Nick Rowe writes:
Worthwhile Canadian Initiative: Bryan Caplan and Joseph Stiglitz: "OK, I've said that Joseph Stiglitz gets Aggregate Demand wrong. It's only fair that I say that Bryan Caplan gets AD wrong too, for much the same reason.
Where are you Mark, Paul, and Brad? Seriously, you're not allowed to do any posts criticising Bryan Caplan for this, until after you have said that Joe Stiglitz is wrong too! It's only fair!
But, curses, I have exams to mark. And I really shouldn't be spending the time to explain fully why Bryan is wrong, until after I've marked my exams.
So here's a quickie:
Bryan Caplan and Joseph Stiglitz are making the same mistake…. The only way to increase output in a demand-constrained economy is to do something that changes that relationship between output demanded and output, so that more output is demanded for any given level of output. That's what monetary and/or fiscal policy are supposed to do. All that micro stuff, messing around with relative prices like the price of food (Stiglitz) or labour (Caplan) won't do anything unless, as a by-product, it happens to change the relationship between output demanded and output.
Macro is not the same as micro. The micro labour demand curve slopes down because it assumes that the extra output produced by the extra workers can in fact be sold. But that's precisely what's at issue here. Otherwise, wage cuts simply cause an equal cut in prices, or else cause a change in the distribution of income only. Unless price cuts cause AD to increase (which depends on how monetary and/or fiscal policy responds), or unless a change in the distribution of income causes AD to increase (which depends on relative marginal propensities to hoard), they won't increase AD…
I haven't read Stiglitz in Vanity Fair yet, or Caplan. I do have a day job...