Behavioral Economics, Episode #27

This week on Crash Course Economics was not so much…economics.  In this economist’s view, behavioral economics is more akin to psychology or sociology, despite having the “economics” in the name.  Nonetheless, we are going to talk about some of the points that Crash Course did make on economics in this weeks episode.

The Big Picture: Predicting Behavior


When economists make their models, they generally assume that people are rational and predictable.  But when we look at actual human beings, it turns out that people are impulsive, shortsighted, and, a lot of times, just plain irrational.

People often point to the existence of human irrational behavior to argue against economic truths that they might not like.  For example, if you are arguing through economic logic that price controls make an economy worse off, a position that economists from all sides of the spectrum agree with, you might hear a response like “well, that assumes that people are acting rationally in their own self-interest, or with perfect information, but that isn’t always the case.”

While this might be true (there isn’t always perfect information, and people aren’t always rational) it doesn’t disprove any economic theories.  What it does support, however, is that economics is very difficult to predict empirically.  Let’s look at an example from this week’s episode:


Some grocery stores in the Washington DC tried to decrease the use of disposable plastic bags by offering five cent bonuses if customers brought reusable bags.  The policy didn’t do that much. Later they tried a five-cent tax on plastic bags, and, this time, people used fewer disposable bags.

While empirical economists would be wrong in their predictions of the effects of the bag bonuses, those economists who shy away from empirical predictions (namely from the Austrian School) would only predict that there would be fewer plastic bags used than before, which is likely true.

In short, Crash Course’s big picture look at behavioral economics shows us how all those brilliant economists working for different government agencies and universities manage to get things wrong.  The problem is not the theory, but the empiricism.

Lack of Information


Classical economics assumes that consumers have perfect information when making choices. That is, they know or at least can quickly access information about prices and quality, but, in reality, they often don’t.  Sure, the consumer could ask around or call their friends to see if they’ve tried that type of ice cream but they’re probably not gonna do that. In this situation, consumers may act on the limited information they have, a suspiciously low price, which means either the ice cream is a great deal or it tastes like mayonnaise.

The way markets work is that the supply, demand, and price work out over time.  Consumers might be cautious to any product at first, but as more people try the product and share the information about it (whether it’s on cnet, yelp, or amazon), the market tends to work itself out, even when it’s a little rocky at first.  As Crash Course points out correctly, perfect information doesn’t happen all at once, but the market does move toward perfection as time goes on.  As for the ice cream example, if the ice cream had a suspiciously low price but tasted like high quality ice cream, over time demand would meet the market’s expectations, although it might not happen at first.  Ever heard of two buck chuck?


Crash Course talked about a fantastic and recent theory in behavioral economics called Nudge Theory.  Best explained in the book Nudge: Improving Decisions about Health, Wealth, and Happiness, Nudge Theory recommends an opt-out system of public policymaking, where the preferred choice is made easier or more visible to to the consumer, while still allowing the consumer to choose the less desired choice:


[Behavioral Economists] wanted to see if they could get children to eat healthier by rearranging school cafeterias.  They put healthier food like fruits and vegetables on eye-level shelves and less healthy foods, like desserts, in less convenient places. Classical economic theory suggests that this idea wouldn’t work since rational people would pick the brownie.  But it turns out, students choose the healthier foods. Nudge theory works and it’s changing how we implement public policy.

What Crash Course failed to mention, however, is that policymakers choose to impelement Nudge theory because it is particularly libertarian.  If schools really wanted kids to stop eating unhealthy foods, they could just ban them entirely.  Instead, Nudge Theory retain’s the consumers’ freedom to choose, while still encouraging them to make the healthy choice.

Bubbles are Caused by Animal Spirits?



Many economists used to believe that assets, like stocks and real estate, would stay at or near their real value because cold, calculating investors would buy undervalued assets and sell overvalued assets. But that doesn’t explain bubbles: In real life, investors aren’t always cold and calculating. They can get worked up and irrational sometimes.  

This helps explain bubbles. From the Dutch Tulip Mania of the 17th century, to the 2008 financial crisis.  Investors became irrationally exuberant, and were driven not by logic, but by what economist John Maynard Keynes once called, “Animal Spirits.”

This is very strange, since back in episode 7 on bubbles and episode 12 on the 2008 financial crisis, Crash Course explained bubbles quite differently.  Back then, bubbles were created by complex financial products and lack of regulation, but maybe those were only the environments to create the bubble, and it was actually the animal spirits that created the bubble all along.


If you, as an economist, are going to stop your analysis of bubbles at “animal spirits,” you might be doing your audience an injustice.  People blame a lot of different things for creating the 2008 bubble (legal incentives to encourage bad lending, poor credit-rating by agencies, monetary policy), but you can’t just dust off your hands and say “it just happens”  Bubbles of 2008’s magnitude don’t happen with animal spirits alone.  The spirits might do the popping, but bubbles are created by other factors.

Thanks for reading, and you can look forward to a new episode reviewed every Thursday! And don’t forget to join our newsletter and our facebook group, and comment below!

Episode #12 – The 2008 Financial Crisis

Personal Note: It’s been a while since I’ve made a post, and my apologies for that.  I currently have a lot on my plate in my non-CCC life (believe it or not, this is not my day job), but I’ve recently received some thoughtful emails concerned with if I have given up or not.  In the blogging world (or any project in digital media for that matter) it can be tough to stick with it, but the encouraging messages like the few I’ve received do make a difference, and for that, this project is revitalized and will be as great as ever.  And away we go…

This episode is a mammoth.  The 2008 financial crisis is one of the most significant moments in US economic history.  600-page books and hours-long debates have dedicated themselves to this topic, and Crash Course bravely tries to sum it all up in about 10 minutes.  That’s a tough task for anyone to do.

For the most part, the facts in the Crash Course video are 100% objectively correct.  The subjective element, however, comes in with the particular ways the hosts describe the events to imply that something is good or bad.  My other main objection to the video comes with what it chooses not to include, despite it being very, very important to what happened.

Mortgages and Lending Practices

It’s very difficult to simply explain what caused the financial crisis without sounding partisan, but I usually explain it this way: banks gave home loans to people who couldn’t pay them back in the future.

This is a good starting point.  Now, whether you want to argue that these loans were made because of capitalist greed or government-created incentives is where the partisan stuff starts coming in.  But let’s look at how Crash Course explains it:

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Investors were pretty desperate to buy more and more and more of these [mortgage-backed] securities so lenders did their best to help create more of them, but to create more of them, they needed more mortgages, so lenders loosened their standards and made loans to people with low income and poor credit.  You’ll hear these called subprime mortgages.

Eventually, some institutions even used what are called predatory lending practices to generate mortgages.  They made loans without verifying income and offered absurd adjustible-rate mortgages with payments people could afford at first, but it quickly ballooned beyond their means.

If you, as an intelligent Crash Course fan, thought critically about the implications of making bad loans, you would ask youself: Why weren’t lenders worried about not being paid back?  Would you, intelligent Crash Course fan, make a loan of $20 to a random person who approached you on the street if he said he would pay you back $40 in a week?  You probably wouldn’t, because he probably wouldn’t pay you back and you don’t want to lose $20.  So why would enourmous financial institutions in the business of giving mortgages make loans to untrustworthy borrowers?  Why would anyone willingly agree to something that will lose them money?  We’ll return to this in a bit.

Financial Products from Morgages

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After our Crash Course hosts briefly talk about the root of the problem (bad mortgages), they spend several minutes on different new financial products derived from mortgages.  These Mortgage-backed Securities include CDOs and Credit Default Swaps.  Crash Course’s explanations of these financial instruments are pretty accurate (from my knowledge), so I don’t think many people, regardless of their political persuasion or economic school of thought, would take issue to how they explained these.

Another accurate point by Crash Course is how leveraged these financial institutions were.  A lot of these firms were holding a large number of these bad financial products as safe assets, especially since the credit-rating agencies rated them the highest rating (AAA).

Credit Rating Agencies

Crash Course mentioned at the beginning of the video the role that the credit-rating agencies played:

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They gave a lot of these mortgage-backed securities AAA ratings–The best of the best.  And back when mortgages were only for borrowers with good credit, mortgage debt was a good investment.

So all these new financial products came onto the scene, and the credit-rating agencies were still rating them AAA, giving a guarantee of the high probability of them being paid back.  They were, of course, completely wrong on this.

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No one knew how bad the balance sheets at some of these financial instutions really were –these complicated, unregulated assets made it hard to tell.

With these two words, Crash Course has diagnosed the problem (assets are too complicated), and has already prescribed the solution (regulation).

The word “unregulated” here is a bit of a misnomer.  Since the financial sector is the most regulated industry in the country, and there exists an enormous agency just for securities (the SEC), calling any financial product unregulated would be a stretch.  However, there were not any specific regulations on these particular financial products, which seems to be what the issue really is.  But since mortgages were heavily regulated and regulators couldn’t stop bad mortgage loans from happening, I doubt any regulation specific to these financial products made before the crash would have done any good.

Crash Course is completely right on their point about how complicated these new securities were.  They were very complicated.  But who is in charge of verifying the quality of complicated assets?  The credit-rating agencies.

Crash Course seems to be giving the credit-rating agencies some slack here, forgiving them for giving good ratings to bad securities because the securities were complicated.

What’s Missing


Crash Course then goes on to talk about the government response to the crisis: bailouts, stimulus, and Dodd-Frank.  Other than the similar partisan phrasing as I mentioned previously, most of their telling of history is spot on.

Mr. Clifford then talked about certain principles (Perverse Incentives, Moral Hazard) that created the crisis, and Adriene summed up the Financial Crisis Inquiry Commision’s report, which blamed the regulators (for not doing enough) and too much faith in free markets.

It seems like Crash Course leaves it at that: either it’s the fault of the financial instutitions, regulators not doing enough, or the free markets.  Pick who to blame among these three.

It’s astonishing to see no mention of any government action (as opposed to inaction) that is to blame for the crash.

Fannie Mae and Freddie Mac were two Government Sponsored Enterprises (SPE) that purchased many subprime mortgages, as they were directed to hold a large number of assets related to affordable housing.  These SPEs contributed significantly to the high demand of subprime mortages and banks issuing these mortgages, since they could be quickly sold to the SPEs for a profit.

The Federal Housing Administration was also missing from the video.  The FHA encouraged banks to issue subprime mortgages by guaranteeing their repayment through their FHA insurance policy.  If a third party takes away all the risk of giving a loan, then why wouldn’t a bank want to give more loans, even if they are to untrustworthy lenders?

These government actors could have been included under Mr. Clifford’s “Moral Hazard” explanation, but it was nowhere to be found.


Crash Course is correct when they say that the financial crisis is incredibly complicated and caused by many different things; however, a little critical thinking would have you leaving this video with more questions than answers.  This post is a brief alternative explanation from Crash Course’s video, but the official Crash Course video left a lot to be explained and the subject deserves multiple explanations.

For a more thorough explanation of the crisis from a free-market perspective, I strongly recommend Tom Woods’ Meltdown.


Thanks for sticking with me, fans of CCC.  I’m still 3 episodes behind, but I’ll try to catch back up ASAP.


Crash Course Episode #8, Fiscal Policy and Stimulus, Part 2

And we’re back for part two!  In this post we’re going to talk about the finer points in episode #8, namely what economists think of “Austerity” and “The Multiplier Effect”


Crash Course explains Europe’s response to the 2008 financial crisis as such:

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[European countries] were pursuing a policy called Austerity: raising taxes and cutting government spending to reduce debt.

While in the US, Keynesian recessionary policy called for increasing spending and increasing their deficit (and debt), countries in Europe were focusing on reducing their deficits (and debt).

Important distinction: A country’s deficit is the difference between what a government spends and the amount of revenue it takes in.  A deficit means that the country has spent more than it has a collected, resulting in more debt at the end of the fiscal year.  In other words, a deficit is the yearly rate of increasing debt.

Side note: When people talk about Austerity, they are usually referring more to the reduction in government spending and less about increasing taxes, while both are technically austere.

Crash Course does not stray from the common opinion that Austerity is bad for an economy:

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Since 2011, when the US and European policies really started to diverge, the US economy has grown at an average rate of 2.5%, while the Eurozone GDP actually shrank by %1.  US unemployment fell to 5.5%, while Eurozone unemployment rose to 12%.

Just the facts here, all of which are true.  From here, Crash Course moves on to talk about another subject, which leaves the viewer thinking “well, with these numbers, austerity clearly doesn’t work and Keynesianism does.”

What needs to be mentioned is what European Austerity really entailed.  How much did governments reduce their spending, and how much debt did they reduce?  Below is a chart of European countries and their deficits (not debt) as a percentage of GDP:

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European countries continued to spend more than they took in, resulting in more debt (also known as taxes on future economies) each year.  While many countries decreased their deficits, they still continued to increase their debt.  Is this really Austerity?

If you compare the resulting budgets (spending and revenue) of the US and Europe following the financial crisis, they don’t look like opposites.  Europe is Keynesianism Light, while the US is like Keynesianism Extra.

As I mentioned in the last post, increasing government spending, financed through debt, will benefit the economy in the short-term at the sacrifice of future economies.  And free market economists would argue that since you are taking from the private sector and spending in the public sector, that action will necessarily make the economy worse off.

Since both Europe and the United States are spending now what they will need to tax later, it makes sense that the present economy of the bigger spender (the US) would be doing better in the short-term.  But to take selected facts and declare “increased government spending = prosperity” would not be showing the full picture.

Multiplier Effect

The multiplier effect theory is often attributed to Keynes (among others), and Crash Course explains how the theory goes:

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The idea here is that if the government spends $100, then the highway construction worker who got the money will save $50 and spend $50 on a concert or something.  The musician who got that money will save $25 and spend the other $25 and so on.  So because of this ripple effect, the initial increase in government spending of $100 might turn out to $175 worth of actual spending in the economy…

Spending on welfare and unemployment seem to give us the most bang for our buck, since people with low incomes spend virtually all of their additional income.

Basically, spending money on the poorest individuals results in a better economy because poor people are more likely to spend that money than save.  Spending is good for the economy, and saving is bad.

I mentioned this before, but money that you put in the bank doesn’t just sit there.  Banks lend out that money to the people who want it and are willing to pay interest on their loan.  Crash Course rests a lot of their economic arguments on the assumption that saving doesn’t improve the economy.  In reality, saving, instead of spending, merely shifts money toward capital goods instead of consumer goods.  The money gets used either way.

The multiplier effect also rests on another principle:

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General cuts to payroll and income taxes seem to have a multiplier of about 1; if the government cuts $100 in taxes, the economy is going to grow by about $100 […] Tax cuts  puts money into people’s hands quickly, but that money might get saved rather than spent.

I don’t know if this is true or not, and Crash Course did not explain why someone’s tax savings (or more like, many people’s marginal tax savings) is not likely to be spent, while money toward a salary would be.

Regardless of whether this is true or not, the money would be used whether government takes it from people, or someone puts in the bank and it’s lent out.

Crash Course’s Greatest Moment Yet

Crash Course concludes this episode with a fantastic point:

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When people are miserable and unemployed, they want to feel like help is on the way.  Doing nothing doesn’t create the kind of confidence that will get consumers and businesses spending again.  And it doesn’t get politicians reelected.  So it looks like Keynesian policies are here to stay.

For now, I’m going to ignore the claim that recessions are corrected by consumers and businesses “having confidence in spending more.”

The most refreshing part is the reluctant acceptance that, whether or not Keynesian economic policy is correct or not, it is going to be implemented because it gets politicians reelected, and it makes people feel like help is on the way.  Nevermind what is effective economic policy, what’s important is that it you believe it’s effective.  And why wouldn’t you?  Policians (and to some extent, Crash Course) tell you it’s effective!


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The Business Cycle, Crash Course Episode #5

Economies grow and recede.  Recently, people have related economic recessions to bursting bubbles.  In 2001, the United States saw the Dot Com bubble burst, and in 2008, there we saw the housing bubble burst.  The ebbs and flows have been a part of every economy since people started keeping track of economic data.  But why does this happen?

Depending on which economic school of thought you prefer, you can have many different answers.  Communists might argue that recessions are caused by capitalists acting in their own self-interest and taking advantage of the working class.  For example, in 2008, banks were giving loans to people who could not afford to pay them back.  When people stopped paying the loans back, money that was relied on was not there, and the economy suffered.


While this explanation of recessions (which can be summed up in one word: greed), is a catch-all for an incredibly complex economic dynamic that occurred over several years, it is not adequate.  A real look into the business cycle would explain not just how the past recession occurred, but why recessions will continue in the future.

Crash Course and Keynesianism

We mentioned before how Crash Course, while admitting that there are different theories for economic phenomena, favors one in particular for macroeconomics: Keynesianism.

To be fair, the Keynesian explanation of the business cycle is also what is taught in your average economic textbook, so we shouldn’t be too surprised.  It is explained in the video using the common analogy of a car:

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If we imagine the economy as a car, then GDP, employment, and inflation are gauges.  A car can cruise along at 65 miles per hour without overheating.  Safe cruising speed is like full employment; unemployment is low, prices are stable, and people are happy.

But if we drive that car too fast for too long, it’ll overheat.  In an economy significant spending increases GDP, causing an expansion.  Unemployment falls and factories start producing at full capacity to keep up with demand.

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Since the amount of products that can be produced is limited, people start to outbid each other, resulting in inflation.  Eventually, production costs increase as workers demand higher wages and the economy starts to slow down.  Businesses lay off a few workers.  Those workers spend less, causing the businesses that produce the goods that they would otherwise buying to lay off more workers.  

This is a contraction.  The economy is going too slow.  Eventually things stabilize, production costs fall as resources are sitting idle, and the economy starts to expand again.  This process of booms and busts is called the business cycle.

A lot of this explanation is fluff, but the essential explanation of the business cycle can be cut down to the following:

People start to outbid each other [for resources], resulting in inflation.  Eventually, production costs increase as workers demand higher wages and the economy starts to slow down.

Essentially, the price of raw materials increases, and workers demand higher wages.  The combination of the two hurts business, which starts the downturn.  Let’s take a look at these two separately:

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1. Increase in the Price of Raw Materials

Resources are scarce, and businesses have to compete for these resources.  When businesses are doing well and demand more of these scarce resources, the price must increase, since the supply cannot increase.  The increased price weakens the businesses.

But businesses can also forecast the prices of raw materials.  In fact, many businesses hire people to do exactly that.  Rising prices like these should come as no surprise to businesses, and if they are expected, they would be accounted for in a way that minimizes damage to the business.

Additionally, rising prices in the provision of raw materials would signal to the market that more resources need to be devoted to it.  The raw materials business is booming in this scenario, so the industry would be hiring workers as the demand for their resources increases.  The market would be shifting jobs from one area of the economy to another, which is normal.  I don’t see how unemployment results from this.

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2. Workers Demand Higher Wages

This is a huge assumption: over time, workers demand higher wages, so employers choose to increase wages, and have to lay off some workers as a result.

This just doesn’t happen.  An employer will usually do what’s good for the business, and if it’s a large company with shareholders, the owner has a fiduciary duty to do what’s good for the business.  In other words, if the CEO of a company knowingly does something that will hurt the business, he/she gets sued.

Sometimes, employees are paid less than what the employer would pay, and the demand for higher wages results in higher wages.  This often happens in a boom economy: employees have many job options, forcing employers to pay them more to keep them at their current job.  But if the employer cannot afford to give higher wages (and we know this because increasing wages would result in lay offs), he won’t, and in many cases, he legally cannot.

Wages are determined by the amount of value created, how much the employer is willing to pay, and how much the worker is willing to work for.  The worker’s demands alone does not determine his/her pay, and businesses likely will not weaken themselves because the employees ask it.

3.  The Spending Spiral Takes Care of the Rest

While the cause of the downturn is debatable, Crash Course’s explanation of the result is rather accurate.  Once businesses start losing money, they start laying off workers, who spend less in the economy, so everybody hurts.

Please note that this is a different situation from that my last post, where money is shifted from spending to saving.  In the current case, spending and saving is replaced with nothing.

The Role of Government

According to Crash Course (and many economics textbooks), the above explanation is what naturally happens in a free market economy, and economists generally favor the government to step in to fix it (again using the car analogy):

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When I’m driving my car on the highway I like to use cruise control to regulate my speed.  So why don’t we have cruise control for the economy?  Well, many economists think that the government should play a role in speeding up or slowing down the economy.  For example, when there’s a recession, the government can increase spending or cut taxes so consumers have more money to spend.

Proponents of this policy argue that it would get the economy back to full employment, but it has its drawback: debt.

Increasing spending or decreasing taxes (absent other changes) would increase the debt, which Crash Course will get into in another video.

My problem is the assumption that government must have nothing to do with the cause of the recession; it is only shown as the possible solution.

Crash Course Criticism will get into alternative business cycle theories and the other possible causes of recessions when we get to the videos on the Federal Reserve.  We have a lot to talk about here.  Stay tuned.


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Robert Wenzel Comments on Episode 1 (and 2)

While my response to episode 2 is in the works, check out Bob Wenzel’s commentary on the first two episodes.

What is Economics?

Wenzel agrees that Crash Course’s definition of Economics is good, but not ideal, because of its potential to delve into behavioral economics.  Let’s look at how Crash Course defined economics through the quote they used by Alfred Marshall:

A study of Man [and Woman] in the ordinary business of life.  It enquires [sic] how he gets his income and how he uses it.  Thus, it is on one side, the study of wealth and on the other and more important side a part of the study of Man [and Woman].

Wenzel cautions that this definition of economics may be “looking and attempting to understand how people reach their goals for action.  [Austrian Economist Ludwig Von] Mises doesn’t do that.  He says ‘okay whatever the reason men have goals, and let’s decide what happens in the economy with regard to exchanges once we understand those goals, regardless of how they come up with those goals’

This is a significant difference in one of the biggest questions in economics: what is economics?

Microeconomics Examples

Wenzel also takes aim Crash Course’s explanation of Microeconomics.  From Crash Course:


There is a whole other side of economics that look at different questions: How many workers should we hire to maximize profit?  If our main competitor releases their product in May, when is the best time to release our product?

Wenzel points out that economics is not the study of business decisions:

The economist can explain how once a businessman has his goals, how he chooses, but there’s nothing that an economist can do as far as providing insights into something that is really a decision of a businessman or entrepreneur.

Economics is about understanding how the economic system works.  It’s not about telling businessmen how to run their business.

So if the example questions from Crash Course aren’t actual examples of Microeconomics, what questions would be?  How about:

If the price of a good increases, what happens to the demand if everything else stays the same?

If the supply of a good decreases, what happens to price if everything else stays the same?

Macroeconomic Predictions

I didn’t know about this at the time, but Robert Wenzel mentioned that he was one of the economists who predicted the 2008 financial crisis in real time.  To read more about that, you can check out his book, or subscribe to his daily financial advice guide.

Read more of Robert Wenzel at his sites and Target Liberty.

Why Didn’t Economists Predict the 2008 Financial Crisis?


This was a great question Mr. Clifford brought up in the first video, but then never answered:

People sometimes criticize economists asking “Why didn’t they predict the 2008 financial crisis?” or “Why can’t they agree on what the government should do or shouldn’t do when there’s a recession?”

These criticisms fails to distinguish between Macroeconomics and Microeconomics.  Specifically, all these complaints are about Macroeconomics.

He then goes on to define and explain the differences between Macro and Micro, without ever coming back to the original questions.  Let’s go back to them.  First, the easy one:

Why can’t economists agree on what the government should do or shouldn’t do when there’s a recession?

As mentioned in previous posts, economics has many different theories and different schools of thought.  Economists can’t agree on how to respond to a recession because they don’t all believe the same principles of economics.  For example, some think government spending helps an economy get out of a recession, while others think that government spending hurts the economy.  So it’s not a surprise that these different beliefs in the fundamentals of macroeconomics lead to different suggestions on what the government should do.

Asking this question is similar to “Why can’t politicians agree about what to do about [policy topic]?”

Why didn’t economists predict the 2008 financial crisis?

This is a great question.  If you were watching CNBC or Bloomberg in 2007, you would not hear any debate as to whether we were headed for a recession.  After all, the stock market was up, unemployment was down, and you just bought a house with no money down!  The economy was looking good.

There were, however, people who warned against the impending financial collapse, primarily from the Austrian school.  They even made some television appearances, where they were ridiculed and laughed at on just about every program:

Does this necessarily mean that the Austrian school was right because they were the ones who predicted the crisis?  It doesn’t, but it would be disingenuous to say that “economists did not predict the 2008 financial crisis.” Some of them did.

The argument against this, of course, is “a broken clock is right twice a day.”  In other words, if you always say that a crisis is coming, then you’re going to be right when it happens.  In fact, right now many Austrians are warning of an impending financial collapse, and some of them have even predicted dates of the crisis which have now passed.  We’ll get to this more when we talk about economics as a social science vs. physical science, but Austrians are often characterized as “doom and gloomers” who always warn that we are close to the next crisis.

However, if you watch the video above, Peter Schiff isn’t only predicting a recession, he says exactly how it’s going to happen:

Today’s home prices are completely unsustainable.  They were big up to these artificial heights by a combination of temporarily low adjustment-rate mortgage payments by a complete absence of any lending standards and by speculative buying.

That’s awfully specific, and even if he was wrong about the year (he clearly jumped the gun by saying the crisis would happen in 2007), the fundamentals are pretty dead on from what we know about the recession today.

So take this for what it’s worth:  Austrians are not great at predicting the timing of recessions (but then again, neither is anyone), but the explanation behind it seems pretty solid.

Keynesian Presuppositions


John Maynard Keynes is probably the most influential economist in currently-practiced economic policy.  Among the Keynesian marks left on economics is the idea of the necessity of government intervention to moderate the booms and busts of the economy.  As the theory goes, governments must spend during a recession to stimulate the economy.

This idea makes a lot of sense if you’re hearing it for the first time.  When you’re tired, coffee helps you get back to normal, and similarly, if the economy is down, you need to kickstart it with some spending to get the ball rolling again.

Adriene alludes to this idea when she says:


Economics is the government deciding whether to increase its spending when there’s a recession, and if it’s worth going into debt.

Usually the answer is yes, increase spending, as the United States did with its $831 billion Stimulus Package (also known as the American Recovery and Reinvestment Act of 2009).

The problem with testing economic theories is that you never know if it actually works.  The 2009 Stimulus Package did not have the kickstarting effect that was predicted; the free-market economists said that this was because Keynes’s theory is wrong and government spending does not help the economy because a stimulus package would only take money from the more efficient private sector economy (through taxation) and transfer it to a less productive public sector economy.  However, Keynes supporters argue that Keynes is correct and the Stimulus Package did work, and the situation would have been much worse if the government had not intervened.

Unfortunately, we’ll never know the truth empirically, since economics is not a physical science where you can have an identical “control group” economy to compare it to.  And while Adriene’s point didn’t directly claim Keynes’s theory to be true, she did imply it.  By presenting the downside of spending as “going into debt,” which isn’t necessarily true, she doesn’t mention what real dissenters of stimulus spending would argue: that stimulus packages are a net negative for the economy, even if the country doesn’t have to borrow money to pay for it.

Mr. Clifford makes another Keynesian presupposition when he posits this question as an example of macroeconomics:


Will an increase in the money supply boost output, or just increase inflation?

Framing the question this way essentially presupposes that increasing the money supply can boost output, but the risk is that it may also increase inflation.

This is also derived from Keynes’s theory of government intervention for a recessed economy: increasing the money supply (i.e. creating money and buying financial products with them) will give more money to banks who then lend out that money to people for long-term capital projects (building construction, investing in companies, etc.).  Now there’s more money circulating in the economy as more people get to borrow money to fund their projects, and the financial industry is booming because they are the first ones to get the newly-printed money.  However, printing money runs the risk of prices increasing as the dollar becomes less valuable.  The Keynesian theory describes money creation as a balancing act; the government needs to print just enough to kickstart the economy, but not too much to create an inflation problem.

Again, real dissenters from Keynesian economic theory (or at least those who follow the Austrian Business Cycle) would argue that increased inflation is not the only risk of increasing the money supply.  As the Austrian theory goes, money printing distorts the economy, shifting production from consumer goods (like stuff you buy at CVS) to capital goods (projects that banks give big loans to).  The shift is harmless at first and may even appear to boost the economy, however, this distortion that provokes an artificial boom will ultimately result in an even greater bust.  In other words, the cups of coffee you drank to wake you up will leave you with a bigger caffeine withdrawal the next day.

With these two examples, it’s not too hard to see a preference toward Keynesian macroeconomics, but who can blame them?  Keynesianism is widely-practiced in countries around the world and is supported by many economists.

The least they can do, however, is correctly present the real concerns about Keynesian policies, and not the Keynesian concerns about Keynesian policies.