Have you ever been in an argument about whether we should raise taxes and then someone tosses out a real whopper? “The top tax rate for decades after World War II was over 90% and look how the economy boomed!”
Or perhaps you read a Paul Krugman column where he said that, “there’s a big problem with the claim that monetary policy has been too loose: where’s the inflation [he means rising prices]?”
Both the Internet troll and Professor Krugman are making the same mistake. Let me explain.
Economists love to use the Latin phrase ceteris paribus. It means all else being equal. It’s great in a thought experiment. For example, what would happen if we made a change in America today? Suppose we criminalized all use of fossil fuels. We can’t really do that (I hope!) but it can serve a pedagogic purpose.
It should be pretty obvious that the consequence of shutting off the motors is to shut off production, and people will soon starve. If this isn’t obvious, then you don’t need my blog entry on economic argumentation. You need The Moral Case for Fossil Fuels by Alex Epstein.
Every economist is aware that in comparing a historical time to the present, or comparing two different countries all else is not equal. There is not one difference between the immediate postwar period and today. There are innumerable differences. You can’t just assume that the one difference you’re debating is the only one that matters.
To say explicitly, “The postwar prosperity was solely due to its over-90% marginal tax bracket,” makes the error clear. I propose we call this the fallacy of assuming only one variable, or in Latin (as elegantly as I could make it with Google Translate) argumentum ad variabilis*.
Krugman is perpetrating the same fallacy. He assumes that the only force that moves prices is monetary policy. It’s not a bad gambit, actually, if he wants to Gruber his reader into supporting disastrous Fed policies. Most people, including Krugman’s critics, assume that prices rise as a direct result of increases in the money supply.
In the 1970’s there was perhaps a tripling of the money supply, depending on how you measure it. According to the Consumer Price Index, prices doubled. But so what? If there is one take-away I hope everyone gets from my theory of interest and prices, it is that prices are set in a system driven by positive feedback loops and resonance. Prices have anything but a simple linear relationship to the quantity of dollars.
It just isn’t possible to compare the rate of money supply growth today to the rate in the 1970’s and predict what will happen to prices. Well, you can try but then you may go bankrupt. Here is my comparison of the two time periods, looking at some startling differences.
Krugman commits an additional, similar, fallacy. He assumes that the Fed’s quantitative easing policy only affects one variable (perhaps this should be called argumentum ad effectum*?) Or least, there’s only one bad effect: rising prices. If prices aren’t rising, then he thinks that’s all there is to say. As I have been writing in my Forbes column, there are many other ways that QE harms us. Rising consumer prices is the least of it.
There are many reasons why economics does not work like physics. In physics you can measure the acceleration when you apply a force to a mass. Then you can increase the mass and measure the acceleration again. If you design and execute your experiments carefully, you can be sure that your result is caused by one variable. A doubling of mass causes acceleration to halve, ceteris paribus.
However, even the simplest economic system has thousands, if not millions of people, with unknown (to the economist) relationships between them. It has various productive enterprises with changing methods of production, entrepreneurs and inventors, etc. You cannot isolate any one of them, in order to conduct an experiment. You can only observe two different economies. If you focus on only one variable and exclude all others, it is not the controlled experiment that you’d like it to be, at all.
You’re just putting blinders on.
*I am no Latin scholar. My guesses as to the proper Latin names for these fallacies are crude. I would welcome anyone who is an expert in this language to suggest better names.