30 Dec 2010

Krugman In Support of the Hangover Theory?

Economics, Krugman 9 Comments

I know, I know, I should stop trying to spot Krugman Kontradictions; the antinomies in his writing merely reflect my mortal mind’s attempt to absorb the infinite.

Lately Krugman has been patting himself on the back for his skepticism about the viability of the euro. He finds it hilarious that two economists published a “duh, what idiots” article on these skeptics, basically just before the euro crisis set in. (I too found that funny; I’ll give Krugman that one.)

Now relying on the theory of “optimal currency areas,” Krugman says that we should have expected the euro-zone to be more vulnerable to crises than the United States:

What was behind those doubts? People like me and Barry Eichengreen — who did more than anyone else to turn the abstract arguments into quantitative research — thought of the euro in terms of the theory of the “optimum currency area”. This theory says that there are both benefits and costs to adopting a common currency. The benefit is reduced costs of doing business; the cost is that it’s harder to get your costs and prices back in line after “asymmetric shocks” — booms and slumps that affect some countries in a currency union but not others.

Both the benefits and the costs are hard to quantify, but there are some indicators you can look at. If the benefits of a common currency are large, you’d expect forming that currency to lead to a large increase in trade. Meanwhile, the costs of difficult adjustment depend on how much adjustment you need to make. The burden is reduced if labor is highly mobile between booming and slumping regions (Mundell’s point) and if you have fiscal integration (a point made by my colleague Peter Kenen)…

OK, now that you have the general idea, check out Krugman’s post yesterday where he compares Nevada and Ireland:

As part of a project I’ve been working on, I’ve been doing some US-Europe comparisons, and have a curious parallel: by the numbers, Ireland looks a lot like Nevada. The populations are similar; the housing bubbles were comparable in their extremity; both currently have roughly 14 percent unemployment.

The comparison also highlights some of the reasons Europe is having more trouble with a single currency than the United States. In both places, emigration is a safety valve — but even though the Irish are unusually mobile by European standards, they probably won’t leave as readily as the workers who moved to Nevada in the boom years.

To be sure, Krugman goes on to talk about other factors. But if I didn’t know any better, just reading the above, I would think that the boom period was characterized by workers flowing into Nevada, and the recovery will be speedier to the extent that those workers get the heck out of dodge and go somewhere else in the economy.

Doesn’t this sound a lot like the hangover theory that Krugman ridiculed? (Specifically, Krugman set up his target by quoting John Cochrane: “We should have a recession,” Cochrane said in November, speaking to students and investors in a conference room that looks out on Lake Michigan. “People who spend their lives pounding nails in Nevada need something else to do.”)

Couldn’t Arnold Kling have written the above, in support of his Recalculation argument?

I know, I know, there is no contradiction here. Cochrane is a moron for thinking the way to end the recession is for workers to leave Nevada, whereas Krugman is a genius for predicting that Europe’s recessions would be worse since their workers can’t move around as easily as Nevadans. Krugman Kannot Kontradict.

9 Responses to “Krugman In Support of the Hangover Theory?”

  1. Blackadder says:

    To see a contradiction here you kind of have to ignore Cochrane’s first sentence: “we need a recession.” Krugman doesn’t believe that. Ideally you would just use monetary policy to fix things. The problem is that Nevada doesn’t control its own monetary policy, and a monetary policy that would be appropriate (by Krugman’s lights) for Nevada wouldn’t be appropriate for other parts of the country. Having people leave the state is a poor second best solution, though in the circumstances it’s better than nothing.

    • bobmurphy says:


      (FYI you are not as intimidating now that I know your real picture from Facebook. You were more of a force when I thought you were Rowan Atkinson.)

      He doesn’t say it explicitly, but from the snippets in the post doesn’t it sound like Krugman is saying that the reason Nevada (as opposed to, say, Tennessee) has such high unemployment, is that it was one of the epicenters of the housing boom? So, it looks like Krugman is saying, “There was a boom in housing, that sucked workers into Nevada. Now the boom is over, so workers need to leave Nevada.”

      Your point is, “…unless we can generate another boom to replace the housing bubble.”

      Right, so Krugman differs only from the Austrians (now) in thinking that the solution to a recession is to create a perpetual string of bubbles.

      Before, he was denying that there was any misallocation of labor at all. He produced charts showing that manufacturing employment had fallen more than construction employment, etc. (I had to correct him, by pointing out that he was looking at absolute numbers and not percentages.)

      So in order to pat himself on the back for his euro skepticism, he is much much closer to the hangover theory than before.

      • Blackadder says:

        Krugman differs only from the Austrians (now) in thinking that the solution to a recession is to create a perpetual string of bubbles. Before, he was denying that there was any misallocation of labor at all.

        All Krugman says in the post is that if you have an area with high unemployment, one solution is for people to move to an area with lower unemployment. That’s true regardless of the reason there is high unemployment. It might be because of a prior misallocation of labor, or it might not.

        FYI you are not as intimidating now that I know your real picture from Facebook. You were more of a force when I thought you were Rowan Atkinson.

        This is why Batman never reveals his secret identity to anyone. As soon as the mask comes off he might as well be Rodney Dangerfield.

  2. Joe in Morgantown says:

    The mortal mind bit is very funny, thanks.

  3. Mike Sandifer says:

    Did Krugman claim that most of the unemployed in Nevada were in construction?

  4. Teqzilla says:


    It’s not just that Krugman views monetary policy as superior, he has previously denied that improper allocation of labour is a significant problem in causing recessions or recovering from them. Don’t you remember that he ‘proved’ it by not understanding how the creation of jobs did not create unemployment yet the destruction of jobs did which makes the hangover theory stupid[/krugman logic].

    Another good pwning of kruggers, Bob. Krugman played with the phlogiston theory of fire and got burnt

    • Blackadder says:


      Saying that the recession was caused by an improper allocation of labor is not the same as saying that the recession caused an improper allocation of labor. The first is the hangover theory (which Krugman denies). The second is accepted by pretty much everyone except maybe some of the Real Business Cycle people.

      Suppose that some new plague breaks out that makes people not want to gamble. You would end up with a lot of unemployed people sitting around Nevada, and you might suggest that the best way for them to find jobs is to move. In saying this, you’ve hardly committed yourself to saying that the plague was caused by an improper allocation of labor.

  5. Daniel Kuehn says:

    Your views of what Keynesians think always surprise me, Bob.

    I’ll have to add this to my list. I was not aware that we were supposed to think that workers should not move from low marginal productivity to high marginal productivity areas. I was always under the impression that they should.

    See Blackadder above for details – although I’d go a little further than him even. I think it’s reasonable to say those construction workers shouldn’t have been there in the first place. I’d lean towards loose credit from global imbalances and good old fashioned bubble psychology, but lets say I even buy arguments about the Fed and Barney Frank as well. The housing bubble bursting was only the spark that lit the fuse. Burst bubbles don’t inherently cause depressions. But bubbles that have broad enough ties in finance and to balance sheets could light the fuse for broader Keynesian liquidity preference dynamics that would cause a depression. That’s what you have here. I buy into ABCT insofar as I think readjusments from credit-induced malinvestments are certainly going to give you unemployment and perhaps even cyclical behavior. But acknowledging “we probably build too many houses in Nevada and we probably won’t need to build more for a while, so there’s no reason for those guys to keep working there” is a far, far, far cry from saying “we have a depression because construction workers won’t find new jobs”.

    In other words, this sounds like common sense and basic neoclassical marginalism – not ABCT.

  6. Yancey Ward says:

    Clearly Nevada needs it’s own currency and get the hell out of this dollar thingee.