Today’s Economic History: Matthew Yglesias: Surplus content: “Keynes on bubbles…

…I think Chapter 22 of the General Theory is enduringly relevant:

“It may, of course, be the case — indeed it is likely to be — that the illusions of the boom cause particular types of capital-assets to be produced in such excessive abundance that some part of the output is, on any criterion, a waste of resources; — which sometimes happens, we may add, even when there is no boom. It leads, that is to say, to misdirected investment. But over and above this it is an essential characteristic of the boom that investments which will in fact yield, say, 2 per cent. in conditions of full employment are made in the expectation of a yield of, say, 6 per cent., and are valued accordingly.

“When the disillusion comes, this expectation is replaced by a contrary ‘error of pessimism’, with the result that the investments, which would in fact yield 2 per cent. in conditions of full employment, are expected to yield less than nothing; and the resulting collapse of new investment then leads to a state of unemployment in which the investments, which would have yielded 2 per cent. in conditions of full employment, in fact yield less than nothing.

“We reach a condition where there is a shortage of houses, but where nevertheless no one can afford to live in the houses that there are. Thus the remedy for the boom is not a higher rate of interest but a lower rate of interest! For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom.”

Think about Greece with its ‘unsustainable’ economy bolstered by government borrowing, or the US with its ‘unsustainable’ housing boom. Indeed, those particular arrangements could not be sustained forever. But why, when they unwound, were they replaced by a boom in unemployment? Surely it’s not hard to come up with a higher-productivity sector for people to work in than the unemployment sector? To simply observe that the old arrangement suffered from some mis-valuation problems doesn’t explain what’s really mysterious and troubling about recessions.