Thursday, March 31, 2011

Me and the Jigsaw Puzzle at Project Syndicate (and apparently I'm an economist, too!)

Brad DeLong has a new Project Syndicate article talking about the sluggish labor market recovery. It draws a lot from previous blog posts of his, and one thing that he draws from those blog posts is a mention of yours truly:

"As the economist Dan Kuehn likes to say, a recession is like somebody knocking your jigsaw puzzle, disturbing the pieces, and turning some of them over. When the Fed ends a liquidity squeeze, it turns the pieces right side up. So it is easy to reassemble the puzzle. Now, however, there is no one to turn the pieces right side up, so things are much harder to correct." [emphasis mine]

I have to credit Steve Horwitz, of course, who initially talked about the jigsaw puzzle analogy for thinking about the recession. I think he did a good job talking about the Austrian approach using this analogy, but a pretty ham-fisted job carrying it over to Keynesianism. My response on how Keynesians see the complex interactions that make up the economy, and how to talk about this with the jigsaw puzzle analogy here and here.

The summary is this: Keynesians see recessions as being caused by interest rates that are too high as a result of liquidity preference and deficient demand. The multiplier process aggravates this because negative demand shocks translate into negative income shocks, which cuts into effective demand down to a new equilibrium point. But the driver of all this is discoordination caused by interest rates that are too high. Keynesians think the market works - it does efficiently allocate goods and services. But if you give it bad signals, it's going to disrupt the price mechanism. The interest rate is that disrupted price signal in a downturn. Given good price signals, entrepreneurs can fit the puzzle pieces together. But with the bad signal that the interest rate is giving firms, many of the puzzle pieces entrepreneurs would normally spend their time fitting together aren't even viable or taken into consideration. The problem, in other words, is not that entrepreneurs can't fit the puzzle pieces together but that certain low marginal efficiency of capital investments aren't even considered when the interest rate is distorted.

As you might expect, this perspective makes it challenging to talk to people who want to pretend that Keynesianism is a claim that the price mechanism does not work, that entrepreneurs can't be relied upon, etc.


  1. But Dan - Keynes DOES say the price mechanism can't work and that entrepreneurs can't be relied on. It's all there in the chapters on investment and savings. I don't have my GT handy as I'm on the road, but having just re-read it - it's there.

  2. Can't be relied on to.... what?

    Certainly can't be relied on to achieve full employment. But they can be relied on to allocate resources efficienly. He said as much in the conclusion.

    Liquidity preferences operates like a price floor on the interest rate. And it's true - entrepreneurs can't arbitrage their way out of a price floor any more than employees and employers can arbitrage their way out of a minimum wage.


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