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.
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
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.
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.
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
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
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.
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!
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
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.”.
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.
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
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
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.
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.
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?
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.”
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.
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.
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.
