Monday, December 13, 2010

"Deficient Demand" and Sectoral Reallocation

Here, Dave Andolfatto looks at some aggregate net flows among employment, unemployment, and not-in-the-labor-force states, and argues that the observations appear to be consistent with a sectoral reallocation process and inconsistent with Keynesian aggregate demand stories. The inconsistency has to do with the fact that flows from unemployment to employment and from non-participation to unemployment have both increased since the beginning of the recession. Krugman claims here that Andolfatto's arguments are "botched." He looks at JOLTS data, and observes that hiring and separations have both decreased, and his conclusion is:
In all such exercises, you’re looking for the “signature” associated with one or another story; and the signature here is clearly the one you’d expect with a general fall of demand. Keynes roolz.
I'm getting a picture of Krugman jumping around his living room in his underwear, like Tom Cruise in Risky Business. Seems to me that sloppy thinking roolz.

Two comments:

1. Krugman's numbers are consistent with sectoral reallocation. Krugman's data consists of observations on aggregate hiring and separations at the establishment level. Separations will in general include workers who leave an establishment to work in another establishment, either in the same sector or in another sector of the economy. In sectors where the employment share is increasing, hiring will of course tend to be high, as this is necessary to expand employment, but separations will tend to be high as well, since this is in part how workers move up the ladder. Workers with human capital specific to the sector move to higher paying jobs that are not available in their own establishment, possibly by forming their own firms. In declining sectors, hiring is low, but separations are low as well. Workers find it difficult to move up the ladder in their own sector, but moving across sectors is insufficiently attractive, because their human capital is specific to the sector in which they are currently working. What do we observe in the aggregate? The key idea is that sectoral reallocation frictions imply that, when there is unusually large dispersion in cross-sectoral factors - technological change or demand factors - aggregate hiring and separations will both be low. First, establishments in sectors growing relatively quickly will not be hiring as much as they would if workers did not have to acquire new skills or move across geographical regions to work in a different sector. Second, in sectors growing relatively slowly, separations are lower than they would otherwise be because moving across sectors is costly, due to skill acquisition and relocation.

2. "Deficient demand," is a cop out. In the mind of an Old Keynesian, if real GDP goes down, this is always due to deficient demand. By virtue of national income accounting, we know that some component of GDP decreased, and the Old Keynesian can then say that we have experienced an "autonomous" decrease in aggregate demand. Of course, this doesn't explain anything. We would like to know what caused some economic agents to be spending less. In New Keynesian models, at least the ones that do not degenerate into Old Keynesian language, one actually has to be explicit about what aspects of preferences, endowments, technology, or policy, are acting to cause aggregate fluctuations. In a fully-articulated New Keynesian model, just as in any fully-articulated general equilibrium model, "aggregate demand" does not have any meaning. It is possible to tie Keynesian ideas to coordination failures and multiple equilibria, as was popular in the past (see this), but that is not what Krugman and company are up to.

28 comments:

  1. Deficient demand is not a cop-out. It's the other face of an excess demand for money. In a barter economy, Say's Law shows that you can never have deficient demand, i.e., the sum of excess demands across markets is zero. But in a monetary economy, it is the sum of excess demands across money and goods markets that sums to zero, so an excess demand for money implies deficient demand for goods, and vice versa.

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  2. That is some very strange Old Keynesian economics. In every Old Keynesian model I saw, whether it was conventional IS/LM or some Tobin 3-asset model, the demand for each asset was always equal to the supply for that asset. There was never any excess demand for money.

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  3. "But in a monetary economy, it is the sum of excess demands across money and goods markets that sums to zero, so an excess demand for money implies deficient demand for goods, and vice versa."

    Where do the extra goods go? Hopefully, not into Paul's underwear.

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  4. I hope not. In a sticky price model, it seems the idea is that a firm's price can be too high, relative to what the firm would choose if it were free to do so. By assumption the firm produces whatever consumers want to consume at the stuck price. In some sense there is excess supply of the good at the market price. Walras told us that excess demands have to sum to zero. So where is the excess demand? It's in the labor market. Given the market wage, the firm would like to produce more by hiring more labor. Of course, there is another sense in which we are in equilibrium here. Given the rules of the game (the firm can't change its price and is required to produce whatever consumers want at that price) everyone is optimizing given their constraints.

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  5. Stephen,

    You wrote,

    "That is some very strange Old Keynesian economics. In every Old Keynesian model I saw, whether it was conventional IS/LM or some Tobin 3-asset model, the demand for each asset was always equal to the supply for that asset. There was never any excess demand for money."

    First, that is because these were static models.

    Second, the idea of an excess demand for money is a distinctly monetarist idea. Friedman and Schwartz's Monetary Trends in the United State and the United Kingdom, they explicitly discuss the role of a actual money balances deviating from desired money balances.

    Third, if you want a story of excess demand for money (and all other assets for that matter), look at Ch. 11 of Jurg Niehans's The Theory of Money (1978). There it is possible for the actual holdings of all assets to differ from desired holdings.

    I have no problem if you don't like this theory, but let's not pretend that this type of theory never existed.

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  6. Excess demand for money is, as Josh says, the standard Friedman & Schwartz explanation of the Depression. How is it that a "new monetarist" is so unacquainted with how the old monetarists thought?

    Scott Sumner, Nick Rowe and Bill Woolsey all consider themselves "quasi-monetarists" and they all think excess demand for money explains not only the Depression but also the current recession. Are you really unaware of this?

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  7. "I have no problem if you don't like this theory, but let's not pretend that this type of theory never existed."

    1. I don't pretend anything.
    2. Yes, I was talking about static models, as I thought that was what the question was about. That's usually what excess-demand disequilibrium people are thinking about.
    3. I don't agree with everything Friedman wrote. That's why I'm New and not Old.

    "How is it that a "new monetarist" is so unacquainted with how the old monetarists thought?" "Are you really unaware of this?"

    Ignorance can be a good thing sometimes.

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  8. Stephen,

    Regarding point (2), Patinkin (1956) tried to argue that a real balance effect existed within a static model. Archibald and Lipsey (1958) pointed out that real balance effects could not exist in static models, but rather required a dynamic framework. Thus, my point is that you don't see excess money demand in static models because it cannot be a feature of such models.

    Regarding point (3), I never said that you should agree with everything Friedman wrote. I brought this up because you explicitly stated that this idea was some sort of Old Keynesian idea. My comment was designed to demonstrate otherwise.

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  9. Josh,

    I get it now. A typical modern macroeconomist would not want to think about models of asset pricing and trading outside of dynamic frameworks. Further when someone starts telling me about an "exess demand for money," this seems like a non-starter to me. I start to wonder where they got ideas like this. I can make some guesses, as long ago some people tried to teach me things that, in fact in static models (like Patinkin's for example). I can't always figure out where people are coming from. I also have a copy of "Monetary Trends..." on the shelf, but I have not read it, or I did and forgot the details.

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