Saturday, February 2, 2013

The Fed and its Role in the Economy: No Conspiracies, Just Bad Policy

In the comment section of my last post, one of my critics identified as JG made a point that I believe truly highlights the differences between Keynesians and the Austrians:
@ Anderson,"The Fed wants to drive money toward those assets by keeping their prices artificially high..."

Is that really what the Fed's goal is? To keep prices high? Do you really believe that QE is really a conspiracy to inflate MBS prices?

Someone less given to conspiracy theories would assume that the Fed was buying MBS to maintain liquidity in the financial system to faciliate lending during a time of weak demand.
True, the commenter was trying to lump me in with conspiracy theorists who seem to believe that the Fed principals conspire to wreck the economy and that they know exactly what they are doing and that is part of their dastardly plan. Now, I would agree that a bad economy in which an increasing number of people become dependent upon the government is good for President Obama in particular and the Democratic Party in general, especially if people come to believe that their state of dependence exists because the government is not taxing others enough or if businesses are conspiring to destroy the economy. We certainly see a lot of that from the Democrat/Keynesian camp, which is not without conspiracy theories of its own.

If I might use somewhat simplistic  models that I believe do reflect the differences in thinking between Keynesians and Austrians, the differences are portrayed as followed:
Keynesians: They believe that a market economy is internally flawed and will hurdle toward underconsumption at every turn. Their underconsumption lynchpin (wild swings in private investment, depending upon the "animal spirits" of investors) differs from that of the Marxists (capitalist profits suck the purchasing power from the proletariat, which leads to internal collapses of capitalist economies), but the results are similar.

For example, the housing boom and bust was a product of a pure, unregulated (by government) market in which none of the government agencies had anything to do with the crisis, except that the animalistic capitalist spirit so infected every regulatory agency that none of the regulatory agents -- even those who had perfect foresight (since most government agents are blessed with such foresight if they are performing under a regime run by the Democratic Party) -- did anything to stop it. The capitalists refused to read any price signals and led the economy into the abyss, as pure, unregulated capitalism always does. Had government agents been properly regulating the directing the housing market, it would have performed perfectly.

The Keynesians believe that capitalists do not respond to price signals (which are overblown, anyway, since an actual economy does not replicate the mathematical models of perfect competition), and that prices are useful mostly in their aggregation into various price indices, which themselves are statistics, not points of economic analysis.On the production side, market economies are prone to slide into the scourge of being overrun by monopolies, which create income inequality when then exacerbates the downward slide even more. Thus, without government oversight, and without the presence of a central bank like the Fed along with various government spending mechanisms, a market economy will implode into a miserable abyss of high unemployment and underconsumption. If there is deflation -- which always looms within a market economy -- then the system automatically will plunge into depression and stay there, since in the real world, entrepreneurs don't respond to price signals, anyway.

The important point here is that the Fed, along with the government agencies, exist in order to respond to private market failures, which the capitalists create on their own, with capitalist failures always being systematic. The Fed and the government, then, do not create conditions that lead to mass unemployment (unless someone at the Fed believes in Austrian theories that will make the central bank raise interest rates and choke off aggregate demand), but rather exists to offset those private market failures.


I believe this has been a fair interpretation of the Keynesian position. I now turn toward the Austrians.

Austrians: They believe that market economies are internally stable, and that government interventions, such as the ones made by the Fed, not only are counterproductive but actually help cause the downturns in the first place. No one is blessed at any time with "perfect information," but a price system actually sends the information that entrepreneurs and managers need to make production and exchange decisions regarding the future. Not all people respond properly to price signals, but the errors tend to be random, not systematic.

Intervention by government is harmful because it creates perverse incentives and directs production away from lines that are sustainable into those lines of production which are not. For example, far from being a free-market failure, the housing boom occurred because government in the form of the Federal Reserve System and the various government agencies that are tied to housing engaged in activities that directed investment and spending toward housing in amounts that could not be sustained. Not only did the Fed push down interest rates that encouraged more home buying and refinancing than what would happen in a normal market (without the intervention), but government agencies especially aimed their programs toward the "sub-prime" market in which were created vast amounts of mortgage securities that sold at prices well beyond what would have been the case had the government not been targeting housing in the first place.

Now, it was Wall Street, with its politically-connected banks and financial houses, that created many of these securities (Freddie and Fannie being the other two entities) but one must remember that these banks did not act within the structure of free markets. Instead, their principals acted knowing that the infamous Greenspan/Bernanke "Put" existed in the background, and that even though the mortgage securities certificates clearly stated that they were not guaranteed by the government, in essence that was a mere formality, for the government stood by to do just that: bail out Wall Street.

The point that Austrians emphasize is that without the government intervention and the promise of bailouts, the banks would have been much more likely to have followed the price signals that the markets were sending and not have marched over the cliff. Government here was not an entity that followed in the wake of private disasters in order to clean up the mess, but rather government was actively taking part in creating the mess in the first place.

As for the post-crisis mess, Austrians believe that since government interventions set the stage for the collapse, doing more of the same will not rescue the economy. In fact, it simply continues the same mistakes that occurred in the first place.

In response to the comment that I see Bernanke's purchases of mortgage securities as some sort of sinister plot to undermine the recovery, that is nonsense. My criticism is not of Bernanke's motives, but rather his actions. He is not "preserving liquidity" or anything like that; instead, he is propping up securities that markets already have rejected and continues to direct resources into lines of production that are unsustainable.
Keynesians counter with the "idle resources" argument that states that in a depressed economy such as ours, there are "idle resources" that are made idle by a lack of aggregate demand. When government resorts to what essentially are financial tricks such as the Fed purchasing securities, it is doing nothing more than engaging in unorthodox actions that are needed at this particular time because of very specific conditions that for the most part don't exist, i.e. the "liquidity trap." Without those actions, the economy will plunge into the abyss of a miserable, high-unemployment steady state in which we will be mired forever.

The Austrian response is that many of the "idle resources" are idle because they were malinvestments. The market does not support them because the patterns of purchasing and preferences shown by consumers do not and cannot keep those resources unemployed. Instead, entrepreneurs guided by price signals and interest rates (that follow a natural rate of interest, not something set by the Fed) will move resources from lower to higher-valued uses.

At the base of the thinking, I believe we can say the following: Keynesians believe that a market is not self-correcting in the event of a downturn, while Austrians believe that it is. There really is no middle ground between the two lines of thinking, which is why we see the kinds of responses we observe on this blog and elsewhere.

41 comments:

Mike said...

Great summary thank you.

If I may add: "Keynesians believe that a market is not self-correcting"

Since the market is the sum total of individual actions, Keynesians don't beleive individuals are self correcting. Individuals are incapable of acting in thier own best interest so centralized group of elites must act to look after them like children. Liberty is sacrificied as a necessary expense.

Zachriel said...

William L. Anderson: They believe that a market economy is internally flawed and will hurdle toward underconsumption at every turn.

Nope. Not even close.

Zachriel said...

Mike: Keynesians believe that a market is not self-correcting

Not correct either.

Mike said...

Zach My statement is supported by evidence of their actions. YOur statement is supported by hot air.

I've demonstrated in the past you are a fraud.

What do you do for a living?

Zachriel said...

Mike: My statement is supported by evidence of their actions.

While Keynes was mostly concerned with situations where markets don't self-correct, he did accept that markets work efficiently within certain bounds, but that markets can become trapped in states of underutilized capacity. To avoid these traps, he recommended counter-cyclical policy.

Mike said...

"markets work efficiently within certain bounds, but that markets can become trapped in states of underutilized capacity."

Statist blather. Listen to yourself. You actually belive that tripe.

What do you do for a living? Oh yeah you won't answer

Fraud. Sell your nonsense to the ignorant.

Dinero said...

" Trapped in states of underutilized capacity"

If an individul chooses to work 30 hours a week instead of 5o that is there choice. If the population chooses to work x million hours instead of y million then that is there choice.

Dinero said...

From the post -
" Not only did the Fed push down interest rates that encouraged more home buying and refinancing than what would happen in a normal market (without the intervention), but government agencies especially aimed their programs toward the "sub-prime" market in which were created vast amounts of mortgage securities that sold at prices well beyond what would have been the case had the government not been targeting housing in the first place."

Who is to say the Fed was "pushing down" interest rates - You could just as easily say they had stopped "pushing them up",- as they do both operations.

Zachriel said...

Mike: Statist blather.

Not an argument.

Dinero: If an individul chooses to work 30 hours a week instead of 5o that is there choice. If the population chooses to work x million hours instead of y million then that is there choice.

Sure. They chose to be unemployed.
http://libcom.org/files/images/history/depression%20unemployment.JPG

Mike said...

Zac said "Not an argument. "

Intelluctuial frauds are not worthy of extending the respect of providing one.

Dinero said...

- Zac


If they choose to work less than full capacity then that fits the phrase "underutilzed capacity"

What is youre defintion of the phrase you use "underutilized capacity"

Zachriel said...

Dinero: What is youre defintion of the phrase you use "underutilized capacity"

We already provided an example:
http://libcom.org/files/images/history/depression%20unemployment.JPG

You never responded to the point raised about the unemployed.

Dinero said...

who is we


invoking unemployment is circular reasoning.



Zachriel said...

Dinero: invoking unemployment is circular reasoning.

You're not making any sense. You brought up employment, when you said, "If an individul chooses to work 30 hours a week instead of 5o that is there choice." Lines of idle but willing workers is idle economic capacity.

Dinero said...

right got that. So "Trapped in states of underutilized capacity". is a strictly a measure of those unemployed but wanting employment and exludes those choosing more leisure time

Zachriel said...

Dinero: So "Trapped in states of underutilized capacity". is a strictly a measure of those unemployed but wanting employment and exludes those choosing more leisure time

Not strictly, as the decision to work is often affected by price. However, there are situations where there can be large numbers of workers willing to work, but there are no jobs.
http://wonkette.com/wp-content/uploads/2008/06/great-depression.jpg

Pulverized Concepts said...

" However, there are situations where there can be large numbers of workers willing to work, but there are no jobs."

You could hire those workers, couldn't you? Unfortunately, as you might discover if you did hire them, not everyone is suitable for a particular employment. Employers are unwilling to pay for employees that don't ad to their profit. And, in fact, workers aren't interested so much in a job as they are in income. Nobody would work if they could pick $20 bills from a tree in the backyard.

It's typical of statist thinkers to lump individuals into classes, endorsing legislation that doesn't apply to everyone but targets these classes. Unemployment is regarded in a Keyensian, aggregate sense, lumping a brick layer that's been laid off because the building has been completed with a photo finisher whose position has been eliminated by technological advancement. If "we" were truly interested in lowering the number of unemployed, we'd sever the relationship between government and employment, erase the laws governing minimum wage, occupational licensing, income tax withholding, and a myriad of other intrusions that discourage hiring. Even so, many would still be unemployed by their own preference. It's pretty presumptuous to believe that everyone has the same world view as you do.

Dinero said...

- Zac

"Not strictly, as the decision to work is often affected by price"


Are you defining capacity in terms of employment or production.

Dinero said...

- Pulverised Concepts

"
It's typical of statist thinkers to lump individuals into classes, endorsing legislation that doesn't apply to everyone but targets these classes."

its also typical of Statist and Keynsian thinkers to start of with undefined pre-conceptions and undefined goals

Zachriel said...

Pulverized Concepts: Unfortunately, as you might discover if you did hire them, not everyone is suitable for a particular employment.

That doesn't explain what happened between 1929 and 1933.

Pulverized Concepts: Unemployment is regarded in a Keyensian, aggregate sense, lumping a brick layer that's been laid off because the building has been completed with a photo finisher whose position has been eliminated by technological advancement.

Technological change didn't lead to a quarter of the workforce unemployed.


Dinero: Are you defining capacity in terms of employment or production.

It's the ratio of actual production and potential production. Labor is a resource, so idle labor is an idle resource.

Dinero: its also typical of Statist and Keynsian thinkers to start of with undefined pre-conceptions and undefined goals

Perhaps, but merely saying others misunderstand doesn't add anything.

Dinero said...

-Zac

Ok ,so is it the possible production that would result if every person above the age of 18 in the country was working every hour of the day possible, or is it the production that would result if everyone that was looking for a job at a particular time was employed at regular 9 to five hours.

Zachriel said...

Dinero: so is it the possible production that would result if every person above the age of 18 in the country was working every hour of the day possible, or is it the production that would result if everyone that was looking for a job at a particular time was employed at regular 9 to five hours

There are different quantitative measures, whether including all practical production, or simply economical utilization. They tend to move in tandem, but certainly, the change from 1929 to 1933 represents a clear drop in either measure.

Did you have a point?

Dinero said...

Yes - simply that in the case of people choosing to work less hours then what could be physically possible then there is no need to refer to them as being "trapped in states of underutilized capacity"
Do you concur.

Zachriel said...

Dinero: simply that in the case of people choosing to work less hours then what could be physically possible then there is no need to refer to them as being "trapped in states of underutilized capacity"

Yes, that's how they would be measured under the economic model.

Now, are you saying that between 1929 and 1933, a quarter of the workforce just decided to take a vacation?

Mike said...

Dinero
While I admire you efforts, you’re wasting your time. He is impervious to critical thinking and disingenuous. He doesn’t warrant the intellectual attention you are providing.

Dinero said...

So are you saying that the state does not need to intervene when people choose to work less hours.

Dinero said...

1.49 is a comment for Zac

Zachriel said...

Dinero: So are you saying that the state does not need to intervene when people choose to work less hours.

We answered your question, but you didn't answer ours. Please enlighten us.

Dinero said...

Seeking and not finding employment is not same as choosing to work less hours.Do you think the state needs to intervene when the population chooses to work less hours.

Zachriel said...

Dinero: Seeking and not finding employment is not same as choosing to work less hours.

We take that to mean you agree that during the Great Depression, millions of willing workers couldn't find employment.

Dinero: Do you think the state needs to intervene when the population chooses to work less hours.

Markets generally work well within certain parameters. There is an ebb and flow in labor markets as prices rise or fall to match supply and demand.

Mike said...

Dinero

He said “Markets generally work well within certain parameters.’

AND THERE YOU HAVE IT.

You see, in addition to not answering your question directly, (intellectual fraud) the insinuation of the statement calls for the enlightened elite to “correct” those situations where markets don’t work. What the definition of don’t “work” is and according to whom is a separate matter. Not to worry. The chosen enlightened few will make all those decisions for the ignorant masses.

Samm said...

I think Zac is George W. Bush, which would actually explain a lot.

GWB:”I’ve abandoned free market principles to save the free market system.”

Zac’s argument: The free market works as long as the government is managing it.

Zachriel said...

Mike: What the definition of don’t “work” is and according to whom is a separate matter.

We know that markets don't always self-correct. One example is the period 1929-1933.

Mike said...

"We know that markets don't always self-correct. One example is the period 1929-1933. "

What a moronic statement. "We...strike that..."You" don't know anything of the sorts.

I suppose government interference had nothing to do with affecting a prospective self correcting environment or help in creating it. Oh and the artificial time line of 1929-1933 didn't fit your statist artificial time line about when things are "supposed" to happen. Go study the 1920 depression for starters. Educate yourself beyond the progressive garbage you may have been taught.

I think Samm hit the nail on the head. You are George W Bush in drag.

Zachriel said...

Mike: Educate yourself

Again, not an argument.

Mike said...

You're right. Its a statement.

You are not worthy of an arguement "George"

Or did your "spam" filter prevent you from reading this

Gary Anderson said...

The Fed's desire is to protect the bankers at all cost. The Fed did conspire to blow the housing bubble and I can prove it.

Tel said...

Mike: Educate yourself

Zac: Again, not an argument.

Mike is remiss in demanding that you educate yourself while at the same time not recognizing that you lack the tools to do so.

Zac, you want to read Murray Rothbard's two relevant books "The Case Against the Fed" and "America's Great Depression" which thoroughly document the large amount of government intervention going on during the Harding, Coolidge and Hoover years. They include both first principles theory and detailed lists of specific examples of price fixing, cartel creation, and the people who were involved, as well as copious references and footnotes.

These books are easily available either to purchase, or as PDF downloads.

Zachriel said...

Tel: "The Case Against the Fed" and "America's Great Depression" which thoroughly document the large amount of government intervention going on during the Harding, Coolidge and Hoover years. They include both first principles theory and detailed lists of specific examples of price fixing, cartel creation, and the people who were involved, as well as copious references and footnotes.

Yes, we're quite aware that ideally free markets didn't exist before or after. Does the Earth follow a perfectly elliptical orbit?

Anonymous said...

Yes, Zachriel, it does.

Zachriel said...

Anonymous: Yes, Zachriel, it does.

Actually not. The Earth's orbit is perturbed by the Moon and other bodies. In addition, there is precession of its orbit.