Download Say`s law

Warwick Economics
Summer School
Money and Banking
Lecture 5b
Marcus Miller
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Say’s Law
• Say's law, or the law of markets, is the controversial assertion,
found in classical economics, that aggregate production necessarily
creates an equal quantity of aggregate demand.
• Jean-Baptiste Say (1767–1832) further argued that the law of
markets implies that a “general glut” (the term used in Say’s time
for a widespread excess of supply over demand) cannot occur.
• Along with Adam Smith’s concept of the "invisible hand", Say’s Law
has been one of the doctrines used to support the laissez-faire
belief that a capitalist economy will naturally tend toward full
employment and prosperity without government intervention.
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Why money and finance matter for
macro
• If money matters, Say’s Law may not apply
• If there is asymmetric information , moral
hazard is likely to present what in finance are
called ‘agency problems’
• Balance sheet constraints will be applied to
limit these principal/agent problems.
• These in turn may generate macro effects, socalled pecuniary externalities
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Keynes’s critique of Say’s Law
• Say’s Law is “ completely out of date in
economies with highly developed financial
systems;
• sale of one commodity may be separated by a
long and variable period from the purchase of
another.
• If lag between sale and purchase lengthens,
there may be insufficient monetary demand to
buy back all commodities produced and offered
for sale on the market.” Duncan Foley(2006)
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"The fox knows many things, but the
hedgehog knows one big thing“
Archilochus of Paros
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was applied by Isaiah Berlin to writers
might it apply to economists?
Hedgehogs:
Leon Walras ,Karl Marx, Milton Friedman
Foxes:
J.M. Keynes, Amartya Sen, Joseph Stiglitz
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Millenium Bridge
When the London Millennium footbridge was opened in June 2000, it swayed alarmingly
Need to update Samuelson’s Synthesis?
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Krugman on Samuelson’s Synthesis
• “In the Samuelsonian synthesis, one must count
on the government to ensure more or less full
employment; only [then] do the usual virtues of
free markets come to the fore.
• [This] requires some strategic inconsistency in
how you think about the economy. When you’re
doing micro, you assume rational individuals and
rapidly clearing markets; when you’re doing
macro, frictions and ad hoc behavioural
assumptions are essential.”
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SS proved 'not intellectually stable’:
• [For policy purposes, inconsistency is OK.]
• “ But economists were bound to push at the
dividing line between micro and macro –
which in practice has meant trying to make
macro more like micro, basing more and more
of it on optimisation and market-clearing.
• The result was the Dark Age of Macro” [in
which the history of the subject is ignored].
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Factors that may drive the economy
outside Leijonhufvud’s corridor
• The DSGE/RBC approaches tend to ignore such
multiple equilibria as bank runs (Northern Rock),
or sovereign debt crisis ( Eurozone).
• Also, as Rajan warned in 2005, ‘financial
development can make the world riskier’
• as financial strategies designed to exploit
asymmetric information may cause crisis.
• In thermodynamics, “Maxwell’s Demon” was a
thought experiment. In economics, it’s a reality!
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Conclusions
• Krugman warns SS not intellectually stable.
– Economists in the corridor strive for the
consistency by extending micro-economic
reasoning to eliminate Keynesian unemployment
and irrational exuberance.
– But as we have seen, this leaves macro-economists
totally unprepared for crisis.
• Alternative: be prepared for events that may
drive you outside the corridor
• Remember Maxwell’s Demon
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Conclusions (cont.)
• Need to have in reserve models of market
failure, e.g., models of involuntary
unemployment, stock market crashes.
• Need to remember lessons from history
(Hicksian view of economics as a discipline not
as a science), different models for different
problems.
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Conclusions (cont.)
• Financial frictions will not generate crisis.
Predictable technology shock generates
amplified asset price response, but these are
all priced in.
• Need to remember lessons from history
(Hicksian view of economics as a discipline not
as a science), different models for different
problems.
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