The Cause of Boom-Bust Asymmetry Is NOT Krugman’s Nominal Wage Rigidity But Mass Destruction of Productive Relationships

Paul Krugman (2013), by no means an adherent to Austrian economics, has drawn attention to the asymmetry problem of booms and busts: the phenomenon that increased unemployment occurs during the structural adjustments of the bust, but not during the structural adjustments of the boom, which he explains by reference to downward wage rigidity. During a boom period wages tend to rise, but during the bust they do not fall as much and as rapidly as they should in order to prevent increased unemployment. 

An alternative explanation is provided by Andolfatto (2013), who argues that the most obvious cause for asymmetry is not to be found in nominal rigidities, but rather in the mass destruction of productive relationships, which takes place during the bust. In his view, the labor market is a market for productive relationships, or what he calls relationship capital. Just like physical capital, relationship capital is redirected onto unsustainable paths during the boom. Relationships are built up, intensified, replaced or adjusted during the boom, merely to get destroyed during the bust. In his own words:

The basic idea is very simple. [. . . ] The labor market is a market for productive relationships. It takes time to build up relationship capital. It takes no time at all to destroy relationship capital. (It takes time to build a nice sandcastle, but an instant for some jerk to kick it down.) (Andolfatto, 2013)

—Karl-Friedrich Israel, “The Costs and Benefits of Central Banking: Modern Monetary Economics along a Methodological Dividing Line” (PhD diss., Université d’Angers, 2017), 250-251.

“Rational Expectations” Theories Explicitly Acknowledge the Postulate of “Money Neutrality”

The theoretical revolution dubbed ‘rational expectations’, which occurred around mid-1970s, came to reinforce the classical dichotomy [between monetary/nominal values and real values] that had already been dominating economic thought for over two centuries. The introduction of expectations of variations in the purchasing power of money was grounded on the postulate that economic agents can understand the connection between money and the price level. On the assumption that economic agents do not suffer from the ‘money illusion’, rational expectations theories expected them to be able to sieve through market signals and discriminate between nominal and real changes. Lucas (1975) and Sargent and Wallace (1976) therefore concluded that only real changes affect real decisions, and that variations in the purchasing power of money are neutralized if correctly anticipated (McCallum 1980)—not only in the long run, but in the short run as well (Kaldor 1970; Lines and Westerhoff 2010). The dichotomy between the monetary and the real sectors of the economy was in this way restated in even stronger terms, with the postulate of money neutrality explicitly acknowledged.

—Carmen Elena Dorobăț, “Cantillon Effects in International Trade: The Consequences of Fiat Money for Trade, Finance, and the International Distribution of Wealth” (PhD diss., Université d'Angers, 2015), 53.