Economics 102

One of Paul Krugman’s favorite tactics is to assert that all he’s doing is channeling the time-honored lessons of Economics 101 — pre-empting dissent with the implication that any dissenter must be either an ignoramus or a radical. (Journalistic honesty compels me to acknowledge that I might have employed this rhetorical tactic once or twice myself over the years.)

It’s interesting, then, to take note of how very far his central arguments actually deviate from Economics 101. Here’s what he said last week on his blog:

Mulligan and others keep emphasizing examples of individual groups that have managed to gain jobs by cutting wages or offering other attractions to would-be employers. They then assert that these examples tell us what would be needed to expand overall employment.

The point, of course, is that all such arguments amount to committing the fallacy of composition…The essence of macroeconomics is understanding why such things are a fallacy, why what happens if one group does something is not at all what happens when everyone does it.

But you see, here’s the thing: According to the standard Economics 101 version of the sticky-wage Keynesian model, this is a case where what happens if one group does something is exactly the same as what happens when everyone does it. According to that model, as long as wages continue to fall, firms will continue to move along their labor demand curves until we reach full employment.

What Krugman presumably has in mind is not the Economics 101 model at all, but some variant of the Barro-Grossman model, which is a canonical source for the kind of conclusions he wants to draw. This is a model with an interesting history. On the one hand, it’s one of the most heavily cited (and presumably one of the most influential) papers in the history of economics. On the other hand, Robert Barro repudiated this paper — and abandoned this line of research — after cracks began to appear in its microfoundations. (Specifically, the paper assumes that people sign certain contracts which there are good reasons to believe that no denizen of Barro-Grossman-land would ever sign.)

Now disowned children are perfectly capable of going on to lead productive lives, and Barro-Grossman has continued to lead a fruitful life without Barro, spawning many variations that constitute a lively branch of modern macroeconomics. There are, however, other branches on that tree, and no one of them can claim to be uniquely rooted in the soil of Economics 101.

Share/Save

13 Responses to “Economics 102”


  1. 1 1 Jonathan Campbell

    I think this is one of the things that bothers people most about economists: they frequently make it very difficult for the layman to determine whether a stated argument follows from uncontroversial principles of the “science,” or not.

  2. 2 2 Keshav Srinivasan

    Here is Krugman’s explanation of why a general fall in prices doesn’t raise employment: http://krugman.blogs.nytimes.com/2008/11/29/changes-in-money-wages-and-amity-shlaes/

    I don’t know whether he’s implicitly relying on Barro-Grossman, but he claims his analysis is just based on Keynes’ General Theory.

  3. 3 3 Will A

    There is nothing wrong with pre-empting dissent with the implication that any dissenter must be either an ignoramus or a radical.

    Everyone knows this. It’s part of Rhetoric 101.

    Duh.

  4. 4 4 Richard

    But you see, here’s the thing: According to the standard Economics 101 version of the sticky-wage Keynesian model, this is a case where what happens if one group does something is exactly the same as what happens when everyone does it. According to that model, as long as wages continue to fall, firms will continue to move along their labor demand curves until we reach full employment.

    What? Unless I’m missing something, the sticky-wage model suggest that there can be unemployment during recessions because workers are unwilling to take a wage cut. This leads to lay-offs, employers not hiring, or both. This is an explanation as to why workers don’t rationally allow for a wage cut, cut in working hours, work for less than average pay, etc. No fallacy of composition here.

  5. 5 5 Steve Landsburg

    Richard: What? Unless I’m missing something, the sticky-wage model suggest that there can be unemployment during recessions because workers are unwilling to take a wage cut.

    Exactly. So if workers *did* take wage cuts then (in this Econ 101 version of the sticky wage model) there would be no involuntary unemployment.

  6. 6 6 Dave

    Will A wins best comment of the year

  7. 7 7 iceman

    The ad hominem attack is always effective, especially when cleverly packaged. The curious thing about the post cited by Keshav is that at least in that case, Krugman seems to be endorsing a ‘continuously clearing’ model: “Suppose that wages across the US economy had been, say, 20 percent lower than they actually were…to a first approximation, prices would also have been 20 percent lower.” While imagining instantaneous change in all variables is like assuming the prevailing conditions never existed, I would think a more relevant question is how exactly prices might adjust if wages actually fall from levels commensurate with high involuntary unemployment. I thought in the long run we were all dead (but of course that was before I read Landsburg’s recent comments about cryogenics).

  8. 8 8 Super-Fly

    So, these days, it seems like the over-simplifications in public policy arguments boil down to “Is Keynesian economics correct?”

    Christina Romer says that denying Keynesian theory is ridiculous. Keynesians say that there wasn’t enough stimulus, and it seems hard to believe that this many economists are wrong about it.

    The Austrians say their theory predicted the economic crisis, and from what I understand, Keynesian theory doesn’t invalidate microeconomics (or provide an excuse for making glaring errors in economics).

    If I may make an intentionally dense request… who is right? Is Keynesian theory a given, or is there still relevant debate among economists? (And, if it is right, how closely does current policy match Keynesian recommendations?)

  9. 9 9 Super-Fly

    So, these days, it seems like the over-simplifications in public policy arguments boil down to “Is Keynesian economics correct?”

    Christina Romer says that denying Keynesian theory is ridiculous. Keynesians say that there wasn’t enough stimulus, and it seems hard to believe that this many economists are wrong about it.

    The Austrians say their theory predicted the economic crisis, and from what I understand, Keynesian theory doesn’t invalidate microeconomics (or provide an excuse for making glaring errors in economics).

    If I may make an intentionally dense request… who is right? Is Keynesian theory a given, or is there still relevant debate among economists? (And, if it is right, how closely does current policy match Keynesian recommendations?)

  10. 10 10 Mike H

    Austrians may say their theory predicted the crisis, but they are wrong.

    Their theory predicted a crisis, but not this one. They predicted a crisis with massive loss of confidence in US govt debt and the US dollar, leading to low low prices on govt bonds, and hyperinflation.

    We didn’t get that. We got a different crisis, with treasury bond prices at an almost all-time high, and low low inflation despite massive amounts money-printing post-2008.

    AFAIK, Keynesian policy recommendations would be for more fiscal stimulus spending now, enough (after accounting for the multiplier) to bridge the gap ($800000000000 per year) between the capacity of the economy and its actual performance.

    Instead, we have both sides of politics talking about the need to cut spending and reduce the deficit.

    If Austrian models are suddenly correct, though they weren’t in 2008-2010, we should see the economy begin to improve (in the US, UK and Europe) as these spending cuts are implemented.

    If Keynesian models are correct, as they were in 2008-2010, we should see the economy (in the US, UK and Europe) continue to grind slowly downwards until something forces someone to start spending trillions of extra dollars.

  11. 11 11 iceman

    To me the debate over Keynesian stimulus is often best framed in terms of short run vs. long run — e.g., “at what cost smoothing?” — and non-ridiculous people will prioritize those trade-offs differently. Surely if $800 billion didn’t have ANY mitigating impact (even if largely spent bailing out profligate states), the program was an unmitigated disaster. But we might still be concerned about the cost per job created/saved (generally estimated in the hundreds of thousands of dollars), and whether we’ve merely delayed a more robust recovery (by kicking the savings rate issue down the road) or even risk lowering future trend growth (by crowding out investment).

    Factoring in the current level of our national debt reminds me of a gambling strategy called a martingale system, which holds that if you keep doubling down you’re guaranteed to win some money — so long as you don’t lose it all first. In that sense, it might be that even if everyone agreed Keynesian theory “correctly” prescribed another, bigger round of stimulus, in practice we might be down to our bus fare.

  12. 12 12 Ricardo Cruz

    Super-Fly asks “who is right?”

    If I may be so bold as to try to tackle that question, let me first preface my answer by making the point that, in a sense, all economists are Keynesians now. As an example, pretty much all macro work is done under the premise that prices take their time to adjust.

    That said, the question is more in the veins of which is better: fiscal stimulus or monetary stimulus? Personally, from the 101 econ classes I took, I always thought fiscal arguments were too convoluted, and my impression was that the general agreement was that some inflation was the best weapon to fight unemployment. But clearly, there’s disagreement there.

    But my point here is just to state that framing the things in terms of “is Keynesianism right” is a too broad of a brush. I’d think every economist out there would fall under that brush. The interesting question is fiscal versus money stimulus. And I am sure prof Landsburg has some interesting things to say on the topic; he co-wrote a very nice textbook on macroeconomics afterall.

  13. 13 13 vic

    Wow! Krugman actually wrote this tripe? What is he- Sephardic? (I am trying to popularize a stereotype that only Ashkenazis are good at Math)
    Why does Krugman deride the Pigou effect? If a small change in the projected secular trend for real estate prices, or, back in the 90′s, Tech Stock can fuel the sort of orgy of spending we saw in the last decades- then why shouldn’t an appreciation in nominal assets- including rents, annuities and so on- provide a huge stimulus? Indeed, even if entrepreneurs don’t suffer from ‘money illusion’ and hire workers recklessly if wages fall, what about ‘the Upper tenth’ (i.e. the 10 percent of Britons who lived off unearned income)? Wouldn’t Bertie Wooster have hired an extra valet? Back then about a tenth of the population was in domestic service.
    Perhaps Keynes couldn’t make this argument- viz. that worker’s money illusion was being fostered by mischievous agitators aiming at Power rather than an improvement in the workers’ material lot- because he himself had servants and managed assets- College leases- with a fixed nominal return.

    Aneurin Bevan, a Welsh miner who became a leading figure in the Labour party, was taught what we would now call the theory of externalities as giving rise to market failure. Why did no one point out to him that downward wage stickiness caused by ‘money illusion’was a similar case of a negative externality?

    Essentially worker’s money illusion re. the ‘fair price for the job’ wrung out of fat cats at the cost of heroic sacrifices- this ‘Remember the Alamo’ theory or collective bargaining- was an availability cascade instrumentalized for political purposes.

    The fact is a lot of the ‘wrong sort’ of people had started dressing decently and having a bit of fun during the 20′s. Arthur Miller’s dad- an illiterate tailor, became a millionaire. Come the Crash, he lost everything. A good thing surely. Keep the scum in their place.

    A Labor organizer, Miller consulted, whom Lucky Luciano drove out of the docks had no option, after the war, but go see one of the factory owners whose lives he’d previously made miserable. But the guy was already insolvent. He had stock on his hands that simply wasn’t moving. The labor organizer decided to try his hands at shifting the inventory in return for a partnership in the business. He turned out to be an excellent salesman. Miller remarks that the skills needed to be a good Labor organizer are the same as those needed to be a great salesman. As happened in this case. Soon, the labor organizer was rich. He was creating jobs not destroying them. Consequently, his conscience nagged at him. He ended up giving a lot of money away to precisely the sort of Organizations and Institutions which fuck up the working class the way he had in his erstwhile career. Miller tells us the whole story in his auto-biography. But, Miller thinks the moral is that the Labor organizer should have stuck to his guns. If Lucky Luciano had driven him out of the docks he should have set up shop elsewhere. In the fullness of Time, he’d have been appointed head of the Peace Corps somewhere like India- a country where Labor militancy killed off the Industrial proletariat.

  1. 1 Economics 102 « Daniel J. Smith
  2. 2 Krugman’s Views on Supply Have More Holes Than Swiss Cheese
Comments are currently closed.