Monday, May 23, 2011

Is it austerity, or reality?

One of Paul Krugman's constant themes has been that "austerity" is the wrong prescription to deal with a shrinking economy. If the economy is going south, he claims, then governments must spend and spend prodigiously in order to prop up everything. (Krugman adds that this should be the case when the economy is in a "liquidity trap," which he believes changes the rules of economics.)

At one level, I understand his point. The "austerity" programs often mean increased taxes and other government activities that can drag down an economic recovery (although Krugman has been insistent that we need massive tax increases in the USA, so I don't know why he would be against that aspect of "austerity").

Yet, there is something else out there, something that really divides the Keynesian and Austrian camps: Keynesians really believe that spending money is what creates wealth, and that governments can create wealth out of thin air simply by cranking up the spending. Furthermore, assets really are not real; if the economy goes into the tank, government simply can declare prosperity and if people believe (yes, only believe) that the spending will make everyone prosperous, then all is well.

How else can someone really claim that heavily-subsidized industries like "wind power" and "corn-based ethanol" can create overall prosperity and lead us into recovery. How else can someone really claim that if government takes enough resources away from everyone else and gives them to GM, Chrysler, and the United Auto Workers, that we will have overall prosperity?

Austrians do not see "austerity" as a policy, but rather a reality. This is not a morality play (even if Krugman has accused us of enjoying the infliction of "pain"), but rather a bowing to reality of the fact that one cannot fix a broken economy by pretending it is not broken.

There is something else I have noticed; in Krugman's view, if a policy has immediate "good effects," then the policy must be good. Thus, ANY liquidation of malinvestments also must be bad, bad, bad, as that means short-term pain.

It was not just the Keynesians who have demanded that we play a "let's pretend" game about the economy. Shortly after the financial crisis of the fall of 2008 became painfully obvious, Martin Feldstein, who was President Ronald Reagan's chief economic adviser, called for the government to enact what was little more than a scheme to prop up housing prices. Like the Keynesians, Feldstein could not recognize that falling prices were a symptom, not a cause of the larger problem.

In the Keynesian world, there are no malinvestments, only idle resources. Spend enough, and those resources will rise up. After all, doesn't Y = C+I+G+(X-M) tell us everything we need to know about the economy?

Well, not it doesn't. In fact, I will go as far as to say that the equation tells us next-to-nothing about an economy and how it works. The economy is not in recession because there is a lack of spending; there is a fall in spending because the economy is in recession, and we cannot spend ourselves into prosperity no matter what Krugman and the Keynesians tell us.

31 comments:

Methinks said...

In the first five minutes of the first econ class I ever took a very long time ago (when electric typewriters roamed the earth), I learned that economics is the study of human behaviour in an environment of unlimited wants and needs and limited resources.

Where oh where is this abundance of idle resources? Why do the laws of economics change based on whether or not we are at full employment? Why does nobody even attempt to acknowledge the costs of pump priming, asset price manipulation and subsidization of failed industries? I found Keynesian economics (which is all I was taught in undergrad) simple. Later, I found it simplistic. It pretends to know much but captures little.

I never even heard about the Austrian school until many years later.

Very nice post, prof. Anderson.

ayassos said...

I believe you're right that Krugman has only a very dim idea of how the American economy works in contemporary times. Often I have the sense that he sees no fundamental difference between the American economy of 1965, say, and modern times. He does not take into account globalization, the job drain to the Third World, and other facts of life. The contraction of the American economy has not been caused by the banking sector over-extending itself on mortgage loans, creating a "deflationary shock" as the sole reason for current hard times. This version of recent history, however, is all that Krugman ever talks about, because he doesn't like focusing on the underlying structural malaise. A true grasp of the underlying problems rules out additional massive government spending because such an approach cannot be sustained with the economy in its delapidated state. Put another way, we skated on huge debt for a very long time (all of which was encouraged by Krugman) until we arrived at the point where the debt could not be serviced. Krugman can't see this because he just doesn't grasp the reality.

TonyD said...

I've read Krugman's blog for a couple of years now. Most of the positions that you are attacking aren't his positions.

And I tend to look at most situations as being complex -- and we often see only symptoms while there are multiple complex causes that can be modeled as probability distributions. (Even if Black-Scholes has been discredited for credit risk evaluation on Wall Street)

So "we cannot spend ourselves into prosperity" is a statement that can be seen to have a probability distribution associated with its truth. So if you and I are standing next to each other, and we trade a nickel in your pocket for my rarely used cell phone, we may both end up more prosperous.

I am neither for nor against debt. There are always trade-offs, and the trade-offs defy simplistic reasoning.

Methinks said...

TonyD

Even if Black-Scholes has been discredited for credit risk evaluation on Wall Street

Poppycock. A long and well known weakness of the Black-Scholes model is the assumption of lognormally distributed returns. Thus, it has long been known that it is terrible at pricing teeny options - which is what CDS are. This is nothing new.

So "we cannot spend ourselves into prosperity" is a statement that can be seen to have a probability distribution associated with its truth.

Driving drunk and blindfolded against the flow traffic also has a probability distribution. After all, you're not guaranteed to get into a wreck and you might even get to your destination faster - making you believe you did a smart thing.

That everything is a trade-off and has a probability distribution is not the relevant point. The relevant point is the expectancy of an action. Both driving drunk and government spending have a negative expectancy.

(expectancy, for those who don't know, is the sum of all possible outcomes weighted by their probabilities)

Lord Keynes said...

"Keynesians really believe that spending money is what creates wealth, and that governments can create wealth out of thin air simply by cranking up the spending."

Wrong, and a caricature. It's no wonder Austrian economics will never be taken seriously by voters or governments.

Money is (1) means of payment, (2) unit of account, (3) medium of exchange and (4) store of value, and when it is spent by government and by people through Keynesian stimulus, THIS creates the demand that causes the private sector to create wealth, either by increasing production or by new capital goods investment.

Just as in private transactions, money is a means by which these things are facilitated.

The level of your argument:

"Austrians idiots really believe that private individuals or businesses spending money is what creates wealth, and that private individuals or busineses can create wealth out of thin air by cranking up the spending."


"In the Keynesian world, there are no malinvestments, only idle resources.

Garbage.

"Spend enough, and those resources will rise up. After all, doesn't Y = C+I+G+(X-M) tell us everything we need to know about the economy?"

If you simply maintain spending at current levels and enact a large tax cut (which is a typical Keynesian method of stimulus), people will buy whatever they desire to satisfy their wants, if they don't want commodity a, b, or c, the producers of those commodities will go bankrupt.

Malinvestments will clear even in a Keynesian system, despite your rubbish.

Bob Roddis said...

1. LK still does not understand the concept of economic calculation or that it is the core concept of the Austrian School. Thus, he cannot understand how economic calculation must be impaired by funny money and government spending. And he doesn’t understand that economies don’t have or lack “traction”. And that printing money, government spending and debt don’t provide “traction” which does not exist. And he doesn’t understand that government spending merely misdirects resources.

http://mises.org/daily/5123

2. LK also insists that “free banking” won’t work because of the example of Australia in the late 1800s.

Remember John Quiggin, Australian Keynesian? Little Matty Yglesias quoted Quiggin to ignorantly smear Tom Woods and the Austrian School:

http://tinyurl.com/3uf2drs

An Austrian School blog writer in Poland demolished Quiggin. Quiggin responded in the comments by explaining that the Australian panic of the 1893 was caused by “free banking”, banks with a 1/3 reserve requirement.

http://tinyurl.com/3bhzgsp

It sounds to me like those Australian problems were caused by that pesky fractional reserve banking dressed up in 100% reserve drag again. Just more support for the Austrian analysis.

Lord Keynes said...

"Thus, he cannot understand how economic calculation must be impaired by funny money and government spending."

I understand ABCT and these other Austrian arguments perfectly well, but reject them as unconvincing.

"It sounds to me like those Australian problems were caused by that pesky fractional reserve banking dressed up in 100% reserve drag again."

Free banking is entirely consistent with FRB.

These comments on Australia are all a waste of time.

Bob Roddis said...

Free banking is entirely consistent with FRB.

If unsophisticated depositors and payees are not made aware that there might not be specie available for immediate redemption, it is an example fraud and will cause problems. If depositors and payees are sophisticated and understand the risks, then there is no fraud and they can suffer the consequences, if any. Whether that particular operation will work is a question of fact for the future. It has nothing whatsoever to do with disproving the Austrian School.

If someone wants to play word games and claim that a cause of action for contract fraud is the same thing as "regulation", that is just silly.

Bob Roddis said...

The end of my first sentence above should have read:

"it is an example OF fraud and will cause problems"

William L. Anderson said...

So, when government spends money, that is what sets the stage for creating wealth. Gee, there is a lot of stuff that seems to be lost in the translation. This just assumes just what I have been saying is the Keynesian prescription: An economy is a homogeneous blend into which you just stir money.

Thanks for making my point.

By the way, why didn't this work in Argentina or Zimbabwe?

Methinks said...

By the way, why didn't this work in Argentina or Zimbabwe?

Their stimulus wasn't large enough!!!

(Oh, gosh. Sorry - channeling Krugman again. Will try to restrain self in future.)

colan042 said...
This comment has been removed by the author.
American Patriot said...

Lord Keynes:

I learned a while ago not to argue with my progressive friends on theory because it gets us nowhere. I have two general questions that I'd like you to answer:
1) Please provide empirical evidence of your theories working in the real world, and
2) If Keynesian economic theories were so great, why did Keynes himself said to Henry Clay "I find myself more and more relying for a solution of our problems on the invisible hand which I tried to eject from economic thinking twenty years ago."

As you see, I am a simple man and ask simple (but hard to answer) questions. So, please tell us why you are more Keynesian than Keynes himself was at the end of his life?

Lord Keynes said...

"By the way, why didn't this work in Argentina or Zimbabwe?"

http://socialdemocracy21stcentury.blogspot.com/2011/05/william-l-anderson-flunks-keynesian.html

Calgacus said...

American Patriot:
Please provide empirical evidence of your theories working in the real world:

The worldwide postwar golden age from 1945 to the 70s/80. (In the US starting from 1933) Keynesian full employment policies caused the greatest prosperity the world has ever seen, before or since. There is a huge academic industry, not only Austrians, devoted to hiding the well-known, utterly obvious and true fact that the New Deal & WWII got the USA out of the Depression, and that Keynesianism - even the watered down, inflation and instability prone variety used, was a roaring success. Of course, this lie industry devoted to proving the sun rises in the west could only get really started once enough people with direct experience grew old and died off.

One side remark made by Keynes, who never was anti-capitalist, means very little. About the same time he was writing to the ex-"Austrian" student of Hayek, Abba Lerner, saying that he now agreed with Lerner's more Keynesian-than-Keynes functional finance. (=chartalism/MMT)

Lerner's thought does have a definite Austrian flavor to it. People like Lerner and Minsky took what was good in the Austrian way of thinking, but did not live in the Austrian fantasy world.

Robert V said...

"The worldwide postwar golden age from 1945 to the 70s/80."

Evidently Calgacus never visited NYC in the 70s.

From 1914 to 1945 governments spent untold fortunes destroying everything in sight, then spent untold fortunes rebuilding what it had just destroyed. This, for a Keynesian, is prosperity.

Never mind the tens of millions of dead. Full employment is the important thing.

Bob Roddis said...

Make sure you read MMT guru Bill Mitchell’s explanation about Zimbabwe inflation (LK provides the link), which starts with:

“Now at the risk of repeating myself a million times, this is the macroeconomic sequence that defines responsible fiscal policy practice. This is basic macroeconomics and the debt-deficit-hyperinflation hyperventilating neo-liberal terrorists seem unable to grasp it:

1. The sovereign government, which is not revenue-constrained because it issues the currency, has a responsibility for seeing that the workforce is fully employed.
etc… ad nauseum.

I bought Abba Lerner’s book “The Economics of Control”. His mission was to save SOCIALISM with some snippets of “capitalism” thrown in without any attention paid to “The Problems of Knowledge in Society”, to coin a phrase.

Chapter l. INTRODUCTION. THE CONTROLLED ECONOMY
The fundamental aim of socialism is not the abolition of private property but the extension of democracy. This is obscured by dogmas of the right and of the left. The benefits of both the capitalist economy and the collectivist economy can be reaped in the controlled economy. The three principal problems to be faced in a controlled economy are employment, monopoly, and the distribution of income. Control must be distinguished from regulation. Liberalism and socialism can be reconciled in welfare economics.


http://www.flickr.com/photos/bob_roddis/sets/72157626353319778/

David Colander, a co-author of a 1980 book with Lerner wrote:

Initially he toyed with various administrative wage and price control policies, but he found those lacking and soon gave them up. He replaced them, first, with a tax based incomes policy and ultimately, a market based[!!!] incomes policy in which property rights in prices are set and individuals have to buy the right to change prices from others who change their price in the opposite direction. It was this idea that formed the basis of our market [!!!!!!] anti inflation (MAP) book. (Lerner and Colander 1980) Under MAP, rights in value added prices would be tradable so that any firm wanting to change its nominal price would have to make a trade with another firm that wanted to change its nominal price in the opposite direction. Thus, by law, the average price level would be constant but relative prices would be free to change [page 12]

http://tinyurl.com/4rfk3jk

Wait! I thought taxes cured inflation.

Tel said...

From the Lord Keynes explanation of Zimbabwe:

You don’t stimulate an economy hit by supply shocks or severe output contraction. That is a basic Keynesian policy.

The US economy faces rising prices of energy, oil, rising prices of basic commodities such as food, metal, etc... would that sound a bit like a supply shock? I guess we agree that Obama's stimulus effort is doomed because of "basic Keynesian policy", so please go explain these basics to Krugman, because it is unlikely he will listen to any of us.

Tel said...

From the Bill Mitchell explanation of Zimbabwe:

In the same way that the Treaty of Versailles was directly responsible for the plight that Germany found itself in during the 1920s, the white racist regime that ruled prior to 1980 and which had broken away from the colonial arrangements with Britain, set up the conditions that are now destroying Zimbabwe. White minority rule in Colonial Africa created such an unfair sharing of land between the whites and blacks that a backlash was always going to occur. The same sort of breakdown will threaten South Africa which is trying to reinvent itself (peacefully) in the post Apartheid era (not very successfully may I add).

Serious? When you run out of theory fall back to blaming racism, even blame racism from long in the past after the supposed racists have been murdered by the supposed victims. South Africa (using capitalism) survived something like 20 years of economic embargo and still emerged as a serious world power. Zimbabwe (using dictatorial socialism) limps along with US dollars as their currency and utilities (such as electricity) provided by South Africa.

So Bill Mitchell predicts that South Africa is due for a crash? In this age of high commodity prices... are you $#!+ing me?

Lord Keynes said...

"The US economy faces rising prices of energy, oil, rising prices of basic commodities such as food, metal, etc."

Wrong, because this is NOT the type of negative supply shock where prices are driven high by a severe or significant fall in output, which is the "supply shock" I am talking about there.

American Patriot said...

Calgacus:

You said:
"The worldwide postwar golden age from 1945 to the 70s/80. (In the US starting from 1933) Keynesian full employment policies caused the greatest prosperity the world has ever seen, before or since."

In what fanrasy world do you reside?
First of all, as RobertV said, the Keynesian view of prosperity is akin to burning your house down so that you can rebuild it.
Secondly, what full employment and prosperity are you talking about starting in 1933? Do you have the remotest idea what unemployment was in mid to late 1930s? Try as high as 16%. In fact, if it was not for WWII, god knows how long that unemployment would last. During those decades there was no true prosperity - nothing like the prosperity of the Reagan era (1980-2005). Check your figures.

Lord Keynes said...

The 1930s was a period of high involuntary employment.

The period of classic Keynesianism was from 1945-1979, though it was aboandoned at different times in different countries.

"nothing like the prosperity of the Reagan era (1980-2005)"

The Reagan era? That was from 1981–1989. And after 1982, after the abandonment of Volcker's diasterous monetarism, Reaganonmics was nothing but conservative Keynesianism:

http://socialdemocracy21stcentury.blogspot.com/2011/02/reaganomics-analysis.html

João Marcus said...

You don’t stimulate an economy hit by supply shocks or severe output contraction. That is a basic Keynesian policy.

Yeah, you stimulate an economy doing exactly what is driving many countries down to a deficit abyss: spending! Who cares? In the long run, we are all dead.

Wrong, because this is NOT the type of negative supply shock where prices are driven high by a severe or significant fall in output, which is the "supply shock" I am talking about there.

This is the direct result of the "money printing leads us all to prosperity" bullshit. It is Keynesianism as its finest. "Prices are rising? No, it's not because the FED prints money like there's no tomorrow. It's not because the stimulus isn't working. Don't come with your reality crap. I don't care. It has nothing to do with my theory, it must be some kind of funky situation where people get all irrational and must be controlled by my dear government".

You repeat yourself, you defend the same policitcs, over and over and over. They never really worked, they always generated HUGE budget deficits and bubbles, the situation is becoming unsustainable, but you still defend the very same politics. You look like those guys from the "Erick, the Viking" movie: they are drowning, but they are still singing and saying everything is fine!

Bob Roddis said...

Tel:

Don't you know that the wholesale importation of "progressive" political theory from the West into the former African colonies including socialism, impairment of private property and contracts, and funny money dilution had nothing to do with their economic collapse?

Tel said...

LK, maybe you want to explain how this supposed "aggregate demand deficit" is driving up the price of commodities?

Given that you seem to believe there are at least two different types of high prices, it would be interesting to know how a factory owner buying copper is supposed to know the difference between high prices caused by a supply shock and some other sort of high prices.

Will said...

Tel- of course there are many kinds of high prices. As any economist (austrian or otherwise) can tell you, a price encodes tons of information about both supply and lots of people's individual preference for the good.

Whenever lots of information (much of it information that no single person has) is bundled together into one number, you lose all the individual details.

A super evolved bacterium that eats copper, a miners strike in China, or a new industry based on copper will all drive the price up. The factory owner can look at the price, but he has no idea WHY its high. Thats the beauty of the price- it contains everything relevant for the factory owner and he doesn't have to deal with all these irrelevant factors.

To sum up- there are nearly infinitely many kinds of high prices, and to purchasers of goods that variety doesn't matter at all. Thats the beauty of a market.

Tel said...

On the basis that the purchasers of commodities tend to also be the providers of jobs (ignoring speculative commodity purchase), and on the basis that the whole idea of Keynesian stimulus is to attempt to boost employment; surely the price perspective of the purchaser is the perspective that is most important in this particular context?

I agree with your point though, "to purchasers of goods that variety doesn't matter at all."

I believe you have made my point... if it is a bad idea to run a deficit-driven stimulus in the face of supply shock, then why is it somehow a good idea to run a deficit-driven stimulus in the face of rising commodity prices? From the perspective of job creation (i.e. the perspective of the commodity purchaser), what makes one type of high price different to another type of high price?

Bob Roddis said...

We all have to face some sad facts. The Keynesians, MMTers and non-Austrians in general haven't a clue about the essential basic concepts and ideas of the Austrian School. They don’t get economic calculation or the pricing process nor do they understand those concepts as the foundation for everything else. They just don’t. No matter how many times we tell them or how many different ways we explain it. It’s unfathomable but true.

Tel said...

We all have to face some sad facts. The Keynesians, MMTers and non-Austrians in general haven't a clue about the essential basic concepts and ideas of the Austrian School.

Oh Bob, it's much worse than that. Here's one of Bill Mitchell's comments on his own blog (talking about Zimbabwe):

Yes I agree. Any institution can fail if it is misappropriated by evil idiots. The gold standard monetary system would deliver the same result as the fiat monetary system is delivering in Zimbabwe at present. They could scrap paper money and some other token would hyperinflate.

None of the other comments on his blog called him on it; but think about the implication of what he is saying -- a gold standard in Zimbabwe would have hyperinflated just the same as fiat currency.

I happen to have (as collector's items) a 1 dollar note issued by the reserve bank of Zimbabwe, along side a 5 billion dollar note issued a year later by the same bank.

One bloody year was all it took.

Let's suppose that $1 represented a milligram of gold, that's about a mustard seed, maybe a bit less. So what does the mustard seed inflate into when multiplied by 5 billion? Well that would 5 metric tonnes of gold. So presuming a stout man can carry 100 kg on his shoulders, it takes 50 strong men just to lift the inflated mustard seed. If you put it in the back of an average vehicle, it would destroy the vehicle. Forget about ever trying a wheel barrow.

Yet Bill Mitchell has made a public statement that it is perfectly possible for a gold currency to inflate the same as Zimbabwe did. That's not a denial of the essential basic concepts and ideas of the Austrian School. It is a denial of the essential basic perspective of big numbers applied to the physical world.

Sadly, I doubt Bill Mitchell is the only one.

Bob Roddis said...

Tel:

I suppose you are right. Someone who denies the essential basic perspective of big numbers applied to the physical world is not going to be able to comprehend economic calculation, much less a distorted capital structure resulting from impairments to economic calculation. Or that a capital structure exists at all for that matter. Or that economics concerns real world people. Little things like that.

Calgacus said...

Robert V.Evidently Calgacus never visited NYC in the 70s. I lived in NYC and its suburbs in the 70s & most of the 80s. Sure, there were bad things, mainly due to insufficient government spending, and policies aimed at harming the poor and benefitting wealthy criminals, but a good place to live, better than now.

Of course concerning the 30s I meant that (insufficiently) "Keynesian" New Deal policies made things progressively better under FDR, until the war completely eradicated the depression. There's a reason why most sources lie about FDR's unemployment record, the reality (the Darby numbers, not the absurd Lebergott ones) contradicts modern quack-economics.

American Patriot: During those decades there was no true prosperity - nothing like the prosperity of the Reagan era (1980-2005).
The idiot Reagan was the end of the golden age - which is not my phrase, but the standard description of the postwar years. Just about whatever developed country you choose, the 1980-2005 period was pitiful for growth & "true prosperity" compared to the previous 35 years. Check your figures. I am just stating universally accepted facts.

You are showing your youth, nobody older could conceive such a statement. Just as there are no old "academic" studies claiming that the war did not cause prosperity in the USA, as they would have been a ticket to a psychiatrist's office, not publication.