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Keynesian Political Economy Is Theft – Monty Pelerin’s World : Monty Pelerin’s World
Keynesian Political Economy Is Theft – Monty Pelerin’s World : Monty Pelerin’s World.
The plague of our time is Keynesian economics. It has destroyed the economics profession and enabled the political class to obtain powers never intended.
Keynesian economics provided the intellectual cover for the criminal class we politely call “government” to plunder its citizenry. In the beginning, clear-thinking, independent economists (not dependent on government largess) expressed objections to this “new economics.” There was little new in Keynes’ work and many errors that had been debunked decades before Keynes was even born. Bastiat’s parable of the “broken window” in 1850 is probably the best-known refutation, although similar arguments preceded Bastiat by a century or more.
In the 1930s leaders were desperate and willing to try anything. Keynes General Theory was published in 1936, during the middle of the greatest depression the world had ever experienced. Politicians, more so than economists, welcomed his ideas as a new approach.
The Austrian economists represented by Mises and Hayek saw the fallacies in this new approach immediately. Some of the Chicago School (Knight, Simons, Viner) did also. Ludwig von Mises, never one to mince words, described Keynesian economics in the following manner:
What he really did was to write an apology for the prevailing policies of governments.
Mises likely was one of the few who saw the full ramifications of what Keynesian economics would provide for government. Most early criticisms were in terms of the economic unsoundness of the theory.
To contrast the blatant differences between proper economics and Keynesian prescriptions, the following two prescriptions were offered early in this century:
It was proper that one of these men should have won the Nobel Prize in economics. It just happened to be the wrong one.
JAMES BUCHANAN, NOBEL LAUREATE
In 1977 James M. Buchanan and Richard E. Wagner wrote “Democracy In Deficit — The Political Legacy of Lord Keynes” (available online). It was the first comprehensive attempt to apply public-choice theory to macroeconomic theory and policy. According to Robert D. Tollison:
The central purpose of the book was to examine the simple precepts of Keynesian economics through the lens of public-choice theory. The basic discovery was that Keynesian economics had a bias toward deficits in terms of political self-interest.
From Buchanan and Wagner came this judgment regarding Keynesian economics:
The message of Keynesianism might be summarized as: What is folly in the conduct of a private family may be prudence in the conduct of the affairs of a great nation. (p. 3)
This fundamental confusion was responsible for the political acceptance of Keynesian economics. Politicians saw the potential for themselves in this new doctrine which advocated central control of the economy and fiscal irresponsibility as a necessary and patriotic thing. Giving them this gift was like providing matches and gasoline to an arsonist. (“I don’t want to spend money, but I have to otherwise the economy will tank.”)
Once government took control of the economy, they needed economists to provide the analysis and justifications for their new policies. Many in the economics profession were procured in similar fashion used with prostitutes. Money and power were heady incentives for a profession that had rightly been consigned to a section in their own ivory tower.
Justifying what government wanted to do and was doing was the only requisite. But, in order to qualify, it became necessary to convert to Keynesianism. Other branches of economics condemned government policies, at least on economic grounds.
Economists more than most understand incentives. When the payoffs increase, some men in any profession find it easy to modify ethics and integrity.
Buchanan and Wagner knew the damage that Keynesian economics had already inflicted and knew its potential was much greater. Thirty-seven years ago they commented:
What happened? Why does Camelot lay in ruin? Viet Nam and Watergate cannot explain everything forever. Intellectual error of monumental proportion has been made, and not exclusively by the ordinary politicians. Error also lies squarely with the economists. (p. 4)
They answered their own question:
The academic scribbler of the past who must bear substantial responsibility is Lord Keynes himself, whose ideas were uncritically accepted by American establishment economists. The mounting historical evidence of the effects of these ideas cannot continue to be ignored. Keynesian economics has turned the politicians loose, it has destroyed the effective constraint on politicians’ ordinary appetites. Armed with the Keynesian message, politicians can spend and spend without the apparent necessity to tax. “Democracy in deficit” is descriptive, both of our economic plight and of the subject matter for this book. (p.4)
Now, thirty-five plus years later, one may judge the merit in this book. Prescience, while not limited to them alone, was amazing.
One must also marvel at the continuation and acceleration of the ruinous policies. Whether Buchanan and Wagner imagined things could go on for so long and to such an extent is not known. However, to appreciate these changes, this graph from Zerohedge shows the effects of Keynesianism and what it has done to governments around the world:
The deterioration in fiscal discipline was astounding and in line what they predicted.
As this false economic theology known as Keynesianism runs its course, the following conclusions are probable:
- Regardless of whether this generation escapes or not, we have impoverished our children and grandchildren.
- Politicians now control most of the economy, including what passes for acceptable economics.
- No honest economist can work for government; nor would one want to.
- The tipping point for reversing this condition has long past.
- Politicians have no incentive to stop the process underway.
- Markets (and perhaps societies and governments) will eventually collapse, ending this terrible period of economic madness.
When this flawed paradigm is finally exhausted, the world may enter a better place in terms of economics and limited government. Without this shift, poverty and misery will grow along with wars used as political diversions.
One can only hope that the world avoids an Economic Dark Age when the collapse occurs.
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Keynesian Political Economy Is Theft – Monty Pelerin's World : Monty Pelerin's World
Keynesian Political Economy Is Theft – Monty Pelerin’s World : Monty Pelerin’s World.
The plague of our time is Keynesian economics. It has destroyed the economics profession and enabled the political class to obtain powers never intended.
Keynesian economics provided the intellectual cover for the criminal class we politely call “government” to plunder its citizenry. In the beginning, clear-thinking, independent economists (not dependent on government largess) expressed objections to this “new economics.” There was little new in Keynes’ work and many errors that had been debunked decades before Keynes was even born. Bastiat’s parable of the “broken window” in 1850 is probably the best-known refutation, although similar arguments preceded Bastiat by a century or more.
In the 1930s leaders were desperate and willing to try anything. Keynes General Theory was published in 1936, during the middle of the greatest depression the world had ever experienced. Politicians, more so than economists, welcomed his ideas as a new approach.
The Austrian economists represented by Mises and Hayek saw the fallacies in this new approach immediately. Some of the Chicago School (Knight, Simons, Viner) did also. Ludwig von Mises, never one to mince words, described Keynesian economics in the following manner:
What he really did was to write an apology for the prevailing policies of governments.
Mises likely was one of the few who saw the full ramifications of what Keynesian economics would provide for government. Most early criticisms were in terms of the economic unsoundness of the theory.
To contrast the blatant differences between proper economics and Keynesian prescriptions, the following two prescriptions were offered early in this century:
It was proper that one of these men should have won the Nobel Prize in economics. It just happened to be the wrong one.
JAMES BUCHANAN, NOBEL LAUREATE
In 1977 James M. Buchanan and Richard E. Wagner wrote “Democracy In Deficit — The Political Legacy of Lord Keynes” (available online). It was the first comprehensive attempt to apply public-choice theory to macroeconomic theory and policy. According to Robert D. Tollison:
The central purpose of the book was to examine the simple precepts of Keynesian economics through the lens of public-choice theory. The basic discovery was that Keynesian economics had a bias toward deficits in terms of political self-interest.
From Buchanan and Wagner came this judgment regarding Keynesian economics:
The message of Keynesianism might be summarized as: What is folly in the conduct of a private family may be prudence in the conduct of the affairs of a great nation. (p. 3)
This fundamental confusion was responsible for the political acceptance of Keynesian economics. Politicians saw the potential for themselves in this new doctrine which advocated central control of the economy and fiscal irresponsibility as a necessary and patriotic thing. Giving them this gift was like providing matches and gasoline to an arsonist. (“I don’t want to spend money, but I have to otherwise the economy will tank.”)
Once government took control of the economy, they needed economists to provide the analysis and justifications for their new policies. Many in the economics profession were procured in similar fashion used with prostitutes. Money and power were heady incentives for a profession that had rightly been consigned to a section in their own ivory tower.
Justifying what government wanted to do and was doing was the only requisite. But, in order to qualify, it became necessary to convert to Keynesianism. Other branches of economics condemned government policies, at least on economic grounds.
Economists more than most understand incentives. When the payoffs increase, some men in any profession find it easy to modify ethics and integrity.
Buchanan and Wagner knew the damage that Keynesian economics had already inflicted and knew its potential was much greater. Thirty-seven years ago they commented:
What happened? Why does Camelot lay in ruin? Viet Nam and Watergate cannot explain everything forever. Intellectual error of monumental proportion has been made, and not exclusively by the ordinary politicians. Error also lies squarely with the economists. (p. 4)
They answered their own question:
The academic scribbler of the past who must bear substantial responsibility is Lord Keynes himself, whose ideas were uncritically accepted by American establishment economists. The mounting historical evidence of the effects of these ideas cannot continue to be ignored. Keynesian economics has turned the politicians loose, it has destroyed the effective constraint on politicians’ ordinary appetites. Armed with the Keynesian message, politicians can spend and spend without the apparent necessity to tax. “Democracy in deficit” is descriptive, both of our economic plight and of the subject matter for this book. (p.4)
Now, thirty-five plus years later, one may judge the merit in this book. Prescience, while not limited to them alone, was amazing.
One must also marvel at the continuation and acceleration of the ruinous policies. Whether Buchanan and Wagner imagined things could go on for so long and to such an extent is not known. However, to appreciate these changes, this graph from Zerohedge shows the effects of Keynesianism and what it has done to governments around the world:
The deterioration in fiscal discipline was astounding and in line what they predicted.
As this false economic theology known as Keynesianism runs its course, the following conclusions are probable:
- Regardless of whether this generation escapes or not, we have impoverished our children and grandchildren.
- Politicians now control most of the economy, including what passes for acceptable economics.
- No honest economist can work for government; nor would one want to.
- The tipping point for reversing this condition has long past.
- Politicians have no incentive to stop the process underway.
- Markets (and perhaps societies and governments) will eventually collapse, ending this terrible period of economic madness.
When this flawed paradigm is finally exhausted, the world may enter a better place in terms of economics and limited government. Without this shift, poverty and misery will grow along with wars used as political diversions.
One can only hope that the world avoids an Economic Dark Age when the collapse occurs.
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The World According To Ron Paul | Zero Hedge
The World According To Ron Paul | Zero Hedge.
With 72% of those polled believing “big Government” is more of a problem now than 4 years ago, it is hardly surprising that Ron Paul blasts “the failure of government is all around us” in this brief FOX news interview. Perhaps it is the fact that “Obamacare has been such a trasparent failure of big government,” along with Keynesian economics, and the NSA debacles; that more and more of even the most liberal are realizing just what America has become. “It’s really great news that people are starting to recognize this,” Paul adds, because there is no way to replace the status quo “until people give up on what we have.”
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Who Needs the Debt Ceiling? – Russell Lamberti – Mises Daily
Who Needs the Debt Ceiling? – Russell Lamberti – Mises Daily.
US lawmakers reached a budget deal this week that will avert the sequester cuts and shutdowns. These fiscal “roadblocks” supposedly damaged investor confidence in 2013, although clearly no one told equity investors who’ve chased the S&P 500 up 26 percent this year. But even so the budget deal is seen by inflationists as only half the battle won, because it doesn’t deal with the pesky debt ceiling. Unsurprisingly, the old calls for a scrapping of the debt ceiling are being heard afresh.
Last week, The Week ran an opinion piece by John Aziz which argues that America (and all other nations for that matter) should keep borrowing until investors no longer want to lend to it. To this end, it is argued, the US should scrap its debt ceiling because the only debt ceiling it needs is the one imposed by the market. When the market doesn’t want to lend to you anymore, bond yields will rise to such an extent that you can no longer afford to borrow any more money. You will reach yournatural, market-determined debt ceiling. According to this line of reasoning, American bond yields are incredibly low, meaning there is no shortage of people willing to lend to Uncle Sam. So Washington should take advantage of these fantastically easy loans and leverage up.
Here’s part of the key paragraph from Aziz:
Right now interest rates are very low by historical standards, even after adjusting for inflation. This means that the government is not producing sufficient debt to satisfy the market demand. The main reason for that is the debt ceiling.
What this fails to appreciate is that interest rates are a heavily controlled price in all of today’s major economies. This is particularly true in the case of America, where the Federal Reserve controls short-term interest rates using open market operations (i.e., loaning newly printed money to banks) and manipulates long-term interest rates using quantitative easing. By injecting vast amounts of liquidity into the economy, the Fed makes it appear as though there is more savings than there really is. But US bond yields are currently no more a reflection of the market’s demand for US debt than a price ceiling on gasoline is a reflection of its booming supply. Contra the view expressed in The Week, low rates brought about by contrived zero-bound policy rates and trillions of dollars in QE can mislead the federal government into borrowing more while at the same time pushing savers and investors out of US bond markets and into riskier assets like corporate bonds, equities, exotic derivatives, emerging markets, and so on.
Greece once thought that the market was giving it the green light to “produce” more debt. Low borrowing rates for Greece were not a sign of fiscal health, however, but really just layer upon layer of false and contrived signals arising from easy ECB money, allowing Greece to hide behind Germany’s credit status. As it turned out, a legislative debt ceiling in Greece (one that was actually adhered to) would have been a far better idea than pretending this manipulated market was a fair reflection of reality. Investors were happy to absorb Greece’s debt until suddenly they weren’t.
This is the nature of sovereign debt accumulation driven by easy money and credit bubbles. It’s all going swimmingly until it’s not. And there is little reason to think this time the US is different. Except that America might be worse. The very fact of the Fed buying Treasuries with newly printed money proves Washington is producing too much debt. China even stated recently that it saw no more utility accumulating any more dollar debt assets. If the whole point of QE is to monetize impaired assets, then the Fed likely sees Treasury bonds as facing considerable impairment risk. Theory and history are clear about the reasons for and consequences of large-scale and persistent debt monetization.
Finally, it is wrong to assert that the debt ceiling is the main reason for America’s fiscal deficit reduction. The ceiling has never provided a meaningful barrier to America’s borrowing ambitions, hence the dozens of upward adjustments to the ceiling whenever it threatens to crimp the whims of Washington’s profligate classes. America’s rate of new borrowing is falling because all the money it has printed washed into the economic system and found its way back into tax revenues. Corporate profits are soaring to all-time highs on dirt cheap trade financing. Corporate high-grade debt issuance has set a new record in 2013. Companies are rolling their short-term debts, now super-cheap thanks to Bernanke’s money machine, and issuing long, into a bubbly IPO and corporate bond market. The last time corporate profits surged like they’re doing now was during the credit and housing bubble that preceded the unraveling and inevitable bust in 2008/09.
These are money and credit cycle effects. The debt ceiling has had precious little to do with it. Moreover, US debt is neither crimped nor the US Treasury Department austere. Instead, the national debt is soaring, $60,000 higher for every US family since Obama took office and rising. Add to this the fact that the US Treasury’s bond issuance schedule is actually set to rise in 2014 due to huge amounts of maturing debt needing to be rolled over next year, and the fiscal significance of the debt ceiling fades even further.
The singular brilliance of the debt ceiling however, is that it keeps reminding everyone that there is a growing national debt that never seems to shrink. That is a tremendous service to American citizens who live in the dark regarding the borrowing machinations of their political overlords. Yes, politicians keep raising the debt ceiling, but nowadays they have to bend themselves into ever twisty pretzels trying to explain why to their justifiably skeptical and cynical constituents. Most people don’t understand bond yields, quantitative easing, and Keynesian pump-a-thons too well, but they sure understand a debt ceiling.
Conclusion
Those who adhere to the don’t-stop-til-you-get-enough theory of sovereign borrowing, and by extension argue for a scrapping of the debt ceiling, couldn’t be more misguided. In free markets with no Fed money market distortion, interest rates can be a useful guide of the amount of real savings being made available to borrowers. When borrowers want to borrow more, real interest rates will rise, and at some point this crimps the marginal demand for borrowing, acting as a natural “debt ceiling.” But when markets are heavily distorted by central bank money printing and contrived zero-bound rates, interest rates utterly cease to serve this purpose for prolonged periods of time. What takes over is the false signals of the unsustainable business cycle which fools people into thinking there is more savings than there really is. Greece provides a recent real-world case study of this very phenomenon in action. In these cases we are likely to see low rates sustained during the increase in government borrowing, only for them to quickly reset higher and plunge a country into a debt trap which may force default or extreme money printing.
Debt monetization has a proven track record of ending badly. It is after all the implicit admission that no one but your monopoly money printer is willing to lend to you at the margin. The realization that this is unsustainable can take a while to sink in, but when it does, all it takes is an inevitable fat-tail event or crescendo of panic to topple the house of cards. If the market realizes it’s been duped into having too much before the government decides it’s had enough, a debt crisis won’t be far away.
Note: The views expressed in Daily Articles on Mises.org are not necessarily those of the Mises Institute.
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Russell Lamberti is head strategist at ETM Analytics, in charge of global and South African macroeconomic, financial market, and policy strategy within the ETM group. Follow him on Twitter. See Russell Lamberti’s article archives.
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Krugman’s Adventures in Fairyland – William L. Anderson – Mises Daily
Krugman’s Adventures in Fairyland – William L. Anderson – Mises Daily.
After studying and teaching Keynesian economics for 30 years, I conclude that the “sophisticated” Keynesians really do believe in magic and fairy dust. Lots of fairy dust. It may seem odd that this Austrian economist refers to fairies, but I got the term from Paul Krugman.
According to Krugman, too many people place false hopes in what he calls the “Confidence Fairy,” a creature created as a retort to economist Robert Higgs’s concept of “regime uncertainty.” Higgs coined that expression in a 1997 paper on the Great Depression in which he claimed that uncertainty caused by the policies of Franklin Roosevelt’s New Deal was a major factor in the Great Depression being so very, very long.
Nonsense, writes Krugman. Investors are not waiting for governments to “get their financial houses in order” and protect private property. Instead, he claims, investors are waiting for governments to spend in order to create enough “aggregate demand” in the economy to bring about new investments and, one hopes, full employment.
According to Higgs, the “humor columnist for the New York Times, Paul Krugman, has recently taken to defending his vulgar Keynesianism against its critics by accusing them of making arguments that rely on the existence of a ‘confidence fairy.’ By this mockery,” Higgs says, “Krugman seeks to dismiss the critics as unscientific blockheads, in contrast to his own supreme status as a Nobel Prize-winning economic scientist.”
It seems, however, that Krugman and the Keynesians have manufactured some fairies of their own: the Debt Fairy and the Inflation Fairy. These two creatures may not carry bags of fairy dust, but they might as well, given that their “tools” of using government debt and printing money to “revitalize” the economy have the same scientific credibility.
Let us first examine the Debt Fairy. According to the Keynesians, the U.S. economy (as well as the economies of Europe and Japan) languishes in a “liquidity trap.” This is a condition in which interest rates are near-zero and people hoard money instead of spending it. Lowering interest rates obviously won’t spur more business borrowing, so it is up to the government to take advantage of the low rates and borrow (and borrow).
If governments issue enough debt, argue Debt Fairy True Believers, the economy will gain “traction” as government spending, through the power of pixie dust, fuels a recovery. Governments spend, businesses magically gain confidence, and then they spend and invest. (At this point, we are apparently supposed to just overlook the fact that the Keynesians are saying that we need the Debt Fairy to resurrect the Keynesian version of the Confidence Fairy.)
The Inflation Fairy also plays an important role, according to Keynesians, for if bona fide inflation can take hold in the economy and people watch their money lose value, then they will spend more of their savings. In turn, this destruction of savings will, through the power of Keynesian sorcery, revive the economy. Thus inflation undermines what Keynesians call the “Paradox of Thrift,” a theory that says if a lot of people withhold some present consumption in order to save for future consumption, the economy quickly will implode and ultimately will slip into a Liquidity Trap in which no one will spend anything.
These fairies can work their magic if (and only if) one condition exists: factors of production are homogeneous, which means that government spending will enable all lines of production simultaneously. The actual record of the boom-and-bust cycle, however, tells a different story. It seems that the Debt and Inflation Fairies enable booms along certain lines of production (such as housing during the past decade), but as everyone knows, the fairy dust lost its magical powers and the booms collapsed into recessions.
Austrians such as Mises and Rothbard have well understood what Keynesians do not: the structures of production within an economy are heterogeneous and can be distorted by government intervention through inflation and massive borrowing. Far from being creatures that can “save” an economy, the Debt Fairy and the Inflation Fairy are the architects of economic disaster.
Despite Keynesian protestations that the U.S. and European governments are engaged in “austerity,” the twin fairies are active on both continents. The fairy dust they are sprinkling on the economy, however, is more akin to sprinkling ricin on humans. In the end, the good fairies turn into witches.
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Economic Prosperity Ahead or A Train A Comin’ – Monty Pelerin’s World : Monty Pelerin’s World
Economic Prosperity Ahead or A Train A Comin’ – Monty Pelerin’s World : Monty Pelerin’s World.
Whether the light at the end of the economic tunnel represents sunshine or an on-coming train depends on whom you ask. I am of the opinion that it is a train a comin’. Economic matters cannot get better until we hit bottom and rebuild from the ashes. That need not be except government policies drive us there.
Government, especially the current one, has incented people to not work by providing overly long and generous benefits. Society has an obligation to take care of its less fortunate, but it does not have an obligation to encourage people to join that group and then make it comfortable enough that they have little incentive or ability to leave. The dole should not be a safety net, not a career choice!
One political party in particular has interest in seeing dependency grow. It forms a substantial part of their support and power. The creation of more dependents is the creation of more voters and more electoral success. No society can grow or recover when government deliberately undermines the need to work. That path leads to poverty and destruction.
Printing money is no substitute for effort. It does not create things or wealth. The myth of Keynesian economics is not the answer to a society that declines in labor force participation and has fewer productive people supporting more dependents. Incentives at the individual level must be changed in order to make work more desirable and attractive than welfare.
A society whose workforce is in decline is one that can pretend to live at former levels only by consuming the wealth and capital created by previous generations. This behavior is equivalent to the man who used to make $250,000 per year in a job and now is unemployed. To save face, he continues to live as if he is still earning at his previous rate. He achieves this short-run living style only by consuming the capital that he built up from years of hard work. At some point, he runs out of capital and must live as a pauper (or the modern equivalent of one).
Our economy and government both behave like this formerly rich man. Both are consuming the seed corn in order to maintain the appearance of well-being. Politicians will continue this behavior until the music stops. Hopefully when that happens there is enough left of society and freedom to allow a rejuvenation.
Many believe that government and its partner the Federal Reserve are wise and strong enough to avoid this crash. If printing money and spending money were a solution, there would be no poverty anywhere in the world. Even the poorest country has a government and can afford a printing press.
Thus far there has been no collapse. However, that is equivalent to the man who jumps off the Empire State building and is heard to say as he flashes by the fortieth floor: “So far, so good.” His fate was sealed when he jumped. Similarly, so is our economy’s. Economics has its own gravity. It is as powerful and immutable as that of physics.
“So far so good” is not acceptable for an economy. There has been no economic recovery since one was falsely declared in June of 2009. The distortions and mis-allocations imposed on the economy for the last several decades are cumulative and have finally reached that stage where they can no longer be covered up. The myth of a recovery is getting harder to maintain.
A complete cleansing of the mal-investments, distorted incentives and regulatory burdens must occur before a true recovery can take place.
Can the economy flutter around is some kind of air pocket at the fortieth floor for a year or even several before resuming its destiny with terra firma? Perhaps, but it cannot fly without wings and these have been removed by regulatory interference and economic interventions over the course of decades. They can re-grow, but not before a complete and total cleansing.
A major crash is coming. The dot.com bubble and the housing bubble were not crashes, at least as I imagine a crash. They were the beginnings of corrections that were aborted by government economic intervention. The country survived these two major bubbles, but only at the cost of making the next one bigger. Government did not save us from these two events. They created them and by deferring their correction assured the next one would be bigger and more painful.
The video below shows a train moving down a track. It struck me as a reasonable metaphor for our economy. The train represents market forces, slow but powerful. The train does not appear threatening. But, like markets, it represents a massive force. That the video is in slow motion exaggerates the surprise and the force.
Government may believe it is in control of the economy, but it is not. It may think it is influencing and controlling outcomes. To some degree it is and has. However the forces that have built up over decades of these interventions cannot, at some point, be controlled. The mismatch between Ben Bernanke, Barack Obama, the Federal establishment and all their dollars and regulations is about to be run over by the train that represents decades of suppressed market forces.
No government is a match for hundreds of millions of citizens who are represented by markets. Suppressing markets is suppressing the will of citizens. At some point markets dig in their heals and say enough. Then government is helpless.
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End this Depression? Never | Business Spectator
End this Depression? Never | Business Spectator.
Larry Summers’ speech at the IMF has provoked a flurry of responses from New Keynesian economists that imply that Summers has located the “Holy Grail of Macroeconomics” – and that it was a poisoned chalice.
“Secular stagnation”, Summers suggested, was the real explanation for the continuing slump, and it had been with us for long before this crisis began. Its visibility was obscured by the subprime bubble, but once that burst, it was evident.
So the crisis itself was a sideshow. The real story is about inadequate private sector demand, which may have existed for decades. Generating adequate demand in the future may require a permanent stimulus from the government – meaning both the Congress and the Fed.
What could be causing the secular stagnation – if it exists? Krugman noted a couple of factors: a slowdown in population growth (which is obviously happening: see Figure 1); and “a Bob Gordon-esque decline in innovation” (which is more conjectural).
Figure 1: Population growth rates are slowing
So is a secular trend to lower growth the reason for the continuing stagnation, six years after the crisis began? And is Summers now the Messiah?
Reading Krugman or Miles Kimball, you’d think so on both counts. Kimball headlines his coverage with “Larry Summers just confirmed that he is still a heavyweight on economic policy”, while Krugman states that while he’s been thinking on the same lines, “Larry’s formulation is much clearer and more forceful, and altogether better, than anything I’ve done. Curse you, Red Baron Larry Summers!”
On the issue itself, you’d also think that suddenly the lightbulb has switched on as well, after years in the darkness before and after the crisis. Though Summers’ thesis has its critics (such asStephen Williamson), there’s a chorus of New Keynesian support for the “secular stagnation” argument, which implies it will soon become the conventional explanation for the persistence of this slump long after the initial financial crisis has passed.
Krugman’s change of tune here is representative. His most recent book-length foray into what caused the crisis – and what policy would get us out of it – was entitled End This Depression Now!. The title screamed that this crisis could be ended “in the blink of an eye”, while the text argued that all it would take is a sufficiently large fiscal stimulus to help us escape the “zero lower bound”. Krugman wrote:
“The sources of our suffering are relatively trivial in the scheme of things, and could be fixed quickly and fairly easily if enough people in positions of power understood the realities.
“One main theme of this book has been that in a deeply depressed economy, in which the interest rates that the monetary authorities can control are near zero, we need more, not less, government spending. A burst of federal spending is what ended the Great Depression, and we desperately need something similar today.”
Post-Summers, Krugman is suggesting that a short, sharp burst of government spending will not be enough to restore “the old normal”. Instead, to achieve pre-crisis rates of growth in future – and pre-crisis levels of unemployment – we may need permanent government deficits, and permanent Federal Reserve spiking of the asset market punch via QE and the like. Not only that, but past apparent growth successes – such as The Period Previously Known as The Great Moderation – may simply have been above-stagnation rates of growth motivated by bubbles:
Krugman asks: “So how can you reconcile repeated bubbles with an economy showing no sign of inflationary pressures? Summers’ answer is that we may be an economy that needs bubbles just to achieve something near full employment – that in the absence of bubbles the economy has a negative natural rate of interest. And this hasn’t just been true since the 2008 financial crisis; it has arguably been true, although perhaps with increasing severity, since the 1980s.”
This argument elevates the “zero lower bound” from being merely an explanation for the Great Recession to a General Theory of macroeconomics: if the zero lower bound is a permanent state of affairs given secular stagnation, then permanent government stimulus and permanent bubbles may be needed to overcome it.
Or, as Krugman puts it: “One way to get there would be to reconstruct our whole monetary system – say, eliminate paper money and pay negative interest rates on deposits. Another way would be to take advantage of the next boom – whether it’s a bubble or driven by expansionary fiscal policy – to push inflation substantially higher, and keep it there. Or maybe, possibly, we could go the Krugman 1998/Abe 2013 route of pushing up inflation through the sheer power of self-fulfilling expectations.”
So is secular stagnation the answer to the puzzle of why the economy hasn’t recovered post the crisis? And is permanently blowing bubbles (as well as permanent fiscal deficits) the solution?
Figure 2: A secular slowdown in growth caused by a secular trend to stagnation
Firstly, there is evidence for a slowdown in the rate of economic growth over time, as well as its precipitous fall during and after the crisis. The growth rate was as high as 4.4 per cent per annum on average from 1950-1970, but fell to about 3.2 per cent per annum from 1970-2000 and was only 2.7 per cent in the noughties prior to the crisis, after which it has plunged to an average of just 0.9 per cent per annum (see Table 1).
Table 1: US Real growth rates per annum by decade
The sustained growth rate of the US economy is lower now than it was in the 1950s-1970s, and the causes go well beyond the undoubted demographic trend that Krugman nominates and the rather more dubious suggestion of a decline in innovation.
Firstly, the corporate transfer of production from the US (and Europe) to the third world over the last 40 years has substituted low-wage, low-consumption third world workers for high-wage, high-consumption Americans and Europeans. This benefited Western and third-world capitalists, but at the expense of reducing global demand. The free trade that conventional economists champion has in fact help replace the ‘beggar the neighbour’ politics of the protectionist past with ‘beggar thy working class’ politics today.
Secondly, there’s the impact of rising inequality on consumption. Inequality is at unprecedented levels today, possibly the highest it has ever been in human history, according to James K Galbraith, the global authority on this topic. That inequality leads to huge demand for luxury yachts, but diminished demand for almost everything else. Demand in the aggregate could fall.
And there’s a third factor that Krugman alludes to in his post, which I suspect might start to turn up in future in his explanation of the crisis: the rise in household debt during 1980-2010. With the notable exception of Robert Shiller, this wasn’t foreseen by mainstream economists in neither thefreshwater nor saltwater sects.
Figure 3, sourced from the St Louis Fed’s excellent FRED database, and taken from Krugman’s post, outlines this trend.
Figure 3: Ratio of household debt to GDP
Now, as any well-trained economist knows, it’s a matter of simple logic that what happens to private debt is irrelevant to macroeconomics most of the time because “debt is one person’s liability, but another person’s asset”.
However, private debt does matter during a liquidity trap, because then lenders might get worried about the capacity of borrowers to repay and impose a limit on debt that borrowers have already exceeded, forcing borrowers to repay their debt and spend less. To maintain the full-employment equilibrium, people who were once lenders have to spend more to compensate for the fall in spending by now debt-constrained borrowers.
But lenders are patient people, who by definition have a lower rate-of-time preference than borrowers, who are impatient people.
In the New York Times, Krugman wrote: “Now, if people are borrowing, other people must be lending. What induced the necessary lending? Higher real interest rates, which encouraged “patient” economic agents to spend less than their incomes while the impatient spent more.”
The problem in a liquidity trap is that rates can’t go low enough to encourage patient agents to spend enough to compensate for the decline in spending by now debt-constrained impatient agents.
Krugman elaborates: “You might think that the process would be symmetric: debtors pay down their debt, while creditors are correspondingly induced to spend more by low real interest rates. And it would be symmetric if the shock were small enough. In fact, however, the deleveraging shock has been so large that we’re hard up against the zero lower bound; interest rates can’t go low enough. And so we have a persistent excess of desired saving over desired investment, which is to say persistently inadequate demand, which is to say a depression.
Summers’ thesis now implies that the US economy has in fact been in a liquidity trap for decades, possibly “since the 1980s”, Krugman contends.
This suggests a hypothesis that I wouldn’t at all be surprised to see tested in the pages of theNew York Times. Firstly, America hasn’t always been suffering secular stagnation, nor has it always been in a liquidity trap. Secondly, sound economics tells us that only when the economy is in one does private debt matter macroeconomically. So it should be possible to work out how long the liquidity trap has applied, by working out when the level (or rate of change, or some other measure) of private debt correlated with macroeconomic variables (say the level, or rate of change of unemployment), and when it didn’t.
I await the test of this hypothesis. I might even check it out myself.
Steve Keen is author of Debunking Economics and the blog Debtwatch and developer of the Minsky software program.
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Bad News for Keynesians: Data Shows the Austerians Are Right | CYNICONOMICS
Anders Aslund of the Peterson Institute recently made an interesting argument about Europe’s winners and losers. In a critique of Paul Krugman’s advice to Europe’s political leaders, he compares economic performance of the southern European laggards to the northern countries and, in particular, the Baltic states.
Aslund concludes that:
Today, the record is clear. The countries that have followed [Krugman’s] advice and increased their deficits (the South European crisis countries), have done far worse in terms of economic growth and employment than the North Europeans and particularly the Baltic countries that honored fiscal responsibility.
He also links fiscal adjustments to structural reforms:
Thanks to greater structural adjustment, the growth trajectory is likely to be higher in countries that quickly and enthusiastically embrace these reforms than elsewhere. Accordingly, the three Baltic countries that suffered the largest output falls at the outset of the crisis because of a severe liquidity freeze returned to growth within two years and have, over the same period, enjoyed the highest growth in the EU. By contrast, Greece, with its back-loaded fiscal adjustment, as recommended by Krugman, has suffered from six years of recession.
By comparing past reforms to recent growth, Aslund takes a sensible approach. But he focuses mostly on the tiny Baltics and secondly on continental Europe, which begs the question: What about larger countries everywhere?
Let’s have a look.
We start with every country that has both a global GDP share of greater than 0.25% in 2007 (pre-global financial crisis) and sufficient data on fiscal balances and growth. This is 47 countries. We then divide the group into a European sub-group (23 countries) and a non-European sub-group (24 countries). For each sub-group, we compare real GDP growth for 2010 to 2012 (post-GFC) to the average structural budget balance for 2008 and 2009 (during the GFC).
Here are the results:
Not only is there a positive relationship between stronger public finances during the crisis and faster post-GFC growth, but the relationship holds both within and outside Europe. (For those who like statistics, the F-stat for the European regression is significant at 99.9%, while the other regression is significant at 90% but not 95%.)
Conclusions
We have two observations. First, the results may help explain why Keynesian pundits resort to nonsensical arguments. They often claim that poor performance in countries attempting to contain public debt proves austerity doesn’t work, which is like deciding your months in rehab stunk, and therefore, rehab is bad and heroin is good. A more honest approach is to compare fiscal actions in one time period with results in later periods, after the obvious short-term effects have played out. But if Keynesians did that, they would reveal that their own advice has failed.
Second, the effects discussed by Aslund don’t receive enough attention. As Tyler Cowen (who gets credit for the pointer) wrote, Aslund’s perspective “is underrepresented in the economics blogosphere.”
And that includes our wee blog.
Regular readers know that we’ve presented research on long-term fiscal policy effects. (For example, see our historical study of 63 high government debt episodes, or our Fonzie-Ponzi theory.) We’ve also argued that the short-term consequences of fiscal tightening, often said to support Keynesian policies as noted above, actually do just the opposite. (Consider that fiscal tightening is motivated by today’s massive debt burdens, and these happen to be explained best by Keynesianism – the deficit spending policies of the past that hooked economies on unsustainable finances in the first place.)
But until now, we haven’t offered research on intermediate-term effects – horizons of 2-5 years as in the charts above. And this evidence supports Aslund’s conclusions.Policymakers should heed his argument that “front-loaded fiscal adjustment quickly restores confidence, brings down interest rates, and leads to an early return to growth.”
(Click here for the country-by-country data that was used in the charts.)
Bad News for Keynesians: Data Shows the Austerians Are Right | CYNICONOMICS.
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The Life And Death Of A Massive Debt Bubble In Seven Charts | Zero Hedge
The Life And Death Of A Massive Debt Bubble In Seven Charts | Zero Hedge. (FULL ARTICLE)
On September 5, 2008, Citi’s Matt King wrote a report titled “Are the brokers broken?” which in its rhetorical question (the answer was and still is yes), implicitly explained why ten days later the world would experience the largest bankruptcy in the history of western civilization, crushing confidence in the financial system to this day, and forcing the Fed for five consecutive years to be the marginal source of credit money in a “not without training wheels” world in which the longer the central bank is the only backstop of anything and everything, and where failure and risk are prohibited through artificial means, the less faith there is in any and every financial counterparty. So when Matt King sat down to pen his latest warning in which he showed how the world is now “positioning for the wrong sort of recovery”, we naturally listened. Below are the key charts which not only show the lifecycle of the source of every modern Keynesian empire’s boom and best, namely debt, but why 5 years later, “the slate has still not been wiped clean.”…
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Is Saving Money Bad for the Economy? – Gregory Bresiger – Mises Daily
Is Saving Money Bad for the Economy? – Gregory Bresiger – Mises Daily. (FULL ARTICLE)
Our grandparents believed in the value of thrift, but many of their grandchildren don’t.
That’s because cultural and economic values have changed dramatically over the last generations as political and media elites have convinced many Americans that saving is passé. So today, under the influence of Keynesian economists who champion government spending and high levels of consumption, thrift has been devalued.
“The growth in wealth, so far from being dependent on the abstinence [savings] of the rich, as is commonly supposed, is more likely to be impeded by it,” according to John Maynard Keynes’s The General Theory of Employment, Interest and Money.
“The more virtuous we are, the more determinedly thrifty, the more obstinately orthodox in our national and personal finance, the more incomes will have to fall,” he writes. “Saving,” Keynes wrote in his Treatise on Money, “is the act of the individual consumer and consists in the negative act of refraining from spending the whole of his current income on consumption.”…
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Olduvaiblog: Musings on the coming collapse 