Those pesky animal spirits

by Russ Roberts on September 24, 2009

in Stimulus

The Keynesian argument for government spending is that when people are scared of the future, they put their money in their mattress instead of spending on consumption goods or investment goods. So, goes the Keynesian story,  the government needs to step in and stimulate aggregate demand. So, the story continues,  building pyramids, digging ditches, fighting a war (all with borrowed money), puts money in the hands of those at work today on the shovel-ready projects.

But if the people are scared of the future, the shovelers put their new found money under the mattress and the multiplier doesn’t multipky. At best it adds.

The Keynesian defense has to be that when people see government stepping in, it gives them confidence and reverse those animal spirits. Could be. Equally plausible is that when people see the massive accumulations of debt, they know that higher taxes or default is coming and this encourages them to actually put even more money under the mattress.

The Keynesian free lunch is a dangerous meal to serve to politicians who always want an excuse to spend money on their friends financed by other people’s money.

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{ 175 comments }

Mogden September 24, 2009 at 6:01 pm

There is nothing that makes me more terrified about the future than the lunatics in charge of Congress and the Administration (both current and former). There are no adults to be found anywhere.

Anonymous September 24, 2009 at 6:06 pm

From the WSJ;

http://online.wsj.com/article/SB125185379218478087.html

U.S. Economy Gets Lift From Stimulus

After steep declines of 5.4% and 6.4% in the previous two quarters, gross domestic product fell only 1% in the last three months. And while the ARRA overall added “up to 3 full percentage points of annualized growth in the quarter,” President Obama’s stimulus helped precisely where it was needed most – rescuing devastated state budgets.

and

Many forecasters say stimulus spending is adding two to three percentage points to economic growth in the second and third quarters, when measured at an annual rate. The impact in the second quarter, calculated by analyzing how the extra funds flowing into the economy boost consumption, investment and spending, helped slow the rate of decline and will lay the groundwork for positive growth in the third quarter — something that seemed almost implausible just a few months ago. Some economists say the 1% contraction in the second quarter would have been far worse, possibly as much as 3.2%, if not for the stimulus.
For the third quarter, economists at Goldman Sachs & Co. predict the U.S. economy will grow by 3.3%. “Without that extra stimulus, we would be somewhere around zero,” said Jan Hatzius, chief U.S. economist for Goldman.

And how about that stock market…. up 17% since the President took over!!! Love those animal spirits!

Anonymous September 24, 2009 at 6:19 pm

Muirgeo,

Your continued inability to distinguish between causation and correlation never ceases to amaze me.

But my favorite part is your quote from a Goldman Sachs economist whose honest opinion is that the stimulus has added 3.3% to the growth rate. I’m sure that Goldman Sachs has no vested interest in ingratiating themselves with this administration. I’m sure that they’re just disinterested analysts.

You are defending crony capitalism and the biggest giveaway from the average American to the richest Americans. Shame on you and every one who defends this Administration and the last one for bailing out some of the richest people on the face of the earth.

Anonymous September 24, 2009 at 6:31 pm

RE: “But my favorite part is your quote from a Goldman Sachs economist whose honest opinion is that the stimulus has added 3.3% to the growth rate. I’m sure that Goldman Sachs has no vested interest in ingratiating themselves with this administration. I’m sure that they’re just disinterested analysts.”

To be fair to muirgeo, it’s not just Goldman Sachs. This is a scatterplot of the impact estimates people have published:
http://delong.typepad.com/sdj/2009/09/sigh-the-effects-of-the-obama-fiscal-stimulus-once-again.html

Goldman is actually on the lower end of the spectrum of impact estimates, and as you allude to they are well known as the financial services firm that is probably the most integrated into the Washington establishment.

So what is the implication? That everyone else just woke up and forgot that correlation isn’t causation, and the one or two data points in this scatterplot that make sense to you were the ones that soberly remembered that correlation isn’t causation?

We should DEFINITELY be skeptical of impact estimates, particularly this early. I’m not arguing with that. But muirgeo’s assertion isn’t as outlandish as you make it out to be.

Anonymous September 24, 2009 at 6:42 pm

Not to mention… didn’t I just read a pretty strong consensus on Don’s “looking in the mirror” post about how it’s a fallacy to presume that someone is always serving the interests and goals of their employer – particularly when they are in a position like an analyst or a professor, where objective analysis (and not ideological loyalty) is what they’re hired for.

How does that apply any less to a Goldman Sachs economist than a GMU economist? Goldman Sachs depends on a continuous stream of accurate information. That’s it’s primary interest from these analysts. That’s what’s profitable for Goldman Sachs – not an economic forecast that makes people at the White House happy.

matt September 24, 2009 at 6:50 pm

Did you just reply to yourself? I gotta know who wins that argument.

Anonymous September 24, 2009 at 6:48 pm

I’m not defending crony capitalism. I AM defending Keyensianism as a way out of the disaster brought to us by deregulated/ poorly markets and crony capitalism.

I have no idea how these trends are causally explained with out respect to the government stimulus. No one else is spending to explain the “recovery”.

MWG September 24, 2009 at 8:39 pm

Fight crony capitalism with more crony capitalism. As Russ said, you’re the one defending “the biggest giveaway from the average American to the richest Americans”.

Have fun defending that…

Sam Grove September 25, 2009 at 3:11 am

Keynesian relief may be the intent, but crony capitalism is the result.

How else to explain 70+ years of agricultural subsidies, market orders, and price supports.

Pauld September 25, 2009 at 10:44 am

I find it interesting that the European countries with the smallest stimulus programs are recovering faster than the U.S. and their big spending neighbors.

JohnK September 25, 2009 at 11:13 am

Oh but muirgeo, you are defending crony capitalism.
Where did this stimulus money go?
Gee, didn’t it go to administration cronies?
And don’t those cronies happen to be capitalists?
From the big banks to the little pet projects, all of this stimulus is funneling taxpayer dollars to Friends of Washington.

So you in fact ARE a big fan of crony capitalism, as long as it is Democrats who are handing out your money.

Anonymous September 24, 2009 at 9:22 pm

Post hoc, ergo propter hoc — plus the fallacy of exclusion (cherry-picking attribution of positive results while ignoring negative results) — plus argumentum ad verecundiam — plus the non sequitur that the truth of a proposition is a function of the number of its adherents.

Anonymous September 25, 2009 at 1:05 am

“the non sequitur that the truth of a proposition is a function of the number of its adherents”

argumentum ad populum

Anonymous September 25, 2009 at 12:59 pm

RE: “plus the non sequitur that the truth of a proposition is a function of the number of its adherents.”

This is an interesting point. In the case of a logical argument, perhaps this is true. But if it’s an estimate he’s after – like an impact estimate – then confidence in an answer IS a function of the repeated reproduction of the result.

Anonymous September 25, 2009 at 3:44 pm

But if it’s an estimate he’s after – like an impact estimate – then confidence in an answer IS a function of the repeated reproduction of the result.

Not to a rational mind — not without an evaluation of the method of making the estimate.

I don’t care how many thousands of astrologers you can find who will all agree on the estimated impact of a given alignment of the stars, I have zero confidence in their estimate.

Anonymous September 25, 2009 at 3:47 pm

RE: “Not to a rational mind — not without an evaluation of the method of making the estimate.”

“A function of the repeated reproduction of the result” is not the same as “solely determined by the repeated reproduction of the result”, michaelsmtih. Of course the method needs to be evaluated. That doesn’t change the fact that when you’re making a fundamentally empirical statement you WANT lots of people to come to the same conclusion. If you’re making a fundamentally logical statement then, as you say, the number of adherents is a non sequitor.

Your astrology example is what’s a non sequitor unless you can draw a parallel between the legitimacy of the methods undergirding impact estimates and the legitimacy of the methods of astrologers.

mesaeconoguy September 25, 2009 at 12:20 am
Anonymous September 25, 2009 at 4:26 pm

Thank you for those two links. It’s more data for muigeo and DK to evade.

Seth September 25, 2009 at 2:40 am

Goldman Sachs? One of the companies that must submit itself to new world order financial regulation by the government that still won’t take responsibility for it’s part in the meltdown? Hmmm….that’s funny. I guess they’re the good guys and there’s no reason to be skeptical when they’re saying stuff you like.

Juan Carlos Vera September 25, 2009 at 2:05 pm

You, sir Muirgeo, in addition to not understand cause-effect relationships, You know nothing about economics. I’m surprised that you, living in a developed country, does not know the mistakes of the Keynesian model. There is no single statistical evidence to confirm Keynesian practices as a source of wealth. All evidence seems to show that, with the excuse of saving the world, Keynesianism is just a sophisticated mechanism to redistribute wealth and work effort from the poorest citizens to the richest

rpl September 25, 2009 at 3:41 pm

Muirgeo, why should we conclude that the positive signs in the economy are a result of the Keynsian stimulus? To the extent that proponents of the stimulus made any predictions at all, they haven’t been very accurate (unemployment, for instance, is currently higher than their “without stimulus” forecasts), so why shouldn’t we conclude that the fallout from the financial crisis has begun to run its course? Indeed, since relatively little of the stimulus money has been spent as yet, Keynsians are forced into awkward arguments about how people ramped up their spending in anticipation of stimulus money yet to come. That story is manifestly untrue where I work, so I’m wondering how you know it to be true in general?

I’m also wondering what could have happened that would have caused you to conclude that the stimulus didn’t work. My impression of the stimulus debate is that there is a sort of heads-I-win, tails-you-lose argument playing out here. If the economy gets better, you credit the stimulus; if not, you claim it would have been even worse without the stimulus. Is there anything empirical at all in these claims, or are they all just proclamations of faith?

If you can explain it, I’d be interested to hear. I’m not interested in “what the experts say” or other appeals to authority; just explain it in terms that would be understandable to a motivated non-economist.

Anonymous September 24, 2009 at 6:16 pm

Well said!

Anonymous September 24, 2009 at 6:17 pm

muirgeo:

Given that a zero sum exists between government and the private market, how can any true ‘growth’ occur? We measure economic growth by additional production, not consumption or higher than expected models. Trillions of dollars of government spending on any resource does not equate to economic growth.

Anonymous September 24, 2009 at 6:39 pm

I think demand side economics explains this. It makes sense to me. If the government wasn’t spending right now NO ONE would be. Things would be a lot worse off with a more prolonged period of stagnation. Getting those government dollars out into circulation, hopefully doing something useful, and creating jobs gets money flowing and hopefully soon the private sector will respond. Once it does revenues will pick up, spending can be curtailed and the debt can be addressed.

Hey this isn’t anything new. We’ve done this before in spite of all the historical re-writing of the Great Depression.

Matt September 24, 2009 at 6:58 pm

“If the government wasn’t spending right now NO ONE would be.”

That point may very well be true. And, taking this a step further, can you demonstrate that anyone besides the government is spending money that they wouldn’t have had the stimulus and bailouts not been initiated?

I don’t think its adequate to justify government stimulus spending by citing short-term economic growth figures. When billions of dollars are dumped in the economy, it stands to reason that SOMETHING will happen. The key is that this is all BORROWED money. Of course life is good in September when you get that shiny new credit card in the mail. Its that billing statement in October’s mailbox you need to worry about.

Anonymous September 24, 2009 at 7:10 pm

Isn’t much of investment that leads to growth based on borrowed dollars? Just because the government is borrowing doesn’t make it a bad investment.

Nathan Scott September 24, 2009 at 7:38 pm

So why not have the government own everything?

Matt September 24, 2009 at 6:59 pm

Also:

“…spending can be curtailed and the debt can be addressed.”

Because governments have such a great track record at this.

matt September 24, 2009 at 7:06 pm

great matts think alike.

matt September 24, 2009 at 7:06 pm

and so do i.

Anonymous September 24, 2009 at 7:14 pm

Sure… they could do better but has the debt ratios been consistently growing since we’ve had government? NO.

Well at least not when democrats have been in charge.

http://news.mortgagecalculator.org/images/National-Debt-GDP.gif

Nathan Scott September 26, 2009 at 2:08 pm

I guess the house and congress are superfluous to government debt, right?

matt September 24, 2009 at 7:02 pm

“If the government wasn’t spending right now NO ONE would be.”

Except for the $7 trillion or so in consumer spending that’s already happened this year. What’s your ARRA spending at in the last seven months? $100 billion? Oh thank goodness!!!

Gee, without that additional $100 billion (or a whopping 1.4%) on top of $7 trillion in money that, per you, wouldn’t have been spent; I really gotta wonder how the US economy would ever have $14 trillion in output by the end of this year.

Anonymous September 24, 2009 at 9:38 pm

Thank you for pointing these facts out, Matt. Now observe the utter silence from muirgeo. This is very typical of leftists — facts which contradict their position are simply ignored.

Anonymous September 25, 2009 at 3:24 am

Me … silent… I don’t think so.

So would you rather have a growth of 0% or 1.4%. And don’t forget multipier effects AND how much of that 7 trillion is already government dollars in the form of unemployment, SSI , government jobs ect ect …???

Sam Grove September 24, 2009 at 7:57 pm

If the government wasn’t spending right now NO ONE would be.

We haven’t changed our spending habits.
I think this is mostly theoretical.

People may be changing from spending to saving, but I think that’s a good thing. Foregoing consumption is prerequisite to investment.

Anonymous September 24, 2009 at 11:30 pm

That’s not what I asked. I did not ask about consumption – I asked about economic -growth-. Government dollars are our dollars. Though rhetorical, I wanted you to provide me with how economic growth occurs with government spending.

You need to re-write your statement to read “If the government wasn’t spending everyone’s money, and if the general population knew that the government exhibited some semblance of fiscal sanity, the private sector would be utilizing their dollars (which they earned), the way they see fit.

Anonymous September 25, 2009 at 3:29 am

You’re are incorrectly assuming that government dollars are being taken out of peoples pay check as they are used. They aren’t… they are being borrowed as future debt. There have been no federal increases in taxes as of yet. So your position is non-sense.

Without the stimulus people would continue to save. More people would be laid off and even less money would be circulating .

Anonymous September 25, 2009 at 4:59 am

You can only borrow from the future if you have a time machine. You always borrow from the present. Always.

Thinking of borrowing as bringing forward goods from the future to the present is a nice accounting simplification, but it has no basis in reality.

Anonymous September 25, 2009 at 11:52 am

So many false assumptions, very little deep thinking, and fallacy upon fallacy. While the current and immediate spending is pulling from inflated dollars, you’ve missed the point entirely.

What you’ve outlined is that aside from pure unconstitutional actions, the fed is borrowing against future debt and setting the stage for stagflation! Man, where do I sign up? The results are even more insidious and harmful that a direct tax and spend.You’re so blinded by consumption and ‘spending’ that you cannot grasp the premise of the question. Consuming everything on all shelves and stockrooms on the entire planet yields not a drop of growth.

Everything you assert is in the middle of the (engineered) problem, or exists after the (engineered) problem has occurred. Why do you think people are concerned about spending their dollars? Why do you think people are hesitant to invest? Are these actions borne of the normal fluctuation in an economic cycle? No.

Again, where is the economic GROWTH? Spending inflated dollars and/or spending directly taxed dollars does not equate to economic growth of any kind – merely consumption, inefficient spending, and the market always reacts to either cancel out the effect or adjust around the unintended consequences due to the intervention.For the last time: Where is the economic growth?

Surfisto September 25, 2009 at 1:41 pm

I am definitetly sympathetic to Keynesian thought. (I have not read the General Theory yet, but it is next after Road to Serfdom. ) At this time of my short economic life I believe there is something to be said for aggregate demand and people saving and gov’t spending. I do believe these are short run phenonema.

“There have been no federal increases in taxes as of yet.”

So if taxes increase at some point will justpassingthrough’s position no longer be be non-sense?
Also inflation is a tax. The expansion of the monetary base is inflation. So money is being taken out of our pay checks.

Justin P September 25, 2009 at 6:55 pm

RE: “If the government wasn’t spending right now NO ONE would be.”

Nope, people still need to consume. They don’t just stop. The only thing that no one would be buying is GM, Chrysler, Houses etc….because demand has fallen. The Keynesian solution is to is to bury cash in tin cans and then consumers will spend it…but they still won’t spend it on GM, Chrysler…etc…why…because they do not want those products.
That’s a problem for politicians, since GM, …etc, contribute a lot to campaign contributions. So they try and induce demand by tariffs, tax incentives or out right bribery (Cash for Clunkers).

Anonymous September 24, 2009 at 6:43 pm

Oh by the way I am totally enjoying my incredibly smooth suspension saving ride on the way to work bought to me by The American Recovery and Reinvestment Act of 2009.

The road is beautiful. Like the ones I saw in Italy when I was there.

Sam Grove September 24, 2009 at 8:45 pm

Are you under the impression that a road was built in less than a year due to stimulus spending?

MWG September 24, 2009 at 9:55 pm

Apparently.

Anonymous September 25, 2009 at 3:26 am

Yes .. it was a shovel ready project that might have otherwise been delayed years.

Sam Grove September 25, 2009 at 4:49 am

Right….

And those children you treat at work will live as serfs to pay for it.

Anonymous September 25, 2009 at 7:25 am

I once stated that it was hilarious that Muirduck doesn’t comprehend the difference between taxing people to build roads that all citizens can use, and taxing one citizen to pay for another’s health care. (He was bitching because the government builds roads that happen to pass by Wal-Mart, on their way to Target.)

Yasafi retorted that he doesn’t drive, and shouldn’t have to pay road taxes. That doesn’t quite compute with the muirdiocy posted above.

Anonymous September 25, 2009 at 9:26 pm

Way to ask an unanswerable question there. If you assume “a zero sum exists between government and the private market”, you can’t show that government spending produces growth because it obviously can’t.

But that’s the question. Does “a zero sum exist between government and the private market”? At first glance it seems it must, since very dollar the government spends must be taxed, or borrowed from lenders who would otherwise lend for private investment.

But this ignores the third thing that people do with money, which is to hold onto it as a hedge against future uncertainty. When the government takes money that would otherwise be stuffed in mattresses and uses it to build bridges, it causes production that would not otherwse have occurred.

Somewhat more subtly, even when the government borrows money on the open market it can still increase production, because it sells debt that’s almost as liquid as cash and spends 100% of the money, where if that money where placed with a bank as a demand deposit a large proportion of it could not be invested and would have to be held as reserves.

Anonymous September 25, 2009 at 9:53 pm

Does the money stuffed in a mattress simply decompose or, is it eventually spent? Why would you deny they bank loaning power in lieu of the building of a bridge?When the spending on a bridge, a road, or Cash for Clunkers ceases, what then? Is the additional production sustained?I ask again: Where is the economic growth? Where is the Constitutional authority?

Anonymous September 25, 2009 at 10:14 pm

I already showed you where the economic growth is. You’d expect that growth to be sustained if the economy was previously below full employment, which at 10% unemployment is … possible.

You’ll have to explain your other questions. I don’t know what relevance whether money decomposes has to the velocity of circulation, I don’t know what “bank loaning power” is or how its relevant, and I don’t know very much about the US constitution.

Anonymous September 26, 2009 at 2:19 pm

“I don’t know what “bank loaning power” is or how its relevant, and I don’t know very much about the US constitution.”
-Simonkinahan

You and the whole of the United States Government. Run – don’t walk – and pick up a copy. Regarding economics: your analysis is wrong, especially considering you do not understand the banking system, but I give you full marks for trying. My question was a trick question – rhetorical at best. Keynes tried to ignore long-term effects, zero-sum, and sustainability as well.

roversaurus. September 24, 2009 at 6:17 pm

What is wrong with people putting money under their mattress? It’s just pieces of paper. If someone puts little IOUs under their mattress every time he does something for me (like build me a house or mow my lawn) am I not getting goods and services for free?

Isn’t stuffing money in your mattress, in a way, anti inflationary?

Production and Consumption are the important things going on. Money is just distributed accounting.

If people suddenly alter their economic behavior (i.e. they begin working more and consuming less) those changes can cause economic shocks. But eventually such shocks will be adjusted for if human beings are permitted to adjust to them (i.e. the government doesn’t step in).

Anonymous September 24, 2009 at 6:23 pm

RE: “Isn’t stuffing money in your mattress, in a way, anti inflationary?”That’s part of the problem! It’s deflationary.RE: “What is wrong with people putting money under their mattress?”I think it’s a little more complicated than that. It’s not just an increase in savings – it’s a drop in the demand for savings (investment demand) to a level so low that the market can’t reach equilibrium because interest rates are at zero. That’s the problem. If the market could equilibrate, Keynes wouldn’t have even brought the issue up. Think of zero interest rates as a price floor. What happens when there is a price floor? Dead-weight loss. The point of deficit spending isn’t to spend because consumers won’t. The point of deficit spending is to make the price floor on money non-binding by borrowing, so that the market clears.And usually there’s enough public goods out there that people have been neglecting that a well crafted stimulus can be highly beneficial in terms of allocative efficiency to boot. You can’t always depend on that, obviously. That’s where the insights of James Buchanan and people like that come in to sober us. But it’s possible to be smart in how you approach it.But the point is, think of it as a naturally occuring minimum wage or other price floor that the economy is stuck with.

Sam Grove September 24, 2009 at 7:55 pm

How many people actually “put money in their mattresses” (rhetorically speaking)?

Don’t most people in this situation try to keep their money in their bank accounts?

Do banks then stuff the money in huge mattress vaults?

I think the mattress stuffing problem is grossly exaggerated.

Anonymous September 24, 2009 at 7:57 pm

tell it to roversaurus :) not my words

roversaurus. September 24, 2009 at 8:54 pm

Certainly it is exaggerated, But how is it detrimental to the economy. I already acknowledged that *any change* in production and consumption patterns is going to take time for market participants to readjust to and that readjustment could be painful, but in the long run if there are vast numbers of people *producing value* and *not consuming* aren’t the folks consuming the extra stuff better off?

You know, if lots of people stopped consuming oil, the price would drop and I would get to fuel my car more cheaply and I’d be happier.

This is not rocket science. If someone is giving you things for free you are far better off than if they demand something in return…. Like, say, interest on the surplus goods they are producing.

Sam Grove September 24, 2009 at 10:44 pm

My question was for DK as I know he is sympathetic to Keynesian thought and the rhetorical concern about “mattress stuffing”, something that concerns me very little.Whenever events are looked back upon, they are subject to interpretation. The official interpretation is produced by people hired by, appointed by, or otherwise favorable toward partisan politicians (redundant?) and thus favorable to a certain viewpoint in which the culpability of political agency for bad results is laundered quite clean and blame placed upon handy scapegoats.Official interpretations may be “official”, but hardly objective.

Anonymous September 25, 2009 at 10:49 am

RE: “You know, if lots of people stopped consuming oil, the price would drop and I would get to fuel my car more cheaply and I’d be happier.”

Yes – and if the price of savings could drop we wouldn’t be having this discussion.

RE: “If someone is giving you things for free you are far better off than if they demand something in return…. Like, say, interest on the surplus goods they are producing.”

Be careful not to confuse nominal interest rates with real interest rates. And be careful not to assume you know that all investments with positive returns haven’t been exhausted faster than savings have. That’s the fundamental difference between a monetary economy and a barter economy – supply doesn’t create it’s own demand.

Anonymous September 25, 2009 at 6:30 pm

The mattress stuffing thing is an exaggeration, although according to the fed there is more non-circulating cash out there than most people suppose. A fair chunk of the population doesn’t have a bank account, after all.

But stripped of the exaggeration, the basic point is still valid – during a recession, people prefer to put their savings in safe liquid assets with lower returns. Savings accounts, money market accounts, govt bonds. Not stocks or corporate debt. Financial institutions therefore need to keep larger reserves, which I believe they prefer to keep with the fed, or barring that in vaults, rather than in mattresses, reducing the velocity of money.

Sam Grove September 25, 2009 at 7:23 pm

Which all seems to skip over the fundamentals.People reduce current consumption if they are worried about their ability to pay for future consumption, hence increased savings, which represents foregone consumption, a necessary component of investment.People will not reduce consumption below their fundamental requirements. There is a floor to this.

The problem isn’t people holding money out of circulation, very few do that for any great length of time. The problem is the conditions that encourage people to do this.

The reactions of people to economic problems may be a problem for the masters of fiscal policy, but perhaps they should take that into account to begin with.

roversaurus. September 24, 2009 at 9:02 pm

Re: “That’s part of the problem! It’s deflationary.”

There is nothing wrong with falling prices. Do you mind when you pay less for goods and services?

What people dislike about the boogey-man “deflation” is that in modern times it is correlated with economic downturns.

If deflation is associated with increased production (as in personal computers) it is a boon. If it is associated with a decrease in demand then those producers who are losing business whine loudly. And a general decrease in demand means there is a recession.

But “deflation” is not an evil. It *MAY* indicate some pain but it is not necessarily so.

Anonymous September 25, 2009 at 1:30 am

The deflated price reflects the true market price. So what do you call it when the government manages to hold up those prices?

Clearly monetary inflation gets well underway before anybody ever even notices rising prices. That’s why you can disregard Bernanke’s glib remark to Congress that he will nip inflation in the bud. He won’t, because it is already too late.

Anonymous September 25, 2009 at 10:14 am

Certainly deflation is not evil. I hope you weren’t thinking that I was saying that it was. Deflation at a time when (1.) wages need to adjust downward, (2.) debt levels are high, and (3.) the interest rate is at or near zero is what’s more troubling. Deflation raises real wages which keeps the labor market from equilibrating. It increases real debt burdens, which pushes more people into default (and in this case foreclosure), and it raises the real interest rate which then is harder to adjust downward if the nominal interest rate is already zero. So of course deflation isn’t evil – I never said it was evil. But there are some circumstances where it’s not as good to see it.

The flip side of that is that inflation isn’t evil either. People have this boogey-man memory of the seventies and for some reason think it is. Why were YOU initially so concerned about inflation?

roversaurus. September 25, 2009 at 5:03 pm

I said:
Isn’t stuffing money in your mattress, in a way, anti inflationary?

You said:
That’s part of the problem! It’s deflationary.

Now do you understand why I assumed you thought deflation in and of itself was a bad thing?

You asked:
Why were YOU initially so concerned about inflation?

My answer:
I never mentioned inflation.

But here I will:
Inflation and deflation and any other change cause people to react and change their behavior to adjust to new realities. Those changes can many times cause changes themselves. Lots of economic change can lead to economic pain.

Anonymous September 30, 2009 at 7:52 am

“The flip side of that is that inflation isn’t evil either.”

Stealing is evil. Monetary inflation, since it is an act of stealing, is evil. Rising prices that reflect choices by voluntary relationships are not evil.

So rising prices may or may not be the result of an evil act.

roversaurus. September 24, 2009 at 9:10 pm

Re: “It’s not just an increase in savings – it’s a drop in the demand for savings (investment demand) to a level so low that the market can’t reach equilibrium because interest rates are at zero. That’s the problem.”

There is a fundamental flaw in that statement or I have misread something:
If interest rates are at zero that means there is no demand to borrow money. It does not mean that there is no SUPPLY (savings) of money.

Furthermore, zero is not a floor.
If a saver (investor) wishes to loan money out so badly he could loan it out for free (zero interest) or he could PAY you to borrow his money (a negative interest rate). Zero is not the floor.

Anonymous September 25, 2009 at 10:17 am

You have misread something. I’ve neither said that there is no demand, nor have I said that there is no supply of savings. There is both – but the supply right now exceeds demand and the market hasn’t cleared.

There are one or two examples of negative interest rates in history – and perhaps it is just a psychological floor. But for all intents and purposes it is one.

roversaurus. September 25, 2009 at 5:10 pm

You’re complaint is that people are saving too much and not borrowing enough? That is a problem?

In your great wisdom can you name the optimal savings rate and the optimal borrowing rate? I guess that means you need to name the optimal interest rate too. Do you really think you know that?

Does anyone?

Or are you really just concerned that the rate of saving and borrowing changed and you’d like to put it back the way it was before? I’m sorry the world changes and human beings need to be able to react to those changes.

simon... September 25, 2009 at 12:56 am

Why exactly it will not “equilibrate”? “…the market can’t reach equilibrium because interest rates are at zero…” sorry, but sounds like bunch of baloney… is it just me?

Anonymous September 25, 2009 at 5:26 am

RE: “Isn’t stuffing money in your mattress, in a way, anti inflationary?”

That’s part of the problem! It’s deflationary.

RE: “What is wrong with people putting money under their mattress?”

I think it’s a little more complicated than that. It’s not just an increase in savings – it’s a drop in the demand for savings (investment demand) to a level so low that the market can’t reach equilibrium because interest rates are at zero.

You really need to get off the beaten path here.

People stashing money, or in any other way un-employing it, is nothing more than giving the Fed an interest free loan. Think about it.

Anonymous September 25, 2009 at 10:42 am

Re: “People stashing money, or in any other way un-employing it, is nothing more than giving the Fed an interest free loan.”

The Fed is borrowing money right now? That’s interesting…

Anonymous September 26, 2009 at 11:04 am

I know you’re smarter than that — you might need to think about this for more than a minute.

Justin P September 24, 2009 at 6:56 pm

I think the bulk of Keynes argument rests in his “Paradox of Thrift” postulate.
It simply isn’t true. There is no paradox at all. It only works if you make some absurd presumptions. I went back and listened to the Econtalk podcasts on the paradox of thrift, and I’m simply amazed at how arrogant that econ professor is to Dr. Roberts.

Dr. Roberts, what do you think about that interview looking back? I think you really had him a few times, but then let him continue with his circular reasoning. He constantly used the paradox to prove the paradox! It’s like me saying I’m god, and when you ask how do I prove that…I just say because I’m god. It was maddening.

Anonymous September 24, 2009 at 7:06 pm

Paradox of thrift is only half the story, and I think people minimize Keynes by relying exclusively on that facet of it.

Paradox of thrift is the supply side of the market for money. The other story is the demand side – the demand for investment. In addition to the supply of savings increasing, demand for savings decreases. Because interest rates don’t move below zero, it acts as a natural price floor – like the minimum wage – and the market doesn’t clear. Deficit spending is an attempt to make the price-floor non-binding. Deficit spending is only advocated when the market can’t equilibrate.

I know that’s not necessarily going to be convincing to everyone – and of course it’s still a simple version of the story – but I really think it’s better than people simply talking about the paradox of thrift without considering the deadweight losses associated with the implicit price floor.

Anonymous September 24, 2009 at 8:32 pm

If demand for money is 0, then there is no reason to accumlate any, and supply is irrelevent. If demand for money is > 0, then interest rates will necessarily be >= 0.

If your model tells you that you need negative interest rates for markets to clear, then either your model is broken, or you’ve extrapolated something beyond the base assemptions that went into the model.

Anonymous September 24, 2009 at 8:45 pm

Who says demand for money is zero? I’m not even sure what that means. The demand for money is a functional relationship between the quantity of money demanded and the price of money. So what does “the demand for money is zero” mean?

Why does a negative interest rate trouble you? I should be more clear – I’m talking about a zero nominal interest rate. The real interest rate is roughly the nominal interest rate minus expected inflation. In a deflationary depression, a zero nominal interest rate with negative inflation leads to a positive real interest rate. Follow? So we have, for all intents and purposes, a zero nominal interest rate right now. We are also mildly deflationary right now. And as long as you’re not Peter Schiff you’re still worried about what deflation might look like in the absence of the stimulus or the TARP. A zero nominal interest rate with negative inflation expectations means a positive real interest rate that obviously isn’t allowing the market to clear. So there are two ways to get the market to clear (1.) inflation (or at least combat the deflation), or (2.) increase the demand for savings by getting the government to borrow. I’m not sure why even a negative real interest rate would bother you so much. Why does that mean “your model is broken”, exactly??? I don’t get it.

Anonymous September 24, 2009 at 9:17 pm

I have no idea how your post is connected to either my reply, or the post I was replying to.

What troubles you about the paradox of thrift being bunk?

Justin P September 25, 2009 at 6:48 pm

That’s because Keynes had no theory of money, it’s uses, where it came from etc…Keynes wanted 0% interest rates.

simon... September 25, 2009 at 1:03 am

“…interest rates don’t move below zero, it acts as a natural price floor – like the minimum wage…” you mean that it is as artificial of a limit in your logic as minimum wage???

Anonymous September 25, 2009 at 10:33 am

It could very well be artificial – Sweden has used negative interest rates, apparently. Whether it’s artificial or not, it’s de facto and it appears to be binding right now. Obviously to the extent it’s not a binding price floor it’s not a problem.

Cody L. Custis September 25, 2009 at 1:37 am

The problem with ‘liquidity trap’ type arguments is that they focus on nominal, rather than real, interest rates. As long as the rate of return on investment is greater than the rate of return on ‘mattress stuffing,’ and sufficiently large to overcome transaction costs / risk of investment, investment will still occur.

Assume that one lives in a deflationary economy where the real return of holding cash is 4% (due to deflation) but the real return of investment is still 8%, investment is risk free, and transaction costs are nominal. Individuals will still invest, rather than hold cash.

Anonymous September 25, 2009 at 10:38 am

I’m not so sure about that Cody. The focus is on real interest rates. The problem is that if the nominal interest rate hits a floor and you haven’t reached the equilibrium real interest rate yet there are only two ways to get there (1.) change the equilibrium by adjusting the demand or supply of savings, and (2.) cause inflation so the nominal floor is non-binding. The real interest rate is integral to these solutions – why do you think it’s missing???

Justin P September 25, 2009 at 6:47 pm

I know Keynes argued for a counter-cyclical policies. The problem with Keynesian economics is that there is no incentive to ever stop deficit spending, ever. How often do you hear from the “textbooks” that surplus’ will cause the economy to go into a recession? It’s everywhere. The only answer of course is more and more deficits, ever expanding if we want the economy to grow. It’s simply the paradox applied to the macro scale. Spending = good, saving = bad.
When does it end? Is there any mention of long run consequences in General Theory?

Anonymous September 25, 2009 at 6:54 pm

Surpluses cause recessions? Hmmm… that’s news.

But that’s not even what I really wanted to respond with. My real question is what’s the problem with running deficits from now until eternity? It would be nice to have deficits sufficiently small such that the debt burden shrinks over time, so that when we have a good reason for larger deficits (war, depressions, etc.) we have some freedom of motion. But what does it matter if we run deficits from now until eternity? We’ve only had a handful of surpluses in our history, after all.

Public finance doesn’t work like family finances. There’s nothing wrong with perpetual debt (there is a parallel with family finances in the sense that excessive debt is bad for both! but what are you suggesting is wrong with perpetual debt?).

Justin P September 25, 2009 at 7:21 pm

Where does the money come from?

Anonymous September 25, 2009 at 6:55 pm

btw – the last chapter of the General Theory, “Concluding Notes on the Social Philosophy towards which the General Theory might Lead” gives a sense of the long run consequences.

Justin P September 25, 2009 at 7:12 pm

Oh you mean like “In the long run we are all dead anyway?”

“Thus it is to our best advantage to reduce the rate of interest to that point relatively to the schedule of the marginal efficiency of capital at which there is full employment.”

Well how does he propose that we do that, with a “Monetary Authority,” which we are living with the long run consequences of now, think housing bubble, tech bubble, bailouts etc. Or Keynes wants just out and out inflation (p205)

Keynes also advocated for the full “socialization of investment.” Hey that’s exactly what we have done….to detrimental effects. What else would you call the bailout of GS, Citi, etc?

Keynes pretty much wanted to move the economy from capitalism to socialism and set out a theory to induce that. That is the ultimate long run effect of his general theory.

Anonymous September 30, 2009 at 5:30 am

“In addition to the supply of savings increasing, demand for savings decreases. Because interest rates don’t move below zero, it acts as a natural price floor”

What do you think creates that floor, the x-axis? You are right, it is a natural floor. It is a natural floor because investment tends to be infinite and savings tends to be zero as rates go to zero. That does not mean that Krugman comes along and draws a line cutting those curves off at the x-axis. It means those curves themselves are asymptotic towards the axis–it means the curves never reach zero. That means the I and S curves always intersect above zero. And that means the IS curve (plotted against GDP) stays above zero. That means that whatever quantity the L-preference plane is dropped at, it always intersects the IS curve at a point above a zero rate.

And ALL of that assumes the IS-LM model is anything close to a reasonable approximation to reality anyway. And yes, I know central banks can force a negative rate–but that is besides the point of where markets naturally clear.

Drawing X’s on supply/demand curves is very qualitatively useful. But it only works as a linear approximation. Clearly as you draw those lines close to the axes, you are losing the linearity assumption and it is no longer reasonable. You can’t just draw the curves willy nilly without regard to the natural restrictions imposed by zero values for price and quantity.

Anonymous September 24, 2009 at 10:35 pm

He’s not arrogant. He was actually trying hard to explain something he understood and I didn’t. I don’t think he’s right, but I have a lot of respect for him. One reason I didn’t understand it was that I was taught that the paradox was something else so I was unprepared for his argument. It was a weird podcast but we were both trying hard to understand each other. At least that’s what I was doing…

Anonymous September 25, 2009 at 10:40 am

Could you post that podcast?

Anonymous September 25, 2009 at 10:49 am
Anonymous September 25, 2009 at 1:01 pm

thanks!

Justin P September 25, 2009 at 6:35 pm

It seemed to me that he was, but I’m sure you both know each other better than I do.That discussion was the first time I heard about the paradox, I guess I just agree more with your argument about it. The thing I really didn’t like, and I mentioned above is how he uses his hypothesis, the paradox, as a postulate to prove his hypothesis. About 16:30 min in, You make the statement that increase savings will produce more cash for investment in an effort to counter the paradox hypothesis, yet he says your wrong because of this paradox which he uses as proof. I know I’m not explaining myself correctly. Another thing I found arrogant was his use of the words “subtle” and “intuitive.” It seemed to me that he used it a lot to mean, it’s something that you just can’t understand so just trust me on this. That’s just my interpretation of the exchange but like you mention a lot, it’s a perception problem.

Have you had the chance to listen to the podcast again? It was only after I listened to it a 3rd time did I pick up on it

Surfisto September 25, 2009 at 1:51 pm

Justin,
You don’t think that even in the short term the Paradox has some basis? Take this crisis for example, I believe there are statistics out there that say people are saving more than ever before. Yes that should lead to banks not sitting on the cash and lending it for investment which would lead to demands for goods ruining the Paradox story. (If I am understanding why the Paradox is not true)
But at this time banks are sitting on their money. They do not trust to lend it out for legit reasons that the borrowers are not safe. Also their capital stocks and investments are decreasing in value and need to be replenished with either gov’t bailouts, stock/bond issuer or deposits.

Justin P September 25, 2009 at 6:41 pm

My interpretation of the paradox is that saving destroys income. So that there should be no savings, in the short run and in times of “crisis.” This leads to ridiculous notions of two groups of workers, one digging holes and one filling them in. Keynesians, thankfully, see the folly in that activity, but the rub here is that according to their theory, those activities are probably the best thing to do. Keynes of course advocated burying money in tin cans.
One thing to think about when discussing Keynes, is his hatred of interest rates. I think that is a key issue in his paradox. Keynes wants 0% rates of interest. And in that world, saving would do nothing for the economy, since banks have no incentive to lend which puts that money into circulation.

Anonymous September 30, 2009 at 6:36 am

“saving destroys income”

More specifically, saving destroys income and doesn’t even affect aggregate savings. The “paradox” is that no savings results from saving. Since to a Keynesiac the ONLY effect of savings is to destroy income, saving should not occur.

The problem with the PoT is that (1) savings does occur, and (2) much more occurs besides destroying income.

To someone who ever asked themselves what the nature of wealth creation is, the PoT is absurd. But Keynesiacs don’t care about that. All they care about are drawing aggregate correlations and trying to effect change by pushing those curves around.

Anonymous September 30, 2009 at 6:28 am

“You don’t think that even in the short term the Paradox has some basis?”

It is particularly baseless in the short term, because of the delays between saving, cutting consumption, and subsequently drawing from savings.

Don’t be misled by it. IF people acted in a particular way in which it is physically possible for them to act, the PoT could be true. The trouble is, nobody in their right mind would think that people ever have or ever would behave like that.

I think that is the sophistry of the PoT. People don’t see a logical contradiction in its description (there isn’t one), and so satisfied that they’ve come to understand a basic principle of economics, they pat themselves on the back and move on. But if you don’t move on, if you instead start asking questions about how realistic the assumptions are, you couldn’t possibly accept it as reasonable.

Surfisto September 30, 2009 at 2:02 pm

Vikingvista,
What I am trying to answer in my head is how recessions start. So, with PoT the idea is that people save, destroying income bringing aggregate demand down. I am more interested in the change in aggregate demand.

“It is particularly baseless in the short term, because of the delays between saving, cutting consumption, and subsequently drawing from savings.”
Isn’t the cause of cutting consumption saving? Also I think that drawing from savings is cutting consumption, people consume less to not draw down their entire savings to rapidly. This affects aggregate demand.

Can we start with this and follow with more questions. Because…
“But if you don’t move on, if you instead start asking questions about how realistic the assumptions are, you couldn’t possibly accept it as reasonable.”

I want to move on.

Anonymous September 30, 2009 at 5:51 pm

“I am more interested in the change in aggregate demand.”

Not all demand is created equal. Demand can be part of wealth creation or wealth destruction. Keynesiacs don’t make that distinction. That’s why they are perfectly happy destroying an economy if they think it will get their unique aggregate demand curve to shift to the right.

And don’t confuse this with charity or bailouts. It is true that in a recession some people may struggle with means for their own survival. The government stimulating their demand may put food on their tables. But that is an EXPENSE–it takes from the economy. It is not economic growth. However, when Keynesiacs talk about government stimulating demand, even though in reality it is the same costly activity, they falsely see it as growing the economy.

A recession is characterized by a drop in aggregate demand. But the phony–and costly–demand that the Keynesiacs shift to the right is a new different kind of demand that leaves the demand in the productive economy behind, and in fact forces it to shift further left.

“Isn’t the cause of cutting consumption saving?”

I was talking about the response of businesses, which is not instantaneous. If you stop going to your favorite Saturday restaurant and instead save that money, there is first the delay before Saturday rolls along. Then there is the delay before your restaurant cuts consumption to its suppliers (and/or finds new efficiencies, new customers, switches consumption, etc). Then there is a delay as the supplier goes through the same process, and so on. During this whole delay as your decision not to spend on the restaurant percolates (as a signal) through the economy, your savings is sitting in the bank. At some later time, a business may, according to the PoT draw on that savings, but never until a transient increase in savings has occurred.

And of course in reality, as that signal percolates, some businesses will find *ways* to make up for some of the lost income OTHER than by cutting consumption or drawing from savings. So when savings does ultimately get drawn down, it is not the full savings you deposited.

And this is exceedingly important: the *ways* I marked above, ARE productivity. That IS the reconfiguration of the economy from past consumer desires to the new consumer desires. And that productivity only develops because the signals are allowed to reach them.

And the PoT is bunk because it unrealistically neglects those *ways* as alternatives to drawing from savings, even though all of those *ways* are more desirable and a greater priority to a business than the loss of savings.

Even cutting consumption is a greater priority. And the *ways* and consumption-cutting both produce signals which efficiently spread out through the economy to find productivity. That means that only a small percentage of businesses need to be able to find *ways* in order for the PoT to be false, and a new productive economy to emerge.

Anonymous September 30, 2009 at 5:10 am

I don’t think he was arrogant. Prof R’s guests, and Prof R, are never arrogant in EconTalk.

I think the missed opportunity was to interrogate him as to why businesses would first react to lost income by drawing from savings. Clearly that is the LAST thing a business would want to do. They would do other things, like SWITCH consumption, find new customers, and improve efficiency first, and then only as a last resort–and even after cutting consumption–would businesses draw from savings. And all of those other things increase efficiency and productivity while simultaneously allowing savings to increase.

And even IF the vast majority of businesses wound up doing the last resort–drawing from savings–this would only occur after a vast set of highly specific signals pervaded the economy in the form of all of those other things. Those signals would tend to seek out efficiencies wherever they may be. And those efficiencies are the root of the new productive economy.

And on top of this, all of that takes time to happen, which means there is at the very least a transient aggregate savings.

So yes, the paradox of thrift is absurdly unrealistic. That is, reality is more accurately modeled by assuming that the PoT is false.

Nathan September 24, 2009 at 7:02 pm

The best critique of Keynsianism I’ve heard is that telling the government that wasteful spending can sometimes actually be useful is like telling an alcoholic that a glass of red wine every night is good for your heart. It’s usually not a good idea to give people who typically engage in reckless behavior a justification for doing so, and then hoping that they won’t overindulge.

Anonymous September 24, 2009 at 8:16 pm

During a recession consumption falls off as people save more of their money by putting it in the bank where it is FDIC insured. Banks become swelled with money as there is a glut of savings, and as a result the interest rate to borrow money drops. Is it not logical to assume that banks eventually will become so stuffed with dollars that they will want to start lending that money out – to make their money work for them. The point at which banks are compelled to lend may take a while, as the “panic” mode of the recession runs its course. But it seems to me, eventually, banks will want to lend out those dollars.

Along comes me with my idea to open a restaurant downtown. I go to the bank with my business plan and collateral, and the bank gives me a loan at a very attractive rate. Immediately I begin the build-out of my restaurant, hiring carpenters, painters, interior decorators, etc, and buying ovens, plates, silverware etc… I have just employed MANY people because consumers saved too much and brought the interest rate low. The savings glut(thrift) enabled me to get a handsome interest rate on a loan which I immediately used to put people to work.

I am not an academic economist, so be polite in your criticisms. But does this not make sense? And does it not disprove the “paradox of thrift?”

Anonymous September 24, 2009 at 8:30 pm

The problem is the paradox of thrift isn’t everything. Paradox of thrift is just the supply side of savings. For that to mean anything we also have to think about what’s going on on the demand side.Yes, you get a nice interest rate right now. But interest rates are bumping around at zero.What happens if the equilibrium interest rate is well below zero? It’s nice that YOU built your restaurant, and that helps, but that price floor doesn’t allow the market to clear. And when markets don’t clear because of a price floor we know there is deadweight loss (think of it like a minimum wage).You use the language “savings glut” which is fantastic. It is a glut. But the point of the glut is that markets aren’t clearing. Not that no one enters the market when interest rates are so low – of course many do. But not enough to clear the market.

Anonymous September 24, 2009 at 8:44 pm

I agree that during the “panic mode” of the recession the markets are not clearing – the markets simply are not functioning. But my point was once the panic is over,and the banks are full of money and the interest rate is low, then banks will lend and entrepreneurs will borrow. It is my understanding that Keynes believed there was no inherent self-correcting mechanism for clearing -and repairing – the markets; an economy in decline will simply continue to decline unless the government spends money. The narrative I gave earlier seems to refute this.

Anonymous September 24, 2009 at 8:50 pm

Why do you think the market will clear at this interest rate, though?

What makes it possible for you to know that the number of dollars willing to be saved at 0% nominal interest rate is the same as the number of dollars willing to be borrowed at 0% nominal interest rates? And if those two numbers DON’T match up, how does the market reach equilibrium if interest rates are already zero?

I’m not sure he ever said it will continue to decline in definitely – but certainly he said it will decline for an extended period of time while it incurs lots of deadweight loss.

Anonymous September 25, 2009 at 6:25 am

apply keynesian superstition to your personal finances .then scale it up to the national level. somehow the sum of parts dont add up the whole.eh?

Anonymous September 25, 2009 at 10:27 am

That’s emergent order for you. That’s the macroeconomy. Simple organizational principles at the level of agents scale up to a complex organization that behaves by different rules.

I’m curious – why would you expect it to apply to personal finances?

Anonymous September 25, 2009 at 7:44 am

for keynesian apologists to make their case, FIRST,goverments need to run surpluses when there is NO recession.then THAT money can be let loose in a recession. since NO GOVT likes to run surpluses (no -clinton’s accounting shenanigans dont count as surpluses), this is definitely the wrong time for deficit spending.
a dumbed down keynesian version is: your father saves up a lot of money when things are going good for you.then when you hit a rought patch,he gives it to you. not a bad idea.but a broke father should not try to pretend his wayward son can still get that non existent money.not if he believes stealing from his unborn grandchild is a horrible idea
keynes doesnt handle intertemporal issues at all. he is a live in the moment hedon

Anonymous September 25, 2009 at 10:50 pm

You’re confusing Keynes’s theory with his policy prescriptions. Parts of the theory are obviously correct, and don’t require any apology. If you don’t think liquidity traps exist you haven’t been paying attention.

Sam Grove September 26, 2009 at 5:29 am

Perhaps is people panic in response to market events, they may also panic in reaction to government reaction to those events as well.

Anonymous September 26, 2009 at 1:28 pm

You have no argument with me on that one.

You often make this “well – the government can screw up” case. Have I ever denied that? I don’t think I have.

Aside from simple questions of liberty (which were enough to sink these two proposals), why do you think I’ve come out against pay regulations and nationalizing GM? I think intervention is occassionally appropriate. That doesn’t mean I countenance spooking the market.

Sam Grove September 26, 2009 at 3:07 pm

The thing is, when the government screws up, it screws up for everyone.

As I have said before, my take on the Austrian BST is that centralized fiscal policy harmonizes market randomness into systemic events.

Loose monetary policy (easy credit):

1. postpones the failure of some businesses that otherwise would have failed in a random manner
2. stimulates the creation of businesses that otherwise would not have been created, in a shared time frame.
3. stimulates higher levels of investment than otherwise would’ve occurred, also in a shared time frame.

All this amounts to the creation of a bubble premature growth.

When the bubble bursts, the panic reaction of many investors causes a simultaneous reduction in consumption and risk taking (investment) which affects not only businesses which should have failed earlier, but also businesses which where otherwise in good shape.

This is not to say that fiscal manipulation is the only thing that produces synchronous reaction patterns, but easy credit under a central monetary authority is necessarily systemic and synchronizing in its effect.

Likewise, if the monetary authority attempts to contract the monetary/credit base, the effect is necessarily synchronizing in its effect.

Sam Grove September 26, 2009 at 3:13 pm

I have no suspicion that authorities attempt to spook the market, therefore I would hold that actions that do so are the product of beneficent intent.

Sam Grove September 24, 2009 at 8:20 pm

The Keynesian defense has to be that when people see government stepping in, it gives them confidence and reverse those animal spirits.

I always feel confident when I see government stepping in.
I’m confident that producers will get screwed even more.

Anonymous September 24, 2009 at 8:21 pm

Paul Krugman recently wrote an article in which he states that behavorial economic analysis needs to be included in our discussions of the ongoing fiscal crisis. He says that financial markets are not rational and that irrationality took place during our most recent crash. The people that would normally buy financial instruments such as bonds and stock shares were too scared and thus irrational. He also states that people who would have been buyers did not this time because of the lack of collateral because of leveraging.

I don’t agree with Krugman that irrationality took hold of the market but that it was market violence. I do agree with him that if more collateral was available then rational buying would have taken place and the market would not have fallen as fast nor as deep by a wide margin. The lesson is that financial firms and individuals need to have much deeper pockets to invest when others fear.

michael_webster September 24, 2009 at 8:50 pm

I am curious as to how your story of what Keynes meant matches up with Krugman recent post, http://www.guardian.co.uk/books/2009/aug/30/keynes-return-master-robert-skidelsky

My sense is that you are both talking past each other.

Anonymous September 24, 2009 at 9:38 pm

Here is the article which is eight pages long:http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html?_r=1

michael_webster September 24, 2009 at 8:51 pm

My sense is that both you and Krugman are talking past each other.

See: http://www.guardian.co.uk/books/2009/aug/30/keynes-return-master-robert-skidelsky

Hope this isn’t a double post.

Anonymous September 25, 2009 at 1:21 am

An honest Keynesiac must admit that the “mattress stuffing” is really in the form of bank deposits and other conservative investments. This results in a growth of potential investment funds in the hands of professional investors. So Keynesiacs argue that potential investors are just hoarding the cash because they cannot find investments worth the “risk” (“risk” here being Keynesiac supposed delusion caused by irrational animal spirits). The government deficit spending then diverts potential investment dollars from potential private investments. Of course they miss the obvious–as the economy massively restructures it requires more effort to find truly profitable investments. That is because the recession is a realization that current activities are not productive. So what you want is a backlog of potential investors frantically scouring the country looking for ways to create wealth. Instead the Keynesiac relieves them of that stress by giving them the easy T-bill option, so that the government can instead invest those funds in known nonproductive or overly risky endeavors (which is the theory, the reality is that the money simply goes to buy votes–but either way, it is counterproductive).

Anonymous September 25, 2009 at 6:23 am

agree. keynesians seem to hate the ‘loss’ part of profit-loss capitalism.if prices are below their liking,it seems to them that markets arent clearing.wtf, dk,interest rates for interbank lending may be near bogus zero rates.have credit card rates come down?.we can never know the real interest rates in the economy as long as the price of money is fixed from the top.just like you cant figure out the real rent rates in a city (unless you are connected well in the black market) where rents are fixed by fiat.

Anonymous September 25, 2009 at 11:18 pm

Banks have to hold reserves against demand deposits. Government spending is more effective in creating demand because the treasury does not have to hold reserves against T-bills, so it is not purely diversionary. You may not like it, but that isn’t the same thing as its being useless.

Whether deficit spending can have a real impact on growth depends on what you think is causing the recession. If it is indeed a shift of resources from an area that was over-invested (housing anyone?) to one that wasn’t, in Keynesian terms the economy was always at full employment so creating extra demand will just create inflation. This is what was called stagflation back when the world was mostly Keynesian. But the idea that T-bills constitute an easy alternative to productive investments in this kind of environment is a bit weird – right now the real return on them is negative! If my fund manager was buying T-bills I’d be quite annoyed,

However, even in Austrian theory not all recessions are like this. They can also have a demand-side component in which the money supply falls, distorting signals to consumers and investors, effectively reducing demand. If you have this kind of recession, deficit spending can be effective since it increases effective demand by increasing the velocity of money, although fixing the underlying monetary issue is likely to be a better idea.

Again, you may not like this, but its a simple matter of arithmetic, and I would not like to try to argue that the current recession is a purely supply-side phenomenon. It was until this time last year, but it sure isn’t now.

Anonymous September 30, 2009 at 6:56 am

“Government spending is more effective in creating demand”

Not all demand is created equal, and not all demand is good for the economy. The government is worse than ineffective at targeting the productive economy. Banks on the other hand, are restrained in the case of “mattress stuffing” not by reserve requirements, but by the difficulty in finding profitable investments.

The solution is not to lend that money to the government so that it can avoid all pretense of productivity altogether.
The solution is not to obscure and hinder the productive economy by propping up the nonproductive economy.
The solution is not to relieve banks of all incentive to find productive investments.

The solution is for the government to freeze, and not cloudy the water, so that the productive economy can declare itself.

And by “solution”, I am referring, in almost every case, to a solution to a problem created by the government.

Daniil Gorbatenko September 25, 2009 at 8:33 am

But even if we suppose for the sake of the argument that the paradox of thrift were even true. That when folkes start saving it temporarily reduces the so-called aggregate demand and causes short-term suffering.

Still, I do not see the justification for the government to step in. I do not understand why the imaginary “short-run” must be preferred to the equally imaginary “long-run”. It is childish reasoning to me.

Anonymous October 23, 2009 at 8:42 pm

The reason why the Keynesian argument works is because the reason people are scared about the economic future has to do with people worried about their income.

at the least the people put to work from the stimulus projects will go out and spend and that spending will be a bust to the economy.

by doing stimulus projects you put people to work. People with a job tend to look more favorably about the future then those with out and since they have an income to spend, they will.

Also most people wont think about the fact that they will have to pay for the debt in the future…at least they don’t think about it much, when compared to people thinking about their financial needs now.

Anonymous September 24, 2009 at 6:54 pm

I usually lose… he can be such a jerk sometimes :)

Matt September 24, 2009 at 7:09 pm

Me too. Lol.

Anonymous September 24, 2009 at 7:39 pm

He said that just because government is borrowing doesn’t make it a bad investment.That doesn’t mean he’s saying it makes it a good investment. I’d guess that’s why not.

Not to mention the basic implications for political liberty.

Anonymous September 24, 2009 at 7:50 pm

Yeah because everything HAS to be all or nothing with you guys. Of course the reverse corallary is why not have anarchy.

But the serious answer is because well regulated capitalism is more effecient and liberating. Most pragmatic answers in life are not neat and siimple and often lie in the middle… with moderation.

Anonymous September 24, 2009 at 7:58 pm

Moderation rocks my world.

For some reason, not everyone seems to find it as sexy and intuitive as I do :)

Sam Grove September 25, 2009 at 3:07 am

But government participation does not stay in the middle.

Incentives are created that push toward increased political intervention, and, in toto, to the benefit of the influential at the expense of the base.

Surfisto September 25, 2009 at 1:27 pm

Muirgeo,”But the serious answer is because well regulated capitalism is more effecient and liberating. “Who among us can say what the “well regulations” should be? Are any of us that smart to say it will work as intended without unitended consequences or leading to abuse or loop holes.To me the biggest problem with capitalism is fraud. Regulation is suppose to curtail these frauds; however, in reality they always work. In the end doesn’t the market regulate by punishing those that needed the regulation? Look at the banks, those who were wild “needed regulation” are now gone.

MWG September 24, 2009 at 9:54 pm

Moderation (like “sexy”) is in the eye of the beholder. Many called Bush a fascist, but he probably thought he was quite “moderate”. You probably think Obama is moderate, though there are millions who would disagree.

Anonymous September 25, 2009 at 3:20 am

Only if government has more incentive to represent the influential over the base.

You guys are the ones opposed to publicallly financed election, unlimited lobbying, corporate personhood, considering money and speech as the same and of giving every other sort of advantage to the influential to undermine government and seek rents.

As you have no solutions and justify more of the same problems that wreck the system you have no right to complain.

Me, on the other hand , I have pragmatic non-dogmatic real world reasonable solutions… so I do get to complain.

Sam Grove September 25, 2009 at 4:47 am

The incentives exist systemically based upon human nature. Your “if” is non sequitor.

All the cures you suggest have been tried with the effect of limiting competition in the political arena and protecting incumbency.

You think you have solutions but the results are perverse because you do not recognize systemic problems of the system.

The incentives do not disappear via legislation any more than recreational drugs disappear from the market because they are prohibited.

You are not willing to acknowledge the essential fascism at the heart of your attachment to the state and therefore cannot see your own corruption via the thought of wielding political power to perfect the world, even if only vicariously.

Anonymous September 25, 2009 at 10:23 am

I’m not sure I can agree with the premise of that question.

Paradox of thrift is an incomplete understanding of Keynes. If you understand the context of the liquidity trap it makes a lot of sense. If you think there’s no good reason why the market for savings can’t equilibrate, then it makes a lot less sense.

Anonymous September 25, 2009 at 10:45 am

I’ve never expressed a concern about “mattress stuffing” either. I think you’re imagining your own opposition. Savings and mattress stuffing don’t bother me. What bothers me is the deadweight loss of a non-clearing market for savings.

Anonymous September 25, 2009 at 3:17 pm

You did exactly as I predicted. You have utterly evaded the point that Matt made, while repeating the fallacies you committed earlier.

matt September 25, 2009 at 8:16 pm

You are a magnificent dumbass.

Sam Grove September 25, 2009 at 3:52 pm

I’ll take your word for it.

Anonymous September 25, 2009 at 4:14 pm

“A function of the repeated reproduction of the result” is not the same as “solely determined by the repeated reproduction of the result”, michaelsmtih.

No, you didn’t use the word “solely” — you merely capitalized the word IS.

Here is your statement:

But if it’s an estimate he’s after – like an impact estimate – then confidence in an answer IS a function of the repeated reproduction of the result.

I merely brought up astrology to illustrate that it is possible to get large numbers of people that can “repeatedly reproduce” an “impact estimate” that is completely irrational.

Using astrology to illustrate this is not a non sequitur. If I asserted, “The methods of astrology are invalid, therefore the methods used by Keynesian economists to estimate impacts are invalid” — that would be a non sequitur. But of course, I didn’t say that.

By the way, the burden of proving that a method of making an estimate is valid rests with those asserting the estimates as fact. That would be you and muirgeo.

Anonymous September 25, 2009 at 5:09 pm

RE: “Now do you understand why I assumed you thought deflation in and of itself was a bad thing?”

I suppose I understand… but I hope you don’t usually interpret things that people say with complete obliviousness towards context. We’re talking about a liquidity trap and a depression on this thread. That’s pretty important context if you’re talking about deflation!!!!

RE: “My answer:
I never mentioned inflation.”

You do realize just a couple lines up you quoted yourself mentioning inflation, don’t you?

Anonymous September 25, 2009 at 5:14 pm

I never claimed great wisdom, and of course no one knows that. Why do you expect they would know that or believe that they would know that?I’m not afraid of change either. These criticisms and questions don’t even make any sense. My problem is that the market can’t change right now. It’s hit a price floor. I WANT it to change and be dynamic. It’s BAD that it can’t.

Justin P September 25, 2009 at 7:20 pm

More good quotes from Chapter 24:

“It will be, moreover, a great advantage of the order of events which I am advocating, that the euthanasia of the rentier”

“Thus we might aim in practice (there being nothing in this which is unattainable) at an increase in the volume of capital until it ceases to be scarce”
How does he want to do that? You get 4 points if you answered, inflation.

“The State will have to exercise a guiding influence on the propensity to consume partly through its scheme of taxation, partly by fixing the rate of interest, and partly, perhaps, in other ways.”
More power of the state….a bold statement to make during the rise of Fascism. Oh but what does he mean when he says, “in other ways?”

“There are, of course, errors of foresight; but these would not be avoided by centralising decisions.”
More power of the state, and any “errors of foresight”….eh…s&*t happens anyway…but don’t worry the State will be there for you.

Anonymous September 25, 2009 at 7:31 pm

RE: “In the long run we are all dead anyway”
I believe that’s Tract on Monetary Reform. I’ve always found the consternation over that one funny :)

Your second quote is more on the mark, and from the General Theory. And look at the sentence before that one – you’ll find an allusion to Keynes’s concerns about a central-bank fueled inflation.

As for the housing bubble, etc. – you are trying to equate any action on the part of the Fed with the sort of action that Keynes would support. That doesn’t really make sense, Justin.

The point is the socialization of investment, as you say. That’s the heart of this chapter. At first glance, we obviously have to reject that option (note it’s not a rejection of the positive conclusions of the General Theory, only this normative conclusion). But if you keep reading, Keynes continues to talk about individualism, liberty, and authoritarianism. He embraces the value of individualism, strongly rejects authoritarianism, and restates the socialization of investment as a general constellation of policies to influence investment and consumption behavior, and not socialism per se.

And now we all know the history of demand management. Even THAT obviously poses problems. But it is what it is, and that was Keynes’s long term vision. I think Keynesians now don’t fully accept Keynes’s version of that idea – but the general thrust of macroeconomic management in a liberal society is the long term vision.

It’s not “Keynes pretty much wanted to move the economy from capitalism to socialism”, as you put it.

Anonymous September 25, 2009 at 7:32 pm

Is this a trick question? From people that buy bonds.

Anonymous September 25, 2009 at 7:37 pm

Re: “It will be, moreover, a great advantage of the order of events which I am advocating, that the euthanasia of the rentier”

:) if Sarah Palin was around in 1936, Keynes NEVER would have taken the risk of using such colorful metaphors.

RE: “”There are, of course, errors of foresight; but these would not be avoided by centralising decisions.”
More power of the state, and any “errors of foresight”….eh…s&*t happens anyway…but don’t worry the State will be there for you.”

This strikes me as a fundamentally cautionary note on his part… a cautionary note that he his repeatedly accused of never making!

Justin P September 25, 2009 at 7:59 pm

RE: “In the long run we are all dead anyway”
Oh because he didn’t say it in “General Theory” then it doesn’t count? I don’t think so Dan.
Re: “As for the housing bubble, etc. – you are trying to equate any action on the part of the Fed with the sort of action that Keynes would support. That doesn’t really make sense, Justin.”

My point is that it is a long run consequence of what Keynes advocated. Your mixing up, “what Keynes wanted and advocated” with the unintended consequences of his policies. My question is about the latter not the former.
The unintended consequences are what is important. Remember what the road to Hell is paved with?
Keynes wanted to induce inflation. We all know the consequences of that.

As for the socialization of investment…well Keynes says it all right here.
“The theory of aggregated production, which is the point of the following book, nevertheless can be much easier adapted to the conditions of a totalitarian state [eines totalen Staates] than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire. This is one of the reasons that justifies the fact that I call my theory a general theory.”

Justin P September 25, 2009 at 8:01 pm

Only a colorful metaphor? Is that how you justify it? To each their own I guess.

Nothing to say about the State exercising “a guiding influence?”

Justin P September 25, 2009 at 8:03 pm

OMG Dan, please give me a break! Please don’t try and play dumb now.
1. Taxation
2. Borrowing
3. Inflation
4. Having the Fed buy the bond by printing money (this is the new way)

Anonymous September 25, 2009 at 8:08 pm

RE: “Oh because he didn’t say it in “General Theory” then it doesn’t count? I don’t think so Dan.”

Do you have short term memory loss or something? You were responding to my point that the last chapter of the General Theory provides a good vision.

RE: “Your mixing up, “what Keynes wanted and advocated” with the unintended consequences of his policies. My question is about the latter not the former. ”

It’s not an unintended consequence of his policies. It was a direct contradiction of his policies. I assume you advocate the existence of a police force, right (just like I advocate the existence of a central bank)? I can’t point to police brutality and unlawful imprisonment, etc. and blame you for that. Your (correct) response would be that you don’t advocate a police force that operates like that. Likewise, Keynes didn’t advocate a central bank that fueled bubbles. He advocated a constant low inflation policy. It’s a bad argument on your part to attribute that to him in the first place – but it’s also a rhetorical strategy that priveleges doing nothing.

As I’ve said I have absolutely no qualms with his German preface. I think people either willfully misinterpreting that or they are so opposed to Keynes that they aren’t able to read it objectively.

Anonymous September 25, 2009 at 8:09 pm

Um, yes.

Are you proposing he actually wanted to kill them?

Anonymous September 25, 2009 at 8:13 pm

You give me a break.
1. (taxation) You don’t get money to run deficits from taxation. If you support a deficit with tax revenue it’s NOT A DEFICIT
2. (borrowing) no beef here
3. (inflation) you asked me how they get the MONEY to do it. this is a result of deficit spending and this is a strategy to reduce the debt burden, but it’s NOT a way to get money to finance deficits.
4. (having the Fed buy the bond) This is the same thing as (2.)

You asked a straightforward question, I gave you the only sensible answer. The DEFINITION of incuring debt is borrowing from someone – issuing bonds. Taxation is antithetical to deficits and inflation is a consequence. Don’t get flustered when I give you a straightforward response.

Anonymous September 25, 2009 at 8:23 pm

I don’t see where there is a fundamental limit on how far people can reduce their consumption, if you accept there’s a role for effective demand. That’s where the liquidity trap Keynes talked about comes from. If everyone chooses to save as much as possible, given their current plans, that reduces the velocity of money, which reduces effective demand, which means production falls and unemployment increases, which means people have to change their plans in order to save more, and so on. If there’s a fundamental limit anywhere it comes somewhere past the point where we’re all living on rice and beans and living in shacks. No thanks.

The issue is precisely that people trying to hold liquid assets creates the conditions that cause other people to try to old liquid assets because they become more worried about the future.

Whether all of this justifies the use of fiscal policy to stimulate the economy once its in a liquidity trap is another matter entirely. Personally I don’t think it does, but thats a totally seperate issue from whether it happens. In order to believe it doesn’t happen you have to have been asleep for the last 12 months.

Justin P September 25, 2009 at 8:28 pm

The question was “Where does the money come from?”

To borrow means you have to pay back, where does that money come from?

Inflating the money supply, means they pay back less on the debt. So it is a way to run deficits.

You advocate a policy of deficits ad infinitium…that all fine and dandy. But debt has to be serviced. You have to pay interest on it and you have to pay the bonds when they are due. The only way to do that is thruugh taxation or inflation.

You seem the think it’s okay because it the government, I disagree.

Anonymous September 25, 2009 at 8:31 pm

I KNOW! The money does not come from inflation – the reduced debt burden does. The money doesn’t come from taxation. To the extent that tax revenues are collected it’s not a deficit. So how can the money for a deficit come from something that negates deficits????

Justin P September 25, 2009 at 8:32 pm

I don’t know, he is dead. Do you know exactly?

Anonymous September 25, 2009 at 8:34 pm

This is getting surreal, Justin. It’s been fun… but it’s starting to get surreal. Not to mention pointless.

Justin P September 25, 2009 at 8:36 pm

No I don’t blame you, I blame the Fed. I wouldn’t say the whole police force is corrupt but I would blame those bad police and their commissioner. Likewise, I blame Keynes because his theory and the corollaries are the main justification for the policies in place, Stimulus etc.
Keynes didn’t advocate bubbles, that I agree but he did advocate polices that lead to bubble formation, and those are the policies I blame him for.

Anonymous September 25, 2009 at 8:41 pm

RE: “No I don’t blame you, I blame the Fed.”

Which is my point. I blame the Fed too. Glad we agree.

Re: “Likewise, I blame Keynes because his theory and the corollaries are the main justification for the policies in place”

Argh – I thought we were making progress. Back to square one.

Justin P September 25, 2009 at 9:10 pm

I was thinking the exact same thing about you…haha

Sam Grove September 25, 2009 at 9:12 pm

I don’t see where there is a fundamental limit on how far people can reduce their consumption

If they want to avoid hunger, then they must eat, if it’s cold out, then they need heat, etc.

IAC, I hear talk of a liquidity trap, or at least the prospect of it, but as near as I can tell, the commute traffic on the highways around here is as congested as ever, so people are buying gasoline, maintaining their automobiles, etc. Most of the stores I frequent or pass buy are still open and parking lots are filled.
Costco is as busy as ever.

So when I hear talk of a liquidity trap, I’m not sure what they are talking about.

Of course, building loans have dropped, but perhaps they should.

So my wife’s business partners won’t be building a new veterinary hospital, but they are going to incur less debt by occupying an empty facility.

Another problem is that the one thing government could do to help, but never will, is reduce government spending.

I suspect all this political discourse is not so much about rescuing the economy as it is about maintaining the status quo.

Justin P September 25, 2009 at 9:13 pm

Running a deficit means you must incur debt. incurring Debt means it must be serviced. Your looking at only the former and I’m looking at both. Your looking at the short run while I’m looking at the long run.

Anonymous September 25, 2009 at 9:16 pm

Well – it’s not a short run/long run issue so much as a stock/flow issue. Deficits are debt as soon as they are incurred. You don’t have to wait for some “long run”.

Even then, you don’t service debt with inflation – you reduce the real debt burden with it (and, I might add, the real debt burden of other borrowers in the economy). I suppose if you’re refering to the debt (I didn’t realize this because we were talking about running perpetual deficits), then sure – taxes work too.

Justin P September 25, 2009 at 9:22 pm

Reducing the debt burden is the same thing as servicing…your just doing it in a different way.

Anonymous September 25, 2009 at 9:53 pm

Even if the “necessities of life” impose a fundamental minimum level of economic activity, that’s an extremely low level compared with where we are now. And they actually don’t – if you can’t obtain the income to support your planned level of consumption you have no choice but to reduce it. When you’re in a liquidity trap, that happens across the whole economy.

The evidence that we were at risk of liquidity trap is everywhere. Unemployment is 10% and rising. Inventories were down. Household savings are up. Real interest rates are negative. Business confidence is extremely low. Bank failures are up massively. CPI growth is almost zero, and RPI growth was negative. All the interest rate spreads – long versus short term, good credit versus so-so – increased hugely this time last year and took months to recover. All the real evidence (discounting your commute traffic, since its not a widely used economic indicator) says we were teetering on the brink.

Which isn’t to say we didn’t need to have a recession. The property bubble had to burst, and its bursting was going to result in unemployed realtors, carpenters and mortgage brokers and some banks and investors were going to lose their shirts (and pants). But that kind of recession is healthy, and benefits as many people as it disadvantages. But that recession started in 2006, and no-one ever suggested fiscal stimulus was necessary. The secondary deflation that started this time last year was a whole different animal, and posed a real risk to the whole economy.

Sam Grove September 26, 2009 at 12:42 am

We can hope that that is all it is.

I think what Americans consider a fundamental minimum of consumption is much higher than the “minimum required” to support life.

Surfisto September 30, 2009 at 7:01 pm

Good Swing VV,
You answered some of my questions.
In the beginning I was talking about the savings/income loss/less consumption shifting the aggregate demand to the left, so the Keynesians have a point in the short term aggregate demand falling. Especially in the short run because people are scared. They see the news every night and they might lose their job or whatever, so in mass we start saving or not going to the restaurant on Saturday and so aggregate demand is affected before those signals percolate through the system and before productivityy can emerge.
I agree their solution of gov’t spending creates demand at the Expense of productivity.
I also want to understand that if the aggregate demand falls and the PoT is not the cause what is? I understand the Austrian view is something to do with interest rates being low so the money is flowing into certain industries creating a false demand and then at some point we have to correct and we have a recession.
What is the Chicago Monetarist view or is the same?
thanks again,

Anonymous September 30, 2009 at 8:04 pm

“so the Keynesians have a point in the short term aggregate demand falling… if the aggregate demand falls and the PoT is not the cause what is”

Keynesiacs did not invent supply and demand analysis. Shifting demand curves is not a keynesiac invention. Nor is the PoT meant to explain it. The PoT merely says that the economy gets nothing for it–because “paradoxically” the presumed shift from demand to savings doesn’t happen, since no aggregate savings develops. Keynesiacs argue the economy would be better off if instead people just kept doing business as usual.

But the economy does in reality get something from it. It does get savings, and it also gets the signals. And not least important, it gets a termination of destructive activity (see below).

The aggregate demand drop is caused by people consuming less.

“Austrian view is something to do with interest rates being low so the money is flowing into certain industries creating a false demand and then at some point we have to correct and we have a recession”

You are asking why we get recessions. They happen as many people realize that their activities are not productive, so they stop them. That could happen, say, if a giant astroid destroyed half of your country, and people suddenly realize that their interests are no longer best served by doing what they used to do.

But usually recessions occur after a realization that the signals they were responding to were falsely telling them what constituted a productive endeavor. That is a bubble.

A bubble represents a mistake–a misallocation of resources. People mistakenly thought they were laboring toward a productive end. Measures of economic activity, like GDP, reflect a false expectation of wealth creation. In reality, all of that activity is wasted–not only was it not creating wealth, but it reflects an opportunity cost as those people could have been doing something else that did create wealth. The result is that wealth declines. When people realize that, they rationally change their behaviors to amend it. The resulting decline in economic activity merely reflects the loss of wealth that has already occurred.

The Austrian view is that the keynesiacs and the monetarists falsely see the recession as the problem when in fact the recession is one of the effects of the problem. The recession is actual part of the solution–the market trying to fix the problem, once its confusion has been removed.

Then the question is what causes the problem–the problem being the misallocation of resources. That can be manifold, but typically is some government policy that interferes with the signals. You mention below market interest rates. That is both a cause and a potentiator for resource misallocation.

When a central bank lowers interest rates, it is NOT as though a helicopter dropped cash on the country (monetarist view). Instead, the central bank first gives newly created money to SOME small group. The money has almost the same value to that group as prior to its creation, since it hasn’t yet been diluted. That group then buys things at full value. The value of those dollars (and of all dollars since they are interchangeable) gradually decreases as they percolate through the economy. Those who first get it are better off at the expense of those who last get it. That represents a transfer of wealth toward the central bank, without regard to productivity. That is a false signal away from productive endeavors. That false signal creates a misallocation of resources.

Low interest rates can also potentiate another misdirected signal. Eventually in a misallocation, the money must run out. It is not wealth creating, so there are not infinite funds for that activity. When that activity drowns out productive activities in the economy, the money must eventually run out, and the bubble pops. The sooner the bubble pops, the less wealth is squandered. But central banks create money and inject it into an economy allowing that activity to be temporarily prolonged (at additional expense, e.g. of inflation). Thus even more wealth is lost through prolonged misallocation, plus paying for the increased liquidity.

Surfisto October 1, 2009 at 3:34 pm

VV,Thank you for your well taught and informative responses, I should probably be paying tuition.I said “Isn’t the cause of cutting consumption saving?”You said “The aggregate demand drop is caused by people consuming less.”was that meant as a postive statement?if so….It makes sense that people will consume less in tough times, but that does not mean they are saving the money, they just have less.”Measures of economic activity, like GDP, reflect a false expectation of wealth creation.”Is this partly because gov’t spending is included in GDP, I mean the gov’t spending does not create wealth just takes it from something that would have been more productive. However won’t the short run gov’t spending cause some increase in demand where the money is spent, create false signals? So Keynesians claim victory?Also something that may be off topic, but has been consuming my time is gov’ts that have state owned oil. Looking at Norway, Russia, Venezuela et al. if they have revenues from oil can they spend without causing the normal problems associated with gov’t spending? For example a rich gov’t could potentially keep taxes low because they have revenue from oil and not taxes. I can see how it would be difficult for a gov’t with vast oil revenues to not keep expanding which is negative, but in theory could they spend stimulatin demand and not destroy wealth in other areas and keynesians would claim victory? I am curious about your thoughts here.Thanks again.

Anonymous October 1, 2009 at 5:46 pm

“was that meant as a postive statement?”I don’t know what you mean. It was an objective statement. When people consume less, aggregate demand drops. Dropping aggregate demand means people are consuming less.”but that does not mean they are saving the money, they just have less”Both happen, but more the former. Even at the height of the great depression, the vast majority of people were employed.”Is this partly because gov’t spending is included in GDP”Not usually. Although monetary policy helps inflate a bubble, fiscal spending isn’t typically a major contributor. It is the hope by keynesiacs, however, that government spending will move the GDP DURING A RECESSION not during a bubble. GDP is a measure of transactions, not wealth. It is incorrect to think that every transaction creates wealth. During a bubble people are engaging in transactions that would be wealth generating IF the circumstances communicated by the signals were correct. But those signals are not correct, so those transactions are not wealth creating, as is eventually discovered with the bubble pops.When people are free to trade and signals are mostly reflective of people’s desires, then GDP, which is always an index of transactions, then also correlates with wealth creation. But there are important times when GDP correlates with wealth loss. One is during a bubble with those transactions reflect wasted effort. The other is when the government spends money, where those transactions reflect a cost of government.”However won’t the short run gov’t spending cause some increase in demand where the money is spent, create false signals? So Keynesians claim victory?”Potentially. GDP in the US went up last quarter, arguably a result of government spending. And keynesiacs do claim victory because they don’t realize that the demand they are stimulating, and the GDP they are growing, is an ENTIRELY different thing than the demand and GDP of the productive economy. And worse, they come at the expense of the productive economy which must fuel their efforts. So keynesiacs claim victory for economic growth when in reality they’ve done exactly the opposite.”can they spend without causing the normal problems associated with gov’t spending?”No. The high oil revenues can insulate against the early growth phase of government, but governments are characteristically insatiable, and will try to continue to grow long after the money runs out. And when the oil runs out (meaning demand for their oil steadily declines), they are left with serious social and fiscal crises.If instead of fueling government, they allowed the money to all flow back to the oil industry and fuel it and ancillary industries, then the ancillary industries may provide a nidus for a non-oil-based productive economy. But having a whole economy dominated by a single product, let alone a single industry, is a risky affair.

Surfisto October 1, 2009 at 6:34 pm

Vikingvista,

“can they spend without causing the normal problems associated with gov’t spending?” Your answer was “No”

I am thinking theoretically, if a gov’t had this revenue and was not insatiable. Then they could keep taxes low which would fuel the non-oil based sector for when the oil runs out.
So the gov’t could spend when needed and stimulate demand without printing money and the negative effects associated with that.
So theoretically could you say maybe and not No?
I ask because the arguement is always that the gov’t should not own any industry and let private firms do what they do best. This also might tie in to an ethics discussion I am having with methinks at the moment.

Anonymous October 1, 2009 at 7:01 pm

“if a gov’t had this revenue and was not insatiable”

Come back to reality, surfisto.

Surfisto October 1, 2009 at 7:17 pm

lol, yes!
Thank you for the help this discussion helped me a lot.

Anonymous October 1, 2009 at 7:21 pm

A pleasure to discuss with you, surfisto. Your understanding is greater, and your manner more polite than many posters here.

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