Tilted Forum Project Discussion Community - View Single Post

aceventura3 · 09-27-2010, 12:56 PM

Quote:

Originally Posted by Willravel

President Obama's last attempt was like a chipmunk trying to turn over a hemi, but we've still managed to make progress. Even the conservative American Enterprise Institute admitted back in January that the stimulus helped to boost the economy by 4%. So, actually, it did work. Whoever told you it didn't is a liar and a fiend.

In response to "it did work", I came across this and thought it interesting enough to share. It illustrates the folly in government's ability to manipulate GDP and why the correlation to unemployment may be more important in our current state of affairs.

Roach is gonna love this.

Quote:

WHY DOES THE ECONOMY HAVE A "SPEED LIMIT"?

With the decline of the traditional extended family, in which relatives were available to take care of children at need, many parents in the United States have sought alternative arrangements. A popular scheme is the baby-sitting coop, in which a group of parents agree to help each other out on a reciprocal basis, with each parent serving both as baby-sitter and baby-sittee. Any such coop requires rules that ensure that all members do their fair share. One natural answer, at least to people accustomed to a market economy, is to use some kind of token or marker system: parents "earn" tokens by babysitting, then in turn hand over these tokens when their own children are minded by others. For example, a recently formed coop in Western Massachusetts uses Popsicle sticks, each representing one hour of babysitting. When a new parent enters the coop, he or she receives an initial allocation of ten sticks.

This system is self-regulating, in the sense that it automatically ensures that over any length of time a parent will put in more or less the same amount of time that he or she receives. It turns out, however, that establishing such a token system is not enough to make a coop work properly. It is also necessary to get the number of tokens per member more or less right. To see why, suppose that there were very few tokens in circulation. Parents will want on average to hold some reserve of tokens - enough to deal with the possibility that they may want to go out a few times before they have a chance to babysit themselves and earn more tokens. Any individual parent can, of course, try to accumulate more tokens by babysitting more and going out less. But what happens if almost everyone is trying to accumulate tokens - as they will be if there are very few in circulation? One parent's decision to go out is another's opportunity to babysit. So if everyone in the coop is trying to add to his or her reserve of tokens, there will be very few opportunities to babysit. This in turn will make people even more reluctant to go out, and use up their precious token reserves; and the level of activity in the coop may decline to a disappointingly low level.

The solution to this problem is, of course, simply to issue more Popsicle sticks. But not too many - because an excess of popsicle sticks can pose an equally severe problem. Suppose that almost everyone in the coop has more sticks than they need; then they will be eager to go out, but reluctant to babysit. It will therefore become hard to find babysitters - and since opportunities to use popsicle sticks will become rare, people will become even less willing to spend time and effort earning them. Too many tokens in circulation, then, can be just as destructive as too few.

What on earth does all this have to do with the new paradigm? Well, a baby-sitting coop is a kind of miniature macroeconomy: a system in which individual decisions to spend and save are crucially interdependent, because your spending is my income and vice versa. The depressed state of a babysitting coop with too few tokens in circulation is essentially the same as that of the U.S. economy as a whole when it slips into a recession. And the ability of a Paul Volcker or an Alan Greenspan to engineer a recovery from such a recession rests on their control over the money supply - which is to say, over the number of popsicle sticks.

There are, of course, some important differences between the full-scale economy and a baby-sitting coop with at most a few dozen members. One difference is that the big economy has a capital market: individuals who are short of cash can borrow from others who are cash-rich, so that the effects of an overall shortage or abundance of money get mediated through the level of interest rates. An even more important difference involves prices. In the typical baby-sitting coop, prices are fixed: one popsicle stick buys one hour of baby-sitting, and that's that. In the big economy firms are free to change their prices - to cut prices if they are having trouble selling their product, to increase them if they think it will not hurt their sales. It turns out as a practical matter that firms are quite reluctant to cut prices (and workers are very reluctant to accept wage cuts): while prolonged recessions do eventually lead to price reductions, they do so only gradually and painfully. Firms have, however, historically been less reluctant to raise prices in boom conditions. For this reason the kind of shortage situation a coop gets into when there are too many tokens in circulation is rarely severe in market economies; excessive money creation gets dissipated in inflation instead.

Still, the popsicle-stick economy may help us to dispel some commonly held misconceptions about why economists generally think that there are limits to how fast the economy can grow. First, nobody claims that the economy has a 2-point-something percent speed limit under all circumstances. When a baby-sitting coop is in a depressed state because of an insufficient popsicle-stick supply, its GBP (gross baby-sitting product) can rise very quickly when that supply is increased. Thus there is nothing puzzling about the ability of the U.S. economy to grow at a rate of more than 3 ½ percent from 1982 to 1989: thanks to expansionary monetary policy the economy was rebounding from a recession that had raised the unemployment rate to 10.7 percent, and left output probably 10 percent below capacity. The "speed limit" applies only when the economy has expanded as much as it can by taking up slack, by employing unemployed resources.

Second, the logic of the standard economic argument against over-ambitious growth targets once the economy is near full employment is also widely misunderstood; many, perhaps most, of the critics of that argument base their opposition on a misleading caricature of what economists are saying. All too often, advocates of faster growth assert that their opponents believe that "growth causes inflation"; this supposed view is then held up for ridicule. After all, isn't inflation supposed to be a matter of too much money chasing too few goods - and if so, how can growth, which means producing more goods, be a cause of inflation? But that is not what economists who think that an overambitious growth target will be inflationary are saying. Nobody claims that a baby-sitting coop would suffer from shortages if it grew by adding new members, or if current members became more efficient at child care and were therefore able to do more baby-sitting. The limits - and the risk of inflation - apply only to growth achieved by expanding demand, say by issuing more popsicle sticks.

So how much is too much? Again, return to the babysitting economy. How would you know when there were too many popsicle sticks in circulation? One useful indicator would be the frequency with which parents sought but could not find opportunities to babysit - which would essentially be the coop's unemployment rate. Another would be the frequency with which parents sought but could not find babysitters. This would more or less correspond to the U.S. economy's "vacancy rate" - the number of jobs offered by business that are still unfilled. If unemployment were very low and vacancies high, this would be an indicator that the coop was suffering from excessive demand. In the full-scale economy it turns out that the vacancy rate and the unemployment rate are very closely (inversely) correlated - but data on unemployment are collected more regularly and systematically, so we can use the more readily available unemployment rate as a pretty good indicator of labor market tightness.

http://web.mit.edu/krugman/www/howfast.html

I did the bolding.