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Much of the conventional economic wisdom prevailing in financial circles – largely
subscribed to as a basis for governmental policy, and widely accepted by the media and the public – is based on incomplete analysis, contra-factual assumptions, and false analogy. Below are 15 such fallacies and explanations as to why each is such.
The above introductory comments are edited excerpts from an article* by William Vickrey entitled Fifteen Fatal Fallacies of Financial Fundamentalism – A Disquisition on Demand Side Economics.
Vickrey goes on to say in further edited excerpts:
We will not get out of the economic doldrums as long as we continue to be governed by fallacious notions that are based on false analogies, one-sided analysis, and an implicit underlying counter-factual assumption of an inevitable level of unemployment…
For instance, encouragement to saving is advocated without attention to the fact that for most people encouraging saving is equivalent to discouraging consumption and reducing market demand, and a purchase by a consumer or a government is also income to vendors and suppliers, and government debt is also an asset. Equally fallacious are implications that what is possible or desirable for individuals one at a time will be equally possible or desirable for all who might wish to do so or for the economy as a whole.
[In addition,] often analysis seems to be based on the assumption that future economic output is almost entirely determined by inexorable economic forces independently of government policy so that devoting more resources to one use inevitably detracts from availability for another. This might be justifiable in an economy at chock-full employment, or it might be validated in a sense by postulating that the Federal Reserve Board will pursue and succeed in a policy of holding unemployment strictly to a fixed “non-inflation-accelerating” or “natural” rate but, under current conditions, such success is neither likely nor desirable.Some of the fallacies that result from such modes of thought are as follows.
Fallacy 1
Deficits represent sinful profligate spending at the expense of future generations who will be left with a smaller endowment of invested capital. This fallacy seems to stem from a false analogy to borrowing by individuals…
Reality:[Go here for a full explanation.]
Fallacy 2
Urging or providing incentives for individuals to try to save more stimulates investment and economic growth. This seems to derive from an assumption of an unchanged aggregate output so that what is not used for consumption will necessarily and automatically be devoted to capital formation. Again, actually the exact reverse is true…
Reality:[Go here for a full explanation.]
Fallacy 3
Government borrowing “crowds out” private investment…
Reality:[Go here for a full explanation.]
Fallacy 4
Inflation is the “cruelest tax.” The perception seems to be that if only prices would stop rising, one’s income would go further, disregarding the consequences for income…
Reality:[Go here for a full explanation.]
Fallacy 5
A chronic trend towards inflation is a reflection of living beyond our means…
Reality:[Go here for a full explanation.]
Fallacy 6
It is necessary to keep unemployment at a “non-inflation-accelerating” level (“NIARU”) in the range of 4% to 6% if inflation is to be kept from increasing unacceptably…
Reality:[Go here for a full explanation.]
Fallacy 7
If only governments would stop meddling, and balance their budgets, free capital markets would in their own good time bring about prosperity, possibly with the aid of “sound” monetary policy. It is assumed that there is a market mechanism by which interest rates adjust promptly and automatically to equate planned saving and investment in a manner analogous to the market by which the price of potatoes balances supply and demand. In reality no such market mechanism exists; if a prosperous equilibrium is to be achieved it will require deliberate intervention on the part of monetary authorities…
Reality:[Go here for a full explanation.]
Fallacy 8
If deficits continue, the debt service would eventually swamp the fisc[?]…
Reality:[Go here for a full explanation.]
Fallacy 9
The negative effect of considering the overhanging burden of the increased debt would cancel the stimulative effect of the deficit. This sweeping claim depends on a failure to analyze the situation in detail…
Reality:[Go here for a full explanation.]
Fallacy 10
The value of the national currency in terms of foreign exchange (or gold) is a measure of economic health, and steps to maintain that value contribute to this health. In some quarters a kind of jingoistic pride is taken in the value of one’s currency, or satisfaction may be derived from the greater purchasing power of the domestic currency in terms of foreign travel.
Fallacy 11
Exemption of capital gains from income tax will promote investment and growth...
Reality:[Go here for a full explanation.]
Fallacy 12
Debt would eventually reach levels that cause lenders to balk with taxpayers threatening rebellion and default.
Reality:[Go here for a full explanation.]
Fallacy 13
Authorizing income-generating budget deficits results in larger and possibly more extravagant, wasteful and oppressive government expenditures…
Reality:[Go here for a full explanation.]
Fallacy 14
Government debt is a burden handed on from one generation to its children and grandchildren…
Reality:[Go here for a full explanation.]
Fallacy 15
Unemployment is not due to lack of effective demand, reducible by demand-increasing deficits, but is either “structural,” resulting from a mismatch between the skills of the unemployed and the requirements of jobs, or “regulatory”, resulting from minimum wage laws, restrictions on the employment of classes of individuals in certain occupations, requirements for medical coverage, or burdensome dismissal constraints, or is “voluntary,” in part the result of excessively generous and poorly designed social insurance and relief provisions…
Reality:[Go here for a full explanation.]
The above fallacious notions, which seem to be widely held in various forms by those close to the seats of economic power, are leading to policies that are not only cruel but unnecessary and even self-defeating in terms of their professed objectives…
Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.
*http://www.columbia.edu/dlc/wp/econ/vickrey.html
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Below is a comment by a reader who sent me a personal email about subject article and subsequently gave me permission to post it here.
Lorimer,
William Vickrey is a very good writer – he seems informed and articulate – but that is the problem. While he has the attributes which enlist confidence leading to acceptance and belief he is, unfortunately, wrong.
What he calls ‘Financial Fallacies’, which he suggests are subscribed to by policy makers in government, business, academic economists and the mainstream media, is almost precisely the opposite. These ‘fallacies’ are in fact what decision-makers and opinion leaders believe…or at least these are the policies these folks subscribe to…and that is why the global economies of ‘first world’ nations are in serious trouble. Most of us are therefore in serious trouble or on the cusp of a great financial unraveling in the near future.
Vast quantities of accumulated debt, that will become totally unserviceable when interest rates return to ‘normal’, will become the trigger. When interest rates return to their traditional positive 3 percent rate over the ‘real rate of inflation’, serious financial implosions will take place in economies generally and within government, business and the consumer sector.
This outcome is both predictable and guaranteed. Only the timing and magnitude of the disaster is less certain.
Lorimer, I was drawn to this article and the writing, but found myself puzzled and confused. It is that these ‘financial fallacies’ are not in fact current policy which is why the financial system is fragile.