Understanding Macro: The Great Depression (1/3)

from  Asad Zaman

Preliminary Remarks: “The trouble is not so much that macroeconomists say things that are inconsistent with the facts. The real trouble is that other economists do not care that the macroeconomists do not care about the facts. An indifferent tolerance of obvious error is even more corrosive to science than committed advocacy of error.” From The Trouble with Macroeconomics (Paul Romer)

Personally, I do not understand why indifference to error is worse than committed advocacy. For an illustration of committed advocacy of error, see postscript below on 70 years of economists’ commitment to a fallacious theory of supply and demand in the labor market. Furthermore, the problem is not confined to macro. Microeconomists are also dogmatically committed to utility maximization, when in fact this hypothesis about consumer behavior is solidly rejected by empirical evidence; see: The Empirical Evidence Against Neoclassical Utility Maximization: A Survey of the Literature

Understanding Macro: The Great Depression

Due to frequent headlines, there is a substantial public awareness of core macroeconomic issues like unemployment, trade agreements, exchange rates, deficit, taxes, interest rates, etc. However, even professionals are often ignorant of the intellectual battles which have shaped modern macroeconomics, since this is not taught in typical PhD programmes in economics. This article attempts to provide the history of ideas which led to the emergence of macroeconomics, since this is an essential background required for informed analysis of these issues.

Lord John Maynard Keynes invented the entire field of macroeconomics in response to the Great Depression in 1929, which could not be understood according to economic theories dominant until then. According to the classical economic theory, forces of supply and demand in the labour market would ensure full employment. Keynes starts his magnum opus, The General Theory of Employment, Interest, and Money, with the observation that the economic theory cannot explain the long, persistent and deep unemployment that was observed following the Great Depression. Keynes set himself the goal of creating a theory which could explain wide fluctuations in levels of employment that he observed. He discovered that creating such a theory involved rejecting deeply held convictions, central to economic theory.  read more

Euro area unemployment rate at 11.1% and EU at 9.6% in June 2015

Why people aren’t working; can we talk about the Fed?

from Dean Baker

In her WaPo column Catherine Rampell points to the sharp decline in labor force participation rates for prime age workers (ages 25-54) in recent years and looks to the remedies proposed by Jeb Bush and Hillary Clinton. Remarkably neither Rampell nor the candidates discuss the role of the Federal Reserve Board.

There is not much about the drop in labor force participation that is very surprising. It goes along with a weak labor market. When people can’t find a job after enough months or years of looking, they stop trying. Here’s what the picture looks like over the last two decades.

So much for ‘expansionary austerity’ solutions

from Lars Syll

Unemployment rates in Europe, Japan and US

Source: Eurostat

If this is recovery for Europe, well, I’ll be dipped! Some years ago unemployment rates at these levels were considered totally unacceptable. And then came the Reagan-Thatcher turnover and price stability was everything and being unemployed was something people freely chose to be …

Next up, Podemos in Spain: European officials will have to change course

from Mark Weisbrot

The electoral victory of Syriza in Greece on January 25 marked the first government that was elected with a strong mandate to finally say no to European officials who have been trying to remake Europe since at least 2010. While many thought it was impossible for a small country with just 2 percent of the economic output of the 19-nation eurozone to change the course of Europe’s history, it is already happening. On Friday, February 20, European officials backed off from their threats and assaults on the Greek financial system, which had already caused more than $13 billion dollars of deposits to flee the country in January. They agreed, for the first time (and for the first country) since Europe’s post-crisis austerity began, that the terms of Greece’s financing could be renegotiated. On Monday, March 9, officials are expected to present their proposals to eurozone finance ministers. If these are eventually rejected, Greece is considering calling new elections or a referendum over its deal with lenders.

This is a milestone on the way to renewed civilization for the rest of the eurozone. The country that has been the next hardest hit, with 23.7 percent unemployment, is Spain. And after years of mass unemployment and “reforms” that have hacked away at public services, pensions, labor and civil rights – a political rebellion has been born in Spain that promises to bring the next democratic alternative government to power.

The ‘bad luck’ theory of unemployment

from Lars Syll

As is well-known, New Classical economists have never accepted Keynes’s distinction between voluntary and involuntary unemployment. According to New Classical übereconomist Robert Lucas, an unemployed worker can always instantaneously find some job. No matter how miserable the work options are, “one can always choose to accept them,” according to Lucas.

This is, of course, only what you would expect of New Classical economists.

But sadly enough this extraterrestrial view of unemployment is actually shared by ‘New Keynesians,’ whose microfounded dynamic stochastic general equilibrium models cannot even incorporate such a basic fact of reality as involuntary unemployment!

Of course, working with microfunded representative agent models, this should come as no surprise. If one representative agent is employed, all representative agents are. The kind of unemployment that occurs is voluntary, since it is only adjustments of the hours of work that these optimizing agents make to maximize their utility. 

America can be a full-employment economy once again

from John Komlos

Irving Berlin was dreaming of an old-fashioned Christmas. I’m dreaming of an old-fashioned economy in which everyone has a job. I know, it was ages ago, but what are dreams for anyway?

Isn’t it strange that full employment has to be a dream, even a quarter millennium after the beginning of our stupendous surge in wealth with the Industrial Revolution? But what is full employment? Well, it’s simple enough, isn’t it? An economy in which there are enough jobs to go around for everyone. But here is where the complications begin.

There are rationalizations galore why we have to accept unemployment as an integral part of our economic system.

Will market forces solve the problem of stagnant wages and growing inequality?

from David Ruccio

Will market forces solve the problem of stagnant wages and growing inequality? 

Full employment: The recovery’s missing ingredient

from Dean Baker

Federal Reserve Chairman Janet Yellen gave a speech a few weeks ago that was doubly unusual.

First, she provided a welcome and trenchant analysis of inequality, focusing on the stagnant income and wealth of middle- and low-income families relative to the top few percent. For the nation’s chief economist to elevate this issue is an important contribution in its own right.

Second, she declined to mention the critical role of slack labor markets in these outcomes. In what is a rare case for her, the word “unemployment” was not even mentioned in the speech. The omission was especially noticeable as Yellen, to her credit, has so consistently pointed out the extent of remaining slack in the U.S. job market.

Unemployment is down and gross domestic product is up, yet there isn’t much progress in real wages and incomes of most working families. While many reasons have been set forth to explain this unfortunate disconnect, including globalization and technological change as well as unmet skill demands and the Federal Reserve’s asset-buying program, our research suggests that the main factor behind both stagnant real wages and rising inequality is the absence of full employment. Truly tight labor markets — an unemployment rate closer to 4 percent than 6 percent — would not only boost real wages, but would give a larger lift to the lowest-paid workers and those with the least bargaining clout, pushing back on stagnation and inequality.

Inflation hawks: The job killers at the Fed

from Dean Baker

Discussions of inflation and Federal Reserve Board policy take place primarily in the business media. That’s unfortunate, because these discussions can have more impact on the jobs and wages of most workers than almost any other policy imaginable.

The context of these discussions is that many economists, including some in policy making positions at the Fed, claim that the labor market is getting too tight. They argue this is leading to more rapid wage growth, which will cause more inflation and that this would be really bad news for the economy. Therefore they want the Fed to raise interest rates.

The part of this story that few people seem to grasp is that point of raising interest is to kill jobs. If that sounds like a bizarre accusation to make against responsible people in public life then you need to pick up an introductory economics text.

The story line there is that we get inflation if too many people are employed. There are all sorts of ways of making the story more complicated, and many people get PhDs in economics doing just that, but the basic point is a simple one: at lower rates of unemployment workers have more bargaining power and are therefore able to push up their wages.

The Jobs Gap (3 graphs)

from David Ruccio

With 217,000 new jobs created in May, the U.S. economy is finally—finally, after 50 months!—back to the pre-recession employment level.

Except it isn’t. Not by a long shot. Not when we consider the “jobs gap”—which we can calculate in one of two ways: by the amount of time it will take at this rate to get back to pre-recession employment levels while also absorbing the people who enter the labor force each month (4 years) or by the difference between payroll employment and the number of jobs needed to keep up with the growth in the potential labor force (6.9 million jobs).

Five economic policy changes for 2014 that could boost employment and reduce climate disruption

from Mark Weisbrot

The U.S. economy is still weak, with 7 percent unemployment, many millions more underemployed and less people employed in November than there were six years ago. At the same time – and not unrelated – we are still devolving along a path toward increasingly ugly inequality, with 95 percent of the income gains since the Great Recession going to the top 1 percent of the income distribution.

Meanwhile, the crisis of global climate change is moving toward more irreversible catastrophic damage each year that the United States, which is responsible for more of the cumulative carbon emissions than any other country, procrastinates in making the necessary changes to reduce fossil fuel consumption.

There are feasible policy changes that can address all of these problems – and we don’t have to sacrifice employment or a more just and decent society in order to make progress on climate change. Here are five of them:

Chart of the day – Young and jobless across Europe

from David Ruccio

US Unemployment edges down as people continue to leave the workforce

from Dean Baker

The unemployment rate edged down to 7.2 percent in September, the lowest level since November of 2008. The Labor Department’s establishment survey showed a gain of 148,000 jobs. With modest upward revisions to the prior two months’ data, this brings the average rate of job growth over the last three months to 143,000. This compares with an average rate of job growth of 186,000 a month over the last year.

In spite of the September drop in unemployment, the employment-to-population rate (EPOP) remained unchanged at 58.6 percent. This continues the pattern that we have seen throughout the recovery as the unemployment rate falls mainly because workers leave the labor market. The unemployment rate is now down by 2.8 percentage points from its 10.0 percent peak in October of 2009. However, the EPOP is up just 0.4 percentage points from its low point in June of 2011. Over the last year the EPOP actually edged down by 0.1 percentage point, while the unemployment rate dropped by 0.6 percentage points. This drop in labor force participation is now occurring at an equal pace among men and women, with the participation of both dropping 0.5 percentage points in the last year.

Greece’s unemployment rate by month (graphics)

from David Ruccio

The unemployment rate in Greece [pdf] climbed to a new record high of 26.9 percent in April (significantly higher than the 23.1 percent registered in April 2012), while the youth jobless rate is now a truly dire 57.5 percent (up from 51.5 percent a year ago)!

Robert Samuelson finds economics is way too complicated (2 graphs)

from Dean Baker

That is quite literally what he told us in his column. His second paragraph tells readers:

“Among economists, there is no consensus on policies. Is “austerity” (government spending cuts and tax increases) self-defeating or the unavoidable response to high budget deficits and debt? Can central banks such as the Federal Reserve or the European Central Bank engineer recovery by holding short-term interest rates near zero and by buying massive amounts of bonds (so-called “quantitative easing”)? Or will these policies foster financial speculation, instability and inflation? The public is confused, because economists are divided.”

See, we don’t know what to do, so we just can’t do anything. All those suckers who are unemployed or seeing stagnant wages, well we just don’t know. And the fact that those on the top are getting rich with 60-year high shares of national income, well what can we do about that? It’s just too confusing.

New Keynesians, price stickiness and involuntary unemployment (wonkish)

from Lars Syll

There are unfortunately a lot of neoclassical economists out there who still think that price and wage rigidities are the prime movers behind unemployment. What is even worse – I’m totally gobsmacked every time I come across this utterly ridiculous misapprehension -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 in General Theory devoted substantial attention to the subject of wage and price rigidities, he certainly did not hold this 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.  

No evidence of “structural unemployment” in the US (2 graphs)

from David Ruccio

Rand Ghayad and William Dickens (pdf) have discovered a shift in the so-called Beveridge Curve (Figure 1) associated with the growth in long-term unemployment (Figure 2).*

Their study is significant in that

Young, educated, and jobless in America?

from John Schmitt

The New York Times has a piece by Steven Erlanger on the “Young, Educated and Jobless in France” that gets most of the facts right, but still might leave its readers with the wrong idea about the real labor-market challenges facing Europe and the United States.

The story focuses on the plight of young, college graduates in France (and several other European countries) who have been unable to find work despite their college degrees and other post-secondary training. 

Unemployment is cyclical: taking Jeffrey Sachs to school

from Dean Baker

Jeffrey Sachs has played a useful role in challenging the economic orthodoxy in many areas over the last three years. However, when he tries to tell us that the current downturn is structural not cyclical he is way over his head in the quicksand of the orthodoxy.

Let’s start with his simple bold assertion: