Comment by mhartl | Hacker News Reader

Comment by mhartl | Hacker News Reader

I've long had a hobby interest in economics, but it's only in the past couple months that I've really dug into macroeconomics and monetary theory (motivated, of course, by current events). It's weird: there's bizarreness at every turn---it's like studying astronomy for the first time, only to discover that the astrologers are in charge. The inmates are running the asylum.

To wit: take a look at "Baby-Sitting the Economy" (http://www.slate.com/id/1937/), an article Paul Krugman wrote in 1998. It describes a simple example: a co-op with a coupon or "scrip" currency redeemable for baby-sitting. By Krugman's own admission, this example inspired his understanding of monetary policy, recessions, and Keynesian economics. In the story, a "recession" occurs when co-op members start hoarding scrip in anticipation of future outings; the result is that the whole system freezes up; and the solution was an injection of liquidity through scrip inflation.

Exercise: discover the flaw in Krugman's analysis. Hint: consider what would happen in a real economy with hard currency by allowing the price of baby-sitting to fluctuate and by replacing "scrip" with gold. Contrast this situation with the long-run effects of the inflationary "solution" on savings and business investment incentives.

I have two predictions: the economy will continue to tank despite (or because of) attempts to "stimulate" it, and Krugman will blame the resulting depression on the stimulus being insufficiently bold---i.e., on not being Keynesian enough.

"Hint: consider what would happen in a real economy with hard currency by allowing the price of baby-sitting to fluctuate..."

You are confusing two different types of analysis. If you had taken a (more rigorous) macroeconomics course you would have learned that there are two types of analysis: long-run and short-run. In the short-run prices are inflexible due to unions, preexisting contracts, menu costs, etc. In the long-run prices can fluctuate and recessions are impossible (we don't worry about some recession that happened in 120 A.D. for example). Keynesian economics only deals with the short run, and only in the short run can the economy be trapped in a temporary disequilibrium. Even though the economy should eventually recover on its own in the long run it can cause a lot of pain in the process, which is why Keynesian economics advocates government intervention.

"I've long had a hobby interest in economics... The inmates are running the asylum."

Maybe a hobbyist shouldn't be suggesting that Nobel prize winners be put in an asylum ;).

Thanks for the explanation. It helps me to understand why so many economists (and politicians) seem to treat our present situation as some sort of short-term technical glitch that can be straightened out with the right kind of fiscal kick. I suspect they are wrong, and that we face deeper structural problems. Indeed, it seems obvious that we do.

I have little confidence in the putative experts because of a long list of seemingly elementary fallacies promulgated by many mainstream economists. Notable among these are the idea that spending causes prosperity, the notion that economic "stimulus" is beneficial, and a persistent conflation of trade deficits with indebtedness. Perhaps most damning is the simple observation that, though people have long been spending beyond their means, and saving more is the obvious antidote, this solution is vehemently opposed by the conventional wisdom. They seem immune to the argument that, while increased savings will result in a contraction of consumer product companies, this is not a bug, but a feature---a painful one, to be sure, but ultimately unavoidable. Seen from this perspective, the present attempts to limit the severity of the recession are not only misguided, they are probably counterproductive.

I do expect to take a course in this at some point, by the way, just for fun (and it really will be only for fun; I'm a 35-year-old physics Ph.D. with little to gain from further formal schooling). Unfortunately, my intuition is that "rigorous macroeconomics" is an oxymoron, and that much of the subject as presently taught is a hopeless lost cause. I hope I am wrong...

Maybe a hobbyist shouldn't be suggesting that Nobel prize winners be put in an asylum ;).

Oh, I've read too many of Krugman's essays to heed that warning. :-)

You should check out Macroeconomics by Mankiw. It's very short and sweet. You really shouldn't judge economics by a few articles aimed at lay audiences just as you wouldn't try to learn about quantum mechanics from the NYTimes. Economics is filled with clever little insights that makes you go "Ahh!".

I'll take the time to explain some of your complaints:

"spending causes prosperity": well, obviously if you don't spend any of your money obviously you don't have prosperity. If you borrow money to spend economics assume that you are rational and that it is because you prefer having a good time now to later. This seems more like a value judgment though, which most economics tend to avoid.

"conflation of trade deficits with indebtedness": well, if country A wants to consume something produced by country B, it can only do so in three ways: 1) give B something A produced, 2) give B a chunk of A (e.g., real estate) or 3) borrow from B. Since most countries don't like 2), trade deficits are settled using 3)

Most economics will say that a higher savings rate will be beneficial in the long run but if people suddenly saved more because of government policy there will a aggregate demand shock and the economy will go into a recession since the price level cannot easily adjust in the short run. (When people save more they have less money to spend and thus all prices become "too high" for them.)

Check out the book for more information. You will find that while economics may have flaws, it is internally self-consistent. It just doesn't take into account that most people are not rational :(.

It's more than just a few lay articles, but your point is well-taken. And I appreciate the book suggestion. Alas:

  Macroeconomics by N. Gregory Mankiw (Hardcover - April 28, 2006)
  Buy new: $117.47

Ouch! I think we've discovered something about required textbooks and the economics of cartels.

N.B. Regarding trade deficits: if Alice from A wants to buy something from Bob in B, she typically pays for it with money. The source of that money is either production (your option #1) or debt (option #3). (Option #2 is just past production, since people usually buy real estate with money.) In either case Alice's purchase increases the A's trade deficit with B. But it's totally beside the point that Bob lives in B. Indeed, the analysis is identical if A = Atlanta and B = Boston.

There's a rough correlation between trade deficits and debt, just as there's a correlation between the number of movies people see and debt: there's a correlation between spending and debt. Focusing on foreign trade---and using the loaded and misleading word deficit---simply feeds people's xenophobia and distracts from the underlying issues.

Reminds me of my favorite Keynes quote when asked how throwing money at problems would ever work in the long run.

"In the long run we are all dead"

My concern with Keynes is that eventually, the long run must come about. ie, the long run has to happen sometime, right?

>> the economy will continue to tank despite (or because of) attempts to "stimulate" it

Perhaps you should make up your mind about basic economic causality before hectoring Krugman for having actually read the original texts. The General Theory is a difficult and dense book and Krugman offers a decent summary of Keynes' paradox of thrift.

If you are interested in economics, the problem with your suggestion is that by the time he gets around to discussing the paradox of thrift, Keynes has already broken claims that Say's Law forces supply and demand into equilibrium through changes to the wage level. If I remember correctly, he did this with the empirical observation that while additional wages may induce labor to enter the workforce, declines in real wages don't generally cause a decline in demand for employment.

I do know about the paradox of thrift, and it seems not only not paradoxical but actually false. Increased saving both lowers prices (increasing quantity demanded) and lowers interest rates (increasing investment), so the dynamical behavior is self-correcting. In Krugman's example, inflation solved the liquidity problem, but it introduces new disincentives to saving and distorts long-term financial planning. The hard-currency/free-market solution not only avoids these problems, it also doesn't count on an enlightened central banker making the right decision at the right time.

My analysis could be mistaken, though, and I'll definitely take a look at Keynes's argument more carefully some time.

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