Co-bloggers Arnold Kling and Bryan Caplan have been discussing Kling's "bizarre" macroeconomics.
Kling insists that the current recession (and perhaps all of them,) are due to a great "Recalculation." Sometimes, this amounts to a claim that there is a need to reallocate resources. Labor and other resources need to be shifted from some industries to other industries.
In macroeconomics, the unemployment associated with these sorts of shifts is called "structural unemployment." People are laid off in shrinking industries, and only very gradually find jobs in expanding industries. There can be a similar impact with capital goods, mostly involving a shift of existing capital goods to less valued uses, or even abandoning them as scrap, and only gradually producing new capital goods appropriate to the expanding industries. (The impact of "heterogeneous" capital goods plays a key role in the Austrian theory of the Business Cycle.)
Usually, the process of reallocation of resources is understood as being continuous, and the structural unemployment and losses from capital goods is one of the determinants of the potential output of the economy. For example, the higher institutional unemployment resulting from the sorts of labor market regulation common in Europe is a reason for their lower potential outputs. However, it is not difficult to see that a large shift in the composition of demand would result in larger shifts in resource allocation, higher structural unemployment, and slower growth in the productive capacity of the economy.
For monetary disequilibrium theorists, this would be described as a higher natural unemployment rate, along with slower growth in potential income. It is possible that in an extreme case, the productive capacity of the economy would shrink. However, as the adjustments are made, structural unemployment should fall, and the productive capacity of the economy should rise. Eventually labor will move, workers will be retrained, and new capital goods will be produced.
Monetary disequilibrium theorists, would insist, however, that this process could not possibly result in slower growth in nominal expenditure or nominal income unless it somehow impacts the quantity of money or the demand to hold money. And further, that if any changes in the demand to hold money are accommodated by changes in the quantity of money, then nominal expenditure and nominal incomes would not be impacted by these changes.
Suppose that such a policy exists. Nominal expenditure continues to grow, but the natural unemployment rate rises and productive capacity falls due to a need to redeploy resources. Then the shortages of goods whose demands are growing will result in higher prices for them. Substitution effects may dampen the decrease in the demands for the products of the shrinking industries, slowing the adjustment. The inflation--the higher prices--will also reduce real wages. This will dampen the losses in the shrinking sectors and so, their reductions in output. The lower real wages, as well as the higher nominal prices in the growing sectors will add to the profits there, both providing motivation and internal funding for a more rapid expansion.
As production expands in those sectors, rising supplies will push their prices back down. Any substitution effect that dampened the decrease in demand in the shrinking sectors is reduced. Real wages rise. That is no longer decreasing costs in the shrinking sectors as much. In other words, resources continue to be pushed out of the shrinking sectors. Further, the extra pull towards the growing sectors created by the temporarily higher prices and lower real wages also are smaller. In the end, the price level falls and real output rises, as do real wages. As a first approximation, the price level, real output, and real wages readjust to their previous growth path.
Looking at this scenario, it seems clear that avoiding monetary disequilibrium, and keeping nominal expenditure growing on its long term growth path, is the least bad option when there is a need for a reallocation of resources.