon time of employment in the 50’s, at least of employment participation rate wasn’t so halcyon…
So what is the total labor participation rate SUPPOSE to be? The same as the 1950’s?

“But the disagreements among Keynesians, or between Keynesians and various heterodox schools, are less important than their collective disagreement with the [pre-Keynesian neoclassical] view.”

I suspect John is emphasizing short-term policy advice. If so, I agree, and I think that many others would too.

One more piece of anecdata about regulations. One by product of a mooted process might be 2 tonnes a month of iron powder. Worth maybe $200 a month. Obviously better to sell it into the scrap chain than throw it away. Yet to sell it we need to register with a bureaucracy in Finland under the REACH regulations. Cost appears to be €8,000 to do that.

I’d not go so far as to insist that this sort of drivel is the source of all our problems. But it most certainly can’t help employment creation. When every single producer of any chemical at all in the EU has to go through that same registration process.

Money is the medium for exchange in a modern economy, it is the means of distribution of goods and services in an economy and allows a delay between sale of one type of good and purchase of another. Money is “claims on future goods and services”. Those claims can be made tomorrow, or 10 years from now. In a stable economy at full employment, the demand for goods and services produced in the present is close to the capacity to produce those goods and services and fully utilizes the employable labor. The velocity of money flow is adequate to create full employment but not so fast as to create runaway inflation.

During a recession, the velocity of money decreases, demand for goods and services today decreases as those with money delay purchases until the far future. There are still people in the economy who need goods and services that could be produced tomorrow, but are denied permission to buy through lack of income, lack of transfer payments, lack of ability to borrow, etc. The velocity of money drops. In a recession, the money goes to people and entities who do not want to increase their demand for goods and services today and so it accumulates, taken out of “circulation” and velocity is too slow.

In a mild recession, the velocity is supported by monetary policy to increase the money supply, lower interest rates (and thus the risk premium on investment) automatic fiscal stabilizers such as UI and increased BigG demand for goods and services. In a severe recession, the automatic fiscal stabilizers are not large enough and do not return demand or velocity of money to a level that creates full employment. The risk premium on investment is a function of demand. At high demand, the risk of investment in increased capacity is low. At overcapacity, the risk of investment in increased capacity is too high to be offset, even by zero interest rates. In a severe recession, demand is so low that investment in increased capacity cannot be stimulated even by zero interest rates. Negative interest rates are necessary to reduce the risk premium (which means that BigG gives away money ‘stimulus’).

The key policy in a severe recession is to increase demand for goods and services today. Much monetary policy works through channels (lending) that lower interest rates and reduce risk premium for borrowers, In a severe recession, the risk premium for borrowers is too high even and zero interest (or potential borrowers lack adequate collateral or income) and borrowers will not use the increased money supply to demand goods and services today. The key to restoring demand is to give money (permission to buy goods and services) to those who have unmet demand or through BigG purchase of Public goods and services (infrastructure, workforce, education, etc.).

Wages and employment are “sticky, for a variety of reasons including training costs for an employee and benefits per employee (health care costs are usually the same for part or full time) which can make 10 full time preferable to 15 part time. Employment would be less sticky if major benefits such as health care were provided by BigG rather than employers (which is why Germany can keep more workers employed, each working fewer hours in a severe recession).

The key policy as Keynes noted is to restore demand and velocity of money.

Dan K.,

Yes, that would be an additional assumption — that the non produced asset for which there’s excess demand is means of payment, safe & liquid assets, or something else that can reasonably be supplied by central banks. Under a gold standard — as I *think* most NKs would agree — this isn’t the case, so price flexibility is really the only way to avoid big output gaps.

The logic comes straight from chapter 17 of the General Theory:

Unemployment develops, that is to say, because people want the moon; — men cannot be employed when the object of desire (i.e. money) is something which cannot be produced and the demand for which cannot be readily choked off. There is no remedy but to persuade the public that green cheese is practically the same thing and to have a green cheese factory (i.e. a central bank) under public control.

To be fair, a lot of macro has consensus on frictional search-and-matching as a framework for understanding unemployment and macro-labor issues more generally. So its not necessarily government imposed regulation that is the main obstacle to employment, but the technology of translating vacancies/unemployment into jobs. These means social networks, spatial distribution of workers and firms, and all sorts of other real world frictions become important in explaining long-term unemployment.

While the question of unemployment is unquestionably macro-economic in nature, quite often, particularly heading into or out of a recession, the macro result is the sum of micro causes. Macro ‘fixes’ by their nature are fairly blunt instruments and sometimes do more to reduce the symptoms than really find a cure….sorta like Tylenol Cold does for winter flu.

For example using low interest rates (NK) as a tool might help in states like Florida where unemployment was driven by a bust in housing, but might do little to help in places like New York or Michigan where wage stickiness might be the greater core issue and a more ‘classic K’ approach might be more effective. In states like California where the problems are diverse (a combination of a housing bust, skills mismatch, regulation and wage stickiness) a much richer cocktail of remedy is needed (presuming there is even political will to do so). A California like mash-up defies K, NK or any-other single vector solution.

There are an increasing number of states where employment is returning to 2007 levels and its likely there will be more in 2013. To the extent the prescription doesn’t fit the illness, and the states impacted are large ones – central banks/policy makers run the risk of over-revving the ‘good’ states while failing to jump start the weak ones. I don’t see this happening in 2013, but its a potential for 2014 if broader growth doesn’t begin to materialize.

Said differently -Tylenol Cold or any other basic prescription might be adequate if the patient only has the flu, but if it turns out to be Pneumonia the doctor will have failed despite the fact the patient felt less bad along the way.

@JWMason:

“Money,” again, could include a more or less broad range of assets. The important thing is that it cannot be produced by the private sector.

But in the modern financial system can’t money[-like] assets absolutely be produced by the private sector? Are you saying that once the recession hits people lose confidence in the banking sector so that the effective money supply drops and cannot be restored privately?

This is a pretty good summing up of the problem. It’s really hard to avoid the conclusion that all the RBC or related people are just ideological jerk offs with nothing to contribute to the debate. You have two really big recessions in the last 100 years in which monetary/fiscal policy didn’t work very well. You have a lot of smaller recessions which monetary policy seemed to patch things up pretty quickly (and there were very strong monetary policy changes leading up to both the start and recovery phases of these recessions). In a sane world we would be having a discussion about which kinds of monetary/fiscal policy is optimal and suitable for the broadest set of cases. This would be a debate between Scott Sumner and various form of Keynesianism, with other interpretations on the side. Instead, all of these together are a minority view and they are all contending with the position that austerity is what the situation calls for.

This isn’t that surprising to me though. Austerity means cuts in social spending. Reading Sumner enough, you get the impression that as a conservative even he would take less than ideal policy if it included slashing social spending. This is just a big priority for elites and conservatives everywhere. So most of them have stumbled onto macro views that say it is the right thing to do.

You’ve posted a great analysis of RBC vs. “demand” (“Keynesian”) explanations of unemployment. And you’re right, that “the disagreements … between Keynesians and various heterodox schools, are less important than their collective disagreement with the classical view. ” Still, I find it sad that you would write “current “liquidity trap” case where … expanding the money supply has no effect”, without even a footnote that the Market Monetarists (e.g. Scott Sumner) have made a compelling case that this claim is incorrect.

Yes, yes, I know you’re just looking at “the big picture” of RBC vs. demand. But the conflict in macro between those who think that monetary policy is impotent at the zero bound, and those who don’t, is almost as profound.

Given that the profession itself seems to be about as split as chemistry was when considering phlogiston and oxygen.

Oh, Tim Worstall is it with the “Shape of Earth: Experts Differ” bollocks now? Michelle Malkin’s No.1 Fan? Hammer of Polly Toynbee? The World’s Most Doctrinaire Neoclassicist? And suddenly we’re all “ooh, what the bleep do we know?” A bit weaksauce isn’t it?

and of course this is followed with a plea for your extremist social engineering scheme. of course. the stylings have moved over to very-serious-person why-oh-why-can’t-we-all-be-bipartisan-in-agreeing-with-me but the bad faith hasn’t.

We are suffering, not from the rheumatics of old age, but from the growing-pains of over-rapid changes, from the painfulness of readjustment between one economic period and another.

Tim, better minds than ours have already observed that these growing pains and painful readjustments are a permanent condition of capitalism, in thrall of which there is no recourse but such change, one economic period supplanting another, world without end amen, for capitalism to thrive. We are and always will be in a posture of readjustment to the pains of technological changes that are themselves never completed, never fully implemented, but superceded yet again by some other partially implemented capitalist formation with its own ration of painful growth. The question is, how metaphorically cancerous, excactly, is such growth? A cancer may devour its host, and there’s decent evidence that capitalism is bothering the planet in just this way. Unemployment, too.

Happy New Year, though.

As the Hall quote makes clear, the NK vision is fundamentally of fluctuations caused by disequilibrium in the asset makret (*not* in the labor market). If the quality of assets on bank balance sheets was restored, there would be no reason for high spreads and credit rationing, no reason for positive net value projects not to be undertaken, and no output gap.

You find the same thing in DeLong. He is very clear that he agrees with monetarists that there is no fundamental difference between fiscal policy and monetary policy, they are both just ways of increasing the stock of safe, liquid government liabilities in private hands. The only advantage of fiscal policy (well, beside the minor technical point that *conventional* monetary policy doesn’t work at the ZLB) is that it is harder to unwind — it’s hard for the government to turn around and sell off public investments. This makes private actors more confident that there will not be a shortage of “money” in the future and therefore makes them willing to hold less of it now. (I can’t be bothered to search through DeLong’s archives for the post now but I think I am paraphrasing him very closely.)

John Quiggin 01.03.13 at 8:48 am

« ponce, nothing more on this thread, please»
May I make a trivial addition?

ponce 01.03.13 at 7:24 am

« Looks like U.S. civilian unemployment:

1. Peaked in Novemeber of 2007 at 146,595,000
2. Dropped to 137,968,000 in December of 2009
3. Is back up to 143,262,000 now.

A rather unremarkable fluctuation?»

I’d think so. The population of the USA has gone from 295,516,600 to 311,591,900 from 2005 to 2011, so employed population has gone from 49,6 % to 45,3 %, that’s well a 4% decline.

I’m wondering why MMT is ignored in the original post as well as in the comments. It seems a bit unusual for CT to be a place where we ignore everybody to the left of (say) Brad DeLong.

Since other comments have brought up Scott Sumner, (http://www.themoneyillusion.com/), and nGDP targeting, I think we might mention that this is an attempt to paper over the use of inflation to solve problems. It is the view of a conservative inflationist, a creature not seen on this earth for decades. Scott Sumner’s story is that Bernanke’s big mistake was tight money in 2008, while ignoring the proximate consequences of Bernanke’s attempt in 2007 to cushion the effects of the on-coming crisis with loose money. That loose money policy fueled the speculation that drove commodity prices through the roof, creating a spike in inflation, which, once the spike passed, made a brief deflation impossible to avoid.

Just because you can draw a smooth nGDP curve on graph paper doesn’t mean either than nGDP is a suitable control variable or that a central bank could manage it in real time. In practice, there are phase changes lurking across the relevant space that will blow up any attempt at such a policy.

Oh, Tim Worstall is it with the “Shape of Earth: Experts Differ” bollocks now?

Err, actually, it’s JQ who says that.

“As well as trying to cover the issues, I’ll be making the point that the (mainstream) economics profession is so radically divided on these issues that any idea of a consensus, or even of disagreement within a broadly accepted analytical framework, is nonsense. ”

Among those who call themselves macroeconomists (even, among those who have won Nobels for being macroeconomists (and yes, the I know, I know, Swedish Bank etc)) there is in fact still debate over shape of the Earth.

This isn’t a great argument in favour of one school, or even another. The actual real experts in this are indeed divided.

“and of course this is followed with a plea for your extremist social engineering scheme. of course. the stylings have moved over to very-serious-person why-oh-why-can’t-we-all-be-bipartisan-in-agreeing-with-me but the bad faith hasn’t.”

Even given that you have a personal animus against me that’s an extreme interpretation of what I actually said:

“Given that this is an idea arrived at independently it’s almost certainly wrong.”

In Old Keynesian models, shocks are transmitted internationally through goods markets (Country A has a recession, import demand falls, producing a shock for exporting country B). This still works in NK models as I understand them.

In the New Keynesian vision, economies are constantly subject to nominal (i.e. demand) shocks of various magnitudes. Given the inflexibility of the price level, the only thing that keeps the economy near full employment is the fact that the central bank follow an appropriate policy rule. Again, that’s why the workhorse NK model includes a Taylor rule as one its basic equations. So it doesn’t make sense to say that an economy is in a deep recession because it has suffered a negative demand shock; you have to explain why the mechanism that normally counteracts shocks didn’t function in this case.

(In the case of international transmission of shocks, there’s a second shock absorber as well, floating exchange rates.)

@Main Street Muse

And (to me, the uninitiated) it seems that the “sticky-wage” theory also is not a great fit for dealing with the reality of stagnant wages we’ve seen over the last few decades. Wages HAVE dropped, but unemployment has risen dramatically. Just what IS the right wage needed to “clear the labor market”?

“Sticky wages” aren’t really related to the idea of stagnant wage growth – it’s just the concept that wages are slow to adjust downward when there’s a drop in aggregate demand in an economy.

As for unemployment, I’m skeptical that recent higher unemployment is anything other than cyclical. It only went up nation-wide at the beginning of the most recent recession, and it was across-the-board unemployment in a wide variety of areas. After previous recessionary periods (such as the early 1990s and early 2000s), unemployment dropped back to the 3-5% area before the next recession.

How does outsourced labor figure into macro models? Do macroeconomists feel US laborers need to settle for the wages of a Foxconn employee? Return to the days of company scrip? Raise Pullman up from the dead? Accept that the only consumers we care about protecting are those at the top of the food chain?

It depends who you talk to. I’ve read economists arguing that we’re seeing the breakdown of national wage equilibria in favor of a global set of equilibrium wages, although without open immigration it will never really settle down that way.

We saw, during the great bailouts, that union employees at GM & Chrysler had to accept wage concessions. But those who were recipients of bank bailouts – their salaries were not questioned, and many also got bonuses as a result of the bailouts. How does this enormous disparity in approach fit into macro models? How does the steady increase in income inequality between the executive class and the workers fit into macro models? Or are the models too rigid to factor in these complex and thorny issues?

The wages and non-wage benefits of employees at those firms really were a significant factor in their costs, though, while wages at the big financial sector firms were not so much that.

I think it’s generally supposed that wages are stickier, downwards at least, than prices.

In my somewhat limited reading, the controversies between New Classicals and NKs over this stuff focus more on price flexibility in general and not really on wages per se. For instance, this polemical paper by several prominent New Classical economists takes toilet paper at a Chicago grocery store as its representative price. in any case, nothing important in the “macro wars” hinges on the relative stickiness of wages.

Main Street Muse: “We saw, during the great bailouts, that union employees at GM & Chrysler had to accept wage concessions. But those who were recipients of bank bailouts – their salaries were not questioned, and many also got bonuses as a result of the bailouts. How does this enormous disparity in approach fit into macro models? How does the steady increase in income inequality between the executive class and the workers fit into macro models? Or are the models too rigid to factor in these complex and thorny issues?”

Brett: “The wages and non-wage benefits of employees at those firms really were a significant factor in their costs, though, while wages at the big financial sector firms were not so much that.”

Me: I don’t understand Brett’s answer in the context of Muse’s question. Is it pretty much that the distribution of wages just isn’t relevant to macro models of unemployment? (Not trying to be snarky, just trying to learn.)

(Further to Dan K. — *If* banks funded themselves only through deposits, and *if* there were no bank runs, then you would be right. But in the real world deposits make up only a minority of bank liabilities, and liquidity constraints are very real — as we saw most dramatically in the fall of 2008.)

Simon Wren-Lewis, December 18, 2012: “What New Keynesian theory does is allow central banks to apply New Classical ideas in a way that is relevant to the task they have to perform, which is inflation control through demand management.”

Inflation control thru demand management? Is that what is going in Spain, or Greece or Italy? Or, the U.S.?

good on ya, JQ for that.

I am wondering if people are seeing a different Great Recession than I do. I am looking at the 2008 crisis as a collapse of our financial institutions, perched as they were on a foundation of debt – little of it collateralized.

So much debt fueled the economy that when the collapse happened, everything froze. Businesses and individuals realized the risk debt posed to their survival and pulled back – if they were employed. Those who were launched into the ranks of the unemployed saw their ability to spend vanish completely.

Which meant demand vanished. And unemployment grew even higher as companies laid off more workers.

It hardly seems a product of a “natural business cycle.” Or is this what economists define as a “natural business cycle?” Are there really economists who feel our current high unemployment is the result of “labour market distortions such as minimum wages, unions, restrictions on hiring and firing, and so on”? Unions created this crash? Damn you unions – for the collapse of AIG? The collapse of Lehman was because ordinary wages were too high in America during the Bush years?

In the run up to the crash, housing prices skyrocketed beyond the support of homeowner salaries, fueled by Vegas-style gambling that turned the housing sector into a craps table. Banks introduced housing market “instruments” so opaque no one really knew what they were – but it was buyer beware. And buyers usually lost out big (a school retirement fund in Kenosha WI was once such example: http://nyti.ms/VG8pnu.)

According to Economics of Contempt, the anonymous finance blogger, Goldman Sachs used “synthetic CDOs to bet against the housing market.”( http://bit.ly/keTwXw)

Consider that statement for a minute. Our “healthiest bank” – Goldman Sachs – created some kind of thing – a synthetic thing no less – to bet against the US housing market. In what planet is that an indicator of a healthy economy? How do macro models factor that kind of (profitable-for-Goldman) lunacy into their equations?

The extraordinary bailout of our financial sector came on the heels of Alan Greenspan’s irrationally exuberant reign over the Fed. The bailout that propped up our rickety financial sector happened to be crafted by a man who led Goldman Sachs just two years prior to becoming the Lord of the Bailout. A few years before becoming Treasury Secretary, Henry Paulson, as head of Goldman Sachs, lobbied hard to reduce capital requirements on banks like his very own Goldman Sachs. (http://onforb.es/UjPsMu) – helping to create the highly unstable financial conditions we all faced in 2008.

There is nothing at all rational about what happened to our economy. This talk of “sticky wages” and “excess supply” and “labour market distortions such as minimum wages, unions, restrictions on hiring and firing, and so on…” sounds almost mystical to me. So much is taken on faith and assumption. And (to me, clearly not an economist!) so much of the language of economists seems designed to prop up a political agenda, rather than provide the science of a business cycle.

The moral and financial corruption of our financial sector cannot fit neatly into any macro model. Until that is fixed, it is not clear how macro models will solve our problems.

“Note that, as someone else pointed out in another thread, the NK story also has problems with the global nature of the recession, since it implies similar errors simultaneously among central banks all over the world.”

Well, on that point, while the evidence is spotty and there are other possible explanations for every individual outlier — those countries with central banks who acted roughly according to NK market monetarist theory in the face of the 2008 crisis seem to have performed remarkably well compared to the rest of the world (CF Canada, Australia, Israel, Sweden). The US and the Eurozone make up a huge percentage of the world economy, but are just two monetary regimes. The US central bank acted marginally more in accordance with MMT, and the US economy is sucking a lot less than the Euro zone.

Generally, everywhere I look, I see weak positive evidence that central banks, all on their own, really could have, if not prevented the disaster, at least mitigated it, and sped up the recovery by a lot.

Are there examples of economies that went all out with “unconventional” monetary easing who still had very high levels of unemployment relative to 2006-2007 continue for 2-3 years like in the US and Europe?

With some mental gymnastics, the current depression can be explained by a model that predicates business cycle swings as the result of technological shocks.

Propaganda, surveillance, and other tools used to control of mass public opinion are technologies. The recent crash came as a result of a shock resulting from elites developing the means to use these technologies to extract unsustainable revenue streams from the public at no risk to their interests.

Since the 1980s, the technology of control has imposed many shocks on the global economy to support ever-expanding elite rentierism. The first shock came from discovering the means to force the public accept stagnant or falling wages without harming elite interests. The second shock came from forcing the public to live on credit to make up for stagnant wages. The recent crash was merely the time when the credit bubble burst–the actual shocks happened much earlier.

Keynes’ claim that a market economy can stay for substantial periods, in a situation of high unemployment and excess supply in all markets. If this claim is false, as argued by both classical and New Classical economists,…

Henry’s post above this one, citing Pohl’s The Tunnel Under the World, reminds me of Pohl’s Midas World stories. If robots could supply all human demand without human labor input, we would have excess supply in all markets and zero unemployment. Might we be partway there – a state where capital and productivity are such that all demand can be met with less than full employment? Which suggests increasing demand might help.

(Also, though not stated explicitly in Pohl’s stories, it seemed the robot capital was socialized, and their output was distributed to everyone. Had there been some person or corporation who could produce 100% of the world’s demand without labor input and expected to be paid for the products, it would have been a grimmer story.)

Main Street Muse @67

You seem to be intertwining a number of concepts and focusing on micro-economics rather than macro. Allow me to take a few of your points and try to refocus them a bit – I’m not entirely disagreeing, just tying to put your points back into a macro context.

Grant that a key component of the 2008 financial crisis was over-levered financial institutions, the question becomes why was that so.

The answer in part, was easy credit facilitated on the macro by the Fed’s easy money/low interest rate choices and on the micro by the creation of CDOs and other hybrid vehicles which leveraged exposure to underlying collateral (i.e a relatively small group of mortgages influenced a large group of securities via indexation). In economic terms these vehicles reduced structural barriers to capital formation, but had a cost in increasing system volatility.

The banks themselves don’t escape blame – their lending standards were crap regardless of how they were facilitated – but these are also micro concerns. The macro is that both supply and demand collapsed concurrently when lending problems materialized…lets just agree there were problems since listing out the dozen or so structural problems with lending on a low collateral basis on inflated asset values is somewhat intuitive.

Staying with the macro – The creation of unemployment was the contraction of GDP which was influenced by credit contraction as well as business cyclicality which included lower construction due to credit contraction, Europe, less-easy money (rates were rising by 2007), political uncertainty….lets say many of the usual business cycle culprits.

No, it wasn’t unions in the case of AIG or Lehman, but union contracts were a factor in airlines, autos and auto parts companies that had to manage the same GDP contraction. The fact that in the case of GM they were also a major participant in real-estate financing through GMAC (and its subs) accelerated their failure…

The question that this board is trying to examine – is not why the unemployment was created, but why it hasn’t eased or what would make it ease. Some examination of causality is helpful in identifying that answer (as I posted at 31), but that is ultimately micro-economics – not macro.

You may (as many have) reach the conclusion that macro economics isn’t helpful in answering this question and that isn’t an unrealistic view – but conspiracy theories about AIG, Goldman Sachs, Paulson and the like while surely interesting, have no relevance to what form of after-the-fact economic policy – spending, monetary policy, easing regulation etc. would be most effective in bringing about the desired outcome of lower unemployment.

In macro economic terms – your concerns about moral and financial corruption (not necessarily off base) are classified as structural impediments that would either be addressed by regulation or would simply demand a greater monetary or fiscal response to overcome depending on bent.

The nature of your questions and comments suggest that you don’t really have the heartbeat of a macro-economist but would fall into the camp (as mentioned in the OP) that thinks micro has more of the answers and macro mostly has questions.

P.S. With reference to my comment @75 – if streams of money income are committed to flow in the future in a certain direction, then even if all other prices are fully and instantly flexible, the neutrality of money is broken.

P.S. That was my response to JW Mason @5

I think it interesting (maybe even indicative) that the worst effected countries have been countries with substantial trade deficits – which rather contradicts some expressed forecasts of bigger effects on exporting countries. Which makes me think that household balance sheet stories (deficits being flows of wealth out of a country) are more convincing.

” I’m dead set certain that there is quite a strong theme in the economics blogosphere, that the really important stickyness may not be wage stickiness but nominal debt stickiness. ”

Fisher’s work on debt and deflation is still valid.

“Everyone who disagrees with me must be an evil liar isn’t all that helpful.”

It is important to know your enemy Tim and be honest to yourself about what he/she really stands for. The choice for right wing economists is evil or stupid. Which is it?

If you treat the financial sector meltdown as a technology shock, RBC amounts to little more than the observation that opium makes you sleepy because of its dormitive quality.

I’m not an economist, but can’t you treat a big increase in crime as a technology shock … including the financial crime that was part of the financial crisis?

So, for example, if we had had a really massive increase in bank robberies, this could be regarded a exogenous shock with real economic impact. In the case at hand, the problem is not guys with masks and guns holding up the banks, but insider fraud: but can’t it be a technology shock in the same way?

I think Ingolf’s diagnosis makes a lot of sense, but less so his prognosis/treatment. I think Minsky’s theories about finance driving business cycles really fits with the current recession.

However, I’d like to suggest an additional factor: secular problems in wage growth and incomes for the vast majority of workers (and arguably relatively high unemployment and underemployment even in boom times compared to the 45-75 period) created a long-term problem of insufficient demand relative to growing supply; financial bubbles and a massive expansion of credit were used to cover for the slack, thus when the bubble burts, demand drops fast.

Now, we’ve shoveled a hell of a lot of money at banks, insurance companies, etc. but far less to actual consumers, which means demand doesn’t recover that much. Hence, relative to the cash on hand they have, capital is holding back from investment because they don’t see consumer demand out there. At the same time, a labor market regime centered on labor shedding/increasing casualization/speed up and stretch out prevents the private labor market from generating enough jobs to really decrease unemployment and generate new consumers, which creates a self-fulfilling prophecy of insufficient demand.