It's an interesting paper (pdf). It's a very standard New Keynesian macro model with one twist. It's a twist worth doing. There are two types of people: the impatient, who borrow from; the patient. And there's an exogenous limit to the debt the impatient are allowed to accumulate.
It's a math model, of course. I'm not going to stick literally to the assumptions of the model, because many of those assumptions were made to make the math simple, and aren't really central. Here's my reading.
Start with an equilibrium in which all people and firms are lending or borrowing as much as they want. Now impose an exogenous borrowing constraint on some people and firms who have borrowed in the past and are now in debt. What happens?
1. For a given level of current and expected future income, the equilibrium real rate of interest will drop. That's because some people and firms who want to borrow won't be able to, or won't be able to borrow as much. The demand for loanable funds from qualified borrowers falls, and so does the equilibrium rate of interest. Equivalently, for a given level of expected future income and real interest rate, there is a fall in the level of current income at which desired savings equals desired investment (ignoring the desires of those who want to borrow and spend but can't). Whichever way you think about the IS curve, it shifts down, or it shifts left. Same thing.
2. The marginal propensity to spend out of current income increases. A change in current income that leaves future income unchanged has little effect on permanent income, and so will normally have little effect on the demand for goods. But borrowing-constrained people and firms will have a marginal propensity to spend out of current income of one. So anything that causes current income to change will have a bigger multiplier effect.
3. A change in the real rate of interest will have a smaller direct effect on the demand for goods. That's because the borrowing-constrained people and firms want to borrow and spend more if the rate of interest falls, but are unable to.
4. The IS curve may become either flatter or steeper, depending on whether 2 or 3 above dominates. A less interest-elastic demand for goods means a steeper IS curve. But a bigger multiplier means a flatter IS curve. With an exogenous borrowing constraint, a given fall in the rate of interest will have a smaller direct effect on increasing demand, but that direct effect will have a bigger multiplier effect. So the total effect of a fall in the rate of interest on demand for goods could be either bigger or smaller.
Now suppose an exogenous shock causes the borrowing constraint to bind more tightly. This causes the IS curve to shift left, and makes the natural rate of interest strongly negative. Since the nominal rate of interest cannot fall below zero, and since the expected rate of inflation isn't high enough, the economy goes into a recession. Any fall in the current price level increases the real value of existing nominal debt, and makes the borrowing constraint bind more tightly still. (That's the Fisher debt-deflation effect).
Monetary policy can only work if it can increase the expected future price level, and thereby increase expected inflation and lower the real rate of interest. Fiscal policy can work because a cut in current taxes will raise the current disposable income of borrowing-constrained people and firms, causing them to increase their demand for goods, even if they know that future taxes will be increased. In effect, the government is acting as lender to the borrowing-constrained, and relaxing that constraint.
One main problem with the model is the exogeneity of the level of real debt at which the borrowing constraint bites. I can think of three main channels in which making the borrowing constraint endogenous might change the results of the model:
B1. The amount that people and firms are allowed to borrow depends on their income. If a recession causes a decline in current and expected future income, this could tighten the borrowing constraints still further, deepening the recession. In effect, we get a borrowing-constraint multiplier.
B2. The amount that people and firms are allowed to borrow depends on the rate of interest. A fall in the rate of interest will lower the interest payments on a given debt, and would loosen borrowing constraints and help the economy escape the recession.
B3. A cut in current taxes implies an increase in expected future taxes, which reduces expected future disposable income, and reduces the ability of debtors to service debt in future, which may tighten the borrowing constraint. So fiscal policy may still fail, because the increased government lending may be fully offset by an equivalent tightening of the borrowing constraint. Ricardian Equivalence may still hold.
Let me add a quasi-monetarist gloss to the model: The recession is not caused by an excess of desired savings over investment. Instead, when lenders are unable to find borrowers they think are safe, they choose to save in the form of money instead. It is the excess demand for the medium of exchange that causes the recession. In a barter economy, those who desired to lend but who were unable to find borrowers they think are safe would be forced to consume or invest their income themselves.
Let me add a more monetarist objection (I'm trying to guess what Scott Sumner would say): It was the Fed, by having too tight a monetary policy, so that expected future nominal income fell, that caused the borrowing constraint to tighten. It wasn't exogenous at all.
And I would add that monetary policy might actually be more powerful in this sort of model than it would be in a similar New Keynesian model with a liquidity trap but without a borrowing constraint. The higher marginal propensity to spend out of current income is higher, so the multiplier effect of anything that gets spending started will be higher. Plus, more importantly, the borrowing constraint creates its own multiplier, because any increase in current or expected future income relaxes the borrowing constraint which creates additional demand and income.
Worthwhile Canadian Initiative 
One thing that I might want to pick out is that out of the points 1-4, the only one we can observe an analogue to in the data is 2, and here the statics point in the wrong direction – the savings rate spiked.
Professor Steve Keen has an interesting model that simulates the “Great Moderation” of the 20 years before the 2008 crisis and then the crisis.
He has a long video presentation here: http://www.debtdeflation.com/blogs/ You can also download his model and the software to run it.
I’d be curious to know what you think of it.
So he’s trying to add Bohm-Bawerk/Mises to macro:
“There are two types of people: the impatient, who borrow from; the patient”
Good. Great to see Paul Krugman trying to catch up to the economics of 100 years ago.
Now lets see Krugman try to add the grown up stuff to his baby Bohm-Bawerk — the fact that entrepreneurs with heterogeneous production goods who will not choose longer production processes unless those processes promise greater output.
That would move Paul Krugman all the way up to the economics of 80 years ago …
Let me say this so even Paul Krugman can understand it.
If you have people who are differentially impatient, if you have production processes which are differentially productive depending on production time, and if people will not choose longer production processes unless those processes promise greater output, then the changing price of credit and the changing quantity / flow structure of money, and the changing structure of leveraged liabilities can produce systematic malinvestment and disequilibrium in the whole of the economy, across the time structure of production, and involving an incompatibility of production and consumption plans across time.
In other words, if you have an economy like the real world — and completely UNLIKE the fake “economy” which is “modeled” by mathematical macro — then you have all the conditions you need for an unsustainable boom and an unavoidable bust.
The other source of the debt constraint is asset values, of course. Declining or rising asset values must have a similar impact to income if you incorporate them into the model – if asset values fall, the debt limit tightens and the impatient find themselves more constrained in their spending, potentially further reducing asset values.
I’m not sure if the division into patient and impatient is quite right either – most people have a mixture of debt and investments with different levels of liquidity. Maybe this doesn’t change anything, but since the choices are partly motivated by taxes (eg, the reason I have a 401(k) and just pay off my mortgage is partly taxes) it might be relevent
what are alternative ways of getting debt into a macro model, other than supposing impatient and patient types? I’d guess different generations or heterogeneity in that some households have income but no investment projects and others have investment projects but no income, so to speak. I haven’t done more than scan paper yet, but would be interested to know how the way in which you introduce debt to the model changes the predictions. Also how well a model of household and firm debt fits a crisis where the ‘problem debt’ was located in the bankign system.
“I’m not sure if the division into patient and impatient is quite right either – most people have a mixture of debt and investments with different levels of liquidity. Maybe this doesn’t change anything, but since the choices are partly motivated by taxes (eg, the reason I have a 401(k) and just pay off my mortgage is partly taxes) it might be relevent.”
Is this true? And even if it is, what are the proportions?
And what about the paper’s observation about spending multipliers being dependant on the share of income held by debt constrained borrowers? What does this mean?
Anyway. Mr. Ransom. Clean up your attitude.
The key is having two types of people instead of one as in Efficient Markets.
In our current economy, the flow of money is blocked to large segments of the economy.
This model is important because it allows transaction dynamics to be explored.
Three observations:
-During the housing and tech bubble, actors believed high current returns were indicative of high future returns. This expectation of high future income, in turn, supported higher current spending and less “money demand”. Is it the Fed’s fault that those income expectations declined, or was it just a consequence of the inevitable fall in bubble returns?
-While a lower rate of interest reduces the borrowing constraint of the impatient actor, it also marginally increases the amount that patient actors have to save in riskless assets in order to generate the same future income.
-What happens if the lower rate of interest results in higher bank spreads — given imperfect competition — rather than lower borrowing costs? The borrowing constraint would not loosen. We see this phenomenon in small business lending and consumer credit. (The higher bank spreads are used to absorb the deadweight loss of loan write-downs.)
Hrmmmm. But 2 says that the marginal propensity to spend increases. While 1 says that the average propensity to spend decreases. It’s perfectly consistent with an increase in desired savings.
Alex: I may take a look at that. But after reading Steve Keen’s previous, post, where he clearly misunderstands something as basic as expected utility maximisation, I am not optimistic.
Greg: It’s one thing to say these things, it’s another thing to model them, so we can see that the explanation is internally consistent.
Simon: good point on asset values. I missed it. My guess is that it would operate through very similar mechanisms to the interest rate and income channels though, since asset prices depend on interest rates and income.
Yes, taxes and compulsory savings plans can mean that the same individual is both a borrower and a lender at the same time. (Example: holding your own mortgage in your RSP, where you really are lending to yourself.)
Luis enrique: I think you have covered the main ways: overlapping generations, different investment opportunities, different preferences, time-varying income (same as OLG in a way).
My guess is that the main effect of introducing banks would be that the supply of money would be linked in with debt. But even though New Keynesian models are models of monetary exchange economies, they don’t have money in there explicitly (at least, the canonical ones don’t).
beezer: The consumption of people who are not borrowing constrained depends on permanent income. A temporary change in income causes a very small change in permanent income and so a very small change in consumption. Their mpc is very small. But people who are borrowing constrained consume all their current income. Their mpc=1. Since the simple multiplier is 1/(1-mpc), the bigger is the average mpc for the population, the bigger is the multiplier.
jonny: efficient markets doesn’t mean that all people are the same. Actually, if all people are the same, you don’t (normally) get a market at all. No motive to trade.
David:
1. Back to the old argument on Scott’s blog about whether the Fed caused the decline in nominal income or failed to prevent it.
2. A lower r has one income effect on lenders and the opposite income effect on borrowers. But the borrowing constraint eliminates the substitution effect for some debtors.
3. Dunno. In general, an increase in spreads is equivalent to a leftward shift in the IS curve.
Alex: I started listening to Steve Keen. I switched off after a couple of minutes. He is already confusing what happens to levels of unemployment and inflation with what happens to their variances. Sorry, but I don’t have the patience.
How would one distinguish lenders deeming borrowers unqualified from borrowers deeming themselves unqualified, that is, no longer deeming their investment projects worthwhile? Credit constraints externally imposed to internally imposed? If the real rate could be lowered to be sufficiently negative than most anything could be seen profitable, but not while its price is still falling or expected to fall or while its supply is still in excess of non-speculative demand. One might consider agents that move between borrower and lender as expectations and rates change.
I wonder if folks like Andolfatto will continue to claim that PK doesn’t do modern macro, and therefore his opinions on things like fiscal stimulus can be ignored.
ISLM: Funny, I had the same thought. He hasn’t updated his blog. There is something about Paul Krugman that makes people lose their minds – for example, someone in these comments starting with “I’ll say this so that even Paul Krugman can understand it” – the man has a Nobel Prize, a John Bates Clark Medal and tenure at Princeton. I think he understands plenty.
Lord: good questions. It might not matter; you might get the same effects either way. Now you mention it, investment might be different from consumption, in how the borrowing constraint gets determined. The GE/PK model only has consumption loans. I talked about investment and consumption here, because I thought they might have similar effects.
ISLM and brendon: Here’s Steve Williamson’s thoughts: http://newmonetarism.blogspot.com/2010/11/eggertsson-and-krugman.html
Beezer is telling this to someone writing about PAUL KRUGMAN? The man has utter contempt for the history of economic thought — and utter contempt for truth when it comes to writing about that economics.
Krugman openly tells the world that he doesn’t read any economics published before the 1970s — and he patently BSs in a truth be damned fashion about the economics of those who wrote prior to the 1970s, writing stuff that EVERY competent authority has identified as utterly incompetent. (See, e.g., Roger Garrison on Krugman on Hayek).
Give me a break. The one who need to clean up his act is Paul Krugman.
“beezer” wrote,
“Anyway. Mr. Ransom. Clean up your attitude.”
Also, “brendon” writes,
“I think [Krugman] understands plenty.”
We know Krugman does not understand much of any economics produced in the period between 1500 and 1970s — that has been shown again and again by many competent authorities.
Competent academic authorities has testified to this fact about Krugman repeatedly. He’s not to be taken seriously when he writes about such things, because it is plain that he doesn’t’ know the stuff and doesn’t understand it.
Competent authorities has said the same even when Krugman writes about Keynes (I don’t claim to be one of those authorities).
There are all sorts of Nobel Prize winning economists with Ivy League tenure who have limited competence in the vast fields of economic thought — this is a given in today’s academy.
I’d suggest folks read some David Colander on this general topic.
“We know Krugman does not understand much of any economics produced in the period between 1500 and 1970s”
This is a very odd claim, and I guess would preclude any knowledge of Keynes which would be news to nearly all of his critics.
The interesting thing about the paper are the paradoxes of toil and the paradoxes of flexibility – these are testable hypotheses, contrary to those tedious ‘microfoundations’ (which are no micro foundations at all, as they are not based upon individual agents) assumptions. The questions therefore are:
– do sudden debt constraints in a severely indebted economy lead to:
A. A backward bending AD curve? The USA and Ireland can serve as an example.
B. larger cyclical swings in more felxible economies?
My work on the Dutch economy in the thirties leads me to believe that back then there indeed was something like a dynamic ‘paradox of toil’, productivity in industry rising thus fast that after 1932 increasing demand and production did not make up for earlier lay offs. It’s not exactly the effect of the model, but it can be identified. And there surely was a ‘paradox of flexibility’: low prices very swiftly led to less business investments and large lay offs, which was not counteracted by more or less stable personal consumption and increasing government investment and consumption. But that’s in fact an old fashioned Keynesian argument.
Interesting: the flexibel neo-liberal prodigies (USA, UK, Ireland) are among the western economies with the fastest deterioration in government finances during the present crisis.
So, let’s use the testable ideas to analyse the past and the present instead of musing ‘what did they really mean’.
Greg, there are any number of websites where people can indulge in Krugman Derangement Syndrome to their heart’s content. WCI will not be one of them. If you want to talk about the paper Nick is discussing, fine. But let’s keep it at that, shall we?
And come to that, we could have done without the crack about David Adolfatto’s hypothetical response. He has a blog; wait until he responds, and comment there.
The greater than zero cognitive worth of many of these “modeling” techniques for explanatory purposes is an open question, isn’t it? I.e. it hasn’t been proven, leaving an open queston which hasn’t been provided a cogent or compelling answer, outside of the persuasive force of an argument from authority.
Nick writes,
“It’s one thing to say these things, it’s another thing to model them, so we can see that the explanation is internally consistent.”
If I say 5 true things, I’ve said 5 true things.
If these 5 true things can’t be forced into a mathematically tractable “model” I’ve still said 5 true things. I’ve merely shown that a mathematically tractable system isn’t going to tell us anything informative about those things — besides what can be learned by the fact that the phenomena is lies outside the domain of mathematically tractable formal systems.
Think about what we have learned about physical systems which can’t be limned by a Laplacean linear predictive math equation. Some types of phenomena lie outside the tractability demands of this formalism — e.g. phenomena involving 3 bodies.
A Laplacean might insist therefore that the world consists of only 2 bodies — and to imagine otherwise is impossible.
Saner minds have prevailed.
It’s weird that I find myself in agreement with the resident Austrian—not on Krugman, but on the value of modelling. There are a whole lot of fundamental reasons why we should be skeptical of the very possibility of economic modelling in which we would put any confidence for policy-prescriptive purposes. Well, I guess it’s not that weird that I agree with Greg considering that we come from the edges of the discussion, if opposite edges.
I believe that there is a greater than zero cognitive worth for many of these “modeling” techniques — but this doesn’t change that fact that economics utterly lacks a coherent account of how their tautological “math” constructs produce informative causal explanations.
I take it as a simple fact that economics has yet to show how all this math helps us understand the world — we have an essentially contested and unresolved problem here.
Until that problem is resolved, it’s impossible to establish the cognitive worth of any of these modeling techniques, or even to specify what that worth might be.
“Greg, there are any number of websites where people can indulge in Krugman Derangement Syndrome to their heart’s content.”
Fair enough, Stephen, but I think it is also fair to point out the deep irony in what Krugman is doing. He’s attempting to incorporate a central distinction at the core of the economics he has been trashing in a very ignorant and nasty fashion for the last few years.
There is nothing “deranged” about pointing to significant facts — unless folks have a problem with telling the truth about what is going on here.
Krugman sees a need to incorporate explanatory elements at the core of an explanatory alternative he brutishly rejects on grounds that competent authorities have shown to be misreadings of science at issue.
This calls into question Krugman’s evaluative judgment between explanatory rivals, with significant public consequence.
It’s bizarre to condemn as “deranged” something at once both interesting and true — unless you have a problem is that kind of thing.
Stephen Williamson and his readers are having an interesting discussion of the Krugman paper here:
http://newmonetarism.blogspot.com/2010/11/eggertsson-and-krugman.html
value of models. I don’t think you can say 5 true things, or at least communicate them to me.
There’s been a debate recently about natural language processing, wolfram alphra is making progress towards it. And a lot of criticism, is based on forgetting the value of formal symbolism, rise of first order logic.
Models get rid of rhetoric.
edeast has never read Wittgenstein
That’s true, on my to do list, but I’m not looking forward to it.
I found his architecture horrible, so if you could summarize ..? I’d appreciate it.
Nevermind, I will read him, but I’m honest in that I’m predisposed not to like it. I think mainly cause he won the new york times favorite philosopher contest last year, + the architecture. weird.
I read Derrida, symbols depend on their context. I tried, to marry information-theory with Derrida, somehow, my prof was patient with me. Here’s what I was expecting you to say.
I am a man.
The sky is blue.
And I was going to counter with, deconstruction,
man, biological definition? Anatomy based or chromosome based? ( some double xx’ers can have penis)
or define what wavelengths you consider blue, then go to work on interpreting sky… is… etc. The other analysis, being information theory, in limiting the number of options of messages by a rigid agreed upon structure, the information content can go up, lowers the entropy.
Thanks for keeping it on topic guys
Hi, Nick. Thank you for sharing your thoughts on the Eggertsson-Krugman paper. I have a query about your comment in B3 and Ricardian Equivalence. If cutting taxes now when unemployment is high and demand is low leads to (a) lower future unemployment, and (b) increased income among the employed, wouldn’t this increase future tax revenues without the government having to raise taxes to a level that is higher than original? So Ricardian Equivalence wouldn’t hold when there is significant unemployment and demand for money is too high?
Paul said nothing in this model. He said, here is the model and here is how it works. Everything else that Paul said was designed to be mis-interpreted favorably by his clientele.
Go back, look at the model. It tells you one thing, things go up and things go down and over the average things hang about the average. If Paul, in this model said that sometimes the government multiplier is greater than one, then by construction, he implies it sometimes is less than one. By corollary, then said that when one calibrates this model, it will give an approximate time in the cycle when multipliers are greater than one.
What is new in this model, vs the other ten million square integrable models of the world that go up and down? Paul uses the forces of patience and impatience. Maybe be useful, but so far it is nothing but a proposal.
Kien: That’s what’s called the “demand-side Laffer Curve” argument. Tax cuts pay for themselves, through their effect on aggregate demand (as opposed to aggregate supply for the normal Laffer Curve argument).
It only works if the equilibrium is unstable, or metastable. If the initial equilibrium is stable, then it won’t work. The equilibrium is (locally) stable in the GE/PK model.
Damn! I ought to be able to explain clearly why this is true. But I can’t right now. (My brain is mush. I just spent today replacing an axle seal, only to find they sold me the wrong part, and I have to do it over again tomorrow morning.)
Sorry, Rob. Greg if you care, you can correct me over here
The equilibrium is globally stable period for the GE/PK model, it has to be globally stable by construction. What the model is doing is peering at that data point when the original assumptions don’t hold, when persistent illiquidity forces a debt spiral as in part one, for example.
As long at is well calibrated for a short term forward look it works. What is new is the classification between he patient and impatient.
Matt: Yep. But this is what I had in mind, but my brain wasn’t working:
The GE/PK model assumes that the economy will revert to normal (escape the liquidity trap) in the future. If you took the GE/PK model, and modified it along the lines of one of George Evans’ models, you could get it stuck in a permanent liquidity trap. But fiscal policy could get it out of the liquidity trap, into the normal equilibrium. A purely temporary fiscal boost could cause a permanent increase in income, with enough tax revenues to pay for the temporary boost. It becomes a “pump priming” model. It’s no longer globally stable. But in that case, even the belief that the economy will escape the liquidity trap could become self-fulfilling.
That’s probably still not clear.
Once you start seeing world without your neo-classical filter, you will start making sense of people like Steve Keen. You can also check other Post-Keynesians such as Bill Mitchell (http://bilbo.economicoutlook.net/blog/) and Randall Wray (http://neweconomicperspectives.blogspot.com/).
Cheers,
Sriram
Greg,
doesn’t basic empiricism (looking out the window), tell you this:
“If you have people who are differentially impatient, if you have production processes which are differentially productive depending on production time, and if people will not choose longer production processes unless those processes promise greater output, then the changing price of credit and the changing quantity / flow structure of money, and the changing structure of leveraged liabilities can produce systematic malinvestment and disequilibrium in the whole of the economy, across the time structure of production, and involving an incompatibility of production and consumption plans across time.”
is wrong. The magnitudes don’t work. The level of background uncertainty (about income, tastes, technology, market share) make marginal interest rate effects relatively insignificant. And besides, the proximate causes of problems is always changes in demand, not supply shortfalls. I don’t know why you keep pushing this on us without any convincing evidence. You may be able to say 5 true things, but how can we tell they are true?
But me, I’m a disequilibrium guy – I think “produce systematic malinvestment and disequilibrium in the whole of the economy” is perfectly normal. If the economy can’t cope with it, we need a different economy.
Simon K.
“The other source of the debt constraint is asset values,…”
yes I noticed that was missing as well. Given that it was the obviously key contributing factor to our current “balance sheet recession”. It seemed a strange thing to omit.
As for the approach used in the paper of using exogenous shifts in credit constraints, isn’t really using a very primitive device to model Minsky effects – i.e. shifts in risk perception and risk appetite. A proper model should not have an interest rate, but a whole range of interest rates gradated by risk. That curve should become much steeper when the Misky moment hits. Yeah, but I suppose that would make the maths more difficult.
Nick thanks for the interesting discussion. I realize that models are helpful for economist to think through complex problems but, as the discussion here shows those assumptions that make the math possible are sometimes at least as problematic the issues the model is intended to illuminate. Such as the usual implicit assumption that the financial system is so perfectly functioning as to be invisible in the model. Yikes!
That’s what I do like about this one though, at least they’ve managed to throw debt into the equation. Interesting is that all it takes is the introduction of heterogeneous beliefs. I wish Rajiv Sethi blogged more, his work on heterogeneous beliefs is some of the most interesting stuff out there.
On the monetarist response:(I’m trying to guess what Scott Sumner would say): It was the Fed, by having too tight a monetary policy, so that expected future nominal income fell, that caused the borrowing constraint to tighten. It wasn’t exogenous at all.
Two things. First if the stock of debt and the flow of debt service payments were growing faster than NGDP expectations for the impatient group it woudn’t take a fall in NGDP expectations necessarily for them to hit a credit limit.
Also, if I remember correctly Sumner likes to use the analogy of the Fed as ship’s captain and the housing crunch as a wind. He says we should blame the captain for failing to correct for the wind. But, that assumes both that the Fed can correct for the wind and as the tools to recognize the magnitude of wind shift.
I’d also prefer to think of the housing crunch as something more endogenous to the ‘economic ship,’ like an engine or propeller, but I grew up in the midwest and do not know enough about ships to make a sensible analogy.
reason: Keeping the math simple is always good. But even ignoring that, I’m always of the view that when it comes to formal models: “if in doubt, leave it out”. If you can tell the story without adding a whole spectrum of interest rates, then just have one rate of interest.
OGT: It’s not really heterogeneous beliefs that are driving debt in the model; it’s heterogeneous preferences.
“First if the stock of debt and the flow of debt service payments were growing faster than NGDP expectations for the impatient group it woudn’t take a fall in NGDP expectations necessarily for them to hit a credit limit.”
Agreed. But, in equilibrium, the debt limit will always be binding for some people. A fall in expected NGDP growth would suddenly shift the debt limit to make it bind more tightly and affect more people.
Mancur Olson claimed in “The Rise and Decline of Nations” that he had the only explanation for the “sticky wages/prices” which cause Keynesian “involuntary unemployment”. What do you think of his explanation?
TGGP, citing authors without describing what theory of theirs that you are citing doesn’t make you mysteriously sophisticated, it just makes you annoying.
Sorry, I was thinking Rowe would be familiar with it and didn’t think about other readers. Quoting from Wikipedia:
The idea is that small distributional coalitions tend to form over time in countries. Groups like cotton-farmers, steel-producers, and labor unions will have the incentives to form lobby groups and influence policies in their favor. These policies will tend to be protectionist and anti-technology, and will therefore hurt economic growth; but since the benefits of these policies are selective incentives concentrated amongst the few coalitions members, while the costs are diffused throughout the whole population, the “Logic” dictates that there will be little public resistance to them. Hence as time goes on, and these distributional coalitions accumulate in greater and greater numbers, the nation burdened by them will fall into economic decline. Olson’s idea is cited as an influence behind the Calmfors-Driffill hypothesis of collective bargaining.
The “stickiness” comes in because such coalitions take time in order to act collectively. Unexpected inflation means the above-market (nominal) price they have previously set is now closer to the market-clearing price.
TGGP/Wonks: Ah! That’s what you meant! I don’t think of that as a theory of nominal stickiness. I don’t see it as a theory of stickiness at all. I see it as a generalisation of the monopoly union theory of why real wages are too high, and why there’s unemployment in equilibrium. As a theory of why the natural rate of unemployment is high, it makes sense. It’s another way of thinking about what I’ve been saying about why monopolistically competitive firms will have excess supply. It’s doesn’t explain why nominal wages and prices are sticky, so that monetary shocks have real effects.
But are wages and prices really sticky? I think there is good data out there (pdf warnings) that says that prices are not sticky at all. But rather that prices don’t respond to macro monetary shocks and output declines in the way that theory predicts, and so they appear to be “stuck” at a level that is not optimal according to the theory. Perhaps the models are wrong, and the prices are not too sticky.
The whole concept of sticky prices is a bit strange. Imagine if physics took this approach, and their response to the Kepler problem was to declare that Mercury was “sticky”, rather than deciding that there was a theoretical deficiency in their current understanding of the laws of motion.
there is good data out there (pdf warnings) that says that prices are not sticky at all
Yes, the concept has always bothered me too, but I attributed that to my relative macro-ignorance.
My personal supermarket experience matches that of the Bank of England 😉