An Open Blog Post to Garett Jones
Hi Dr. Jones, I look forward to your posts on EconLog. I see right out of the chute you’re having a tussle with Scott Sumner. I’ve been watching him for years, in much the same way that the FBI tracks Sicilians. Let me give you a tip regarding your recent exchange.
Economists tell a lot of stories about how a fall in dollar spending can hurt the real economy. And we should be forced to tell these stories–we shouldn’t take it for granted that a fall in spending causes a fall in output, we shouldn’t assume the can opener of general gluts.
Why bother explaining the root causes of gluts when so many think they can see a glut by just looking out the window? Because gluts conflict with one of the best ideas economists have ever had: That surpluses–of workers, of unsold homes, of cars rusting on the lot–push down prices and move the product out the door.
Surpluses set in motion a process that ends the glut: Just watch the last half hour of a garage sale.
Any force strong enough to fight against the power of prices should be a strong force indeed, strong enough for all to see. But when economists talk about the “frictions” that keep gluts alive, we usually talk about “sticky prices” and “sticky wages” and cultural norms and public sector unions and a few other forces. Strong forces, yes, and forces I believe in, but stronger than creative destruction and supply and demand? For years on end?
Here’s my favorite friction, one that exists by force of contract, not because of worker sociology: Debt.
OK, fair enough. Rather than coming up with things like “employers don’t want to hurt morale,” here Jones is saying that a contractually fixed debt payment is certainly something that could explain why nominal levels matter, and the economy can’t just instantly readjust to a new situation.
Enter Scott Sumner. He was being playful in the beginning, of course, but he wrote this:
I’m still morose about Arnold Kling’s retirement from blogging, but the entry of Garett Jones into the blogosphere is a nice silver lining. I plan on welcoming him the only way I know how—attack, attack, attack.
Garett argues that the sticky wage/price mechanism is not strong enough to create major business cycles, and that debt is the key sticky price:
Any force strong enough to fight against the power of prices should be a strong force indeed, strong enough for all to see. But when economists talk about the “frictions” that keep gluts alive, we usually talk about “sticky prices” and “sticky wages” and cultural norms and public sector unions and a few other forces. Strong forces, yes, and forces I believe in, but stronger than creative destruction and supply and demand? For years on end?
Here’s my favorite friction, one that exists by force of contract, not because of worker sociology: Debt. Debt in the household, debt in the firm, and–for state and local governments at least–government debt.
I have several objections to this. Debt prices are not sticky at all (check out the bond market.) I believe Garett is referring to debt payments, which are sticky. That’s true, but they aren’t prices. Debt coupon payments are sunk costs and benefits that have almost no effect on the incentive to produce output at the margin. Even worse, any impact they do have goes the wrong way. A debt crisis often makes people poorer. But we have a lot of evidence that leisure is a normal good, and hence people work harder when they are poorer. Americans used to work six day workweeks. If I became bankrupt, I’d work much harder, I wouldn’t take a vacation.
Now from the above, you’d think that not only was Sumner saying that Garett Jones was a little off on his nomenclature, but that the very idea of using debt to explain the relevance of nominal variables was wrong.
And yet, Scott has often said the exact same thing, at least upon my reading. For example:
In the long run NGDP is of no importance at all; Japan’s NGDP is nearly 40 times larger than America’s. But sudden unexpected changes in NGDP matter a lot. Because nominal wages are sticky, a sudden downshift in NGDP growth will cause fewer hours worked and (except in Germany) a sudden upswing in the unemployment rate. More than enough reason for me to be monomaniacal about NGDP.
But there’s more, debt contracts are also denominated in nominal terms. During most recessions that’s not a big problem. However this time around there were two factors that made the NGDP downshift have a much bigger impact than usual. First, the decline in NGDP growth was unusually large. And second, both debtors and financial institutions were already greatly stressed by the sub-prime fiasco, even before the NGDP crash occurred. The NGDP crash then made the debt crisis much worse.
When I made this argument in early 2009 I don’t recall finding many takers. It seemed obvious that “the” debt problem was due to reckless practices of US banks and GSEs. But then the crisis spread out of the sub-prime ghetto and engulfed other types of real estate debt. Then municipal debt came under stress. And now we have the euro-debt crisis. Is it just a coincidence that all these separate debt crises flared up at about the same time? Is it just coincidence that they all occurred just after the biggest drop in NGDP since the Great Depression? Given that economic theory predicts that a sudden drop in NGDP growth will make it much harder to repay loans, my monomaniacal focus on NGDP doesn’t seem quite as crazy as in early 2009.
So back in that post, Scott wasn’t arguing that debts make us all work harder…
Anyway good luck Dr. Jones. Don’t let Sumner scare you.
Sumner’s critique of Jones is quite specific: he is saying (correctly) that debt cannot by itself explain *unemployment*. This is not the same as saying that the ‘stickiness’ of precontracted nominal debt is economically irrelevant.
he is saying (correctly) that debt cannot by itself explain *unemployment*.
Did Jones even say “by itself” though? He said that debt is a “friction”, along with wage and price stickiness.
Jones is saying that while wage and price stickiness can contribute to unemployment, that it is unreasonable to assume that they can keep employment down for years on end.
Can an NGDP collapse 4 years ago, which has since 2010 been rising at 4-5% per year, explain unemployment that lasts years?
If I am a payer of wages, and I have a fixed debt obligation that expires 5 years in the future, then should my revenues fall, I would lay off some employees than default on my debt. Laying off employees won’t harm my ability to borrow in the future as much as defaulting.
4 years later, I am still paying off my debt. If I didn’t have that debt however, then maybe I would have been hiring more people by now.
I think that is what Jones is saying. He is saying debt is being ignored. Sumner I think is treating Jones’ argument as if he is saying debt is the sole cause of unemployment in general, when Jones said that wage and price stickiness are “strong forces.”
I think the question is why we get lay-offs instead of falling wages. As Karl Smith is fond of saying, prices clear markets: if there is still unemployment, wages must not have adjusted downwards to clear the labor market.
I interpret the claim Jones made (that Sumner finds objectionable) to be that he is skeptical that the effects of sticky wages could last for this long, and I take Sumner as saying you have to believe they can if involuntary unemployment remains. But that’s just my read!
We do get falling wages — just not in explicit dollar form: they reduce every other perk associated with employment.
“As Karl Smith is fond of saying, prices clear markets: if there is still unemployment, wages must not have adjusted downwards to clear the labor market. ”
Depends how you define unemployment. The market may have cleared but at lower levels of employment that people feel comfortable with.
The debate is over. Sumner saved the economy:
http://finance.yahoo.com/news/blogger-saved-economy-152643601.html
Holy crap. That article’s author is absolutely bonkers.
NGDP targeting is taking on a life of its own. Funny how “money printing” keeps needing a new name every so often. Maybe we should put together a handy index page to list the names: ZIRP, QE, etc.
This latest round of QE has got to wash through into price inflation, that’s my prediction. Probably around 5% on food and fuel, those being the purchases that people can’t easily do without.
There’s a guy called Curt Doolittle who popped up on Karl Smith’s blog with the excellent nutshell: “Human plans are sticky.”
Of course, there’s a good reason why human plans are sticky, because any respectable sized project requires some degree of commitment if it is going to get completed. People can glimpse the future but they can’t be sure what they see until they get there, so when you start something you have an expectation to carry that through into a future scenario that you hope will be successful.
The Central Planner type people (you know who you are) talk about stickiness like it is some sort of dreadful human foolishness that thwarts their brilliant plans and undermines their efforts to twiddle with stuff.
Libertarians should talk about commitment instead, where individuals make up their minds and commit to working towards a future scenario that suits themselves. Thus, the business owner commits to establishing a new branch in some town, the employees of that new branch commit to whatever contracts they are working under, then they show the bank that they have jobs and they buy houses and commit to making payments on their mortgages, and the bank in turn makes commitment to get return on people’s savings so they can retire, and the old folks with savings encourage their grandkids to make a commitment to go to university and get an education, and maybe help them out with some money (knowing that their retirement funds are in good hands).
From this perspective we see stickiness in every aspect of human activity, it doesn’t always manifest as a sticky price. If those central planning twiddlers insist on messing with everything, it breaks the chains of commitment the entire economy depends on.
I’ll also point out that the Capitalist “creative destruction” process also breaks the chains of commitment, and in doing so it loosens those “sticky prices” but if bankruptcy is properly managed, the creative destruction process selectively breaks out only those commitments that weren’t viable anyhow. The subprime mortgage that was never going to get paid, or the hopeless car maker that just wasn’t competitive. There is a decision-making process at work here, and the central planners trying to jigger those sticky prices seem unable to lift the lid and look at what goes on. That’s the limitation of working with aggregates.