Saturday, December 31, 2011

A Quasi-Keynesian Solution to the Great Recession

In the perfectly competitive economy of the textbooks, firms can sell as much as they want at prevailing prices. This premise is especially out of place at the moment. Many firms would be happy to sell more at prevailing prices if only there were buyers. Let's start with an oversimplified model of our current predicament.

Imagine a two-firm economy in which the wages paid out by firm X are spent on the output of firm Y, and vice versa. If X believes Y will be hiring additional labor, then X will expand its output, and if Y believes the same about X, Y will expand, and the result will be a high-output equilibrium. If both X and Y expect the other to reduce output, then you’ve got a low-output equilibrium.

There are, of course, more than two firms in the real-world economy, but can we modify our simple model easily enough. Let's keep our original firm X, but call it General Electric. But now let Y represent not a single firm, but the other 499 firms in the S&P 500. Since the "S&P 499" comprises a large share of economy, it's not implausible to suppose that General Electric's sales revenue will depend on the hiring decisions of the "S&P 499." 

And, we may add, that all the firms in the S&P 500 face General Electric's predicament, which is to say that their sales will also depend on the hiring decisions of the S&P 499. The trouble, of course, is that each of the S&P 500 firms is uncertain about the hiring plans of the S&P 499. So, what is to be done?

First, we can hook up all S&P 500 firms via a computer network (alternatively a wider range of firms could be included). Second, the "auctioneer" at the center of this network asks each firm how many additional employees it would hire in the U.S. if total hiring by other S&P 500 firms in the U.S. increased by X%. This pooling of conditional intentions would continue until a consistent set of intentions is found. If firms fail to meet their hiring "commitments," they are subject to a tax, and some portion of the revenues from this tax would be transferred to the firms which kept their commitments.

By this method, we can transform a coordination game, which has both high- and low-output equilibria, into an assurance game in which a high-output outcome is more likely than a low-output equilibrium.

1 comment:

  1. Can the firms thus be coordinated unless they all have growth potential?

    Let us consider the possibility that there would not be a demand for General Electric’s products even if people had plenty of money and saw no reason to save. They might be trying to sell products wrongly prognosticated to fill the consumer’s needs. And let us consider that this predicament had befallen a large part of the S&P 500 firms, resulting in lots of people losing their income and fear gripping those who still could spend, spreading the problems all through the economy in untraceable patterns. Then partly, or even if possible, fully, reinstating that lost purchasing power would not help, as the partial glut initiating the depression would still remain. There has to be, in my model, some painful redistribution of capital, with those unknown firms who made the wrong decisions disappearing, or downsizing, or coming up with better products.

    (But of course reinstating confidence and keeping the really radical monetary cranks at bay might still be necessary, and might only be done with convincing theatre. I for one would much prefer Roosevelt to many of his contemporaries, and would vote for Obama rather than Romney if I were an American!)

    S. J. B.