2007-12-04

Are economists paradigm-challenged?

From http://www.pkarchive.org/theory/hotdog.html

"But wait--what entitles me to assume that consumer demand will rise enough to absorb all the additional production? One good answer is: Why not? If production were to double, and all that production were to be sold, then total income would double too; so why wouldn't consumption double? That is, why should there be a shortfall in consumption merely because the economy produces more?


Here again, however, there is a deeper answer. It is possible for economies to suffer from an overall inadequacy of demand--recessions do happen. However, such slumps are essentially monetary--they come about because people try in the aggregate to hold more cash than there actually is in circulation. (That insight is the essence of Keynesian economics.) And they can usually be cured by issuing more money--full stop, end of story."


Keynesian economics, whose essence Paul Krugman thus summarized in January 1997, was valid when the world was far from the physical limits to growth (or in other words, when the world was on the way up to Hubbert's Peak), and lack of aggregate demand was the factor that prevented economic output (and employment) from growing at their potential sustainable levels. That was indeed the case for the Depression and all recessions up to and including the brief one in 2001 (and Argentina 2001, which was a neat Great Depression redux with the dollar playing the role of gold), with the exception of the 1970's oil shocks, which could be viewed as a drill for Peak Oil.

But now the world economy is bumping against the physical "limits to growth" - most notably, but not exclusively, in oil production -, with Hubbert's Peak either having been in May 2005 or being in the best case in 2012, and on the way down from it the foreseeable negative growth rates in economic output (until stabilizing at a lower REALLY sustainable level(*)) will not be the consequence of insufficient demand but of a physical constraint from Nature, namely the relentless decline in the production rate of fossil fuels. In this new scenario, stimulating aggregate demand with ANY policy (be it monetary, fiscal, or any other kind), however progressively distributive of wealth and/or income it may be, will not be able to increase output at all, as no monetary or fiscal stimulus can reverse the decline of an oil field, and no such stimulus will be necessary to increase oil exploration efforts since the price of fossil fuels will be high enough to do the job by itself. Monetary stimulus in this context only raises the price of the critical limiting resource.

An apt analogy is that of a pub. When there's plenty of beer, giving purchasing power to the customers if they do not have it (Eccles' income distribution proposal), or turning heating on to make them thirsty, in case they do have money (Krugman's inflation proposal for Japan) will make the trick of increasing beer sales (demand is the limiting factor). But when beer is running out, neither strategy will increase sales (supply is the limiting factor).

There are a few big mountains in the world where you can drive to the very top. Those who have done that know quite well that it would be very unsafe to drive on the way down in the same way as on the way up. They make a driving paradigm change when they start the descent. In contrast, today's economists are severely paradigm-challenged. They have known nothing but the way up (to Hubbert's Peak), and they don't seem to be able to make the mental adjustment to the way down. As a result, their driving paradigms are becoming unsafe.

Now, how could be a monetary policy be "safe" in this brave new world? E.g. by applying the following "safety overrides". Defining stocks as those of crude oil, gasoline or distillates:

- If any stock is in the lower quintile of its average range, do not cut rates.

- If any stock is in the lower decile of its average range and going down or flat, raise rates.

- If any stock is below its minimum operating levels, raise rates.

Sure enough, a matching "safe" fiscal policy should exempt inventories of crude oil and petroleum products from any tax.

(*) Since fossil fuels are an absolutely exhaustible resource, any economic activity based on them is by definition unsustainable.

2 comments:

Anonymous said...

What difference would it make if economists did "get it?"

They're modern day court eunuchs whose primary function is to justify why some are very rich and the rest of us are dirt poor. Maybe Krugman is different.

Point is that, like roosters greeting the dawn, they don't make the sun rise. They just make a lot of noise, strut around a bit and then dig for grubs.

Beach Boy said...

Well, their actions still do influence people's decisions. E.g. they decide what to tax and how much. And they set interest rates.