22.6.06

TWO SYSTEMS OF BELIEF IN ECONOMICS? Jared Bernstein suggests that economics is a discipline with the purpose of Solving Problems.

For decades after the Great Depression, economics had two main policy goals: (1) ensuring that we as a society tap our collective potential and fully employ our economic resources, especially people, and (2) providing individuals with ample protections and publicly provided insurance against undesirable market outcomes-weak job creation, high unemployment, rising poverty rates, and falling real incomes-and other challenges like aging out of the workforce or becoming disabled.

This approach ran into trouble in the latter 1970s, when two villains who are not supposed to appear on the same stage-high unemployment and inflation-combined with another potent force to knock the dominant regime out of the box. That other force was the rise of "neo-classical" economics.

This approach to economics also has two goals: (1) getting rid of the policy set associated with the old economics and (2) making sure that individuals are offered the optimal incentives, the ones that should lead them to behave in ways that, according to the mathematical models, bring about the most efficient results.

In other words, the target of economic policy has shifted from maximizing society's potential through promoting full employment and insurance against market failures, to incentivizing the individual's interactions with the market.

In Mr Bernstein's view, the evolution of economic policy prescriptions into what he calls "You're On Your Own," or YOYO economics, has not been for the better.

Reality might be a bit more subtle than that. The first paragraph alludes to Congressional creation of macroeconomics as a policy discipline in the 1947 Full Employment and Price Stability Act. The second paragraph alludes to the manifestation of something that wasn't supposed to happen. One could trade a bit of price instability for more employment, or conversely, and some of the most daring of the macroeconomists envisioned fine-tuning the economy. It's just a matter of having sufficient instruments to move each target. (I remember something very much like this from income theory in graduate school, albeit without benefit of Power Points or Adobe Pagemaker.) But the second paragraph suggests that the instruments would counteract each other, or act in unpredictable ways (remember this?) such that the Keynesian nostrums (Mr Bernstein is using an extremely elastic definition of market failure; we're not talking about unpriced bads or goods -- negative or positive nonpecuniary externalities -- or nonrivalrous consumption -- public goods -- or missing markets -- costly to organize -- here.) His third paragraph illustrates the real policy problem. The targets he's talking about are aggregates -- the money supply and the interest rate and the rate of change of the price level and the unemployment rate -- but these aggregates reflect adaptations in a large number of markets for a number of assets and a larger number of goods and a variety of people, and the microfoundations of aggregation often suggest that individuals, free to act on their own initiatives, can use local knowledge either to their advantage, or to defeat attempts by the government to move the targets.)

That the government might have failed, for instance, to equip all its citizens with the proper bag of tricks to participate in an economy that rewards knowledge remains a neglected actor, both in Mr Bernstein's post, and in mine.

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