Lectures on Macroeconomics, No. 14
This lecture looks at a recession as an information problem. It is a synthesis of a number of the ideas mentioned in previous lectures. The market solves a complex information problem. The economist who emphasizes this the most is Hayek. He (and Mises) made the point that no central planner can acquire the information needed to adjust resources to meet economic needs.
The information problem includes making sure that your grocery store has enough milk but not too much. However, it also includes allocating long-term investment between, say, pharmaceutical research and new microbreweries.
As a follower of Hayek, I believe that government will do a poor job at solving this information problem. However, that does not mean that I think that markets will do a perfect job of solving this information problem. A tiresome rhetorical tactic of anti-free-market economists is to say that when markets fail to solve information problems this discredits markets.
Instead, recall what I wrote.
Masonomics says, “Markets fail. Use markets.”
My view is that markets fail all the time at solving information problems. By the same token, market innovation seeks to arrive at better solutions. Thirty years ago, large inventory buildups could occur at retail stores without other participants in the supply chain being aware of the problem. It took months to unwind these unwanted inventory buildups. Today, thanks to market innovation, such information problems are less severe.
I also reject what I call the naive Austrian view, which is that the only information problem that markets cannot solve is that of seeing through the distortions caused by government money. Yes, the monetary authorities can mess things up. But there are also many naturally-occurring information problems that markets have difficulty solving. I do not believe that markets would work perfectly if only there were no government.
On the other hand, I do not believe that government intervention is called for whenever the market trips over an information problem. Government does not have an automatic advantage in solving information problems. On the contrary, the Hayekian view suggests that government is at a disadvantage in solving information problems.
I view a recession as a special case of an information problem. A recession arises because individuals, investors, and entrepreneurs realize that they have committed resources to unprofitable projects. Currently in the United States, too many resources were committed to housing and mortgage securitization. Perhaps this information error was caused in part by monetary policy. Perhaps it was caused in part by other government distortions. Perhaps it was mostly a naturally-occurring information failure caused by speculative fever and poor judgment. It does not matter to me whether the cause was government or the market. There was an information failure, and now the economy needs to make a sudden, sharp adjustment. We have unnecessary resources in the construction and finance sectors.
The problem is to figure out where the resources should go. Which other sectors have the greatest marginal use for these resources? This problem eventually will be solved by the market. However, in the short run, the problem is so severe that the market is overwhelmed. Many of the adjustments that are taking place, rather than absorbing unemployed resources, are generating reductions in economic activity in other sectors. This is the problem that Leijonhufvud describes. The market may solve information problems quite well near full employment, but it staggers and stutters when there is a crisis.
Government can promote the use of unemployed resources in a recession. The government can borrow money from savers and give it to spenders, whose purchases will lead firms to absorb unemployed resources. The spenders could be individual consumers, or they could be government technocrats managing programs.
However, it is misleading to suppose that a government transfer from savers to spenders necessarily puts the economy on a better path. Instead, such a transfer may keep resources from getting to where they need to go in the long run.
If the spenders make decisions that are compatible with the long-run path for the economy, then this fiscal stimulus will be helpful. However, if the spenders cause resources to be committed to projects that ultimately are unsustainable, then any relief is only temporary.
Politically, the temptation is to try to fight the signals that the market is sending. If the housing market is headed down, the political impetus is to prop it up. If there is too much capacity in automobile manufacturing or financial services, the political impetus is to try to prop up those industries. To the extent that spending is focused on these political goals, it will be counterproductive. Rather than helping the market find its way to sustainable full employment, the prop-up strategy instead serves to impede the necessary adjustment.
Another way that government can cause harm is by creating uncertainty. In recent months, policymakers have contributed to uncertainty in many ways. Alarmist rhetoric that leaders used to motivate Congress to pass major legislation. Sudden, unpredictable changes in tactics for handling financial institutions. Frequent revisions of the rules for mortgage borrowers and lenders. Many questions about the future financial condition of the U.S. government, given the new path of deficits.
It is true that markets have been overwhelmed by today’s information problems, and consequently resources are unemployed. However, the ultimate solution of where resources belong is not known by government officials any more than it is known by private investors. A large “fiscal stimulus” is, ultimately, a major transfer of power away from the trial-and-error process of entrepreneurial markets and instead toward the bureaucratic planning process. It is not clear to me that technocrats have suddenly acquired the wisdom that would justify such a transfer. In fact, while they may have an air of certitude, they may know even less than usual about the best future direction for economic resources. It could be that, relative to central planning, private trial-and-error is as advantageous in a recession as in a boom.