Arnold Kling  

Recalculation and State and Local Relief

Clarification on my Punk'd Epi... Mad About Trade...

Tyler Cowen finds and responds to some criticisms of the Recalculation story.

Avent and Yglesias suggest that Kling is making up his own macro but the innovation is simply to call the adjustment process "recalculation," to give it a more Austrian gloss.

He mentions plenty of predecessors to the sectoral shift story. I would add James Tobin's AEA Presidential Address on inflation and unemployment. For that matter, the old Lucas-Phelps "island" model is an adjustment story. I am pushing the Recalculation story hard because I think that it is a mistake to try to do macro with a one-sector model where all off us work at GDP factories. I want the profession to emerge from what Krugman calls the Dark Age of one-sector, representative-agent, rational-expectations models.

The point of the Recalculation story is not to argue against stimulus. In fact, I am in favor of stimulus. The Recalculation story may help support the kind of stimulus that I favor, which is an immediate cut in the employer contribution to the payroll tax. I do not see how any story can support the kind of stimulus that was passed, where much of the spending will not take place until 2011 and after.

The Recalculation story does not tell you whether relief for state and local governments is a good stimulus idea. But it does lead you to ask whether it is right to think of state and local governments as 50 Herbert Hoovers or 50 Wesley Mouches.

For those of you who do not know, Wesley Mouch is a fictional character in Atlas Shrugged who increases government control over the economy. Herbert Hoover is also a fictional character, whose policies are laissez faire and balanced budgets. (There was a real President Herbert Hoover, but he was interventionist and ran deficits.)

State and local governments obtained a lot of revenue during the boom--higher home prices do tend to raise property tax revenues. So payrolls and pension plans expanded, average government salaries rose relative to average private sector salaries, state universities competed for top-drawer professors, and school systems held onto incompetent teachers. If you think that ought to continue, then you should favor aid to state and local governments to get them through this period of low tax revenues. If you think that has to change at some point, then stimulus funds will better help recalculation if they are distributed to other sectors.

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COMMENTS (9 to date)
winterspeak writes:

ARNOLD: Are you being serious? In California, inmates are being released from prison, and hospitals are shutting down because the Government has no money. Obama will let California repair potholes on the Federal dime, but not run prisons, hosptials, or schools.

And your solution is to turn off the pothole money too and say "go recalculate yourself!"?

Please tell me what the difference is between cries of "go recalculate yourself" and Mellon's "Liquidate labor, liquidate stocks, liquidate farmers." At least Mellon lived during a gold standard, so his point kind of made sense. No excuse in our fiat world.

Greg Ransom writes:

Guess what? Lucas says he was trying to get back to a Hayekian micro/recalculation explanation with his New Classical work -- he explicitly cites Hayek's micro/recalcation based macro as the paradigm behind his own work.

Arnold writes:

" the old Lucas-Phelps "island" model is an adjustment story"

I'd add that Lucus utterly botched it as an attempt to bring genuine micro back to macro, for the reasons Arnold suggests.

Greg Ransom writes:

Hayek's position is exactly Arnold's:

"The point of the Recalculation story is not to argue against stimulus. In fact, I am in favor of stimulus .. "

quadrupole writes:

Winterspeak: Seriously, you don't know the traditional government spending cut game? They *always* cut bone and leave fat. That encourages the electorate to allow them to raise taxes.

A classic example was in North Carolina during the dotbust. They closed threatened to close the schools for the blind, reduce aid to the mentally retarded, etc. At the same time they were spending hundreds and hundreds of millions of dollars and easily identifiable pork that was never ever ever anywhere near the chopping block.

When governments are in financial trouble they *always* cut essential services, they never cut pork.

California in this case is no different.

Dan writes:

"Herbert Hoover is also a fictional character, whose policies are laissez faire and balanced budgets. (There was a real President Herbert Hoover, but he was interventionist and ran deficits.)"

Great line. It boils my blood when I see someone talking about "neo-Hoover" policies, or some other such nonsense.

jeff writes:

Steinglass accuses Dr Kling of thinking too "deterministically" about things, but he then goes on to state that if we throw enough stimulus money at (his example) high-energy electric motor companies, sooner or later we'll have a vibrant, self-sufficient high-energy electric motor industry.

Which is allegedly a good thing, but I'm not aware of any massive unfulfilled demand for high-energy electric motors.

Yancey Ward writes:

When you boil down a lot of the objections to the idea of recalculation being a massive undertaking, it comes down to this fundamental faith- that there are mostly "innocent" economic participants being forced to downsize by the adjustment being made in, for example, housing.

Take, for example, the idea that federal funding f state budget shortfalls is a good idea that doesn't hinder the recalculation. Seriously, does one have to point out that these state governments were growing their budgets and payrolls the last 15 years on the back of the huge credit induced bubbles in, first, technology stocks and then real estate? These are not "innocent" participants that are in a hole due to no fault of their own. The same applies to durable goods producers/vendors- their increased sales were a direct result of the credit bubble, in thousands of different ways.

winterspeak writes:

Yancey: Most of the 10% unemployed are innocents economic participants being forced to downsize by the adjustment being made in non-govt sector savings.

Quadrupole: I am no fan of how California is run. But while we're getting rid of incompetence with a purging fire, why not clean up the tenured Professorship at every major econ department in the US? They have proven themselves to be clueless as well.

Richard Ebeling writes:

If you look beneath the macro-aggregated surface to the underlying microeconomic processes at work in the market, then it is impossible not to appreciate it that during the "boom" period it is not just "demand" that was inflating the now burst balloon, but a variety of particular demands upon which the newly created Federal Reserve money and credit was being spent.

Relative profitabilities were modified, resource allocations (including portions of the labor force) were changed, and the structure of relative prices and wages were impacted.

Once the boom ended, many of the projects and employments artificially generated by the easy money years inevitably were going to be shown as unsustainable. Supply and demand relationships are found to be different than they appeared in the boom period.

This inescapably requires reallocations of misallocated resources (including labor), the writing down of investments now found to be less or unprofitable. And wages and prices must adjust to reflect the actual patterns of demand to which the means of production should be properly oriented.

Standard macro frameworks tend to hide and deflect attention away from an understanding of these necessary microeconomic adjustment processes if there is to be restoration of sustainable market coordination and growth in the years ahead.

Richard Ebeling

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