Krugman might respond to the first point by saying we should dump the new Keynesian model and go back to the old Keynesian unemployment equilibrium model. But even that won’t work, as the old Keynesian model used unemployment as the mechanism for the transmission of demand shocks to low output. If you showed Keynes the US unemployment data since 2009, with the unemployment rate dropping from 10% to 6.1%, he would have assumed that we had had fast growth. If you then told him RGDP growth had averaged just over 2%, he would have had no explanation. That’s a supply-side problem. And it’s even worse in Britain, where job growth has been stronger than in the US, and RGDP growth has been weaker. The eurozone also suffers from this problem.
The truth is that we have three problems:
- A demand-side (unemployment) problem that was severe in 2009, and (in the US) has been gradually improving since.
- Slow growth in the working-age population.
- Supply-side problems ranging from increasing worker disability to slower productivity growth
Likely all those things are true. But why? I posit that the demand shock was so severe (and long lasting) that it greatly helped mess up the supply side. That means that now, the previous level of activity is not attainable (at least for a long time). The charts indicate that all those supply side factors went “off” after the “Great(demand shock)Recession” hit, a consequence of the Fed´s (and many other central banks) “Great Monetary Policy Mistake” of 2008.
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