Real Adjustment Costs

It is a story in which people try a configuration of activities and it is not profitable. Their marginal products in that configuration are so low that the characters end up not engaged in market activity

yes, but why?

Is it because sustainable patterns of specialization and trade are made unsustainable by the reduction in the medium of exchange or is it because people value their free time more than the products?

Why do you think that the patterns are independent from money in the short run?

In the PSST model, all the price signals can be correct, but entrepreneurs have not yet done the right experiments and invested in the right business models to create the patterns of trade that will result in full employment.

So… AS/AD with sticky quantities (i.e., with new unexplored “right business models” stuck at zero?)? Is that a fair characterization?

There is nothing logically wrong with your macro play, Arnold. The story makes sense.

As *measured*, if all 4 players are hard at work *investing* in setting up 2 new restaurants in scene 1. That investment will be valued at cost. So it counts towards RGDP. But in reality, as we learn with hindsight, in scene 2, that investment is worthless. So all 4 players were simply wasting their time. (Although, you could argue that it was a valuable investment in information — in learning whether or not it was a PSST — because sometimes the only way to find out is to try it and see if it works in the market).

It’s a malinvestment story. And that story is being played out every day somewhere in the economy. As a *micro* play it’s fine. (Though, why does Act 2 take more than a few seconds? Why doesn’t the play go straight from Act One to Act Three? What are they waiting for?)

But, empirically, why should those malinvestments be correlated across the economy, so it shows up in macro data? How does it work as a *macro* play?

The old Austrian story is that the central bank sets the real rate below the natural rate, so a lot of people malinvest at once.

I think Kling’s point is that Act Two does take a long time.

But it seems to conflict, as it stands, with existing theories of search/matching. Plus, there is the uncomfortable result that PSST would imply a search for patterns suitable for a high-unemployment economy (e.g., investment in more bulletproof glass and burglar alarms factories), thus slowing movement toward lower unemployment in the absence of stabilization policy. Cue Sumner charging in yelling “NGDP!”

It is easy to make up stories but it is difficult to make them consistent.

1) What were they doing before in Act Zero? Were they working across the street at Chuck and Bill’s burger stand? Were the restaurants new or were they left over from some previous attempt? Was the boom in Act One due to labor or investment, or was their no boom at all?

2) One assumes they exist in a larger economy for if they didn’t they couldn’t possibly have failed. Instead they simply end up cooking for themselves rather than each other. There may be a measurement problem due to lack of exchange but no difference in production otherwise.

3) Chuck and Bob may have lost a little business that they regain when they close so why don’t they go back to working there? If dedicated to their own concept then when they succeed Chuck and Bob have lost some business and they have gained an income, but there is no net change.

4) Rather than specialization this is more a tale of tastes. Some tastes may be more enduring than others but change over time and popularity waxes and wanes. If production changes, Chuck and Bob must not have had all the business before so what actually causes the change in eating out? Previous boredom and satiation with burgers? Excitement over new options? A change of mood or taste?

I think people might need to define what they mean by “full employment”.

David Laidler has some good comments on the fetish with sticky wages/prices in “The Monetary Economy and the Economic Crisis” http://hayekcenter.org/?p=4122

Now “a general anxiety to sell” is a central characteristic of what our anonymous cartoonist called “convulsion”, and Mill was here exploring the economy’s transition from this state to one of “stagnation”. But he did not complete this task, either in (1844) or in the parallel passages dealing with the cycle in his (1848) Principles. In (1879), however, Alfred and Mary
Paley Marshall paraphrased Mill’s by then quite standard account, noted that “the connexion (sic!) between a fall of prices and a suspension of industry remains to be worked out” (Marshall
and Marshall 1879, p. 155), and proceeded to fill in this gap by examining the consequences of the fact that “. . . when prices are falling, the fall in the price of a finished commodity is generally more rapid than that in the price of the raw material, always more rapid than that in the price of labour ” (p. 156, italics added). Thereafter, and for more than half a century before the publication of the General Theory, nominal wage stickiness was the standard “Classical” explanation of unemployment in a monetary economy, and today’s practice of making it the defining postulate of “New-Keynesian” macroeconomics is simply another symptom of how
badly our discipline’s history is misunderstood by its practitioners.11

11 I discussed the evolution of ideas about wage and price stickiness in my 1991 Henry Thornton Lecture “Wage and price stickiness in macroeconomics: an historical perspective” (Laidler 2004, Ch.12) Wage stickiness had made a brief appearance in Henry Thornton’s (1802) Paper Credit but only found a central place in the mainstream literature after the Marshalls’ deployment of it. Their analysis, and that of their immediate successors, not least Pigou (e.g.1913), went on to emphasize the effects on real wages and hence on the demand for labour of interactions between sticky wages and more flexible prices, thus deploying a not quite satisfactory application of partial equilibrium labour market analysis to the economy as a whole to explain the emergence of unemployment. In (1913), however, Ralph Hawtrey began to argue that the real significance of wage stickiness arose because, by way of markup mechanisms, it created stickiness in money prices too, thus inhibiting the price level adjustments needed to
eliminate the excess demand for money and associated excess supplies of output and labour that developed during the transition from “convulsion” to “stagnation”.

PS, the quote above won’t make much sense until the previous post is posted.

Yes, the old Austrian story has prices wrong before the recession. Keynesian/New Keynesian/monetarist stories have prices or wages wrong during the recession. Pretty much only RBC insists that prices are generally right. Happily, we can all agree to reject RBC, yes?

(conveniently, this comparison should highlight the Austrian problem of curiously myopic and/or gullible investors, who could hedge but don’t. Better “change happens, and we have trouble adjusting to keep up” than “y’all were pricing things wrong”)

To the people asking how this effect can take effect economy wide, it goes like this.

Act I. A million people are building houses, and new houses are selling for X dollars per year.

Act II. Houses now sell for X/2 dollars per year. Many of those million are unemployed.

Daublin, nice and succinct!

Laidler points out that Mill never interpreted Says law as dealing with a money economy, but with barter. In barter there can be no unemployment, but as Mill wrote a money economy makes unemployment possible. That’s why I don’t understand how people can wonder about why unemployment takes place. Here’s what Mill wrote:

But those who have, at periods such as we have described, affirmed that there was an excess of all commodities, never pretended that money was one of those commodities; they held that there was not an excess but a deficiency of the circulating medium. What they called a general super-abundance, was not a super-abundance of commodities relative to commodities, but a superabundance of all commodities relatively to money” (Mill 1844, pp. 69-71)

A demand to hold more money creates a shortage of money relative to goods/services and thereby unemployment. That should be obvious. The real question, though, is why do people suddenly demand more money at the same time? And why do businesses stop investing at the same time?

If they did so randomly (not at the same time) then there would be no cycle but just random clusters of people suddenly deciding to hold more money for no reason at all. But I’m not convinced that people do anything for no reason at all. If they’re rational, they have a reason for wanting to hold more cash. Keynesian and RBC and purely monetary theories of crises fail utterly to answer that most important question.