The Depression and Now: Why I’m not as concerned

Anti-Dismal does a set of posts on this issue which are worth a read (here, here, and here).  I will try to put down my own take on the issues for New Zealand specifically in this post.

When thinking about declines in economic activity I have to think – what is the actual cost to people, what is the issue that concerns people which they didn’t have any control over.  My impression is that the fundamental concern surrounding a big slowdown is unemployment – more so than the decline in average incomes or production persee.

This concern makes sense to me as the labour market is the market that has one hell of a lot of trouble adjusting to a significant change in economic conditions.  During the good times wages increase too slowly – leading people to believe there is such a thing as a “labour shortage”.

When bad times come along wages refuse to head down – a factor that leads to more people being laid off, and thereby leads to a disparity between those that have a job and those that don’t.

Now in the Depression this downside “stickiness” in nominal wages was inflamed by mass deflation.  With the price of everything else falling, labour was become relatively more expensive – and so firms used less of it, increasing unemployment.

In this sense we have to ask – are we going to have a massive deflationary episode?  If we do then we will see unemployment pick up – but those that actually keep their jobs may do alright.  However, given the determination of central banks to print acres of money we are more likely to have inflation and as a result, falling real wages.  This will make workers relatively “cheaper” and will prevent the type of mass layoffs we saw during the Great Depression.

These nominal rigidities in the economy are imperfections – they don’t fit the standard economic models, which is why government policy to inflate prices actually makes sense in a short-horizon.

However, government action can’t do anything to prevent the worst case scenario – when the price of our exports fall through the floor, and household income decline 10%+.  This would be damn ugly, but beyond taking account of these nominal rigidities there is nothing the government can do about it.

This view will be contentious for two reasons:

1. I am deeming that the short-run impact of inflating prices will be a good thing with no evidence,
2. I am ignoring confidence and any “demand deficiency” type argument – fundamentally I am saying that as long as the nominal rigidities are not allowed to constrain matters agents will react optimally.

So discuss, surely people would like to have a go at me about this – I will check this when I get back and get involved.