Friday, December 12, 2008

Stories of the panic

Steven Landsburg wrote, "Most of economics can be summed up in four words: 'People respond to incentives.' The rest is commentary."

Peter J Walliston has been doing commentary, arguing that the incentives created by the government in its attempt to use markets to pursue social aims are the source of the current financial meltdown.
...U.S. housing policies are the root cause of the current financial crisis. Other players...played a part, but they were only following the economic incentives that government policy laid out for them.
Does it matter how we interpret events such as the current financial mess? Interpretation certainly mattered in the 1930s, when the predominant story was that the Great Depression was a failure of the market. That interpretation justified a many government programs and created a generation of socialist intellectuals. After World War II when decolonization took place, that interpretation led to many of the new nations pursuing socialist policies, with disastrous results.

The story that the current financial mess is the result of deregulation, which is popular in some parts of the press, is also a story that the market failed, and it logically leads to larger government. A story that government involvement led to the current crisis has completely different implications.

A major achievement of Milton Friedman was a convincing argument that the Great Depression represented a failure of government policy. The Federal Reserve pursued a procyclical rather than a countercyclical monetary policy. Without this reinterpretation of the Great Depression, the Ronald Reagan presidency would not have been possible. Keynes was right about the power of ideas.

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