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How the Economy Works: Confidence, Crashes and Self-Fulfilling Prophecies Hardcover – April 8, 2010

ISBN-13: 978-0195397918 ISBN-10: 0195397916 Edition: 1st
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Editorial Reviews

From Booklist

Farmer explains the differences between classical and Keynesian economics and shows how they influenced the policy debate that developed after the 2007 world financial crisis began and exploded into a global disaster, with the collapse in the U.S. of Lehman Brothers in the fall of 2008. Along with a history of economic thought from 1776 to the present (noting it is incomplete), the author offers his suggestions for preventing future financial crises. “The correct response to the crisis is to set in place, in every country in the world, an institution to control the value of national stock market wealth by targeting the rate of growth of an index fund.” “Central banks should use changes in the size of their balance sheets to prevent inflation from rising too high or too low. They should use changes in the composition of their balance sheets to prevent bubbles and crashes.” This challenging book will appeal to the academic community but not to a broad range of readers. --Mary Whaley


"Roger Farmer offers a new diagnosis for what ails the economy. His clear and forceful writing encourages policymakers and the public to think out of the box and reach for new solutions."--Greg Mankiw, Professor and Chairman of the Economics Department at Harvard University

"In the morass of me-too books about the financial crisis, How the Economy Works stands out as a truly big idea." --BusinessWeek

"Bringing new research to life in guiding policy in the aftermath of the financial crisis, Roger Farmer takes the economic ball up the middle between Hayek and Keynes. With an emphasis on swings in confidence and wealth, Farmer's criticisms of fiscal stimulus and interesting prescriptions for monetary policy should be essential reading for anyone trying to understand what happened, especially for economists and policymakers focused on recovery. Nonspecialists will find the book full of fascinating stories; economists will see some surprising new twists."--Glenn Hubbard, Dean of the Columbia Business School, Columbia University, former Chairman of the Council of Economic Advisers

"This is an important policy proposal from a top thinker. Farmer balances the traditions of Hayek and Keynes to formulate a new way to stabilize the economy-and to solidify society's confidence about its future prospects. He returns us to first principles and builds a clear, succinct argument in language that is easy to follow. No policymakers are rushing to adopt Farmer's approach; but the same was true for Keynes in the 1930s. Let's hope we don't need to experience another Great Depression before our economic leaders are seriously willing to rethink everything."--Simon Johnson, Ronald A. Kurtz (1954) Professor of Entrepreneurship at the MIT Sloan School of Management, former chief economist at the International Monetary Fund

"Farmer provides an excellent discussion of what went wrong with modern economics in the run up to the recent crisis. And to deal with the effects of the financial crisis, boosting investment and employment in the short and the long run, he provides a policy plan to induce a rapid and sustainable recovery through direct intervention in the stock market. If he is right it would improve things quickly, and if he is wrong the tax payer ends up receiving dividends through the Central Bank investment portfolio. It is worth a try."--Ray Barrell, Director of Macroeconomic Research and Forecasting, National Institute of Economic and Social Research, UK

"Readers with a serious interest in this subject will find this timely book informative..."--Publishers Weekly

"Readers who lack the time or interest to sift through in-depth explanations of economic theories will gain from Farmer's brief explanations of standard economic theories and biographical sketches of major thinkers."--Library Journal

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Product Details

  • Hardcover: 208 pages
  • Publisher: Oxford University Press; 1 edition (April 8, 2010)
  • Language: English
  • ISBN-10: 0195397916
  • ISBN-13: 978-0195397918
  • Product Dimensions: 8.3 x 0.8 x 5.8 inches
  • Shipping Weight: 13.6 ounces (View shipping rates and policies)
  • Average Customer Review: 3.8 out of 5 stars  See all reviews (51 customer reviews)
  • Amazon Best Sellers Rank: #914,360 in Books (See Top 100 in Books)

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More About the Author

Roger E.A. Farmer is Professor and Chair of the Economics Department at UCLA. He is a member of the Financial Times Economists Forum, a specialist on macroeconomic theory and the author of six books and numerous scholarly articles in leading economic journals. In 2000, he was awarded the University of Helsinki medal. Professor Farmer is internationally known for his work on self-fulfilling prophecies in economics. His book, the Macroeconomics of Self-Fulfilling Prophecies explains how changes in market psychology can cause depressions and his two new books on the current economic crisis, Expectations, Employment and Prices and How the Economy Works: Confidence, Crashes and Self-Fulfilling Prophecies are forthcoming with Oxford University Press. These works integrate Keynesian economics with classical ideas and provide a new paradigm for macroeconomics in the 21st century.

Customer Reviews

3.8 out of 5 stars

Most Helpful Customer Reviews

19 of 21 people found the following review helpful By Barb Caffrey VINE VOICE on February 21, 2010
Format: Hardcover Vine Customer Review of Free Product ( What's this? )
"How the Economy Works: Confidence, Crashes and Self-Fulfilling Prophecies" is an excellent summation of the current problems with the world-wide economy (paying close attention to the American economy), summed up well for the layman. Roger E. A. Farmer is a professor at the University of California-Los Angeles, and perhaps because he's worked so often with students, he did his best to stay away from jargon (as he said in his preface) in order to sum up the best-known economic ideas since the mid-1700s through today and give some idea of what the best course of action might be to alleviate further pain and confusion in the future.

Farmer talked about Adam Smith ("On the Wealth of Nations"), David Hume (Scottish philosopher, who wrote a witty piece about how money is used toward the end of the 18th century that still stands up today), Keynes and Keynesian theory (or, put simply, "Why markets don't always work the way they should"), the turn away from Keynesian economics in the late 1970s-early 1980s, and the "New Keynesianism" that has turned up today that is prevalent in the Obama Administration that is trying to take the best of both classical economics (as seen by Smith, et. al.) and Keynes in order to prevent a second Great Depression.

Does this book succeed? Yes, it does; I am not an economist, but I understood every word of this book, and I believe anyone sufficiently motivated can as well.
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15 of 18 people found the following review helpful By Greg Nyquist VINE VOICE on February 19, 2010
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Roger Farmer is a professor of economics at UCLA. As such, he appears to accept many of main paradigms that define mainstream academic economics, including belief in the importance of mathematics and many of the constructs of Keynsian macroeconomics and Walrasian general equilibrium. What makes his book How the Economy Works particularly valuable is its overview of some of the main lines of thinking that define academic economics, starting with Hume and Adam Smith and concluding with excellent, brief discussions of Lucas, Prescott, and Kydland. Professor Farmer thankfully avoids any mathematics or pedantic jargon. Indeed, the book is quite well written, so that just about any intelligent reader, whether economically literate or not, can profit from reading it. For those interesting in imbibing a brief outline of mainstream academic economics, I cannot think of a better work.

In the second half of his brief tome, Professor Farmer introduces his own theory concerning the cause of business cycles. Farmer tries to synthesize the two main positions that have dominated modern economics: classical and Keynesian economics. He takes from Keynes the notion that markets do not always work. "In the real world, confidence determines wealth, wealth determines demand, and demand determines employment," Farmer tells us. This doesn't strike me as very convincing. Usually, there's a very good reason why investors and businessmen lose confidence: namely, because the fundamentals of the economy are so deplorable. I suspect that, like most academic economists, Professor Farmer's has only a superficial, over-generalized understanding of the pricing system, so that he doesn't entirely grasp what leads to the market failure he attempts to in his theory to explain.
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6 of 7 people found the following review helpful By Jesse D. Walker on January 28, 2010
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I really enjoyed reading this book. It's written for the non-economist, and no prior knowledge of economics is assumed or required. The author balances his time between explaining the history of economics, including key historical figures, key concepts, and (most importantly) how all of that "theory" stuff relates to what actually happens in the real world. There's plenty of discussion of our modern economic crisis, and the author proposes a solution that, while it seems novel, I'm not sure I'm willing to judge (it has to do with the central bank using index funds to prop up the economy in critical times). There's plenty of discussion of both classical and Keynesian economics (both the strengths and the weaknesses of each). Anyway, an excellent primer on economic thought and practice. Well-written, and not terribly long... makes for an informative and enjoyable read.
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2 of 2 people found the following review helpful By watzizname VINE VOICE on February 7, 2010
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Dr. Farmer's slim volume hints at a synthesis of classical and Keynesian economic theory to be presented in his forthcoming volume "Expectations, Employment, and Prices" (EE&P). He has found a connection between the level of unemployment and the price level trend in the stock market, with which he can correct deficiencies in both classical and Keynesian theory and reconcile the two.

Unfortunately for my needs in reviewing this book, the reasoning behind this reconciliation is to be found not here, but in EE&P, for which the present volume seems almost to be advance publicity. Also, there is one statement on page 147 that is questionable, to say the least: "It was the wartime stimulus that pulled the United States out of the Great Depression, not Roosevelt's New Deal, as some commentators have claimed." But on the same page is a graph which, with the associated commentary, belies the quoted statement. It shows the fall of Gross Domestic Product (GDP) from 1929-32, and its growth in two stages, 12½ % in stage 1 from 1933-37, and another 12½ % in stage 2 from 1938-42. Stage 1, entirely prior to WWII, can not reasonably be attributed to "wartime stimulus," and most of stage 2 occurred before Pearl Harbor Day, 7-Dec-41, when United States entered the war. So credit for more than half of the recovery (Stage 1 and at least part of stage 2) belongs to FDR, albeit the war effort finished the job. I consider this a moderately serious flaw, hence only four stars.

If EE&P fulfills the claims made in HTEW, it is truly a seminal work, on a par with Smith's Wealth of Nations and Keynes' General Theory; and I am looking forward to reading EE&P when it comes out. Meanwhile, there is not enough here to make a fair judgment.
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