My macroeconomic framework, circa 2015

by on November 13, 2015 at 12:44 am in Economics, Uncategorized | Permalink

A while ago Scott Sumner laid out at least part of his framework, I thought I should lay out some key parts of mine.  Here goes:

1. In world history, 99% of all business cycles are real business cycles.  No criticism of RBC can change this fact.  Furthermore the propagation mechanism for a “Keynesian business cycle” (arguably a misleading phrase) also relies on RBC theory.

2. In the more recent segment of world history, a lot of cycles have been caused by negative nominal shocks.  I consider the Christina and David Romer “shock identification” paper (pdf, and note the name order) to be one of the very best pieces of research in all of macroeconomics.  Sometimes central banks tighten when they shouldn’t, and this leads to a recession, due mainly to nominal wage stickiness.

3. Workers are laid off because employers are often (not always) afraid to cut their nominal wages, for fear of busting workplace morale, or in Europe often for legal and union-related reasons.

4. Overall I favor a nominal gdp rule for monetary policy.  But most of its gains would come in a few key historical episodes, such as 1929-1932, or 2008-2009.  In most periods I don’t think we know what the correct monetary policy should be, nor do we know that it matters.  Still, that uncertainty does not militate against an ngdp rule.

5. Once workers are unemployed, nominal wage stickiness is no longer the main reason why they stay unemployed.  In fact nominal wage stickiness is largely taken out of the equation because there is no preexisting nominal wage contract for these workers.  There may, however, be some residual stickiness due to irrational reservation wages, also known as voluntary unemployment due to stupidity.  (You will find a different perspective in Scott’s musical chairs model, which I may cover more soon.)

5b. Monetary stimulus to be effective needs to be applied very early in the job destruction process of a recession.  It is much harder to put the pieces back together again, so urgency is of the essence.

6. The successful reemployment of workers depends upon a matching problem, a’la Pissarides, Mortensen, and others.  Yet this matching problem is poorly understood, and it can involve a mix of nominal and real imperfections.  Sometimes it is solved more quickly than expected, such as in the recent UK experience, and other times more slowly than expected, as in current Spain.  Most of the claims you will read about this reemployment of workers are wrong, enslaved to ideology or dogmatism, or at the very least unjustified.  Hardly anyone wants to admit this.

7. Really bad recessions involve deficient aggregate demand, negative shocks to intermediation, some chronic supply-side problems, negative wealth effects, and increases in the risk premium, all together.  It is hard to find a quick fix.  Furthermore models where AS and AD curves are independent and separable are often misleading, despite their analytic convenience.

8. Given that weak AD is only one of the problems in a bad downturn, and that confidence, risk, and supply side problems matter too, the best question to ask about fiscal policy is how well the money is being spent.  The “jack up AD no matter” approach is, in the final political equilibrium, not doing good fiscal policy any favors.

9. You should neither rule out nor overstate the relevance of Hayek and Minsky.  Their views have much in common, despite the difference in ideological mood affiliation and who — government or the market — gets blamed for the downturn.  For really bad recessions, usually both institutions are complicit to say the least.

10. All propositions about real interest rates are wrong.

There is more, but I’ll stop there for now.

1 ChrisA November 13, 2015 at 1:00 am

“There may, however, be some residual stickiness due to irrational reservation wages, also known as voluntary unemployment due to stupidity.” – I think that stupidity is probably not the right way to describe this. Working is not only a cost, in many cases it is a reward in itself. That is people often would work just because they enjoy the sense of purpose. But people don’t want to be thought of as patsy’s, and if you offer them something significantly less than what they think they should get, then the sense of purpose is lost. This is a genuine loss, so the effective compensation, when you offer “insulting wages” is actually a lot lower than just the lower wage suggests. So it is hard to say that there is a genuine welfare loss when people refuse to work for lower wages. They would not actually be happier working at these wages than staying at home and living on a low budget.

2 dan1111 November 13, 2015 at 1:46 am

Furthermore, how are workers supposed to know what their market value is? What if they settle for a low paying position, but the next day they would have gotten offered a higher paying one? There is a huge amount of uncertainty and no way to measure relative probabilities of getting jobs with different pay. Their previous salary is at least one data point about their market value.

“Stupidity” is a particularly harsh term here.

3 Kevin Dick November 13, 2015 at 2:18 am

+1 From the worker perspective, it may be hard to know whether their true market value has declined or potential employers are engaging in strategic bargaining behavior. The Myerson-Satterthwaite Theorem may prevent even perfectly rational actors from consummating a beneficial employment transactions. Let alone normal humans.

Perhaps during normal times, the prevailing wages provide a behavioral anchor that facilitates transactions in relatively narrow ranges around those wages. But once expectations become unmoored, the problem looks more like the Myerson-Satterthwaite conditions. Bumping up against the math of impossibility would hardly be “stupidity”.

4 dan1111 November 13, 2015 at 2:44 am

Yet another factor: evidence shows that a lot of people do not save any money, meaning they have a lifestyle built to depend on their previous salary level. Taking a job with slightly lower pay might mean bigger costs than one would think just by looking at salary difference alone: the new salary level might require big lifestyle changes, or even lead to catastrophic consequences like bankruptcy or losing your house.

In such circumstances, refusing a lower paying job might be more rational than it first appears to be.

In the linked post above, it is stated that “those who had nontrivial savings at the start of the study” were more likely to lower wage expectations, supporting this view.

5 ChrisA November 13, 2015 at 3:38 am

Dan – surely in this example (of having to make drastic lifestyle changes) it would be better to take the lower paying job than no job at all? If I understand you correctly your model is that once you have taken a job, you can’t continue to look for a more higher paying one? Which doesn’t seem correct to me. Perhaps you mean there is a signalling component – if you take a low paying job, this may signal to other potential employers that they also don’t need to pay you higher wages. But that signalling model only works in the case where there is not really a competitive job market and employers make salary offers on the basis of societal norms. Which may be true in some places, like say academia or government, but in industry I would guess long term wages are set more by competition.

6 MC November 13, 2015 at 4:07 am

People who do not save any money are stupid, which results in magical thinking that they are likely to get another job at their previous wage rate.

7 Ricardo November 13, 2015 at 5:56 am

“surely in this example (of having to make drastic lifestyle changes) it would be better to take the lower paying job than no job at all? If I understand you correctly your model is that once you have taken a job, you can’t continue to look for a more higher paying one?”

The practical problems with this strategy are both the signalling problem you mention as well as the risk of being seen as a job-hopper. In real-world hiring situations, employers often weed out candidates using simple heuristics. The trade-off that anyone who has ever been unemployed will know too well is that waiting too long before accepting an offer means you have the dreaded “resume gap.” But being too quick to accept a sub-par job that you intend to leave in less than a year makes you a job-hopper. If the position is also more junior than one’s previous job, it also means you won’t have the sort of “career progression” that more selective employers will look for in your next job search.

8 Cyrus November 13, 2015 at 7:05 am

The line of causality between beliefs about future income and past lifestyle expenses seems backwards here.

Under a lifecycle savings theory, net savings occur when current income exceeds future expectations. So former savers had expectation of a future decline in income while they were saving, and when it happens, moves on.

The person who believes current income is near lifetime normal is not the net saver.

9 Bernard Yomtov November 13, 2015 at 8:25 am

Under a lifecycle savings theory, net savings occur when current income exceeds future expectations. So former savers had expectation of a future decline in income while they were saving, and when it happens, moves on.

This may apply over a very long term, with saving for retirement being one example, but it doesn’t seem accurate to me in other contexts. Do 30-year olds who save money really do so only because they expect to run into problems in their 40’s? That strikes me as dubious.

10 dan1111 November 13, 2015 at 8:30 am

@ChrisA, practically speaking, accepting a job significantly hampers your ability to search for another job. The time you can spend job-hunting drops dramatically, and making time during the day for an interview can be a real problem for people with normal work schedules. Taking time off (for an unspecified reason) just after starting a job will be very difficult. This is in addition to the signaling and job-hopping aspects already mentioned. I agree that signaling by itself is a fairly weak explanation, but there is probably at least some truth to it.

11 dan1111 November 13, 2015 at 8:33 am

@MC some, but not all. Plenty of smart people get into trouble simply because of undiscipline.

12 Gochujang November 13, 2015 at 8:36 am

I think the stupid/irrational in 5 is kind of a tip-off that this macro framework is not real comfortable with living, breathing, humans.

The RBC is about rational adjustment to exogenous shocks – except for the pesky humans in the system.

13 Gochujang November 13, 2015 at 8:43 am

Re. Savings – that is one they say has a strong genetic component. That should make it harder for those of us who do save to claim virtue.

It should also imply a macro which recognizes a population with varied proto-economic biases.

(The girl who skips rent to buy an iPhone may be “irrational” but an economic theory must still include her type)

14 Thelonious_Nick November 13, 2015 at 11:32 am

“Re. Savings – that is one they say has a strong genetic component. That should make it harder for those of us who do save to claim virtue.”

Bravery, discipline, orderliness, etc., likely all have strong genetic components. Are those also not true virtues, then?

15 Gochujang November 13, 2015 at 11:54 am

It is well established that bravery is overcoming fear, and so too the others, overcoming one thing or another. Diet is overcoming appetite. Training is overcoming sloth.

16 Gochujang November 13, 2015 at 12:16 pm

And of course this applies in that we should beware Economics which depend on people overcoming too much, too often. That isn’t us.

17 Brian Donohueb November 13, 2015 at 11:04 pm


In this life, there are ants and there are grasshoppers.

Social Security is a pro-ant policy. I think it goes far enough.

Beyond that, grasshopper-away if you’re so inclined! You won’t have a great retirement, but you won’t starve.

18 John November 13, 2015 at 10:01 am

I think there is another aspect. No idea if it’s discussed in labor economic lit or not. Pay within large corporations is not a pure market set price but is also a political distributional process. Perhaps entry pay is market and then the growth a combination of the external market and the distributive process of the internal market. I’m not sure how well that gets teased out in the wage theory.

19 mike November 13, 2015 at 10:30 am

“Furthermore, how are workers supposed to know what their market value is?”

How about that old democratic favorite: collective bargaining?

20 Floccina November 13, 2015 at 1:57 pm

Open books management might help with that.

21 ChrisA November 13, 2015 at 3:58 am

“In most periods I don’t think we know what the correct monetary policy should be, nor do we know that it matters.” – massive depression in 1930’s, sky rocketing inflation in the 1970’s, near financial system collapse in 2008 and super slow growth, all caused by bad monetary policy. And we don’t know that it matters?

22 mike November 13, 2015 at 12:41 pm

Sure it matters. The question is: “How much?” A lot of pain aswell as secular stagnation could have prevented by the sensible fiscal policy of infrastructure investment spending.

The demand pump must be primed. No business is going to expand until it sees some sign of a demand for its goods. In the standoff among spenders/investors, someone has to move off the dime, and this someone is the guvment. We know how to do it.

23 BC November 13, 2015 at 4:36 am

5 and 5b) I’ll look forward to Tyler’s take on Scott’s musical chairs model, in particular why the Fed’s late-to-the-game QEs did seem to coincide with decline in unemployment, as predicted by musical chairs model, rather than increase in inflation and nominal wages with no gain in employment, as would be predicted if nominal wage stickiness was no longer important once the unemployment rate was high. As Scott points out in the linked post,

total labor compensation = W * hours_worked,

and NGDP and total labor compensation are highly correlated. Thus, increases in total labor compensation and/or NGDP have to show up as either gains in hours_worked and/or Y (musical chairs model) or gains in nominal wages and/or inflation (musical chairs model falsified).

24 rayward November 13, 2015 at 6:33 am

“The future ain’t what it used to be”. Words of wisdom from a highly acclaimed economist. Most of the time an economist, like the weatherman in the summer, has a fairly easy time of it: for the weatherman, hot and humid with thunderstorms in the afternoon, and for the economist, real business cycle. In those times, the advice is simple and effective: take an umbrella, make minor adjustments to interest rates. But then along comes a key historical episode: such as Hurricane Sandy in 2012 and the financial crises in 1929-1932 and 2008-2009. It’s these “key historical episodes” that separate the exceptional from the pedestrian, when umbrellas and minor adjustments to interest rates won’t do the job. It’s encouraging that Cowen acknowledges that “key historical episodes” can’t be explained by RBC, but it’s discouraging that his advice in those instances is “the best question to ask about fiscal policy is how well the money is being spent”. It’s discouraging not because policy makers should ignore how well the money is being spent, but because it elides the cause of these “key historical episodes”. To be fair, I could make the same comment about Krugman, and I have (many times). That highly acclaimed economist also stated: “You’ve got to be very careful if you don’t know where you are going, because you might not get there.”

25 ibaien November 13, 2015 at 6:41 am

taking work at a significantly lower wage, especially mid-career, is a tacit admission that all your hard work was for naught, that you were replaceable, and that the arc of your life may be bending in decline. are those admissions you’d make cheerfully to yourself and those close to you, Tyler?

26 derek November 13, 2015 at 8:09 am

A free market will stack up with stupidity, the stupidity will be the rule with exceptions, and downturns are when the barn gets mucked out. How can monetary policy be even available as a solution when likely the assumptions of the central bankers were one piece of the whole that led to the downturn? The stupidity that leads to long term unemployment is the series of bad decisions based on the assumption that tomorrow will be the same as yesterday. As well as cockamamie schemes that encourage long term unemployment by paying people to not make the adjustments and decisions that would lead to reemployment.

What are sticky are the institutional costs, such as government, regulation, debt instruments, educational infrastructure, any large operation that by size of positioning is resistant to change. To clear a debt instrument takes months or years where an equity position can lose or gain half it’s value in a day. If your education and debt is expensive, specialized and high, to change in response to the market will be slow. How long has it taken for businesses schools to stop teaching the algorithmic pricing of risk that led to 2008? How much of the policy response to 2008 was a doubling down on what had failed? Inertia is fine as long as it isn’t like a large boat headed for the rocks.

Authoritarian or centrally planned systems fail catastrophically when the do fail because of the accumulation and institutionalization of misguided ideas. For many reasons, one being the tendency to filter out bad news. The authoritarian can wield power to fix things at the edges, but eventually the internal contradictions cannot hold. The power of the free market is that these contradictions take less time to become apparent and be sorted out. It took 70 out so years for the Soviet system to fall apart but only a decade and a half for the Microsoft empire to lose its dominance.

2008 was an accumulation of bad ideas coming to fruition. Almost all of them had institutional, debt instrument, regulatory inertia whose indications of weakness were covered by authoritarian type interventions.

27 Gochujang November 13, 2015 at 9:25 am

You seem to be saying that there is a party and there is a punch bowl, but only “authoritarian regimes” would attempt to take it away.

28 Gochujang November 13, 2015 at 8:37 am

Needs more Shiller.

29 Gochujang November 13, 2015 at 8:51 am

(I do actually like the framework, and the accessible way it is presented, but as I say, I think it needs a behavioral tilt. Probably everything in it is good as a first approximation, but individual choice and social trends affect everything at all levels.)

30 Jon November 13, 2015 at 9:27 am

On wage stickiness and reservation wages, point 5.

Tyler leaves two other issues out:
1) Employers have some reluctance to hire workers ate much lower than their prior nominal wage for fear that the worker will leave. This is more an issue where there are higher costs to turnover.

2) Because firms use an employee’s wage history in hiring and compensation decision, an employee risks permanently locking in a lower compensation by prematurely accepting a lower wage.

There is no meter that reads out the marginal product of an employee and what the right compensation is.

I have first hand experience with these issues both as an employer and one seeking new positions.

31 Brian Donohue November 13, 2015 at 9:48 am

I think this is an excellent post, Tyler. Bravo.

Question: are there any key insights you’ve picked up or changes you’ve made in your macroeconomic worldview since, say, 2005?

32 John November 13, 2015 at 9:53 am

Re #5 There was a recent report in the news suggesting that those who were unemployed and took lower paying positions to have stop-gap incomes were then less likely to get offers for positions they would have held or been looking for if they had never been unemployed. That is a demand side aspect that points to an aspect of wage stickiness having nothing to do with the supply side evaluation or view of the price.

33 Gochujang November 13, 2015 at 10:00 am

Summers on RBC:

Even at this late date, economists are much better at analyzing the optimal response of a single economic agent to changing conditions than they are at analyzing the equilibria that will result when diverse agents interact. This unfortunate truth helps to explain why macro-economics has found the task of controlling, predicting, or even explaining economic fluctuations so difficult. Improvement in the track record of macroeconomics will require the development of theories that can explain why exchange sometimes works well and other times breaks down. Nothing could be more counterproductive in this regard than a lengthy professional detour
into the analysis of stochastic Robinson Crusoes.

FWIW, I agree. None of the macro schools discussed above gets to be right 99% of the time. Not without a serious blind eye applied.

Economic history too is one damn thing after another, and too often judged as it affects status of the observer – which makes it pretty hard for the general public to get a straight answer.

34 Ray Lopez November 13, 2015 at 10:59 am

The Romer et al. paper is nonsense on stilts. It is untestable see below (starting at “on the one hand”). In fact, Ben S. Bernanke et al in their 2003 FAVAR paper found monetary policy shocks by the Fed had a very weak effect on real variables (3.2% to 13.2% for 1959 to 2001)

Romer: “This paper investigates whether nominal disturbances have important real effects. What differentiates the paper from the countless others on the same subject is that it focuses not on purely statistical evidence but on evidence derived from the historical record-evidence based on what we call the “narrative approach.” This approach was pioneered by Fried- man and Schwartz in their Monetary History of the United States and has provided the evidence that we suspect has been most important in shap- ing economists’ beliefs about the real effects of monetary shocks. The reason that purely statistical tests, such as regressions of output on money, studies of the effects of “anticipated” and “unanticipated” money, and vector autoregressions, probably have not played a crucial role in forming most economists’ views about the real effects of mone- tary disturbances is that such procedures cannot persuasively identify the direction of causation. On the one hand, if firms that are planning to expand their output first increase their demands for liquid assets (or for loans from commercial banks), money could rise before output rises even though money had no causal role (King and Plosser 1984; Tobin 122 * ROMER & ROMER 1965). On the other hand, if the Federal Reserve were actively using monetary policy to offset the effects of other factors acting to change output, there might be no discernible relation between money and out- put even though money had large real effects (Kareken and Solow 1963)

35 Art Vandalay November 13, 2015 at 11:21 am

In this post, a guy who knows nothing about macroeconomics makes claims about what is true. Tyler, you really are a ridiculous embarrassment to the profession you really aren’t even a part of.

36 Flying Spaghetti Monster Theorist November 13, 2015 at 1:29 pm

Exactly. Everybody please just stay in your own domain.

37 Gochujang November 13, 2015 at 12:55 pm

It seems clear that individuals and markets grope toward optimum solutions. They are successful enough that at first glance some (especially formal) markets seem rational. When examined more closely though, I think individuals and markets behave too strangely for any one theory to always apply.

Sometimes people believe that house prices only go up, other times they believe they should sell every stock in their retirement account. Sometimes they are busy enough with work and family that they do neither, not out of judgement but out of inattention.

I think there is still a strong feeling in macro that most people get it right most of the time. I am not so sure. I think it is more that people are self-consistent most of the time. A society can do any dumb thing you name and be self-consistent enough for a growth economy. (Especially if that dumb thing is biased towards consumption, and satisfying consumption.)

In times of “shocks” people are forced to break habit and consistency. One can say “animal spirits” but that is kind of a catch all, and kind of implies underlying rationality. More likely it is one crazy thing after another.

All this makes monetary policy difficult, but sadly as much as some politicians would like to punt, you can’t *not* have a monetary policy. And so central banks have to use their limited power to smooth the shocks as best they can.

I just wish they’d stop trying for models to satisfy any decade, any craziness.

38 TallDave November 13, 2015 at 1:26 pm

10. A thousand times yes.

I have a largely intuitive, quite possibly wrong, but empirically intriguing pet theory that inflation targeting regimes that fall into ZLB regimes depress growth for reasons which are as yet largely unknown, mostly aside from the recessionary problem of sticky wages, perhaps in some sense a “feedback effect” from the poorly managed recessionary times that depresses the subsequent recovery. This might help explain why Japan’s growth fell to almost zero after 1990, after decades of rapid growth.

39 Art Deco November 13, 2015 at 5:08 pm

This might help explain why Japan’s growth fell to almost zero after 1990, after decades of rapid growth.

Might. A huge inventory of sour bank loans might help explain some of it. Incipient demographic implosion might help explain some of it. Arriving at the technological frontier might help explain some of it.

40 Gochujang November 13, 2015 at 5:25 pm

Don’t forget losing TV manufacturing to other Asian countries in just that timeframe.

41 TallDave November 14, 2015 at 3:46 am

I suppose the bank consolidations of the early 1990s could be considered a slow-motion crisis, but remember their CB did that rate hike on purpose in 1989, to “fight inflation.”

42 TallDave November 14, 2015 at 3:13 am

Bad loans are more a result than a cause. Japan didn’t have a financial crisis around 1990, and look what fiscal stimulus has wrought. Demographics didn’t radically alter their trajectory around 1990. And Japan is now significantly poorer relative to the United States than they were around 1990, but we share the same the tech frontier.

I posted the numbers a while back. believe they fell around 10-20% relative to US PPP GDP per capita. At the same time, S Korea seems likely to overtake them soon. This is probably most shocking to people of my age, who grew up hearing how Japan was taking over the economic world, while South Korea was considered just another poor and politically unstable SE Asian country.

Keep in mind too, the rise of China and other Asian countries should have been enormously beneficial to Japanese living standards because of comparative advantage and geographic proximity.

43 Floccina November 13, 2015 at 1:55 pm

8. Given that weak AD is only one of the problems in a bad downturn, and that confidence, risk, and supply side problems matter too, the best question to ask about fiscal policy is how well the money is being spent. The “jack up AD no matter” approach is, in the final political equilibrium, not doing good fiscal policy any favors.

Maybe the best thing would be to chop the bottom off FICA and matching FICA until unemployment is below 5%. That is pay not FICA or matching FICA on the first $20,000.

44 Jeffrey Deutsch November 13, 2015 at 10:15 pm

What Gochujang said about Shiller.

In particular, macroeconomics (and quite often microeconomics too) is a matter of group/mass psychology. Whether through network effects, signaling or relative purchasing power (a redundancy when prices move freely and hence one “bids” against others), folks need to get on (or ahead of) the bandwagon. Ask anyone who’s been gentrified out of their neighborhood.

Check out George Akerlof’s and Robert Shiller’s _Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism_.

So expectations matter. A lot. And hence, I think a highly transparent central bank can do a lot of good. In my opinion, inflation targeting is a good idea because a credible central bank can serve as a focal point and coalesce expectations around a good (however defined) and *stable and predictable* level of inflation.

People can take their cue from Federal Reserve governors and bank presidents who announce, say, a 2% or 3% inflation target. (And I’m aware that of course it’s a little looser if set for, say, a three-year period than for a one-year period.) Everyone not only knows, but also knows that their neighbors know — and that their neighbors know that they know, and so on.

Whereas with something like NGDP…suppose the president of the New York Fed calls for, say, a $10 trillion NGDP. What the heck does that mean to you? Especially if your only education in Economics was a dim memory of college two decades ago with lines and graphs and formulas and you skated by with a C anyway because your first love was Computer Science/Engineering/Art History/Philosophy/What have you?

Not to mention…what do you mean nominal wage stickiness doesn’t matter to the unemployed? Whether or not they can underbid incumbents and get themselves jobs that way* bloody well matters.

[*] Assuming both the current going pay and the incumbents’ reservation wages significantly exceed the unemployed’s reservation wages.

Excellent point about intra-stimulus multipliers (ie, the right kind of stimulus, executed well, effectively multiplies the dollars spent).

Last but not least, formal and informal institutions matter — as we’ve seen when discussing why some unemployed people hold high reservation wages. (Eg, they know if they settle for a low-wage job for one thing they’ll have trouble finding it anyway as those employers hesitate to hire high-wage people, and if they do get it they’ll have a hard time bouncing back up to a high-wage job later. As you rightly point out, matching matters.)

45 James November 14, 2015 at 1:26 am

5) There may, however, be some residual stickiness due to irrational reservation wages, also known as voluntary unemployment due to stupidity.

This coming from someone who does well paying, intellectually interesting work for a living. Some jobs are demeaning and soul-crushing. I value my time more than the $10-12 someone is willing to pay me for it, and use it to keep my interests alive by reading blogs such as this one, while retraining myself as a programmer. Why is this stupid?

46 mulp November 14, 2015 at 1:33 am

6. “Yet this matching problem is poorly understood, and it can involve a mix of nominal and real imperfections.”

As long as economists continue to deny the laws of physics, they will continue to be baffled by the inability of individuals to find and take jobs for low wages 1000 miles from where they live without any assets or transportation, or where their only assets are their housing fixed to a point in space with no buyers around willing to pay a price equal to the present value of housing for all the years required to have housing at wages economists believe the individual should accept.

It seems economists believe workers have zero costs of living, transportation, or responsibility to pay real or imputed debts, because economists believe workers are not consumers, and consumers are never workers.

Otherwise, the “matching problem” will be simple:

Income from potential job minus cost of taking job minus debt service less than zero equals no match.

For example, an individual living in city with elderly parent on SS without car offered a low wage job in suburbs requiring a car plus money for gas is not a job match. No Fed easy credit and no amount of deregulation of lending will ever make that a job match. Government funded transportation, ie, free cars and gas for the low wage workers, would make some job matches possible. But employers are already getting huge subsidies with food stamps, housing subsidies, free health care, cash aid from the IRS, but that is still not enough to, first boost demand and thus GDP to create jobs, and second, enough to reduce the cost of working below the wages employers are offering for workers with higher job qualifications than those available workers who can’t afford to take the job.

47 mulp November 14, 2015 at 1:40 am

7. “Furthermore models where AS and AD curves are independent and separable are often misleading, despite their analytic convenience.”

Here, Tyler is expressing discomfort with free lunch economics, yet he can’t quite declare


AS and AD are absolutely intertwined and must be zero sum after accounting for intertemporal shifts in supply and demand.


Demand can not exceed supply and supply can not exceed demand.

Further, aggregate labor costs must equal aggregate supply must equal aggregate demand.

(All profits must be consumed by labor costs.)

48 Tom Warner November 14, 2015 at 8:15 pm

1 and 2 are just embarrassingly foolish. 99% of business cycles are financial cycles. there is nothing cyclical about technological progress. cycles are not caused by “nominal shocks,” they’re caused by financial markets lurching back and forth between overheating and overcooling. tasking a public committee with deciding when commercial banks should be encouraged by monetary policy to loosen or tighten credit, theoretically in a countercyclical manner, might have somewhat moderated cycles but has not changed their nature. with or without a central bank there’s going to be some group of people in charge of deciding whether to loosen or tighten credit, and historically such people have always reacted late and in a lurching manner. deceleration of credit expansion is the main driver of recession, but wage stickiness does indeed worsen the lurching to overcooling

#4 makes no sense, except to confirm what I’ve argued here before, that an NGDP targeting policy would only ever find support at the ZLB with high unemployment, and an NGDP targeting would be abandoned as soon as there were other conditions. NGDP targeting is really no more than an ideological cover to break the taboo on CB involvement in fiscal policy. From what you’ve indicated elsewhere about allowing the CB to buy a broader variety of assets, apparently your proposal would be to do that through some kind of CB industrial policy lending (eg having the FOMC announce standards of corporate bonds it would purchase).

6, 8 and 9 are good points, but Hayek and Minsky were financial cycle theorists

49 Benoit Essiambre November 14, 2015 at 9:50 pm

There is more to wage stickiness than that. There is a coordination problem where even if some workers are willing to lower their wages significantly, this won’t save their jobs or cause them to be hired because whole businesses or departments will close unless most workers, as well as the workers upstream and down stream in the supply chain lower wages at the same time.

Knowing this, the Nash equilibrium for workers is to extract the most out of their employer even if it kills the business. When prices are too low, unless workers are able to coordinate with the whole industry to collectively bargain their wage down (good luck with that) they will end up unemployed without help on the monetary or fiscal side.

Do the calculation. For example, if prices of final products were too low by 5% and wages consisted of 50% of costs and you could only convince 10% of workers in the supply chain to take a wage cuts, how much do you think they would have to cut to save the business?

50 The Arthurian November 16, 2015 at 6:23 am

“the best question to ask about fiscal policy is how well the money is being spent.”

That question arose long ago in response to Keynes, who said that if lawmakers are prevented (by their misunderstanding of the economy) from spending on worthwhile objectives when fiscal stimulus is needed, then even spending foolishly would be better than failing to provide stimulus.

The question only arises if you misunderstand the point Keynes was making.

51 jonathan November 18, 2015 at 9:06 am

“1. In world history, 99% of all business cycles are real business cycles. No criticism of RBC can change this fact.”

This is false if we mean by “business cycles” the modern phenomena, characterized by periods of high unemployment. It is true if we define “business cycles” as all short-run deviations from trend. However, even under the latter definition the RBC model is inappropriate for analyzing these cases.

I assume you are referring to fluctuations in output in a primarily agricultural subsistence economy, in which most output is food, and most fluctuations in output is due to exogenous variation in agricultural productivity (crop failures, bumper crops, etc).

However, this is not at all what the RBC model is about. The RBC model includes exogenous TFP shocks, yes, but also consumption-leisure substitution and capital accumulation. This produces procyclicality of labor and investment. In other words, it’s a model of fluctuations in an industrialized economy, in which capital allow people to smooth consumption and shift production to periods with higher productivity.

A model of an agricultural economy would have a fixed factor of production and no capital (or very little, e.g. seed corn). We would not expect to see procylical labor, because in a subsistence economy income effects would surely dominate. There would be limited capacity for consumption smoothing.

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