Gary North on Keynsian insanity

[grapejelly]

Excellent dissection of Keynsian bs, that is prevalent even on iTulip and I think the greatest error being made today, that will perpetuate the current depression and make it very bad.

Also fun: North skewers our pal Ben Stein.

http://www.lewrockwell.com/north/north672.html

To tell American consumers that they can improve the productivity of the economy merely by going out and spending money is Keynesianism. It is utter nonsense. The only way to increase the productivity of the economy is through thrift. The money generated by this thrift must then be invested wisely, in terms of future conditions, so that the company or fund making the investment can reap a profit. If economy cannot do this through increased productivity, it will eventually find itself incapable of raising additional capital. Without additional capital, there can be no increase in productivity.


Economists are supposed to know this, but ever since the Great Depression and the publication of Keynes's magnum opus, most economists have not believed this. They believe that we really can spend ourselves into prosperity, either through personal spending or through government spending. The Keynesian system is opposed to investing during recessions.



I can remember the slogan that was promoted by the government in 1958: "you auto buy now." It was preposterous then, and it is preposterous now. The government today is lending money to Chrysler and General Motors because American consumers are not buying the output of those two companies. The government understands that it cannot afford to give every citizen enough money to go out and buy a new General Motors or Chrysler car, so it uses tax dollars to offer below-market loans to companies that would otherwise go bankrupt. This is the government's alternative to relying on the general public to go out and spend money in a way approved by politicians.



The fact that professional economists have returned to Keynesianism, in the words of the Bible, like a dog to its vomit, should not surprise anyone. Professional economists cannot shake their faith in big government. They cannot shake their faith in deficit spending. They also cannot shake their faith in the power of government to increase productivity merely by spending money on boondoggles. They believe in government, and in government boondoggles, with the same kind of commitment that theologians in the Middle Ages believed in scholastic theology. They cannot think outside the box. The box is labeled: "Spend!"

[mattley]

Re: Gary North on Keynsian insanity

Hear, hear. Read the whole thing.

Too bad he's a lost voice crying in the wilderness. I do not believe the U.S. will ever return to a base of economic sense. Well, as they say, there is a lot of ruin in a country.

[vinoveri]

Re: Gary North on Keynsian insanity

The fact that professional economists have returned to Keynesianism, in the words of the Bible, like a dog to its vomit, should not surprise anyone. Professional economists cannot shake their faith in big government. They cannot shake their faith in deficit spending. They also cannot shake their faith in the power of government to increase productivity merely by spending money on boondoggles. They believe in government, and in government boondoggles, ...!"

Of course economist support big governments. Who would employ, must less elevate economist to the level of sages and oracles except for central planning governments? ) No offense to any professional economist out there.

[ASH]

Re: Gary North on Keynsian insanity

To tell American consumers that they can improve the productivity of the economy merely by going out and spending money is Keynesianism.

The description of Keynesianism sounds like a straw man argument to me. From a Wikipedia passage on Keynesian fiscal policy:

Keynes's theory suggested that active government policy could be effective in managing the economy. Rather than seeing unbalanced government budgets as wrong, Keynes advocated what has been called countercyclical fiscal policies, that is policies which acted against the tide of the business cycle: deficit spending when a nation's economy suffers from recession or when recovery is long-delayed and unemployment is persistently high—and the suppression of inflation in boom times by either increasing taxes or cutting back on government outlays. He argued that governments should solve problems in the short run rather than waiting for market forces to do it in the long run, because "in the long run, we are all dead." [3]

This contrasted with the classical and neoclassical economic analysis of fiscal policy. Fiscal stimulus (deficit spending) could actuate production. But to these schools, there was no reason to believe that this stimulation would outrun the side-effects that "crowd out" private investment: first, it would increase the demand for labor and raise wages, hurting profitability; Second, a government deficit increases the stock of government bonds, reducing their market price and encouraging high interest rates, making it more expensive for business to finance fixed investment. Thus, efforts to stimulate the economy would be self-defeating.

The Keynesian response is that such fiscal policy is only appropriate when unemployment is persistently high, above what is now termed the Non-Accelerating Inflation Rate of Unemployment, or "NAIRU". In that case, crowding out is minimal. Further, private investment can be "crowded in": fiscal stimulus raises the market for business output, raising cash flow and profitability, spurring business optimism. To Keynes, this accelerator effect meant that government and business could be complements rather than substitutes in this situation. Second, as the stimulus occurs, gross domestic product rises, raising the amount of saving, helping to finance the increase in fixed investment. Finally, government outlays need not always be wasteful: government investment in public goods that will not be provided by profit-seekers will encourage the private sector's growth. That is, government spending on such things as basic research, public health, education, and infrastructure could help the long-term growth of potential output.

Invoking public choice theory, classical and neoclassical economists doubt that the government will ever be this beneficial and suggest that its policies will typically be dominated by special interest groups, including the government bureaucracy. Thus, they use their political theory to reject Keynes' economic theory.

A Keynesian economist might point out that classical and neoclassical theory does not explain why firms acting as "special interests" to influence government policy are assumed to produce a negative outcome, while those same firms acting with the same motivations outside of the government are supposed to produce positive outcomes. Libertarians counter that because both parties consent, free trade increases net happiness, but government imposes its will by force, decreasing happiness. Therefore firms that manipulate the government do net harm, while firms that respond to the free market do net good.

In Keynes' theory, there must be significant slack in the labor market before fiscal expansion is justified. Both conservative and some neoliberal economists question this assumption, unless labor unions or the government "meddle" in the free market, creating persistent supply-side or classical unemployment. Their solution is to increase labor-market flexibility, e.g., by cutting wages, busting unions, and deregulating business.

Deficit spending is not Keynesianism. Governments had long used deficits to finance wars. Keynesianism recommends counter-cyclical policies to smooth out fluctuations in the business cycle. An example of a counter-cyclical policy is raising taxes to cool the economy and to prevent inflation when there is abundant demand-side growth, and engaging in deficit spending on labor-intensive infrastructure projects to stimulate employment and stabilize wages during economic downturns. Classical economics, on the other hand, argues that one should cut taxes when there are budget surpluses, and cut spending—or, less likely, increase taxes—during economic downturns. Keynesian economists believe that adding to profits and incomes during boom cycles through tax cuts, and removing income and profits from the economy through cuts in spending and/or increased taxes during downturns, tends to exacerbate the negative effects of the business cycle. This effect is especially pronounced when the government controls a large fraction of the economy, and is therefore one reason fiscal conservatives advocate a much smaller government.

I think some of the animus expressed against Keynes is actually intended for the politicians who find "crib note Keynes" a useful justification for their short-sighted big government policies -- the politicians are happy to engage in deficit spending during downturns (and every other time, too) but don't like to raise taxes and pay off public debt in periods of higher economic growth. Keynes said to do both. Also, Keynsian fiscal policy is not really about productivity so much as demand and full employment.

The only way to increase the productivity of the economy is through thrift. The money generated by this thrift must then be invested wisely, in terms of future conditions, so that the company or fund making the investment can reap a profit.

Productivity gains can be realized in many ways. Labor productivity can be improved by better equipment, infrastructure, or technology (physical capital), or better training and healthier workers (human capital), among other things. One assumes that the commentator regards investment in these productivity-increasing areas to be "wise". Keynesian counter-cyclical policies involve borrowing money (or, these days, more likely creating money) to pay for such "wise" investments -- investing tomorrow's savings today and keeping workers employed through the downturn. ... Only the way our politicians do it, we never actually do any saving when tomorrow arrives.

However, there is a larger problem with the way the commentator frames the issue. Productive capacity without demand doesn't keep people employed. Improvements to productive capacity realized either through investments from "thrift" or Keynsian deficit spending only improve matters once a recovery is underway and there is rising demand to employ the higher productivity. The Keynsian idea of using deficit spending to increase aggregate demand is meant to maintain higher employment rates through a period of low intrinsic demand.

If economy cannot do this through increased productivity, it will eventually find itself incapable of raising additional capital. Without additional capital, there can be no increase in productivity.

Based upon what this commentator wrote about Keynsianism, and based upon his fixation on productivity alone, I don't think he actually knows what Keynsianism is, or indeed understands what the problem is, either. I also get the impression that he's not very comfortable with the concept of credit (else he wouldn't be pretending that most investment in productive physical capital comes out of thrift). All-in-all, more of an ideological piece than anything else.

[mattley]

Re: Gary North on Keynsian insanity

I think some of the animus expressed against Keynes is actually intended for the politicians who find "crib note Keynes" a useful justification for their short-sighted big government policies -- the politicians are happy to engage in deficit spending during downturns (and every other time, too) but don't like to raise taxes and pay off public debt in periods of higher economic growth. Keynes said to do both. Also, Keynsian fiscal policy is not really about productivity so much as demand and full employment.

You can make a case that the USSR wasn't really Marxist, but most people will take your meaning if you say that it was a Marxist state.

Likewise I think it is fair to call Bernanke et al Keynesians or neo-Keynesians or something like that. They certainly believe that increasing "demand" and loose money are instrumental in leading us to recovery.

Keynesian counter-cyclical policies involve borrowing money (or, these days, more likely creating money) to pay for such "wise" investments -- investing tomorrow's savings today and keeping workers employed through the downturn. ... Only the way our politicians do it, we never actually do any saving when tomorrow arrives.

Part of the point of the article is that Keynesianism, as actually practiced, is always used as a justification for more government spending today.

However, there is a larger problem with the way the commentator frames the issue. Productive capacity without demand doesn't keep people employed. Improvements to productive capacity realized either through investments from "thrift" or Keynsian deficit spending only improve matters once a recovery is underway and there is rising demand to employ the higher productivity. The Keynsian idea of using deficit spending to increase aggregate demand is meant to maintain higher employment rates through a period of low intrinsic demand.

Part of the point of the article is that throwing government money at a recession in order to boost demand is destructive in the long run. Printing and handing out money, inventing make work jobs, buying up milk and then it pouring into the gutters, all of these create "demand", but they do not and cannot create real prosperity.

Some people believe that the government can reliably invent projects that bring benefits greater than their costs. While this does ever happen, I think it is unlikely when the underlying motivations are a) finding a way to shove a pile of money into the economy, and b) shoring up interest group support for your re-election.

Based upon what this commentator wrote about Keynsianism, and based upon his fixation on productivity alone, I don't think he actually knows what Keynsianism is, or indeed understands what the problem is, either. I also get the impression that he's not very comfortable with the concept of credit (else he wouldn't be pretending that most investment in productive physical capital comes out of thrift). All-in-all, more of an ideological piece than anything else.

Note, even if you buy a tractor on credit, the money comes from somebody. That somebody gave up consumption today in order to increase productivity tomorrow.

You can argue that the views he is ridiculing are not proper textbook Keynesianism, but I don't think you can argue that they are not common, or are not popular, particularly in Washington. If it is ideological to mock these views, it is no less ideological to promote them, and I hear a lot more of the promoting.

[The Outback Oracle]

Re: Gary North on Keynsian insanity

I'm always intrigued by the idea we can generate productive physical capital out of thin air. Dunno why we just don't get on with it, create an unlimited amount of it, and live in luxury forever.
Or did we just try that?

[grapejelly]

Re: Gary North on Keynsian insanity

The idea of economic stimulus working is about on a par with statist communism "working."

[mcgurme]

Re: Gary North on Keynsian insanity

Maybe both sides are wrong.

We are in an unprecedented situation (in terms of world history), where productive capacity is well beyond meeting our physical needs (at least in the western world). Nobody needs more ipods or tvs or cars or etc to survive, or even to be happy (though, sadly, many people believe that they do).

I like the idea of saving and investing. But, if we all do that, just investing in more productive capacity won't solve anything. There's already plenty in China and India. Working for less than $1/hour, people their can easily produce any physical good we need. While it would be nice if some of that production were in places like the USA, ultimately, the location doesn't matter - what matters is that there is a glut of capacity.

The "demand stimulus" has attempted to soak up some of that capacity, and we did a pretty darn good job of it, too. But, in the process, we over extended ourselves. People became more and more busy, and less and less interested in talking to their neighbors, or participating in community. And they got hugely in debt.

The demand stimulus clearly did work in the past, though its gains were temporary, and led us to the point where we are today. More of that won't work. People are fed up with it. Happiness in the US (and England) has been steadily on the decrease for many years (even before the downturn). In that I agree with Mr. jelly.

Where I think he falls short is on the production side. We don't need more stuff. We have satisfied our material needs, and then some. What we need is higher quality of life. And that's where I find these discussions lacking in vision.

What is quality of life? How can we achieve that? Is it really brought to us by buying cheap Chinese goods at Wal Mart? I really doubt it. Is it brought to us by making more of everything and then having to consume it? I doubt that too.

People talk about dollars here as if they had some intrinsic meaning, but they do not. The only meaning they have is that which participants in their exchange ascribe to them.

If we consider the history of the great depression, there were a number of fiscal "stimuli." Those stimuli had effect only to the extent that the participants believed in their worthiness. While they mitigated the worst of the depression, they did not get the economy roaring again. What did that was WWII. Why did WWII get things going? It gave meaning and a shared purpose to our activities.

The present economic malaise has an underlying problem - the lack of meaning and purpose. Producing ever more big screen TVs ultimately is meaningless. It does not serve any higher purpose, and in fact, it just isolates people. Rather than going down to the corner pub to watch a game on the big screen TV together, people hole up in their McMansion and watch the game in isolation. Study after study has shown that such isolation breeds unhappiness. We in the western world are ever more isolated by our wealth, and ever more unhappy as a result.

I don't believe that any particular economic policy will "solve" our current problems until it deals with this underlying issue - whether it promotes more production (which requires a consumer somewhere), or more consumption (which requires an appetite to keep consuming).

Sadly, it seems to me, most economists lack insight into this issue. While they acknowledge the role that people play in an economy, people are seen as being very simple agents/players, who are solely out to maximize their profit/wealth accumulation. While that simple equation may be true for people who go into economics, there are many people for whom it is not true at all. Just look at the large numbers of people who are by choice taking up small-scale, local farming in order to live a simpler life. I have friends like that. They don't care about being rich. They live in a yurt on a large piece of land, with a huge garden, chickens, etc. And they are some of the happiest people I know.

I hold very little hope for any "economic" solution to our current problems, because none of those solutions addresses the problem of "meaning" or "quality of life". In fact, the latter are explicitly ignored by most economics, which is why they are doomed to fail. Hence, I think the most likely outcome is that various attempts will be made to "rescue" the FIRE economy, that will fail, and at some point our economy will collapse (maybe 3 months, maybe 10 years). When that happens, it will really force a change in how things are done, once and for all.

Nobody can say whether that change will be good or bad. I see a lot of people on this forum and others talking about "Mad Max" scenarios (almost as if that's desirable). That outcome is plausible. But few economic collapses in the past have led directly to Mad Max. Equally likely is that Mad Max will occur in places where social structures have already disintegrated, like Detroit, and many far-flung exurbs. But in places with intact social structures, where communities work together to solve problems like feeding themselves and defending themselves if necessary, life will go on. One can either start building towards that ultimate future now (by building community), or just ignore it and think that buying a bunch of gold, ammo, and a good bunker is going to be good enough. It won't.

[LargoWinch]

Re: Gary North on Keynsian insanity

The idea of economic stimulus working is about on a par with statist communism "working."

GJ, is 2009 the year of the "commodity-backed currency"?


PS: Great find. Enjoyed the article.

[ASH]

Re: Gary North on Keynsian insanity

Note, even if you buy a tractor on credit, the money comes from somebody. That somebody gave up consumption today in order to increase productivity tomorrow.

It seems to me that with fractional reserve lending, the money associated with credit creation doesn't come from somebody giving up consumption... or, at least, only the tiniest fraction comes from somebody giving up consumption and the rest is generated out of thin air. The consumption that is being given up is the consumption tomorrow, when the debt that was created must be paid, and the marginal drop in consumption associated with the reduced purchasing power of existing money which was diluted by adding the newly-created credit to the money supply. (And, if you manage to create even more credit tomorrow, you can put off cutting consumption until the day after tomorrow... etc. etc. etc.) Not saying this is the best way to do things -- just that this is what actually happens. The bank isn't directly lending money that other people deposited as savings. The bank is creating credit from a much smaller base of reserves (which did partly come from savings). Right now, we're living through what happens when this game of perpetual credit expansion is interrupted.

Nit-picking aside, I can accept your perspective about the use of language, with respect to whether a Keynsian is somebody who does what Keynes suggested, or somebody who claims to be doing what Keynes suggested. I suppose I would still call the crusaders of the middle ages "Christians", even if they weren't overly scrupulous in the application of his ideas.

However, since this is a website devoted to the study of economics, I suggest to you that we take a somewhat more precise approach to our use of language, where economic theory is concerned. Since I fall into the camp that thinks Keynsian counter-cyclical fiscal policies are a good idea in general, but that the bozos who only indulge in the first half of the policy have created this mess and are leading us to ruin, some distinction is required in order to carry on a conversation. I'm open to a counter-proposal.

[ASH]

Re: Gary North on Keynsian insanity

The idea of economic stimulus working is about on a par with statist communism "working."

Those stimuli had effect only to the extent that the participants believed in their worthiness. While they mitigated the worst of the depression, they did not get the economy roaring again. What did that was WWII. Why did WWII get things going? It gave meaning and a shared purpose to our activities.

My take is that WWII had the effect of a huge government bump to demand, and is the clearest example in history of stimulating the economy from the demand side. I have fairly conventional views on the political history of WWII, but the economic effect was to pour enormous resources into the gutter while providing a national security justification for massive deficit spending. (The point of this comment is that although I recognize the economic impact, I don't regard the war as originating as a jobs program. ;)) The meaning and shared purpose were nice, but from the standpoint of economics, the jobs were nicer. I think it is indeed fair to question what scale of demand-side stimulus is required to achieve reasonable results. WWII was good enough; the WPA and other such programs may not have been. Neither is it clear that the stimulus being contemplated today will be effective. If my choice is between WWIII and finding out how things work themselves out if we do things grapejelly's way, then my vote is for grapejelly. I am not a wide-eyed Keynsian -- I just don't think its fair to describe all stimulus and no damping as Keynsianism.

[Munger]

Re: Gary North on Keynsian insanity

It seems to me that with fractional reserve lending, the money associated with credit creation doesn't come from somebody giving up consumption... or, at least, only the tiniest fraction comes from somebody giving up consumption and the rest is generated out of thin air. The consumption that is being given up is the consumption tomorrow, when the debt that was created must be paid, and the marginal drop in consumption associated with the reduced purchasing power of existing money which was diluted by adding the newly-created credit to the money supply. (And, if you manage to create even more credit tomorrow, you can put off cutting consumption until the day after tomorrow... etc. etc. etc.) Not saying this is the best way to do things -- just that this is what actually happens. The bank isn't directly lending money that other people deposited as savings. The bank is creating credit from a much smaller base of reserves (which did partly come from savings). Right now, we're living through what happens when this game of perpetual credit expansion is interrupted.

Nit-picking aside, I can accept your perspective about the use of language, with respect to whether a Keynsian is somebody who does what Keynes suggested, or somebody who claims to be doing what Keynes suggested. I suppose I would still call the crusaders of the middle ages "Christians", even if they weren't overly scrupulous in the application of his ideas.

However, since this is a website devoted to the study of economics, I suggest to you that we take a somewhat more precise approach to our use of language, where economic theory is concerned. Since I fall into the camp that thinks Keynsian counter-cyclical fiscal policies are a good idea in general, but that the bozos who only indulge in the first half of the policy have created this mess and are leading us to ruin, some distinction is required in order to carry on a conversation. I'm open to a counter-proposal.

Great fun to contrast Ash's informed and thoughtful posts with buzzword-filled tirades from people who do not understand the role that saving, consumption, banking, capital, etc play in the economy. Austrian ideas certainly make for good morality rants though.

[The Outback Oracle]

Re: Gary North on Keynsian insanity

Oh CharlesI am sure you are an intellectual giant amongst us poor ignorant. First thing though, I think you ought read what is said sometimes. Grade 1.

[bart]

Re: Gary North on Keynsian insanity

The description of Keynesianism sounds like a straw man argument to me. From a Wikipedia passage on Keynesian fiscal policy:

Keynes's theory suggested that active government policy could be effective in managing the economy. Rather than seeing unbalanced government budgets as wrong, Keynes advocated what has been called countercyclical fiscal policies, that is policies which acted against the tide of the business cycle: deficit spending when a nation's economy suffers from recession or when recovery is long-delayed and unemployment is persistently high—and the suppression of inflation in boom times by either increasing taxes or cutting back on government outlays. He argued that governments should solve problems in the short run rather than waiting for market forces to do it in the long run, because "in the long run, we are all dead." [3]

Quite true, and just one of many holes in the Austrian and others criticisms of Keynes... and it also misses an even bigger point and massive hole in Keynes overall theory.

"Governments should solve problems" being that hole, since it inevitably leads towards socialism and the nanny state and worse. I know I'm quoting and making the point out of context but I think you'll grant it, being that Keynesianism is about big(ger) government at root even though his theory seems to state otherwise - the actual effect is clear. He seemed to be coming around a bit more to the points that Mises & Hayek & Rothbard made that are covered fairly well in "The Road to Serfdom" when he died at an early age in 1946... but it remains.

Keynes almost childlike trust that encouraging and bringing government deeply into economics would turn out ok, even given his comments about how little FDR had a clue about economics as early as 1933, also betrays his relative lack of human understanding and consequences.

And now all three levels of government approach half of the total economy.

[ASH]

Re: Gary North on Keynsian insanity

Quite true, and just one of many holes in the Austrian and others criticisms of Keynes... and it also misses an even bigger point and massive hole in Keynes overall theory.

Keynes almost childlike trust that encouraging and bringing government deeply into economics would turn out ok, even given his comments about how little FDR had a clue about economics as early as 1933, also betrays his relative lack of human understanding and consequences.

And now all three levels of government approach half of the total economy.

Yes. I think mattley was right when he posted that "Keynesianism, as actually practiced, is always used as a justification for more government spending today." Your comments about Keynes's "childlike" trust in government and his "relative lack of human understanding" seem spot on to me.

Keynes proposed methods which may have been theoretically sound, but which were bound to be misapplied and abused in practice. My complaint about the commentary is that it co-mingles the correct observation that Keynesian economics is used to justify reckless and routine government deficit spending with more dubious assertions about what exactly Keynes proposed, and its supposed mechanical problems.

I bother to split hairs for two reasons. First, I'm very tired of crooks and charlatans cloaking their snake oil with borrowed prestige. We should demonize the swindlers rather than the thinkers whose work and name they appropriate, and we should remember men for their own ideas. Second, to understand economics, we need to grasp both the mechanical and the human. I think it is useful to know that the major problem with Keynesian economics lies in the human sphere, because if the underlying mechanics is valid, it can still advance our understanding of economic relationships. We still need to understand how things work, even if a particular policy based upon that understanding is (or should be) barred to us by human nature.

Lastly, the volume of my posts notwithstanding, I am not widely or deeply read in economics. I mean no disrespect to anyone here by arguing my opinions, and I feel no disrespect to anyone, either. (Now, cross me on a matter of the physical sciences, and then I'll be a total a**hole!)