The link: http://crookedtimber.org/2012/04/27/classical-economics-and-recession-in-many-countries-wonkish/

It’s by a person called John Quiggin, may he see the light soon. With our usual convention of all quotes in italics, and my observations in normal font, here’s his proof that Keynes was right

There is, though, one way in which the current Great Recession/Lesser Depression provides a sharp test of a critical proposition in economics. All forms of classical economics involve, in one form or another, the claim that the causes of unemployment are to be found in labour markets, and not in macroeconomic variables such as the level of aggregate demand. That’s equally true of the Say’s Law version of classical economics criticized by Keynes, the New Classical macroeconomics of Robert Lucas and the attempts by Real Business Cycle theorists like Kydland and Prescott to explain cyclical fluctuations in terms of labor market shocks.

The crucial problem for all these theories is that labor markets and the associated institutions operate mainly at the national level. Even within the EU, different countries have very different labor markets. So, it is essentially impossible for labor markets in many different countries to move together, except as the result of macroeconomic influences operating at an international level[1]. That means that the occurrence of a sharp and sustained increase in unemployment, taking place in many countries at once, is inconsistent with classical economics.

This point seems trivially obvious, but as far as I can tell hasn’t been made, or at least not clearly. Once it’s conceded, it seems impossible to avoid a view of the world that is basically Keynesian in its analysis of the macroeconomy. It is possible to hold such a view and reject Keynesian policies on pragmatic grounds, as in Friedman’s critique of ‘fine-tuning’. But the longer and deeper the recession the harder it is to sustain this view.

Where to begin?

1. How about if we [with great reluctance] hoist Mr. Quiggin on his own petard? I’m going to rewrite his arguments, almost word for word, to prove the same way he did that aggregate demand cannot be the cause of recessions. I will requote him, putting my changes in bold.

There is, though, one way in which the current Great Recession/Lesser Depression provides a sharp test of a critical proposition in economics. All forms of Keynesian economics involve, in one form or another, the claim that the causes of unemployment are to be found in level of aggregate demand, and not in govt meddling with the money supply. That’s equally true of the …version of… economics beloved by Keynes, the New Keynesians, and all the Keynesians of various stripe.

The crucial problem for all these theories is that aggregate demand operates mainly at the national level. In fact, it is a meaningless statistic, since demand operates at an individual level. Even within the EU, different countries have very different people, each one making his own personal decision about whether to buy something or not. So, it is essentially impossible for aggregate demand in many different countries to move together, or even within one country, or one building on one street in one village, except as the result of macroeconomic influences operating at an international level. That means that the occurrence of a sharp and sustained increase in unemployment, taking place in many countries at once, is inconsistent with Keynesian economics. Indeed, Keynesian economists have no explanation of why there is a lack of aggregate demand. Their grasp of economics is so superficial they don’t even think it’s a question worth asking.

This point seems trivially obvious, but as far as I can tell hasn’t been made, or at least not clearly. Once it’s conceded, it seems impossible to avoid a view of the world that is basically non-Keynesian in its analysis of the macroeconomy. It is possible to hold such a view and push for Keynesian policies on mystical grounds. But the longer and deeper the recession the harder it is to sustain this view.

2. According to AE, both lack of aggregate demand and unemployment are not causes, but symptoms and results, of recessions.

What causes recessions are what Krugman has called degradation of the country’s underlying productive capacity. And the unemployment that follows is a result of that degradation, as the decline in aggregate d. We’ve spoken about this on our humble blog here: https://smilingdavesblog.wordpress.com/2013/03/22/flaws-in-krugmans-hangover-theory-in-simple-language-part-two/

And what causes that degradation? All the things Mr Quiggin is so in favor of [from the best but the most misguided intentions], mainly deep govt involvement in the economy. What starts the degradation is inflation of the money supply, and what keeps it from being repaired is all the laws made to increase unemployment, such as minimum wage, support of illegal union activity, so called environmental laws that ultimately destroy the environment, govt protection of … but the list is long. This is not the place to repeat it all. Just search the articles at mises.org and this humble blog.

3. As for Mr Quiggin’s query about how recessions go international, there are two simple answers. First of all, now that all Europe has one currency, inflating its supply means inflation of the money supply in 23 countries simultaneously. In fact, that is the whole reason the Euro was invented, as Phillip Bagus lays out in his free book, Tragedy of the Euro. Since inflation of the money supply is what causes recessions, as AE explains at length [search here and mises.org], we’ve already accounted for half the Western world.

But even without the Euro, Mr. Quiggin has temporarily forgotten the very basics of economics when he asks that question. I refer, of course, to Say’s Law. Even those who reject certain forms of the Law all agree with this version of it, that you cannot trade for something unless you offer something else in return. That’s what trade means. Thus, if there is a recession in one country, say the United States, it can no longer trade with other countries, because it is no longer producing anything to trade with. Which means all the countries the US trades with have lost hundreds of millions of customers.

In modern times, meaning since the 1800’s or so when stock markets came into existence, there is yet another simple answer which Mr Quiggin temporarily forgot about. If, as if of course the case, citizens of other countries own stock in American companies, and America goes into recession, all those stockholders will lose a lot of money, driving their countries too into recession if the losses are big enough.

Mr Quiggin has written a book called Zombie Economics, about silly economic ideas that still persist. Bottom line, I think it fair to say that his article deserves a chapter in that book.

LATER: Mr Quiggin was kind enough to email me about this article, and allow me to reply here. The email:

Dear David,

Thanks for writing. I’ll ignore the preliminary throat clearing, since you only get to the point in the final two paras, where you give a straightforward Keynesian explanation of the international transmission of demand shocks

“Thus, if there is a recession in one country, say the United States, it can no longer trade with other countries, because it is no longer producing anything to trade with. Which means all the countries the US trades with have lost hundreds of millions of customers. In modern times, meaning since the 1800′s or so when stock markets came into existence, there is yet another simple answer which Mr Quiggin temporarily forgot about. If, as if of course the case, citizens of other countries own stock in American companies, and America goes into recession, all those stockholders will lose a lot of money, driving their countries too into recession if the losses are big enough.”

I agree. Demand shocks cause recessions, as Keynes said.

Sincerely