DeLong Smackdown Watch: Dan Kuehn on Structural Adjustment, Numbers of Equations, and Numbers of Unknowns
Dan Kuehn:
Facts & other stubborn things: Price Coordination, Structural Adjustments, and Keynesian Downturns: I obviously don't need to be convinced that we're facing demand problems... what I'm a little confused about is precisely what structural problems we're facing that Brad refers to. Certainly there's the issue with housing. That strikes me as a bubble that popped and we're going to need some reassignment of resources previously dedicated to that. Is that all we're talking about here? Or is there something deeper?... Is there large scale technological unemployment associated with skill-biased technological change that we need to adjust to?...
The important point, though, is that Keynesianism is all about problems with the price mechanism. The nice, tight, Walrasian system is actually over-identified which interferes with price signals sent to investors especially. You can think of it as an "interest rate wedge" similar to the "tax wedge" that is standard fare in undergraduate economics. I don't know if anyone has talked about it in this way before, but it seems like a useful way of doing it for people who seem to think Keynesians ignore price coordination.... If interest rates are artificially higher than the equilibrium rate, you're going to have a stable Keynesian obstacle to structural adjustments just like you have to any other investment. As Brad said initially, ""structural adjustment" takes place when unemployment is low, not when unemployment is high"...
In the language that Dan is talking, I think that the right thing to say is that if the price level is sticky then the Walrasian system is over-identified. If the price level is flexible then the Walrasian system is just identified--the thing that is supposed to move in order to eliminate the excess demand for financial assets is the price level, and it does not, or it does not move fast enough.
Of course, in the real world it is not at all clear that we want to have downward-flexible aggregate price and wage levels in a world with nominal debt contracts. Think we have a financial crisis now? What we had was a 30% decline in housing prices. Where would we be if we had had a 30% decline in all wages and prices?
