The Source of the Problem Ain’t Inadequate Aggregate Demand

by Don Boudreaux on September 8, 2011

in Country Problems, Data, Inventive intervention, Myths and Fallacies, Regulation, The Economy

Neal Phenes sent me this item from The Daily Ticker.

Mr. Task and his interviewees should check the data before concluding that the problem with today’s economy is inadequate demand – that is, before concluding that what today’s economy needs above all is “demand stimulation.”

Inflation-adjusted personal consumption expenditures in the U.S. today are higher than they were in the third quarter of 2007 (the quarter before the recession began).  True, these expenditures are only about one-percent above their pre-recession level, but higher they nevertheless are – a fact that requires some twisting of Keynesian dogma in order to continue making a case for more government ‘stimulus’ spending.

The problem isn’t that consumers aren’t spending; it’s that businesses aren’t investing.  And businesses aren’t investing because Congress and, especially, the administration exhibit a ceaseless fetish for top-down, command-and-control, debt-financed ‘governance’ of the economy – an enterprise-quashing recipe made only more poisonous by Mr. Obama’s soak-the-rich speechifying.

…..

Relatedly, see Michael Boskin’s fine essay in today’s Wall Street Journal.

UPDATE: I’ve updated the title of the post to better reflect my intended meaning – which was never that aggregate demand is today at its full-employment level.  Rather, my meaning was, and is, that the originating problem – the cause of our woes – isn’t inadequate aggregate demand but, rather, whatever is causing business investment (and, hence, aggregate demand) to be too low.  Failure of households today to spend seems an unlikely candidate.

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{ 63 comments }

Daniel Kuehn September 8, 2011 at 11:57 am

re: “The problem isn’t that consumers aren’t spending; it’s that businesses aren’t investing.”

Which is precisely what Keynesians say, from modern versions back to the General Theory, Don. Consumption declines as a result of the multiplier process, it’s true (when investment is reduced, an MPC between 0 and 1 means that consumption will take a hit) – but the problem of a recession is a problem of investment.

Pointing to the fact that consumption is less volatile than investment isn’t proving that aggregate demand is a problem because Keynesianism isn’t consumptionism and it never was.

Keynesians say recessions are caused by weak investment because liquidity preference allows for increased savings without the placement of specific orders (by firms or households) for output in the future. One need not make a specific order for future demand to save, but firms need specific orders of future demand to invest. Increased liquidity preference that reduce these returns on investment increase the interest rate at the same time, so that the economy can settle at a point considerably below full employment.

Please, criticize naive underconsumptionism. But please don’t call that Keynesianism.

Invisible Backhand September 8, 2011 at 12:42 pm

“I’ve got customers pounding on my door, and my salesmen are getting carpel tunnel from taking orders and my refurbed product is selling for more than my new product, but I’m not going to hire any more people because I’m uncertain what the regime is going to do next!”

Invisible Backhand September 8, 2011 at 1:36 pm

“The concept of underconsumption had been used repeatedly as part of the criticism of Say’s Law until underconsumption theory was largely replaced by Keynesian economics which points to a more complete explanation of the failure of aggregate demand to attain potential output, i.e., the level of production corresponding to full employment.”

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

Daniel Kuehn September 8, 2011 at 1:55 pm

See my description of Keynes’s thoughts on the underconsumptionists if you’re interested. Chapter 23 – where he talks about both mercantilism and underconsumption – is a fascinating read.

What Don says below about Keynes being an underconsumptionist is completely, transparently, wrong.

Economic Freedom September 8, 2011 at 2:51 pm

Which is precisely what Keynesians say, from modern versions back to the General Theory, Don.

LOL!

Consumption declines as a result of the multiplier process,

There is no “multiplier.” It’s a myth.

Keynesians say recessions are caused by weak investment

Rational people say that weak investment is caused by recessions. Keynesians have it backward. Recessions are an “unwinding” process of a series of malinvestments.

because liquidity preference

i.e., because the desire to save money now for the purpose of spending later,

allows for increased savings without the placement of specific orders (by firms or households) for output in the future.

i.e., because of regime uncertainty, businesses (and individuals) prefer to sit on cash for the sake of waiting out the uncertain times rather than make commitments with it that might backfire and lead to losses. It’s called “common sense.”

One need not make a specific order for future demand to save,

i.e., Just because someone puts $100 in the bank doesn’t mean that he has any clear idea now of what he intends to spend it on later. Because of uncertainty, he just wants to have the cash on hand.

but firms need specific orders of future demand to invest.

Wrong. They just need to have an idea of what future demand might be and be willing to take a risk for the sake of earning entrepreneurial profit. That requires removing institutional problems like the current “regime uncertainty.”

Increased liquidity preference

i.e., increased desire to hold cash

that reduce these returns on investment

What “returns on investment?” You jumped from “firms need specific orders of future demand to invest” to “returns on investment.”

increase the interest rate at the same time, so that the economy can settle at a point considerably below full employment.

Now you bring in “full employment” as if it follows somehow from anything you’ve said above. It doesn’t, but it reveals the habitually unfocused way in which the Keynesian mind tends to work.

“Liquidity preference” means “desire to hold money” = “saving.”

Contrary to Keynes, “saving” doesn’t mean “hoarding.” He had the notion that “saving” meant that people were stuffing their mattresses with money, as opposed to what they actually do: putting it in the bank. When more people put more money in the bank, reflecting their desire to hold cash rather than spend it, the interest rate falls, not rises — banks have to lower the interest rate in order to find more borrowers. As more businesses borrow and start projects (taking advantage of the lower interest rate), this intensifies the division-of-labor and creates a longer structure-of-production — more subdivisions in the higher-orders of production inside the “Hayekian Triangle” — leading to higher productivity, overall, in the economy (because a longer structure-of-production, entailing more “roundabout methods of production” are more productive than direct methods of production). The higher productivity leads to lower prices, which — later — lead to higher consumption.

But greater productivity begins with abstaining from present consumption.

Troy Camplin September 8, 2011 at 6:12 pm

Let’s see. Keynes equates savings and investments. Meaning if you are saving you are not spending, and if you are not spending you are saving, which is the same as investing. If there is not investing, then there is no saving (since they are the same to Keynes), meaning there is consumption. But increasing saving is what causes recessions. Meaning increasing investments is what causes recessions. So if investments cause recessions, how is increasing investments going to get us out of the recession?

A few other thoughts:

http://zatavu.blogspot.com/2011/02/keyness-general-theory-ch-6.html

http://zatavu.blogspot.com/2011/03/keynes-general-theory-chapter-7.html

anthonyl September 9, 2011 at 9:10 am

How can there be underconsumption? How is “FULL” consumption determined? It seems to me that all “underconsumption” would be naive as all one can know is what “I” demand now at the current price. I can’t know what I would demand at a different price until that other price is existent.

Daniel Kuehn September 8, 2011 at 11:59 am

And unless you want people to start calling your carefully considered views “dogma” you probably shouldn’t call Keynesianism “dogma” either.

Methinks1776 September 8, 2011 at 12:37 pm

Start?

Daniel Kuehn September 8, 2011 at 12:55 pm

As in, people who never used to call him a dogmatist but might start if their ideas keep getting refered to as dogmatism.

Methinks1776 September 8, 2011 at 1:21 pm

God forbid!

Invisible Backhand September 8, 2011 at 12:49 pm

Cultists, as in people who are genetically hard wired to follow a leader, can’t understand that not everybody is a cultist too. So they claim atheism is a religion or evolution is ‘Darwinism’ or that somehow we worship Keynes and Krugman and we just won’t admit it to ourselves.

Edward Cox September 8, 2011 at 12:17 pm

I can’t tell you the last time I heard a self-proclaimed Keynesian claim that recessions are caused by too little investment. It’s always too much S, too little AD, and the panacea is more G.

Daniel Kuehn September 8, 2011 at 12:27 pm

re: “I can’t tell you the last time I heard a self-proclaimed Keynesian claim that recessions are caused by too little investment….too little AD”

Is this a joke? What do all economists – Keynesians or otherwise – always point to as the single most volatile component of AD. INVESTMENT.

Bill September 8, 2011 at 12:33 pm

And how does your dogma deal with that problem?

Economic Freedom September 8, 2011 at 3:02 pm

What do all economists – Keynesians or otherwise – always point to as the single most volatile component of AD. INVESTMENT.

All economists? Hardly.

Keynesiacs start with a big circle called “Aggregate Demand” that they divide in half: one half is labeled “consumer spending”, the other half is labeled “business investment.” The latter, they claim, is governed by unaccountable “animal spirits.” For unaccountable reasons, businessmen lose these “animal spirits” and therefore stop investing. The unaccountable “animal spirits” of businessmen are supposedly what make the “business investment” half of the circle “volatile.”

In Keynesiac: “volatility” = “unaccountability of animal spirits.”

Except for the fact that powerful politicians implement destructive policies based on such goofiness, this sort of reasoning would not merit any serious consideration at all.

Edward Cox September 8, 2011 at 5:53 pm

Of course I was joking. I’m just sick of Krugman et al’s endless proposals for business-friendly policies designed to increase capital investment. Investment investment investment! That’s all we hear from you Keynesians. Never C or G. Just I. It drives me mad!

Methinks1776 September 8, 2011 at 12:47 pm

Eddie,

Ya’ gotta have more G because when the folks running G jack up the cost and risk of investment (reducing reward for a given level of risk) with 7 million pages of new regulation nobody can understand, (let alone comply with) and increase government aggression against anyone trying to invest, G’s all ya’ got left.

That’s why Keynesian like Chrissy Romer, Paul Krugman, and our very own Danny Kuehn either ignore these new risks and costs entirely or claim that they’re actually helping. If people are allowed to function normally without the interference of the Gestapo, then these smart and unwise folks won’t get a chance to foist their ineffective policies on us.

I say “ineffective”, but that all depends on what they’re trying to effect. These policies are awesome at robbing the population of liberty, prosperity and peace of mind in exchange for empty promises of security.

Daniel Kuehn September 8, 2011 at 1:16 pm

Why aren’t the risks you describe incorporated into the estimates produced by, say, Romer (Krugman and I don’t do this sort of estimation – but she does)? If I understand her work right, she is including these. Why do you say she doesn’t – could you explain?

Methinks1776 September 8, 2011 at 1:29 pm

You and krugman claim that regime uncertainty is not a concern because it doesn’t exist. You are so disconnected from what’s going on around you and so devoted to the current regime that you dismiss it as a possibility.

Chrissy claims that the avalanche of new regulation and aggressive government is not only not an impediment but a boon to businesses. That she estimates the effect of regulation and comes to conclusions about their effect doesn’t mean she’s correct.

What evidence to you have that her conclusions are correct? Or that it’s even logical that decreased demand coupled with higher costs is a net positive and should spur investment?

Daniel Kuehn September 8, 2011 at 1:37 pm

Methinks go spread lies somewhere else. I’ve never said regime uncertainty is not a concern and I’ve never said it doesn’t exist. Indeed I’ve said that it does exist and that it is a concern. I may not rank it as high as Don or Bob Higgs, but I’ve never said it doesn’t exist.

re: “That she estimates the effect of regulation and comes to conclusions about their effect doesn’t mean she’s correct.”

As usual you are completely missing the point. If you don’t like her estimation strategies, then tell us what you have a problem with – but if you’re going to claim she IGNORES it you need to provide us with reasons why you think that. My understanding is that the work she did with her husband does not ignore it – it’s incorporated into the model. If you have a different understanding, I’d appreciate it if you clarified why.

Methinks1776 September 8, 2011 at 2:18 pm

Is that so, Danny?

Was this not you agreeing with Krugman that regime uncertainty is not an issue for businesses today, not a reason for sluggish investment and that it’s just trotted out to hurt Dear Leader? It seems you have a lot of issues remembering where you stand on anything and what you might have said.

http://cafehayek.com/2011/04/krugman-and-expectations.html

If you don’t like her estimation strategies, then tell us what you have a problem with

I have. Repeatedly. I repeated myself again in the comment to which you are responding. You won’t answer these inconvenient questions hoping to distract from the issue with content free irate comments. My questions were not rhetorical. You obviously don’t have a good answer.

…but if you’re going to claim she IGNORES it you need to provide us with reasons why you think that.

Your reading comprehension could use some work. I thought English is your first language. The immigrant will help:

Keynesian like Chrissy Romer, Paul Krugman, and our very own Danny Kuehn either ignore these new risks and costs entirely or claim that they’re actually helping.</i?

Did you notice the word "or"? That means any of the people in the list could be doing either. She does not ignore it. She's on record claiming that the tsunami of aggressive government action (in the form of new regulation and enforcement) is a plus. I clarified that Chrissy, unlike Krugman, doesn't ignore this issue. I don't know how much clearer I can be for you. It is in English.

Another question for you: Why do you ignore the effects of rising compliance costs and increased barriers to entry in your models?

Methinks1776 September 8, 2011 at 2:19 pm

Dang tags.

Daniel Kuehn September 8, 2011 at 2:32 pm

Methinks –
You do realize you are linking to a thread where I said: “It’s not a question of whether regime uncertainty matters – of course it does”. What’s the deal – were you hoping nobody would actually bother to read what you linked to??? Do I place the same emphasis on it that you and Don do? No. I never said I did – there is a difference of opinion. But don’t lie and tell people I ignore it, I don’t think it exists, or I don’t think it matters.

Daniel Kuehn September 8, 2011 at 2:35 pm

re: “I have.”

Humor me and copy and paste where you addressed this. I didn’t read you explain how her work failed to include this. Her instrumented reduced form models seem like they would capture exactly what you said they wouldn’t capture, but maybe I’m misunderstanding something. Copy and paste is all I ask – I don’t mean to make you keep re-explaining things. I genuinely don’t know where you’ve spoken to this point.

Methinks1776 September 8, 2011 at 2:52 pm

Yes, I provided the link so nobody would be able to check. Kid, I can’t keep doing this with you. One more time and then I’m just going to have to throw in the towel on you. I quote myself:

Was this not you agreeing with Krugman that regime uncertainty is not an issue for businesses today, not a reason for sluggish investment and that it’s just trotted out to hurt Dear Leader?

The avalanche of new regs – more than one per day in the mortgage industry, dozens in the financial industry, more rules from the EPA and the alphabet soup of reg agencies, Dodd-Frank, Obamacare, and increased aggressiveness of government toward business – Krugman says are not a hindrance to investment for businesses. Not regime uncertainty in general, mind, specifically these events. According to Krugman, claiming that any of this load is burdensome is a slur against Obama. You agree that he’s correct. why?

I didn’t read you explain how her work failed to include this.

You need to not only read, but try to understand what you read. Reread what I wrote.

maybe I’m misunderstanding something.

This is the first thing you’ve said that I can agree with.

BTW, thanks for yet again not answering a single substantive question. These exchanges with you are as enlightening as ever.

Daniel Kuehn September 8, 2011 at 3:01 pm

re: “BTW, thanks for yet again not answering a single substantive question. These exchanges with you are as enlightening as ever.”

Right back at you. You’re clearly not interested in actually talking about these things because you’re deflecting as usual.

I know you included the “or” in there. But she doesn’t directly estimate the impact of regime uncertainty on its own, so she’s clearly not claiming that “they’re actually helping”. The only logical thing left was that you thought she ignored it – and there’s no evidence of that either.

So are you saying that her estimates include regime uncertainty? If that’s what you’re saying I agree. Is it so hard for you to just say you think she measures it?

But the point is, she doesn’t isolate it – so you simply cannot accuse her of making the “claim that they’re actually helping”.

I don’t know why you always act so embattled – why don’t you just tell me exactly what you’re concerns are about Romer instead of whining so much.

Methinks1776 September 8, 2011 at 3:02 pm

But don’t lie and tell people I ignore it, I don’t think it exists, or I don’t think it matters.

You really have to stop accusing people of lying if you’re not going make even a minimal effort to try to understand what they’re saying to you.

Why aren’t the risks you describe incorporated into the estimates produced by, say, Romer (Krugman and I don’t do this sort of estimation – but she does)?

Why is that sort of estimation not included in your and Krugman’s models? In other words, Why do you ignore the effects of rising compliance costs and increased barriers to entry in your models? Get it?

It’s an actual question. This seems like a big thing to leave out. I don’t understand why you would.

Methinks1776 September 8, 2011 at 3:15 pm

I know you included the “or” in there. But she doesn’t directly estimate the impact of regime uncertainty on its own, so she’s clearly not claiming that “they’re actually helping”. The only logical thing left was that you thought she ignored it – and there’s no evidence of that either.

Ah. I see the problem. Danny, I don’t spend time digging through other economists’ models. I spend time digging through my own financial models and complying with regulation.

During an interview before she stepped down from her position in the current regime, she was asked her opinion of all the new regulation and if she thought that wasn’t part of the reason the recovery is so sluggish. She replied that she thought the avalanche of regs are not hurting the recovery and that they are actually a plus. This is what I am referring to.

It has occurred to me that since she’s not an idiot, she may actually have quite the opposite view, but she couldn’t voice it as she was loyal to the regime. If that’s the case, interviewing these people is useless because you’ll just get the current president’s political views. It is serious, though, as the whole country is listening.

I’ve written about the effects of regulation many times here in the comment section. I’m assuming you caught one or two of them, so I won’t repeat unless you ask again.

Invisible Backhand September 8, 2011 at 12:58 pm

“Ya’ gotta have more G because when the folks running G jack up the cost and risk of investment (reducing reward for a given level of risk) ”

I remember a time when Lehman Brothers and the Fed and AIG et. al. jacked up the cost and risk of investment.

Methinks1776 September 8, 2011 at 1:13 pm

Thanks for clarifying the fact that you don’t have a clue what any of organizations do and that you don’t know what “investment” means. Again.

Invisible Backhand September 8, 2011 at 1:37 pm

Risk only comes from the government. Got it.

Methinks1776 September 8, 2011 at 2:23 pm

That’s exactly what I said. Congratulations. You are a bigger moron than even I imagined.

Invisible Backhand September 8, 2011 at 3:32 pm

I’m loving the way Daniel caught you lying and your non-denial denial.

Methinks1776 September 8, 2011 at 6:37 pm

Not nearly as much as you love your sock.

spencer September 8, 2011 at 1:02 pm

But personal consumption expenditures are only one component of AD..

Two other measures of the economy are more comprehensive me-assures of AD and both of them are below their third quarter 2007 level.

One is real final sales of domestic product, It is now $13,223.2 (billion 2005 $s) versus $13,231 (b 2005$s) in III Q 2007.

The other measure is real final sales to domestic purchasers . It’s now
$13,635 b 2005$ vs $14870 b 2005$ in III q 2007.

Next time try to do a better job of cherry picking your data.

Don Boudreaux September 8, 2011 at 1:07 pm

I’m quite aware of Y=C+I+G+(X-M).

No cherry-picking was going on. The prevalent view in the economy – if not at the moment by Keynesians who are unaware that Keynes himself was an underconsumptionist – and the view to which my note is specifically addressed, is that consumers aren’t spending enough and THAT’S the reason businesses aren’t investing more.

You’ll notice that in my post I explicitly acknowledge that investment spending is down.

L. F. File September 10, 2011 at 9:09 pm

Yeah but you never allow for population growth. Population grows about 1% a year and if personal consumption doesn’t grow at least as fast then it is below what it should be.

Accounting for population growth personal consumption is down 3%.

lff

spencer September 8, 2011 at 1:04 pm

Sorry, that should be $13,870 in 2008 not $14,870.

But it is still below its 2007 level.

jjoxman September 8, 2011 at 1:16 pm

1) No working macroeconomists are Keynesians anymore. The Lucas critique ended that nonsense, although the great W.H. Hutt had debunked Keynes’s ‘General’ Theory much earlier than that. Even Clower and Leijonhufvud, who tried to rehab Keynes, took strides away form it. In academic circles, Keynesianism is dead.

New Keynesianism is very much alive, and is much more sophisticated. I still think it’s more wrong than right, and it’s only one of many competing macro frameworks. The latest and greatest is New Monetarism (see Stephen Williams for more on this).

Of course, Austrian macro continues to be ignored by the mainstream.

2) Keynes is still taught at the undergraduate level, however. And sometimes to non-econ masters students. I broke out my copy of Bernanke and Frank, and examined the chapters regarding the business cycle. Low and behold, business investment is just a part of the aggregate spending formula. It doesn’t even merit a section in a chapter, much less a chapter of its own.

No, the way business cycles are presented to undergraduates, and also to the world, is through deficient AD, specifically calling out consumption, not investment. If Keynesians are all thinking investment (and I agree Keynes himself was) then the message isn’t getting across.

I recommend that Keynesians dropping the AD language, and just saying ‘deficient investment.’ It is a much less confusing terminology.

It will also change the focus; instead of looking at G’s effect on GDP, you look at G’s effect on I.

vikingvista September 8, 2011 at 1:55 pm

There is a chapter on investment. It is short, so you must’ve missed it. Here I include that chapter in full:

Chapter 6
Investment

Animal spirits.

Cahal September 8, 2011 at 2:52 pm

If you think animal spirits is all Keynes had to say about investment then you haven’t understood Keynes.

But then, neither have any Austrians, as Henry Hazlitt demonstrated so clearly in his ‘refutation’ of TGT.

jjoxman,

Lucas’ critique basically amounted to ‘Keynes says people aren’t rational! But we ASSUME they are, so they must be!!!!’

This is the same Lucas who said in 2008 ‘I guess we’re all Keynesians in the foxhole’, btw. Maybe even he wasn’t convinced by his awful economics.

Daniel Kuehn September 8, 2011 at 3:04 pm

I’m not quite sure that’s a fair assessment of the Lucas critique – and I’m not sure Keynes thought people weren’t rational. This isn’t to say jjoxman is right either – Lucas really shot a hole through the way macroeconometrics was done. I don’t see how he can be said to have closed the book on Keynesianism.

Put it this way – the Lucas critique applies to all macroeconometric efforts of that flavor, even if they’re completely non-Keynesian. So how could you say he ended it?

jjoxman September 8, 2011 at 5:00 pm

Macroeconomics until Lucas’ critique was basically focused on business cycles, with some young growth theory stuff. It was vastly Keynesian-inspired.

Frankly, it saddens me that policy issues are framed in the hydraulic Keynesian framework. It’s like the last 30 years never happened.

vikingvista September 8, 2011 at 3:05 pm

Cahal,

You may be right. What is thrust of Keynes’s theory of investment and its association with recession?

jjoxman September 8, 2011 at 4:58 pm

The Lucas critique is that the macro done to that time, which was Keynesian-inspired, did not account for microstructure. In other words, it was hydraulic – economy as machine, not as organism.

Note that New Keynesians have done a lot to incorporate microstructure into their models. Again, I don’t think they’ve done it sufficiently, and I’m not convinced it can be done in a symbolic logic setting.

Cahal September 8, 2011 at 5:56 pm

Sorry – I was thinking of a very specific part of Lucas’ work, not the general critique of econometrics. My mistake.

jjoxman,

Do you think we’ve been using Keynesian policies for the last 30 years ??

I also don’t really rate neoclassical-Keynesian amalgamations like IS/LM and so forth. I don’t think you can draw Keynesian conclusions from neoclassical economics.

vikingvista

Briefly, low long term interest rates and international stabilisation to give monetary authorities control over their domestic economy. Keynes would have argued that interest rates have been far too high (ignore the base rate, we are talking corporate borrowing) which has bred the low investment and volatility we’ve seen for ~30 years. I can’t find any data but Geoff Tily argues this incredibly convincingly in Keynes Betrayed.

vikingvista September 8, 2011 at 7:20 pm

Thanks for the response.

You say it has bred low investment for ~30 years. But we haven’t had a 30 year recession. Keynes’s story of recession and his policy prescriptions usually start with a precipitous fall in investment. When Keynes writes of that fall in investment, what is his theory for why it occurs?

Cahal September 9, 2011 at 5:56 am

Surely you’d agree that the last 30 years have been more volatile and had lower growth than the 30 years preceding?

As for why a recession occurs when it occurs, it would be:

a) A spike in interest rates to really high levels (they spiked up to 20% in 1928-9)

b) If rates are high but steady, it would be the interest catching up with investors as they had trouble making sufficient profit to cover repayments.

c) As for why recessions – albeit far less severe ones – occur even when interest rates are low (post WW2, for example), I’ll admit there is a certain degree of mysteriousness to this. Minsky’s financial instability hypothesis is probably the best explanation.

However, I don’t think admitting that recessions are slightly mysterious in nature is the self evident joke that Austrians believe. Saying ‘well, it’s partially this and partially this, but since it has persisted throughout history we aren’t entirely sure’ is less ridiculous than simply attributing it to the government, fiat currency or w/e else.

vikingvista September 9, 2011 at 2:40 pm

Cahal–

“However, I don’t think admitting that recessions are slightly mysterious in nature is the self evident joke that Austrians believe.”

Given Milton Friedman’s utterly non-explanatory “plucking theory”, I can hardly fault Keynes as being unique in having an incomplete theory of recession. But I do find it interesting to learn that Keynes did, as you say, have something of a theory to back his well known “animal spirits” phrase.

“A spike in interest rates to really high levels…If rates are high but steady, it would be the interest catching up with investors as they had trouble making sufficient profit to cover repayments”

So when Keynes writes of “animal spirits”, he is referring (at least in some instances) to how investors rationally respond to high interest rates?

Does Keynes then explain why there is a precipitous rise in interest rates? Is it an overcompensation in monetary policy? A natural market response to economic expansion?

Cahal September 10, 2011 at 6:48 am

‘So when Keynes writes of “animal spirits”, he is referring (at least in some instances) to how investors rationally respond to high interest rates?’

I guess he was referring to the fact that investors make decisions in the face of irreducible uncertainty i.e. they *cannot* know the outcome of their investment. So they suffer from cognitive biases because they have to use rules of thumb, current trends etc. But he mentions it 3 times in TGT – I don’t think he attributed much to it. In some ways you shouldn’t read too much into specific parts of Keynes – he was prone to flourishes of randomness and also facetious jokes.

‘Does Keynes then explain why there is a precipitous rise in interest rates? Is it an overcompensation in monetary policy? A natural market response to economic expansion?’

He would have attributed it to tight monetary policy. He was interested in keeping short and long term borrowing rates low and anchoring expectations, so he wanted to central bank to make a credible commitment to stick to low interest rate policy, so fluctuations like this wouldn’t have happened.

vikingvista September 12, 2011 at 12:53 am

“But he mentions it 3 times in TGT – I don’t think he attributed much to it. In some ways you shouldn’t read too much into specific parts of Keynes”

I take it that you are not getting Keynes’s elaboration of the meaning of “animal spirits” from TGT. In which of his writings do you get it?

Curt Doolittle September 8, 2011 at 1:49 pm

Theory is wonderful. Data is something else. But reality consists of a greater set of variables:

1) While big companies have cash, banks that serve small and mid-sized business are still unwilling to lend. Even the larger banks are extremely sensitive. They are sensitive to balance sheets, not revenue and profit.

2) The American public has decided that the secondary effects empowering government through debt are higher than the cost of suffering a continued recession. This is not an illogical choice. It is simply a choice. Preferences are preferences and americans are demonstrating their preferences. It’s not that they don’t understand. They understand just fine. Which is what they keynesians don’t grasp.

3) The American public has decided that the government is irresponsible. This is because the diversity of interests in the country is higher than can be satisfied by any set of extant solutions.

4) The conservatives believe that they have an opportunity to shrink the government and it’s influence on their lives, even if comes at a high cost.

5) A ‘whole buncha’ of white people are beginning to act like a minority.

6) It is impossible to employ modern macro without forcible transfers. Daniel Keuhn thinks that this is ok. Austrians don’t. In fact, it’s the only ethical proposition possible in economics. (And while Daniel is wrong a lot on the logic, he knows his dogma, he’s about the only guy on the other side who is even worth arguing with. – backward compliment that it is.)

Arguing over technicalities is an idiot’s distraction. Because the keynesian argument assumes a homogeneity in the polity that does not exist outside of small nation states. In our current empire, the changes in status signaling and political power are currently valued more than is money.

Why this is hard to understand, I can’t comprehend – other than it invalidates their assumptions. But I pretty much beat the drum for it against Krugman and his tribe on a daily basis.

The only tolerable political solution today is industrial policy. Everyone will back it. The only tolerable political solution in 2008 was to bypass the banking system and directly address homeowner mortgages. Unfortunately, only Galbraith and I were advocating it seriously, and he died and I’m nobody. Today we are stuck with industrial policy. That will work. it makes everyone happy. But it makes the left less happy than the right, because it bypasses government, and its dependents.

Dan J September 8, 2011 at 3:08 pm

Obama and his cronies are, and have been, invoking the cronyism and corrupt policies of FDR. Underconsumption theory became ‘ lack of aggregate demand’ ad concluding need for stimulants. Whether it is the WPA which was used for patronage and to punish enemies by holding back monies for districts that did not support FDR in contrast with today’s idea on a ‘jobs bill’ to direct billions to unions for ‘infrastructure’ rebuilding.
Why not revitalize the NIRA and have price controls and wage controls. Punishment for not complying can be jail and fines that would bankrupt businesses that dare to cross the admin……. Gibson Guitars….. Boeing… Humana…..

Dan J September 8, 2011 at 3:21 pm

I don’t think Obama and leftists truly embrace Keynes. They just use the theory and advices given to govt on steering an economy as a tool. Any idea that brings more power to govt and centralizes authority will be latched on to by the far left. Keynes irrelevant. Earlier last year, there were attempts by the left in media, a few legislators, and tv to minimize the term ‘socialism’ as a pejorative. It is still. They back away. Because communism, socialism, Marxism are provocative and viewed horribly, and rightfully so, they must describe it in a different light. Hence, attacking ‘the rich’ and corporations.

muirgeo September 8, 2011 at 3:25 pm

Wait, wait, wait…. yes CHECK the data it doesn’t support the claims. I’m here at Disneyland blogging while waiting to get on the Matterhorn Bobsleds and I showed Mickey Mouse your blog post and he, Dumbo and Goofey all spotted the hole in your claims about the data.

Greg Webb September 8, 2011 at 4:17 pm

George, I hope that you are having a good time at Disneyland. I see you are still listening to the typical Keynesian economists like Mickey Mouse, Dumbo, and Goofy. But, I did not know that you were such friends with Thomas Friedman, Paul Krugman, and Brad DeLong that you could use their nicknames.

Dan J September 8, 2011 at 6:09 pm

Years and years of hell under FDR. Check that data. a lost decade. You will find FDR at the Pirate of Caribbean. Being the rapacious, corrupt, lying, thieving scoundrel that he was.

John Donnelly September 8, 2011 at 3:46 pm

I apologize for not reading all the comments but it seems to me that businesses aren’t investing because the economy sucks and they are waiting to see if we can get this Jumbo Jet off the ground (i.e. boost growth) so to speak.

So now we define “economy sucks” and that isn’t that we are afraid of what the government will do next but rather, we want to see some action out there. Once a few businesses start investing we are off to the races.

thales September 8, 2011 at 7:03 pm

Businesses are not investing now not because of regime uncertainty, but because of “regime certainty”.

It is all too certain that government regulations and taxes have increased, and will increase, the cost of doing business sufficiently to stifle economic growth, while government spending will misallocate resources and stifle growth even more, all of which is associated with considerable, but roundly ignored, deadweight loss.

The races won’t start until more than a year after November 2012.

Methinks1776 September 8, 2011 at 8:59 pm

Don’t be so sure. Establishment Republicans are almost as interventionist as Democrats and unless Dodd-Frank, Obamacare, the new “consumer protection” regs, etc. are repealed (super unlikely as they have the support of politically connected insiders), we’re stuck with the giant addition to the deadweight.

samgrove September 10, 2011 at 11:06 am

If businesses don’t invest, they won’t be hiring.

L. F. File September 10, 2011 at 9:01 pm

Total personal expenditure was up 1% since Q3 2007. And annual population growth is about 1%. Doesn’t that mean that for aggregate demand to not decline total personal expenditure has to increase by 1% per year? If so then the contribution that personal expenditure makes to aggregate demand is 3% less than what it should be.

lff

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