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Thoughts from the Frontline

Time to Put a New Economic Tool in the Box

July 26, 2014

[E]conomists are at this moment called upon to say how to extricate the free world from the serious threat of accelerating inflation which, it must be admitted, has been brought about by policies which the majority of economists recommended and even urged governments to pursue. We have indeed at the moment little cause for pride: as a profession we have made a mess of things.

It seems to me that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences – an attempt which in our field may lead to outright error. It is an approach which has come to be described as the “scientistic” attitude – an attitude which, as I defined it some thirty years ago, “is decidedly unscientific in the true sense of the word, since it involves a mechanical and uncritical application of habits of thought to fields different from those in which they have been formed.

– Friedrich Hayek, from the introduction to his Nobel Prize acceptance speech in 1974

Last week we took a deep dive into how the concept of GDP (gross domestic product) came about. We looked at some of the controversies surrounding GDP statistics that we use to measure the growth of the economy, and we noted that the GDP tool seems designed to reflect and serve an economic theory (Keynesianism) that prefers to focus on the demand side of economic activity. If your measurement of the growth of…

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Today, 2:32 a.m.

I agree.  GO is an important part of an economy which is complex and multifactorial.  But the question that begs to be asked is Why did GO move more dramatically negative than GDP during the 2008-09 recession?  The most obvious answer would be businesses are very sensitive to anticipated demand.

Today, 1:35 a.m.

This is one of the best articles John has ever written. Now everything makes more sense. I always thought consumer spending was over-emphasized. It never made sense to me how consumers were goaded into taking on more debt to “help” the economy, since the economy is the sum of our individual balance sheets.

I certainly hope this article is read by economic planning busybodies in Washington, D.C.!

Karlheinz Ramm

Yesterday, 9:39 p.m.

If economists want to understand whats driving the economy they will have to understand that the economy is something like a thermodynamic machine.

If you think about it you find that the proper measure for the energy gradient thats driving the economy (and connects it to the real world) is the interest rate that’s imbedded in the price structure. This is different from the market rate of interest because the latter is affected by the actual money flow which includes new credit created the increase of which may deviate in value from the additional resources made available by investment (you have to correct the price structure for this effect). Artificially low interest rates can feign the impression that there are more future recourses available than there actually will be. This way (by paying people with claims to future resources that won’t exist) people can be tricked into producing things that are actually not worth producing (because they ultimately don’t add exergy available for humans). This is reflected in rising debt to gdp numbers. (People are effectively made to overestimate the present value of the payments they receive for their services which in an economy working with credit money consists of claims to future resources.)

GO doesn’t help this understanding. But the intuition that the efficiency of businesses matters is of course the correct one. In microeconomics economists get it sort of. The macro sort is generally hapless. Unfortunately.

Correcting these distortions requires an adjustment of the price system which requires some valid signal
about the actual deviations which is normally provided by a recession. Without such a correction there has to be an inordinate amount of credit to be created to keep the economy “going”. When the debt carrying capacity is reached this is impossible. So central banks have started to take the surplus credit necessary onto their balance sheets to keep the impression of a somewhat functioning economy.

Jack Hiller

Yesterday, 7:51 p.m.

Mauldin’s review of alternative measures of economic activity and output provides truly important concepts for improved economic systems analyses. But even so, the quote from Hayek, about the limitations of human knowledge, and ineffectiveness or even mischief of deliberate social planning, provides an essential counterweight to the hubris of government intrusion into business affairs and the markets.

Well done John!