Bryan Caplan  

Sumner Channels Yglesias Against Jones

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Garett Jones is one of the most Sumnerian macroeconomists I know.  But he's not Sumnerian enough for Sumner.  Sumner channels Matt Yglesias to question the importance of Garett's debt deflation mechanism (or to be more precise, debt less-than-expected-inflation mechanism):
Debt prices are not sticky at all (check out the bond market.)  I believe Garett is referring to debt payments, which are sticky.  That's true, but they aren't prices.  Debt coupon payments are sunk costs and benefits that have almost no effect on the incentive to produce output at the margin.  Even worse, any impact they do have goes the wrong way.  A debt crisis often makes people poorer.  But we have a lot of evidence that leisure is a normal good, and hence people work harder when they are poorer.  Americans used to work six day workweeks.  If I became bankrupt, I'd work much harder, I wouldn't take a vacation.
Touche.  Debt deflation is a serious macro problem.  But with flexible wages, it would cause rising employment as people struggled to make their debt payments.  This could in turn conceivably spark a downward spiral of labor income (higher employment reduces wages, possibly reducing take-home pay, exacerbating deflation).  Yet as far as I know, this specific conceivable downward spiral has never occurred.

COMMENTS (7 to date)
Scott Sumner writes:

Where do you think Matt gets all these great macro insights? :)

(Seriously, I don't know if Matt got it from me, we tend to think alike.)

Garett Jones writes:

There are many paths from debt deflation to unemployment--though I don't mind the sticky wage channel as part of it. Here are 3:

1. Relationship macro, which Fisher drew on himself. Bankruptcy has supply-side effects, disrupting patterns of trade and making some workers nearly useless in the short run. They get thrown back into the search pool.

2. Sticky prices + Leontief production functions: Jobs are recipes, and if people are buying less real output, companies linearly scale back on the flexible inputs, including workers. Short-run production functions are probably less substitutable than long run production functions, since it takes time to figure out how to prudently use cheaper means coming up with a new recipe, and that's expensive.

Example: Just look at the restaurants that have converted from table service to fast food since 2008: That didn't happen overnight. It took time to switch Leontiefs....

3. A version of 1, noted by Fisher: Amid bankruptcy and asset fire sales, productive assets wind up in the wrong hands...they wind up in inefficient hands. So for a while, capital is less productive, until the invisible hand gets assets back to their highest uses. That can get you an RBC-style bad productivity shock, pushing down wages. Flat labor supply curves (either from worker pickiness, a simple substitution effect, or sticky wages) turn lower productivity into lower employment.

I teach aggregate production functions and big-picture AD-AS models, and they have a lot of insight, but the paths from aggregate disruptions to job breakups (I use that term intentionally) are many.

People may be encouraged to work harder during a debt inflation, but that does not imply employers will be willing to hire more workers. Part of the issue that arises with debt is the divergence between the price at which creditors expect to get repaid and the cost that debtors expect to have to repay. If debt deflation reduces demand for certain goods, then the reduction in income will cause employers to hire less people and/or offer lower wages, regardless of the willingness of employees to work harder.

Nathan Smith writes:

Bryan, I don't think you're allowed to use the word "Touche" on someone else's behalf. To say "Touche" is to concede a point, but since you're not the one who made the point, you don't have the right to concede it.

Nathan Smith writes:

Thanks for the defense of debt-deflation. Very astute. I tend to think that Fisher's response to the Great Depression contributed more to the sum of human knowledge than Keynes'. He may have added more. He certainly subtracted a lot less.

Mr. Econotarian writes:

"Yet as far as I know, this specific conceivable downward spiral has never occurred."

Even during the Great Depression? This guy differs...

The depression out of which we are now (I trust) emerging is an example of a debt-deflation depression of the most serious sort. The debts of 1929 were the greatest known, both nominally and really, up to that time.

They were great enough not only to "rock the boat" but to start it capsizing. By March, 1933, liquidation had reduced the debts about 20 per cent, but had increased the dollar about 75 per cent, so that the real debt, that is the debt as measured in terms of commodities, was increased about 40 per cent

Jobs are recipes....

They're more like ingredients in recipes. They're a cost, not a benefit.

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