Sunday, June 21, 2009
The Vengeance of Keynes
From higher altitude than usual (Big Sky MT)...
Keynes returns, with a vengeance. And the destruction of capital is elevated to an economic principle.
Keynesian economics was killed in the 1970s and 1980s. Milton Friedman’s monetarism and the Rational Expectations revolution killed it, and decades of economic theory and empirical research buried it, at least in academic circles. But now, with no theoretical or empirical justification at all, it’s back.
Paul Krugman and now Alan Blinder doubt that the Fed's explosive injections of liquidity pose any risk. And Robert Reich can't imagine that exploding federal deficits are cause for concern. What to make of all this?
Former economist Paul Krugman is simply a political hack, an ideologue who will say anything at all if it suits his political purposes.
But as for Blinder...on the one hand, I wish I could simply say Blinder is nuts. The like of James Hamilton, Nouriel Roubini, and even Ben Bernanke have warned of the dangers of a longer run inflation problem. And despite what Blinder says, the timing issue is not symmetric, either. It's much more likely that the Fed would move too late than too soon in sucking excess liquidity from the economy: Bernanke has explicitly said that his greatest fear is a repeat of the Fed's sharply contractionary actions following the 1929 crash, and that he'd rather see inflation. Also, the data are not observed contemporaneously, there's a substantial lag. What actually is happening in the economy occurss before we can recognize it. Recall that it wasn't until September 2008 that the data were available showing a recession had already started the previous January. As for the wisdom of the bond markets, I'm pretty suspicious. They are subject to foreign central bank demand, which has its own purposes, and also are trying to second guess the Fed, while the Fed is trying to second guess the economy, and no one has a generally accepted theory of exactly how real interest rates and long term nominal rates are exactly generated. Hence, Blinder's cavalier attitude seems crazy to me.
On the other hand, Blinder is a Keynesian, and there's a fundamental difference in how he & I see things. The Austrian *micro*economic view looks at the price level as at best a shorthand abstraction. In this view, inflation is better thought of as an expansion of the money supply, and a monetary expansion cannot be neutral. It shifts relative prices and changes the structure of the economy. If we had predictable uniform " helicopter money" general price increases, no one would care about inflation. We don't have this, of course, and it is the (mis)allocative effects of inflation (however defined) that we fear. In my Austrian view, we are getting these effects regardless.
That said, I am rather doubtful that the Fed is going to remove excess liquidity the way Blinder hopes.
Relatedly, two things of note in the news: 1) Bernanke is in hot water for his alleged participation in pressuring BOA to violate SEC laws; potentially he could even face felony charges. 2) Apparently the Obama administration has proposed rules that would give Treasury some authority over the Fed.
The politicization of Fed policy and Bernanke’s own problems make it that much more unlikely that the Fed can engage in successful contractionary policy.
Of course, none of these concerns really fit the Keynesian paradigm. Keynes is all about generating aggregate demand and aggregate output and employment. It doesn’t matter to Keynes what it is, "it's all good." The issues of misallocating capital can't arise in the model, and as for destroying the value of money, well, that's one of those long run issues.
And then there's Robert Reich. Lawyer Reich knows less about economics than my dear missing Labrador retriever Dushka does. His economic expertise is entirely self-proclaimed. I miss the good old days when Economist Paul Krugman would regularly lambaste Reich for his economic know-nothing-ness.
Even today's Krugman the political partisan has expressed a little concern about the growing debt of late (i.e. since Obama took office). Of course, prior to the election Krugman correctly howled that the growing debt under Bush was a disaster.
The truth is that we are headed for a much worse crisis, as our foreign creditors become increasingly doubtful about our creditworthiness. And Reich's idea that health care reform is going to reduce the debt burden is a fantasy; the federal gov't has consistently failed to run entitlement programs in a fiscally responsible fashion, and they'll fail to do so with health care, for several reasons:
1) Politicians have strong incentive to provide benefits, actions, programs, etc. by increasing borrowing rather than direct taxation. They have very little incentive to be fiscally responsible.
2) Administrators of federal programs have little incentive to control costs in a rational fashion. They'll control costs that *they* face, but these differ from the costs borne by health care consumers and taxpayers.
3) The cost reductions that reformers promise come in large part from improving medical recordkeeping, increased preventive care that supposedly saves by heading off worse problems, and cutting out middlemen. Unfortunately, the med records savings cited are always the best case scenario estimates, and numerous studies suggest these are fictional gains -- from my own conversations with medical professionals I am extremely doubtful about big savings. Preventive care savings really are a fiction, most studies I've seen suggest that while preventive care can certainly provide health benefits, the financial savings are minimal. As for cutting out the middlemen, good luck. When I worked with federal crop insurance programs I had a front row view of bureaucratic incompetence: these programs are very badly run, with a whole new level of middlemen (USDA bureaucrats) added. Don't expect federal health insurance to be better.
But if Reich is right, why, then let's accelerate our accumulation of debt; he thinks it is positively beneficial, so by all means let's spend! spend! spend! No need to worry about the future, in Reich's view, because the certainty of strong economic growth will make it easy for us to pay it off. Deficit spending guarantees free lunches for all!
I could understand if Reich's message terrified people, or if it triggered belly laughs -- but how can this be treated as even vaguely sensible?
But even the Chicago schoolers are now saying that Keynesian stimulus is a necessity, and in true Keynesian fashion, they don't even care if it is wasteful; stimulus is stimulus.
Hence we destroy our capital, our wealth, and our future, as slaves to this defunct economist. No wonder Keynes said that in the long run, we’re dead.
With regard to the Austrian perspective, it is even scarcer over this side of the pond than over your side. I understand that the reason that the IEA's Shadow Monetary Policy Committee has given a (near enough) unanimous thumbs-up to the BoE's program of QE, despite the IEA's history and the personal views of some of the staff, is that they have difficulty finding a credible and authoritative academic anywhere in the UK with an Austrian, or at least sound-money perspective specialising in macroeconomics. But there is a glimmer of hope - I hear that a businessman is trying to fund a chair to resurrect Austrian economics at the LSE. Perhaps you should apply if it materializes. You'd be surrounded by communists, but that should just make it more entertaining. Bigger problem is: it's a long way from London to decent mountains...
It's very interesting that when the downturn first started becoming obvious, a number of big name economists here began citing Hayek. It's only when the mess turned into a "crash" (most probably triggered by Paulson & Bernanke, IMO) that people began talking about Keynes. It's partly b/c many economists didn't know what else to say, and also b/c there's an obvious propaganda war going on.
At the American Economic Assn meetings last January I did not detect anything like a universal groundswell of Keynesianism, or support for bailouts & stimulus for that matter. I haven't given up hope that the American economics profession may yet do something good here.
I'd apply to LSE if there were such a position. As for mountains, U.K. has fell running, and I'd love to give that a try.