Thanks, I remember stumbling onto a blog last year written by econ professors (I think they were Austrian School) and one of them discussed this and his prescription for the downturn was increasing money supply to deal with the problem of sticky wages. I was new to AS, so I was curious how inflating the currency would work in practice, specifically how the inducer of that inflation could make sure it flowed to the industries/jobs that were meant to be helped.
I never really got a good answer to that, unfortunately and don’t have it book marked anymore, Shame.
Oh, and let me get this straight. Classical or Neoclassical depends on rational expectations and AS doesn’t?
That’s not the same as describing actions by market participants as rational in ABCT theory even though the outcomes are disastrous, is it? What I mean is that I understand that according to AS, firms that are over borrowing/malinvesting during the boom phase are not acting irrationally at all, but are responding to false signals the market is giving them due to monetary inflation. How does this differ from rational expections? Different theories?
Well Keynes believed that the labor market was entirely unique due to the irrationality of laborers and their unwillingness to accept nominal wage reductions (he called it the “money illusion”). One of his solutions was to inflate away nominal wages, that is, keep nominal wages stable but reduce real wages through inflation. This would, at least in his mind, remedy mass unemployment. The Austrians, on the other hand, don’t believe that the problem lies in the labor market, but rather that capital has been accumulated and organized in inefficient combinations, leading to a malformed capital structure. Austrian macroeconomics is capital based, while Keynesian’s focus on the labor market.
Not all neoclassical economists believe in rational expectations. One of my professors once said that “rational expectations proclaims that everyone is right but the economists.”
Rational expectations assumes that people do not make systematic errors when predicting the future, and deviations from perfect foresight are only random and occur only at the individual level; economic agents identify and incorporate all relevant information. So, for example, if the FED continuously suppresses interest rates, and if this continuously leads to a recession, then individuals will realize this, and factor it into their calculations (they won’t engage in new investments at this lowered interest rate, or refinance their homes, or whatever). Basically, people have some intuitive and mystical connection to some illusory general equilibrium.
Essentially, rational expectations was a convenient way to deal with choice under uncertainty in economic modeling, but it turned out to be the biggest disaster since the Keynesian episode. I mean, if this is true, then why have markets and prices at all?
Individuals would accept lower wages because, at least according to rational expectations, they would eventually realize that accepting a lower wage means preventing mass unemployment.
Not to be pedantic, but do you mean that they would accept a lower wage to prevent their unemployment? I’m not sure a lot of people are worried about mass unemployment (at least, as long as it pertains to their wage… otherwise, people would vote to abolish minimum wage), or would be aware that by not accepting a lowered wage themselves this would lead to mass unemployment.
Anyone have a criticism of this? One thing I can think of is human error, whether it’s reasonable to assume that entrepreneurs will be able to anticipate increased desire to hold cash, or at least well enough/enough of them will be able to do so to avoid large consequences, but I don’t know what the effects of increased desire to hold cash are, I haven’t read about it. There’s also the issue of possible ignorance about the effects of increased desire to hold cash.