Saturday, October 29, 2011

The Barter Delusion

A lesson in why mainstream, free market fundamentalist economics, based on essentially non-dynamic equilibrium models that fundamentally misrepresent reality, are flawed from Prof. Steve Keen, Assoc. Prof. @ the University of Western Sydney:

The Barter Delusion

Joan Robinson once remarked that Milton Friedman was like a magician who put a rabbit into a hat in full view of the audience, and then expected applause when he pulled it out again.

There is no better instance of this than his influential admonition against analyzing the dynamics of the nominal money stock:
IT IS A COMMONPLACE of monetary theory that nothing is so unimportant as the quantity of
money expressed in terms of the nominal monetary unit— dollars, or pounds, or pesos. Let the
unit of account be changed from dollars to cents; that will multiply the quantity of money by 100,
but have no other effect. Similarly, let the number of dollars in existence be multiplied by 100;
that, too, will have no other essential effect,
goods and services, and quantities of other assets and liabilities that are expressed in nominal
terms) are also multiplied by 100
provided that all other nominal magnitudes (prices of. Friedman (1969, p. 1; emphasis added)
Indeed, if there were a planet on which all nominal magnitudes including debts were perfectly adjusted when inflation or deflation occurred, this statement—and the neutrality of money it supports—could be true. Since Earth is not such a planet, nominal monetary values can and do matter, because they are the link between financial commitments entered into in the past and our capacity to service them today.


And the major way in which nominal debts matter is that, when they generally reach a level beyond which they can be reliably serviced, they can ignite liquidity and solvency crises that lead to a retrenchment in debt. 

Households suddenly "buckle down" and tighten their belts in order to pay down debt, which would otherwise be used for consumption.

Firms, in response to reduced aggregate demand, borrow less to finance production, and lower payroll by laying off workers (which further impairs household's incomes, further reducing funds that otherwise be used for consumption).

Lenders tighten their credit standards, and reduce lending to both households and firms.

And since real economic activity is not just GDP growth, but GDP + the rate of change in debt [another lesson to be discussed in a later blog posting], then mainstream macro economics -- which only recognizes GDP -- generally understates the negative effects and impacts of a debt-deflation recession.

This is [part of] why Obama's stimulus of 2009 did not work as well as his advisers projected, and why this recovery remain jobless:  it was not sized to address the additional drag of shrinking private sector debt. 

Another reason is that the monetary stimulus from the Fed targeted to the wrong part of the private sector:  the funds would have been far more effective at mitigating debt-deflation impacts if it had been given to households and firms, rather than to banks (never mind the unfairness of bailing out the actors who arguably are most responsible for raising private debt to unsustainable levels).

But that's another, longer lesson.

No comments:

Post a Comment