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Monday, August 23, 2010

Broken Window Fallacy

Posted by Hugh MacIntyre on August 23, 2010 | Permalink


Excellent Hugh, I will bookmark that one. I noticed thought that Ms. Malibu explains this too and while not academic looking, she is quite easy on the eyes. http://www.youtube.com/watch?v=QzpZK9pnEU4&feature=related

Posted by: TM | 2010-08-23 3:30:09 PM

Suppose the baker had a lot of money stuffed in his mattress as savings. In that case, the broken window would not stop him from buying the suit, as the money that pays for the new window is coming from a source that is currently non-circulating. So if the result is he gets the suit and the window, but just has a little less in his mattress, then there is no fallacy and the broken window did stimulate the local economy.

When it comes to large government expenditures, if the taxes that they raise to pay for these projects cause a reduction in savings rather than just a redirection of spending, then it similarly would stimulate the economy. To the extent that such expenditures would come from new government borrowing, then it also could be at least partly the introduction of currently non-circulating money into the system. To the extent that money is borrowed from foreign sources, it has the effect of introducing money into the local economy and away from a distant one, thus having a local stimulation effect.

Public works programs for the purpose of stimulating the economy is something that can legitimately be debated and criticized, but to entirely dismiss the claim that it can at least introduce some stimulation into the economy is to overstate the lesson of the baker's story.

Posted by: Fact Check | 2010-08-23 3:55:10 PM

Fact Check, you are wrong. Suppose the baker has a lot of money in his mattress as savings, could easily afford to pay for a new window if he was forced to. Yet happily on this day the little vandal chooses to do his homework and the window never gets broken. So the baker decides to not only buy the suit but also a new iPad. Now he has the window, the iPad, and the suit.

Posted by: TM | 2010-08-23 4:42:31 PM

Fact Check, I am guessing you will say "suppose the baker was going to choose to do nothing but continue to keep his money under the mattress?" Most people today don't actually keep their money under the mattress though, but rather in some kind of investment that is creating wealth for them and others. By forcing the baker to withdraw his cash from the bank he is no longer creating wealth as he chooses. In addition he has lost the chance to use the capital for some other wealth generating opportunity.

One can choose to believe whatever they want but the 2 - 1 always = 1.

Posted by: TM | 2010-08-23 5:07:10 PM

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Posted by: Cammie Novara | 2010-08-24 1:03:23 AM

Fact Check,

You're sounding like Keynes.

In your first paragraph, the only way you have a leg to stand on is if you assume that the money being hoarded will never be spent or invested and you assume "sticky wages".

In your second paragraph, let's assume that that is what happens. The government taxes rich people (who are hoarding for whatever reason), and current spending and investing is not affected. This is a highly dubious position since higher taxes would diminish the incentives to invest. But nevertheless, let's say this is what happens. How is the gov't to know what type of investments are required? I challenge you by asserting that it is impossible for the gov't to know this. In fact, unless they are incredibly lucky, they will be squandering resources to produce stuff that people are not interested in purchasing (think bridges to nowhere and empty stadiums). This amounts to a net loss to society and destruction of capital.

Even worse, since there no longer is any real act of savings, no one can possibly purchase all the new stuff that is being produced. Normally, if someones saves and invests, they are in position to buy the increased production once the production process is complete. This is not what happens in this case. The gov't is not officially saving anything. They have simply given the money away to the producers. Unless those who receive the new money save every single penny (which never happens), no one will have the savings to purchase all this new stuff. Now, if the gov't actually made a loan (with a promise of repayment), then this particular argument does not hold.

In the end, the gov't has just created an unsustainable boom. During that boom, they have directed resources into the wrong channels. So yes, you can stimulate with public works in the short term - but that's all it is - unsustainable.

The same arguments apply to borrowing.

Of course, if the gov't simply spends the money, that will lead to immediate inflation since production has not increased.

Posted by: Charles | 2010-08-24 6:05:51 AM

Now that think of it, even if the gov't makes a loan to producers, what is it going to do? Buy the stuff itself? How does that increase the well-being of society? So no. Public works don't work. They amount to theft and are extremely damaging to society in terms of economics.

Posted by: Charles | 2010-08-24 6:09:41 AM

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