The parallel between Hayek in the 1930s and misguided pro-market economists today
January 9, 2013
Posted by on
Hayek during the Great Depression knew that according to his own model that the central bank should be pursuing a more expansionary policy. But he saw the Great Depression as a way of breaking the back of organized labor in Britain. So he made the judgment that politically it was more important to strip the unions of their power once and for all instead of ensuring that money would be as neutral as possible. He would later come to regret that.
I think “we” are repeating this mistake. There is a truckload of evidence showing that wages today (regardless of what happened in the 19th century) are way too sticky to get away with a system with an implicit or explicit 0%-2% NGDP growth target. We get this evidence in labs. We get this evidence when you look at micro case studies. We get this in modern historical examples – can anyone who argues for the 0%-2% target (or free banking) explain Dutch Disease to me? Then there are the traditional econometric papers also showing this result.
When you point out all this data, the response is incredulity. Or insistence that stickiness is fake because it doesn’t cohere to what they like to think about “economics” as they define it. Or the dishonest red herring about how inflation will inevitably get out of control.
Instead of modifying their own macro model (i.e. Hayek’s model) to account for the scientifically established effect of wage stickiness – which would be market monetarism with Cantillon effects – everything is reduced to supply side effects. I believe these effects exist. The unemployment insurance extensions especially have some effect (likely one percentage point). Monkeying around with the minimum wage doesn’t help matters. But the regime uncertainty stories and their ilk cannot tell a consistent story matching the patterns of unemployment we observe across countries. The demand side stories are crystal clear.
Decades from now people will recognize (a) their failure to adjust their mental model to reflect wage stickiness and (b) that like Hayek, they erred when departing from their macro to emphasize the various “real” factors affecting the economy during the recession.