Greg Mankiw criticizes "extreme Keynesians" - basically people who he says think that aggregate demand explains everything. I couldn't agree more. Indeed, this is the argument I make in my paper on the 1920-21 depression. Although there I critique Powell (2009), Woods (2009), and Murphy (2009) for acting like this "extreme Keynesianism" is "Keynesianism" and for pretending that a Keynesian's response to every downturn is fiscal and monetary stimulus (it's quite clearly not but that didn't get through to them).
So from a theoretical/rhetorical perspective I agree with Mankiw completely. From a nuts-and-bolts perspective I think there are some problems with what he uses to critique the demand-side view in this recession. He writes:
"University of Chicago economist Casey Mulligan offers a challenge to that view. Casey points out that there is a regular surge in teenage employment during the summer months because more teenagers are available to work (that is, the supply of their labor has increased). That is no surprise: It is normal supply and demand in action. But if aggregate demand were the main constraint on employment, this increase in supply should not translate into higher employment during deep recessions such as this one. But it does!"
I'm not sure Mulligan was really reading Eggerston's point about the "paradox of toil" very closely. What is the mechanism through which increased labor supply negatively impacts unemployment? Eggerston says that: "Higher short-run supply may create deflationary expectations and increase the real interest rate. This lowers aggregate demand, since aggregate demand depends on the real interest rate." Isn't that precisely what we've seen this summer - the return of deflation risks? The impact of that higher [real] interest rate on demand and employment will unfold in the coming months. This whole "paradox of toil" thing, which I honestly haven't looked into that closely, doesn't say that supply and demand don't work anymore. An increase in the supply of labor still impacts employment like it always has, it just sets in motion mechanisms that might also counter-act that increase. But you have to consider these mechanisms carefully. How would we expect the specific mechanism Eggerston identifies to effect employment? We would (1.) not expect it to do anything to normal supply-and-demand relationships, but (2.) set in motion a reduction of demand for labor with some sort of lag.
So anyway - click through the links to look at the stuff yourself, but I don't see how Mulligan really proves what he sets out to prove unless he completely misunderstands what Eggerston and Krugman have been saying on this. I should note that Greg Mankiw indicates he thinks Mulligan's claims are too strong as well.
Anyway, this gets me to a post by Peter Boettke on the Higgsian uncertainty point. It's all good, but I would make the same critique of Boettke that Mankiw makes of unnamed "extreme Keynesians". How do you attribute the weight that you do to policy regime uncertainty? Your logic is impeccable - I buy the logic. How important is that logic to the functioning of the economy right now? This is my beef with a lot of macroeconomics. Some people try to frame macroeconomics as "ex post story telling" with lots of theories floating around, and that it's unscientific because it has lots of theories floating around. The problem is, very few of these theories contradict each other. There is no reason to think that we aren't going through an industrial restructuring (a la Kling), a rebalancing of malinvestments (a la the Austrians), a deficiency of demand (a la Keynes), and some important supply shocks (a la RBCT). All these things can happen at the same time. I could throw in Jonathan Catalan's recent post contrasting Kling and the Austrians here too.
Mankiw ends with a really great anecdote that I can identify with:
"I am reminded of a response I once gave to a reporter who asked whether I was a supply-sider or a Keynesian. "I am neither a supply-side economist nor a demand-side economist," I said. "I am a supply-and-demand economist.""
I think we all should be supply-and-demand economists. Isn't that kind of what you learn on day one? Understanding all these theories and trying to figure out how they work together would go a long way towards making us less ridiculous when we fight over stuff that isn't even mutually exclusive. Or put it this way - if it is mutually exclusive it's because we've unnecessarily defined it that way when what we should be doing is identifying processes that describe the way the world works.
UPDATE: Now that I think about it, a funny irony is that many of the economists who only tell demand stories are the same economists that can't seem to get through their heads what the impact of a demand shock like a mandate will do!
Friday Night Music: When I’m 64
1 day ago