Monday, April 13, 2009

Markets work--Use markets

Another good find by Kendall posted at simply Capitalism: Austrian Economists on the Crisis.

On Bloggingheads.tv, Arnold Kling and Russ Roberts, two economists with approaches heavily influenced by the Austrian School of economics, discuss key contributing factors to the current economic crisis along with the rationale behind many of the responses by government.

I have thoroughly enjoyed Russ Robert and Arnold Kling's contributions to the discussion on EconTalk and elsewhere. Both are informed, appear to be honestly curious and critical, and make attempts to engage the other side in a respectful manner.

This clip has many worthwhile take-home points, but perhaps my favorite is Kling's summary of the various approaches to government's role in the economy. As he put it:

The Chicago School (monetarists) say: "Markets work--use markets."

Keynesians say: "Markets fail--use government."

Economists from George Mason University (heavy Austrian influence) say "Markets fail--use markets."

Pithy, but not quite accurate. First off, monetarists are only partial advocates of the free market. Milton Friedman (and many others) believe in the market for goods and services, but support the government's role in the market for money through Federal Reserve manipulation of the money supply. Some in the Austrian School might say that markets fail, but that is because of how they are defining failure. If "failure" means that mistakes will occur, then all human activities (not just markets) are failures because humans are neither omniscient nor infallible--and never will be. Such a definition equates human life with failure!

I think the following formulation is more accurate and more helpful:

Markets work (as a discovery process.)
Governments fail in markets (by disrupting market discovery.)
Use markets.

None of the above formulations, however, address the other crucial aspect of markets vs. government. Free markets are based on voluntary exchange; government is based on coercion. Not only does government intervention into the market disrupt proper market functioning, but the way that it does so is to violate its primary raison d'etre: the protection of individual rights. One more, and perhaps the primary, reason to "use markets."

.

4 comments:

Anonymous said...

Beth,

I don't think you are giving Friedman enough credit. Friedman traces the Great Depression to the mistakes made by the Federal Reserve and advocated replacing the Fed with a single clerk who would automatically increase the money supply at an annual rate commensurate with the long-term growth of the economy (thus keeping prices stable). He is firmly in the camp that believes the Fed's discretionary powers with respect to the money supply should be replaced with a simple rule. http://en.wikipedia.org/wiki/Friedman's_k-percent_rule

He also provided some support to the ideas of free market banking. Hummel can provide specifics on this.

That said, I like your formulation :-)

- cfc

Beth said...

Hi Chris--
I was wondering if you would object to my characterization of Friedman.
My understanding is that he traced the Great Depression to the Fed by saying it inadequately inflated in response to the contraction--but he denied the Fed's responsibility for inflating prior to the crash. He did advocate a steady rate of inflation instead of today's highly manipulated rate -- but, that is still advocating intervention based on the conclusion that markets won't function adequately on their own.

There were a lot of positive contributions Friedman made--I just don't think his recommendations regarding the need for inflation is one of them. I will look further into what he says on banking--thanks for alerting me to that.

Anonymous said...

Beth,

I think you are conflating inflation with an increase in the money supply :-) Yes, too big of an increase leads to inflation. But not enough leads to deflation. If you don't increase the money supply to keep up with the growth in the economy, you get deflation. Friedman did not advocate inflation but he did advocate increasing the money supply in order to keep prices stable. Stable prices are usually considered a good thing as they allow individuals and firms to plan better.

And yes, you can make a case for free banking to provide that same level of increase. But I have not studied monetary theory enough to know which would be a more reliable means of achieving the goal of stable prices.

Of course, you can also argue about whether the goal is important :-)

- cfc

Beth said...

Chris:

RE: I think you are conflating inflation with an increase in the money supply :-) Yes, too big of an increase leads to inflation. But not enough leads to deflation.

This depends on how you define inflation and deflation.

I had to look up conflate. Dictionary.com definition: to fuse into one entity; merge

So yes, I am conflating.

Here's my definition of inflation:
an increase in the quantity of money more rapid than the increase in the supply of gold and silver.

Since we no longer have money backed by value, the definition has to be modified.

Inflation is the increase in the quantity of money.

Creation of arbitrary (fiat) money makes it impossible to pin down precisely what is money, which helps to explain the attempts to empirically derive it through measuring M-1, M-2 MZM, etc.
Another way to put the definition would be, inflation is the increase in the quantity of money caused by the government. That would include both the printing and coining of currency as well as the enabling of credit pyramiding via regulation of the fractional reserve banking.

I understand that "inflation" is commonly used to refer to a general rise in prices, but that is to define the concept by an effect. There are several other things which can lead a rise in prices. Inflation (increase in the quantity of money) is only one of them. As concepts should serve the purpose of improving one's grasp of things, defining inflation in terms of its cause is far more accurate and helpful!

So yes, I conflate inflation and in the increase in the quantity of money.

The same problem arises if you attempt to define deflation as a fall in prices (effect) rather than a contraction in the quantity of money (cause.)

I strongly disagree that attempting to stabilize prices by manipulating the quantity of money aids economic calculation and planning. By creating a variable quantity of money, prices no longer accurately reflect a change in supply and demand. There is no way to isolate what part of a price change is due to supply/demand change and what part is due to a change in the quantity of money. Friedman's system of a rigid rate of inflation is superior to the politically controlled, and therefore arbitrary, rate changes of the current system, but it will still cause distorted price signals and therefore misallocation of resources.

I think this difference in how to view inflation is worth the effort to change how the term is used. Imprecise definitions hinder clear thinking.