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Saturday, January 05, 2013

Towards Reasonableness in Cycle Theory

Here's Scott Sumner: "The recession was mostly caused by a big fall in AD, although real factors such as reallocation out of housing might have played a modest role."

Too often macroeconomics is conducted like warfare, where one's favorite theory has to crush all others and emerge as the "victor." I think this is wrong-headed: it's as though we were doctors, and each held a theory as to what makes people ill: "It's viruses!" "No, bacteria!" "Ridiculous: it's cancer!"

The fact is that all of these things can happen to people. And there is simply no reason in the world an economy can't suffer from both an Austrian-type misallocation of resources and an aggregate demand shortfall, as Sumner correctly notes.

2 comments:

  1. This is an interesting post. I think though, when very different methodologies are used, it's hard for two explanations of the business cycle to be integrated. So although it's entirely possible for Austrians to say there's also an aggregate demand shortfall, they're much more likely just to throw it out the window due to a methodology they just don't accept and can't confirm through their own deductive methods. Meanwhile, those who use an empirical methodology and find any sort of evidence for the Austrian explanation are less likely to reject it so quickly. After all, to them, the Austrian explanation is just another theory that can be tested and verified.

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  2. Right, but to some, saying a fall in AD *causes* recessions is like saying having a tumor *causes* cancer. We need a prior theory of a healthy economy--or a healthy body--in order to correctly attribute cause and effect.

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