Krugman’s blog, 7/10/17

There was one post yesterday, “Formerly True Theories (Wonkish and Self-Indulgent)”:

Taking a break from health care, treason, and all that to read David Glasner on the price-specie-flow mechanism. The exposition of this mechanism by David Hume in his 1752 “Of the balance of trade“, was a landmark in the development of economics — arguably the first real economic model, making sense of the real world (and giving important policy guidance) via a simplified thought experiment, basically a model despite the absence of explicit math. Glasner argues, however, that it had ceased to be a good model by the 19th century due to the rise of fractional reserve banking and central bank discretion.

I think this critique may go both too far and not far enough. In systems where bank reserves still took the form of specie — and bank notes were backed by specie, as in the United States — a lot of the specie-flow mechanism remained in place for most of the 19th century. On the other hand, the simple link between trade balances and specie flows was broken by the rise of widespread capital mobility: when British investors were buying lots of US railroad bonds, we were no longer in Hume’s world.

But that doesn’t mean that Hume was wrong about *his* world. And reading Glasner made me think of a category of economic ideas that’s crucial, I’d argue, in making sense of part of the history of economic thought — the category of “formerly true” ideas. That is, ideas that were either good descriptions of the world the classical economists lived in, or had been good descriptions of the world just before the classicals wrote.

Pride of place here surely goes to Malthusian economics. You still see people saying flatly that Malthus was wrong. But over the roughly 60 centuries that have passed since civilization emerged in Mesopotamia, the Malthusian proposition — population pressure swallows up any gains in productivity, so that most people live on the edge of subsistence — was true for 58. It just so happens that the two centuries for which the proposition didn’t hold were the two centuries after Malthus wrote.

Actually, of course, this wasn’t an accident. Malthus didn’t kill Malthusian economics; but the rise of intellectual curiosity, of systematic hard thinking, of the scientific attitude, gave rise both to people like Malthus — who tried to approach economics in a recognizably modern manner — and to the dramatic acceleration of technological progress that took us out of the 58-century Malthusian trap.

Similarly, I don’t think there can be any doubt that something like Hume’s specie-flow mechanism did indeed operate through all of history from the first introduction of metallic money to sometime in the late 18th or early 19th century. How did Spanish silver end up fueling a rise in prices all across Europe? As Hume himself said, because silver raised Spanish prices, leading to trade deficits, and the silver flowed out to Spain’s trading partners.

Eventually, however, people — especially the Scots! — developed modern banking and learned to invest capital across borders. These commercial innovations were part of a general spirit of inquiry and innovation that produced, among other things, David Hume and Adam Smith.

Are there other examples? The self-correcting economy — in which unemployment leads to deflation, which increases the real money supply, and thus restores full employment — is another thing that probably did work for most of history, but began to fall apart as agrarian economies gave way to industrialized economies with less flexible prices. David Ricardo’s rejection of the possibility of demand shortfalls eventually turned out to be very wrong — and was surely already wrong in Britain by 1817 — but had been true in the past.

Is there a moral to this story? Maybe it is that things economic do change. By and large they change more slowly than many people think; understanding the 1930s was still immensely valuable to understanding the world after 2008. But economic “laws” — I generally hate that term — aren’t immutable, and good economists can be both right about the past and wrong for today.

I now return you to our regularly scheduled Trump coverage.

 

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