August 30, 2010 12:43PM

Tyson’s Keynesian Confusion

UC‐​Berkeley Professor, and former Clinton economic advisor, Laura Tyson lays out why she believes we need a second stimulus. Her op‐​ed is a worthwhile read for understanding the basic assumptions behind modern Keynesian thinking.

Foremost among those assumptions is a belief we are in a recession due to “a collapse in private demand.” In Professor Tyson’s world, if only everyone would buy more, everything would be OK (starts to sound a lot like President Bush in 2002). But what exactly has been going on with private demand? Judged by private personal consumption expenditures, it is actually up and higher than at any point during the boom, after reaching bottom in the Spring of 2009.

The following chart, from the St. Louis Federal Reserve, nicely illustrates the direction in private demand.

Media Name: consume.bmp

So if Tyson’s narrative that weak demand is holding back employment is false, or at least incomplete, then what is holding back unemployment? In a word: Investment.

Unlike consumption, which has largely rebounded, investment today is about 20% below its peak. Of course we should keep in mind, that peak was a bubble. The good news is that investment in such things a equipment and software, are slowly, but steadily, climbing back. The real drag on investments is from the construction industry, particularly residential, which is still down about 50% from its peak. 

Media Name: invest.bmp

What most of this suggests to me is that unemployment is being driven mainly by a mismatch between skills of the unemployed and available job openings. You simply cannot, overnight, turn a construction worker into a nurse or computer programmer. Tyson seems to half‐​way recognize this when she argues for stimulus to be directed into education, although she only seems to be talking about future skills mismatch and ignores the mismatch facing the economy today. For if increased aggregate demand is all we need today to reduce unemployment, then wouldn’t the same hold true for future unemployment, removing the need for educational funding?

At the end of the day, what we need to get employment increasing is to create an environment where business feel confident to invest.