To Tivoli Gardens in the heart of Copenhagen, one of the world’s oldest amusement parks. It was founded 180 years ago, and its creator George Carstensen secured the land by petitioning King Christian VIII, arguing, “When the people are amusing themselves, they do not think about politics.”
In Tivoli, I don’t think about politics either. But during the wait to ride the Demon and the Star Flyer, I can’t help but think about economics. Specifically, I think about Robert Lucas’s charming speech, “What Economists Do”. It was delivered as a commencement address in 1988, seven years before the hugely influential macroeconomist was awarded the Nobel memorial prize.
I revisited the speech when news reached me of Robert Lucas’s recent death at the age of 85. “We are basically storytellers,” wrote Lucas, “creators of make-believe economic systems.”
To illustrate his point, he told a story about a depression in an amusement park. In Lucas’s imaginary park, people buy a wad of tickets at the entry kiosk and spend them on anything from rollercoaster rides to hotdogs. Each attraction is run as an independent business, while the ticket desk serves as a central bank.
On a slow day, the ride owners will send their workers home. Both employment (hours worked) and the number of tickets bought (call that GDP if you wish) will vary depending on school holidays, the weather and chance.
Should we call a slow Monday in March a depression? No, said Lucas. “By an economic depression, we mean something that ought not to happen, something pathological.”
So then imagine that the central bank — sorry, the ticket kiosk — decides to crack down on fun by squeezing the money supply. Instead of issuing 100 tickets for DKr100, the kiosk charges DKr100 for 80 tickets. Importantly, it doesn’t tell the businesses in the park that it has decided to make this change. Without their consent or knowledge, it has effectively raised all their prices. What happens?
Some customers grit their teeth and spend a bit more to ensure they get all the tickets they would have expected anyway. Others buy fewer tickets. Some walk away without buying any.
Inside the park, tumbleweed. There are fewer customers, and they bring sandwiches rather than buying hotdogs. They spend less on the rides and take more time to enjoy freebies such as walking around the lake. Operators who had been planning to expand in the face of long queues will now not be so sure. Other operators who had worried that their ride was going out of style see gloomy confirmation and may close permanently to cut their losses. The amusement park as a whole will lose its mojo, with physical capacity, output and employment shrinking to match a misunderstood fall in demand.
As Lucas explained, this slump “is indeed a kind of pathology. Customers are arriving, eager to spend . . . Concessionaires are ready and waiting to service them.” All the pieces are in place, but they don’t fit together because of a monetary policy mistake.
Eventually, the park should recover its equilibrium. The ride owners can ask for fewer tickets per ride; the customers will come to realise that 80 tickets will buy as much as 100 tickets did before the price change. The amusement park will be lively again. But all this will take time, and permanent harm may have been done.
Flip the story around: what if the central bank — sorry, the ticket kiosk — gets excited and hands out too many tickets instead? In effect, the kiosk has slashed all the prices without telling the concession-holders. Expecting bargains, people cram into the park. The hotdog stand runs out of hotdogs; the mustard and ketchup run dry. Park-goers spend most of their time queueing rather than rollercoasting. The businesses inside may call up extra staff, even borrow money to expand. Yet eventually they will realise the double-handfuls of tickets they’ve taken in aren’t worth as much as they expected.
These stories tell us how a central bank might engineer a recession — or cause shortages and inflation. I find them a delightful window into how economies work.
True, there are other types of recession. In my book The Undercover Economist Strikes Back, I told a true story about a recession in a prisoner-of-war camp in the 1940s, as described by one of the POWs, the economist RA Radford.
The camp, like the amusement park, had a simple economy. It was fuelled by the supply of packages from the Red Cross, the contents of which were then traded: the Sikh prisoners didn’t want razor blades or beef, the French were desperate for coffee, the English craved tea.
The prison-camp recession occurred, not because the money supply was constricted, but because the Red Cross parcels stopped arriving — what an economist might call an “exogenous shock”. (For a real-world example, imagine a war interrupting the supply of oil, natural gas and food. It shouldn’t be too much of a stretch to do that.)
These little stories teach us that sometimes an economy can be dragged down by a simple mistake in monetary policy, while sometimes a recession occurs because the economy has hit an implacable obstacle. One job of a good central bank is to make sure that it perceives the difference, something central bankers are puzzling over right now.
The disadvantage with such stories, admitted Lucas, “is that we are not really interested in understanding and preventing depressions in hypothetical amusement parks . . . the analogy that one person finds persuasive, his neighbour may well find ridiculous.”
So then what to do? “Keep trying to tell better and better stories . . . it is fun and interesting and, really, there is no practical alternative.”
Tim Harford’s children’s book, “The Truth Detective” (Wren & Rook), is now available
Follow @FTMag on Twitter to find out about our latest stories first
Source: Economy - ft.com
