Today’s economic trends are not promising. In the United States, the European community and Japan, the prospect of dismal growth is too often met with desperate measures that only make matters worse. There are endless claims about the failure of austerity to spur growth, and impassioned attacks on the folly of unbridled spending that will drown the nation in debt. What a choice!
The debate over the proper level of government spending and taxation is itself a powerful cause of our current economic malaise. The current uncertainty over the use of these key policy levers leads to further uncertainty about the possibility of a rise in interest rates that will send the economy into a tailspin. Unstable currency injects a gratuitous element of uncertainty into every private transaction denominated in dollars. That uncertainty is a cost to both parties in any routine business transaction. When the costs of transacting rise to the point where they exceed the anticipated gains from trade, the deal is off.
Thus, suppose that S owns something that he values at $10 and which B values at $15. A voluntary transaction that costs nothing to arrange would generate a gain of $5 by moving the resource to B.
The zero transaction cost model may be mythical, but its implications are intensely practical. In the example given, so long as the costs of the transaction in the aggregate is kept below $5, the deal goes through. The result is otherwise when those costs go above that level. The constant uncertainty about taxes and regulations is a deal-killing transaction cost that produces no collateral benefits. So long as macro-economic policy remains fixated with moving all the levers at once in different directions, it will act as a drag on the marketplace. Stability of expectations is key to a strong macroeconomic market.
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