The two economists that have most informed my view of the current macroeconomy are Arnold Kling and Scott Sumner. In both cases, their models and explanations make sense to me. They use solid reasoning and evidence; I don’t feel I’m getting a lot of hand waving. Unfortunately, at first glance, their views seem mutually exclusive. Kling believes business cycles are the result of many planning errors by individual agents (for example, this recent post and this follow up). Sumner believes business cycles are the result of contractionary monetary policy by the central bank (for example, this recent post and this one).
How can they both be right? I think they are operating at different levels. Yes, individual agents make their particular planning decisions. In aggregate, these decisions drive monetary variables like interest rates, exchange rates, liquidity demand, etc. However, these variables then feed back into the next round of planning decisions. Moreover, at least some of these plans take into account the effect of the agent’s actions on the monetary variables. So you get classic chaotic/complex behavior with temporarily stable attractors, perturbations, and establishing new regimes. There may even be aspects of synchronized chaos. I think the monetary variables are the key emergent phenomena here. They are like “meta prices” that provide a shared signal across just about every modern economic endeavor.
Food for thought. I’m going to keep this in mind when processing future articles on the economy and see if it helps my thinking.
Some of you may recall my post Organic Farming Harms the Environment. As I wrote, one of the things that bugs me about organic proponents is that they act as if there are no tradeoffs. I don’t understand much about farming, but I do understand something about how economic activity works. I presume that modern farming has responded to market pressure and evolved to optimize along many different dimensions. I’m pretty sure you can’t magically improve along one dimension without sacrificing along another dimension.
Thus, I was not surprised to read this article (hat tip to Tyler Cowen at Marginal Revolution) on modern farming by an honest to goodness family farmer. It is full of good examples of the tradeoffs I suspected were lurking. For instance, by using herbicides, farmers reduce the need to till, which is a major source of soil erosion. Hog crates and turkey cages may seem inhumane, but they prevent sows from killing piglets and turkeys dying from drowning. Crop rotations that decrease the need for synthetic fertilizer increase the amount of water needed to produce the desired crop.
Read the whole thing. It reinforced my confidence in the general rule of trying to avoid legislating solutions. Send pricing signals by allocating resource rights and taxing negative externalities. Then let the market do its optimization.
The following quotes are from a book describing a real set of events:
[The incident] is an extraordinary example of what happens when you get… a dozen people with an average IQ of 160… working in a field in which they collectively have 250 years of experience… employing a ton of leverage.
It’s hard to overstate the significance of a [government-led] rescues of a private [corporation]. If a [company], however large was too big to fail, then what large [company] would ever be allowed to collapse? The government risked becoming the margin of safety. No serious consequences had come about in the end from the… near-meltdown.
Was the incident:
a) The savings and loan scandal
b) The collapse of Enron
c) The sub-prime mortgage meltdown
d) none of the above
First correct answer gets to invest in an exciting new bridge project I’m involved with in New York!
It is by now common wisdom that our current financial crisis is due in large part to misplaced incentives in our financial system. Analysts and fund managers were rewarded for short-term thinking and risk-taking. If we can rework our financial system to reward long-term, careful planning, it is often argued, we can avoid collapses like this in the future.
While I agree that misplaced incentives were a fundamental problem, the question of how to change this is rather more deep and complex than I think many people realize.
I apologize for the non-existent blogging the past few weeks. I’ve been really busy with my new company. I’m going to try blogging more short items rather than my trademark essays in the hope that reduced barrier to entry will result in more supply.
First up is a provocative post by the ever-interesting Scott Sumner. Rafe in particular should read it because Sumner starts from one of Rafe’s favorite premisse that “laws” of nature are purely cognitive constructs. We should measure them by their usefulness and not ascribe to them any independent existence. So Newton’s laws of motion are useful in certain contexts. Einstein’s are useful in others. But neither are ground truth. Moreover, we will never find ground truth. Just successively more accurate models.
Sumner uses this bit of philosophy to justify abolishing inflation, not, “…the phenomenon of inflation, but rather the concept of inflation.” More specifically, price inflation. He explains why this concept is ill-defined and not only unnecessary, but confusing, for understanding the macroeconomy. He asserts that we should expunge it from our models. It doesn’t really exist anyway, so if models do better without it, we won’t miss it in the least.