I agree that there is a flight to quality. Professor Lucas says that one way that people attempt to buy safe securities is to spend less on consumption goods. That makes sense -- but the same logic implies that people should work harder (earn more) as another means to accumulate those securities. The facts show that people are working less. Barro and King (1984) explained it best -- the basic puzzle of recessions (this one included) is that consumption and leisure move in opposite directions. Wealth effect and intertemporal substitution effect explanations of recessions (Professor Lucas' story is one example) imply that they move together.
That's why I believe that the "flight to quality" is a symptom rather than a cause.
Professor Lucas arrives at the conclusion that the Fed should print money. Despite the arguments above, I agree that such a Fed policy would do more help than harm.
Professor, why should labor supply be an issue here given that most adjustment happens at the extensive margin and not at the intensive margin (for institutional and technological reasons which are irrelevant at this point) and since the puzzle you reference might just be primarily a side product of assuming preferences with additive separability across time and states of nature? (Fisher Black is someone I would take to have argued this forcefully.)
ReplyDeleteFinally, it's really difficult, if not impossible, to understand recessions (as opposed to efficient fluctuations) within a framework of clearing spot labor markets with perfect information in which case we should expect to see behavior inconsistent with such a setup in the first place.