A few years back, I was explaining how out-of-control inflation is to a college student who was majoring in economics. He told me how impossible that is, because interest rates are low. While it is true that the market does tend to account for inflation by tacking an inflation premium onto interest rates, inflation is not synonymous with rising interest rates.
"Again, suppose, that all the money of GREAT BRITAIN were multiplied fivefold in a night, must not the contrary effect follow? Must not all labour and commodities rise to such an exorbitant height, that no neighbouring nations could afford to buy from us; while their commodities, on the other hand, became comparatively so cheap, that, in spite of all the laws which could be formed, they would be run in upon us, and our money flow out; till we fall to a level with foreigners, and lose that great superiority of riches, which had laid us under such disadvantages?" -- David Hume, Essays, Moral, Political, and Literary (see http://www.econlib.org/library/LFBooks/Hume/hmMPL28.html#Part II)
A few years back, I was explaining how out-of-control inflation is to a college student who was majoring in economics. He told me how impossible that is, because interest rates are low. While it is true that the market does tend to account for inflation by tacking an inflation premium onto interest rates, inflation is not synonymous with rising interest rates. There are a plurality of factors which govern prices (i.e., interest rates), some being stronger than others at different times.
I then explained that inflation itself can suppress nominal interest rates. In case you have ever heard certain economists (e.g., Austrian Schoolers, www.Mises.org) referring to "artificially" low interest rates, it is about this that they are speaking.
When the government sends a bond over to the Federal Open Market Committee [FOMC] to finance its spending orgy, the FOMC writes out a check, depositing all newly created funds out-of-thin-air into the loan market. By injecting these new funds into the loan market, the supply of loanable funds is increased. In and of itself, this increase in the supply of loanable funds has a suppressive effect on nominal interest rates, as would increasing the supply of anything else tend to reduce its price.
As I mentioned previously, it is true that the market can account for inflation by raising interest rates. The reason for this is because inflation also lowers the real rate of interest (i.e., nominal rate discounted for inflation), by allowing borrowers to pay back lenders with a devalued dollar. However, the act of increasing loanable funds, by itself, tends to lower nominal rates. The movement of nominal rates depends upon which force is more dominant.
After I explained how the supply of loanable funds is one of the determining factors for interest rates, this college student chastised me for my heresy of "mixing" in a microeconomic principle (i.e., the law of supply and demand) with macroeconomics. Apparently, neo-orthodoxy fragments economics into two separate fields that are meant to remain in airtight compartments, each removed from the other.
The error of separating the two begets more error. One example: prevailing orthodoxy inverts the trade cycle. Orthodox doctrine tells us that inflation, i.e., expanding the money supply, mitigates the "national" trade "deficit." One of the first errors of macroeconomics is using the term "national."
By inflating the money supply, dollars will become less attractive to foreigners. Thus, runs the argument, foreigners will follow by curtailing exports to the U.S., while somehow domestic productivity will magically be increased, stimulating U.S. exports. If this was true, one would have to wonder why Zimbabwe isn't the world's leading exporter.
The pathological genesis of this miscalculation is with the underlying macroeconomic assumptions. Myopic macroeconomics doesn't see the individual. Macroeconomics only sees aggregates (e.g., national, America, the country, etc.) that individuals have been lopped out of. Because of that, it is easy for me to see why the error in trade cycle theory.
Translated, the macroeconomic analysis is this: the country has dollars. If the country, or nation, or government, or whatever aggregate you wish to use, decides to print more dollars, obviously the country or nation isn't going to refuse to use its own dollars. However, the country or nation of, say, France, being a different country, won't like very much the devalued American currency.
I guess we aren't supposed to ask why both inflation and the trade deficit have been increasing in juxtaposition with one another. Sound economics provides us with that answer.
The economy is made up of individuals making choices in exchanges. When the government devalues the currency, this doesn't just make dollars less attractive to individuals abroad, it also makes dollars less attractive to individuals right here at home - this is reflected with higher prices. It isn't about aggregates printing more money for use by aggregates.
In fact, since the government dumps dollars on us here at home first, it is right here where the effects of inflation are first felt. The domestic cost of production goes up. Thus, to reduce costs, capital flight takes place. Inflation actually increases the dependance upon cheaper foreign markets to supply goods. As David Hume saliently articulated in 1752, inflation makes the higher-priced goods less attractive; not just the currency less attractive. Using inflation to remedy the trade "deficit" is akin to breaking a leg to make yourself more competitive.
So, what is macroeconomics in its real substance? Is it some neo-form of enlightened economics, standing by itself?
I have seen one economist who is a disciple of the same school of economics that I am (i.e., Austrian School) compare microeconomics to the study of the trees, while macroeconomics is the study of the forest. That comparison is on the right track, because it does make room for the integration of the two by using microeconomic principles to explain macroeconomic phenomenon. But, it is hard to study the forest without studying the trees.
To answer the question, I asked myself: if what was removed, would also remove the field of macroeconomics? Central planning. If central planning - i.e., the state and its machinations - was removed, the entire field of macroeconomics would disappear. Macroeconomics is simply the study of central planning, i.e., the state apparatus. Thus, I would allow for macroeconomics in the social sciences. I would just remove it from economics and place it into political science. Make it a part of polimetrics.
Mark served honorably for four years on active duty in the Marine Corps infantry, and was a Libertarian endorsed candidate for a municipal office in 2002. He has held the NFA Series 3 license (commodity futures and futures options broker) which he did a voluntary withdrawal on so that he can trade futures for his personal account. Since the year 2000, he has spent much of his free time reading the great minds of the Austrian School of economics, such as Murray Rothbard, Henry Hazlitt, Ludwig von Mises, et al.
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Mark served honorably for four years on active duty in the Marine Corps infantry, and was a Libertarian endorsed candidate for a municipal office in 2002. He has held the NFA Series 3 license (commodity futures and futures options broker) which he did a voluntary withdrawal on so that he can trade futures for his personal account. Since the year 2000, he has spent much of his free time reading the great minds of the Austrian School of economics, such as Murray Rothbard, Henry Hazlitt, Ludwig von Mises, et al.