Today I’ll link to a post by Bryan Caplan, and then a couple comments from my previous post. Here is Tyler Cowen discussing wage flexibility:
Keep in mind that unemployment rates today are disproportionately concentrated in low-income and low-education workers. Haven’t we been told, for years, that these same individuals are seeing some mix of stagnant and eroding wages? That they are experiencing downward mobility? That the real value of health care benefits has been falling and that more and more jobs don’t offer health care benefits at all?
Doesn’t that mean…um…their wages aren’t so sticky downwards? And thus Keynesian economics is not the final story?
And here is Bryan’s response:
The obvious responses:
1. The erosion we’ve been told about for years is supposed to have taken years to happen. Three or four decades, actually. Even staunch Keynesians probably think that the labor market could right itself over such a long timespan.
2. This erosion took place alongside positive inflation, year after year. It’s perfectly consistent with complete nominal rigidity. Consider: Between January 1978 and January 2008, the CPI (set to equal 100 for 1982-4) rose from 62.5 to 211.1 – enough to reduce constant nominal wages by over 75% in real terms. Tyler mentions the real-nominal stickiness distinction later in the post, but it doesn’t enter into his analysis.
Overall, I think Tyler’s completely wrong here. Ticker-tape flexibility in the labor market wouldn’t solve all our economic problems overnight, but would quickly solve the unemployment problem.
This is pretty close to what I would have said. I’m not sure complete wage flexibility would eliminate cyclical unemployment, but I think it would greatly reduce it.
BTW, the sticky-wage theory of business cycles does not predict that industries with flexible wages will have lower unemployment during recessions. Rather industries that produce acyclical goods will tend to have lower unemployment. Surprisingly, if the wages of factory workers are quite flexible, and the wages of health care workers are quite sticky, it is still likely that factory workers will suffer higher unemployment during a recession. To see why just consider a thought experiment where money and NGDP fall by 10%, and the economy is 50% health care and 50% manufacturing. If health care wages are sticky, and output is stable, then nominal spending on factory goods will fall by about 20%. Unless factory workers accept a 20% nominal pay cut (i.e. 10% lower real wages) they will suffer higher unemployment. A more plausible outcome is that both prices and output fall in the manufacturing sector.
In my previous post I suggested that Obama erred in allowing two Federal Reserve Board seats to lie empty for a year and a half. A commenter named Ted finds a plausible explanation for this mistake:
I’m wondering if Larry Summers is telling Obama nothing can be done on the monetary front. I remember in a paper he wrote at least two decades ago where he argued against a long-run zero inflation target partially on the grounds that we needed to avoid a “zero interest rate trap.”
He appears to be pushing that view recently as well too:
“In settings where an economy’s level of output is constrained by demand where the Federal Reserve is unable to relax that constraint, fiscal policy will through the multiplier process have significant impacts on output and employment. … Moments like the present – when the economy faces a liquidity trap and when the Federal Reserve is constrained by a zero bound on interest rates, and when the financial system is functioning imperfectly because of credit problems in financial intermediaries and because of overleveraged borrowers – are moments when these conditions, for fiscal policy to have an expansionary impact, are especially likely to obtain.”
“Economists in recent years have become skeptical about discretionary fiscal policy and have regarded monetary policy as a better tool for short-term stabilization. Our judgment, however, was that in a liquidity trap-type scenario of zero interest rates, a dysfunctional financial system, and expectations of protracted contraction, the results of monetary policy were highly uncertain whereas fiscal policy was likely to be potent.”
Assuming he’s as influential and overbearing as the press reports him as (as if I can trust that?), then he might have already convinced Obama there is nothing that the Fed can do and any argument to the contrary is silly because the effects of monetary policy may be, in Summers words, “uncertain” where as fiscal policy is “potent.”
I don’t think I even need to comment here. Even Krugman, DeLong and Yglesias have called on the Fed to raise its inflation target.
I once heard a (possibly apocryphal) story, which goes as follows: Sometime around 1978 Jimmy Carter asked his economic advisors if there was any downside from the dollar’s recent depreciation in the foreign exchange market. No one spoke up. Can anyone confirm that story?
This is a comment made by Luis Arroyo:
Is not J Taylor a cheat?
See http://johnbtaylorsblog.blogspot.com/where he use Zolti/$ data To prove that it has not depreciated in 2009. But REER and Zolti/euro data say clearly that it does depreciate.
see the true data in my blog.
No, John Taylor is not a cheat; I don’t doubt he is sincere in the views he expressed. But unless I am mistaken, Luis is correct. I wasn’t able to find the graph in Luis’s blog, but just looking at the graph in Taylor’s post, it seems obvious to me that the zloty must have depreciated substantially against the euro, which I presume is Poland’s most important trading partner. I must say that I find Luis’ explanation to be far more plausible that Taylor’s. Yes, it’s good that Poland had its house in order when the crisis hit. But surely there were other Europeans countries that also had sound macro policies in 2008.
PS. If Luis or someone else can find the graph he refers to, I’ll provide a link.
Update: Indy sent me this link. The zloty clearly depreciated against the euro during the key period of late 2008 and early 2009. (And this occurred despite the fact that the euro depreciated against the dollar in late 2008.)