05 Aug 2009

O’Driscoll Economizes on My Words

All Posts No Comments

For a while, I think Mario Rizzo and I were the two contributors to the geeconosphere who most succinctly pointed out the micro-coordination problems that macro stimulus would distort. But in a short post, I think Jerry O’Driscoll crystallizes it even more tightly:

Consider the current economic situation. A financial crisis has been brought on by, first positive, and then negative monetary shocks. In the short run, individuals are increasing their demand for money (velocity is declining), and are simultaneously increasing their long-run, desired savings to a more normal rate. These effects combine to place downward pressure on nominal demand in many markets.

But the decline in nominal demand is not evenly spread across all markets. If demand is to be stimulated consistent with the new consumption/savings equilibrium, it would need to be supplied in the precise proportions that correspond to the new pattern of demand across markets (including inter-temporal markets). The information requirements to accomplish that task are nothing short of what would be required for comprehensive economic planning of the economy. Moreover, Public Choice tells us that stimulus will always be applied according to political, not economic, criteria.

If nominal demand is falling at uneven rates, then relative prices are changing. The same self-regulating forces are at work as described in microeconomics. Resources are being re-allocated across markets even as this is being written. A macroeconomic model with one good (output), one price, one interest rate, one wage rate, etc. is incapable of capturing those forces. The rationale for stimulus makes sense only in terms of such models and not in terms of how market economies actually work.

Comments are closed.