27th September 2012
"I think there is good reason to think that the short run is over-it is short, after all."
"My first bit of evidence is corporate profits. They are at an all time high, around two-and-a-half times higher in nominal terms than they were during the late 1990s, our last real boom…If you think that unemployment is high because demand is low and therefore business isn't profitable, you are empirically mistaken. Business is very profitable, but it has learned to get by without as much labor. "
Indeed, The Economist's Ryan Avent says there are situations where a shortfall in demand should translate into low corporate profits-in particular, when sales fall rapidly before firms have had time to cut back on its operating expenses, including labour. However, "that need not always be the case," he writes. "Firms could be enjoying high profits simply because revenues have stabilised while costs are low, perhaps because low expectations for future nominal spending growth have discouraged investment."
But how is it that these profits can persist? Here, Avent thinks it's useful to think about the externality (the side effect or consequence of an industrial or commercial activity that affects other parties without this being reflected in the cost) of the demand shortfall:
"Larry Ball, Greg Mankiw, and David Romer have a discussion of it in a paper on New Keynesianism….When confronting a demand shortfall, they write, a firm may be indifferent as to whether it responds by adjusting prices or quantities, but there is a negative spillover effect when the choice is made across many firms to cut quantities."
Bryan Caplan, also picking up on Durado's point that corporate profits are at record highs, asks confusingly, "What is Dourado arguing?"
"If spending on output rises back towards (or all the way to) the trend of the Great Moderation, all that would happen is that profits would rise while production would remain on its current low growth path? For profits to rise with no added growth in output, firms would need to respond to the added sales solely by raising their prices (more quickly.) If profits are to rise, their costs can't rise as quickly, which could occur because their debt service costs don't rise. And, of course, wages might stay on their current growth path too."
Moreover, he says, increased productivity doesn't require reduced employment:
"If firms have figured out ways to produce a given level of output with less labor, this just suggests that real demand needs to increase even more."
Update: Here is Eli Dourado's point by point response to his critics. He argues that none of his critics seem willing to make any sort of broadly falsifiable claim about how long the short run lasts.
Update 2: There's more economic cat fighting as Ryan Avent responds to Dourado's response: "I have to say I find his dismissal of much of the criticism unduly breezy," Avent writes.
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