It's no secret that I'm a Keynesian. I feel like I have eclectic interests, an open mind, and great respect for many non-Keynesian thinkers, but I am decidedly in that camp and have only found myself more firmly under the sway of the old Cambridge don since the beginning of the Great Recession. Moreover, I personally feel like I was ahead of the curve. I first read his magnum opus, The General Theory of Employment, Interest, and Money (1936) in 2006 - way before it was cool. It was this reading that confirmed my earlier suspicions about my own affiliation.But lately I've been doing quite a bit of introspection on the nature of my inner Keynes, namely: am I a Post-Keynesian or a New-Keynesian? Specifically, do I think that nominal wage cuts are effective at fighting depressionary conditions? It's the sort of school of thought sub-sub-classification internecine struggle that seems somewhat appropriate to this blog (particularly now that I know we have at least a couple economics-inclined readers). However, like most who engage in these internecine struggles, I'm personally convinced of the importance of the question. Millions of livelihoods and perhaps trillions of dollars are on the line, after all! Why haven't I decided!
Well, because it's a very tough question. Standard theory says that wage cuts should raise the employment level, and some very smart people have highlighted rigid or sub-optimally high wages as the source of involuntary unemployment. That's the New Keynesian position, and if pressed that's what I'd call myself. It's a safe and respectable default. The problem with that is, standard theory often breaks down in unstandard times - and we're living through very unstandard times in the economy right now. Markets are gumming up and failing to function normally all over the place. It's important to recognize that it's not just a hard period - things are not really working how they're supposed to work. The government borrows around a tenth of GDP and interest rates on short-term government debt are bumping around at 0%?!?!? The money supply shoots through the roof and we're seeing exceptionally low inflation?!?!? For an economist, this is the equivalent of a Salvador Dali painting. But we've been here before, and one of the most prescient thinkers on these problems the last time we were here was John Maynard Keynes. And Keynes (1936) said that nominal wage cuts in depressions would worsen depression.
So what motivated this blog post? What do I have to share with you besides my own soul-searching? Well, there has been quite a bit of chatter on other blogs over this very question that I wanted to share. Because some of the recent posts reference back to it, we can start with a year-old op-ed by Paul Krugman, arguing the classic Keynes position on the issue. Krugman is interesting - he's always been in the New-Keynesian camp, but he's been sounding a lot like a Post-Keynesian lately. Bryan Caplan responded at that time. A recent heated exchange between Brad DeLong (New Keynesian) and Steve Horwitz (Austrian School) over a somewhat different (but related) question turned up this comment by DeLong on David Henderson's (ummm... I guess Austrian School) blog. This is when the real nominal wage discussion begins.
Henderson responds to DeLong's comment. Menzie Chinn (I suppose also a New Keynesian) responds to Henderson's head scratcher of an attempt at ad hoc empiricism. Caplan responds to Henderson and DeLong. And as usual, Scott Sumner makes me wonder if I have everything wrong and should just become an unrepentant Monetarist. Then again, Scott Sumner is sort of out in left field... by which I mean the parking lot. I don't mean that as an insult at all - he just has a very different perspective on things from most people.
So there's a bunch of links to wade through - and my guess is there will be more today. The other reason why I mention this is because the back-and-forth mentions the last time nominal wage cuts did decidedly lead us out of a recession: the 1920-21 Depression, to be exact. I'm currently about half to two thirds of the way through a paper critiquing the Austrian School interpretation of the 1920-21 Depression, so that caught my eye in a big way. Throughout the last year, several Austrians and libertarians have argued that the quick exit from the 1920-21 Depression vindicates the Austrian school and proves that active fiscal and monetary policy only makes depressions worse. I point out that the 1920-21 Depression was very unusual. It was a manufactured depression - the Federal Reserve created it. Moreover, they justified their quite deliberate actions with arguments that Keynes himself put forward in 1923. Depressionary conditions that necessitate a Keynesian response (liquidity trap, low interest rates, high savings, depressed aggregate demand) were not in force through 1920-21, so a Keynesian response was entirely unmerited. And the coverage the 1920-21 in the recent blog debate only drives home that point (which is nice... makes me more confident in my thesis) - if Keynesian depression conditions don't hold, then we shouldn't be surprised that wage cuts got us out of depression in that case. If Keynesian depression conditions did hold, then successful wage cuts would lead you to question Keynesian prescriptions. So anyway, as a result of this work I'm officially obsesssed with the 1920s now. It was a fascinating time. Perhaps look for more on that in the future.
By the way - I found a piece by F.A. Hayek on the 1920-21 depression and its aftermath that he wrote in 1925. If anyone knows of anything that Ludwig von Mises wrote about the post-war downturn, I would be very, very interested in hearing about it. I don't know von Mises very well.
Posts
So something just struck me as very, very odd.
ReplyDeleteAll the people I cited defending the old Keynesian opposition to wage cuts in a depression are New Keynesians (DeLong, Krugman). And yet I said that one of the major differences between Post-Keynesians and New-Keynesians was the nominal wage cut issue.
So here's my take on that - perhaps the point is that in depressionary conditions the old Keynesians are right and in normal conditions New Keynesians are right. Nominal wage rigidities are decisive in the modern economy, but the standard solution to nominal wage rigidities can introduce its own "paradox of thrift".
Anyway - sorry if that was confusing. Take my Post-Keynesian/New-Keynesian distinction with a grain of salt. There are honestly lots of reasons for the emergence of the New Keynesian school. New Keynesianism has been less charitably described as an intellectual movement that just tries to cobble a bunch of frictions and exceptions on Keynes to deal with the problems that Keynesian theory ran into in the 1970s. I think that's somewhat unfair. Once again, Keynesian depressionary conditions (ie - liquidity trap, paradox of thrift) DIDN'T HAPPEN in the 1970s, so don't blame Keynes for not working in the 1970s!!!! That's largely why I view the New Keynesians more charitably - they added to Keynes to make him even more relevant to a broader range of scenarios, which is very different from salvaging and clinging to a lost cause.
great, informative read. i'm a sociology student trying to learn economics as much as possible on his own time, so blogs such as yours (and DeLong's) are all I got until I get someone to hold my hand through the mathematics part
ReplyDeleteI'm glad you enjoyed it, and welcome to the blog. I actually have a sociology background too - I double majored in economics and sociology in college, and I've presented papers a couple times at the Southern Sociological Society conference, so I'm still marginally in touch with that community.
ReplyDeleteIf you ever want to continue in economics, the math is absolutely essentialy. I had a standard non-math major undergrad math education - through calculus and linear algebra. I'm supplementing that now in a major way taking more math as a non-degree student. Even if you never read or write the math-heavy papers, you still need to be comfortable with a lot of math to do good economics - so I advise you to keep pushing through that material.
It's one of the nice things about economics blogging, though. Bloggers still want to engage the important questions but have to approach it in a non-mathematical way.
Please continue to read our blog, and share it with friends. We'd also appreciate suggestions on how to make it more accessible to people like you - with varying backgrounds and broad interests. Evan and I come from two very different backgrounds, and we want to make sure our material is accessible and interesting to a wide audience.
If you like DeLong, you should also read Krugman if you don't already. Also Mark Thoma. Arnold Kling on econlog offers a good alternative to those sorts of guys, although I haven't been impressed with some of the others blogging on econlib. Scott Sumner is also a good alternative view from Krugman-DeLong, but he's usually more exclusively concerned with monetary questions - and his blogging can be more technical (not necessarily mathematical, but technical).