The big issues in macroeconomics: unemployment

by John Quiggin on January 3, 2013

Following up my previous post, I want to look at the main areas of disagreement in macroeconomics. 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. The fact that, despite these radical disagreements, many specialists in macroeconomics don’t see a problem is, itself, part of the problem.

I’ll start with the central issue of macroeconomics, unemployment. It’s the central issue because macroeconomics begins with 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, then there is no need for a separate field of macroeconomics – everything can and should be derived from (standard neoclassical) microeconomics.

The classical view is that unemployment arises from problems in labor markets and can only be addressed by fixing those problems. Within the classical camp, Real Business Cycle theory allows for cyclical unemployment to emerge as an voluntary response to technology shocks and changes in preferences for leisure – hence Krugman’s snarky but accurate quip that, according to RBC, the Great Depression should be called the Great Vacation. More generally, on the classical view, long-term unemployment has to be explained by labour market distortions such as minimum wages, unions, restrictions on hiring and firing, and so on.

The RBC school mostly treated the Great Depression as an exceptional case, to be dealt with later, and they have been no better on the Great Recession. While some have tried, it’s obviously silly to explain the current recession as the product of technology shocks in the ordinary sense of the term. 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. Since financial sector booms and busts are clearly driven by the the general business cycle, you get the theory that the business cycle is caused by … the business cycle.

Looking at the broader classical view, there are two big problems. First, over the past twenty or thirty years unions have got weaker nearly everywhere, minumum wages have generally fallen in real terms, or at least relative to average wages, and labour markets have been ‘reformed’ to become more flexible. So, you would expect low and falling unemployment. The low rate of US unemployment in the 1990s and (to a lesser extent) 2000s was indeed taken as a vindication of this prediction. So, sharp increases in unemployment are the opposite of what was expected. The even bigger problem is that, since 2008, unemployment has risen sharply in many different countries, with very different institutions. Many of these countries have reacted by cutting social protections (here’s Latvia, for example)[1] but unemployment has remained high.

The main alternative to the classical view is a “sticky wage/price” interpretation of Keynesianism. The basic idea is that the aggregate economy is subject to demand shocks, which result in prices and wages being too high. But reducing wages and prices is difficult, because of co-ordination failures. Reducing wages and prices in one sector, or reducing wages but not prices doesn’t help. In fact, cutting wages on a piecemeal basis depresses demand even further. So the economy stays under-employed for a long time.

If you accept the sticky wage story, then you get the kind of policy line supported by the New Keynesians in the current debate. This says that, under normal conditions, monetary policy can be used to avoid deflation. In the current “liquidity trap” case where interest rates are at zero, and expanding the money supply has no effect, it’s necessary for governments to create demand directly through fiscal policy.

Lots of Keynesians (including me) and other critics of the classical view aren’t satisfied with the sticky wage interpretation, or at least regard it as incomplete. There isn’t a single well-developed alternative, however, so I’ll give some thoughts of my own, and invite others to comment. 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”). So cutting real wages in a depression may produce a new lower-wage equilibrium, which leaves existing wages still “too high” to clear the labor market. Obviously, there are limits on this process, but they may not be relevant.

In empirical terms, the sticky wage story implies that real wages should be countercylical (higher in recessions). The alternative versions of Keynesianism generally imply the opposite. The empirical evidence, sadly, is indecisive.

But the disagreements among Keynesians, or between Keynesians and various heterodox schools, are less important than their collective disagreement with the classical view. According to classical economics, a global recession like the one we are observing, occurring simultaneously in many very different countries and lasting for many years, should be impossible, or at least highly improbable. For the classical view to work, lots of separate and differently organized labor markets must have simultaneously gone haywire, and stayed that way for a long time. But the improbability of this hypothesis hasn’t shaken the faith of classical supporters.

fn1 The linked NY Times story is the most striking example of the body contradicting the lead that I have seen in recent times. After proclaiming Latvia a success, the story notes that, in addition to 14 per cent unemployment, 5 per cent of the population has emigrated, poverty is worse than anywhere in the EU except Bulgaria, and output is far below the pre-recession level. The concluding comment The idea of a Latvian ‘success story’ is ridiculous,” ought to be the opening.

{ 88 comments }

1

Brett 01.03.13 at 6:25 am

@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.

2

ponce 01.03.13 at 6:44 am

Is going from 95% employment to 92% employment and back again that big of a fluctuation?

3

Zamfir 01.03.13 at 7:04 am

@ponce, from observation: yes, obviously yes.

4

John Quiggin 01.03.13 at 7:07 am

If you want to talk about (US) employment, you should use E/P ratio, which dropped from 63 to 58 in 2009, and hasn’t recovered at all since then.

5

JW Mason 01.03.13 at 7:24 am

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.

6

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?

7

ponce 01.03.13 at 7:25 am

Err…civilian employment :)

8

Michael Harris 01.03.13 at 8:14 am

ponce, in raw number terms, I think you’d expect it to be up from where it was 5 years ago.

9

ponce 01.03.13 at 8:21 am

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

In fact, I think it’s an A+.

10

fgw 01.03.13 at 8:27 am

@10
The average daily temperature for Death Valley is 298.15° kelvin, for Antarctica 224.26° kelvin. Seems pretty unremarkable too.

11

Michael Harris 01.03.13 at 8:29 am

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?

12

ponce 01.03.13 at 8:33 am

Economics as speculative fiction?

13

Michael Harris 01.03.13 at 8:38 am

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.

14

ponce 01.03.13 at 8:47 am

My comparison point is: The highest number of people ever employed in the U.S. civilian workforce.

A good, scientific number.

Not n imaginary, touchy-feely one.

15

John Quiggin 01.03.13 at 8:48 am

ponce, nothing more on this thread, please

16

Marco 01.03.13 at 9:15 am

About the Latvian success story, Pilkington has a great analysis at naked capitalism. Bottom line, it is really just a new year`s tale about the virtues of hard times on the spirit of men that presupposes the “countries are just like households” trope. The fact that the numbers don`t match the narrative under a close scrutiny is only relevant for those who are not going to buy that bs anyway; the article is not written for them(us).

http://www.nakedcapitalism.com/2013/01/philip-pilkington-the-new-york-times-bizarre-and-misleading-praise-of-austerity-poster-child-latvia.html

PS: Thanks for this and the previous post, you filled a lot of gaps on my understanding of the current macroeconomic debate. If a daily reader/erratic commenter may dare to suggest something to CT bloggers, they should all do something like these posts about their fields of expertise.

17

Slex 01.03.13 at 9:43 am

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

IMO, it is possible that the lower unemployment in USA is partly due to the larger prison population relative to other industrialized countries. Probably it is not a coincidence that the incarceration rate has increased after the 1980s (see graph <a href="http://en.wikipedia.org/wiki/Incarceration_in_the_United_States&quot; here). They are not counted in the unemployment survey, however, if not incarcerated, some of them would have been considered unemployed. Given that there are ~2,5 million inmates and ~12 million unemployed as of 2012, it could probably increase the unemployment rate with half a percentage point.

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).

18

WM 01.03.13 at 10:02 am

Is it really correct to refer to the “classical” economists in the manner of the article, for example referring to the “classical view”? Isn’t that label reserved for people like Adam Smith, etc. whereas neo-classical refers to the modern schools of economics which the author is comparing?

19

fresno dan 01.03.13 at 10:18 am

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?

20

HM 01.03.13 at 10:29 am

One possible way of reconciling it with the classical view would be that there is some technological spillover and/or that one country gets a technological shock, but is demanding goods from other countries whose real incomes does fall during the recession.

If all countries have some sort of minimum wage, falling productivity should be associated with unemployment.

21

Robert 01.03.13 at 11:08 am

“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.

22

Tim Worstall 01.03.13 at 11:46 am

“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.”

It’s not actually a stirring call for everyone to immediately implement the plans of economists really. Given that the profession itself seems to be about as split as chemistry was when considering phlogiston and oxygen. Just not a good basis from which to persuade everyone that allowing politicians to spend another trillion is a good idea.

Admittedly, I’m very pre-General Theory in my views:

“I believe that this is a wildly mistaken interpretation of what is happening to us. 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. The increase of technical efficiency has been taking place faster than we can deal with the problem of labour absorption; the improvement in the standard of life has been a little too quick; the banking and monetary system of the world has been preventing the rate of interest from falling as fast as equilibrium requires.”

I don’t claim that it’s purely a structural problem: but I do that it is partly, along with other rather more famous people than I.

“While some have tried, it’s obviously silly to explain the current recession as the product of technology shocks in the ordinary sense of the term.”

But it could still be partly. The increases in manufacturing productivity and the consequent decreases in manufacturing employment (for those who don’t know, manufacturing employment is falling rapidly all over the world: yes, even in China) mirroring the steep falls in agricultural employment that took place with mechanisation in the 20s and 30s.

“minumum wages have generally fallen in real terms, or at least relative to average wages,”

In one specific case that I’ve actually dug out the numbers for this isn’t true. The UK’s “youth” minimum wage is now some 65 % of average wages for that age group. Sure enough, we’ve seen a steep rise in youth unemployment.

Similarly, I’m aware that you’ve rather dissed Mulligan’s argument (food stamps cause unemployment wasn’t it?) but there has been a rise in US long term unemployment associated with an extension of unemployment benefits to 99 weeks. As Richard Layard would predict there would be and as one recent paper claims the one has caused (part) of the other.

I end up though being a rather strange blend of Austrian (or RBC maybe) and New Keynesian. It is a structural problem, labour needs to change sectors (to put it very crudely indeed). Yes, it’s brought about by a technology shock. The NK part being that there is stickiness. But it’s not particularly in prices or wages. It’s in the regulatory difficulty of starting up new businesses.

Obviously this is anecdata, me just talking from personal experience. But as an example, I was rather shocked to find that setting up a little factory to process tungsten ore would cost some $10 million or so. That’s fine. But even if we put it on a site that had been doing exactly that 20 years ago, has all the ancillary services, the site being part of an already licensed chemicals factory, it would still take 18 months to do the environmental impact study. That’s longer than it would take to order, install, test and get running the equipment. More than half the time from start to production would be paperwork. According to what I’ve been told that 18 month paperwork cost exists on all and any physical production process in the EU these days.

Or looking at smartphone services like Uber. It’s really just a new way to hail a cab (or at least part of it is). Yet they’re having to fight with each and every Taxi Commission in the US to be able to roll it out. Delays of a year aren’t uncommon.

I seem to recall it being accepted as standard that employment growth comes from new firms entering the market. If it’s now more difficult because of regulatory barriers to enter the market then we shouldn’t be all that surprised that employment growth ain’t that great. Or in those NK terms, the stickiness is in those regulations.

Given that this is an idea arrived at independently it’s almost certainly wrong. But it does explain a lot of what I’m actually seeing on the ground.

23

Tim Worstall 01.03.13 at 11:53 am

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.

24

Zamfir 01.03.13 at 12:50 pm

Tim, those issues are also there in boom times.

25

jonny bakho 01.03.13 at 12:54 pm

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.

26

Dan Kervick 01.03.13 at 2:31 pm

@ JW Mason

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.

It seems to me that the previous part of your discussion does not in fact explain why NKs and monetarists believe in the omnipotence of central banks. It only explains why they believe the first conjunct in the antecedent of your conditional. It doesn’t explain why they believe the second conjunct: “the central bank controls the supply of such [moneylike] assets.”

27

JW Mason 01.03.13 at 3:32 pm

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.

28

gastro george 01.03.13 at 3:56 pm

@Tim 22

“In one specific case that I’ve actually dug out the numbers for this isn’t true. The UK’s “youth” minimum wage is now some 65 % of average wages for that age group. Sure enough, we’ve seen a steep rise in youth unemployment.”

So the high relative value of the minimum wage is the cause of unemployment. Rather than the low level of average wages being caused by unemployment?

29

idlehands 01.03.13 at 4:06 pm

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.

30

Barry 01.03.13 at 4:09 pm

Tim: “It’s not actually a stirring call for everyone to immediately implement the plans of economists really. Given that the profession itself seems to be about as split as chemistry was when considering phlogiston and oxygen. Just not a good basis from which to persuade everyone that allowing politicians to spend another trillion is a good idea.”

Except that one half has theories which match the truth, and one half doesn’t. And that second half, the freshwater people, are at this point very clearly lying. And one of the reasons that they are lying is to give cover for people like you.

31

Trader Joe 01.03.13 at 4:20 pm

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.

32

Anarcissie 01.03.13 at 4:22 pm

How much demand should there be?

33

PGD 01.03.13 at 4:46 pm

@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?

34

chris 01.03.13 at 4:51 pm

My comparison point is: The highest number of people ever employed in the U.S. civilian workforce.

Just in case someone else wanders by and thinks “Hey, that ponce guy had a point before he was told to shut up”: this would be a good comparison point if the size of the workforce was constant, which it’s not. The correction to that problem is to use E/P ratio instead, about which see Quiggin @4.

35

mpowell 01.03.13 at 5:00 pm

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.

36

Dan Kervick 01.03.13 at 5:01 pm

JW, what I was thinking about was not the possibility that the assets that the central bank produces and supplies are not the right kind of asset, but rather that the central bank has limited institutional powers for supplying them. The central bank can’t exchange the government liabilities it produces for a school, a tunnel, a park, a battleship or a labor service delivered to the public sector. All they do, even in extraordinary times, is exchange those liabilities for other financial assets held by banks and other financial institutions. These financial institutions can already have abundant supplies of the monetary reserves they need to make good on payment obligations they incur by making loans. If at that point, the financial institution still sees few profitable opportunities for exchanging their own IOUs for borrower promissory notes, then there is not much the central bank can do to impact the financing of consumption and production in the real economy.

37

Don Geddis 01.03.13 at 5:06 pm

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.

38

SamChevre 01.03.13 at 5:16 pm

I still (and I’ve been following this since you were posting chapters from Zombie Economics) see no reason why the combination of a massive rise in energy prices and a massive loss of safe assets is insufficient to create a world-wide recession in any model you care to name.

39

Alex 01.03.13 at 5:41 pm

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.

40

Main Street Muse 01.03.13 at 5:43 pm

Once again, I note that I am not an economist. I come at this curious to understand how our economy fell off a cliff in 2008.

In terms of macroeconomics, you say this: “Within the classical camp, Real Business Cycle theory allows for cyclical unemployment to emerge as an voluntary response to technology shocks and changes in preferences for leisure.”

I am puzzled by the language of this theory as it relates to what just happened to our economy. What exactly is unemployment as “voluntary response to tech shocks and changes in preference for leisure”? Is this for real? Are there macroeconomists who are trying to use this theory to explain the great crash of 2008? I can see why they struggle. It’s a theory that seems ill-suited for the reality we faced as the “wheels fell off” the economic engines of America. But it is well-suited for the political view that half the people in America are moochers and takers.

We live in a consumer-driven economy. Over the last 30 years, since Reagan launched his boats dedicated to helping all of navigate those promised “rising tides,” consumer wages have shrunk or remained stagnant as expenses (like health care) have risen far beyond the cost of inflation. It seems obvious that consumer demand will fall in this situation.

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”? 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?

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?

41

peter ramus 01.03.13 at 5:56 pm

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.

42

JW Mason 01.03.13 at 6:04 pm

Dan,

Right. But in the New Keynesian vision, it is basically impossible for the economy to be demand-constrained for reasons other than a lack of safe assets on bank balance sheets. Heres Robert Hall, in one of the definitive New Keynesian post mortems on the crisis:

A large decrease in the value of asset holdings of financial institutions resulted in dramatic intensification of the agency problems in those institutions … Credit spreads widened and credit rationing became widespread. The diminished ability to finance the acquisition of capital goods resulted in huge cutbacks of all types of investment … while other categories of GDP remained roughly constant. … All of these events fit existing macro models quite well. Conditional on a large decline in asset values among financial institutions, we got things right.

43

JW Mason 01.03.13 at 6:12 pm

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.)

44

Dan Kervick 01.03.13 at 6:53 pm

JW,

So what’s their excuse now? Banks have been swimming in ultra-safe excess reserve assets since 2009.

45

Antoni Jaume 01.03.13 at 7:18 pm

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.

46

JW Mason 01.03.13 at 7:42 pm

Dan K.-

In a New Keynesian-monetarist framework, the statement “output is below potnetial because of a lack of demand” is logically equivalent to “there is excess demand for money” (or money-like assets). So if we see output remain low in the face of a big increase in the supply of money, either the increase wasn’t enough (in which case enough QE will eventually fix the problem) or else output is not constrained by demand after all; aggregate supply must have fallen. This is just the logic of their vision of the economy, where “potential output” means the unique Walrasian equilibrium that we’d have if all markets cleared.

47

kent 01.03.13 at 7:47 pm

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.

48

Bruce Wilder 01.03.13 at 8:16 pm

The main alternative to the classical view is a “sticky wage/price” interpretation of Keynesianism. The basic idea is that the aggregate economy is subject to demand shocks, which result in prices and wages being too high. But reducing wages and prices is difficult, because of co-ordination failures. Reducing wages and prices in one sector, or reducing wages but not prices doesn’t help. In fact, cutting wages on a piecemeal basis depresses demand even further. So the economy stays under-employed for a long time.

I thought I would offer what I hope is a clarification. A cyclical “demand shock” reduces demand in almost all markets, and so puts downward pressure on almost all wages and prices, willy nilly. Only a change in relative price can act to “clear” a market, and “relative” implies some not all. If almost all markets are seeing pressure for downward changes in nominal prices, whatever relative price movements that might occur are muted by this general downward movement, and the movement toward full-employment of resources is frustrated. And, there’s no reason to think the right prices — the prices that ought to decline relative to other prices to restore the possibility of a full-employment general equilibrium — are any less sticky than the prices that ought to rise relatively.

Many economists seem to believe that the monetary authority can solve this problem by introducing a bit of inflation, with the inflation acting as a lubricant to make sticky prices less sticky. The prices are still sticky in nominal terms, but in the presence of inflation, unchanging prices and wages are declining in real terms, while inflation makes increasing other prices (the right prices, we hope) easier.

Of course, other economists are committed with a religious fervor to the idea that inflation (in wages at least) is the worst thing imaginable, to be avoided even in distant prospect at all cost. And, in practice, central banks have been observed to induce recessions, and to time their interventions at a point in the business cycle, where wages are beginning to rise. It is almost as if central bankers think they have a mandate to control inflation, where inflation is operationalized as, make sure wages are stagnant or falling.

The New Keynesians have basically only studied the case, where the economy, ex ante, was not experiencing any great structural problems. The economy before the “demand shock” was humming along near its Solow path, near full-employment of resources, and near a presumed general equilibrium of markets, and the “demand shock” is relatively small, and the problem facing monetary authorities is to accelerate the economy’s move back to the Solow path. The “consensus” seems to consist of the New Keynesian concession that the economy would be able to make this movement, even without “help” from favorable policy, but would just take a long, suboptimal time.

Arriving at the zero-lower-bound implies that the “demand shock” this time was not small enough.

Without getting distracted by the monetary implications of the zero-lower-bound, a “large demand shock” could also imply that the economy is now outside the territory where it can be relied on to find a full-employment equilibrium on its own, so to speak, outside “the corridor” where all the consensus verities apply. A large enough shock exposes structural problems; or, if you prefer, latent structural problems make the normal business cycle into a big “demand shock”, big enough to put the economy onto a permanently lower Solow path, or more scary, induce a downward spiral of wages, that leads the economy, stepwise, toward one lower Solow path after another.

49

Bruce Wilder 01.03.13 at 8:21 pm

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.

50

Barry 01.03.13 at 8:24 pm

Alex @39, in reply to Tim: “And suddenly we’re all “ooh, what the bleep do we know?””

Thanks for spotting this. Yes, it’s amazing how fast certain people can suddenly become oh-so-unsure of things, when that’s what’s needed.

51

Tim Worstall 01.03.13 at 8:42 pm

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.”

52

John Quiggin 01.03.13 at 8:46 pm

JWM @5 Agree in principle, but I think it’s generally supposed that wages are stickier, downwards at least, than prices.

On your second point, I agree that money and asset markets are critical, but I think you’ve taken it a bit far with your conclusion. 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.

53

JW Mason 01.03.13 at 9:30 pm

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.)

54

dBonar 01.03.13 at 9:31 pm

Not a macro economist by any stretch.

Surely people don’t want money qua money, they want a secure share of future production. The central banks (or the central banks plus retail banks) can given them money qua money, but in doing so at least raise the fears of each unit of that money being a claim on a smaller share of future returns. Which gives us both the paradox of thrift (fighting for larger shares of a smaller pie due to hording money) and fears of inflation (what we have managed to save gets diluted).

55

Brett 01.03.13 at 9:33 pm

@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.

56

Dan Kervick 01.03.13 at 9:45 pm

JW, I know you are just describing the view and not defending it. But it seems really nuts to me. If a bank has the option of creating a demand deposit balance for a loan customer in exchange for a promissory note from that customer giving specific payment terms and interest rate, and if the bank already has the clearing balances it needs to handle any payments out of that deposit account, then that’s all there is to it. Either the exchange is acceptable for them or it isn’t acceptable for them. How can it make a difference whether their clearing balances are 10 times or 100 times higher?

Don’t institutions mean anything in these models? It doesn’t matter where the money is on deposit, which agents have those deposits, or what role those agents play in the economy?

57

JW Mason 01.03.13 at 9:46 pm

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.

58

Sebastian H 01.03.13 at 9:48 pm

Isn’t the unifying ‘shock’ a sudden worldwide loss in trust in the banking system? I tend toward NK thought myself, but unless I’m misreading you, it seems that is a shock that would appeal to a more RBC-style theory.

Or most likely it is sticky wages plus loss of banking trust plus other stuff.

Could it be that we are stuck in a situation where the answer is ‘both’ and few theorists are interested enough in both to try to work both in?

59

krippendorf 01.03.13 at 9:52 pm

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.)

60

JW Mason 01.03.13 at 10:00 pm

If a bank has the option of creating a demand deposit balance for a loan customer in exchange for a promissory note from that customer giving specific payment terms and interest rate, and if the bank already has the clearing balances it needs to handle any payments out of that deposit account, then that’s all there is to it. Either the exchange is acceptable for them or it isn’t acceptable for them. How can it make a difference whether their clearing balances are 10 times or 100 times higher?

I think you’re in danger of throwing out the baby with the bathwater here.

A bank considering making a loan is not directly constrained by its deposit base. But it does have to consider both the expected return on the loan (i.e. interest net of defaults and intermediation costs) *and* liquidity risk, i.e. the possibility of finding itself in a state of the world in which it has positive present value but cannot meet its current payment obligations, for instance because its creditors are unwilling to roll over their loans. It is true that reserves are not a constraint for the banking system as a whole, but this does not carry over to individual banks; it is not always the case that a bank can acquire whatever reserve balance it needs to settle its current obligations. Banks *do* fail, quite often, in fact.

So a bank when considering a loan needs to consider its liquidity position, both market liquidity (its ability to quickly & reliably convert other assets on its balance sheet into means of payment) and funding liquidity (its ability to issue new liabilities). A bank with a balance sheet composed mostly of safe, liquid assets and stable and/or long-term liabilities (deposits, bonds) will be more willing to make loans than a bank that already has many illiquid assets and/or riskier sources of funding (interbank loans, short-term commercial paper). So there is nothing unreasonable a priori in thinking that a central bank operation that replaces risky or illiquid assets on bank balance sheets with safe liquid assets could increase lending.

My own criticism of NKs is that they think this is the entire explanation for business cycles and depressions; I don’t think it’s wrong, just insufficient.

61

JW Mason 01.03.13 at 10:05 pm

(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.)

62

Bruce Wilder 01.03.13 at 11:19 pm

Then, there’s also the possibility that financial fraud and stupidity will make bad loans and bad securities, creating the problem of insolvency.

And, there’s the related problem dBonar @ 54 refers to, of financial institutions fabricating claims on future production, which affect the behavior, interests and expectations of people, who buy them, and then, as reality rears its ugly head, some large part of those claims require some kind of political intervention to make them “good”.

63

Bruce Wilder 01.03.13 at 11:22 pm

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.?

64

JW Mason 01.03.13 at 11:28 pm

BW-

Yes, good quote. I’m afraid Simon Wren-Lewis is more representative of New Keynesian macroeconomists than John Q. is.

65

Bruce Wilder 01.03.13 at 11:50 pm

good on ya, JQ for that.

66

Barry 01.03.13 at 11:57 pm

Tim: “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.”

Please have somebody read and explain my comment about this.

67

Main Street Muse 01.04.13 at 1:24 am

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.

68

mclaren 01.04.13 at 1:42 am

Quiggin claims: “While some have tried, it’s obviously silly to explain the current recession as the product of technology shocks in the ordinary sense of the term.”

This statement is provably false. Quiggin is either pervasively uninformed or he’s having us on.

“Before the collapse of Soviet communism, China’s movement toward market capitalism, and India’s decision to undertake market reforms and enter the global trading system, the global economy encompassed roughly half of the world’s population–the advanced OECD countries, Latin America and the Caribbean, Africa, and some parts of Asia.
“Workers in the US and other higher income countries and in market-oriented developing countries such as Mexico did not face competition from low wage Chinese or Indian workers nor from workers in the Soviet empire. Then, almost all at once in the 1990s, China, India, and the ex-Soviet bloc joined the global economy and the entire world came together into a single economic world based on capitalism and markets.
“This change greatly increased the size of the global labor pool from
approximately 1.46 billion workers to 2.93 billion workers (exhibit 8.1). (..)

“What impact might the doubling of the global workforce have on workers? To answer this question, imagine what would happen if through some cloning experiment a mad economist doubled the size of the U.S. workforce. Twice as many workers would seek employment from the same businesses. You don’t need an economics PhD to see that this would be good for employers but terrible for workers. Wages would fall. Unemployment would rise.”

Source: “The great doubling: the challenge of the new global labor market,” Richard Freeman, August 2006. Link to pdf at the UC Berkeley.edu website.

Quiggin will now predictably counter by trying to claim that what counts is not the vast increase in the size of the global labor force (courtesy of the internet + market reforms + fall of USSR) in the 1990s but the total ratio of capital to labor, and Quiggin will now falsely assert that China and India and the former USSR brought so much new capital into global markets that the capital to labor ratio hasn’t worsened over the last 20 years.

The facts of course comprehensively contradict that laughable false assertion.

“Using data from the Penn World tables on yearly investments by nearly every
country in the world, I have estimated the level of capital stock country by country and
added the estimated stocks into a measure of the global capital stock. My estimates
indicate that as of 2001 the doubling of the global work force reduced the ratio of capital to labor in the world economy to 61 percent of what it would have been before China, India, and the ex-Soviet bloc joined the world economy.”

Source: op. cit.

The reason for catastrophic and persistent mass unemployment in America post-1991 is a simple and obvious technology shock: the internet + the liberalization of Russia, India and China, combined with America’s gross lack of an adequate social safety net. The introduction of the internet during the 1990s was a huge technology shock, and Quiggin’s statement that it is “obvious” that this massive technology didn’t occur and can’t explain our current global economic problems simply qualifies as bizzare. It’s in the same category as a putative assertion that “the sun obvious cannot explain the daylight.” Mere obtuseness can’t be problem here: one suspects controlled substances as a more complete explanation for a claim this outlandishly contrafactual.

Quiggin goes on to further display his utter lack of basic knowledge of economics by asserting in a comment:

If you want to talk about (US) employment, you should use E/P ratio, which dropped from 63 to 58 in 2009, and hasn’t recovered at all since then. — John Quiggin

This once again pervasively contradicts observed reality. Germany has by far the best economy in Europe right now, and one of the most dynamic economies in the world. If there’s any country that doesn’t suffer from an unemployment problem in the world, it’s Germany. Yet, according to the World Bank, Germany’s E/P ratio hasn’t budged from 55% from 2008 through 2012.

If Quiggin’s claim that E/P ratio is the key to diagnosing mass chronic unemployment pathologies in a first-world economy, then the German economy should be in the ER on life support. In reality, of course, the German economy is going like gangbusters, and the obvious reason is that their economy is highly automated (thus their low E/P) but Germany, unlike Shithole America, has managed to implement an effective enough social safety net to avoid destroying their middle class.

69

Michael Sullivan 01.04.13 at 2:36 am

“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?

70

John Quiggin 01.04.13 at 3:06 am

@mclaren As your link shows, all these trends were well in evidence in 2006. It’s absurd to suppose that they manifested themselves as a sudden shock in 2008.

I’ll let you have one comment in reply to this if you want, and that’s it. To be clear, you’re banned from commenting on my threads in future. Anyone else who wants to emulate mclaren’s commenting style can save me some trouble by going elsewhere.

71

Curmudgeon 01.04.13 at 4:04 am

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.

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Tim Worstall 01.04.13 at 8:30 am

@30.

“And that second half, the freshwater people, are at this point very clearly lying. And one of the reasons that they are lying is to give cover for people like you.”

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

“Yes, it’s amazing how fast certain people can suddenly become oh-so-unsure of things, when that’s what’s needed.”

And I’m afraid that it’s not all that fast at all. With a little digging around I could show that I’ve been making the point for some years now. I’m dubious about the entire field of macro for exactly the reason JQ gives at the top. Even among the Nobel Laureates in the field there seems to be no consensus. Thus:

“everything can and should be derived from (standard neoclassical) microeconomics.”

It may well not be a complete picture but until there is indeed some macro that all the smart guys will sign onto that seems to be all that we actually know.

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Ken 01.04.13 at 1:39 pm

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.)

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Barry 01.04.13 at 1:45 pm

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

I’m not just saying that because you disagree with me.

And you are still not replying to my simple point that we have evidence of the shape of the Earth.

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Trader Joe 01.04.13 at 1:46 pm

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.

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reason 01.04.13 at 2:00 pm

John Q,
I haven’t read the whole thread – so apologies if I’m repeating something – but I scanned the thread for “debt” – and only main street muse @67 seems to have mentioned it – and then only with reference to the financial sector. 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. I’m sort of wondering why this hasn’t even been touched on.

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reason 01.04.13 at 2:11 pm

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.

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reason 01.04.13 at 2:36 pm

JW Mason
“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.”

Not necessarily – not if the USD is a de facto global currency. This comes back somewhat to the (for me at least) tricky question of “what exactly is money”!

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reason 01.04.13 at 2:39 pm

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.

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Dan Kervick 01.04.13 at 3:09 pm

So a bank when considering a loan needs to consider its liquidity position, both market liquidity (its ability to quickly & reliably convert other assets on its balance sheet into means of payment) and funding liquidity (its ability to issue new liabilities).

Sure JW. That’s true in principle. But once a bank has abundant liquidity and it is still not lending, I see no reason to think that the central bank can impact things by swapping in even more liquidity for other financial assets.

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Barry 01.04.13 at 3:24 pm

” 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.

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ragweed 01.04.13 at 4:17 pm

But once a bank has abundant liquidity and it is still not lending, I see no reason to think that the central bank can impact things by swapping in even more liquidity for other financial assets.

It depends on what finanial assets are being swapped. It’s hard to argue that swapping safe and liquid assets (Treasuries) for reserves would make a substantial difference on bank balance sheets, but purchase of more risky assets could. In QE1, the Fed purchased a lot of low-quality high-risk assets (mostly MBS) from banks, which did substantially reduce risk off of the balance sheets. At the time, the primary impact was to keep banks from failing, rather than giving them more space to make loans. The current rounds of MBS purchases are hoped to help make more space for loans.

But even people like Bernanke have been saying that there is a limit to what monetary stimulus can achieve. The first part of the factors JWM cites at 60 comes into play – the banks calculation of the potential risk and returns for making loans. If the bank feels that demand is too low and thus the loan too risky, they won’t fund it. For that matter, if businesses feel that customer demand is insufficient to support the loan, they won’t apply in the first place. It is not clear that the reason for the slow recovery is still due to lack of credit.

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MPAVictoria 01.04.13 at 4:43 pm

“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?

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Tim Worstall 01.05.13 at 11:56 am

“The choice for right wing economists is evil or stupid. Which is it?”

You’ll have to define right wing for me. Authoritarian fascists? Yup, you’re right. Might be a little extreme as a description of those who argue, for example, that detailed planning of the economy isn’t all that good an idea. A statement that 30 years ago would have been described as “right wing” and today has JQ signing up to it.

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SusanC 01.05.13 at 10:16 pm

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?

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Ingolf 01.05.13 at 11:08 pm

“Since financial sector booms and busts are clearly driven by the the general business cycle . . . . . .”

I think the causality, if anything, runs the other way. It’s an interactive process, of course, but underestimating the influence of credit in intensifying, prolonging and distorting business cycles may be the main reason why mainstream economics gets so tangled up over our current unhappy state of affairs.

Certain consequences tend to follow such credit driven booms:

- Since a decent (and increasing) chunk of demand during the boom years was funded by borrowing, when it finally ends ongoing, sustainable demand is necessarily reduced. Particularly compared to the apparent boomtime trend.

- The productive structure created to meet that (partially) unsustainable demand isn’t all that well aligned to the new, more austere state of affairs. Even if everyone does everything right, sorting out those misalignments and excesses takes time and money, and both employment demand and new investments unavoidably suffer.

Until the sector balance sheets that got badly out of whack during the boom are sorted out, renewed organic growth is essentially impossible. Indeed, in the absence of official efforts to sustain liquidity, bolster demand and generally force-feed economic activity, I’m pretty sure most countries would have experienced full-blown depressions in recent years.

Unfortunately, many (perhaps most) of these official efforts either ignore the need for these adjustments or actively fight them. That in turn slows and confuses the private sector’s attempts to sort itself out. Certainly, once enough economic activity has been “borrowed” from the future during an extended credit-based boom, there’s no easy answer.

In any case, it doesn’t seem to me either the source (or the continued intractability) of these macro problems is all that mysterious.

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StevenAttewell 01.06.13 at 10:52 pm

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.

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reason 01.09.13 at 10:11 am

Ingolf @86
There is another name for a “credit-based boom” – it is a current account deficit. I think international finance needs reform first.

But yes, we need to get away from the idea that encouraging increased household sector indebtedness is a good idea. I would much rather that household sector balance sheets were expanded by government spending than by debt financed asset purchases (and the resulting volatile asset price inflation). The banks would be against that though, and that might be a problem in a political system vulnerable to corruption.

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