Sunday, August 31, 2014

Search Theory And Idle Capacity

Through Mainly Macro, a blog about macroeconomics from a New Keynesian perspective, I discovered this paper by Pascal Michaillat and Emmanuel Saez. The associated slides are a good summary. The paper is very hardcore economics theory paper, aimed a a very hardcore economics question - why does unemployment lurch around the way it does? It's a difficult question. Why did people gainfully employed in 1928 suddenly find themselves without jobs for 11 years? No matter what your opinions  are on this matter, this paper will be of a benefit to you for clarifying how that cause got into the economy as a whole.

This paper takes a search theory perspective on the subject. This improves on the repeatedly cited Barro model because it allows Saez and Michaillat to use supply and demand to analyze the situation. In addition, they are able to use this model in a compartmentalized way. For instance, in this paper, they just use aggregate demand, but the model can be relaxed with different models of demand. Different ways of finding prices are examined in this paper, from crude price fixing to Nash bargaining. As far as I can tell, one could take any pricing mechanism and get a new version of this model as a result. Risk and uncertainty are abstracted out, meaning this is not a model of - say - the 2007-8 financial crisis (which in this model is just "some demand shock"), but rather of how the crisis got into the economy. Since prices are affected by risk and the pricing mechanism in this model is arbitrary, this would be a good place to put that. For instance, there is a great deal of difference (in productivity) in hiring different people for a given position, even a "low skill" position. How is the model affected by increasing uncertainty of hiring?

I don't know much about the relevant precursor model. I will say that as a mathematician, I think that the name "disequilibrium" is a bad choice of words. The word "equilibrium" means that there is no change over time, the use comes from mechanics and has been extended by physicists and mathematicians (and economists!) in appropriate ways. When Barro, Fisher, etc. call a model "disequilibrium", they mean that the economy is not assumed to rapidly respond to changes in the way that the old fashioned Alfred Marshall model. That means that this paper is equilibrium analyses of a disequilibrium model, which is comprehensible only if you already know what this is all about. I am against this word, antidisequilibrium. But unfortunately antidisequilibriumism has little chance against established use.

Also, economists draw charts sideways. The variable x (market tightness, illustrated on slide 9 and 10) is the independent variable and quantity of a good is the dependent variable (with a maximum capacity k). They can't help it, Alfred Marshall did it and people had to do it to match him, then their students had to do it to match them, etc. But surely even economists can see that this is worse than Hitler and that the only use for such charts is discovery of landmines? Can't economists and publishers band together to rid of us this evil?

Why are they doing that? I've seen this show and I have no idea...

Because there is already a good explanation of the bones of the model (from a New Keynesian perspective) on the blog I found this paper on, I'll end by talking about myself. Though you can't tell from this post (in which I talked about famous crises), I have a really hard time thinking about economic models in relationship with the world I am in directly. When I read the excellent textbook The Spatial Economy I found myself thinking a lot more about Sun Tzu than the highway system. When I read this paper, up until section 5 (the empirical part) I found myself thinking a lot more about feudal societies (such as the Tokugawa Shogunate) than modern fluctuations. It's strange, because the modern ones have actual time series and other empirical data - which is what I do! Perhaps it is just more fun.

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