Bryan Caplan  

Self-Correction: How It Works, When It Works Worse

Four Principles of Human Actio... Government Fraud...
In 12th grade, I took a one-semester economics course.  My high school didn't have A.P. econ (though I took the test on my own initiative), so the course was a little dumbed down.  Actually, to be blunt, the teacher didn't know enough econ to need to dumb it down; he just taught what he knew.

I still remember his discussion of the Great Depression and Keynesianism.  The teacher's story was that the New Deal cured the Great Depression using Keynesian methods.  (The teacher didn't know enough about either to make the smarter argument that, "Keynesianism didn't fail; it wasn't tried.")  A student asked him, "What would have happened without the New Deal?"  His approximate reply: "Then the Depression would have gone on until the government came to its senses."

I remembered this vignette a few minutes ago when Scott Sumner gave the correct answer to the student's question:
Those who teach the AS/AD model may do the example of the big drop in AD after 1929.  Then you are supposed to show two alternatives; either the Keynesian policy of boosting AD to try to speed up the recovery, or merely waiting for the AS curve to shift right as wages and prices adjust downward.
Scott interestingly observes that the U.S. is trying the self-correcting mechanism this time around.  But it's not going to be a fair test:
[T]he Fed has decided to rely on the self-correcting mechanism this time, and just wait for the long and painful adjustment in wages and prices to play itself out.  If this is the strategy, then it would have been better not to have recently boosted minimum wage rates by 40%, quadrupled the duration of UI, passed a health care tax increase, and cracked down on immigration.
I feel a little like my bullish bets on U.S. unemployment are jinxing the world, but in the end I still think I'll win.  As Smith said, there is "a great deal of ruin in a nation."  The economy's rebounded despite crummy policies many times before.  In the long-run, we're all rich.

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COMMENTS (4 to date)
Ed writes:

Public school teacher?

What would have happened without the New Deal started by Hoover and expanded by Roosevelt, is that there would not have been the level of investor uncertainty there was.

Doc Merlin writes:

"In the long-run, we're all rich."

I don't know, some countries are doing markedly worse than they were 30 years ago.

mulp writes:

Most people will need to earn far above minimum wage to survive.

But the real impediment was the bankruptcy law changes that took away the judges ability to lower the prices of goods bought on credit, from cars, houses, to food.

If wages are to fall, prices need to fall as well. And the biggest chunks of prices are for housing and transport.

But with the bankruptcy law changes, the way houses and cars will be reduced in prices is by foreclosure and repossession and the netting to the lender less than what the borrower could pay after a reasonable modification.

And the borrowers who borrower more than they might have were as Goldman executives explained, just supplying the highly risky debt the sophisticated investors wanted. So, writing down that debt is just exactly the kind of activity that is needed to fulfill the demand for risky debt. Having a bankruptcy judge do it is more efficient with lower losses to the lenders, and that was the system when the credit models were setup, but with the bankruptcy law changes, the models became broken.

Chris T writes:

There's also the strong possibility that if there had been no New Deal there would have been no country that we could recognize regardless of the efficacy of the policies. There are far more radical ideas than the New Deal.

Action is often less important than the perception of action.

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