In a recent Bloomberg debate, there was an interesting exchange. First, Tyler Cowen:
But Noah, I have a question for you. You've written several columns about how the American economy is becoming more monopolistic. If true (and it is not exactly my view), that implies output could be much higher with current resources, even at full employment. A boost in demand could spur firms to produce more, rather than restricting output so much. So are you now a fan of these Trumpian deficits? They may not be your preferred form of deficit spending, but do you see them still as a net positive?
Then Noah Smith:
As you say, monopoly power could potentially increase the case for stimulus in bad times.
Actually, that's not what Tyler said, nor is what Tyler said true. (Now everyone will be annoyed at me.)
One of the fundamental principles of modern macro is that demand-side stimulus cannot solve real problems. It can overcome problems such as high unemployment caused by sticky wages and prices combined with inadequate spending, but that's all it can do. Inefficiencies associated with monopoly are a real problem, and cannot be solved by printing money. There are actually a number of issues here that need to be disentangled, some of which are quite subtle.
- Monopoly is a microeconomic problem, not a macroeconomic problem. Thus it's quite possible to have low unemployment rates and high levels of monopolization. Indeed, I'd argue that's true in America right now. Employment in the monopolistic sector is indeed lower than we'd like, but the result of this is not unemployment, it's workers being employed in the less efficient competitive sector of the economy. This is important, because the mechanism by which demand stimulus creates growth is by encouraging more employment (not moving workers between sectors). But we are already at full employment.
- Suppose I'm wrong, and monopolization causes the natural rate of unemployment to be higher than otherwise. Say America's natural unemployment rate rises to French levels, due to monopolization. Is Tyler correct in that case? No, demand stimulus is still not called for even if monopolization causes the natural rate of unemployment to be higher than otherwise. That's because when you are at the natural rate, demand stimulus basically tricks workers and firms into producing more output than they'd like, by pushing up nominal spending in the face of sticky wages and prices.
So doesn't that make us better off? In the short run yes, but only at the cost of being worse off in the long run. When prices are sticky, demand stimulus can reduce a monopoly's real price, which is its price relative to NGDP. But once the monopoly catches on to the higher NGDP, it will raise the real price again. That might not sound so bad, but it leads to cyclical instability. Ditto for wage stickiness. Demand stimulus will give monopolies an incentive to hire more workers, as long as nominal wages are sticky. That will indeed make the economy more efficient for a short time (this may have been Tyler's intuition), but at a cost of future instability.
This is why we have independent central banks. Because our economy is riddled with inefficient policies such as minimum wage laws and taxes on labor, our natural rate of output is suboptimal. Demand stimulus tricks us into producing more, and we move closer to the optimal position for the economy. But it's not sustainable. It's a sugar rush. Minimum wages eventually get increased with NGDP, and workers renegotiate contracts. In the short run, the stimulus really does make us better off as a country (with or without monopoly), but it overheats the economy and leads to a painful recession in future years.
Once mainstream monetarist and New Keynesian economists understood this problem, they decided the best we could do was to keep the economy close to the natural rate of unemployment, and then advocated setting up independent central banks that would be immune from pressure by a corrupt future president that might have a big ego and a short attention span. (Hmmm . . . )
Unless I'm mistaken, there is nothing particularly controversial about this post. Think about a standard NK model, which produces an optimal policy of 2% inflation. How would the existence of monopoly change the optimal policy? Make it more expansionary? But what does that even mean? In the standard model, money is neutral in the long run. Going to 3% inflation doesn't have any long run benefit. I suppose you could advocate steadily rising inflation, ending up in hyperinflation, but that won't work if there are any welfare costs of inflation. In fact, the optimal policy under a NK model is no more expansionary with monopoly than without.
Now I suppose there might be models where the optimal policy is more countercyclical if there is monopoly, and this seems to be what Noah is hinting at. But that doesn't help Tyler's argument, as in that case policy should actually be more contractionary when unemployment is 4.1%. And I'm not even sure that claim is true; do NK models imply that more weight should be put on output, and less on inflation, when the economy is more monopolistic? Are there any models that do so?
P.S. Tyler might argue that the monopoly argument was not his view, just the implication of Keynesian models with which he does not agree. But I'm saying even that's not true. The argument he makes is not even an implication of any sound Keynesian model that I'm aware of.