Wednesday, June 18, 2014

The Broken Window Fallacy


  1. The fallacy of the "Broken Window Fallacy" is that it assumes that the baker with the terrible Italian accent has a *fixed* amount of money, which he *will* spend, on some combination of repairs, luxuries, and business expenses (flour, sugar, etc.). Nothing could be further from the truth:
    - If the economy is bad, i.e., no demand (no customers), the baker will not spend on his business: he will save his money as much as possible. He will probably--grudgingly--repair the broken window, but even if the window is not broken, he will not buy a new suit or shoes.
    - If the economy is good, i.e., he has customers willing to buy his products, he will spend whatever is needed to satisfy that demand; if he doesn't have enough cash on hand, he will borrow, because he knows he can repay the loan, with a profit, when he sells his products. He will repair a broken window, and will probably have enough left over to buy the new suit and shoes as well.
    So in bad times, if the baker has to repair a broken window, money will be spent that would not otherwise be spent, and there will be a stimulative effect on the economy. Better still, if the government does the spending, using borrowed money if necessary, there is the stimulative effect without drawing down the baker's limited savings.

    1. Merlin, for your "logic" to work, you must point out what makes for a bad economy, and ABCT is the only logical explanation.

      In your logic, breaking every window and burning down all the houses would be stimulative since they would need repairs. But repairs require capital equipment, and capital equipment can only come from delayed gratification of current wants.