What socialist planning might look like...

The Socialist Workers Party proposes this alternative to market capitalism:

SOCIALIST PLANNING

There are three main prerequisites for genuine socialist planning:

First, as we have seen, the major corporations must be taken into public ownership. Planning cannot work if elected representatives draw up a plan but do not [have] the means to implement it. The requirement for public ownership need not apply to every small business. But socialist planning only requires that the major levers of the economy are in the hand of the representatives of the people. ...We would need to take control of the banks, the major construction companies, the major manufacturing plants currently run by multi-nationals, the food industry and the major supermarket chains.

Second, planning requires that all economic information is available to the public. ... If people are to collectively decide how to allocate resources, commercial secrecy must be abolished. There will be no need for such secrecy in an economy built around co-operation rather than competition. The absurd notion that individuals can hold ‘intellectual property’ over knowledge will also have to be abolished. How can we develop the productive forces of society, if individual scientists ‘own’ the fruits of scientific research and can charge a fee for giving others access to the data?

Third, socialist planning requires a form of economic democracy that goes well beyond the limited political democracy of capitalism. It requires co-ordinating institutions where delegates discuss and deliberate on where the major funds for investment are to be allocated and what type and what quantity of goods are to be produced. To accurately reflect the needs to society, delegates will have to be mandated from gatherings of their constituents and will have to report back regularly. To safeguard against bureaucracy and elitism, there should be a facility to re-call them if they do not carry out their mandate.

What do you think? Could this work? What would be necessary for such a transition to take place? What would be the greatest strength of such an economy? What would be its greatest weakness?

Has the market system failed?

Don Boudreaux says no:

It's become an article of faith among lots of people that recent events prove (or at least suggest) that markets don't work very well.....

The vast majority of market exchanges and relationships work smoothly and to the advantage of all participants. Indeed, the market works so well and so consistently that it creates ever-higher expectations among the broad populace. When these expectations are dashed, if only for a handful of persons and if only rarely, the market is deemed to have failed.

But despite the current downturn, the market continues to work well in its typical silence. Do you have trouble today finding gasoline to buy? Are your local supermarket's shelves not stocked with food, wine, and (watch for it soon!) Easter candy? If your cat eats your socks, will you have trouble buying several new pair? If your car's battery dies this afternoon, must you resort to bicycling or public transportation because you can't replace your dead battery? If you're bored this evening with nothing to do, is there no movie you can go to or no DVD you can rent? If you miss your mom in Minneapolis or your boyfriend in Boston, can you not call them on your cell-phone — or even buy a plane ticket and go visit them?

What do you think? Has the market system failed? Why or why not? What specific characteristic has failed? What is the market system's greatest strength? Its greatest weakness? In what ways might the market system need government involvement?

Welcome to AP Microeconomics!

Hey there! I'm glad you're signed up for AP Microeconomics. This will be an intense class, but I also think you'll find it to be really interesting and relevant to what's going on in the world.

This discussion blog will be one way we look at real-life events and current issues. You'll need a Google account or OpenID in order to sign in and post.

In your introductory post, I'd like you to do three things:

1) Tell us why you're taking this class.
2) You received a letter from a student in last year's class. Write about two important or interesting things the student mentioned in that letter.
3) Respond to one of your classmate's posts: agree, disagree, or comment in some way. Then justify your response.

If you're one of the first five people to post, you don't have to do #3... So post early!

Can a tax cut deepen the recession?

We've seen that demand-sided policies always have a trade-off between unemployment and inflation, yet supply-sided policies don't have that same trade-off. Gauti B. Eggertsson, an economist with the Federal Reserve Bank of New York, makes quite a convincing argument that supply-sided policies may not work when the interest rates are close to zero:

At zero short-term nominal interest rate, tax cuts reduce output. They do so because they increase deflationary pressures. Policies aimed at stimulating aggregate demand work better. These policies include (i) a temporary increase in government spending and (ii) a commitment to inflate. The multiplier of tax cuts goes from positive at positive interest rates to negative once the interest rate hits zero, while the multiplier of government spending not only stays positive but becomes many times larger at the zero bound.

There has been much discussion in recent weeks about a stimulus plan to revive the US economy. Many economists argue that a recovery plan should include aggressive tax cuts. In this paper I show that under the special circumstances which the US is experiencing today — interest rates that are close to zero and deflationary pressures — tax cuts are contractionary in a standard New Keynesian model. Why? Tax cuts cause deflationary pressures in the model and thereby increase the real interest rate. The Fed can’t accommodate this by cutting the Fed Funds rates, since they are already close to zero. Higher real interest rates are contractionary.

Wow... That's a lot of economics! Can you summarize Eggertsson's argument? What are supply-sided policies, and why does he say that supply-sided policies won't work right now? What's the deal with the multipliers? What happens when the real interest rate increases? Why would this be bad for the US economy right now?

Negative interest rates?

My economics hero, N. Greg Mankiw, proposes an ingenious solution to the recession:

Until recently, most economists relied on monetary policy [to escape a recession]. Recessions result from an insufficient demand for goods and services — and so, the thinking goes, our central bank can remedy this deficiency by cutting interest rates. Lower interest rates encourage households and businesses to borrow and spend. More spending means more demand for goods and services, which leads to greater employment for workers to meet that demand.

The problem today, it seems, is that the Federal Reserve has done just about as much interest rate cutting as it can. Its target for the federal funds rate is about zero, so it has turned to other tools, such as buying longer-term debt securities, to get the economy going again. But the efficacy of those tools is uncertain, and there are risks associated with them.

In many ways today, the Fed is in uncharted waters. So why shouldn’t the Fed just keep cutting interest rates? Why not lower the target interest rate to, say, negative 3 percent? At that interest rate, you could borrow and spend $100 and repay $97 next year. This opportunity would surely generate more borrowing and aggregate demand.

The problem with negative interest rates, however, is quickly apparent: nobody would lend on those terms. Rather than giving your money to a borrower who promises a negative return, it would be better to stick the cash in your mattress.

Unless, that is, we figure out a way to make holding money less attractive.

There is a way of obtaining negative interest rates: through inflation. Suppose that, looking ahead, the Fed commits itself to producing significant inflation. In this case, while nominal interest rates could remain at zero, real interest rates — interest rates measured in purchasing power — could become negative. If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend.

Having the central bank embrace inflation would shock economists who view price stability as the foremost goal of monetary policy. But there are worse things than inflation. And guess what? We have them today. A little more inflation might be preferable to rising unemployment or a series of fiscal measures that pile on debt bequeathed to future generations.

Wow! What do you think? Evaluate Mankiw's proposal using sound economic theory on monetary policy, recessions, and inflation. [Remember that evaluate means to show pros and cons as you commit to a decision.]

Obama Gives Keynes His First Real-World Test

National Public Radio broadcast this report on January 29, 2009:

John Maynard Keynes is an unlikely hero for our time.

Keynes, a British economist who died more than 60 years ago, inspired President Barack Obama's plan to save the U.S. economy with a massive round of government spending. The British economist published his big theory, the one underpinning most of what Obama intends to do, in 1936.

Keynes corrected what he saw as a fundamental error in the economics that had come before. Classical economics teaches that if there's a downturn, the economy will eventually sort itself out. If people aren't buying enough, prices will drop to a point where people start spending. Keynes' radical insight was to look out the window in the 1930s and see that sometimes things don't right themselves. The economy goes into a downward spiral. The usual dynamic of supply and demand breaks down.

"A failure of effective demand is what he called it," says Alan Blinder, a Princeton economist who served as economic adviser to President Bill Clinton. Basically, people aren't spending enough money, either because they don't have any or because they got laid off or are afraid they're about to get laid off. If people aren't spending enough money, there's no way for the economy to automatically adjust. During the Great Depression, no one had figured out how to get people spending again. Then came Keynes.

"The Keynesian prescription is if all else fails, the government can spend the money," Blinder says. Normally, in a free-market economy, the public doesn't look to the government to prop up spending. "But Keynes' idea, which was revolutionary at the time, is if the private sector won't do it, then the public sector can do it as a fill-in stopgap," Blinder adds.

The Great Experiment

Many of the economists say they just don't know whether the Keynesian approach will work. Financial catastrophes don't happen often enough to prove theories like his. In fact, as economists like Blinder will tell you, this is the problem with economics.

Anti-Keynesians say this massive stimulus package is too risky an experiment on an unproven theory. It might not get America out of the recession, they say. It might cause vicious inflation and a bloated government, and leave a trillion more dollars in debt as a constraining burden on Americans' children and grandchildren.

The Obama administration is betting that won't happen. They're trusting this theory. They're trusting Keynes.

How might Neo-Classical and Keynesian economists look at this current crisis? Examine their differences. What are their respective strengths and weaknesses?

Responding to an Historic Economic Crisis: The Obama Program

Larry Summers, Director of President Obama's National Economic Council, made these remarks on March 13, 2009:

First, I'd like to describe how best to think about this crisis.

One of the most important lessons in any introductory economics course is that markets are self-stabilizing.

• When there is an excess supply of wheat, its price falls. Farmers grow less and others consume more. The market equilibrates.
• When the economy slows, interest rates fall. When interest rates fall, more people take advantage of credit, the economy speeds up, and the market equilibrates.

This is much of what Adam Smith had in mind when he talked about the "invisible hand."

However, it was a central insight of Keynes' General Theory that two or three times each century, the self-equilibrating properties of markets break down as stabilizing mechanisms are overwhelmed by vicious cycles. And the right economic metaphor becomes an avalanche rather than a thermostat. That is what we are experiencing right now.

What is the task of policy in such an environment?

The first component of the President's program is direct support for jobs and income to engage the multiplier process in favor of economic expansion. Increases in income lead to financial repair which supports further increases in income. Rising employment will lead to rising spending, which leads to further increases in income and employment.

The Recovery and Reinvestment Act is the largest peacetime economic expansion program in the country's history. It will inject nearly $800 billion into the economy, ¾ of it within the next 18 months. The Council of Economic Advisors' estimates suggest that the Recovery and Reinvestment Act will save or create 3.5 million jobs. It will at the same time do some of the work that the nation has needed done for a long time—doubling renewable energy capacity in the next 3 years, supporting middle class incomes, modernizing ten thousand schools, and making the largest investment in the spine of our national economy – the nation's infrastructure – since Dwight Eisenhower's investment 50 years ago.

It is surely too early to gauge the broader economic impact of the President's program. But it is modestly encouraging that since it began to take shape, consumer spending in the US, which was collapsing during the holiday season, appears, according to a number of indicators, to have stabilized.

What specific fiscal policy priorities seem to be at work here, and what are their pros and cons for AD or AS? You can view the line-item breakdown here. What specific things in this economic climate might hinder the multiplier effect of Obama's fiscal policy? Don't just write about general theory...