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Peter you have it right. As I talk to politicians I always am amazed by two facts, first they do not economics and second they do not understand hat the economy sooner or later must pay the price for their misallocation of resources.
Sooner or later the economy will have to adjust postponing the inevitable does not solve the problems just forces someone else to deal with the issues.

$4/gallon gasoline pushed many consumers to the tipping point, as domestic drilling was on the political table, and investment in alternative forms of energy was greater than perhaps at any other time in history. "Health care reform" has so many people vexed with government in general that we have thousand-people marches on D.C.(9/12), and Texas even breathed a breath of cessation from the Union. Let's not forget that any climate change bills are off the table for the near future. People are angry.

With this said, Pete, I agree that the best Washington is a divided Washington. But that's also only if we seek to keep things as they are. But wouldn't it almost be better if there wasn't a divide, if government could run amuk, thus pushing people even farther (hopefully to a Texan extent)?

I don't mean to go psycho-anarchist on your blog, but with our current political system, it seems like we only receive real change when people get really upset. I question whether the short run gains that come with a divided Washington outweigh the long term possibilities.

In our times I find it's best to lighten the mood about the state of the economy with this :) http://www.youtube.com/watch?v=gACEVoqT7cY


The connection between fear and macroeconomic disturbance is a failure of the real quantity of money to adjust to the demand to hold money. Or, equivalently, the inability of the nominal interest rate on low risk, liquid assets to turn negative (which, matters because it impacts the demand for money, as above.)

If all prices were perfectly flexible, and, perhaps, because of this, long term nominal contracts weren't important, then fear might impact the allocation of resources (consumption rather than investment, leisure rather than labor, backyard bunkers rather than vacations) but they would not result in what always looks like excess supplies of resources, including labor, pretty much across the board.

Sumner and I (and I think Selgin, Horwitz, Garrison, and White) pretty much agree that an increase in the nominal quantity of money can substitute for unrealistically flexible prices and will avoid disrupting nominal contracts to boot. That doesn't mean that fear won't impact the allocation of resources.

After Bush and Paulson spoke about the financial crises, a majority of Americans thought that another great depression was either somewhat or highly likely. What is the rational response to that irrational belief? What is the market process that coordinates those actions with fundamentals of scarcity?

Of course, it would be bad if people foolishly decided to switch to part time paid employment to work on their home gardens. But that would imply a shortage of labor. If people pulled their money out of banks and spent it on rifles and ammo, firms would hardly be able to upgrade those networks, but the armaments industries would boom.

But we have a monetary economy. And if fear causes people to demand more money, the market solution is lower prices and wages, and the signal provided that these changes need to be made are surpluses of products and resources, and labor, across the board. And because nominal contracts are all partly speculations on the purchasing power of money, this is going to result in the real costs of bankruptcy.


Look you have forgotten more monetary economics than I can remember. I agree with you that in theory, if the demand for money increases there has to be a change in the quantity of money to offset. But I really cannot wrap my head around the Sumner idea that the Fed has been too restrictive the past 12 months, and that what we need to worry about now is that the end game of this monetary policy path is not possible to negotiate in a way that will get us "back on track".

But I just don't see the real economy has being "completely" determined by expectations. I see a role for expectations (and important role), but ultimately it is the dovetailing of the underlying variables (tastes, technology, resources) with the induced variables (relative prices and profit/loss) that governs market activity unless there is intervention which steers us in wrong directions (which we must come back to the more correct path).

What am I missing in this story?


P.S.: I think it is great that you are blogging as I think you have written some of the most insightful stuff I've read over the past several months.

It seems to me that resource misallocation precipitates fear-based crises.

There are more ways to misallocate than not; we shouldn't presume that a reallocation will not just be another misallocation. There are a narrow range of sustainable reallocations, and the market has to discover at least one of them. Unfortunately, the original misallocation produced illusory price signals, and so there is a lot of unlearning that must occur. Once investors realise how little they understood before the bust, the future starts looking unpredictable, and, for investors in particular, that's very scary. The government just sits on the sidelines encouraging everyones' worst fears, (and then promises to protect people from unpredictability).

In any case, it seems to me that people who focus on fear are not wrong to be concerned with it, but are just looking at one link in the chain.

But what do I know ...

IT IS hard to look at the Capitol in Washington, DC, without a frisson of excitement

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