economy question?

Question

if we leave the economy alone (no government involvement) will the market naturally correct itself? please list reasons or sources

Answer 1

Sure it will, eventually in the long run. But if I remember one thing from Econ 101 is a quote from Keynes. "In the long run we are all dead."

So you have to look at your problem and decide if it could possibly last 10 years. (Like the Depression of the 30's that only ended because of WW2 labour demand, weapon production and basic spending.) If it could last that long, then you have to decide on if you want to put up with it. Today, we wouldn't.

But the opposite is also true. If you have some little glitch. Maybe government should leave it alone and solve itself. Especially if your solutions are coming from vote buying politicians instead of economists.

Answer 2

Maybe, the idea of market failures is the important counter example. A market failure happens when a market cannot correct itself. They are often created by market created distortions. A simple example is sticky wages. Wages in the United States tend to be "sticky," in other words people would generally prefer to be laid off than have their pay reduced. Because of this, the labor market cannot necessarily move to an optimal price in the short run. The inability to hire at appropriate wages limits production overall. While this is not a market failure, distortions in the market are a necessary precondition for market failures. And in this case, the market distortion came from ordinary behavior rather than from a governmental intervention.

Now, moving to the classic example of a market failure, the Japanese depression they have had for over a decade. Market created and socially created constraints limited the ability of both the government and the market to correct itself. The Japanese economy has been suffering under persistant deflation for a decade. Deflation is a monetary event where money held today becomes more valuable held than spent. Because money's primary purpose is to effect transactions and it is more valuable not effecting transactions, nothing happens in the economy everything gradually shuts down. The banking system's response was to pump more money into the system, but this just lead to more hoarding of money actually causing the available money supply to shrink even as more and more money is put into it. Only when the Japanese consumer really begins to release that cash into the system will the markets begin operating normally again.

By the way, the reason that the market is failing there is that the LM curve is M/P=L(y,i,q) where M is the supply of money, p is the price level overall, y is the national income, i is the available interest rates and q is the preference to hold cash is flat right now in Japan. This is the classic form of the equation. However, the curve is basically flat, in other words moving along the curve produces no changes. It is flat because the price level is a function of the money supply and people are hoarding the money. Adding money, making M bigger, isn't actually happening. This is because the natural interest rate in Japan has been negative. In other words, when you borrow money, the lender should pay you interest for the priviledge of loaning you money. But of course since that cannot happen rationally, money is more valuable than debt. Imagine how the American economy would shut down if everyone simultaneously and voluntarily decided to destroy their credit cards and decided to save up for every purchase. That is what has been happening in Japan. It is beginning to look like they are coming out of it, but it is not clear yet.