Wednesday, June 22, 2016
The common failing of Keynesian and neoclassical models of fluctuations in the economy as a whole is that they are concerned with the economics of "stuff". By this I mean that they focus on total spending - aggregate demand - rather than take seriously the fact that it is the very multiplicity of things which households could buy that creates problems in coordinating spending plans in the economy. If the only choice for households and businesses was to buy "stuff", then it would be easier to coordinate plans because only one price - the real interest rate (the price of "stuff" today in terms of "stuff" tomorrow) - would need to move to coordinate total desired spending with desired investment. But the purpose of a market economy is to provide households and businesses with opportunities to spend their money on a wide variety of goods and services, as well as holding some back for unimaginable events or opportunities. Radical uncertainty ("stuff happens") means that many of the markets in which prices might move to produce an equilibrium simply cannot and do not exist. The market economy cannot, therefore, coordinate spending plans. There are too many missing markets. As a result, a market economy is not self-stabilising, leading to occasional sharp ups and downs in total spending. Traditional macroeconomics is the economics of "stuff". We need instead the economics of "stuff happens".
-Mervyn King, The End of Alchemy: Money, Banking, and the Future of the Global Economy