(Almost) everyone believes big falls in NGDP cause lots of unemployment

I haven’t commented on Paul Krugman for a while:

Hiring plunged; job separations also mostly fell, but that was due to a fall in quits rather than layoffs, which rose during the worst of the crisis, then returned to normal levels.

In all such exercises, you’re looking for the “signature” associated with one or another story; and the signature here is clearly the one you’d expect with a general fall of demand. Keynes roolz.

He’s completely right of course, except for that last sentence.  What could he have been thinking?  All the data shows is that negative demand shocks cause unemployment.  Doesn’t everyone believe that?

1.  Friedman and Schwartz certainly argued that tight money causes unemployment.

2.  Hayek certainly believed that falling NGDP causes unemployment.

3.  Robert Lucas completely accepts Friedman’s and Schwartz’s monetarist interpretation of the Great Contraction, and suggested in a recent talk that falling velocity was a big problem in late 2008.

4.  All the old, new, and post-Keynesians believe demand shocks matter.

5.  RBC-types started out denying the importance of money, but latter added nominal shocks to better fit the data.

I’m not saying that there aren’t a few loonies out there who think if the Fed cut M in half and NGDP fell in half that there be no loss of jobs.  That wages and prices would fall just as fast as M.  But surely not more than a handful.

Here’s what everyone agrees on.  NGDP fell in 2009 at the fastest rate since 1938.   Big falls in NGDP cause lots of unemployment.  The only debate is over whether in addition to the demand-side unemployment, there are also some structural problems.  I think there are, although less than many other right-wing economists seem to believe.  But evidence showing that demand shocks cause unemployment tell us nothing about the relative merits of various business cycle theories.

Part 2.  Krugman and Wells need to consult Mishkin

In another recent post, Krugman makes this admission:

. . . finishing the redraft of the monetary policy chapter in Krugman/Wells 3rd edition (how the heck do we get quantitative easing in without totally muddying everything else?)

It’s easy if you have the right model.  Yesterday I taught Frederic Mishkin’s view of monetary policy at the zero bound, and I had the easiest class of my life.  Everything Mishkin has been saying for years came true in September-October 2010, on rumors of QE2.  I’m referring to his chapter 23, where he looks at unconventional monetary policy transmission mechanisms, which still work at the zero bound.  He lists 10.  Here are a few of the 10 he lists:

1.  Monetary stimulus raises stock prices, and hence the Tobin q, increasing the incentive to invest.  Check.

2.  Monetary policy raises inflation expectations, lowers real i-rates, and increases the incentive to invest.  Check.

3.  Monetary stimulus lowers real rates, depreciates the dollar, and boosts exports.  Check.

4.  Monetary stimulus raises asset prices, raises wealth, and hence increases consumption.  Check.

I would add that monetary stimulus raises commodity prices, and hence raises output in commodity industries.  And because it raises prices, it also reduces real wages.  He’s also got 5 credit view channels that I won’t even bother to discuss.

Of course Krugman’s often argued that QE doesn’t really do much more that change the term structure of government debt.  If that’s all it did, he’d be right to be skeptical.  But we now know it does lots of other things to various asset prices, even though the recent Fed move was far less than we needed.

I’d suggest Krugman and Wells just copy Mishkin’s chapter 23.  If doing so means “muddying everything else” up, then he might want to consider re-evaluating whether “Keynes roolz.””



26 Responses to “(Almost) everyone believes big falls in NGDP cause lots of unemployment”

  1. Gravatar of marcus nunes marcus nunes
    11. December 2010 at 12:57

    There are always “structural” elements present. After all the economy is always changing (evolving?). But in the picture I sent you it is very clear that falling AD is responsible for the brunt of unemployment. Rise in lay-offs, drop in hires and quits all begin when “NGDP falls off the cliff”

  2. Gravatar of scott sumner scott sumner
    11. December 2010 at 13:33

    Marcus, I agree.

  3. Gravatar of gnikivar gnikivar
    11. December 2010 at 15:13

    Krugman’s case may sort of make sense (I don’t think it does, but I can see how someone could believe it), but I fail to see how that effects interest on reserves. Negative IOR, means more bank lending, which should increase NGDP.

    As far job losses go, I think its pretty clear that its been a demand shock. More jobs have disappeared from manufacturing and other competitive industries than from government aided ones like health care and education. More faster reduction in NGDP, and I’m guessing even more resources get stuck in the state system.

  4. Gravatar of Britonomist Britonomist
    11. December 2010 at 15:36

    Isn’t it true though that Krugman et al consider Friedman and Schwartz to be a lot more Keynesian than many in the media would have you believe? In that case, is this not another case of you actually agreeing with Krugman after all?

  5. Gravatar of scott sumner scott sumner
    11. December 2010 at 15:44

    gnikivar, I don’t follow your IOR argument, but I agree about the demand shock.

    Britonomist, Recently Krugman has argued that the monetarist model of Friedman and Schwartz’s “Monetary History” has been discredited. I think he’s wrong, but he certainly doesn’t consider monetarists (or Austrians like Hayek) to be Keynesians. Even the pre-Keynesians (Pigou, Hawtrey, Fisher, Wicksell, Cassel) all thought that falling NGDP caused unemployment. There is nothing “Keynesian” about that view.

    BTW, I wonder whether anyone will notice that this post is 10% anti-Krugman and 90% anti-conservative.

  6. Gravatar of OGT OGT
    11. December 2010 at 16:02

    I did, the implications for Andlofatto’s post that Krugman is responding to are less than flattering, for example.

    Interestingly though there may be something to the popular perception that Keynesianism is the primary school of economic thought that is concerned with demand shortfalls. Conservatives know that they don’t like Keynes, so they search for arguments against NGDP’s importance (Why some conservative economists appear to be playing along is a different question).

    BTW, I’d love to see your take on Andy Harless’s latest post denying the existence of monetary policy at all.

  7. Gravatar of Britonomist Britonomist
    11. December 2010 at 16:03

    You’re right, but maybe Krugman was talking about a caricature of Keynesian economics rather than actual Keynesian economics, if that makes sense? After all I see a lot of people (e.g. on that rubbish site American thinker) refer to things like QE2 as a ‘Keynesian measure’. In fact, it seems almost any idea that isn’t strictly supply side is wrongly attributed as Keynesian, not by smart economists, but by angsty journalists (and they would make up a much higher proportion of his blog traffic). Maybe he’s just responding to that? I mean I doubt that Krugman doesn’t realise that any sensible economist, wherever they are on the spectrum, agrees that drops in NGDP leading to unemployment.

  8. Gravatar of Luis H Arroyo Luis H Arroyo
    11. December 2010 at 16:34

    Scott, what do you call conservative? I think that is a big mistake to value economics ideas with political label. I consider myself quite consevative, ad least in economics themes. I am (quasi)monetarist, and quite near Friedman´s ideas. I suppose that it is imposible to name Friedman as non-conservative. I don´t believe at all in the benefits of State intervention or in the advantage of high public expenditure or déficits. I´m no problem in being labeled as conservative, in spite, or precisely because of, to be an universal and quite expanded taboo.
    I remember -thanks to my old age- when Friedman recieved his Nobel prize, He was contested by some young peoples that claims he was a “Fascist”, because his adviser work to Pinochet. Now, we know that his advice trigger the modernization of Chilean Dictatorship and its opening to democracy. Firedman always defended Freedom and democracy. But he was a conservative. As democrat I would say you that Liberty is better defended by the conservative: The individual values flow much mor from this side than from the socialism, incapable of discarding its marxistorigins and colectivists adhesions.

  9. Gravatar of Benjamin Cole Benjamin Cole
    11. December 2010 at 17:10

    Is it my imagination, or has the anti-QE2 clamor died away?
    Is that just the news cycle?

    And notice how the rectitude-y fervor connected to Simpson-Bowles (sooo long ago, like two whole weeks) has evaporated with the giddy embrace of new tax cuts.

    Simpson Bowels? As in Bart? Yuck, yuck, yuck.

    Some righties were saying QE2 was already a flop as interest rates were going up; but when rates rose further after the latest round of announced tax cuts, nary a peep.

    My guess is that Sarah Palinized right-wing is happy for now, and has forgotten QE2. If the Dow keeps going up and the economy keeps growing, I suspect the right will move to other issues, such as the threat of the Taliban, gays, or abortion etc.

    True classic economists and Milton Friedmanites are hoping QE2 will work. I sure hope it does, and I am no Obama supporter–he gets a C+ in my book, though he seems a very decent fellow. Too civilized for this country, in some regards.

    This was another excellent posting by Sumner. I am a full convert to the NGDP camp. I am even more converted to the camp that believes growing real economic output is more important than fancied levels of inflation. If the “best” inflation rate works out around three percent, so be it. We sure grew nicely in the 1990s.

  10. Gravatar of MikeDC MikeDC
    11. December 2010 at 18:00

    LOL at “civilized” Obama and a “Palinized” right-wing. Over the past few days, didn’t Obama just negotiate a deal for a massive and irresponsible tax cut, beyond even extending the Bush tax cuts, call the people he negotiated the agreement with hostage takers, and call his political base a bunch of inane zealots? Why… yes… right before he turned over a Presidential news conference to a former President to go off to a party.

    Meanwhile, the last couple days have seen Palin endorse the Ryan Plan (which is about the only semi-serious plan for getting the government on a long-term sustainable path I’ve seen from any elected official).

    This isn’t an endorsement of her or overall indictment of Obama… it’s mostly to indicate that, at best, reasoned discourse isn’t going to come but through fits and starts from politicians.

    Hell, to get more to the point, take a brilliant economist like Krugman and look at how often his political views drive him well beyond any scientifically supportable view.

    The only logical conclusion to reach from this is to take important decisions, as much as possible, out of these folks’ hands.

  11. Gravatar of gnikivar gnikivar
    11. December 2010 at 18:45

    You are right, I worded what I meant to say terribly. I meant to say the eliminating or negative IOR is potentially much more powerful and direct than quantitative easing. Maybe it is true that the amount of QE necessary is unfeasible, but that probably isn’t the case for negative interest on reserves. On a side note, I suspect negative IOR is a lot tougher to demagogue against than QE. I’ve found people are much more receptive to the idea of NIOR than they are to QE.

  12. Gravatar of scott sumner scott sumner
    11. December 2010 at 18:57

    OGT, At your request I have a new post.

    Regarding conservatives, in this post I’m grabbing them by the shoulders and shaking them; “This is what you believe, remember?!?”

    Britonomist. I agree.

    Luis, My views on economics are certainly closer to those of conservatives than liberals. So I have nothing against conservatives. See my response to OGT.

    I’m a huge fan of Milton Friedman. I’d like to think that I am doing what he’d be doing if still alive and 40 years younger.

    Benjamin, You may be right. If even QE2 plus a big increase in fiscal stimulus still leaves us perilously close to deflation, it’s pretty hard to argue QE2 by itself wasn’t needed. Even more was needed, and still is.

    MikeDC, I agree that the Ryan plan or the Simpson-Bowles plan would be a step in the right direction, in terms of the long term fiscal problem. The easiest way to improve the fiscal situation, however, is easier money. And Palin is opposed. So I’d say I have mixed feelings on her policy views.

    gnikivar, Now I understand, and agree.

  13. Gravatar of CTPete CTPete
    11. December 2010 at 21:33

    Is it possible that point number four “raises wealth” is only a short term phenomenon that will reverse due to inflation or when an asset bubble caused by overinvestment bursts? If that is the case, then does credit expansion used solely as a means to encourage investment potentially cause more harm than benefit because of persistent misallocation of capital?

  14. Gravatar of scott sumner scott sumner
    12. December 2010 at 09:20

    CTPete, Credit expansion should never be used to raise investment, it should be used to raise NGDP. The goal is to keep NGDP growing steadily, which will reduce malinvestment.

  15. Gravatar of Mike Sandifer Mike Sandifer
    12. December 2010 at 12:30


    Do you buy the argument that Robert Reich makes that the shift of wealth upward since the early 80s has hurt sustainable AD, causing consumers to feel they have to borrow more to try to realize/maintain their standards of living?

  16. Gravatar of Mark A. Sadowski Mark A. Sadowski
    12. December 2010 at 12:40

    Scott wrote:
    Krugman quote “Keynes roolz.”

    This ranks as the dumbest statement by a Nobel Prize winning economist this year. (Maybe there should be an award of sorts.)

    And wrote:
    “It’s easy if you have the right model. Yesterday I taught Frederic Mishkin’s view of monetary policy at the zero bound, and I had the easiest class of my life. Everything Mishkin has been saying for years came true in September-October 2010, on rumors of QE2. I’m am referring to his chapter 23, where he looks at unconventional monetary policy transmission mechanisms, which still work at the zero bound. He lists 10. Here are a few of the 10 he lists:”

    etc. etc. Agreed. And I’ve been drumming this chapter into my students more than once this semester. It’s nice to hear we are on “the same chapter”.

    P.S. I apologize for any statements I may have made this year that were “over the line”. I get caught up in the passion of my beliefs from time to time. I have never meant to do bodily harm to anyone except metaphorically. (It get’s me so mad!!!) Happy New Year!!

  17. Gravatar of Bill Woolsey Bill Woolsey
    12. December 2010 at 18:11


    For every borrower there is a lender.

    For every debtor there is a creditor.

    Output generates an equal income.

    Nearly all expenditure is directly funded out of income.

    Credit–borrowing and lending–shifts funds between and mong households and firms.

    There is no need for ever increasing debt for money expenditures to grow. Money expenditures can grow with no debt, with debt growing, or with debt shrink. These just shift who does the spending.

  18. Gravatar of Scott Sumner の最初のエントリ About this blog – 道草 Scott Sumner の最初のエントリ About this blog – 道草
    13. December 2010 at 03:18

    […] とはいえ、Sumner の読者は、これと内容と後日 About this blog に追加されたFAQ(himaginary氏の紹介)を読んでおくといいでしょう。本人もそう言ってます。このFAQもちょっとややこしくて、今回のAbout this blogにコピーを追加しているものの、元のFAQページの方だけアップデートしてたりします(だからリンクを張れば…) というわけで、 ä»Šå›ž About this blog の内容を紹介します(FAQ部分以外)。彼はこの時から気持ちがいいほど一貫していて2008年暮の引き締め(超過準備金へ付利)を問題にし続けています。昨日も(2010.12.11)、そして今日も(2010.12.12。ずっと激賞していたMishkinの教科書↓は改訂で改悪されてしまったとのこと)。  […]

  19. Gravatar of marcus nunes marcus nunes
    13. December 2010 at 08:32

    Steven Williamson agrees with Andolfatto:

  20. Gravatar of CTPete CTPete
    13. December 2010 at 08:52

    Q: “Is it possible that point number four “raises wealth” is only a short term phenomenon that will reverse due to inflation or when an asset bubble caused by overinvestment bursts? If that is the case, then does credit expansion used solely as a means to encourage investment potentially cause more harm than benefit because of persistent misallocation of capital?”

    A: “Credit expansion should never be used to raise investment, it should be used to raise NGDP. The goal is to keep NGDP growing steadily, which will reduce malinvestment.”

    OK, I am still trying to wrap my head around this point so bear with me.

    If NGDP growth (my presumption may be flawed) is primarily a result of incremental increases in total private sector investment much of which comes from borrowed capital, then it could be said that monetary policies encourage (or at least facilitate) or discourage investment which raises or lowers short term NGDP growth.

    So…..is it possible that arbitrary monetary policies intended to expand credit by forcing borrowing costs below free market driven (free floating) rates in the short run can be counterproductive and ultimately cause lower NGDP growth in the long run? It is my understanding QE2 has two stated or inferred goals. a. stimulate inflation and b. drive loan rates to stimulate borrowing and thus increase business investment.

    My concern is that the short term goal of trying to “juice” short term NGDP will be at the expense of long term growth. Malinvestment would seem inevitable in this scenario and future opportunity costs would outweigh momentary gains.

    Would a more sound approach be to allow market demand dictate monetary policy instead of monetary policies dictating market demand?

    The housing bubble may help explain my thinking.

    I assume that there are hundreds of thousands if not millions of homes that are either vacant or occupied by non-paying home owners. Although credit expansion helped fuel the housing boom which translated into significant increases in NGDP, the economy is now coping with trillions of dollars of misallocated capital that did not create real wealth, but only the illusion of wealth.

    All that capital is locked up in those unnecessary and now depreciating over-priced homes. It seems the private sector is unable or unwilling to fund growth opportunities until real demand driven market prices are re-established and government intervention ceases.

    I suspect that most of the NDGP that was realized from the manufactured credit expansion of the previous decade will stifle growth in the coming decade and negate much of if not all of the artificial spike in NGDP.

    Would we have been better off now and into the future if the Fed had let rates rise with demand for credit after 2002 and allowed these floating rates constrict monetary supply and thus limit housing construction, employment, and NGDP growth?

    If it was a bad idea in 2002-2006, then why would it make sense to encourage credit expansion now?

  21. Gravatar of scott sumner scott sumner
    13. December 2010 at 17:26

    Mike, No, as Zimbabwe showed any level of AD is sustainable if you print enough money. That’s not the problem, the problem is getting the Fed to be more aggressive. (You may be confusing NGDP and RGDP.)

    Thanks Mark, And re-reading that I see a typo.

    Marcus, I suppose one can tell a sectoral story for any set of stylized facts, but I think the AD story is far more plausible for the events of late 2008.

    Since he calls himself a monetarist, I assume he would not deny that a sharp fall in NGDP raises unemployment.

    CTPete, NGDP equals C+I+G+NX. The Fed determines the total, not the composition. It’s possible that monetary stimulus would raise I. Whether that comes from borrowed money or from the corporate sector’s huge cash hoards is another question.

    The Fed should not be trying to “juice NGDP”, they should aim for steady growth in NGDP. This should minimize misallocation. Misallocation tends to occur when NGDP growth is unstable.

    You asked:

    “Would a more sound approach be to allow market demand dictate monetary policy instead of monetary policies dictating market demand?”

    We have a fiat money regime. If we allow market demand to determine the money supply, it would be infinite. (Counterfeiters would go wild.) Obviously that’s not what you mean, but think about how the market determines the money supply in a world where only the Fed can legally print dollars. You still need a nominal anchor, or the price level is indeterminate. NGDP is one such anchor, although there are others such as gold, or the CPI. Once you have a nominal anchor, I’m fine with allowing the market to determine the money supply. Let them determine how much money they think will keep NGDP stable.

  22. Gravatar of Mike Sandifer Mike Sandifer
    13. December 2010 at 19:28


    That had been my thought, but I had begun to wonder after reading some people like Reich. Reich has a lot more formal education in econ than I do, though I don’t think his goes beyond the bachelor’s level. He’s an attorney. He’s certainly given to basic economic fallacies at times.

  23. Gravatar of CTPete CTPete
    14. December 2010 at 09:20


    “NGDP equals C+I+G+NX”. I have always had difficulty swallowing this equation for the simple reason that G is the confiscation of private sector assets (present and future).

    This component does not represent an expansion of wealth or production, but instead a mere transfer to a highly inefficient and wasteful bureaucracy. This is why I view “I” as the essential driver of sustainable, long term wealth creation and the bedrock for steady NDGP growth.

    If “I” was reduced to zero and G increased to make up the difference, I contend both C and NDGP would collapse. And vice versa if G was reduced to nearly zero (reality precludes zero) NDGP and C would grow rapidly.

    “If we allow market demand to determine the money supply, it would be infinite.” Would the rising cost of borrowing in a free market in response to increased demand be the governor that limits demand and thus supply? Also, if NDGP growth is considered to be infinite then either the supply of money must be correspondingly infinite or we accept deflation (an idea to which I am not opposed).

    I do acknowledge your point that a fiat currency lacks an “anchor”, but arbitrary Fed decisions based on presumptions of NDGP and CPI cannot fulfill this function.

    CPI, as it stands now, falls short since it excludes too much and inherently lags trends. Also, the Fed (in fact everyone) cannot accurately project future NDGP and is too slow and even reluctant to admit and correct its mistakes.

    My vote is for a tying the dollar to gold or a basket of commodities and ending fiat control and associative human factors.

    BTW, counterfeiters are already going wild. According to the GAO, Secret Service and Federal Reserve data showed that, in fiscal year 1994, of the $380 billion in circulation, $208.7 million had been identified as counterfeit notes. But these phony dollars do not remain in circulation for very long. Foreign and domestic banks and government agencies readily detect and eliminate the vast majority of counterfeit bills.

  24. Gravatar of JimP JimP
    17. December 2010 at 13:00

    The power of money.

    If only Ben had done this two years ago. And now on a bigger scale.

    Will lessons be learned?


  25. Gravatar of JimP JimP
    17. December 2010 at 13:01

    Long lags?


  26. Gravatar of Scott Sumner Scott Sumner
    17. December 2010 at 19:47

    CTPete, The amount of estimated counterfeiting seems low to me.

    The gold standard won’t work in a modern economy.

    JimP, Yes, more evidence the lag issue is overrated.

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