Saturday, January 25, 2014

Wisdom Of The Week

The world is full of people who will tell you that there is. Tie your currency to gold! Always balance your budget! Protect manufacturing! Eliminate red tape! That kind of thing. You can safely ignore these people. Anyone who insists that running a modern economy is a matter of plain common sense frankly doesn’t understand much about running a modern economy.

This week I started reading Tim Harford's new book The Undercover Economist Strikes Back: How to Run-or Ruin-an Economy. It's a must read and cannot recommend more. Tim does a brilliant job of explaining most of the important macro-economic concepts from both sides of the aisle in a simplified conversational style sans any biases.

Is there a way to reconcile the classical and Keynesian views? As it happens, there is. In fact, for many economists there’s no need to reconcile anything. Sometimes economies suffer from demand shocks and sometimes they suffer from supply shocks. Both the Keynesian and classical perspectives can be helpful, depending on the circumstances.

There’s a reconciliation on a geekier level, too. Much of modern macroeconomics is some kind of synthesis of classical and Keynesian analytical techniques— but that is far too technical for us to worry about.

But there is also a really simple way to combine the two views. We need to introduce a concept you’ll hear discussed often in economics— the “short run” and the “long run.” Most economists would agree that in the short run, it is Keynes’s Law that is relevant. Many recessions happen because of a lack of demand, and this lack of demand can be fixed by smart policymakers working with the right tools. And most economists would also agree that in the long run, it is Say’s Law that counts: ultimately the output of an economy is determined by its capacity to supply goods and services. Given enough time, demand will catch up and that potential to supply will be fulfilled.

Even this is an oversimplification. The 1970s oil shocks happened very quickly, but they were a classical problem, and Keynesian, demand-side approaches would not have helped. Still, “short-run Keynes, long-run classical” is not a bad rule of thumb.

Also I highly recommend Tim Harford's weekly BBC podcast - Popup Economics.

“The master-economist must possess a rare combination of gifts.  .  .  . He must be a mathematician, historian, statesman, philosopher— in some degree. He must understand symbols and speak in words. He must contemplate the particular in terms of the general, and touch abstract and concrete in the same flight of thought. He must study the present in the light of the past for the purposes of the future. No part of man’s nature or his institutions must lie entirely outside his regard.”

John Maynard Keynes

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