Friday, January 19, 2007

Still desparately trying to get Paul Krugman to notice me

I hearby sink to proposing a real business cycle model

I can't defend Hayek, but I am interested in the possibility of a theory which has nothing to do with money or nominal prices. Here I think a key issue is that wages and price cost margins are higher in capital goods production than in consumer goods or, especially, services. This is a stylised fact. I will claim it is due to a higher minimum efficient scale for prices and efficiency wages for wages. Nothing nominal here yet.

This means that a shift from capital goods production to other sectors implies a decline in national income. This is consistent with an increase in consumtion under a couple of conditions. One is that it is anticipated so perceived permanent income doesn't change. The other is that the decline in the percieved return on capital causes consumption to shift forward. The second effec is tiny according to all empirical estiamtes. The first argument is irrelevant, since we are assuming irrationa exuberance.

So how can unemployment be avoided ? I think a decline in real wages would do the trick, but I believe in real wage rigidity (I also believe in nominal wage rigidity but I am pretending not to)

To be actually semi serious, I think people who worked in capital goods manufacturing are very reluctant to accept jobs in other sectors (cause they say so). I suspect their first reaction is to hope the recession passes quickly. Only after long an painfully disappointing unemployment will they stoop to flipping hamburgers.

This is an asymmetry. Unemployment is not needed to move workers from McDonalds to GM, because McDonald's workers are eager to get GM jobs. The other way, not so much.

In any case, in the original Austrian model, there is no explanation for why market clearing real wages are high during investment booms and low during periods of liquidation. With imperfect competition, labor market rents and Cobb Douglas production functions, this follows immediately. Much less national income, similar labor's share, lower market clearing wages.

The theoretical presumption that sectoral shifts do no change national income requires the assumptions that price is equal to marginal cost and that wage differentials are due to differences in workers' ability. These assumptions are obviously nonsense.

Now I don't doubt that demand for cash money was key in the great depression (recall my last comment on this blog). I just think that once one steps away from neoclassical fantasy land, the relative absence of un-necessary economic suffering becomes more surprising than the occasional recession, that there are many things that can go wrong with an economy and that they all hit at once in the great depression.

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