Unemployment in Different Universes

I think I need to be more clear about how Paul Krugman is “wrong” on unemployment.

It seems that Krugman, himself, happens to be an inter-dimensional super-being, as well. It’s also really easy to see where he jumps between universes; it’s predicated upon the “liquidity trap”. Krugman spends much time in the alternate universe, where everyone else seems to hang out (except for the really disconnected left/right wings), where he finds himself writing things like this:

Public policy designed to help workers who lose their jobs can lead to structural unemployment as an unintended side effect. . . . In other countries, particularly in Europe, benefits are more generous and last longer. The drawback to this generosity is that it reduces a worker’s incentive to quickly find a new job. Generous unemployment benefits in some European countries are widely believed to be one of the main causes of “Eurosclerosis,” the persistent high unemployment that affects a number of European countries.

But as soon as the fabled “liquidity trap” becomes binding, Krugman jumps through the interdimensional vortex, to emerge as Mr. Keynes[1], and starts in like a lunatic with things like the ‘paradox of thrift’, and how high wage policies can increase employment…and, most detrimentally, how monetary policy is ineffective at the zero bound.

Reading Keynes, you would never know that elsewhere, the sensible Dr. Krugman has written that monetary policy is, in fact, the the first best solution.

In essence, what unemployment insurance does is increase the price of labor to whatever the unemployment payout happens to be. Why would you take a job that paid less than what you get paid on unemployment? So if AD curves slope downward (as the evidence states that they do), then raising the price of labor will increase the length of time an individual remains unemployed. Exactly how long will it increase the length of unemployment? Well, data suggest until the benefits run out.

Unemployment insurance may boost aggregate demand if the AD curve is upward-sloping (which is a theoretical argument, with very little data to support)…but that fact it isn’t as clear as Mr. Keynes would lead you to believe.

P.S. Finding ways to create employment is not that hard. The hard part is finding ways to increase wealth.
[1]H/T Scott Sumner =].


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