Business cycle asymmetry and sectoral shocks

Paul Krugman asks a good question:

And now as then, the whole notion [TC: what I call sectoral shift theories] falls apart when you ask why, say, a housing boom – which requires shifting resources into housing – doesn’t produce the same kind of unemployment as a housing bust that shifts resources out of housing.

This of course was also Sraffa's 1932 critique of Hayek.  I would cite a few points:

1. Bloom, Floetatto, and Jaimovich focus on factors of confidence and option value in a real business cycle model to help explain the asymmetry.  Alex and I present related arguments in our Principles text.

2. Standard models of matching and job search generate cyclical employment behavior in the required manner when combined with varying real shocks; see for instance Mortensen and Pissarides (1994).  The asymmetry in these models comes from the difference between job creation and job destruction, which is again related to option value.  M&P even build some simulations to show the effects can be quite large and that they fit to some extent with real world data.  This is one of the best macro papers of the last twenty years and it is commonly recognized as such.

3. Caballero and Hammour have done relevant work in this area.  You may recall their modeled proposition, published in the QJE: "Government incentives to production may alleviate unemployment but exacerbate sclerosis. In contrast, creation incentives increase the pace of reallocation."  (As you'll see in a later post, that's not even the main claim I wish to make.)  See also this paper.

4. Greg Mankiw, with Ricardo Reis, has some excellent and still undervalued papers on sticky information and business cycles.

5. The asymmetry between the upward and downward phases of the cycle was very much a concern of Knut Wicksell in his 1898 Interest and Prices.  Wicksell's account, as I understand it, emphasizes the interaction between real and monetary shocks.  This is still a better book than most of contemporary macroeconomics.

6. I still believe Krugman is correct in leveling "the asymmetry charge" against Austrian business cycle theory, with its excessive emphasis on monetary tricks.  That doesn't mean the asymmetry charge always defeats a sectoral shock theory.

7. I don't think that sectoral shifts explain most business cycles.  I was convinced by Christina Romer's work that a lot of downturns are simply the result of contractionary monetary policy at the wrong time.  I'm also convinced by the Brainard and Cutler paper that sectoral shifts didn't have much to do with the downturn of the early 1980s.  Nor do I think that the recent crisis is all about real shocks or that sectoral shifts explain every aspect of the downturn — hardly.  Still, the theory behind real shocks, sectoral shifts and the like has improved a good deal since Schumpeter.

Overall I'm puzzled by Krugman's post in response.  Why cite a weak argument by Schumpeter when so much stronger work is available to discuss?

By the way, Schumpeter himself charged that the Keynesians were misunderstanding the real accounts of the business cycle, including Pigou (and I read him as referring to himself as well); see p.944 in his History of Economic Analysis.  Schumpeter was a selective re-reader of the past, however, so perhaps Krugman's interpretation of him remains correct.

Addendum: Arnold Kling comments.  And Robert comments.


Seriously? Am I missing something or is this not a fair restatement of Krugman's question:

"Why does growth in a sector not cause unemployment while an imploding sector imploding does?"

Or another way of phrasing my incredulity: "Who holds aggregate (across all sectors) demand constant in business cycles?"

Any chance of a link--or, failing that, at least a cite--to "one of the best macro papers of the last twenty years"?

"Why cite a weak argument by Schumpeter when so much stronger work is available to discuss?"

Because Schumpeter is associated with the so-called austrian depression doctrine, saying that the depression was a just punishment for all the wrong things people had done. There is some moralizing in the austrian narration, so much is true. But reducing it to that is a straw man tactic which makes ABC all the easier to attack, and that's what Krugman is doing. I'd rather focus on his economics, on the infos you are providing - or Bob Murphy provided in several posts - than focus on Krugman's obsession with hangovers.

I'm out of my depth in economics here, but perhaps one reason it's different when there's a bubble inflating rather than bursting is *information*. When the housing bubble or the bubble is inflating, it's fairly easy for people to know that it's inflating, and thus where the new jobs are. People from hundreds of other parts of the economy know that there are jobs to be had (and pretty good investment opportunities to be had) in housing (real estate, construction, selling mortgages) or in dot.coms (software, selling development tools, investing in startups).

When the bubble pops, the information about where jobs are is much more diffuse. It's not "go west (to the Bay Area) young man," but rather "go back wherever you came from and see what's available."

Krugman has a gift that so far eludes "freshwater" and Austrian economists. That gift is the ability to zero in on the precise criticism that discredits every idea he ever had, and go public smearing it in the popular press, even if it's an idea that most people don't even know about.

The freshwater economists' shortcoming, and the Austrians' shortcoming, is that they believe there is an honest debate going on. So they keep responding with clarity, reason, and sound theory. We may disagree with what they have to say, but they're putting it out there for honest critique.

Meanwhile, Krugman and his ilk aren't interested in determining who is right and who is wrong. They simply want to convince their audience that their strongest opponents are ridiculous. Krugman isn't interested in responding to criticism, he's only interested in defending himself TO HIS OWN AUDIENCE. For Krugman, if his readers side with him, then he is right, regardless of which theory is actually correct.

In Krugman's world, truth is a popularity contest. If people believe you, then you're right. If people don't believe you, then you're wrong. Theory is beside the point. This is precisely why he is an old school Keynesian. In Keynesian economics, all you have to do is trick the nation into believing that they're rich, and they'll start spending money, which magically "fixes the economy." So it is with the world of economic theory.

This, by the way, is fully evident when you actually follow Krugman's links and compare them against why Krugman is citing certain papers. I've seen him cite papers as "proof" of his ideas that were nothing more than high-profile papers that merely made the same initial assumptions Krugman refers to.

It's a game of let's-pretend.

Krugman is all over the map. One week he says we are in a recovery, the next week he says we are heading into another downturn. One week he says the stimulus package was too small, the next he says it was sufficient. One week he shows pithy plots with intersecting lines that he claims can be used to calculate the necessary size of a stimulus package, the next he says that economists rely too much on models that are unreliable. When the Republicans were in power he argued that the deficits they were running were dangerous. Now, he says that deficits are beneficial. He is just another economist who looks at a trend and extrapolates. If you read him regularly AND don't dump everything you read down the Memory Hole you'd realize that he is not at all consistent in what he writes, even from week to week. Plus, his fiscal theories ($3.0 Trillion dollar proposed deficit??) are absolutely insane.

I don't know much about economics, but it seems mighty generous of Tyler to refer to Krugman's objections as a "question".

To #6, the Austrians have a defense against this charge: money-driven booms involve production outside the PPF. By drawing into employment resources that in equilibrium would be properly unemployed, the pumped sector(s) of the economy can grow without inducing observed unemployment in other sectors.

Tyler contribution here barely skims even a small part what you'd find in Hayek which addresses Krugman's "argument".

And note well -- Hayek endorsed monetary and fiscal measure to counter the secondary deflation, including public works projects and very explicitly some of Keyne's own proposals for countering a deflationary environment with a significant degree of deflation cause unemployment.

Keynes was arguing this stuff well before 1936, before even 1930, and Hayek explicitly endorsed it as early as 1931 -- in part because this stiff is completely consistent with Hayek's 1929 and earlier work, as Lawrence White has explained.

And Tyler, note well, Jeff Hummel 30 years ago in a published paper explained that Hayek's cycle theory could be sent in motion by private lending and private credit with NO central bank required, exactly what Hummel says happened over the last decade in his "China did it" story. So even Hummel -- who you cite in your "case again the ABCT" -- acknowledges that this China story IS a version of Hayek's ABCT. Let me say that again HAYEK'S ABCT, not your false explication of it.

Everyone who mattered understood that Keynes most everyone's economics wrong -- Pigou berated Keynes for his false and nasty abuse of Hayek, everyone knew that Keynes was willfully botching Pigou which he misleadingly labeled "classical" economics, and on and on. Ask David Laidler how much in Keynes was already known to pretty much everybody. Knight said that everything true in Keynes was already known, and everything new was false. Hayek's contempt for Keynes' mastery of the economic literature almost knows no bounds ...

"Schumpeter himself charged that the Keynesians were misunderstanding the real accounts of the business cycle, including Pigou (and I read him as referring to himself as well); see p.944 in his History of Economic Analysis."

Schumpeter himself charged that the Keynesians were misunderstanding the real accounts of the business cycle, including Pigou (and I read him as referring to himself as well); see p.944 in his History of Economic Analysis."

Read Hayek on Keynes' gaping misunderstandings of Wicksell if you enjoy detonation ...

Perhaps we should make Hayek a non Austrian since that term has already been abused beyond belief.

I think Krugman is just pointing out sectoral shift arguments have a long history which you should be familiar with before recreating a new one.

Sectoral shift asymmetries may produce unemployment but don't really justify the business cycle as a whole or widescale unemployment. Why is the economy a one trick pony? Why can the economy only do one thing at a time? Why can't other sectors take over from the failing ones? Or is it indicative of the economy having become a one trick pony?

...why didn't sub 4%...

I have a question regarding Schumpeter's appreciation of the austrian cycle theory. I read somewhere that he considered ABC to be one of the gravest mistakes made by the economics profession. The person who said that obviously agreed with the criticism, but he could not find Schumpeter's quote, and neither could I. Did Schumpeter ever write anything like this?

Alisdair McKay and Ricardo Reis in the Journal of Monetary Economics ( are the latest word on business cycle asymmetries. They find that in the data the asymmetries are in unemployment but not in output. They think that firms' choices of when to adopt technology explains the employment asymmetries.

I found the Mortensen/Pissarides paper at

I find it hard to take the Mortensen/Pissarides (MP) paper seriously because it relies on shocks, as does all mainstream cycle theory. But shocks are not explanations of anything. They’re descriptions. For example, suppose two guys get in a fight. You ask one what caused the fight and he responds “He hit me.† That’s not a cause; it’s a description. The obvious question is why he hit you. In the same way, saying the price of labor changed because of a shock doesn’t tell us anything about why the price of labor changed.

The purpose of economics is to explain the shocks, not just accept them as explanations. Austrian economics explains the shocks that mystify mainstream macro.

The MP paper appears to do a good job of describing what happens to job creation and destruction, and therefore employment, after a shock. However, it appears to be nothing more than a mathematical description of Hayek’s Ricardo Effect with a little more detail. In MP’s simulation, the price of labor changes randomly and produces the same effects that Hayek describes in his Ricardo Effect. The main difference is that labor prices change randomly for MP and Hayek explains the real causes of those changes.

The simple explanation for unemployment during a depression is the stickiness of fixed capital. Modern jobs require capital. During the boom, liquid capital (such as money) gets invested in fixed capital (such as buildings). The process is easy and painless. However, during the bust when capital needs to be reallocated to different industries, fixed capital is much more difficult to convert back to liquid capital so it can be reallocated. Fixed capital in overbuilt industries, such as housing and autos, loses much of its value. In other words, wealth/saving is destroyed. Less capital exists after the bust than before the bust to use in creating new jobs. It takes a while for people to save enough to make up that lost capital and re-employ the jobs lost.


I'm sympathetic, but the explanation needs to be more precise. "Liquid capital" (e.g. money) is not on a continuum with "fixed capital." The former is a claim on production while the latter is an input to production. ("Fixed capital" does exist along some sort of continuum of generality versus specialization, but that is not relevant to your argument.) You're on the right track, but the issue is not the trapping of liquid capital in the wrong sectors; it is the trapping of specialized physical and human capital.

When an individual invests in a new building, he trades his claims on output (money) to the suppliers of the building's components and construction. Krugman appears to be arguing that as long as these claims are circulating freely and being exchanged for stuff (velocity), then overall employment shouldn't be affected by where the money is spent or how that sectoral pattern is changing. Tyler and the commentators have exploded this argument by pointing out the many asymmetries between shifting resources into a growing sector and shifting them out again (speed differences, labor search starting from an employed vs. unemployed state, option value of waiting to invest until you know which sectors are the right ones, etc.). Your point could be amended to say, in addition, that the transformation of general productive resources (skills, machines, relationships, structures) into sector-specialized resources is asymmetric also and that a sectoral boom results in both a different distribution of specialized resources across sectors and a higher level of specialized as opposed to generalized resources in the economy overall. When the boom is over, all those specialized resources are hard to transform back into general ones.

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