PAUL KRUGMAN: Exchange Rates and Wages

December 24, 2011, 8:56 AM
A followup to my post about modern Chicago economists forgetting what Milton Friedman knew: recent events have actually given us a dramatic demonstration of the reality of nominal wage stickiness. Here’s a graph I’ve shown before:
It shows wages in domestic currency for three crisis economies, Ireland, Latvia, and Iceland; it also shows Icelandic wages converted into euros at the market exchange rate. What you see here is that despite crushing unemployment, wages in Ireland and Latvia have come down only slightly — but Iceland, by letting its currency devalue, achieved a quick 30 percent fall in wages relative to the euro zone.
And international macroeconomists know that the behavior of real exchange rates — exchange rates adjusted for relative inflation — is a prime piece ofevidence for price stickiness. Not only do real rates move very closely with nominal rates, but the behavior of real rates changes dramatically when you move from floating to fixed rates or vice versa.
It would be one thing if people like Cochrane had a serious critique of all this evidence, and of the decades-long research agenda that has confirmed the importance of price stickiness. But what’s clear in this discussion is that these guys are simply unaware of all this work, and feel entitled to make proclamations a priori.
What went wrong with the economics profession?


Share your thoughts.
    • Jake Wagner
    • Santa Barbara, CA
    Krugman's graph is indeed a stunning verification of wage stickiness.

    But the workers in Iceland who saw their incomes in euros go down by 30% experienced a mixed blessing indeed.

    This underscores the fact that devaluation achieves lower unemployment by simply spreading the pain from the unemployed to those who have jobs.

    Many of the economic policies described by Krugman are this way---they provide short-term mechanisms for achieving more efficiency in an economy, while in the long term, efficiency isn't the only issue.

    As I've mentioned before, population growth would drive down living standards in the long run, and would require policy changes that are never discussed. Yet the improvements in living standards are likely commensurate with those achieved through greater economic efficiency.

    Krugman himself admits the importance of global warming, which is one of the symptoms of population growth. Another long-term consequence of population growth is higher food and energy prices as the world runs out of resources sufficient for an exponentially increasing population.

    At what point do we start discussing population growth and the policies necessary to bring it to zero? When the polar ice caps have melted and the streets of Manhattan are flooded? Will the issue be taken seriously then?
      • JAC
      • Monroe, Michigan
      "What went wrong with the economics profession?"

      Too many forgot that a Professional must first search for the truth.
        • Kevin MacDonald
        • Seattle
        This is the view of a lay person attempting to become more versed in this area: Reading books such as Beinhocker's "The Origin of Wealth", and Smith's "ECONned...", and thereby understanding some of the out outrageous fallacies that modern economic theory is based on, I came away believing that wall street is the new aristocracy, and economists are their astrologers. Economics is a field awash in complex mathematics that means essentially nothing under anything but the most idealized circumstances.

        So, I would counter by asking whatever went right with the economics profession? If only the pseudo-science of economics were not so heavily swayed by money and power it might begin to look more clearly at the available data and come up with empirical models that make sense. Or failing that, admit when understanding is lacking, which is after all where learning begins.

        I am an engineer. Materials science works. Geometry and calculus work. These are not simple areas of study, and steady progress has allowed us to achieve amazing things. I will say that as I read more I have come to have a greater respect for those grasping to comprehend economic systems, and I imagine with continued study that respect will grow. It is a noble task because it is so important to our future. But at the moment I don't think economists should be walking the halls of power. They haven't earned it.
          • Davis X. Machina
          • SW Maine
          "...and feel entitled to make proclamations a priori."

          They're not making "proclamations a priori", they're going into all the world, and preaching the gospel to every creature.

          You can't refute a theology. You certainly can't kill one by throwing scholarly papers at it.
            • commenter JM
            • Seattle, WA
            I suspect PK knows the answer to his own rhetorical question, but I'll supply one anyway.

            Economic analysis and research has political (policy) implications, and is therefore subject to political calculations and influence.

            In a contrasting example, the mass of the Higgs has no such implications, so physicists mostly concentrate on proper and honest data collection and analysis. In other words, it's not that economists are particularly corrupt, it's that the field lives in a bad neighborhood.
            1. Shamemen said it, economists were PAID to produce the results that Corporate America wanted, no matter the facts or reality. All these bogus " think tanks" have been established to confuse and misinform the american people. The idea was to give credibility to TRICKLE DOWN ECONOMICS which failed to produce promised results.
              It was all a lie, constructed by the NEOCONS 30 years ago to grab power and money for the privileged all the while shrinking the middle class. The neocons took every advantage of DISASTER CAPITALISM as exposed by Naomi Klein and they created disasters when opportunity KNOCKED. Iraq is a very good examples of the RICH GETTING RICHER off prolonged national and international disasters. If Halliburton had pulled its crookery during WWII, someone would have been hung for treason. Wall Street Hustlers would be in jail for sure.
              America is a unique experiment with a blend of DEMOCRACY and CONSCIENCE CAPITALISM as perceived by Adam Smith. Capitalism is not meant to empower the few, it was always intended to benefit the greater good, by expanding economic reach and rewards for all level of contributors. The neocons have twisted and distorted capitalism into a system of inequality and fascism. Something never intended by Adam Smith. The TPARTY PATRIOTS wish to reshape america into a brutal, social darwinist society taking us backward to the dark ages of CLASSISM and poverty for the masses.
              Democracies can die. The TPARTY radicalism of US policy must be stopped.
              1. Those in Power saw economics as a way of getting reasonable, intelligent people to do what they wanted so the Powerful people made sure their people got in.
                  • query
                  • west
                  Human is what has happened to the economics profession. Part of human is some are blindly devoted to one ruling idea that is wrong, part is narcissism combined with hubris, part is summed up in a musical take on gangs,

                  When you're a Jet you're a Jet all the way
                  From your first cigarette
                  To your last dying day
                  When you're a Jet if the spit hits the fan
                  You've got brothers around

                  All normal.

                  It is too much forgotten that the liberal arts and sciences are actually the result of an arduous, long, ongoing, struggle involving only fallible mortal humans that is never won, never over. The liberal arts and sciences has many cheats and freeloaders, as is inevitable and documented in the literature of game theory and social altruism among other places. The Cochranes and Famas and Barros and Taylors and Prescotts and Lucas's are always with us. Now, it is completely the fault of the economics profession that it is not policing itself by calling out its cheaters and false claims of knowledge based on economics authority. Corrupt. it is kinda funny that the University of Chicago, with it's supposed devotion to the tradition, is ground central of the narcisstic worship of false gods by second rate equation buffs who could not survive in the physics or math professions.
                  1. The economics profession has no official standards - no state or licensing requirements- anybody can write as an economist with little fear that there credentials will be challenged. This has been exploited by the right. Other professions requiring licenses include Acupuncturist, Adult Care Administrator, Aerial Pesticide Applicator, Air Traffic Control Tower Operator, Aircraft Dispatcher, Aircraft Mechanic, Aircraft Repairperson, Alarm Installer, Alarm System Business Licensee, Alcoholic Beverage Distributor/Vendor Representative, Ambulance Attendant, Architect, Armed Security Guard, Athlete Agent, Athletic Trainer, Attorney, Auctioneer, Audiologist, Automobile Dealer, Automobile Salesperson, Bail Bond Runner, Barber, Barber Instructor, Boarding Kennel Operator, Boiler Inspector, Boxing/Kickboxing/'Toughman' Promoter, Building Inspector, Cemetery Sales Contractor, Cemetery Salesperson, Certified Public Accountant, Certified Registered Nurse Anesthetist, Certified Structural Pest Control Applicator, etc.
                      • samos2
                      • Portland, OR
                      As I suspected, these so-called scholars fail to realize the limits of their knowledge base!!! They are clearly not open-economy Macroeconomists. But even more pitiful is the narrowness in their understanding of even closed- economy macro. They should learn to keep their incorrect thoughts to themselves, instead of creating a generation of ideologically infused wrong-headed macroeconomists from their programs!
                      1. A propos of the post on exchange rates and wages, thank you for explaining what the graph says. But the following paragraph on price stickiness was too difficult to understand.
                          • gwborg
                          • Chicago
                          Another reason wages are "sticky" is that U.S. employers have complete license to pursue the most brutal and inhumane course when reducing payroll and choose to "push the unhappiness out the door" by cutting workforce rather than cutting wages.

                          If employees had any rights whatsoever, if they were anything other than serfs and had even a modest degree of control over their own lives, they might well choose to take a substantial wage cut rather than risk the complete loss of income and health insurance, prolonged unemployment and the likelihood they'll never find decent work again.

                          Of course, they never have that choice, and it's light years beyond our feeble ability to even conceive of such a thing in the United States.
                            • John
                            • Washington
                            "What went wrong with the economics profession?"

                            I'd look first at peer review quality. Once it degrades it will take a generation or more to recover.
                              • Nancy
                              • Great Neck
                              Ireland and Portugal and Spain among other European economies are be ruined by conservative economic policies but where are the liberal voices in opposition? All I hear from Europe are conservative voices. British Labour is really British Tory or Conservative and British Conservative is completely in control of policy.
                                • HCG
                                • Cincinnati
                                Cochrane has an undergraduate degree in physics. Although his Ph.D. is in Economics, I hypothesize that he focused on finance in grad school, and missed the courses in international economics and the history of economic thought. Thus there may be a large hole in his training. This could be verified.

                                And it is not the entire profession suffering from this -- just some macroeconomists and concentrated in a few places at that. Microeconomics remains vibrant and vital.
                                1. There never was an economics "profession".

                                  The sad fact is that economists never accepted the intellectual demands of being true scientists, i.e., caring about methodology by placing the scientific method at the center of all economics research. That commitment would have established a basis for professionalism by denying acceptance and credibility to the types of sycophants and liars that have dominated the field for decades.

                                  Instead, as we have watched with disgust and dismay, economics has become nothing more than a captive of the financial elite, who can buy off our business schools, economics departments, and social and political discourse. We now have an academic community that largely acts like the communist economics and science departments of the Cold War, spewing a sort of laissez faire Lysenkoism aimed at propping up the failed ideas of America's proto-fascist right wing and financial robber barons.

                                  You and a small band of others keep up the good fight. But I just think of how the Obama administration has catered to the Lysenkoism of Messrs. Geithner and Summers, and I know that any sense of economic professionalism is a long way off.
                                    • John H.
                                    • Northern California
                                    Season's best to you.

                                    Argentina is actually a very good example of the point that you are making regarding devaluation with some additional useful comparisons. In addition to devaluation of their currency, they significantly improved the sharing of productivity with wage earners and thus equality. This is all well documented by a recent Levy Institute Presentation by Marco Del Pont, head of their central bank.

                                    Cochrane is right up there with meteorologists who refuse to look out of the window when making pronouncements about the weather. Witness his comments about crowding out by government investments. Here's an example using the Hoover Dam.

                                    The unwillingness of much of the economics profession to test their hypotheses against reality is quite striking.

                                    John H
                                      • medgeek
                                      • ny
                                      What went wrong? The economic profession, along eith the politics profession, was purchased by right wing big money.
                                        • skeptonomist
                                        • Tennessee
                                        Isn't it wonderful when liberal and conservative economists argue about the best way to beat down wages? Why would capitalists think there is anything wrong with the economics profession when this happens?
                                          • R. Law
                                          • Florida
                                          We have to agree with commenter ' shamemen - Detroit ' and need only point to the recent news of the Koch Bros. endowing university economics dept. chairs.

                                          Of course, this just continues what has gone on in other professions, such as accounting and finance, where people who used to just apply well-known principles and standards, calling balls and strikes, just keeping score as it were.

                                          Those people were long ago relegated to cubicles while the executive suites are now occupied by financial ' artistes ' who know how to come up with numbers to satisfy Wall Street's Gekkos (or else).

                                          But the trend really started with the lawyers, metastasizing from there over other professions, like ripples in a pond.
                                            • G. Morris
                                            • NY and NJ
                                            They allow their Ayn Rand demons into their frontal lobe. This in turn seems to diminish the role of empirical data. They also operate in a closed society of mutual respect and sycophants.
                                            1. Oh how nice. The nice lady said someone will call me within the next 24 hours.
                                                • winchestereast
                                                • USA
                                                From an old NYT article by Sue Hubbell we find an Scottish prayer that might be apt for the economists (and VSP's)
                                                " Oh Lord, grant that I may always be right, for Thou knowest how hard I am to turn" ......
                                                  • mickeyrad
                                                  • Centerville Iowa
                                                  This chart is the key to understanding why the Euro is a disaster for every country but Germany. People say that if Italy were on (went back to) the lira, then the price of oil and gas and other imports would rise. That's the point! Imports rise in price, so you use less. Exports drop in price, so you export more.

                                                  Italy successfully competed with Germany and the rest of Europe from 1946-1999. Italy's exports - not just Fiats and food, but household appliances - drove an economy that surpassed the UK in the 1990s. Then, enter the Euro - which devastated Italy's economy.

                                                  Italy - Iceland - every country except Germany would be better off without the Euro. German Empire founded on the Euro is as bad as a German empire based on rifles and cannon.

                                                  For people who are ignorant about italy's export sector, read about Italy's motor vehicles (Fiat, Aprilia, Ducati, Piaggio, Iveco); tyre manufacturing (Pirelli); chemicals and petrochemicals (Eni); energy and electrical engineering (Enel, Edison); home appliances (Candy, Indesit); aerospace and defense technologies (Finmeccanica, Alenia Aeronautica, AgustaWestland, Oto Melara); firearms (Beretta, Benelli); fashion (Armani, Valentino, Versace, Dolce & Gabbana, Roberto Cavalli, Benetton, Prada, Luxottica); food processing (Ferrero, Barilla Group, Martini & Rossi, Campari, Parmalat); sport and luxury vehicles (Ferrari, Maserati, Lamborghini, Pagani); yachts (Ferretti, Azimut).

                                                No comments:

                                                Post a Comment