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February 02, 2010



I suspect it is a combination of the two. We've seen huge negative demand and supply shocks (in contrast to the last decade when the supply shocks were positive). This is going to be a huge headache for policymakers because it implies the growth-inflation mix has changed for the worse. If the inflation target is left as it is, then we will have to accept weaker real growth. That will be a genuine test for whoever is in Number 11 after 6 May.


Perhaps the measure of productivity is wrong. Chris acknowledges the concept of labour-hoarding, but is there productivity hoarding too? If you are confident that there will be a recovery shortly, why not deploy your workers to create a better company for the next "normal times"?


One big difference between now and the early 80s is that the unions were far more powerful then. In their usual considerate way they were happier to see people laid-off rather than taking a pay cut which could bugger-up their precious industry-wide rates of pay. Now I suspect pay cuts are far more widespread in those businesses that cannot to retain all their workforce on the same wages; thereby allowing the workers to remain employed and the employer to have his workforce in place for any upturn.

chris c

Macro policy being called into question?

Who would've thunk it.



The problem is that if the economy has misallocated resources (too many estate agents and bankers), any labour hoarding here is simply deferring the adjustment (the government subsidy to banks has encouraged this).


For the economy as a whole, there is no evidence of pay cuts - though pay growth has moderated. Unfortunately, given the collapse in productivity, this has still forced up unit wage costs. That is eroding corporate profit margins and also holding up inflation.

The level of aggregate employment is too high given the economy's diminished output and potential to grow. When the banks and the public sector start to shrink, then unemployment will rise again.


Then you have to explain what the supply shock is! You are not only claiming that there is a fall in the rate of improvement of productivity, but there is a fall in the absolute productivity.

But lets just imagine that there was persistant mispricing of important classes of goods. And these goods were cheap to produce. Then observed productivity could fall dramatically, without any change in real productivity. Seems more likely to me.


One explanation would be that the housing-financial boom resulted in a structural misallocation of resources into finance, real-estate, import-intensive consumption, and construction. While the boom lasted, this would have looked like a gain in productivity, precisely because the outputs were mispriced upwards.

We're now seeing the painful reversal of this phenomenon - redistributing resources into exporting and import-competing manufactures and services, shrinking the financial and real estate sector, and possibly underpricing its outputs (if they could be overpriced before they can be underpriced now).


P.S. Hint - I think the mispriced goods are financial assets and the income generated from their turnover (agency fees) is easy to produce. It also conveniently is not part of the CPI.

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