Wednesday, March 23, 2011

Man-Q: Ridiculous Business Cycle Theory

The article is Economics in Disarray, by N. Gregory Mankiw.

Toward the end of the Mankiw article noted in my previous post, N.Gregory writes:

Controversy peaks when economists turn to the theory of economic fluctuations. Broadly speaking, there are two schools of thought: new classical and new Keynesian economics...

Those working in the new classical tradition have recently been emphasizing "real" business cycle theory. This theory proceeds from the assumption that there are large random fluctuations in the rate of technological change...

Real business cycle theory contrasts sharply with the consensus view of the 1960s. I will mention briefly three assumptions of these models that would have been considered ridiculous 20 years ago and that remain controversial today.

First, real business cycle theory assumes that the economy experiences large and sudden changes in the available production technology...

Second, real business cycle theory assumes that fluctuations in employment reflect changes in the amount people want to work... This assumption conflicts with the beliefs of many economists that high unemployment in recessions is largely involuntary.

Third, real business cycle theory assumes - and this is the assumption from which the theory derives its name - that monetary policy is irrelevant for economic fluctuations...

Well, you know my view is that money is the driving force behind economic fluctuations: the business cycle, the long wave, and the cycle of civilization. I don't know what that says about "monetary policy" ... But I say monetary and fiscal policy together have driven money out of circulation and replaced it with the use of credit; and I say absolutely and without question that this is the root of our economic problem. So I don't buy Mankiw's third point. Money is not irrelevant.

And as for the first point -- technological change -- again I say Real Business Cycle Theory has it backwards. I say technological change, or economic progress built on technological change, is hindered by problems of the money.

Economic progress is hindered by problematic money whenever the technological change adds to what we can achieve, as opposed to simply lowering the cost of existing technologies.

One could argue that "large random fluctuations in the rate of technological change" lead to a business cycle several years in length. But such fluctuations cannot account for cycles within cycles; only money accounts for this. And only money accounts for a slump long enough and deep enough to be called a Dark Age. There is no random fluctuation that could cause a dark age.

In his "Prize lecture" Robert Lucas wrote:

In a period like the post-World War II years in the United States, real output fluctuations are modest enough to be attributable, possibly, to real sources. There is no need to appeal to money shocks to account for these movements. But an event like the Great Depression of 1929-1933 is far beyond anything that can be attributed to shocks to tastes and technology. One needs some other possibilities. Monetary contractions are attractive as the key shocks in the 1929-1933 years, and in other severe depressions, because there do not seem to be any other candidates.

"Real" shocks can account for the business cycle, Lucas says, but not for cycles the length and depth of the Great Depression. The problem seems to be in the money, he says.


I do recognize some irony here. Mankiw writes:

Before real business cycle theory entered the debate in the early 1980s, almost all macroeconomists agreed on one proposition: money matters... Real business cycle theorists have challenged that view using the old Keynesian argument that any correlation of money output arises because the money supply responds to changes in output.

The argument with which I disagree states that "any correlation of money [to] output arises because the money supply responds to changes in output."
"Responds to"?? No. Is intimately involved in? Yes.
My argument is that any correlation between technological advance and output arises because money helps or hinders the process.

And as for Point #2 of Mankiw's summary --

real business cycle theory ... conflicts with the beliefs of many economists that high unemployment in recessions is largely involuntary

-- I say, look at where we are today, and where we've been for the past two years, with unemployment near ten percent, and everyone nervous and angry about it. These people, these angry, nervous people, do not accept unemployment voluntarily. It is impossible to accept Point #2. It is ridiculous even to suggest it.

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