Friday, January 17, 2014

Recessions and Ethical Norms

Tim Hartford has a nice piece outlining the basic understanding amongst economists for Recessions. He gives it a behavioral spin by including the very human reaction against price gouging. To wit:
There are obvious microeconomic consequences of this pigheaded insistence on the appearance of fairness: ticket touts, empty supermarket shelves in unseasonal weather and restaurants at which one cannot get a seat.
But what is less obvious is that the course of recessions and booms might also be shaped by our desire for prices that move in line with accepted ethical norms rather than the laws of supply and demand.
If prices adjusted swiftly and smoothly, “Say’s Law” would always hold true. The gnomic law, named after a Napoleonic-era French economist, is that “supply creates its own demand”. The implication is that recessions can only be due to supply shocks, not simple lack of demand, as Keynesians claim. Prices and wages should adjust to ensure that supply and demand are always equal. In the world of Say’s Law, monetary policy should have little or no effect. Quantitative easing would be of scarcely more significance than a new set of commemorative postage stamps.
Yet prices and wages sometimes fail to adjust. Occasionally this is for psychological reasons; at other times the hassle of changing the price tags, reprinting the menus and so on can delay price adjustments... Of such inflexibilities are born substantial economic fluctuations – the intellectual descendants of John Maynard Keynes often look to price rigidities to explain why recessions happen at all.
The riddle of a recession is why the market -- usually for labor in the case of unemployment -- fails to clear. If someone cannot get a job for $100/hr, why not accept one for $80/hr instead of being unemployed and collecting $0/hr?

I've promised a longer post on unemployment, which is still to come, and I think that understanding unemployment is important in understanding economic booms and busts. However, I do think that Hartford should look at Keynes' own work on debt driven deflation and perhaps talk to some households and businesses, ideally with nominally fixed mortgages, about why they don't simply work for less. Economic models wash out debt because "for every borrower there must be a lender and so, at the economy level, it balances out". But the fixed, nominal price of outstanding debt is the rigidity which keeps prices and wages failing to adjust.

Taking Hartford's argument at face value though, price gouging is usually triggered by higher prices, not lower. In a recession, the required price adjustments would be downwards. So I don't know if the irrational reaction to gouging is helpful in understanding this observation.


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