Arnold Kling  

Reply to Robert Waldmann

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Obama's New Deal... Masonomists in the Media...

He writes a long post that agrees with some of what I write and disagrees with some of my views.

I said that the labor force is becoming more heterogeneous.


As far as I can understand it, you are arguing that the Beveridge curve has shifted out... In other words you seem to be arguing that natural rate of unemployment has increased

Not quite. The more heterogeneous labor force does not necessarily raise the natural rate of unemployment. However, it makes it harder to recover from an adverse shock. In the 1950's, when 4/5 of the labor force (and an even higher proportion of cyclical unemployment) is low-skilled workers, it does not matter where you raise demand--you're bound to increase the demand for the workers who were unemployed. That is still true in 1970, when 2/3 of the labor force has a high school education or less.

Fast forward to now, when 2/3 of the labor force has some college education, and they are a significant component of unemployment. Now, in order to get them back to work you need to add demand that specifically uses their skills. This is a much harder trick to pull off. My Hayekian point is that this sounds like a task better suited to the market, not for Washington--hence my remark about "central planning."

I think that a stimulus that allows the private sector to figure out resource allocation (my preferred approach being a cut in the employer contribution for Social security) is more likely to be effective than a stimulus where the government tries to figure out the resource allocation (health care IT, "green jobs," etc.).

My third point about Minsky is that policymakers have got it all wrong by saying that we need to get lending going again. At this stage of the cycle, business expansion is going to come from profits, not from leverage.

In layman's terms, the situation now is that borrowers don't want to borrow, and risk averse investors don't want to lend. The policymakers are trying to prop up/cajole banks into getting borrowers and investors to do what they don't want to do. Why fight the market? If consumers don't want to be NINJAs any more (a reference to buying homes with no income, no job, and no assets), fine. If firms don't want to be in debt up to their eyeballs any more, fine. Let's let folks recover the way they want to. In the case of business, that means prudent expansion based on earnings, not ponzi finance.


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COMMENTS (10 to date)
dWj writes:

After years of griping about the low savings rate, there's suddenly a focus on only giving tax breaks to people who are going to spend it; letting people save their own money is considered "waste". I don't necessarily believe that there's no role for changes in government policy to stimulate C+I+G+NX; it just seems like we're entirely focused on the wrong two. Cutting the employer's contribution to social security is an excellent way to reduce the effect of layoffs on aggregate demand, perhaps helping to hold up C, but primarily by encouraging I.

dontstealmyidea writes:

perhaps i'm being naive here, i just started reading your blog. you're saying that profits are key to business expansion. isn't that contingent on business owners reinvesting their profits?

and with the kind of economic forecasts we're seeing, let's say i'm a business owner and you cut my taxes. why would i reinvest that, considering i'm already getting hammered by lower revenues? seems to me like i would just put it in my pocket to cover the 40% loss i've experienced on my investments in equities.

Rdan writes:

Robert lives in Italy...he should be along in his daytime. Best, Rdan

N. writes:

Mmmmm... not to take anything away from your larger point, which I agree with, but shouldn't the increase in college educated professionals create a more flexible work force and not less?

That is to say, when a widget factory closes due to reduced demand in widgets, doesn't that labor sector have a harder time finding productive work than so-called 'knowledge workers' who tend to have a greater breadth of abilities?

I'm not asking rhetorically; I really don't know what to think.

Dan writes:

@don'tsteal
Reducing the payroll tax reduces the price of labor (a business has to match the taxes paid by its employees). Reducing a price leads to a greater qunatity demanded. Simply put, reducing the payroll tax should create some jobs in profitable industries and/or save jobs in industries that are marginally profitable.

As to the profits/reinvestment question, I'm not sure what Arnold would say about profits ameliorating the recession. I think he's more concerned with the subsequent recovery. He doesn't want it to be based on cheap credit and leverage, which was the source of this bubble. That's my two cents.

GabbyD writes:

"Fast forward to now, when 2/3 of the labor force has some college education, and they are a significant component of unemployment. Now, in order to get them back to work you need to add demand that specifically uses their skills. This is a much harder trick to pull off. My Hayekian point is that this sounds like a task better suited to the market, not for Washington--hence my remark about "central planning.""

it depends on the structure of production and the flexibility of college workers.

regarding flexibility, isn't it true that a college educ preps u for practically anything? i.e. a history major can sell mortgages, run a business, a business major can be a writer, etc...

if college grads are flexible, then if you increase demand for workers, then you raise demand for college workers in general...

Chris writes:

GabbyD,

College education prepares you for any entry level job - but how many people that have 10 or even 5 years experience are willing to start all over again with entry level wages?

Even if that wasn't a barrier - how do you increase the demand of entry-level jobs?

GabbyD writes:

@chris

well, on the job experience means its harder for you to get fired. its a stylized fact in labor that the more experience u've got, the more likely it is to retain your job. Robert Shimmer has a nice paper, ins and outs of employment about the relevant empirical analysis.

second, one hypothesized reason for this is that laborers learn on the job. but this learning by doing affects everyone. so its not a skilled worker issue per se -- its an experienced worker issue. so ur 10 year experience guy that happened to be let go will have the same problems no matter what skill level.

we increase demand for entry level jobs by increasing the demand for the industry's output. higher output, more input, one of which is the entry level position kind of jobs.

but ur right -- not all industries are the same as to the expansion of job opportunities, so oversight over what is spent where is key.

Bill Woolsey writes:

Waldeman was interesting--how little he understands.

First, he claims that the macroeconomic scientits aren't really scientists because of lack of testing. I think that Kling's point is that the scientists are interested in explaining business cycles. Figuring out how government intervention might make things better is of secondary interest. It isn't about figuring out what to do. It is about understanding.

He is also complaining about the dominant macroeconomic scientists. They do insist on special kind of complete formalization to count as a scientific theory. But they also do respect empirics and it is done all the time.

An idea that no one has figured out to formalize in the context of intertemporal utility maximization is ruled out of bounds. That the model is inconsistent with causual empirics (start asking everyone you know how much they are saving to pay taxes on the stimulous bill) is also ruled out of bounds.

But if a model is generates results inconsistent with empirics, then they accept that it needs modification.

The engineers, on the other hand, try to figure out how policy tools, like open market operations, impact macroeconomic variables like prices, production, and the unemployment rate. How can the tools be manipulted to get the outcomes desired.

As for the substance-- the Hayekian view isn't that people need to be punished. Or that high unemployed should be engineered so resources can be reallocated.

Hayek (and Kling) believe that there is a desirable resource reallocation now, and that as the resources are being reallocated, there will be higher unemployment. It is similar to the unemployment that would exist if an expansion of trade led to a contraction of import competing industries and an expansion of export industries.

Macro policy either can't or shouldn't interfere with that process.

I think it is obvious. It is being asserted that there is extra structural uemployment at this time. The "natural" unemloyment rate is somewhat higher than usual. Expanding aggregate demand won't fix this problem--whether is is done by some kind of monetary policy or else govenment spending projects.

After working so hard to explain how he believes expansionary monetary policy creates a new allocation of resources that monetary policy cannot maintain and so must eventually be reversed--and calling the revesal the "depression," he mentions in passing a "secondary recession" that he believes is not desirable and subject to correction by monetary or fiscal policy.

And that is what Keynesians and old monetarists are talking about. What Hayek called the secondary depression.

Still, if we combine these ideas, the notion would be that policy should not aim to get unemployment back to the pre-crisis level immediately. If a drop in aggregate demand is causing unemployment, then policy to expand aggregate demand could, and maybe should, fix that. But trying to expand aggregate demand enough to get unemployment immediately back to the pre-crisis level is a mistake. However, it should get close to the level eventually--once the extra large rescourse reallocation is finished.

These "structural unemployment" impacts will be felt in total production as well. As the resources are moving, output will be lower than usual. Eventually, it should catch back up, If low aggregate demand results in output being low, then that can be reversed. But getting output back up to where it was pre-crisis immediately, is a mistake.

It is even true that maybe it will never get back up to its earlier growth path. While resource reallocation and mistakes happen all the time, they always having consequences for long run output. (If no one every made mistakes, we would always produce more, obviously.) If there are an extra lot of mistakes, then the permanent consequences will be large.

So, using policy to get output back to its long run growth path might be a mistake too.

I think there is _no doubt_ that there is a "necessary evil" resource realocation going on now--out of housing construction. And a temporary drop in production due to low aggregate demand because of a very high increase in the demand for money and drop in velocity. The second can (and should) be corrected by policy-- I think quantiative easing is the least bad option. But, the expansion shouldn't be aimed at somehow gettting the unemployment rate immediately back down to 4.8% or output back to its 2006 growth path. That would be a mistake--ignoring the strucural and reallocation problems.

My view is the best way to deal with this is to keep total domestic spending growing at past trend. While I prefer a slower growth path (and so zero inflation on average) the one we had was aimed at 2% inflation. That should be the target and quantitative easing to perhaps a heroic degree should aim at that.

This implies that the reallocation of resourcs would involve some price inflation. That is, stagflation. Slow growth and maybe a drop in production as well as higher structural unemployment when faced with a contant growth path of spending is going to give you price inflations. Nominal incomes would stay about the same in aggregate, but real incomes fall due to the inflation. Well, really due to the reallocation of resources going on.

That panic that led people to hoard money and so result in less nominal spending is something that should be offset. Trying to get home building up to 2006 levels should not be attempted.

Alex writes:

I read some comments of "Bill Woolsey" and I always find them insightful whether I agree or not with them.

Do you (Bill W.) have a blog, a website, or something similar where you put your ideas?

It seems to me your comments often get lost among uninformed or superficial comments.

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