So, what is the idea of the defunct economists?
So you got these markets, see. And buyers will be more interested in buying stuff at lower prices, and sellers will be more interested in selling stuff at higher prices, so if you just step back, there will be a price that 'clears the market'.
That's the 'equilibrium' price, the "equal weight' price, where the weight of surpluses pushing prices down and shortages pushing prices up come into balance.
Now, pretend (1) that the markets are not brought into existence by social institutions, many of them relying on the force of law, (2) and that people have more information to make more far-sighted decisions than people really have, and you can pretend that the economy is made up of a bunch of these markets, all connected together, and if "the government" just steps back out of the way, there will be an equilibrium for the whole economy.
Now, the "labor market" is just one more of these markets, and unemployment is just a bunch of labor markets failing to get to equilibrium, so if we just step back, and let things sort themselves out, unemployment will go away.
Now, its not just that: you also have to describe the connected systems of markets and the decisions of people with a whole lot of multi-dimensional calculus. Whatever is said in English is just a rough "intuition" of the "real" analysis, which is all hidden safely away in mathematical equations.
But this interconnected system of markets, with "the government" stepping back: that's a big chunk of what those equations are describing.
Who Builds New Systems?
Real monetary systems are inconvenient for these mathematical systems, so instead pretend that "money" is just one of many things that is traded in markets, and we measure the prices in that commodity for convenience.
As it so happens, these mathematical systems cannot describe the creation of new systems. Genuinely new technology, genuinely new social institutions, would require the actions of people ~ who have largely disappeared off the page ~ to be able to change the mathematical relationships of the system of models, and doing that makes the whole damn thing impossible to solve analytically. So for "tractability" genuine innovation, cultural change, technological invention, are assumed away and replaced by simulations of innovation.
This is tremendously useful for transnational corporations, since if you build a system in which it is assumed that government should "not interfere with the economy", that includes not getting involved in designing new systems. And since markets cannot design new systems, and individuals can only design new systems of a certain size ...
... that clears the field for transnational corporations to be the ones designing big new systems.
Now, Build a New Economic System
Under this fantasy economy, in the face of economic crisis, there may be short term and temporary interventions that government needs to make to stabilize things in an economic crisis. But the best thing that government can do is to push down the interest rate, to tell "the market" that now is the time to borrow and spend, and faced with that discounted funds, market will shift to a new equilibrium and the economic storm will pass.
All of this is a system that automatically tends toward full employment anyway so all this is really doing is speeding up that shift.
Now, go back to the real world and the 1990's. Pragmatically, a bunch of shifting exchange rates were screwing up with the process of spreading production processes across the borders of different European States in the European Common Market. So first they tried to stabilize exchange rates, but that fell apart. So then they settled on the decision to have a common currency. After all, a common currency will always have a 1:1 exchange rate ~ one German Euro will equal one French Euro will equal one Polish Euro will equal one Italian Euro.
And around the turn of the century, they put it into place. The Eurozone has grown since first established, and it now covers the majority of the European Union economy.
Sovereign Monetary Economies In the Real World
The United States is a monetarily independent economy. If US bonds come due, and the US government decides to, the bonds can be paid by just creating more US dollars. The UK is the same, Japan is the same, Australia is the same, Sweden and Norway are the same, etc.
But a state in the United States can't do that. Its not "California" dollars just because the money was created by a bank banking at the San Francisco Federal Reserve Bank, nor "Ohio" dollars because it was created by a bank banking at the Cleveland FRB. Its Federal money, if it is in bank accounts that settle payments through the Federal Reserve system.
A state that borrows has to pay back.
Also, in the real world, the economy is not always busily heading toward full employment. If people in the private sector as a mass try to save more money than they try to borrow, that puts a drag on the economy, which can only be offset by export surpluses, or by the government running a deficit.
Now, the people with money to save tend to have more money than the people that lack money to save, so that "decision" to have a depressionary private sector imbalance is one made fairly high up the income ladder. Especially now, in the aftermath of a financial crisis, with the fundamental underlying problems not yet fixed and so a credible fear among the wealthy that there are more financial crises coming.
So we have an imbalance, and need deficits. And the Federal level is the level that ought to be running those deficits, because the Federal level cannot be forced into bankruptcy (setting aside that political lunatics could decide to refuse to pay the Federal debt).
And the Federal government kind of did as it should in late 2009 and early 2010, though not at the scale required, and so we covered some, though not all, of the depressionary imbalanced.
In the past year and a half, the Federal government has failed in its responsibility to even run deficits sufficient to cover budget cutbacks at the state and local level. It has completely failed to come anywhere close to the level of deficits a responsible national government would run in the face of our current private sector imbalances.
But ... it could be worse.
What happens when you design a boat assuming that boats cannot sink?
Why is the Eurozone in particular and the EU in general in worse shape than we are?
They built their system broken. In the Eurozone, it has been state governments, acting the way they have been used to acting in a recession, who have been responding to the downturn by trying to pay out unemployment insurance, other social safety net programs, and also to bail out their banking systems.
But state governments can only go on deficit spending as long as someone with the ability to lend will lend to them. Its the sovereign government that can spend without running into a threat of going bankrupt. But when they built the Eurozone, they built it broken: they did not build a sovereign government with the power to spend the Euros at the Eurozone level.
What has the result been? The "central" economies have been trying to punish the naughty "peripheral" economies into cutting their deficits by cutting government spending. In the face of a cutback in government spending, the economy slows down. As the economy slows down, tax receipts fall. So the expected surplus does not arrive, and its time to dig the hole deeper.
There are only two long term outcomes: either a system is created at the Eurozone level with the power to issue Eurozone bonds and finance the amount of deficit spending that the Eurozone required ... or else the Eurozone will collapse, as populations subjected to neo-Herbert Hoover policies rebel against them.
As far as whether the Eurozone can arrive at the first solution, which would be the far better of the two in my view ~ I have no idea. Certainly the US administration economic team labors under the same misconceptions about how national economies work that led the Eurozone to be built broken, so its not as if the Europeans are going to fix their broken system under pressure from the US.
Where to learn more
An excellent source of daily news collected from around Europe is the European Tribune. There are several bloggers and commentators at the Eurotrib who are clued into the economy of the real world, so they also feature excellent posts such as their recent: Sen: Europe Betrayed By Austerity.
And for more on this approach to understanding the economy, search for "Modern Monetary Theory". For a fairly intensive, weight approach, see billy blog. For an academic but topical approach on this side of the Big Pond, see New Economic Perspectives. And on twitter, #MMT will give breadcrumb trails to all manner of interesting stuff.
And of course, your humble correspondent will continue occasionally reporting from the front.
Message from Marley: Get Up, Stand Up!
Preacher man, don't tell me,
Heaven is under the earth.
I know you don't know
What life is really worth.
It's not all that glitters is gold;
'Alf the story has never been told:
So now you see the light, eh!
Stand up for your rights. come on!