Sunday, January 1, 2012

Relative vs. average prices, again

It came up twice recently, in fact.

First, Bryan Caplan praised Matt Yglesias as a "good Keynesian" (a little redundant, isn't it?) because he joined Caplan's "wages must fall" chorus...

... sort of.

I say "sort of" because while there is some discussion by Yglesias of the average wage level, most of what Bryan focuses on is the parts discussing wages in manufacturing falling and manufacturing jobs coming back to the U.S.. OK, fine, but this is a relative wage issue. It's one thing to say that U.S. manufacturing jobs have high wages for a variety of institutional reasons - much higher than foreign competitors, and therefore there's going to need to be a fall in wages. But that's all relative wage talk. It has nothing whatsoever to do with the recession.

Of course, as Nick Rowe and Paul Krugman are always good at pointing out, it's not clear that a general fall in wages would help matters, but even if Caplan were to argue that point he's not going to achieve it by making the observation that manufacturing labor is overpriced.

The second instance of confusion over relative and average price changes is covered by David Glasner, who criticizes a recent post by Jonathan Catalan (congratulations, Jonathan, for getting linked to by Glasner! Regardless of whether it's a critical review or not, it's always good to be linked by the high-traffic sites). I interpret Glasner as acknowledging Jonathan's point that not all prices are going to change at the same rate, but contending that this point misses the forest for the trees. Relative prices fluctuate all the time, either as a result of market forces (Caplan and Yglesias's discussion of falling manufacturing wages), the sort of Cantillon effects that Jonathan alludes to, or simply noise from the market process. But these fluctuations don't change the fact that (to quote Glasner): "the existence of inflation is predicated on an increase in total spending compared to an alternative world in which there was no inflation. I am not saying that inflation raises all prices proportionally, I am just saying that if prices in general have risen, total spending, and therefore total income, must also have risen" (I'm not sure this is quite right, though - there's always the prospect of stagflation - but the point about the difference between relative and average prices is important).

In my email exchanges with him, John Papola will often make a point about how strong growth in the health care industry is, as an attempted argument against claims of mine that we are experiencing a general decline in economic activity. My response to him is always the same and quite analogous to the relative wage point: relative economic activity is always fluctuating due to market conditions. Health care was growing before the recession, growing during the recession, and it will grow after the recession. Simply noting that it is growing is not the same as comparing it to a counterfactual. There is a persistent problem among non-economists of not thinking about these things relative to a counter-factual. Health care could be growing at the same time that it is depressed. There's absolutely nothing preventing that.


  1. On health care:

    I think that it is important to identify why it is growing and where it is depressed. More specifically, where the demand is coming from for growth (nominal or real) and what actors comprise the marginal buyers.

  2. I think Bryan Caplan needs to read Chapter 19 in Book V of the General Theory closely...


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