Monday, 30 November 2009

Economic illiteracy - from two professional economists.

Gary Becker and Richard Posner, two economists provide some strange analysis of the current recession. They advocate the old myth, which I thought had been disposed of in the 1930s, namely that cutting wages would help raise employment or cure the recession.

The nonsense starts in their para which begins “Keynes and many earlier economists emphasized that unemployment rises during recessions because nominal wage rates...”

The suggestion here is that simple micro economic ideas about supply, demand and price apply at the macroeconomic level. That is the suggestion appears to be that if wages dropped 10% or so, demand for labour would rise 10% or so (assuming for the sake of simplicity that we have elasticities of supply and demand for labour of unity).

This is precisely the idea that Keynes debunked. As he rightly pointed out, if wages drop by X%, this means that demand will drop by significant proportion of X%, since wages are the single biggest component of demand. That means MORE UNEMPLOYMENT at least initially. However, as Keynes righly pointed out, competitive forces will result in employers dropping prices by about X%, which means everyone is pretty well back where they started. Net effect on unemployment: about zero.

The only net effect of the above farce is the Pigou effect. That is the above drop in prices raises the real value of money, which equals an increase in the real value of household savings. This WILL stimulate demand, but as Keynes pointed out, “wages are sticky downwards” thus the Pigou effect takes an unacceptably long time to work.

The other piece of nonsense by Becker and Posner is in their last para where they claim that extra stimulus requires expanding the national debt and that the latter is some sort of problem. This is a much more widely held view than the above “cutting wages” idea.

Well if you want stimulus and you think extra national debt is a problem, then stimulate WITHOUT extra debt. That’s what the UK did in 2009. Magic! How was it done? The answer is that the entire deficit in 2009 (more or less) was quantitatively eased. I.e. the government central bank machine just printed £200bn of extra money.

Of course this involves a NOMINAL debt: an extra £200bn owed by the UK Treasury to the Bank of England. But this is a huge paper shuffling nonsense (the purpose of which is to get round some silly European Union regulations, as I understand it). The government debt or “gilts” in the hands of the Bank of England might just as well be shredded.

For more on this see 13th Oct post below, “£200bn off the national debt.....” and the “Governments should stop borrowing” link top right above.

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