"Running the economy hot" is the buzz phrase of the last month. The metaphor is of an engine that's more efficient when it's run at higher RPM. Your car does this: it probably chugs a bit while idling at a signal at about 650 RPM, but it purrs when you drive around town at 1800 RPM.
In the pandemic/lockdown recession, this metaphor suggests that previous administrations and Congresses did not give the economy enough gas (probably because mean Republicans somehow benefited from this), and only this spring has Democratic control of Washington come in the nick of time to stomp on the gas.
As if.
Tyler Cowen is economics most popular blogger, a columnist for Bloomberg, and professor at George Mason University with a serious (but not amazing) publication record. Back in January he posted this (quoted nearly in full, no need to click through):
In Keynesian economics, “running the economy hot” boosts employment by lowering the real wage.
In Lucasian economics, “running the economy hot” boosts employment by fooling people into thinking that real wages are higher, when they are not.
In #thegreatforgetting economics, “running the economy hot” boosts employment and real wages by…boosting employment and real wages.
It is actually the much-maligned supply-side economics that, at least in principle, makes sense here.
That's not a real hashtag. Rather it's a sort of a text meme that they use at Marginal Revolution to draw attention to the fact that a lot of tweeters seem to not know much that happened before a decade or so ago. (And personally, I think a lot of those people are still upset that Obama didn't turn our world into one in which unicorns eat candy and poop rainbows ... and their preferred solution is to amp things up this time around).
In Bloomberg two weeks ago, he gave a fuller (and lower level) explanation in the article entitled "Will 'Running the Economy Hot' Really Help Workers?" (this might be gated, check the library if you can't find it online).
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The thrust of all this is that a lot of people seem to be ignoring tradeoffs ... ya'know, that core thing we start teaching you in the first week of principles of micro?
The tradeoff to think about is that employers do not employ people out of the goodness of their hearts. They employ them because they are worthwhile. And ... at any point in time they're probably OK with the mix of workers and wages they have, since if they weren't they'd be changing things in an obvious way, and most of the time we don't see that.
Employers would happily hire more people if they could pay them less. This is the Keynesian story.
Employees would happily work more if they were fooled that they were getting paid more, while employers would take advantage of that is they have better information. This is the Lucas' story.
Running the economy hot means pushing demand to shift to the right with fiscal policy, causing a movement up and to the right along supply. Q goes up, and P goes up (and remember that a wage is a form or price). Ouila!
This runs into the problem that demand shifts have transitory effects. Some people don't like all the extra work, and they respond by demanding a higher real wage. But note that's the opposite of the two one-sentence stories laid out at the top. In both of these stories, it means that rising employment will be followed by falling employment ... a point some of you may remember from my principles class.
An additional problem is if the effects are transitory, and you're an elected official, that next election is a very serious event. And the way that you make transitory effects "permanent" is by following them with more of the same. It isn't a mistake that as soon as ARPA was passed, that the White House started pushing for a big infrastructure bill. It isn't a mistake that ARPA, like the ARRA of 12 years ago, really spreads the spending out through time, so that as the effect of earlier spending fades, new spending comes online.
All in all this might be a good time to go back and skim Friedman's 1968 Presidential address to the American Economics Association, or Edmund Phelps who'd been making the same point for a few years before that. Not surprisingly, they both went on to win Nobel Prizes. Hmmm. The point they made back then is that each repeat of the expansionary fiscal policy cranks up the inflation rate by a bit ... and that it has no little tendency to come down on its own ... until you start pursuing contractionary fiscal or monetary policies. In the U.S., it took about 15 years for the 'run the economy hot' people in the 60s and 70s to begin to undo their damage. Of all people, it was a Democrat — Jimmy Carter — who came to his senses first.
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4/16 Update
It occurs to me that the quote "It is actually the much-maligned supply-side economics that, at least in principle, makes sense here." might not make much sense to students without a little more background.
Supply-side economics is the idea, mostly associated with some Republicans (like Reagan) that the economy would improve if government focused more on the (aggregate) supply side.
The name itself is kind of a slam at Keynesian policies that prevailed before 1980. Those were focused almost exclusively on the aggregate demand side.
Now, there's some rhetorical sleight-of-hand here: suppliers of goods and services are the ones who demand labor. (In micro, this is called a derived demand). So a policy that helps out suppliers is going to shift the demand for labor to the right. That will tend to increase both Q and P: in the labor market, those are employment and wages.
Cowen's snarky point is that supply-siders (though much-maligned over the last 30 year) at least had a theory of how they were going to increase employment and wages at the same time. And, while there's a lot of people in denial still, the data tends to support their position.
Cowen asserts that #thegreatforgettingeconomics don't seem to have a theory about how this will happen, and given his assertion elsewhere that there's little evidence for procyclical wages without a supply-side push, no past data to back themselves up with either.
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