Thursday 3 December 2015

The free market’s cure for unemployment.


Krugman considers the free market’s cure for recessions, and points to the fact that in a recession, prices would fall, which would raise the real value of money, which in turn would increase the paper assets of the population, which in turn would encourage spending. That’s known as the Pigou effect (though Krugman doesn’t mention Pigou). As Krugman puts it:

“How is the self-correction of an economy to its long-run equilibrium supposed to work? In textbook analysis, the story is that falling prices raise the real money supply, pushing down interest rates, and hence restoring employment.”

Note that BASE MONEY is the all important form of money here because base money is a net asset as far as the private sector is concerned. In contrast, commercial bank created money nets to nothing because for every dollar or pound of such money, there is a dollar or pound of debt. Thus commercial bank created money is not a net asset as far as the private sector is concerned.

Krugman however doesn’t mention Say’s law, which is another mechanism that tends to bring full employment (though like the Pigou effect it doubtless doesn’t work all that well). Say’s law works even in a barter or non-money economy. I set out a full explanation here.

At least I take it the latter exposition of mine is how Say’s law works. Maybe I’ve thought up an entirely new mechanism that enables the free market to bring full employment, in which case I’d like a Nobel Prize please.


3 comments:

  1. Ralph (quoting Krugman)> "How is the self-correction of an economy to its long-run equilibrium supposed to work?"

    Krugman mentions "long-run equilibrium" here, and avoids any reference to "full employment", for good reason. The long-run equilibrium of a self-correcting economy does not necessarily correspond to full employment or anything close. In fact it often doesn't. That was the great innovative insight of Keynes.

    Ralph> Krugman however doesn't mention Say's law, which is another mechanism that tends to bring full employment.

    Krugman doesn't mention Say's law because he knows it's a fallacy. Google on "debunking Say's law" to find out why.

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    Replies
    1. Krugman doesn’t mention “full employment”? Yes he does: see his second paragraph. Plus I take it that by “long run equilibrium” he means full employment. At least his 3rd para says, “How is the self-correction of an economy to its long-run equilibrium supposed to work? In textbook analysis, the story is that falling prices raise the real money supply, pushing down interest rates, and hence restoring employment.”

      I tried Googling “debunking Say’s law” and didn’t find anything very clear and concise. I’ve just looked up Say’s law in my Oxford Dictionary of Economics, and it seems very similar to what I take it as consisting of in the earlier post of mine linked to above. I.e. (very briefly) an unemployed baker can simply bake loaves and sell them at marginally below the going price. The price of bread falls marginally compared to other goods. Hey Presto – full employment or “equilibrium” is restored. Though (to repeat) that doesn't work very well in the real world.

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  2. Ralph> I tried Googling “debunking Say’s law” and didn’t find anything very clear and concise.

    I've added links to relevant Krugman posts on my blog.
    https://erikdesonville.wordpress.com/2015/12/03/free-market-equilibrium/

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