Solving the Puzzle

by Don Boudreaux on March 16, 2011

in Complexity & Emergence, State of Macro, Stimulus, The Economy

Coordination Problem’s Steve Horwitz riffs on a brilliant ;-) economic analogy to help explain an important difference between Austrians and Keynesians.  Here’s a key passage:

The argument for stimulus spending by Keynesians amounts to saying we need to activate idle resources either without thinking about whether the puzzle pieces actually fit together or, more subtly, not thinking about, or not caring about, whether they produce a meaningful pattern.  The point is just to make sure they are being “used.”

Steve’s point seems to fit well with Arnold Kling’s concept of Patterns of Sustainable Specialization and Trade (PSST).

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{ 54 comments }

John V March 16, 2011 at 8:29 pm

Like I always say:

Capital is leggos not playdough. Once that makes sense, keynesian stimulus seems absurd to the point of ridicule.

Don Boudreaux March 16, 2011 at 9:46 pm

Yep!

Economic Freedom March 16, 2011 at 11:08 pm

Excellent analogy by Horwitz. Thanks!

muirgeo March 16, 2011 at 8:54 pm

Absolutely!!! Better to put 100 people to work fixing the roads, 100 people to work researching renewable energy and 500 people digging holes burying jars of money and the 300 more to dig up the jars of money then to have all 1000 sitting just as idle as the billionaires savings account. That’s a no brainer!

Methinks1776 March 16, 2011 at 9:39 pm

Um…I guess we can tell Professor Horowitz that in Muirdiot’s version of the Keynesian stimulus argument we should neither think nor care. Don’t look around. Just go for broke.

Don Boudreaux March 16, 2011 at 9:44 pm

That IS pretty much the Keynesian solution – one that makes a great deal more sense in the imaginary world of homogeneous capital K; homogeneous labor L; and homogeneous consumption goods Q. That someone with Muirgeo’s utter utter lack of even the most rudimentary knowledge of economics so readily finds sense in Keynesian diagnoses and prescriptions speaks volumes about Keynesian economics.

John V March 16, 2011 at 10:04 pm

What I find most interesting is that some of the brighter people I have interacted with on blogs who support Keynesian policies sometimes scoff at the notion of heterogeneous capital…but not because they don’t think it matters. Instead they say something to the effect that:

“Oh please, do really think heterogeneous capital is something Keynesian economists are NOT aware? Of course they are. They are totally aware that capital is not one lump of homogeneous mass.”

Yes, they claim that such ideas and the ideas of patterns of production and capital structure are so obvious as to not be worth mentioning. From there, the further explanations vary:

1. We have to clear inventories to avoid an over-correction and spare undue pain. (Of course, they have no way of knowing whose inventories to clear or who can better manage with the assistance of stimulus.)

2. The increase in aggregate demand is more important during this dark time than lazy liquidationist thinking. (But the idea of getting bad investments weeded out and poorly allocated capital moved to better uses ASAP so the economy can actually RECOVER strikes them as lazy because there’s no imaginative policy behind it to show others they care. I think THAT’S part of the problem.

3. Then there’s just the standard notion that fuzzy ideas about capital structure aren’t putting bread on the table and boosting demand when we need it most. (IOW, they really don’t get the idea of heterogeneous. Otherwise, they’d realize how unhelpful trying to boost aggregate demand really is.)

Back to square one.

JohnK March 17, 2011 at 9:36 am

“because there’s no imaginative policy behind it”

It always comes back to policy. Policy, policy, policy.

Government must be involved.

The alternative is freedom, and we can’t be trusted with that.

JCE March 16, 2011 at 10:38 pm

What troubles me is YOUR utter lack of even the most rudimentary knowledge about keynes. let’s see here, he wrote ‘treatise on probability’, ‘a tract on MONETARY reform’, ‘treatise on MONEY’, and ‘ the general theory of employment, INTEREST AND MONEY’
it’s pretty evident, and indeed it is the case, that he was concerned throughout his career first and foremost about the nature of money and it’s role and impact on the economy. as a matter fact, the original title of the general theory was to be ‘ a monetary theory of production’.
and no, money is not just a veil. you should maybe read marx, wicksell (among others) that proved that is the case
nothing about spending. nothing at all.

keynes’ ideas on deficit spending became all the public (and, unbelievably, most PhD economists) knows about him. yet they are as important to his work as adam smith’s inivisible hand story is to his (he mentions it ONCE in his two books)

al little knowledge of the history of economic thought would be nice

John V March 16, 2011 at 11:22 pm

“keynes’ ideas on deficit spending became all the public (and, unbelievably, most PhD economists) knows about him.”

But THAT is the part in question. Or didn’t you notice?

Methinks1776 March 16, 2011 at 11:24 pm

I’m just shocked you didn’t drag Milton Friedman into this. He claims that the Chicago economics department (I forget the economist’s name whom Friedman named as the leader of the pack) dreamed up Keynesian solutions before Keynes did and Friedman himself fully bought into them. At first.

Sam Grove March 17, 2011 at 12:13 am

money is not just a veil

Money is a veil only to those who do not look beyond it.

Sam Grove March 17, 2011 at 12:21 am

it’s pretty evident, and indeed it is the case, that he was concerned throughout his career first and foremost about the nature of money and it’s role and impact on the economy.

That certainly helps explain the shortcomings of his economic theorizing.

kyle8 March 17, 2011 at 7:46 am

Keynes wrote a lot of things, some of them mutually exclusive. But Keynesianism has taken on a life of it’s own. It has come to mean mainly one thing; the stimulus of aggregate demand using monetary and fiscal policy.

Those of us who understand that this is a prescription for disastrous policies are greatly incensed against Keynesianism.

What he may or may not have written about monetary policy is besides the point.

Methinks1776 March 16, 2011 at 11:39 pm

I can hardly blame Muirdiot.

In my undergraduate economics program we were fed a steady diet of Keynes’ free lunch. The only Austrians I’d heard of were from The Sound of Music.

A friend graduated from Princeton and he seemed to remember Bastiat – but he can’t remember if that’s because he grew up in France or because somebody accidentally mentioned him at Princeton. We all went into finance, so maybe we’ve just forgotten random non-Keynesian theories, but the one thing we all clearly remember is Keynes and his prescription for raising the amorphous aggregate demand.

purplefox March 17, 2011 at 12:13 am

I had one econ class in college that I rarely went to, didn’t study much and got a C. At the time I listened to the news enough to have the opinion that economists were a bunch of idiots that couldn’t predict nor explain (in any way that passed the sniff test) what had just happened.

Then I heard about the Austrian school of thought that can predict and explain. Economics got a lot more interesting at that point.

Methinks1776 March 17, 2011 at 11:30 am

aack. That was so long ago all I remember is the definition of economics burned into my brain the moment I read it and that Keynes was immediately appealing. Not only was he a crack investor and took a dim view of th Treaty of Versailles, but he also had the answers to saving us from from the terrifying liquidity trap (aargh! Trap! TRAP! The end of the world as we knew it) by simply (presto!) raising aggregate demand (aggregates were very appealing!) and all serious economists were Keynesians.

Maybe I don’t remember the progression from the definition of economics to supply/demand curves to Keynes, but we were thrust into the General Theory very quickly. It was indescribably cool that we inexperienced, wet-behind the ears kids were suddenly in possession of The Answer (well, at least for the nerds I hung out with). Only later do I remember actually starting to think. Thinking is messy and inconvenient and often avoided by people who wish to keep their blood pressure normal, so it’s not as popular as I’d hoped it would be.

muirgeo March 17, 2011 at 9:29 am

Hey the Keynsian solution proved far more effective than the Coolidge/Hoover solution. And the Keyensian solution isn’t the one requiring a full rewriting of history to prop its mortified remains up.

John V March 17, 2011 at 9:55 am

???
Coolidge isn’t an issue in this.

What you think happened with Hoover, didn’t happen.

FDR’s fiscal policies didn’t do anything to fix the Great Depression. You’ll be hard pressed to find proof of anything else. And his cartelizing of major industries and constant rule-changing actually inhibited any kind of recovery.

OTOH, FDR’s move toward getting the dollar unhinged from Gold expanded the money supply and actually did have effect. Hoover effectively let the money supply “shrink”. Sadly, Bernanke dwells on this and this only and has taken it to ridiculous extremes.

Who’s rewriting history here??

Ken March 17, 2011 at 10:56 am

You mean the Hoover/FDR solution. I fixed your typo muirgeo. FDR’s first term was pretty much Hoover’s second, since most of what he did was continue Hoover’s policy of massive intervention into the economy.

muirgeo March 17, 2011 at 6:18 pm

HEY!!! I thought I said no re-writing history.

Seriously you guys claim I am the goofy one but you’re calling their policies one and the same….. IT’S BULLSHIT… even if it is required of you to spew it to get your Libertopian Credentials.

http://www.fasttrackteaching.com/Unemployment_300g15.gif

http://3.bp.blogspot.com/_yBU2IH33oeM/RqILr0PDHXI/AAAAAAAAAdo/ut4bQcDPthQ/s1600-h/Hoover,+FDR+graph.jpg

muirgeo March 17, 2011 at 8:57 pm

HEY!!! I thought I said no re-writing history.

Seriously you guys claim I am the goofy one but you’re calling their policies one and the same….. IT’S Boloney… even if it is required of you to spew it to get your Libertopian Credentials.

http://www.fasttrackteaching.com/Unemployment_300g15.gif

http://3.bp.blogspot.com/_yBU2IH33oeM/RqILr0PDHXI/AAAAAAAAAdo/ut4bQcDPthQ/s1600-h/Hoover,+FDR+graph.jpg

Sam Grove March 16, 2011 at 10:01 pm

It seems that muirgeo, being unable to follow the economic or political arguments, must rely on his progressively acquired assumptions.

Methinks1776 March 17, 2011 at 8:58 am

What can you expect from a single cell organism?

John V March 16, 2011 at 9:45 pm

twit.

JohnK March 16, 2011 at 9:47 pm

“as idle as the billionaires savings account”

You think being a billionaire means having a billion dollars in the bank?

Talk about not understanding the difference between wealth and money.

As VV said, you would be so much better off if you sold all of your possessions, clothing included, and put it into a bank account.
You’d be rich with all those dollars!

Or would you prefer the wealth you traded for those dollars?

Commentator March 16, 2011 at 9:56 pm

It’s all so absurd; it’s as if the theory is that people are substantively (underscore) rather than at the absolute marginally buying gold or otherwisek keeping dollars in the bottom of their yacht rather than investing as wisely as they can in stocks and bonds, including T-bills.

Look, if there are bread lines, put a shovel in a citizen’s hands (citizen, not illegal immigran) and pay them minimum wage to use it for now. They’ll take that 30% pay decrease and demotion to get back to work they’ve been avoiding or they’ll do good work on infrastructure. FDR was right about that, not about the Keynsianism and the “shovel work” that really fixed things was paying soldiers to work. There were no civil service unions then.

Of course, removing the illegal immigrant workers either by prosecution of their employers or by police force would also end the unemployment.

This is just political-cronyism, corruption however technically legal (note it can still be corruption by definition), at it’s worst.

But those would reform the USA, Democrat or Republican, must find a way to mitigate this through the political process or it will never change, perhaps just get worse.

kyle8 March 17, 2011 at 7:40 am

How do you put an icon onto your posts?

DG Lesvic March 16, 2011 at 10:05 pm

Prof. Horwitz is a Keynesian himself, one of the Keynesian Austrians, and even the author of a book on “macro-economics.”

“The Keynesians (including the Keynesian Austrians, Selgin, White, Horwitz, Rizzo, Garrison, O’Driscoll) see the flight to safety as an “excess demand for money,” sending prices and markets into a deflationary tailspin; and, to stabilize them, would increase the supply of money until it equaled the demand for it.”

From The Cause and Cure of the Depression at

http://econotrashtalk.org/#The Cause and Cure of the Depression

purplefox March 17, 2011 at 12:49 am

I have been reading your eBook and enjoying it. Thanks for writing it. It’s a good blend of snark, logic, and facts.

DG Lesvic March 17, 2011 at 3:25 am

Thanx.

What’s snark?

JohnK March 17, 2011 at 9:42 am

snide remark

DG Lesvic March 17, 2011 at 11:28 am

Thanks John, that’s me, snide DG.

kyle8 March 17, 2011 at 7:37 am

I don’t mean to threadjack here but I have a question. Yesterday I saw both Art Laffer and Nial Ferguson on the Kudlow show. They were both saying that the Japanese were pulling assets out of the American Economy to help with the disaster. Now they both said that this would have an inflationary effect on the USA.

That is what I don’t get, what it the connection, can anyone tell me? Why would money moving out of an economy have an inflationary effect? Seems counter-intuitive.

Their reason March 17, 2011 at 10:47 am

Without commenting on the validity of their argument I would interpret that argument as saying:

“Japan is pulling assets out of the US. When they sell their US assets they get US dollars. They will exchange part of those dollars for other currencies. When selling US dollars and buying other currencies, the dollar weakens relative to the other currencies. When people want to transact in US dollars, or John Smith wants to import something from somewhere, his dollars will be worth less and he has to pay more US dollars for the same goods. This is inflation from the importing sector of the economy.”

That is just how I think they might reason.

One might however also ask the question: “well, in the above scenario, what happens to the price of the US assets they sell?”

DG Lesvic March 17, 2011 at 11:29 am

Wow. good analysis.

Methinks1776 March 17, 2011 at 1:50 pm

“well, in the above scenario, what happens to the price of the US assets they sell?”

Depends on demand for U.S. assets, doesn’t it? If, for instance, holders of Japanese sovereign debt simply switch to the now comparatively more stable US Treasuries, then I think nothing happens to either asset prices or inflation.

JCE March 17, 2011 at 12:47 pm

“That certainly helps explain the shortcomings of his economic theorizing.”

Sam Grove, maybe you should……um……. READ and understand his economic theorizing before you point out what you believe to be its shortcomings.
actually introducing money ijnto economic analysis does change some conclusions. again, read wicksell, the stockhold school, say, mill who have concluded precisely that

John V says “But THAT is the part in question. Or didn’t you notice?”
John, that part fits into a much much much larger whole

listen, i´m not saying that keynes doesn´t have flaws. i just think it’s very wrong to label and judge one of the deepest thinkers ofthe 20th century based on a cartoon version of his thoughts

John V March 17, 2011 at 1:02 pm

What it fits into isn’t the point. We’re talking about “that part”. If “that” seems flawed on its own, whatever else he said on other matters isn’t going to change that.

JCE March 17, 2011 at 3:51 pm

true. but i think they are oversimplifying his ideas

Methinks1776 March 17, 2011 at 1:20 pm

JCE,

Do you think Boudreaux, Roberts, Horowitz and others are passing judgment on the man or his work (in part or in whole)? Keynes can both be wrong about something AND one of the deepest thinkers of the 20th century. Those two things are not mutually exclusive.

JCE March 17, 2011 at 3:52 pm

*** that should have been a reply to Methinks

true. but i think they are oversimplifying his ideas

Methinks1776 March 17, 2011 at 4:49 pm

Perhaps. Have you considered that others may be complicating his ideas in order to make them appear better than they are – sometimes for their own purposes?

Economic Freedom March 17, 2011 at 5:37 pm

Keynes can both be wrong about something AND one of the deepest thinkers of the 20th century. Those two things are not mutually exclusive.

(LOL!) They are with Keynes.

Sam Grove March 17, 2011 at 3:57 pm

I haven’t read much economics, well, maybe four or five works. Mostly I listen to/read what people say, and so far, even Keynes defenders seem unable to clarify what the gist of Keynesian economics is other than using monetary policy to adjust the broad economy.

Of course they have models and formulas to aid in doing just that, but despite my reasonably strong aptitude in math, I don’t get much from economic models and formulas.

What I am pretty strong with is logic and a fair comprehension of human nature, particularly in regard to politics.

Keynesian economics, as I see it, is about centralized management of economic behavior via monetary authority, that is heavy politicization of the financial sector.

I understand that there are so called ‘shocks’ I understand how a a FREE market system can handle such ‘shocks’ without the aid of political authority.

I understand how a monetary authority can screw up economic functioning, which “Keynesians” seem not to acknowledge as possible. All is good when political authorities are in “control”. (/sarcasm)

There seems to be no mathematical factor in the formulas for something we might call corruption, including the systemic variety.

In the Keynesian world, if the formulas produce answers (inevitable, that’s what equations do) then they assume that they’ve got a handle on reality, that and the guns of government to adjust factors.

I joined the libertarian movement in 1980 because I grasped the argument that markets should be free from political “management” and I saw that, despite all the rhetoric that we enjoyed a free market in the U.S., close examination reveals that the market is extensively under the thumb of the government through many thousands of laws, many regulatory agencies, and even more thousands of regulations created by unelected bureaucrats, and most especially control of the monetary system by a politically created central bank.

When I now hear people attack the “unfettered markets” and blame economic problems on some mythical “deregulation”, I know they are either supremely ignorant or are liars.

These are the people that promoted the stimulus, cash for clunkers, engineered the bailouts, and cling to our empire.

If Keynes were here to choose sides, where do you suppose his sympathies would lie?

I think I have a fair idea.

DG Lesvic March 17, 2011 at 4:33 pm

Sam,

For a summary of Keynesian Economics, see Political Economy, Public Policy, and Monetary Economics: Ludwig von Mises and the Austrian Tradtion, by Richard M. Ebeling. It’s pretty expensive, almost $130, but worth every penny, and, for me, the indispensable reference and guide.

Ebeling summarizes it this way: “It’s two central tenets were the claim that the market economy is inherently unstable and likely to generate prolonged periods of unemployment and underutilized productive capacity, and the argument that governments should take responsibility to counteract these periods of economic depression with the various monetary and fiscal policy tools at their disposal. This was bolstered by Keynes’ belief that policy managers guided by the economic theory developed in his book could have the knowledge and ability to do so successfully.”

I would add several things to that, the artificial division between Micro and Macro Economics, and the ultimate denial of economics and of human nature itself, the conception of economics as a science not of economization but consumption, and the linchpin of it all, the premise that the market actors think more of money than the things it buys, and would rather starve than even live better at a lower nominal wage.

carlsoane March 17, 2011 at 6:28 pm

Keynes was brilliant but his economic theories were not. You’ll find that the namesake of this website, who was about as well versed in Keynes’ theory as anyone who ever lived, also didn’t think much of Keynes as an economist. Read this interview: http://hayekcenter.org/?p=843

ROSTEN: How do you think he will rank in the history of economic theory and thought?

HAYEK: As a man with a great many ideas who knew very little economics. He knew nothing but Marshallian economics; he was completely unaware of what was going on elsewhere; he even knew very little about nineteenth-century economic history. His interests were very largely guided by aesthetic appeal. And he hated the nineteenth century, and therefore knew very little about it — even about the scientific literature. But he was a really great expert on the Elizabethan age.

vikingvista March 18, 2011 at 12:46 am

For those of you who don’t speak Gentleman, let me translate that to English for you: “Keynes was an idiot.”

rhhardin March 17, 2011 at 2:52 pm

I’d reduce it to voluntary exchange.

Any trade which isn’t a voluntary exchange reduces the standard of living of the nation instead of increasing it.

Because both sides don’t profit from it (otherwise it would happen voluntarily).

muirgeo March 17, 2011 at 7:18 pm
muirgeo March 17, 2011 at 8:59 pm

http://www.economics21.org/files/charts/07262010_receiptssurplusesdeficits.png

Compare federal outlays with the year we started recovery.

You guys have nothing but denial of facts to support your position.

Methinks1776 March 18, 2011 at 4:11 am

I often wonder if most of your posts are generated by a cat walking on your keyboard.

John V March 18, 2011 at 12:27 pm

You ignore lots of responses all over the place and then post these little links well after the fact. Where have you been? You got some work to do. Go and address everyone’s points, you little mentally stunted troll.

You have nothing….period. You simply post and then ignore and retreat.

vikingvista March 18, 2011 at 12:44 am

There are countless more ways to spend money against prosperity than for it.

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