Thursday, 3 December 2015
The free market’s cure for unemployment.
Krugman considers the free market’s cure for recessions, and points to the fact that in a recession, prices would fall, which would raise the real value of money, which in turn would increase the paper assets of the population, which in turn would encourage spending. That’s known as the Pigou effect (though Krugman doesn’t mention Pigou). As Krugman puts it:
“How is the self-correction of an economy to its long-run equilibrium supposed to work? In textbook analysis, the story is that falling prices raise the real money supply, pushing down interest rates, and hence restoring employment.”
Note that BASE MONEY is the all important form of money here because base money is a net asset as far as the private sector is concerned. In contrast, commercial bank created money nets to nothing because for every dollar or pound of such money, there is a dollar or pound of debt. Thus commercial bank created money is not a net asset as far as the private sector is concerned.
Krugman however doesn’t mention Say’s law, which is another mechanism that tends to bring full employment (though like the Pigou effect it doubtless doesn’t work all that well). Say’s law works even in a barter or non-money economy. I set out a full explanation here.
At least I take it the latter exposition of mine is how Say’s law works. Maybe I’ve thought up an entirely new mechanism that enables the free market to bring full employment, in which case I’d like a Nobel Prize please.