Department of "Huh?!": How-Long-Is-the-Short-Run? I Really Thought Eddie Lazear Was Smarter Than This Edition
One of the major--perhaps the major--point at issue in the ongoing struggle over macroeconomics over the past century was how long it took the "long run" to arrive. Economists do believe that when the "short run" demand-driven storm is past the ocean is flat again. But how long does that take? One year? Three years? Ten years? Twenty years?
Milton Friedman's greatest intellectual victory in his long career was to convince mainstream American economists that the answer was: three years. Aggregate demand thus rules for a very short time--barely time enough for the government to notice that there is a problem. Then it passes, and the situation is ruled by aggregate supply.
Or so we mainstream economists thought back five years ago.
Back in 2007, I was one of those saying: "this will be over and things will be back to normal in three years". Well, it has been four years--and there is no end in sight. It is past time for us to mark our beliefs to market.
This time, it is different: this time the "short run" looks to last for a decade, if not longer.
But Eddie Lazear has not updated his beliefs:
Edward P. Lazear: The Euro Crisis—Doubting the 'Domino' Effect: [E]veryone is worried that problems in Europe will derail our fragile recovery…. [M]arkets breathed a sigh of relief when the Europeans came up with a plan to provide yet another reprieve to Greece…. [T]he fundamental problem facing Europe is one of governments becoming too big to be supported by the economy… a temporary debt restructuring, no matter how clever, will fail to right the ship. Closer to home, the same issues that threaten Europe may soon become immediate concerns to Americans….
[C]onsider two theories… the domino theory and the popcorn theory. Everyone knows the domino theory…. [O]il and corn kernels are placed in the bottom of a pan, heat is applied and the kernels pop. Were the first kernel to pop removed from the pan, there would be no noticeable difference. The other kernels would pop anyway…. The fundamental structural cause is the heat, not the fact that one kernel popped, triggering others to follow.
Many who believe that bailouts will solve Europe's problems cite the Sept. 15, 2008 bankruptcy of Lehman Brothers as evidence of what allowing one domino to fall can do to an economy. This is a misreading of the historical record…. At the risk of sounding defensive (I was in the government at the time), I believe that Lehman's downfall was more a result of the factors that weakened our economic structure than the cause of the crisis…
Financial markets disagree:
A 25% fall in equity values is not a market reaction to just another in a long series of popcorn kernels popping. It is a game-changing shock to expectations and confidence triggered by the unmanaged collapse of Lehman Brothers.
Lazear would have seen how implausible his "popcorn" argument is if he had mentioned an additional number (or two) in his op-ed. We learn that before Lehman: "The Dow Jones Industrial Average had lost about 3000 points from its peak by September 2008."
But Lazear doesn't look at asset prices, interest rate spreads, credit availability, or what financial market participants were saying about the crisis at the time. He doesn't tell his readers that Lehman triggered an additional 2500 point decline. Lehman's collapse was a big deal. People whose business is to invest money said it was a big deal. Asset prices say it was a big deal.
Lazear closes his ears.
If you believe that demand-side shocks have effects that last for only a short time, then you don't need to look at the data or the evidence: if the effects last for a long time, you know it must have a supply-side cause.