Tuesday, September 21, 2010

Nick Rowe on Liquidity Data

Nick Rowe has recently climbed several slots in my list of favorite bloggers with a lot of great posts recently. This one on the need for considering liquidity data ("L-data") is especially good and important:

"Economists have got lots of P-data and Q-data, and we pay a lot of attention to it. I think we don't have much L-data, except anecdotal, and we don't pay much attention to the hard L-data we do have.

P-data is data on the prices at which goods are traded. Q-data is data on the quantities of goods traded. We've got it, and we use it. And it's good we've got it and we are right to use it. P-data and Q-data are important. But they are not the only data that are important.

What do I mean by L-data? I'm going to come at that slowly.

Think about the "stylised facts" of the business cycle. In a recession, output and employment fall, or rise less quickly than before. That's Q-data. Prices and wages also fall, or rise less quickly than before. That's P-data. Looking at the P-data and Q-data can help us test theories and understand the causes of the business cycle. But there's some other data that isn't P-data or Q-data that has a big impact on why I think about business cycles the way I do. We ought to be able to explain why we believe what we do believe, and I can't fully explain why I believe that business clcyles are largely demand-driven without talking about L-data.

When we go into a recession, many things become easier to buy and harder to sell. And when we go into a boom, those same things become easier to sell and harder to buy. A recession has lots of buyers' markets and a boom has lots of sellers' markets. That's what I mean by L-data. There's something more going on than what is captured in the P-data and Q-data. There's something more going on than the P-data and Q-data that tell us all we need to know about perfectly competitive markets for perfectly liquid goods with perfectly flexible prices. And that something more is crucial to the way I think about the business cycle....

I think that prices and wages are sticky. And I think that sticky prices and wages are important in understanding the business cyle. Those two things go together. The main reason I think that prices and wages are sticky is not just that they look sticky, but because if I assume that prices and wages are sticky i can make sense of the fact that we get buyers' markets for goods and labour in a recession, and sellers' markets for goods and labour in a boom. If aggregate demand falls, either prices and wages fall, or we get buyers' markets for goods and labour, or we get a bit of both. If aggregate demand rises, either prices and wages rise, or we get sellers' markets for goods and labour, or we get a bit of both. And we generally get a bit of both, in both recessions and booms, though the proportions vary from market to market. And because of imperfect competition, with sellers usually having market power to set prices on average above competitive equilibrium, buyers' markets are normally more common, on average over the business cycle, than sellers' markets."

He goes on to ask for examples of liquidity data that are out there. Several financial examples are given, which isn't surprising - bid-ask spreads, etc. I think the components of the Beveridge Curve - some measure of job seekers, matches, and vacancies is going to be important. There are good points in the comment section - it's worth reading through.

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