Remember Austrian economics? In the aftermath of the 2008 financial crisis, a number of conservatives rejected Keynesian economic prescriptions and claimed instead to be devotees of the Austrian School, especially Friedrich Hayek.
It’s questionable how many of these self-proclaimed “Austrians” actually knew what they were endorsing. In general, when right-wingers talk about intellectual history, you want to fire up your fact-checking. For example, Mark Levin of Fox News has a best-selling book claiming not just that the current American left is in the thrall of European Marxists but more specifically that they’re followers of Herbert Marcuse and the Frankfurt School — except that he keeps calling it the “Franklin School.”
And the idea that there was a titanic intellectual battle in the 1930s between Hayek and John Maynard Keynes is basically fan fiction; Hayek’s views on the Great Depression didn’t get much intellectual traction at the time, and his fame came later, with the publication of his 1944 political tract “The Road to Serfdom.”
Nonetheless, there was an identifiable Austrian analysis of the Depression, shared by Hayek and other economists, including Joseph Schumpeter. Where Keynes argued that the Depression was caused by a general shortfall in demand, Hayek and Schumpeter argued that we were looking at the inevitable difficulties of adjusting to the aftermath of a boom. In their view, excessive optimism had led to the allocation of too much labor and other resources to the production of investment goods, and a depression was just the economy’s way of getting those resources back where they belonged.
This view had logical problems: If transferring resources out of investment goods causes mass unemployment, why didn’t the same thing happen when resources were being transferred in and away from other industries? It was also clearly at odds with experience: During the Depression and, for that matter after the 2008 crisis, there was excess capacity and unemployment in just about every industry — not slack in some and shortages in others.
This time, however, is different. Although we aren’t hearing much about Austrian economics these days, the pandemic really did produce an Austrian-style reallocation shock, with demand for some things surging while demand for other things slumped. You can see this even at a macro level: There was a huge increase in purchases of durable goods even as services struggled. (Think people buying stationary bikes because they can’t go to the gym. Hey, I did.)
You can see it even more clearly in the details: Record vacancies in the market for office space, a crippling shortage of shipping containers.
So we’re finally having the kind of economic crisis that people like Hayek and Schumpeter wrongly believed we were having in the 1930s. Does this mean that we should follow the policy advice they gave back then?
That’s the message of a paper by Veronica Guerrieri, Guido Lorenzoni, Ludwig Straub and Iván Werning that was prepared for this year’s Jackson Hole meeting — an important Federal Reserve conference that often produces influential research. (Fun fact: I’ve been blackballed from Jackson Hole since the early 2000s, when I had the temerity to criticize Alan Greenspan before it was fashionable.) Guerrieri et al. never explicitly mention the Austrians, but their paper can nonetheless be construed as a refutation of their policy prescriptions.
Hayek and Schumpeter were adamantly against any attempt to fight the Great Depression with monetary and fiscal stimulus. Hayek decried the use of “artificial stimulants,” insisting that we should instead “leave it to time to effect a permanent cure by the slow process of adapting the structure of production.” Schumpeter warned that “any revival which is merely due to artificial stimulus leaves part of the work of depressions undone.”
But these conclusions didn’t follow even if you accepted their incorrect analysis of what the Depression was all about. Why should the need to move workers out of a sector lead to unemployment? Why shouldn’t it simply lead to lower wages?
The answer in practice is downward nominal wage rigidity: Employers are really reluctant to cut wages, because of the effects on worker morale. Here’s the distribution of wage changes in 2009-10, from the linked paper:
The big spike at zero represents large numbers of employers who had an abundance of job applicants but didn’t want to cut wages, so they just left them unchanged.
However, if wages can’t fall in the sector that needs to shrink, why can’t they increase in the sector that needs to expand? Sure, it would lead to a temporary rise in inflation — but that would be OK.
Guerrieri et al. argue, with a formal model to back them up, that the optimal response to a reallocation shock is indeed a very expansionary monetary policy that causes a temporary spike in inflation. Workers would still have an incentive to change jobs, because real wages would fall in their old jobs but rise elsewhere. But there wouldn’t have to be large-scale unemployment.
Maybe this was obvious from the start — or maybe not, because most of us were so focused on the wrongness of the Austrians’ diagnosis of the problem that we didn’t spend much time thinking about their solution. Now that we’ve finally had the shock Austrian economists kept imagining, we can see that they were still giving very bad advice.
And in case you’re wondering, the Fed, by accepting transitory inflation, is getting it right.
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