Wednesday, February 22, 2012

Higgs vs. Krugman

I feature a wonderful 2009 piece by Robert Higgs (I had a link to it last year) that I think really shows the differences between the Austrians and what Higgs calls the "Vulgar Keynesians," including Paul Krugman.

Higgs lays out six areas where the Keynesians especially are weak, including:
  • Aggregation: Keynesians believe that they can explain an entire economy through aggregate demand, aggregate supply, price levels, and the rate of interest;
  • Relative prices: The only thing that means anything regarding prices to Keynesians is the overall "price level. Higgs writes: "If relative prices change, which of course they always do to some extent, even in the most stable periods, these changes are "averaged out" and affect the calculated change, if any, in the aggregate price level only in a shrouded and analytically irrelevant manner."
  • The rate of interest: Higgs points out that the rate of interest "is a crucial relative price — namely, the price of goods available now relative to goods available in the future." Keynesians, on the other hand, believe it is just a "price of money," so the lower the price, the better;
  • Capital and its structure: In the short run, notes Higgs, Keynesians view capital as being homogeneous, with its only real value being the money spent in creating it. Furthermore, Keynesians see capital stock as a "given" and cannot conceive of malinvested capital, believing that capital that is not in use only is "idle," and can be revived with enough spending;
  • Malinvestments and money pumping: Because Keynesians don't believe that massive malinvestments have anything to do with an economic downturn, their "solution" of pumping more money into the economy cannot have any other result except success -- provided government pumps enough money. Higgs writes that Keynesians also seem to have an abiding faith in the healing powers of inflation;
  • Regime uncertainty: What Krugman calls the "Confidence Fairy," Higgs notes that the political atmosphere does make a difference regarding investment and especially long-term capital investment. He writes: "The vulgar Keynesian does not understand that policy activism itself works against economic prosperity by creating what I call "regime uncertainty," a pervasive uncertainty about the very nature of the impending economic order, especially about how the government will treat private property rights in the future. This kind of uncertainty especially discourages investors from putting money into long-term projects."
While I am sure that Higgs' points will enrage the Keynesians, nonetheless it is clear that Higgs is writing about economics, not statistical aggregates. There really is a difference.

48 comments:

Major_Freedom said...

There are more:

Consumptionism versus Productionism: Keynesianism is based on the philosophy of consumptionism, which holds that humans have a limited desire for wealth and so must be prodded and encouraged by extra-market forces to increase their consumption spending, lest they hoard cash from their incomes, and business profitability and employment will fall. (See "marginal propensity to consume"). Austrianism is based on the philosophy of productionism, which holds that the desire for additional wealth is practically infinite, and the real problem is how to produce the most given resource scarcity, and that the more people save in the present, the more they can produce in the future.

Epistemology: Keynesianism is based on the philosophy of positivism, which holds that the only valid knowledge humans can acquire is by means of empirical observation. Austrianism is based on the philosophy of rationalism, which holds that valid knowledge can also be acquired by means of self-reflection. Keynesians hold economics to be a positivist science, whereas Austrians hold that economics is a praxeological science.

LK said...

(1) Austrians also use aggregation, and it is only the most ignorant and stupid Austrians who would reject it.

E.g., the only serious Austrian measures of real national output proposed in place of GDP, such as Rothbard’s Gross Private Product (GPP) and Mark Skousen’s Gross Domestic Output (GDO) are nothing but aggregates.

http://socialdemocracy21stcentury.blogspot.com.au/2012/01/austrian-substitutes-for-gdp-they-are.html

(2) Higg's assertion is false.

(3) Higg's assertion depends on the false and mistaken time preference theory of interest rates. Interest rates aren't explained by time preference, and even a few Austrians - e.g., Robert P. Murphy - think so.

(4) Only New Keynesians see capital goods as homogeneous. This i does not and has never applied to Post Keynesianism.

(5) This depends on the fantasy ABCT. Also, the assertion that "Keynesians also seem to have an abiding faith in the healing powers of inflation" is nothing but a contemptible caricature.

(6) While regime uncertainty was a problem back in the 1930s when the level of government intervention was new, it has long since ceased to be a serious factor in modern economies. Only the contrary, there are large sector so of the business community that look to government for protection, and who understand that government's interventions assist them. Even the level of "regime uncertainty" in the 1930s is exaggerated by Higgs:

“While encouraging the growth of big labor and ministering to the needs of the elderly and the poor, the New Deal also provided substantial benefits to American capitalists. Business opposition to Roosevelt was intense, but it was narrowly based in labor-intensive corporations in textiles, automobiles, and steel, which had the most to lose from collective bargaining. The New Deal found many business allies among firms in the growing service industries of banking, insurance, and stock brokerage where government regulations promised to reduce cutthroat competition and to weed out marginal operators. Because of its aggressive policies to expand American exports and investment opportunities abroad, the New Deal also drew support from high-technology firms and from the large oil companies who were eager to penetrate the British monopoly in the Middle East. Sophisticated businessmen discovered that they could live comfortably in a world of government regulation.” (Levy, L. W. et al. (eds), Encyclopedia of the American Constitution (vol. 1), Macmillan, New York. pp. 447-448).

LK said...

"Keynesianism is based on the philosophy of positivism, which holds that the only valid knowledge humans can acquire is by means of empirical observation. Austrianism is based on the philosophy of rationalism, "

Austrian economics is divided on the issue of methodology. Your statement on praxeology merely applies to some Austrians, not all of them.

There is a subgroup of Austrians who reject praxeology and hold an important role for empirical method in economics:

http://socialdemocracy21stcentury.blogspot.com.au/2011/05/hayek-on-mises-apriorism.html

http://socialdemocracy21stcentury.blogspot.com.au/2010/10/mises-praxeology-critique.html

E.g., Hayek rejected Mises's apriorism:

“I had never accepted Mises’ a priorism .... Certainly 1936 was the time when I first saw my distinctive approach in full clarity – but at the time I felt it that I was merely at last able to say clearly what I had always believed – and to explain gently to Mises why I could not ACCEPT HIS A PRIORISM” (quoted in Caldwell, B. 2009. “A Skirmish in the Popper Wars: Hutchison versus Caldwell on Hayek, Popper, Mises, and methodology,” Journal of Economic Methodology 16.3: pp. 323–324).

Also, O’Driscoll and Rizzo, following Hayek, envisage a role for empirical tests in economics (see O’Driscoll and Rizzo’s The Economics of Time and Ignorance, Oxford).

"Austrianism is based on the philosophy of rationalism, which holds that valid knowledge can also be acquired by means of self-reflection."

Mainstream economics methodology (including Keynesianism) does not reject deduction either.

macroman said...

Keynesians [believe] that capital that is not in use only is "idle," and can be revived with enough spending;

And Austrians believe what? That idle capital cannot be put to use, which may be different from its last use? That idle workers cannot start working, and working at a job somewhat different from their last one? I don't get it.

macroman said...

The vulgar Keynesian does not understand that policy activism itself works against economic prosperity by creating what I call "regime uncertainty," ...

I think you will find that that "vulgar Keynesian" Krugman has said that the fight over the borrowing limit did indeed create uncertainty and had some effect on economic prosperity. And I think you will also find that Krugman uses the "confidence fairy" to ridicule the idea that policy uncertainty is much more important than lack of demand to explain why business is not investing. Does anyone think business would invest when business thinks no one wants to buy its output?

Scott D said...

LK: Austrians also use aggregation, and it is only the most ignorant and stupid Austrians who would reject it.

Notice that LK doesn't argue the point, and that his rebuttal is completely irrelevant. "Using aggregates" is not the issue, but the idea that aggregate measures alone can give you enough information to make macro policy decisions. Austrians do use aggregates in their analysis, but understand that the information gained from such analysis has limited applications.

LK: Higg's assertion is false.

Keynes spoke to relative prices in a few instances, but not in the way Higgs is referring to. Austrian analysis of prolonged unemployment and recession focuses on the role of prices being out of kilter. If the economy is in a recession, prices of goods and labor in some segments of the economy need to fall so that the markets can clear. Keynsian economics rejects this analysis and proscribes an increase in aggregate demand as the cure.

LK: Higg's assertion depends on the false and mistaken time preference theory of interest rates...

The upshot being that his assertion about Keynsians is correct. Keynes basically views interest as an unnatural impediment to growth and of no benefit to the larger economy. Such a view fails to account for why interest exists at all except as a kind of conspiracy by rentiers to personally gain at the expense of everyone else. Yes, this is a very "weak" position as it fails to find any purpose for a deeply-ingrained economic mechanism and ends up simply pointing fingers at bad people who want to hurt us.

LK: Only New Keynesians see capital goods as homogeneous.

You have to treat capital goods as homogenous to think that government spending automatically puts idle resources to work.

LK: This depends on the fantasy ABCT.

Keynsian economics depends on a homogeneous capital structure and rejection of the idea that spending can ever be harmful.

LK: While regime uncertainty was a problem back in the 1930s when the level of government intervention was new, it has long since ceased to be a serious factor in modern economies.

Because "we're all Keynsians now"? It is difficult to argue that the effect doesn't exist. You can see extreme cases in the third world, so it is reasonable to argue that a more stable regime would experience this to a lesser degree. I think that, at most, you can argue that this is a difficult effect to quantify.

Mike Cheel said...

@ScottD

"Notice that LK doesn't argue the point, and that his rebuttal is completely irrelevant."

It is the simple questions he refuses to answer.

@LK

What is the formula that determines the floor (and ceiling) for minimum wage?

Why is it ok to destroy savings via Keynesian policies?

Major_Freedom said...

It's always fun to see LK flail about and fall over himself trying and failing to understand Austrian economics, let alone refute it.

(1) Austrians also use aggregation, and it is only the most ignorant and stupid Austrians who would reject it.

It's not about "use", it's about what they can tell us about the economy. Keynesians think they can tell us everything about the economy. Austrians know economics is based on individual action. The reason why traditional Keynesianism fell out of favor is because it didn't have a micro-foundation. The Keynesian-neoclassical synthesis via Hicks and Samuelson was a hobbled attempt to salvage Keynesianism.

(2) Higg's assertion is false.

LK's assertion is false. Yippee!

(3) Higg's assertion depends on the false and mistaken time preference theory of interest rates. Interest rates aren't explained by time preference, and even a few Austrians - e.g., Robert P. Murphy - think so.

The time preference theory is neither false nor is it redundantly mistaken. The liquidity preference theory is false. It is easily disproved by simply considering periods of rapid and high inflation (but not hyperinflation). The demand for money falls and yet contrary to what the liquidity preference theory predicts, interest rates rise. Once inflation comes back down, the demand for money rises, and yet contrary to what the liquidity preference predicts, interest rates fall.

Interest rates are determined by the rates of profit in the economy, and the rates of profit are determined by the difference between two different demands, the demand for output and the demand for input factors. This difference is ultimately grounded in the consumption time preferences of those who make productive expenditures.

(4) Only New Keynesians see capital goods as homogeneous. This i does not and has never applied to Post Keynesianism.

False. Every Keynesian believes that the government printing and spending money can reduce "idle resources". This aggregation of capital goods is only possible if they are treated as homogeneous.

(5) This depends on the fantasy ABCT.

ABCT is not fantasy, it actually explains the business cycle.

Also, the assertion that "Keynesians also seem to have an abiding faith in the healing powers of inflation" is nothing but a contemptible caricature.

It is not a caricature. Keynes said inflation was like turning stone into bread.

(6) While regime uncertainty was a problem back in the 1930s when the level of government intervention was new, it has long since ceased to be a serious factor in modern economies.

False. Regime uncertainty persists and still explains a substantial portion of the lack of investment.

Major_Freedom said...

LK:

"Keynesianism is based on the philosophy of positivism, which holds that the only valid knowledge humans can acquire is by means of empirical observation. Austrianism is based on the philosophy of rationalism,"

Austrian economics is divided on the issue of methodology. Your statement on praxeology merely applies to some Austrians, not all of them.

I wasn't referring to "Austrians". I was referring to Austrian economics. The core of the theory itself is praxeological.

If any economist rejects praxeology, they aren't Austrian.

There is a subgroup of Austrians who reject praxeology and hold an important role for empirical method in economics:

E.g., Hayek rejected Mises's apriorism:

By the late 1930s, Hayek transitioned into more of a sociologist than an economist. In his early years, under Mises, he did not reject praxeology.

Also, O’Driscoll and Rizzo

Both O'Driscoll and Rizzo reject positivist economics. See Rizzo, "Praxeology and Econometrics: A Critique of Positivist Economics - Louis M. Spadaro, New Directions in Austrian Economics" and, ironically, the very book you cited as well.

Where they are distinct is their rejection of apriorism, and instead favor a combination of Lachmannian subjectivism, Weberian mind constructs, and Hayekian institutional development.

They are not "empiricists".

Mainstream economics methodology (including Keynesianism) does not reject deduction either.

In practise, in terms of what they do, no, not often, but in what they say, how they argue, they always defer to empiricism. They aren't always practising what they are preaching.

Major_Freedom said...

macroman:

Keynesians [believe] that capital that is not in use only is "idle," and can be revived with enough spending;

And Austrians believe what? That idle capital cannot be put to use, which may be different from its last use? That idle workers cannot start working, and working at a job somewhat different from their last one? I don't get it.

Austrians believe that the most optimal use of ANY resource, in use or in idleness, is the use that follows from unhampered, unadulterated economic calculation. This requires a monetary system that must be at the very least itself market driven, not monopolized and external to the market process, whereby money is printed and interest rates are changed from where they otherwise would have been.

If in an unhampered market there are unemployed workers and idle resources, then the free market process itself is the only way that the requisite information is produced that can enable their owners to know where they are most valued.

See William Hutt, "The Theory of Idle Resources."

(Warning: PDF) http://mises.org/books/theory_of_idle_resources_hutt.pdf

The vulgar Keynesian does not understand that policy activism itself works against economic prosperity by creating what I call "regime uncertainty,"

I think you will find that that "vulgar Keynesian" Krugman has said that the fight over the borrowing limit did indeed create uncertainty and had some effect on economic prosperity.

Krugman interprets this not as policy activism itself creating uncertainty, but as GOP/Republicans/Conservatives creating uncertainty.

And I think you will also find that Krugman uses the "confidence fairy" to ridicule the idea that policy uncertainty is much more important than lack of demand to explain why business is not investing.

Business is investing, and they never stopped investing.

The idea that a lack of demand for a particular businesses' products leads to less investment at that particular business, doesn't mean that the way to stimulate aggregate investment is by stimulating aggregate demand. That's the fallacy of composition. In the aggregate, demand for output is in competition with demand for input. The higher the demand for output, the lower the demand for input can be.

Businesses don't invest when the prices for inputs are too high relative to the demand for their output. The thing that should change is the prices for input, not outputs. The prices of inputs should fall to their true value, given that the prices of accumulated savings were bid up too high via past inflation, and are not in line with their marginal value.

Major_Freedom said...

macroman:

Does anyone think business would invest when business thinks no one wants to buy its output?

But there are people who want to buy output. This silly argument of "nobody wants to buy anything" is a red herring and doesn't come close to representing reality. There is always consumer demand. Consumer demand has never dropped to zero, and probably never will. Consumption is necessary for people to even live, let alone live and be prosperous. The fact that there is a need for consumption, makes the need for production arise.

If consumers decrease their consumption (not to zero you fool), and they hold more cash, then what they are telling all investors in the price system is that they want to consume less in the present, and more in the future (since they're holding their money and not burning it).

If consumers consume less in the present and hold more cash to consume more in the future, then in an unhampered market, this will send signals throughout the market to tell producers to produce less in the present. Consumer profits will fall. Since investors chase profits, a fall in consumer profits will make the higher stage capital goods industries, that are targeted towards future consumption, relatively more profitable. By chasing these profits, investors would be doing exactly what the consumers want them to do.

The problem is that Keynesians don't want the sovereign consumer to determine what is produced. Keynesians want employment for the sake of employment, production for the sake of production, and spending for the sake of spending. They don't want saving and production for the sake of the consumers. Austrians on the other hand in their means and ends framework, know that production is geared towards consumption, so it would be silly to put the means (employment) as above the ends (consumption). It's reversing economic reality. Keynesianism is only popular with governments because it gives them not only an excuse to "spend", and thus justify their political corruption, but it also helps the government increase its tax revenues, by bringing out more "spending". With a higher nominal spending (e.g. GDP), the government can tax more transactions and spend more money.

Keynesianism is not economics. It is a political tool that intellectually justifies state aggression and attacks on the free market economy, to impoverish the poor and aggrandize the wealthy elite.

LK said...

"Every Keynesian believes that the government printing and spending money can reduce "idle resources".

Of course, government spending can use idle resources. It is plain idiocy to deny it.

Even some Austrians hold that government spending can put idle resources and capital goods to use, especially in a depression situation, e.g., the later Hayek:

http://socialdemocracy21stcentury.blogspot.com.au/2011/09/did-hayek-advocate-public-works-in.html

Ludwig Lachmann in his own words:

“In the British situation of 1932, Hayek and his friends rejected the proposals of Keynes and some non-Keynesian British economists – that at the bottom of the depression the government should take certain steps, and so on. Hayek has now realised that that was wrong. That is to say, I think Austrians today would not reject all measures to relieve unemployment and increase employment, in a situation in which nothing really is scarce.”

http://socialdemocracy21stcentury.blogspot.com.au/2012/02/lachmann-endorsed-keynesian-stimulus-in.html

This aggregation of capital goods is only possible if they are treated as homogeneous."

The use of idle capital in a government stimulus does not require any assumption of homogeneous capital.

LK said...

Scott D@February 23, 2012 11:25 AM

">LK: This depends on the
> fantasy ABCT.

Keynsian economics depends on a homogeneous capital structure and rejection of the idea that spending can ever be harmful."


Post Keynesianism does no such thing. And. moreover, that does not refute the charge that the ABCT is a false theory of cycles.

"Keynes basically views interest as an unnatural impediment to growth and of no benefit to the larger economy."

That is so laughably wrong it demonstrates you have no idea what you talking about. Keynes viewed interest rates as an important variable in a capitalist economy.

Mike Cheel said...

@LK

The formula and answer to why it is OK to destroy savings please?

I have requested the first item now specifically from you 4 times in the past 3 posts. I assume you are dodging both questions because you cannot answer them with a simple straightforward answer.

My answer is it is NOT OK to destroy my savings and there is no formula, it is made up by elite (around election time usually).

Bob Roddis said...

1. As he continues to demonstrate, LK still does not comprehend the concept of economic calculation or exchange. So he flails about spending all of his time finding minor inconsistencies and/or poor choices of words by Austrians.

2. I would add to Higgs' list the fact that the market does not fail and cause unemployment and that economies does not have or lack "traction".

3. The universal emphasis by Keynesians on spending demonstrates that they do not comprehend economic calculation or exchange.

Bob Roddis said...

On the MMT front, the MMTers are going bonkers because someone wrote about them in a Washington Post blog.

One of the new things I learned this week from their flurry was the MMTer's theory of the cause of mass unemployment. MMT guru Bill Mitchell says:

“So it is now possible to see why mass unemployment arises. It is the introduction of State Money (which we define as government taxing and spending) into a non-monetary economics that raises the spectre of involuntary unemployment.”

http://bilbo.economicoutlook.net/blog/?p=18291

http://mikenormaneconomics.blogspot.com/2012/02/izabella-kaminska-on-mmt-at-ft.html

Further, an MMTer over at FT.com wrote:

@Bob Roddis: Bill Mitchell's distinction is between a monetary and non-monetary economy. He says that (i) it takes a government/state to monetise an economy, and (ii) once you monetise an economy, then you have the possibility for unemployment. The state needs to step up and inject net financial assets (money or bonds) into the non-government sector, if that is what the non-government sector wants.

This claim has nothing - NOTHING - to do with claims about the size of the state.


http://tinyurl.com/6s88f7k

macroman said...

LK. It is futile to tell them Hayek eventually supported public works in a depression, they will just claim he is "not a true Austrian". After all Hayek was influenced by Popper. Or maybe Hayek "sold out" to retain some academic credibility in the English speaking world. I left the wonderland of Ayn Rand and Austrian Economics, many years ago, when I saw a claim that Milton Friedman was too "left wing". It makes sense that they don't like Milton Friedman, but "left wing"?

Major_Freedom said...

LK:

"Every Keynesian believes that the government printing and spending money can reduce "idle resources".

Of course, government spending can use idle resources. It is plain idiocy to deny it.

You moron, the point is that this proves Keynesianism view capital as a homogeneous concept. The point is not whether or not government spending can reduce idle resources.

The use of idle capital in a government stimulus does not require any assumption of homogeneous capital.

Yes, it does. It's why you morons say "idle resources", rather than "idle capital at stage 1, idle capital at stage 2, idle capital at stage 3".

You lump it all together into "idle capital", call for government "spending" rather than economic calculation based on private property exchanges to put that "idle capital" into "motion" again.

"Keynsian economics depends on a homogeneous capital structure and rejection of the idea that spending can ever be harmful."

Post Keynesianism does no such thing.

Yes, it does.

And. moreover, that does not refute the charge that the ABCT is a false theory of cycles.

You haven't proven the charge that ABCT is false.

"Keynes basically views interest as an unnatural impediment to growth and of no benefit to the larger economy."

That is so laughably wrong it demonstrates you have no idea what you talking about. Keynes viewed interest rates as an important variable in a capitalist economy.

The charge isn't that Keynesians hold interest rates to be "not important". That is a straw man. The charge is that Keynesians hold interest rates to be an IMPEDIMENT, a BARRIER, that reduces and limits economic prosperity and it's up the funny money counterfeiters to ensure that the "important" interest rates are below the unhampered free market rates.

Keynesians don't understand that interest rates are a reflection of time preferences, and that free market interest rates mean something, that they regulate the economy in its temporal structure to align investment with consumer temporal preferences.

macroman said...

@MF: If consumers decrease their consumption (not to zero you fool), and they hold more cash, then what they are telling all investors in the price system is that they want to consume less in the present,

What you say sounds OK about a normally functioning economy adjusting to gradual changes in the rate of saving. If however, there is such a thing as a general loss of confidence, and lots of consumers who reduce their spending because they lose their jobs, things may be different. Even Hayek admitted that Keynes theory was a "tract for the times". I am suggesting your perfectly functioning economy cannot adjust infinitely quickly - there are some shocks it cannot handle and it settles into a non-optimum equilibrium. This doesn't necessarily make Hayek's business cycle theory wrong, just limited in its applicability. There may be different kinds of recession/depression.

macroman said...

@Mike Cheel> You asked LK Why is it ok to destroy savings via Keynesian policies?

If you mean destroy savings via inflation, then I have a parallel question for you, the answer to which may indicate what sort of answer to your question I should look for.

The question is: Why is OK to make debtors pay back more value, via deflation, than they contracted to pay back when prices where higher.

Bob Roddis said...

Why is OK to make debtors pay back more value, via deflation, than they contracted to pay back when prices where higher.

Personally, I don't think it is right when the cause of the deflation was a previous funny money inflation. But the bankruptcy code forbids modification of a loan secured by a residence. Section 1322(b)(2)

http://www.law.cornell.edu/uscode/text/11/1322

Get rid of the Fed and Keynesian policy and the problem disappears.

Further, Hayek was clear that he wouldn't have had to answer whether another round of funny money to reflate might be wise in a depression if the inflationists hadn't caused the boom/bust in the first place. He was quite clear: Don't cause the problem in the first place. Once you've caused the problem, don't come running to me for solutions, none of which are pleasant.

Bob Roddis said...

From "A Discussion With FRIEDRICH A. VON HAYEK"
Held at the American Enterprise Institute on April 9, 1975, pages 8-9. At the time, there was an inflationary recession.

For forty years I have preached that the time to prevent a depression is during the preceding boom; and that, once a depression has started, there is little one can do about it. My advice was completely disregarded as long as the boom lasted. Now suddenly, when my prediction has come true and we have reached the stage where, in my opinion, little can be done about the inevitable reaction which has set in, people suddenly turn to me and ask for my opinion. I am very much tempted to answer, "Well, if you had listened to me before, you wouldn't be in that mess". Of course, I do not mean you—I mean the public in general.

What I want to discuss is policy in the long run—by which I mean not only the very long run in the Marshallian sense, but policy over the next few years. What we should absolutely avoid is any attempt to recreate employment, or diminish unemployment by a further does of inflation.

I will confess that I do not know whether, at this moment, even a strong additional dose of inflation would still be effective. I expect that it will be attempted, and I rather hope that it will not succeed and that we shall be forced to turn to the fundamental problem of the readjustment of the structure of production.
But the main point is: what can we do to avoid the same sort of mistakes in the future?

The public, having so long been taught false doctrines, is still convinced that the government has it in its power substantially to reduce or perhaps, in the short run, completely to abolish unemployment by such tricks as deficit spending, increasing the quantity of {p. 9} money, and so on. Is there any possibility of preventing the government, even if it should wish to act more sensibly, from being forced by public opinion into repeating its mistakes and being driven to more and more-inflation?

This leads me to a point where I am afraid I have persistently disagreed with many of my closest friends and associates. I believe that if we want to prevent the government from giving in to public pressure for quick and rapidly effective measures, we must put fetters on what the government can do and restore several institutions which were designed to prevent the government from abusing its powers, and particularly its powers to inflate.


So, I don't want to hear anything about Hayek from Keynesians who do not even understand the basic concept of economic calculation.

Anonymous said...

XX. INTEREST, CREDIT EXPANSION, AND THE TRADE CYCLE: 3. The Price Premium as a Component of the Gross Market Rate of Interest

He who expects a rise in certain prices enters the loan market as a borrower and is ready to allow a higher gross rate of interest than he would allow if he were to expect a less momentous rise in prices or no rise at all. On the other hand, the lender, if he himself expects a rise in prices, grants loans only if the gross rate is higher than it would be under a state of the market in which less momentous or no upward changes in prices are anticipated. The borrower is not deterred by a higher rate if his project seems to offer such good chances that it can afford higher costs. The lender would abstain from lending and would himself enter the market as an entrepreneur and bidder for commodities and services if the gross rate of interest were not to compensate him for the profits he could reap this way. The expectation of rising prices thus has the tendency to make the gross rate of interest rise, while the expectation of dropping prices makes it drop. If the expected changes in the price structure concern only a limited group of commodities and services, and are counterbalanced by the expectation of an opposite change in the prices of other goods, as is the case in the absence of changes in the money relation, the two opposite trends by and large counterpoise each other. But if the money relation is sensibly altered and a general rise or fall in prices of all commodities and services is expected, one tendency carries on. A positive or negative price premium emerges in all deals concerning deferred payments.

macroman said...

@Rothbardville: Hayek's opinion about what to do in 1975 in the middle of "stagflation" is different from his reluctant opinion of what to do in 1936 when he, and most of his initial supporters, came to realise that the depression was something different and may not fit his theory. Today is not like 1975, it is like 1933.

Do you want me to find the the quote where Hayek says Keynes's general theory was a "tract for the times" (i.e. and admission that it was the right response)?

And, I think there there is a certain element of self-justification and sour grapes in how Hayek describes, after the event, his relationship to Keynes. I am thinking in particular of his poor excuse for why he didn't write a book to destroy Keynes's theory.

LK said...

The context of your quote was 1970s stagflation - not deflationary depression. Therefore it does not contradict Hayek's support of monetary and fiscal interventions during depression.

And Hayek also said this:

“There is no doubt, and in this I agree with Milton Friedman, that once the Crash had occurred, the Federal Reserve System pursued a silly deflationary policy. I am not only against inflation but I am also against deflation! So, once again, a badly programmed monetary policy prolonged the depression” (Pizano, D. 2009. Conversations with Great Economists, Jorge Pinto Books Inc., New York. p. 13).

And only 3 years later in 1978 he said this:

“Although I do not regard deflation as the original cause of a decline in business activity, such a reaction has unquestionably the tendency to induce a process of deflation – to cause what more than 40 years ago I called a ‘secondary deflation’ – the effect of which may be worse, and in the 1930s certainly was worse, than what the original cause of the reaction made necessary, and which has no steering function to perform. I must confess that forty years ago I argued differently. I have since altered my opinion – not about the theoretical explanation of the events, but about the practical possibility of removing the obstacles to the functioning of the system in a particular way” (Hayek 1978: 206).

Bob Roddis said...

The fact remains that we don't have to worry about how to fix a depression caused by interventionist policies if we have no interventionist policies. Hayek is quite clear on that. In 1977, Hayek said that Keynes' "General Theory" was written solely for 1930s Britain in order to trick workers into accepting lower real wages. The recording at this link was provided by me as I recorded it live off of TV.

http://hayekcenter.org/?p=2701

Once one understands economic calculation (and the problem of knowledge as propounded by Hayek), one understands that Keynesian policy consists of nothing but theft and shifting of purchasing power from unsuspecting victims which distorts prices, and the investment and capital structure. Thus, unless there is a need to inflate to satisfy the hysterical rabble and avoid the Nazis coming to power, there is generally no need to inflate ever. It is also quite obvious that Keynesians do not or will not understand the concept of economic calculation and or exchange.

The market does not fail so there is no excuse for a Keynesian "cure". Keynesian policies distort the essential pricing process and are the cause of the problem. Never the twain shall meet.

Mike Cheel said...

@macroman Thanks for answering for LK since the basic questions seem to deter him.

As far as deflation I would say it matters as to what is causing it. I agree with what Bob Roddis said.

I mean, would we even be discussing this if we were on the gold standard (sans government printing presses running)? The only reason we left the gold standard was because we were doing things the Keynes way (printing and more printing) and people started buying the gold back. Wuh-oh though Nixon.

Now, you tell my why it is OK to destroy savings (this time with an answer please instead of a question).

LK said...

"Why is it ok to destroy savings via Keynesian policies?"

The question itself in fact reveals deep ignorance of the basic nature of capitalism:

http://socialdemocracy21stcentury.blogspot.com.au/2012/02/endogenous-money-savings-and-inflation.html

The endogenous expansion of the money supply is an internal, normal aspect of modern capitalism: it happens by free, non-fraudulent, voluntary processes, such as (historically) creation of bills of exchange, promissory notes and fractional reserve banking (FRB).

The endogenous money system confers benefits: it meets demand for credit for trade, commerce and investment. A consequence of the process is that it often produces inflation. Even in the 19th-century gold standard era, booms were basically inflationary (outside of the historically aberrant 1873-1896 period).

Central bank endogenous money systems merely continue what was already a fundamental feature of earlier capitalism.

Savers don't have some god given right to no inflation: the consequences of prohibiting FRB would be blatant violation of private free contract.

A system of perpetual deflation, on the other hand, would impose a "tax" on producers and businesses that take on debt to expand output and increase employment: the deflation tax penalises productive businesses and individuals who must pay back money with higher purchasing power. There would be debt deflationary effects, as well.

And powerful disincentives to capital goods investment would arise. By holding money idle, you have a guaranteed return. The relentless deflation would after some years - say, a 100 years or so - see an astonishingly unequal and high disparity of wealth.

LK said...

I mean, would we even be discussing this if we were on the gold standard (sans government printing presses running)?

Yes, you would. The gold standard was no protection against price inflation: the US had inflation under the gold standard in booms, in 1811-1814, 1825, 1834-1837, 1844-1847, 1841, 1852-1855, 1857, 1859, 1880, 1896-1914.

The UK had price inflationary periods in 1823-1825, 1831, 1835-1840, 1845-1847, 1853-1855, 1860-1861, 1865-1867, 1871-1873, 1882, 1888-1892, 1897-1903, 1905-1912.

UK historical rates:
http://safalra.com/other/historical-uk-inflation-price-conversion/

Nor did the gold standard era maintain a stable money supply either.

LK said...

"The fact remains that we don't have to worry about how to fix a depression caused by interventionist policies if we have no interventionist policies. Hayek is quite clear on that."

Hayek "accepted that bank credit and fractional reserve banking — even if they contributed to business cycles — were necessary."

http://en.wikipedia.org/wiki/Criticism_of_fractional-reserve_banking#cite_note-23

Hayek:

"So long as we make use of bank credit as a means of furthering
economic development we shall have to put up with the resulting
trade cycles.
They are, in a sense, the price we pay for a speed of development exceeding that which people would voluntarily make possible through their savings, and which therefore has to be extorted from them."


Hayek, 1966. [1933]. Monetary Theory and the Trade Cycle. p. 189-190.

Modern capitalism is stuck with business cycle.

macroman said...

Mike Cheel,

Thanks for mentioning the gold standard. We would be discuss inflation and deflation under a gold stand (new discoveries of gold, new releases of gold money from hoards) for inflation, and deflation when the supply of goods and services outruns the increase in the money supply.

Bob Roddis said...

I submit that to the extent private competing FRB can function in a non-fraudulent manner, only depositors or holders of a particular firm's paper and notes would ever suffer a loss of purchasing power due to an expansion of that firm's money supply. A private competing FRB firm would be competing with other private FRB firms and with 100% reserve backed notes. Such a situation is completely distinct from LK's historical anecdotes about government monopoly notes backed up by 40% or less in specie, the inherent dangers of which the public did not really comprehend.

As always, LK is mixing apples and oranges by conflating two completely distinct situations while admitting that it's perfectly fine to be robbed of purchasing power under his beloved fiat system. He does not understand economic calculation and its impairment under his fiat regime and he insists upon sticking us with the historic mess that was FRB, such as existed in Australia in the late 1800s.
Pursuant to John Quiggin, here's a quote from a paper with a relatively positive view of the free banking era, which nonetheless notes the systemic collapse of 1893:

Australia provides a textbook example of free banking in practice. One writer on the subject commented that in Australia “the legal framework with which banks operated was perhaps the least restrictive of any on record” (Dowd 1992).Butlin (1953),commented that "there was no tender law, no central bank, no legal control over the total volume of bank loans, and only a very primitive control by the banks themselves through a loosely applied rule of thumb (cash reserves should be to one-third the sum of deposits and notes) concerning reserves against all liabilities”.

The 1840 Colonial Bank Regulations issued by British Treasury governed colonial banking. The requirements included that: capital should be a determinant amount and must be fully subscribed; total debts must not exceed three times the paid up capital and that all notes were to be payable on demand in specie at the place of issue. Failure to pay on demand for a total of 60 days in any year entailed forfeiture of incorporation. Personal liability for bank shareholders was capped at an amount equal to twice capital and loans against real estate, shops or merchandise were to be prohibited. Amendments to the regulations in 1846 limited the note issue to the amount of paid up capital.

Banking was not substantially affected by the regulations, however. For example, the restrictions on total debt and note issue were largely ignored (Butlin 1986). Likewise, banks found loopholes around the prohibition on lending for land (Pope 1989). In practice, Australian colonial banks were allowed to raise the limits on note issue by including coin and bullion in paid-up capital. Over time, even this stricture was relaxed; by 1856 the Bank of Australasia secured a licence to print private notes up to the value of three times its specie and bullion holdings. Reserve requirements were easily met as “double counting” was permitted: reserves used to back the note issue were simultaneously used to provide liquidity in the event of a deposit withdrawal. Rules limiting total indebtedness were also no threat because deposits were excluded.

This freedom of note issue was, however, accompanied by strong liability provisions. In most colonies by the late 1860s, shareholders had unlimited liability for their note issue (Pope 1989).


Source is OPTIMAL REGULATION OF ELECTRONIC MONEV: LESSONS FROM THE “FREE BANKING” ERA IN AUSTRALIA
by THOMAS A. ROHLING AND MARK W. TAPLEY* Economic Papers: A journal of applied economics and policy

http://critiquesofcollectivism.blogspot.com/2011/02/john-quiggin-on-abct.html

What was described above was a massive fraud which has always been the subject of attack by Austrians. But LK wants to hang it on us.

ekeyra said...

LK,

"They are, in a sense, the price we pay for a speed of development exceeding that which people would voluntarily make possible through their savings, and which therefore has to be extorted from them."

Creating bank credits doesnt increase production. Thats why everyone here keeps reminding you of says law. Of course you will have crashes if you accelerate production along lines of production that, under the influence of manipulated interest rates and credit expansion look profitable, that then turn out to be boondoggles once exposed to the sobering reality of real economic laws.

Thats the ABCT you keep claiming is bunk.

Bob Roddis said...

Jonathan F. Catalan deals with LK's alleged "deflation tax" today:

One of the best histories of this period is provided by Robert Higgs, in his book The Transformation of the American Economy — I review the book here. As I note in the review, during this period, moneylenders actually allowed for a dynamic interest rate, which would let the rate on loans fall with prices.

http://www.economicthought.net/blog/?p=745

macroman said...

Ekeyra, think you just quoted Hayek, not LK, and claimed the quote showed no understanding of ABCT. I knew you would have to get round to saying Hayek was "not a true Austrian".

Bob Roddis said...

I really don’t even know what the hell Keynesians mean when they use the term “ liquidationist”. As opposed to what? Who decides who is to get a bailout? Is a loan modification in bankruptcy “liquidationist”? Is the lack of a loan modification in bankruptcy liquidationist? Is the prohibition against the modification of loans secured by a residence in the bankruptcy code liquidationist?

When the Keynesians have induced a boom which collapses, prices and values need to change to reflect reality. Someone has to take the losses that were not foreseen. Who should the victim be other than the person that owns the asset? Why? Why isn’t a case by case analysis in bankruptcy better than an indiscriminate reflation of a distorted price structure?

Mike Cheel said...

@macroman

Are you insinuating that inflation and deflation if gold were the standard (again) would be more of a crazy train and ultimately savings killer as the paper we are forced to use today?

LK said...

"I really don’t even know what the hell Keynesians mean when they use the term “ liquidationist”."

It means what Hayek was advocating in 1931: no intervention whatsoever in the face of a debt deflationary depression, with financial sector collapse, severe contraction of the money supply.

LK said...

"Jonathan F. Catalan deals with LK's alleged "deflation tax" today:"

Except that doesn't deal with the deflationary tax issue at all:

http://socialdemocracy21stcentury.blogspot.com.au/2012/02/endogenous-money-savings-and-inflation.html

ekeyra said...

Macro,

I knew exactly who I was quoting. Im not the brightest bulb here but Im not going to say hayek didnt understand the theory he created.

You and LK miss the entire point of the quote. When you accelerate economic development past the point that would have been sustainable with a given amount of private savings, the economy crashes. The question is HOW does an economy, which austrians say is entirely dependent on private savings to function, somehow overshoot its naturally limiting factors?

Could it have anything to do with fiat currencies, fractional banking and interest rate manipulation that, even if present in a free market, would not be as coordinated as they are under government control?

The quote doesnt support anything LK or you have said, and merely underlines the dangers of the very policies you advocate.

macroman said...

ekeyra: Could it have anything to do with fiat currencies, fractional banking and interest rate manipulation that, even if present in a free market, would not be as coordinated as they are under government control?

Yes, I think it could have something to do with with these things, especially fractional reserve banking. But that doesn't mean I accept this is the ONLY reason for the boom-bust cycle; there may be different kinds of cycle, and some of them might be controllable by Friedman style policies for example.

I am still slightly puzzled why business can't work out that interest rates vary, or even that central banks have targets, and plan to take account of these things.

Wicksell had a reasonable explanation of how an economy can be pushed to invest more than the sum of what individuals want - what is called forced saving via inflation; inflation, by reducing consumers purchasing power, forces them to consume less, forces the saving necessary to fund the investment dictated by banks. So it isn't clear why that is not sustainable.

I think the whole thing is more complicated that you think, and I think Hayek realized that and gave up.

ekeyra said...

Macro,

" some of them might be controllable by Friedman style policies for example."

If youd bothered to read hayek more than to confirm your own bias you'd know this is an impossibility. You would need information that is not available to anyone, much less some government or central bank that is removed from the realm of voluntary exchanges.

"Wicksell had a reasonable explanation of how an economy can be pushed to invest more than the sum of what individuals want - what is called forced saving via inflation; inflation, by reducing consumers purchasing power, forces them to consume less, forces the saving necessary to fund the investment dictated by banks. So it isn't clear why that is not sustainable."

You cant figure out why forcing people to spend money they otherwise would have saved leads to unsustainable lines of production...?

You really dont get it.

macroman said...

ekeyra: You cant figure out why forcing people to spend money they otherwise would have saved leads to unsustainable lines of production...?

Wicksell's "forced saving" theory is not about forcing people to spend money they otherwise would have saved, it is about forcing people to spend less, in effect saving what otherwise would have been spent.

Why can't it go on forever?

And weren't we discussing the origin of the business cycle, not here arguing what to do about it?

macroman said...

ekeyra: If youd bothered to read hayek more than to confirm your own bias you'd know this is an impossibility.

I know Hayek makes this assertion, but he is not so clear on his proofs. I no longer think everything he says is necessarily right.

macroman said...

Bob Roddis.

You continually say so-and-so "doesn't understand exchange and economic calculation". Perhaps you are waiting for someone to ask you to explain. I'll bite, would you explain the bits about exchange and economic calculation that people don't get?

macroman said...

The rate of interest: Higgs points out that the rate of interest "is a crucial relative price — namely, the price of goods available now relative to goods available in the future." Keynesians, on the other hand, believe it is just a "price of money ..."

I think that is wrong. Keynes said there is more than one thing going on with interest rates. The first being desired savings and desired investment, basically the present goods/future goods thing Higgs mentions. The second thing is liquidity preference (the desire to hold liquid assets, the most liquid being money; this corresponds to the thing Higgs claims is ALL Keynes worried about. And Keynes made another point; that all these things, desired savings, desired investment and liquidity preference depend on GDP (or wealth) - much more complicated that Higgs imagines.

Hicks formalised that part of Keynes into the IS-LM theory. It may be wrong (though Krugman seems to have used to to make some surprising and accurate predictions 3 years ago about the rate of interest). But if IS-LM is wrong, I think one will never make headway criticising the theory until one understands it.

ekeyra said...

Macro.

"Wicksell's "forced saving" theory is not about forcing people to spend money they otherwise would have saved, it is about forcing people to spend less, in effect saving what otherwise would have been spent.

Why can't it go on forever?"

Because producing more dollars does not produce more goods and services those dollars can purchase, only production made sustainable by individual voluntary exchange can do that. Actual resources will still be just as scarce no matter how many dollars people have to bid on them.

To describe the erosion of purchasing power due to inflation as "savings" seems absurd. Whatever mind altering chemical you and wicksell have I demand you share with the rest of the class.

"And weren't we discussing the origin of the business cycle, not here arguing what to do about it?"

Im not the one who threw this gem out:

" But that doesn't mean I accept this is the ONLY reason for the boom-bust cycle; there may be different kinds of cycle, and some of them might be controllable by Friedman style policies for example."

You brought up the idea that economic interventions by the government can control problems caused by economic interventions by the government all on your own. That was your suggestion.

macroman said...

Why can't it [involuntary saving] go on forever?"

Ekeyra: Because producing more dollars does not produce more goods and services those dollars can purchase, only production made sustainable by individual voluntary exchange can do that. Actual resources will still be just as scarce no matter how many dollars people have to bid on them.


Ekeyra, What would this theory predict about Australia’s compulsory superannuation, if anything? It is required by Australian law that about 10% of wages be deposited with a superannuation scheme (the superannuation provider and the investment strategy can be chosen by the worker, and the money so deposited is taxed much lower than the usual income tax rate). The worker cannot access the money until age 65 (but the worker is the only one who can access it). So it is involuntary saving. Can it go on forever?

I guess you could say this “forced saving” is not caused by new money, so perhaps it can go on forever?

In Wicksell’s analysis (I think it was developed in Hayek’s theory, Wicksell expressed no view that I know of on the sustainability question) the new money does not produce new resources, it draws resources into investment away from consumption. The economy consumes less (consumers are forced to consume less by inflation eroding their purchasing power) and therefore more goes into long term projects (investment).

Hayek says it can’t go on forever, or sometimes just says when it stops there is trouble. I think he doesn’t address whether the market can handle voluntary changes in propensity to save or spend, if these changes were sudden. Perhaps it is the suddenness of changes that matter, rather than the “involuntary” aspect; when everybody gets scared simultaneously, and tries to save when no one wants to invest.