Thursday, January 24, 2008

Arnold Kling on the Keynesian emperor and lack of clothes

Once you accept the notion that jobs can be scarce, you can turn the rest of economics upside-down as well.

In macroeconomics, more saving is "contractionary" and more consumer spending is "expansionary."

In macroeconomics, it is bad to have foreign trade in which the value of what we buy is greater than the value of what we sell. Thus, a trade deficit is "contractionary" and a trade surplus is "expansionary."

3. In macroeconomics, a balanced budget or surplus can be "contractionary," while a deficit is "expansionary."

No wonder first-year economics students end up knowing very little economics. What they learn in micro gets canceled out in macro.

Classical economics does not allow for such a thing as a "general drop in demand for goods and services." Again, in classical economics, we have unlimited wants. There is never a need to increase demand.

The problem for classical economics is to explain the high unemployment rate of the Great Depression. As the late Nobel Laureate Franco Modigliani said in a famous address, are we to believe that the Depression was a massive outbreak of laziness?

My current view is that what we call "cyclical" unemployment is in fact a severe version of structural and/or frictional unemployment. During the Great Depression, many government policies, such as the National Recovery Administration, served mainly to create structural unemployment. There also was an unusually high level of frictional unemployment, as the spread of motorized road transport greatly altered the efficient structure of production.

Given this theoretical outlook, I would be inclined not to forecast a severe recession in 2008. There have not been any major developments that would have an impact on structural unemployment.

But I may be wrong. There is a chance that the Keynesian story is correct. If unemployment were to spike up toward 10 percent, I would be very sympathetic to attempting Keynesian remedies, including monetary expansion and deficit spending. But for now, the main "crisis" motivating "stimulus" is the fact that this is an election year.


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