Episode in Review – Page 4 – Crash Course Criticism

Crash Course Episode #9, Deficits and Debt, Part 1

In this week’s episode of Crash Course Economics, the hosts talk about deficits and debt. This episode might have better scheduled if it were before the videos on Keynesian Macroeconomic Policy, where they talked about deficits and debt, only to define the terms later.

Debt and Spending

Crash Course opens the episode by defining the terms debt and deficit, and explaining how the United States has the largest debt of any country, but the US debt as a percentage of GDP is not as high as a few other countries whose economies are doing fine, namely Japan. However, the major concern isn’t the current size of the debt, but the growing deficit.

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Most economists are not worried about the borrowing that the US has done already, because they are too worries about the borrowing they’re going to do.

This is true, and as shown in the graph above, the US deficit is scheduled to increase through in future decades as government spending increases.

In the “too much spending vs. not enough revenue” argument, Crash Course shows that revenue (i.e. taxes, fees, tariffs, etc.) is set to increase (as a percentage of GDP) in the coming decades, so this is “not the problem”. While this is a subjective political argument (socialists and progressives might say that taxes are not high enough), we’ll assume that what she meant was that the increasing deficit is caused by increasing government spending, not decreasing revenue.

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To de-politicize the spending issue, our co-host Adriene gives her explanation of which side is right when it comes to the question of “Where is there too much spending?”:

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Let’s look at where the government actually spends its money. Conservatives might complain “It’s obvious! Handouts!” Liberals will say “It’s obvious! Defense!” Well, they’re both wrong. So who’s the biggest recipient of federal dollars?

Grandma and Grandpa. The government spends about a quarter of the budget on Social Security, and another quarter on healthcare programs. A lot of that goes to retired people on Medicare. They deserve it! They worked hard. And those are the programs that are expected to grow as baby boomers retire and live longer. Defense and other discretionary programs are actually projected to shrink slightly as a percentage of GDP.

First, let’s ignore the out-of-place and opinionated commentary of “they deserve it! They worked hard.”

Second, while retirement spending is scheduled to increase significantly, so is defense.

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The graph above shows the nominal costs of the Department of Defense. Until about 2022, there is an increase in spending. After that, it will stay at about 600 billion per year.

However, Adriene is right that Defense will shrink as a percentage of GDP, as you can see in the graph above. So if we’re looking at the cause of the increase in the deficit, as opposed to the already large deficit/debt or spending in general, she is correct.

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Also, if tax-funded healthcare for the elderly is one of the leading causes of the increasing deficit, are conservatives actually wrong when they complain about “handouts”? I understand that Crash Course tries to remain politically neutral, but if the argument is between handouts vs. defense being the cause of a rising deficit, and you explain that Medicare is a primary cause, conservatives (in this case) are not wrong.

Also, in the liberals vs. conservatives argument, rarely have I heard the argument phrased within the context of defecit as percentage of GDP. Liberals are usually arguing that there is and has been too much defense spending generally, and conservatives argue against handouts being such a large part of the budget generally.

Debt and Borrowing

Our co-host Mr. Clifford explains how the US finances its debt:

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First, to borrow, you need lenders, people who have decided to save money and loan it out, rather than spend it on something else. But there is a finite amount of money that savers can lend, and most of that savings is borrowed by the private sector, which is consumer that take out car loans and businesses that pay for things like factories and computers.

When the government runs a budget deficit, it borrows from that same pool of savings. And if the government continues to borrow, many economists worry that there will be fewer loans available for businesses, and that will hurt the long-run growth of the economy.

This is a huge misrepresentation of how government fuels its debt. Here is a graph that accurately shows who hold the government debt:

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As you can see, domestic private investors, like what Mr. Clifford was talking about, account for less than 15% of government debt. The largest portion (34%) comes from international investors, which could be foreign governments or foreign citizens who are lending money to the US government and hoping to be paid back when the bond matures.

Federal Accounts accounts for 28%. This is where the government essentially borrows money from itself. Since different departments have different budgets, and some don’t necessarily need to spend it this year (for example, the budget that holds the Social Security deposits you’ve contributing to and hoping to get back eventually), other departments can borrow from those accounts and promise to pay it back later.

The Federal Reserve accounts for 14% of the debt. This is when the government creates money with a push of a button and buys treasury bonds (which is what you get when you loan money to the government). When the loans matures, the money is then just put into the treasury.

This is a big misrepresentation by Crash Course, and I was very surprised that they described US debt holders as only domestic lenders. How did this script get through production without someone saying “maybe we should say that this is only about 15% of debt, and there are many other ways the US finances its debt?”

We’ll pick back up with the rest of the video in Part 2. Stay tuned to see what Crash Course says about interest rates, and scenarios when spending might not get out of control.

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Crash Course Episode #8, Fiscal Policy and Stimulus, Part 2

And we’re back for part two! In this post we’re going to talk about the finer points in episode #8, namely what economists think of “Austerity” and “The Multiplier Effect”

Austerity

Crash Course explains Europe’s response to the 2008 financial crisis as such:

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[European countries] were pursuing a policy called Austerity: raising taxes and cutting government spending to reduce debt.

While in the US, Keynesian recessionary policy called for increasing spending and increasing their deficit (and debt), countries in Europe were focusing on reducing their deficits (and debt).

Important distinction: A country’s deficit is the difference between what a government spends and the amount of revenue it takes in. A deficit means that the country has spent more than it has a collected, resulting in more debt at the end of the fiscal year. In other words, a deficit is the yearly rate of increasing debt.

Side note: When people talk about Austerity, they are usually referring more to the reduction in government spending and less about increasing taxes, while both are technically austere.

Crash Course does not stray from the common opinion that Austerity is bad for an economy:

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Since 2011, when the US and European policies really started to diverge, the US economy has grown at an average rate of 2.5%, while the Eurozone GDP actually shrank by %1. US unemployment fell to 5.5%, while Eurozone unemployment rose to 12%.

Just the facts here, all of which are true. From here, Crash Course moves on to talk about another subject, which leaves the viewer thinking “well, with these numbers, austerity clearly doesn’t work and Keynesianism does.”

What needs to be mentioned is what European Austerity really entailed. How much did governments reduce their spending, and how much debt did they reduce? Below is a chart of European countries and their deficits (not debt) as a percentage of GDP:

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European countries continued to spend more than they took in, resulting in more debt (also known as taxes on future economies) each year. While many countries decreased their deficits, they still continued to increase their debt. Is this really Austerity?

If you compare the resulting budgets (spending and revenue) of the US and Europe following the financial crisis, they don’t look like opposites. Europe is Keynesianism Light, while the US is like Keynesianism Extra.

As I mentioned in the last post, increasing government spending, financed through debt, will benefit the economy in the short-term at the sacrifice of future economies. And free market economists would argue that since you are taking from the private sector and spending in the public sector, that action will necessarily make the economy worse off.

Since both Europe and the United States are spending now what they will need to tax later, it makes sense that the present economy of the bigger spender (the US) would be doing better in the short-term. But to take selected facts and declare “increased government spending = prosperity” would not be showing the full picture.

Multiplier Effect

The multiplier effect theory is often attributed to Keynes (among others), and Crash Course explains how the theory goes:

The idea here is that if the government spends $100, then the highway construction worker who got the money will save $50 and spend $50 on a concert or something. The musician who got that money will save $25 and spend the other $25 and so on. So because of this ripple effect, the initial increase in government spending of $100 might turn out to $175 worth of actual spending in the economy…

Spending on welfare and unemployment seem to give us the most bang for our buck, since people with low incomes spend virtually all of their additional income.

Basically, spending money on the poorest individuals results in a better economy because poor people are more likely to spend that money than save. Spending is good for the economy, and saving is bad.

I mentioned this before, but money that you put in the bank doesn’t just sit there. Banks lend out that money to the people who want it and are willing to pay interest on their loan. Crash Course rests a lot of their economic arguments on the assumption that saving doesn’t improve the economy. In reality, saving, instead of spending, merely shifts money toward capital goods instead of consumer goods. The money gets used either way.

The multiplier effect also rests on another principle:

General cuts to payroll and income taxes seem to have a multiplier of about 1; if the government cuts $100 in taxes, the economy is going to grow by about $100 […] Tax cuts puts money into people’s hands quickly, but that money might get saved rather than spent.

I don’t know if this is true or not, and Crash Course did not explain why someone’s tax savings (or more like, many people’s marginal tax savings) is not likely to be spent, while money toward a salary would be.

Regardless of whether this is true or not, the money would be used whether government takes it from people, or someone puts in the bank and it’s lent out.

Crash Course’s Greatest Moment Yet

Crash Course concludes this episode with a fantastic point:

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When people are miserable and unemployed, they want to feel like help is on the way. Doing nothing doesn’t create the kind of confidence that will get consumers and businesses spending again. And it doesn’t get politicians reelected. So it looks like Keynesian policies are here to stay.

For now, I’m going to ignore the claim that recessions are corrected by consumers and businesses “having confidence in spending more.”

The most refreshing part is the reluctant acceptance that, whether or not Keynesian economic policy is correct or not, it is going to be implemented because it gets politicians reelected, and it makes people feel like help is on the way. Nevermind what is effective economic policy, what’s important is that it you believe it’s effective. And why wouldn’t you? Policians (and to some extent, Crash Course) tell you it’s effective!

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Crash Course Episode #8, Fiscal Policy and Stimulus, Part 1

Crash Course’s most recent video on Fiscal Policy and Stimulus has its ups and downs. The show’s hosts acknowledge the controversy surrounding Keynesian economics, but not before treating the ideas favorably. The show equates free market economics with antiquated (and wrong) medical science, and presents only two (both government-centered) economic policies as the potential solutions to national recessions. Let’s start from the beginning:

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Recessions vs. Unemployment

Crash Course spends the first few minutes of the video talking about what it means when a country is in a recession, followed by a brief history of recessions in post-WWII United States.

The episode notes that dips in the economy correspond with rising unemployment, and unemployment is linked to a number of other negative societal factors: namely suicide, domestic violence, and social upheaval.

Fortunately, Crash Course also mentions that unemployment is not the only potential monster to the economy. The show gives equal time to discussing the problems with inflation:

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High inflation can be just as bad. Rising costs wipe out savings and have been the root of protests and riots around the world…

…Many economists argue that policymakers should intervene in the macroeconomy in order to promote full-employment or reduce inflation.

Without directly saying so (at least not yet), the show implies that large-scale unemployment and inflation happen naturally, and government policy may be necessary to fix these problems.

As I wrote about in last week’s episode on inflation, inflation doesn’t just happen naturally in the market. Widespread price increases happen from new money being created and flowing through the economy. When Crash Course says “many economists argue that policymakers should intervene in the macroeconomy,” they should also clarify that government monetary intervention has already occurred, and now people are considering if fiscal economic intervention is necessary.

To give them credit however, they are correct that unemployment would still occur in a free market. All schools of economic thought would agree that as industries are constantly growing and shrinking, and people get laid off when their industry shrinks. The real question between schools of thought is how a very high unemployment rate occurs, and whether government intervention prevents this from occurring (or causes it to occur).

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Expansionary/Contractionary Policy

Before mentioning that what they are about to explain is debated between schools of economic thought, Crash Course explains Keynesian fiscal policy as generally agreed upon by economists. They later use examples from the 2008 recession to illustrate how this method of thinking is practiced in the United States, explaining away common objections to their example:

In 2009 the US government launched a huge stimulus program in response to the financial crisis. Despite that, employment and GDP both fell. That sounds like a failure, but the majority of economists think that the situation would have been far far worse without that stimulus.

I mentioned this in a previous post, but if a scientist declares his hypothesis to be true, and then despite their own contrary experimental results, still declares his hypothesis to be true, there’s no use trying to convince him. They will declare themselves the winner regardless.

Keynesian fiscal theory is based on two main assumptions: decreasing taxes and increasing government spending help the economy (and the reverse hurts the economy). Their own admitted problem is that helping the economy in this way requires the government to increase their debt, which will be paid back in better economic times.

Taxes hurt the economy. This is agreed upon by all economic schools of thought, even the communists. When you take away wealth from a people, what is left is worse off than before.

Government spending helps the economy. Freemarketeers may disagree with me here, but hear me out: government spending, per se, generally helps the economy. The problem is that government spending necessitates taxes in one form or another. Free market theory argues that money is better spent in the market than by governments, not that government spending (again, per se), doesn’t do anything good for anyone.

The problem is, you can’t have government spending without taxes, and while Keynesian expansionary policy may seem like you can have your cake and eat it too, issuing debt in the present is the same as taxing the future. Keynesian economic policy taxes the future for government spending and lower taxes in the present.

Since the increase in present government spending has to come from somewhere, this policy shifts spending from the future market to the current government. Since freemarketeers argue that any shift from the market (present or future) to government necessarily makes the economy worse off, freemarketeers oppose Keynesian fiscal policy.

So what’s up with the video’s comments on Austerity and the Multiplier Effect? Stay tuned for Part 2.

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Crash Course Economics #7, Inflation and Bubbles

Crash Course’s episode this week deals with inflation and bubbles, and while they do a solid job on explaining how the CPI is calculated and the difference between nominal and real numbers, their explanation of the definition of inflation and causes of inflation were either misrepresented or not fully explained. Let’s start from the top:

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What is Inflation?

The first thing I noticed about this video is that they never really define what inflation is. Instead they start with the question “Why should we care?” and then explain how a reduction in your purchasing power limits the amount of stuff you can buy, so you should care.

This is probably the best time to note that there is a difference of opinion on what the definition of inflation is, and this debate is particularly between the Austrian School and everyone else. The Austrian School of economics defines inflation as an increase in the money supply (often referred to as “printing money”), while price inflation is when the prices of goods rise. Austrians get kind of nit-picky when people refer to inflation as an increase in the price of goods, as Crash Course does here, so I felt I needed to mention it.

As a personal view, I think a lot of time is wasted in debate talking about what the definition should be, so if people want to call the increase in prices inflation, I’m okay with it as long as we both use the term the same way. The more important conversation is what causes [price] inflation, why, and is it a good thing?

After explaining how inflation is calculated, the video identifies that there are really two types of inflation:

Demand Pull Inflation

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They define this as “too much money chasing too few goods.”

Crash Course’s explains Demand Pull Inflation by saying:

If people have a lot of money, and they want to buy more stuff, they are going to bid up the prices for things, causing [demand pull] inflation.

This explanation of inflation is generally agreed upon between schools of economic thought, but it doesn’t fully explain what makes people have a lot of money.

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Sometimes, but rarely, a whole town strikes it rich (which is more or less what is depicted in the Crash Course video). For example, some towns in North Dakota are now seeing prices rise because an oil field was discovered under the town, creating thousands of high-paying jobs. Since more people have more money to spend, prices in the town increase. But this rare scenario is not what most people consider to be inflation.

Inflation is generally thought of as prices increasing across the country, which means that both my local pizza shop and Amazon.com have increased their prices. This kind of inflation is caused by an expansion in the money supply, meaning that new US currency has been printed and is circulating throughout the country, bidding up the prices of all goods. Those who benefit most from inflation are the ones who get to touch the newly-printed money first before prices have risen (which are, generally speaking, investment banks), and those who suffer the most from inflation are those who touch the money last, as they usually get their wages increased only after prices have risen.

While Crash Course wasn’t wrong in their explanation, they did leave out the very important point of the origins of inflation, which they will hopefully cover in a future video.

Cost Push Inflation

Crash Course also includes a second type of inflation, which is referred to as Cost Push Inflation:

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Another cause of inflation is the decrease in availability of an important productive resource, like oil or something. An oil shortage would increase the price of gasoline, increasing the cost of delivering flour, cheese, and pepperoni. This would increase the cost of producing pizza, therefore decreasing the number of pizzas that can be produced. Economists call this a supply shock and it causes something called cost push inflation.

Cost Push Inflation is actually a controversial subject between schools of economics, and Wikipedia even includes a section on its criticism.

The problem that some schools of economic thought have with this idea is that Cost Push Inflation essentially expands the definition of inflation beyond monetary policy. Since inflation is generally associated with interest rates, the money supply, and purchasing power, the term Cost Push Inflation conflates monetary policy and simple microeconomics.

The critics of the term Cost Push Inflation argue that natural disasters and other events that affect the price of goods should not be considered inflationary, since inflation is a term for monetary policy and affects consumers’ purchasing power, not just the price.

In other words, calling supply shortages “inflation” confuses the term. Inflation is something that is willfully created by controllers of the money supply (usually the Fed lowering interest rates or the practice of Quantitative Easing), as opposed to something that is caused by nature (Crash Course cites disease and drought as a potential cause of Cost Push Inflation).

Crash Course’s Definition versus Others’

Crash Course sums it up this way:

To keep it simple, inflation is caused by consumers bidding up the price of stuff or producers raising prices and producing less because there’s an increase in production cost.

As I mentioned before, this is a controversial definition of inflation between economic schools of thought, but let’s look at the most cited definitions of inflation. Let’s look at the top three google results for the definition of inflation:

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From Google’s dictionary: “A general increase in prices and fall in the purchasing value of money”

From Investopedia: “Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling.”

From Dictionary.com: “a persistent, substantial rise in the general level of prices related to an increase in the volume of money and resulting in theloss of value of currency.”

I would understand if Crash Course were following the most widely-used definition of inflation, or stated that there is debate over the proper definition, but instead they chose a definition from a particular school of thought and stated it as fact.

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Productivity and Growth: Crash Course Economics #6

Episode 6 might not be Crash Course’s greatest episode, but it is certainly the most unobjectionable to any school of economic thought (except maybe communism). In this video about Productivity and Growth, Crash Course attempts to answer a big question about the world: why are some countries rich and others poor?

While Crash Course doesn’t explicitly say “it’s because of X,” it gives some suggestions as to what could contribute to national wealth, namely capital and technology. But first, they accurately rebut arguments that size and resources determine a country’s wealth.

Size and Resources

Crash Course uses GDP per capita and the Human Development Index to determine a country’s wealth. Of course, both of those metrics have their own problems with measuring wealth and should be taken with a grain of salt, but they point you in the right general direction to show a country’s wealth.

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Our co-host Adriene points out that Singapore is a tiny island nation and ranks very high in GDP per capita and the Human Development Index. Similarly, Switzerland has very limited natural resources and is relatively small in size, and is also high in the two indices. So if small and resource-bare countries are able to be so developed and wealthy, how do they do it?

Government (or lack thereof)

The episode points to the tragic example of Zimbabwe, a country rich in resources, but with a terribly poor economy. Crash Course explains it this way:

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Their incompetent and corrupt government keeps them poor.

Sometimes I feel like the term “corrupt government” is used as a catch-all to explain why a country is not doing well without further explanation. Government corruption is something we all dislike, but shouldn’t we explain what the government actually does to inhibit economic activity?

Besides hyperinflating away the value of their currency, Zimbabwe is one of the least economically free countries in the world. A restricted labor market, burdensome business licensing, and the violent seizure of land by the government impedes economic development.

But absent government interference, how does a country actually create wealth?

Capital, Technology, and Productivity

After giving the example of a company producing doughnuts nonstop, Crash Course explains that the amount that a business can produce determines the amount of money that worker can make:

Simply put, the more that each worker can produce, the more money each can earn. Economists argue that the main reason some countries are rich is because of their productivity…the ability to produce more output, per worker, per hour.

While entirely true, this seems weird after the last episode, which seemed to suggest that workers demanding more pay is what raises wages.

But how to people and business increase productivity?

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Capital is the first suggestion, but as our co-host Mr. Clifford admits, it also has a cost:

More capital only gets you so far. It increases your production capacity, but it also eats up some of that production capacity. You have to devote more factories and workers and machines to make more capital, and then replace them when they wear out.

This is the risk that businesses take when they invest their company’s profits into things like research and development. The money spent on R&D could be used to create and sell more products now, but investment into R&D will hopefully help create even more profit.

Something not mentioned by Crash Course here is that investments in capital don’t only benefit the business and employees. They benefit consumers as well, since with more capital, the cost of making each good is reduced, allowing businesses to lower their prices to be more competitive in the marketplace. Consumers are now able to purchase the same goods for cheaper, having more money leftover to spend on other goods, thus increasing their standard of living.

But as Mr. Clifford notes, investments in capital come at a cost to the business. What doesn’t have as much of cost is technology:

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Technology on the other hand, takes the same amount of resources and organizes them in a way to produce more output.

The internet alone has created an incredible increase in our productive capacity, and in many ways it creates goods and services that were impossible before.

Technology comes at a cost as well, and it’s much less than investing in capital, but the two are not necessarily mutually exclusive. Many countries don’t the same access to internet (technology) because businesses have not invested in the capital of laying down high-speed cables throughout the area. In this way, businesses’ capital investment creates the access to technology for other businesses.

Crash Course also mentioned a future episode on income inequality, which sounds like a great subject for this course. Will they make income inequality seem like a zero-sum game, or will they include the famous Margret Thatcher argument?

The Business Cycle, Crash Course Episode #5

Economies grow and recede. Recently, people have related economic recessions to bursting bubbles. In 2001, the United States saw the Dot Com bubble burst, and in 2008, there we saw the housing bubble burst. The ebbs and flows have been a part of every economy since people started keeping track of economic data. But why does this happen?

Depending on which economic school of thought you prefer, you can have many different answers. Communists might argue that recessions are caused by capitalists acting in their own self-interest and taking advantage of the working class. For example, in 2008, banks were giving loans to people who could not afford to pay them back. When people stopped paying the loans back, money that was relied on was not there, and the economy suffered.

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While this explanation of recessions (which can be summed up in one word: greed), is a catch-all for an incredibly complex economic dynamic that occurred over several years, it is not adequate. A real look into the business cycle would explain not just how the past recession occurred, but why recessions will continue in the future.

Crash Course and Keynesianism

We mentioned before how Crash Course, while admitting that there are different theories for economic phenomena, favors one in particular for macroeconomics: Keynesianism.

To be fair, the Keynesian explanation of the business cycle is also what is taught in your average economic textbook, so we shouldn’t be too surprised. It is explained in the video using the common analogy of a car:

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If we imagine the economy as a car, then GDP, employment, and inflation are gauges. A car can cruise along at 65 miles per hour without overheating. Safe cruising speed is like full employment; unemployment is low, prices are stable, and people are happy.

But if we drive that car too fast for too long, it’ll overheat. In an economy significant spending increases GDP, causing an expansion. Unemployment falls and factories start producing at full capacity to keep up with demand.

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Since the amount of products that can be produced is limited, people start to outbid each other, resulting in inflation. Eventually, production costs increase as workers demand higher wages and the economy starts to slow down. Businesses lay off a few workers. Those workers spend less, causing the businesses that produce the goods that they would otherwise buying to lay off more workers.

This is a contraction. The economy is going too slow. Eventually things stabilize, production costs fall as resources are sitting idle, and the economy starts to expand again. This process of booms and busts is called the business cycle.

A lot of this explanation is fluff, but the essential explanation of the business cycle can be cut down to the following:

People start to outbid each other [for resources], resulting in inflation. Eventually, production costs increase as workers demand higher wages and the economy starts to slow down.

Essentially, the price of raw materials increases, and workers demand higher wages. The combination of the two hurts business, which starts the downturn. Let’s take a look at these two separately:

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1. Increase in the Price of Raw Materials

Resources are scarce, and businesses have to compete for these resources. When businesses are doing well and demand more of these scarce resources, the price must increase, since the supply cannot increase. The increased price weakens the businesses.

But businesses can also forecast the prices of raw materials. In fact, many businesses hire people to do exactly that. Rising prices like these should come as no surprise to businesses, and if they are expected, they would be accounted for in a way that minimizes damage to the business.

Additionally, rising prices in the provision of raw materials would signal to the market that more resources need to be devoted to it. The raw materials business is booming in this scenario, so the industry would be hiring workers as the demand for their resources increases. The market would be shifting jobs from one area of the economy to another, which is normal. I don’t see how unemployment results from this.

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2. Workers Demand Higher Wages

This is a huge assumption: over time, workers demand higher wages, so employers choose to increase wages, and have to lay off some workers as a result.

This just doesn’t happen. An employer will usually do what’s good for the business, and if it’s a large company with shareholders, the owner has a fiduciary duty to do what’s good for the business. In other words, if the CEO of a company knowingly does something that will hurt the business, he/she gets sued.

Sometimes, employees are paid less than what the employer would pay, and the demand for higher wages results in higher wages. This often happens in a boom economy: employees have many job options, forcing employers to pay them more to keep them at their current job. But if the employer cannot afford to give higher wages (and we know this because increasing wages would result in lay offs), he won’t, and in many cases, he legally cannot.

Wages are determined by the amount of value created, how much the employer is willing to pay, and how much the worker is willing to work for. The worker’s demands alone does not determine his/her pay, and businesses likely will not weaken themselves because the employees ask it.

3. The Spending Spiral Takes Care of the Rest

While the cause of the downturn is debatable, Crash Course’s explanation of the result is rather accurate. Once businesses start losing money, they start laying off workers, who spend less in the economy, so everybody hurts.

Please note that this is a different situation from that my last post, where money is shifted from spending to saving. In the current case, spending and saving is replaced with nothing.

The Role of Government

According to Crash Course (and many economics textbooks), the above explanation is what naturally happens in a free market economy, and economists generally favor the government to step in to fix it (again using the car analogy):

When I’m driving my car on the highway I like to use cruise control to regulate my speed. So why don’t we have cruise control for the economy? Well, many economists think that the government should play a role in speeding up or slowing down the economy. For example, when there’s a recession, the government can increase spending or cut taxes so consumers have more money to spend.

Proponents of this policy argue that it would get the economy back to full employment, but it has its drawback: debt.

Increasing spending or decreasing taxes (absent other changes) would increase the debt, which Crash Course will get into in another video.

My problem is the assumption that government must have nothing to do with the cause of the recession; it is only shown as the possible solution.

Crash Course Criticism will get into alternative business cycle theories and the other possible causes of recessions when we get to the videos on the Federal Reserve. We have a lot to talk about here. Stay tuned.

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Deflation, Episode #5: Macroeconomics

This episode of Crash Course was a major one: Macroeconomics. This is the big picture of economics, and as the hosts accurately mention in the beginning of the video:

If you ask three economists the same question, you are likely to get three different answers. “But how,” you ask, “can the dismal science be so subjective? Well, economics is not a traditional science because it’s nearly impossible to control all the different variables like all the social sciences.

Way ahead of you, Crash Course. Economics is not like physics, and the lack of variable controls frustrates everyone.

While Crash Course correctly notes that economics is pretty subjective, they do not hesitate to claim some debatable economic theories as fact.

Deflation

When prices fall, everyone is happy, except some economists (including those at Crash Course):

Deflation seems like it would be a good thing, but most economists see falling prices as a bad thing. Falling prices actually discourage people from spending since they might expect prices to fall more in the future.

Less spending in the economy means GDP is going to decrease and unemployment is going to increase, and that becomes a vicious cycle. So severe recessions are actually accompanied by deflation because the demand for goods and services falls.

There’s a lot to unpack here, so let’s go through a couple main points they make:

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1. Falling prices makes people expect prices to fall more in the future

When a consumer sees a lower price, he might think three things: 1. The price is low and will continue to get lower 2. The price is low and will stay that way, and 3. The price is low only temporarily, and the price will increase in the future.

The fear of deflation relies on only option 1 being true, and the other two options not being true. While I can see option 1 as being a possibility, I have yet to hear an explanation of why the other two options could not also occur. People perceive falling prices in different ways; why do we assume that everyone will assume that prices will continue to fall? If the economy is an enormous complexity to most people, why do we assume they they will be able to accurately predict the future economy? Professional economists can’t even do that!

But let’s even say that number one is true, and people will expect prices to fall.

2. When people expect prices to fall, they will not buy products now

Every year, there are a number of products that people expect to get cheaper in the future:

How much will the new iPhone cost when it is released next month, and how much do you think it will cost a year from now? Does this stop people from getting the iPhone as soon as it comes out?

Clothing companies release a new season’s collection, and nearly all of the clothes will be on sale within the next two to three months. Does that stop people from buying the clothes as soon as they come out?

People still buy products, even when it’s a near-certainty that it will be cheaper in a couple months. Some people do hold out for prices to fall, but does this collapse the industry when new products are released?

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3. If people reduce spending, the economy will suffer

If people decide to put money in the bank and wait, instead of spending money now, what happens? Certain industries do suffer, namely those in the business of providing consumer goods as opposed to capital goods. Simply stated, consumer goods are the stuff you buy to enjoy, and capital goods are the goods that are used to make consumer goods, such as machinery to make products, buildings to house companies, etc.

So when you decide to save, consumer goods places like Amazon, Disney World, and your favorite Italian restaurant will suffer, but does that mean that the entire economy will do poorly?

Where Does Saved Money Go?

When you put money in the bank, it doesn’t just sit there. Banks lend out their money to people and business who eagerly want to spend that money for themselves (to buy a house, for example) or business. Your money in the bank actually ends up going to those who are the most eager to spend it (and are likely to pay the bank back).

So saving does not weaken the economy; it merely shifts the economy toward capital goods instead of consumer goods. Wal-Mart may contract, but steel and construction companies will prosper, and jobs will move from the former to the latter.

Less overall spending is generally an effect of a bad economy, not the cause. People being laid off have both less to spend and less to save, but it is not their original saving that caused the economy to bust.

Nonetheless, there are times when there is high unemployment, and businesses cut jobs without other jobs opening in different parts of the economy. If less spending doesn’t cause the economy to weaken, then something else must be the cause. We will get to that when we look at Crash Course’s explanation of the Business Cycle.