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12/07/2008

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Edward J. Dodson

One must ignore crucial aspects of our history to conclude "the past quarter century has been a great period of growth and stability for most of the world."

Economics needs to re-examine some of its fundamental methods of analysis.

Understanding the causes of the business cycle is impossible relying on the neoclassical assertion that the price mechanism operates to return unstable markets to a circumstance of general equilibrium. The only way the mathematical equations even make sense is by recategorizing nature as a form of capital. The political economists understood the distinction, and they debated at length whether "rent" -- as a claim on production -- ought to be treated as common property or as private property. Economists early in the 20th century abandoned this line of investigation because it involved questions of moral significance and with greater frequency came to redefine "rent" as any return above what is minimally required to bring any factor of production to market.

And, then, there is the unwillingness to discard GDP as a measurement of anything that provides insight into the well-being of a society. Redefining Progress came up with a much more accurage gauge in the 1990s -- the GPI (Genuine Progress Indicator). By the GPI, the quality of life for a majority of the U.S. population has been declining since the mid-1970s.

neilehat

The Grand Illusion? The Grand Illusion is the idea that the U.S. can have an economy without employment. In excess of a half a million Americans lost their jobs in November. going forward, how many in Dec., Jan., Feb., March, April, May, June, July, August, September, Oct.? And going backwards ... how many millions of jobs lost? Remember the experts said there "IS NO RECESSION besides they're only temporary dislocations"!

The secret of a well functioning economy is Employment, Stability, Security, and the elimination of FEAR. The problem is how do we get to there from here. Now that the system has been wrecked.

Greg Ransom

In 1954 the price of a stamp was 3 cents.

In 2008 the price of a stamp is 42 cents.

That Mr. Becker is MASSIVE inflation, and it's a massive institutional failure, a failure of the first order.

The job of money is to be a store of value.

An constantly inflated currency is an ongoing act of theft -- its a currency that robs class of economic agents for the benefit of another.

3 cents in 1954, 42 cents in 20008 -- that's a LOT of theft.

Bob K.

Economists from the Austrian School were not unprepared for this crisis.

Richard

It seems to me that some recessions have more clearly followed the inflation-got-too-high-and-The-Fed-stepped-on-the-brakes model than others. The 1969-70 and 1981-2 recessions are clearly of that type.

But some are caused by factors that are largely exogenous to inflation and interest rates. I would include in that category the recessions of 1973-5 (oil shock), 2001 (dot-com bubble) and 2007-? (imprudent mortgage lending). Of course, the 1973-5 recession was accompanied by high inflation, but there seems to have been more to it than overly expansive monetary policy.

Monetary policy might be less efficacious (if at all) for this second category of recessions. Therefore, if one sees monetary policy as a panacea for all recessions, yes, I suppose that is a grand illusion.

Dan

Richard, the Fed's monetary policy certainly contributed to the current crisis by maintaining a low rate for too long.

But I do agree with your point that too much faith has been placed in the relatively meager tools of current monetary policy.

I think medical analogies are apt here. The human body is a highly complex system but that fact alone does not discourage the developments of new treatments. It seems to me the development of treatment modalities for different economic ailments should be an incredibly exciting field to be in but most of what I read here is the same old same old.

Guy

I think you overstate the benefits. Introducing capitalism into countries without institutions equipped to handle it has resulted in disgusting displays of inhumanity. While improving the monetary lives of many, the destruction left in the wake of unregulated (quasi-pure) capitalism (in 3d world countries) is, at least, a counter-balancing consideration. Further, the wealth gap has increased in many of these countries (and in the US, I might add), creating a system that makes it more difficult for the impoverished to lift themselves out of the doldrums.

Grad Student

Greg,

You can't define inflation as the price of a stamp. Inflation has to do with all prices.

ZR

Here in Malaysia, the fact that rapid growth in global trade and stability in the global economy has led to rising standards of living is a reality, not merely something that is read off textbooks. In almost 4 decades since 1971, the poverty rate here has declined from more than 50% to 3.6pct in 2007.

As a country that continues to be dependent on global trade (our total trade amts to more than 100 pct of GDP), Malaysia will surely be greatly affected by a global recession, if it comes to pass. But I don't think any emerging country, Malaysia least of all, would go so far as to reject wholesale the global economic consensus of the past few decades.

What needs tweaking, should be tweaked. But that opportunity must be seized, now, before the crisis passes and we lose that window of urgency to make the necessary structural changes.

John Papola

I don't see how anyone can view the fiscal picture of the US government and feel that our policies have been reasonable or sustainable. All of this wonderful "moderation" for the past 25 years has been bought on a credit card called the national debt. If you gave me the kind of unlimited credit the government gives itself, I guarantee you'd see my personal economic situation be very prosperous and moderate looking too.

Add to that the fact that our monetary policy has been at the heart of the two enormous bubble/bust cycles in the past 20 years and I see more justification than ever for the elimination of the central bank. And, of course, one can't underestimate the moral hazard problems inherent in have a "lender of last resort". Bank failures, like all business failures, are part of the creative destruction that teaches the market what does and does not work. The Fed's existence has enabled banks to reduce their equity and capital to dangerous levels and, combined with pyramid scheme of fractional banking, we're now seeing the result: systemic fragility on an epic scale.

I just don't get it. Mainstream economists decry the negative savings rate of the average American, yet seem to miss the fact that Central bank price-fixing of interest rates as well as inflation fundamentally undermine savings. These policies literally FORCE people to speculate with their savings in investments lest they watch inflation destroy them.

Then there's the immoral redistribution of wealth from the average person to the banks and government contractors who get the Fed's new money first and subsequently drive up prices for the rest of us.

Even more bizarre and insidious is the irrational fear of deflation that has been propagated by the Federal Reserve and it's supporters.

I see no reason to fear the gentle, productivity-driven price deflation of a fixed or slow-growing money supply based on precious metals. The technology industry has been fundamentally deflationary since it's inception with no ill effects on the growth of the business and huge benefits for consumers. Prices SHOULD go down as the cost of production go down in competitive markets.

The past 25 years have had unique successes driven in large part by new information technology and deregulation but our public fiscal and monetary policy has been a total disaster. The Fed has gotten away with massive inflation on behalf of the government and the banks while the effect on consumer goods has been muted by the deflationary forces of globalization. But those forces couldn't mask the destructive mal-investment in unproductive assets and speculative commodities at the heart of this enormous crisis.

It's time to kill the fed and re-instate the gold standard. Clearly the government and the politically connected economists don't deserve the discretion of a fiat money supply. Clearly.

Gu Si Fang

Pr. Becker,

I am confused that you chose to so ignore the austrian business cycle theory. The Nov 9 post displayed no acquaintance with ABCT, and described it as an old-fashioned theory aiming at "removing the poison from an economy that builds up during good times". In response to this post, Robert Murphy has written an open letter which can be found here : http://mises.org/story/3220

One of Milton Friedman's immense contributions was to convince academia that the expansion of the money supply was the main cause of inflation, at a time when some economists were still denying this assertion. He was also very critical of the arbitrary power of central banks and wished they were replaced with a laptop computer. But they were not, and no one seems to understand the consequences better than the austrian school.

What they say is basically that central banking etc. are the cause of business cycles. They are still there, and they certainly cannot be expected to rid us of business cycles. Quite the contrary.

Dan

Inflation by itself is not necessarily harmful. If everything else (salaries and interest rates, especially) keeps pace with inflation, it's a wash. You don't lose buying power as long as your wages keep up with inflation.

Where inflation is a problem is when your savings account gives you a 2.5% interest rate but the annual inflation rate is 3% or 5%. Then you really are losing buying power.

thanks

thanks

Phillip Huggan

I guess if you define economy as GDP it is been a nice run. But real earning power has fallen for most Americans since Reagan. It is the opiate of Moore's Law and cheap electronics in everything that have pacified the masses. I'm sure the latter could occur in a way that doesn't induce a depression among the economy of most Americans.

China has been a beneficiary but saw most of its growth not even noted by economists as massive food production gains and associated nutrition gains. Russia and Africa haven't been so lucky (alcoholism and AIDS, respectively).

I'd call the performance mixed. There really haven't been any innovations since the Great Depression and a central bank can't tell the difference between supply and demand inflation.

Skimming through the CB wiki: interest rates were obviously set way to low since 9-11. Federal debt should be treated as if it were increased inflation; is ignored. Reserve requirements for banks have been lowered while derivative gambling increases?! No novel advances for assets to replace millenia old gold reserves. I'm thinking things like wheat reserves, nationalizing rich mineral reserves, copper reserves, nickel reserves, natural gas reserves...
Banks will change lending rates through time, but not penalize investment banks and banks with shoddy accounting?!
Mixed record. No creativity. You'd swear Central bankers are nothing but old white Republicans.

Redmund Sum

I am amused by one of the above post that says the postage rise from 3 cents in 1954 to 42 cents in 2008 is a LOT of theft.

It is not that at all. Nor is money's function a store of value.

The function of money is a mediating agent for trade; a "lubricant", if you will. As such, it is also a temporary store of value.

If you had put your 3 cents in the bank at compound interest rate of 5 percent per annum, your bank would have exactly 42 cents today.

Chris Graves

Professor Becker's title to his essay this week is fitting. It is a grand illusion to believe that one person or committee of people can discern the ramifications of tinkering with the money supply continually. Contrary to some comments above, the complexity and dynamism of the economy prevents central planning of any sort, including continuously managing the intricacies of money supply. As F.A. Hayek observed, as those in authority on high have more discretion in discharging their responsibilities, those who make decisions on the spot correspondingly have less discretion to alter their actions to meet the demands of the moment.

Also contrary to comments above, inflation is not harmless. The fact of the matter is that some people receive the increases in money first and they benefit unduly as prices have not yet responded to the injections of money as the new money has not yet worked its way through the system. These people not only gain personally at everyone else's expense, but they also bid up prices in selective sectors of the economy creating distortions in relative prices. Monetarists falsely believe that inflation is only manifested in rises in the general price level while changes in relative prices are only due to market fluctuations in supply and demand. This assumption is tragically false as Greenspan and Bernanke have found out the hard way. The distortions in relative prices created by inflation, even if the general price level is stable, creates the overinvestment in certain sectors of the economy that not only misallocate resources but sow the seed for bubbles and their subsequent collapses as we are in the process of witnessing once again.

I am sorry to see Professor Becker praise the Fed for lowering interest rates to stave off recession (depression). Once again, if the Fed artificially lowers interest rates without the necessary attendant real savings to sustain investments undertaken, then entrepreneurs spurred on by the false signals sent out by the Fed will overinvest in projects that cannot be sustained over time. We will just have another round inflation followed by a more severe correction later.

What both Professor Becker and Judge Posner, along with most Keynesian and Monetarist economists, completely overlook in this crisis and macroeconomic theory generally is the importance of Say's Law especially in the essential area of the circular flow of savings and investment as well as a theory of capital.

Sr Max Higgins

Bank of America and Mr. Higgins missing $millions, It can happen to you, my fellow Americans


More info: http://mrhigginsbank.blogspot.com/

nathan

more on influence costs

Distinction between treasury and fed was interesting

اس ام اس عید نوروز پیامک عید نوروز

Merry Chrismas and happy new year for becker-posner-blog.com team & everyone!
New year new becker-posner-blog.com

Joyce

I recently came across your blog and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.

Joyce

http://www.videophonesguide.com

Joyce

I recently came across your blog and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.

Joyce

http://www.videophonesguide.com

Eddie Allen

CHICAGO - WE HAVE A PROBLEM. What about the '97-98 Emerging market meltdown. What about '94 Tequila Crisis. What about the Japan bubble and "Lost Decade" of the 90s. I somehow fail to see the brilliance of monetary management of the past 25 years; I also see a big hole in our understanding of the economy which has completely been ignored by the Chicago School and white water macroeconomists. (Lucas will regret his AEA Presidential Address where he basically said the big problems of the business cycle are not as important as growth.)

If this crisis does not put a nail in the coffin of the real economy dogmatists, then they are beyond saving.

Eddie Allen

CHICAGO - WE HAVE A PROBLEM. What about the '97-98 Emerging market meltdown. What about '94 Tequila Crisis. What about the Japan bubble and "Lost Decade" of the 90s. I somehow fail to see the brilliance of monetary management of the past 25 years; I also see a big hole in our understanding of the economy which has completely been ignored by the Chicago School and white water macroeconomists. (Lucas will regret his AEA Presidential Address where he basically said the big problems of the business cycle are not as important as growth.)

If this crisis does not put a nail in the coffin of the real economy dogmatists, then they are beyond saving.

Eddie Allen

CHICAGO - WE HAVE A PROBLEM. What about the '97-98 Emerging market meltdown. What about '94 Tequila Crisis. What about the Japan bubble and "Lost Decade" of the 90s. I somehow fail to see the brilliance of monetary management of the past 25 years; I also see a big hole in our understanding of the economy which has completely been ignored by the Chicago School and white water macroeconomists. (Lucas will regret his AEA Presidential Address where he basically said the big problems of the business cycle are not as important as growth.)

If this crisis does not put a nail in the coffin of the real economy dogmatists, then they are beyond saving.

Anonymous

دردشة صوتية

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