The Recalculation Model in a Journal

I guess haven't been following this academic dispute closely enough, but are you saying that your "recalculation model" of recessions is barely even heard of within academia?

That's bizarre. That's the most damning thing I've heard about economists in years. They must not have much experience in managing businesses.

What are the Recalculation theory's implications for inflation?

In most theories real shocks (like a recalculation) don't result in decreases in the price level. But post-September 2008 we saw declines in the price level even deflation (and large declines in output of course). Declines in the price level and output are associated with demand shocks in most standard models.

Was the Recalculation responsible for the mild recession we had before September or for the whole thing?

Steve, it depends on the professor's answers to my questions above, but I believe he's just relabeling what economists call "real shocks" and giving a nice intuitive story for them.

pushmedia1: "In most theories real shocks (like a recalculation) don't result in decreases in the price level."

That's because mainstream economics (shockonomics) doesn't have a theory of money. In recalculation macro, people recalculate because they have lost wealth in bad investments, such as housing. The lost wealth an uncertain climate cause businesses to reduce borrowing and further decrease the money stock. The falling money stock and increased demand to hold money due to uncertainty, causes prices to fall.

The recalculation story is good as far as it goes, but it only explains why the depression hangs on. It doesn't explain how so many businessmen made so many errors in calculation in the first place. For that, you need the Austrian business cycle theory.

When will economists credit BIS chief economist William White for identifying these recession / unemployment causing coordination problems _before_ the onset of the bust?

Steve -- econ models with more than one capital good have been banned in economics for more than 60 years -- more than one production good models are mathematically intactable, so economists pretend that heterogenous production processes don't exist. This is the central innovation of 'Keynesian' economics.

"The lost wealth an uncertain climate cause businesses to reduce borrowing and further decrease the money stock."

Do you mind unpacking that? I get that in an uncertain climate investment declines. What happens from there?

Greg, simple searches on google scholar seem to contradict what you're saying. What do you mean by heterogeneous production?

"Krugman cannot just sneer "hangover theory" and dismiss it out of hand."

I think you're seriously underestimating Mr. Krugman here.

Deflation as the cure? Not likely. But can it be prevented if everything implodes? Not likely. Inflation is our friend.

pushmedia1,

Greg's talking about heterogeneous production goods. The papers in the google search you link too deal with heterogeneous agents or heterogeneous firms, but they still deal with stocks of capital (k) and labor (l). Heterogeneous capital goods can't be summed up into an aggregate stock of capital k any more than heterogeneous firms can be added together into an aggregate stock of firm-stuff f.

Aside from being the best explanation, the Recalculation Model has a great name.

It reminds me of the comic sci fi radio program/ novel etc. The Hitchikers Guide to the Galaxy, by Douglas Adams - in which the earth and the people on it are a gigantic organic computer constructed to calculate the ultimate question.

Now for the obligatory comment.

Dude, you are so an Austrian.
(It had to be said)

-Doc Merlin/Jorge Landivar

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As much as Krugman complains about this sort of stuff, this seems very reminscent of Keynesian concerns about planned vs. actual investment and the old "general glut" controversy.

Are there deep roots that connect recalculation and Keynesian theory? Because honestly it's the Keynesian in me that has attracted me to your explanations as opposed to the Chicago or Austrian explanations.

pushmedia1: "I get that in an uncertain climate investment declines. What happens from there?"

The money stock is made up of currency and deposits in banks. The ratio of currency to deposits is about 1:20, so bank deposits make up most of the money and most of that is loans. So when businesses quit borrowing, repay loans, or default on loans, the stock of money declines, or doesn't grow. When the quantity of money falls relative to output of goods/services, prices fall. That's the loose quantity theory of money.

Of course, falling prices then make it harder for debtors to repay loans and causes more defaults and business failures. We enter a deflationary spiral that continues until prices have fallen enough that people with money see real bargains and start buying again. Then prices recover and confidence returns.

I'll put in a plug for Hayek's Ricardo Effect here: prices fall faster than wages, so wages are increasing relative to prices, making wages too high for makers of consumer goods. To boost profits, they buy labor-saving equipment, such as computers and software, from capital goods makers and the recovery is on its way.

So if the Fed is doing its job, money supply wouldn't fall. The recession was caused by mistakes made by the Fed?

Jim, this model has "an infinite number of sector-specific differentiated intermediate inputs".

pushmedia1: "So if the Fed is doing its job, money supply wouldn't fall."

That is the monetarist (Friedman and Sumner) view of things. But from the Austrian perspective the Feds can't do anything about the fall in money. For one, as Friedman himself pointed out, the lags between Fed policy implementation and its effects are too long. By the time the policy takes effect, the economy is recovering on its own and the added money only causes the next bubble. Also, monetarists take the quantity of money theory to literally. They believe it works mechanically: the Feds lower interest rates or buy bonds and the money supply automatically increases. In the Austrian view there is only a tendency for such things to increase the money supply and raise prices. It's not automatic and not immediate.

pushmedia1: "The recession was caused by mistakes made by the Fed?"

Yes, but not the mistake of keeping interest rates too high before or during a depression, as monetarists think. The mistake is to lower interest rates too low (below the market rate) in an effort to rescue the economy from a depression. As I mentioned, due to the long lags in effectiveness of Fed policy, loose monetary policy does not help during a depression and ends up boosting an already recovering economy and causing another bubble. Fed policy has proven to be pro-cyclical throughout its history, contray to their intentions. If the Feds did nothing but keep the Fed rate at say 5% and never buy or sell bonds, bubbles and busts would virtually disappear after awhile.

No they wouldn't, fundamentalist.

Pro-cyclical behavior and groupthink is pretty standard in humans. Some guy has a good idea, everyone tries to copy him. You get overshoot in the investment, stuff comes crashing down. The same story most of the time.