Knowing and Making

I've had a go at Allister Heath in this blog before. Looking back , I realise that it was on the same subject as today's post: quantitative easing. As I read his column in City AM today, I wondered: when I disagree with someone this much, and yet he is so sure of himself, should I question my beliefs? So I questioned them, and read the column again, and realised: no, 90% of macroeconomists are right, and Allister Heath is wrong. Heath argues with conviction that the Federal Reserve's "hubris" will cause inflation without helping the economic recovery. It's a version of the Austrian story: the economy must undergo a necessary recalculation, restructuring, reallocation of resources, before a recovery can happen. Stimulus will just paper over the cracks and maintain the distortions in the economy. There are reasonable arguments that this may be true of fiscal stimulus (though on balance, I don't agree with them). But monetary stimulus (including QE) can h...

Another example of how Austrian economics is nearly right but, at the last minute, gets it all wrong. This article from Peter Boettke on Coordination Problem makes an insightful distinction between order and complexity in two different dimensions. He says: I often use a 2 x 2 matrix to communicate to students the different schools of thought in economics. The rows reflect the problem situation we are find ourselves in (simple or complex), the columns reflect the outcome of our interactions (order or disorder). Neoclassical economics is found in the simple/order cell; Keynesian and market failure theory is found in the complex/disorder cell; Marxism and critics of economics are found in the simple/disorder cell. What does that leave? The complex/order cell and that is the intellectual home of the Classical economists such as Smith-Say, the Austrian school from Menger to Mises to Kirzner, and the New Institutional school of Alchian, Buchanan, Coase, Demsetz, North, Olson, Ostrom,...

Interesting but depressing Paul Krugman interview Interesting but depressing Economist cover story I was going to write about bubbles, but an almost throwaway point from the Krugman interview led me into thinking about devaluations instead. He suggests that Spain might need to (as Estonia has already done) reduce wages and prices across its economy to regain competitiveness, because they can't take the shortcut of devaluing their currency. And this, as he points out, is going to be difficult. Devaluations were a concept that used to fascinate me as a teenager (OK, maybe I was an odd teenager - but in my defence this was before I had a girlfriend). The topic hasn't been as prominent recently, except in the debate on the Chinese-US exchange rate. But Krugman's comment started me wondering just why it should be so hard to achieve a cut in prices these days. After all, wages and prices are just nominal values; yes, there are costs to changing them but they're not tha...

Do we implicitly extrapolate, unconsciously, from how we make a single trade to how we behave in markets generally? We have a basic need to fix the price of a transaction for long enough for the trade to complete. If I agree to buy this beer from you for £3.40, and by the time it's finished pouring, the price might be £3.75 (or indeed £2.90) neither of us is likely to buy or sell much beer. For a transaction of this kind to work, the terms should be known in advance to both parties and remain the same for the duration of the trade. And with our minds' amazing capacity to extrapolate, it's not such a big leap from there to the expectation that prices will remain stable over a slightly longer period of time (an hour, a day, a month, a year?) Whatever learning mechanism creates this stability of expectations over the duration of a single transaction can surely be fooled into expecting the same thing for a bit longer. This is reinforced by the tentative and exploratory nature ...

Synthesising the whole stimulus debate into a few lines, there seem to be a small number of messages: Stimulus is good because it gets idle resources producing something Stimulus is bad because it moves productive resources into less productive use Stimulus is bad because its cost has to be paid back, reducing future efficiency Stimulus won't work because rational consumers will save as much as the government spends Stimulus is good/bad because government spending is efficient/inefficient These messages are not necessarily contradictory - some of them are orthogonal. The truth of each assertion all depends on your model of how the economy works - and especially on one big factor: how much friction is there? In an economy without friction, much of the argument would disappear. Idle resources would be immediately reallocated to some other use, since there is always somebody with savings that they could switch to consumption. Prices would adjust. Resources would always go to the most ...