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Volatility in the news

Larry Summers had op-eds in the Financial Times and the Washington Post this week with essentially the same message. (Well played, Larry: apparently the Post’s editors do not read the Financial Times. It would not hurt them to start.) In both, he used the line, “Government has no higher responsibility than ensuring that economies have an adequate level of demand.” So, that stuff about securing life, liberty, and the pursuit of happiness is all secondary to ensuring an adequate level of demand?

That brings me to another recent column, also in the Washington Post, by Robert Samuelson. Though not an economist by training, Samuelson’s curiosity, willingness to listen to different views, and frank admission of how much he (and we) do not know make him consistently interesting to read.  By combining those characteristics with diligence, he has become a better economist than most professional economists. He writes:

"There’s a paradox to economic policy. The more it succeeds at prolonging short-term prosperity, the more it inspires long-run destabilizing behavior by businesses, banks, consumers, investors and government. If they think basic stability is assured, they will assume greater risks — loosen credit standards, borrow more, engage in more speculation, relax wage and price behavior — that ultimately make the economy less stable. Long booms threaten deep busts."

Samuelson expresses a view that the Austrian school of economics is somewhat comfortable with but that most other schools are not. Cross Ludwig von Mises on the drawbacks of interventionism and Joseph Schumpeter on the “creative destruction” of capitalism, and you get the conclusion that an unhindered market economy may in fact seem quite unstable in some ways, but that it is in fact less so than an economy that government is continuously trying to stabilize. It’s a “pay me now or pay me later” view that a market economy contains an irreducible minimum volatility. If you want to stabilize it permanently you have to suppress its dynamism.

I said the Austrians are somewhat comfortable with this view because it is in partial conflict with the idea that absent government intervention, many problems of scarcity would be greatly reduced, improving and even saving lives. I think the key is to understand that, as one of my economics professors, the late Don Lavoie, used to stress, we must ask “Compared to what?” That is, what is the workable alternative to an economy that experiences a shallow bust now and then: an economy that experiences no busts, or an economy that experiences deep busts? This is a topic that requires further development by Austrian economists.

Finally, I note a poll of 40 economists in which they unanimously disagreed that a gold standard would result in better price stability and employment outcomes for the average American. The poll taker remarks that “The panel members are all senior faculty at the most elite research universities in the United States.” That must account for the deadening uniformity of opinion; normally it’s hard to get 40 economists even to agree that the sky is blue. The economists who offer short answers for their votes say something along the lines of “the price of gold would be too volatile.” Compared, for instance, to the dollar, which was $35 per troy ounce about 40 years ago and is now around $1700? What would it take to pry open a few minds among these elite economists? First, evidently, a calamity; the near-calamity of 2008-09 was not enough. Second, they would have to know to distinguish among different types of gold standard, a topic I have discussed before and which I will soon return because it is still not sufficiently appreciated.

ADDENDUM: If the Austrians are somewhat comfortable with the idea of minimum volatility, some economists who work on "real business cycle" theory are completely comfortable. I thought when I wrote the post that after waiting awhile I might have something to say about them later, but I don't. They seem content to stick to their classrooms and their academic papers, and haven't made as much noise in newspapers or in blogs as other tendencies of thought.

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