New Frontiers in Economic Barbarism, by Paul Krugman, in NY Times: I’ve written quite a lot about the way much of the macroeconomics community has descended into a Dark Age, forgetting the things they used to know. I was originally set off by the way some economists were propounding Say’s Law — the idea, refuted 75 years ago, that all income must be spent and hence that supply creates its own demand — as a profound insight, somehow missed by three generations of economists.
Well, new forms of acquired ignorance keep surfacing.
Matthew Yglesias finds John Cochrane ridiculing the notion that devaluation makes it easier to bring a country’s relative wages down, whereas the empirical evidence is overwhelming that devaluation does, in fact, do just that.
Now, Yglesias has some fun with Cochrane’s violation of the extended version of Godwin’s Law, which says that the first person to mention either Weimar or Zimbabwe in a discussion of current issues loses. But Matt’s main point is that there are very good reasons why changing relative currency values is a lot easier than changing the whole structure of nominal wages and prices:
Depreciation makes vacations in Spain cheap, it makes Spanish exports cheap, and it makes it attractive for rich foreigners to actually go buy up excess Spanish housing stock to use as vacation homes and such. Everyone’s taken a hit, but they’re back on the path to growth.
The other alternative — the road we’re actually traveling down — is one in which all of these adjustments need to happen piecemeal. To make the same adjustment happen, every single contract in the country needs to be piecemeal renegotiated. That’s every town budget, every cell phone plan, every commercial lease, every salary, etc. It’s not “impossible” but it’s a logistical and political nightmare. And it takes time. During that time instead of everyone working harder because they’re poorer and more indebted than they realized and need to raise their incomes what happens is that 10-20 percent of the population does nothing because they can’t find jobs.
Quite. What Matt may not know, however, is that this is a classic argument in international macro, and the person who made it best was …. drumroll … Milton Friedman. Here’s a snip from Friedman’s 1953 essay “The case for flexible exchange rates”:
Is it really possible that people at the University of Chicago have unlearned not only Keynes but Friedman? Alas, yes.