Arnold Kling  

Morning Commentary

PRINT
Reagan's Medicare Bill... Body Scans and WikiLeaks...

On three links from Mark Thoma, on macro theory, the euro, and the stalled housing market.

1. Nick Rowe writes,


If people could trade goods and labour directly at zero transactions costs, without having to use monetary exchange, all Keynesian macroeconomics would be total rubbish. All Keynesian macroeconomics, either explicitly or implicitly, assumes monetary exchange. It's not just sticky prices that generate Keynesian results. It's sticky prices plus monetary exchange.

He then goes through an elaborate modeling exercise to demonstrate this. I have a simpler version. If barter were possible, then firms would pay their workers in goods. If you can pay your workers in the goods and services they produce, then you eliminate any wedge between the real wage and the marginal product. So there is full employment. QED.

This is one reason why I prefer to think of the macroeconomic problem in terms of patterns of sustainable specialization and trade. With the PSST model, I think of a recession as resulting from existing trade patterns not being sustainable, which means that new patterns have to be discovered. Until those patterns are discovered, people are unemployed. If workers were paid in the form of their output, they would not know what to do with it. They do not know how to discover the patterns of specialization and trade. So barter solves nothing in the PSST model. In my view, the PSST model stays away from a number of intellectual traps, of which money vs. barter is just one.

Another way to put this is that the types of models Rowe is talking about assume away all sorts of costs of discovery and co-ordination in creating PSST. In the Keynesian paradigm, the patterns are there, it's just that the aggregate wage and price are out of line.

The advantage of the aggregate wage-price misalignment theory (in its Keynesian or monetarist incarnations) is that you can solve unemployment with fiscal and monetary policy. That makes a lot of economists, including me, wish that aggregate wage-price misalignment were true. But unlike Prad Krulong, I am not adamant that it is true. In my mind, it has a chance of being that is more than zero but less than fifty percent.

2. Antonio Fatas writes,


I think that it is healthy to question our priors on the importance of the exchange rate in explaining some of the empirical phenomena we observe these days in Europe.

Yesterday in my high school econ class, I found myself trying to explain why having a separate currency that could depreciate would enable the PIIGS to live happily ever after. I made the textbook argument, but I found myself not so convinced. OK, so maybe you can tell a story where one country that has a recession and a large fiscal deficit would be better off with devaluation. But there are so many countries in that position right now, and they cannot all devalue.

Speaking of "cannot all devalue," doesn't the impact of the PIIGS crisis completely nullify QE2? If the dollar appreciates 10 percent and the foreign sector is 10 percent of the economy, then that represents 1 percent disinflation, which probably more than wipes out any inflationary impact of the Fed's new bond buying program.

3.Vernon Smith writes,


New housing expenditures started to recover in 1934, buoyed perhaps by Congress's creation of the Home Owners Loan Corporation (HOLC). This agency bought underwater home mortgages and reissued them at values that were based on prevailing home prices.

The reason that you might want the HOLC in 1934 is that there were people living in houses who actually belonged in those houses. That is not true in the current crisis. Many do not live in the houses. Others who live in them were counting on price appreciation to overcome the fact that they had bought houses that were way to expensive relative to what they could afford. The housing market today is choked with speculators.

The current crisis calls for a different sort of policy response. I would propose a Resettlement Agency, to move people out of houses that are inappropriate for them. Get the excess housing inventory on the market where everybody can see it, let it get absorbed, and then we can finally move on. Until that happens, the housing market is going to be paralyzed.


Comments and Sharing


CATEGORIES: Macroeconomics



COMMENTS (15 to date)
Floccina writes:

No number 2 wouldn't competitive devaluation in a non gold standard world be good?

Alex J. writes:

The currencies can't all devalue relative to each other, but they can all devalue relative to everything else e.g. goods, services, debts, sticky wages and prices.

Brian writes:

Arnold, have you worked on a DSGE framework for your PSST model? Not necessarily a working one, but just an outline of the moving parts it requires.

jsalvatier writes:

One thing I don't think you emphasize enough is that PSST and monetary-disequilibrium are not mutually exclusive theories. One could explain some recessions or part of recessions and the other (or another theory) could explain others or other parts of recessions.

jsalvatier writes:

I remain convinced that you don't really grok the logic of monetary disequilibrium theories of recessions. Go read Nick Rowe's old posts. Monetary disequilibrium theories are *NOT* based on relative exchange rate effects, and *NOT* based on the substitution effect (if a good is higher priced, people substitute away from it). Monetary disequilibrium based theories are based on people spending less as they try to accumulate higher real cash balances. Until you understand this, you're going to continue to look foolish when criticizing existing macro.

Arnold Kling writes:

Jsalvatier,
I would suggest you wait to see how Nick Rowe responds himself. Your comment has no bearing on what is under discussion here.

You would be better served not calling me a fool on this topic.

azmyth writes:

"Speaking of "cannot all devalue," doesn't the impact of the PIIGS crisis completely nullify QE2? If the dollar appreciates 10 percent and the foreign sector is 10 percent of the economy, then that represents 1 percent disinflation, which probably more than wipes out any inflationary impact of the Fed's new bond buying program."

That sounds like a good thing. QE2 shouldn't create 10% inflation. Maybe QE2 was necessary to maintain stable prices in the face of the Euro crisis. I would rather the central bank not frame its actions as one time massive money printing excercises, but rather as stating a target and doing their best to hit that target in the face of severe shocks. If they miss, it's excusable, but why not let people know at least what you are aiming for?

Lord writes:

You like to blame unemployment on the unemployed. Others would blame it on the employed. If the economy is less productive, real wages should fall allowing employment to rise and their failure to do so is what creates unemployment. New PSST may have to be found to return real output to what it was, but there is no reason for prolonged high unemployment than market failure.

Lewis writes:

"If workers were paid in the form of their output, they would not know what to do with it." What does that mean? Is a sustainable economy one where steel workers know what to do with batches of steel? Is sustainability falsifiable? Or is it specific enough to measure something else on a rubric of sustainability?

I think you once said that a sustainable pattern of trade and specialization is one that depends on comparative advantage. But usually comparative advantage is just assumed. A lawyer might actually be able to mow the lawn better than a yard worker, but just because he chooses to hire a yard worker doesn't mean he's reallocating his time to producing legal services as in the textbook. It's still comparative advantage, though, because we infer whatever he spends his time on is worthwhile, at least in a private sense.

As long as people are voluntarily engaging in transactions, I don't see how one pattern is more "sustainable" than another if sustainability depends on comparative advantage. Comparative advantage is itself an inferred idea most of the time.

Currently, sustainability just looks like Monday-morning quarterbacking. If NGDP drops, then the previous arrangement was unsustainable.

Nelson Woodard writes:

Arnold: I share your view of how to think of the current macro situation. As a markets guy, I spend a lot of time looking at the function of capital markets. In thinking about QE2, I did a quick calculation of world capital needs relative to capital availability. If the Fed wasn't buying Treasury debt, who would be buying and at what price. In my view, there is a shortfall of available capital in the world to fund the total of deficit spending at "workable" prices ( it easy to calculate where Japan would be in they had to pay 3-5% on their debt.) My fear is that the world level of debt is not sustainable. The US level of GDP, produced by high levels of debt, may not be sustainable. The path that the Fed is taking may well be their view of the least cost method of bringing the economy back in line.

Nick Rowe writes:

Arnold, jsalvatier: Peace be upon you both!

Three points:

1. When I say "Keynesian macro only makes sense under monetary exchange, and makes no sense under barter", I seem to get two very different reactions:

A. "That's obvious; everyone knows that. The unemployed could just barter their labour (which they can't sell) for goods (which the firm can't sell)".

B. "That's totally false! It makes no difference for Keynesian macro if we assume monetary or barter exchange!"

Arnold clearly belongs to the first group. But I am currently desperately arguing with two commenters on my blog who belong to the second group. They think that New Keynesian macro works just as well in barter. And these two are seriously trained in economics, and can run rings round me in formal theory, I think. They can't be alone.

I just can't make it out!

2. It's not quite clear from what you say Arnold, (I think this is what jsalvatier was getting at), but you can get a deficient demand recession and unemployment *even if the real wage W/P is at the right level* (as long as barter is ruled out). For example, in a simple model of aggregate demand, W/P can be right, but if M/P is too low, you get unemployment (that barter could fix). I'm not sure if you knew that or not. Methinks you probably do. Some people don't.

3. I only partly understand your PSST model. That said, I have a hunch that PSST and monetary vs barter exchange may be related. It's hard finding PSST. It would be even harder to find PSST if we had to use barter as well. Maybe that is (partly) what you are saying?

Anyway, thanks for the response!

Nathan Tankus writes:

"The reason that you might want the HOLC in 1934 is that there were people living in houses who actually belonged in those houses. That is not true in the current crisis. Many do not live in the houses. Others who live in them were counting on price appreciation to overcome the fact that they had bought houses that were way to expensive relative to what they could afford. The housing market today is choked with speculators." frankly Mr kling, i think you're not very familiar with the housing market in the 1920's and 1930's if you think that it was driven by people who were living in their houses. There is so much to say about this i don't know where to start. first there was a housing boom (and eventually land boom) in florida in the 1920's that was based on speculation that was just as slimy and sometimes criminal as now. Remember one of the schemes that Charles Ponzi is so famous for is selling tiny tracks of land to investors and promising huge profits. the land was actually swampland very far away from where he claimed it was. second although they didn't have a crazy technical securitized financial market based around mortgages, they did have balloon mortgages very similar to sub-prime loans now that were used to deceive or defraud borrowers. i could go on and on and on but i will not. i will ask you to delve a little more into the literature on the housing market in the 1920's and 1930's. john kenneth galbraith has a decent account of all this in his "the great crash:1929" book

jsalvatier writes:

@Arnold Kling
You're probably right I was too rude.

To clarify, I was talking about #2, not #1. #1 is obvious. I've made a fuller criticism here: http://goodmorningeconomics.wordpress.com/2010/12/01/559/ I provide another example of what makes me think you don't understand the mechanism by which money based macro works.

fundamentalist writes:

Could you guys get me up to speed on neo-Keynesian econ? paleo-Keynes said that the animal spirits of businessmen caused depressions. Is the neo-Keyensian position that the desire to hold more cash causes depressions?

Kling's PSST is very close to Hayek's cycle theory. As Hayek wrote, equilibrium requires perfect coordination of all actors in the economy, not only in terms of price, but in terms of timing and quantities as well. Perfect coordination requires perfect knowledge, so we never achieve equilibrium. Prices in a free market get us as close to equilibrium as possible. In a market constrained by state intervention, prices are so distorted that coordination is possible only by accident. At time, prices are so distorted that coordination totally breaks down and we have a depression. That's my spin on Hayek, not Hayek directly.

fundamentalist writes:

Could you guys get me up to speed on neo-Keynesian econ? paleo-Keynes said that the animal spirits of businessmen caused depressions. Is the neo-Keyensian position that the desire to hold more cash causes depressions?

Kling's PSST is very close to Hayek's cycle theory. As Hayek wrote, equilibrium requires perfect coordination of all actors in the economy, not only in terms of price, but in terms of timing and quantities as well. Perfect coordination requires perfect knowledge, so we never achieve equilibrium. Prices in a free market get us as close to equilibrium as possible. In a market constrained by state intervention, prices are so distorted that coordination is possible only by accident. At time, prices are so distorted that coordination totally breaks down and we have a depression. That's my spin on Hayek, not Hayek directly.

Comments for this entry have been closed
Return to top