by Jerry O’Driscoll
In the August 24th Wall Street Journal, Harvard Professor Robert Barro penned a hard-hitting op ed: “Keynesian Economics vs. Regular Economics.” He contrasts the lessons of standard economics with some of the unsubstantiated claims of Keynesian economics. He zeroes in on the idea that transfer payments provide economic stimulus.
Transfer payments in the guise of food stamps, unemployment benefits, and income redistribution generally have been the centerpiece of this administration’s policy to stimulate the economy. Barro quotes Agriculture Secretary Vilsack’s claim that the multiplier effect of food stamps is close to 2.
Trouble is, as Barro notes, “there is zero evidence that deficit-financed transfers raise GDP and employment – not to mention evidence for a multiplier of two.” As regular economics teaches, deficit-financed transfer payments must be paid for by future taxes. Future taxes bear on present plans, and depress spending. Additionally, transfer payments diminish the incentives to work and that depresses GDP.
Barro argues the empirical evidence of the administration’s policies is lacking. He suggests further that the theory behind such efforts to stimulate aggregate demand is also lacking. “Keynes, in his ‘General Theory’ (1936), was not so good at explaining why this worked, and subsequent generations of Keynesian economists (including my own youthful efforts) have not been more successful.”
The real world seldom provides experiments. But the Obama administration has given us one: the extension of unemployment benefits to 99 weeks. Predictably, the fraction of those who are long-term unemployed (more than 26 weeks) has risen from around 26% in the 1982-83recession to around 44% today. Again, transfer payments do not stimulate, but rather depress economic activity through their bad incentives. (Barro does acknowledge there may be justifications for some transfer payments. But that justification is not that they provide stimulus. Quite the contrary.)
Barro concludes that stimulus through transfer payments is either “a divine miracle – where one gets back more than one puts in – or else it’s the macroeconomic equivalent of bloodletting.” He opts for the latter view.
So, let’s stop listening to the aggregate demanders and nix further talk of stimulus through transfer payments. The only sound economic stimulus comes from good incentives and mainly on the supply side. As Hayek and Friedman taught us, demand management is a fool’s game. Short-run expedients come at the expense of long-run economic growth.
ThinkMarkets 
Right on, Jerry. Pete Boettke talks about “mainline” economics, which is probably about the same thing as Barro’s “regular economics.” As you know, there was a time when an economist was someone who understood J. S. Mill’s fourth fundamental proposition regarding capital: The demand for commodities is not the demand for labor.” Today, many economists deny it or, what is probably worse, just don’t know what it means. “Regular economics” still contains an honored place for Mill’s fourth.
Thanks, Roger,
In today’s WSJ,Gary Becker has a complementary piece on government failure as the source of the great recession. He repeats Barro’s point, hwoever, that there was “essentially no evidence” for the stimulus pacakge.
Jerry,
You write, “Trouble is, as Barro notes, ‘there is zero evidence that deficit-financed transfers raise GDP and employment – not to mention evidence for a multiplier of two.’”
There’s only “zero evidence” if you ignore all the studies that contradict Barro’s view, and there are quite a few. Try a little Googling; they’re easy to find.
“As regular economics teaches, deficit-financed transfer payments must be paid for by future taxes. Future taxes bear on present plans, and depress spending.”
Suppose the government borrows $100 billion and sends the proceeds to households with low incomes. Further, suppose the public generally believes that the additional spending will, in fact, increase demand and income. Now, if people expect their incomes to be higher in the future, even after taxes, will they not be inclined to increase their current spending?
“Additionally, transfer payments diminish the incentives to work and that depresses GDP.”
It’s easy to imagine other outcomes. E.g., food stamps may allow me to feed my family while I finish up my web design courses at the local community college. Take food stamps away, and I’m forced to work at a fast food restaurant and end up paying far less taxes than I would have as a web designer. In short, it’s more complicated than you and Barro suggest.
“Barro argues the empirical evidence of the administration’s policies is lacking.”
Again, only if you ignore the all the evidence to the contrary, e.g., CBO’s assessment, Mark Zandi’s work, Goldman Sach’s evaluation, and many more.
“Keynes, in his ‘General Theory’ (1936), was not so good at explaining why this worked, and subsequent generations of Keynesian economists (including my own youthful efforts) have not been more successful.”
In fact, Barro’s “youthful efforts” were unnecessary and misleading insofar as he assumed that Keynes’ conclusions depended on fixed nominal wages, which they do not.
“The real world seldom provides experiments. But the Obama administration has given us one: the extension of unemployment benefits to 99 weeks. Predictably, the fraction of those who are long-term unemployed (more than 26 weeks) has risen from around 26% in the 1982-83 recession to around 44% today.”
And, nothing is different between the 1982-83 recession and our current circumstances except the extension of unemployment benefits? I mean, really?
“So, let’s stop listening to the aggregate demanders and nix further talk of stimulus through transfer payments. The only sound economic stimulus comes from good incentives and mainly on the supply side. Short-run expedients come at the expense of long-run economic growth.”
Did you know that if you exclude the top 1% of income earners in both the U.S. and France, average household income in France actually grew more than average household income in the U.S. between 1975 and 2009?
I’m going to let Barro defend his position that there is zero evidence for the benefits of deficit-financed fiscal transfers. Google him.
Greg Hill’s next point begs the question, and illustrates how advocates of fiscal stimulus try to conjure up wealth creation out of thin air.
Jerry,
Let me see if I’ve got this right. When Barro says that people (implicitly holding an anti-Keynesian view) will spend less today if they know taxes will rise tomorrow, Barro begs no questions.
But when I say that people (holding a Keynesian view) will spend more today because after-tax incomes will be higher tomorrow, I’m begging the question.
I think you’re missing the symmetry here.
I’m touched that anyone thinks that someone can become a professional web designer by doing a course at a community college 🙂
Hmm… Zandi and CBO. Is running old keynesian models in reverse which are built on the assumptions of Keynesianism “evidence”? Sigh. I thought a “science” would question and challenge its theories and computer models whose predictions fail instead of assuming the world was “worse than we thought” and sticking with the model over the evidence.
Demand has a real source: production of what other people are willing to trade to acquire. That’s it. That’s the root source of demand. Demand is a result, a sign of effective production.
Now, if a group of people demand higher cash balances, the solution to that circumstance is NOT to borrow from OTHER people and give the money to yet another group of unrelated people. None of that will address the worries of those hoarding cash, unless you manage to get more cash to those people (as a free banking system would do).
Yes, money-demand deflation can cause problems of money illusion for firms as they struggle to keep track of falling demand relative to falling input prices and can cause trouble for those who have wage “stickiness” for some reason, if the deflation actually is impacting them (see housing). But if keynesians actually took these concerns seriously, they’d be the loudest supporters of policies and rule changes which would help make wages and prices more flexible. Instead, they tend to be vocal opponents to wage flexibility (see Krugman). As a result, they reveal their own hypocrisy.
Keynesianism isn’t economics. It’s revived monetary crank rantings gussied up in math. It’s blinded by aggregates so high flying that the whole system lacks both people and prices. No people and no prices means no economics. There is no “flow”. There is only trade. Trade requires two goods and people to trade them.
….or we could listen to the guys hoping that some billionaire will fake an Alien invasion so that the US can go broke militarizing for existential war all in the name of “stimulus”. Thats not economics. It’s not even sane.
Greg… The question you must ask yourself is: WHICH PEOPLE? Talk of “people” as some aggregate blob entity misses the economics. Again, grock Mill. Increased demand for, say, doctors might just push up the price of doctors given short term supply constraints. The result is that the customers for those doctors see their real wages fall by the same amount as the price rises, which means that the will have less to spend on other things. And that assumes that your so-called “stimulus” goes to the right region.
Have you looked at the unemployment rates by region and compared them with housing rise and fall over the past 5 years? I believe it ends up making a clear case for plain old microeconomic sectoral shifts, not over-aggregated “demand”. Plus, we do have inflation now, even with the high unemployment. Riddle me that?
Keynesians say that none of this matters, but that’s just because they use tools which don’t account for these things. It’s tautological.
This post and comment about the specificity of labor puts a very fine point on the deep flaws that come from discussing “people” in general with macro:
http://www.thefreemanonline.org/anything-peaceful/labor-is-not-fungible/
Welcome to John Papola here, the genius behind “Fear the Boom and Bust” and sequel. I have nothing to add to his comments, but greatly appreciate his participation.
“Trouble is, as Barro notes, “there is zero evidence that deficit-financed transfers raise GDP and employment – not to mention evidence for a multiplier of two.” As regular economics teaches, deficit-financed transfer payments must be paid for by future taxes. Future taxes bear on present plans, and depress spending. Additionally, transfer payments diminish the incentives to work and that depresses GDP.”
This Ricardian equivalence argument of Barro assumes and requires rational expectations – you must know this, surely.
Yet you are an Austrian, and (I assume) you hold the normal Austrian view – that expectations are subjective.
If you seriously subscribe to subjective expectations, then this Ricardian equivalence argument of Barro is ruled out as nonsense, because rational expectations cannot be true.
I remember when Paul Davidson (1989) reviewed the The Economics of Time and Ignorance, he accused Austrians of not taking their alleged fundamental ideas – neutral money, fundamental uncertainty, and subjective expectations – seriously. Has anything really changed?
Davidson, P. 1989. “The Economics of Ignorance or Ignorance of Economics?,” Critical Review 3.3/4: 467–487.
Barro stated there is no evidence. The absence of evidence doesn’t not assume a strong form of rational expectations.
The evidence is inconsistent with an expectational theory in which economic agents can be systematically fooled by policymakers. As I recently commented at Coordination Problem, all that must be assumed is that agents make the best use of available information. It is obvious from daily public discourse that ordinary citizens understand that spending today entails higher taxes tomorrow. QED
Wicksell, Mises and Hayek each explained the core principle of rational expectations. Mises called it “Lincoln’s law” — You cannot fool all the people all the time. Stimulus advocates assume you can.
Barro stated there is no evidence.
If you mean “no evidence” that fiscal stimulus via deficit spending leads to higher investment and consumption spending, and only leads to higher saving, then Barro and the New Classicals were refuted as early as the 1980s on that when they made utterly wrong predictions about the effects of Regan’s stimulus after 1982:
http://bilbo.economicoutlook.net/blog/?p=15774
As I recently commented at Coordination Problem, all that must be assumed is that agents make the best use of available information.
And they have any amount of empirical evidence that fiscal expansion leads to higher investment and consumption spending. Obama’s stimulus reversed a massive fall in GDP by Q3 2009, taking the US out of recession into positive GDP growth:
http://www.tradingeconomics.com/united-states/gdp-growth
If this Ricardian equivalence theory were correct, then one would have observed a tail-spin into even worse recession as the stimulus was implemented, as people saved more to make up for the deficit spending.
I recently had a discussion about this with a Keynesian, it may have been LK I can’t remember.
The problem the Keynesians have here that we don’t believe in Ricardian equivalance, nobody does anymore. LK can claim that we do all he like, nobody will be convinced. We’re simply taking the view Jerry laid out above, which falls far short of Ricardian equivalance.
The problem we have is that the Keynesians don’t need a strong form of their expectations theory to justify stimulus. The theory that some people will look ahead accurately while some won’t is just as acceptable to them now as it is to us. They can say that yes, much of the stimulus may be wasted because income earners will save it. But, some of it won’t and that means it will still have a stimulating effect. So, this simply means that the quantity of stimulus needs to be greater. This is essentially what LK is arguing. He’s saying that increasing government spending increases GDP, he’s not saying by how much or that it follows an IS-LM or Keynesian cross model.
I don’t like this whole approach to the problem. I think we should be concentrating on the question: does stimulus significantly distort the capital structure? I think the Keynesians have shown that it increase GDP. The question is what’s the significance of that.
“he accused Austrians of not taking their alleged fundamental ideas – neutral money”
Stop right there. I thought the Austrian Perspective is that money is non-neutral in the short run.
Also, I think we’re contradicting ourselves if we look at income multiplier arguments too differently from inflation issue.
We always argue that inflation can’t be perfectly expected ahead of time. That is an important aspect of modern ABCT. If we say that the effect of fiscal stimulus can be then we’re contradicting ourselves.
I’m not saying that the questions about relative-prices and capital are the same for monetary policy and fiscal policy, I don’t think they are. But the question about what an income earner does when he/she receives some income is very similar.
Dear John Papola,
1. “Hmm . . . Zandi and CBO.” Why do so many S&P 500 firms use Keynesian models in their forecasting? If these models weren’t any good, wouldn’t an efficient market weed them out? Is it a coincidence that the U.S. economy is stalling just when the stimulus has run its course, or that European austerity is producing the exact outcome an old Keynesian would expect?
2. Suppose I produce some stuff by myself, sell it for $100,000, and put the money under my mattress. There’s some production that’s taken place, but it doesn’t seem to have generated any demand. On the other hand, suppose I borrow from my bank and spend the proceeds. I’ve haven’t produced anything, but surely my spending counts as increased demand.
3. Poor people don’t hoard cash (if I may be permitted to generalize); they have little choice but to spend what they get. At the moment, there’s a strong demand for safe assets, but if you think unregulated banks without a lender of last resort could supply these safe assets, you’re deluding yourself.
4. There’s very little math in Keynes’s General Theory, but there’s quite a bit about people and prices. A “flow” is simply a measure of something over a period of time, e.g., an accounting of goods bought and sold between two countries in the course of a year.
5. You ask, “which people?” Well, they could be poor people or people who are looking for work and are about to run out of unemployment insurance. That doesn’t make them “some aggregate blob entity.” You might want to reread your John Stuart Mill; you’ll find lots of references to social classes as well as to individuals, not to mention a commitment to equality.
6. I agree that there’s a relationship between housing bubbles and regional unemployment rates, but that doesn’t come close to a complete explanation of the great recession in terms of “plain old microeconomic sectoral shifts.” Many European countries had no housing bubble at all, but still have lots of unemployment.
8. What’s more puzzling for whose theory: 2% inflation coupled with 9% unemployment for the Keynesian; or 2% interest rates in the face of massive government borrowing for the Austrian?
p.s. Enjoyed your video. I’ve rewritten the Keynes-Hayek debate in way that, in my view, does more justice to Keynes’s arguments if you’re interested.
First LK invokes RE and now Ricardian equivalence. I call it shifting ground.
Fiscal stmulus doesn’t work. Period. There are any number of possible reasons why that might be true.
As I explained, the evidence does not depend on a strong form of rational expectations. Nor does it depend on Ricardian equivalence.
It is highly amusing that LK tries to associate me with Ricardian equivalence. He obviously does not have the command of the literature on that topic that he wants readers here to believe he has. Or he would know better.
What is the track record of reliability or private sector macro forecasting? My guess is, it sucks. Of COURSE you’re going to have firms using keynesian-like models when the schools have been churning out mostly keynesian-like economists. If you’re taking econ and wish to be a pro, it’s macro nonsense all the way so that you can get a job in government or the Fed. They’re big employers for economists, after all. It’s not a free market, but there are clear market forces producing all of this nonsense.
Efficient markets aren’t driven by forecasts. They’re driven by ACTION. It’s the trial and mostly error process which discovers prices, not computer models about where prices might go. Of course, as an Austrian-minded non-economist, I find the talk of “efficient markets” a little strange. The world isn’t efficient, that’s why we use markets to discovery ways of making it better.
What austerity? Please elaborate on where total government spending is actually declining year-over-year besides, say, Greece or other places already on the verge default and collapse. Of course, it’s pretty hard to keep track of these goal posts. After all, I thought Paul Krugman recently said that we never actually got any stimulus at all because of state-level offsets (again, how me the year-over-year declines). So did we get “stimulus” or no? More importantly, though, isn’t the whole point to get unemployment down? Did that actually happen during the peak of the stimulus? Nope. So how exactly are you arriving at this idea that the ending of the stimulus marks some special period correlating with the theory? NGDP numbers are a means, not an end in themselves are they not? Unemployment shot up straight through the stimulus. Saying “it would have been worse without it” is tautological, counter-fictional nonsense. Again, we’ve seen the opposite happen before in 1921, 1946 in the US and during the late 1990s in Canada. Large fiscal contractions don’t have to cause higher unemployment. History is clear on that.
I’m not sure what you’re getting at here. Hoarding cash leads to deflation and can have negative effects due to money illusion. Neither I, nor Jerry, nor Hayek disagree with that. As George Selgin lays out, a free banking system would (and has) tended to accommodate increased demand for notes with increased supply. On the flip side of that is the “real cash balance” effect, but this comment is already too enormous. Regardless, I don’t see a central banking being able to know that YOU are hoarding cash and injecting money in such a way that it offsets your demand. Instead, they’ll just buy treasuries from Goldman Sachs so that they can turn around a buy commodity futures, making the food you eat more expensive. There are crude tools with unintended consequences.
Still, you are begging the question, though. So what? You sell your widget and hoard the money. What makes you think that the dopes in DC are going to be any good at spending it instead by borrowing from someone else? Socialist calculation problems apply. If you were to spend it, that spending would be creating demand for something you actually value, not bailing out the post office.
Still, you got right to the heard of where demand comes from. It comes from producing things which other people value. This is the inescapable truth of Say’s Law, short-run monetary equilibrium problems aside.
Most importantly, though, why are you hoarding the cash? Isn’t the real key getting to THAT issue?
Again, WHY are some people so risk averse? Not everyone is, mind you. But there is clearly an increase, given treasury yields. It’s a little strange to believe that, amidst sovereign default worries, what these safety-seekers are signaling is a desire for our government to go into deeper debt. I’ve never understood this DeLong-style interpretation of the price signal from Treasuries. What makes treasuries “safe” is that the government can send out men with guns to take the money. Walmart can’t do that, so their bonds trade at a premium to treasuries. But how much REAL asset creation is the Treasury doing? Very very little. Again, we have this divorcing of nominal from real. Investors buy Walmart bonds because they see value creation and productivity. Treasuries are the opposite of that.
But, as we’ve seen with sub-prime mortgages and sub-prime countries like Greece, predictions of debt prices is a fools errand and can change quickly.
Assertions about what “people” as a general declaration do is not the same as thinking about what specific people as individual actors exerting their subjective preferences do. Keynes’ “people” is much like his “labor”. It’s an aggregate. It’s pop psychology, not econ. More importantly, though, is what the framework and theory treat, and there, again, are no people or prices. It’s all aggregates. I’ve never been to an aggregate supply store or tried to price compare their offerings against a competitor… because it’s an ex-post statistical artifact.
I’m a little lost on what this means. Honestly. It just looks like “you don’t care about the unemployed”. I don’t play that game. There’s nothing in the keynesian framework that addresses equality.
It’s not the whole story, obviously. We can’t possibly know even a large portion of the story, and have even less ability to manipulate it from the top down. Still, the point remains that there are areas of the economy where there is no slack capacity in either capital equipment or labor supply and others where there is slack capacity because the customers have left and aren’t coming back and, yes, there may indeed be some sectors which are seeing temporary slack demand due to an increase in cash hoarding by their customers. Finding out which is which is called “entrepreneurship” and I see no evidence that the Keynesian planners are capable of discovering these differences. Certainly not the wizards who came up with “cash for clunkers”. Working people are STILL paying substantially higher used car prices than has been the pre-clunker trend because of that nightmarishly immoral catastrophe of ignorance. Talk about concerns for equality! Holy cow.
I thought you said there’s a gigantic demand for safe harbor assets? There’s also depressed demand for credit is there not? I don’t see anything incompatible between low treasury rates today and Austrian economics at all. It’s just supply and demand. We are seeing the same thing happen with gold prices. More people are freaked out than usual (maybe ever) right now. So demand for treasuries is high, as you said. That’s what the price tells us. Big deal. Or are you using ad hominem logic where “Austrian” means “particular Austrian economists”?
But since inflation is indeed a function of NGDP growth, and we are seeing inflation, that makes the talk of “general gluts” and “slack capacity” and the need from even more “aggregate demand” a little odd. If there is this “aggregate supply” which responds to “aggregate demand” and they intersect at the “price level”, than so long as the “price level” is rising, aggregate demand is exceeding aggregate supply. And yet… zero net jobs. There’s a reason the stagflation of the 70s knocked Keynesianism out of favor in some parts (not in DC, mind you).
Thanks for the compliment. I would be interested in seeing what you’ve written. I think we’ve been very fair to Keynes and empowered our version in the raps with as full a treatment of his theory and as strong a set of arguments for his/the worldview as can be done in the medium. We’ve certainly treated Keynes BILLIONS OF MILES better than Keynesians have treat Hayek and the Austrian approach. But hey, there’s always a way to take an even higher road. I’m open to it.
Sorry for the long comment, Jerry! I probably missed many things and made some mistakes. Here’s to learning from them (instead of trying to re-inflate them back to their former level).
Here’s a little reminder about just how hopeless the battle for these ideas is among so many. Nothing in the debate is any different at all from 2009 or 1995. Sigh. Note that it seems that many of the Japanese appear much less enthusiastic about their multi-trillion yen “stimulus” then the Americam Keynesian boosters. It turns out, watching the waste and debt first hand makes it a little hard to buy the “it would have been worse” assertions.
“First LK invokes RE and now Ricardian equivalence. I call it shifting ground.”
There is no ground shifting.
My original position is that rational expectations is false. Therefore Ricardian equivalence is false, because the latter depends on the former.
You’ve not adressed the utter failure of Barro and co back in the 1980s when their “predictions” (based on Ricardian equivalence) where utterly refuted by the effects of Reagan’s fiscal stimulus.
And, by the way, I am well aware of ‘The Ricardian Nonequivalence theorem,’ Journal of Political Economy 85.2 (1977): 207–10.
““he accused Austrians of not taking their alleged fundamental ideas – neutral money”
Stop right there. I thought the Austrian Perspective is that money is non-neutral in the short run.”
Yes, that is a typo for “non-neutral money”.
LK,
Your posts are non-responsive to either Barro’s op ed or my post. Barro made a statement about empirical evidence. That statement’s truth or falsity is not dependent on the correctness of the theory to which Barro ascribes.
Your comments are basically potshots aimed at him and come close to being ad hominem attacks.
As for my alleged failures, I don’t accept your characterization of the facts either in the 1980s or today. Under Reagan, spending fell as a percent of GDP. Keynesians predicted disaster. They, not Barro were proved wrong.
For those interested in what “infrstructure” spending actually is, here is a link to post by Chris Edwards. The short version: sheer economic waste.
http://www.cato-at-liberty.org/federal-infrastructure-spending-how-about-this-boondoggle/
Jerry, weren’t there also cries of recession and disaster from Keynesians regarding the fall in government spending under Clinton and the conservative Congress?
Greg Hill and John Papola have begun debating huge tracts of the ground contested between Keynesians and their opponents.
Jerry and LK’s debate is more restricted though. They’re looking at expectations. I don’t want to spend half a day writing a reply, so I’m going to concentrate on that part.
Both Jerry and LK agree with the proposition that agents are forward looking but have imperfect expectations. Both think that that view supports their case.
I think the view of LK and Greg Hill is that even if rational expectations is just a little bit false then that means that Keynesian policies will work.
Greg Hill mentions Post Keynesian theory of demand here:
I know some of these sort of people. A friend of mine has been unemployed for many years. Michał Kalecki would be happy to know that this guy acts as he would have predicted, he spends all his dole every week.
I don’t act like that. I read the financial pages and only increase my spending when I believe my permanent income has increased. To a Post Keynesian this doesn’t mean that I disprove the efficacy of fiscal stimulus, it simply means I’m irrelevant. My unemployed friend is relevant though, because if his income increases then he will spend the extra. So, Keynesian stimulus will continue to increase NGDP if given in a larger dose. The employment multiplier gets smaller but doesn’t disappear.
I think Jerry’s view is that such “leaks” in perfect rational expectations do occur. That’s certainly my view. (I don’t think the theory I’ve expressed above is a good way of getting there, I think the difficulty of predicting the future is more important than people with high discount rates and little choice). But, do such leaks mean that Keynesianism escapes unscathed except for a change in the required size of fiscal stimulus?
I think Jerry’s case is that it doesn’t. I think this is correct the other disadvantages of fiscal stimulus still remain. If expectations are important, and the employment multiplier is low then the disadvantages become more important than the stimulus that is achieved.
In my opinion we make too much of the question of whether Keynesians are right about NGDP. The important thing is whether they’re right about long-run wealth which isn’t reliably represented in short-run NGDP. I think they’re wrong. But to bring that up we have to move away from incomes and look at capital, interest and relative prices.
Put another way… “recovery” is not really different from normal growth. And normal growth is driven by productivity-enhancing investments which increase the supply of goods and services which people actually voluntarily demand. Since the process of investment and invention involves time, during which the product is not ready to be sold and generate and income, savings are required to fund it.
You must save to invest and invest wisely. That doesn’t change with unemployment.
An emphatic yes to John Papola’s last comment.
I would add only that businessmen will tell you that the Administration’s policies have created huge uncertainties for them, and they are reluctant to invest or hire. Healthcare, taxes and regulation are the constant refrain.
(CEOs of multinational businesses add the EU situation. I’m talking mainly of small- and medium-sized firms.)
Dear John Papola,
You claim that “efficient markets aren’t driven by forecasts. They’re driven by ACTION. It’s the trial and mostly error process which discovers prices, not computer models about where prices might go.”
I think you’re missing the point about forecasting. In the absence of complete markets in contingent commodities, firms must act on the basis of their forecasts of future demand, future prices, and future costs (granted, some of these can be tied down by contracts or in limited forward markets).
I realize that you don’t care for aggregates, but when large corporations forecast demand for their products they often begin with a forecast of GDP because demand for most products is positively correlated with GDP.
A “trial and error process” won’t reveal the price of natural gas twenty years hence. Hence, a firm trying to figure out how much to invest in natural gas exploration may “use computer models” to help them forecast the future price of natural gas.
Now that you see the role and importance of forecasting in decision making, don’t you think that the market value of a good forecast would drive firms to hire the best forecasters they can find? So the question is: why don’t these firms hire Austrian economists to help them forecast the demand for their products?
You write that “the whole point [of the stimulus is] to get unemployment down? Did that actually happen during the peak of the stimulus? Nope.”
In fact, the unemployment rate did fall during the peak of the stimulus. You can’t just make stuff up. Well, you can, but you shouldn’t.
Regarding the stimulus, you argue that “saying ‘it would have been worse without it’ is tautological, counter-fictional nonsense.”
Claiming that unemployment would have been higher without the (inadequate) stimulus is, indeed, a counterfactual claim, but it’s neither tautological, nor nonsense. Don’t Austrians make counterfactual claims, e.g., if there had been no stimulus at all, unemployment would be lower than it is today.
You insist that demand “comes from producing things which other people value. This is the inescapable truth of Say’s Law, short-run monetary equilibrium problems aside.”
The existence of non-reproducible assets invalidates the “inescapable truth of Say’s Law.” If some people wish to hold the bulk their wealth in money, or in land, or in Old Masters, the services I supplied in earning this income will not automatically generate demand for products people produce. On the other hand, if I borrow money from a bank and spend it, I’ve increased demand for the products I bought even though I haven’t produced anything.
You complain that “Keynes’ ‘people’ is much like his ‘labor’. It’s an aggregate. It’s pop psychology, not econ.”
I’m guessing that you haven’t actually read much of Keynes’s work. In the General Theory, Keynes outlines several motives for saving. Keynes doesn’t claim that everyone acts from all these motives or that they exert the same influence on everyone. Take a look at Keynes’s psychological portraits of President Wilson, Lloyd George, and Clemenceau in The Economic Consequences of the Peace and see you if regard this as “pop psychology.” If you’re reluctant to explore Keynes’s work, you might recall that Hayek called Keynes “the only great man he ever met.”
You say you’ve “never been to an aggregate supply store or tried to price compare their offerings against a competitor.”
No doubt, but I bet you’ve purchased goods made by workers whose wages are tied to the Consumer Price Index.
In regard to my reference to J. S. Mill, you reply, “Honestly. It just looks like ‘you don’t care about the unemployed’. I don’t play that game. There’s nothing in the keynesian framework that addresses equality.”
You suggested that I read J. S. Mill to see the problems that arise in thinking in terms of groups rather than individuals. I pointed out that Mill, himself, often referred to social classes in analyzing economic and social problems. And Keynes concludes the General Theory by referring to capitalism’s “inequitable distribution of wealth and income” and by pointing out that a more egalitarian distribution of income would mitigate problems of aggregate demand. You may disagree with this, but it’s part of “the Keynesian framework.”
You “don’t see anything incompatible between low treasury rates today and Austrian economics at all” given the strong demand for “safe harbor assets.”
Treasuries are not a safe harbor if you’re worried about inflation, and, if you’re an Austrian, you’re apt to be worried about inflation if the market rate of interest is being forced below the “natural rate” by the Fed. Perhaps you think the market rate is equal to, or above, the natural rate. But in this case, you might wish the Fed would take further steps to reduce interest rates.
The way Keynesians think of Say’s law and the way Austrian Economists (and most others) think of it is quite different.
To Austrian economists the issue of monetary disequilibrium comes up because of what Steve Horwitz calls “Wicksellian Cumulative Rot”. Those of us in the monetary disequilbrium side see a problem when there is a rise in demand for money that isn’t met by a rise in supply. That will cause some people to save out of income to increase their money holding, causing a decline in NGDP. This is a short-run issue and it isn’t very closely connected to interest and the savings-investment market. We’re concerned with the demand for money, not loans.
Keynesians are concerned about falls in NGDP. In old Keynesianism there was risk in any act of saving that it would produce a “leakage” from the output-income flow. The problem here is the one that Greg outlined. If money is borrowed from savers to invest in newly produced goods then that increases output. But, if income is used to buy existing assets, or borrowed from savers to fund buying existing assets then this may not drive NGDP. If those existing assets don’t compete with newly produced assets (e.g. land, old masters) then NGDP will fall.
The problem here is that to the Austrians the closing of the broad market in savings and investment is considered a separate problem. To the Keynesians though it’s considered as a part of the problem.
If I said to Bill Woolsey “what happens if I buy land with my spare income”, I expect he would say “The value of other assets falls until returns on them rise to make them competitive with land” (we had a similar discussion). This is true over some run of time, though not of-course true immediately. The same is true of wages here, because of my demand for land, the wages of labour in other industries will fall until something close to an equilibrium reemerges.
To Keynesians Say’s law is something about short-run aggregates. That’s what they criticise as incorrect, and if Say’s law is viewed like that then it is incorrect. To Austrians it’s often a process idea, about self-correcting forces that come into play after disturbances. I agree with this interpretation, but I think we have to rememeber that there are two self-correction issues. There’s firstly the real supply of money coming into equilibrium with the real demand for it. Secondly, there’s the change in demands for different assets causing a repricing of assets.
Greg,
For starters, I am not really as concerned with the particular brilliance of Keynes the man as I am concerned with the actually ECONOMICS which bears his name. You are correct that I have not read the entire general theory, nor have I read Hayek’s “Prices and Production”. I have read and watched a great deal about the actual theories and methodologies of both approaches through more modern sources including my personal favorite, Roger Garrison’s Time and Money. I also extensively follow the policy prescriptions of those who claim to be relying on Keynesianism.
So Keynes may have asserted various imaged reasons for why people may do this or that, but his actual methodological framework jumps from some to all at seemingly every turn. So the desire of some workers to demand a higher wage becomes the self-defeating aggregate of ALL workers seeking to demand a higher wage. I don’t see any play given within what I’ve read of Keynes or, more importantly, today’s “keynesians” to relative prices, relative choices, individual sectoral adjustments, monetary injection effects in particular sectors or through particular institutions, or any such microeconomic foundations. The keynesian framework is not rooted in a methodology built on individual action. It’s build on aggregates interacting. This is how we get the “it doesn’t matter where the spending goes” claims, which are frankly ludicrous. When Paul Krugman and Joe Stiglitz are to this day repeating the value of ditch digging and faked alien invasions, I feel quite justified in my criticism.
So it is from this vantage point that I claim there are no “people or prices”. The circular flow model has no people or prices. I see the jump from imagining why some typical “person” saves to the “paradox of thrift” along the same lines.
Now, to some other points.
Working backwards, the track record on macroeconomic forecasting at large is comparable to that of weather forecasting. Which is to say, it blows. I’m with Nassim Taleb on the uselessness of forecasting of this sort. Sure, everyone tries to do it, and that is surely because, as you put it, economic activity for many firms does correlate with positive aggregate activity. Let’s leave aside for the moment the fact that GDP also counts that which is not wealth creation, like make work, ditch digging and war. Explain again why such a thing isn’t pure tautology? You write about “GDP” as if it is some thing other than the ex-post accounting of activities by all firms.
GDP is not a thing unto itself. Now, if you want to talk about why NOMINAL GDP tends to correlate pretty strongly with REAL GDP, that’s a more interesting discussion. But that still doesn’t account for the fact that, yes, NGDP growth can be positive while RGDP growth is negative. It also doesn’t address the fact that the assertion of a strong relationship between NGDP/inflation and unemployment, the Philips curve, is falsifiable. These “macroeconomic” tools aren’t tools at all because the economy is not a “system” or a “machine” (or a car that can stall). It’s an ecosystem of individuals acting and interacting and responding in demonstrably unpredictable ways.
I don’t recall seeing any self-proclaimed Austrian economists putting out graphs of counterfactual unemployment trajectories, such as the infamous one the administration released. I don’t see Austrian economists releasing estimates of “multipliers” with two decimal points (or any such silliness at all). Most Austrian critics I see are referencing history when they offer the notion that things could have been different. They point to the rapid recovery after the 1920/21 downturn. They point to the low unemployment and solid growth of the late 1940s. This is counterfactual analysis along the lines of the bizarro assertions made about numbers of jobs lost or gained by this or that policy that come from Keynesians and their modern macro contemporaries.
No Austrian economist I’ve seen has ever put out such downright bizarre, thin-air assertions as Mark Zandi’s claim back in march that the tiny blip of a “GOP spending cut” would cost “700,000” jobs. That’s clearly nonsense. Luckily, it’s unfalsifiable, immeasurable and thus unaccountable. Not science. Not economics. All politics.
My point about Say’s law isn’t about the problems of short-run monetary equilibrium, as I stated. They are about the nature of demand and economic growth. Keynesians are all talking about how we need to “grow our way out” of the recession, to quote Lord Skidelsky from his recent BBC debate with George Selgin. Well, growth doesn’t come from demand. Growth comes savings which get invested into productivity-enhancing innovations that lower the real prices of goods and thus release real resources to expand the realm of possible production. THAT is the insight of Say’s Law. Increasing productivity is what opens up the possibility of new production possibilities that generate growth. There isn’t demand for products which do not exist. When Apple began internally investing resources in the development of the iPad, there was no demand for an iPad. More clearly, there was no demand for electronics when most humans farmed. It was only with the invention of the tractor and other labor-saving capital, that human and physical resources were freed to pursue other possibilities. THAT is growth. Before you can have the “flow”, someone has to save up so that they can build the damn factory on the right side of that insipid diagram.
Before you understand how things can go wrong, you have to understand how they could ever go right.
Keynesianism, or the economics of Keynes, have no model of growth that makes any sense. It’s made dramatically worse by their stunning assertion that where spending goes doesn’t matter and their constant focus on CONSUMPTION, such as the talk of various groups “propensity to consume” and the so-called stimulative effect of programs aimed at lower incomes because they will “spend more”. Say’s law illuminates why such talk is utterly backwards, destructive nonsense. Consumption is consumption. It is the using up of wealth. It is the opposite of real growth.
Now, the particular monetary disequilibrium you are talking about, where on net there is an increase in the demand to hold “non-reproducible assets” is built on the assumption that prices and wages don’t adjust. It’s also based on the assumption that the goods and services which these hoarders cease demanding are going to see that demand return when the panic stops. Why should one assume such a thing? And more importantly for my view of Keynesianism, why do Keynesians seem to advocate policies which will make prices and wages MORE sticky?
We had a giant real estate bubble blown up by a combination of inflationary easy money from the Fed, regulatory, tax and housing policies which incentivized capital flows into housing and then a set of financial derivatives which, starved for yield by the Fed’s policies, chased out the risk curve at the behest of everyone from state pension fund managers to fixed income retirees getting squeezed. When input price inflation squeezed out the profit because the Fed’s policies drove us into the real resource supply constraint (grasping for too few resources), credit demand shot up along with the Fed’s worry about inflation. Boom turned to bust. So now we’re in the bust and society is poorer for having dumped trillions into housing and accessories to housing (which is LOTS of non-housing goods and services) which people truly couldn’t afford or didn’t want at real market prices.
Given that, there are a bunch of people who’ve moved into “non-reproducible” safe assets and out of housing and housing securities. How do we know this? Asset prices have gone up, housing prices have gone down. They DON’T want to get back into housing. We don’t know what they want. There is no one thing. But you know who’s going to find out what they want? Entrepreneurs. The task that lies ahead is the task of entrepreneurship. The state is terrible at that (see solar energy boondoggles) It actually IS useful that housing prices have fallen RELATIVE to other things. And, if you look around, we have clear areas where prices are rising, like energy, education and healthcare. We’ve also got clear areas where labor market supply is short and wages are rising, like technology. Too bad the government has such a vast control over the new commanding heights of education and healthcare.
Aggregate nominal income accounting stats don’t help any of this. Now, I’m sympathetic to the idea that nominal spending matters and that money-demand deflation is bad. Hayek thought the same thing. Many pre-keynesian economist did, maybe most. This isn’t new. But the demand for money is the demand for money. It is NOT the failure to demand aggregate goods. An increase in the demand for money is NOT a “general glut”. I reject the usefulness of that term and concept. You can’t produce “general goods”. Having the government dig ditches or subsidize solar panel scams doesn’t address the increased demand for money. If money demand is increasing, the monetary authority should increase the supply to meet demand. Policy wise, this makes me sympathetic to Scott Sumner only I want an NGDP growth target of zero.
The “general theory” thus is a set of institutional assumptions and assertions centering around monetary disequilibrium but failing to actually address that problem and instead seeking to shim and hack everything else to get there.
Again, interest rates are a product of credit supply AND DEMAND. It’s not un-Austrian to have an increase in the supply of loanable funds but an decrease in the demand for credit. Take a look at the excess reserves or the broader money aggregates. I still haven’t seen any Austrian macro graphs charting their projected inflation rates. What I’ve seen is worry. I’m worried too. It’s an uncertain time and I don’t think any of these policy makers have a clue what’s going to come next.
As to the fact unemployment declined very slightly, well, when you dump hundreds of billions into the economy, you are bound to temporarily employ people, just as clunkers created a temporary increase in auto demand… before it crashed again. Big deal. If the spending didn’t produce productive, sustainable businesses, it’s just a waste. So stimulus fails on the socialist calculation grounds. We’re seeing a sample of that result with this Solyndra Inc bankruptcy (talk about abject corruption in the name of “stimulus”). Spend and Boom, fail and bust. That’s not growth. That’s not recovery. That’s a hair of the dog.
Eugene Fama sums it up well:
“Again, here is my argument in three sentences.
1. Bailouts and stimulus plans must be financed.
2. If the financing takes the form of additional government debt, the added debt displaces other uses of the same funds.
3. Thus, stimulus plans only enhance incomes when they move resources from less productive to more productive uses.
Are any of these statements incorrect?”
http://www.dimensional.com/famafrench/2009/01/bailouts-and-stimulus-plans—addendum-12809.html
Greg,
Gold prices seem like they’re indicating something about worries on the inflation and/or sovereign debt front, do they not?
Thanks to John Papola and others, this discussion has gone forward just fine without me.
I was surprised, however, by the claim that companies begin their investment plans by looking at GDP forecasts. Most nonfinancial corporations no longer even employ economists.
In an August 25, 2011 commentary in the Financial Times, John Kay addressed the issue of economic forecasting in business. “Mostly they [economists] are employed in the financial sector — for their entertainment value rather than their advice.”
A bit harsh, and apologies to my talented colleagues who still do this for a living. But it has an element of truth.
Jim Rose,
Thanks for the concise statement of Fama’s critique of increased government spending as a means of mobilizing idle resources. The same argument was put forward in England in the 1930’s in what became known as “the Treasury View.”
Here’s Keynes’s own (1929) statement of Fama’s argument, which is intended to convince you that Keynes was aware of this argument: “money raised by the State for financing productive schemes must diminish pro tanto the supply of capital available for ordinary industry . . . it will merely substitute employment on State schemes for ordinary employment.”
And here is Keynes’s response to the orthodox Treasury View:
1. If the Treasury View is correct, it would apply to private investment as well as public investment. Thus, if General Electric announced plans for a new plant, we’d cheer this investment and expect an increase in employment, but if the Treasury View is right, we’d be wrong; and
2. There are three sources of funds that enable an increase in total investment: a) savings from a reduction in government payments to the unemployed; b) savings that now run to waste because of credit constraints; and c) a reduction in foreign lending.
To bring the last point up to date, it’s important to bear in mind that foreign investors buy a lot of Treasury bonds, so that when Fama complains that “the added [government] debt displaces other uses of the same funds,” we must remind Professor Fama that a significant portion of these funds are not diverted from endeavors that would otherwise be undertaken in the U.S.
There’s a lot more to say, but let me simply conclude by accepting Fama’s claim that “stimulus plans only enhance incomes when they move resources from less productive to more productive uses,” but contend that moving unemployed workers into productive employment is, in fact, moving “resources from less productive to more productive uses.”
Thanks greg hill,
Fama’s response to De Long’s similar identification of the Teasury view is at http://www.dimensional.com/famafrench/2009/01/bailouts-and-stimulus-plans—addendum-11509.html#more
Appeals to the open economy usually weaken the potency of Keynesian style fiscal policy because of exchange rate crowding out effects.
More government borrowing leads to higher interest rates, which attract inflows on the capital account from foreign financial markets into the domestic currency.
Under floating exchange rates, this leads to an appreciation of the exchange rate and the crowding out of exports (which become more expensive to those using foreign currency). This counteracts the demand-promoting effects of government deficits.
more imports favouring government purchases would be at the expense of moving resources out of the export sector. This movement of resources will reduce productivity.
When the debt is repaid, net exports must later expand at the expense of domestic consumption. Random movements of resources into and out of the export sector reduces productivity.
As Barro points out, the uncertain incidence of the taxes needed later to repay the external government debt cannot be assumed to work in a special and convenient way to result in short-sightedness among taxpayers.
Precautionary savings usually increase in the face of more uncertainty. This depresses consumer demand.
The open economy effects of fiscal policy are therefore exchange rate crowding out, reduced consumption, lower productivity and more precautionary savings.
Capital account deficits and surpluses reflect the international trade in savings.
To the extent that fiscal policy moves resources from lower to high value uses in the borrowing economy, that would make that economy more rewarding to invest in. Arbitrage would rebalance the portfolio of global savings in favour of that economy.
The Treasury view you mentioned prevailed in Australian and New Zealand fiscal policies from late 1930 onwards. their unemployment rates were 25% or more by 1931. By 1935, their unemployment rates were in mid-to-high single digits.
In Australia, the massive fiscal contraction from late 1930 onwards was called the Premiers’ Plan, which of which Keynes in June 1932 said “I am sure that the Premiers’ Plan last year saved the economic structure of Australia. I am not prepared to dispute that another dose of the same medicine may be necessary.” See http://ipa.org.au/keynes-article/
There is no basis in the article just quoted or in Keynes’s other writings or in his actions to doubt the sincerity of this praise for the massive Australian fiscal contraction. Keynes was not slow to criticise the British Government, the Bank of England, or private interests.
Nor can Keynes’s support for the Premiers’ Plan be dismissed as ‘pre-Keynesian’. Keynes had already on many occasions advocated public works to promote employment in depressions; he did so in the very article just cited in which he endorsed the Premiers’ Plan.
HT: KEYNES AND AUSTRALIA, Donald J Markwell
Research Discussion Paper 2000-04, June 2000, Research Department, Reserve Bank of Australia,
Jim,
I can’t respond to all of your points, but I do want to question this claim: “More government borrowing leads to higher interest rates.” The U.S. has done a lot of borrowing lately, yet interest rates are very, very low. And Japan, which has a very high debt/GDP ratio also has very low interest rates.
I’m no expert the particulars in Estonia or Europe at large, but it sure appears like taking the anti-keynesian approach after a MASSIVE boom/bust shock, as Estonia experienced… works.
http://www.economist.com/node/18959241
This also appears consistent with ECB research prior to this dubious post-bust Keynesian resurgence:
Click to access ecbwp519.pdf
Keynesians love to say “the facts are on our side”. I’ve never seen those facts presented outside of “WWII ended the depression” which is clearly false.
Governments are bad at entrepreneurship. They lack the information and incentives to create real subjective value for voluntary people. Mandating customers and production at virtual gunpoint (see ethanol) is NOT entrepreneurship. It’s tyranny. Government’s are good at tyranny. But that’s not “economics”. Socialist calculation problems which render socialism unworkable even when attempted by benevolent despots apply equally to keynesian spending programs. People see this. They see the California rail boondoggles and the fraud and the political patronage.
This is REAL RESOURCE waste. I could care less about nominal interest rates and arguments about nominal “crowding out”. Sure, if you have a DC spooking business with regime uncertainty (and sometimes full on DOJ raids), then of COURSE you’re going to see loan demand plummet. Having the very crooks that destroy loan demand with their policies then turn around and take the resources for their own uses doesn’t prove anything good about so-called Keynesian policies. And, yes, they are so-called. We can’t know if Keynes would have even approved any of this nonsense.
Keynes WAS brilliant. I respect his brilliance, especially in his work on the Economic Consequences of the Peace. I love that he was NOT an inflationist, which was partly why Hayek found it better to have Keynes in the ascent than the alternatives in the 40s. But today’s “keynesians” are advocating nonsense. Meanwhile, REAL austerity, you know, where spending actually SHRINKS between two periods, works. Economies have, can, do and are recovering fast from giant busts as government spending contracts. There is no such thing as a natural “unemployment equilibrium” absent price controls and destructive interventions.
Dear John Papola,
You write, “The keynesian framework is not rooted in a methodology built on individual action. It’s build on aggregates interacting.”
I think you’re confusing the notion of an aggregate as a sum of particular things, e.g., the sum of all wages paid in a given year, with the notion of an aggregate as some kind of group actor. You claim the General Theory is “built on aggregates interacting,” but that’s simply not true. Consumption in Keynes’s model is not an aggregate that interacts with Investment. Rather, C = total consumption spending, and I = total investment spending. Now you may think it’s unavailing to add things up at this level of aggregation, but that complaint is quite different than claiming that C and I interact in the same way that, say, two particular human beings interact.
“The circular flow model has no people or prices. I see the jump from imagining why some typical ‘person’ saves to the ‘paradox of thrift’ along the same lines.”
Keynes’s point about the paradox of thrift was simply that while one person can increase his saving by reducing his expenditure, if everyone were to attempt this at the same time, everyone’s income would fall because income and expenditure are two sides of the same coin. In making this logical point, it doesn’t seem necessary to go into all the particular considerations that move specific people to reduce their spending.
Rather than “jumping” from the individual to aggregate, Keynes was actually cautioning against adding up individual saving decisions without taking account of their effect on income, that is, the fallacy of composition.
“You write about ‘GDP’ as if it is some thing other than the ex-post accounting of activities by all firms.”
Permit me to return to my original point, which is that firms making investment decisions must forecast sales revenue (among many other things) because futures markets are incomplete; and if the Austrian theory were superior to Keynes’s theory, then Austrian economists would supplant Keynesian economists at many S&P 500 firms. (Jerry’s mention of a funny remark in the Financial Times isn’t really convincing evidence that large corporations don’t hire economists of any stripe, and I used GDP as a shorthand for all kinds of macro variables that could be related to a firm’s future sales revenue.) If you’re trying to decide whether to build a power plant that may last thirty years, you’d better be looking at more variables than today’s relative prices.
“The economy is not a ‘system’ or a ‘machine’ (or a car that can stall). It’s an ecosystem of individuals acting and interacting and responding in demonstrably unpredictable ways.”
Keynes didn’t think of the economy as a machine, and he gave as much weight to the forces of ignorance and uncertainty as anyone who has ever written about economics (with the possible exception of the Hayekian-turned-Keynesian, G.L.S. Shackle). Although aggregates like GDP (nominal or real) do not exist apart from the items that comprise them, many individual market participants think in terms of these aggregative concepts. That is to say, they belong to the subjective orientation of market participants (which is, I believe, of some importance to the Austrian camp).
“No Austrian economist I’ve seen has ever put out such downright bizarre, thin-air assertions as Mark Zandi’s claim back in march that the tiny blip of a ‘GOP spending cut’ would cost ‘700,000’ jobs. That’s clearly nonsense. Luckily, it’s unfalsifiable, immeasurable and thus unaccountable. Not science. Not economics. All politics.”
I’m sympathetic to your point about the ridiculous precision claimed in some of these estimates. Keynes, himself, was suspicious of econometrics. But I think you’re unfair to Mark Zandi when you say his estimates are “all politics.” Robert Barro, whose editorial initiated this blog post, builds models with multipliers less than 1. Is Barro’s work “all politics” too? And with regard to historical analogies, you’ll see lots of these on the Keynesian blogs.
“Well, growth doesn’t come from demand. Growth comes from savings which get invested into productivity-enhancing innovations that lower the real prices of goods and thus release real resources to expand the realm of possible production. THAT is the insight of Say’s Law.”
I’ve never seen this particular interpretation of Say’s Law, which, I think, would be more accurately summarized as “supply (factor payments) creates its own demand (as these factor incomes are spent), so that demand can’t fall short of supply, at least over ‘the long run.’”
Keynes’s point in this regard was that savings won’t necessarily get invested in “productivity-enhancing innovations,” nor, for that matter, into capacity expansion with existing technology, because saving and investment decisions are made by different groups of people whose decisions aren’t well coordinated by the rate of interest.
“Keynesianism, or the economics of Keynes, have no model of growth that makes any sense.”
Now, really, John, have you surveyed the variety of growth models that draw from Keynes? You might take a look at Nicholas Kaldor’s model, which is, in fact, driven by investment.
“It’s made dramatically worse by their stunning assertion that where spending goes doesn’t matter and their constant focus on CONSUMPTION, such as the talk of various groups ‘propensity to consume’ and the so-called stimulative effect of programs aimed at lower incomes because they will ‘spend more.’”
Keynes’s first choice was public works, and he was “not an enemy of Thrift, but a champion of Enterprise.” Although you hear a lot of complaints about “regulation” and “taxes,” the number one concern of businesses in several surveys is “lack of demand.” I’m sure many firms worry about taxes and costs, but I’m also sure many firms are reluctant to hire because they don’t know whether they can sell the additional output. Consumption may be “the using up of wealth,” but if people aren’t buying things, firms are less likely to invest in capacity expansion or in innovation (though there are doubtlessly many exceptions to this generalization).
Here’s another way of looking at the problem. Suppose I’m unemployed but that, if someone were to hire me, I’d buy X, Y, and Z. Unfortunately, I have no way of communicating this intention. Of course, the firm that might hire me doesn’t care what I’d buy, but this firm would be interested in what it could sell to other newly employed people if they were hired. In a Walrasian market, all these conditional intentions can be brought into harmony, but real-world markets don’t provide for this pooling of conditional intentions; they respond to demands backed by purchasing power, which may not be sufficient to mobilize idle resources.
“Now, the particular monetary disequilibrium you are talking about, where on net there is an increase in the demand to hold ‘non-reproducible assets’ is built on the assumption that prices and wages don’t adjust.”
Quite the contrary, although Keynes believed that wages were “sticky” as a matter of fact, and that this was actually a good thing, he did contemplate something like the following “sequence”: 1) an increase in the demand for money, which 2) means a reduction in spending and, hence, in sales revenue, which leads to 3) a fall in prices in the face of unsold inventory, which 4) pushes nominal wages lower, which 5) reduces expenditure on wage goods, which takes us back to 2). Now, while Keynes allowed that falling prices would increase the real value of cash balances, which might result in increased spending, he also reiterated Irving Fisher’s point that the real burden of debts would rise, leading to bankruptcies and their many adverse consequences. Sound familiar?
“Too bad the government has such a vast control over the new commanding heights of education and healthcare.”
Here’s a question for all Austrians: do you have a criterion for evaluating the outcomes produced by markets and governments? I ask this because, by most measures, including cost, the healthcare outcomes we see in Canada, Sweden, etc., are superior to the outcomes produced by America’s healthcare system. And the students who are outperforming American kids are not, for the most part, attending private schools.
A second question: do you think markets are the best way of organizing the provision of everything? I ask this because Kenneth Arrow, who knows a thing or two about markets, wrote a paper explaining why the market provision of health insurance was problematic because of information asymmetries, adverse selection, and moral hazard. Do you just close your eyes to this sort of argument?
Greg Hill,
No disrespect, you seem like a smart guy, but the fact that you would have to ask those two questions shows you’re not very informed about what Austrians, and free market proponents, actually believe.
I know of no Austrian who would endorse the American health care system, nor do I know of any Austrian who thinks the American health care system embodies a free market system. Truthfully I’m getting more than a little tired with this accusation which has absolutely no bearing to reality whatsoever. Do I even really need to explain why?
Also you ask if Austrians think if the market always allocates resources better than the government. I’m honestly surprised you don’t know what an Austrian would say. Most will tell you that we, in fact, don’t know if the market provides the absolute best outcome, because we simply don’t know what the “best” outcome is. The “best” outcome is not something we can even define objectively. The best way of finding out, however, is to allow individuals acting in their own interest (broadly defined) to find out what it is they value the most and to voluntarily cooperate with others through the complex web of the division of labor to bring that about. Seriously, have you even read Hayek, or Mises, or Lachmann?
Theoretically I can imagine a scenario in which the government creates a better world, but how likely is it that this hypothetical government can really know all that it would need to know to make this better world? And given what we can reasonably assume about how government’s behave, how likely is it that somewhere along the way this ideal plan won’t be hijacked by special interests? Any serious Austrian will never say the world with a free market is optimal or perfect; this is silly to even consider since human beings are imperfect. It is about comparative institutional analysis, that is, what is better on the margin. A free market will not cure all social woes; it is not a panacea. But will it make the world a better place than the one we have now? I’m confident that it can. Is it possible that I’m wrong? Sure. We’ll never know though if the only place we go is up.
Damn, nix the apostrophe on gov.
Brad W.,
I asked whether Austrians have a criterion by which to judge the outcome of a market vs. a state provision of goods.
In effect, your answer is: “The ‘best’ outcome is not something we can even define objectively. The best way of finding out, however, is to allow individuals acting in their own interest (broadly defined) to find out what it is they value the most and to voluntarily cooperate with others through the complex web of the division of labor to bring that about.”
If I may paraphrase, you’re saying that the whatever results from voluntary cooperation (exchanges?) in markets is best. This is what I was trying to get at. Iif this is your standard of evaluation (and I don’t reject it out of hand), then, by stipulation, market outcomes are always better than government outcomes, which means that it’s pointless for critics to raise questions about externalities, information asymmetries, public goods, moral hazard, and so forth.
Am I ignorant of Austrian economics? I’m not the best person to answer this question, but you might be in a better position to answer it by taking a look at my debates with Roger Garrison, Steven Horwitz, and Bruce Caldwell in the pages of Critical Review over the last decade or so.
Greg Hill,
You are always assuming that it’s worthwhile for input goods to be made into output goods. Marx made the same assumption and there is a term for it though I can’t remember it right now.
We have the situation where the reason investment spending is low is because holders of assets don’t believe that transforming them from one form into another is worthwhile. Surely it is possible that they are *right* about this. Why must they be assumed to be wrong?
Current,
I don’t think that any individual asset holder is necessarily wrong in believing that investment at the moment would be unprofitable. However, I do believe that low levels of investment can be the result of a coordination failure.
Imagine a two-firm economy in which the factor incomes paid out by firm X are spent on the output of firm Y, and vice versa. If X believes Y will be hiring additional labor, then X will expand its output, and if Y believes the same about X, Y will expand, and the result will be a high-output equilibrium. If both X and Y expect the other to reduce output, then you’ve got a low-output equilibrium.
Greg,
Lots of stuff here. First off, let me re-iterate that I believe you’re focusing too much on Keynes the man and not on what Keynesianism today is about. Keynes himself was a complex thinker and an opportunistic policy strategist. Arguing about what Keynes would say is not the same thing exactly as debating the merits of Keynesianism as taught in intro-macro or the intro-macro-level version of Keynesianism currently animating everyone from the Obama administration to pundits like Paul Krugman.
With regard to the accounting identity Y = C + I + G (+ Nx), I see this basic identity as giving rise to a host of silly thinking. For starters, consumption and investment aren’t additive in the short run. Investment funding must come from savings, which means that consumption must fall for investment to rise. Now, as investments yield productivity gains, real income rises and we can get increasing real consumption AND investment over a the longer run. But that’s not how I see C + I + G talked about.
The revelation of aggregate-blog thinking comes in the way today’s Keynesians pay short shift to the productivity of spending. In fact, the less productive the better it would seem (tsunamis, alien invasions, war, etc). Sometimes, it would seem, that these aggregates become so visceral for these folks that they cease being simply ex-post summaries and actually take on physical, dividable, sharable properties.
DeLong, Stiglitz, Krugman, Bernanke, Schiller, Eichengreen and the administration ALL focus on aggregate spending with no particular care for what the spending is on or whether it’s actual “investment” vs. pure consumption. Let’s run through a few:
Brad DeLong Nov 30th, 2009:
“At this point, anything that boosts the government’s deficit over the next two years passes the benefit-cost test–anything at all.”
Joe Stiglitz re-iterated before a congressional hearing in Summer 2010 that paying people to ditch-dig and refill them would be better than not increasing government spending.
Krugman has recently said that increased regulations on business would be good because they’d force increased spending. He’s repeatedly slammed tax cuts (or failure to raise taxes) on the “rich” because, well, the rich will SAVE the money while lower income people will spend it on consumption. Then there’s he nut job alien invasion rant. Yikes.
Bernanke just came out again talking about the problems of “consumer confidence” as if it is consumption spending itself which increases productivity and leads to growth.
Schiller has talked about GDP as if it is a thing which we all a “stake” in and “share” during a lecture with DeLong at the New School back in 09. Strange.
Barry Eichengreen referred to the problem of imports and trade deficits during high unemployment as sending a “fixed lump of demand” to China due to their monetary policy (of keeping up with the Fed’s expansion).
And of course, there’s the countless claims by the administration and many of the above that programs aimed at lower-income people or the unemployed, like UI benefits, have a higher “multiplier” because these people must go out and spend (on unproductive consumption) every single nickel.
Meanwhile, as Alan Meltzer pointed out back in Feb of 2010, Keynes himself wasn’t worried about consumption but instead on the volatility in INVESTMENT during the business cycle. He (incorrectly) believed that the government could stabilize investment spending in the face of wild business animal spirits.
So, you could say that all of the above are not “keynesian”. Perhaps. But the aggregate framework Keynes laid out has produced this nonsense. I wish he could have lived long enough to change his mind, as Hayek believed would have been likely.
Oh… and, ehem, consumer spending returned to it’s pre-crisis peak a year ago and is at an all time high, so all of this talk of shaky consumers is, well, appears to be a complete sham.
First of all, that is the very definition of jumping from some to all, which Keynes (and you) make repeatedly. If you seek to apply the behavior of “one person” to “everyone”, that is jumping from the individual to the aggregate. You did it. But you’re also being very very narrow in your reading of Keynes. He did NOT like saving. Period. He saw it as a moral failing.
“Capitalism and the Jews” goes into great detail of the broad distain Keynes held for the Jews penchant for being forward-looking and, you know, saving their money (and thank go many did given what happened later). He looked down upon the “purposiveness” of saving “to secure a spurious and delusive immortality”. This is NOT a man who had merely pointed out a quirky extreme case where efforts by everyone to hoard cash would prove self-defeating. That you believe this to be the case suggests that you hold an even more, shall we say, “stylized” version of Keynes than I do.
As for this notion that those who save and those who “invest” are different people, I don’t get the problem. I wish to save. I put my money in my savings account. Money is fungible. The bank can lend my money as part of it’s reserves out to whoever appears to be the best opportunity. They are lending it in a pool that doesn’t distinguish between my savings and everyone else’s. It’s a pool of loanable funds. Increased savings allow the bank to compete for borrowers by lowering their rates. Those lower rates, quite clearly, make new certain investments potentially more profitable at the margin. It is irrelevant whether my bank lends to a firm which will somehow produce the goods I personally may want in the future. The entrepreneurial discovery process relies on a vast wealth of particular knowledge, and the price of time and money is but one factor of many.
I have yet to see any evidence that macro forecasting done by anyone is anything but nearly-worthless. Take a breeze down the financial magazine fund manager all star picks and review the prior year’s winners following year performance. It’s terrible, across the board. I’ve seen detailed, and downright hilarious, presentations of just how awful macro prediction and market projections are unilaterally. Corporate bean counters do ALL SORTS of wastefully things and me-too nonsense. So what? Must we go any farther than the Administration’s recovery act unemployment graph? It’s a mega-fail.
He didn’t TALK about it like a machine, but his system of aggregates TREAT it like a machine. Future Keynesians simply took the next logical step. Some even built actual hydraulic machines in an effort to simulate an economy (Arthur Okun). We are left with the dreadful car metaphor where the economy is “stalled” or “stuck in a ditch” and needs a “pump priming” (a phrase Herbert Hoover coined, btw). Yuck. All wrong. Dead wrong. The economy is not a car. There’s no engine to stall.
And while I also believe Keynes to have been a skeptic of econometrics, his framework of aggregate analysis played right into the Samuelsonian ruination of economics as a discipline. I heard that Paul Krugman claimed to have taken an interest in economics because it showed you how to “fix things” with the “push of a button”. On October 12th, 2009 he summarized Keynesianism as:
Only there is no button because there is no machine. Krugman got interested in economics based on a delusion it appears.
Nope. You’re wrong. You’re quoting the hacked up wreckage of Say’s law which Keynes used as a straw man. “Supply creates its own demand” doesn’t even make a damn bit of sense. If I go in my back yard and make a mud pie, the creation of that supply does NOT create demand. In order for supply to create demand, it must be traded. And that demand is not for “its own”. The demand is for OTHER GOODS.
Read this: http://www.thefreemanonline.org/featured/understanding-says-law-of-markets/
Check into the work of Steven Kates. Get that god awful “supply creates it’s own demand” nonsense out of your head. It’s wrong. It’s not Say. It’s meaningless. This is the CRUX of where the general theory is wrong and the fake victory that enabled it to overturn classical macroeconomics (which already otherwise fully appreciated the problems of money-demand deflation, btw).
There can be no “general gluts” because there is no such thing as a “general good”. Some production may fail to be sellable profitably. If something (like monetary mischief) leads large numbers of businesses to miscalculate together, we can get coordination failure. When that happens, we need re-allocation. Injecting demand for particular goods isn’t going to fix that unless those are the goods that people actually want. If government can do that, than socialism works.
If people wish to hold money, produce more money (as a free banking system would do). If prices are flexible enough, you won’t even need to that and the real cash balance effect will work fine.
This example doesn’t illuminate anything about an economy. Your situation happens ALL THE TIME in the economy. Some people are unemployed, other people aren’t sure if their idea will sell at a profit. Somehow, people coordinate their efforts. In fact, people managed to build modern civilization without any “demand management” despite all of these difficulties. Go figure. Oh, and once the pump-primers started tinkering, we got a global great depression like none to come before. Go figure.
I don’t get “general equilibrium” but it seems like something built out of hubris regarding what one believes they can know about an economy of people.
The question which recessions beg is: why did so many people make the same mistakes? What caused this strange cluster of errors? “Animal Spirits” doesn’t even attempt to answer. In fact, as Krugman said in his attempted 1998 take-down of Austrian business cycle theory (via straw man and hackery, btw), it DOESN’T MATTER why in the keynesian view. Well, I’m sorry. But that’s not a answer. It DOES matter so that policy makers don’t repeat the same mistakes and re-inflate another bubble (which is what Krugman repeated called for through the 2000s).
Keynesianism, in the end, is all about spending. It doesn’t on what or why. That’s not economics in my view.
(PS. I find Barro’s multiplier work to be subject to all of the same criticism I have of Keynesianism. It’s the pretense of knowledge. Garrison, funny enough, critiques new classical economics via an assault on Barro’s “back scratching penguins” model in Time and Money.)
Dear John Papola,
I think we’re starting to repeat ourselves and to rehearse the same arguments, so, in hopes of breaking some new ground, I’m going to focus narrowly on your complaint that Robert Schiller “has talked about GDP as if it is a thing which we all have a ‘stake’ in and ‘share’ . . . Strange.”
Shiller wrote a book called “Macro Markets” the mere title of which must make the Austrian’s skin crawl. What on earth is a “macro market?”
Well, suppose that you want to pursue a career in web design, but you’re worried that wages in this field may not rise as much as expected. What if there were a “macro market” in which you could buy insurance against this prospect. For example, you could enter into a contract wherein you would receive a payment if the average wage of “web designers” (SOC 15-1134) were below some threshold in the year 2020, and you would make a payment of the average wage exceeded some threshold in 2020.
Although you’ll never buy anything from “web designers in general,” there’s a correlation between an individual web designer’s pay and the average pay of “web designers,” so that by “shorting” the wage index for this occupational group, you can hedge your occupational bet. The same correlation is present in housing, i.e., the price of my home (in Seattle) is correlated with Case/Shiller index for Seattle, and I could reduce my “housing risk” by shorting the Seattle index.
Although the stock market allows lots of diversification, there’s much less opportunity to reduce labor income risk. My wages depend on my productivity, but they’re also correlated with national income. I suspect this is what Shiller meant when he said we have “stake” in GDP. What Shiller has proposed is a macro market in national income. If such markets existed for all countries, then people could take the short positions in their own country’s market, and the long positions in all other countries’ markets, thereby completely hedging themselves against national income risk.
So here are three aggregates: web designers, regional housing, and national income. They are not “things” in your sense, but they are not phantasmagoric entities either. If Shiller’s macro markets came into being, and if individuals took positions in the “macro securities” traded there to reduce their risks, would you call these people “strange”?
Greg,
I think your “two-firm economy” is useful.
But we must be very clear about what we’re talking about.
I your example you talk about both firms hiring additional labour. That means you’re assuming that we have unemployment of people. Specifically, you’re assuming that there is unemployment above the level caused by frictions such as search costs and skill mismatches. If there wasn’t then firm X could only expand output by hiring employees away from firm Y.
You’re assuming that a reserve of consumer goods or capital goods exists, or that an income stream can take their place. There are two possibilities here… Firstly, a stock of consumer goods may exist to pay newly hired workers. Then while consuming those goods the workers can create capital goods from raw inputs. So, at some point in the future firm X and firm Y can expand output, but not straight away. In fact, to assume that surplus workers will continue to survive between one period and the next we must assume that they have a reserve of some sort, or that they have an income (e.g. from savings or government welfare). But an additional reserve of existing goods or a promise of future returns would be needed incentivise workers to work rather than relying on their reserve.
Alternatively, there could be unemployed capital goods in firm X and firm Y. In that case if those firms can find workers with the right skills then they can easily expand. If these criteria aren’t met than expansion can’t occur. If both businesses are using all their capital goods and they can’t obtain a reserve to pay workers with while they make more capital goods then expansion isn’t possible. This is why Keynes says that in some situations the special-case of what he calls “Classical Economics” holds, just as Newton’s laws hold as a special case of Einstein’s.
(This brings us to the impact of expected productivity on interest. Firms bid down the price of bonds because they believe expansion will be profitable. But there’s no need to go into that here.)
I agree that the situations I describe above can occur. The issue you’re describing is only really relevant for recessions. Your argument is that the problem in a recession is assets (including money) that have being placed on the side-lines by capitalists, rather than being invested in creating output. I agree that this happens and that it decreases GDP in the short-run. I’m not convinced that the government should do anything about that though.
You argue that coordination failure occurs because there is no way to communicate the plans involved. As John Papola points out, that’s always the case to some extent. In a real economy experimentation, expectations and forward planning help to deal with this issue. To think about this we have to move away from the two firm model. Rather than their being a single firm in the position of firm X there are many, some will experiment with expanding production, and some with keeping it the same or reducing it. The set of firms in the position of firm Y in the two-firm model will respond to this and do it themselves. It could be argued that this process of discovery can be bypassed, as I understand it that’s what you’re arguing.
One problem with this is that it assumes that the fall in output is a composition problem. That is, you’re assuming that it would be rational for society as a whole to expand production. You’re only considering the case that it’s irrational for particular agents, but rational for society as a whole. But it could also be both rational for particular agents and for society as a whole.
It may be that for a particular project, business, or industry the conversion of inputs into outputs isn’t profitable in the new economic conditions and wouldn’t be profitable even after recovery has occurred. In that case it’s wise for anyone for capital to be directed into that project. Keynesian stimulus depends on businesses taking increase demand as a signal to increase output. That means that when and where that signal is misplaced waste will occur. When the government spend money on investment we must hope that the outputs of that investment are worth more than the inputs. If they are worth less then we may hope that the extra investment spurs extra output elsewhere and that output is worthwhile. It’s similar for the stimulus spending that is spent on consumption. Directly that leads to greater satisfaction for the consumers at the cost of consumption of resources. Again, we are hoping that as a spin-off of that income will be spent elsewhere and will aide recovery.
Notice I’m not just saying that the multiplier is low. I’m saying that that multiplier must be high enough to compensate for the waste involved in stimulus. Modern Keynesians have latched onto the idea that the PIH is wrong as though it proves their case. All it proves is that stimulus may expand GDP. It doesn’t prove how much of that GDP expansion represents additional wealth society has.
This is without considering the negative effect stimulus may have on expectaions. If investors believe stimulus won’t be effective that may decrease investment and offset the effect of stimulus.
Current,
Very interesting and thoughtful post. I need to mull it over for awhile. In the meantime, here’s my Walrasian, “voluntary cooperation” solution to our current difficulties.
http://humanpredicament.blogspot.com/2011/09/walrasian-solution-to-our-current.html
When I wrote:
“In that case it’s wise for anyone for capital to be directed into that project.”
I meant to write
“In that case it isn’t wise for anyone for capital to be directed into that project.”