Richard Williamson wants an answer

Back in November, Karl Smith made the clearest statement I have ever read of the New Keynesian explanation of a recession:

I can’t hammer this home enough. A recession is not when something bad happens. A recession is not when people are poor.

A recession is when markets fail to clear. We have workers without factories and factories without workers. We have cars without drivers and drivers without cars. We have homes without families and families without their own home.

Prices clear markets. If there is a recession, something is wrong with prices.

Right now, unemployment remains at over 8% in the UK while real wages are lower than they were 7 years ago and are continuing to fall. Yes, you read that correctly. Which immediately leads one to ask: on this explanation of a recession as expounded by Karl, how much further do real wages have to fall to eliminate disequilibrium unemployment?

I am not a political person, I’m trying to ask an intellectual question here.

I don’t know. I say that with a heavy heart.

I don’t have immediate access to British data but the first question is: where are the margins going?

When an item is sold we can think of the revenue from that item as being broken up into pieces. Some of the revenue is paid to labor. Some is paid to capital in the most fundamental sense. Some is paid to natural resources or foreign inputs. Some is paid to residual claimants who are typically entrepreneurs or shareholders.

If prices are rising and wages are falling then one of these other group(s) must be getting more margin from the items being sold. If we know who this group is then that will help us attempt to untangle this puzzle.