Monday, March 16, 2009


Ecomomy Oscillates

During my working career I learned something about constrol systems. I learned the meaning and the effects of positive and negative feedback, proportional, integral, and derivative control signals, feed-forward systems, process controllers, and other things. I think of our economic system as being similar to a process. It is a process with positive feedback. When the economy is rising, the feedback signal is also rising and causes the economy to expand faster than it should. When the economy is falling, the feedback signal is also falling with the result that the economy tends to fall into depression rather than recession.

What is the feedback signal? The feedback signal is the news about the economy. Then the economy is declining, merchants hold back on ordering to refill inventories, hold back on hiring replacements to workers who retire, and finally let workers go in the expectation of little business in the future. When the economy is rising, merchants are eager to fill depleted inventories and try to hire more workers to handle the expected increase in business.

State Governments add to the positive feedback. When the economy is declining, tax revenues also decline. State employees are let go and State-funded programs are discontinued or reduced. Many people think that States should in fact operate just that way. When everyone else is laying off workers, the States should do the same. And vice versa.

Of course, not every employee is laid off or fired during a downturn of the economy. When unemployment reaches ten percent, ninety percent of available workers are still employed. Booms and recessions affect mostly those workers that are the least desirable, the ones that can be shed during recessions and hired back during good times. Because of the oscillation (I use that term rather than instability) of the economy, the economic system necessarily creates an underclass of workers who lack permanent jobs.

Is there anything government can or should do to reduce the amplitude of the oscillation? I believe Abe Lincoln's aphorism: government should do for the people those things the people can not do for themselves. The people themselves, especially the members of the underclass, can do nothing to change the amplitude of oscillation. I think that government can do something. What it has to do is to provide negative feedback to the system. When the economy is falling, government should provide temporary but useful jobs for the unemployed workers and should inject money into the system in ways that slow down the decline and perhaps even reverse its direction. When the economy is rising, government should then take money out of the economy by increasing taxes and putting money aside for the next recession.

Politically, this is hard to do. It's hard to persuade politicians to increase taxes when the economy seems to be rising out of a recession. The instinct is the opposite: "Let the good times roll." Nobody wants to squelch a boom in which daring investors (gamblers) are about to make fortunes. Nobody will agree that the economy is overheated and that the oscillation has risen above the median point.

What we need is some policy or institution in our economy that will provide the needed damping of the oscillation or the negative feedback needed to stabilize the system. This policy or institution should be immune from political pressure.

OK, I've posed a problem. I don't know the solution. I await your proposals.

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