2010-12-20

Open Question to the Macroeconomic Community

By now, everyone is talking about Scott Sumner's NGDP targeting idea for central banking.

Here's an open question to macroeconomists: Can you provide a compelling reason why the expenditure levels in an economy "should" grow at any particular rate?

Don't brush me off just yet. I understand that in good times, people will have more money and want to consume more stuff - and they'll be able to buy much of that stuff despite scarcity. This points to growth. I understand that in bad times, people will save for that hypothetical "rainy day" in the future rather than spending their money today; this points to slow growth or no growth.

But aren't the motives behind these spending decisions the real economic story here? Sure, you can target economic growth and screw with the money supply, but doesn't that just gloss over the fact that economic conditions have caused people to change their spending behavior? Isn't that what economists should be focusing on, rather than just skipping that step altogether and going straight to a "solution?"

How would you feel if a doctor treated you that way? "Well, Sam, the thing of it is, no one really knows why you cough up blood every night. We just know that for whatever reason, your body does this. So what we're proposing is to inject a tranquilizer into your lungs to stop the coughing..."

Big difference between attempted symptom-alleviation and an actual cure.

2010-12-08

Definition of a Bubble

This question has been floating around the economics blogosphere recently. My consideration of the topic came after reading Arnold Kling's What is a Bubble? I started this as a blog comment, but ultimately realized I had typed too much and decided to cut-and-paste it here:

All popular definitions of a bubble come down to this: "Bubbles occur when most people get the future price of an investment incorrect."

When a minority of investors do this, however, we don't call it a bubble. We call it poor market savvy.

For me, it's difficult to understand asset bubbles in any context other than Austrian theory. Bubbles occur when investments in a given asset exceeds the economy's ability to realistically make use of that asset for its intended purpose.

It should be obvious that the problem with most bubble definitions provided is that they provide no reference to the actual economic use of a good. They speak only to esoteric figures for price, interest, and expectations as though the numbers themselves were ultimate abstract unquestionable concepts like the set of All Real Numbers.

So maybe bubbles occur when a critical mass of investors forget that the price of an asset reflects its price as a utilizable product, and instead come to believe that the price is a reflection of expectations about future prices, i.e., when perhaps the majority of investors plan to sell the asset to someone else later, rather than consume the asset themselves.