Self-Correction: How It Works, When It Works Worse
In 12th grade, I took a one-semester economics course. My high school didn’t have A.P. econ (though I took the test on my own initiative), so the course was a little dumbed down. Actually, to be blunt, the teacher didn’t know enough econ to need to dumb it down; he just taught what he knew.
I still remember his discussion of the Great Depression and Keynesianism. The teacher’s story was that the New Deal cured the Great Depression using Keynesian methods. (The teacher didn’t know enough about either to make the smarter argument that, “Keynesianism didn’t fail; it wasn’t tried.”) A student asked him, “What would have happened without the New Deal?” His approximate reply: “Then the Depression would have gone on until the government came to its senses.”
I remembered this vignette a few minutes ago when Scott Sumner gave the correct answer to the student’s question:
Those who teach the AS/AD model may do the example of the big drop in
AD after 1929. Then you are supposed to show two alternatives; either
the Keynesian policy of boosting AD to try to speed up the recovery, or
merely waiting for the AS curve to shift right as wages and prices
Scott interestingly observes that the U.S. is trying the self-correcting mechanism this time around. But it’s not going to be a fair test:
[T]he Fed has decided to rely on the self-correcting mechanism this
time, and just wait for the long and painful adjustment in wages and
prices to play itself out. If this is the strategy, then it would have
been better not to have recently boosted minimum wage rates by 40%,
quadrupled the duration of UI, passed a health care tax increase, and
cracked down on immigration.
I feel a little like my bullish bets on U.S. unemployment are jinxing the world, but in the end I still think I’ll win. As Smith said, there is “a great deal of ruin in a nation.” The economy’s rebounded despite crummy policies many times before. In the long-run, we’re all rich.