Yesterday I remarked that Okun's Law seems to be broken. I think I should provide more background on this. Of course "Okun's Law" isn't a scientific law at all - it's just a rule of thumb. But it' a consistent rule of thumb that is worth remarking on when it breaks down. It states that for every two percent decrease of output from potential output, we can expect to see the unemployment rate rise by one percent. We're not seeing this now (and I should note - people have been remarking on this for a while now, it's just gotten new attention recently, even if not by name from all commenters) - unemployment is a lot higher than Okun's Law would predict. It's just a rule of thumb - there's nothing deeply existentially troubling for the economist to see that it's not working. But it is grounded in enough sensible economics that it's worth asking "why is this time so different?"
It is useful to note that this break-down is happening in a lot of places. Greg Mankiw suggests that the Phillip's Curve might be exhibiting unusual behavior too (this is not new misbehavior for the Phillip's Curve, a more regularly misbehaving rule of thumb).
Mark Thoma and David Altig note another misbehaving rule - the Beveridge Curve, which relates unemployment to job vacancies. Like the Phillip's Curve, it's not particularly surprising that the Beveridge Curve is misbehaving. It shifts up and down with the matching efficiency of the labor market. So this change is the least mysterious.
Russ Roberts remarks on the same disconnect between employment and output, and he seems to think that this is troubling for Keynesians. He circles around a couple (IMO) relatively unimportant issues for a while, and then he writes this:
"I’m not saying Keynes (or Obama or Larry Summers) is wrong because all spending does is bid up prices and wages. I’m not trying to prove that the stimulus failed. I’m challenging the standard macro textbook story that says aggregate demand leads to output that leads to employment."
So we have a situation where Russ is not trying to say that employment isn't going up because stimulus is channelled into wage and price changes (a little redundant, but nevertheless...). He makes it clear that he's not making that argument. The stimulus-to-output chain may be weak for him, but it's plausible. His problem is how "the standard macro textbook" explains the output-employment link. Okun's Law, in other words. Roberts goes on:
"The textbook aggregate demand story ignores how people view the future– the animal spirits–the confidence employers, investors, and consumers have about the future. If employers are anxious about the future (partly because the government is running up debt and because the regulatory environment is highly uncertain and partly because we’ve had a run of bad times), then spending doesn’t obviously create jobs."
I did a double-take when I read that, because it was easily the most Keynesian thing I've ever read on Cafe Hayek. Concern about the future means that money may not go to prices or employment - it may go to liquidity which ultimately has it's roots in fear of "the dark forces of time and ignorance that envelope our future". Of course Roberts doesn't seem to recognize that this is a very Keynesian insight. Perhaps he does, but there's no indication of it.
What does this have to do with all the other rule-breaking? The best explanation I've seen so far for why changes in the Beveridge Curve, the Phillip's Curve, and Okun's Law all relate to liquidity preference is Roger Farmer. I really, really, really need to get this man's new book.
So the obvious question in my mind is "did Keynes forsee this". Unfortunately, I can't say right now but I'm going to check up on it this weekend. Hicks clearly didn't. For Hicks, liquidity preference broke the link between money and output, not between output and employment. In other words, in the IS-LM model, Okun's Law should work fine because all the disruption of liquidity preference happens before output even comes into the picture. I know Hayek did critique Keynes for not presenting a detailed enough explanation of the relationship between employment and output (does anyone know where he said this... I'm very, very curious now). What I don't know is whether Hayek's critique was valid or not. Did Keynes have as simple of a view of the output-employment relationship as Hicks (in which case the critique is valid), or didn't he?
1 hour ago