Keynesianism Vs. Coordination

by Don Boudreaux on April 7, 2009

in Stimulus

The April 2009 issue of The Freeman is chock-full of excellent articles.  I'll mention here three, because each is especially relevant to the current economic downturn and the question of how best to analyze it — and how best to deal with it.

- Roger Garrison on "The Trouble with Keynes"

- Peter Lewin on "Recycling Discredited Ideas"

- Mario Rizzo on "A Microeconomist's Protest"

(Mario articulates far better than I have been able to do a point that I've tried to make for several months now — as I put it (unhelpfully), "fiscal stimulus is an attempt to re-create the bubble conditions."  Mario says it much better.)

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Speedmaster April 7, 2009 at 8:40 am

Drs. Boudreaux & Roberts,

I know that if I was a student at GMU I would rightly be accused of apple-polishing. But I'm not, so here goes. ;-)

In the last 4-5 years I have followed this blog and the links daily. I've long ago lost track of how much I've learned and the misunderstandings I've put behind me. Thanks for this resource!!!

Chris

MnM April 7, 2009 at 8:57 am

Rizzo not only hits the nail on the head, he drives it one blow:

The hastily approved macroeconomic schemes of the Bush and Obama administrations will not succeed in promoting lasting recovery because they ignore the microeconomic fundamentals. The direction of spending and hence resource allocation they generate are fragile—they are not consistent with the preferences of consumers, savers, and investors. Therefore, once the putatively temporary stimulus is complete, the corrective forces that are now trying to undo previous resource misallocations will reassert themselves.

Precisely. I've been trying to explain exactly that to some friends of mine…

Daniel Kuehn April 7, 2009 at 9:06 am

Thanks for these – I plan on reading them later this evening.

I think if the stimulus reinflates the bubble, it's not a good stimulus. I know it'll pain you to hear this, but Krugman has repeatedly talked about making sure we don't reinflate the bubble. It's definitely an important and widely held concern.

The first paragraph of the "Stimulus ex Machina" section of Mario's article is a very realistic and reasonable explanation of the Keynesian position. The problem is that additional negative feedback loops kick in, beyond the normal "creative destruction" that we need for a dynamic economy. I appreciated that straightforward and fair treatment of the Keynesian perspective on the problem.

I think the mistake in Mario's analysis comes here: "The direction is unsustainable because, as the original bubble revealed, it was not consistent with the preferences of consumer-saver-investors."

He acts as if the original bubble will be replicated with an increase in the money supply. Why would he assume such a thing? Does anybody really think that the banking industry is going to be footloose in it's mortgage lending or securitization in the forseeable future? I doubt it. Now, as Greenspan demonstrated in 2001, if we're not careful expansionary Fed action can create new bubbles. We do need to be concerned about that. But I don't see why we should be concerned that the late bubble is just going to reinflate as a result of expansionary monetary policy.

geoih April 7, 2009 at 9:57 am

Quote from Daniel Kuehn: "Does anybody really think that the banking industry is going to be footloose in it's mortgage lending or securitization in the forseeable future?"

You mean we've never had problems with banks before? This situation is completely unique?

The government is clamoring for banks to lend. The Fed rates are at zero. If the banks won't lend, the government will, either by taking over the banks or by loaning directly.

Daniel Kuehn April 7, 2009 at 10:02 am

geoih -
Emphasis on "in the forseeable future". The concern now is that they aren't lending to much of anyone – not that they're not originating and securitizing sub-primes anymore.

I'm reading Friedman and Schwartz right now – and maybe that's the right angle to take this from. Rizzo and especially Lewin sound like they might be more receptive to that argument. As Friedman and Schwartz point out – the problem isn't the contraction of bad lending – it's the contraction of all lending as a response to the shock of the burst bubble.

Market distortions are obviously a concern – but part of the justification for a system-wide response is that there is a system-wide contraction in response to a sector-specific shock.

Methinks April 7, 2009 at 10:28 am

Krugman has repeatedly talked about making sure we don't reinflate the bubble.

I'm sure Krugman has the magic code to push only the correct buttons to ensure this.

oes anybody really think that the banking industry is going to be footloose in it's mortgage lending or securitization in the forseeable future?

Yes. The banks are now run by the same government which manipulated interest rates to below market levels, created incentives to invest in one asset (housing) over all other assets and has a social agenda of subsidizing the subprime market through programs such as the CRA and GSEs. The government's agenda has not changed. Why should we expect a different outcome now that it is directly running the banks (let's get past the fiction that the banks aren't nationalized, shall we?) rather than manipulating decisions via regulation and legislation.

But I don't see why we should be concerned that the late bubble is just going to reinflate as a result of expansionary monetary policy.

It doesn't have to be the same bubble to be bad, but I fear it may well be. The Fed is running an inflationary policy. Houses are real assets which are an inflation hedge. It doesn't have to be houses – it could be any commodity. The Fed intends for even investment, but it doesn't actually control where the money it prints is invested, raising the probability of bubbles.

Blackadder April 7, 2009 at 10:51 am

"fiscal stimulus is an attempt to re-create the bubble conditions."

Indeed, according to Brad DeLong, that's precisely the point.

vidyohs April 7, 2009 at 11:09 am

BTW Sir Don,

My post "The Plan", I do hope you realize was not pointed at your blog or your ideas.

It was a pointed description of the process by which we wound up with such as Fannie Mae & Freddie Mac, besides being funny.

I guess I now wear the proud honor of being censored.

Don Boudreaux April 7, 2009 at 12:00 pm

Vidyohs,

Please elaborate. I'm unsure what you mean when you say that you were censored.

Don

Crusader April 7, 2009 at 12:17 pm

Please god, recreate the bubble. I will worship you forever if you mortgage the future of this country for just 10 more FAT years!!!

vikingvista April 7, 2009 at 12:42 pm

"it could be any commodity"

Seen the price of gold recently? How would that be for a sad irony?

geoih April 7, 2009 at 1:13 pm

Quote from Daniel Kuehn: "Market distortions are obviously a concern – but part of the justification for a system-wide response is that there is a system-wide contraction in response to a sector-specific shock."

So, we need more distortions to counter the previous distortions? And what is a "system-wide response"?

Sam Grove April 7, 2009 at 1:35 pm

Council of Economic Advisers

Governments seem to always have a priesthood of some kind.

Does anybody really think that the banking industry is going to be footloose in it's mortgage lending or securitization in the forseeable future? I doubt it.

If they have been chastened by the collapse, then why does government need to intervene?

The presumption of your comment is that the banking industry is responding appropriately to market signals. I think you are correct.

"Market distortions are obviously a concern – but part of the justification for a system-wide response is that there is a system-wide contraction in response to a sector-specific shock."

The focus of the bubble may have been sector specific, but the sector specific bubble was puffing up the whole economy by misleading people into the perception that actual wealth was expanding and that they could increase consumption.

The correction NEEDS to be system-wide because the signals from reality are encouraging people to reduce consumption and increase savings/investment.

Flailing around by the administration introduces uncertainty, causing investors to hold off until the future course becomes clearer.

As long as the administration views the economy like a pump that needs priming, they will continue to stimulate until they get signals that it's working.

Unfortunately, they won't know if the signals are a result of their actions or due to some other cause.

The possibility of large rates of inflation will is an encouragement to hoard.

Sam Grove April 7, 2009 at 1:37 pm

inflation will is

MnM April 7, 2009 at 1:41 pm

I fear Sam is right.

Oil Shock April 7, 2009 at 1:42 pm

Market distortions are obviously a concern – but part of the justification for a system-wide response is that there is a system-wide contraction in response to a sector-specific shock.

I borrowed $30,000 from citibank mastercard at 0% interest rate for 15 months, that was in October of 2008. Not that I needed the money, but I took it since it came without a cost. Bay area home sales have perked up, granted from really depressed levels of last year, so people are receiving plenty of loans. Mind you, it takes a jumbo loan to buy most houses in Bay area, still.

vikingvista April 7, 2009 at 2:00 pm

"I borrowed $30,000 from citibank mastercard at 0% interest rate for 15 months"

Good move. You can pay them back with a less valuable 2010 $30K. Apparently there is some pressure on the bank overcoming any inflation concern they might have.

indiana jim April 7, 2009 at 2:25 pm

Garrison has it right in saying:

"There is good reason, then, to study Keynesian theory: It helps us understand what the policymakers in government are likely to do in any given circumstance."

This is a reasonable way to teach macro: explain "textbook" Keynesian theory because so many policy makers parrot it. Then, hit students a dose of Garrison's Capital-based macro; Garrison's book makes it easy to contrast with Keynesian theory.

Sam Grove April 7, 2009 at 2:43 pm

It seems to me that contemprorary Keynesian practice operates on the implicit assumtion that we can fake fiscal reality until economic reality catches up.

Methinks April 7, 2009 at 3:01 pm

Daniel,

As Friedman and Schwartz point out – the problem isn't the contraction of bad lending – it's the contraction of all lending as a response to the shock of the burst bubble.

As Anna Schwartz pointed out a few months ago – that was the problem during the great depression. Then there was a lack of liquidity. Today's problem is a lack of solvency.

There's plenty of good lending going on. The problem with credit, of course, is that it is a loan against future production (broadly – future cash flow, more narrowly). There are fewer positive expectancy projects to fund, so there should be fewer loans. What is being encouraged now is loose lending.

Sam Grove April 7, 2009 at 3:50 pm

BTW, here is a lengthy interview with Robert (Bob) Higgs.

Crawdad April 7, 2009 at 4:32 pm

This is a little off topic, but since Sam mention Dr. Higgs I have a question. It kind of goes along with the lengthy back and forth over the "Not my religion" post. Dr. Higgs has a short article, link below, which outlines how there never really was a credit crunch. He calls it a hoax. This raises a lot of issues for me. Wasn't the credit crunch supposed to have precipitated this entire mess?

http://www.independent.org/newsroom/article.asp?id=2402

Lee Kelly April 7, 2009 at 4:38 pm

Interest rates co-ordinate production with consumption across time.

Today's savers are tomorrow's spenders. When savings increase interest rates decline and more investment projects become profitable. In other words, low interest rates today are the market's way of signalling increased spending in the future. But when interest rates are artificially lowered the signal is corrupted. There is no increase in future spending, but perhaps even a decline. Investment projects that would otherwise not be embarked upon appear profitable. Resources are unknowingly squandered on goods and services at prices which nobody actually wants to purchase.

Home equity mimicked the role ordinarily played by savings i.e. it encouraged people to feel wealthy and spend as though there was a safety net. Under such conditions the demand for all kinds of goods and services, from golf courses to wide-screen televisions, began to rise, and investors–under the spell of low interest rates–began directing resources to those uses.

The economic impact of the real estate bubble could never be contained in the way which some people presume. The malinvestment created by the boom permeated the economy; it is merely concentrated in some sectors more than others.

What is most troublesome now is the destruction of knowledge which the boom perpetrated: so long has the government pumped us full of its hullucinagen, it is difficult to know what was real and what was a delusion.

Sam Grove April 7, 2009 at 5:03 pm

Wasn't the credit crunch supposed to have precipitated this entire mess?

I believe it is supposed to be that the meltdown precipitated the credit crunch, and the credit crunch is preventing a speedy recovery.

Seth April 7, 2009 at 5:41 pm

"I know it'll pain you to hear this, but Krugman has repeatedly talked about making sure we don't reinflate the bubble." -DK

And how does propose we make sure that we don't do that?

Sam Grove April 7, 2009 at 5:51 pm

I don't talk about Krugman because I pay him absolutely no attention.

dg lesvic April 7, 2009 at 5:59 pm

Daniel,

Your friend Gil accused me of ducking you, but here I am chasing you from one thread to another.

You can run but you can’t hide from the challenge, for it’s the same wherever you are

You had addressed a comment to Gil about my approach to these issues, and then one directly to me about their relation to the Holocaust.

First, the Holocaust, and from the Wall Street Journal this morning, Anti-Semitism and the Economic Crisis by Ira Stoll:

"Jews have been victims not only of unrest prompted by economic distress but of attempts to remedy such economic distress with socialism. Take it from Friedrich Hayek, the late Nobel Prize winning Austrian economist. In 'The Road to Serfdom,' Hayek wrote, 'In Germany and Austria the Jew had come to be regarded as the representative of capitalism.' Thus, the response in those countries, National Socialism, was an attack on both capitalism and the Jews."

You had written, and, would no doubt, repeat:

"…we weren't defending socialists…We were just saying regulating the banking history is in no way parallel to the holocaust."

As the earlier are in no way parallel to the terminal stages of cancer.

That is respectable Holocaust denial, denying its middle-of-the-road origins, which is worse than denying the Holocaust itself.

From Fascism and National Socialism by Michael T. Florinsky, 1936, P 69:

"The course they have chosen is a middle one between socialism and capitalism."

Their middle way to holocaust, and now yours.

Next, my whole approach to economics.

You wrote that my theory "IS sensible IF you assume completely unrealistic responses to redistribution and taxation. Those completely unrealistic responses are very easy to argue if you have an aversion to using numbers to estimate actual responses, as dg lesvic does."

I'm still waiting for you to give us just one example of those elusive numbers in economics. I am absolutely sure that you will never do so, that you will tap dance around it, and pretend to do so, but never really do it. We will never get any of those alleged numbers of economics from you.

Never!

Let me repeat that, Never!

One more time.

Never!

And don't ask me to define never.

Posted by: dg lesvic | Apr 7, 2009 12:50:06 PM

Gil,

You wrote:

"So does that make dg lesvic an answer ducker (especially since Daniel Kuehn had a go)?"

What have I ducked? I can tell you this, I wouldn't duck Daniel Kuehn any more than a free meal. And that guy is a slice of rare roast beef.

Posted by: dg lesvic | Apr 7, 2009 1:06:35 PM

John Pertz April 7, 2009 at 7:08 pm

Is it just me or is Mario Rizzo the most important public intellectual on the pro market side? Arnold Kling and Robert Higgs have also been extremely insightful in dealing with this crisis too.

vidyohs April 7, 2009 at 7:45 pm

Don,

I tried to post an explanation, an apology, and the satirical piece again and it doesn't come through.

I don't know what the deal is.

Sam Grove April 7, 2009 at 10:54 pm

I like this from Garrison:

Thus, while the intention of Keynesian policy is to stabilize the economy, the actual effect is to “Keynesianize” the economy. It causes the economy to behave in exactly the same perverse manner that is implied by the Keynesian assumptions. This convoluted interrelationship between theory and policy has long obscured the fundamental flaws in the theory itself.

I'll have to process that for a while.

Gil April 7, 2009 at 10:59 pm

Golly, let's see, after giving my 'burger' example:

"I don't recall whether it was you or someone else who previously had pointed out that my theory would not hold true in the case of taking from the employed to give to the unemployed.

And you may not recall that I agreed with that, with certain qualifications, and limited the main part of my theory to the case of taking from the richer to give to the poorer among the employed themselves." – dg lesvic

and:

"dg lesvic's masterstroke would respond: "but the loss of the burger would present a huge burden to the burger maker, he would have no incentive to work anymore and he would just close his shop in despair – leaving everyone poorer". This is the problem with the masterstroke – it IS sensible IF you assume completely unrealistic responses to redistribution and taxation. Those completely unrealistic responses are very easy to argue if you have an aversion to using numbers to estimate actual responses, as dg lesvic does. As long as he lives in the world of foundational axioms, he can have whatever axiom he wants to describe how the burger maker will respond – it doesn't have to resemble reality!" – Daniel Kuehn

Yep. It's sounds as though D. Kuehn gives a direct response whereas you waffle about whether it was me or someone else who posted something about the employed and unmployed (which must have been someone else since I don't know what you're going on about).

dg lesvic April 7, 2009 at 11:52 pm

Wow! First, rare roast beef, and now waffles.

Don't forget the apple pie.

OK, Gil, you give us the numbers!

And no more waffles, now, nor French toast, either.

Just the numbers.

dg lesvic April 7, 2009 at 11:53 pm

And, by the way, can't the redoubtable Daniel Kuehn speak for himself?

Does he need Sir Gilahad to fight his battles for him!

dg lesvic April 8, 2009 at 12:51 am

Still nothing from Daniel.

It looks like fools may rush in, but Daniel ain't no fool.

And nothing more from Gil, either, so maybe he's getting a little smarter, too, which couldn't have been too hard.

dg lesvic April 8, 2009 at 12:56 am

Fellows,

Don't take it to heart. I'm just having a little fun with you. I really like you both, even if you are stupid assholes.

dg lesvic April 8, 2009 at 2:05 am

Just got through watching a film about Auschwitz. I knew one of the survivors in the film personally. A great lady. A privilege to have known her.

Makes me a little ashamed of my frivolity above. This is serious business. For my children and grandchildren. For yours.

Again:

"The course they have chosen is a middle one between socialism and capitalism."

That was the Nazis. And it's us again today.

And that's no laughing matter.

Gil April 8, 2009 at 2:09 am

What the hell are you going on about dgl?

dg lesvic April 8, 2009 at 2:28 am

Gil, and Daniel, too:

Be honest, now.

Don't you feel just a little bit uneasy following in the Nazis' goosesteps?

John April 8, 2009 at 8:05 am

Where dg goes, Godwin follows.

Aaron April 8, 2009 at 10:49 am

Perhaps, dg, it's hard to respond to your equating the progression in Nazi Germany with the progression here and now because it seems beneath reason.

Personally, I was refraining from saying anything, even though it may have been my comment that sparked this fairly crazy debate, because it is just hard to know how to respond to something this preposterous.

Jews (and Gypsies and gay people, etc) were vilified in Nazi Germany because they were Jews (or Gypsies or gay). It was an issue of race, or sexual preference. Describing Jews as 'bankers' was a way to get people to focus their ire, to engage ethnic stereotypes, to inflame an existing prejudice. But the prejudice itself came first. That is not what's happening now.

Now, another thing about your recent posts, dg, that concerns me, is that you seem to be trying to claim a certain kind of authenticity by identifying a holocaust survivor whom you recognized in a film about Auschwitz.

If I trot out the survivor friend of my family who was a lifelong leftie, a doctor who was a proponent of, for example, socialized medicine, does that impact this discussion? Does it make my opinion more worthy?

I would have to say in both our cases it doesn't, except perhaps to illustrate that you cannot generalize about concentration camp survivors or authenticity. I would have to say it cheapens us. My apologies to my family's friend.

Sam Grove April 8, 2009 at 11:02 am

Jews (and Gypsies and gay people, etc) were vilified in Nazi Germany because they were Jews (or Gypsies or gay). It was an issue of race, or sexual preference.

Part of the reason Jews have often been chosen as scapegoats is that they have a strong work ethic, laud intelligence, are culturally cohesive, and tend to be successful wherever they go.
So it's not an issue of race per se, after all they share a racial heritage with many Arabs, but nonetheless, many Arabs hate Jews.

As outsiders, and successful ones at that, they make easy targets for envy during hard times, no matter the cause of the hard times. Politicians seem to have an instinct for picking easy targets.

dg:

Yes, your theory of redistribution making the poor poorer may be the case, but it's not obvious on its face and you don't seem to be able to explain it in such a way that it becomes obvious to others.

Maybe you should work on that instead of disrupting forum threads with repetitions of your mantra.

dg lesvic April 8, 2009 at 11:47 am

Sam,

I explained it in such a way that it became obvious to you. Getting you to see the light is no longer the problem. Getting you to pass it on to others is the problem. What are you waiting for, the next holocaust?

John,

You wrote:

"Where dg goes, Godwin follows."

If that old barbarian followed me back to civilization, he'd be way ahead of you.

Aaron,

Rather than righteous indignation, I would propose shame for a follower of Marx, Stalin, and Hitler.

And Daniel, where are you? Cow brains are alright, but I really miss that prime rib.

dg lesvic April 8, 2009 at 11:54 am

Sam,

If you really don't understand it, and want to be helpful, tell me what about it you don't understand.

dg lesvic April 8, 2009 at 12:46 pm

Sam,

Hayek began The Constitution of Liberty with an apology.

"The apology concerns the particular state at which I have decided to submit the results of my efforts to the reader. It is perhaps inevitable that the more ambitious the task, the more inadequate will be the performance. On a subject as comprehensive as that of this book, the task of making it as good as one is capable of is never completed while one's faculties last. No doubt I shall soon find that I ought to have said this or that better and that I have committed errors which I could myself have corrected if I had persisted longer in my efforts. Respect for the reader certainly demands that one present a tolerably finished product. But I doubt whether this means that one ought to wait until one cannot hope to improve it further. At least where the problems are of the kind on which many others are actively working, it would even appear to be an overestimate of one's own importance if one delayed publication until one was certain that one could not improve anything. If a man has, as I hope I have, pushed analysis a step forward, further efforts by him are likely to be subject to rapidly decreasing returns. Others will probably be better qualified to lay the next row of bricks of the edifice to which I am trying to contribute. I will merely claim that I have worked on the book until I did not know now I could adequately present the chief argument in briefer form."

Sam, you can either waste that great intelligence of yours heckling from the sidelines, or lay the next row of bricks.

MnM April 8, 2009 at 12:48 pm

Sam,

I explained it in such a way that it became obvious to you. Getting you to see the light is no longer the problem. Getting you to pass it on to others is the problem. What are you waiting for, the next holocaust?

I know I run the risk of speaking for Sam, but dg, you miss his point. He is saying that you are a poor ambassador for your ideas. Rather than expounding on the idea you simply assert and these assertions are disruptive.

dg lesvic April 8, 2009 at 1:04 pm

MnM,

You may not have noticed, but I have "expounded" on the idea repeatedly and at great length.

Would you like me to do so again?

Sam Grove April 8, 2009 at 1:24 pm

Dg, Hayek wrote a book. Where's yours?
Before you lay bricks, you need a foundation, and you assume that you can lay bricks anywhere without checking the foundation.

BTW, I already knew that government hurts the poor the most long before I ever came to Cafe Hayek.

You assert that income equality is the issue for most people.

I do not assume that. I think most people support political government rather reflexively because they haven't learned to imagine any other order.

They believe that government orders society, and they are willing to accept the harm it causes for the sake of that order.

For me, the foundation issue that people need to learn is that political government actually causes disorder.

dg lesvic April 8, 2009 at 1:29 pm

Sam,

Here, again, a brief summary of the idea:

Taking from the rich to give to the poor doesn’t just draw money but manpower downward upon the hierarchy of production, and the manpower faster than the money. For manpower doesn’t merely follow money but anticipates it. And, with manpower and competition among the poor increasing faster than the redistributed money, they’ll be poorer than they would have been without it.

Is there anything about it that you don't understand, or could improve upon?

And, MnM, any other ambassadors of it anywhere?

MnM April 8, 2009 at 1:30 pm

dg,

Personally, I don't care whether or not you expound upon it. The point is, there are people reading your posts who haven't seen your rationale. Do you wish to leave them in the dark?

Sam is simply asking that you explain your meaning to those you speak with and to stay on topic.

MnM April 8, 2009 at 1:33 pm

And, MnM, any other ambassadors of it anywhere?

Why do you expect others to be the ambassador for your ideas?

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