Wednesday, April 6, 2011

Are we in a "liquidity trap"?

Paul Krugman insists that at the present time, the economy is in what Keynesians call a "liquidity trap," so the ONLY policy that will set the economy back on a boom track is massive government spending. In my Wednesday column for the Freeman Online, take on that point:

Some economists claim the economy is in a Keynesian liquidity trap, which makes it a special case calling for “unorthodox” policies. Paul Krugman writes:
I know that some people find this hard to understand — perhaps because they don’t want to understand — but people like me have never claimed that fiscal expansion is always and everywhere the right policy, even in response to recession…. All of the unorthodox policy recommendations and conclusions are contingent on the economy being in a liquidity trap, in which short-run nominal interest rates are up against the zero lower bound and can’t go lower.

And liquidity-trap conditions are rare; in fact, they’ve only happened twice in US history. Unfortunately, we’re living in one of those episodes right now.

Well, are we in a liquidity trap? And does the present situation require constant bursts of government spending?

Read the rest of the column


burkll13 said...

Whenever the topic of liquidity traps come up, i always picture scrooge mcduck swimming around in his giant money silo. thats all i could think of when my macro teacher tried to explain it to the class.

Bob Roddis said...

In only one sense is there really such a thing as “the liquidity trap”: It’s that short period of time when people are no longer so stupid that they will unthinkingly borrow more funny money because, as the Keynesian-bust ensues, potential deflation means they might have to pay back more than the face value of their loan in real terms. Because “the printing money” by “the Ben Bernank” is engine that drives the Krugmanite world, this is seen as a horrible crisis. Thus, according to Krugman, spendthrift spending must ensue to give the economy the “traction” it needs in lieu of funny money dilution which won't work in the short run. It never occurs to Krugman that economies don’t have or need “traction” or, that like “the printing money”, government spending is problematic.

Jonathan Finegold Catalan applies Austrian concepts to government spending in this excellent new article:

Mike M said...

“I know Mr. Krugman and company finds this hard to understand – perhaps because they don’t want to understand…”
It’s not a liquidity problem; it’s a debt problem in relationship to income. You can’t solve a solvency problem with liquidity. By the way even if this was a liquidity problem, the US Government knows nothing but perpetual fiscal expansion. The concept of temporary fiscal expansion is alien to them.

Mike M said...

Unbelievable! Krugman basically says we would be good little socialists in America if we weren’t racists.
Can we please stop taking this guy seriously?

Bob Roddis said...

Our crazy aunt in the attic, Lord Keynes, still has his blog. He writes:

Maybe there is a solution to the contradictions, absurdities, and mountains of empirical evidence against neoclassical and Austrian economics.

The answer: magic dust.

But since LK never demonstrated the slightest familiarity with any Austrian concepts, I fail to understand how he could make such a statement.

In his next most recent post, LK tries to tie Mises to Dollfuss, the Austrian corporatist dictator who was murdered by local Nazis in 1934 AFTER Mises left Austrian for Geneva.

Will said...

A question I often use with my residents to distinguish actual reasoning from ideology. For the Austrians- what would it take to prove the theory incorrect in your mind? What data would it take?

My issue with Austrian economics is that it seems like folk medicine- you can make the arguments fit any situation.

burkll13 said...

ill tell you what, will, when we stop getting rather specific, predictable results from Keynesian behavior, ill reconsider the validity.
it seems to me that you think that Austrians always have a way out. in other words, no matter what happens, theres an excuse. But that thought could not be more wrong. Keynesians, on the other hand, always have an excuse. when it doesnt work, it should have been more, or in a different way, etc. theres almost no thought that the theory behind it is faulty. And its not as if Austrians are shying away from debate. they are marginalized, slandered, and/or ignored at almost every turn. Austrians want an open, honest, intellectual debate.

but if you want a homework assignment on what would 'open up my eyes', ill give it to you. Disprove the broken window fallacy. im all ears (so to speak), and if you can do that, it will make me reconsider my entire economic foundation.

Bob Roddis said...

you can make the arguments fit any situation

That’s pretty much correct. Human action is invariable and universal. Austrian analysis is based upon WHAT IS NOT KNOWN AND WHAT CANNOT BE KNOWN BY HUMAN BEINGS. We get pretty cocky about understanding what cannot be known. With any set of facts, we will immediately focus upon how the statists have interfered with the essential information communication system. Then the statists and non-Austrians show up and without having the faintest idea about any of our basic concepts, start the name-calling and infer that they have the knowledge that we say no one can have. But because they are such incoherent hysterical anti-intellectuals, they fail to understand the even nature of the argument. Usually, they just bring up some historical event out of context as if that could possibly establish basic economic laws.

What would it take for just one statist to actually bother to familiarize themselves with basic Austrian concepts like acting man, subjective value and the problems of economic calculation? Either these statists are dumber than the family poodle or we aren't making ourselves clear. I don't know what could be more clear:

Will said...

First, I'm not an economist, and am not particularly married to any given economic theory. I ask questions here about Austrian concepts because thats who frequents here.

So burkll13, what counts as a "disproof" of the broken window fallacy? If Japan ends its economic malaise in the wake of the current tragedy would that count?

Bob Roddis- so basically you agree my suggestion that no matter what happens in the US, or any economy, one could make an Austrian argument for why it happened? Doesn't this diminish the utility of the theory?

To answer my own question, all cards on the table and whatnot, there are lots of things that would make me lean towards a more Austrian framework. If the US starts to have hyperinflation, I will admit my understanding of money is wrong. If a big spending cut gets pushed through in this latest budget and the economy expands, I'll admit my understanding of macro principles is wrong. If the spending curve for medicare doesn't slow in the next 10 years (assuming the new healthcare law isn't repealed), I'll admit my understanding of health care economics is wrong. In short, there are lots of things that can convince me I'm wrong, in which case I'll gladly change position.

Bob Roddis said...

so basically you agree my suggestion that no matter what happens in the US, or any economy, one could make an Austrian argument for why it happened? Doesn't this diminish the utility of the theory?

No. Here, there is an implicit attack on both basic Austrian principles (OMG, you have AXIOMS!!, whatever they might be) and methodology (do you really think you can apply those axioms [unnamed, of course] to all human behavior?) without ever mentioning what those even are. A horse race involves horses. The “economy” involves people and “human action”. Always. Immutable, invariable truths. If you bothered to understand the axioms, you would see how they MUST always apply when studying human action.

2. One cannot establish economic principles by examining historical data. Further, cutting a $1.6 trillion deficit by $100 billion is not a lab test of anything.

3. There is really no such “thing” as macro. MMT guru Bill Mitchell claims:

"The general reasoning failure that occurs when one tries to apply logic that might operate at a micro level to the macro level is called the fallacy of composition."

This is absolute nonsense and the basis for most Keynesian chicanery. The natural and immutable economic laws and principles that apply to households and small businesses apply exactly the same to government and the fiat money hoax.

4. Jonathan Finegold Catalan explains the a) “liquidity trap“:

b) Government spending from an Austrian standpoint (there is no such thing as “traction“):

and c) And the bad alleged lessons of 1937:

Bob Roddis said...

Speaking of “axioms”, why don’t the Keynesians admit that they have a bunch of axioms too, but which aren’t true, really don’t exist and which Austrian theory exposes as nonsense. Further, Keynesian axioms are based upon a pretext of knowledge which Keynesian do not and cannot have. Here are some Keynesian “axioms”:

1. There is a separate world, universe and logic of macro.

2. “Aggregate demand” really exists as a thing in the universe, as opposed to a data collection category that may or may not be helpful in analysis.

3. Economies can have and lack “traction”. Money dilution and government spending can and do provide such traction which would not exist without such “help”.

4. “Spending”, “capital”, “investment” and “labor” are generic and homogenous. Spending a certain sum of money subsidizing unemployed factory workers to buy sausage and cheese sandwiches and get lap dances at sleazy Detroit bars is exactly the same as spending money successfully teaching them to be expert organic vegetable gardeners and organic vegetable chefs.

5. A bureaucrat can know what the interest rate should be and can actually set it at the proper rate.

Will said...

Bob, I feel like you aren't addressing my question. I'm not here to defend any economic theory, I'm hear to learn.

I understand that Austrian economics starts from axioms, but any argument must be developed from those axioms. Even with valid axioms, those arguments can be wrong. You haven't really directly addressed the question- is there any observation that would cause a reconsideration of Austrian economics?

Mike M said...

Will, I sense you are looking for some type of economic nirvana. It doesn’t exist. Austrian economics has flaws because it is a framework created by human beings which are inherently flawed. The real question should be not what abstract observation would cause reconsideration but rather, what economic theory withstands the scrutiny of logic, reason and real world human experience. I have yet to be convinced of any other theory other than the Austrian school being able to do that.

Keynesian theory (particularly the current practice) is a shill for the statists. It gives them cover to practice their abuses on the masses that are woefully ignorant of economics due to the pathetic public education system in this category. Interesting to note that while the public understanding of these matters is weak, their gut instinct is usually good and is perhaps the genesis of the Tea Party movement.

Bob Roddis said...

Even with valid axioms, those arguments can be wrong.

I agree. One must engage in a thorough factual analysis of what is going on in the world and apply the axioms to those facts. It's quite possible to misconstrue facts in the world. For example, assuming that hyper-inflation was just around the corner due to increased reserves when the reserves weren't entering the market was a fact-based error. The fact that money dilution will TEND to cause errors in calculation does not mean that one can easily predict exactly where those errors will occur before the fact. Life is complex and human beings are unpredictable.

At the same time, if Keynesians have problems with basic Austrian axioms, I have been beseeching them to explain those problems. That never happens. Invariably, all statist critiques of Austrians take the form of quibbles about some historical problem or event taken out of context by the statist and where the problem certainly could not be blamed on prior use of Rothbardian principles.

1937 is one such Keynesian quibble and which has been answered by Mr. Catalan.

Will said...

"The real question should be not what abstract observation would cause reconsideration but rather, what economic theory withstands the scrutiny of logic, reason and real world human experience."

Logic only gets you so far- lots of logically sound arguments lead to bad conclusions, especially in complicated systems. Thats why I think its important to check your work against actual real world indicators.

Also, arguing from real-world-human-experience tends to lead to trouble. Everyone has different experiences.

I find this idea that there is literally nothing that could happen to make practitioners rethink Austrian economics to be very troubling. Maybe its better to think of the Austrians as moralists rather than economists?

Bob Roddis said...

Here's what could make me rethink Austrian economics: Find me an omniscient person who can read all other peoples’ minds and knows and completely understands their hopes and dreams verbatim. As in, “Here’s that person who knows all the things you say can’t be known.” A walking talking human God. The Magic Bureaucrat.

This little mind experiment about what it might take to refute Austrianism is getting pointless. If you have a problem with Austrian axioms, explicitly say so. Demonstrate that a ball (or your wife) can be in two places at one time. Go for it. After 38 years of being an Austrian and having never heard a single non-Austrian demonstrate familiarity, much less a refutation of those axioms, what exactly am I supposed to do?

This endless theorizing about these axioms without even knowing what they are is truly a waste of everyone’s time.

Bob Roddis said...

If the Keynesians know so much, why don't they simply go through the Austrian argument line by line and refute it? Why the name-calling and why the perpetual aversion to examining the basic concepts?

Then PROVE there really is an alternative universe of macro. If people’s values are objective and not subjective, prove it. If the Keynesian can indeed measure other peoples’ values with a ray gun, orgasmatron machine or whatever, show us. Then translate those values into numbers that can be punched into math formulae and predict the future with the same certainty as predicting the temperature at which water freezes.

We are really open to having this debate. Really.

Will said...

First, I am not a Keynsian economist, I never claimed to be. You insist on dividing the world between Austrians and Keynsians, but there is a huge spectrum in between.

I have no problem with a theory built on axioms, what I do have a problem with is a theory that isn't open to the possibility of being wrong. History is literred with dead theories built on perfectly reasonable axioms. Galen's medicine and Aristotle's science come to mind. In both cases, empiricism is what did the theories in.

If any event can be fit into an Austrian framework, then it has no real explanatory power. To explain everything is ultimately to explain nothing.

Mike M said...

“Logic only gets you so far- lots of logically sound arguments lead to bad conclusions, especially in complicated systems.”
Not if you continually check its premise. Logic and reason is what separates human beings from the rest of the world.

“arguing from real-world-human-experience tends to lead to trouble”
And the alternative would be what? Arguing from a delusional world experience? That is what the dependent class is now doing failing to recognize our fiscal reality.

“Everyone has different experiences”
Obvious observation but without a point. The fact supports that macro economics is an artificial construct. There is only collective micro economics.

“I find this idea that there is literally nothing that could happen to make practitioners rethink Austrian economics to be very troubling”
I don’t believe that is what anyone here is saying. Show the Austrians something better and using logic and reason the intelligent ones will accept. Has not been done to date.

If by moralists you mean advocating an economic system grounded in liberty and sovereignty of the individual, then guilty as charged.

Will said...

Mike, my point is NOT that the premises are flawed. Its that lots of logical arguments make implicit assumptions that break down, or go wrong in some other ways. Its not enough to check premises, you have to be wiling to check conclusions!

If there is no way to check your conclusions your theory isn't even wrong.

Mike Cheel said...

Regardless of what your economic belief is, at least I think it should be obvious that the government and federal policies are not in place to benefit the average person.

Further, it should be obvious that the things that they are doing are not helping anything get better, only stalling the inevitable.

Typically doing more of the same gets you more of the same.

Anonymous said...


You must have serious problems with Mathematics. It's conclusions aren't falsifiable based on evidence either.


Will said...

Math is a set of abstract, self-consistent rules. It has no bearing on the real world, and makes no claim to. The branch of mathematics that DOES describe the world (physics) is constantly being verified.

Unlike mathematics, economics purports to describe the world. Hopefully you see the difference.

Anonymous said...

So the next time you place 2 sticks of length 3m and 4m at right angles to each other with one end of one stick touching one end of the other stick and you find that the distance between the other 2 ends is not 5m, will you proclaim that Maths is false or will you check to see if the angle is something other than a right angle? My suspicion is that you will do the former going by your approach to economics.


Anonymous said...

The claim that Mathematics says nothing about the real world is funny at best. Anyone who wants to say that should try making sense of the real world without the tools of Mathematics.


Tel said...

What bothers me is that Krugman detects the presence of a "Liquidty Trap" by checking treasury bond interest rates against the "zero limit".

That might be well and good if such interest rates floated in any meaningful sense, but the Federal Reserve is the one setting that interest rate, and they have happily admitted that their answer to everything for the last couple of decades has been to push interest rates down. Of course it was going to hit the zero limit!

This is effectively using the results of Federal interference as justification for more Federal interference. If government can't solve your problems, what you need is more government.

Tel said...

... is there any observation that would cause a reconsideration of Austrian economics?

Well, I guess that if the Soviet Union had won the Cold War by their overwhelmingly superior productivity and citizens from the West were finding ways to sneak inside the Iron Curtain to get a better life for themselves... that would be an observation that would have put a big dent into the Austrian theory.

If the QE and QE2 had caused prices to go down, and the massive stimulus had caused employment participation to increase continuously for several years, it would have given reason to question the Austrian theory.

If the price of gold in US dollars had been falling over the previous decade while the interest rates were held near zero and the monetary supply ballooned, it would have been rather curious. Worthy of investigation at least.

Lots of possible observations would necessitate a reconsideration of Austrian theory, but we just have not been seeing those.

Steve said...

Here's what would shake my faith in Austrian Economics.

If gold prices as well as commodity prices dropped during periods of ultra low (zero bound) interest rates while money supply and credit increased greatly at the same time, and the dollar gained in value vs. gold while this happened.

If during the bust cycle, long term capital goods (things that take a long time to make) didn't drop in price nearly as much as goods that are quickly manufactured and (staples/necessary goods). That would be a bad sign for me.

If we saw high inflation in countries with hard currencies and without central banks. That would kill my whole faith in Austrian Economics right there.

So far Austrians haven't disappointed. Keynes has proven wrong time and time again yet that hasn't stopped guys like Krugman from rethinking the basic tenets of their philosophy yet. Maybe they should be asked this question.

Bob Horn said...

I take it that Krugman poses a real threat to right wing ideology. Austrian school of economics? Are you guys associated with the Wastafarian School. Funny stuff.