7 comments on “Your vital economics lesson of the day

  1. That’s a bizarre thing to say. Nowadays pretty well everyone, including I think Tyler Cowen, believes in some sort of hybrid theory of business cycles. Pure RBC theory just doesn’t fit reality.

  2. A general theory that doesn’t apply generally isn’t a theory. It’s a coincidence.

    One interesting question to ask would be whether there is a business “cycle” at all. The fashionable length of ladies’ skirts varies on all timescales. But is there a hemline “cycle”, or would that be a misleading concept? A cycle implise both periodicity and inevitability. Is either true?

  3. “Nowadays pretty well everyone, including I think Tyler Cowen, believes in some sort of hybrid theory of business cycles.”
    Theories should be able to predict. Trouble with these sort of theories, they only seem to predict in retrospect. Lot of learned economists sitting round saying “Aha! What happened on that graph agrees with our so & so explanation of so & so cycles.” But don’t seem to get the bit where they predict the next bit of the graph right very often, do they? The bit that ain’t occurred yet.
    Why is that?
    Can think of one reason & it’s one reason Keynesianism won’t work, in the real world. World doesn’t consist entirely of economists. The data that they’re working with is the same data’s available to all the economic players. At all levels. Everyone, to some extent, is trying to make guesses about the future. The attempts to manage economies on the macro scale by means of the levers available to do so are factored in by the cannier players. They only have to read the books, don’t they? So they try to capture what benefit they can from the attempts. So distorting the outcomes.

  4. BIS-

    A well known example of that being the Keynesian prescription for using inflation to lower wages while the foolish workers with their “money illusion” don’t realise it’s happening. But of course they do, so they then get together and demand pay rises to compensate.

    As it goes, one thing I was thinking about the other day, is the question of what your pay rise ought to be in an inflationary economy. The initial thought would be, “inline with inflation”, so if inflation is 3%, you get a 3% pay rise. But it ought to be inflation+growth[1]. So, if measured inflation is 3%[2] and growth is 2%, the workers’ pay rise ought to be 5%.

    (With a fixed money supply, growth of 2% would reduce the price level by 2%, so to raise the price level by 3%, you have to inflate the money supply by 5%).

    Hence, if you index link pay rises, and avoid “inflation busting” pay rises, during a period of economic growth, the wage share of the national income will gradually fall, and The Workers will fail to get their “share of the proceeds of economic growth”, as the saying goes.

    ___
    [1] To be precise, inflation multiplied by growth, but close enough for small numbers.

    [2] Assuming the macrostats are accurate, which may be impossible, but let’s not worry about that.

  5. Tim, i think you may have completely misinterpred this, although I’m not confident of my interpretation either

    I think he means that most recessions are best interpreted as the economy reacting to a negative real shock, most often interpreted as a shock to the technology of production, broadly interpreted.

    First, even if so, this does not mean Keynsians policy responses play no role. A New Keynsian model gets hit by real shocks, and fiscal stimulous may be the appropriate response depending on what other ingredients your model contains (I.e. depending on how you think the actual economy responses to these real shocks).. I don’t think he’s saying RBC models, with flexible prices, and active policy never being called for, are right. If he is, he’s a fool, which I don’t think he is.

    Second, this looks like an odd claim in any case. What about the Volker recession, for instance, or recessions caused by other financial crises?

  6. “one thing I was thinking about the other day, is the question of what your pay rise ought to be in an inflationary economy. ….etc”
    Well….from my memories of the back end of the 70s when inflation was….er….not the figure they were telling it was, anyway The workers of the company I was at screwed 10% out of it. And a totally unachievable 12% productivity agreement on top. Company went bust about 2 years later of course but…la-de-da.
    Think that probably answers your question & saves a lot of math.

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