Sunday, June 12, 2011

Don't break your arm patting yourself on the back.

Boom and bust cycles are a natural feature of free markets, since producers do not have exact information about the market-clearing price. Thus they will tend to overshoot, leaving inventory unsold or forcing the price down until the market clears. While the market is clearing, unprofitable producers go out of business, reducing supply, which raises the market-clearing price.

What stands out is that, the more perfect the information available to the producers, the less pronounced the boom and bust will be. They will overshoot by less, and prices will have to decline less to clear the market. Price swings will be moderated solely by increasing information.

What does that say about the Great Moderation? The world's central banks figured they had them problem well in hand, when it could be that digital inventories and just-in-time production had done the job of moderating the economy for them. The luck of Greenspan, not the wisdom, is what set the course.

2 Comments:

Blogger Yoel Natan said...

The economic bubbles bursting cause so much of a general slowdown, that demand can dry up across the board even in areas of the economy without inflated prices. Moreover, it's hard to predict when a bubble will burst, so while people know there's a bubble, they can't forego economic activity just because they know there's a bubble since the bursting maybe years off.

Your other thesis about natural selection pressures on business is exactly backwards from reality a great many times in that the most efficient companies don't survive a recession while the inefficient do. Here's the scoop.

This recession, as with others, businesses actually make more profit when they downsize, often cutting off the 3rd or even 2nd shifts, and maybe trimming the 1st shift since they have fewer expenses and they sell off previously made inventory. The companies have all lean and no fat left, and thus there is a jobless recovery, at least on paper. The businesses have great balance sheets but refuse to invest and create more jobs.

What's happened is many businesses have escaped economic Darwinism by transferring Darwinism to the employees. A company with loyalty to its employees is more likely to go out of business than an inefficient business since it doesn't downsize fast enough, meaning that all too often only the undesirable factories and employers weather a recession regardless of their year-in and year-out efficiency:

Economic Bubble:
http://en.wikipedia.org/wiki/Economic_bubble

8:03 PM  
Blogger Octavo Dia said...

that demand can dry up across the board even in areas of the economy without inflated prices.

Because counter-cyclical activity is hard to maintain. It's easy to sell when everyone is buying.


a great many times in that the most efficient companies don't survive a recession while the inefficient do.

You are misunderstanding efficiency. A company that is all highly productive employees seems more efficient, but it is not. A company that can still turn a profit with marginal employees is more efficient, and it also has the advantage of shedding the marginal employees when things turn unprofitable.


since it doesn't downsize fast enough

Germany's "unemployment" program which subsidizes reductions in work hours, is ideal in this regard. It's quick and easy to cut or increase hours, whereas firing employees is destructive and rehiring is expensive and time-consuming.

8:51 PM  

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