Thursday, April 5, 2012

Horowitz on Keynes; Tucker on Murray


Steve Horowitz has a good piece in the Freeman Online about some of the Keynesian errors of aggregation. The following point especially is instructive:
The Austrian insight is relevant to both capital and labor. In standard Keynesian models (as well as most other macroeconomic models), capital is understood as an undifferentiated mass. The Keynesian model also assumes that interest rates do not equilibrate the supply of savings and the demand for investment funds. Thus when people save more, there’s no signal transmitted to investors that they should build more for the future. As a result, the decline in consumption that accompanies the increase in savings causes firms to invest less as their inventories pile up without any offsetting increase in investment elsewhere due to the lower interest rate.
There is much to like in this piece and I hope readers will examine it.

Jeff Tucker, one of the most insightful people I know, has written this piece in answer to the recent work by Charles Murray that calls attention to what he calls the "Great Divide" between American social and economic classes. Tucker notes that the system is rigged against the poor in ways that neither conservatives nor liberals can begin to understand:
That leaves the fundamental question: Why has this actually happened? From what I’ve read, Murray seems to overlook the political reasons for why the lower third has begun to eschew the bourgeois virtues. It all comes down to economic opportunity and deep integration into the division of labor, for it is through commerce that individuals acquire value in the eyes of themselves and others.

The regulatory and tax states have made the lower classes into pariahs from the point of view of the commercial world. They are expensive to hire and hard to fire, which makes them even more expensive to hire. The minimum wage is bad enough, but that is only the beginning. A giant machinery governs how, where, when, and under what terms they can work and enjoy fulfilling lives. Business creation is harder than ever for anyone but the highly educated elite.

When they do get jobs, the whole system is allied against their social advancement. Cash business is criminalized. Everything requires a permit. The bureaucracy rules, instead of the entrepreneur. The laws, taxes, mandates, programs — and everything else the state has done — work like a giant bed of sharp rocks in the middle of a river that punishes those who tried to get to the other side.

Inflation and the Fed’s interest-rate policy have punished the accumulation of wealth and shortened the time horizon of the lower third of the population classes. The rise of the police state and the criminalization of their lifestyle have driven them into a culturally, socially, and legally marginal existence, so that they are always one step away from entanglement with police, courts, and jail.

As government grows — and the regulatory and tax states expand — and as the prohibitions on behaviors, services, and goods grow and grow, society becomes ever less economically mobile and dynamic. The class system that is part of every society becomes a caste system of entrenched position. It becomes a society of the put-upons versus the privileged.
That certainly seems to be the case in Maryland, which is a one-party state dominated by urban Democrats. All of the Democrats I know here at Frostburg State (which is most of the faculty and student body) claim to have Great Compassion for the poor, but that compassion is reflected ONLY in their view that to really help the poor, we need to make sure that they have enough welfare benefits. Raising the minimum wage also is Holy Grail, and the fact that the minimum wage puts a lot of poor people out of work either is ignored or is dismissed with a reference to the Card-Krueger AER paper (if they know about that paper) or to something else

What I find is that the poor are revered, but only if they can be revered from a distance, as faculty members and poor people really have nothing socially in common.

19 comments:

Zachriel said...

Steve Horowitz: Thus when people save more, there’s no signal transmitted to investors that they should build more for the future.

That is incorrect. Keynes certainly did recognize the relationship between savings and interest rates, however, he rejected the simplistic classical theory of a direct, positive relationship. Rather, there are other determinants, including income levels, and market confidence. In other words, he divied up the demand for money into inelastic (e.g. security) and elastic (e.g. speculative investment) components; the latter being more influenced by rates than the former.

Pete said...

Zachriel:

That's false. Keynes did not recognize a relationship between savings and interest rates. He held that interest rates are determined by liquidity preference, not the extent of savings.

He also argued on many occasions that people reducing their consumption (saving) isn't the same thing as investing. He held that people can save more but investors won't be signalled of this through lower interest rates.

And the divorcing of demand for money into two alleged purposes, is utterly fallacious. There is only one demand for money, namely, the money that people hold.

Zachriel said...

Pete: Keynes did not recognize a relationship between savings and interest rates.

So, if everyone stopped saving, then Keynes would say it would have no effect on interest rates?

If all money that was saved was put into the bank available for long term lending, then the classical view would be correct, however, saving money in the cookie jar (liquidity) removes money from the pool of money available for long term lending. So, only part of savings are available for long term investment.

Joseph Fetz said...

Zachriel,

I believe that you and Pete are using two separate concepts of saving. Merely putting pieces of paper into an account is not saving, there must be deferred consumption to go along with it.

For instance, if newly printed money was simply put into a savings account, you would have us believe that this is an act of saving (in the economic sense). It isn't, because no consumption has been deferred, rather all that has been done is pieces of paper were printed up and put into an account. In fact, consumption would remain the same, or if some of that newly created money was spent, then consumption would surely increase. Absolutely no savings (in the economic sense) took place.

So, your example is actually that of Keynes' line of thought, that liquidity was the determinator of interest rates rather than real savings. Of course, we realize that interest isn't that simple. Merely the supply of stored money doesn't determine the rate of interest, because there are other factors such as the demand to hold money (which is related to time preference), as well as the subjective value placed on money vs other goods.

Zachriel said...

Savings is net income minus consumption. However, liquidity is part of the savings decision.

Keynes: "But this decision having been made (how much of his income he will consume and how much he will reserve in some form of command over future consumption), there is a further decision which awaits him, namely, in what form he will hold the command over future consumption which he has reserved, whether out of his current income or from his previous savings. Does he want to hold it in the form of immediate, liquid command (i.e. in money or its equivalent)? Or is he prepared to part with immediate command for a specified or indefinite period, leaving it to future market conditions to determine on what terms he can, if necessary, convert deferred command over specific goods into immediate command over good in general? In other words, what is the degree of his liquidity-preference ... the mere definition of the rate of interest tells us in so many words that the rate of interest is the reward for parting with liquidity for a specified period."

So to say "when people save more, there’s no signal transmitted to investors that they should build more for the future," is an oversimplification. Rather, according to Keynes, there are two decisions, two components; the decision to save, and the decision of how much of that savings to risk or to hold. The signal transmitted depends on these two decisions. Another way to say it would be that savings are necessary, but not sufficient.

Joseph Fetz said...

Savings is entirely independent of money. Do you agree with that statement?

macroman said...

Prof Anderson that the minimum wage puts a lot of poor people out of work either is ignored or is dismissed with a reference to the Card-Krueger AER paper

The convincing way to discredit published empirical work that disagrees with your views of how the world must work is to add "which, along with Card and Krueger's subsequent book 'Myth and Measurement: the new economics of the minimum wage', has been thoroughly refuted by Ref1 and Ref2 and Ref3, ..." where Ref1, Ref2, and Ref3 are studies published in refereed journals, or if you are scrapping the barrel, published by the Mises Institute. I agree that their result is surprising, but a surprising result that withstand criticism is what we look for in the pursuit of knowledge, isn't it?

macroman said...

Joseph Fetz ... Keynes' line of thought, that liquidity was the determinator of interest rates rather than real savings.

Hicks interpreted Keynes to mean that both savings and liquidity preference determined the interest rate. My understanding is that Hicks expressed this interaction with the IS-LM model (that's Investment-saving and Liquidity-Money) in which the interest rate and GDP are simultaneously determined.

Zachriel said...

Joseph Fetz: Savings is entirely independent of money.

People save by deferring consumption and storing up money. They might put the money in the bank, or in a cookie jar.

Joseph Fetz said...

Zachriel, that is not what I said. I am asking you if money must exist for savings to exist? Or if savings can exist entirely independent of money? What say you?

macroman said...

Zach. He wants you to admit that in a moneyless economy you could save up dried fish (a favorite Austrian example from Bohm-Barwek I think) and use the dried fish to divert labor from fishing (for immediate consumption) into building a canoe.

Zachriel said...

In the modern world, savings almost always refers to money, but certainly someone can save some of their crops, for instance, by deferring present consumption.

-
Genesis 41

Pharaoh had a dream: He was standing by the Nile, when out of the river there came up seven cows, sleek and fat, and they grazed among the reeds. After them, seven other cows, ugly and gaunt, came up out of the Nile and stood beside those on the riverbank. And the cows that were ugly and gaunt ate up the seven sleek, fat cows. Then Pharaoh woke up.

Pharaoh said to Joseph, “I had a dream, and no one can interpret it. But I have heard it said of you that when you hear a dream you can interpret it.”

Then Joseph said to Pharaoh, “God has revealed to Pharaoh what he is about to do. The seven good cows are seven years. The seven lean, ugly cows that came up afterward are seven years of famine.

“And now let Pharaoh look for a discerning and wise man and put him in charge of the land of Egypt. Let Pharaoh appoint commissioners over the land to take a fifth of the harvest of Egypt during the seven years of abundance. They should collect all the food of these good years that are coming and store up the grain under the authority of Pharaoh, to be kept in the cities for food. This food should be held in reserve for the country, to be used during the seven years of famine that will come upon Egypt, so that the country may not be ruined by the famine.”

So Pharaoh said to Joseph, “I hereby put you in charge of the whole land of Egypt.”

Joseph stored up huge quantities of grain, like the sand of the sea; The seven years of abundance in Egypt came to an end, and the seven years of famine began, just as Joseph had said. There was famine in all the other lands, but in the whole land of Egypt there was food.

Joseph Fetz said...

You're once again missing the point. I am trying to show what savings actually is at root, that it is necessary for the investment into capital. Macroman is correct that consumption does need to be deferred in order to save (Yes, the Crusoe model does aid in understanding this), however he is wrong in that I am trying to get you to admit anything. Why would I try to get you to admit something that I am quite certain you don't understand in the first place.

Once the origin and meaning of savings is understood (as compared to consumption), only then can one understand interest. Further, once you add money into this dynamic, you must realize that unless the money's supply is entirely market driven it loses its relevance to real market phenomena. Rather, it becomes an influencer of market phenomena rather than an objective indicator of the state of the economy.

People can have increasing amounts of currency in their accounts (or under their mattress), yet the amount of total consumption can remain unchanged, and interest rate can be unchanged or even increasing (as in historical cases of high inflation or hyperinflation). Liquidity preference cannot explain this phenomenon, yet time preference can due to its being based upon the root ideas of saving and consumption (i.e. consume now or in the future). If you base your idea of interest on the monetary unit, then you miss the entire meaning altogether.

Joseph Fetz said...

The interest rate in the above example is that found in the loanable funds market, not the originary interest rate (which has not changed). That should be obvious by the fact that consumption remains constant, but I figured I'd mention it anyhow.

Pete said...

Zachriel:

"Pete: Keynes did not recognize a relationship between savings and interest rates."

So, if everyone stopped saving, then Keynes would say it would have no effect on interest rates?

He would say interest rates would only be affected to the degree liquidity preference changed. This is separate from saving, as cash balances can be increased by reducing investment expenditures, but retaining consumption and not abstaining from consumption.

If all money that was saved was put into the bank available for long term lending, then the classical view would be correct, however, saving money in the cookie jar (liquidity) removes money from the pool of money available for long term lending. So, only part of savings are available for long term investment.

I don't consider increased cash as savings. Saving is abstaining from consumption. Since cash holdings can be increased via inflation of the money supply, or by abstaining from investment expenditures, all the while never abstaining from consumption over time, I hold it is wrong to consider increasing cash holdings as saving.

macroman said...

Pete Saving is abstaining from consumption. Since cash holdings can be increased via inflation of the money supply ... while never abstaining from consumption ...

You might want to consider Wicksell's theory of "forced saving" via a monetary mechanism. The inflation of the money supply increases prices and forces consumers on fixed money income to consume less, thus making way for increased production of investment goods. This is part of Hayek's cycle theory as far as I know.

In much the same way a government could (and has in the past) forced saving by taxing more or imposing rationing, thus allowing the production of more war goods.

Pete said...

macroman:

You might want to consider Wicksell's theory of "forced saving" via a monetary mechanism. The inflation of the money supply increases prices and forces consumers on fixed money income to consume less, thus making way for increased production of investment goods. This is part of Hayek's cycle theory as far as I know.

Monetary inflation doesn't just increase the price of consumer goods. It enters the market as loans for business investment as well as consumer loans. To the extent that it initially increases investment, it's not forced saving, but positively, yet artificially, goosed investment without being backed by prior real saving

macroman said...

Pete Perhaps Wicksell's forced saving theory is as follows: The increased investment draws resources away from producing consumer goods towards producing investment goods. The reduce supply of consumer goods forces consumers to consume less (the mechanism is the increased price of the reduced supply of consumer goods). So the investment spending forces the required saving.

Similar to a wartime government which force saving (reduced consumption) by various laws.

Jason thomas said...

"So it is with Paul Krugman, who this week calls Mitt Romney the "Amnesia Candidate" because Romney dares hold Barack Obama's policies as being responsible for there not being any real economic recovery. Why everyone at the NYT and Princeton KNOWS that EVERYTHING is the fault of George W. Bush BECAUSE HE CUT THE TOP INCOME TAX RATE FROM 39.6 PERCENT TO 35 PERCENT. Yes, anyone who knows ANYTHING about economics knows that slightly lowering income tax rates will cause massive unemployment, or that least that is what Krugman wants us to believe."

Wait, was there an argument here? We're you even going to attempt to refute the point that you were taking issue with, that Krugman says Romney has amnesia? Or was your intention to fire off a reaching rant about the NYTimes by using one anecdotal example (thus committing the same sin you rail against) while simultaneously kind of making a half completed ad hominem attack on Krugman without ever circling back to give evidence or even present an argument to refute the orriginal claim you took issue with and thus started to write about?

He's a few tips. Walk down to the English dept and A) learn how to construct and present an argument B) learn some basic form and cadence, writing using the technique of facetious negation for the entire length of the article is neither clear nor good form even for a blog rant. It's not clear whether you are being serious or facetious in any given paragraph. C) toss in a basic logic course, you committed more than one logical errors or flat out fallacies here.

Krugman is playing a bit of politics for sure; very insightful of you to notice, given the name of his colum. I don't like the perspective he writes from, but he's writing as a columnist, not purely an economist (not that Macro policy is his AOE or even interest.) Likewise,Mathis is your blog, so rant away focusing on one person and using an empirically invalidated perspective. It's your blog.

That being said, even hold the title of professor, don't expect anyone serious to take you serious when you write in this manner. I could not believe a professor would be this deficient In both language and argument construction, even at a no-name institution. We're I a freshman composition instructor, you would have just recieved an F. Were, I a parent with a child enrolled at your school, your department head and dean would be getting a call from me tomorrow.

Open your mind and think a little, you have the greatest job in the world, you get paid to think. You yourself, however, are supposed to shed bias in the pursuit of truth, which you can not do "arguing from the Austrian school perspective," a bias, one with massive massive empirical problems, that no one outside a few niches takes seriously anymore.