Good News; M. Skousen

by Mark Skousen "The AS/AD model ... is seriously flawed . . . a model of the worst type-a model that obscures, rather than clarifies."~I -David Colander F inally, a major academic economist has repudiated the dangerously flawed macro model used in all standard text books-the so-calledAggregateSupply (AS) and Aggregate Demand (AD) curves. David Colander, well-respected economics profes sor and author, has. written a devastating critique of AS-AD macroeconomics in the latest issue of the prestigious Journal of Economic Perspectives, an officialjournal of the American Economic Association. What is more remarkable is that he consid ers himself a Keynesian' 'and proud of it," yet he is in the forefront of revamping the way economics is taught.2 The teaching of macroeconomics needs a new approach on college campuses. A millionand a half students study economics each year and they are receiving a heavy dose of bad economics, especially in the macro sections. The AS-AD model cur rently in vogue in virtually all textbooks3 is a fatally flawed assault on free-market economics. To understand why, see the standard diagram of AS-AD analysis at the top of the next page.

Dr. Skousen is an economist at Rollins College, Winter Park, Florida 32789, and editor of Fore casts & Strategies, one ofthe largest investment newsletters in the country. For more information about his newsletter and books, contact Phillips Publishing Inc. at (800) 777-5005. The Fatal Flaw in Macroeconomics What's wrong with this model of the economy? First, it is rooted in the Keynes ian theory that the free market cannot guarantee full employment. The diagram illustrates how the economy can alleg edly be stuck forever at a high level of unemployment and recession. Note that point E, where aggregate demand and supply meet, is at less than full employ ment. By implication, increased govern ment spending (the Keynesian prescrip tion) can stimulate economic activity and push the AD curve forward until full em ployment is achieved, where the AS curve is vertical. However, most economists now recog nize that this old-fashioned Keynesian view of stagnation is fallacious. The free market will always achieve full-employment equi librium as long as wages and prices are flexible and the government doesn't engage in perverse monetary/fiscal policies.

Another problem with the AS-AD model arises when the economy reaches the point of full employment (where the AS curve is vertical). The model suggests that further deficit spending or inflating the money sup ply will only drive up prices without affect ing real output. Yet numerous studies of countries suffering from runaway inflation demonstrate that inflationcauses real output to fall also. These arejust a few of the many problems with the AS-AD model. 54 55 AS Price Level Equilibrium Price Level AD AS--------AD Equilibrium Output Real Output Full Employment Output Professor Colander doesn't address any of the criticisms mentioned above, how ever. Instead, he focuses on the inner contradictions in the AD and AS curves themselves. Essentially, Colander shows how AS-AD analysis is internally inconsis tent because it relies on contradictory as sumptions. The supply relationships packed into AD are at war with the supply relation ships underlying AS. Moreover, the text book model implies that supply and demand are totally independent of each other in the aggregate economy, a theory that contra dicts all common sense.

So what to do? Many of Colander's col leagues favor complete banishment. Reuven Brenner, an economist at McGill Univer sity, not only dismisses textbook macro as "pseudo-science" but considers astrology as its closest allied field!4 Needed: A New Macro Model Yet Colander is afraid to scrap AS-AD entirely, and opts to salvage the faulty model in his current textbook, not because he is academically dishonest, but because he doesn't have a legitimate alternative. A bad theory won't disappear until you have a good theory to replace it with. The problem remains: What can replace the AS-AD model? Austrian economics comes to the rescue! The stages-of-produc tion model developed by Ludwig von Mises and Friedrich Hayek offers an excellent alternative. My own four-stage macro model provides agraphic representation of the whole economy. It incorporates the two most important variables in the aggregate economy-what Roger Garrison, econom ics professor at Auburn University, labels "time and money.,,5 Professor Garrison and I are among those free-market economists attempting to develop the graphics of a new macroeconomic model. Stay tuned. 0 1. David Colander, "The Stories We Tell: A Reconsider ation of AS/AD Analysis," Journal ofEconomic Perspectives (Summer, 1995), pp. 169-188.

2. Professor Colander has been directly involved in two popular studies, The Making ofan Economist, co-authored by Atjo Klamer (Westview Press, 1990), and Educating Econo mists, co-authored by Reuven Brenner (University of Michigan Press, 1992), both of which are damning critiques of the economics profession. 3. Paul Heyne's Economic Way of Thinking (Macmillan, 1994, 7th edition) is the only exception, and it is regarded primarily as a micro text. 4. Reuven Brenner, "Macroeconomics: The Masks of Science and Myths.of Good Policies," Educating Economists, pp. 123-151. 5. Garrison has developed a fascinating graphical technique linking Keynesian and Austrian economics with a production possibility curve. See Roger Garrison, "Linking the Keynesian Cross and the Production Possibilities Frontier,' , Journal of Economic Education (Spring, 1995).For a full exposition of my 4-stage model, see my work, The Structure ofProduction (New York University Press, 1990),Part 2. This book also introduces an alternative form of aggregate supply and demand curves.

Send to: The New American P.O. Box 8040 Appleton, WI 54913 Call 24 hours, 7 days a week 1-800-727 -TRUE o Payment Enclosed 0 Bill Me Hawaii & Canada, add $9 per year Foreign, add $27 per year • Airmail rates on request *off the $2.50 cover price Many Americans are tired of magazines that champion foreign governments sworn to bury America - while smearing those who support us. Sick of writers who think one human's right to "choose" outweighs another's right to live. And fed up with the editors who think those living off the govern ment deserve a higher standard of living than those who support it. H you want a magazine that reflects your attitudes while it respects your intelligence, you need The New American. I 0 1 year (26 issues): $39 - Save400/0* I 02 years (52 issues):$68 - Save480/0* I 0 3 years (78 issues):$89 - Save 540/0* II Name _ I Address _ I City/State/Zip _ I I~ O~ I Credit Card # Expires 0 MasterCard I ./ 0 Discover ~ Authorized Card Signature 0 American Express IE • L ~ BOOKS The Lustre of Gold With an Introduction by Hans F. Sennholz Foundation for Economic Education. 1995 • 153 pp. +iv • $14.95 paperback Reviewed by Ron Paul T he lustre of gold indeed! Unearth an ancient Roman coin, and it gleams as surely as it did in the Forum of The Republic. Melt down (Heaven forbid) a gold Eagle from the presidency of George Washington, and the gold-shorn of any numismatic value-will buy about what it did then. The paper dollar, on the other hand, has lost almost all of the value it had before the founding of the Federal Reserve and the destruc tion of the classical gold standard.