Price Stickiness is Only One Coordination Failure

Steven Randy Waldman writes,

For both firms and individuals, resistance to downward price adjustment is often rational, even when at a macroeconomic level universal downward adjustment would be desirable (perhaps because the central bank and/or state have failed to accommodate the expected path of nominal incomes, perhaps because nominal exchange rates are rigidly misaligned). If we could wave a magic wand and have wages, prices, and especially debts all simultaneously scale downward, that might be awesome. But, unfortunately, we can’t.

I think both Tyler Cowen and Mark Thoma pointed to this post. Read the whole thing.

The problem with the macroeconomic perspective is that when you think of the economy as a GDP factory, then the only reason you can think of for it not to operate at capacity is that the ratio of M to P is too low. Instead, if you think in terms of PSST, you can think of all sorts of reasons for coordination failure.

The chains of production are really long and complex. Somebody has a job doing “business development” for a company trying to make money out of an app. That job is so far from producing widgets that it is ridiculous.

In addition, pretty much everything we buy is discretionary. The seller of almost any product or service could wake up tomorrow and find the demand for that product or service poised to fall off. Need I cite landline telephones, retail music stores, or taxi drivers?

In the PSST story, the rigidities that matter are the burdens of trying to start a new business and the reluctance of people to relocate and to change occupations. The ratio of M to P just doesn’t amount to a hill of beans in an economy that depends on deep, complex coordination in the market process.

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11 Responses to Price Stickiness is Only One Coordination Failure

  1. Lord says:

    A little coordination failure isn’t sufficient though. Nothing is ever totally coordinated and there is always slack in the system as the system evolves. There are always areas that are growing while others decline. It takes truly massive failure to result in a recession, failure so massive it impairs the adjustment process itself. The explanations never change, expectations/money/psychology/technology, together with real forces not properly called a recession. We probably shouldn’t even consider them distinct explanations but a common one expressed through multiple channels.

    • Yancey Ward says:

      It takes truly massive failure to result in a recession, failure so massive it impairs the adjustment process itself.

      But what exactly is the impairment/failure. When one can’t answer that, I don’t think the economics profession has clue, what do you do?

  2. Floccina says:

    But it seems like low skill employment would be less dependent on PSST. Like while you are waiting for entrepreneur to find a more valuable use for you, you can work as a gardener.

    • Slocum says:

      ” Like while you are waiting for entrepreneur to find a more valuable use for you, you can work as a gardener.”

      Can you? What if you suddenly have both A) an increase in the number of people looking for gardener jobs, and B) a decrease in the number of people wanting to hire gardeners (because they’re economizing and have resumed mowing their own lawns)?

      I don’t think it’s generally the case that low-skilled workers are generally found in the ‘necessities’ sector rather than the ‘luxuries’ sector — after all, the biggest categories of near minimum wage workers are in restaurants and retail.

    • Arnold Kling says:

      Tyler Cowen’s hypothesis about ZMP (zero marginal product) workers is not that the lack skills, but that they lack the emotional skills to hold a job. But I do spend time wondering why we don’t observe unemployed workers being scooped up as dishwashers or gardeners. In some sense, the worker’s required wage for doing such work has to be above the wage that employers can pay. One can come up with many reasons for that.

      • Andrew' says:

        There is a somewhat fixed cost of the risk of letting a zmp in the door. E.g. almost any employee can cause your firm to be sued one way or another.

        So, what we should see is a lot of firms that provide outsourcing- cleaners, dish washers, etc.- that shield the parent company from risk. So do we see that? If not, maybe it isn’t worth starting an outsourcing business due to risks, transaction costs, the fact everyone can still be sued, etc.

  3. I certainly agree that there are many, many important coordination failures in economics! (I’m also broadly sympathetic to your PSST perspective.)

    I just think this coordination failure — the difficulty of simultaneously adjusting the price one receives and the prices one has already committed to pay — is an important explanation of one phenomenon, why prices adjust downward with difficulty and slowly, on a timescale that depends upon the timescale with which debt overhang and lifestyle costs also adjust.

    I don’t claim, by the way, that price stickiness is uniquely responsible for recessions. It’s a plausible macro view, but as I said, I’m also sympathetic to your view that sometimes things change and people just don’t know WTF to do. I don’t mean to take a position on that question, except to say that I don’t think they are mutually exclusive hypotheses, and I think some potential remedies, like direct-to-citizen-in-equal-amount helicopter drops, might address both. (Helicopter drops could obviously help under aggregate demand/price rigidity stories. Bottom-up transfers help under informational stories too, because it gives the full public the ability to express preferences that will provide better incentives to entrepreneurs than, say, traditional monetary or fiscal policy.)

    • Andrew' says:

      Steve, if the big one is debts, is there any way (or new ways) to ration the new money to the solvent but illiquid?

      One problem we can imagine with multiple equilibria is firms could be solvent in the old equilibrium than no amount of money would take us back to.

  4. Michael says:

    To me, PSST is a “real” story and P=MV is a “nominal” story. They connect because monetary stability removes a headwind that opposes the finding of those connections that lead to PSST. It’s not an impassable headwind, some connections are going to be made regardless of the monetary system, but they will be fewer and often different.

    PSST defines how an economy as a whole can be rich or poor. (It determines what I can get for my money and what I can produce for pay).

    Money is just one of many forces that can affect the formation of economic networks… but it is a very central force because so many PSST involve money going back and forth.

    • Arnold Kling says:

      I would amend this to say that financial intermediation is a central force. The crude, mechanical view of the money supply serving as the economy’s gas pedal is what I think is wrong.

  5. Yancey Ward says:

    Link

    Snider seems to see the economy much the way you do- asking the same questions about how it is measured.

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