Why do booms feel good?
By Scott Sumner
The answer to this question might seem obvious, but it isn’t. Yes, booms feature lots of jobs and income, but most standard macro models suggest that booms feature “excesses,” with too much employment and perhaps over-investment too.
In the sticky wage/price model, recessions are bad because workers are working less than they’d prefer to work, and booms are bad because workers are working more than they’d prefer to work (in a non-distorted economy.) So why do booms feel so much better than recessions? Indeed even better than long run equilibrium?
The answer to why booms feel good is actually quite subtle. The economy is riddled with labor market distortions that cause people to work less than the optimal amount, even when wages and prices have fully adjusted to any change in NGDP. These include taxes on labor and subsidies for not working (implicit taxes on labor.) So the “normal” or natural rate of employment is far below the optimal level. A boom pushes employment closer to the optimal level, even if the result is not sustainable. (Eventually wages and prices adjust, returning you to the suboptimal “natural rate.”)
Note that one cannot examine welfare issues here by looking at the behavior of an individual. Given the array of tax and subsidy distortions in the labor market, each worker may be “optimizing.” But because those taxes and subsidies lead to external effects, the optimal level of labor supply for the individual will typically be below the optimal level for society.
I’ve noticed that a number of liberals have overlooked this problem when discussing the job losses that will result from Obamacare (now estimated at more than 2 million full-time equivalent jobs.) They claim that this sort of job loss is a good thing, because workers will be responding optimally to the incentives created by the law. I don’t doubt that some workers will respond optimally, given their situation, but that doesn’t mean the loss in employment will be optimal from the perspective of society.
Keynesians tend be especially aware of the asymmetrical effect of business cycles on welfare, much more so that real business cycles proponents. They understand the role of sticky wages and prices, and that the optimal level of employment is not the average level experienced in the US, but something closer to the boom level. Thus it’s ironic to see Keynesian less aware of the dangers of Obamacare than are the real business cycle economists.
Patrick Sullivan directed me to an excellent Wall Street Journal article that discusses the views of Casey Mulligan, a famous RBC economist:
Instead, liberals have turned to claiming that ObamaCare’s missing workers will be a gift to society. Since employers aren’t cutting jobs per se through layoffs or hourly take-backs, people are merely choosing rationally to supply less labor. Thanks to ObamaCare, we’re told, Americans can finally quit the salt mines and blacking factories and retire early, or spend more time with the children, or become artists.
Mr. Mulligan reserves particular scorn for the economists making this “eliminated from the drudgery of labor market” argument, which he views as a form of trahison des clercs. “I don’t know what their intentions are,” he says, choosing his words carefully, “but it looks like they’re trying to leverage the lack of economic education in their audience by making these sorts of points.”
A job, Mr. Mulligan explains, “is a transaction between buyers and sellers. When a transaction doesn’t happen, it doesn’t happen. We know that it doesn’t matter on which side of the market you put the disincentives, the results are the same. . . . In this case you’re putting an implicit tax on work for households, and employers aren’t willing to compensate the households enough so they’ll still work.” Jobs can be destroyed by sellers (workers) as much as buyers (businesses).
He adds: “I can understand something like cigarettes and people believe that there’s too much smoking, so we put a tax on cigarettes, so people smoke less, and we say that’s a good thing. OK. But are we saying we were working too much before? Is that the new argument? I mean make up your mind. We’ve been complaining for six years now that there’s not enough work being done. . . . Even before the recession there was too little work in the economy. Now all of a sudden we wake up and say we’re glad that people are working less? We’re pursuing our dreams?”
Tyler Cowen also has an excellent post on this:
A lot of Keynesians try to maintain the communication of the feeling (if not the outright statement) that demand-driven employment shocks have very little to do with the choices of workers but that is closer to wrong than right. (By the way, sarcastic comments about soup kitchens causing the Great Depression belie an understanding of both this argument and of contemporary search models for the labor market.)
OK, given all that, when those workers, hit by negative shocks, do not rush to go back to work at lower reservation wages, we then read a portrait of hysteresis, despair, and soul-crushing joblessness, a psychic swamp so difficult to escape that even summoning up the strength to go back to work may be difficult.
In other words, would-be workers irrationally undervalue the benefits of having a job and they also underestimate the costs of remaining unemployed.
Now let’s switch settings. A benefit shock comes along, positive for many people, and it induces many of them to work less or not work at all. How happy should we be? And here I mean happy at the margin, due to their change in employment decision.
People, it is rather difficult to have it here both ways.
All I would add here is that it’s an externality problem. And that means that one cannot look at the motivations of individual workers responding to the Obamacare incentives as providing any sort of reliable estimate of the social impact of the loss of jobs.
In countries with great disincentives to work (parts of Europe), people work less than in America. In regions with fewer disincentives to work (parts of East Asia) people work more than in America. Obamacare moves us closer to the low employment European equilibrium. Liberals may like that, but then they need another explanation of why a boom feels better than an economy operating at the natural rate.