Keynes vs. Reality

by Russ Roberts on July 13, 2011

in Stimulus, Uncategorized

Here is Paul Samuelson in 1943 (HT to David Henderson):

When this war comes to an end, more than one out of every two workers will depend directly or indirectly upon military orders. We shall have some 10 million service men to throw on the labor market. We shall have to face a difficult reconversion period during which current goods cannot be produced and layoffs may be great. Nor will the technical necessity for reconversion necessarily generate much investment outlay in the critical period under discussion whatever its later potentialities. The final conclusion to be drawn from our experience at the end of the last war is inescapable–were the war to end suddenly within the next 6 months, were we again planning to wind up our war effort in the greatest haste, to demobilize our armed forces, to liquidate price controls, to shift from astronomical deficits to even the large deficits of the thirties–then there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced.

From Paul Samuelson, “Full Employment after the War,” in S.E. Harris, ed., Postwar Economic Problems, 1943.

And now a quote from the The Economic Report of the President, page 1, issued by Harry Truman on January 8, 1947:

During 1946, civilian employment approached 58 million. This was the highest civilian employment this Nation has ever known— 10 million more than in 1940 and several million higher than the wartime peak. If we include the military services, total employment exceeded 60 million. Unemployment, on the other hand, remained low throughout the year. At the present time it is estimated at about 2 million actively seeking work. This is probably close to the mini- mum unavoidable in a free economy of great mobility such as ours.

Thus, at the end of 1946, less than a year and a half after VJ-day, more than 10 million demobilized veterans and other millions of war- time workers have found employment in the swiftest and most gigantic change-over that any nation has ever made from war to peace.

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Jonathan M. F. Catalán July 13, 2011 at 7:04 pm

I, of course, disagree with Samuelson, knowing that labor is the fundamental scarcity. But, (and, I say this with absolutely no authority; it is a sincere, innocent question) didn’t the government deliberately slow the demobilization to account for the alleged problem of post-war unemployment?

Russ Roberts July 13, 2011 at 7:09 pm

Not that I know of.

Tim July 13, 2011 at 10:07 pm

Russ,

Does one need to account for the fact that the world’s other major industrial centers lay in ruins for this analysis to work? In other words, does the fact that Keynes seems to be wrong rest on the fact that output everywhere else fell off the charts?

vikingvista July 13, 2011 at 7:19 pm

But that’s not what Robert Reich says.

Kirby July 13, 2011 at 7:20 pm

3 1/3% unemployment. So why did the economy spark after the war compared to before? I can’t believe it was the welfare, it wasn’t the war, was it maybe that some unemployed bums before the war suddenly realized that they could hold a job successfully?

Jonathan M. F. Catalán July 13, 2011 at 8:52 pm

I think there are two major reasons:

1. A relative deregulation which took place during and after the war.
2. A rise in personal savings, since personal consumption fell dramatically during the war.

MWG July 14, 2011 at 1:27 am

I would add a 3rd:

The rest of the industrialized world was in shambles, making the US one of the main source of… just about everything.

Desolation Jones July 14, 2011 at 10:29 am

I hear that theory often. If it were correct, you would expect to see exports as a percentage of GDP to soar after the war ended, but it didn’t.

http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=14&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear=1944&LastYear=1953&3Place=N&Update=Update&JavaBox=no#Mid

Paul Andrews July 13, 2011 at 11:24 pm

People left to their own devices started to do useful things for one another, and received other useful things in return.

vikingvista July 14, 2011 at 12:08 am

Exactly. It wasn’t about what happened. It’s about what stopped happening, for the first time in 15 years.

tkwelge July 14, 2011 at 10:50 am

The other important thing to point out is that before the war, there was no international backing of money, so all countries had competing fiat currencies that exacerbated trade wars. The Smoot Hawley tariff also sat on the chest of international trade in the pre WW2 period. During and after the war, international trade returned to a specie backed normalcy, and trade barriers that existed during the great depression were lifted or relaxed.

DIY Investor July 13, 2011 at 7:31 pm

Pent up demand.

Craig July 13, 2011 at 7:33 pm

I had been taught since childhood that WWII ended the Depression. As I studied economics, I struggled mightily to understand the arguments against that theory. It seemed the only logical answer.

Surely all the tanks and armaments were signs of wealth creation. Of course, then, there was all those savings bonds accumulated painfully by soldiers and their families with nothing else to spend their money on.

Eventually, the answer seeped into my pea brain. Unemployment was surely ended by WWII — but that was the result of government conscription. The tanks and rifle bullets weren’t demanded by consumers and, thus, had no value that could be compared to consumer goods.

And all those savings were just government debt that had to be taxed from citizens after the war to pay back. What ended the Depression was the economic freedom that followed the war when the New Deal was finally dismantled. Interesting that it’s still misunderstood by most.

Methinks1776 July 13, 2011 at 9:18 pm

So, hang on! Are you saying that “shared sacrifice” does not lead to prosperity? I really wish that would seep into the pea brain of the horror in the white house. Maybe if you could just get that info to one of the new army of czars we’ll have a chance.

Henry Bowman July 13, 2011 at 9:19 pm

The tanks and rifle bullets weren’t demanded by consumers and, thus, had no value that could be compared to consumer goods.

Absolutely correct, most war time production is, economically, futile. A nation pulls out all the stops to build munitions and weapons, most of which are quickly destroyed. A complete waste, except for specific industries. Every time I hear someone state that war is good for the economy, I cringe, as wars are almst always bad for most participants (especially the losers).

Methinks1776 July 13, 2011 at 9:33 pm

I just offer to take a sledge hammer to their house (I am dead serious). Oddly, nobody ever takes me up on that. Shame – manual demolition is a great workout.

jehu July 13, 2011 at 7:37 pm

Actual analysis of events related to demobilization might be in order. According to Wikipedia, 1945 saw a severe recession with peak to trough GDP drop of about 12.7%.

http://en.wikipedia.org/wiki/List_of_recessions_in_the_United_States

Subhi Andrews July 13, 2011 at 7:44 pm

Keynesian multiplier should have worked in reverse.

Multiplier = Marginal Propensity to Consume/Marginal Propensity to save. Since the multiplier in the keynesian calculus greater than 1, the ripple effect ( another way of saying multiplier) in the circular flow should have caused decline in consumption & therefore investment. G actually collapsed in 1946 & 1947, by 2/3 in 3 years. While G was collapsing C+I was booming, but sure since C+G+I+NX was declining – because government was cutting spending. Goes to show you why looking at GDP as the health of the economy is not always the best way.

jehu July 13, 2011 at 7:52 pm

What is clear, by the loss of output of some 12 percent during demobilization, is that the Great Depression had not ended by a long shot. It had merely been papered over by massive armament spending and wholesale destruction of productive infrastructure over the face of the planet. This, I would argue, set the stage for the golden years of the post-WWII period.

Josh S July 13, 2011 at 9:06 pm

The output that was lost was tanks, planes, guns, and bombs…and so what? Those aren’t things that civilians need (outside of a few collectors, of course).

jehu July 13, 2011 at 10:09 pm

Have you ever seen pictures of Berlin, Dresden, Hiroshima, Tokyo, Stalingrad? A lot more was lost than a few worthless munitions.

vidyohs July 14, 2011 at 10:29 am

So jehuj, are you making an intellectual argument on the subject of economics; or are you being pinned against the wall and now using the typical lefty tactic of shifting to an emotional based argument?

Make the argument one or the other and don’t be disingenuous, we see enough of that already from a couple of regulars.

vikingvista July 13, 2011 at 11:50 pm

“It had merely been papered over by massive armament spending and wholesale destruction”

Papered over by government forced transactions at government set prices. And employment was due to government forced labor at government set wages. All references to GDP and unemployment during a command economy should have an asterisk next to them.

Neither this nor destruction set the stage for anything good, except in the same sense that when you stop pounding your head against the wall you set the stage for headache relief.

Jonathan M. F. Catalán July 13, 2011 at 8:53 pm

Jehu,

You have to adjust that GDP deflator for the fact that government spending/inflation fell once there was no more war to spend money on.

Henri Hein July 13, 2011 at 9:33 pm

Jehu,

I don’t know about Wikipedia, but I looked it up at BEA (bea.gov). It shows that GDP in 1945 was 223.0 billion dollars and in 1946 it was 222.2 billion dollars. Hardly a 12% drop. In 1947 the economy was growing again. It also shows personal consumption went from 120 billion to 140 billion, meaning people were getting richer by quite a lot.

Paul Andrews July 13, 2011 at 11:27 pm

Yes, a short term recession, closely followed by a medium to long term boom. Short term pain for long term gain.

This was merely the period of readjustment, when private actors altered their activities in a self-organizing fashion. The period of time during which people learned new skills and ramped up new operations to fulfil each others needs.

tkwelge July 13, 2011 at 11:45 pm

1945 also saw a huge amount of borrowing:

http://www.usgovernmentspending.com/downchart_gs.php?year=1940_1950&view=1&expand=&units=p&log=linear&fy=fy11&chart=G0-total&bar=1&stack=1&size=l&title=&state=US&color=c&local=s

Notice how the economy actually improved after borrowing slowed down. The recession in 1945 occurred as the allies had just set up the plan for the post war bretton woods monetary system. This created a sudden brake to the potential for monetary expansion, and the economy took a hit because of it, in spite of record levels of government borrowing at the time. The war was still going on.

jehu July 13, 2011 at 7:41 pm

BTW, that was nearly half of the entire decline posted by the Great Depression. It might be of interest to know what Washington did during that period to halt the slide. I see a dissertation in this.

Jonathan M. F. Catalán July 13, 2011 at 8:55 pm

See Robert Higgs’ book “Depression, War, and Cold War”.

jehu July 13, 2011 at 10:06 pm

Thanks for the suggestion.

jorod July 13, 2011 at 8:16 pm

Perhaps they spent all the money they saved during the war until growth picked up steam. People had a lot of war bonds that slowly matured over 30 years.

jorod July 13, 2011 at 8:30 pm

Perhaps they spent the money they saved during the war. The war bonds matured over 30 years.

Jim July 13, 2011 at 8:36 pm

First, there is concern that cutting government spending would cause deep unemployment. Is that not an argument against stimulus, since it implies that stimulus is a combination of forward buying or a delay tactic? IOW, when stimulus ends, we are left with the same high unemployment only with higher debt. How do Keynesians answer this?

Second and contrary to all Keynesian thought, GDP growth exploded after WWII, even while government contracted more than any time in American history. How do Keynesians explain that?

W.E. Heasley July 13, 2011 at 8:48 pm

In the long run, Keynesianism is dead.

jehu July 13, 2011 at 8:52 pm

All the other industrial nations saw their productive capacity destroyed during the war. The was no competition to US industry, and every other major industrial nation needed to rebuild with money and capital borrowed from the US.How is that for an explanation?

Henry Bowman July 13, 2011 at 9:22 pm

Did not the Marshall Plan actually give money, rather than lend money, to the European economies? I don’t know the answer, just looking for a clarification.

Methinks1776 July 13, 2011 at 9:35 pm

They paid the U.S. back by allowing America to pay for most of NATO and the U.N. while blaming all the world’s ills on this country. The Europeans are generous like that.

jehu July 13, 2011 at 9:58 pm

With which they could purchase… what? The money was worthless ex nihilo currency, which could be printed on demand by Washington. However, it created a huge market for US output.

Jim July 13, 2011 at 10:34 pm

Actually, your explanation does not answer the questions.

It might explain the extent of demand, but not the elemental principles of Keynes, does it?

But maybe you are on to something. More than tax rates, I believe the economy would be boosted by ridding ourselves of regulation that makes markets much smaller than they otherwise would be; oil exploration and the minimum wage are great examples.

W.E. Heasley July 13, 2011 at 9:20 pm

“The final conclusion to be drawn from our experience at the end of the last war is inescapable–were the war to end suddenly within the next 6 months, were we again planning to wind up our war effort in the greatest haste, to demobilize our armed forces, to liquidate price controls, to shift from astronomical deficits to even the large deficits of the thirties–then there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced”. – Paul Samuelson

Note. When studying Samuelson, always go with the very, very, very short list which is: how many times Samuelson was correct regarding economics.

Moreover, Samuelson’s argument [above] lives on even today. Oh yes. The argument, mostly from the chattering class (media) and those that see state as the director of all activities is: to shrink government means recession, more unemployment, and basically disaster. The implicit and explicit assumption is that government “produces”.

Wrong Way Samuelson, the chattering class, and the state directed [the economically misinformed] miss a basic economic issue: government, in the U.S., exists due to a transfer payment from the private sector and hence produces nothing that the private sector would not have produced in the absence of the transfer payment (albeit a different basket of goods and services). Stated alternatively, rejoining the transfer payment [that creates government] to the private sector leaves the aggregate economy in the same position except more efficient.

Robert Nozick argued quite effectively in his book Anarchy, State, and Utopia that the minimal state (associated with the protective society predecessor) was likely the most rational and most moral. Maybe its time to try Nozick’s view.

jehu July 13, 2011 at 10:04 pm

Well, when you convince 51 percent of the population on that minimal state wake me up. State intervention into the economy doesn’t occur only because of the “chattering class (media) and those that see state as the director of all activities”. Unfortunately almost all Americans see the State as essential to their economic well-being at this point.

You are pretty much spitting into a hurricane unless you can come up with an alternative organization of the economy that is not dependent on the State for fifty percent of all economic demand.

W.E. Heasley July 13, 2011 at 11:07 pm

“Unfortunately almost all Americans see the State as essential to their economic well-being at this point.”

How so? Empirical evidence supports your notional point? “Almost all” is 90%? That is a very weak debate point and adds no insight.

“You are pretty much spitting into a hurricane unless you can come up with an alternative organization of the economy that is not dependent on the State for fifty percent of all economic demand“.

All demand created comes from the private sector as the transfer payment to government is merely a transfer of demand.

jehu July 14, 2011 at 9:05 am

I wasn’t making a debating point — I was making an empirical observation: what is occasionally referred to as a fact. If you don’t think 70 million people collecting Social Security is an important consideration for action, we can’t have a debate, since we can’t agree on anything.

Of course all demand comes from the private sector — this is because only the private sector produce anything. What has to be explained is why despite the truth of this fact, nevertheless hundreds of millions of people are dependent to one extent or another on routine government support. We have to explain why democracy leads to the Fascist State.

vidyohs July 14, 2011 at 10:37 am

We don’t have to explain why democracy leads to having a huge percentage of the people living on welfare checks from the government. That explanation has already been given over and over.

“When people find they can vote themselves largess from the public treasury, that is exactly what they will do (and have done).”

Surely the fact that many people are lazy, shameless , and perfectly willing to be parasites on the public back is no secret to you.

jehu July 14, 2011 at 7:03 pm

Vidyohs,

Unfortunately that explanation is no explanation at all, since they ARE both the public and the “parasites”.

Daniel Kuehn July 13, 2011 at 10:35 pm

Samuelson was wrong in forecasting. Keynes wasn’t wrong in theorizing.

Why did Samuelson end up being wrong? Have you ever thought that through?

Because post-war demand was substantial and he didn’t expect that.

High levels of private sector demand and a full employment economy… where the hell do you get “Keynes vs. Reality” from that? That has Keynes written all over it.

All you’re demonstrating is that Samuelson didn’t have a crystal ball. That isn’t exactly a news flash.

Henri Hein July 13, 2011 at 10:43 pm

Daniel,
That is disingeneous. If Keynes’ theory was correct, we should expect a slowdown after a 60% reduction in government spending. Lots of Keynesians at the time *did* predict such a slowdown. They were all wrong. You cannot dismiss the post-war events with a handwave.

Daniel Kuehn July 14, 2011 at 6:23 am

No handwaving at all Henri -
Nothing in Keynes’s theory says “if government doesn’t spend nobody ever will”.

If you can find something to that effect please let me know, because I’ll be compelled to stop talking about him so much.

Henri Hein July 14, 2011 at 2:52 pm

No, but he did think that demand is a driver of economic activity. Since the reduction in spending — and therefore demand — represented a 27% of total 1945 economic activity, if that part of the theory is correct, I would have expected at least some reduction in overall activity. Since such a reduction was not observed, I’m honestly miffed that you don’t think that at least raises some interesting questions.

Jonathan M. F. Catalán July 13, 2011 at 11:18 pm

Daniel,

Let’s not be sloppy. Samuelson didn’t think there could be an increase in private investment after the war. It’s not just about not forecasting an increase in aggregate demand, because we’re not just talking about a rise in consumption. If Samuelson would have predicted a rise in investment then there would be no basis whatsoever for expecting mass unemployment!

The reason they predicted the way they did was because they didn’t see possible the necessary rise in private investment. They made their predictions based on Keynes’ theories.

Subhi Andrews July 14, 2011 at 12:00 am

So right. C+I+G+NX. G is supposed to have a multiplier on both consumption & investment. If multiplier is + when G increases, it will be negative when G decreases. G didn’t just decrease, it cratered. Demand collapsed. Daniel is frantically waving his hand, and getting mad for no reason here. Keynesian theory does say recessions happen due to some strange “demand shock”, and that would be a devastating keynesian “demand shock”, except that it wasn’t.

Daniel Kuehn July 14, 2011 at 6:25 am

re: “The reason they predicted the way they did was because they didn’t see possible the necessary rise in private investment. They made their predictions based on Keynes’ theories.”

Now I’m lost Jonathan. What among Keynes’ theories could have possibly formed the basis of the prediction that investment demand could not be high after the war? I’m not sure what you’re driving at and you’re not making it very easy to infer.

DAVE July 14, 2011 at 11:15 am

The question you ought to be asking here is:

What among Keynes’ theories could have possibly formed the basis of the prediction that investment demand COULD be high after the war?

Don Boudreaux July 14, 2011 at 11:21 am

Right. Given Keynes’s own belief in stagnationism, and given Keynes’s and Keynesians’ obsession with aggregate demand as the economy’s chief driver, Keynesians quite understandably believed as WWII ended and the military largely decommissioned that the economy would be Greatly Depressed.

Daniel Kuehn July 14, 2011 at 11:34 am

Easy. Deficit creation during WWII provided a plentiful supply of liquid assets. This eliminated the excess demand for money and liquidity which is the primary driver of deficient demand. With demand back at full employment level, income from those expenditures is sufficient to preserve full employment (until another reason for a spike in excess demand for liquidity comes along… say, a finanical crisis in 2008).

The backlog of demand for consumer goods while Americans were risking their lives driving fascists out of the Pacific, France, and China, and North Africa is icing on the cake for post-war demand.

It’s very easy to understand the post-war economy using Keynesian theory.

The problem is, Samuelson wasn’t using Keynesian theory. Samuelson was using the empirical precedent of the post-WWI economy which he did not understand as well as people like Romer, Temin, Vernon, and Broadberry do today.

vikingvista July 14, 2011 at 12:19 pm

“It’s very easy to understand the post-war economy using Keynesian theory.”

It’s very easy to “understand” any imaginable economy using Keynesian theory.

Jonathan M. F. Catalán July 14, 2011 at 3:30 pm

I don’t think the issue before 1939 was a problem of excess demand for money, and there was certainly sufficient “deficit creation” during the Great Depression. Furthermore, none of this explains the transition from war time industry to peace time industry (do we really have to fall back on the absurd notion of “pent-up demand”, as if demand for goods would be lower if it wasn’t “pent-up”?).

Daniel Kuehn July 14, 2011 at 3:40 pm

Wait – explain why “pent up demand” is an absurd notion Jonathan.

If you cannot buy certain appliances because the war is on and you wear those appliances to the bone, you don’t think more people on average will demand new appliances in the immediate post-war years when things are deregulated and controls are loosened?

What exactly is so absurd about this, Jonathan?

Jonathan M. F. Catalán July 14, 2011 at 3:26 pm

Daniel,

Why would Keynes believe that the economy could have reached full employment on its own without socialized investment?

Daniel Kuehn July 14, 2011 at 3:38 pm

I’m not sure I understand the question.

What’s supposed to be preventing him from believing that?

Didn’t he say that the entire 19th century was serendipitous in that precisely this happened – investment opportunities were plentiful enough that full employment could be achieved at prevailing interest rates. Didn’t he say that this serendipity lead to the unfortunate assumption that full employment was somehow necessary?

Why do you think it would be so hard for Keynes to believe that conditions could hold in a couple years in the late 1940s that had held for a century?

vikingvista July 14, 2011 at 12:18 am

Surely you see how your very same type of reasoning can be used to explain either result.

Paul Andrews July 14, 2011 at 3:03 am

“Because post-war demand was substantial and he didn’t expect that.”

He didn’t expect post-war demand to be substantial because his mental model, based on the theories of Keynes, was incorrect.

Yes, post-war demand did drop, but it recovered very quickly as private individuals were left free to contribute to an expansion of the division of labor, instead of doing the government’s bidding.

Daniel Kuehn July 14, 2011 at 6:28 am

re: “He didn’t expect post-war demand to be substantial because his mental model, based on the theories of Keynes, was incorrect.”

Same question as I posed to Jonathan above – what theory of Keynes says that investment demand could not be high after the war? I am completely ignorant of such an element of Keynesian theory. Please let me know what you have in mind.

re: “Yes, post-war demand did drop, but it recovered very quickly as private individuals were left free to contribute to an expansion of the division of labor, instead of doing the government’s bidding.”

Yep. That’s how things get demanded in a market economy.

Methinks1776 July 14, 2011 at 8:46 am

Keynes is like global warming. When he’s right, he’s right and when he’s wrong, he’s even more right.

So, your position is that Samuelson just wasn’t much of an economist then.

Samuelson couldn’t work out that women will want stockings and families will need houses after the war. It never crossed his or Keynes’ mind that people’s wants are insatiable and that this insatiable want leads people to figure out how to produce things that are wanted. Nor could he comprehend that people would be miserable if subjected to terror in the process of producing “economic growth” measured in ten ton ball bearings. In fact, for a social scientist, he didn’t seem to at all understand the species he was ostensibly studying.

I hear he was a hell of a mathematician, though. Of course, so were all the authors of the CDO, MBS and securities ratings models that lead us to 2008.

Don Boudreaux July 14, 2011 at 9:32 am

Exactly right, Methinks. Keynes was a demand-sider. Prosperity is caused by people demanding stuff. All the conditions that affect people’s willingness to supply the stuff people demand is of tertiary importance. Any changes in the constraints that affect supply – tax rates, regulatory burdens, security of property rights, and the like – are of little moment. Change these, at least within very broad parameters, and the effect on production will be small as long as aggregate demand remains unchanged.

On the other hand, success at raising aggregate demand will increase economic activity, period. (Or, if not ‘period,’ colon.) Those supply-side factors that the classical economists focused on, well, those are given pride-of-place only by benighted “pre-Keynesians” too dull-witted to understand the multiplicative wonders of demand-side spending.

Keynesians since the “neoclassical synthesis,” of course, deny the above. “Oh no! We Keynesians understand the importance of sound microeconomic conditions. How dare you say otherwise! But we’re scientists. Good science allows – nay, commands – us to hold those other, microeconomic conditions constant, to take them as given. They are determined by forces sufficiently different than are the phenomena we deal with. That’s why we have, don’t you see, the distinction between ‘macroeconomics’ and ‘microeconomics.’

“This distinction – and it must reflect an important reality, otherwise the distinction wouldn’t exist, now, would it? – is based on the settled matter that ‘macroeconomics’ deals with business cycles and fluctuations in the rate of economy-wide employment (among a handful of other ‘macroeconomic’ matters). ‘Microeconomics’ does not deal with these matters. (Check the textbooks. You’ll see!)

“So ‘microeconomics’ has nothing much to say about ‘macroeconomic’ phenomena. (It’s much like the fact that, say, dentists, as helpful as they are in dealing with teeth, have nothing much useful to say about gastrointerology. Both dentistry and gastrointerology are medical disciplines, but let’s not confuse them with each other.)

“It’s no surprise, then, that when doing ‘macroeconomics,’ even the great Paul Samuelson can be excused for overlooking microeconomics. He was making a ‘macroeconomic’ prediction based on widely accepted macroeconomic assumptions, distinctions, models, and modes of thought.

“Of course, we know now that those microeconomic conditions did in fact change in ways that Prof. Samuelson and all the Best and Brightest Keynesians 65 years ago didn’t foresee. But that’s because they were doing ‘macroeconomics.’ Their ‘macroeconmics’ was spot-on correct.”

Daniel Kuehn July 14, 2011 at 9:56 am

Don -

re: “Change these all you want and the effect on production will be small as long as aggregate demand remains unchanged.”

If this is really what you think the claim is and if you tell people this is what the claim is, you’re doing your readers and your students a disservice. For the time being, I’m going to charitably assume you’re just getting worked up.

One of Samuelson’s problems was drawing the wrong lessons from the 1920-1921 depression (he was not alone – Irving Fisher was guilty of this too and BIS projections in the mid-forties also cited the post-WWI economy in considering post-WWII prospects).

Thanks to the terrific work by a lot of great economists – Romer, Temin, Vernon, etc. – we are now pretty sure that 1920-1921 had little to do with demand deficiency and therefore simply presuming that in a post-war period demand must of necessity drop is a bad assumption. I review a lot of this work and provide my own commentary on some recent interpretations of 1920-1921 in the most recent volume of the RAE, which came out a couple days ago.

I know it’s easier to just say Keynesians don’t know microeconomics, but I thought I’d throw those two cents in.

Daniel Kuehn July 14, 2011 at 9:58 am

Don -
Also – I just submitted a shorter article to the Cambridge Journal of Economics on the 1920-1921 depression, and I wanted to let you know that in discussing net exports during this period I acknowledged you. Your post on that a couple months back first brought the export conditions of the period to my attention.

Daniel Kuehn July 14, 2011 at 10:00 am

One more point – the guy everyone likes to quote on 1920-1921, Tom Woods, claims:

1. That Keynesians don’t write about it, and then
2. Completely neglects to cite some of the most famous recent work on it by Romer, Temin, and Vernon (and Broadberry who covers the British downturn but comes to much the same conclusion).

That assertion of neglect by Keynesians followed by Woods’s own failure to provide his readers with a full account of the literature is – to say the least – deeply disconcerting.

Don Boudreaux July 14, 2011 at 10:05 am

Keynesians (apart from the non-Keynesian ‘Keynesians’ inspired by Clower and Leijonhufvud) pay precious little attention to microeconomic conditions.

Want evidence? Take Mr. Modern Keynesian himself, Paul Krugman. What’s the chief problem today? Inadequate aggregate demand. Where does Krugman talk about the disincentives created by capital-gains taxation? Where does he even remotely hint that he’s aware of the importance of microeconomic coordination over time as an important factor in determining the health of the economy? Where does he pay attention to the sorts of issues that Arnold Kling highlights with PSST?

Nowhere these days that I see.

He’d say “Of course I don’t emphasize these things because I take it for granted that you understand that I understand that microeconomic conditions must be in reasonably good order.”

And I’d reply – again – microeconomic disorders are the very source of today’s sluggish economy, and to ignore them in order to focus on Keynesian aggregates is indeed to be a good Keynesian. It is also, however, to be a lousy economist.

Daniel Kuehn July 14, 2011 at 11:08 am

You’re moving the goalposts, Don.

First you claimed Keynesians think microeconomic issues have no effect on the macroeconomy. That was a ridiculous thing to claim.

Now in this second post you’re simply claiming that they have a disagreement with you over the role of micro vs. macro factors in the current downturn. That’s true that they have a disagreement with you on this specific question – but that’s a very different point from your earlier claim.

Why are you changing the claim?

Daniel Kuehn July 14, 2011 at 11:11 am

Also – since you bring up Arnold Kling and PSST – what do you think of the question I posed to you over email?

To refresh your memory – I expressed skepticism that Obama really fails to understand that technological progress causes growth.

But I also asked you what you thought of the fact that Arnold Kling HIGHLIGHTED Obama’s ATM line as an EXAMPLE of PSST. PSST is simply technological unemployment, although Kling specifically emphasizes the impact of changes in technology on the patterns of trade.

Kling claims that the PSST argument is to a large extent that the Great Depression is the result of more efficient agricultural production techniques which put a lot of people out of work.

How do you square this with your multiple posting on Obama and the ATM just recently?

I’m legitimately asking – PSST I think is a very good way of thinking of at least one process that goes on. But at it’s heart, it’s technological unemployment writ large.

Daniel Kuehn July 14, 2011 at 11:12 am

You don’t have to email me back on the PSST point. It would make a great blog post.

vikingvista July 14, 2011 at 11:53 am

“Tom Woods, claims:

1. That Keynesians don’t write about it, and then
2. Completely neglects to cite some of the most famous recent work on it by Romer”

http://www.tomwoods.com/blog/small-is-beautiful-guy-hearts-fed/

It took me about 90 seconds to find this on Google. Your research capabilities are unimpressive.

Daniel Kuehn July 14, 2011 at 12:08 pm

vikingvista I don’t think you read me carefully enough. I didn’t say that Woods has never ever cited Romer in his life. I said that he accuses Keynesians of ignoring the 1920-1921 depression and then fails to cite Romer’s paper. Romer’s paper on the 1920-1921 depression is probably the best known analysis of it ever written. Don’t you think that’s a bizarre one for Woods to omit?

I can’t imagine it didn’t come up when he searched the literature.

Methinks1776 July 14, 2011 at 12:16 pm

DK: “I expressed skepticism that Obama really fails to understand that technological progress causes growth.”

The Obamessiah may also understand that extortion and thuggery is wrong, but he won’t allow that understanding to stand in his way of committing those two wrongs.

vikingvista July 14, 2011 at 12:26 pm

“Completely neglects to cite some of the most famous recent work on it by Romer”

“Completely neglects”

“Completely”

Your false words, DK. Shameless of you to continue to deny it. I stopped at the first hit I found after 90 seconds of work. I’m not inspired by your reputation to spend time scouring all of Tom Woods numerous footnotes and citations in his volumes of work, just to show the degree to which you are wrong.

Daniel Kuehn July 14, 2011 at 12:36 pm

vikingvista – when I wrote “work on it” what do you think the “it” was that I was refering to? Come on, dude. Read the comment before you start tossing around words like “shameless”.

vikingvista July 14, 2011 at 1:23 pm

DK–

Alright, let me be as generous as possible. What SPECIFIC Romer paper(s) are you talking about that is a “deeply disconcerting” omission by Woods? At the very least, Woods cites her 1986 and 1994 papers.

Daniel Kuehn July 14, 2011 at 1:25 pm

Her 1988 paper on the 1920-1921 depression.

In Woods’s work on the 1920-1921 depression he says Keynesians ignore it and then he fails to cite probably the most prominent and widely cited paper on the 1920-1921 depression.

vikingvista July 14, 2011 at 4:05 pm

DK–

“In Woods’s work on the 1920-1921 depression he says Keynesians ignore it and then he fails to cite probably the most prominent and widely cited paper on the 1920-1921 depression.”

I agree that he should’ve mentioned it.

It isn’t true that he says keynesians ignore it (he references a keynesian’s 1970’s comment on the subject). And he certainly can’t be expected to address every keynesiac gyration to an apparent failure of their theories (they will always be endless). But his thesis would’ve been stronger if he had mentioned Romer’s 1988 paper. This is not because her thesis that aggregate demand wasn’t as much a problem in 1920 has forever changed the keynesian rhetoric of policy makers (it won’t, because they will never going forward want to encounter an excuse not to “stimulate” in a recession). Nor is it because this isn’t addressed elsewhere, as there are arguments by others dismantling the utility of the aggregate demand concept.

It is weakened because his thesis now only selectively explains Romer’s empirical work (from earlier papers). He can disagree with it, explain it, or dismiss its relevance, but he knows he has critics, and should he shouldn’t ingore it.

Good point. Touche.

Paul Andrews July 16, 2011 at 9:33 am

“what theory of Keynes says that investment demand could not be high after the war?”

None that I know of. Samuelson’s mental model of the world, based on the theories of Keynes, caused him to think that there would be massive unemployment for a long time due to decreased government spending after the war, as indicated by this part of the quotation:

“to shift from astronomical deficits to even the large deficits of the thirties–then there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced”

Eric July 14, 2011 at 7:37 am

The Samuelson quote deserves to be the quote of the day. Not all quotes of the day should have to be positively exemplary in their wisdom…

Don Boudreaux July 14, 2011 at 7:41 am

Good point! I agree.

Warren Smith July 14, 2011 at 8:59 am

Samuelson wrote this in 1943. Certainly he should have foreseen that
1) Europe would be in ruins when the conflict ended
2) The US as an island fortress would have a ready industrial base with excess capacity.
Regardless of Samuelson’s economic philosophy how could he have missed this?
Joseph Kennedy bought the Merchandize Mart in Chicago for a song circa 1945. It had been occupied by war time bureaucrats and the prospect of loosing those tenants depressed the then current owners. Kennedy preceived the low price he was offered as enough of an incentive to believe he could lower rents to a level where he could profitably attract new tenants.

jehu July 14, 2011 at 9:09 am

I think this is because Samuelson was not making a prediction: he was making an argument, using fear, precisely to argue for ever greater involvement of the State in the economy. A lot of the points being made here completely ignore this involvement; and makes the fallacious assumption that the economy bounced back on its own.

In fact, what we see here is the institutionalization of the Fascist State.

Warren Smith July 14, 2011 at 9:01 am

Please add point #3 to above
3) the excess capacity in USA industries would be employed to rebuild Europe.

lucklucky July 14, 2011 at 9:07 am

In 1945 the world was much poorer than in 1939 with hundreds of cities reduced to ashes. The people that survived needed many essential item that only USA industry could provide. I am not only talking about end products necessarily but many non-sexy items, components, etc. Then started to world trade again. In many countries that was only possible because there were hundreds of Liberty ships to replace destroyed European Merchant marine.

muirgeo July 14, 2011 at 10:42 am

This post could have been titled;
How to use the MAssive Post FDR Economic Boom to Argue Against Samuelsonianism…oops I Mean Keynesianism.

To bookend with the ones written here now like;
How to use the Current Economic Corporate Cash Glut, Low Tax Rates, Record Trade, Low Wages, Low Employment and Ongoing Economic Stagnation to support Neoliberal Economic Doctrine.

dsylexic July 14, 2011 at 10:48 am

bogus.nobody here supports the current economic doctrine -which is still cronyist with a keynes overhang in the academic ivory towers(as seen by a recent poll of academics)

Slappy McFee July 14, 2011 at 10:47 am

Don -

I spit out a little bit of soda when I read this:

“(Or, if not ‘period,’ colon.) ”

Thanks for the chuckle-I do enjoy punctuation humor on the Internets

Greg July 14, 2011 at 2:58 pm

How many of those 10m new workers took over existing jobs from women who left the labor force?

In other words: were 10m new jobs created or did 10m women quit their jobs just as 10m men arrived to fill the vacancies?

Warren Smith July 14, 2011 at 5:28 pm

Re Jehu 9:09 am comment

I believe that this is an excellent point.  Many today forget the influence of Samuelson’s text book and the guilt invoking popularizations of John K. Galbraith, the Canadian who became the czar of the US war time price control board.  These two brillant men never met a regulation which they could not love. They argued much more for means of controlling economic events than understanding them. They slithered across the American political scene for fifty years, only being set back by the humor and logic of Friedman and the consistency of the Reagan presidency.  

For an historical comparison of what a truly decent and self sacrificing president can look like watch Youtube’s coverage of the Dwight D. Eisenhower speech of January 17, 1961.  It is often referred to as the “military industrial complex” address.  Ask Johnson, Nixon, either Bush, Clinton, or God forbid Obama to speak this much truth in public.

a_murricun July 14, 2011 at 5:57 pm

Lived through it. In 1945, Dad bought fishing gear at lower-than-prewar prices, including an outboard motor. The next year we got our first-ever “electric icebox” and the iceman never cameth because he was out of a job. Also we got our own washing machine! IOW, consumer goods manufacturing took the place of war goods manufacturing.

WW2 pulled the US out of the 1931-40 depression, and the momentum has continued almost to the present day. But not to worry, Obama will take care of that!

Don Boudreaux July 17, 2011 at 8:26 am

The case for the Great Depression being cured by WWII is, at the very least, questionable; in my view it is wrong:

http://cafehayek.com/2008/10/wwii-cured-the.html

http://cafehayek.com/2006/06/challenging_a_d.html

Eric July 15, 2011 at 7:52 am

I recently read my Grandfather’s diary from the days before and shortly after VE day. He was a shop foreman with Alcoa in the Pittsburgh area, and his diary was mainly about things at work, short entries about his workers and the jobs they had. Shortly before VE Day it became apparent that the end of hostilities in Europe was near. All work stopped for the celebration of VE Day. The next day – the very next day! – all the ladies that had been hired to augment the work force were laid off. In other words, it didn’t take business long to figure out what they needed to do.

Warren Smith July 17, 2011 at 7:35 am

What Alcoa probably figured they needed to do was to respond to the end of the war entailing a fall in airplane aluminum demand. By your own sources, the employees laid off were the employees hired to “augment” the war time work force. This seems appropriate.

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