Hamilton hits the nail on the head:
…[I] disagree with some of my colleagues is in their presumption that wage or price rigidities are the core frictions that are responsible for producing the present situation. I have in my research instead stressed technological frictions. For example, when spending on cars abruptly falls, there is a physical, technological challenge with getting the specialized labor and capital formerly employed in manufacturing cars into some alternative activity. In my mind, it is a mistake to pretend that any federal program is capable of immediately re-employing those resources into an alternative, equally productive enterprise. More fundamentally, I have suggested that our present situation is as if someone had quite successfully sabotaged the basic functionality of our financial system. Until we once again have a financial sector that can successfully allocate credit to worthy projects, we're not possibly going to be able to produce as much in the way or real goods and services, no matter what the level of aggregate demand or stimulus package might be. In terms of the textbook Keynesian models that people play with, I'm suggesting that "potential" GDP growth for 2009:Q1– that growth rate which, if we try to exceed it by stimulating aggregate demand, we primarily just get more inflation– is in fact a negative number. I do not accept the proposition that there is a level of government spending– however large a number you choose to suggest– that will prevent the unemployment rate from rising above 8%. But I do believe that if the government borrows a sufficiently large amount, we will have to worry in a very concrete way about what will sustain the foreign demand for U.S. assets.
Hamilton continues by noting that such a position is quite compatible with spending to maintain state and local government expenditures with block grants, fundamental infrastructure spending on things like the electric grid and working hard to restore the financial sector.
But rushing through new government spending plans, just for the sake of spending? Count me off of that bandwagon.
“Until we once again have a financial sector that can successfully allocate credit to worthy projects,”
Ummm, when was the last time we had such?
No one has ever chartd a ‘potential GDP rate of growth’ quarter by quarter in a way that made even rough sense. But technical/managerial frictions in adjusting to changed circumstances are real. There is no way the US economy (nor many others) could avoid contraction in 2009 Q1.
Back in the days when recessions were generally caused by over accumulations of stocks of goods in the economy, the technical frictions were subsuned in the stocks adjustment. Nowadays we need to take notice of them.
And macro-economists should probably stop worrying (or at least worry much less) about price and pay rigidities. Those rigidities are robust features of all developed economies. At micro level, they appear to add value. We had better get used to living with them.
Interesting. Thanks for posting this. David Vanhoose and Carl Gwin also find that price stickiness doesn’t seem to be the thing going on in downturns. (see here). But I hadn’t heard of this alternative explanation. One thing I don’t understand from what Jim says, though, is that if there is a left-ward shift in the potential output (longrun aggregate supply) curve, then why aren’t we seeing rising inflation? If AD is downward sloping, and Y* is vertical, then a leftward shift in Y* causes us to move up the AD curve, corresponding to an increase in measured inflation. But right now we’ve got measured deflation.
For those of you hearing this concept for the first time (and especially those that find it intriguing) what is being put forth is essentially the second half of the Austrian Business Cycle Theory.
Sounds like “heterogeneity of capital” to me. Otherwise known as “the Austrians were right all along.”
Alex,
As some of the earlier commentators have noted, a lot of this sounds like nails that were already hit into place by the Austrians. (Now in fairness, Hamilton’s JPE paper came out a long time ago, so it’s not as if he’s recycling recent comments by Austrians on capital heterogeneity.)
So I’m surprised that neither you nor Arnold Kling even compared/contrasted the two. Is Hamilton saying something different, for example, from what Mario Rizzo has been saying for months over at ThinkMarkets? If he’s not, that’s fine–I think Rizzo has been right and so I’m glad others are catching on!
But normally bloggers put somebody’s ideas in context of the discussion, and so I’m surprised that people aren’t saying whether Hamilton is subscribing to ABCT, or if he’s actually talking about something else.
Hamilton is closer to a version of real business cycle theory with reallocation than to ABC (see also David Lillien’s work on this approach.) Of course, many theories may agree on key points. Tyler and I have also been hammering these points in many posts over some time. I thought Hamilton put it all together in a nice way.
“technological frictions” as the cause of labor and resource unemployment = HAYEK
In the IT world, while there certainly is lots of specialization, a DB admin in the financial industry can become a DB admin in the health industry. A developer of architectural CAD software can become a CAD developer in the solar power industry. There is specialization, but often there are plenty of transferable skills.
I wonder how specialization is a curse in manufacturing. My impression is that most Detroit workers are now “robotic worflow planners” but “Chevy Suburban exhaust manifold assember”.
PCLE: Here you go:
http://www.econbrowser.com/archives/2008/12/the_auto_downtu.html
http://www.econbrowser.com/archives/2009/01/december_auto_s_1.html
Don’t mean to spoil this Austrian kool-aid party here, but the entire process was far more elegantly described by Minsky.
Silas,
Good point about the financial system. I tried in vain to tell people during the dot-com boom that silicon valley was printing money, because people were accepting stock as payment for real goods. Minsky recognises the money creation process happens all the time, in a variety of ways. When this process stops, we have problems.
to mickslam
Were is the deflation to this point? Housing prices could not, and should not, stay above affordability levels for the population. They were a bubble waiting to burst.
This massive debt will need to be paid. How do you do it? Raise taxes and drain resource from the economy? Or inflate the currency?
In order to attract foreign capital we will need to raise interest rates. We are financing this massive debt with an ARM.
We are leaving a large toxic pile of debt to our children. Why?
So Alex,
The parts of Hamilton’s post you clipped were 100% Keynesian.
Does this mean you’re a Keynesian after all and you didn’t realize it? There are a lot of reasons why Keynes was right. And almost everyone who thinks he was essentially right agrees that the underlying mechanism is uncertain and likely multifaceted.
You’re cherry picking.
Hi,
http://www.marginalrevolution.com – da best. Keep it going!
Charlie
Hello,
Can i take a one small pic from your blog?
Have a nice day
I hope you also are against the idea that the rest of the country pays California’s state expenditures. Jim Hamilton lives in California but has not addressed the serious financial crisis of his state government.
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