How the Economy Works: Confidence, Crashes and Self-Fulfilling Prophecies

Overview

"Of all the economic bubbles that have been pricked," the editors of The Economist recently observed, "few have burst more spectacularly than the reputation of economics itself." Indeed, the financial crisis that crested in 2008 destroyed the credibility of the economic thinking that had guided policymakers for a generation. But what will take its place?

In How the Economy Works, one of our leading economists provides a jargon-free exploration of the current crisis, offering a powerful argument for how economics ...

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How the Economy Works: Confidence, Crashes and Self-Fulfilling Prophecies

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Overview

"Of all the economic bubbles that have been pricked," the editors of The Economist recently observed, "few have burst more spectacularly than the reputation of economics itself." Indeed, the financial crisis that crested in 2008 destroyed the credibility of the economic thinking that had guided policymakers for a generation. But what will take its place?

In How the Economy Works, one of our leading economists provides a jargon-free exploration of the current crisis, offering a powerful argument for how economics must change to get us out of it. Roger E. A. Farmer traces the swings between classical and Keynesian economics since the early twentieth century, gracefully explaining the elements of both theories. During the Great Depression, Keynes challenged the longstanding idea that an economy was a self-correcting mechanism; but his school gave way to a resurgence of classical economics in the 1970s-a rise that ended with the current crisis. Rather than simply allowing the pendulum to swing back, Farmer writes, we must synthesize the two. From classical economics, he takes the idea that a sound theory must explain how individuals behave-how our collective choices shape the economy. From Keynesian economics, he adopts the principle that markets do not always work well, that capitalism needs some guidance. The goal, he writes, is to correct the excesses of a free-market economy without stifling entrepreneurship and instituting central planning.

Recent events have shown that we cannot afford to treat economics as an ivory-tower abstraction. It has a direct impact on our lives by guiding regulators and policymakers as they make decisions with far-reaching practical consequences. Written in clear, accessible language, How the Economy Works makes an argument that no one should ignore.

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  • How the Economy Works
    How the Economy Works  

Editorial Reviews

Library Journal
Farmer (economics, Univ. of California, Los Angeles; Macroeconomics) succinctly traces the history of economic thought; explains landmark U.S. economic events, including the 2007–09 recession; and proposes improved macroeconomic theory. The task of explaining so much is near impossible, yet Farmer succeeds remarkably well. After summarizing classical and Keynesian economics (along with their variants), he synthesizes the two into a radical but pragmatic new proposal, "a plan to end bubbles and crashes." He builds on existing macroeconomic thought to argue for a strikingly ambitious novel monetary policy. His recommendation calls on the Federal Reserve and other central banks to smooth out swings of confidence in the economy by making timely purchases or sales of stock index funds. With a more stable stock market and thus more enduring confidence, consumers would spend more consistently, and "bubbles and crashes" would be prevented. VERDICT Readers who lack the time or interest to sift through in-depth explanations of economic theories will gain from Farmer's brief explanations of standard economic theories and biographical sketches of major thinkers. Those looking for a mathematical outworking of his provocative proposed model will have to look beyond this volume to the author's oft-referenced other—more "wonkish"—works.—Jekabs Bikis, Dallas Baptist Univ.
Publishers Weekly
Farmer, professor and chair of the economics department at UCLA, offers a detailed explanation of macroeconomics, showing how unemployment, inflation, and interest rates are connected and how they are influenced by government monetary and fiscal policy. Attempting to speak to the layperson as well as the academic (with mixed results; Farmer's real audience might be the latter), he wades into the difference between classical and Keynesian economics and shows how they have influenced recent policy debates. He shows how central banks influence individual lives, why unemployment persists, and why the stock market matters to everyone. Farmer also ponders if there will be another Great Depression and puts forth a solution for solving and preventing financial crises. Along the way, he provides an abbreviated history of economic thought from Revolutionary days to the present. Readers with a serious interest in this subject will find this timely book informative, but those looking for a gentler introduction will need to look elsewhere. (Apr.)
From the Publisher
"Roger Farmer offers a new diagnosis for what ails the economy. His clear and forceful writing encourages policymakers and the public to think out of the box and reach for new solutions."—Greg Mankiw, Professor and Chairman of the Economics Department at Harvard University

"In the morass of me-too books about the financial crisis, How the Economy Works stands out as a truly big idea." —BusinessWeek

"Bringing new research to life in guiding policy in the aftermath of the financial crisis, Roger Farmer takes the economic ball up the middle between Hayek and Keynes. With an emphasis on swings in confidence and wealth, Farmer's criticisms of fiscal stimulus and interesting prescriptions for monetary policy should be essential reading for anyone trying to understand what happened, especially for economists and policymakers focused on recovery. Nonspecialists will find the book full of fascinating stories; economists will see some surprising new twists."—Glenn Hubbard, Dean of the Columbia Business School, Columbia University, former Chairman of the Council of Economic Advisers

"This is an important policy proposal from a top thinker. Farmer balances the traditions of Hayek and Keynes to formulate a new way to stabilize the economy-and to solidify society's confidence about its future prospects. He returns us to first principles and builds a clear, succinct argument in language that is easy to follow. No policymakers are rushing to adopt Farmer's approach; but the same was true for Keynes in the 1930s. Let's hope we don't need to experience another Great Depression before our economic leaders are seriously willing to rethink everything."—Simon Johnson, Ronald A. Kurtz (1954) Professor of Entrepreneurship at the MIT Sloan School of Management, former chief economist at the International Monetary Fund

"Farmer provides an excellent discussion of what went wrong with modern economics in the run up to the recent crisis. And to deal with the effects of the financial crisis, boosting investment and employment in the short and the long run, he provides a policy plan to induce a rapid and sustainable recovery through direct intervention in the stock market. If he is right it would improve things quickly, and if he is wrong the tax payer ends up receiving dividends through the Central Bank investment portfolio. It is worth a try."—Ray Barrell, Director of Macroeconomic Research and Forecasting, National Institute of Economic and Social Research, UK

"Readers with a serious interest in this subject will find this timely book informative..."—Publishers Weekly

"Readers who lack the time or interest to sift through in-depth explanations of economic theories will gain from Farmer's brief explanations of standard economic theories and biographical sketches of major thinkers."—Library Journal

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Product Details

  • ISBN-13: 9780195397918
  • Publisher: Oxford University Press
  • Publication date: 4/8/2010
  • Pages: 193
  • Sales rank: 813,035
  • Product dimensions: 5.90 (w) x 8.60 (h) x 0.71 (d)

Meet the Author

ROGER E. A. FARMER is a 2013 Senior Houblon Norman Fellow at the Bank of England. He is a Distinguished Professor of Economics at UCLA and served as Department Chair from July 2008 through December 2012. The author of six books and numerous academic journal articles, he is a Fellow of the Econometric Society, a Research Associate of the National Bureau of Economic Research and a Research Fellow of the Centre for Economic Policy Research. Professor Farmer has served, and continues to serve, as a consultant to central banks around the world. He is a regular contributor to the Financial Times, Project Syndicate and VoxEU. He is a co-winner of the 2013 Maurice Allais Prize in Economic Science for his work on the inefficiency of financial markets; and in 2000, he received the University of Helsinki medal in recognition of his work on self-fulfilling prophecies.

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Table of Contents

Preface
1. Introduction
2. Classical Economics
3. Keynes and the World Economy
4. Where the Keynesians Lost Their Way
5. The Rational Expectations Revolution
6. How Central Banks Impact Your Life
7. Why Unemployment Persists
8. Why the Stock Market Matters to You
9. Will There be Another Great Depression?
10. Will Monetary and Fiscal Policy Work?
11. How to Solve a Financial Crisis
Glossary
Notes

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