{"id":8709,"date":"2010-03-14T19:03:11","date_gmt":"2010-03-14T08:03:11","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=8709"},"modified":"2010-03-14T19:03:11","modified_gmt":"2010-03-14T08:03:11","slug":"saturday-quiz-march-13-2010-answers-and-discussion","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=8709","title":{"rendered":"Saturday Quiz – March 13, 2010 – answers and discussion"},"content":{"rendered":"

\t\t\t\tHere are the answers with discussion for yesterday’s quiz. The information provided should help you work out why you missed a question or three! If you haven’t already done the Quiz from yesterday then have a go at it before you read the answers. I hope this helps you develop an understanding of modern monetary theory (MMT) and its application to macroeconomic thinking. Comments as usual welcome, especially if I have made an error.
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\nQuestion 1:<\/strong><\/p>\n

\nFrom the US National Accounts, you find that in 2006, the share of Personal consumption expenditure in real GDP was 69.9 per cent and by 2008 it had fallen to 69.8 per cent. Similarly, the share of Gross private domestic investment on real GDP was 17.2 per cent in 2006 and by 2008 had fallen to 14.9 per cent (and further to 11.8 per cent in 2009). The net export deficit over the same period (2006 to 2008) fell from -5.7 per cent of real GDP to -4.9 per cent in 2008. Finally, the share of Government consumption expenditures and gross investment in real GDP rose from 18.8 per cent in 2006 to 18.9 per cent in 2008 (and 19.7 per cent in 2009). These relative changes tell you that real GDP was lower in 2008 compared to 2006 because the increase in Government spending and the falling negative contribution of net exports were not sufficient to offset the declining contribution from consumption and investment.\n<\/p><\/blockquote>\n

The answer is False<\/strong>.<\/p>\n

The detail in the question relates to expenditure shares in real GDP and clearly does not tell you anything about the growth in GDP. All that you are being told are that the shares are changing over the period 2006 to 2008 in favour of public spending.<\/p>\n

The shares are given by the following equation:<\/p>\n

\"\"<\/a><\/p>\n

<\/div>\n

where A(t) is the value of aggregate A in quarter under consideration (say Personal consumption expenditure) and GDP(t) is the value of GDP in the same quarter.<\/p>\n

So a change in the public spending share from 18.8 per cent in 2006 to 18.9 per cent in 2008 just says that in 2008 the flow of public spending is a greater proportion of the flow of real output in 2008 than it was in 2006. The rising share could be associated with a declining, constant or growing real GDP.<\/p>\n

The fact you know that over this time that real GDP growth in the US was falling is irrelevant – the question asks whether you can conclude from the information before you.<\/p>\n

The other related measure is the contributions to GDP growth which tell you each quarter what the expenditure components contributed to the GDP growth in that quarter.<\/p>\n

From the Australian National Accounts – December 2009<\/a> you can find the definition of the contributions to GDP growth which is represented by the following equation:<\/p>\n

\"\"<\/a><\/p>\n

<\/div>\n

where A(t) is as before; A(t-1) – value of aggregate A in previous quarter; and GDP(t-1) – value of GDP in previous quarter.<\/p>\n

The ABS indicate that “the contributions to growth of the components of GDP do not always add exactly to the growth in GDP. This can happen as a result of rounding and the lack of additivity of the chain volume estimates prior to the latest complete financial year.<\/p>\n

From the US National Accounts data you see that real GDP grew in 2005-06 by 2.7 per cent; then slowed to 2.1 per cent in 2006-07, 0.4 per cent in 2007-08 and plunged to -2.4 per cent in 2008-09. Over the period 2006-2008, real GDP grew overall by 2.6 per cent. The following table breaks down the contributions to that growth by the individual spending components (computed as per the Equation above).<\/p>\n

\"\"<\/a><\/p>\n

<\/div>\n

The point of the question (if any) is to warn you into being careful to clarify the concepts being used before drawing conclusions. Too many people think they know what these terms mean and either mis-use them themselves to reach erroneous conclusions or allow themselves to be fooled by others who are touting erroneous conclusions.<\/p>\n

If you are interested in more detail on national accounts then the 5216.0 – Australian National Accounts: Concepts, Sources and Methods, 2000<\/a> – is the place to go. Recommended reading if you want to get all the concepts and stock-flow relationships really sorted out. The system is universal and used by all statistical agencies.<\/p>\n

Question 2:<\/strong><\/p>\n

\nThe US Senate has recently debated whether to extend unemployment benefits given the lack of job opportunities currently available. One side of the debate says the proposal will reduce growth because it reduces the incentive to search for work although the evidence for this impact is weak. The other side of the debate says the proposal will maintain and perhaps stimulate growth because it will maintain spending capacity of those without work. Even if the former effect was strong, the proposal would not harm growth at present.\n<\/p><\/blockquote>\n

The answer is True<\/strong>.<\/p>\n

The clue to the answer was in the last two words of the question at present<\/em>.<\/p>\n

First, the proposition that unemployment benefits reduces the incentive to search and therefore prolongs unemployment is a popular claim made by neo-liberals who seek to undermine systems of income support. There is no<\/strong> convincing research that establishes that proposition.<\/p>\n

The conceptualisation comes from the (erroneous) view that mainstream economists have that mass unemployment is a supply-side phenomenon driven by the preferences of the workers for leisure when the real wage on offer is too low. This theoretical idea sees workers managing each hour of their day by making choices between leisure and income. Income can be gained only by working and work is conceived as bad and leisure good.<\/p>\n

The price of leisure per hour is the foregone income or the real hourly wage. So as the real wage rises it become more expensive to enjoy leisure. A worker chooses leisure when their preference for it (the utility they gain from the extra hour) is greater than the real wage.<\/p>\n

You will immediately see that the mainstream economics profession conceptualises unemployment as a choice of leisure. They argue there is always enough work around if the worker is prepared to take the real wage on offer (that is commensurate with their productivity).<\/p>\n

As an aside, another major shortcoming of the model is that they conceive of productivity as being innate to an individual (either by nature or human capital investment) rather than being embedded in production and work processes which involve team-based outcomes. The industrial organisation literature, which the economists ignore, is full of evidence to support the latter construction of productivity.<\/p>\n

Anyway in the context of this mainstream model, if you then introduce a “subsidy for leisure” which is how they conceive of the provision of unemployment benefits then you further distort the work-leisure choice in favour of leisure. So the dole becomes a subsidy for remaining jobless and the higher the payment the greater likelihood the individual will choose leisure. Further, the longer the payment is extended for the longer the individual will refrain from job search.<\/p>\n

The survey literature finds overwhelmingly that unemployed workers will accept job offers made to them. The problem is that the lack of job offers not the income support regime in place (at the sort of levels that unemployment assistance is offered in various countries).<\/p>\n

A major empirical flaw in the mainstream model is that they assume that quits rise when unemployment rises. This is because they consider movements from employment to unemployment are largely driven by workers realigning their choice of hours in favour of leisure. So the quit rate should rise if this behavioural explanation was accurate.<\/p>\n

The fact is that quit rates are strongly counter-cyclical – they fall in a recession and rise in a boom. This simple fact completely obliterates the supply-side explanation of mass unemployment and students should be taught it on day one of their labour economics courses. Knowledge of that fact would avoid them having to wade through the nonsense that Barro and others have dished up to them over the years trying to convince them of the alternative view.<\/p>\n

Second, at present in the US there is clearly a lack of jobs. So even if we accepted that the supply-side of the labour market has traction as the mainstream economics textbooks would like us to believe then that can only be the case if the the demand and supply relationships in the labour market intersect at the going real wage.<\/p>\n

The following diagram explains this.<\/p>\n

The mainstream model is the labour demand and supply model. Labour supply slopes upwards in terms of real wages because as the price of leisure rises workers are assumed to supply more hours of work. The demand for labour slopes downwards in their models because productivity declines per worker and so firms will only offer lower real wages to increase employment (so-called law of diminishing marginal productivity)<\/p>\n

I don’t accept this model at all – and one day I will write a thorough critique of it. The fact is it fails to explain anything at the macroeconomic level and is also highly flawed at the microeconomic level. But for now let’s just assume it is the correct depiction of what goes on.<\/p>\n

The real wage and employment level that the “market delivers” is at A in their model and so the supply relationship is playing a part to determine that nexus between supply and demand.<\/p>\n

Now suppose there is a major failure in aggregate demand and a jobs ration (red vertical line) is imposed on the economy’s labour market. Then at that the going real wage, the “neoclassical” demand and supply curves have no bearing on the outcome which would be at point B<\/strong>.<\/p>\n

So even if the supply relationship shifted (inwards a bit) as the unemployment benefits further reduced the hours they would be willing to supply at each real wage level, it would have no bearing on the outcome.<\/p>\n

\"\"<\/a><\/p>\n

<\/div>\n

Third, the provision of unemployment benefits is likely to boost (or at least maintain) aggregate demand. The choice is between no income or some pitiful handout. So the extension of the income support will avoid a further collapse in spending by households. The loss of income arising from 10 per cent unemployment in the US (and up to 17 per cent if you count those who have given up looking) is enormous and highly deflationary.<\/p>\n

The provision and extension of unemployment benefits will thus maintain spending and via multiplier effects could even provide stimulus to increase private employment.<\/p>\n

That is why the US Democrats claimed this was a job plan. I think that is nonsense. It is a minor income support provision but better than the Republican alternative, which is based on spurious understandings of how the labour market functions.<\/p>\n

Fourth, to further appreciate how mass unemployment arises, recall the parable of 100 dogs and 95 bones – now 90 bones in the US and elsewhere!<\/p>\n

The main reason that the supply-side approach is flawed is because it fails to recognise that unemployment arises when there are not enough jobs created to match the preferences of the willing labour supply. The research evidence is clear – churning people through training programs divorced from the context of the paid-work environment is a waste of time and resources and demoralises the victims of the process – the unemployed.<\/p>\n

Imagine a small community comprising 100 dogs. Each morning they set off into the field to dig for bones. If there enough bones for all buried in the field then all the dogs would succeed in their search no matter how fast or dexterous they were.<\/p>\n

Now imagine that one day the 100 dogs set off for the field as usual but this time they find there are only 90 bones buried.<\/p>\n

Some dogs who were always very sharp dig up two bones as usual and others dig up the usual one bone. But, as a matter of accounting, at least 5 dogs will return home bone-less.<\/p>\n

Now imagine that the government decides that this is unsustainable and decides that it is the skills and motivation of the bone-less dogs that is the problem. They are not “boneable” enough.<\/p>\n

So a range of dog psychologists and dog-trainers are called into to work on the attitudes and skills of the bone-less dogs. The dogs undergo assessment and are assigned case managers. They are told that unless they train they will miss out on their nightly bowl of food that the government provides to them while bone-less. They feel despondent.<\/p>\n

Anyway, after running and digging skills are imparted to the bone-less dogs things start to change. Each day as the 100 dogs go in search of 90 bones, we start to observe different dogs coming back bone-less. The bone-less queue seems to become shuffled by the training programs.<\/p>\n

However, on any particular day, there are still 100 dogs running into the field and only 90 bones are buried there!<\/p>\n

You can find pictorial version<\/a> of the parable here (for international readers this version was very geared to labour market policy under the previous federal regime in Australia and was written around 2001).<\/p>\n

The following blogs may be of further interest to you:<\/p>\n