Hayek’s Solution

There’s no shortage of worrisome trends on the macro stage, but perhaps the most troubling is the trend in real (inflation-adjusted) hourly earnings and personal consumption expenditures. Both have been falling persistently on a year-over-year basis. Some economists see this as a dark sign for the business cycle. It’s also a test of Hayek’s idea that falling wages will plant the seeds of economic recovery. By that standard, macro salvation is coming.

The New Yorker’s John Cassidy explains:

Before the Great Depression, most economists adhered to a Newtonian conception of the economy as a self-correcting system. When the economy entered a slump, businesses laid off workers and shut down factories—but these negative trends contained their own remedy. The trick was to look at price changes. Unemployment drove down wages (the price of labor) until firms found it profitable to start hiring again. Idling factories drove down interest rates (the price of borrowing) until entrepreneurs found it worthwhile to take out loans and re-start production. Before very long, prosperity would be restored. Attempts to hasten this process were liable to interfere with the natural forces of adjustment and make things worse. As Hayek wrote in “Prices and Production ” (1931), “The only way permanently to ‘mobilize’ all available resources is . . . not to use artificial stimulants—whether during a crisis or thereafter—but to leave it to time to effect a permanent cure.”

If there’s hope in falling wages, the chart below should inspire Hayek’s followers to see revival approaching. Real average earnings are plumbing depths unseen in recent history. And on Friday we can ponder a new data point via the September update for personal income and spending. The question before the house: Will Hayek’s cure will bite or befriend? The crowd’s reaction to Friday’s report may offer a clue.

3 thoughts on “Hayek’s Solution

  1. Glen

    Real average earnings may be going down, but what about the cost to the employer considering taxes, regulations, health care requirements, etc, both current and anticipated?

  2. josh

    How can we be “testing Hayek’s solution?” This is not a free market. We are attempting “artificial stimulants” left and right. (“left and right”–double entendre intended.)

  3. oldone

    Yes, labor prices must come down before employment picks up. But as your chart also shows if labor prices are consistently below expenditures, then at some point expenditures will drop, and recession follows. The end of a recession is preceeded by a period where labor costs rise faster than PCE.
    Actually, it seems like recession is defined as the period immediately following a drop in PCE, and the end of recession the point where PCE begins to rise again.

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