Kenneth Arrow: Well, that's the intellectual issue. The major driver
of economics is the equilibrium approach, which has taken various forms
over the years. General equilibrium is the statement that all the
different parts of the economy influence each other, even if it's
remote, like mortgage-backed securities and their demands on
automobiles. Repercussions can go on for a very long time and in
different routes. That's where the world of general equilibrium comes
from -- and it's also the idea that the things tend to balance out. The
central picture we have is that prices will adjust so that balancing
occurs.
Markets clear. People want to buy what is offered and prices will
reflect that. When the price of one thing goes up others will too --
like the price of gasoline and automobiles. When prices go down that
affects the number of workers and when workers are out of jobs that
affects the amount of houses. The general equilibrium picture -- which
goes back to Adam Smith the late 18th century -- is that the prices
will reflect all of this. Basic things, like productivity. A new
product comes on the market. A hurricane calls for repairs.
All these things change the economy and the economy changes itself.
More capital changes how you supply goods, and this feeds back on
investment. It's a complicated set of reactions and the equilibrium
picture creates a favorable and smooth picture and, seemingly, more or
less in balance. The trouble is that -- while it is a very important
that things do balance and respond to fundamental changes -- we also
are accustomed to the fact that things don't balance and that things
will go array. In the medieval ages, things fluctuated -- but that was
due to war. Our market cycles were due to the weather or wars or
clinical circumstances, diseases and so forth. People got impoverished
if soldiers were fighting in their territory. But things that happen
under capitalism -- which was observed fairly early, maybe in the late
18th century -- well, those fluctuations are not because of outside
influences but due to the market itself.
The business cycle.
The business cycle. We saw it after the Napoleonic Wars and we saw
it in the Depression. We don't understand why and how we have recurrent
business cycles but there's always a lot of talk about how to
understand them.
Like sticky prices and so forth.
Dr: Right, wages and prices -- and wages especially -- tend not to
change as quickly as the theory says -- you know, demand drops and the
prices will drop. You do see this with the securities markets, which
are the best organized. Everywhere else you have little complications.
Especially with wages, because of the human relations involved, the
social relations, the interactive relations.
And on top of all of this there is another question about what we now
call a financial crisis. Not every business cycle has a financial
crisis. Frequently they do. A whole apparatus is needed to oil the
economy: you need a flow of money and a flow of credit. That's the
essential thing. You need credit. As people lay out money, as
businesses lay out money, they hire workers, buy goods -- you don't get
paid for some time and you need some credit to bridge this. Someone
needs to finance that. You don't use your own money, you borrow money
from other people who don't need the money right now.
