Noah Smith has joined Paul Krugman in the intellectual mud-wrestling melee of Simon Wren-Lewis and Mark Toma on the rise of New Classical (Friedman-esque) Economics, especially as a cornerstone of right-wing fiscal policy. And so will I, but as an Economic Sociologist, because there is a lot that is missed on how society actually responds to economic crises.
The backdrop is this: Milton Friedman’s theory of Stagflation gave rise to the idea that free markets should be left to correct themselves, and no government intervention is needed. The loss of aggregate demand means nothing. High unemployment was “natural” in the markets according to New Classical theory – it was a part of the “Real Business Cycle.” It was a rebuke of Keynes’ idea that aggregate demand drives the economy. If people don’t buy stuff, then producers don’t produce stuff, and people get laid off, who then can’t buy stuff. And the model looks like this:
Stagflation is a supply side problem. And the New Classical idea is simple for free marketers: if you build it, they will come. Sometimes though, as in the 2009 lackluster recovery, they don’t actually come. My guess is that because Wall Street have been the only “builders.”
Milton Friedman, in an attempt to explain Stagflation, gave rise to “rational expectation” theory. It’s the idea that people will make “rational” decisions about their money based on what they expect the economy to be like in the future – that expecting something to happen (or not happen) will make it actually happen, as if a self-fulfilling prophesy. Except who expects wars, housing bubbles, or bank collapses? And human beings, individuals and organizations are not known for acting “rationally” to begin with.
New Classical assumes “rational” human behavior, instead of studying rational human behavior. When there is scarcity, as we saw with the Stagflation of the 1970s, people do not behave rationally. Even micro models assume people make rational choices between A and B, and assumes that scarcity only exists when there is rational desire for both. But if Stagnation has taught us anything, people do not act rationally when they are financially afraid, and there’s some things that people do’t actually want in lieu of their survival needs. As this chart from the General Social Survey shows, people are not generally satisfied with their finances. How will their behavior change based on their level of “satisfaction,” or fear?
There is no scarcity of fear in the lowered supply of financial resources for people. And this simply needs to be studies more, instead of assumed.