The Great Uncertainty

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Conservative economists believe that the most serious problems facing the economy are budget deficits, the threat of a future inflation, and the government's aggressive economic interventions in the economy, which include the stimulus package, the health care plan, and the takeover of General Motors. Liberal economists believe that the most serious problems facing the economy are that the depression may deepen and that the recovery from it, when it comes, will be shallow and protracted. Some of them believe that there is still a threat, indeed an actuality, of deflation; with the consumer price index flat for the past year, anyone who borrowed money last year when interest rates included an inflation component will find himself repaying the loan this year with dollars that are worth more than he expected.

The strong positive correlation between economic diagnosis and ideological presupposition tells you something about economics, more precisely about the economics of the business cycle. If this branch of economics were scientific, the conclusions of economists would be "observer independent" rather than inflected with each individual economist's political outlook. It is when science and other methods of exact reasoning (such as logic and mathematics) give out that a person's political preconceptions influence his views.

Macroeconomists look at the same evidence, the same phenomena, and see different things. Conservatives see a self-regulating economy, which achieves and maintains equilibrium (or an approximation to it) with minimal government regulation. Liberals see an unstable economy that requires, at times, including the present time, aggressive government action to keep the economy from running off the rails.

Conservatives typically believe in "Say's Law"--that supply creates its own demand. There can never be oversupply, because whatever is produced can be sold at some price; if the demand for some product falls, its price will fall until all of it is sold. Say's Law implicitly describes a barter economy, in which the role of money is incidental. Someone produces one good, and someone else another, and the terms on which the goods are exchanged reflect demand and supply. Ordinarily perhaps one widget is valued at two gidgets, but if demand for widgets falls perhaps the widget producer will have to accept one gidget in exchange for a widget. The "good" may of course be labor, but as long as prices are flexible, there will be no unemployment, just as there will be no excess supply. Of course at some point the price of labor may fall so low that many workers may prefer not to work. But they are not unemployed; they just are substituting one job, paid for in leisure, for another, paid for in other goods.

Keynes, the great denouncer of Say's Law, argued that money shouldn't be regarded as a veil between goods that merely facilitates barter. For when A sells B a good, A may decide not to buy any good or service with the money he receives in the sale, but instead to hold the money in some form. And if enough people do this, there may (depending on the form in which the money is held) be excess supply, contrary to Say's Law,. Producers may not be able to cut prices far enough to restore equilibrium. Instead, as prices fall, consumers and businesses may hoard cash all the more, because as prices continue to fall the purchasing power of cash will rise. With demand below the quantity of goods and services that full employment of the society's labor and other productive resources could supply, the government must have to step in and supply the missing demand, for example through a massive public works program employing workers for whom private producers have no jobs. But to a believer in Say's Law, the only effect of governmental demand is to augment private demand, so that total demand exceeds supply and therefore generates inflation.

There is much more to be said about the rival positions, but my simplified version will give the reader an adequate sense of the basic dispute. Although my own view, which is also that of a majority of economists at the present time, leans toward the second, the Keynesian, position, even if it could be proved correct (or more correct) than Say's Law it would not resolve the debate with which I opened. Keynesians acknowledge that there can be excessive government intervention in the economy, that enormous deficits can give rise to inflation, and that inflation can impose substantial social costs. And some conservative economists will concede, however grudgingly, that a stimulus program (Keynesian deficit spending, as on public works) may be a proper supplement to less intervenionist measures for arresting an economic downturn. Conservatives have generally supported the Federal Reserve's efforts to simulate lending by reducing interest rates and the efforts by the Fed and the Treasury Department to recapitalize banks, because bank lending is essential to production and consumption. But as I keep saying, you can lead a bank to money but you can't make it lend, and the experience since last fall has been that banks, nervous about lending into a depression and facing a reduced demand for loans, are not lending enough to stimulate economic recovrery, but instead are hoarding most of the cash that the government's monetary and bailout policies have given them.

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Richard A. Posner

Richard Posner is an author and federal appeals court judge. He has written more than 2500 published judicial opinions and continues to teach at the University of Chicago Law School. More

Richard A. Posner worked for several years in Washington during the Kennedy and Johnson Administrations. He worked for Justice William J. Brennan, Jr, the Solicitor General of the U.S., Thurgood Marshall, and as general counsel of President Johnson's Task Force on Communications Policy. Posner entered law teaching in 1968 at Stanford and became professor of law at the University of Chicago Law School in 1969. He was appointed Judge of the U.S. Court of Appeals for the Seventh Circuit in 1981 and served as Chief Judge from 1993 to 2000. He has written more than 2500 published judicial opinions and continues to teach at the University of Chicago Law School. His academic work has covered a broad range, with particular emphasis on the application of economics to law. His most recent books are How Judges Think (2008), Law and Literature (3d ed. 2009), A Failure of Capitalism: The Crisis of '08 and the Descent into Depression (2009). He has received the Thomas C. Schelling Award for scholarly contributions that have had an impact on public policy from the John F. Kennedy School of Government at Harvard University, and the Henry J. Friendly Medal from the American Law Institute.
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