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Anna Karenina and the Business Cycle
...To take the extreme case, clearly we’ve never had a period when the economy was as far above capacity as it was below capacity in the Great Depression. And even in the postwar record, if we look at unemployment rates, troughs – local minima in the rate – are more closely clustered than peaks – local maxima:
There’s also the now very clear evidence that the old notion that wages are sticky downward in a way they’re not sticky upward is entirely true – and downward nominal wage rigidity eliminates the symmetry between over- and under-employment. Here’s the SF Fed data:
Last but maybe not least, there’s the question of what’s supposed to be going on when the economy is operating above capacity. How do you force people to work more than they would want to in equilibrium? Now, NK models do have an answer of sorts: they’re always models characterized by imperfect competition, so prices are above marginal cost, and there’s a sense in which the economy is always operating with some excess capacity in the sense that people are willing to produce more at current prices. But my vague sense is that this only gives you a limited amount of wiggle room, and that really big upward deviations in output can’t happen, while really big downward deviations can.
So, why should you care? Well, Fatas and Mihov have it right: if the business cycle is a matter of the economy falling below capacity, rather than fluctuating around potential output, the costs of recessions are much bigger than often portrayed, and focusing on “stabilization” greatly understates the importance of good macro policy.
http://krugman.blogs.nytimes.com/2013/08/19/anna-karenina-and-the-business-cycle/
There’s also the now very clear evidence that the old notion that wages are sticky downward in a way they’re not sticky upward is entirely true – and downward nominal wage rigidity eliminates the symmetry between over- and under-employment. Here’s the SF Fed data:
Last but maybe not least, there’s the question of what’s supposed to be going on when the economy is operating above capacity. How do you force people to work more than they would want to in equilibrium? Now, NK models do have an answer of sorts: they’re always models characterized by imperfect competition, so prices are above marginal cost, and there’s a sense in which the economy is always operating with some excess capacity in the sense that people are willing to produce more at current prices. But my vague sense is that this only gives you a limited amount of wiggle room, and that really big upward deviations in output can’t happen, while really big downward deviations can.
So, why should you care? Well, Fatas and Mihov have it right: if the business cycle is a matter of the economy falling below capacity, rather than fluctuating around potential output, the costs of recessions are much bigger than often portrayed, and focusing on “stabilization” greatly understates the importance of good macro policy.
http://krugman.blogs.nytimes.com/2013/08/19/anna-karenina-and-the-business-cycle/