Does Capitalism Cause Recessions?

Why do recessions occur? This question divides free market economists. After recently blogging on the classical conception of the business cycle, in which I described how “classical” economists believed that economic crashes are due to production errors, a commenter linked to an alternative perspective which suggests that recessions are the result of central banking. While this is true some of the time, it doesn’t explain why recessions plagued the economy before the introduction of the Federal Reserve (Fed) in 1913.

Is Classical Theory Irrelevant?

For the last 70 years, macroeconomics has become so entrenched within a demand-side framework that arguments that don’t operate within that paradigm are often derided as irrelevant.

A couple weeks ago I wrote a piece explaining classical business cycle theory and its denial of demand deficiency. Someone from a prominent think tank (not my former employer) messaged me, asserting that although he agreed classical theory is routinely misunderstood, he didn’t understand why it mattered:

It seems to me that the piece is really about …the fact that goods will command some price in the market - that demand for them will never literally reach zero – [which] is not a terribly interesting finding … and I would really like a clear explanation of why this matters...

Given the difficulty of discarding the macroeconomic lens that has prevailed since the 1930s, this misunderstanding and subsequent dismissal of the argument isn’t surprising. Virtually all modern theory is rooted in an “aggregate demand” paradigm—that is, demand management is understood as the key to a well-run economy. This is true for “Monetarists,” “Keynesians,” and even many free market variations, where disagreement has been reduced to whose model best achieves that end.

How Keynesian Economics Has Distorted Economic Thinking (Somewhat wonkish)

For the better part of a century, most economists have believed that recessions are caused by overall demand failure—total purchasing power dropping below the number of total goods on the market.

Part of the reason for the predominance of this thinking is that the man who popularized it, John Maynard Keynes, mischaracterized “classical” arguments in order to better refute them. Unfortunately, few are aware of the success these distortions have had on economic theory.

Keynes began his criticisms of the classical school by insisting that it offered no explanation for “involuntary unemployment”—or forced unemployment—and hence recessions:

Classical theory…is best regarded as a theory of distribution in conditions of full employment. So long as the classical postulates hold good, unemployment, which in the above sense involuntary, cannot occur… [emphasis added]

He then added to his criticism by accusing his opponents of fallaciously arguing that “supply creates demand,” which Keynes would repudiate:

What is economic mobility?

Tim wrote a thoughtful rebuttal to my posts on economic mobility, but it seems we’re at least partly talking past one another.

One of Tim’s central arguments is that some of the studies I highlighted miss the point he has in mind—whether “someone from a poor or lower-income family has the same or better chance of attaining such a position than in an earlier generation”—and instead reflect the fact that part-time high school and college workers rise to higher income brackets over time.

King for a Day, Reconsidered

A couple of weeks ago, I critiqued a number of David’s pieces on the topic of income inequality. In those pieces, David seemed to accept that income inequality had grown over time, but claimed that it was no big deal because people move up and down the income distribution over the course of their lives—what economists call ‘income mobility’. I pointed out that one of the main sources for David’s claims—a study conducted by the U.S. Treasury in 2007—seemed to 1) confirm the notion that income mobility is low in the U.S., yet still managed to 2) overstate the amount of income mobility we actually have. David promptly composed a follow-up post responding to the former but ignoring the latter, arguing that

A deeper look at economic mobility

I recently wrote several posts on the issue of income differences. My central argument is that, to meaningfully measure the economic gap, one must observe individuals and how they fare over time.

Regrettably, most studies instead take a snapshot of statistical categories in time—such as the “top one percent” and the “bottom 99 percent”. Problem is, categories are not people, which is why major studies that track individuals over time contradict the popular studies.

My counterpart Tim differs with me, and in a recent post he makes his case in large part by critiquing a study from the U.S. Treasury, which shows high income mobility. There are a few points he raises that are worth further reflection.

King for a Day

Over the past few months, David has posted several times on the topic of income inequality (for example, see here, here, and here), which he deems to be a non-issue. To support his case, a recurring point of his is that comparing percentiles of the income distribution—such as the ‘top one percent’ and the ‘bottom 99 percent’—is fallacious. In a recent column, David explains that

"The late economist Joseph Schumpeter compared income groups to hotel rooms: just as the former ranges from high to low, so the latter ranges from high-end to low-end. But the different categories fail to reflect who occupies them and whether occupants move to higher categories over time." 

In other words, if we have high income mobility—that is, lots of movement up and down the income distribution—then comparisons between different portions of the distribution are meaningless. But unfortunately, we don’t have high income mobility.