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I don't quite agree with Jason Furman today
I very often do, but I think he overreaches when responding to Steven Landsburg (who himself overreaches). Jason writes:
...there is near universal agreement (and if it were not for you I probably would not have needed the word "near") that when the economy is operating below its productive capacity the problem is insufficient aggregate demand, and the solution is to temporarily boost spending or investment through monetary or fiscal policy.
Usually, yes. Sixty percent of the time, I will agree. But sometimes real shocks and sectoral shifts are the problem. Can expansionary monetary policy help an economy adjust to sectoral shifts? Sometimes but not always. Is Furman correct that deregulation won't help in the short run? Yes. Is "the solution...to temporarily boost spending or investment through monetary or fiscal policy"? Probably not. The solution is for the economy to adjust. The flow of investment is hard to encourage and the best monetary policy can do in such instances is to prevent a deflation. If the government can do something to help short-run sectoral adjustments, it is usually clarity of expectations and legal and regulatory benchmarking in the interests of transparency. Today that means clear standards for future lending and securitization.
As an aside, if you are someone who complains about stagnant American median wages, that means many particular nominal and real wages have been falling. (It could be in theory that the entire distribution is strictly stagnant but in reality no.) Tricky distinctions between real and nominal wages lie beneath the surface, but overall this flexibility of wages makes it harder to embrace the Keynesian framework. Keynesianism requires sticky nominal wages and since we have been having low inflation times (until now, at least) that means relatively sticky real wages as well. Yet it is claimed implicitly that many real and nominal wages have been falling. Beware the Keynesian who wants to have it both ways (I'm not accusing Jason of this).
Posted by Tyler Cowen on February 1, 2008 at 11:07 AM in Economics | Permalink
Comments
I find this strange. The quote says that all (or nearly all) economists agree on this concept of using monetary and/or fiscal policy as a short run stimulus to increase aggregate demand in the economy. Perhaps they are a small percentage, but isn't this leaving out Austrian economists?
I would like to see a debate between you (who agree 60% of the time apparently) and Pete Boettke or somebody who could represent the Austrian position.
Posted by: liberty at Feb 1, 2008 12:11:21 PM
The Austrians certainly wouldn't agree that the problem is "insufficient aggregate demand". The problem is malinvestment, for which little demand exists, and for which demand should absolutely NOT be artificially created through policy.
As with the internet bubble, Austrian theory is vindicated by the housing bubble. Massive increase in the money supply -> distorted investment, this time in housing -> collapse -> adjustment. Also as before with the internet bubble, the central bank (which initiated the inflation in the first place) is attempting to prevent the adjustment phases, thus perpetuating the cycle.
Posted by: Noah Yetter at Feb 1, 2008 12:17:55 PM
I thought that Keynesianism required sticky wages in the short run. In the long run, wages could still fall as people move to different jobs.
Posted by: jsalvati at Feb 1, 2008 12:47:32 PM
"There is near universal agreement ... that when the economy is operating below its productive capacity the problem is insufficient aggregate demand"
No.
Financial shocks, real shocks, asset bubbles, ...
Posted by: PJ at Feb 1, 2008 12:47:56 PM
if you are someone who complains about stagnant American median wages, that means many particular nominal and real wages have been falling. (It could be in theory that the entire distribution is strictly stagnant but in reality no.)
another possibility for average (real or nominal) wages to be stagnant is to have a sector with high wages to contract and a sector with low wages to expand, with each particular wage slightly growing or stable
Posted by: mic at Feb 1, 2008 12:56:50 PM
Who determines and how do they determine if the economy is operating below its "productive capacity"? It seems dangerous to aim for some target output and tax and spend if output is below that level. Haven't we learned from all the banking crises throughout history, the stagflation of the 70s, and the recent attempts to spend or inflate our way out of downturns that there is something fundamentally wrong with 1) having the government and the pseudo governmental banking system control the money supply and allocation of loans and 2) aiming for some optimal output and trying to tinker with the economy using the banking system or government spending when output is perceived to be suboptimal.
Posted by: conservative of progress at Feb 1, 2008 1:22:19 PM
Thanks for the compliment. In some senses my statement was tautological. And there is near universal agreement that tautologies are true.
When I first started graduate school I loved reading about the micro-foundations of macroeconomic models, and in particular New Keynesian ones. But then it seemed to me like the problem had been solved sufficiently that for everyday purposes I could just use the macro models. I thought that some of the leading solutions, like small menu costs for prices, are not inconsistent with stagnant wages. But I’ll think more about it. That said, I’m much more guilty of one of the sins you identified. The evidence clearly shows that median compensation, properly measured and adjusted with an accurate inflation measure, has been growing – just not as quickly as productivity or mean compensation.
Posted by: Jason Furman at Feb 1, 2008 1:52:17 PM
Jason argues that property adjusted real compensation has been rising.
The official data shows real compensation rose 0.91%, 0.67% and 0.64% over the past three years.
But this data is deflated by the CPI and because of the very low weight
the CPI gives health care that is a very poor measure to use to deflate compensation. In the CPI total health care has a 5%-6% weight and health insurance has a weight of 0.37% or 0.36%, depending on which CPI you use.
With health care accounting for a much larger share of labor compensation--something more on the order of 5% to 10%-- in recent years and now 16% of GDP the CPI has been a particular bad measure to use to deflate labor compensation and obviously causes the reported data to significantly overstate real compensation.
maybe Jason would like to explain why he think the official data understates real compensation. Remember, health insurance alone is one of the most important reasons total compensation is much larger then wages and salaries.
Posted by: spencer at Feb 1, 2008 2:23:06 PM
I *often* operate below my productive capacity. Sometimes I need to, sometimes I'm screwing up, sometimes I'm feeling perverse, sometimes I feel like I need a day off. Some days I just have no interest in even addressing the "productivity" thing. Good riddance to it.
Anyway, is there any reason to think that "operating at its productive capacity" is always and everywhere a good or desirable thing for an economy? It isn't for me as an individual.
And, as Conservative of Progress asks, how can we possibly know what the economy's "productive capacity" is? Doesn't that the give the person in charge of measuring "productive capacity" an awful lot of power?
Posted by: Michael Blowhard at Feb 1, 2008 2:55:10 PM
Spencer just because we spend more in healthcare does not mean that the costs are inflating. It may be that we are buying more.
Posted by: Floccina at Feb 1, 2008 3:58:17 PM
Floccina I did not say that the rate of cost increases reported in the CPI is wrong. I am well aware that the price of health insurance includes both real growth and higher prices.
What I pointed out is that it only a weight of 0.3% to 0.4% in the CPI
and since health care costs are rising faster then overall inflation this creates a very strong bias in the deflator for compensation.
Do you want to take the position that health insurance only has a weight of 0.3% of total labor compensation? I do not think you would get very far with that argument with any businessman who is making those payments.
Posted by: spencer at Feb 1, 2008 4:24:15 PM
Floccina -- my argument is that in deflating the benefits portion of labor compensation health insurance should have a weight of somewhere between 25% to 75%, not under 1%.
Can you provide any evidence that that is incorrect?
The CPI base is 1982-84 equals 100. The overall index is now 211.1 while the index for medicine is 358.8. So by giving that segment where price increases have been greater then the average such an unrealistic low weight the real compensation estimate massively overstates the real increase in fringe benefits. In no way am I arguing that all the increase in health insurance is for prices, but a large portion is.
Posted by: spencer at Feb 1, 2008 4:38:38 PM
By "problem" I suspect Jason meant "cause"? I cannot see how insufficient (how much is sufficient?) aggregate demand could be responsible for either the housing or dot-com booms. Both were very clearly and obviously caused by terrible investments.
Or does Jason mean the recovery (re-allocation of capital, labor, etc) from these events is slowed due to insufficient aggregate demand?
Posted by: Grant at Feb 1, 2008 4:48:15 PM
Another point of correction: Keynesianism doesn't "require" sticky nominal wages. Keynes said he believed nominal wages were flexible but real wages were sticky, and you can specify systems of equations where the aggregate demand problem is manifested in excatly that way. For example, you can have a model where low aggregate demand causes nominal prices and wages to fall, but the two fall at the same rate. As a result, the real wage does not change and unemployment isn't alleviated.
Posted by: steve at Feb 1, 2008 5:15:57 PM
...there is near universal agreement (and if it were not for you I probably would not have needed the word "near") that when the economy is operating below its productive capacity the problem is insufficient aggregate demand, ...
Count me as another observer who took it for granted that few people think this way anymore.
An economy operates below its productive capacity for exactly one reason: the capital of the economy is not allocated to the productive uses people are demanding.
The present slowdown, for example, is because significant capital has been invested in houses no one wants to live in. The problem won't be fixed until the lower prices and the lost apparent wealth percolate through the economy.
...and the solution is to temporarily boost spending or investment through monetary or fiscal policy.
People can discuss the technical reasons why or when this approach will or will not work. But it would work mostly by accident. Giving people more (apparent and transient) wealth will not make them want what the capital is misallocated to produce any more than before. Perhaps an intentional demand pulse helps by providing a quick and strong signal indicating what new investments of capital should be redirected to.
But believing that insufficient demand is the cause of recession is loony -- unless, of course, you believe that "insufficient" translates to "incorrect", with blame left to be assigned.
Posted by: MikeP at Feb 1, 2008 5:48:18 PM
MikeP,
But believing that insufficient demand is the cause of recession is loony
I think "loony" might be putting it mildly. I'd say "bat-sh*t crazy", although I don't think Jason meant to say the cause of the recession was insufficient aggregate demand.
Although while we are on the subject, can anyone point to a single recession which was caused by a drop in aggregate demand alone?
Posted by: Grant at Feb 1, 2008 7:01:35 PM
Perhaps aggregate demand drops for a reason: Fischer Black's theory of mis-match. People choose to produce goods they think others will value at a certain price. They turn out to have been wrong, and there's a downturn. Maybe pumping money into the banking system increases noise and the chance of mis-match.
Posted by: conservative of progress at Feb 1, 2008 7:08:05 PM
I don't quite follow the last paragraph. It says that it's inconsistent for someone to believe that wages are stagnant and also advocate a policy that assumes sticky wages.
I guess I don't buy the argument that "stagnant" and "sticky" are somehow in conflict with one another. They do sound an awful lot alike.
In particular, if the median wage is stagnant it does not follow that some wages are falling. The distribution doesn't have to stay the same, either--it may be that the high end is running away while everyone else stays the same. If that's happening, then the vast majority of wages may still be highly sticky, no?
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