The second reason is that Keynesian analysis is pretty easy to understand and to teach. (I always wait until the end of the semester to teach the "aggregate demand -- aggregate supply lessons, but students have no problem understanding how the graphs work and the Keynesian claims.) According to the Keynesians, the entire economy is moved by aggregate spending on consumption goods and services. There is no concern at all about the factors of production, no messy "structure of production" to analyze, nor should one worry about inflation, as inflation is good for the economy. Just spend, spend, spend, and everything is fine.
Thus, Krugman's column today in which he foresees a "lost decade" for the United States, does not surprise me. His prediction might be true, but perhaps it is ironic that Krugman's very policy prescriptions that the government is following will be the reason for that "lost decade."
First, he writes:
Recent data don’t suggest that America is heading for a Greece-style collapse of investor confidence. Instead, they suggest that we may be heading for a Japan-style lost decade, trapped in a prolonged era of high unemployment and slow growth.In other words, the problem is that we don't have enough inflation. However, there is something that Krugman misses, and that is the fact that there are massive malinvestments in our economy that the government continues to try to prop up. Furthermore, the government is forcing billions of dollars to be spent on resources that cannot be sustained in our economy without draining the healthy industries. That is the meaning of "malinvestments."
Let’s talk first about those interest rates. On several occasions over the past year, we’ve been told, after some modest rise in rates, that the bond vigilantes had arrived, that America had better slash its deficit right away or else. Each time, rates soon slid back down. Most recently, in March, there was much ado about the interest rate on U.S. 10-year bonds, which had risen from 3.6 percent to almost 4 percent. “Debt fears send rates up” was the headline at The Wall Street Journal, although there wasn’t actually any evidence that debt fears were responsible.
Since then, however, rates have retraced that rise and then some. As of Thursday, the 10-year rate was below 3.3 percent. I wish I could say that falling interest rates reflect a surge of optimism about U.S. federal finances. What they actually reflect, however, is a surge of pessimism about the prospects for economic recovery, pessimism that has sent investors fleeing out of anything that looks risky — hence, the plunge in the stock market — into the perceived safety of U.S. government debt.
What’s behind this new pessimism? It partly reflects the troubles in Europe, which have less to do with government debt than you’ve heard; the real problem is that by creating the euro, Europe’s leaders imposed a single currency on economies that weren’t ready for such a move. But there are also warning signs at home, most recently Wednesday’s report on consumer prices, which showed a key measure of inflation falling below 1 percent, bringing it to a 44-year low.
This isn’t really surprising: you expect inflation to fall in the face of mass unemployment and excess capacity. But it is nonetheless really bad news. Low inflation, or worse yet deflation, tends to perpetuate an economic slump, because it encourages people to hoard cash rather than spend, which keeps the economy depressed, which leads to more deflation. That vicious circle isn’t hypothetical: just ask the Japanese, who entered a deflationary trap in the 1990s and, despite occasional episodes of growth, still can’t get out. And it could happen here.
So what we should really be asking right now isn’t whether we’re about to turn into Greece. We should, instead, be asking what we’re doing to avoid turning Japanese. And the answer is, nothing.
It’s not that nobody understands the risk. I strongly suspect that some officials at the Fed see the Japan parallels all too clearly and wish they could do more to support the economy. But in practice it’s all they can do to contain the tightening impulses of their colleagues, who (like central bankers in the 1930s) remain desperately afraid of inflation despite the absence of any evidence of rising prices. I also suspect that Obama administration economists would very much like to see another stimulus plan. But they know that such a plan would have no chance of getting through a Congress that has been spooked by the deficit hawks.
In short, fear of imaginary threats has prevented any effective response to the real danger facing our economy.
Will the worst happen? Not necessarily. Maybe the economic measures already taken will end up doing the trick, jump-starting a self-sustaining recovery. Certainly, that’s what we’re all hoping. But hope is not a plan.
Is there an alternative view? Doug French, in a recent article, points out that the Japanese economy in the late 1980s had a both real estate and stock market bubbles (Sound familiar?) and the government did exactly what Krugman has said needs to be done. French writes:
After the bubble popped in Japan, that government pursued a relentless Keynesian course of fiscal pump priming and loose fiscal policy with the result being a Japan that went from having the healthiest fiscal position of any OECD country in 1990 to annual deficits of 6 to 7 percent of GDP and a gross public debt that is now 227 percent of GDP. "The Japanese tried to cure an alcoholic with heroin," writes Bonner. "Now, they're addicted to it."The simply question, then, is this: Why didn't this "stimulus" work in Japan and why won't it work here? The answer can be given in one word: malinvestments.
Japan's monetary policy was to aggressively lower rates to .5 percent between 1991 and 1995 and has operated a zero-interest policy virtually ever since.
Between 1992 and 1995, the Japanese government tried six stimulus plans totaling 65.5 trillion yen and they even cut tax rates in 1994. They tried cutting taxes again in 1998, but government spending was never cut. Also in 1998, another stimulus package of 16.7 trillion yen was rolled out nearly half of which was for public-works projects. Later in the same year, another stimulus package was announced, totaling 23.9 trillion yen. The very next year an ¥18 trillion stimulus was tried, and, in October of 2000, another stimulus for 11 trillion was announced. As economist Ben Powell points out, "Overall during the 1990s, Japan tried 10 fiscal stimulus packages totaling more than 100 trillion yen, and each failed to cure the recession," with Japan's nominal GDP growth rate below zero for most of the five years after 1997.
In the Keynesian world, all assets are homogeneous, and all that needs to be done is to stimulate consumer spending. If consumers spend, then the factors of production automatically adjust and the economy is fine. However, Austrians point out that the real activity is in the factors themselves, and when government "stimulus" programs encourage people to spend now, their spending patterns will change the very structures of production.
The recessions begin when the production structures develop problems, which then leads to less spending by consumers. In other words, Keynesians get it backwards. They believe that the recessions begins with a fall in consumer spending when then moves to the production side.
In other words, the gulf between Keynesians and Austrians is huge and cannot be bridged. That people in power are listening to Krugman and the Keynesians means that we are in for a long, harsh, and ruinous recession. Unfortunately, the government and its allies will blame private enterprise, and the Congress will pass news laws that will make us even poorer. Like it or not, that is our future.
To reference Japans attempts to stimulate the economy via aggressive monetary and fiscal and not bother to reference the repeated monetary and fiscal contractions as soon as any recovery started to take hold is not telling the entire story. The consumption tax of 1997 is the most obvious example. But there are numerous others. In reality, every stimulus plan mentioned above was undone by trigger happy policy makers that removed the stimulus too soon. In reality, a truly Keynesian stimulus was not enacted until the very late 90's and it proved effective as growth took hold in the early 2000's. It seems you are chosing to ignore facts and data to support your opinion (that's just my humble opinion)
"any kind of analysis that claims only government can create prosperity is going to be the ideology of choice by those in government"
Could you reference where Keynes said this in any of his works? It's one thing to disagree with Keynes, it's another to repeatedly misrepresent Keynesians by saying he believed only the government can create prosperity. This is nonsense.
I was reading the intro to a cosmology book and it delved into how cultural precepts can drive cosmological theory. They went into a discourse on the principle of plenitude and its effect on cosmology. In economic thought I think that Krugman and most Keynsians adhere to the principle of plenitude. I think this is why they can't get a grip on the concept of malinivestment. They believe that there is an infinite amount of capital available and you just have shovel it out there and the aggregate wheels will keep running. It doesn't really matter where it goes. If you really believe in the principle of plenitude then the nature of the capital structure doesn't really matter.
On the other hand, if you adhere to the prinicple of plenitude then you can't be much of an economist since economics is all about what you do when there is a finite amount of capital to go around.
If you believe that resources and capital are finite then you appreciate the fact that people only become better off through improvements in productivity. You have to get more out of a finite capital and resource structure. If productivity matters then the capital structure becomes paramount.
Yea I was thinking the same thing. It seems that Keynsian, Socalist and Marxist ideas all stem from denying the problem of scarcity. Well maybe 'deny' is too strong a word, their view seems more to be that manufacturing and transportation technology has made scarcity all but irrelevant.
This explains the Kenseian focus on 'aggregate demand.' If there are pleanty of goods, then the obvious problem is that for some reason people arent buying them anymore.
It might also explain the liberal instance that businesses/society can 'afford' enviormental leglislation, universal healthcare or whatever other demands they have. If scarcity isnt a problem, then implimenting these things are effectively costless.
Maybe liberterians in general, and Austrians in particular should give a greater degree of focus on the issue of scarcity.
The fact that when the "stimulus" is removed the economy corrects just proves the Austrians point. Money printing and government spending only paper over the underlying malinvestment. The boom is the anomaly, the bust is necessary.
Austrians do not misrepresent Keynesians. We simply point out his error and follow his argument to the logical conclusion.
Keynes believed that the only gov't spending during a recession can offset the decrease in aggregate demand leading to economic growth, right?
Sorry Johnny the laws of economics do not change with the macroeconomic situation. So Austrians remove the part about recessions thus following Keynesian logic -- only gov't spending [...] lead[s] to economic growth.
"any kind of analysis that claims only government can create prosperity is going to be the ideology of choice by those in government"
Could you reference where Keynes said this in any of his works? It's one thing to disagree with Keynes, it's another to repeatedly misrepresent Keynesians by saying he believed only the government can create prosperity. This is nonsense. "
Keynes didnt say this (to my knowledge), Dr. Anderson did. and it makes absolutely perfect sense.
Keynes believed that because capital investing was dominated by "animal spirits" (his words) of investors, the multiplier effects of investment spending would be up and down, so government spending needed to fill in the gaps, as it were.
Likewise, Keynes wrote that inflation would serve as the tonic to bring about a necessary "wage cut" that would lower unemployment, as Keynes wrote that workers only were interested in their "money wage." I would recommend your reading two books besides the General Theory.
The first is Wallace Peterson's intermediate macro text, which at one time was very popular and quotes Keynes like scripture. It is clear in that book (which I have used as a text before) that spending is the key to everything. For example, the book condemns the stock market because most stocks are sold in a secondary market, and secondary markets don't boost investment spending, according to Keynes.
The second book is Henry Hazlitt's The Failure of the New Economics, in which he goes through the General Theory almost line-by-line and refutes the Keynesian doctrines. It is true that Keynes (and Krugman) do NOT say that "only government can create prosperity," but it is clear from reading their works that they believe that a market economy is internally unstable and cannot create prosperity on its own.
"Keynes believed that the only gov't spending during a recession can offset the decrease in aggregate demand leading to economic growth, right?"
Not right. Keynes advocated deficit spending during liquidity traps. My point is not if Keynes is right or wrong. That's a pointless debate for this blog since it will never get settled without bias. My point was over the constant misrepresentation of Keynesian
"It is true that Keynes (and Krugman) do NOT say that "only government can create prosperity,""
Thank you for acknowledging your error.
However Keynes wrote about the need for the socialization of investment as as tool to eliminate the scarcity of capital and achieve full employment at all times.
you seem to be policing every word in this blog for any discrepancy you can find, but what you fail to realize is that the people who read this blog understand the difference between a statement accurately reflects Keynesian thought, and statements that are reflections of an Austrian view of Keynesian thought. you see, we arent learning about it from this blog, we already understand Keynesian theory and why its BS. your 'work' is not needed.
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