Tuesday, April 5, 2011

Krugman on Bob Hall

Paul Krugman covers a seminar by Bob Hall's paper on search and matching models at the zero lower bound, and writes this:

"So the point, as I get it, is that zero-lower-bound models work very well in practice, but have a problem in theory: it’s not at all clear how to reconcile them with Diamond-Mortenson-Pissarides-type models of the labor market."

I think one of the solutions is to recognize that in a lot of ways a labor contract is more like an investment than a consumer good. Labor isn't bought on a spot market for the most part - it is rented for an indeterminate period of time (as long as both the renter and the rentee find it to their advantage). The marginal product of labor, in that sense, is going to be compared to interest rates in the same way that the marginal efficiency of capital is, and we would expect to see high marginal products of labor with low hiring for the same reason that only high MEC investments are being made right now.

I am not well placed - right now - for integrating this into a search and matching model. But this is precisely the sort of thing that I want to do doctoral work on. I have two main project ideas I've been noodling over:

(1.) Taking Bob Shimer's model that combines wage rigidity with search and matching to describe fluctuations and letting firms react to wage rigidity by increasing turnover (wages for existing labor contracts are rigid, but new contracts aren't - job turnover is a wage adjustment strategy), and

(2.) Precisely the point I made above: the implications of labor as an investment for macroeconomic performance at the zero lower bound.

I'm hoping to do something like "Three Essays on the Macroeconomics of Labor Market Dynamics" so I can treat somewhat disparate topics and get a few papers out of it.


  1. Okay, both Krugman's and yours uber-wonkish posts lost me. ;)

    I am guessing you mean that when only the most efficient workers are hired, very few workers are hired. And when the most potentially rewarding investments are made, very few investments are made. Am I right?

    And so it is wrong to assume that when you have very productive workers willing to work for low wages, you will see increased employment. Am I still on track?

    Instead, we may still see low wages and low employment during a recession, even with high productivity, because there is little demand for whatever is being produced and sold? Okay never mind, but I am just trying to keep up. :)

  2. Yes, essentially.

    When you buy a sandwich the interest rate doesn't matter all that much because it's a spot market - you will buy other sandwiches in the future at varying prices - and you get the benefits of the sandwich concurently with the cost. The extent to which you discount the benefits of the sandwich don't really matter.

    If you enjoyed the sandwich over the course of several years, you would take the interest rate into account in the way you discounted those benefits.

    Economists treat labor like consumption for firms. They buy it on a spot market and they get the benefits from it in the period that they buy it. Really, it's more of an investment. A lot of the labor contracting literature and human capital literature does take this into account.

    On your "willingness to work for lower wages" question - sure, if you've got a lower reservation wage you'd expect employment to increase. This is a supply point. The point I was making above is a demand problem - which is precisely what you point out in your last paragraph.

    Garret Jones at GMU apparently talks a lot about labor as an investment.


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