Sunday June 12th 2011

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A Challenge to Extreme Keynesians

The key insight of Keynesian economics is that the problem during recessions is inadequate aggregate demand.  Taken to the extreme, which some Keynesians do, it says that aggregate demand is the only thing you need to worry about during downturns.  Changes in aggregate supply (due to, say, high marginal tax rates or adverse incentives associated unemployment insurance) don’t matter, they argue, because employment is being constrained by the low level of aggregate demand.

University of Chicago economist Casey Mulligan offers a challenge to that view.  Casey points out that there is a regular surge in teenage employment during the summer months because more teenagers are available to work (that is, the supply of their labor has increased).  That is no surprise: It is normal supply and demand in action.  But if aggregate demand were the main constraint on employment, this increase in supply should not translate into higher employment during deep recessions such as this one.  But it does!

Most economists, Keynesians and otherwise, ignore this summer change in employment because we focus on seasonally adjusted data.  But as Casey points out, the raw unadjusted data may have something important to teach us.

Casey might want us to take this as evidence against the entire Keynesian worldview.  I would not go quite that far, but it surely provides a challenge to extreme Keynesianism.  I am reminded of a response I once gave to a reporter who asked whether I was a supply-sider or a Keynesian.  “I am neither a supply-side economist nor a demand-side economist,” I said.  “I am a supply-and-demand economist.”

This article was originally posted on Greg Mankiw’s Blog