Thoughts on economics and liberty

Tag: Keynesianism

The melting pot of the world is now ready for a MASSIVE melt down

This article in The Australian today is mind-boggling. If true (and I have no reason to doubt the facts it cites), then the world is in for a huge shock in the coming years. Maybe sooner than we anticipate. Imagine if USA became Greece. Imagine if USA became USSR (which it is perilously close to becoming, due to an endless surge of socialist policies).

I'd not touch the US dollar with a broomstick. Sell the Bernanke Ponzi scheme before it bites you.

Drowning in debt: US crisis lurches closer
by: Satyajit Das, October 29, 2012

Whoever wakes up in the White House after the inauguration ball will have to soberly confront the ugly reality of US government's debt levels, which totals about $US16 trillion ($15.4 trillion). There are other current and contingent commitments not explicitly included in the debt figures: US government support for Freddie Mac and Fannie Mae, government-sponsored enterprises of more than $US5 trillion, and unfunded obligations of more than $US65 trillion for programs such as Medicare, Medicaid and Social Security. US state governments and municipalities have more debt, about $US3 trillion. [Sanjeev: this comes to around $88 trillion.]

Federal Reserve chairman Ben Bernanke told the house financial services committee the US faces a debt crisis: "It's not something that is 10 years away. It affects the markets currently. It is possible that the bond market will become worried about the sustainability (of deficits over $US1 trillion) and we may find ourselves facing higher interest rates even today."

Given 45 per cent of households do not pay tax and 3 per cent of taxpayers contribute about 52 per cent of total tax revenues, a major overhaul of the taxation system would be necessary.

Successive US administrations have sought to avoid dealing with the US debt problem. But as English writer Aldous Huxley observed: "Facts do not cease to exist because they are ignored."

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“I am not, nor will I ever be, a Keynesian”. And I agree.

I came across Richard Epstein’s article in Spring 2010 edition of the Harvard Journal of Law & Public Policy, entitled, ‘Why I will never be a Keynesian’. Fortunately, this article is publicly available in full, so please read it.


Fortunately, it is not necessary to plow through Keynes in order to get some sense of his basic position. I come away from reading the new Keynesians more convinced than ever that they lack a coherent diagnosis of the origins and depths of the Depression. By implication, they lack a sensible program to shake the current economic malaise.

Any centralized effort to rejigger aggregate levels of consumption or savings will only make the task of economic recovery more perilous. The key move is to eliminate waste so as to allow both savings and consumption to expand.

Notwithstanding Keynes’s doubts on the subject, vibrant international trade is clearly important to the overall health of the economy today, and it was also important (albeit at a smaller level) when transportation and communications costs were higher during the Depression. His general theory neglected to warn against misguided government interventions, which are easily condemned within the standard neoclassical framework.
Posner seeks to find a larger space for public investment in a downturn by declaring that “[an a]mbitious public-works program can be a confidence builder,” seeking to tap into Keynes’s explanation of how the government can promote the “return of confidence.” But the argument ignores the obvious indignant response that a poorly run government program can destroy confidence and further demoralize businesses who think that higher taxes will snatch away the fruits of their efforts.
The motivations of individuals arenot amenable to public intervention, but the rules that either shackle or encourage innovation are. Figuring out what these are, and how they relate to the current malaise is difficult. One need only look to the ever greater threats to solvency in Medicare, Medicaid, and Social Security to realize that incremental changes and adjustments can produce long‐term effects. The same can be said about the accumulated public pension liabilities that are now the norm in states like New York and California, owing to the enormous strength of their public unions. My own sense, therefore, is that we must start dismantling these programs if we as a nation are to get out of the long‐term stagflation (or inflation?) that is our due. The Keynesians have little distinct to say about this dilemma. Nor, in the end, do they have much useful to say about the issues of employment, consumption, investment, and savings that lie at the core of their theory.
We start with the brutal truth that production and consumption do not move in lockstep progression over time. In the agricultural realm, the common insight is that the individual must decide what portion of the crop to consume today, what to save and to consume in winter, and what to keep as seed corn to plant for the next year’s crop. “Do not eat your seed corn” has a descriptive as well as metaphorical meaning. Essentially the individual makes the choice in terms of discounted present value, which inclines one weakly toward present consumption. But the desire to equalize consumption in all states of the world pushes strongly toward savings and investment. At this point the individual problem looks like the one that Milton Friedman addressed in dealing with his permanent income hypothesis in the absence of trade. In periods of slack production, the individual will consume some of his store of savings; in periods of abundant production, he will replenish the stores. The objective is to even out consumption in the face of variable production.
The next stage in the model asks what happens when we introduce the possibility of trade. At this point speaking about money as a means of exchange makes sense, and the question is how any group of individuals exploits the prospects for gains from trade. The answer, straight from Adam Smith, is through specialization. The decision to put money into a savings account or a debt instrument represents the choice to take a low but secure rate of return. Not all individuals will prefer that option, which in turn creates the opportunity for additional gains from trade by having those banks that receive their deposits lend money out to others for a higher rate of interest that compensates for the additional risk. The bank then seeks to minimize this risk by a range of good practices that include due diligence at the one end and the receipt of appropriate real security or personal guarantees at the other.
This division of labor seems desirable.
Nor is there any reason to worry that this investment will reduce aggregate consumption below the appropriate level any more than there is reason to fear that it will raise it above the appropriate level. In the case of the individual who has to deploy his assets over time, there is no one formula that indicates how much he should consume in the first period or save for each future period. A lot depends on present and future labor skills, levels of accumulated capital, and estimation of future personal needs and social conditions. Similarly, on the trade front, there is no reason to fret if some individuals decide to save more and consume less, and others do the opposite.
In dealing with this question, the wrong approach is to buy into the Keynesian emphasis on “aggregates,” whether for consumption, savings, investment, or anything else. This collective obsession is sure to take us down the road to national industrial policy in which we think that we can name some form of collective decision about which sectors and which firms should receive government largesse.
What is there to fear if governments do not seek to tweak these aggregates, but just let each individual decide for himself how much to save and how much to spend? As people will all be at different stages of their own life cycles, we should expect these decisions to be all over the lot.
But who cares about the supposed social implications of these private acts? If I decide to save everything I have above subsistence level, it does not mean that overall savings levels will go up. The amount that I invest may lower the overall rate of return on investment, which could easily encourage others to shift toward consumptive activity. In addition, my dollars when invested get paid out to other individuals, for example, workmen in construction, who then make their own decisions as to how much to consume or to save. We cannot, therefore, draw any inference as to the total level of savings by just watching the herky-jerky movements of any one individual. We have to look at them all.
Should we be concerned with these choices because of the supposed multiplier effect gained from present consumption? Not really. The decision to save counts as deferred consumption, which has its own multiplier effect. Here it is best to drop the term and just substitute for multiplier effect the traditional concern with gains from trade through voluntary transactions, which typically have positive external effects by creating additional opportunities for others.
As one person saves the other invests in long term projects with borrowed capital. The key point is that stable expectations require enforceable contracts and steady and predictable price levels. So long as each person makes informed trades, each of these contracts over time should be a positive sum.
Reduce the transaction costs in good Coasean style by supporting stable property relationships and the temporal consumption issue will take care of itself in the same way that all such allocations take care of themselves.
In the end, I can see nothing distinctive in Keynesian theory that advances our understanding of economics.
The real task is to figure out the right set of property rights that will give individuals incentives to make the right personal choices. Sound institutions will boost confidence across the board and encourage investment so long as no one has to factor into the equation the huge levels of gratuitous uncertainty that stem from useless government intervention.
But the purpose of government is not to eliminate all the uncertainties of nature and politics. It is to not add to the confusion by creating baroque structures of taxation, regulation, and government spending that add fresh layers of uncertainty through mechanisms that expend real resources in order to reduce social output. One does not have to be a Keynesian to know that the sum of three negatives (administrative cost, allocative distortions, and unneeded uncertainty) is always negative, no matter what their relative proportions. Getting out of the gimmick business will do more good than all the bogus short-term stimulus packages that muddle-headed or devious politicians can generate. We do not want government to do nothing, but we do not want it to do something stupid either. The presumption remains: Government intervention is bad until shown to be good. For that reason I am not, nor will I ever be, a Keynesian.

Also see Steve Horwitz’s recent, short, and very crisp rebuttal of Keynesianism

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Meghnad Desai, from the Labour (Fabian Socialist) Party – no less, decries Keynes’s ideas

Meghnad Desai (formerly of the London School of Economics) spoke at the Melbourne University a few years ago. I came out feeling that he was a sensible person, despite being a Fabian Socialist (Labour Party member).

Today he has come out against Keynesian stimuli. Extracts below. The original article is available here.

Meghnad Desai
Jul 30, 2012

The US is barely managing to keep its head above the water despite having freedom to print money and a large fiscal package earlier in the Obama administration. Now, with four months to go before the election, there will not be any further stimulus.

Keynesian economics is a delusion, and hopes of a return to sustained growth a mirage. Keynesian theory is for a closed economy where the government can print money to pay its debts. The creditors are citizens of the same country—rentiers, as they are pejoratively called—and it is assumed that they can be squeezed. Keynes wanted to drive interest rates to zero as he was worried about excess savings.

Keynes also wrote a model in which output did not matter; only expenditure did. Demand will create its own supply, reversing the Classical adage that supply will create its own demand. Employment could be created by hiring workers to dig holes and fill them up. Thus, wages were the key, not output produced by workers. Investment is important more as expenditure; its effect on future output is ignored in the General Theory.

A whole generation grew up thinking all one had to do was to keep spending up and growth would follow.

Even the Monetarists—New Classical economists—did not demur from this. New Classicals operate on full employment assumptions; productivity is a ‘shock’ and beyond policy. So, they too don’t care about output.

Western economies went on for a while thanks to new innovations, baby boom and unfulfilled demand for goods after the War.

There was a switch to services, which sparked another boom in the 1990s. This was based on excess spending, negative savings and large borrowings from Asia. Output growth was mainly in services; trade deficits could be financed by capital inflows. But these creditors are foreign ones.

That credit-fuelled boom having now collapsed, there is no way out for western economies except a hard slog. Policies like QE, which lower interest rates, are exactly the wrong policies. Any attempt to ease the pain will prolong the agony.

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Why is Keynesianism so popular among “economists”?

Saurabh has asked a good question: Why is Keynesianism so popular?

Here's my attempted response. Happy to receive any other thoughts.


Keynesianism has the advantage of providing mathematical “tools” that can be used to “understand” the macroeconomy. Whereas the classicals debated issues on the basis of reason, Keynesianism brought in mathematics. Keynes himself brought in very elementary maths, but his followers expanded this “toolkit”.

People like Hayek and Mises (and Rand) would dispute the role of maths in economics, given we don’t understand the underlying dynamics of any “variable”.

Imagine saying c=w+s (i.e. climate = wind plus sun) or some such “macro” mumbo-jumbo. No scientist would come anywhere near such formulation but Keynesianism uses many such formulations to represent the ENTIRE society. Then it goes very, very wrong.

But the use of maths made Keynesianism very attractive to many “smart” people. They thought that economics had “arrived”.

The rebuttal of Keynesianism came through another set of maths – the micro-foundations of the economy (Lucas, etc). But this could not bring in the fine-grained complexity of human behaviour into play, either.

All mathematical approaches to “macro” economics are doomed to fail since there is no way known to mankind to model the behaviour of billions of humans, taken as a whole.

A typical example is the Philips curve which seemed to, at some level, support Keynesian hypotheses empirically, but then failed, entirely. It was just luck that some variables “lined up” for a while.

But given the assertions of Keynesian economics, and its claim that the government can DO something about every economic “issue”, it remains the most heavily used “tool” in economics.

The world is run by “intelligent” quacks.

You can’t stop the continued use of Keynesian economics until economists are taught the complexity of the world and asked to step back and think through human incentives. That’s unlikely to happen, since teaching maths is easy. Teaching complexity is hard.


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