BERKELEY – It is said that the early nineteenth-century British economist J.R. McCulloch originated the old joke that the only training a parrot needs to be a passable political economist is one phrase: “supply and demand, supply and demand.” Last week, US Federal Reserve Chairman Ben Bernanke said that McCulloch’s economics – the economics of supply and demand – was in no way discredited by the financial crisis, and was still extraordinarily useful.
It’s hard to disagree with Bernanke’s sentiment: economics would be useful if economists were, indeed, likeMcCulloch’s parrots – i.e., if they actually looked at supply and demand. But I think that much of economics has been discredited by the manifest failure of many economists to be as smart as McCulloch’s parrots were.
Consider the claims – rampant nowadays in the US – that further government attempts to alleviate unemployment will fail, because America’s current high unemployment is “structural”: a failure of economic calculation has left the country with the wrong productive resources to satisfy household and business demand. The problem, advocates of this view claim, is a shortage of productive supply rather than a shortage of aggregate demand.
But it should be easy – at least for an average parrot – to tell whether a fall in sales is due to a shortage of supply or a shortage of demand. If a fall in sales is due to a shortage of demand while there is ample supply, then, as quantities fall relative to trend, prices will fall as well. If, on the other hand, the fall in sales is due to a shortage of supply while there is ample demand, then prices will rise as quantities fall.