There's something very appealing in Arnold Kling's posts on "PSST", which is basically just a rebranding of a conception of the market that we've had for a very long time. PSST is essentially just an extended division of labor, after all - specialization and exchange. Modern market economies are nothing if not groups of people specializing and exchanging.
That's Adam Smith, and so it's no wonder we all find something appealing about it.
The problem comes in when you start to say that because complex specialization and exchange is what the market economy is, it follows that when market economies break it must be because something was unsustainable about the nature of the specialized exchange. This is an odd route to take, whether it is via Arnold Kling (who talks in terms of major "regime changes" - displacement of agriculture, IT revolution, etc.) or via Hayek (artifically elongated capital structure gets revealed to be unsustainable). The romance and enticement of organic, complex systems can mislead people. When other complex, emergent systems like organisms or ecosystems get sick, we don't just assume that the complexity that used to work no longer works anymore. We assume something specific went wrong with it. So why don't we all assume that with markets? I'm not sure.
Brad DeLong isn't sure either. He writes: "When you ask believers in "recalculation" what pattern of production and trade proved to be unsustainable in 2007, they answer: "building so many houses." When you ask believers why the market economy has been unable to sort out this problem in three years, they answer with nothing--silence. When you say that OK, there were $300 billion of excess houses at the start of 2007 but now construction has been so depressed for so long that there are $1 trillion fewer of houses than trend and why isn't the 2007 pattern of production and trade sustainable again, they answer once again with nothing--silence. That annoys me."
Markets work. What a lot of the PSST talk amounts to is the suggestion that not only can markets spontaneously stop working, but they have a very hard time picking themselves up when they trip after going down an unsustainable path. Hayek is slightly better on this count than Kling - Hayek actually offers a mechanism: artificially low interest rates that allow an elongated capital structure to actually build up before it is revealed to be a house of cards. That's somewhat better than Kling's story which is basically the old technological unemployment case.
We need something better than that PSST story. We know why markets work so well. We know how markets correct themselves. So when markets break you have to have a pretty specific mechanism in mind not only for why they break so sharply, but also why (in this case, as in the 30s) they don't always seem to fix themselves. The mechanism I have in mind is that a popped bubble (which is psychological and institutional - and also well understood - not vague hand waving about "patterns of exchange breaking down") increases demand for safe and liquid assets, and exogenously increases savings rates for all actors at once. Traditional monetary accomodation is limited by a zero lower bound on the nominal interest rate. Interest rates that can't adjust to the negative-whatever-it-is-according-to-the-Taylor-Rule percent they need to be depress investment because the marginal efficiency of capital consistent with full employment is negative. Massive underutilization of resources means there is little demand-pull on inflation - which is one thing that could actually help the interest rate situation (or sticky wages - if you're the sort of person that worries about that).
That's the mechanism I have in mind. It seems to me to fit the facts better than any other mechanism I've ever been offered. It also tells me why we had a recovery in 1920-21, why we didn't for a while in 1929, why we had a reasonably quick recovery for most of the post-war period, and why Japan didn't have a quick recovery in the 1990s and why we aren't having one now. When you have an explanation that fits with a broad set of data like that, that's a useful theory.
Hayek's elongation of the capital structure sounds plausible to me, and certainly interesting. Jonathan Catalan makes it more plausible by regularly reminding us that ABCT can result in a general depression - it doesn't have to have the naive "internet Austrian" impact of only being concentrated in certain sectors. But it still leaves open the question: why are we still in this pit after three years? And for that matter - why was 1921 and 1981 different from 1929 and 2008? ABCT can't answer that very well. DeLong, Keynes, Friedman, Hicks, and Krugman can answer that question.
I would add to Brad DeLong's list of absurdities that nobody can provide a reasonable answer to this question of "regime uncertainty". The argument goes that we haven't recovered because investors are tremendously uncertain. But just as Brad notes "If you want to argue that there is a disruption of patterns of sustainable specialization and trade, you need to point to such a disruption right now that is large enough to produce an 8% shortfall in spending", I could also say that if you want to argue that regime uncertainty has kept us in the doldrums for three years you need to point to something people are uncertain about that is large enough to produce an 8% shortfull in spending. Health reform? That was the schtick originally - they said that "regime uncertainty" about health reform kept investors from investing. But now it's done and passed and there's no appreciable difference in the macroeconomic situation. They try and argue that the details and regulations are still being worked out for health reform, and that's true - but are they really convinced by that? Is that really sufficient to keep us in depression? Our health reform is modest by the standards of many of our peers, and they didn't seem to get caught in a depression because of their health care system. And are any businesses actually saying that's why they're not investing? Is there any sign at all that investors are worried about tax increases or health reform? No! There's no evidence of this whatsoever. Time after time when businesses are surveyed they cite demand as the problem - not concerns about government overreach or taxes. This whole "regime uncertainty" argument doesn't even pass the smell test in the first place, and on top of that there is no empirical evidence for it.
There's a lot of bad economics out there, despite the fact that we have a pretty decent sense of what's going on. Even if we have some disagreements about what to expect from the slightly less predictable fiscal policy and whether we've fully used up monetary policy options, there is still a broad agreement about the mechanism that is causing this depression. And as Brad has pointed out in the past, it's an agreement that unites Keynesians, monetarists, and many others - back to both Jean Baptiste Say and Malthus.
Friday Night Music: Tom Lehrer
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