Why is America in debt and how can we fix it?

[PeterDonis]

nothing will wipe put debt faster than a hyperinflation. High inflation has many other problems of course

Um, yes, that's one way of putting it.

 

[BWV]

The current deficit/gdp is about 2.8%, which is easily sustainable with modest growth assumptions- say, 2% real gdp growth and 2% inflation. The problem is the demographic-driven ramp up in entitlement spending in coming decades and the fact that there will be future recessions where deficits explode to 5-10% of gdp or more like they did in 2008-2009


https://research.stlouisfed.org/fred2/series/FYFSGDA188S

 

[mheslep]

It is my view that what is important is cutting government spending, however spending is financed. A so-called deficit is a disguised and hidden form of taxation. The real burden on the public is what government spends (and mandates others to spend). As I have said repeatedly, I would rather have government spend one trillion dollars with a deficit of a half a trillion than have government spend two trillion dollars with no deficit.

Federal, state and local spending. Constant dollars, per capita.

 

[indio007]

Debt is rolled over. The very first US gov't bond ever issued is still outstanding. The national debt means very little.

I should also add the US gov't doesn't adhere to GAPP. The accounting was changed to make the US gov't look broke by changing some accounting items which were based on accrual accounting into cash basis items.

It's a bunch of smoke and mirrors for the purpose of strip-mining the middle class.

 

[PeterDonis]

The current deficit/gdp is about 2.8%, which is easily sustainable with modest growth assumptions- say, 2% real gdp growth and 2% inflation.

Now you're talking about real GDP instead of nominal GDP. Which is it? If you want to talk about real GDP, then you can't just throw around debt to GDP ratio numbers, because those are nominal. You have to actually look at whether wealth is being created or destroyed, on net, eliminating dollars from the analysis entirely. 2% real GDP growth won't be enough if the government's activities, on net, are destroying more than 2% of the country's wealth per year. The deficit/GDP ratio tells you nothing about that.

 

[BWV]

Now you're talking about real GDP instead of nominal GDP. Which is it? If you want to talk about real GDP, then you can't just throw around debt to GDP ratio numbers, because those are nominal. You have to actually look at whether wealth is being created or destroyed, on net, eliminating dollars from the analysis entirely. 2% real GDP growth won't be enough if the government's activities, on net, are destroying more than 2% of the country's wealth per year. The deficit/GDP ratio tells you nothing about that.

Not sure what your problem is, just mentioned a realistic scenario to get to 4% nominal GDP growth (2% real plus 2% inflation). Presumably whatever wealth the government is destroying would be netted in the real GDP figures , assuming they are measured accurately

 

[PeterDonis]

Presumably whatever wealth the government is destroying would be netted in the real GDP figures , assuming they are measured accurately

Do you know of any measurements of real GDP?

 

[BWV]

Yes

https://research.stlouisfed.org/fred2/series/GDPC1

 

[Astronuc]

https://www.cbo.gov/topics/
https://www.cbo.gov/topics/social-security

Social Security is the largest federal program, paying benefits to retired workers and their dependents and survivors through the Old-Age and Survivors Insurance program and to disabled workers and their dependents through the Disability Insurance program. Those benefits are financed primarily by payroll taxes. CBO projects Social Security’s finances under current law and analyzes a wide variety of possible changes to the law.

The 2015 Long-Term Budget Outlook Report June 16, 2015
If current laws remained generally unchanged, federal debt held by the public would exceed 100 percent of GDP by 2040 and continue on an upward path relative to the size of the economy—a trend that could not be sustained indefinitely.

https://www.cbo.gov/topics/defense-and-national-security

About one-sixth of federal spending goes to national defense. CBO estimates the budgetary effects of legislation related to national security and assesses the cost-effectiveness of current and proposed defense programs. CBO also analyzes federal programs and issues related to veterans.

https://www.nationalpriorities.org/budget-basics/federal-budget-101/spending/
https://www.socialsecurity.gov/budget/hist/histdata.html

The bottom line is that the government revenues (taxes, fees, etc) have been less than expenditures, so either the government cuts expenditures or increases tax revenues, or both. Chronic deficits eventually lead to crushing debt, and so far the economic policies of the successive administrations have failed to achieve a responsible fiscal policy.

 

[kinimod]

National debt simply means that people are wealthy, they have excess money supply that (in people's mind) has no practical/"risk-free" use.

So instead of money "laying around", government prefers to motivate people to give it to the government. Government takes this money and locks it (e.g. by selling a bond). The people then own a piece of paper (the bond with some promises of benefits), the government owns the money.

Government does not necessarily need this money. A sovereign country like US with fiat currency can just print more if they choose to. It's not like the government is desperate to ask people for money. In fact the opposite, that's why the interest rate on bonds is so low. Government would instead like people to take risks and be productive and innovative with their money to grow the economy.

As you can see, this debt doesn't mean anything, except that people are too rich and don't know what better to do with their excess money, so they put it into this "safe".

 

[PeterDonis]

instead of money "laying around", government prefers to motivate people to give it to the government. Government takes this money and locks it (e.g. by selling a bond). The people then own a piece of paper (the bond with some promises of benefits), the government owns the money.

Selling bonds to private individuals is one way the government can go into debt, yes; but it's not the major one. The major one is the government selling Treasury bills to the Federal Reserve, which prints the money that is used to buy them. The money gets spent by the government; the Fed holds the T-bills as securities. This is how the Fed manages the money supply (or at least one way it does); when it wants to increase the money supply, it prints money and buys government T-bills with it; when it wants to decrease the money supply, it sells T-bills back to the government and "retires" the money received for them. (AFAIK the Fed hasn't done this in quite some time.)

 

[kinimod]

Selling bonds to private individuals is one way the government can go into debt, yes; but it's not the major one. The major one is the government selling Treasury bills to the Federal Reserve, which prints the money that is used to buy them. The money gets spent by the government; the Fed holds the T-bills as securities. This is how the Fed manages the money supply (or at least one way it does); when it wants to increase the money supply, it prints money and buys government T-bills with it; when it wants to decrease the money supply, it sells T-bills back to the government and "retires" the money received for them. (AFAIK the Fed hasn't done this in quite some time.)

Exactly, and it's a deliberate strategy. One could conclude that government is "overspending" and in "debt", but we can not in fact interpret that as government being economically insolvent,... it just generally means that the entire country is doing well, and we need the prices to go up, we need inflation, so government sells treasury bills to Fed to print more money into the circulation, and we have a perfect equilibrium (at least in the way the current monetary policy works).

 

[kinimod]

I would also add that it would be fantastic if the government took even more debt on itself, e.g. by printing money as described above.

Then they would use the money to hire private contractors and companies to build roads, railways, bridges, etc. Those private contractors then use the money to pay their employees. Employees then buy food, cars, pay other people for services, etc.

You can see there's risk; there's a sudden, abrupt injection of new excess funds in the private environment among people. If not under just the right balance, people become too rich. When people are too rich suddenly, all producers, businesspeople and entrepreneurs raise prices (seeing that people can afford it). This can turn into an uncontrolled volatile situation on the market, lots of destabilization, market not predictable. When market is not predictable, many panic, and when people panic, markets crashes. When markets crash, people are laid off, etc etc.

My point is: government of a sovereign country (in which people and banks think about money the way we generally think today) should always be in a ton of debt. Just the right amount. Debt in this case does not mean overspending or economically insolvent, it means more like "stimulating the future". It's hard to say how much without looking at many data inputs from the entire country's economy and demographic situation.

It is also possible that there's indeed structural deficit where social benefits drain the money supply faster than it grows. In that case the government is betting on some sort of long term beneficial strategy that may also end terribly.

 

[PeterDonis]

it would be fantastic if the government took even more debt on itself, e.g. by printing money as described above.

You have an extraordinary faith in government's ability to make efficient use of resources. That faith is not justified by government's actual performance at doing that. The US government has been doing what you describe for quite some time now. The results have not been "fantastic".

You also appear to mistakenly believe that printing money creates wealth. It doesn't. See below.

it would be fantastic if the government took even more debt on itself, e.g. by printing money as described above.

Then they would use the money to hire private contractors and companies to build roads, railways, bridges, etc.

You're assuming that whatever the government hires the contractors to do is the most efficient use of those resources. Governments are extremely bad at making those judgments. And since printing money does not create any weath, the resources that are used for whatever the government hires contractors to do using the printed money get taken from other sectors of the economy; which means that, if what the government is hiring the contractors to do is not the most efficient use of those resources, then the government printing money makes things worse, not better.

there's a sudden, abrupt injection of new excess funds in the private environment among people

No, there isn't. Money is not wealth. Printing money does not create wealth; it just redistributes it. Economically, it's the same as if the government taxed everyone and then gave the tax revenues to whoever they give the printed money to.

When people are too rich suddenly, all producers, businesspeople and entrepreneurs raise prices

You are misdescribing what happens. What happens is that, when the money supply increases without a corresponding increase in actual wealth, everybody has to raise prices, because the real value of the money they are receiving has decreased--it takes more money to buy the same amount of wealth. Nobody is actually getting richer.

 

[BWV]

Selling bonds to private individuals is one way the government can go into debt, yes; but it's not the major one. The major one is the government selling Treasury bills to the Federal Reserve, which prints the money that is used to buy them. The money gets spent by the government; the Fed holds the T-bills as securities. This is how the Fed manages the money supply (or at least one way it does); when it wants to increase the money supply, it prints money and buys government T-bills with it; when it wants to decrease the money supply, it sells T-bills back to the government and "retires" the money received for them. (AFAIK the Fed hasn't done this in quite some time.)

That is not correct, open market activities by the fed have nothing to do with the level of government borrowing. The fed increases (decreases) liquidity in the banking system by buying (selling) T-bills from the private sector. Aside from the recent spike due to QE (which again was purchases from the private sector) fed holdings of government debt have been a very small fraction of the total debt outstanding. The private sector (including Foreign government entities like the PBOC or Middle Eastern Sovereign Wealth funds) are the lenders to the us government, not the Federal Reserve

 

[phyzguy]

No, there isn't. Money is not wealth. Printing money does not create wealth; it just redistributes it. Economically, it's the same as if the government taxed everyone and then gave the tax revenues to whoever they give the printed money to.

You are misdescribing what happens. What happens is that, when the money supply increases without a corresponding increase in actual wealth, everybody has to raise prices, because the real value of the money they are receiving has decreased--it takes more money to buy the same amount of wealth. Nobody is actually getting richer.

When you make these statements, you are assuming that the economy as a whole is running at full capacity. In this case, it is true that injecting more money just causes prices to rise, and no more goods are produced. However, when you have a depressed economy, as we have today, the economy as a whole is producing far less than it could. People are sitting around unemployed when they could be doing productive work. Factory capacity is sitting idle that could be producing goods. In this case, injecting money into the depressed economy can and does produce more wealth, because it stimulates idle capacity to be put to use. There are many historical examples that prove this.

 

[PeterDonis]

The fed increases (decreases) liquidity in the banking system by buying (selling) T-bills from the private sector.

I was under the impression that they do both.

Aside from the recent spike due to QE (which again was purchases from the private sector) fed holdings of government debt have been a very small fraction of the total debt outstanding.

Looking at the breakdown here:

https://www.nationalpriorities.org/campaigns/us-federal-debt-who/

You are correct; the Fed's holdings total about $2.46 trillion, which is indeed not much above what they have built up through QE. So I was mistaken. Private investors (international and domestic) total about $8.8 trillion, which is the largest fraction; but federal government accounts total about $5.2 trillion, which is also significant. (The major one of those is the Social Security trust fund.)

 

[PeterDonis]

People are sitting around unemployed when they could be doing productive work.

It certainly seems like this is true; but you can't just assume it. It could also be that people are sitting around unemployed because government manipulation of the economy caused them to invest time and effort building up skills that turned out not to be useful.

Factory capacity is sitting idle that could be producing goods.

Perhaps; but it could also be that factory capacity is sitting idle because it was designed to produce something that is not worth enough to justify the investment.

In both of the above cases (people investing in the wrong skills, and factories designed to produce the wrong things), it is certainly possible for them to happen in a fully free market economy where there is no government manipulation. However, when they happen in a fully free market economy, they don't last long, because people who don't have necessary skills become unemployed very quickly, and companies with factories that can't build the right things soon go bankrupt. In other words, people who try things that are bad ideas get quick feedback that they are bad ideas, so they can stop doing them and start doing something else.

But when the government manipulates the economy, it can make bad investments look like good investments, because printing money masks the price signals that tell people how much their skills are worth and companies how much the goods their factories can produce are worth. So people and companies can be led down unproductive paths for a much longer length of time before the fact that the paths were unproductive becomes apparent. Then, when it does become apparent, you get a crash as a lot of people suddenly become unemployed and a lot of companies suddenly go bankrupt (or get bailed out by the taxpayers if they can convince politicians that they are "too big to fail").

There are many historical examples that prove this.

I would say there are many historical examples that prove that governments can create apparent increases in wealth; but they do it, as above, by making bad investments look like good investments--for a while. But it never lasts, and the resulting crash is worse with government manipulation than it would have been without, because it comes after a longer period of bad investments that looked like good ones. The latest example was the crash of 2008, which came after a sustained period of bad investment that looked like good investment, because of government manipulation.

How can you tell the difference? How can you tell whether a depressed period is just a natural cycle (which, perhaps, might be mitigated by finding ways to encourage people to create weath), or is due to government manipulation? Here's the key: in a natural cycle, you don't have multiple sectors of an economy going bad all at once. One sector might have a bad period because of some natural fluctuation; but in a free market economy, that just means people shift more productive effort to other sectors to make up the difference. Only in a manipulated economy do you get a depression that affects all sectors at once.

In other words, this...

the economy as a whole is producing far less than it could.

...is not a sign that the government needs to step in. It is a sign that the government has already stepped in, far too much, and has manipulated the economy to the point that nobody can tell what is productive and what isn't, so the only thing they can do is to not take any chances--don't produce anything unless you absolutely need to. In a free market economy, the condition you describe could not exist, because people would not create productive capacity in the first place unless they intended to use it; and if it turned out to be a bad investment, it wouldn't just sit idle; it would get converted to some other use that was a better investment.

 

[mheslep]

It is not remotely the case that Keynesian fiscal stimulus is historically "proven". The debate rages on with evidence for and against, does Bastiat's Broken Window parable apply or not. Most recently, see the outcome of the 2009 Recovery Act. The blue line is the employment rate forecast by Obama economic adviser Romer as an outcome of the 2009 stimulus, almost a trillion dollars. The top dotted line was the actual employment rate.

 

[BWV]

The value of money and government debt are tied together - money in modern economies primarily exists only in electronic form within the banking system. it is the banking system through the mechanics of fractional reserve banking, not the Treasury that usually exerts the greatest influence on the money supply. The provision of a public good - money, by private firms lies at the heart of the financial instability that leads to periodic financial crises such as in 2008. One option is to strip banks of this ability by requiring much higher amounts of equity capital (maybe not 100%, but this is still called full reserve banking). While likely a political nonstarter, it has some serious and thoughtful proponents and advantages to the current solution which is hyper-regulation:

http://www.ft.com/intl/cms/s/0/7f000b18-ca44-11e3-bb92-00144feabdc0.html#axzz3rCU9ZLsq

The value gov debt flows from confidence in the stability and adequacy of the future tax revenues necessary to service government debts. The value of money stems from confidence in the financial stability of the issuer. The classic monetarist inflation description of too much money chasing too few goods is correct but trivial in that it fails to address the fiscal solvency issues that historically have ignited periods of high inflation:

http://faculty.chicagobooth.edu/john.cochrane/research/papers/cochrane_fiscal_theory_panel_bfi.pdf

 

[AgentSmith]

I disagree. Name a country where the fundamental infrastructure (roads, water supply, sewage removal and treatment, ...) has been built and financed by private companies.

In virtually all countries the infrastructure is built by private companies, even in socialist ones like Sweden. Today most financing is public, but right into the 20th century much infrastructure was financed by private firms in order to carry out their primary business. Most railroads in the US were self-financed for example. In the 19th century private postal systems operated quite well until government made them illegal. Private water and sewage treatment systems existed all over the place until government declared them illegal also. Governments don't like competitors.

 

[PeterDonis]

The value of money and government debt are tied together - money in modern economies primarily exists only in electronic form within the banking system. it is the banking system through the mechanics of fractional reserve banking, not the Treasury that usually exerts the greatest influence on the money supply.

I agree with this, but bear in mind that "the banking system" is controlled by the Federal Reserve, i.e., by a government agency. A purely private banking system would have different incentives and be under different constraints.

For example, a purely private banking system could still print money (in fact, historically that was how fractional reserve banking originated--private banks began printing more of their notes than the actual deposits they had to back them, counting on the fact that only a small percentage of their depositors would actually want to withdraw their deposits at any given time). But a purely private banking system that printed money and got found out would be immediately subject to a run, which would probably put them out of business (historically, a lot of private banks failed this way). When the government prints money, they brag about it, as Bernanke did when he said he had a "device called a printing press" that could get the economy out of any jam.

The value gov debt flows from confidence in the stability and adequacy of the future tax revenues necessary to service government debts.

This doesn't quite get at the root of the issue. Taxes are denominated in currency, so the government can increase tax revenues, nominally, by printing money and seeing that it eventually gets into the hands of taxpayers.

The root of the issue is that the value of government debts flows from confidence in the ability of the country being governed to create wealth. Historically, the US, as a country, has been better at that than anyone else, which is why US government securities are considered safer than any other government's. But if the government continues to discourage wealth creation by manipulating the economy, it will kill the goose that laid the golden eggs.

 

[phyzguy]

PeterDonis: Your faith in the free market economy is touching. I wish it were as all-powerful and self-correcting as you make it sound. If it is, explain to me why we have economic depressions. In 1929, the US government was a small part of the economy; government expenditures were only 5% of GDP. So it is hard to see how you can blame the great depression on government manipulation. Yet we had a major economic downturn that threw more than 25% of the US work force out of work. Things did not really pick up again until the US government began to heavily deficit spend as a result of WW2.

The reality is very different than your narrative. The reality is that since WW2 when we have had more government intervention in the economy, that there have been fewer economic downturns, and they have been shallower than they were when the free market economy reigned supreme. Why would you expect otherwise? It is obvious that the free market economy has significant positive feedback built into it, and this is why there have historically been boom and bust cycles. Adding some level of negative feedback, as the Federal Reserve attempts to do, should help stabilize the economic system, and it does.

 

[PeterDonis]

Your faith in the free market economy is touching.

It's not "faith" in a free market; it's lack of faith in government.

I wish it were as all-powerful and self-correcting as you make it sound.

I'm not saying free markets are all-powerful and self-correcting. I'm only saying government manipulation is worse.

If it is, explain to me why we have economic depressions.

Because governments manipulate economies. This is not a new thing; it's been happening as long as there have been governments. Just to take the US as an example, the federal government started manipulating the economy almost as soon as it was formed; in fact, even before the Constitution, under the Articles of Confederation, the Continental Congress printed money in order to try to finance the Revolutionary War, and then kept on doing it to try to stave off the bad effects of the original printing.

Once again: in a free market economy, all sectors don't go bad at once. In some of the American colonies in the late 17th and early 18th centuries (for example, Pennsylvania--see Rothbard's Conceived in Liberty for a good discussion), there was virtually no central government, and there were no economic depressions; different sectors would have booms and slumps at different times, and it all averaged out. In other colonies, where the governments were much stronger, there were economic slumps that affected all sectors at once--because government manipulation affects everything. No other cause does.

In 1929, the US government was a small part of the economy; government expenditures were only 5% of GDP. So it is hard to see how you can blame the great depression on government manipulation.

I didn't say government expenditures; I said government manipulation of the economy. The government doesn't have to expend money directly in order to do that. It can do it simply by changing the rules under which economic activity is forced to operate.

In the case of the Great Depression, the worst wasn't in 1929; in fact, there was a partial recovery after the 1929 stock market crash. If the government had just left things alone, it would have become a full recovery--which is exactly what happened in the early 1920's, when there was a brief slump and the government did absolutely nothing. In 1930-1931, however, the Hoover administration refused to do nothing, and as a result, the partial recovery turned into a depression. FDR then rode the wave of dissatisfaction into office--and proceeded to try the same sorts of manipulations that Hoover had tried, which failed. What eventually kicked the US economy out of depression was World War II.

The reality is that since WW2 when we have had more government intervention in the economy, that there have been fewer economic downturns, and they have been shallower than they were when the free market economy reigned supreme.

The 2008 downturn was the second worst in US history (the worst being the Great Depression), and it was caused by government manipulation of the economy.

It is obvious that the free market economy has significant positive feedback built into it

Really? It's not obvious to me. Please elaborate.

 

[Smattering]

As a German I find this discussion somewhat amusing. As some might know, the German government has recently followed a balanced budget doctrine, and it has been critizised very sharply for this policy. Many economists worldwide advised them to stop this policy and increase public spendings.

My impression is that the majority of influencial U.S. economists is currently advocating monetary financing as a kind of perpetuum mobile of economic growth.

 

[mheslep]

The idea that free market failures caused the Great Depression and that the federal government only acted as a rescuing hero is a myth, a quite outdated myth at this time. The actions of the federal government via the Federal Reserve were the primary cause of the Depression, not the other way around. That is, the federal government turned a recession into the Depression by cutting off the money supply and thereby forced the banks out of business. In addition government enacted the 1930 tariff laws that destroyed trade, so that retaliation cut off US farmers from foreign markets, so that, so that ...

Fed Chair Ben Bernanke Regarding the Great Depression, 2002

As everyone here knows, in their Monetary History Friedman and Schwartz made the case that the economic collapse of 1929-33 was the product of the nation's monetary mechanism gone wrong. Contradicting the received wisdom at the time that they wrote, which held that money was a passive player in the events of the 1930s, Friedman and Schwartz argued that "the contraction is in fact a tragic testimonial to the importance of monetary forces"...
.
.. so that the Great Depression can reasonably be described as having been caused by monetary forces. ...

...You're right, we did it. We're very sorry. But thanks to you, we won't do it again.

Yes there was a stock market bubble and collapse in '29; there will inevitably be more in the future. But these are mere economic blips compared to what government malpractice has done the economy.

 

[BWV]

The idea that free market failures caused the Great Depression and that the federal government only acted as a rescuing hero is a myth, a quite outdated myth at this time. The actions of the Federal Reserve were the primary cause of the GD, not the other way around. That is, the federal government turned a recession into the Depression by cutting off the money supply and thereby forced the banks out of business. In addition government enacted the 1930 tariff laws that destroyed trade, so that retaliation cut off US farmers from foreign markets, etc, etc.

Fed Chair Ben Bernanke Regarding the Great Depression, 2002


Yes there was a stock market bubble and collapse in '29; there will inevitably be more in the future. But these are mere economic blips compared to what government malpractice has done the economy.

While I don't disagree that government policies, both of the Fed and the Hoover and FDR administrations made the Great Depression worse than it needed to be, there was more than just a stock market bubble in the late 20s. The rapid expansion of private credit in the 20s and the subsequent bust were the real story, the stock market collapse being just one class of asset whose value was over-inflated by abundant credit. This is not a controversial issue, it was recognized at the time by Von Mises and the rest of the Austrian school along with Irving Fisher and Keynes. There were similar credit booms and busts in 1873 and 1907, both of which occurred without any intervention by the government.

 

[mheslep]

Agreed, though I'd not call the loose/leveraged credit the "real story" of the period. Yes certainly those excesses occurred. And as you say there have been several credit/financial driven busts in US history, not instigated by the government, nor was the stock market crash of 1929 (and credit bubble) instigated by the government. My point is that in all of these market bust cases, without exception, the downturn was relatively short lived and mild compared the Great Depression; the 1907 panic for instance was 13 months per the NBER. Even the Oct 1929 market collapse had recovered 50% of its Oct-Nov losses by the Spring of 1930. It was government that made that particular panic, that recession, into the generational catastrophe that it became. Markets are incapable of cutting off the money supply for any length of time, and thus destroying the value of otherwise stable, non-speculative assets (i.e a car, a horse, a gallon of milk) as opposed to lowering the value temporarily. Market-makers can't cut off trade across borders for long periods. Markets can not set wage and price controls across a nation. Government does, and did these things, where as markets eventually (in months) clear. To use your phrase, the government policy causes of the Depression, or perhaps, the conversion of the panic into a depression, these are no longer a controversial issue.

 

[PeterDonis]

the issuance of notes are not the money that matters - its the creation of money through credit.

If a bank issues more notes than they have deposits to back them, that effectively is creation of money through credit: credit being provided to the bank, unwittingly, by its depositors.

The only thing the Fed adds to the system is a lender of last resort to stem panics and bank runs.

Instead we get massive bailouts of those who were financially imprudent, at the expense of those of us who were financially prudent. I'm not sure that's an improvement.

 

[phyzguy]

Well, I'm not sure we're getting anywhere, other than to see that there is a lot of disagreement. It amazes me that on a topic so important to the human race, namely economics, that we don't even agree on the very basics. Some people say, as mhslep said, that the 2009 stimulus was unsuccessful because unemployment went higher than forecast. Others say (Paul Krugman for example) that the 2009 stimulus prevented things from being much worse, and that the reason it wasn't more successful was that it was too small. How do we get it to be a more quantitative science, so at least we can agree on the basics? With the computer power we have today, why can't we build a detailed model of the economy so we can run scenarios? It would be great to re-run the last 5 years with no stimulus, bigger stimulus, etc. Until we can do something like that, each of us will continue to revise history to adhere to whatever model we think is correct.

 

[PeterDonis]

It amazes me that on a topic so important to the human race, namely economics, that we don't even agree on the very basics.

That's because economics is not a hard science. (I'm tempted to say it's not a science at all, but that would be a bit uncharitable. Perhaps "proto-science" would be a better term.) Our knowledge of economics today is more or less at the stage our knowledge of chemistry was at when phlogiston theory was on the way out but there wasn't yet anything to replace it with.

With the computer power we have today, why can't we build a detailed model of the economy so we can run scenarios?

Because the computer power we have today is still many orders of magnitude too little to run such models. An economy is too complex. Roughly speaking, the complexity of an economy is exponential in the number of people (since that's a rough first-order estimate of the number of potential interactions). So an economy consisting of, say, 1000 people (a village) already has complexity of order $e^{1000}$, a number vastly larger than the number of elementary particles in the universe or the number of Planck intervals since the Big Bang.

Until we can do something like that, each of us will continue to revise history to adhere to whatever model we think is correct.

There is an alternative: admit that nobody knows how to run an economy, and therefore stop trying. Free markets don't need anyone to "run" them; nobody needs to understand how a free market works in order for it to work. That's why free markets work better than government regulation, since the latter does require somebody to know enough about how an economy works to regulate properly. (And to be able to process enough information to act on their knowledge--which is really the reason why centralized control doesn't work. Exponentials are a bummer.)

Note that I did not say free markets work well; I only said they work better than government regulation. I'm not sure there is any economic system that will work "well" in the sense that everybody living in it will be happy and not complain that they aren't getting what they want. An economy depends on cooperation, and large economic projects depend on cooperation among large numbers of people. The conditions for effective cooperation among large numbers of people are very hard to meet: everybody has to have the same, or at least compatible, goals; and everybody needs to have the same, or at least compatible, factual beliefs about how to achieve those goals. That combination of things is rare, which is why effective cooperation on any large scale is rare. Free markets, however, do not require effective cooperation on such a scale; they can benefit from it if it exists, but they don't require it in order to work, whereas government regulation does.

 

[Imager]

The conditions for effective cooperation among large numbers of people are very hard to meet

There is the Milron Friedman "Pencil" video, explaining how large numbers of people do cooperate:

 

[PeterDonis]

There is the Milron Friedman "Pencil" video, explaining how large numbers of people do cooperate:

Yes, but this is a much weaker sense of "cooperate". Most of the people involved in making a pencil never meet each other, and never even know the names of most of the other people involved. They just act on their own local incentives. They don't have to agree on anything except the individual transactions they engage in. They don't even have to agree on the overall objective in view; the people making the wood, for example, might not even know or care that it's going to end up in a pencil. To them, the objective is to supply wood.

The kind of cooperation government regulation tries to achieve is much, much more difficult, because it requires people to agree on a lot more, and treats failure to agree as a conflict, whereas a free market treats failure to agree as simply "no transaction".

 

[Evo]

Nasty posts deleted, thread is done.