The Function of MarketsEssay Preview: The Function of MarketsReport this essayThe most fundamental function of a market is to serve as a convening place that enables buyers and sellers to gather information and trade goods and services. Many believe that a free market system–one largely free of government intervention–is the most efficient and effective mechanism in ensuring that resources are optimally allocated throughout society and being put to their most productive use. The notion of “markets do it best” was first introduced to the mainstream through Adam Smiths metaphorical depiction of markets as having an “Invisible Hand” that, by nature, will guide the self-interested motivations of individuals towards producing what society seeks most. But in order for this theory to hold true, certain conditions must exist. And unlike in textbooks, the world doesnt operate in a chronic state of “ceteris paribus”, meaning that these conditions are going to be prone to breakdowns– two in particular:
Information is abundant– Even though information is more accessible now than ever before, people are not always able to interpret this information correctly. In addition, obtaining the “best” information requires the ability to decipher and identify what information is relevant, and accordingly, separate and filter the information that is not. Furthermore, information may at times be asymmetric, meaning that one side of a transaction, either knowingly or unknowingly, has more or better information than the other side.
Behavior is economically rational– This condition is particularly susceptible to failure because individuals are not robots, and as such, are likely to make decisions that stem more from their emotions and less from rationale. Economically irrational behavior can also take the form of people taking on more risk than they otherwise should.
When the financial system began to unravel three years ago, the question about the appropriate balance between reliance on markets and government intervention came back to center stage. And today, there is still ongoing debate regarding who or what was most responsible for lighting the fire that led to the economic meltdown. Those who believe that unregulated markets generally work well express the view that the cause of the crisis can be traced back to the governments interference in the housing market. In contrast, those who hold a more skeptical view about the functioning of free markets believe that the crisis stemmed mainly from the destructive consequences of factors such as information asymmetries in financial markets and distortions to incentives that encouraged excessive risk-taking. In truth, both sides are right, which leaves the mighty challenge in figuring out how where the balance lies between the two.
The Independent: _________________________________________
[1] The official story as presented is somewhat similar (here are some of the main changes) to the official account of the crisis:
…the US, European and regional governments, as well as the central banks, have stepped into the role of providing support for the government in various ways. The American Department of Housing and Urban Development is making loans available to financial institutions to help them provide loans to businesses that need the services and assistance they are requesting and to individuals and families with financial difficulties who are faced with financial difficulties who are struggling. In addition to providing the government with certain benefits, such as financial aid to individuals and families with financial difficulty, the Federal Reserve System and Bank of England are also providing financial help for the private sector and the private sector is also providing financial assistance to businesses that are dealing with issues, such as housing affordability.
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2″Fiscal austerity” is simply referring to how the private sector and the banks act, not who is responsible for the behavior of the government, or how it works. The official version is that the private sector is in charge and is responsible for the “fine lines” and the “balance of payments”. What is far more correct is that Treasury Secretary Alan Greenspan was not supposed to talk about those balance of payments or some of the other issues that affected the “balance of payments” in the Federal Reserve System. The full story is available in one paragraph:
Fed officials raised the question of whether their main policy interest should be in ensuring that the $3 trillion in “budget-closing” cuts to Social Security, Medicare and Medicaid go into fiscal 2014 and beyond (see “Fiscal Impacts on the Federal Funds”). In a letter last month, John Roberts, the Fed president, asked the Federal Reserve to consider whether the Fed should continue funding $3 trillion in “budget-closing” fiscal deficit spending, the first priority for the nation’s central bank since the Great Recession. “A federal agency’s budgetary goals should not be arbitrary or capricious or rigid. Those goals should inform policy objectives,” Roberts wrote during a meeting in September. Mr. Roberts was told that “this time, the focus should be on the fiscal responsibility, not the programs that the central bank is expected to deliver.” That led to an announcement that the Fed was beginning discussions on an expanded funding role for the federal funds that was now under development, in addition to increased efforts to increase the Federal Funds’ role as a private sector in keeping the Federal Funds flowing.
The money may be coming from the Treasury, but there is still a substantial amount of debt to write off and to cover the costs incurred by the central banks. The official narrative is that Mr. Greenspan intended to use the Treasury’s fiscal power — which he claimed had been so recently — to “fix these problems” (as if such problems were somehow more severe than the Fed’s actions at the beginning of this century). The official version is that the central banks are creating debt out of thin air.
This is absolutely false. Mr. Greenspan is wrong about fiscal policy; however erroneous his version is, it is what the president and the Federal Reserve are actually doing. In actuality, Mr. Greenspan was not in full control of the Fed as Secretary of Labor:
In response to Congressional hearings last month focusing on the financial crisis, which ended in a financial meltdown that began in 2009, the Federal Reserve issued a warning in its “Payment and Reform Guidance.” The warning “impaired the Federal Reserve’s ability to maintain its monetary policies, provided that there was no credible link between the financial crisis and monetary tightening,” wrote a Federal Reserve official, who spoke on condition of anonymity for business