March 06, 2009

A break from the world of claudia; a bit of the real world

Either I have a short memory (or was half-asleep at that particular history of economic thought class which is improbable because an attractive lecturer -which was the case - is always a good motivator to open your eyes and ears) or I had never heard of Pigou.

Either way, I've been defending his theory lately without knowing it was his.

(also, these days, I'm so proud I went to a Keynesian college)

*****

However, Keynes can be our savior only to a very partial extent, and there is a need to look beyond him in understanding the present crisis. One economist whose current relevance has been far less recognized is Keynes's rival Arthur Cecil Pigou, who, like Keynes, was also in Cambridge, indeed also in Kings College, in Keynes's time. Pigou was much more concerned than Keynes with economic psychology and the ways it could influence business cycles and sharpen and harden an economic recession that could take us toward a depression (as indeed we are seeing now). Pigou attributed economic fluctuations partly to "psychological causes" consisting of

variations in the tone of mind of persons whose action controls industry, emerging in errors of undue optimism or undue pessimism in their business forecasts.[5]

It is hard to ignore the fact that today, in addition to the Keynesian effects of mutually reinforced decline, we are strongly in the presence of "errors of...undue pessimism." Pigou focused particularly on the need to unfreeze the credit market when the economy is in the grip of excessive pessimism:

Hence, other things being equal, the actual occurrence of business failures will be more or less widespread, according [to whether] bankers' loans, in the face of crisis of demands, are less or more readily obtainable.[6]

Despite huge injections of fresh liquidity into the American and European economies, largely from the government, the banks and financial institutions have until now remained unwilling to unfreeze the credit market. Other businesses also continue to fail, partly in response to already diminished demand (the Keynesian "multiplier" process), but also in response to fear of even less demand in the future, in a climate of general gloom (the Pigovian process of infectious pessimism).

--excerpt from Amartya Sen's article at the NRB, yet another successful case of clear writing; it would make Feynman proud (he once said that if you really understand something in physics you should be able to explain it to your grandmother)

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