Sunday, December 11, 2011

Financial Magic

Magic can work. Here is a bit from Paul Krugman on the strategy of "inflating your way to prosperity". From his NY Times blog:
One thing I often see in comments is people attributing to me, or to others, the notion that you can inflate your way to prosperity — which is presented as self-evidently absurd.

Well, if you think that it’s self-evidently absurd, you’ve been listening to the wrong people.

Nobody thinks that an economy operating somewhere near full employment can inflate its way to higher output. But under depression conditions — which is what we have now — inflation is very much a positive thing.

Here’s a quick example from Eichengreen and Sachs showing changes in the gold value of currencies 1929-35 versus changes in industrial production; the devaluation of currencies against gold was closely related to the changes in their overall price level:

Click to Enlarge

Yep, countries were able to inflate their way to prosperity. And you get an immediate failing grade if you start ranting about Zimbabwe or Weimar.
If you have ever seen a magician do sleight of hand, it looks impossible. But the magic works. He does a real illusion by manipulating weaknesses in our psychology. To ignore the power of placebos or magic by being an economic "fundamentalist" is as nutty as being a religious fundamentalist. In the real world you should seize and use whatever real effects that are out there. Even if they are "magic" and depend on strange attributes of humans and their psychological make-up.

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