Another Neo Austrian Rant

Nick Rowe notes that Keynes was very monetarist compared to his teachers and his confused followers (or shold I say the heretics who take his name in vain). Brad brings up the shortage of safe instruments argument again.

I respond with my usual semi-neo-Austrian rant


Here I am making the same comment I always do. I agree that a shortage of safe assets caused the current recession. I don't think that this is the reason unemployment remains high. As far as I know, quality premia are back to normal, banks are flush with cash and real interest rates are microscopic (the 5 year rate is negative). I think the only things the current state has in common with 2008-9 are unemployment and an excessive stock of housing.

Starting with Rowe's triangle, I note that he stuck to the service sector. This is not innocent. There is no stock of massages and nails and hair grow rather quickly. Can he deal with, say, a bloated housing stock created by the irrational belief that house prices must always rise 20% ? How about excess productive capacity ? He doesn't consider either.

Just before moving on, I'd like to note that the game he describes can change from a coordination game to a prisoners' dilemma due to changes in other sectors. Let's say that the spouses of the three subjects he considers used to work one in construction and two in manufacturing. Now what the unemployed manicurist would like best is to manicure then spend the money of food. Even if she were employed, she wouldn't buy a massage, because she is hungry what with the unemployed spouse (note how carefully I avoid both gender stereotypes and dismissal of same sex marriages). My point is that trouble can spill over from construction and manufacturing to services due to income effects, so the fact that employment in services has declined isn't proof that money matters right now.

So I will attempt a not at all Keynesian explanation contradicting Rowe and you. It will be, I admit, fairly Austrian. I add one assumption things -- labor market rents -- I assume that it is better to have a job in manufacturing or in construction than in services and better to have a job in equipment manufacturing than in consumer goods manufacturing. I assume this because it is obviously true and everyone knows it.

Could employment in construction declinei in a barter economy ? Well obviously yes if there can be irrational housing bubbles (I assume people are not rational, because that is obvious and everyone knows it). How about manufacturing ? Sure if perceived wealth declines due to the end of irrational exuberance or due to irrational pessimism then demand for durables consumption goods falls more than demand for non durables and service but less than demand for capital goods. It is theoretically possible for nominal interest rates on 30 year bonds to be zero, but for optimal investment to be zero too. It is realistically possible that for any dynamically consistent monetary policy, investment will be far below what it was in 2007.

So far no problem. Since I allow irrationality, I can easily get investment (including investment in structures that is construction) and durable goods consumption to bounce around.

So why don't the construction and manufacturing workers get jobs cutting hair or manicuring nails ? I propose asking people in any bar in the world. They will be highly amused. It is clear that shifting to services would be costly. For one thing it would require leaving Las Vegas. For another what the hell to manicurists actually do ? They know but I sure don't. Then the worker would get a much lower wage. Oh and lose contact with his or her friends in construction or manufacturing so when population growth and depreciation and such caused new demand for construction or equipment manufacturing or durable goods manufacturing, he or she wouldn't get the jobs.

I think the explanation is that to get people to move from good jobs with good wages to bad jobs at bad wages requires enormous unemployment. So much so that the economy recovers before there is much of a shift.

Notice no money, no risk nothing like that. If you have labor market rents, then unemployment can fluctuate.




On the history of thought, Rowe has a point. His view is shared by someone who is generally considered an expert on Keynesian economics -- Keynes.

In "The General Theory ..." Keynes explaines that New Keynesians are, in fact, Pigouvians writing (actually mostly quoting) "The difference in the conclusions to which the above differences in assumptions and in analysis lead can be shown by the following important passage in which Professor Pigou sums up his point of view: 'With perfectly free competition among work people and labour perfectly mobile, the nature of the relation (i.e. between the real wage-rates for which people stipulate and the demand function for labour) will be very simple. There will always be at work a strong tendency for wage-rates to be so related to demand that everybody is employed. Hence, in stable conditions everyone will actually be employed. The implication is that such unemployment as exists at any time is due wholly to the fact that changes in demand conditions are continually taking place and that frictional resistances prevent the appropriate wage adjustments from being made instantaneously.'[2]"

Oddly some people suggest that Keynes was unfair to Pigou, because he didn't admit taht Pigou made the observation about "frictional resistance" which Keynes quoted word for word. I often feel that most Keynesian economists haven't actually read "The General Theory ..." but of course what I really think is that they read it long ago and don't remember all of it.