By Arnold Kling
On three links from Mark Thoma, on macro theory, the euro, and the stalled housing market.
1. Nick Rowe writes,
If people could trade goods and labour directly at zero transactions costs, without having to use monetary exchange, all Keynesian macroeconomics would be total rubbish. All Keynesian macroeconomics, either explicitly or implicitly, assumes monetary exchange. It’s not just sticky prices that generate Keynesian results. It’s sticky prices plus monetary exchange.
He then goes through an elaborate modeling exercise to demonstrate this. I have a simpler version. If barter were possible, then firms would pay their workers in goods. If you can pay your workers in the goods and services they produce, then you eliminate any wedge between the real wage and the marginal product. So there is full employment. QED.
This is one reason why I prefer to think of the macroeconomic problem in terms of patterns of sustainable specialization and trade. With the PSST model, I think of a recession as resulting from existing trade patterns not being sustainable, which means that new patterns have to be discovered. Until those patterns are discovered, people are unemployed. If workers were paid in the form of their output, they would not know what to do with it. They do not know how to discover the patterns of specialization and trade. So barter solves nothing in the PSST model. In my view, the PSST model stays away from a number of intellectual traps, of which money vs. barter is just one.
Another way to put this is that the types of models Rowe is talking about assume away all sorts of costs of discovery and co-ordination in creating PSST. In the Keynesian paradigm, the patterns are there, it’s just that the aggregate wage and price are out of line.
The advantage of the aggregate wage-price misalignment theory (in its Keynesian or monetarist incarnations) is that you can solve unemployment with fiscal and monetary policy. That makes a lot of economists, including me, wish that aggregate wage-price misalignment were true. But unlike Prad Krulong, I am not adamant that it is true. In my mind, it has a chance of being that is more than zero but less than fifty percent.
I think that it is healthy to question our priors on the importance of the exchange rate in explaining some of the empirical phenomena we observe these days in Europe.
Yesterday in my high school econ class, I found myself trying to explain why having a separate currency that could depreciate would enable the PIIGS to live happily ever after. I made the textbook argument, but I found myself not so convinced. OK, so maybe you can tell a story where one country that has a recession and a large fiscal deficit would be better off with devaluation. But there are so many countries in that position right now, and they cannot all devalue.
Speaking of “cannot all devalue,” doesn’t the impact of the PIIGS crisis completely nullify QE2? If the dollar appreciates 10 percent and the foreign sector is 10 percent of the economy, then that represents 1 percent disinflation, which probably more than wipes out any inflationary impact of the Fed’s new bond buying program.
New housing expenditures started to recover in 1934, buoyed perhaps by Congress’s creation of the Home Owners Loan Corporation (HOLC). This agency bought underwater home mortgages and reissued them at values that were based on prevailing home prices.
The reason that you might want the HOLC in 1934 is that there were people living in houses who actually belonged in those houses. That is not true in the current crisis. Many do not live in the houses. Others who live in them were counting on price appreciation to overcome the fact that they had bought houses that were way to expensive relative to what they could afford. The housing market today is choked with speculators.
The current crisis calls for a different sort of policy response. I would propose a Resettlement Agency, to move people out of houses that are inappropriate for them. Get the excess housing inventory on the market where everybody can see it, let it get absorbed, and then we can finally move on. Until that happens, the housing market is going to be paralyzed.