No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Seventeen: A Short History of Macroeconomics 428 slump is simply evidence of disproportionality in production, and the only solution is for production to be restored consistent with true consumer’s preferences. If there are institutional barriers to changing prices and wages (such as heavy unionization which will not allow wage cuts in the relatively overproduced area, or government price controls in another), there is nothing in Say’s Law that says you will have full employment. AFTER THE CLASSICAL ECONOMISTS Explaining business cycles by theories of disproportionality may be theoretically satisfying in the “boom,” but often is rejected during the bust. Why? Continuing our quick economic walk through history may help explain. In the 1800s, many economists studied business cycles, with some economists (such as Marx) suggesting that cycles were a natural result of a capitalist economy. As noted above, other economists like Malthus concluded that business cycles were a result of under-consumption (or conversely a general overproduction), while still others (e.g. J.S. Mill, David Ricardo, et al. ) recognized that too much production in one area necessarily meant that there was too little production in other areas. In the former case, what was needed was additional spending in the economy. In the latter case, what was needed would be a reallocation of resources between sectors—and the necessary corrective agent would be price adjustment, to include the price (or wage rate) of labor. Even classical economists recognized that Say’s Law did not preclude business cycles. An excessive change in money demand during a crisis was explicitly recognized as a source of instability leading to depression. John Stuart Mill, whose Principles of Political Economy was the economic text for a generation after its publication in 1848, said thi s 4 : “Although he who sells, really sells only to buy, he needs not buy at the same moment when he sells; and he does not therefore necessarily add to the immediate demand for one commodity when he adds to the supply of another. The buying and selling being now separated, it may very well occur, that there may be at some given time, a very general inclination to sell with as little delay as possible, accompanied with an equally general inclination to defer all purchases as long as possible.” In Mill’s view, the circular flow could very well be disrupted by decisions to hold money. Money allows an individual to maintain purchasing power across time; if the flow of spending is disrupted in time we can have problems. Why would people want to hold more money? Financial panic! Again fromMill: “I have already described the state of the markets for commodities which accompanies what is termed a commercial crisis. At such times there is really an excess of all commodities above the money demand: in other words, there is an under-supply of money. From the sudden annihilation