Glasner on Merkel’s Legacy

by Andreas Hoffmann

I enjoy reading David Glasner’s commentaries. But his latest post, “What Hath Merkel Wrought?“, is absolutely misleading (with regard to Merkel and German elections).

Lawrence Klein: Keynesian Economist Who Wanted to Sidestep the Constitution

By Richard M. Ebeling

Nobel Prizing-winning Keynesian economist, Lawrence Klein died on October 20, 2013, at the age of 93. A long-time professor of economics at the University of Pennsylvania, he was awarded the Nobel Prize in 1980 for his development of econometric (or statistical) models of the United States “macro” economy for purposes of prediction and “activist” government policy making.

 

He also was a senior economic advisor to Jimmy Carter during his successful run for the presidency in 1976, but Klein declined a position in the Carter Administration for fear of the negative publicity from his membership in the American Communist Party in the 1930s. 

 

What is less well known today is that immediately after World War II he was one of the great popularizers of the “new economics” of John Maynard Keynes, especially in his widely read book, The Keynesian Revolution, published in 1947.

 

Keynes’ Conception of Government as Savior

In The General Theory of Employment, Interest, and Money (1936) Keynes had argued that the market economy was inherently unstable and susceptible to wide and unpredictable swings in output, employment, and prices. Worse yet, he asserted, the market could get stuck in a prolonged period of high unemployment and idle resources. Only judicious government monetary and fiscal policy could assure a return to sustainable full employment.

“Modern Market” Monetarism?

by Mario Rizzo

Douglas Irwin, a very fine economist at Dartmouth College, has a very puzzling opinion piece in yesterday’s Financial Times. The root of the puzzle is that Irwin seems to accept what I consider the naïve monetarist view, yet calling it by a new name “market monetarism,” that the effectiveness of monetary policy largely revolves around portfolio adjustment effects that are induced by an increase in real balances. (Isn’t this warmed over Pigou, and 1970s monetarism?)

What seems to be new is the “Divisa monetary indexes” which weight the different components of the monetary aggregates by their monetary services. In principle, this is what Milton Friedman talked about in his course “Money: The Demand Side” in the early 1970s. He said then that he thought it would be a good idea to weight the various components of the money supply by their “degrees of moneyness.” He did wonder, as I recall, if these weights would be stable over time.

Now, by this new measure, monetary policy has been tight. In fact, the money supply is no higher today than in early 2008.

Uncertainty and the Keynesians

by Chidem Kurdas

At the current economic juncture two camps offer diametrically opposed macro policy prescriptions. Economists on the Keynesian side such as Joseph Stiglitz and Paul Krugman advocate further monetary easing by the Federal Reserve and massive new federal deficit spending. The opposing camp includes Austrians and monetarists. Among its distinguished members is Allan Meltzer, who in a recent Wall Street Journal op-ed column argues against monetary stimulus and favors reduced government spending.

These correspond to two ways of understanding the sluggishness of the US economy,  explanations based on different time horizons

European Austerity in Perspective

by Chidem Kurdas

Attempts to rein in government spending necessarily have unpleasant side effects.  Thus the Dutch government collapsed amid budget talks to control the deficit.   And British national output appears to be shrinking.

Keynesians and advocates of the Obama administration’s colossal budget see this as vindication for unrestrained government spending. But in fact what we see in Europe is a very unfortunate consequence of past unrestrained spending.

Supply and Demand in Music

by Edward Peter Stringham*

Many economists are criticized for being unable to communicate their ideas in am intelligible and non-boring way. How many people, for example, jump to listen about a debate about the Austrian theory of the business cycle? It turns out quite a lot. John Papola and Russ Roberts demonstrated to the world that lots people will actually listen to an economics discussion if presented in an interesting way.  Their videos recently surpassed 4.5. million views. They did an amazing job especially with their good casting decisions for the reporter at the end of the second video.

This year I decided to run a video contest for students to create music videos that help illustrate the laws of supply and demand.

Keynes, the Future and Present Austerity

by Chidem Kurdas

In 1930, John Maynard Keynes dashed off an amazing prophecy. Extrapolating from the productivity gains of the past centuries, he came to the bold conclusion that the fundamental economic problem of scarcity would fade away in 100 years or so. Thanks to technological innovation and the accumulation of capital, the ancient condition of limited resources to satisfy competing wants would give way to a new age of plenty. Human beings would then face a very different quandary, namely what to do with themselves once they no longer have to work in order to survive.

Eighty-one years into the timeline Keynes suggested in his article, “Economic Possibilities for Our Grandchildren,” scarcity shows no sign of disappearing. Where did he go wrong?

“A Divine Miracle”

by Jerry O’Driscoll  

In the August 24^th 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.”

“Keynesian Death Spiral”

by Jerry O’Driscoll  

In Wednesday’s Wall Street Journal, Kevin Hassett explains the economic logic against fiscal stimulus (“Stimulus Optimists vs. Economic Reality”). It’s a superb piece.

The more powerful one believes fiscal stimulus to be, the more adept the Keynesian policymaker must be. If the stimulus has powerful positive effects when added, it will have powerful negative effects when withdrawn. Hence, the application of stimulus and its withdrawal must be precisely timed. An economist would ask from whence the knowledge to do this would come.

As Hassett notes, however, stimulus has not two but three stages. It may boost growth when added, but must slow growth when withdrawn. The third stage comes when taxes (current or future) must be paid to fund the stimulus. That stage is always negative in its effects. Thus, Hassett concludes that “the total impact of the Keynesian policy is negative over its life.”

The case for fiscal stimulus is even weaker in the aftermath of a major financial crisis, such as we have experienced. Downturns, measured by employment, are longer in the wake of such crises. Hassett cites the Reinhart and Rogoff estimate of an average duration of 4.8 years. Short-term stimulus becomes very problematic in the wake of such crises.

 “…Aggressive stimulus sets off a kind of Keynesian death spiral in which nervous politicians adopt repeated stimulus packages in order to avert near-term distress, the cumulative effect of which can be ruinous.”

(Though Hassett does not note it, Keynes was aware of the problem. He described it as the bismuth/castor oil cycle. The patient inevitably dies.)

Hassett’s analysis fits the current situation very well.

George Soros, F.A. Hayek, and The Constitution of Liberty

by Mario Rizzo

I think George Soros is a good man. To me he seems like a person who wants to make the world a better place. He, like Keynes, is against comprehensive economic planning (ambiguities about “planning” noted) but thinks that financial markets are inherently unstable and thus must be regulated by a nimble or flexible regulator.

I was at a forum last Thursday at the Cato Institute in Washington, DC in which Ronald Hamowy, Bruce Caldwell, Richard Epstein, and George Soros ostensibly discussed F.A. Hayek’s The Constitution of Liberty (the new, definitive edition). This post is not meant as a report of the event. I am not a reporter. However, I want to focus on a number of points that Soros made about Hayek’s views. I hope this will clarify some sources of misunderstanding about Hayek that may be quite common in some quarters.

Keynes Versus Hayek: An Empirical Matter

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?

Hayek and Keynes Debating in Wonderland

by Thomas McQuade

Here’s what Alice might have recited to the Caterpillar, had Charles Dodgson been a 20th century economist of sorts:

You are old, Maynard Keynes, and your theory’s askew,
It’s easy for one to see through it –
Yet everyone thinks that you’ve said something new.
Just how did you manage to do it?

In my youth, said the sage, I dabbled in stock,
For serious profits contesting,
And it wasn’t too long but I saw what a crock
Was the classical take on investing.

Brad DeLong Should Read More

by Mario Rizzo  

In March of this year Brad DeLong wrote a post called “More from the History of Economic Thought: John Stuart Mill Contra Say’s Law, 1844”  

It contained a long quotation from John Stuart Mill from his essay “Of the Influence of Consumption on Production,” in Some Unsettled Questions of Political Economy (1844, but written in 1829/30). The quotation purports to show that even John Stuart Mill did not believe “Say’s Law.” However, DeLong leaves out the three final paragraphs of the article. (I append them at the conclusion of this post. The italics are mine.)  

These paragraphs make clear that to say “there cannot be excessive production of commodities in general” is not to say that depressions are impossible. Mill makes clear that this is a wrong interpretation of Say’s Law: “[I]t in no way contradicts those obvious facts.” Furthermore, Mill says that the deniers of general overproduction have never claimed otherwise.  

The only meaning of a general “excess” of commodities that makes sense is a fall of their value relative to money.  In other words, people might want to hold more money as a proportion of their income. Say’s Law does not exclude this.  

What is does exclude is the possibility that production of wealth might not create the potential to demand it. In other words, we need not worry about deficient demand when commodities are produced in the proportions desired by consumers.  

The Second Austrian Moment

by Mario Rizzo  

This is an important time for Austrians. During the Great Depression and for many years thereafter, J.M. Keynes and his followers dominated macroeconomic theory (some say they created it) as well as the conventional wisdom about the historical lessons of the Depression and the New Deal.  

We are now witnessing many important developments that will affect economics and public perceptions for a long time to come.

Keynes on Confidence

by Jerry O’Driscoll  

Amity Shlaes has written an enlightening op ed on “FDR, Obama and ‘Confidence’” in today’s Wall Street Journal. She details how FDR destroyed investor confidence in the 1930s by his incessant attacks on business and businessmen, and by his policy inconsistency.

Treasury Secretary Morgenthau at first served as FDRs “yes” man and cheerleader.  But he came to realize how destabilizing FDRs actions were. The Treasury Secretary began resisting his boss’s policies.  She writes that Morgenthau “found an unlikely supporter” in John Maynard Keynes. Keynes wrote a critical letter to FDR about his persecution of utilities. “What’s the object of chasing them around the lot every other week?”

Market confidence returned when FDR concluded he needed to make allies of business once he decided he needed to plan for war. She concludes: “Perhaps Mr. Geithner might like to read up on Morgenthau’s progress.  Treasury secretaries who forget the past condemn us all to repeat it.”

Still Hearing Defunct Economists in the Air: Krugman’s Misplaced Attack on Hayek

by Richard Ebeling*  On July 9th, Nobel economist and New York Times columnist, Paul Krugman, gave his read on the recently unearthed letters between J. M. Keynes and F. A. Hayek in the London Times in October 1932, which have been posted and discussed on ThinkMarkets. (and in the Wall Street Journal). Krugman insists that Hayek is worse than he thought and that Keynes was better than he imagined. He attacks Hayek for insisting that the best cure for recovering from the Great Depression would be to free up markets both domestically and internationally, and to rein in government spending. This, Hayek said, would create the political and fiscal environment that would foster a positive private sector return to a job generating rebalancing of supply and demand, and a sustainable investment climate. Not surprisingly, Krugman instead, hails Keynes as the advocate of fiscal stimulus that would “prime the pump” through deficit spending and government sponsored job creation. He thinks it is all a great tragedy that the same battle has to be fought all over again for sound Keynesian policies, nearly eighty years after the exchange of these letters. But what, instead, is Krugman missing?

F.A. Hayek and Tyler Cowen

Do we have more evidence of the continuing great debate between Hayek and Keynes?

In the now “famous” 1932 letter to The Times of London signed by F.A. Hayek, Lionel Robbins, T. E. Gregory and Arnold Plant, we read: 

The signatories of the letter referred to [by Keynes, Pigou et al.], however, appear to deprecate the purchase of existing securities on the ground that there is no guarantee that the money will find its way into real investment.  We cannot endorse this view.  Under modern conditions the security markets are an indispensable part of the mechanism of investment.  A rise in the value of old securities is an indispensable preliminary to the flotation of new issues.  The existence of a lag between the revival in old securities and revival elsewhere is not questioned.  But we should regard it as little short of a disaster if the public should infer from what has been said that the purchase of existing securities and the placing of deposits in building societies, etc., were at the present time contrary to public interest or that the sale of securities or the withdrawal of such deposits would assist the coming recovery.  It is perilous in the extreme to say anything which may still further weaken the habit of private saving.

And now we read Tyler Cowen at Marginal Revolution who is discussing the alleged problem of too much corporate saving: 

Hayek versus Keynes in the Wall Street Journal

by Mario Rizzo

The discussion of the Hayek-Keynes letters of 1932 in The Times of London continues in 2010 in the Wall Street Journal in today’s issue. The opinion piece is by Jerry O’Driscoll, a frequent blogger at ThinkMarkets.

My previous TM discussion is here.

Update: For the ungated version of the WSJ article, place the title of the article in quotes in Google. The title is: “Keynes vs. Hayek: The Great Debate Continues.”

Keynes versus Hayek: Past is Prologue

KEYNES HAYEK 1932 Cambridge vs.LSE

by Mario Rizzo  

My friend economist Richard Ebeling has discovered two extremely important letters. (Click the link above.)

In 1932 before John Maynard Keynes’s General Theory was written, these letters appeared in The Times of London regarding the appropriate economic policies for Britain to follow during the slump.  

There are a number of things that catch the eye.

“In the Long Run We Are All Dead” What Does It Mean?

by Mario Rizzo 

Paul Krugman continues to invoke Keynes’s famous statement. I wish Krugman and others would give some serious thought about what it is supposed to mean and the errors it involves.   

In the first place, Keynes was complaining about the “classical” economics, that is, the ideas of the economists before him who believed that the market, if unhampered after a recession, could reduce or eliminate the unemployment associated with the business cycle.  

Of course, this puts many economists – with different ideas – in the same category and treats the issue of cyclical unemployment in a grossly simplified way. But this, in general, is how Keynes treated those who disagreed with him. Keynes, the polemicist, was without inhibition. 

Some basic methodology is in order. When economists talk about “the long run” they do not mean calendar time. Yes, that’s right.

The Fed’s Coming Indiscretion?

by Mario Rizzo  

There seems to be broad agreement among economists that the current recovery from the recession will be characterized by a slowly falling unemployment rate. This makes a good deal of sense since the problem that created the recession was a misdirection of resources into a number of sectors including housing construction and the financial industry.  

Reallocation of resources takes time. The government is not helping matters in trying to prevent adjustments by various (but not very successful) efforts to slow or reverse the rate of fall in housing prices. It is also difficult for market participants to determine the effect of possible new policies like Obamacare or any further jobs-stimulus legislation.  

Keynes on the Bismuth — Castor Oil Cycle

by Jerry O’Driscoll     J. M. Keynes was well-aware of the problems of conducting counter-cyclical policy to stabilize employment.   The problem is when to add stimulus, when to withdraw it, and not to overdo it.    In Keynes’ Treatise on Money (1930), Keynes analogizes it to a family taking care of a sick child with doses of castor oil, a laxative. “It is as though different members of the family were to give successive doses to the child, each in ignorance of the doses given by the others. The child will be very ill.  Bismuth [an antidiarrheal] will then be administered on the same principle.

Pigou is the new Keynes

by Sandy Ikeda

A full-page article in today’s Wall Street Jounal begins:

At the Heavenly Models home for deceased economists, an award is being presented to the resident whose work best explains financial crises, global warming, and other pressing issues of today.

The winner, according to author John Cassidy, is A.C. Pigou, the new flavor of the day.

The article implies that Pigou was the first to articulate the concepts of externalities and market failure.  I’m not sure that’s right, though I haven’t gotten around to reading The Economics of Welfare, but I believe we do have to credit him with the Pigou tax.  So in some ways he’s been almost as dangerous as his “smarter colleague,” although I’ve always felt sympathy for someone who was so much in Keynes’s shadow.

The article also has a sidebar quoting Mises (as well as Friedman, Kindleberger, and of course Keynes) apparently calling last year’s economic crisis.

The New Interventionist Economics

by Roger Koppl

Two recent posts on this blog (here and here) raise the issue of animal spirits and where macro is headed.  I’ve recently completed a draft manuscript saying we are headed for “BRACE” economics.  I say the “New Interventionist Economics” will be characterized by five features:

Bubbles

Radical Uncertainty

Animal Spirits

Complexity Dynamics

Extra-Market Control

(giving the BRACE acronym).

Animal Spirits

by Jerry O’Driscoll

In a previous post, Mario Rizzo reminds us that Keynes was concerned with the volatility of investment.  Keynes was not alone.  By the dawn of the 20^th century, virtually every significant business cycle theorist viewed the volatility of investment as the central theoretical problem.

In the General Theory, Keynes (p. 149) posed the problem as follows: “The outstanding fact is the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made.” It quickly becomes clear that Keynes means “expectations,” not knowledge.  And investment is not governed by “the genuine expectations of the professional entrepreneur” (p.151).