Must-Read: David Glasner: Price Stickiness a Symptom Not a Cause
Must-Read: David Glasner is a Clower/Leijonhufvud student. Listen to him. Mind you, I am not sure that the Clower/Leijonhufvud point-of-view is the best first approximation. But the argument made against it is never that it is a wrong approach, but always that it is difficult to do journeyman work in. Keynes was definitely very attracted to it, in some of his moods. For example:
Ricardian analysis… Marshall’s contribution…. Edgeworth and Professor Pigou and other later and contemporary writers have embroidered and improved… [while] still dealing with a system in which… At any given time facts and expectations were assumed to be given in a definite and calculable form; and risks… capable of an exact actuarial computation… probability… reducing uncertainty to the same calculable status as that of certainty itself….
There are two important sub-issues here that are often confused:
- At the individual level, Bayesian probability versus Knightian uncertainty.
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At the aggregate emergent-properties-of-systems level, the consistency of plans and expectations with respect to all of the missing futures markets:
David:
David Glasner: Price Stickiness a Symptom Not a Cause:
Nick [Rowe], following a broad consensus among economists, identifies price stickiness as a critical cause of fluctuations in employment and income….
The real problem is not that prices are sticky but that trading takes place at disequilibrium prices and there is no mechanism by which to discover what the equilibrium prices are. Modern macroeconomics solves this problem, in its characteristic fashion, by assuming it away…. Economists have allowed themselves to make this absurd assumption because they are in the habit of thinking that the simple rule of raising price when there is an excess demand and reducing the price when there is an excess supply inevitably causes convergence to equilibrium. This habitual way of thinking has been inculcated in economists by the intense, and largely beneficial, training they have been subjected to in Marshallian partial-equilibrium analysis…. But that analytic approach can only be justified under a very restrictive set of assumptions…. All partial equilibrium analysis involves a certain amount of hand-waving. Nor, even if we wanted to be careful and precise, could we actually dispense with the hand-waving; the hand-waving is built into the analysis…. I have often referred to these assumptions required for the partial-equilibrium analysis–the bread and butter microeconomic analysis of Econ 101–to be valid as the macroeconomic foundations of microeconomics….
So the assumption, derived from Modigliani’s 1944 paper that “price stickiness” is what prevents an economic system from moving automatically to a new equilibrium after being subjected to some shock or disturbance, reflects either a misunderstanding or a semantic confusion. It is not price stickiness that prevents the system from moving toward equilibrium, it is the fact that individuals are engaging in transactions at disequilibrium prices….
It is also a mistake to assume that in a world of incomplete markets, the missing markets being markets for the delivery of goods and the provision of services in the future, any set of price adjustments, however large, could by themselves ensure that equilibrium is restored. With an incomplete set of markets, economic agents base their decisions not just on actual prices in the existing markets; they base their decisions on prices for future goods and services which can only be guessed at. And it is only when individual expectations of those future prices are mutually consistent that equilibrium obtains…. So that’s why I regard the term “sticky prices” and other similar terms as very unhelpful and misleading; they are a kind of mental crutch that economists are too ready to rely on as a substitute for thinking about what are the actual causes of economic breakdowns, crises, recessions, and depressions…