Recession and recovery: six fundamental errors of the current orthodoxy.

• Author: Higgs, Robert
• Position: Etceteras ...

As the recession has deepened and the financial debacle has passed from one flare-up to another during the past year and a half, commentary on the economy's troubles has swelled tremendously. Pundits have pontificated; journalists and editors have reported and opined; talk radio jocks have huffed and puffed; public officials have spewed out even more double-talk than usual; awkward academic experts, caught in the camera's glare like deer in the headlights, have blinked and stumbled through their brief stints as talking heads on TV. We have been deluged by an enormous outpouring of diagnosis, prognosis, and prescription, at least 95 percent of which has been appallingly bad.

The bulk of it has been bad for the same reasons. Most of the people who purport to possess expertise about the economy rely on a common set of presuppositions and modes of thinking. I call this pseudointellectual mishmash "vulgar Keynesianism." It's the same claptrap that has passed for economic wisdom in this country for more than fifty years and seems to have originated in the first edition of Paul Samuelson's Economics (1948), the best-selling economics textbook of all time and the one from which a plurality of several generations of college students acquired whatever they knew about economic analysis. Long ago, this view seeped into educated discourse, writing in the news media, and politics, and established itself as an orthodoxy.

Unfortunately, this way of thinking about the economy's operation, in particular its overall fluctuations, is a tissue of errors of both commission and omission. Most unfortunate have been the policy implications derived from this mode of thinking, above ali the notion that the government can and should use fiscal and monetary policies to control the macroeconomy and stabilize its fluctuations. Despite having originated more than half a century ago, this view seems to be as vital in 2009 as it was in 1949.

Let us consider briefly the six most egregious aspects of this unfortunate approach to understanding and dealing with economic booms and busts.

Aggregation

John Maynard Keynes persuaded his fellow economists and then they persuaded the public that it makes sense to think of the economy in terms of a handful of economywide aggregates: total income or output, total consumption spending, total investment spending, and total net exports. If people remember anything from their introductory economics course, they are most likely to remember the equation:

Y = C + I + G + (X - M).

Sometimes Q * P is equated to the variables on the right-hand side of the equation.

So the idea is that aggregate supply (physical output times the price level) equals aggregate demand equals the sum of four types of money expenditure for newly produced final goods and services.

This way of compressing diverse, economywide transactions into single variables has the effect of suppressing recognition of the complex relationships and differences within each of the aggregates. Thus, in this framework, the effect of adding a million dollars of investment spending for teddy bear inventories is the same as the effect of adding a million dollars of investment spending for digging a new copper mine. Likewise, the effect of adding a million dollars of consumption spending for movie tickets is the same as the effect of adding a million dollars of consumption spending for gasoline. Likewise, the effect of adding a million dollars of government spending for children's inoculations against polio is the same as the effect of adding a million dollars of government spending for 7.62-millimeter ammunition. It does not take much thought to conceive of ways in which suppression of the differences within each of the aggregates might cause our thinking about the economy to go seriously awry.

In fact, "the economy" does not produce an undifferentiated mass wc call "output." Instead, the millions of producers who bring forth "aggregate supply" provide an almost infinite variety of specific goods and services that differ in countless ways. Moreover, an immense amount of what goes on in a modern market-oriented economy consists of dealings among producers who supply no "final" goods and services at all, but instead supply raw materials, components, intermediate products, and services to one another. Because these producers are connected in an intricate pattern of relations, which must assume certain proportions if the entire arrangement is to work effectively, critical consequences turn on what in particular gets produced, when, where, and how.

These extraordinarily complex microrelationships are what we are really referring to when we speak of "the economy." It is definitely not a single...