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assumptions please !
"Start with an economy with a zero output gap and no involuntary unemployment. "
no modern market economy has ever been" there" at the zero output gap in reality .
.not a small gainsay comrades
"Everything in the economy is efficient. "
i'll leave that to stand as is
"Then a ‘crisis’ happens that leads consumers
to consume less and save more, so aggregate demand falls."
consume less or spend less ?
a crisis ?
the fabled external shock mayhaps ?
or endogenously generated convulsion
like a minsky moment ?
"Normally in these situations the central bank
cuts nominal and thus reduces real interest rates sufficiently
to restore aggregate demand."
ie reduce nominal rates more then price inflation falls
"Once this has happened, call everything in this economy ‘natural’,"
" the real interest rate that restores natural full demand is the natural rate of interest."
'
" The new natural level of output may not be the same as the pre-crisis level
'
note given this caveat
the use of the word "restores " above is not general enough
" the new natural rate of interest can have knock on effects
on how much people want to work. "(and invest )
" this new natural level is the level of output that policymakers should aim for. "
"In the Great Recession this mechanism did not work
because nominal interest rates hit zero"
,
" maybe also monetary policy put a cap on inflation expectations."
" As a result, actual real interest rates are above the natural level."
" In addition, fiscal policy is in the hands of people
who know nothing about macroeconomics
so there is no help from there."
" However monetary policymakers still think
they could do something ‘unconventional’,
so they want to know what to aim for. "
"The answer is that, as long as what they do does not seriously distort the economy,
they should try to get to the natural level of output,
because that produces an efficient economy."
we circle here from assumption to assumption ... but no great harm
because nominal interest rates hit zero"
,
" maybe also monetary policy put a cap on inflation expectations."
" As a result, actual real interest rates are above the natural level."
" In addition, fiscal policy is in the hands of people
who know nothing about macroeconomics
so there is no help from there."
" However monetary policymakers still think
they could do something ‘unconventional’,
so they want to know what to aim for. "
"The answer is that, as long as what they do does not seriously distort the economy,
they should try to get to the natural level of output,
because that produces an efficient economy."
we circle here from assumption to assumption ... but no great harm
"The difference between the actual level of output
and the hypothetical natural level is called the output gap. "
comes now a digression :
"The traditional way of defining the output gap
was the difference between actual output
and
‘productive potential:"
"the amount that could be produced
if all factors of production were fully utilized. "
"The problem at a conceptual level is that this approach
downplays considerations of optimality, "
much lies buried under that fudge bridge
"so nowadays theoretical macroeconomics uses
the natural level of output to define the output gap. "
"This has the advantage that we know what policy should be aiming to do:
achieving the natural level of output. "
I have an incipient mad tea party reeling here
and the hypothetical natural level is called the output gap. "
comes now a digression :
"The traditional way of defining the output gap
was the difference between actual output
and
‘productive potential:"
"the amount that could be produced
if all factors of production were fully utilized. "
"The problem at a conceptual level is that this approach
downplays considerations of optimality, "
much lies buried under that fudge bridge
"so nowadays theoretical macroeconomics uses
the natural level of output to define the output gap. "
"This has the advantage that we know what policy should be aiming to do:
achieving the natural level of output. "
I have an incipient mad tea party reeling here
"Now imagine three almost identical economies
where an output gap exists because nominal interest rates have hit zero."
three ?
there are two categories
wage rates and product prices
three moves
up , down and stay put
2 x 3 => 6 cells
jerry s-l
looks at three of those
and even if neither prices or wage rates rise by assumption
there should be
four cells to look at
1) wage rates stay put / prices fall
2) wages rates fall / prices fall
3) wage rates fall / prices stay put
4) wages stay put / prices stay put
at any rate
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" The level of real interest rates that would eliminate the output gap
is the same in all three economies
thus . they have the same natural levels of output."
" In the first economy, workers resist nominal wage cuts, so this puts a floor on how much unemployment reduces real wages. "
wages stay put prices....?
" If nominal wages stop falling, at some point firms will stop cutting prices
to protect their profits. "
ahh prices fall then stay put so this is cell four ...right ?
"We settle down to a new lower level of demand deficient output,
high unemployment, but stable wages and prices. "
"There is plenty for unconventional monetary policy to do,
even though inflation is not falling".
where an output gap exists because nominal interest rates have hit zero."
three ?
there are two categories
wage rates and product prices
three moves
up , down and stay put
2 x 3 => 6 cells
jerry s-l
looks at three of those
and even if neither prices or wage rates rise by assumption
there should be
four cells to look at
1) wage rates stay put / prices fall
2) wages rates fall / prices fall
3) wage rates fall / prices stay put
4) wages stay put / prices stay put
at any rate
------------------------------------------------------
" The level of real interest rates that would eliminate the output gap
is the same in all three economies
thus . they have the same natural levels of output."
" In the first economy, workers resist nominal wage cuts, so this puts a floor on how much unemployment reduces real wages. "
wages stay put prices....?
" If nominal wages stop falling, at some point firms will stop cutting prices
to protect their profits. "
ahh prices fall then stay put so this is cell four ...right ?
"We settle down to a new lower level of demand deficient output,
high unemployment, but stable wages and prices. "
"There is plenty for unconventional monetary policy to do,
even though inflation is not falling".
"In the two other economies nominal wages carry on falling."
wages fall in both cells two and three
" In the second economy prices get cut pari passu, so real wages remain unchanged,"
prices fall
"while in the third they do not, so real wages fall."
prices stay put
missing cell
wages stay put prices fall
cell one
" in the second economy inflation is lower than in the first, but real wages are the same. "
"Does this lower rate of inflation increase or decrease the output gap? "
"That depends only on whether actual output falls or increases because of lower inflation:"
" the natural level of output involves a hypothetical economy
which is unaffected by whether nominal wages fall or not in the actual economy"
". Actual output may fall if negative inflation makes debtors spend a lot less but creditors not much more "
a likelihood no ?
"however, if monetary policymakers have been inhibited from doing much because inflation was not falling .. lower inflation may raise actual output by encouraging expansionary unconventional monetary policy."
this implies the best strategy for job class solidarity
is cut wage rates in exchange for increased CB action...
yes the policy actions matter
wages fall in both cells two and three
" In the second economy prices get cut pari passu, so real wages remain unchanged,"
prices fall
"while in the third they do not, so real wages fall."
prices stay put
missing cell
wages stay put prices fall
cell one
" in the second economy inflation is lower than in the first, but real wages are the same. "
"Does this lower rate of inflation increase or decrease the output gap? "
"That depends only on whether actual output falls or increases because of lower inflation:"
" the natural level of output involves a hypothetical economy
which is unaffected by whether nominal wages fall or not in the actual economy"
". Actual output may fall if negative inflation makes debtors spend a lot less but creditors not much more "
a likelihood no ?
"however, if monetary policymakers have been inhibited from doing much because inflation was not falling .. lower inflation may raise actual output by encouraging expansionary unconventional monetary policy."
this implies the best strategy for job class solidarity
is cut wage rates in exchange for increased CB action...
yes the policy actions matter
'How about the third economy, where real wages have fallen?"
" Suppose firms respond to lower real wages by substituting labour for capital"
what in hell does this mean in the short run ?
idling machines not hands ?
", and this process continues until all those who want to work can find a job. "
without building new machines !
"So in the third economy involuntary unemployment goes away."
" But is the output gap any lower? "
"Once again, the natural level of output has not changed"
". (It was set in our hypothetical economy
where real interest rates fell to their natural level.) "
so by CB action increasing AD we get a burst in prices a raise in profits for owners
of active machine owners of inactive machines get profits as machines get re activated
to fill orders ?
"So the key question becomes whether lower real wages and lower unemployment reduces or increases aggregate demand"
", and therefore actual output. "
"It could go either way."
" So it is perfectly possible that both actual output and therefore the output gap
is exactly the same in all three economies "
" even though unemployment has returned to its natural rate in one, and the other two have very different inflation rates".
" Suppose firms respond to lower real wages by substituting labour for capital"
what in hell does this mean in the short run ?
idling machines not hands ?
", and this process continues until all those who want to work can find a job. "
without building new machines !
"So in the third economy involuntary unemployment goes away."
" But is the output gap any lower? "
"Once again, the natural level of output has not changed"
". (It was set in our hypothetical economy
where real interest rates fell to their natural level.) "
so by CB action increasing AD we get a burst in prices a raise in profits for owners
of active machine owners of inactive machines get profits as machines get re activated
to fill orders ?
"So the key question becomes whether lower real wages and lower unemployment reduces or increases aggregate demand"
", and therefore actual output. "
"It could go either way."
" So it is perfectly possible that both actual output and therefore the output gap
is exactly the same in all three economies "
" even though unemployment has returned to its natural rate in one, and the other two have very different inflation rates".
"(I would) that the third economy is better off than the other two
because the pain of deficient demand is evenly spread
(everyone has lower real wages)"
i'm wobbly
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,"But the first best solution is to raise aggregate demand, because that gets rid of the pain".
by restoring real wages in economy three and full utilization of machines
and by restoring full utilization of hands in economies one and two
????????
because the pain of deficient demand is evenly spread
(everyone has lower real wages)"
i'm wobbly
----------------------------------------------------------------------
,"But the first best solution is to raise aggregate demand, because that gets rid of the pain".
by restoring real wages in economy three and full utilization of machines
and by restoring full utilization of hands in economies one and two
????????
-----------------------------------------
now we get two real economies in motion over an interval
which of our three types is each ?
which of our three types is each ?
 |
| Unemployment in the US and UK: Source ONS and BLS |
 |
| Growth in compensation per employee less GDP deflator: OECD Economic Outlook |
"for the factor substitution story to explain most of what we have seen in the UK,
investment should have completely collapsed, which it has not. "
investment should have completely collapsed, which it has not. "
so UK isn't a type three economy must be a type two
"However most seem to agree that some factor substitution is going on in the UK."
errrr its a little like a type three though
if so
" by spreading the pain of deficient aggregate demand further,
" this ‘real wage flexibility’ in the UK has been a good thing"
class solidarity forever !
", but it does not mean the aggregate demand problem has decreased"
". If anything, it suggests that looking at unemployment underestimates
the size of the output gap."
because the machine to hands ratio has changed and machine idleness is under counted if you use the old ratio
" Monetary policy makers please note."
errrr its a little like a type three though
if so
" by spreading the pain of deficient aggregate demand further,
" this ‘real wage flexibility’ in the UK has been a good thing"
class solidarity forever !
", but it does not mean the aggregate demand problem has decreased"
". If anything, it suggests that looking at unemployment underestimates
the size of the output gap."
because the machine to hands ratio has changed and machine idleness is under counted if you use the old ratio
" Monetary policy makers please note."
