Sunday, December 11, 2011

The Crisis In Europe As An Experiment In Macroeconomics

One of the problems with economics as a science is that it is not often possible to test economic theories by conducting experiments. Krugman argues that the eurozone crisis has enabled economists to test the theory of expansionary contraction. It has been proven to be wrong in each of the countries where it has been tried. Cutting government budget deficits by raising taxes and cutting spending does not expand economic output. The lesson is that government contraction in a period of recession leads to more contraction. The experience in Ireland also shows how difficult it is to reduce nominal wages even in recession, The idea that wages will fall in recession and lead to a rise in employment has been disproven in Ireland.

Krugman also alludes to another of the problems in economics as a science. When data fails to confirm a theory, it has little impact on adherence to the theory. That is because economic theory is embedded in ideology about the way economies should behave. He provides the example of a professor at the citadel of "free market economics" who insists that jobs are readily available at a market price. At the University of Chicago it is gospel that unemployment is voluntary. The market would clear if workers would accept the market price. We have learned that there is no way to test gospel. Faith in economic ideology is not testable. That is why zombie ideas cannot be killed. Economic ideas that have survived for hundreds of years have done so for a reason. They support the interests of those who benefit from the status quo. The folks who funded the Milton Friedman Center for Economics at the University of Chicago share the gospel that emanates from its halls of ivy.

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