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The Broken Window, Reexamined

November 25, 2011

Bastiat’s essay on the broken window fallacy is one of the greatest economic parables of all time. If you have not read it, do so now. The tale provides a clear example of how ignoring the possible alternatives and the “unseen” effects can lead one astray. At its core, the Broken Window Parable is a tale of opportunity costs. What is James B.’s next best alternative? If he does not buy a new window, what then? Bastiat asks: “What would become of the glaziers, if nobody ever broke windows?” They would become tailors, farmers, doctors and teachers. Other things would be produced and people would have not only windows, but also everything else that could be made with those productive resources.

Stocks vs. Flows
A stock is an accumulated amount, while a flow is a rate over time. If we use the water metaphor, a pond is a stock and a stream is a flow. GDP measures a flow – how much is being produced in one year? However, for economic utility, it also matters how much people have accumulated. How many clothes you buy this month is less important than your accumulated wardrobe. How much houses are built this year is less important than how many houses are in good condition. The broken window represents a loss of the stock. The repairing of the window represents an increase in the flow. After the flow goes by, the stock remains unchanged. After all the activity, you are back to where you started. The broken window does not cause any increase in real wealth or happiness.

Say’s Law and Monetary Equilibrium
The biggest critique of Bastiat’s tale is that it assumes Say’s Law is true. The money that James B. spent on the window would have been spent anyway on new shoes. The employment of the glasier is at the expense of the employment of the shoemaker. But what if James B. did not spend the money? One person’s spending is another person’s income. Without spending in general, both the glaser and the shoemaker would be unemployed. There are times when the total activity in an economy decreases, and since prices do not instantly adjust, some productive resources are left idle. In the meantime, Keynesians argue, it is better to break some windows and get people back to work than to wait for prices to adjust and have them allocated to the more productive future uses of their effort. The debate on this issue is highly controversial and has been raging for around 200 years. Ultimately, whether the spending would have happened anyway is a statement about monetary policy. If the central bank increases the money supply by the amount of money held by James B., someone else will spending is and the money that would have been spent on the broken window will be spent by someone else. Thus, when the central bank is doing its job well, the broken window fallacy will remain a fallacy and not a way to increase aggregate demand.

Further reading:
Bob Murphy on the Broken Window

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