Saturday, January 3, 2009

The Economic Content of Politically Correct Business Cycle Analysis

  1. An economic tautology says that all market fluctuations are explained by some combination of preferences, technologies, and market distortions.
  2. A recession is defined (by NBER) to be a reduction in the quantity of employment.
  3. It is political incorrect to blame a significant part of recession on a reduced preference for working.
From these three, basic logic implies that either (a) the preference for working never falls, or (b) that it falls only at times when it is fully compensated by demand increases (that it, it only falls during non-recessions).

(b) seems like a remarkable coincidence, so we must conclude that the preference for working never falls.

Moreover, given that the preference for working never falls, the same logic implies that the preference for working never increases, or else (after 1000s of years of the human race) all we would do is work.

Political correctness makes labor market analysis easy -- we only have to study demand and distortions; supply can (and must) be ignored!

I really should stop fighting the utter neglect of supply, and instead appreciate its productive value.


Angry at the Margin said...

Professor, you have been the target of a lot of ad hominems over the last few months because of your views, but it doesn't seem OK to answer them with ad hominems of your own.

Most of the profession will be more than happy to acknowledge the prime importance of (labor) supply at low frequencies.

It just happens that few people are willing to drink the Kool-Aid w.r.t. what intertemporal elasticities are required to have employment fluctuations of the right magnitude at "cyclical" frequencies. That, plus we have theories which make more sense (for some), as far as cyclical fluctuations go.

Finally, let me point out that you haven't address the problem of "involuntary" unemployment, i.e. the existence of people who are willing to work at the prevailing wage and that cannot, due to lack of vacancies.

If I happen to believe that unemployment (in the involuntary sense) is real and I happen to disbelieve that we're experiencing a wave of laziness, does that make a politically correct fool?

Tino said...

“people who are willing to work at the prevailing wage and that cannot, due to lack of vacancies.”

If there are no vacancies than that’s hardly the “prevailing wage” now, is it? You may mean that it’s the prevailing wage for those who have jobs.

The interesting question is if workers are willing to work at the lower wage that is required for the market to reach equilibrium. Often they are not, and rather wait it out (unemployment). To give a simple example unemployment in the auto industry WOULD NOT BE AN ISSUE if workers were willing to take a (say) 25% wage cut. They are not, so they may risk unemployment.

The market sometimes adjusts through quantities, rather than prices, but it’s still a market, and it’s still follows the rules of supply and demand.

There are jobs where there really is involuntary unemployment, often at the top, due to agency reasons. You can’t get an executive position even if you offer to work at 90% less than the prevailing wage. I have heard about the same phenomenon in finance. But it is atypical.

I don’t have strong views about real business cycle theory. The problem is that Keynesians sort of identified part of a real phenomenon of psychology driven business cycles, but have lousy theories.

What is interesting is that people give the benefit of the doubt to the literal translations of Keynesian model explanation of business cycles (as Mulligan pointed out monopoly power, which is just ridiculous) but refuse to give the benefit of the doubt to the literal interpretation of real business cycle theory (tastes, technology).

This is despite the fact that Keynes “animal spirits” (which there clearly is something to) are much closer to preference changes than monopolistic competition or the deux ec machine of the Keynsian models.

What economists probably should do is:

1. go back to Fisher, and the balance sheet and leverage explanation (households as a whole try to increase savings while firms are cutting investments, which creates asset deflation with multipliers) What seems to make most sense for is groups psychology. What we observed in the financial sector at least was a Fisher crisis.

What I never heard my teachers or textbooks explain is why exactly the link between saving and investment is broken during recessions or upswings.

2. Integrate Diamonds coconut model of multiple equilibrium better with other theory, especially regarding the timing of investments. Business cycles are, as liberals never understand, only about shifting growth, not changing the actual level . Exclusion policy response The crisis of 2008 will have about zero effect on the expected level of per capita gdp 2018.

A simple Diamond model doesn’t work in this cycle, by the way, as Mulligan pointed out productivity is going up while the number of hours is going down, if a Diamond setting my productivity is increasing in the number of hours so they should move together

Lastly, if one accept mass psychology as a driving force the correct policy prediction is to calm everyone down, not exaggerate the problems for political or other purposes or through panic spending measures a la Bush and Obama.

77% of the public agrees that the media is making the crisis worse by projecting fear.

Angry at the Margin said...

Tino, there are many considerations that one can bring to bear on this issue but my point was pretty straightforward.

There's no way to square an analysis based on clearing, competitive markets with the existence of excess (labor) supply. -- There's a strong sense in which downturn unemployment is involuntary, i.e. excess supply, and therefore analyses based on clearing, spot labor markets are misleading (e.g. you end up talking about the "unwillingness" to work of people who are queuing for menial jobs).

buermann said...

Maybe it'd be less "politically incorrect" if you suggested some believable reasons for why the labor supply appears to be shrinking? Your audience over there sounded personally insulted.

E.g.: there are over 12 million households with negative equity locking them into their homes, which would pretty drastically reduce labor mobility. Isn't that consistent with your model?