I don’t understand what Williamson is talking about; not just specifically, I mean generally. I find his material confusing as there doesn’t seem to be any attachment to overarching heretofore established logic other than mathematical, resulting in a flavor of model-oriented cognitive dissonance. I kept looking for a golden thread of logic to grasp onto, but am left empty handed after reading several days’ worth of blog posts including the comments where I assumed he’d clear up lost connections. In other words, he seems incredibly attached to models for various situations whether they form a cohesive hypothesis when stitched together or whether they accurately describe reality.
Here’s a case in point from Intuition Part II:
Here’s what happens in a conventional sticky-price New Keynesian model at the zero lower bound. Anticipated inflation is essentially fixed (anchored), and the central bank would like to lower the real rate of interest but cannot do so. Thus, the real interest rate is too high, which makes consumption too low. Firms hire fewer workers “because demand is low,” and for the workers to be happy with working less, the real wage must be low.
In my model, consumers need liquid assets to purchase goods. Here, liquid assets include all assets – not just money – that have some use in exchange or as collateral. In the model, the economy can be in a state where there is a shortage of liquidity. The low supply of liquid assets makes consumption low. Indeed we could say that “demand” is low, though I’m not a big fan of that language (as it’s misleading in general equilibrium). The people living in this world work today, acquire assets, and consume tomorrow by selling the assets. When there is a shortage of liquidity, firms hire fewer workers, and the workers are reconciled to working less because the return they are getting on their assets is low – that’s another way of looking at the high liquidity premium. The real rate of return on assets is essentially determining the effective wage the worker faces, so what’s going on in the labor market looks exactly the same as in the New Keynesian model – the real wage is low. What’s different is that the real interest rate is not too high, it’s too low.
I think this is wrong, as in the tail wagging the dog. And I am not sure how one can reconcile an assessment of real wages being too low when the counterintuitive would be that, by extension, the price level is too high. It doesn’t make sense in the same way 2+2 doesn’t equal 5. Translating this argument into more basic terms, he is saying that people would rather be homeless than have any income at all, which I find absurd (thinking about the woman in worn-out sweatpants and gloves with holes in them that I met at work on a sub-zero degree day). The demand problem is not in the labor force, but rather in the reason there is a shortage of, or high demand for safe assets. Why are people hoarding and risk adverse, unwilling to invest in potentially productive business? It takes money to make money, and it takes investment to hire people to develop products to produce. And that can’t happen with the majority of potentially productive capital piled into to government bonds regardless of negative net yield, or stuffed in a mattress, or in a gold vault, or buried in the basement.
The cognitive dissonance displayed here leaves me speechless. It makes far more sense to assert that nominal wages are too high for the price level – meaning that wages rose with the price level, then the price level took a dive as shown by this GDP deflator graph. It’s okay if Williamson wishes to challenge sticky-wage theory, but he really can’t do it with the information he has here, at least not convincingly.