Sumner vs. Kling: Don’t Get Hit By Those Goalposts

This is quite strange. It shows the versatility of economists and how they can always make it sound like they’re winning the argument, no matter what happens.

Earlier this month, Arnold Kling wrote:

So to avoid confusion: In the above excerpt, Kling starts out with a quotation from Erik Hurst, and then Kling says, “The point is that we do not have a single aggregate economy…”

I’ve put in bold “The point is” because Scott Sumner then proceeds to change what Kling’s point (allegedly) was. Sumner writes in response:

I’ve done a lot of posts on wage stickiness, but misconceptions keep popping up. The sticky wage theory of the business cycle is based on the notion that only a fraction of wages get adjusted each period. This leads to some odd results. The bigger the fall in the equilibrium wage rate, the bigger the fall in the actual wage. That’s no big surprise.

But what does seem to surprise people is that the bigger the fall in the equilibrium wage, the more that actual wages exceed equilibrium wages. That means that, according to the sticky wage theory, during periods where wages fall most the rapidly, we should expect to see the highest rates of unemployment. The same is true regarding cross sectional data.

Thus suppose that Nevada was hit by a severe real estate collapse, and its equilibrium wage fell by 10%. Also suppose that at the same time Texas was buoyed by an oil boom and its equilibrium wage rose by 4%. Finally, assume that due to sticky wages, the actual wage only moves by 1/2 of the amount that the equilibrium wage moves, in a given period. In this example, Nevada’s actual wages would fall by 5% and therefore end up 5% above equilibrium, leading to mass unemployment. Texas wages would rise by 2% and end up 2% below equilibrium, leading to a tight labor market.

Now consider this example, when reading the following comment by Arnold Kling, who is discussing some research by Erik Hurst…

And then Sumner quotes the excerpt that I put up, originally. Sumner then concludes, “Actually, that’s exactly what you’d expect if sticky wages caused business cycles. And for similar reasons, interest rates tend to be at their lowest when they are the furthest above the Wicksellian equilibrium interest rate.”

Do you see the problem? Kling was saying “The point is” that the regional differences in unemployment and wage growth show that we don’t have one giant, homogeneous economy that faces a single Aggregate Demand curve. Yes, Kling says that Hurst “goes on” to talk about wage stickiness, but there’s more to the argument–seriously, click the link and search for “stick” to see how many times “stickiness” or “sticky” appear. The guy’s estimating model parameters etc.; the quick snippet from Kling’s quotation wasn’t about wage stickiness.

OK, so thus far you might think that all I’ve done is show that Sumner changed what Kling was arguing about, with that specific quotation. But it gets much odder.

You see, Sumner is making it sound like his own model–which he’s been tirelessly explaining, and quite frankly is frustrated that so many other economists still don’t get!–is perfectly able to handle an outcome like a real estate bust hitting Nevada harder, and thus causing higher unemployment there. Right? That’s clearly what Sumner is saying.

And yet, back in 2010, Kling was offering his same “Recalculation Story” about the sluggish recovery, and how the housing crash meant workers were in the wrong spots in the country, and that’s why unemployment was higher in states that had had bigger housing bubble peaks. At that time, Sumner certainly didn’t say, “Of course, that’s exactly what you’d expect from my sticky wage model.”

No, at that time Sumner totally rejected Kling’s misallocation of resources story, and said his sticky wages / Aggregate Demand story fit the facts better:

There’s no question that Arnold Kling’s recalculation view is more intellectually appealing than the messy arguments about wage stickiness used by us “GDP factory” proponents…

Yes, macroeconomics should be all about specialization and trade.  Except business cycle theory, which needs a special ad hoc sticky wage/price model.  Why?  Because the evidence simply doesn’t fit any other approach.  Here’s Kling on the construction bust:

I want to suggest that the output that is “lost” is output that people do not want. In 2008 and 2009, Americans do not want 2 million houses to be built. So I do not think that it is right to speak of a shortfall in output. Instead, we should say that the people who were building houses have not found a pattern of trade in which they can produce something that people want.

Yes, housing output was low in 2009 and unemployment was high.  But is there a causal relationship?  I say no.  Housing starts peaked in January 2006, and then fell steadily for years:

January 2006 — housing starts = 2.303 million, unemployment = 4.7%

April 2008 — housing starts = 1.008 million, unemployment = 4.9%

October 2009 — housing starts = 527,000, unemployment = 10.1%

So housing starts fall by 1.3 million over 27 months, and unemployment hardly changes.  Looks like those construction workers found other jobs, which is what is supposed to happen if the Fed keeps NGDP growing at a slow but steady rate.  Then NGDP plummeted, and housing fell another 480,000…The reason housing fell far below normal is because the severe fall in NGDP created a deep recession.  Unemployed factory and service workers aren’t going to buy new houses.

Most importantly, the huge run-up in unemployment did not occur when the big fall in housing construction occurred, but much later, when output in manufacturing and services also plummeted.

I realize I threw a lot of stuff at you, and I am 99.4% sure that Scott Sumner would read all of his quotations above and respond, “Yes, I was dead right in 2010 and I’m dead right today. What’s your point?”

My point is that Sumner back in 2010 was saying Kling had to be wrong, and only the sticky wages story made sense, because (he argued) unemployment had nothing to do with housing.

Now, in 2016, Kling is pointing to unemployment being tied to regional housing markets, and Sumner is saying, “Yes, that’s exactly what the sticky wage model predicts.”

Both of those stances can’t be right.

P.S. If you want to see my reaction to the Kling/Sumner battle last time, read this. I think Kling threw in the towel prematurely.

Brad Birzer Talks to Tom Woods About Mythology, Christianity, and Liberty

Sure I’ll go ahead and post this on a Sunday. Listen to two Catholics talk about Thor. (Joking aside, this is really good stuff.)

*Risen*

I worry that this trailer gives away too much, but probably on balance it will goad more of you into watching the movie.

This is a surprisingly good movie. It was not the cheesy, preachy kind of “Christian” film. It had good acting (especially the lead role) and did a good job of making the Resurrection into a dramatic mystery.

So, if you are vaguely interested but need a nudge, I’m giving the nudge.

Three Oldies But Goodies on Utility Theory

Ah, my previous post on Mises vs. David Friedman has sparked controversy over cardinal vs. ordinal utility. Here are three things I wrote on this general topic: one, two, three.

However, I should admit that at some point, I am pretty sure I made a major concession to David Friedman (we were going back and forth on this stuff) that modern economists use a cardinal notion of utility in some applications. To be clear, I was NOT saying, “OK David you win, now I believe in cardinal utility,” but rather I said something like, “OK I will agree with you that there is no way to take what modern economists do in this setting and transform it into an equivalent (but more cumbersome) approach that is clearly based on ordinal preference rankings.”

However, I cannot right now say what that application was. I don’t think it can simply be the use of a “pure discount” on future utils, because in this paper Koopmans shows the assumptions one can make on ordinal preferences over streams of consumption in order to derive such a discount rate:

Koopmans, Tjalling C. (1960) “Stationary Ordinal Utility and Impatience,” Econometrica, Vol. 28, No. 2 (April), pp. 287-309.

But, presumably I remembered that paper when I made the concession to David, so I don’t know what to tell you kids right now except that some of my sweeping statements in the “one” and “two” essays above may be too much. In other words, even though Austrians are still right (in my mind) that utility theory should have an ordinal foundation, if David Friedman wants to argue that you can only do certain modern things with cardinal utility functions, he may be right (whereas in those essays I argued that he wasn’t).

Contra Krugman Episode 50 — What’s Causing Maternal Deaths in Texas?

There has been a spike in maternal deaths in Texas. The authors of the study documenting this disturbing fact don’t know the cause, but Paul Krugman is pretty sure it’s misogynist (and racist) Republicans. Tom and I investigate.

Krugman’s ObamaCare Predictions Spiraling to Their Death

I know this is par for the course, but when I put all of these things together, the result impressed even me. Just look at how cagey Dr. Krugman has been on the issue of “death spirals.”

Potpourri

==> This was a good Tom Woods show, where Michael Malice gives a great analysis of how the PC warriors think. What may have seemed incomprehensible to you before, will at least seem more understandable. As an added bonus, your sensitivity training comes from a man you may have thought was very rude.

==> A great analysis of paid family leave from David R. Henderson, where he cites the work of Jonathan Gruber (!).

==> Scott Alexander has THE BEST post on the EpiPen issue. Make sure you read to the end. (I may have already blogged this, but so what, you need to read it.)

==> Libertarian sociology professor (that’s not an oxymoron) Kimberly Johnson sends me her new paper on midwives and the medical establishment. Fight the patriarchy!

==> The eagle-eyed von Pepe also spotted this article on the woes in life insurance. However, notice that the article says the problem is in universal life policies (and long-term care insurance). With that context, consider the following excerpt from a video on the Infinite Banking Concept put out by James Neathery (one of the financial professionals on our IBC Practitioner Finder):

The reason I stress this is that Nelson Nash is adamant in his book and public lectures that people should NOT try to implement IBC using a Universal Life policy. This was actually a sticking point with some people; they thought Nash was being a fuddy duddy and not appreciating the flexibility of the new UL policies versus the old-fashioned Whole Life policies.

Such was our concern on this front–i.e. to avoid just the type of nightmares that are described in the NYT article–we have our financial professionals sign a contract agreeing that they can only use dividend-paying Whole Life policies (i.e. not UL policies) for people who want an IBC policy. See 3.3 in our FAQ for our Practitioner Program.

For one last pat on my back, go to Episode 18 of the Lara-Murphy Show, and listen from 11:00 – 13:30. You will hear me stress that you should make sure you are getting a dividend-paying Whole Life policy, and I warn that if someone tries to get you to use a policy with “more versatility” (I don’t call it UL by name but that’s what I had in mind), that it could “go south on you.”

In summary, I feel badly for the people who are getting shocked by the poor performance of their Universal Life insurance policies, but this is a testament to the wisdom of Nelson Nash. He has always been adamant that people who bought those policies were playing with fire, and that’s why he insists that IBC be implemented only with a dividend-paying Whole Life policy.

Did Hayek Favor Targeting NGDP?

I think I may have blogged about this before, but hey, if I can’t quite remember, maybe you guys can’t either. (Plus, there could be new readers.)

Sometimes I see people claiming that Hayek supported NGDP targeting, or perhaps that Hayek’s preferred monetary regime would mimic NGDP targeting. I am by no means a Hayek scholar, but when I dug up his Nobel acceptance speech (for other reasons) I was struck by this passage:

The theory which has been guiding monetary and financial policy during the last thirty years, and which I contend is largely the product of such a mistaken conception of the proper scientific procedure, consists in the assertion that there exists a simple positive correlation between total employment and the size of the aggregate demand for goods and services; it leads to the belief that we can permanently assure full employment by maintaining total money expenditure at an appropriate level. [Hayek, 1974]

That doesn’t sound like a full-throated defense of stable NGDP growth.

Now, I think the issue is that perhaps earlier in his career, Hayek had supported the maintenance of MV during a depression. I asked von Pepe, who keeps track of such things better than me, and he dug up this comment from Jerry O’Driscoll:

I wasn’t at the debate and don’t know what Larry White or anyone else said. I do know what Hayek said, however, and I know my economic history.

It is entirely anachronistic to say that Hayek or anyone else wanted to maintain nominal GDP in the Great Depression. National income accounting hadn’t been invented yet. Here is a link to the history of NIA.http://www.bea.gov/national/pdf/nipaguid.pdf

[What] Hayek wrote in P&P [Prices and Production] is that neutral money meant keeping MV constant. He later clarified that he never intended this to be a guide to policy for any number of reasons. Velocity was not observed in real time and he thought the demand for money changed cyclically and unpredictably. And then there is the knowledge problem I referenced.

(His statement of the knowledge problem predates P&P. So we have additionally textual evidence that the concept of money neutrality wasn’t intended be a guide to activist policy.)

To say something would be desirable in [principle], but is impossible to execute in practice is not a fault. It is intellectual honesty. I don’t think he ever used these words, but Hayek thought that fractional reserve banking with central banks was inherently unstable.

On this, he was in the Henry Simons/Milton Friedman camp. He expressed support for both 100% reserve banking and free banking, but did not think either…was politically possible.