from Lars Syll
There are unfortunately a lot of mainstream economists out there who still think that price and wage rigidities are the prime movers behind unemployment. What is even worse is that some of them even think that these rigidities are the reason John Maynard Keynes gave for the high unemployment of the Great Depression. This is of course pure nonsense. For although Keynes devoted substantial attention to the subject of wage and price rigidities in General Theory , he certainly did not hold that view.
Since unions/workers, contrary to classical assumptions, make wage-bargains in nominal terms, they will – according to Keynes – accept lower real wages caused by higher prices, but resist lower real wages caused by lower nominal wages. However, Keynes held it incorrect to attribute ‘cyclical’ unemployment to this diversified agent behaviour. During the depression money wages fell significantly and – as Keynes noted – unemployment still grew. Thus, even when nominal wages are lowered, they do not generally lower unemployment.
In any specific labour market, lower wages could, of course, raise the demand for labour. But a general reduction in money wages would leave real wages more or less unchanged. The reasoning of the classical economists was, according to Keynes, a flagrant example of the ‘fallacy of composition.’ Assuming that since unions/workers in a specific labour market could negotiate real wage reductions via lowering nominal wages, unions/workers in general could do the same, the classics confused micro with macro.
One of the problems with the present Irish upswing is the curious case of the missing money. Economic growth (estimated at 7%) may be somewhat cosmetic (look here) but employment and consumption have been increasing at a brisk rate, too. Which is, also considering the upswing in house prices, remarkable as Irish households are deleveraging and rapidly so, while companies are not really borrowing, according to the Bank of Ireland. Total loans owed by non financial companies behave slightly erratic but are still lower than in 2012.This runs counter to ideas about balance sheet recessions: deleveraging should lead to less consumption and investment. So, where does all the money come from? Trade credits. See graph 1 (the flow of funds data from the Irish central bank show that this increase went on at least until the third quarter of 2016 and possibly even at a faster rate). Irish companies are accepting ‘promises to pay’ from their customers as a (legally binding) means of payment, therewith pulling themselves and the Irish economy out of the morass.
from Peter Radford and the WEA Newsletter
I have become so enmeshed in political activity here that I rarely have time to reflect on the strangeness of it all. Why Trump? Why now? But I was prompted to think a little harder about it when I re-read the following in Karl Polanyi’s “The Great Transformation”:
“Market society was born in England – yet it was on the Continent that its weaknesses engendered the most tragic complications. In order to comprehend German fascism, we must revert to Ricardian England.”
Now I don’t want to plunge into a detailed re-capitulation of inter-war history – that is not my point. I want to focus our attention on the analogy Polanyi brings to mind, and especially how deeply ideas can scar a society when they are applied with religious ferocity without regard to their flaws.
Nor do I want to re-litigate the entire argument about neoclassical economics. Frankly I am tired of wasting my time. If the preponderance of economists want to disconnect from reality, then who am I to argue? Let them. And ignore them. Their ignorance of the real world is both willful and necessary for the alternative world in which they think to cohere. So be it.
But… Read more…
from Lars Syll
Commenting on the state of standard modern macroeconomics, Willem Buiter argues that neither New Classical nor New Keynesian microfounded DSGE macro models have helped us foresee, understand or craft solutions to the problems of today’s economies:
The Monetary Policy Committee of the Bank of England I was privileged to be a ‘founder’ external member of during the years 1997-2000 contained, like its successor vintages of external and executive members, quite a strong representation of academic economists and other professional economists with serious technical training and backgrounds. This turned out to be a severe handicap when the central bank had to switch gears and change from being an inflation-targeting central bank under conditions of orderly financial markets to a financial stability-oriented central bank under conditions of widespread market illiquidity and funding illiquidity. Indeed, the typical graduate macroeconomics and monetary economics training received at Anglo-American universities during the past 30 years or so, may have set back by decades serious investigations of aggregate economic behaviour and economic policy-relevant understanding. It was a privately and socially costly waste of time and other resources.
from Lars Syll
Paul Krugman had a piece up on his blog last week arguing that the ‘discipline of modeling’ is a sine qua non for tackling politically and emotionally charged economic issues:
You might say that the way to go about research is to approach issues with a pure heart and mind: seek the truth, and derive any policy conclusions afterwards. But that, I suspect, is rarely how things work. After all, the reason you study an issue at all is usually that you care about it, that there’s something you want to achieve or see happen. Motivation is always there; the trick is to do all you can to avoid motivated reasoning that validates what you want to hear.
In my experience, modeling is a helpful tool (among others) in avoiding that trap, in being self-aware when you’re starting to let your desired conclusions dictate your analysis. Why? Because when you try to write down a model, it often seems to lead some place you weren’t expecting or wanting to go. And if you catch yourself fiddling with the model to get something else out of it, that should set off a little alarm in your brain.
Hmm … Read more…
Labour day (no, not ‘labor day’…). Here a labour day special of Eurostat. Below, the labor day special of this blog.
The percentage of labour force which is unemployed and which, in the next quarter, is still unemployed can reasonably be called ‘involuntary unemployment’. Unemployment on the micro level is, by definition, a situation which people are actively trying to change, if this does not result in employment in a reasonable period of time (one quarter) this indicates, also considering the very large and cyclically sensitive differences between countries and cyclically induced changes in individual countries, that unemployment is not just involuntary on the micro level but also on the macro level.
from Robert Locke
Ken Zimmerman’s reference to the hermeneutic circle in Asad Zaman’s post about the Education of an Economist sent me scurrying in my mind back fifty years to the seminars on historiography I took in my PhD studies in history and to Widepedia, where I found the following about the hermeneutic circle:
Eurostat has published regional data on unemployment (map). For several reasons I include Turkey in Europe, hence the title of this blog. In the rest of Europe, there is some bewilderment why these Turks (often smart, well-educated people) vote for an unenlightened autocrat like Erdogan. The map gives a clue: except for the Kurdish area of Turkey, unemployment is at least not disastrous and sometimes even pretty low. Turkey does much better than either Greece, Italy or Spain. At this moment, Greek emigration to Turkey is a more realistic idea than Turkish emigration to the rest of Europe. Read more…
from Peter Radford
There are a few thoughts or words in a normal economics discourse that trigger what I call my ‘market reflex’. Asad Zaman just triggered it. Of course he didn’t mean to, and the sentence in question is in an article I agree with. Further, the sentence, on the surface, looks and sounds so innocuous. Here it is:
“Free market economists believe that markets work best when left alone, and any type of government intervention to help the economy can only have harmful effects”
See what I mean? Innocuous. Asad is totally correct, they do think that. Worse: they mean it. And even more worse: they teach it.
Which gets me truly bothered.
The entire enterprise of contemporary economics, aside from its fringes, is built on this shady and unsubstantiated premiss. It’s shady because it is laden with ideological bias, and it’s unsubstantiated because, well, its unsubstantiated.
Which gets me even more annoyed. Read more…
from Lars Syll
In the standard mainstream economic analysis — take a quick look in e.g. Mankiw’s or Krugman’s textbooks — a demand expansion may very well raise measured productivity in the short run. But in the long run, expansionary demand policy measures cannot lead to sustained higher productivity and output levels.
In some non-standard heterodox analyses, however, labour productivity growth is often described as a function of output growth. The rate of technical progress varies directly with the rate of growth according to the Verdoorn law. Growth and productivity is in this view highly demand-determined, not only in the short run but also in the long run.
Given that the Verdoorn law is operative, expansionary economic policies actually may lead to increases in productivity and growth. Living in a world permeated by genuine Keynes-type uncertainty, we can, of course, not with any greater precision forecast how great those effects would be.
So, the nodal point is — has the Verdoorn Law been validated or not in empirical studies? Read more…
from Asad Zaman
Many leading economists have come to agree with Nobel Laureate Stiglitz that modern economic theory represents the triumph of ideology over science. One of the core victories of ideology is the famous Quantity Theory of Money (QTM). The QTM teaches us that money is veil – it only affects prices, and has no real effect on the economy. One must look through this veil to understand the working of the real economy. Nothing could be further from the truth.
In fact, the QTM itself is a veil which hides the real and important functions of money in an economy. The Great Depression of 1929 opened the eyes of everyone to the crucial role money plays in the real economy. For a brief period afterwards, Keynesian theories emerged to illuminate real role of money, and to counteract errors of orthodox economics. Economists believed in the QTM, that money doesn’t matter, and also that the free market automatically eliminates unemployment. Keynes started his celebrated book “The General Theory of Employment, Interest and Money” by asserting that both of these orthodox ideas were wrong. He explained why free markets cannot remove unemployment, and also how money plays a crucial role in creating full employment. He argued that in response to the Depression, the government should expand the money supply, create programs for employment, undertake expansionary fiscal policy, and run large budget deficits if necessary. read more
from David Ruccio
Here’s a description of the minimum-wage machine [ht: sm]:
This machine allows anyone to work for minimum wage for as long as they like. Turning the crank on the side releases one penny every 4.97 seconds, for a total of $7.25 per hour. This corresponds to minimum wage for a person in New York. This piece is brilliant on multiple levels, particularly as social commentary. Without a doubt, most people who started operating the machine for fun would quickly grow disheartened and stop when realizing just how little they’re earning by turning this mindless crank. A person would then conceivably realize that this is what nearly two million people in the United States do every day…at much harder jobs than turning a crank. This turns the piece into a simple, yet effective argument for raising the minimum wage.
The machine can also be reprogrammed to pay the minimum wage of wherever it happens to be currently exhibited.
In the comments to this post, there is some discussion about credit provided by Eurozone banks to their governments. I stated that ‘credit to the government’ is at this moment (!) the most important reason the stock of money in the Eurozone is increasing, some comments are skeptical. A re-investigations shows that it is all slightly complicated. According to the Eurozone law, national central banks are not allowed to provide credit to their governments. Normal banks are however allowed to do so. And according to ECB statistics, they do (see the graph, source). Bank ‘credit’ to the government is growing at a 10% a year rate, while the growth rate of credit to other Euro area residents is barely positive. I do however seem to have misread or at least misunderstood the word ‘credit’ in this graph.
According to this source (p. 111), credit is defined by the statisticians of the ECB as: Read more…
from Lars Syll
Thus your standard New Keynesian model will use Calvo pricing and model the current inflation rate as tightly coupled to the present value of expected future output gaps. Is this a requirement anyone really wants to put on the model intended to help us understand the world that actually exists out there? Thus your standard New Keynesian model will calculate the expected path of consumption as the solution to some Euler equation plus an intertemporal budget constraint, with current wealth and the projected real interest rate path as the only factors that matter. This is fine if you want to demonstrate that the model can produce macroeconomic pathologies. But is it a not-stupid thing to do if you want your model to fit reality?
I remember attending the first lecture in Tom Sargent’s evening macroeconomics class back when I was in undergraduate: very smart man from whom I have learned the enormous amount, and well deserving his Nobel Prize. But…
He said … we were going to build a rigorous, micro founded model of the demand for money: We would assume that everyone lived for two periods, worked in the first period when they were young and sold what they produced to the old, held money as they aged, and then when they were old use their money to buy the goods newly produced by the new generation of young. Tom called this “microfoundations” and thought it gave powerful insights into the demand for money that you could not get from money-in-the-utility-function models.
I thought that it was a just-so story, and that whatever insights it purchased for you were probably not things you really wanted to buy. I thought it was dangerous to presume that you understood something because you had “microfoundations” when those microfoundations were wrong. After all, Ptolemaic astronomy had microfoundations: Mercury moved more rapidly than Saturn because the Angel of Mercury left his wings more rapidly than the Angel of Saturn and because Mercury was lighter than Saturn…
Brad DeLong is of course absolutely right here, and one could only wish that other mainstream economists would listen to him … Read more…
from Peter Radford
Some things get too expensive. When they do, people tend to buy less. Duh. This quite simple and intuitive observation sits at the heart of all that fancy math we call economics. We don’t need the math to understand the relationship between the cost of, and the demand for, something, but having lots of complicated looking equations gives us comfort: there is a universal law lurking in the intuition. With exceptions of course. This is, after all, economics. There are always exceptions.
One of the things that is getting too expensive, if it hasn’t already arrived there, is higher education. The cost of going to college is becoming prohibitive. Sooner or later the cost of college will cut into the demand for education.
Just as it ought.
In our contemporary economy we are accustomed to being told that ever higher levels of education are not just desirable, but they are essential. One idea endlessly tossed about, especially on the right in politics, is that our workers are insufficiently skilled to compete with their foreign peers, and so the nation is at risk of losing its competitive edge. This is then twisted into the follow-up idea that we need a higher percentage of our population at college.
But what happens when we arrive at saturation? What is saturation? What is the value of a college degree when everyone, or nearly everyone, has one? Do we all then need to go on and get a post-graduate education? And once we all have PhD’s, then what?
Clearly there is something amiss in the thinking. Read more…
from David Ruccio
It’s been more than seven years and yet we’re still haunted by the spectacular crash that took place on Wall Street.
The big banks have been fined but no one, at least at or near the top, has been prosecuted let alone gone to jail.
The question is, why?
We know why the Eric Holder and the Justice Department didn’t go after the top executives: they were afraid of undermining the fragile recovery.
What about the Securities and Exchange Commission (which, remember, was set up during the first Great Depression to stem the fraud and abuses on Wall Street)?
We now know, thanks to Jesse Eisinger (based on a treasure-trove of internal documents and emails released by James A. Kidney, a now-retired SEC lawyer) that in the summer of 2009 lawyers at the SEC were preparing to bring charges against senior executives at Goldman Sachs (over a deal known as Abacus) but they never took the case to trial.