Friday, August 27, 2010

Reduction


If I've learned one thing from my time at computer programming, it's that to solve a problem, you break it into smaller problems and solve the smaller problems. It's a rule I rely on. But it is not infallible.

After the death of Keynesian economics, the reduction of the economic problem into smaller, more manageable problems caused incorrect solutions to be developed.

From mine of 5 July:

The shift from Keynesian economics to Reaganomics was an attempt to fix a problem. That problem was slow growth. (The problem was that we could grow faster only by accepting more inflation. Since we (reasonably) rejected that alternative, the problem was reduced to "slow growth." But perhaps this reduction muddied the analysis from which the solution emerged.)

We didn't have a problem making the economy grow. The problem we had was that we were getting inflation along with growth. When we stamped out inflation, we lost the growth. When growth came back, inflation came back. It was the Seventies.

Reduction of the problem encouraged us to think of inflation and slow growth as two separate problems, to be dealt with separately. But there were not two separate problems. We did not have a problem getting the economy to grow. We did not have a problem keeping inflation under control. We could do either one exceptionally well.

The problem that caused the death of Keynesian economics and gave birth to Reaganomics was not an "either/or" problem. The problem was that we couldn't get healthy growth and price stability at the same time. Splitting the problem into two smaller problems was not a reasonable approach, because it was the combination that was the problem.

At the time, people did not understand that the combination was the problem. People still don't understand it today. Let me give you one example. Paul Krugman writes:

Here’s what I think: inflation did have to be brought down — and Paul Volcker, not Reagan, did what was necessary. But the rest — slashing taxes on the rich, breaking the unions, letting inflation erode the minimum wage — wasn’t necessary at all.

Paul Krugman in 2010 -- May 24, 2010 -- still separates the monetary policy from "the rest" of policy. Still separates anti-inflation policy from pro-growth policy. Still sees the separate application of these two policy tools as the right way to approach the economic problem.

We still have not solved this problem, which emerged in the 1970s, because we still think of it as two separate problems. But it is not two separate problems. It is one problem. The problem is that we can't get healthy growth and price stability at the same time.

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