Of Krugman & Minsky

Paul Krugman just did something mind-bending.


In a recent column, he cited Minsky ostensibly to defend Alan Greenspan’s loose monetary policies:

Business Insider reports on a Bloomberg TV interview with hedge fund legend Stan Druckenmiller that helped crystallize in my mind what, exactly, I find so appalling about people who say that we must tighten monetary policy to avoid bubbles — even in the face of high unemployment and low inflation.

Druckenmiller blames Alan Greenspan’s loose-money policies for the whole disaster; that’s a highly dubious proposition, in fact rejected by all the serious studies I’ve seen. (Remember, the ECB was much less expansionary, but Europe had just as big a housing bubble; I vote for Minsky’s notion that financial systems run amok when people forget about risk, not because central bankers are a bit too liberal)

Krugman correctly identifies the mechanism here — prior to 2008, people forgot about risk. But why did people forget about risk, if not for the Greenspan put? Central bankers were perfectly happy to take credit for the prolonged growth and stability while the good times lasted.

Greenspan put the pedal to the metal each time the US hit a recession and flooded markets with liquidity. He was prepared to create bubbles to replace old bubbles, just as Krugman’s friend Paul McCulley once put it. Bernanke called it the Great Moderation; that through monetary policy, the Fed had effectively smoothed the business cycle to the extent that the old days of boom and bust were gone. It was boom and boom and boom.

So, people forgot about risk. Macroeconomic stability bred complacency. And the longer the perceived good times last, the more fragile the economy becomes, as more and more risky behaviour becomes the norm.

Stability is destabilising. The Great Moderation was intimately connected to markets becoming forgetful of risk. And bubbles formed. Not just housing, not just stocks. The truly unsustainable bubble underlying all the others was debt. This is the Federal Funds rate — rate cuts were Greenspan’s main tool — versus total debt as a percentage of GDP:

fredgraph (18)

More damningly, as Matthew C. Klein notes, the outgrowth in debt very clearly coincided with an outgrowth in risk taking:

To any competent central banker, it should have been obvious that the debt load was becoming unsustainable and that dropping interest rates while the debt load soared was irresponsible and dangerous. Unfortunately Greenspan didn’t see it. And now, we’re in the long, slow deleveraging part of the business cycle. We’re in a depression.

In endorsing Minsky’s view, Krugman is coming closer to the truth. But he is still one crucial step away. If stability is destabilising, we must embrace the business cycle. Smaller cyclical booms, and smaller cyclical busts. Not boom, boom, boom and then a grand mal seizure.


Do Wages Benefit From A Shrinking Labour Force?

Dean Baker says yes:

The retirement of the baby boom cohorts means that the country’s labor force is likely to be growing far more slowly in the decades ahead than it did in prior decades. The United States is not alone in facing this situation. The rate of growth of the workforce has slowed or even turned negative in almost every wealthy country. Japan leads the way, with a workforce that has been shrinking in size for more than a decade.

Baker concludes:

With a stagnant or declining labor force, workers will have their choice of jobs. It is unlikely that they will want to work as custodians or dishwashers for $7.25 an hour. They will either take jobs that offer higher pay or these jobs will have to substantially increase their pay in order to compete.

This means that the people who hire low-paid workers to clean their houses, serve their meals, or tend their lawns and gardens will likely have to pay higher wages. That prospect may sound like a disaster scenario for this small group of affluent people, but it sounds like great news for the tens of millions of people who hold these sorts of jobs. It should mean rapidly rising living standards for those who have been left behind over the last three decades.

Of course, Baker could just look at the data from Japan. Real wages there have been depressed in recent years, even while the labour force has shrunk:


Even more damningly, labour’s share of income in Japan has declined even more considerably than the United States, and other nations with a growing working-age population:


Matthew C. Klein asks an important question:

Perhaps Mr Baker was thinking of an older example: the Black Death, which killed about half the people in Europe. Many (including me until I looked it up) believe that the resulting shortage in agricultural labour led to soaring real wages for peasants and a redistribution of economic power away from landowners. Recent evidence, however, casts doubt on this hypothesis. While nominal peasant wages did indeed increase in the aftermath of the Black Death, real wages may have actually fallen for decades. That may have helped heavily indebted peasants, but everyone else had to endure punishing declines in their standard of living, not to mention the psychological trauma of surviving such a devastating plague.

And the evidence on the Black Death seems conclusive:

In southern England, real wages of building craftsmen (rural and urban), having plummeted with the natural disaster of the Great Famine (1315-21), thereafter rose to a new peak in 1336-40. But then their real wages fell during the 1340s, and continued their decline after the onslaught of the Black Death, indeed into the 1360s. Not until the later 1370s – almost thirty years after the Black Death – did real wages finally recover and then rapidly surpass the peak achieved in the late 1330s.

And if we look at China — a country which has seen stunning real wage growth in recent years — it is clear that that growth has come in the context of a growth in the working-age population. China’s working-age population hit one billion for the first time in 2011.

To me at least, this seems to suggest that while all else being equal, a shrinking working age population might lead to a more competitive labour market, all else is not equal. Employers invest in more capital-intensive processes like automation and robots to compensate for a lack of workers, or in our globalised world they shift operations to somewhere with a stronger labour force (like China today, or perhaps like Africa further into the future). Even more simply, a falling population as a result of a natural disaster like the Black Death, or even just as a result of demographic trends like Japan, may lead to an economic depression due to falling demand.

This suggests that Baker’s conclusions are extremely optimistic for labour, and that shrinking populations may be bad news for wages.