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Alex Tabarrok posted at Marginal Revolution about sticky wages. It’s an interesting bit of mathematics. I can see his point, that sticky wages for employed people can keep the labour market from adjusting. Because the unemployed are a minority of the labour force, even large reductions in the wages they are willing to accept have a small impact on the total wage bill.

My reaction to this bit

If all employed workers accepted a 5% pay cut (or if the government ordered such a cut) and the Fed kept targeting inflation, we’d experience rapid economic growth.

was, ‘What’s this “we” stuff?’.

Tabarrok is saying that if ‘we’ take a 5% pay cut, ‘we’ can have economic growth. What kind of economic growth entails having less? My only explanation is that Tabarrok is treating labour costs only as costs, as something to be reduced. There is no recognition that those costs are also the returns to people’s labour, and that increases in those returns are exactly what most people experience as growth.

The second problem with this idea is that it doesn’t fix the problem. The US economy is depressed because of low aggregate demand. Tabarrok’s solution is to take the same insufficient demand and spread it amongst more people. That will put more people back to work, but it doesn’t really solve the underlying problem.

This sort of analysis seems to forget that the economy exists to provide people with goods and services. It isn’t some separate entity whose growth somehow has nothing to do with the people involved.

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I’ve been turning this over in my head for weeks. Obviously, the economic/political problems in the US are one of biggest economic issues going, and I’ve not blogged about them. Part of the reason I haven’t is that it is very difficult to separate the political from the economic.

I should also say that I’m not a macroeconomist. I discussed this a bit here (p. 6), but I studied macro in the 1980s, and what I remember most is confusion. Our professors tried to teach us all the contemporaneous strands – Keynesian, neoclassical, monetary – but I didn’t understand until much later that they couldn’t all be true. Going into the problems of 2007, I didn’t have good models for thinking about what was going on. For example, I saw the huge build-up of the money supply, and thought it would bring inflation.

I have learned a lot about macro in the last few years. I have spent a fair amount of time reading articles and blogs, trying to make sense of what has been happening in the US. What I have found is that Krugman and DeLong have been right, and lots of other economists have not. That is, they have been able to say, ‘here is what we would expect to happen in this situation’, and they have been right.

Thus, it is also a distinct disappointment to find posts like this one from kiwiblog. He has the economics all wrong. The economic situation is what we would expect – given the correct model – from this type of recession and the tepid government response. The US is suffering from a lack of aggregate demand, and the government can currently borrow at zero percent to lift demand now. To quote Krugman:

By contrast, the Krugman/Thoma/DeLong axis (I still like it!) is basically using standard macroeconomics, applied to a nonstandard situation. The Hicks/Keynes model — in which demand drives output in the short run, interest rates are determined by the tradeoff between liquidity and yield, and extreme negative shocks push you into a liquidity trap in which conventional monetary policy loses traction and deficits don’t crowd out private spending — has worked very well in this crisis, which is why we keep using it with a few twiddles (such as emphasizing the role of private debt).

We are lucky, here. I shouldn’t say this too loudly, but I think NZ is probably well-placed to weather this storm without too much trouble. Government debt is low. Our main trading partners are Australia and China, both doing well. We export food, which people still need. We should take the opportunity to learn from other countries’ pain. We could learn which models fit the facts, and which ones don’t.

Nationwide spending through the Paymark electronic payments network dropped 6% from year-ago levels on Tuesday 22 February, the day of the second major Christchurch earthquake, mostly due to a 33% spending drop in the Canterbury region. Subsequent to this there has been only partial recovery in Canterbury and some shift in spending to South Canterbury, but spending beyond these two regions has resumed at the faster-than-of-late 6% p.a. witnessed earlier in February.