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The big issues in macroeconomics: unemployment

January 3rd, 2013

Following up my previous post, I want to look at the main areas of disagreement in macroeconomics. As well as trying to cover the issues, I’ll be making the point that the (mainstream) economics profession is so radically divided on these issues that any idea of a consensus, or even of disagreement within a broadly accepted analytical framework, is nonsense. The fact that, despite these radical disagreements, many specialists in macroeconomics don’t see a problem is, itself, part of the problem.

I’ll start with the central issue of macroeconomics, unemployment. It’s the central issue because macroeconomics begins with Keynes’ claim that a market economy can stay for substantial periods, in a situation of high unemployment and excess supply in all markets. If this claim is false, as argued by both classical and New Classical economists, then there is no need for a separate field of macroeconomics – everything can and should be derived from (standard neoclassical) microeconomics.

The classical view is that unemployment arises from problems in labor markets and can only be addressed by fixing those problems. Within the classical camp, Real Business Cycle theory allows for cyclical unemployment to emerge as an voluntary response to technology shocks and changes in preferences for leisure – hence Krugman’s snarky but accurate quip that, according to RBC, the Great Depression should be called the Great Vacation. More generally, on the classical view, long-term unemployment has to be explained by labour market distortions such as minimum wages, unions, restrictions on hiring and firing, and so on.

The RBC school mostly treated the Great Depression as an exceptional case, to be dealt with later, and they have been no better on the Great Recession. While some have tried, it’s obviously silly to explain the current recession as the product of technology shocks in the ordinary sense of the term. If you treat the financial sector meltdown as a technology shock, RBC amounts to little more than the observation that opium makes you sleepy because of its dormitive quality. Since financial sector booms and busts are clearly driven by the the general business cycle, you get the theory that the business cycle is caused by … the business cycle.

Looking at the broader classical view, there are two big problems. First, over the past twenty or thirty years unions have got weaker nearly everywhere, minumum wages have generally fallen in real terms, or at least relative to average wages, and labour markets have been ‘reformed’ to become more flexible. So, you would expect low and falling unemployment. The low rate of US unemployment in the 1990s and (to a lesser extent) 2000s was indeed taken as a vindication of this prediction. So, sharp increases in unemployment are the opposite of what was expected. The even bigger problem is that, since 2008, unemployment has risen sharply in many different countries, with very different institutions. Many of these countries have reacted by cutting social protections (here’s Latvia, for example)[1] but unemployment has remained high.

The main alternative to the classical view is a “sticky wage/price” interpretation of Keynesianism. The basic idea is that the aggregate economy is subject to demand shocks, which result in prices and wages being too high. But reducing wages and prices is difficult, because of co-ordination failures. Reducing wages and prices in one sector, or reducing wages but not prices doesn’t help. In fact, cutting wages on a piecemeal basis depresses demand even further. So the economy stays under-employed for a long time.

If you accept the sticky wage story, then you get the kind of policy line supported by the New Keynesians in the current debate. This says that, under normal conditions, monetary policy can be used to avoid deflation. In the current “liquidity trap” case where interest rates are at zero, and expanding the money supply has no effect, it’s necessary for governments to create demand directly through fiscal policy.

Lots of Keynesians (including me) and other critics of the classical view aren’t satisfied with the sticky wage interpretation, or at least regard it as incomplete. There isn’t a single well-developed alternative, however, so I’ll give some thoughts of my own, and invite others to comment. The big problem with the the sticky wage story is that it implicitly assumes a unique general equilibrium with an associated distribution of real wages. But in reality, there’s a lot of room for political processes/class struggle to influence wages and unemployment is part of that struggle (the “reserve army of labor”). So cutting real wages in a depression may produce a new lower-wage equilibrium, which leaves existing wages still “too high” to clear the labor market. Obviously, there are limits on this process, but they may not be relevant.

In empirical terms, the sticky wage story implies that real wages should be countercylical (higher in recessions). The alternative versions of Keynesianism generally imply the opposite. The empirical evidence, sadly, is indecisive.

But the disagreements among Keynesians, or between Keynesians and various heterodox schools, are less important than their collective disagreement with the classical view. According to classical economics, a global recession like the one we are observing, occurring simultaneously in many very different countries and lasting for many years, should be impossible, or at least highly improbable. For the classical view to work, lots of separate and differently organized labor markets must have simultaneously gone haywire, and stayed that way for a long time. But the improbability of this hypothesis hasn’t shaken the faith of classical supporters.

fn1 The linked NY Times story is the most striking example of the body contradicting the lead that I have seen in recent times. After proclaiming Latvia a success, the story notes that, in addition to 14 per cent unemployment, 5 per cent of the population has emigrated, poverty is worse than anywhere in the EU except Bulgaria, and output is far below the pre-recession level. The concluding comment The idea of a Latvian ‘success story’ is ridiculous,” ought to be the opening.

  1. Christopher Armstrong
    January 3rd, 2013 at 16:30 | #1

    Forgive my poor reading of Keynes, but isn’t the Keynesian view that unemployment is caused by a reduction in investment by the private sector i.e. businesses have reduced investment in their businesses, leading to less hiring of new staff and/or sacking existing staff members?

    In my mind, this relates to the Keynesian view that governments need to increase spending and investment during downturns to make up for the reduced investment by the private sector.

  2. hc
    January 3rd, 2013 at 17:41 | #2

    Wages might not have been that sticky but they were sticky enough to create problems that arose when globalized labour markets began putting pressures on the unemployment prospects of those with average to poor skills. The gains from globalization went to capital and the well-paid while wages and employment opportunities for most US workers stagnated. Sluggish aggregate demands were offset by over-expansionary monetary policies while tax policies, which should have effected compensatory redistributions, didn’t occur for political economy reasons and because of fears about ageing populations – the overexpansionary monetary policies created an illusion of prosperity and eventually led to speculative asset bubbles and the GFC.

    Closed economy macroeconomics isn’t relevant for developed countries anymore. Indeed I think a major error remains the neglect of globalisation.

  3. TerjeP
    January 3rd, 2013 at 17:52 | #3

    The classical view is that unemployment arises from problems in labor markets and can only be addressed by fixing those problems.

    The Austrian Economists would also mention mal-investment due to monetary policy errors.

  4. PeakVT
    January 3rd, 2013 at 17:59 | #4

    Lots of Keynesians (including me) and other critics of the classical view aren’t satisfied with the sticky wage interpretation, or at least regard it as incomplete.

    Perhaps it is considered co-ordination failure, but it seems to me that debt is a major reason why prices and wages are sticky downwards. If we lived in a purely cash economy, prices and wages would be more flexible, but of course that would be a significant limitation on growth.

  5. D’Agostino
    January 3rd, 2013 at 18:03 | #5

    Très pédagogique. Je crois qu’il faudrait/qu’on pourrait ajouter l’incertitude qui est au coeur de l’analyse keynesienne et absente des modèles de la nouvelle école classique. D’ailleurs, la flexibilité des salaires accentuerait l’incertitude en période de récession ce qui n’est pas de nature à améliorer la situation sur le marché du travail.

    Very educational. I think it should be / that could be added the uncertainty that is at the heart of Keynesian analysis and absent from the models of the new classical school. Moreover, wage flexibility would exacerbate uncertainty in period of recession that is not likely to improve the situation on the labor market. “Koo-koo-ka-choo, Mrs. Robinson…”

  6. January 3rd, 2013 at 21:29 | #6

    What happened to Steve Keen’s hypothesis, presumably based on Minsky’s Financial Instability Hypothesis, that booms and busts are often caused by over-extension of credit by lenders, and then the withdrawal of that credit? Or, that certain borrowers eventually find they cannot repay the loans they took out in an expansionary moment, and inevitably collapse when they default? There is little role for the study of debt in neo-classical economics, or even Keynesianism, but what did we see in the Great Depression — speculation in share prices, with purchases being made on margin as the banks optimistically lent to buy shares; 70s inflationary spiral started by an explosion of credit in the late 60s; 80s recession with excessive lending to property developers and other businesses, and finally the 2000s GFC caused by excessive lending on housing. It’s all about money supply and the banks wishing more money into the economy in the form of new credit than it should have — i.e. the increased money supply is greater than the ‘real growth’ in the economy due to increased population, and it may well be allocated in the wrong places — the soft target of mortgage lending, for instance. Thoughts?

  7. Chris Warren
    January 3rd, 2013 at 22:08 | #7

    One day, I dream, I will turn on my computer, and just maybe, I will find a Keynesian talking about “sticky profits”?

    A fair dinkum tripartite “Prices and Incomes Accord” with monitoring systems, should be able to minimise any problem with sticky prices and wages. But business interests interfere too much for this to ever reach implementation. You can have good economic theory – but meaner spirits actually drive policy outcomes.

  8. John Brookes
    January 3rd, 2013 at 23:12 | #8

    On a related note, I’ll stick my neck out and say that unemployment in Australia will now rise, because of the transfer of single parents to Newstart, and the corresponding drop in their income. That is income that was all spent, much of it on stuff made by workers right here.

  9. Eric Titus
    January 4th, 2013 at 00:02 | #9

    This issue is not resolved in labor market economics (microeconomics) either. There is still a fair amount of disagreement on “frictions” in the labor market, how wages change over time, etc.

  10. rog
    January 4th, 2013 at 03:26 | #10

    Apparently Latvia achieved success at the cost of the workforce, 10% (not 5%) emigration is given as the figure. Now that economy is “stable” money launderers are happy to invest.

    ‘No People, No Problem’: the Great Latvian Exodus

    http://www.counterpunch.org/2013/01/03/latvias-economic-disaster-as-a-neoliberal-success-story/

  11. January 4th, 2013 at 04:50 | #11

    Negeroes wehre do my comment be?

    I is cryin’ over here and drankin’ Purple Drank!

  12. January 4th, 2013 at 05:55 | #12

    In a government department that i am familiar with the directive from [above] was to restructure to reduce the permanent salary/wage bill

    in all sections it was managed the same way

    the “directors” cut the defenseless workers and boosted their own pay or the pay of their most sycophantic underlings

    the net effect was to make 2 out of 3 people unemployed yet not to effect the office average income

    this is a government office so how “cost savings” were accomplished was contrary to what we would do if this was a real business in financial trouble where, most usually, it would be the actual workers kept and the managers dumped

    what it taught me was that people latched on to a source of blood will sacrifice any and all to keep or even increase their share

    this is maybe a source of your “sticky” wages

    congealed blood

    pop

  13. Ikonoclast
    January 4th, 2013 at 06:14 | #13

    It is of diagnostic value to note what happens when a democratic mixed economy nation adopts the dirigist or command economy approach when faced with a crisis of existence. World War 2 is a good example.

    The U.S.A. was at war from Dec. 8, 1941 until Sept. 2, 1945. The unemployment rate for 1941, mostly a year of peace for the U.S.A., averaged 9.9 percent (as then measured). Unemployment fell rapidly through the war reaching a low of 1.2 percent by 1944. Between 1941 and 1944 real gross national product rose by 37 percent. In short, World War II reduced unemployment and raised GNP. Thus, in a sense, World War II was good for the U.S. economy though in many other senses war is bad (obviously). Furthermore, civilians were affected by rationing as much production went into the war effort. Finally, we must note that lives and materials are destroyed by war so the increased GDP seems highly unlikely to increase net national assets.

    Leaving aside the inevitable sad end of men and materiels used in the war effort, we note that the command economy approach can rapidly mobilise the nation and put an end to unemployment. The U.S. government imposed military conscription in 1940. Between 1940 and 1944, the size of the military increased by almost 11 million people. We must note that they had “jobs”, if conscripted soldiering can be called a job, because of the command approach and thus the unemployment rate dropped to 1.2%.

    The empirically proven take-away message is that dirigist action by government (direct provision of jobs) can solve unemployment and increase GDP. If that dirigist action were implemented in peace time and the “war” effort was the battle against poverty and unemployment, against global warming and environmental destruction then GDP, net national assets and net human well-being would all rise.

    Draconian measures like conscription are highly unlikely to pass muster in peace time. Indeed, one ought to oppose conscription at all times on moral grounds. Nevertheless, a workable alternative is possible. The reserve army of the unemployed should be converted into a job Guarantee workforce following the ideas of CofFEE (Centre of Full Employment and Equity).

    I won’t put forward here the details of the CofFEE proposals. You may search for them on the net. I will note however that a staggered or rolling implementation could progressively move people off Newstart and onto the basic wage in training courses and then into government, social and environmental jobs. In addition, in my view, a large national works program should be implemented, again on a staged or rolling implementation basis, to move Australia’s economy (starting with the energy sector) to a completely sustainable and renewable basis.

    Again, in my view, instead of increasing Newstart, persons should be given the option of taking Newstart (unemployment benefit) without conditions or compliance tests or of taking the minimum wage Guarantee Job (more than twice Newstart) being trained and subsidised to move (if necessary) to perform that job.

    It really is that easy to solve our crisis. It takes vision, courage and a plan. The plan is there. Where are the vision and courage in this country? Well, we know where they are not. There is no vision and courage (of the humane and inclusive kind) in the hearts and minds of Oligarchs, Liberals or the now sadly mis-named Labor party. We can forget about any of them. They are an institutionalised and entrenched part of the problem and will never be any part of the solution.

    Disclaimer: I am not associated in any way with CofFEE. I am simply a blogging supporter of their views.

  14. Chris Warren
    January 4th, 2013 at 09:57 | #14

    Keynes’ claim that a market economy can stay for substantial periods, in a situation of high unemployment

    This is a famous claim.

    But was Keynes’ looking at “a market economy” or a capitalist market economy.

    Outside capitalism, and with stable population and debt, what is the basis for non-frictional unemployment?

    Of course the Right are going to contest Keynes, because they camouflage the existing market with a theoretical market theory that omits capitalist expropriation.

    Of course the Left is going to contest Keynes’ because he assumed levers were available to rectify matters, and also omitted from his schema, capitalist exploitation.

    So the only defence Keynesians have is that they are in the middle so must be saying something right.

    Where is there any rigor?

  15. Tom
    January 4th, 2013 at 10:22 | #15

    Unemployment is an interesting and very important issue, I might sound a bit like a Marxist here (of course, only to those who isn’t a Marxist will feel this way).

    A few economists have argued that the improvements in productivity and efficient over the decades might have contributed to some increase in structural unemployment. Although usually the increase in output and income should counter this argument. The problem is with the trend of increase in profit share as a % of GDP, the staggering real income of workers (using US as an example, Australia is “a bit” less serious but wage rise is less than productivity increase since the 70s also) meant that all of the increase in productivity went to capital. Now assuming that capital do contribute to surplus (as opposed to Marxism), this would mean that if this trend is to reflect effective allocation of resource (income), all of the increase in productivity would have to come from capital. I, for one, do not believe in this non-sense, which means, in my opinion, the share in the increase in output is screwed over the decades. Not only this, but the increase in the share of income being paid as capital based earnings (but classified as wage income in the national accounts) for the high income earners do not contribute much, if any, to aggregate demand at all.

    http://economistsview.typepad.com/economistsview/2012/12/the-political-economy-of-inequality.html

    How this contribute to unemployment is that, if the increase in output and productivity have not been shared to the workers (who usually spends more of their income on consumption than investment), their purchasing power decrease over time and this negative contribution to demand might of affected the need to produce more goods and service thus leading to unemployment. Far worse is the unproductive investment by the high income of the economy (as people see in the GFC) and the leakage of the productive funds from consumption (leakage in the surplus recycling mechanism).

    I don’t know what exactly Chris Warren meant by sticky profit, but I see a problem, in fact a very big problem with a trend of increase in profit share as a % of GDP due to uncompetitive market and inefficient allocation of resources resulting deficiencies in aggregate demand. Just to be clear for some people with economic terminology, an increase in profit share as a % of GDP is DIFFERENT to income inequality, I have not bother to put effect of income inequality in this comment as even the conservative neo-liberal IMF have said it harms growth (thus unemployment).

  16. Ikonoclast
    January 4th, 2013 at 10:30 | #16

    @Chris Warren

    Chris, within a given mode of political economy, namely democratic govt. with a mixed economy of public and private spheres, it is valid to make an analysis of and within the extant system. The theoretical analyses of the extant system which accord best with the empirical outcomes of a range of policies in that general extant system are the analyses of of the Keynesians, New Keynesians (I think JQ called them) and MMT theorists. I would give other heterodox economists like Steve Keen a good mark too for their debt and instability work. The theories of the Classicals, neo-Classicals, Monetarists and Austrians do not explain the empirical data, in fact they programmatically ignore empirical data.

    The Classicals, neo-Classicals, Monetarists and Austrians are total ideologues, serial apologists for Oligarchic Capital, often deliberately intellectually dishonest like Milton Friedman certainly was and in many cases suborned and in the pay of the Oligarchs and corporate capitalists.

    The Keynesians, New Keynesians and MMT theorists are gnerally rigorous and do have regard for the empirical data while working within the parameters of examining the existing system. If one wants to draw a longer political economy bow and criticise them for failing to properly analyse and critique class relations and bourgoise legitimisation of capitalist ownership then this is fair enough and I would (and do) go there too. However, I would see these Keynesian and heterodox (but still not strictly Marxist) economists as social-democratic allies. Best to pick your battles with the real right-wing apologists and sympathisers, namely the Classicals, neo-Classicals, Monetarists, Libertarians and Austrians.

  17. Chris Warren
    January 4th, 2013 at 12:35 | #17

    I see good points in both Tom and Ikonoclast.

    However the issue really is – how you understand the economy, not get too fixated on money, debt, unemployment and GFC.

    Keynes presented a view on the economy, that then had consequences how money, debt, unemployment, and crisis was subsequently understood and supposedly dealt with.

    Unfortunately we have to go through the brain-ache of dealing with both Keynes and Marx.

    Keynesian theory claims that prices do not fall to average prime cost 1) because they chase marginal revenues or 2) because of “user costs” (Keynes’ personal view it would seem).

    Marxists would say that under capitalism, prices do not fall to average prime costs (exchange value) because of 1) politics or 2) introduction of surplus value.

    However, if all products are sold, or a sought to be sold, above prime costs – the circular flow is disrupted and we end up with; initially ratcheting macro instability (1970′s to 2006), and eventually a GFC (2007 to 2012+) – with worse to follow?.

    If a Keynesian can come up with a way of ensuring that goods and services can be sold for average prime costs, “within the extant system”, then you can call me a Keynesian.

  18. Ikonoclast
    January 4th, 2013 at 14:06 | #18

    @Chris Warren

    I have to admit I am not enough of an economist to make that comparison. I would have to study Keynes and Marx in detail and side-by-side as it were. To date, all my studies (if I can call them that) of economics have been private reading. I have done no formal studies in economics.

    I do strongly tend to the labour theory of value from the human end and the natural theory of value (materials and energy) from the environmental end. These two views are not incompatible at all IMO. In fact it is in combining them that we come to the most empirically and morally supportable theory of value. I will post more on my theory of value soon.

  19. BilB
    January 4th, 2013 at 17:27 | #19

    There is a time warp at play here with this subject.

    When Keynes developed his theories production multipliers were nearer to 1, one man one machine, one man machine output per day. Women had a far lower participation in the work force, and a services industry was principally domestic help for the higher end of the income spectrum. Living “rough” for the under endowed and or unemployed was both possible and common. The economic world was relatively homogeneous and inflexible. These are essential preconditions for ” a market economy can stay for substantial periods, in a situation of high unemployment and excess supply in all markets” to be true.

    Warp forward to today’s economies and there is very little similarity with Keynes’ world. Production multipliers of 10 to 1 are common, many economies have broad spectrum services industries that have higher participation than production industries, women’s participation in the economy nearer to equal, people have far greater asset holdings and the means to cross convert those assets at will, most significant economies have social welfare functions that discourage “living rough”.

    So to take Keynes exact words and conclusions from his time and expect them to predict present day outcomes is as meaningful as predicting the future from a literal translation of the Bible.

    We then come to unemployment in our modern mixed economy where the main means to manage unemployment has been through economic “growth”. Without that all encompassing driver governments’ only other method appears to be through stimulus spending. The key problem facing “western” economies is that they have become dependent on expanding their apparent standard of living with imported cheap labour performance from developing countries. In the so doing they have undermined their basic manufacturing industries and shifted those workers into service industry roles. So when their economies face a downturn the way the economy performs internally is no longer properly aligned to the Keynesian pathway. Manufacturing, small and mdium scale, generally reacts to a downturn by maintaining staff and reducing overtime hours, thus not requiring alteration to labour rates. Large scale manufacturing generally reacts initially by shedding some staff and improving their technological footprint with more advanced machinery. As small business employs three quarters of the workforce downturn effects within an economy with a strong manufacturing sector is softened. However where an economy has “outsourced” low fundamental and consumer products manufacturing this softening influence is reduced. Their services industry reacts more rapidly to downturns by laying off staff and improving remaining workforce with improved software for that industry’s primary performance multiplier, computers.

    Agriculture has its own independent cycle of performance swings and can coincide with a general downturn to either exacerbate or relieve depending upon the climate. Mining is a wildcard performer.

    But I will argue yet again that there is an unutilised device that governments have available to them that will serve to auto balance an economy that is exposed to over competitive labour markets in a time of rising (and falling) unemployment. This mechanism is to proportionally link a uniform levy on all imports of goods and services to the unemployment level. The proceeds of this levy directly fund employment enhancing stimulus measures through business and education pathways. The advantage of this approach is that all sectors are disadvantaged equally and minimally for the common objective of improving the economy’s labour and performance competitiveness. The auto linking means that as unemployment falls so too does the levy and the mended economy accelerates out of a tightened position.
    So if economists cannot agree on macroeconomic methods to tackle unemployment, it is not that Keynes has become irrelevant, it is that the understanding of each county’s economic dynamics has not kept apace with our dramatically changing world.

  20. Jordan
    January 4th, 2013 at 17:58 | #20

    Due to baning the role of money in economy Keyness saw the problem as “sticky wage/price” but they are not sticky in real world. I witnessed mass firing of workers and then couple months later rehiring same workers with a new contracts and erasure of accumulated benefits in past work, i witnessed replacing full time workers with temp agency workers, i witnessed pressure on pay time worked and on pay level. Wages are not sticky today.

    It is sticky debt and interest rates that is the problem.
    Individual debt is unchanged or fixed rate interest is unchanged and flexible rates are barelly lowered when interest rate goes to 0.

    So, we have lower wages and sticky debt, which pulls consumption down which discurages investment which lowers wages, hence permanent downturn. Balance sheet recession/depression.
    Logical solution would be higher minimum wage, much higher.
    Another additional support for solution is high marginal tax rate that would encourage lower business expenditure for management class and allow for rise in workers wages. Total employee cost would not change but distribution have to change.

  21. Chris Warren
    January 4th, 2013 at 21:31 | #21

    @BilB

    As increase in multipliers will not change the role of average prime costs nor the role of marginal revenue curve.

    Of course there have been changes but to present them needs more explanation and the right context. In general capitalism has relied on countervailing tendencies to maintain their system – so we have different exchange rate mechanisms, different debt systems, and different populations and so on. In order to maintain surplus, circulation must speed up, and this will appear in any multiplier.

    If you are not willing to use the words of Keynes, could you please post your view of the definition of Income, Saving and Investment that replaces Chapter 6 of “General Theory of Employment, Interest, and Money” (Keynes).

    By itself, switching to service industries does not create any disconnect with some vague “Keynesian pathway”. Although the underlying reason for switching from manufacturing to service industries may play a part. But this is expected – capitalism has to eventually dump Keynesian principles (or leave the pathway if you want) when countervailing tendencies are exhausted.

    Levies on imports are a separate issue. It is best to explore how an economy operates by starting with a closed economy. Presumably unemployment occurs in a closed capitalist society.

  22. BilB
    January 5th, 2013 at 02:09 | #22

    Chris W,

    These

    “As increase in multipliers will not change the role of average prime costs nor the role of marginal revenue curve”

    are only relationships, not laws of nature. To use a microeconomics icon, the loaf of bread, in most towns across our country there are bakeries that supply a loaf for as little as $1.20 while at the supermarket a comparable loaf costs $3.30 , and yet both operate stably just a few blocks from each other. That represents a market deviation factor of 3 and highlights the difficulty of understanding a modern economy purely in micro economic textbook terms.

    Capitalism thrives on performance multipliers, in primitive terms ….a stick …or tool, in modern terms machinery and technology. This is the “countervailing tendency” to which you refer. Performance enhancers, or multipliers, enable our economy to employ more people while at the same time be able to afford more and higher quality goods.

    What I was referring to in my earlier comment is the way various industry sectors react to a downturn with relation to their employment retention. The one pivotal industry that I did not cover is the construction industry. I simply ran out of time. However this is the one industry that responds directly to interest rate adjustments. This industry employs a huge number of small business contractors and feeds a large section of the manufacturing sector. Without the relationship between interest rates and property investment, managing an economy with monetary policy is far less effective. Spain Ireland Japan and the US are examples of where this relationship has failed, and these economies have become unwieldy to control. Australia is close to where that relationship will break down as property values become unaffordable to an ever increasing percentage of the population.

    An interesting figure that requires some explanation is the average minimum wage for most US states which is fully half that for Australia, and yet the US has the unemployment problem.

    Service industries fall largely into the “overheads” side of the business balance sheet and are therefore the first sector to suffer shedding of staff in a downturn. By significantly altering the ratio of overheads/production employment in an economy the unemployment reaction response time in a downturn becomes more acute. This is the point that I was making.

  23. Ikonoclast
    January 5th, 2013 at 06:18 | #23

    “An interesting figure that requires some explanation is the average minimum wage for most US states which is fully half that for Australia, and yet the US has the unemployment problem.” – BilB.

    A good point and one TerjeP would need to consider.

    However, it would be more accurate to say “… yet the US has the unemployment problem.” We still have an unemployment problem in Australia and an officially ignored under-employment problem of discouraged workers not in the official statistics.

  24. Jordan
    January 5th, 2013 at 06:23 | #24

    @BilB

    An interesting figure that requires some explanation is the average minimum wage for most US states which is fully half that for Australia, and yet the US has the unemployment problem.

    Only believers in supply side economics need such explanation. The “discrepancy” should prove demand side economics as correct theory.
    It is true that supply side suports demand side, but demand side initiate supply side economy. That is where clear distinction is impossible only due to ideological bent and what is cause of what is unclear at first look.

    Agregat demand can be supported by increase in private debt when wages are insuficient for full employment equilibrium, also by goverment demand as best case in WWII where government nedded a lot of materials and services.
    But still the only sustainable demand is from wages high enough not to need increase in private debt for consumption besides housing and cars. That would explain why higher wages in Aus then in US produce higher employment. Higher wages also mean that there is more room for increase in private debt which also pulls AD.
    Higher wages can be maintained only by minimum wage requierments since unions have proven as breakable over time, even tough unions maintaned levels of minimum wage initially trough demands on governments.

    The reason that minimum wage is only thing that can sustain increased demand is due to external shocks on supply side from energy and resource prices which breaks its suport of demand side and can increase unemployment which puts pressure on wages unless government reacts and cover for unemployment increase by strong safety net. Government is only sector that can stop spiriling fall into depression with automatic safety net/ increase in deficit spending. AUS has strong and automatic safety net while US cut it under Clinton.

    In case of US the lower marginal taxes allowed mangement to take over the benefits of rising productivity for themselves while at the same time, with increased incomes, bribing politicians and academics to produce arguments for their benefits and providing savings for debt to labor class to continue sufficient demand. You get society that glorifies wealthy and businesses against labor and unions which also produces more savings and more indebtness that support AD instead of wages. This all got triggered by energy price shocks on supply side. Ever increasing debt becomes crucial supporter of AD which keeps supply side functional.

    Reduce the increase in debt and you get a recesssion. And without strong government automatic stabilizers and panic in supply side (confidence) you get a depression. That is what happened in US. AUS also did a stimulus in housing which prevented supply side panic and private debt kept rising but question is for how long will keep rising.

  25. Ernestine Gross
    January 5th, 2013 at 11:59 | #25

    Prof Q, I have a few questions. They may appear faux naive but they are actually serious. I don’t know how else to escape from the conceptual boxes of contemporary macroeconomics. Since my undergraduate time, I find again and again the boxes are empty and the empirical measures of the so-called critical variables are a movable feast. Some policy proposals (eg CofFEE (Centre of Full Employment and Equity) scare the daylight out of me because people are treated like a thing that is supposed to serve ‘the economy’. While I like to re-read Walras, Keynes, van Hayek and Adam Smith, I have no time for macroeconomic texts such as Mankiw.

    Here are my questions:

    1. Are macroeconomists in ‘the labour markets’?

    2. Why is unemployment critical to macroeconomics?

    3. How is ‘the economy’ described in macroeconomics?

    4. How do authors such as Arrow, Blad, Boehm, Debreu, Geneakopolous, Grandmont, Grodal, Hahn, Hildenbrand, Keiding, Malinvau, Radner, Tobin, Vind, Wiesmeth and many more, fit into the classification of ‘standard neoclassical’ or ‘neoclassical’ or ‘micro’ or ‘macro’ economics? (I mention these authors because I know they had influence on the education of economists in the EU[Euro] who are now at an age where their opinions matter.)

  26. Will
    January 5th, 2013 at 12:04 | #26

    Fortunately this thread has been free of the tired old platitudes concerning the plight of the unemployed and others at the mercy of the neoliberal revised welfare system. I have come to the conclusion that those who spout the well-worn century-old canards, such as stop whining, or get a second job, must either be fellow poor people who are terrified that others might have a slightly easier time of their lives, or solidly middle class people who have no idea what it is like to come from a lower-class family. Surely no-one who had to work hard to escape the entrenched social class system would have anything but sympathy for the most vulnerable.

  27. Jim Rose
    January 7th, 2013 at 16:17 | #27

    Most Keynesian economists are convinced that something exists called involuntary unemployment and people can be unemployed through no fault of their own.

    Involuntary unemployment is like saying you are involuntarily unmarried. You could marry the first person you meet, if they will have you, but few would say that is wise. search and matching costs are real.

    In the late 1970s, Modigliani dismissed the 1969 Lucas-Rapping paper on the U.S. great depression as the great vacation theory where the mass voluntary unemployment of the 1930s is explained, in Modigliani words, as a congenital attack of laziness.

    An increased preference for leisure is another name for voluntary unemployment.

    As Prescott pointed out, the USA in the Great Depression and France since the 1970s both had 30% drops in hours worked per adult. That is why Prescott refers to France’s economy as depressed.

    Others such as Blanchard attribute the much lower labour force participation in the EU to their greater preference for leisure in Europe.

    An unusual left-right unity ticket emerged to explain the great depressions in the 1930s and the depressed EU economies after the 1970s: the great vacation theory.

    p.s. on “a global recession like the one we are observing, occurring simultaneously in many very different countries and lasting for many years, should be impossible, or at least highly improbable”, Finn Kydland and co-authors have spent 20 years writing on international real business cycles. They showed that real economic activity tends to move together across industrialised economies over the business cycle.

    The result was the Backus–Kehoe–Kydland consumption correlation puzzle. It is one of the six major puzzles in international economics. Read the wiki!

  28. BilB
    January 8th, 2013 at 01:44 | #28

    Jim Rose,

    If a business shuts down laying off, say, 100 workers, even if it takes only one week for those workers to find new employment, those 100 workers are involuntarily unemployed for one week. That represents 500 man days of involuntary unemployment. Now if those workers did 30% overtime in their last fortnight of “employment” and were subsequently unpaid for their last fortnight’s work, an outcome not uncommon from Libertarian employers who seek to obtain maximum advantage at minimum cost, then effectively that period of involuntary unemployment is now 3.6 weeks per person totaling 1800 man days of involuntary unemployment.

    I think that it is conclusively proven that the Keynesians are correct, involuntary unemployment not only exists, but is by far the most common form of unemployment. And I have to say that was a very lame attempt at labeling the unemployed as being rent seekers at the public expense.

    Similarly any population gender mismatch will potentially provide a percentage of people who are involuntarily unmarried. Myth Busted.

    Now it is also true to say that there is voluntary unemployment. Anyone on unpaid leave is voluntarily unemployed. Not all women chose to seek employment some preferring to be totally immersed parents. But it is similarly false to claim that a 30% drop in hours worked in, your example France since the 70′s, represents a “lazy” community seeking leisure over work. For starters what certainly is the case is that their was a greater workforce participation over time as more women entered the work force. The 35 hour week did not arrive in France till the year 2000, and in the 1970′s French workers put in slightly longer hours than Americans. Furthermore European communities are far more efficient than American communities as they are more compact and distances for all aspects of people and product movements are far shorter. There is a claim that Europeans were less productive during the last several decades of the last century, and that may well be the case as the US had maintained the position of having the highest degree of automation in the world, a position that they have now lost.

    So I think that in short Prescott’s claims are dubious and based on an artificial selection of criteria.

    As for the Backus–Kehoe–Kydland consumption correlation puzzlement, the answer is simply wastage, false accounting, distribution inefficiency, corruption and theft.

    “……….it fell off the back of a truck”

  29. Jim Rose
    January 8th, 2013 at 11:04 | #29

    @BilB Suppose you are divorced, but remarry a week later. (Were the grounds adultery?)

    For one week you were involuntarily single. You could have gone from the court to a singles bar to try you luck but true companionship is rarely found in one night stands.

    The concepts of marriage and divorce and of employment and unemployment are much the same analytically and in welfare terms too. Many recently divorced are unhappy and striving for new fulfilment.

    The economic concept of unemployment was rather primitive until Hutt write his hard to read theory of idle resources in 1939, Stigler’s paper in 1962 and the Phelps book in 1970.

    see http://www.american.com/archive/2010/july/labor-pains showing that French hours per adult aged 15 to 64 dropped by 1/3rd between 1960 and 2000. US hours per working age adult rose; hours per working age Australian dropped trivially. The differential changes between the United States and France is more than 45 percent.

    Those countries with higher marginal income tax rates have systematically lower employment in activities with good non-market substitutes such as home production. The European services sector is much smaller than in the USA.

    Time use studies find that lower hours of market work in Europe is entirely offset by higher hours of home production, implying that Europeans do not enjoy more leisure than Americans despite the widespread impression that they do.

  30. Jim Rose
    January 8th, 2013 at 11:05 | #30

    thanks Bilb, suppose you are divorced, but remarry a week later. (Were the grounds adultery?)

    For one week you were involuntarily single. You could have gone from the court to a singles bar to try you luck but true companionship is rarely found in one night stands.

    The concepts of marriage and divorce and of employment and unemployment are much the same analytically and in welfare terms too. Many recently divorced are unhappy and striving for new fulfilment.

    The economic concept of unemployment was rather primitive until Hutt write his hard to read theory of idle resources in 1939, Stigler’s paper in 1962 and the Phelps book in 1970.

    see http://www.american.com/archive/2010/july/labor-pains showing that French hours per adult aged 15 to 64 dropped by 1/3rd between 1960 and 2000. US hours per working age adult rose; hours per working age Australian dropped trivially. The differential changes between the United States and France is more than 45 percent.

    Those countries with higher marginal income tax rates have systematically lower employment in activities with good non-market substitutes such as home production. The European services sector is much smaller than in the USA.

    Time use studies find that lower hours of market work in Europe is entirely offset by higher hours of home production, implying that Europeans do not enjoy more leisure than Americans despite the widespread impression that they do.

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