Wednesday, October 1, 2008

Government's role in the Economy

Adam Smith has been added to the current economists who are discussing the current financial crisis. Yes, it is him who founded Economics and argued that the seeking of individual benefits will led by the "invisible hand" to achieve maximum social welfare. But remember the "invisible hand" theory is based on perfectly competitive market and arm-length transactions with perfect information and the price is determined by the market. In the US economy today, these conditions for the invisible hand to work simply do not meet. So the government need to come in to maintain the justice in transactions (which function is ruined by the lobbyists who twist the laws towards big corporations but not the small customers through legislation) and come to rescue when the market tends to collapse (The Paulson plan is not a good plan and that's why economists are against it but the rescuing functions of the government have to be carried out). There is one more thing the Fed can do: lowering the reserve requirement but how can they reverse that back once they lowered it is a problem.

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