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Posts Tagged ‘Uncertainty’

Over at the Kauffman Foundation, Tim Kane has released his latest quarterly survey of economic bloggers. Here’s the usual word cloud reflecting the adjectives (up to five per respondent) that we econobloggers offered up to describe the U.S. economy:

That’s much better than last quarter, when you needed a magnifying glass to find any optimistic sentiments:

As usual, the survey also includes various questions about economics, policy, and haiku. Yes, the survey solicited haiku about the European debt crisis. My inner muse didn’t speak that day, so I don’t have my own to share. So let me offer up Jeff Miller’s (A Dash of Insight) as food for thought … and not just for Europe:

When the task is great

take but one step at a time

Compromise builds strength

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Over at the New Republic, Bob Solow offers a thoughful review of Sylvia Nasar’s new book, Grand Pursuit: The Story of Genius. Along the way, Solow provides a characteristically clear explanation of what he views as John Maynard Keynes most important contribution:

Back then [in the 1930s], serious thinking about the general state of the economy was dominated by the notion that prices moved, market by market, to make supply equal to demand. Every act of production, anywhere, generates income and potential demand somewhere, and the price system would sort it all out so that supply and demand for every good would balance. Make no mistake: this is a very deep and valuable idea. Many excellent minds have worked to refine it. Much of the time it gives a good account of economic life. But Keynes saw that there would be occasions, in a complicated industrial capitalist economy, when this account of how things work would break down.

The breakdown might come merely because prices in some important markets are too inflexible to do their job adequately; that thought had already occurred to others. It seemed a little implausible that the Great Depression of the 1930s should be explicable along those lines. Or the reason might be more fundamental, and apparently less fixable. To take the most important example: we all know that families (and other institutions) set aside part of their incomes as saving. They do not buy any currently produced goods or services with that part. Something, then, has to replace that missing demand. There is in fact a natural counterpart: saving today presumably implies some intention to spend in the future, so the “missing” demand should come from real capital investment, the building of new productive capacity to satisfy that future spending. But Keynes pointed out that there is no market or other mechanism to express when that future spending will come or what form it will take. Perhaps God has not yet even decided. The prospect of uncertain demand at some unknown time may not be an adequately powerful incentive for businesses to make risky investments today. It is asking too much of the skittery capital market. Keynes was quite aware that occasionally a wave of unbridled optimism might actually be too powerful an incentive, but anyone in 1936 would take the opposite case to be more likely.

So a modern economy can find itself in a situation in which it is held back from full employment and prosperity not by its limited capacity to produce, but by a lack of willing buyers for what it could in fact produce. The result is unemployment and idle factories. Falling prices may not help, because falling prices mean falling incomes and still weaker demand, which is not an atmosphere likely to revive private investment. There are some forces tending to push the economy back to full utilization, but they may sometimes be too weak to do the job in a tolerable interval of time. But if the shortfall of aggregate private demand persists, the government can replace it through direct public spending, or can try to stimulate additional private spending through tax reduction or lower interest rates. (The recipe can be reversed if private demand is excessive, as in wartime.) This was Keynes’s case for conscious corrective fiscal and monetary policy. Its relevance for today should be obvious. It is a vulgar error to characterize Keynes as an advocate of “big government” and a chronic budget deficit. His goal was to stabilize the private economy at a generally prosperous level of activity.

A second characteristically Keynesian theme meshes very well with the first. In a complex economy, many business decisions have to be made in a fog of uncertainty. This is especially true of investment decisions, as already discussed: a lot of money has to be placed at risk today in an enterprise whose future success can only be guessed. (Much the same can be said of consumer purchases of expensive durable goods.) The standard practice is to focus on the uncertainty and think about it in terms of probabilities, which at least allow for an orderly analysis and orderly decision-making. Keynes preferred to focus on the fog. He thought that some of the important uncertainties were essentially incalculable. They would end up being dealt with in practice by a mixture of apprehensiveness, rules of thumb, herd behavior, and what he called “animal spirits.” The point of this distinction is not merely philosophical: it suggests that long-term investment behavior will sometimes be irregular, unstable, and given to doldrums and stampedes. Expectations can be volatile, and transmit their volatility widely. Passive or perverse policy can be dangerous to the economy’s health.

Solow thus credits Keynes with pioneering the “uncertainty” meme, although in a different sense than many commentators invoke it today.

His whole review is well worth a read if you are interested in the history of economic thought, including Fisher, Hayek, and Schumpeter.

P.S. Solow’s comments on Hayek are less enthusiastic than for Keynes, but he does note that “the Mises-Hayek critique of central planning was convincing (and clearly confirmed by subsequent facts).”

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Over at the Economist’s Free Exchange blog, Grep Ip offers an excellent, balanced analysis of regulatory uncertainty and our weak economy. Here’s a short excerpt:

How much of our economic malaise can be blamed on regulatory uncertainty? Conservatives argue that a wave of Obama administration regulations and the threat of more to come are the primary hindrance to business confidence and hiring. Liberals say that the weak economy is far more important and that any regulations being enacted more than pay for themselves in economic terms.

I’ve been struggling with this question for months and have found the debate frustrating: the terminology is wrong and the subject poorly framed, the evidence fragmentary and unhelpful, and generalisations are rampant. So what follows are a few thoughts that I think clarify the debate, though without necessarily resolving it.

First, it is not “uncertainty” per se that bothers business. Whether uncertainty is unwelcome depends entirely on what’s at stake. What would you prefer: 100% probability of dying next year, or 50%? Most of us would choose the latter. Similarly, business would prefer zero probability of a burdensome new rule, but if that’s not possible, would certainly take 50% probability over 100%. The administration’s decision to delay implementation of a new ozone standard perpetuates uncertainty. Business welcomed it nonetheless because now they do not have to spend money to meet it for at least two years, and perhaps forever if in the interim a new president chooses never to implement it. Does the Federal Reserve create some uncertainty when it undertakes quantitative easing? Probably, but in the process it makes the stability of inflation around 2% much more certain, and that, most businesses would say, is a reasonable trade-off.

Second, “regulation” doesn’t capture the breadth of government activity that affects business confidence, investment and hiring. The threat that America might default must surely have been one of the most toxic sources of uncertainty America’s political classes have yet inflicted on the economy, something you’ll see mentioned in the Federal Reserve’s latest beige book. This speaks to a more deep-rooted alienation between business and Washington.

Read the whole thing, it’s the best treatment I’ve seen.

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