All Commentary
Monday, March 21, 2011

Basic, but Not Simple

Economic theory has an amazing ability to explain the world around us. It explains human behavior of all sorts, from the mundane to the deadly serious, from the trivial day-to-day of our lives to the most important policy issues. Yes, the discipline of economics has become more complex in theory, often shrouded in mathematical formulations. Still, at the heart of mainline economics is the catallactic tradition (also known as the exchange paradigm), which emphasizes rational choice, subjective preferences, decisions made at the margin, and the importance of institutions. The world is complex, and sometimes complex theories are necessary, but basic economics does more explaining than many think.

Today’s document is a negative review of Henry Hazlitt’s book The Inflation Crisis and How to Resolve It by Marilyn Vencel, published in the Wilton Bulletin in September 1978, and two letters to the editor in response, one from Hazlitt’s friends Richard and Viola Turner and another from Hazlitt himself. Vencel’s review is mostly vicious and empty rhetoric, as the Turners point out, but at its heart is the complaint that Hazlitt’s theory on inflation is simplistic. Ironically, in making this argument she oversimplifies Hazlitt’s arguments to the point of distorting his position.

Now it stands to reason that a complex theory isn’t correct merely because it is complex. And similarly, a simple theory isn’t necessarily wrong because it is simple. After all, there is danger in overcomplicating matters. As Occam’s razor states, “Entities should not be multiplied unnecessarily.”

But there is another problem. Hazlitt’s argument against inflation uses basic economic theory, which is not really simple. Basic economic theory describes a complex order of economic forces at work, matching the most willing suppliers and the most willing demanders in order to realize mutual gains from exchange. It shows us markets work extremely well but only in the correct institutional context. Leonard Read’s “I, Pencil” tells us exactly why this is far from simple. And Hazlitt’s work on inflation tells us exactly why inflation distorts market signals.

Hazlitt’s book was of course put in simple terms. After all it was written for a popular audience, and the solution of “stop printing more money” is simple, but it is not a description of a simple theory. Inflation’s distortion of market signals is real and has negative consequences. Hazlitt’s book shows us why those consequences, such as the undermining of production incentives, are not something to brush aside. Institutions matter, and the rules regarding money are particularly important. Sound money is crucial for market forces to function properly. When one understands basic economic theory, one intuitively sees why inflation is undesirable, but that doesn’t mean the theory is simplistic.

Download the Wilton Bulletin review of Hazlitt’s The Inflation Crisis and How to Resolve It here.

  • Nicholas Snow is a Visiting Assistant Professor at Kenyon College in the Department of Economics, and previously a Senior Lecturer at The Ohio State University Economics Department. His research focuses on the political economy of prohibition.