A friend writes to say that Recalculation sounds like an interesting theory, but he finds it hard to explain to others. Below are some thoughts.1. Markets are decentralized. However, decentralization is so non-intuitive that we often resort to fictional characters in our narrative. There is the “Walrasian auctioneer” who brings about market-clearing prices. Another example is in How the Economy Works, where on p. 28 Roger Farmer writes,

Pareto is known to economists for asking the question: Could an omniscient planner reallocate commodities…in a better way than the free market?…

The planner is a fictitious character who symbolizes perfect knowledge.

For Recalculation, the fictional character is an economic boss. The boss has just discovered a big mistake–people who supposedly were doing useful work in fact have been laboring in vain. The allocation of effort needs to be re-thought. While the boss is thinking, lots of people just stand around idle. Being unemployed during a Recalculation is like being on a work site where the boss has temporarily run out of things to tell you to do.

2. Conventional economics makes much use of the phrase, “In equilibrium, …” We say that “we know that in equilibrium, X has to happen.” We do not talk much about the process of getting from disequilibrium to equilibrium. We talk even less about the things that go on while we are out of equilibrium. What makes Recalculation different, and awkward, is that it is explicitly not an equilibrium concept. In that sense, it has an affinity with other heterodox economic views that scorn equilibrium. Austrians who focus on dynamics and creative destruction are in that camp. But so are post-Keynesians who insist that Keynesian economics is a disequilibrium theory.

3. One of the reasons that nobody likes to do disequilibrium theory is that “out of equilibrium, anything can happen.” Disequilibrium in one market can spill over into another market. Rather than converging rapidly and smoothly to equilibrium, markets might move farther away from equilibrium or overshoot equilibrium. The equilibrium concept lets you rule things out. Any disequilibrium story is less precise.

4. Both Keynesian and Austrian theories of business cycles start with a particular type of disequilibrium, relating to the supply and demand for capital goods, viewed in the aggregate. In the Keynesian story, there is an excess desire to hoard for the future. The capitalists lack the “animal spirits” to invest to satisfy this demand to provide for the future, and instead that demand is channeled into sterile money balances. In the Austrian story, the economy suffers from an excess of capital goods, probably brought about by central bank distortion of interest rates, misleading investors into believing that the demand for future consumption was higher than it truly was. Now that reality has sunk in, capital goods producers need to cut back in order to work off the excess.

Recalculation does not require that capital goods per se are in excess supply. Instead, I think of particular types of human and physical capital losing value. Suppose that we had a sushi fad that went out of control, so that lots of entrepreneurs built sushi restaurants and trained to become sushi chefs. When it turns out that sushi is not quite so popular, other uses need to be found for the restaurants and the chefs.

5. Reallocation of resources is taking place all the time, even when the aggregate unemployment rate is low. Taking the preceding example, the movement of resources into the sushi industry was a reallocation, also. So the question about Recalculation as a story for recessions is what makes them so sharp and severe. Why is adjustment to a boom any harder than adjustment to a bust? I have given two answers.

a. One answer is speed–that a boom tends to take place slowly, while a bust takes place quickly. Imagine that in any industry in any point in time, the short-run supply curve is kinked. It is steeply sloped to the right, and flatter to the left. If demand goes up, in the short run it takes a while for new supply to enter the market. At first, you see a big price response, and only gradually do you get a quantity response. However, if demand falls, it is easier for the industry to cut back on output and employment than to reduce wages and prices. Yes, this is a Keynesian story, and yes, it deserves further explanation.

b. Another answer is availability of information. In a boom, you know where resources need to move to. You don’t know where resources need to move from, but that is not a terribly hard problem for markets to solve. Nobody has to leave their old job until they have already found a new one. On the other hand, in a bust, you know where resources need to move from, but you do not know where resources need to move to. People get laid off without knowing where to find a new job.

6. I do not think of the recalculation story as describing either a demand shock or a supply shock. It is a story about adjustment. As such, I think we ought to be agnostic about the effects of fiscal and monetary policy. The recalculation story does not rule out the possibility that they could speed the process of adjustment. However, it does not offer the sort of reassuring precision that is provided by Keynesian multiplier analysis or faith in a stable velocity of money. Other people want to talk about how more government spending or more money growth changes equilibrium. Recalculationists have to re-cast the question, because we do not think in terms of equilibrium.