Question/Challenge for my economist friends.
The Mises/Hayek/Classical business cycle story is a story of mis-allocated capital due to monetary manipulation that sends systematically false price signals throughout the economy. It's a story which seems to correlate strongly with what we actually observe in the business... cycle, especially our recent boom and bust. It explains why so many people would make the same mistakes in the same way at the same time, wasting resources in projects whose final cost will come to exceed the final market price. It explains why REAL growth slows or turns negative during the bust.
The presumed cause of unemployment as a result of this cycle is mass relocation of workers from malinvested industries into a new positions, often in the context of reduced wages as formerly high-return skills are devalued with the need to retrain. This is the "cyclical" unemployment in the classical/Austrian story. However, this part of the story seems to be weak in light of some stylized facts.
1. The housing bust began in 2006 and job losses in construction began mounting. Yet overall unemployment didn't rise much. The sectoral shift in the labor market seems to be moving pretty smoothly until the breakdown of the financial system in mid/late 2008. Scott Sumner makes this point and it should be taken seriously.
2. We classicals love to point out how wrong the Keynesians were about the aftermath of WWII. They predicted depression, and instead we got a boom in 1946 even as government spending collapsed. BUT... the successful reintegration of 9 million soldiers into the labor market in short order ALSO undermines the "recalculation" story of unemployment. The classical coordination story should apply equally to ANY very large scale change in the composition of the economy. Yet the troops came home and got back to work producing value.
3. The Japanese tsunami also represents a significant shock to the structure of production. Yet unemployment didn't move up much if at all.
One conclusion to draw is that relatively open labor markets are pretty darn flexible, at least in the context of price stability. Another could be that unemployment isn't particularly well explained by the classical/Austrian story. The classical debate over a "General Glut" focused on goods going unsold at remunerative prices. This is explained beautifully by the classical/Austrian story.
But what if Sumner is closer to right about cyclical unemployment? Even Keynes focus on money and wage rates points toward elements of truth in his otherwise confused approach. Keynes goes wrong with his methodology, conflating monetary effects and real effects, over-aggregating, confusing the role of interest rates, saving vs. hoarding, etc. But the general notion that cyclical unemployment is a monetary phenomenon driven by downward wage inflexibility seems both compelling and compatible with the classical/Austrian story for real growth.
The solution, it would seem, is to attack any and all public policies which promote wage inflexibility (minimum wages, length unemployment benefits, etc). That Keynesian economists tend to actively promote these policies is yet more proof that the Keynesian model is confused nonsense. The other solution is to work towards monetary institutions which give rise to monetary equilibrium/neutrality. That means being as worried about money-demand driven deflation as we are about money-supply driven inflation. And, of course, we need to work towards preventing the central bank-induced credit cycle which gives rise to malinvestment inflationary booms and then financial crises and deflationary busts.
Thoughts?
The Mises/Hayek/Classical business cycle story is a story of mis-allocated capital due to monetary manipulation that sends systematically false price signals throughout the economy. It's a story which seems to correlate strongly with what we actually observe in the business... cycle, especially our recent boom and bust. It explains why so many people would make the same mistakes in the same way at the same time, wasting resources in projects whose final cost will come to exceed the final market price. It explains why REAL growth slows or turns negative during the bust.
The presumed cause of unemployment as a result of this cycle is mass relocation of workers from malinvested industries into a new positions, often in the context of reduced wages as formerly high-return skills are devalued with the need to retrain. This is the "cyclical" unemployment in the classical/Austrian story. However, this part of the story seems to be weak in light of some stylized facts.
1. The housing bust began in 2006 and job losses in construction began mounting. Yet overall unemployment didn't rise much. The sectoral shift in the labor market seems to be moving pretty smoothly until the breakdown of the financial system in mid/late 2008. Scott Sumner makes this point and it should be taken seriously.
2. We classicals love to point out how wrong the Keynesians were about the aftermath of WWII. They predicted depression, and instead we got a boom in 1946 even as government spending collapsed. BUT... the successful reintegration of 9 million soldiers into the labor market in short order ALSO undermines the "recalculation" story of unemployment. The classical coordination story should apply equally to ANY very large scale change in the composition of the economy. Yet the troops came home and got back to work producing value.
3. The Japanese tsunami also represents a significant shock to the structure of production. Yet unemployment didn't move up much if at all.
One conclusion to draw is that relatively open labor markets are pretty darn flexible, at least in the context of price stability. Another could be that unemployment isn't particularly well explained by the classical/Austrian story. The classical debate over a "General Glut" focused on goods going unsold at remunerative prices. This is explained beautifully by the classical/Austrian story.
But what if Sumner is closer to right about cyclical unemployment? Even Keynes focus on money and wage rates points toward elements of truth in his otherwise confused approach. Keynes goes wrong with his methodology, conflating monetary effects and real effects, over-aggregating, confusing the role of interest rates, saving vs. hoarding, etc. But the general notion that cyclical unemployment is a monetary phenomenon driven by downward wage inflexibility seems both compelling and compatible with the classical/Austrian story for real growth.
The solution, it would seem, is to attack any and all public policies which promote wage inflexibility (minimum wages, length unemployment benefits, etc). That Keynesian economists tend to actively promote these policies is yet more proof that the Keynesian model is confused nonsense. The other solution is to work towards monetary institutions which give rise to monetary equilibrium/neutrality. That means being as worried about money-demand driven deflation as we are about money-supply driven inflation. And, of course, we need to work towards preventing the central bank-induced credit cycle which gives rise to malinvestment inflationary booms and then financial crises and deflationary busts.
Thoughts?
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