Stimulus Bites: Fun With Made Up Macro

by: Ryan Avent

We’re roundtabling at Free Exchange today, so here’s an economics post. Arnold Kling has been developing his own macro theory, which is a fun thing to do. He’s now applying his theory to stimulus, writing:

From the Recalculation perspective, the economy needs to shift resources out of some sectors and into others. The government is either (a) permanently shifting resources from the private sector to government or (b) temporarily shifting resources from the private sector to government. If it is doing (a), then we are not facing mere temporary deficits but permanent increases in government spending, and eventually we will have to figure out how to pay for them. If it is doing (b), then the Recalculation problem isn’t really being solved. Instead, at best the government is redistributing the pain from the reallocation process out of the present and into the future. People who otherwise would be unemployed can find temporary work on government projects, but when those projects expire they will go back to being unemployed. This is what makes the fiscal exit strategy so problematic.

Tyler says he thinks this is “exactly correct.” I think it makes no sense at all. The “Recalculation” perspective, by the way, is that the economy has almost no cyclical unemployment — it’s all structural unemployment generated by the fact that many old production activities no longer make sense, and so the economy is sitting a bunch of people out of the workforce at the moment, while it strokes its chin, “recalculates,” and figures out where they ought to go next.

There are currently 15 or so million people out of work. The stimulus may have saved or created several hundred thousands jobs, or perhaps much more, but it is clear that it has not prevented many millions of workers from being unemployed. I don’t think that stimulus’ strongest supporters would advocate a package so ambitious that unemployment was scaled back to pre-recession levels.

So while stimulus means that several hundred thousands of workers who would be out of a job are not, and are spending, therefore supporting several hundred thousand more workers, it’s still the case that there are a lot of people out there cooling their heels. If one believes the recalculation story, then one has to think that those workers might soon be directed by the great TI-85 in the sky toward some new industry. In that case, when government stimulus is removed and workers entirely dependent on that spending are let go, the next growth industries will be up and running, ready to absorb new workers.

If one doesn’t accept that story, one is essentially saying that the process of recalculation requires precisely the number of people driven out of work by recession to be out of work for the period during which the recalculating is taking place. If government absorbs even a few hundred thousand workers, that will throw the whole process off, meaning that only when they’re returned to unemployment by the exit from stimulus can the recalculation proceed, generating, somewhere down the road, employment growth.

That set of beliefs would be, I think, a little nuts. It suggests that any interference in the labour market (and presumably this would include unemployment benefits at all levels) will disrupt the recalculatory process. And it suggests that workers will be more likely to find new employment sooner by spending the duration of the recession out of work, skills eroding, than staying busy at some job which wouldn’t exist without a little government help.

It makes no sense.