Wednesday, November 4, 2009

Terrific Article by Edmund Phelps

Nobel laureate Ned Phelps writes : "The lesson the crisis teaches, though it is not yet grasped, is that there is no magic in the market: the expectations underlying asset prices cannot be 'rational' relative to some known and agreed model since there is no such model."


Greg Hill said...

I think Professor Phelps owes us a list of the “Keynesians” who claim that “fiscal ‘stimulus’ of all kinds is effective against slumps of all causes” and that “all slumps, all of the time, are entirely the result of ‘co-ordination problems.’” I’ve never seen this view expressed by an Old Keynesian, a New-Keynesian, or a Post-Keynesian.

Phelps thinks he’s articulating a “Keynesian” view when, in explaining the crisis, he says that “companies appeared to underestimate the cutbacks and price cuts of competitors on the way down.” But this explanation is neither Keynesian, nor plausible.

Some companies can overestimate demand for their products and find themselves with excess inventories, but it would be very difficult for a preponderance of firms to make this “mistake.” The reason, of course, is that when bullish expectations are widespread, they are also self-fulfilling.

Thus, it makes little sense to conclude, as Phelps does, “that excessive optimism signaled deficient demand for goods and labor,” for optimism that signals a “deficient demand for goods and labor” is simply not optimism.

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