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If John Maynard Keynes and F.A. Hayek got into a fight, who’d win?

If it was a real knock-down, drag-out brawl, my money would be on Keynes.  At 6’ 6”, he’s got the size, the weight and the reach.  Hayek couldn’t  lay a glove on him.  

But what if they were cutting heads and throwing down rhymes?  Then, Keynes could have a real fight on his hands.

mogul ski

That’s Fear the Boom and Bust by film maker John Papola  and George Mason University economist Russ Roberts.  They’ve distilled eight decades of economic debate into 5:26 of rap, been translated into a dozen languages (including Estonian "Karda buume ja surutisi") and have racked up almost a million YouTube hits.

But what does it mean?  The rap is dense with economics and in-jokes. It almost requires an graduate degree to get everything.

If you don’t know a liquidity trap from a malinvestment, if you think the Austrian School is where you learn to shred moguls, this Cliff Note’s version might help.

Somebody Give Me A Beat

John Maynard Keynes, F.A. Hayek
Yeah, we’re opposed.  We oppose each other philosophically
In the same studio.

We’ve been going back and forth for a century

Keynes

A century? Not quite. In 1910 Keynes was in his mid-twenties and Hayek was still in short pants. Their rivalry didn’t start until the 30s.

But “We’ve been going back and forth for 80 years starting with our debates over various economic paradoxes near the beginning of the Great Depression.” is a terrible way to start a rap. Let's give Papola and Roberts some poetic license, since they’re off to a good start.

[Keynes] I want to steer markets.
[Hayek] I want them set free.
There’s a boom and bust cycle and good reason to fear it.
[Hayek] Blame low interest rates.
[Keynes] No… it’s the animal spirits.

hayek

Keynes and Hayek are the archetypes of two very different schools of economic thought. Keynes was a leading proponent of interventionist government policies. His ideas influenced, and often drove, economic policies in Western nations from WW II through the late ‘70s. In 1942, for his service to Britain, he was elevated to the peerage and become the First Baron of Tilton.

Hayek was the leading voice for free markets and against collectivism. He helped lift the Austrian School of economics from its mid-century obscurity. He described how spontaneous order can emerge from the uncoordinated actions of billions of people and how prices help society best use the local knowledge available to individuals. His ideas, with a little help from Milton Friedman and ‘70s-style stagflation, overturned Keynesianism in the early ‘80s, at least temporarily.

Hayek won the Nobel Prize in Economics for his efforts, but it’s Keynes who’s on top today.

[Keynes Sings:]
John Maynard Keynes, wrote the book on modern macro
The man you need when the economy’s off track, [whoa]
Depression, recession now your question’s in session
Have a seat and I’ll school you in one simple lesson

Keynes literally wrote the book on modern macroeconomics, the study of trade, money, wealth, production, goods and services on a world-wide basis. The General Theory of Employment, Interest and Money built on ideas from Adam Smith, David Ricardo, Knut Wicksell and many others to lay the foundation for almost all the macroeconomic theories which followed.

BOOM, 1929 the big crash
We didn’t bounce back—economy’s in the trash
Persistent unemployment, the result of sticky wages
Waiting for recovery? Seriously? That’s outrageous!

Before the Great Depression, neo-classical economics was the dominate school. According to neo-classicals long periods of very high unemployment shouldn’t be possible. As unemployment climbs, job seekers should lower their wage demand. Eventually wages will fall enough that it’s profitable for businesses to employ people, even in a severe recession. At that point the job market clears, unemployment falls to pre-crisis levels and the economy can start growing again.

great depression

As the Great Depression deepened and unemployment climbed, the neo-classical theory lost credibility.

To solve this dilemma, the New Keynesians who built on Keynes’s own work  postulated the existence of sticky prices. They saw that manufacturers don’t have unlimited flexibility in setting prices. They were hemmed in by long term contracts, sunk costs in inventories and customary price schedules.  They could not react like the perfect black-box corporations of neo-classical theory.

Similarly, workers could not or would not accept greatly diminished wages just for the sake of having a job. An offered wage might be so low the worker could not live on it or he might think a better job was around the corner. In those cases, it makes sense for him to remain unemployed so he can devote all his time looking for a better opportunity.

The New Keynesians claimed that these sticky prices (just "sticky wages" to Papola and Roberts. They need the rhyme for “outrageous”) keep the economy from self-correcting. Only government intervention could break the log jam and get people back to work.

Like any good archetype, the Keynes in the video represents more than just the views of the historical Keynes.  He’s often rapping about ideas, like sticky prices here, that really come from neo-Keynesian followers. Archetypical Hayek does the same in his half.

I had a real plan any fool can understand
The advice, real simple—boost aggregate demand!

Keynesians have one big advantage in policy fights. Their policies are common sense. If people are out of work because of falling demand, use government spending to drive demand back up. It just makes sense.

C, I, G, all together gets to Y
Keep that total growing, watch the economy fly.

C to the I to the G to the Y. It’s the central equation of macroeconomics.

C + I + G = Y

Consumer spending (C) plus Investment (I) plus government spending (G) equals aggregate demand (Y) (technically you should add in exports (X) and subtract out imports (M), but in rap meter is as important as rhyme).

Keynes thought that as long as Y was growing the economy would be healthy. If C and I were falling, you could boost G and keep the economy from tanking. Of course, Keynes knew this was a short term strategy. Increasing G was only intended to tide the economy over till C and I recovered and to “prime the pump” to speed that recovery.

We’ve been going back and forth for a century
[Keynes] I want to steer markets,
[Hayek] I want them set free
There’s a boom and bust cycle and good reason to fear it
[Hayek] Blame low interest rates.
[Keynes] No… it’s the animal spirits

You see it’s all about spending, hear the register cha-ching
Circular flow, the dough is everything
So if that flow is getting low, doesn’t matter the reason
We need more government spending, now it’s stimulus season

Moeny

Keynesian stimulus must come from government spending. In Keynes’s model there is no other source, since C is already dropping like a stone and I has dried up.

Only the government, with its great capacity to borrow money (or just print it) was able to pick up the slack.

So forget about saving, get it straight out of your head
Like I said, in the long run—we’re all dead

Keynes had a way with words. “In the long run we are all dead.” is one of his most famous quips. The full quote is “The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again.”

Keynes was making a narrow, but valid point about what economists liked to study.  But the phrase has taken on a life of its own outside of that context. Today it means “The economy is burning! We must act now.  We'll sort out the consequences in the long run.”

Savings is destruction, that’s the paradox of thrift
Don’t keep money in your pocket, or that growth will never lift…

Keynes’s Paradox of Thrift postulates that total aggregate savings could fall even though everyone is trying to save more. The paradox arises because when people save they slow the rate at which money flows through the economy (the circular flow from the previous verse).  That reduces everyone's earnings and thwarts their efforts to save.

If I stop eating out once a week in order to save more, that reduces cash flow for the local restaurants. They must cut back spending with their wholesalers who cut back spending with their suppliers and so on and so on.

One criticism of the paradox is that it ignores I. If people are saving money, that money has to go somewhere. Under normal circumstances, that money would flow into investments. As savings accumulate in banks and other institutions, that excess capital should drive down interest rates which will make it easier and more profitable for businesses to borrow. That leads to a surge in investments, thus avoiding the paradox.

because…
Business is driven by the animal spirits
The bull and the bear, and there’s reason to fear its
Effects on capital investment, income and growth

Bull and Bear

Could it be that “animal spirits” cause the Paradox of Thrift? "Animal spirits” was Keynes’s phrase for the general level of confidence people have about the future. It’s their gut instincts telling them whether things will get better or worse.

When people’s animal spirits swell, they spend and invest more. Confident that the future is bright, they take the risks needed to keep a dynamic economy growing.

But when their animal spirits desert them, people hunker down. They hoard cash and avoid risks. In his podcast EconTalk, Roberts often says today’s crisis is more about confidence than economic fundamentals. It’s a problem for psychologists, not economists.

That’s why the state should fill the gap with stimulus both…

The monetary and the fiscal, they’re equally correct.

Fiscal stimulus simply means spending your way out of a recession. But Keynes also wrote about monetary policy, manipulating the money supply through interest rates and inflation, to re-balance an out of whack economy.

Today we loath and fear run-away inflation, so thinking of it as a cure for the Great Depression is alien to us.  But the big problem during the Depression was deflation. If inflation makes you want to spend today, because your dollar loses value the longer you hold it, deflation provides the opposite incentive. You should hold onto your money because it will buy more tomorrow. That reduces circular flow and drives the economy down deeper. Reinflating currency was a big concern world-wide.

Public works, digging ditches, war has the same effect

In the General Theory, Keynes wrote, “To dig holes in the ground, paid for out of savings, will increase, not only employment, but the real national dividend of useful goods and services.”

Notice that he said "paid for out of savings" not "paid for by hocking the whole country to the Chinese".  Many neo-Keynesians, especially politicians, miss this important distinction.

Photobucket

Even when paid for by savings, digging ditches isn't the best way to restart an economy, “It is not reasonable, however, that a sensible community should be content to remain dependent on such fortuitous and often wasteful mitigations when once we understand the influences upon which effective demand depends.” At best, ditch digging is a way to soften the impact of a down-turn and prime the pump.

After a decade of depression, Keynes realized the economy was a very large pump which requires a lot of priming. The escalating war on the continent provided the justification for that spending.  “It seems politically impossible for a capitalistic democracy to organize expenditure on the scale necessary to make the grand experiment which would prove my case--except in war conditions."

Keynes didn’t think starting wars to fix the Depression was a good idea, but he did think that it would accomplish that goal.  Many of his later day acolytes push this theory.  Keynes also thought, as the above quote shows, that politicians would never have the will to spend enough to fix the Depression, unless there was some emergency on the scale of WW II.

I’ve tried to avoid editorializing in these comments, but I can’t let this pass. War is death and destruction, two things which are known to be bad for people’s wealth and well being. Breaking things and killing people is not a wealth generating enterprise. I don’t care how many Nobel Prizes you have. If you claim it is, you are wrong (I’m looking at you, Krugman).

If Keynesianism really requires a world war to have a provable effect, then we should pay people to dig a ditch and bury Keynesianism in it.

Even a broken window helps the glass man have some wealth

From Adam Smith on, most economists have firmly held that war causes poverty, not prosperity. War as economic stimulus may be the ultimate example of The Broken Window Fallacy.

If Frederic Bastiat proved, 110 years ago, that breaking one window is a lose for society, how can destroying an entire continent be a gain?

The multiplier driving higher the economy’s health

A stimulus dollar’s impact on the economy doesn’t stop when it is spent. The recipient of that dollar gets to keep a piece of it, as profits, and spends the rest with his suppliers. The dollar continues to flow through the economy (circular flow, again) and it’s real impact is the sum of all the subsequent transactions it enabled.

It’s notoriously hard to measure any multiplier, though. Liberal estimates always put it greater than 1. 1.5 to just north of 2 seem to be the consensus values, though I’ve seen claims as high as 5. Conservatives always say it’s less than 1, that it takes more than a dollar of government spending to achieve one dollar of economic activity. When you factor in taxes, which have their own multiplier, the multiplier could actually be negative.

And if the Central Bank’s interest rate policy tanks
A liquidity trap, that new money’s stuck in the banks!

U Bend

Keynesian economics is full of danger; weird and wild snares where normal economic mechanisms are powerless and only government intervention can save us.  The liquidity trap is one such peril. In Keynes’s theory, a liquidity trap occurred when interest rates fell so low that people and institutions preferred to hold cash rather than make investments and loans. They wanted the cash as a hedge against future uncertainty. The miniscule earnings they could get from investing weren’t enough to tempt them to risk their cold, hard cash.

When the economy enters a liquidity trap, money piles up in banks, as deposits and reserves, and businesses can’t get the financing they need to fund day to day operations. This drives the economy further into recession/depression.

Today, the formal trap Keynes described has fallen out of favor with most economists.  But people still talk about liquidity traps whenever interest rates fall near zero ("The Fed is out of ammo"), regardless of the prevailing cash preference.

Deficits could be the cure, you been looking for
Let the spending soar, now that you know the score

My General Theory’s made quite an impression
[a revolution] I transformed the econ profession
You know me, modesty, still I’m taking a bow
Say it loud, say it proud, we’re all Keynesians now

Nixon

Many people proudly claim to be Keynesians now.

How many of them remember that it was Richard Nixon who made that line famous? He converted to Keynesianism back in 1971 as war spending and the first signs of the coming stagflation damaged his reelection chances.

Like most fox-hole conversions, I question the sincerity of Nixon and other politicians who find that stimulus religion during economic down-turns. Keynesianism was heavily criticized in the ‘60s and ‘70s.  Did Keynes’s new followers really re-examine the fundamentals of macroeconomic theory and find new evidence supporting him?

Or were they simply afraid of becoming the new Hoover, accused of standing idle while the economy collapsed? Fear of that historical legacy could drive anyone to the Politician’s Syllogism: “We must do something. This is something. Therefore, we must do this.”.

Keynes

We’ve been goin’ back n forth for a century
[Keynes] I want to steer markets,
[Hayek] I want them set free
There’s a boom and bust cycle and good reason to fear it
[Keynes] I made my case, Freddie H
Listen up , Can you hear it?

[Hayek sings:]

Things get much more technical from here on. Most people understand what Keynes said (at least they think they understand what they think Keynes said), so Keynes’s half of the rap was pretty straight forward. Grasp a little bit of jargon about Y and demand and you’ve pretty much got it.

Hayek’s ideas are both more complicated and less well known. To do justice to his ideas, Papola and Roberts have to go pretty deep.

I’ll begin in broad strokes, just like my friend Keynes
His theory conceals the mechanics of change,
That simple equation, too much aggregation

One major criticism of C + I + G = Y is that those four simple looking variables conceal tremendous complexity. In the US alone, C represents the spending, preferences and habits of 308 million people and G is 3.69 trillion dollars! If you take the “macro” in macroeconomics seriously, that innocent looking ‘Y’ stands for 6.8 billion people.

Globe

Hayek would argue that these aggregate numbers are meaningless and misleading. There is an almost fractally complex structure inside these variables. Policies which ignore that complexity simply have no chance of working.

For example, the official unemployment rate at this writing is just under 10% (broader measures like U6 are just under 17%). The government might try to reduce this rate with general stimulus spending. But general spending might not get us the biggest bang for our stimulus buck.

Looking under the hood, policy makers find that almost one quarter of the unemployed are construction workers. Great! Now they can target the stimulus! They can load the stimulus up with shovel ready infrastructure projects and put those construction workers back to work.

But there’s a rub. Those construction workers have different skills and are spread unevenly across the country. How many of them are dry-wall hangers who won’t benefit at all from highway building? Are the shovel ready projects concentrated in the areas with the highest unemployment rates?

Let’s face it, politics are going to steer a lot of this money. Do the projects with the most powerful political supporters also have the greatest potential to relieve unemployment? It would be a miracle if they did.

No matter how closely policy makers fine tune their interventions, there will always be mis-matches like these. This is one aspect of the local knowledge problem, one of Hayek's strongest arguments against central planning.

Ignores human action and motivation

gas

Treating C, I and G like real variables also misses how people respond to government attempts to manipulate these quantities. Physicists can get away with equations like PV = nRT because the billions of trillions of molecules in a sample of gas basically are all identical. They are, for most purposes, interchangeable. That makes things easy.

Economists don’t have that luxury.  People don’t bounce around the world like mindless atoms in a jar. People have unique goals, desires, skills and wants. They will act to fulfill those needs regardless of how policy makers want or expect them to react. “After you control for every variable and experimental condition, the organism will do whatever the hell it wants.”

Remember how Bush’s tax rebates were suppose to stimulate the economy? That didn’t work because people didn’t spend them. Instead of running to the mall in a great rush of consumerism, they saved their rebate or used it to pay down debts. Even though Bush really wanted that spending, people had their own ideas and decided they’d rather try to get their financial houses in order to better weather the coming storm.

And yet it continues as a justification
For bailouts and payoffs by pols with machinations

Politicians love Keynes. There is no limit to how far they can stretch his theories and there is no program so shamefully pork-laden that they can’t slap on a Keynesian label and sell it as a public good.

You provide them with cover to sell us a free lunch
Then all that we’re left with is debt, and a bunch

Crying “Stimulus” gives the pols an excuse to indulge in their favorite pastimes, spending and more spending.

But if these stimulus programs don’t work, then we’ve maxed out the nation’s credit cards and have gotten nothing in return. Even if the free lunch never arrives, the bill always does.

If you’re living high on that cheap credit hog
Don’t look for cure from the hair of the dog

Hog

Austrians believe that the business cycle is primarily driven by monetary policy. If the government lets the money supply grow faster than the economy can usefully absorb it, the result will be a speculative bubble erupting in one or more sectors of the economy. This leads to the upswing in the business cycle. When that bubble bursts, it knocks the real economy for a loop and down we go.

Real savings come first if you want to invest

There is something close to a miracle here.  When we consume less than we produce, we can accumulate savings. We store that surplus in the form of money, fancy scraps of paper that are little more than a promise that society and government will pay their debts and play by the rules.

We can invest that surplus in new ideas, new technologies and new businesses which make our lives better. We can cure disease, live longer, more healthy lives, cloth and house ourselves better. We no longer worry about our children surviving their first year and child birth is not a leading killer of women. For the first time in history, we worry that the poorest people are too fat.

In the US and Western Europe we’re so accustom to savings, investment and growth we often ignore it. We sometimes even denigrate it as a dirty, greedy, soulless activity.

Yet it is the closest thing to magic you will ever see. Dumbledore and Potter can’t touch it.

The market coordinates time with interest

One caveat though is that the savings have to find productive investments before the magic can happen and no one can know a priori which investments will be productive. The only way to find out is to place your bets and take your chances. Who knew 12 years ago that something called Google would be central to so many people’s work and play?

For Hayek, interest rates help, over time, guide savings to worthwhile investments. This is an important point. We’ll see more of it in a couple of verses.

Your focus on spending is pushing on thread
In the long run, my friend, it’s your theory that’s dead
So sorry there, buddy, if that sounds like invective
Prepared to get schooled in my Austrian perspective

Ahhh, the Austrians. The nutty uncles of economics. They’re all shills for hard right ideologues. They provide intellectual security blankets for Gold Bugs. At night they check under their beds for Bernanke and Geithner.

Austria

Talk about an image problem.

Over the last several decades, the Austrian school has become short hand for a set of fringe political policies which have little to do with actual Austrian thought. The problem has gotten so bad the blog formerly known as The Austrian Economists has changed its name to the Coordination Problem. After years of trying to rehabilitate the term, they’ve given up.

To some extent, the Austrians have only themselves to blame. Try describing prominent latter day Austrians like Murray Rothbard and Lew Rockwell without using words like “strident”, “loud” and “way out there”.  The fundamental insights of the Austrians, going back to Carl Menger, have been lost in the noise.

Which is too bad. Austrians still have much to teach us.

We’ve been going back and forth for a century
[Keynes] I want to steer markets,
[Hayek] I want them set free
There’s a boom and bust cycle and good reason to fear it
[Hayek] Blame low interest rates.
[Keynes] No… it’s the animal spirits

The next four verses cover the Austrian Theory of the Business Cycle. Hayek won his Nobel, in part, for his work on the Business Cycle. Here’s a broad outline of the theory. We’ll go into details later.

Austrians believe that savings drive the rate at which the economy can sustainably grow. It may be savings within a single nation or it might be international transfers of savings, like we receive from China, Japan and other nations.  Either way, savings create real loanable funds which feed the investment cycle and drive growth.

Interest rates paid on savings are signals, telling people how much savings the economy can profitably use. When interest rates are high, that means entrepreneurs need money for new ventures. When rates are low, it tells people there’s enough money in the system now. Go to Hawai’i instead of socking more money into that 401K.

If the world were Austrian, this feedback loop would work pretty well. Not perfectly, of course. The market isn’t omniscient. It doesn’t have perfect foreknowledge of how much savings we’ll need in 5, 10 or 50 years, but it should work well enough to moderate the ups and downs.

But the world isn’t Austrian. In our world, interest rates are set by central bankers whose foreknowledge is even worse than the market’s. They are also subject to biases, fears, prejudices and the occasional lose of their animal spirits. This causes a mismatch between sustainable interest rates and what the Fed sets.

That mismatch starts the boom.

The place you should study isn’t the bust
It’s the boom that should make you feel leery, that’s the thrust

This may be one reason the Austrians are so unpopular. They’re a bunch of wet blankets. You don’t win friends by reminding the hung-over and half-dead of all the Jäger shots they did the night before.

Shots

An Austrian will tell you that you can’t cure a recession because the recession isn’t the disease. The boom was the disease.

Trying to cure a recession with more cheap credit is like trying to cure chemotherapy with more cancer.

Austrians aren’t all doom and gloom. They have positive policy recommendations. Austrians say that booms are hard to detect at the beginning and are impossible to control once they start. The most important policy goal therefore is to avoid booms in the first place. This means fiscal restraint and stable money, not trying to juice the economy before an election, avoiding foreign cash flow “bonanzas” and generally having politicians act like grown-ups.

People rarely listen to Austrian policy recommendations.

Of my theory, the capital structure is key.
Malinvestments wreck the economy

The mismatch between the market interest rate, driven by the balance between savings and investment, and the lower interest rate set by central bankers makes excessively speculative investment, especially long term investments, seem less risky and therefore more profitable. A lot of projects which would never find funding at the more expensive market rate get greenlights. People pour into newly created jobs and the initial pay-offs from these projects make early investors look like geniuses.

It’s the collapse of these malinvestments that triggers the bust.

The boom gets started with an expansion of credit
The Fed sets rates low, are you starting to get it?

Inflation

Central bankers are subject to many political and policy restraints. The Federal Reserve is explicitly tasked, by law, to control inflation and keep unemployment low (which, to a Keynesian, is like raising both ends of the see-saw). It’s also implicitly responsible for financing Federal spending, making good on all the deposit and asset guarantees we’ve made and a dozen other goals.

When central bankers set interest rates according to these pressures, they are not trying to find the right “natural” rate. They’re trying to keep themselves from being hauled up in front of congress.

Central bankers might set interest rates too low to “accommodate” a real economic expansion, like they did in the late ‘90s with the Tech Bubble. Or they might try lowering rates again to stimulate a recovery. That’s what happened in the early 2000s when interest rates, after adjusting for inflation, were negative for several years.

Lurching from good times to bad, central bankers tend to over-correct. Like drivers on ice, the economy fishtails from one extreme to the other and sometimes ends up in the ditch, shiny side down and greasy side up.

That new money is confused for real loanable funds
But it’s just inflation that’s driving the ones

Inflation is more than just rising prices. It is “always and everywhere a monetary phenomenon.” As the money supply increases faster than the economy can productively absorb, inflation distorts the prices which tell people what is worth buying and what is worth investing in.

Who invest in new projects like housing construction
The boom plants the seeds for its future destruction

In the beginning, inflation feels good. Businesses think their new ability to raise prices without reducing demand is a good thing. They invest in new jobs and machinery, in anticipation of even greater future demand. They build more houses, more cars and more of everything, as the economy gets more top-heavy.

The savings aren’t real, consumption’s up too
And the grasping for resources reveals there’s too few

So the boom turns to bust as the interest rates rise
With the costs of production, price signals were lies

The good times are just an illusion. Eventually the sources of easy money dry up and interest rates head up again.

Investors who were fooled by low interest rates now find that their projects never made sense in the first place. Some projects go under and investors are left scrambling for new funding to keep the rest going.

If investors were foolish enough to fund their long term projects with short term debt (which would have a lower interest rate), they find they can’t secure another round of financing. The same goes for home-owners who used adjustable rate mortgages to buy more house than they could afford.

Without the ability to roll over that debt, these malinvestments collapse.

The boom was a binge that’s a matter of fact
Now its devalued capital that makes up the slack.

Savings , which were once productive wealth, have been turned into abandoned condos, repossessed houses, holes in the ground which should have been skyscrapers and unsold inventory in car lots and electronics stores.

Whether it’s the late twenties or two thousand and five
Booming bad investments, seems like they’d thrive
You must save to invest, don’t use the printing press
Or a bust will surely follow, an economy depressed

The allusion to the printing press is so quaint. In Weimer Germany they may have had to run 30 entire printing plants 24/7 to drive their hyper-inflation.

Today we just move some accounting entries between the Treasury and the Fed, issue some more debt and new money appears as needed.

Your so-called “stimulus” will make things worse
It’s just more of the same, more incentives perverse

On stimulus, Keynes wrote, “Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of classical economics stands in the way of anything better.”

piles of rocks

He knew that there are better ways to stimulate economies than piling up rocks or killing each other. But if politicians can’t support smarter policies, piling up rocks will have to do.

Hayek, OTOH, says, “Look at how people will respond to these perverse incentives. If we start spending billions of dollars building pyramids, pretty soon we’ll have entrenched pyramid lobbies, pyramid schools cranking out stone cutters and sled pullers and ramp maker unions living off pyramid building.”

In the long run, we’ll end up hostage to the pyramid-industrial complex and the economy will be hobbled.

And that credit crunch ain’t a liquidity trap
Just a broke banking system, I’m done, that’s a wrap.

Remember the liquidity trap, where money piles up in banks because people have lost their animal spirit? With bank reserves climbing from $10B in August of 2008 to over a $1T now, it sure looks like a classic liquidity trap.

Except it isn’t. Banks are keeping huge and increasing sums of money in reserve because we’re paying them to!

The Economic Stabilization Act of 2008 allowed, for the first time ever, the Fed to pay banks interest on reserve funds. That rate was set at .25% originally and was recently raised to .5%, an ample return during this “flight to quality”.

In a time when small businesses are starving because of lack of credit, we’re paying banks to keep a trillion dollars on the shelf.

The idea is to strengthen banks with new money and new reserves without actually letting that new money touch the real economy, where it could trigger inflation. It may work, but I don’t think Hayek would approve of this financial Rube Goldberg machine.

We’ve been goin’ back n forth for a century
[Keynes] I want to steer markets,
[Hayek] I want them set free
There’s a boom and bust cycle and good reason to fear it
[Hayek] Blame low interest rates.
[Keynes] No it’s the animal spirits

“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”

John Maynard Keynes

The General Theory of Employment, Interest and Money

Too true. A politician might not even be aware of the ideas that are guiding his actions. But that doesn’t mean those ideas lack power. They move the Overton Window, control what policies are within the bounds of polite discussion and make up the common wisdom people take for granted.

“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

F A Hayek

The Fatal Conceit

It’s said that the two most important things to know about economics are “Incentives matter” and “There ain’t no such thing as a free lunch”.

That’s not bad advice. In fact, “Incentives matter” is a core Austrian insight.  If you don’t spend your day trying to fine tune the economies of nations, it may be all you really need to know.

But if you happen to run the central bank of a major developed nation or create law on Capitol Hill, you should really understand the two things Hayek says here. We don’t understand macroeconomics nearly as well as we think we do and we can really screw things up by fiddling with a system so far beyond our comprehension that we’re basically twisting the knobs at random.

As friend of mine likes to say, “You’ve got enough rope to hang yourself, plus 8 feet.” That’s a good thing to keep in mind when you’re messing with the lives, health and prosperity of 6.8 billion people.

So I’m an Austrian. Sue Me.

Hayek Close Up

You may have noticed my Hayekian leanings more than once. I like the Austrian school for its emphasis on what we don’t know. Most macro schools can be defined by what they leave out of their models, how they simplify our staggeringly complex world in order to make their problems tractable.

The Austrians are always there to remind us that the details are crucial, that there are important things we can’t know, even in theory. Our models, no matter how mathematically elegant, will mislead us when stretched too far.

In Praise of Keynes

Recognizing my own bias, let me end with a defense of Keynes. Keynes was a brilliant and original thinker. He worked on some of the most difficult problems the modern world has ever faced during some of the most difficult times imaginable. He laid the foundation of modern macro. Generations of economists have studied him profitably.

Keynes was a vocal critic of the Treaty of Versailles. He understood that the economic costs reparations would impose on Germany would destabilize Western Europe.  During WW II, he advocated financing the war through savings, not borrowing. Worrying about inflation, he sounds almost like a monetarist.  If politicians had followed his advice, we would have been spared much of the pain of the Great Depression and possibly even WW II.

Unfortunately, much of the nuance and subtlety of Keynes’s thought has been lost over the years. American economists in the ‘50s and ‘60s simplified his ideas to make the math easier. Pundits and policy makers used his flair for a well-turned phrase to turn complex concepts into meaningless buzz words.  The thin paste they’ve made of him is used to justify policies which Keynes would never have supported.

Keynes/Hayek Limo Ride

Researching this diary, I gained a better understanding of the breadth of Keynes’s thinking. The booze swilling, limo riding dandy in the video may have made good footage but it was unfair. I hope it was aimed at the neo-Keynesian hacks who have co-opted him, not at the man himself.

I still think Keynes was wrong about many important issues, including the power of stimulative spending which has become his most enduring legacy. But he was wrong in interesting and fruitful ways. Sometimes, that’s almost as good as being right.

Hayek and Keynes

Two brilliant thinkers who suffered the two worst fates for public intellectuals. Hayek’s forgotten. His ideas are largely ignored by policy makers and lampooned by pundits. Keynes has been reduced to a cartoon, hauled out by politicians every time the economy noses down.

The world would be a richer place, literally, if we paid attention to the real men. Not the cardboard cutouts we have today.

Originally posted to VA Classical Liberal on Mon Mar 01, 2010 at 05:09 AM PST.

Poll

Honor system here. If you read the diary, you get to vote. Who won- Keynes or Hayek?

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78%3571 votes
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3%169 votes

| 4555 votes | Vote | Results

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Comment Preferences

  •  What is economics? (2+ / 0-)

    Art, science, mixture of both, or just plain religion?

    Looks good. Don't have time to read right now, but will get to it.

    •  Roberts would answer "All of the above" (2+ / 0-)
      Recommended by:
      fitzov rules, Terra Mystica

      Roberts is a micro-economist.  He studies things on a much smaller scale than "the whole damn world".

      He's very skeptical about macro-economics.  He thinks it's mostly post hoc story telling.

      Check out EconTalk.  He covers this theme often.

      Results count for more than intentions do.

      by VA Classical Liberal on Mon Mar 01, 2010 at 05:50:40 AM PST

      [ Parent ]

    •  Economics is the astrology of social... (1+ / 0-)
      Recommended by:
      fitzov rules

      ...science. It roots can be traced to something that was real (like how astrology is based on the moon, stars, etc.), but whose accuracy is questionable in today's world. Most economists are matematicians who make models that don't relect the real world to back up their free market dogma. Members of the "Austrian School" are bacically the dogma without the math.

      "...if my thought-dreams could be seen, they'd probably put my head in a guillotine...." {-8.13;-5.59}

      by lams712 on Mon Mar 01, 2010 at 12:10:56 PM PST

      [ Parent ]

  •  I blame Uncle Miltie, (2+ / 0-)
    Recommended by:
    chipoliwog, VA Classical Liberal

    That's all I have to say.
    Free-market fundies ?
    These fools have had their day.

    Good diary, thanks, (and yes, I read it all).

    •  Free markets don't have a "maestro" (1+ / 0-)
      Recommended by:
      Azazello

      First, thanks for reading the whole thing.  I owe you beer.

      Regarding free-market fundies, free markets do not have a Maestro with the whole economy marching to his beat.

      One of Hayek's main points is that central banks are fundamentally about perverting free-markets ("The Fed sets rates low, are you starting to get it?").  Interest rates are a price that tells you the value of money today verses money next year ("The market co-ordinates time with interest").

      Governments setting prices is not a free market.

      Results count for more than intentions do.

      by VA Classical Liberal on Mon Mar 01, 2010 at 05:48:20 AM PST

      [ Parent ]

  •  This is great but (2+ / 0-)

    it does sort of skip over the fact that Keynes was basically written off in the eighties by the Friedmanites and their hyper rational and hyper wrong successors.

    Milt should be in there somewhere lying about the relative importance of the money supply too.

    Just so y'all know. Keynes should have had an upper class English accent. This would never have happened when we still had an Empire.

    Remember to kick it over.

    by sprogga on Mon Mar 01, 2010 at 05:42:30 AM PST

    •  I did cover Milton, a bit. (1+ / 0-)
      Recommended by:
      Terra Mystica

      But there just wasn't space to go into every facet of econ.  It would have been a thesis, not a diary.  So I stuck to just what was in the lyrics.

      Just so y'all know. Keynes should have had an upper class English accent. This would never have happened when we still had an Empire.

      And Hayek should have had an Austrian accent, too.

      Keynes and Hayek were played by a rap/comedy team called Billy and Adam.  I imagine there were some serious constraints in casting those roles.  "We need two guys, a tall one and a short one.  They need to be funny.  They have to be able to rap and they've got to be available in New York on this date."

      Throw in "And one the tall has to be English and the short one Austrian" and you might as well go home.

      Results count for more than intentions do.

      by VA Classical Liberal on Mon Mar 01, 2010 at 05:55:56 AM PST

      [ Parent ]

  •  The Rap, and the Post also ignore - (3+ / 0-)

    Externalities. I think the biggest criticism I have of Austrian economics is that it basically ignores externalities - third party costs incurred by production. There is a cost to pollution (HIGCC is the biggest example). There is a cost to cancer-causing chemicals. There is a cost to a lack of regulation of our food and our drugs.

    Austrians say Government has no business regulating the market in those cases, but has no answer to the high cost of not regulating those markets. In a perfect world, companies would behave in their customer's best interest when it comes to safety and the environment, seeing a long term advantage. But companies don't think in that way. As Keynes said, in the long run we are all dead. That applies to CEOs as well. They need not worry about the long term effects and costs of their work. In the end, they will have died with the most toys.

    Austrian economics is very, very sexy because it's fairly simplistic and it sounds very "liberal" in the classic sense. However, we can all see that as we progress towards more liberal markets, we incur massive costs that cripple us all.

    The video, and the post, were too biased and ignored the key criticism of Austrian economics in favor of presenting a pre-determined conclusion.

    •  This is something of a mis-conception. (0+ / 0-)

      The idea that Austrians are 100% against any government intervention in the market is one of those "nutty uncle" things I was referring too here:

      Over the last several decades, the Austrian school has become short hand for a set of fringe political policies which have little to do with actual Austrian thought.

      Hayek, for example, supported social insurance, industrial regulations and many other government programs which put him at odds with strict anarcho-capitalists.

      Rothbard, who would be the Tea Bagger's econ-hero if they knew who he was, was also very concerned about externalities like pollution.  The big difference is he considered pollution to be a violation of natural rights, not an economic by-product to be regulated.

      To Rothbard, regulation just created a protected class of government approved externalities.  He thought the right place to fight pollution was in the courts.

      I don't agree with his view.  I think they're unworkable.  But to say he (and other Austrians) ignored externalities is off-base.

      Results count for more than intentions do.

      by VA Classical Liberal on Mon Mar 01, 2010 at 06:05:48 AM PST

      [ Parent ]

  •  Skimmed and bookmarked. Can I still vote? ;) (1+ / 0-)
    Recommended by:
    VA Classical Liberal

    I did anyway.  Me bad.

    I think (from reading the diary as much as I did) that:

    A) Massive intervention should have a purpose or objective that will correct structural drags on an otherwise productive economy.  In our times that means building a two way electrical grid or high-speed and cheap internet access for all the utility model (Rural Internetification Agency?), etc.  Otherwise it's simply damping.  Damping is good and necessary, but it's not necessarily forward looking (cliché alert:  In chaos there's opportunity).

    B) If gov't is used to form capital (re: Wall Street or land developers that get public roads put into their property), it must also be used to direct its use, to a degree commensurate with its capital formation use, to address societal needs whether they be temporary assistance or basic/applied research to be shared domestically to better the lives of the people.  That is always wrongly and politically characterized as "picking winners and losers" but it doesn't have to be, and really isn't a binary decision.  Direction into/funding broad areas of development, while letting the diverse vision (macro) yet granular and focused energy of the individuals land upon what creates value or not.  NASA is kinda sorta doing this now with its fostering of a broad array commercial space efforts.  Fair is fair.

    C) Neither of these folks did their work in a time of globalization.  That context really really changes things from a discrete national policy perspective.  You can't effectively stimulate in the Keynsian sense if you don't know what the stimulus is stimulating.  Similarly, you can't create a path (if the objective is to raise the standard of living in the "host" country) for free movement of capital if you don't know where that investment is going to head off to (whether that be value destroying derivatives or another country).  This, imvvho, is the major flaw in the thinking of either school of thought - and our politics.

    Excellent diary.  Thanks for the thought experiment.  

    "Dega dega dega dega. Break up the concrete..." The Pretenders

    by Terra Mystica on Mon Mar 01, 2010 at 05:57:28 AM PST

    •  Thanks and a reply (1+ / 0-)
      Recommended by:
      Terra Mystica

      About gov't and capital formation, that's a fair point.  

      You can use it next time someone living in the Louisiana Purchase complains about America becoming too much like France.

      But I disagree with this:

      That is always wrongly and politically characterized as "picking winners and losers" but it doesn't have to be, and really isn't a binary decision.

      If the government is setting broad rules, applicable to all players and enforcing them evenly, you're right.  But that rarely happens.  Instead we get govt officials and lobbyists explicitly picking winners and losers.  Leahman Bros. goes under but Bear, Sterns gets a bail out.  Chrysler's union employees get a sweetheart deal in a sweetheart bankruptcy, but Indiana's teacher and police unions lose the Chrysler bonds their pension fund bought.
       

      Neither of these folks did their work in a time of globalization.

      Not globalization like we have today, but certainly internationalization generated huge issues.  Keynes's early work for the British government was around correcting the intercontinental distortions caused by gold flow and other issues related to WW I and the fiendishly complex political/financial repercussions of the Treaty of Versilla.  

      The Lords of Finance: The Bankers Who Broke The World is a great book on this subject.

      Results count for more than intentions do.

      by VA Classical Liberal on Mon Mar 01, 2010 at 06:57:59 AM PST

      [ Parent ]

  •  A friend had sent me the video (3+ / 0-)

    I listened to it many times and told him I only understood a little of it.  Thanks for this great background piece, I plan to email it to my friend.

    Diaries like this are why I check DKos every day.  Many smart people come here to share their knowledge and many other smart people challenge them to keep their arguments logical and fact based.

  •  Sorry, the only thing about the Austrian School.. (0+ / 0-)

    ...that is good is that is eschews to overly mathematical and statistical approach of most other schools of thought.

    "...if my thought-dreams could be seen, they'd probably put my head in a guillotine...." {-8.13;-5.59}

    by lams712 on Mon Mar 01, 2010 at 07:16:40 AM PST

    •  Would you elaborate? (0+ / 0-)

      That's a pretty broad statement, especially when describing something that been around for almost 150 years.

      What don't you like about it?

      Results count for more than intentions do.

      by VA Classical Liberal on Mon Mar 01, 2010 at 07:23:41 AM PST

      [ Parent ]

      •  Well, you kind of say it youself... (1+ / 0-)
        Recommended by:
        VA Classical Liberal

        ...in your diary (you were being sarcastic and not meant to be literal). I feel the Austrian School is just a bunch of free-market dogmatic hooey that fails to reflect the REAL world in any way (the crazy uncle indeed). It has an extremely oversimplified view of the world and too much of a faith in "free markets". The only redeeming quality of the school is that it is less emphatic about mathematics (I personally feel economics in general has become the astrology of the social sciences overly dependent on math).

        Take my criticism with a grain of salt. I can write a whole diary on the subject so I do not want to engage in a huge back and forth debate here. I am an economics grad. school dropout, so don't worry, my criticism doesn't mean diddly.

        I took this quiz and it basically brands my a leftist/socialist/communist/Keynesian or something. I guess I am just not sympathetic to your school of thought.

        This was a very good diary you wrote, however, and despite my antipathy towards Autrians, I tipped and rec'd.

        "...if my thought-dreams could be seen, they'd probably put my head in a guillotine...." {-8.13;-5.59}

        by lams712 on Mon Mar 01, 2010 at 08:44:46 AM PST

        [ Parent ]

        •  I'm not a big fan of that quiz. (1+ / 0-)
          Recommended by:
          lams712

          I've seen it before, but literally have never made it through the first choice on the first question.  I doubt the validity of anything written like this.

          Have you seen this quiz?  I like it because it's short, simple and seems to do a good job categorizing the people I know who have taken it.

          Results count for more than intentions do.

          by VA Classical Liberal on Mon Mar 01, 2010 at 09:00:33 AM PST

          [ Parent ]

          •  I am a left-liberal according to... (1+ / 0-)
            Recommended by:
            VA Classical Liberal

            ...that quiz (90% on personal issues and 10% on economic ones).

            "...if my thought-dreams could be seen, they'd probably put my head in a guillotine...." {-8.13;-5.59}

            by lams712 on Mon Mar 01, 2010 at 09:20:29 AM PST

            [ Parent ]

            •  I'm P 100/E 80. (0+ / 0-)

              May I ask which P question you disagreed with?

              And do you think the quiz and the chart represent your views well?

              Results count for more than intentions do.

              by VA Classical Liberal on Mon Mar 01, 2010 at 11:14:05 AM PST

              [ Parent ]

              •  Yes, the chart reflects my views... (0+ / 0-)

                ....accurately. The question on the Personal scale that I disagreed with was:  Government should not censor speech, press, media or Internet. I put "maybe". I believe that there might be circumstances where certain rights are NOT absolute (yelling "fire" in a crowd and all that).

                "...if my thought-dreams could be seen, they'd probably put my head in a guillotine...." {-8.13;-5.59}

                by lams712 on Mon Mar 01, 2010 at 12:05:49 PM PST

                [ Parent ]

                •  Another example, please. (0+ / 0-)

                  I don't think prohibiting yelling fire in a movie house is censorship.  Other examples I can think of, like liable laws, etc., aren't really censorship either (at least not as I see it).

                  What's another example?

                  BTW, I agree with all the P questions (obviously, since I score 100 on that axis) and most of the E questions.  The two I answered maybe to are "Replace Government welfare with private charity" because I think it really depends on what you call charity and "Cut taxes and government spending by 50% or more." because I think this is the wrong question.

                  The question of how big government should be (and therefore how much taxation and spending it should have) can't be answered until you figure out what government should be doing.  That's the important question we keep glossing over.

                  Results count for more than intentions do.

                  by VA Classical Liberal on Mon Mar 01, 2010 at 12:16:32 PM PST

                  [ Parent ]

        •  maths and oversimplifying... (1+ / 0-)
          Recommended by:
          VA Classical Liberal

          I find your comment at odds with your others, given that Keynesianism relies on the maths considerably. That, and the basic formula (C + I + G = Y) behind it treats society like a physics equation and not the complex adaptive system it truly is. While it may not be as oversimplified as the Austrian view, its assumptions can be just as dangerous as those made by the free marketeers.

          That being said, I've enjoyed your commentary throughout this thread.

  •  I did my best -- again. I have read economics (1+ / 0-)
    Recommended by:
    VA Classical Liberal

    books for years including Hayek and Keynes. I have recently read Krugman's huge economics textbook -- yes, I really did. I have taken three economics courses. Two in college and one by an insurance industry educational coop more than thirty years ago. And I still don't get it.

    There only seems to be competing theories each of which claims followers who have a one-size fits all attitude. If this "science" is so powerful, then where is it useful? Is it really knowledge or vaporous argument?

    It seems to me that economists, professional ones, hire themselves out to the highest bidder and they tell their employer what he wants to hear -- and no one can convincingly refute them.

    But other professions don't work that way. Bridge builders hire themselves out to the highest bidder, but no matter what their employer wants, at the end of the project -- and there has to be an end -- the bridge will have to be finished and it will have to safely and expeditiously carry traffic. Not so with economics. If the measures proposed by an economist don't deliver the promised results then the economist is free to proclaim that outside, unpredictable influences produced the disaster.

    The whole mismash reminds me of psychological counseling. There are no dependable procedures, there are many theories that range from scientific to theological. For example in my small town a woman opened a counseling office about six years ago and her process works like this: first she gathers information from the patient concerning the problems that need attention. Then as the patient comes for a session the practitioner alerts her prayer counselors to pray for the patient while the session is underway. They pray for specific solutions to the problems at hand. The counselor, and many of her patients apparently, claim wonderful results. God has intervened on their behalf.

    Economists are the same way. Some pray to the unseen hand, others worship macro models, others...

    Oh, what is the use? Will no one rid the world of this false science?

    Might and Right are always fighting, in our youth it seems exciting. Right is always nearly winning, Might can hardly keep from grinning.

    by hestal on Mon Mar 01, 2010 at 07:25:38 AM PST

  •  i adore this video (2+ / 0-)

    even if I don't totally agree with the conclusions. The way of teaching and educating is opened up by this method/approach.

    Hayek is "better" than Keynes because he accepts we cant have complete knowledge and must accept complexity as well as seeing that the boom is the problem.

    But he never understands the source of the boom. That, plus the fact that Hayek (plus the Austrian school doesn't consider externalities) and considers eternal growth a necessity is part of where Hayek falls short in my mind.

    Hayek doesn't deal with monopoly power or resource hogs which actually are the fuel for the boom. His point is true that it hard to see when the boom starts - but only because we aren't looking in the right place - land (in the classical economic sense).

  •  Wow, Hayek "wins" a poll on Daily.... (0+ / 0-)

    Kos. Either this poll is rigged or the people who voted for Hayek DON'T KNOW shit about him or conversely DON'T know their party's legacy and whose economic thought is was rooted.

    For SHAME, for shame on thsoe who chose Hayek.

    "...if my thought-dreams could be seen, they'd probably put my head in a guillotine...." {-8.13;-5.59}

    by lams712 on Mon Mar 01, 2010 at 08:50:51 AM PST

    •  We're getting a lot of guest today. (0+ / 0-)

      I'm a big fan of Dr. Roberts's EconTalk podcast.  So I sent him a link to the diary.

      He tweeted about it this morning.  Roberts's blog is called Cafe Hayek, so you can guess how his twitter followers are voting.

      Before that, Keynes was winning in a walk.

      OTOH, it's not a scientific poll and there is only one right choice on it.  8 people have picked that one so far.

      Results count for more than intentions do.

      by VA Classical Liberal on Mon Mar 01, 2010 at 09:06:35 AM PST

      [ Parent ]

  •  Thank you for this analysis (1+ / 0-)
    Recommended by:
    VA Classical Liberal

    I have been thinking a lot about this video since I saw it.  I have always leaned more Keynesian but I agree with Hayak that the boom is the problem.  Pretty much everyone here recognized the growth of the Bush years was not real or healthy.

    After thinking more about it I actually think I agree with Hayak on several points but I do not agree that a market with no refs is good for our country.  I could probably fully support Hayak if it wasn't for his idea that the market always will work things out.  A market without refs is anarchy and that is exactly what we got.  

    Read any of Taibi's articles on Goldman -

    http://www.rollingstone.com/...

    http://www.rollingstone.com/...

    This is what happens when people put too much trust in the all knowing market.  People that have more information, use that information to game the system.  It is called information asymmetry.  We must have regulation in place to ensure that those with more information do not take advantage of those with less information.

    Sadly the necessary financial reforms have not occurred and these OTC derivatives are still a problem and will blow up on this country once again.  Then it does I am sure the likes of Jim Bunning will be right there to make sure poor people pay for the excesses of wall street.

  •  This is an exceptionally produced companion piece (2+ / 0-)

    This is a brilliantly written and researched expansion of "Fear the Boom and Bust" and the editorializing within it is totally in line with my personal beliefs and intentions as the co-creator of the song and video.
    Bravo.

    One must distinguish between what's called Keynesian economics and the economics of Keynes if you are to engage in a fair discussion of the man and his ideas. I know I'm still seeking out all the nuances. We mixed both in the video for a synthesis that we felt was fair to his views and to the understanding of his views by most modern self-proclaimed keynesians and as they are taught in intro classes on macro. Though critics, we tried to be fair and sought (and received) the approval of a number of keynesians, including his famed biographer Robert Skidelsky, in the process. This is classroom-grade Keynes.

    If you are to invoke Keynes today, especially as the justification for stimulus, one should consider that Keynes himself rejected the idea of stimulus spending by the British government during the 1937 downturn, despite 11% unemployment. He was openly critical about the political process's ability to time and direct a stimulus effectively. Instead, his final aim appeared to be the more radical approach of "socializing investment" in order to stabilize long term expectations and thus interest rates.

    Keynes was also a remarkably eloquent opponent to inflation and his writing in The Economic Consequences of the Peace alone could have easily come from Hayek on that underhanded and dastardly monetary policy mistake.

    None of this is represented in the justifications for stimulus spending that invoke Keynes today.

    Keynes was a deep, complex thinker. VA has done a superb job giving him his due and I agree with his praise for the contributions Keynes made.

    If one believes, as professor Krugman has repeated asserted, that the overly-mathematized and sterilized macroeconomics of the past 30 years has been a road leading to a dead end, and thus we must look back to Keynes anew, surely that rational opens the field for a reconsideration of Hayek and his nobel-prize-winning Macroeconomics of Capital Structure (to use Roger Garrison's modern phrasing).

    One must also recognize in these criticisms of statistical macro who lead the charge on the mathematization and sterilization of economics: Paul Samuelson and his so-called keynesian successors. The Austrian economists had no role in that sandblasting of the complexities in our complex economy. They have been, in fact, repeatedly ridiculed and marginalized for their unwillingness to use complex statistical analysis as a policy and predictive tool in economic analysis.

    Keynes had useful insights into the way in which cultural shock and subdued animal spirits by reluctant investors could prevent increased savings from translating into increased investment during a depression and thus keep it going. His mistake, in my view, was mistaking the unique problems of the downturn, with its indebted and broken banking institutions from prior excesses, for inherent failing in the free market system.

    Hayek certainly has a major contribution in his explanation of why the boom contains its own undoing and turns to bust in the first place. Keynes and Keynesians (and monetarists of the Chicago School for that matter) have waved away the reasons for the downturn itself. They take no issue with the boom.

    Hayek and the Austrians have an important story to tell in how and why the boom turns to bust that I believe should be considered if we are to avoid a repeat of the same. Their resurgence, to the extent that it is taking place (along with Keynes, of course), and my interest in both are driven directly by how remarkable the Austrian theory applies to the recent series of booms and busts.

    Keynes and Hayek were intellectual adversaries but also colleagues of great mutual respect and admiration. All of us, if nothing else, can learn from that example.

    I'll end with a joke which Keynes and Hayek would likely enjoy equally:

    How do you know macroeconomists have a sense of humor? They use decimal points.

    - John Papola

    •  Thanks for making this video! (1+ / 0-)
      Recommended by:
      VA Classical Liberal

      It is brilliant and I hope it gets more people thinking about the economic forces that caused the situation we find ourselves in.

      I could fully support Hayek if it wasn't for the idea that a free market means no refs and rules. It seems that people that claim to follow the Austrian school of economics (including Chicago) push the idea of deregulation the most.  Probably because these people also happened to be corporatist that want to enjoy the unregulated boom and then leave the tax payers pick up the pieces when things go south.

      A market without refs and rules is anarchy and that is exactly what we got.  Please see my previous comment - http://www.dailykos.com/...

      •  Thanks… now about those regulations. (1+ / 0-)
        Recommended by:
        VA Classical Liberal

        Marshall,

        Thank you for the praise for our video. It’s a genuine education effort and I’m very excited to see it being used enthusiastically in schools already.

        Now, about those regulations…

        Those of us that disagree with government regulations aren’t against refs and rules. We’re against a single monopoly of the rulemaking that has been repeatedly and almost universally captured by the very industries it supposedly “regulates” and used to harm consumers, restrict competition and erect barriers to entry in order to protect politically powerful incumbent corporations.

        There are many natural forces of true regulation. Reputation is a very powerful one. Take note of how Apple and Walmart have both improved (or have claimed to be improving) the working conditions of the Chinese factory partners without any government regulatory changes. Notice how Apple has gone from the bottom to the top of greenpeace’s list for green electronics. This is all the power of reputation.

        Consumer reports is regulation. JD Power and associates is regulation. If these competitive private reputation firms become corrupt or unreliable, they go out of business. Reputation is their sole product. Competition and free entry into the market is regulation.

        Consider the role of the FDA and FCC in restricting competition for big pharma, telecom and broadcast. That’s pure corporatism. And it’s not like the FDA is actually keeping us “safe”. PBS’s frontline has a documentary on the flim flam operation that is the FDA. Same with the USDA. Have you seen Food Inc?

        Did you know that Philip Morris has been lobbying to have tobacco regulated by the FDA for a decade? Why? Because the unnecessary costs it would add would put their small competitors out of business.

        How about that SEC? Their special rules for the financial rating agencies are what allow them to remain a protected cartel. Same goes for the FDIC. Deposit insurance was always a scheme to protect weak and risky banks from the scrutiny of depositors. That’s why FDR was vocally opposed to it and why it lead to bank failures in all of the states that had it prior to the creation of the FDIC.

        Remember the Civil Aeronautic Board? How many new airline licenses did it issue? Zero?  I wonder who that benefitted?

        Do I even need to go into The Fed and it’s bailouts. “Too Big To Fail”?

        I’ll end with an oldie but a goody: the Interstate Commerce Commission. This agency, which was created in 1887 to regulate the big railroads was almost instantly captured and used by them to reduce competition. The regulations it imposed put smaller upstarts and competitors out of business.

        I could go on and on and I’ve only been reading about this stuff for the past few years.

        Maybe this litany isn’t convincing. Go dig into the history and make your own judgements. At the very least, I hope you can entertain the idea that many of us, especially Hayek, oppose government regulations precisely because we want corporate power and greed to be kept in check.

        Government regulations are a “Baptist and the Bootlegger” problem. The politicians play the moralizing preacher, telling us all how they’ll keep us safe and fight evil big business. But history shows that the monopoly power gets used to enrich the bootlegger.

        Cheers.

        •  Thanks for the feedback. (1+ / 0-)
          Recommended by:
          VA Classical Liberal

          Here is an article that does support your argument about reputation being a form of regulation, too bad it didn't kick in until Goldman took the taxpayers for all we are worth - http://finance.yahoo.com/...

          I just have seen time and time again that a corporation harms (physically and financially) American citizens and us having to wait years for the law to catch up to them.  Think about Exxon.  They didn't even have to pay a year of profit for the disaster they caused in Alaska.  Maybe their reputation was harmed but then they just lost the tiger.

          I just think that the Austrian school of economics overestimates the economic force of reputation, especially in industries where there is a significant economic startup cost that inhibits new entrants.  When Exxon is one of the few oil producers then the harm to their reputation can only be so deep.  If a consumer wants oil then they only have a few suppliers to choose from and creating a new oil company is very difficult.  Goldman is one of the few investment banks left and it is very difficult to create a new investment bank so the harm to their reputation can only go so deep.  

          I do agree capture is a problem, as far as I am concerned FASB has been fully captured, especially with the accounting treatment of derivatives.  It just seems to me that capture will always occur and the problem isn't the capture, the problem is that we must ensure that those that regulate these corporations are answering to the taxpayers.  This is difficult because corporations can spend unlimited fund on elections because then corporations will try to make sure those that are friendly to them are elected.

      •  Carter, Kennedy and Deregulation (1+ / 0-)
        Recommended by:
        John Papola

        Marshall,

        Just two points to follow-up on John.

        First, all but the most philosophically radical libertarians agree that the government has a valid regulatory role in markets.  We're happy to have government provide the courts and police power needed to prevent fraud, enforce contracts, punish cheating, etc.  If you believe Edmund Burke's observation that government is that entity with a monopoly on the use of legal force then, by definition, only government can provide these services.  The force which can put you in jail, is the government.

        What we don't want to see is government picking winners and losers in the market.  John gave many good examples.  I'll add one more.

        In the '70s the Clean Air Act required the EPA set rules to reduce smog.  They could have just said that no car can emit more than some level of NOX per mile and let the automakers fight it out to find the best way to meet those goals.

        Instead, the EPA mandated that every car be equipped with an expensive catalytic converter.  Why?

        Because Honda had a well established Clean Engine research program which would have met the EPA standards with no add-on technology. GM, OTOH, had sunk their money into the tailpipe converter.

        Rather than compete with the cheaper, better Honda solution, GM lobbied to force all auto makers to include catalytic converters. That's the regulatory capture John is talking about.  When industry takes over the very body that is suppose to regulate it for it's own benefit.

        Now we're stuck with more expensive cars that perform no better and every time the price of platinum goes up, there's a rash of converter thefts because EPA rules require you to leave $500 of easily fenced precious metal parked at the curb.

        Second, deregulation is not (or at least wasn't always) a partisan activity. The Interstate Commerce Commission was stripped of much of its power by the Motor Carrier Act of 1980.  The MCA was written by Ted Kennedy and signed by Jimmy Carter.  It created hundreds of billions of dollars of new wealth, turned FedEx from a tiny side-player into one of the largest employers in the world, ultimately gave us Amazon.com, and radically reduced corruption and mob influence in trucking.

        It also, ironically, caused the Teamsters to endorse Ronald Reagan in 1980 and pushed Carter's reelection chances even deeper underwater.

        I'll end with a joke too.

        How do you tell the astronomers at the science convention?

        They're the ones with error bars on their exponents.

        I love that one.

        Results count for more than intentions do.

        by VA Classical Liberal on Wed Mar 03, 2010 at 06:23:40 AM PST

        [ Parent ]

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