The employment market is a market, with the salary being the price. Why doesn’t this market clear? Why doesn’t the price (salary) simply adjust, and then everyone gets a job? It seemed profoundly mysterious that this didn’t happen.
Pointer from “Scott Alexander.”
I commend Armstrong for posing the issue and thinking through it. Everyone who studies economics needs to puzzle it out. However, my viewpoint differs from his.
To me, you have to distinguish real wages from nominal wages. For just a moment, I will play the macro game of treating the economy as a giant GDP factory with identical workers, so I will speak of “the” real wage and “the” nominal wage.
The simplest macro theory of unemployment is that it is due to money illusion. The real wage needs to be lower in order to clear the labor market, but workers will not accept lower nominal wages. Meanwhile, the price level is determined by something else (the money supply, say), so you can be stuck at the wrong real wage. The Keynesian/monetarist cure for this is a higher price level, at which workers are willing to accept the lower real wage that they would not accept previously. It’s the most coherent way to tell the macro story, but it is not very popular. Scott Sumner likes it. I think Bryan Caplan likes it. I think most modern Keynesian macro folks consider it to be too simple.
The theory of unemployment that Robert Solow taught when I was at MIT was from Edmund Malinvaud’s book, The Theory of Unemployment Reconsidered. It did not rely on money illusion. Instead, both wages and prices were sticky. If they both happened to be too high relative to another nominal variable (again, the money supply is a standard candidate), then the demand for goods will be low, and this will reduce the demand for labor. This was called a general disequilibrium model, because it shows how problems in one market can spill over into another market. So, in 2008 there is excess supply in the construction market, and as workers are laid off there they reduce their demand for consumer durable goods, and so you get layoffs there, and so on.
General disequilibrium never really caught on as a story. Instead economists went for the sort of stuff that Stan Fischer and Olivier Blanchard were pushing, which was representative-agent intertemporal optimization with some ad hoc rigidities thrown in. And if you do not know what that means, just suffice to say that Solow and I hated it then and hate it now, while Paul Krugman likes it when it’s used to support Keynesian policies. When it’s used to oppose Keynesian policies, he calls it Dark Age Macro.
The stickiness of “the” price and “the” wage are ad hoc rigidities in the Malinvaud model. To get from there to what I currently believe, you need to incorporate all sorts of other adjustment problems or coordination failures. Imagine the economy being run by a central planner. What does the central planner want to do with those laid-off construction workers, or with the 19-year-olds who took a few courses at community college and then dropped out, or with the 57-year old manufacturing worker whose job was just taken by a robot or by a factory worker in Vietnam?
Substitute for the central planner the set of all entrepreneurs in the economy. Well, it turns out that the entrepreneurs are, collectively, almost as bereft of ideas as the central planner. Meanwhile, the unemployed folks are not so desperate that they go around offering to wash dishes or empty bed pans or do yard work for $5 an hour. Instead, they subsist on savings and handouts from various sources until the set of entrepreneurs figures out something useful for them to do. That is what Tyler Cowen and I started calling the recalculation problem five years ago. It is what I mean when I say that the entrepreneurs have to discover new patterns of sustainable specialization and trade.
In the Malinvaud model, if you could “unstick” wages and prices, you would get out of general disequilibrium. In PSST, it’s probably better to keep prices and wages where they are, so that the existing sustainable patterns of specialization and trade don’t get lost. In order to raise employment, entrepreneurs will have to discover new patterns, and that is a time-consuming, trial-and-error process. Monkeying around with the money supply or the government deficit is not necessarily going to make the process go any faster.
This doesn’t seem that far from what Sumner is saying. He’s just saying that stable NGDP is the best way to keep the signals clear for PSST.
That’s my read too. And if you do find circumstantial evidence that monetary policy does matter (for this period, the EU experiment, Abenomics, Australia/Canada) then doesn’t that imply that the PSST story is not particularly important for a given period?
It is the last line that seems wrong. It could only be true if money was always neutral, but we know it is not. Nor is there any way of not monkeying around; everything we do is monkeying around.
“The employment market is a market, with the salary being the price. Why doesn’t this market clear?”
Employment does not clear, because it is not a market.
Up until the creation of the administrative state, there was no unemployment. People found some form of profitable exchange, often at unpleasant terms.
From the employer perspective, there are a variety of bureaucratic costs associated with employing. From the employee perspective, there are a variety of incentives (most obviously the unemployment check) that decrease the propensity to work.
I think instead of relying on “entrepreneurs” to figure out what we should be doing, you would be better off letting us figure it out for ourselves. Give us a choice of a basic income, and hold challenges to stimulate innovation. Google Bug Bounties, Netflix Prize, X Prize, kaggle.com, challenge.gov, NASA, DARPA use challenges now. Expand that, and give everyone the choice of a basic income so we get to choose whether we want to enter the market and work for a little napoleon boss, or try to advance knowledge and technology on our own or in ad hoc groups made possible by the unprecedented communication that the internet provides.
We know the Fed, and private entities, create trillions of dollars without much inflationary consequence. The BIS (see http://www.bis.org/publ/otc_hy1405.htm) reports $710 trillion in worldwide OTC derivatives. Bernie Sanders’s Fed audit (http://www.sanders.senate.gov/newsroom/press-releases/the-fed-audit) found $16 trillion created by the Fed, previously unreported. Use the Fed to create money to fund fiscal policy that establishes a basic income (opt-in).
As a hedge against inflation, index everything (bank accounts, transfer payments, everything, as Israel has done for decades) to inflation. If incomes increase along with prices, even the quantity theory of money agrees that purchasing power does not decrease.