Category: Current Affairs

Christie Romer basically says yes, Arnold Kling dissents.

I don't expect Romer to turn a speech into an academic debate and in this sense I don't fault her.  Nonetheless I did not find her account very persuasive.

I would start with the fact that output has bounced back more robustly than employment has.  AD theories per se do not explain that differential.  One simple possibility is that better management and better measurement have allowed us to identify (and fire) hundreds of thousands of low-wage people who just weren't producing much of value.  That's a real shock, even if it does not qualify as a sectoral shift in the traditional sense.

It's also the case that the rate of new job creation has been especially low.  Yet the nominal wages on those jobs-to-be are not constrained by previous contracts or agreements.  Tell stories as you may, but it's hard for me to see that as exclusively an AD problem.

I wonder what is the behavioral postulate for how long all these unemployed workers are all staring jobs in the face yet persistently stubborn about their appropriate nominal wage.  I'm all for behavioral economics, but I don't buy the necessary story here.

I don't want to oversell the minimum wage hike + unemployment compensation extension + means-testing hypothesis here, but surely it deserves a mention as one relevant factor.  Those are real factors too.

I also see that wages, and the job market, are more flexible today than in a long time, with so much service sector employment, so much flex-time and part-time, and such a low rate of unionization.  In most AD theories that implies the job market bounces back relatively quickly yet that is not what we observe.

A separate question is what Romer believes the major AD shock to have been.  She clearly repudiates the Scott Sumner story that monetary policy was too tight.  Is it all from the collapsed bubble in the housing market?  Keep in mind those are paper values and that the real services from the country's housing stock haven't declined.  Again, you can tell behavioral stories about the asymmetric perception of losses vs. future gains (for many people, buying a future home is now much cheaper, though perhaps they don't notice the positive wealth effect), but is that going to drive the whole cycle?

To be sure, AD is a major factor in this recession but it is not the entire story by any means.  In major recessions usually it is AD and AS forces together.

Most of all, the Romer essay convinces me that current economic policymakers — not to mention many bloggers — should not be so certain they understand what is going on.

Addendum: I sometimes have the feeling that commentators on the left reject the "real shocks" hypothesis because they think it implies government can't do much to make things better.  That doesn't follow.  Most of what government does, for better or worse, is an attempt to solve a real rather than a nominal problem.  It might imply "intervention is less effective" but it also (possibly) can imply "intervention is more necessary."

Hotels filled with stranded passengers are also profiting. “I spoke to a few of my students who are doing internships in hotels,” said Ms. Fleischer of Hebrew University. “They are happy. The guests don’t leave.”

Here is a bit more.  Of course there's a stock-flow problem here, namely that "permanent residents" won't stay in hotels forever and people need to keep on coming.

Air freight is responsible for a quarter of the value of all goods moved into and out of the UK…

I believe that is a rough rather than exact estimate.  If European air travel continues to suffer, Kenya will be one of the most immediate big losers, for reasons of tourism and agriculture and flower-shipping (see my favorite economics textbook!).

Here are some general figures on air freight around the world.

Peter Boone and Simon Johnson serve up the bottom line.  Here is one good excerpt of many:

Often assistance packages of this nature just help “smart money” to get out ahead of a default.  This could be the case here; 40-45 billion euros total money could last roughly one year.  Both Russia and Argentina got large packages in the late 1990s but never regained access to private markets, so eventually everything fell apart.

Peter Boone and Simon Johnson explain:

This may not be obvious, but, creating money in a currency union is no simple task.  In any single country, central banks usually restrict themselves to buying government bonds, and making loans to regulated commercial banks.  Net purchases of these securities by central banks creates what is called “high-powered money”; this feeds into the financial system and results in the creation of what we all use to make payments and store value, i.e., money, plain and simple.

However in the European Monetary Union there are now 17 nations and a plethora of banks.  So, to put it crudely, there is sure to be a fight to decide who gets the newly printed funds.  The ECB resolved this by what seemed like a fair rule:  All commercial banks can borrow from the ECB if they provide collateral, in the form of highly rated government and other securities, to the ECB.  So, for example, a Greek bank can gain liquidity by depositing Greek government bonds with the ECB – as long as those bonds are “investment grade”, i.e., highly rated.

This simple and seemingly reasonable rule created great dangers for the eurozone, which have come back to haunt Mr. Trichet. The commercial banks in the zone are able to buy government bonds, which “paid” 3-6% long term interest rates (for all the sovereign bonds of members) over the last decade, and then deposit them at the ECB.  They could then borrow from the ECB at the ECB financing rate, which today is 1%, against this collateral so pocketing a profit – and then buy more sovereign bonds with the funds.  Mr. Trichet recognized this system had inherent dangers of turning into a new Ponzi game:  if nations spent too much, and built up too much debt, eventually the system would collapse. So at the foundation of the eurozone, Mr. Trichet led a contingent within the EU that demanded all nations live by a “Growth and Stability Pact”, whereby each nation could only run deficits of 3% of GDP, and they had to keep their debt/GDP ratio below 60% of GDP.

Of course, politics trumped Mr. Trichet – as it always must – and the Greeks, along with the Portuguese, used their new found cheap lending system to run large deficits and build up debt.  The cheap access to money also helped feed the real estate booms in Ireland and Spain. 

There is much more of interest in their post, none of it good news for Greece or the ECB.