At the risk of dating myself, this post will be about my economics text book my freshman year of college. The copyright dates are 1979 and 1982. What it says about macroeconomics is interesting.
The primary viewpoint is simple Keynesian. There is a tradeoff between inflation and unemployment. We can choose what we want that tradeoff to be. The best way to counteract the business cycle is by increasing or decreasing government spending. (On what gets little emphasis). The tradeoff between inflation and unemployment is on the demand side. It does acknowledge the possibility (at the time, the reality) of stagflation from supply side shocks, specifically increases in oil prices.
As a sort of counterpoint, it also introduced the monetarist theories of Milton Friedman. Friedman emphasized nominal, rather than real, GNP (that’s gross national product; gross domestic product was not generally accepted at the time), which was determined by money supply times velocity. It also ended up sort of walking back the tradeoff between inflation and unemployment. There is a natural level of unemployment. Measures to bring unemployment to that level cause very little inflation. Any attempt to lower beyond that does no good and just causes inflation.
The book focuses a lot on inflation. This was at the end of the ‘70’s, after all, and inflation was a big problem. It ends up concluding that high inflation is here to stay, that there is not much we can do about it, and discusses strategies for coping. As interesting as what my text discusses is what it does not discuss. Its entire discussion of deflation is a single paragraph saying that deflation no longer happens and it is not sure why. There is no discussion of asset bubbles or credit bubbles. In the 1970’s stock prices were stagnant and bubbles were the last thing on people’s minds. Besides, at the time most people held the illusion that bubbles (at least serious ones) were a thing of the past, and that we had conquered them by tough financial regulation.
I will also recount my reaction to all of it. By and large, it was very enlightening because I didn’t have most of these concepts before. In particular, I did not have the concept that a recession or depression is an economy falling below capacity, or even shrinking. I knew that everyone was getting poorer, but was utterly stumped where the wealth was going. Nor did I have the concept that inflation results when an economy strains against its capacity. I certainly did not have the concept that constraint on money could hurt the real economy.
Interestingly enough, the one concept I did sort of have was velocity. In puzzling over the Great Depression and wondering where all the money went, one thought that did occur to me was that it just was still there, just not circulating so fast. Basically true. It did also confirm two things I knew anyhow from high school economics. One was that the economy suffers if people stash their money under the mattress instead of putting it in a bank where it can be loaned out and invested. The other was one I figured out in response to teachers who said Germany and Japan had the “advantage” over us of having their industrial base blown up in WWII, so they could start out with newer plant. My thought was, couldn’t you get equally good results by less drastic methods, like regularly investing in upgrades. The answer, of course, was yes.
Given the choice between Keynes and monetarism, I preferred Keynes. The most obvious reason was because that was what we had learned and it was uncomfortable rearranging the furniture in my head. Another reason was that I really didn’t understand money and finance; the workings of the real economy just seemed more, well, real. Also, Keynes focused on real GNP and Friedman on nominal GNP. I couldn’t understand why anyone cared about nominal GNP; wasn’t it what was really produced that mattered? Friedman said the central bank could always expand the nominal GNP by printing more money. But everyone knew that. What good was nominal GNP expansion if it just consisted of inflation?
We were expected to write a term paper about a macroeconomic subject. I wrote about the causes of the Great Depression because it was a subject that had long baffled me. In researching the subject, I read four works representing two outlooks. One was a left wing outlook that the Depression was caused by income inequality. Economic growth was concentrated too heavily at the top and therefore went disproportionately into investment instead of consumption. This led to lots of stuff being produced and not enough people who could afford it. The speculative bubble arose when productive investment stopped paying off, and was not a sign of economic health, but a symptom of illness. (I do not remember the names of the authors or the publications).
The other two were far right views. I read Murray N. Rothbard’s America's Great Depression. Rothbard was an Austrian school economist and (I would later learn) an extreme one at that. The other was by British economist Lionel Robbins, who was not an Austrian, but shared their general outlook. Their viewpoint was that too-easy credit led to a lot of bad investments that had to be shaken out, and that any attempt to counter the process merely prolonged it. Like the lefties, they regarded the stock bubble as a symptom that the underlying economy was in trouble. Indeed, they did not see the bust as pathological at all. The boom was the pathology; the bust was merely recovery.
In the clear light of hindsight, I regret not reading the views of two more mainstream economists, although they may not have been seen that way at the time. One was our friend Milton Friedman's The Great Contraction. Friedman's theory was that the Great Depression was caused by monetary constraint, and that the proper remedy was monetary expansion (Ben Bernanke's much-mocked comment about dropping money from a helicopter originated with Friedman).
The other was the debt deflation theory of Irving Fisher. Fisher believed that depressions were caused by too much debt building up in the system and then all being called in at once. When everyone tries to pay down debt at once, it causes the economy to become deflationary, which makes the debt burden worse than ever. His remedy was “reflation.” This, by the way, clears up the mystery of why Milton Friedman should care about the nominal economy. Debt burden cannot exist relative to the real economy, only to the nominal economy. Nominal growth that consists mostly of inflation is beneficial in an over-indebted economy because it shrinks the debt burden.
The primary viewpoint is simple Keynesian. There is a tradeoff between inflation and unemployment. We can choose what we want that tradeoff to be. The best way to counteract the business cycle is by increasing or decreasing government spending. (On what gets little emphasis). The tradeoff between inflation and unemployment is on the demand side. It does acknowledge the possibility (at the time, the reality) of stagflation from supply side shocks, specifically increases in oil prices.
As a sort of counterpoint, it also introduced the monetarist theories of Milton Friedman. Friedman emphasized nominal, rather than real, GNP (that’s gross national product; gross domestic product was not generally accepted at the time), which was determined by money supply times velocity. It also ended up sort of walking back the tradeoff between inflation and unemployment. There is a natural level of unemployment. Measures to bring unemployment to that level cause very little inflation. Any attempt to lower beyond that does no good and just causes inflation.
The book focuses a lot on inflation. This was at the end of the ‘70’s, after all, and inflation was a big problem. It ends up concluding that high inflation is here to stay, that there is not much we can do about it, and discusses strategies for coping. As interesting as what my text discusses is what it does not discuss. Its entire discussion of deflation is a single paragraph saying that deflation no longer happens and it is not sure why. There is no discussion of asset bubbles or credit bubbles. In the 1970’s stock prices were stagnant and bubbles were the last thing on people’s minds. Besides, at the time most people held the illusion that bubbles (at least serious ones) were a thing of the past, and that we had conquered them by tough financial regulation.
I will also recount my reaction to all of it. By and large, it was very enlightening because I didn’t have most of these concepts before. In particular, I did not have the concept that a recession or depression is an economy falling below capacity, or even shrinking. I knew that everyone was getting poorer, but was utterly stumped where the wealth was going. Nor did I have the concept that inflation results when an economy strains against its capacity. I certainly did not have the concept that constraint on money could hurt the real economy.
Interestingly enough, the one concept I did sort of have was velocity. In puzzling over the Great Depression and wondering where all the money went, one thought that did occur to me was that it just was still there, just not circulating so fast. Basically true. It did also confirm two things I knew anyhow from high school economics. One was that the economy suffers if people stash their money under the mattress instead of putting it in a bank where it can be loaned out and invested. The other was one I figured out in response to teachers who said Germany and Japan had the “advantage” over us of having their industrial base blown up in WWII, so they could start out with newer plant. My thought was, couldn’t you get equally good results by less drastic methods, like regularly investing in upgrades. The answer, of course, was yes.
Given the choice between Keynes and monetarism, I preferred Keynes. The most obvious reason was because that was what we had learned and it was uncomfortable rearranging the furniture in my head. Another reason was that I really didn’t understand money and finance; the workings of the real economy just seemed more, well, real. Also, Keynes focused on real GNP and Friedman on nominal GNP. I couldn’t understand why anyone cared about nominal GNP; wasn’t it what was really produced that mattered? Friedman said the central bank could always expand the nominal GNP by printing more money. But everyone knew that. What good was nominal GNP expansion if it just consisted of inflation?
We were expected to write a term paper about a macroeconomic subject. I wrote about the causes of the Great Depression because it was a subject that had long baffled me. In researching the subject, I read four works representing two outlooks. One was a left wing outlook that the Depression was caused by income inequality. Economic growth was concentrated too heavily at the top and therefore went disproportionately into investment instead of consumption. This led to lots of stuff being produced and not enough people who could afford it. The speculative bubble arose when productive investment stopped paying off, and was not a sign of economic health, but a symptom of illness. (I do not remember the names of the authors or the publications).
The other two were far right views. I read Murray N. Rothbard’s America's Great Depression. Rothbard was an Austrian school economist and (I would later learn) an extreme one at that. The other was by British economist Lionel Robbins, who was not an Austrian, but shared their general outlook. Their viewpoint was that too-easy credit led to a lot of bad investments that had to be shaken out, and that any attempt to counter the process merely prolonged it. Like the lefties, they regarded the stock bubble as a symptom that the underlying economy was in trouble. Indeed, they did not see the bust as pathological at all. The boom was the pathology; the bust was merely recovery.
In the clear light of hindsight, I regret not reading the views of two more mainstream economists, although they may not have been seen that way at the time. One was our friend Milton Friedman's The Great Contraction. Friedman's theory was that the Great Depression was caused by monetary constraint, and that the proper remedy was monetary expansion (Ben Bernanke's much-mocked comment about dropping money from a helicopter originated with Friedman).
The other was the debt deflation theory of Irving Fisher. Fisher believed that depressions were caused by too much debt building up in the system and then all being called in at once. When everyone tries to pay down debt at once, it causes the economy to become deflationary, which makes the debt burden worse than ever. His remedy was “reflation.” This, by the way, clears up the mystery of why Milton Friedman should care about the nominal economy. Debt burden cannot exist relative to the real economy, only to the nominal economy. Nominal growth that consists mostly of inflation is beneficial in an over-indebted economy because it shrinks the debt burden.
Friedman, as I mentioned, was mentioned in our text, but mostly as an afterthought and a challenge to the accepted view. Neither Fisher nor his debt deflation theory were ever mentioned in our economics text at all. They may not have seemed as mainstream then as they do now. But Friedman's ideas were gaining ascendance, especially as they were being successfully used to tame the doubt digit inflation that seemed unstoppable. And Fisher is only now becoming fully appreciated.
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