"Is the macroeconomy self-equilibrating?" is a stupid question

"At the macroeconomic level, is the market economy self-equilibrating?"

I used to think that was the most important and fundamental question in macroeconomics.

Now I think it's a stupid question that doesn't make sense.

So when I read Paul Krugman saying:

"Think of it this way: Friedman was an avid free-market advocate, who insisted that the market, left to itself, could solve almost any problem. Yet he was also a macroeconomic realist, who recognized that the market definitely did not solve the problem of recessions and depressions. So he tried to wall off macroeconomics from everything else, and make it as inoffensive to laissez-faire sensibilities as possible. Yes, he in effect admitted, we do need stabilization policy — but we can minimize the government’s role by relying only on monetary policy, none of that nasty fiscal stuff, and then not even allowing the monetary authority any discretion.

At a fundamental level, however, this was an inconsistent position: if markets can go so wrong that they cause Great Depressions, how can you be a free-market true believer on everything except macro?"

I read Paul as accusing Milton Friedman of giving an inconsistent answer to a stupid question. It's a stupid question Paul. Of course Milton would give an inconsistent answer. That's the only sort of answer you can give to a stupid question.

Why is it a stupid question? Here's why:

Let your imagination run free. Think up the worst possible monetary policy you can imagine. What precisely that would be would depend on your particular model of the economy, and on your imagination. But it would probably have something like the following feature:

MP(worst): When you see inflation rise and market activity rise, loosen monetary policy a lot; and when you see inflation fall and market activity fall, tighten monetary policy a lot.

What precisely you will mean by "loosen/tighten monetary policy a lot" will depend on your particular macroeconomic model and how you conceptualise monetary policy. I will leave that up to you. But Paul's answer would probably not be terribly different from mine; we would both think that the other's personal MP(worst) was pretty terrible.

Now ask yourself this more precise question:

"Conditional on my MP(worst) being followed: at the macroeconomic level, is the market economy self-equilibrating?"

And (at least) 99.9% of macroeconomists would answer that question: "Don't be stupid. Of course it isn't!"

What sort of economist would answer "Yes" to that question? Who's in the 0.1%?

Maybe, just maybe, an extreme RBC theorist who happened to be smoking crack and who had a very stunted imagination would answer "Yes" to that question.

"At the macroeconomic level, is the market economy self-equilibrating?" is a stupid question because it doesn't specify the monetary policy being followed.

The only person who would answer "yes" to that unconditional question is someone who can't think up a worst possible monetary policy. Which means that person thinks that all conceivable monetary policies are equally good. Which means he doesn't think that monetary policy matters.

If I had to summarise Milton Friedman's thought in three words they would be: "Monetary policy matters".

I'm old enough to remember when that was a highly controversial statement in macroeconomics. Modern macroeconomic fish don't feel the Friedmanite water they swim in.

And if there is one thing we ought to have learned from the recent recession, as we ought to have learned from the Great Depression of the 1930's, as Friedman tried to teach us, it is that monetary policy does indeed matter, and matters a lot.

The most dangerous idea in macroeconomics is that monetary policy doesn't matter. [link here (pdf) Thanks Lorenzo!. link to that recent paper please, because I left my brain back on the farm.] Or, since that was precisely Friedman's message, to say the same thing a different way: the most dangerous idea in macroeconomics is that Friedman is an unperson.

Update: and make very sure you read Frances' comment immediately below. Because my point here generalises beyond macro/money. Institutions matter. Monetary policy is one of those institutions. So are markets. So is government.

Update2: as an antidote to all this "Friedman is an unperson" stuff, read R.A.'s superb essay in the Economist.

Update3: or this good post by Scott Sumner.

Comments

[Franceswoolley]

Nick, this illustrates a point you've made before: institutions matter. A very confused person might think that the statement "a market economy is self-equilibrating" implied "there is no need for government intervention in the economy." But government exists; its very existence is part of the structure of the economy. A government cannot do anything but intervene, because it has to create some kind of rules and institutions (that's what governments do).

[Nick Rowe]

Frances: Bingo! Yep. You have generalised my point from macro to micro.

I would only change what you wrote very slightly. Governments, like markets and money, *are* part of those rules and institutions, and are created in the same act as the creation of those rules and institutions.

[Lorenzo from Oz]

Nick, the link you want is:
http://elsa.berkeley.edu/~dromer/papers/Dangerous_Idea.pdf

[Nick Rowe]

Thanks Lorenzo! Updated.

[Franceswoolley]

Nick, I agree, they are part of those rules and institutions. What I had in mind is that the government is the name we give to the institution that determines a particular set of rules for other people to follow i.e. laws.

[J.V. Dubois]

It is good that you covered this, but I think that many economists do not grasp that Monetary Policy is just another government policy. They confuse what neutrality/superneutrality actually means. I was just recently discussing this with Scott Sumner arguing that bad monetary policy is "supply side problem". I see that most economists do not have issue claiming that bad tax policy, or bad justice system, bad property laws etc. constrain long-term economic growth. Why should monetary policy be different? It can even be explained by generally accepted facts:

1. Monetary policy affects real economy short term
2. Long term is series of short terms
3. Consecutive bad monetary policy decisions therefore affect long-term real economy
4. (Optional): "Doing nothing" is also monetary policy decision. So monetary policy "doing nothing" may mean passively making mistakes that affect long-term real growth.

PS: In a very funny way RBC economists may have been right all along. Business cycle is caused by "technology shock" of introducing inferior methods of management of aggregate demand. Therefore recession always and everywhere a "supply side" phenomenon :)

[erik]

I do not understand this post.

Are you saying that "money" unlike, say, cars, is external to the "market economy" per definition?

Of course monetary policy matters, and so do industrial policy, financial and environmental regulations etc. Thus, the question would have to be made conditional on a lot of things, or is there something special about "monetary policy"?

[Nick Rowe]

JV: Yep. The only person I can imagine who thought that monetary policy really didn't matter at all would be someone who believed literally in (both short run and long run) neutrality and superneutrality. But (almost?) no economist believes that. Our models where money is (in every respect) neutral and superneutral are benchmark starting points, from which we ask "Now, how do we need to modify this model so it works?"

I disagree with your 2, but that's a side-issue I won't go into here.

I would re-phrase your 4 as " 'Doing nothing' is meaningless" See my old post on the macroeconomics of doing nothing

(I think you are stretching the definition of "supply-side" beyond what's useful, but I take your point!)

Frances: Yep.

[J.V. Dubois]

Erik: Imagine Krugman would say this

"Think of it this way: Friedman was an avid free-market advocate, who insisted that the market, left to itself, could solve almost any problem ... Yes, he in effect admitted, we do need property rights policy — but we can minimize the government’s role by relying only on markets to produce most stuff people need, none of that nasty planned economy.

At a fundamental level, however, this was an inconsistent position: if markets can go so wrong that they can fail without property laws , how can you be a free-market true believer on everything except property laws?"

Or thinking about it in another way, even Krugman says that Friedman insisted that market, left to itself, could solve almost any problem. Since Friedman said that monetary policy matters can we add it to that group of exceptions behind the word almost? Friedman was no anarchocapitalist, even of some people would like to see him as one.

[J.V. I edited your comment to close the quotation marks. Let me know if I closed them in the wrong place. NR.]

[Nick Rowe]

erik: "Are you saying that "money" unlike, say, cars, is external to the "market economy" per definition?"

No, I wasn't saying that. And I would say just the opposite. Money, and monetary exchange, is a good, and a social institution, that is created by (or maybe with) markets, and is part of the market economy. And that is true even though governments may (and usually are) part of the story of the existence of money (and markets).

[Duncan Cameron]

Nick you only need two words for Milton not three. "Money matters".
The debate within economics is more about is money a veil or is it not neutral. Keynes, Galbraith, Joan Robinson, Minsky all think money matters, but none of them accepted the quantity theory of money. The "monetarist" school wanted the profession to understand money was much more than a veil.
I had trouble with those arguing for free trade and not including exchange rate considerations, interest rates, or banking practices. I suspect any attempt to simplify by makiing money neutral disorts policy debates
Most of the intersting debates are among the money matters people Keynes and Dennis Robertson or Hawtry, Galbraith and Freidman, Minsky and neo-classicals like Tobin or Solow.
When you talk about monetary policy are you trying to slip the quantity theory in through a side door? Just asking.

[Gene Callahan]

Nick, I think we can regard the question as sensible if it is meant as "Could the market handle money fine on its own, with no government involvement?" i.e., would a free banking regime be best? If the answer is "no," then in some sense the macroeconomy is not stable on its own but needs (good) government monetary policy to make it stable.

[Nick Rowe]

Duncan: "Nick you only need two words for Milton not three. "Money matters"."

That almost works, but not quite. Because someone might try very hard to (mis)interpret it as "The fact that there is *some* money matters, but aside from that, monetary policy doesn't matter." Yes, I know that's a bit of a stretch, but the marginal benefit of that extra word seemed worth it!

"I suspect any attempt to simplify by makiing money neutral disorts policy debates"

Well, I would say that anyone who says that if money is literally neutral and superneutral in all senses then there is no point in having any debate about monetary policy, because it doesn't matter.

"When you talk about monetary policy are you trying to slip the quantity theory in through a side door? Just asking."

Nope. You could agree with me on this post without accepting the QT. Actually, it's closer to the other way around. The only person why would be likely to disagree with me, and say that the macroeconomy was self-equilibrating for any imaginable monetary policy, would be someone who held a very extreme version of the Quantity Theory, because you can only fully accept an extreme version of the QT if you think money is neutral and superneutral in all senses.

When I bring in the QT, I bring it in through the front door!

[Mike Sproul]

Nick:

Where do you stand on the subject of free banking these days? I ask because a few of us think that banks will naturally provide the right amount of money in the same way that farmers will naturally provide the right amount of apples. So when we see something like the great depression, caused by the government's crazy-tight monetary policy, we blame the government, not the free market.

[Nick Rowe]

Gene: I agree that would be a sensible question, but it's a different question, because Paul Krugman is talking about (presumably) the US in the 1930's and the recent recession, where the government is very much part of the monetary system.

Mike: short answer: I don't know, and can't make my mind up. I tend to think that money is a natural monopoly, because of network externalities, which *maybe* creates a case for government producing money. But then governments can fail too, so maybe it's an empirical question, and depends on how bad the government is. Zimbabwe under Mugabe? No contest.

[Philo]

“A government cannot do anything but intervene, because it has to create some kind of rules and institutions (that's what governments do)” (Frances Woolley). But it seems infelicitous, at best, to call what a minimal, nightwatchman government is doing “intervening in the economy.” Establishing and enforcing the rules that allow a market to exist is not “intervening,” at least not *in the operation of that market*. Nor would the minimal government’s buying and selling of goods and services count as “intervention” in that market, any more than my personal buying/selling would. Finally, it would even be questionable to call the minimal government’s taxation, if instituted purely for revenue to support its enforcement activities without ulterior motive, “intervention.”

An analogy for the minimal government would be the Deist God, who sets the world in operation according to laws and then does *not* intervene (as opposed to the traditional Theist/activist God, who repeatedly inserts miracles into the established order of events).

[erik]

Nick:
"Since Friedman said that monetary policy matters can we add it to that group of exceptions behind the word almost?"

I think this is a better question. Like in the case with externalities, public goods etc., there must be some market failure that forces us to have policies in this area (maybe the real economy lacks the central planner who are supposed to find the new equilibrium price vector). To say that the government should intervene, or exist,in a certain area is more or less equivalent to the claim that the decentralized interaction between individual actors do not produce the desirable result in that area.

Whether property rights is a part of the definition of a "market economy", or the answer to another "market failure" (i.e. things that cant be handles by the market economy), is maybe a matter of semantics - but Ariel Rubensteins "jungle economy" worked without them if i remember correctly. On the other hand, the most common definition of a "free market economy" is probably, in practice, "whatever set of institutions a libertarian (or anarcho capitalist) prefers" - which would include property rights, but not monetary policy and certainly not e.g. the institutions that allow founding of public goods through taxation - but I do not know what the distinction between a "market economy" and a "free market economy" is.

Still, I do not really see what it is that you are disagreeing with Krugman about. Is it that he argue against the (anarcho capitalist)"free market economy" (with predefined monetary policy or, as the free marketers would put it, absents of monetary policy) while using the term "market economy" (which, I guess, means something different than "free market economy").

[Nick Rowe]

Philo: If I said "Governments should have no *industrial* policy and just do nothing" most people in market economies would understand roughly what I meant by "doing nothing". They would know I meant "governments should just enforce property rights and contract law and not subsidise particular firms and industries". But even here it's not so clear, because for example it's not obvious what sort of intellectual property rights a minimalist government would enforce, and different systems of intellectual property rights might have different effects on different industries.

But if I said "Governments should have no monetary policy and just do nothing" (in a world where base money is government money) I have no idea what "doing nothing" means. Does it mean: hold money base constant, hold the price of gold constant, hold CPI inflation constant, hold NGDP growth constant, or what?

[Frank Restly]

Nick,

"If I said Governments should have no *industrial* policy and just do nothing most people in market economies would understand roughly what I meant by doing nothing. They would know I meant governments should just enforce property rights and contract law and not subsidise particular firms and industries."

It depends on what you mean by subsidize. In a market economy (with property and contract protections) a government should not purchase or destroy excess production, nor should it compete with private enterprise in the production of goods. There are no particulars here.

A government in the enforcement of contract law should seek win-win resolutions. And the reason is simple - no contract, no matter how well written and thought out, can conceive of every possible contingency.

[primedprimate]

'Monetary Policy Matters' couldn't possibly have been Friedman's primary contribution - important though that idea is, I don't think that Friedman was the originator. I was under the impression that Hicks (and Keynes) as well as many others before agreed with the idea that monetary policy matters.

I was under the impression that Friedman's real contribution was that monetary policy matters to such an extent that fiscal policy is irrelevant for macro-stabilizing. So I would venture to summarize Friedman thus: Fiscal policy is irrelevant for macro. And by irrelevant, I mostly mean redundant once monetary policy has been adequately employed.

From your previous posts I believe that you yourself agree with the idea that fiscal policy should take care of various micro needs while monetary policy is the optimal tool for macro needs.

On a related note, I am curious about the worst possible macro-stabilizing fiscal policy. How do you think you, Krugman, and Friedman would rate the monetary authority's ability to counteract such a policy? I am guessing Scott Sumner would argue that a competent monetary authority can counteract even the craziest fiscal policy from a macro-stabilizing or demand-side perspective. Sure, the worst fiscal policy could be terrible from various supply-side and micro perspectives as well but let's ignore that for the sake of argument.

[Nick Rowe]

primed: very good comment.

paragraph 1. Yes, Keynes and Hicks did think monetary policy mattered. But I think of Friedman as very much a post-WW2 economist, and by that time the pendulum had swung a long way from monetary policy, and Friedman pushed it back. Scott Sumner in the post I linked above (in Update3) is worth reading on this.

Paragraph 2. Good point.

paragraph 3. Yep.

paragraph 4. A lovely question. I had to think about that one. My first instinct was "Yes! MP could handle it!". Then I thought up an even worse fiscal policy, where the government tried to spend more than 100% of potential GDP in a closed economy, and had serious doubts that MP could handle it. Then I thought "Hang on, if MP was truly independent, would the government be able to get its hands on that much money?" and decided it couldn't. Then I thought about government taxing more than 100% of GDP, (with lump sum taxes, to avoid micro distortions). And I conclude.....dunno!

[Patrick R. Sullivan]

'But if I said "Governments should have no monetary policy and just do nothing" (in a world where base money is government money) I have no idea what "doing nothing" means.'

Zimbabwe gives an example. Having nearly run out of space to print zeroes on the Zim-$, in 2009 they stopped printing them altogether, and legalized the Rand, Pound, Euro and US-$. What happened is pure Friedman; inflation stopped.

Krugman's fear is that it will be he who becomes only a footnote.

[Simon Wren-Lewis]

Could not agree more, and very nicely put. But why do people ask such a silly question? Could it be because the text book encourages the idea that there is a 'default' or 'neutral' kind of monetary policy, which is to fix the money supply? If we replaced this with - say - a Taylor rule, then it would be obvious that monetary policy was always doing something.

[JW Mason]

So a market economy without a central bank is not possible even in principle? Would we expect an economy with pure commodity money (gold, bitcoins, whatever) to have a stable equilibrium? If the answer is, "it depends," what does it depend on?

[JW Mason]

What about the US before the creation of the Fed? Stable, not stable, not a market economy?

To me this post comes worryingly close to confusing a question that is meaningless within the models we normally use, with a question that is meaningless full stop.

[Frank Restly]

JW Mason,

Stable / Not Stable: If you are asking were there any recessions, panics, etc. before the creation of the Fed, yes there were. In fact, that was one reason why the Fed (as lender of last resort) was created.

http://en.wikipedia.org/wiki/Panic_of_1907
http://en.wikipedia.org/wiki/Panic_of_1893
http://en.wikipedia.org/wiki/Panic_of_1873
http://en.wikipedia.org/wiki/Panic_of_1857

Market Economy / Non Market Economy: Yes the U. S. had a market economy prior to the creation of the federal reserve. What it did not have was marketable government securities.

http://en.wikipedia.org/wiki/Federal_Reserve_Act
The federal reserve was created in the 1913.

http://en.wikipedia.org/wiki/Banking_Act_of_1933
The federal open market committee wasn't created until 1933.

[JW Mason]

Frank, it's not a question about reality. It's a question about how Nick thinks.

[Nathan Forczyk]

Great post - I have begun explaining the same thing in a slightly different way, but maybe you guys can tell me if its wrong.

Why doesn't the US government pay for its expenses by printing out money and stopping all taxation?

I think in the simplistic view, there ought not to be a difference. Taking a % of a dollar in taxes shouldn't be that much different than degrading the value of a dollar.

But they're not the same. Human's hate quick changes and permanently higher inflation would cause a much higher level of market anxiety and uncertainty. It should be the same, but its not. Its much less scary to investors and consumers if we take a % in taxes and have lower inflation than if we take it the same way indirectly.

Does this make any sense? Am I wrong or delusional on this explanation?

[Peter N]

What you've been saying seems to be equivalent to saying that it isn't usefully possible to treat monetary policy as exogenous, which the question does.

There's also the hidden assumption that this equilibrium implies some sort of economic stability in an every day sense, like limitations on unemployment or CPI. It's hard to see why this should be true.

The whole thing seems to be more of an ideological strawman than economics - the magic of the completely free market producing an economic utopia. I don't think Friedman believed anything as crude as "that the market, left to itself, could solve almost any problem".

[Greg Ransom]

Nick writes, "is the market economy self-equilibrating?"

The widely recognized most important defender of the market economy in the modern period --Hayek -- spent his early career explaining why & how the market economy contains a 'lose joint' which allows the market to become systematically discoordinate across time -- even as the market is self-coordinating well enough to produce massive quantities of goods and services. And Hayek showed that 'lose joint' situation cannot be eliminated no matter the monetary regime.

Yes, indeed the question Nick repeats is incoherent.

The question is -- what causes systematic discoordination across the overall pattern of ever coordinating individual plans of the global market economy.

One of Hayek's great scientific achievements is to cast the problem correctly -- just as one of Darwin's great acheivements is to cast the problem correctly.

[Frank Restly]

Nathan,

"Why doesn't the US government pay for its expenses by printing out money and stopping all taxation?"

If you were selling goods to the government under this arrangement, what price would you charge?

"I think in the simplistic view, there ought not to be a difference. Taking a % of a dollar in taxes shouldn't be that much different than degrading the value of a dollar."

There is a limitation on how many percent in taxes a government can take (up to 100%). There is no limitation on how many dollars it can print.

[Ryan Murphy]

Nick Rowe for Fed chairman.

[Determinant]

The root problem a bit of a more basic philosophical difference. Classical economics broadly tended to a bias to "negative liberty" and Austrian Economics today is entirely predicated on this view of liberty.

If you assume all markets (including employment) will clear quickly, you're going down the road to Negative Liberty.

Negative Liberty is the freedom from external restraint; you are free to be what you are and you don't need any help in that.

Keynes them came in an turned this position upside down; he showed that markets could stay uncleared for a long time due to deficient demand. He then said that if you took care of demand through targeted action, you'd solve the problem. That's a Positive Liberty argument, where Positive Liberty is the possession of the freedom and power to reach one's own potential, you have to have (or strive to get) the right tools or power to be "free".

Government is just the ultimate tool. It's big, it takes in a lot of money, the Manhattan Project demonstrated it can do whatever it wants given the resources. So is government a tool to achieve our potential (the fundamental thinking of the Welfare State) or is it "Not just the Problem, it is the problem", a la Ronald Reagan.

Keynes' General Theory was a watershed in turning academia around to the concept of Positive Liberty, which hitherto had been reserved for Marxists.

Nick and Frances have admitted they believe in Positive Liberty, government has to do something (Frances), and monetary policy is usually first the list (Nick). Shows you how much Keynes won, eh?

So the difference between them (let's say they don't vote NDP) and me, an NDP Member, is only one of degree, not of definition or orientation. How very Social Democratic of you both!

Friedman, starting in the 1950's, banged on about Free Markets and Liberty and Choice and tried really, really hard to be a good Negative Libertarian like his friend Hayek. But when push came to shove, he wouldn't or couldn't throw away Keynes and a shred of Positive Liberty.

That's Friedman's fundamental inconsistency. He was rather smug about his politics which in light of the philosophical foundations and conclusions of his economics was at best inconsistent or at worst intellectually dishonest.

The only difference between Friedman and me, the Big Government, Big Spending Positive Liberty Social Democratic Left-Winger (no granola, please) is scale. I just dream bigger about government's possibilities than he did.

[Frank Restly]

Determinant,

I see it as a difference in market pricing (not downwardly rigid) and contract pricing (downwardly rigid). Which is probably why Friedman was hesitant to explain monetary policy and the Great Depression with regard to interest rates and debt (unlike Fisher). A free market anarcho-capitalist would abandon legal protection of contracts. A practitioner of state issued (not borrowed) money would abandon capital markets altogether (no debt, no equity).

[Christiaan Hofman]

Indeed, the only way this question makes sense is when you add "in the absence of monetary policy" (i.e. when there's no monetary authority at all.) But even then it's a stupid question, because we already know the answer, as we've tried that before: no. The economy would be going into crisis faster than the macro economy would go to equilibrium. And therefore, it's not a relevant question, because we're not living in such a world (or should I say country.) Except of course when talking to Rand Paul or someone like him. But even there it's not relevant, but he would shut down his ears and go "lalalala." Well, in perhaps one place it would be a sensible question: the EU.

[Nick Rowe]

Simon: Thanks!

"But why do people ask such a silly question? Could it be because the text book encourages the idea that there is a 'default' or 'neutral' kind of monetary policy, which is to fix the money supply?"

I think that may be roughly the answer. Though it may not be only "fix the money supply", it may be "fix the price of gold" or "fix the rate of interest", or something, we always have some sort of default position that constitutes "doing nothing" at the back of our minds when we draw the AD/AS curves, and that default position may be a stupid monetary policy, as well as being an arbitrary implicit assumption. Replace it with "fix the inflation rate" or "fix NGDP growth rate" and you get different answers, with any reasonable macro model.

I suddenly remember Brad DeLong (and someone's) very good old paper "is price flexibility stabilising?", and I'm trying to remember what monetary policy he assumed fixed in that paper. And it worries me that I can't remember what he assumed about monetary policy, because that assumption would presumably be the most important assumption in that paper.

[Nick Rowe]

Peter N: "What you've been saying seems to be equivalent to saying that it isn't usefully possible to treat monetary policy as exogenous, which the question does."

I would re-phrase it as follows: When we say we are holding monetary policy exogenous, *what particular* monetary policy are we holding exogenous? There are millions of different possible monetary policies, and we would get a different answer depending on which one we assume.

JW: a market economy without a *government-owned/controlled* central bank is certainly possible in principle (and has existed historically, in e.g. Canada, Scotland, the US, etc.). (I think that one bank will naturally tend to evolve into the central bank, whether or not it's government owned/controlled). Though governments historically may still have imposed rules (sensible or silly) on private banks. I'm not really up on the literature, but I vaguely remember hearing that Scotland did quite well, and the US banks had some silly regulations imposed? And it's an open question, I think, whether countries did better or worse after governments created/took over central banks.

[John H. Morrison]

"At the macroeconomic level, is the market economy self-equilibrating?" Presumably this means self-equilibrating without "governmental" or perhaps external intervention or interference. (I think that a hidden assumption is that the equilibrium point would be benign at worst.)

I don't view that as a stupid question. Rather, I view as stupid the notion of "external intervention" or "governmental intervention" as distinct from participation in the market economy. Would a multi-decabillionaire's action be considered external intervention? How about IBM's action, or Citigroup's action? If one thinks of laws and enforcement and "guns", one might ask that about Halliburton or Blackwater.

Maybe one might view the actions of IBM in its own firm -- central planning, by-laws, top-down control, and planning as opposed to free-market behavior by its employees -- as external intervention. If not IBM, then suppose someone came to own a huge block of land occupied by others. Would it be external market intervention if the landowner made rules regarding the acts of persons on the land?

I find it useful to think in terms of ecology. "At the large-scale level, is ecology self-equilibrating?" Okay, maybe that is a stupid question. "At large scales, is nature self-equilibrating?" Now that I think about it, these are probably stupid questions. They show a fundamental uninterest or ignorance of nature and ecology. I'm reminded of Steven Pinker and his identification of statements as so bad they're not even wrong.

In any case, ecology can self-equilibrate in only one way: complete utter death. And even there, it's not necessarily a stable equilibrium. Start with a carbon-dioxide water-vapor atmosphere with lightning strikes for a few tens of millions of years, and life will form (there may be other requirements). (Probably enough molecules containing carbon and hydrogen atoms, lightning bolts, and perhaps a stable environment would suffice. I don't know whether Jupiter has any chance of at least microscopic life forming.)

But I was thinking of the absurd notion of (the badness of) human intervention in nature, or interference with the Darwinian process -- an absurd notion of social Darwinists. Whatever humans (or any other species or any other individuals) do is automatically participation in the Darwinian process. Forming governments, welfare, government regulation, etc. might be a Darwinian solution to the problem of survival.

Likewise, the market comprises the actions of everyone -- including "government" (which may mean private landowner or large firm). (What made Khmer Rouge Cambodia and mainland China during its first decades horrendous was not their non-existent Marxist attributes but rather their resemblance to huge lands owned by a single entity.)

[John H. Morrison]

"At the macroeconomic level, is the market economy self-equilibrating?" I still don't know whether it's a stupid question. I think that if it is, one can still use it to address issues intelligently.

For example, one might assume that everyone is rational and has perfect information. That means everyone makes the same choices, knows what to do and what not to do -- leading to the "No-Trade Theorem," the "No-Bubble Theorem," and everyone building their buildings and bridges to satisfy stringent standards of earthquake resistance, hurricane resistance, etc. without any building codes or other regulations. (There's also the question of what is meant by "perfect information." One can't foresee the future with perfect accuracy, based on present information.)

On the other hand, one might divide persons into "stupids" and "smarts." Some stupids are very intelligent in their stupidity, and win against the smarts not only in the short run, but also in the intermediate run. They win sufficiently to put the smarts out of business, or to render the smarts' activities ineffective. In these cases, it's only in the long run where their stupidity becomes evident -- through crashes which destroy (or merely severely damage) all of us.

And even then, the intelligence of the stupids may rationalize away their conduct as cause of the disaster.

It's far cheaper to build a building susceptible to earthquakes and other damage, than to make it properly safe. The stupids may build against the immediate, obvious dangers, but not think of (and be impervious to information of) rarer or more subtle dangers. They save money over the smarts, and can charge cheaper rents or prices -- sufficient to put the smarts out of business. They can advertise as well as the smarts, too.

The difference between the stupids and the smarts may be as incremental as cutting an occasional corner. Stupids may then progressively cut more and more corners, competing against other stupids for the slight economic advantage.

[Determinant]

JW: a market economy without a *government-owned/controlled* central bank is certainly possible in principle (and has existed historically, in e.g. Canada, Scotland, the US, etc.). (I think that one bank will naturally tend to evolve into the central bank, whether or not it's government owned/controlled). Though governments historically may still have imposed rules (sensible or silly) on private banks. I'm not really up on the literature, but I vaguely remember hearing that Scotland did quite well, and the US banks had some silly regulations imposed? And it's an open question, I think, whether countries did better or worse after governments created/took over central banks.

The Bank of Montreal functioned as the "default Central Bank" prior to 1935. It had been the bank of the Government of Canada since 1867 and the Province of Canada since 1854. It's main job as a "central" was to lead bailouts of weak banks and provide enough liquidity so that financial stress was manageable most of the time.

The Commonwealth Bank of Australia did the same job but it was government owned; it was both a commerical bank and a central bank though. It lost the Central Bank job when the Reserve Bank of Australia was founded in 1960.

[Declan]

"A very confused person might think that the statement "a market economy is self-equilibrating" implied "there is no need for government intervention in the economy."

I find there's a lot of people out there confused in this manner, and that many of them got that way by studying economics (or in rarer cases, the work of Milton Friedman :)

Certainly, that's what I was taught in undergraduate economics.

Anyway, this post seems to be written as an attempt to defend Milton Friedman from Paul Krugman, when the reality, as I think Krugman was pointing out, is that he needs defending from the prevalent right-wing position that "there is no need for government intervention in the economy."

[Greg Ransom]

The *central* thing Hayek does that others have not done is to characterize how boom/bust discoordination is a discoordination between *all* relative price relations and *all* time-consuming and time-valued production and consumption channels which are *never* accurately/perfectly captured by a math construct such as a GE construct.

The market process is always producing some level of coordinated order -- they *key* thing is to show and conceive how there can be a systematic pattern of discoordination across time & production channels within that larger pattern of order.

Marginalism and Marginalism applied to time-relative valued alternative production channels is the hint that 'K' and 'L' aggregates will not allow you to see the causal mechanism producing patterns of systematic discoordination within the larger network links of relative prices and alternwtive production channels.

The is why Hayek is the Darwin of macroeconimcs in a field stiuck in a pre-scientific Platonic conceptual world of fixed aggregate kinds, backward measured and somehow functionally related, ie 'K' and 'L' and all the rest.

Prior to Darwing biology was stuck with fixed Platonic kinds -- horse, pig, duck, whcih could not change and with that coukd not evolve. Economics is in a similar situation in macroeconomics, with fixed 'K' and 'L' without internal structure and without the causal relations needed for providing the mechanism necessary for understanding the system,

[A H]

Well it's certainly a good thing that Macro has been domninated by general equilibrium models for the past 30 years.

[gofx]

Determinant-
Your metaphor or distinction of free markets (“negative liberty”) and Keynes interventionist implications (“positive liberty”) is fallacious. Your statement, “Government is just the ultimate tool” begs the entire question and distorts the meaning of liberty. Friedman clearly had “issues” with fiat money, as evidenced by his rules-based approach and his overall distrust towards the end of his life. It’s not all or nothing. Classical liberalism: Maximize: Individual Liberty; S.T. basic functions (courts, defense, etc.); whereas Keynes and other see : Maximize: Collective “Liberty” (as translated to economic outcomes by your metaphor); S.T. Not taking everything away from individuals like Marx wanted. That Friedman struggled with the institution of fiat money, a very complex and vexing subject, still not fully understood (and being scorned by Mises because of it), does not mean he wasn’t, on the whole, a classical liberal.

[W. Peden]

Determinant,

Someone can have a Keynesian view of how the economy works and be a hardcore Nozickian libertarian. Similarly, Peter Jay was a monetarist, but also an adviser to Jim Callaghan (and, coincidentally, also Callaghan's son-in-law) and thus to the left of any major political figure in Britain today.

"Keynes' General Theory was a watershed in turning academia around to the concept of Positive Liberty, which hitherto had been reserved for Marxists."

That's completely wrong. The shift in the British Liberal Party from a focus on "negative liberty" to a focus on "positive liberty" takes place no later than 1908. Social liberalism did not begin with Keynes. German revisionists had worked out a social democratic political theory (that is still extremely influential even today) long before 1936. And non-Marxist socialism PRECEDES Marxism.

The idea that government intervention in the macroeconomy is necessary was also not original with Keynes. In terms of practical policy, Keynes's proposals were either familiar to some people (e.g. proponents of the Chicago Plan) or too timid and laissez-faire (e.g. to Irving Fisher).

I've been looking around for a really right-wing Keynesian recently, i.e. someone who had very fiscally conservative views, like wanting the government to spend no more than 25% of GDP, but had a basically Keynesian analysis of how the economy works. If he had views on social issues that would now be considered intolerably right-wing e.g. if he strongly favoured eugenics and considered it one of science's great achievements, so much the better. Now, the thinker I found didn't agree with the Keynesians on everything, but he's generally regarded as a Keynesian by intellectual historians. His name? J. M. Keynes.

[Nick Rowe]

W Peden: That sounds right to me.

In a Canadian context, what about some Social Creditists? Not strictly Keynesian, but very definitely not monetarist. Weren't some of them very right-wing in other respects? And they pre-date Keynes' GT.

[W. Peden]

Nick Rowe,

I forgot about the Social Credit types. Major Douglas was anti-semitic and the Canadian Social Creditists weren't dishonouring their tradition by adopting the "Christian Freedom Party" label.

Keynes agreed with Major Douglas enough to be about as complementary about his SC views as one could be in polite company back in 1936.

[Determinant]

Your metaphor or distinction of free markets (“negative liberty”) and Keynes interventionist implications (“positive liberty”) is fallacious.

I got it from Isaiah Berlin and his "Two Concepts of Liberty", 1958.

W.Peden:

That's completely wrong. The shift in the British Liberal Party from a focus on "negative liberty" to a focus on "positive liberty" takes place no later than 1908. Social liberalism did not begin with Keynes. German revisionists had worked out a social democratic political theory (that is still extremely influential even today) long before 1936. And non-Marxist socialism PRECEDES Marxism.

The British Liberal Party was at its climax in 1908 and it was all downhill from there. It was not coincidental that this was when the Liberals were being lapped by the Labour Party and the switch shows.

I said academia, not politics. Social Credit was barely acceptable in the 1930's (and barely tried by the actual Alberta Social Crediters, the BC and Quebec versions of the party shared nothing but the name).

Keynes provided the intellectual foundation and his followers were the "school" that both created and sustained the post-war Keynesian consensus. Before Keynes there was no consensus, and it got undone (sadly) but c. 1980 in most places.

[W. Peden]

Determinant,

There were no shortage of British Liberals in academia in the pre-WWI period, not to mention the post-WWI period.

The Liberal peak was actually in the 1906 election. 1908 was when the Radical Campbell-Bannerman was replaced by the New Liberal Asquith.

[Determinant]

I forgot about the Social Credit types. Major Douglas was anti-semitic and the Canadian Social Creditists weren't dishonouring their tradition by adopting the "Christian Freedom Party" label.

Bible Bill Aberhart and his successor, Earnest Manning, are also the only examples of the "Christian Right" in English Canadian politics.

The only other example is Quebec, especially the Unione Nationale. It's no coincidence that Quebec was the other heartland of the Social Credit Party.

[George Selgin]

Replying to Determinant (8/10, 11:54): If the mere fact that some commercial bank served as a government depository, or assisted another illiquid bank in trouble, qualifies it as a "Central Bank," then of course we should never be allowed to speak of any past banking system as lacking such a bank. But a central bank isn't merely a government depository bank or one that occasionally supports (or acquires) an illiquid rival (as commercial banks have always done during crises--there's a reason, after all, why genuine central banks are called lenders of last resort!). It is a bank enjoying substantial monopoly privileges, particularly with regard to the right to issue paper notes. The Bank of Montreal was certainly not a central bank according to the usually meaning of the term.

[RebelEconomist]

Catching up on your recent posts, and was puzzled by this:

"Conditional on my MP(worst) being followed: at the macroeconomic level, is the market economy self-equilibrating?" And (at least) 99.9% of macroeconomists would answer that question: "Don't be stupid. Of course it isn't!" What sort of economist would answer "Yes" to that question? Who's in the 0.1%?

Count me with the 0.1%. I don't see why the market economy should not adjust to some kind of equilibrium - in the extreme, the economy could simply substitute some other monetary area's money for nearly all purposes and get on with it. I presume you have in mind the same "efficient" equilibrium regardless of which monetary policy, no?