Home > New vs. Old Paradigm > In DSGE models the unemployed are happier than the employed

In DSGE models the unemployed are happier than the employed

from Lars Syll

January, 2014 at 21:50 | Posted in Economics  |  2 Comments

In the model [Gali, Smets and Wouters, Unemployment in an Estimated New Keyesian Model (2011)] there is perfect consumption insurance among the members of the household.unemployed-thumb

Because of separability in utility, this implies that consumption is equalized across all workers, whether they are employed or not … Workers who find that they do not have to work are unemployed or out of the labor force, and they have cause to rejoice as a result. Unemployed workers enjoy higher utility than the employed because they receive the same level of consumption, but without having to work.

There is much evidence that in practice unemployment is not the happy experience it is for workers in the model.  For example, Chetty and Looney (2006) and Gruber (1997) find that US households suffer roughly a 10 percent drop in consumption when they lose their job. According to Couch and Placzek (2010), workers displaced through mass layoffs suffer substantial and extended reductions in earnings. Moreover, Oreopoulos, Page and Stevens (2008) present evidence that the children of displaced workers also suffer reduced earnings. Additional evidence that unemployed workers suffer a reduction in utility include the results of direct interviews, as well as findings that unemployed workers experience poor health outcomes. Clark and Oswald (1994), Oswald (1997) and Schimmack, Schupp and Wagner (2008) describe evidence that suggests unemployment has a negative impact on a worker’s self-assessment of well being. Sullivan and von Wachter (2009) report that the mortality rates of high-seniority workers jump 50-100% more than would have been expected otherwise in the year after displacement. Cox and Koo (2006) report a significant positive correlation between male suicide and unemployment in Japan and the United States. For additional evidence that unemployment is associated with poor health outcomes, see Fergusson, Horwood and Lynskey (1997) and Karsten and Moser (2009) …

Suppose the CPS [Current Population Survey] employee encountered one of the people designated as “unemployed” … and asked if she were “available for work”. What would her answer be? She knows with certainty that she will not be employed in the current period. Privately, she is delighted about this because the non-employed enjoy higher utility than the employed … Not only is she happy about not having to work, but the labor union also does not want her to work. From the perspective of the union, her non-employment is a fundamental component of the union’s strategy for promoting the welfare of its membership.

Lawrence J. Christiano

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To me these kind of “New Keynesian” DSGE models, where unemployment is portrayed as a bliss, are a sign of a momentous failure to model real-world unemployment. It’s not only adding insult to injury — it’s also sad gibberish that shamelessly tries to whitewash neoliberal economic policies that put people out of work.

All empirical sciences use simplifying or unrealistic assumptions in their modeling activities. That is not the issue – as long as the assumptions made are not unrealistic in the wrong way or for the wrong reasons.

Theories are difficult to directly confront with reality. Economists therefore build models of their theories. Those models are representations that are directly examined and manipulated to indirectly say something about the target systems.

But models do not only face theory. They also have to look to the world. Being able to model a “credible” DSGE world — how credible that world is, when depicting unemployment as a “happy experience” and predicting the wage markup to increase with unemployment, I leave to the reader to decide — a world that somehow could be considered real or similar to the real world, is not the same as investigating the real world. Even though all theories are false, since they simplify, they may still possibly serve our pursuit of truth. But then they cannot be unrealistic or false in any way. The falsehood or unrealisticness has to be qualified.

If we cannot show that the mechanisms or causes we isolate and handle in our models are stable, in the sense that what when we export them from are models to our target systems they do not change from one situation to another, then they only hold under ceteris paribus conditions and a fortiori are of limited value for our understanding, explanation and prediction of our real world target system.

The final court of appeal for macroeconomic models is the real world, and as long as no convincing justification is put forward for how the inferential bridging de facto is made, macroeconomic model building is little more than “hand waving” that gives us rather little warrant for making inductive inferences from models to real world target systems. If substantive questions about the real world are being posed, it is the formalistic-mathematical representations utilized to analyze them that have to match reality, not the other way around.

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Categories: New vs. Old Paradigm
  1. January 26, 2014 at 6:41 pm

    “Suppose the CPS [Current Population Survey] employee encountered one of the people designated as ‘unemployed’ … and asked if she were ‘available for work’.”

    That really says it all. If the unemployed were happy being unemployed they wouldn’t be available for work and thus could not be classified by the CPS as unemployed. Bingo!

  2. January 26, 2014 at 7:38 pm

    I’ve been living off capital for ten years and can say with authority that people WANT to work. We want to work because we want to be perceived as useful. I tried to package that here

    http://banksneedboundaries.wordpress.com/2013/11/26/first-and-last-2/

    Most people are unaware of this, and say “I want a job”, when what they really mean is “I want an income”.

    Craziest of all is the “killer criterion”: if you don’t get paid for it, it isn’t called work. My dear mother, bless her, recently told me it was troubling that I didn’t work. Yet she knows exactly how I work my butt off to keep various blogs in shape, and put some presentable texts online.

    Here, if you will allow a little more guerrilla advertising before I discuss your text, is the only text I know of that distinguishes between Good and Bad unemployment!

    http://www.banks-need-boundaries.net/unemployment.php

    Some people are starting to distinguish between the two types of “workless income”
    see http://banksneedboundaries.wordpress.com/2013/03/03/what-is-workless-income/
    notably people associated with a German-Canadian group wissensmanufaktur.net

    …but still unemployment is treated primarily in two ways.
    1) on a propaganda level it’s treated as something bad that must be avoided
    2) a method of social control, to coerce everyone (even the employed) to make themselves increasingly useful to corporations.

    Artists can invent their own work, but – like scientists – often end up spending a lot of time “selling the ideas” in order to obtain funding. I believe it was Orson Welles who said something to the effect that “80% of my life as an artist is wasted trying to sell what I do in the remaining 20%”.

    Nothing to add to Lars Syll.

    However, to Christiano: A labour union, if anything, “wants” workers to be employed and happy. Sorry to ruin the crescendo of the smart paragraph, but are you aware of the Mohawk Valley Formula? http://en.wikipedia.org/wiki/Mohawk_Valley_formula

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