'The Price Is Wrong'

As noted below, it is a slow day, but this is well worth reading (there's quite a bit more in the original post):

The Price Is Wrong, by Paul Krugman: It’s a slow morning on the economic news front, as we wait for various euro shoes to drop, so I thought I’d share a meditation I’ve been having on the diagnosis and misdiagnosis of the Lesser Depression. ...

So, start with our big problem, which is mass unemployment. Basic supply and demand analysis says that ... prices are supposed to rise or fall to clear markets. So what’s with this apparent massive and persistent excess supply of labor? In general, market disequilibrium is a sign of prices out of whack... The big divide comes over the question of which price is wrong.

As I see it, the whole structural/classical/Austrian/supply-side/whatever side of this debate basically believes that the problem lies in the labor market. ... For some reason, they would argue, wages are too high... Some of them accept the notion that it’s because of downward nominal wage rigidity; more, I think, believe that workers are being encouraged to hold out for unsustainable wages by moocher-friendly programs like food stamps, unemployment benefits, disability insurance, and whatever.

As regular readers know, I find this prima facie absurd — it’s essentially the claim that soup kitchens caused the Great Depression. ...

So what’s the alternative view? It’s basically the notion that the interest rate is wrong — that given the overhang of debt and other factors depressing private demand, real interest rates would have to be deeply negative to match desired saving with desired investment at full employment. And real rates can’t go that negative because expected inflation is low and nominal rates can’t go below zero: we’re in a liquidity trap. ..

There are strong policy implications of these two views. If you think the problem is that wages are too high, your solution is that we need to meaner to workers — cut off their unemployment insurance, make them hungry by cutting off food stamps, so they have no alternative to do whatever it takes to get jobs, and wages fall. If you think the problem is the zero lower bound on interest rates, you think that this kind of solution wouldn’t just be cruel, it would make the economy worse, both because cutting workers’ incomes would reduce demand and because deflation would increase the burden of debt.

What my side of the debate would call for, instead, is a reduction in the real interest rate, if possible, by raising expected inflation; and failing that, more government spending to increase demand and put idle resources to work. ...

So yes, the price is wrong — but it’s a terrible, disastrous mistake to focus on the wrong wrong price.

Why should workers bear the burden of a recession they had nothing to do with causing? We should do our best to protect vulnerable workers and their families, and if it comes at the expense of those who were responsible for the boom and bust, I can live with that (and no, the cause wasn't poor people trying to buy houses -- people on the right who are afraid they will be asked to pay for their poor choices, or who want to pursue an anti-government, do not help the unfortunate with my hard-earned investment income agenda have tried to make this claim, and they are still at it, but it is "prima facie absurd").