More about the Nature of Economics

At this point it is necessary to remind you about what I said about money in the paragraph “a Definition of Economics”. That is that economics is the study of human behaviour not the study of money itself.

Economics is the study of people and how they react to money - which is a very different thing. A$100 dollar note lying on the pavement has no life of its own. It is quite incapable of jumping up into your pocket. You have to bend down and pick it up. Therefore economics is the study of human behaviour in relation to money. It has been found over a long period of time that most people react in fairly similar ways to money and economics is based on these broad principles. Economics can therefore never be an exact science because it is impossible to know always and under all circumstances how people will react to it. Economics is based on the almost universal observation that 99% of people will pick up the $100 dollar note - but some won’t!

Hindus entertain the unreasonable idea that cows are in some way sacred - so India is not an ideal place for cattle ranching.

In Ireland, it was recently reliably reported that in the County of Kerry, a number of citizens fell out with their local bank and were determined to drive the bank from the town or into insolvency. One of these Kerrymen had read a book on economics in which he was informed that every bank note issued was a credit owed to the bank and therefore an asset of the bank (which indeed it is and which we shall discuss in more detail later). With this knowledge they determined to destroy the assets of the bank by destroying their own bank notes which they did in a large bond-fire. I mention all this not to call attention to the intellectual superiority of the Irish (of which I am one) but to show the irrationality to which all men are inclined.

Economic behaviour, or the so-called behaviour of money, will only be rational insofar as the people who handle it are rational.

Inflation and A W Philips

Both Keynesian and Monetarist economists were primarily concerned with the demand side of the economy - how to stimulate demand and thereby production and concomitantly expenditure. So along came A W Philips.

Philips got the notion that a high rate of unemployment is usually accompanied by a low rate of inflation, and vice versa. (Full employment accompanied by high rate of inflation). Consequently it was thought that if you deliberately caused inflation you could wipe out or reduce unemployment. This is fallacious reasoning. It is obvious that printing money will for a short period cause high employment. You can provide money for gangs of men to make clothes pegs and then throw them away- the problem comes when you have to pay for them.

If the money was used to produce something useful and that could be sold at a profit, then although t there would indeed be a rise in the price of the wood and wire to make the pegs (because of the extra demand) but such increase would be repaid when the pegs were sold.

Furthermore, the demand for pegs, schools and airports is usually fictitious. No money is generated by their construction and therefore the loans cannot be repaid. Real inflation now starts when the money supply is again increased to repay these borrowings. So Philips is partly right - if you increase the money supply to stimulate useful production and provided it is repaid, higher employment can be achieved.

The problem is that Governments think they know better than businessmen what to produce. Business men (and women) have to repay their debts or suffer for their mistakes. Governments can simply print more money. But in the end even they become nervous at the rising inflation: the merry-go-round is abruptly stopped, the workers fired. Now unemployment increases and it is expected that inflation will come down -but it doesn’t. It does not come down because the money supply has not been curbed and debts paid out of real money.