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-- Brad Delong

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Monday, November 1, 2010

Great Expectations

In another chapter of the Krugman-Beckworth fundamental disagreement about how economics works in a liquidity trap, PK emphasizes this point.

But in the 30s, we were mainly talking about ending expectations of deflation, or at most creating expectations of a rise in the price level to where it was before the Depression; remember that even in 1938, prices were well below 1929 levels:

That’s very different from trying to create expectations of inflation looking forward with no actual deflation in our past.

Here is what strikes me: economists of all stripes, who cannot seem to agree on much of anything else*, agree on the power of expectations.   The mechanism must be something along the lines of:

Current Reality --> Future Expectations --> Future Actions -->  New Set of Conditions --> New Reality

This reminds me of a scene in Peter Pan, where wishing makes it so.   If we all chant, "I do believe in inflation!" then it will happen.   Do I totally misunderstand, or is this magical thinking?

I see Karl Smith has posted on this today, using the same  quote and graph.
*  A bit off topic, but why let that stop me?  In comments to one of Karl Smith's posts, I opined thusly (emphasis added):

The physical sciences continue to advance at a nuanced detail level. The basic tenets are not being challenged (they are not WRONG, they are incomplete and/or inexact*) – at least not very often. The reason for this is scientists are able to devise and run controlled experiments and reach a fundamental understanding of principles, and specifically, cause and effect. The growth of scientific knowledge over time is something like an asymptotic approach to reality. The things that are difficult to know and understand are the new things that are being discovered.

* Relativistic mechanics does not refute Newtonian mechanics; rather, it subsumes it.

The agreement you cite among the economists you listed is at the level of “Which way is up?” Where they disagree is on whether you can get there more effectively by climbing a ladder or digging a hole, because they do not agree on the basic nature of ladders and holes.

Economics is now revisiting the same battleground as it was 80 years ago. It seems not to advance because past lessons are relatively ineffective at informing current thought. It happens this way because economic thought is contaminated by political ideology, and ideology trumps reality far too much of the time.
That really is dismal,

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