Keynes Versus Hayek: An Empirical Matter

January 22, 2011

by Gene Callahan

Imagine that you saunter to the faculty cafeteria one day and sit down at a table already occupied by two theoretical physicists. You discover them deep in a debate. One says he has developed the wind-driven theory of leaf fall that portrays the path of a leaf, once it has left its parent tree, to be determined almost entirely by the wind. The other fellow has a gravity-driven model of leaf fall, which has it that it is gravity controlling the show. You are somewhat amazed by the fierceness of their debate, and by the fact that they just keep going on at the level of theory. Finally, exasperated, you ask, “Has it ever occurred to either of you that you are both right? That both things are at play in the fall of leaves? And that rather than having this bitter argument, you’d both be better off working together, to see which of your theories works best at which times? For instance, it seems to me that, on a very still day, the gravity theory is going to be highly accurate. However, during a hurricane, it will apply hardly at all, while the wind theory will be almost the whole story?”

That little tale is a metaphor for how I have come to view the debate between the followers of Keynes and the followers of Hayek over how to describe the business cycle. Both of them have logically coherent models that plausibly describe some things that might result in an economic downturn. The real dispute between them ought to be, “To what extent do (or did) each of our models apply to this (or some past) economic downturn?” Instead, the dispute too often proceeds as if the goal is to crush the rival model, rather than to find out what models work where and when.

It seems obvious to me that, if a nuclear war took place tomorrow that wiped out three-quarters of the world’s population, economic activity would suffer a severe setback due to a collapse of aggregate demand. Similarly, if the government of the US chose to subsidize peacock farming to the tune of a trillion dollars a year, and then a new party in power suddenly withdrew that subsidy, economic activity would suffer a severe setback due to a sectoral imbalance. And, in historical reality, the most die-hard Austrian ought to be willing to admit that Rome, from 200 CE to 400 CE, suffered from a collapse of aggregate demand, as the population was repeatedly decimated by plague. And even Paul Krugman admits that there are times when economies suffer from sectoral imbalances in the capital structure: “I like this story [by Bob Murphy, of sectoral imbalance], and there are probably other cases besides China 1958-1961 to which it applies.”

Krugman proceeds to ask: “But what reason do we have to think that it has anything to do with the business cycles we actually see in market economies?” And this is exactly the right question, as Pete Boettke acknowledges. (And please note Mario Rizzo’s remark in the comments on Pete’s post that finding the Austrian model useful is not at all the same as finding it is the only model that is useful!) In Weberian terms, both the Hayekian and the Keynesian cycle theory have explanatory adequacy: both, if their assumptions hold true, would explain why an economic downturn would take place. So the issue that ought to be under discussion is: when, and to what extent, do these two theories have what Weber would call causal adequacy, meaning, is the ideal type they depict not merely plausible, but does it also help to describe various actual social goings-on?

As Roger Garrison notes, they key differentia of the Keynesian and the Hayekian models is the ability of wages and interest rates to adjust to a drop in the willingness to invest on the part of businesses. Do wage rates and interest rates adjust sufficiently, in the face of a drop in investment spending, to maintain equilibrium, or do they not? Moreover, if they do adjust, how fast do they do so? (No Austrian should dare to give the answer “instantaneously”!) If they don’t perfectly adjust, or if they adjust only slowly, how far out of equilibrium do they get? And why in the world should we believe the answer to these questions is the same for every business downturn?

Is our aim, as economic theorists, to defend our initial position come what may, or to advance our understanding of economic reality? If the latter, shouldn’t we be open to empirical evidence as to what model (or combination of models) most closely captures the current historical reality? Because I can’t help but believe that the key points of divergence between Keynes and Hayek are empirical matters, and can’t be answered on the plane of pure theory.

33 Responses to “Keynes Versus Hayek: An Empirical Matter”

  1. koppl Says:

    I agree with a lot of your post, Gene, especially the general spirit of empirical testing. I think you may have overstated your case a bit if you meant to say that the differences are *strictly* empirical. Bill Butos and I have argued (HOPE 1997) that K & H had quite different epistemologies, which would have to be reconciled in any synthesis.

    The Big Players literature (to which you have contributed!) puts the emphasis on the theory of expectations. Keynes was saying that expectations are essentially exogenous and thus subject to collapse for no particular reason. Hayek had a more evolutionary and adaptive view, creating a presumption that expectations will generally fit. I like the Hayek version better, but agree that it does not wipe out the logical possibility that expectations or the state of confidence will fall apart for no particular reason. Thus, IMHO, you gotta figure out in what circumstances do expectations tend to fit and in what circumstances are they more volatile. That’s both a theoretical and an empirical question, which is why my 2002 book on Big Players starts out with methodology, moves on to theory, and finishes with empirical studies.

  2. Richard Ebeling Says:

    In the first half of the 1930s, when one of the “duels” in economics was going on between Keynes (of “The Treatise on Money”) and Hayek (of “Prices and Production”), there appeared several works offering summaries and critical analysis of the various competing conceptions of how a money-economy works and its implications for the business cycle, and the
    Great Depression through which the world was living.

    Often the writers attempted to address Gene’s point: Are there overlapping elements in two or more authors’ expositions of the causes, consequences and cures for economic downturns? Does one author seem to have a more insightful and persuasive explanation of the “up-turn” than the “down-turn”? Might one author’s theory be more applicable in explaining one particular historical business cycle sequence than some other’s theory?

    Even “Banking and the Business Cycle” (1937) by Philips, McManus and Nelson (which is usually highly regarded as an analysis of the 1930s Depression by many Austrians including Murray Rothbard, for instance) attempts to ask the relevance of these type of questions as part of their interpretive narrative. And certainly that search for a “synthesis” of theories of the business cycle was the thrust of Gottfried Haberler’s classic study, “Prosperity and Depression.”

    But, having said this, there remain, to my mind, essential methodological and theoretical differences between the conceptual worldview created by Keynes and the conceptual framework posited by Hayek, which makes it more difficult than just saying: “Well, this business cycle (or its phase) is better understood by taking from column “A” (Keynesianism) and for this business cycle (or its phase) its better to take from column “B” (Austrian cycle theory).

    Keynes argued that a totally different set of theoretical tools and framework were needed to analyze economic-wide fluctuations in output and employment. What has come to be called the aggregate functional relationships in standard macroeconomics.

    The structure of relative prices, resource allocations among sectors of the economy, inter-temporal choices and investment decisions as influenced by changes in the money rate of interest relative to a “natural” rate, for example, have little or no place in the Keynes’ conception of things. These are only relevant when (or if!) an economy is functioning at or very near “full employment.”

    But in the Mises-Hayek theory of the business cycle these “micro-economic” aspects of the analysis are not just crucial, but central to the theory. Indeed, the Austrian argument (and by other non-Austrians such as Arthur Marget in the 1930s and 1940s, who was without a doubt the most well-read scholar on the history of monetary theory in all leading Western languages), there is no way to adequately and logically explain the sequences of the business cycle unless it is grounded in a micro-foundational process analysis.

    As many Austrians over the decades have insisted, when these micro relationships, interconnections and temporal-sequences are ignored or downplayed, one, instead, runs the risk of focusing on aggregated “surface” aspects of the analysis that hide from view all the “real” elements that explain both relative changes and economy-wide fluctuations in the market system.

    This also explains a primary basis for the difference between Keynesians and Austrians concerning the efficacy of various monetary and fiscal policies to “restore” sustainable full employment.

    Richard Ebeling

  3. Bill Woolsey Says:

    I like this post, but..

    A collapse of the population due to plague or nuclear war is an aggregate supply shock. It is the epitomy of a real business cycle recession.

    Sectoral imbalance accounts have more in common with adverse productivity shocks than with aggregate demand.

    Aggregate demand issues are really about the quantity of money and the demand to hold it.

    Can a significant excess demand for money develop, causing a singificant decrease in money expenditures? And does a significant decrease in money expenditures cause a significant decrease in real income and employment, or just a decrease in money prices and wages? Whether or not an excess demand for money is likely to because of lower animal spirits is less interesting.

  4. gcallah Says:

    “A collapse of the population due to plague or nuclear war is an aggregate supply shock.”

    Well, Bill, I think both occur. The division of labor is limited by the extent of the market and all. Of course, a lot of productive people vanished — but ALSO, a lot of consumer demand vanished, so that even the people left cannot continue the division of labor to the extent that it once took place. In late Western Rome, this resulted in the cities collapsing and urban life vanishing in many places, while the countryside went on nearly as before.

  5. Richard Ebeling Says:

    Bill Woolsey suggested that the interesting question is, whether a “significant” decline in monetary expenditures will bring about a decrease in output and employment, or just a decrease in money prices and wages?

    Unless one considers that money is merely a “veil,” or a “numeraire,” then any “significant” increase or decrease in monetary expenditures (whether from a change in the demand for money to hold, or from a change in the quantity of money in the market), will invariably bring about both.

    Unless we assume the market participants possess “perfect knowledge” or “foresight,” then any such change will result in a process over time to adapt and adjust to the monetary change.

    This will only be reinforced if one takes a more “Austrian” view that changes in the demand or supply of money do not impact simultaneously and proportionally across all markets.

    There is an “injection” point from which new spending emanates (given an increase in the supply of money or a decrease in the demand to hold money), or an initial “withdrawal” point form which some existing spending declines (given a decrease in the supply of money or an increase in the demand to hold money). From that starting point, ripples of change are sent out, impacting in a certain temporal-sequence on price-after-price, demand-after-demand, sector-after sector, until the change will have run its course through the economy.

    There is no escaping the non-neutrality of money. So, in a crucial way, this dichotomy between price effects and output effects due to monetary changes is a false dichotomy.

    A relevant issue, however, is what factors, say, with a decline in monetary expenditures, delays the market’s adjustment and adaption to the change, beyond some inescapable duration and re-alignment of relative prices and productions to a lower general scale of prices that the decline in monetary expenditures makes necessary?

    Trade union wage resistance? Unemployment insurance that lowers the costs of search and re-employment? Regulatory rules and restrictions that inhibit or delay necessary price and cost adjustments? “Regime uncertainty” — increased unpredictability about the course, type and frequency of government policy changes that make the market environment more “cloudy”? Psychologies of “entitlement” concerning prevailing prices and wages, and types of production and employment, due to expectations based on past and likely government intervention in a “crisis”?

    Now these are interesting questions.

    Richard Ebeling

  6. Lord Keynes Says:

    An enjoyable post.
    Obviously not all business cycles are the same.

    A further important model of the business cycle is the debt deflation model of Irving Fisher, developed by Post Keynesians like Hyman Minsky and Steve Keen.

    When the principle of effective demand is combined with liquidity preference, subjective expectations, and debt deflation, we have a fairly good model of many recessions.

  7. Troy Camplin Says:

    “A collapse of the population due to plague or nuclear war” — if this is what the Keynesian business cycle theory can explain, then it’s not really a business cycle theory. There’s no cycle, and the problems are external to the economy itself, and is not therefore an economic explanation, even if it does describe what is happening to the economy as a consequence of the external shock. Thus, Keynesian theory is much like the meteorite theory of dinosaur extinction: it exlpains why the dinosaurs went extinct, but it’s not a theory of evolution, even if it does explain why there was a sudden opening for the emergence of mammals as the dominant land vertebrates. But if you want a biological explanation for evolution, you go to Darwin, not to Luis Alvarez (who theorized the astreroid theory of the dinosaur extinction); if you want an economic explanation for business cylces, you go to Darwin, not to Keynes.

    At the same time, some of the post-Keynesians are doing actual economic work, and can be combined with Austrianism, such as Prytychko’s combination of ABCT and Minsky.

  8. Bob Murphy Says:

    Gene, I have to agree with Woolsey. When you started off your nuclear war example, I was dead certain you were using that as an example of a supply-side “real” disruption. Same with the plague. To see why, note that no amount of monetary pumping or fiscal stimulus is going to get real GDP up to pre-crisis levels. So it’s not about demand at all.

    Even your response I think isn’t right. If the productivity of labor goes down, because the population is decimated and there aren’t economies of scale as much as before, then that is a “real” shock to the supply side. I understand why you think that should be considered a demand shock, but I think the way most economists use those terms, it would be a supply shock.

    (For a dumb example, if customers started making unreasonable demands of sales clerks when making purchases–like telling them to bark like a dog and so forth–then this might reduce the retail sector because nobody could stand dealing with such customers. That would be a supply shock I think.)

    So anyway, back to the important stuff, you haven’t yet shown me an example where a government would be better advised by Keynes than Hayek. Certainly not after a nuclear attack or plague. Pumping up aggregate demand would be a really bad idea in those cases, because the real economy would already be in such dire straits.

  9. Lord Keynes Says:

    “So anyway, back to the important stuff, you haven’t yet shown me an example where a government would be better advised by Keynes than Hayek.”

    Examples of real world failures in aggregate demand include the following:

    (1) a fall in a country’s exports causing recession (e.g., China in 2008/2009, which the Chinese dealt with by massive Keynesian stimulus)

    (2) changes in consumer spending due to uncertain conditions (e.g., numerous post-WWII recessions)

    (3) a fall in investment spending due to subjective expectations and some shock to the economy (e.g., in 2009 in many countries after the financial system meltdown in 2008 and global recession).

    (4) the collapse of an asset bubble, a fiancial crisis, bank runs and bank collapses, causing debt deflation, and a significant fall in aggregate demand (e.g., 1929-1933, Australia’s depression of 1892-1893).

    All can be dealt with Keynesian stimulus, although in the case of (4) other more radical interventions are necessary too.

  10. Gene Callahan Says:

    Bob, I think it is very important to distinguish a correct explanation of what caused a downturn from any possible prescription as to what might might cure it. As such, we might understand the situation of the late Western Roman Empire as one in which both aggregate demand and aggregate supply both collapsed, without in the least believing that there was some sort of monetary stimulus that might have ‘cured’ the problem. Indeed, recognizing the difference between understanding the roots of some phenomenon and having sufficient power and foresight to control its evolution very much motivated my post. For instance, one might have a totally Keynesian view of what causes downturns, whilst at the same time being profoundly sceptical of any actual central banks’ ability to alleviate the economic pain. Conversely, one might adhere to a Hayekian understanding of how downturns come about, and also believe that wise central bankers might be able to steer investments in such a way as to ameliorate the imbalances in the capital structure produced by the boom.

    In brief, initially can we just set aside our policy preferences as to how much macroeconomic intervention by the government is desirable, in the interest of comprehending the cause(s) of the recent downturn?


  11. 2Gene Callahan,

    Murphy’s comment, as I read it, was not about policy preferences but about the coherence of the Keynesian model.

    I think that there are good reasons to believe that for what we know about human beings, the Keynesian scenario just can’t happen.

    It’s as if one of the physicists from your example were arguing that leaf fall is caused by the spirits of the leaves. Would you try to settle the diagreement empirically?

  12. Bill Stepp Says:

    Hayek (and the Austrians) had a more developed theory of capital than Keynes did.
    Keynes entitled his chapter on capital in TGT “Sundry Observations on the Nature of Capital,” implying that it was more or less an afterthought in his theory.


  13. I like this post!

    “In brief, initially can we just set aside our policy preferences as to how much macroeconomic intervention by the government is desirable, in the interest of comprehending the cause(s) of the recent downturn?”

    I agree! To me it seems the positive analysis of what caused a cycle is often blured by the normative question of “what should be done to cure it or what one thinks would better work?”

    These are two different pairs of shoes!

  14. Current Says:

    Over at “this side of town” few are taking the 100% reserve position that money supply must not expand to meet demand in a recession. I don’t think that argument is very interesting we can do it another time.

    The interesting argument here is about what causes recessions in the first place. I agree entirely that it would be useful to have more empirical work on this question.

    There is one empirical point that I think is often overlooked though, and that’s what liquidity preference says in the long term. If the interest rate is always determined by liquidity preference and “animal spirits” then the degree of roundaboutness used is effectively random. How then has economic development occurred in the past before Keynesian economics was developed?

    The money economy and capital markets are very old, much older than the industrial revolution. How did the industrial revolution occur with them in place but without interventionist monetary and fiscal policy?

    I think the argument that science and technology by themselves caused that development is very weak (even though I’m an Engineer myself). Technology still needs investment, to some degree it is a production stage. Most new technology only gives a small advantage over older forms.

  15. Blackadder Says:

    So anyway, back to the important stuff, you haven’t yet shown me an example where a government would be better advised by Keynes than Hayek.

    Wasn’t Hayek’s mature view that governments in the 1930s would have been better off taking Keynes’ advice that the advice Hayek was giving at the time?

  16. Blackadder Says:

    than the advice Hayek was giving at the time.

  17. Lord Keynes Says:

    “but Milton Friedman’s”

  18. Silas Barta Says:

    I don’t think the followers of Hayek have ever disputed (and nor have I) that a collapse of aggregate demand can be “a problem” in the sense that the economy will need to painfully adjust to this shock, incurring real costs that wouldn’t be present if (the factors that caused) the collapse in aggregate demand didn’t happen.

    Rather, the argument from Hayek’s supporter’s is that lower AD can never be bad *as such*, if that’s really how much people want to, er, demand in the aggregate. This contrasts with the Keynesian view that every decline in AD must be fixed by pumping up spending, irrespective of the disutility to individuals of spending at higher levels.

    So a Keynesian would react to a plague by saying something like, “Whoa, Nelly! In order to get this economy working again, these remaining survivors are really going to have to pick up the slack from their dead comrades. They’ll need to up their spending, and if we need a government program to subsidize the (Roman) McMansions people wanted before the plague, then so be it!”

    (If you believe I’m being unfair, you haven’t kept up with Keynesians recently, such as Krugman demanding a new housing bubble, or Scott Sumner types demanding that we get NGDP back up to 5% trend, no matter how little people want to spend, no matter if they want different goods than are being produced.)

    The Hayekian, in contrast, would say that, well, “Consumer tastes (and numbers!) have changed, so people are going to want different things from what they wanted before the plague. Production processes that were oriented toward pre-plague desired goods are going to have to change — so it’s not total spending that matters, but coordination between producers and consumers.”

    It seems obvious, which is why it’s so frustrating dealing with Keynesian support for GDP factories.

  19. Silas Barta Says:

    Sorry, to follow up in regard to Gene_Callahan’s latest post: it’s true that you have to separate the diagnosis of a problem from debate about the merits of possible solutions. However, my point is that the actual disagreement is over the solutions, not the diagnosis. I don’t see Hayekians disputing that, in some sense, the collapse in AD caused the recession — it’s just that they differ from Keynesians in *why* the collapse is bad (as I detailed above), which mainly has implications for what the appropriate solution is.

  20. stickman Says:

    An admirable and sensible post. I wonder, however, at the next problem facing you… Which is to convince the growing legion of Austrian “admirers” to take up your challenge when they have already been inducted to believe that anyone bar Mises, Hayek and Rothbard (or their direct followers) are the devil incarnate and unworthy of empirical refutation… let alone engagement.* I’ve always regarded Mises a priorism as intellectually untenable and welcome your call – which echoes those I’ve seen from Pete Boettke – to put Austrian theory to real empirical/falsification scrutiny. (I believe that Hayek himself felt much the same way on this matter.)

    * As someone who has watched from the sidelines, much of the problem IMO comes directly out of the Mises Institute… Which often seems to promote little more than epistemic closure (despite the key role it has played in promoting Austrian material and providing intelligent commentary in other areas).

  21. Anon Says:

    So if the problem is the Mises Institute, why are you criticizing “Austruqan economics”?

  22. Greg Ransom Says:

    You don’t need the physicist to invoke wind and gravity.

    And my understanding is this is one of those large segments of phenomena where science can’t give us “scientific” answers — stuff discussed by Nancy Cartwright and John Dupré.

  23. Greg Ransom Says:

    Gene,

    The dispute is more like Darwinian vs Platonist on the topic of species and their origin.

    The Darwinian causal mechanism happens at the margin of the “aggregates” involved — the Platonist scientific conception views a species as a natural kind, without causal interaction at the margins of the population.

    The Platonic explanation for the aggregates of interest — the coming into being of these “natural kinds” — is via magical creation.

    Ditto Hayek vs Keynes.

    Hayek insists that the causal mechanism operates across all markets — including the market across time — at the margin and via entrepreneurial learning and relative price changes (marginal analysis & production structure & learning).

    The Keynesian explanation for the aggregates of interest — their moving into and out of equilibrium — is via the miracle of direct, unmediated aggregate interaction. Money is dumbed or created and my magic (i.e. without any need causation at the margins or via entrepreneurial learning) the economy is put back in equilibrium.

  24. Greg Ransom Says:

    Aristotelians & Plantonists rejected Darwinian thinking out of hand because they were scientifically committed to prior theoretical categories incompatible with Darwinian population and adaptation thinking (see Ernst Mayr).

    It wasn’t until late in the 20th century that Darwinian thinking finally over through the Aristotelian tradition on the Continent.

    Similarly Keynesians & Fisherians & post-Lucas mathematical economists have rejected marginalist macro of the Hayekian sort on theoretical grounds — it doesn’t fit their theoretical demand for mathematical tractability, among other demands.

  25. Greg Ransom Says:

    From the scientific point of view, and explanation which invokes “and then a miracle occurs” does _not_ have explanatory adequacy.

    Hayek’s charge against Keynes has _always_ been that Keynes assumes away scarcity, and posits magical interaction between aggregates, including a “money” aggregate.

    Hayek argument — in short — is that is “and then a miracle occurs” right at the heart of the Keynesian framework.

    Hayek is saying that Keynes doesn’t provide an explanation at all.

    Keynes provides smoke and mirrors and a causally impossible “mechanism” — unless we grant the Keynesian mechanism the power of the miraculous.

  26. butos Says:

    I’d like to ask Bill W. and Richard the following question: does an increase in the demand for money leading to price deflation necessarily imply non-benign, as is claimed by monetary equilibrium theo deflation? For a free banking system, the typical claim, which I agree with, is that banks who experience an increase in the demand for their liabilities will have additional reserves available to further increase the quantity of their currencies, thereby adjusting the quantity of money to demand. Suppose, though, these very same banks have reason to play it close to the vest and do not issue more liabilities. Will not this require price deflation? Is this, then, a harmful deflation, since it has originated from an increase in money demand and not from a productivity increase? If a free banking is a system that provides the correct quantity of money (assuming commodity redemption, etc) as an inhernet feature of the sysytem’s functioning, then what would constitute a “harmful deflation”? Or, does the concept of a “harmful deflation” really only apply to a central banking system?

  27. butos Says:

    In my haste, I failed to catch a couple of nasty typos. Lines 3 and 4 should read “non-benign deflation” and “monetary equilibrium theory.”
    Bill Butos

  28. Bob Murphy Says:

    Gene,

    I understand what you are saying (in your response to me), and why my use of the phrase “back to the important stuff” made it look like all I cared about was zinging the interventionists. But that’s really not what my point was.

    I was saying that I did not–and still don’t–agree with your classification of nuclear war or the plague as a problem caused by the collapse of AD. I grant you, AD *does* collapse in those scenarios, but that’s not what’s driving the collapse of the economy.

    In other words, I am saying that after a nuclear war, real GDP collapses, and nominal aggregate demand collapses too. But if you ask me, “So is the problem at least partially due to the collapse in spending?” I’m going to say no, it’s not. And then the way I prove that, is have the central bank print up a bunch of money and boost nominal spending back up to pre-crisis levels. But oops, for some reason, the 10% of the population doesn’t seem able to produce the same amount of stuff–even per capita–as the population could before the nuclear war.

    So that’s why it is a supply-side shock, not a demand shock.

  29. Troy Camplin Says:

    Say’s Law in reverse?

  30. Roger McKinney Says:

    I have a real problem accepting “shocks” as any kind of explanation. It’s the reverse of “then a miracle happens.” Shocks are nothing but random events. Saying a shock happened is just saying “%^&* happens!” That’s not an explanation.

    Is is possible for investors to suddenly stop investing for no reason at all? Not if they’re rational. Is there data that shows investors suddenly stop investing? Of course there is. But we need an explanation and no mainstream theory offers one. The ABCT does.

    The same goes for monetary theories. Do people hold more cash in a depression? Of course they do. The evidence is obvious. Do they hold more cash for no reason? Again, not if they’re rational. Monetary theories have no explanation of why people suddenly decide to hold more cash, other than “stuff happens!” The ABCT offers an explanation.

  31. John Papola Says:

    My understanding of the upper turning point is that it comes when projects become unprofitable because input inflation (labor, capital goods, land, commodities) outpace revenue/consumer demand. The relative boom in interest-elastic sectors eventually compared with the next stage of production or consumer goods pushes them into the red.

    The keynesian concerns about money demand, in so far as they are cyclical and endogenous, are the product of people’s reaction to upper turning point. Now, could a giant bat begin flying across the sky, freak everyone out and lead them to hoard cash? I guess. A war could happen. A drought could happen. A crop could fail. None of that seems to be what business cycle theory is seeking to address. So the “animal spirits” explanation seems to be an assertion in place of a theory.

    The other components which comprise the model are institutional. Sticky wages and prices vary based on the institutional situation. The “liquidity trap” is especially dubious. It basically amounts to a very narrow central bank instrument failure that can only be relevant when they use short-term rate targeting as their tool. Switch to price level or NGDP targeting, and the “liquidity trap” goes away.

    In both of those cases, though, the economist should see these and advocate policies which make wages and prices LESS STICKY and monetary policy that isn’t subject to the trap. Keynesians don’t do this. They assume the institutions as fixed in stone even though they are themselves a product of government policy.

    The “paradox of thrift” is equally dependent on these institutional assumptions. If people save in the form of currency, it is as if they have destroyed it. Fine. But that leads to deflation. Deflation is bad because of wage and price stickiness (and fix debt obligations). Again, all institutional constraints which should point the reformer toward liberalizing those.

    Now, lets grant that ABCT offers a credible explanation for the upper turning point and increased money demand, and Keynesianism offers a credible framework for understanding unemployment in the face of increased money demand given the above institutional rigidities… what does this have to do with digging ditches or building bridges to no where?

    So-called “fiscal policy” seems to be a slight of hand that comes about due the failure to treat the “liquidity trap” like a central banking mistake (which it is).

    Moreover, it seems to emerge from the level of aggregation and this bizarre idea of a “general glut”.

    If some people increase their cash balances, they are increasing their demand for a specific commodity: cash. The flip side of that choice is that they are decreasing their demand of one or more other goods or services. They are NOT decreasing their demand for “goods in general”. I can’t go to a “general store” and buy a “general good”. This “general glut” concept seems to be the crux of the weirdness in Keynesianism. It leads to the strange aggregate of “excess capacity”.

    The question must be this: how, theoretically or practically, can the administrator of a Keynesian fiscal policy determine whether slack capacity in certain industries during a recession is the result of temporary demand shortfalls due to increased money demand or whether said slack is the result of real preference changes.

    Put another way, isn’t the information that emerges during a money-demand deflation regarding preferences just as important to entrepreneurs as any other preference change? Isn’t the only solution to an increased demand for money to increase its supply?

    It seems like the Keynesian concerns are real institutional problems, but their solution is bascially just socialism-lite. It’s central planning only with the calculation problems hand-waved away by “multipliers”.

    Sorry for the massive screed. I’ve been grappling with this a ton and want to make sure I’m not holding bad ideas in my head.

  32. j Says:

    can you do a large, randomized controlled trial to test the theories? can you do a true experiment on the theories? do you have some method to see if a theory is correct and can show causation instead of correlation?


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