Is the Keynesian spell breaking?

In July, there was a media frenzy suggesting that the economy would tank if Congress did not pass another huge stimulus bill. According to the Financial Times, the spell finally seems to be breaking:

Hopes of Congress and the White House reaching a deal on further economic stimulus have faded, as an unexpectedly steep drop in the jobless rate has stifled appetite among Republicans and the White House for a compromise on new coronavirus relief.

Haggling over fresh federal support for the US economy will resume when lawmakers return to Washington after their summer break this week, as the impact of $3tn in relief funds approved at the start of the pandemic fades.

Economists and analysts expected an agreement to be struck by the end of the month to plough about $1.5tn in new government money into the economy, which could be pivotal to sustaining the US rebound. But prospects for a deal have diminished.

The strength of equity markets throughout August, as well as Friday’s data showing joblessness dropping to 8.4 per cent, below the unemployment peak during the Great Recession, has removed some of the pressure on Republicans on Capitol Hill, and Trump administration officials, to strike a deal. 

That’s not to say I entirely support the GOP position. There may be elements of a stimulus package that can be justified on humanitarian grounds, or to help with the Covid emergency. But we certainly don’t need fiscal stimulus to boost demand.

Bloomberg provides further evidence that the main problem is on the supply side:

As the economy picks up, America’s warehouse and factory owners increasingly find they can’t fill jobs without boosting meager wages.

E-commerce is driving a surge of orders, with U.S. manufacturing expanding in August at its fastest pace since late 2018. That has employers racing to bulk up staff to keep production rolling and satisfy demand. . . .

“It just doesn’t make sense,” said Richard Wahlquist, chief executive of the trade group American Staffing Association. “It’s an employment market like no one in our industry has ever seen.” . . .

It suggests the ample supply of available labor hasn’t necessarily cured the nation’s skills gap, where workers don’t have the qualifications employers need, and the pandemic probably will speed up the use of robotics that’s already under way, Moutray said.

Online retailer CJ Pony Parts in Harrisburg, Pennsylvania, tries to fulfill orders from Ford Mustang and Jeep fanatics the same day it receives them. A shortage of workers, though, is keeping it from hitting its goal by 40% some days, said President Mike Large.

The “it just doesn’t make sense” comment reflects the fact that we are experiencing a supply shock that is unique in US history. We need to quickly move millions of workers from service jobs eliminated by social distancing to other sectors like goods delivery, construction, and manufacturing. That re-allocation takes time and requires job training. Thus employers bid up wages even though overall unemployment is still high. (Generous unemployment compensation may also be a drag on re-employment, although some studies suggest otherwise.)

Keynesian stimulus is not designed to address this situation. Textbook models of stimulus are aimed at addressing falling wages due to deficient AD, not rising wages due to supply bottlenecks.

Keynesians have the wrong diagnosis and are recommending the wrong medicine. This is what Arnold Kling calls a “recalculation recession”. The solution is not stimulus, it’s masks plus test/trace/isolate. In the long run it’s a vaccine and or drug treatments.

PS. Tyler Cowen just linked to a new paper by Raj Chetty, John N. Friedman, Nathaniel Hendren, Michael Stepner, and the Opportunity Insights Team. This is from the abstract:

Stimulus payments to low-income households increased consumer spending sharply, but little of this increased spending flowed to businesses most affected by the COVID-19 shock, dampening its impacts on employment. Paycheck Protection Program loans increased employment at small businesses by only 2%, implying a cost of $300,000 per job saved. These results suggest that traditional macroeconomic tools – stimulating aggregate demand or providing liquidity to businesses – have diminished capacity to restore employment when consumer spending is constrained by health concerns. During a pandemic, it may be more fruitful to mitigate economic hardship through social insurance.