Arnold Kling  

The Recalculation Model in a Journal

I Just Pre-Ordered The Cart... Irony in the News...

Brad Cornell writes (don't expect the link to work smoothly)

The recession is due primarily to a widespread mismatch between current conditions and previous plans, relationships, and contracts. As a result, consumer desires, resources, and production technology are also misaligned. That misalignment has been greatly exacerbated by the collapse of financial intermediation. The best path for the government is to promote aggressive recognition of losses and a restructuring of the financial system. To the extent that the government becomes involved in restructuring financial institutions, it should avoid any unnecessary wealth transfers from taxpayers to the security holders of the financial institutions. Beyond that, the realignment process is best left largely to private agents. The government has neither the necessary information nor the proper incentives to do the job.

Cornell is known as a finance guy, and he cites Fischer Black as his main influence. Alex Tabarrok forwarded the link to me and said that I should have been cited, but of course my thoughts are derivative of Black's also. I am sure that the Austrians will want to jump in and claim some credit, for which they are entitled.

Cornell's article appears in The Economist's Voice, a legitimate peer-reviewed journal, started by Joseph Stiglitz and Brad DeLong. That doesn't make the Recalculation Model the winner over Keynesian macro, but having it in a journal does give it a certain level of legitimacy. Krugman cannot just sneer "hangover theory" and dismiss it out of hand.

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CATEGORIES: Macroeconomics

COMMENTS (20 to date)
Steve Sailer writes:

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.

pushmedia1 writes:

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?

pushmedia1 writes:

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.

fundamentalist writes:

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.

Greg Ransom writes:

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

Greg ransom writes:

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.

pushmedia1 writes:

"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?

pushmedia1 writes:

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

Andy writes:

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

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

Lord writes:

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

Jim writes:


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.

bgc writes:

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.

Doc Merlin writes:

Now for the obligatory comment.

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

-Doc Merlin/Jorge Landivar

anon writes:

[Comment removed for supplying false email address. Email the to request restoring this comment. A valid email address is required to post comments on EconLog.--Econlib Ed.]

Daniel Kuehn writes:

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.

fundamentalist writes:

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.

pushmedia1 writes:

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

pushmedia1 writes:

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

fundamentalist writes:

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.

Doc Merlin writes:

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.

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