Keynesianism is an ass

[Augustine2004]

Pilgrim called me an ass. Now he has an excellent chance to thoroughly demonstrate that I am.

Murray Rothbard reviewed Henry Hazlitt’s challenge to Keynesianism, The Failure of the “New Economics.” He described the book as “vitally important and desperately needed” and “a detailed, thoroughgoing refutation of the General Theory.

The Keynesian Revolution did not succeed because the theory was obviously correct or supremely useful. Keynes apparently cleverly dressed up fallacies in “a wilderness of unclear writing and pretentious jargon” and “a bewildering morass of strange concepts.” Keynes’ followers “claimed to be the only ones able to understand the Master.” Old economists were cowed by those people, who were 35 or younger. And there was Keynes himself “an eminent, aristocratic Englishman–witty, charming, and thoroughly irresponsible.”

Two other factors boosted the revolution. The world was tilting towards statism. And Cambridge, Keynes’ home, previously taught a kind of economics that had important gaps, such as a theory of the business cycle.

Many Austrian school economists went over the Keynesian camp. Rothbard didn’t really explain why, but my guess is they were drawn to the state’s lure of material benefits. Another factor that Rothbard really didn’t cite, is that Mises’ Human Action wasn’t published until 1949. Hazlitt used principles from that book to demolish Keynesianism.

I’ve only just begun to study Hazlitt’s book .

[Augustine2004]

Hey Pilgrim, you got something to prove.

Keynes often used mathematical equations in his work. That’s a red flag. Now, to be sure, Man, Economy, and State by Rothbard does use equations. However, he made use of tables and diagrams far more often. I flipped through 885 pages of Human Action by Mises and failed to spot any equation. Both Rothbard and Mises use logic, all right, but there are indeed no constants in human action. Action taken by people or the choices that they make are essentially unpredictable. That leads to the conclusion that we can’t have equations in economics that are the counterparts of an equation in physics like F = ma where F is the force imparted to the free mass, m, and a is the mass’ acceleration. In some situations, like a rocket accelerating away from Earth, the mass varies with time, but its variation is known. Usually the mass is a constant, to the disappointment of many a miss who is vainly dieting.

[Sheepdog]

you expect Pilgrim to do more than toss bricks? to actually carry a substantive conversation? seriously?

[Augustine2004]

I guess I should not expect Pilgrim to be better than a brick tosser. Hey Pilgrim, you're a brick, nayah, nayah.

Moderator, it may be necessary for me to chain my posts now and then. Is that OK?


On page 50 (the book itself, not the PDF), Hazlitt wrote, “Keynes manages to insinuate the notion that the way people spend their incomes is essentially non-rational or irrational.” I’m not sure I agree with Hazlitt’s disapproval. If you ask a person why he choose to spend his money on a particular thing, he may give you reasons, but they may be not rational. Why those reasons and none other? He may not be able to answer. An economist would just have to take a person’s choice or action as granted, or assume it for the purpose of giving an example or analyzing a particular situation.

Hazlitt quotes Keynes, "But although the [Ricardian] doctrine itself has remained unquestioned by orthodox economists up to a late date, its signal failure for purposes of scientific prediction has greatly impaired, in the course of time, the prestige of its practitioners." (page 57) While economics is an useful science, you know already what I’m going to say, that people’s actions or choices are not perfectly predictable by any known means. I myself did predict in a way that we’re in for another Great Depression, but the timing and severity I didn’t know and still don’t know.

Mises did predict in a way the demise of the Soviet Union, but he didn’t know when and exactly how it would die. What effect did Ronald Reagan’s deal with the Saudis to keep oil prices low have on the Soviet Union?

Today the economy is manipulated by the government to benefit the ruler class. If you agree that the economy should be for the benefit of everyone, it follows that the government should refrain from manipulating the economy to benefit the ruling class. Is manipulation for the benefit of everyone still a good idea? No. The government must be able to forecast the consequences of any given manipulation. If the consequences do not benefit everyone, then don’t do the manipulation. The principle must be that no one should be made to suffer more than otherwise as a result of the manipulation. Do no harm. Because people’s choices or actions are not precisely predictable except rather broadly and in the short term usually, the government can’t do anything therefore with the economy. In any case, Austrian school economists have not found any case of putative manipulation that would benefit everyone. Take minimum wage legislation, for example. Analysis show that the people earning marginal wages are likely to lose their jobs. The people who do benefit are those who earn above-minimum wages. They have less competition, so can become lazy a bit, while they continue to earn cushy wages and enjoy greater job security.

What is left is laissez faire. If the government cannot do more except to take resources from the economy, what would be the point? How to spend those taken resources? Away with the USFG! The State governments! Also the local governments, but I would allow panarchy. Let those crazies choose their statist government, as long as it’s local, and everyone has some choice of governments–or none.

Another reason for laissez faire, is that generally speaking everyone knows his desires and situation in the world better than the government could. For the government to know what any given individual wants, he has to be allowed to act freely. To be sure, that means everyone has to allow everyone else his liberty.

Justice is necessary, because we will have evildoers. When they are caught, they must make their victims whole in so far as that is possible.

[Augustine2004]

I find it hard to believe anyone would take a guy seriously after he defines two terms in such a way that they must be identically the same, and afterwards go for pages like those terms are not really the same (pages 80-1). See page 95, in which saving is sinful, yet investment is a virtue.

Now, economics is not ethics, judging acts as sinful or virtuous, though Austrian School economists often assume or discuss the free market, in which everyone follows the Maybury precepts. I.e., we won’t have the free market unless everyone follows the Maybury precepts. You don’t have to point out that in that sense today’s economy is far from being free.

Hazlitt sums up what he thinks Keynes is advocating: “The great virtue is Consumption, extravagance, improvidence. The great vice is Saving, thrift, "financial prudence." We are to be improvident. I doubt Keynes was a Christian or believed in miracles. Something has got to be off kilter in his theory. Would you be improvident on the grounds it would help everyone else? Including your kids? Bah, humbug. In the great housing bubble, were we not improvident? Are we not now suffering greatly? More suffering yet to come, I’m afraid.

[Augustine2004]

From page 133 of Hazlitt’s book:

It is this wilful blindness to the two-sidedness of every transaction—this concentration on the incentives to borrowing and obliviousness of those to lending, on the incentives of the buyer and not of the seller, of the Consumer and not of the Producer, this terrific to-do about the propensity to consume while the propensity to work is taken for granted or forgotten—it is this one-eyed vision that constitutes the Keynesian "revolution."

I’d guess 80% of people hired to work as economists or maybe 90% are one-eyed people. Unfortunately most work for the government. Nobelist Paul Krugman, for one, is a columnist, but he does definitely work for the government, though not in an official capacity.

Ah, at last, the fabulous creature, the Multiplier, the Shmoo of our times (page 135). If I understand Hazlitt right, Keynes thinks that government’s spending can act like a car’s supercharger on the economy, except the government can create ‘money’ simply by pressing a button on a computer keyboard. The more inflation, the greater the prosperity. Wheeaaooo! Flattened like a pancake by the sheer acceleration. But many people were flattened in the current depression and many more will be.

I am amazed that someone like Keynes apparently does not understand why gold is so valuable. Furthermore, do 80% or so of professional “economists” really not understand? Or pretend that gold should not be regarded as valuable? (Page 155.)

[Augustine2004]

Hazlitt considers what Keynes wrote about risk, starting on page 165. I doubt Hazlitt handled the topic adequately. To be sure, Hazlitt may have much narrower definitions of risk in mind or considered rather specific situations. Nevertheless, his treatment seems to me at least misleading.

Every action has its own set of risks, without exceptions. Wits may put it this way: Life is a gamble. To be sure, by taking a new and different action, one may exchange one set of risks for another. Or, transform a present set of risks into another.

What cannot be done is to meaningfully reduce the level of risk, whatever that phrase may mean in the sense of an operational definition. It may be possible, but we shall never know for sure. To be sure, if one feels uncomfortable with one’s current set of risks, he may seek to transform that to one that he feels more comfortable with. Two or more actors may cooperate so as to transform their respective sets of risks. For example, insurance and futures trading.

By the same token, it’s not meaningful either say that the overall level of risk is thereby increased. Some people are thrill-seekers, but can we say that their lives are thereby more risky than the stay-at-home people? What about the risk of boredom? I do not see why we should value that any less than that of bungee jumping or parachuting, in view of our lack of knowledge about the future and inability to properly evaluate any particular risk.

In a related matter, you may have heard a lot of USFG chatter about systemic risk in the ‘free’ market.
http://www.lewrockwell.com/blog/lewr...es/025978.html
Anyone talking that up should be challenged to give an operational definition. I.e., is there a way to measure it? If so, what procedure should we follow? I’m sure you are going to get nothing substantive in whatever response there is.

Please, any criticism or questions?


...

On page 182, Hazlitt wrote, “The difference between gambling and speculation is clear: in gambling, the risks are arbitrarily invented or created; in speculation, the risks already exist, and somebody has to bear them.” It’s possible I fail to understand what is meant by arbitrarily invented or created risk. Anyway, I say that the gambler may have a different tolerance for risk in general than a given speculator. However, that’s a corollary of the truth that everyone has a different tolerance for risks than does everyone else.

Is there indeed a difference between gambling and speculation? The answer depends on the precise definitions of both terms. In general, however, I would say no.


...

I should have read on instead of immediately uploading my last post. Hazlitt wrote this: ‘The world would probably be richer rather than poorer if gambling casinos and race tracks did not exist at all.’
Wow, how could he make a statement like that? What about the risk of boredom, for one thing?

Anyway, pages 182-5 make it evident why politicians, including totalitarians and authoritarians, love Keynesianism. People who desire power can rationalize their taking it by quoting Keynes, especially those pages.

On page 191 Hazlitt seems to think that sometimes people don’t speculate. I wish there were a definition of speculation. As I’ve implied before, every time we choose some course of action and put that in effect, we are in some sense speculating. The guy that saves his money under his mattress is speculating as much as the guy that puts his money on pig-belly futures options.

No one can be considered a scientist who does not pay the requisite attention to necessary facts. On page 195 Hazlitt says that Keynes ignores real factors in the level of rates of interest. For that reason I say Keynes was no scientist.

[Augustine2004]

In an economy like the USA one in the decade after World War II, the following conclusion may apply:
‘So the process by which the Central Bank originally was able to lower interest rates, will now simply serve to raise them.’ The explanation on page 214 involves inflation.


Hazlitt espies another connection between Keynes and the Marxists.

Keynes was left with no real theory of interest. But on second thought it is clear that he was flirting with the oldest theory of all—the Exploitation Theory. This was once described by Irving Fisher as the persistent idea that "to take interest is, necessarily and always, to take an unfair advantage of the debtor. This notion is something more than the obviously true idea that the rate of interest, like any other price, may be exorbitant. The contention is that there ought to be no interest at all." After tracing the persistence of this notion through primitive societies, ancient Rome, and the Middle Ages, Fisher declared that, "Today the chief survival of the exploitation idea is among Marxian Socialists."13 But Fisher wrote this some years before Keynes attempted still another revival in "modern" guise.

(Page 216.)

[Augustine2004]

On page 222, Hazlitt wrote, ‘Every manufacturer or seller knows that when by production or offer he increases the supply of a commodity he does not thereby raise its price . . .’ Surely Hazlitt meant the average price of commodities like what the manufacturer makes, that were sold in the past. Of course the manufacturer is free to set whatever price on his own manufactured goods he likes, but one knows that it would be foolish to set a price so high that prospective customers would think it ‘highway robbery.’

On page 225, Hazlitt wrote:

For if prices and wage-rates are fluid in both directions, the immediate response to a falling off in the desire to buy goods or to hire workers would be a lowering of prices or wage-rates to a point where people would cease to attempt to save more than before and would consent to make their usual purchases again. In any case, the reduced supply of money
offered would now be sufficient to buy the previous volume of goods and to employ the previous number of workers at the now lower prices and wages.

I’m afraid some readers would think this is wrong. How could a diminished supply of money buy the same goods as before? That’s because sellers set their prices lower. The average height of prices is lower in conformance with the smaller size of the money supply.

As long as prices are free to move up or down, that is the reason why, as we add to our gold stock, it would still be able to buy any constellation of goods, no matter how big. Suppose that on the average there’s more gold per person than before. No problem! Prices will simply go up, without any dire economic consequences. On the other hand suppose we have less gold per person. Prices goes down, again no problem.


On pages 228-9 before Section 3, I think Hazlitt had the Federal Reserve System or some generalized central bank system in mind. The free-market banking system and the free-market money system don’t work like what Hazlitt describes. If someone wants, I can recommend books to read on the free-market systems.


Section 3 on page 229 may puzzle some readers. I suggest that they read Section 1.4 (page11?) of Man, Economy, and State by Murray Rothbard available in the Mises.org bookstore bookstore

Of course if some readers are still puzzled, they will have to go to the beginning of Chapter 1 of M,E,S.
I would be glad to answer any reasonable question.

[Obsidian]

Austrians wrongly condemn the use of equations. Equations are only bad if they contain serious flaws.

In the case of Keynesian economics, the flaw is quite simple:

GDP = G + I + C + NX --- The GDP formula is itself the problem.

Obviously government expenditures (G) will always be more wasteful than consumer (C) expenditures. Therefore, our basic formula for calculating national wealth is erroneous!

One other flaw of Keynesian economics is that consumer spending (C) may be manipulated through national debt. The manipulated spending will be more wasteful than natural spending levels. Republicans frequently make this error. They use national debt to obtain money for tax cuts, and then they give the money to the consumers to spend, thinking they are creating wealth.

*Sigh*

[Augustine2004]

Obsidian, will you please give us an example of a equation that does not contain any serious flaw and is useful for something?

[Augustine2004]

• Edited by a Moderator •

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Darn it Aug, you KNOW BETTER than to argue moderation in the thread

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[joel]

I decided to post here. I assume you are still free to dialogue here.

Are you reading Keynes' General Theory too, or just Hazlitt? I recently read the General Theory and Hazlitt's book side-by-side. My general impression is that Keynes was a poor writer and a poor thinker. I find it difficult to understand how anyone took Keynes for a serious economist.

Keynes offers the absurd ideas of the multiplier and the liquidity preference theory of interest. And then the rest of his reasoning is based on those ideas.

I think the point Obsidian made was valid, that it is useful to explain why a use of equations is wrong, as opposed to dismissing it with "equations are useless in economics" (though that may be the case).

For example, consider Keynes' use of algebra. He declares functional relationships that don't exist. For example, he defines O(N), the function of total output as a function of total employment of labor. Even ignoring the fact that total output and total employment of labor cannot be objectively quantified, there isn't a functional relationship. Given the same value of N, those workers could work on different projects, using different materials and different techniques. All of these choices affect output, and thus there is not a unique value of output for a given value of N. If x workers moved from project A to project B, then N stays the same, but total output may, as a result, increase or decrease.

In chapters 19, 20, 21 which are supposed to be his crowning achievement, he defines several functions (that aren't functions) like this. Then he does a bunch of differential calculus on them and derives equations relating their elasticities. But if there does not really exist a functional relationship--if O(N) is not a function in the real world--then you can't differentiate it. It's not a function (let alone a continuous, differentiable function), thus it does not have a slope or an elasticity.

Another part of the problem is that he seems to lose sight of cause and effect. For example: He divides all spending Y (and thus money income) into the categories consumption C and investment I, thus:

Y = I + C

is true by definition. If Y increases by a small amount ΔY, C and/or I must also change (by ΔC and ΔI), thus

ΔY = ΔI + ΔC

is also true by definition. Keynes then does some algebraic manipulation to get:

ΔY = (1/(1 - ΔC/ΔY))*ΔI

And defines k = (1/(1 - ΔC/ΔY)) as the "multiplier", thus ΔY = k * ΔI.
He takes this to be a functional relationship (Note that k hides a ΔY inside it; thus ΔY is on both sides of the equation, and thus this equation does not even define a proper algebraic function.), and thinks that we can then infer that an increment in investment will cause an increase in total income by k times that amount. Now, the equation is true--by definition. But Keynes' problem is that he (mis-)reads cause and effect into it.

The equation is true for any three quantities such that X = Y + Z. For example, suppose we have a bucket of marbles, some green G and some blue B. If M is the total number of marbles, then we have M = G + B, and we can do the same algebra as keynes to get

ΔM = k * ΔG,

with k = (1/(1 - ΔB/ΔM)) as the "multiplier". Supposing we add only green or blue marbles to the bucket, this equation is true, but we cannot safely conclude that all we have to do is add some green marbles to the bucket and then the total number of marbles will increase by more than that, as if additional blue marbles pop into existence by magic because some mysterious force holds k between 0 and 1.

Also if ever ΔC = ΔY, which is certainly possible, then the multiplier becomes infinite! (or rather, undefined. k will approach infinity in the limit.) Keynes' assertion of this cause and effect relationship also rules out the possibility of people deciding to consume less and invest more (or vice versa), so that ΔC = -ΔI, and Y stays the same. This, again would cause the multiplier to have a division by zero, and thus be undefined (though its limit would be zero).

Keynes was a hack. He overcomplicated some things and grossly over-simplified other things, and these errors led him to absurd conclusions.

[Augustine2004]

I didn't read the General Theory. I think Keynes wanted the kind of conclusions that supported big-government socialism or maybe rather fascism--like Nazi Germany's economic policy. The General Theory was created and shaped to obtain that kind of conclusions, and promoted to appeal to politicians and other socialists.

[joel]

I didn't read the General Theory. I think Keynes wanted the kind of conclusions that supported big-government socialism or maybe rather fascism--like Nazi Germany's economic policy. The General Theory was created and shaped to obtain that kind of conclusions, and promoted to appeal to politicians and other socialists.

Let's suppose you are correct. Then Keynesian ideas became mainstream because mainstream economists also desired justification for their previous love of big government?

But then why does the mainstream still hold onto Keynes' framework? Even Milton Friedman, who was for the most part a libertarian and apologist for small government, bought into this basic framework and made a case for small government from within the framework instead of refuting the framework itself. (For this reason, Friedman still couldn't reject monetary policy.) From what I understand, Friedman and some neoclasical "mainstream" economists argue for smaller government, but still hold onto ideas such as a consumption function and the multiplier, an aggregate demand function, liquidity preference theory of interest, the IS-LM model. But economists like Friedman have no reason such as you suggest for buying into this framework. So why do they? (After reading General Theory, I read this http://legacy.ncsu.edu/classes/ec348001/TextLinks.htm which I think gave me a better understanding of what "mainstream" economists think today. On the other hand most of the derivation of the models in this book consists of unsupported assertions, thus leaving me in the dark as to why they believe these things.)

Do you know of any debates between 'Austrian' and 'mainstream' economists (say, over something like the IS-LM model), that would help illuminate their point of departure? Or it would also be helpful if I had one or more 'mainstream' economists with whom I could dilalogue.