Is the Economy Ever in Equilibrium?

An important criticism of traditional economic analysis is that is often is comparative-static, i.e., it deals with equilibria in the economic system by comparing two or more of them with each other. Whereas more complex models allow for dynamic analysis, much of the simpler (and widely used) ones do in fact ignore adjustment processes between equilibria.

However, there is a problem with this comparative-static perspective: it is reasonable to assume that such complex societal systems as the economy seldom (if at any time at all) reach equilibrium. Since the latter depends on a large spectrum of variables, it suffices that one of them changes, and the equilibrium is not only postponed, but also changes. Imagine, for instance, a model used to assess a certain economic policy measure (say, the introduction of a new tax) that assumes for simplicity constance in some variables (e.g., unemployment rate, other taxes, external balance etc.). If this is a comparative-static model, then it predicts the consequences of the policy measure given the assumptions and in equilibrium state. It tells nothing about the adjustment process. Meanwhile, it is likely that the adjustment process will be infinite, since in the meantime other variables (those that have been assumed constant) change and the system moves toward a new equilibrium – without reaching this one, either.

So, is this criticism relevant? Or is it reasonable to assume that the economy is in equilibrium at least from time to time and that we are able to predict this state? I has been argued that no, this is not a reasonable assumption. For example, it has been stressd that, in equilibrium, firms would necessarily produce efficiently – which never seems to be the case. Firms are not really “rational” actors (especially, they do not possess complete information about issues relevant for their production activities) – not all information is avaiblable in the first place, much is too costly to attain it, and most of it becomes outdated at a very fast pace. Therefore, firms are – to different extents – inefficient in the economic meaning of this word. The economoy may be moving toward an equilibrium, but it neber wil reach it. Moreover, it seems that it is not even moving toward the same equlibrium all the time, but that it changes the path frequently.

This argument would be reinforced if Alvin Tofler’s proposition that the pace at which society is changing is increasing is right. And, out of casual observation (since this is difficult to measure), I would argue that it is.

What is the consequence of these insights, then? A possible interpretation could be that comparative-static analysis (particularly in macroeconomics) – still preferred by economists because it is much easier to handle than dynamic modelling – has very little explanatory power (if any at all). And that would be nad news for economic policy consulting.



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