Quote of the Day: January 3, 2012
Joe Nocera on Peter Wallison and Company

Matthew Yglesias and Paul Krugman Read John Cochrane...

Paul Krugman:

New Frontiers in Economic Barbarism: 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”:

The argument for flexible exchange rates is, strange to say, try nearly identical with the argument for daylight saving time. Isn't it absurd to change the clock in summer when exactly the same result could be achieved by having each individual change his habits? All that is required is that everyone decide to come to his office an hour earlier, have lunch an hour earlier, etc. But obviously it is much simpler to change the clock that guides all than to have each individual separately change his pattern of reaction to the clock, even though all want to do so. The situation is exactly the same in the exchange market. It is far simpler to allow one price to change, namely, the price of foreign exchange, than to rely upon changes in the multitude of prices that together constitute the internal price structure.

Is it really possible that people at the University of Chicago have unlearned not only Keynes but Friedman? Alas, yes.

Indeed. Cochrane:

How Bad Ideas Worsen Europe’s Debt Meltdown: John H. Cochrane: Defenders think that devaluing would fool workers into a bout of “competitiveness,” as if people wouldn’t realize they were being paid in Monopoly money. If devaluing the currency made countries competitive, Zimbabwe would be the richest country on Earth…

Matthew Yglesias snarks:

Let's Play Analogies With John Cochrane: Try this mode of argument on for size. If water made agriculture possible, then the Pacific Ocean would be the breadbasket of the earth. Or: If flooding is a problem, then the Sahara Desert would be the best place to live. Right?

I just want to point out that Cochrane's claim that devaluation won't help reduce unemployment--even when unemployment is as high as it is in southern Europe today--entails a more general claim that not just fiscal policy but monetary policy has no effect on employment or production. For, after all, one would say:

Advocates of monetary expansion think that increasing liquidity would fool workers into working more and longer, as if people wouldn’t realize they were being paid in Monopoly money. If expanding the money supply made countries prosperous, Zimbabwe would be the richest country on Earth…"

What is the difference? None.