Keynesian follies make the news

An article by John Papola – you know, the chap who did the Macro Follies video and the Keynes-Hayek Rap – on the impossibility of consuming one’s way to prosperity. He has taken Say’s Law to places it has never been before, in this case into the PBS News Hour in the US. Many great observations but I will restrict myself to this:

As John Stuart Mill put it two centuries ago, ‘the demand for commodities is not the demand for labor.’ Consumer demand does not necessarily translate into increased employment. That’s because ‘consumers’ don’t employ people. Businesses do.

Since new hires are a risky and costly investment with unknown future returns, employers must rely on their expectations about the future and weigh those decisions very carefully. Economic historian Robert Higgs’ pioneering work on the Great Depression suggests that increased uncertainty can depress job growth even in the face of booming consumption. Consumer demand that appears to be driven by temporary or unsustainable policies is unlikely to induce businesses to hire.

Increased investment drives economic growth, while retrenched investment leads to recession and reduced employment — and it always has. John Maynard Keynes, like most business cycle theorists before him and since, paid particular attention to this boom and bust in investment, blaming volatility on the ‘animal spirits’ of businessmen. This observation about the importance of ‘confidence’ is surely true, if somewhat obvious.

Unfortunately, Keynes and his successors focus on aggregate levels of spending and often explicitly disregard the details of how money is spent and resources are employed. This led him and the profession down a dark road to the defunct underconsumptionist ideas of the early 1800s which haunt us to this day. Keynes repeatedly asserts throughout his famous tome, The General Theory, that even wasteful expenditures could increase the wealth of society.

Is it any wonder that so many of our policies are focused on consuming and sometimes even destroying wealth rather than creating it?

Do you ever wonder whether the mainstream economic establishment will ever begin to wonder whether this theory they have been peddling for three quarters of a century may be wrong?

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14 Responses to Keynesian follies make the news

  1. Skuter

    The more I read about Keynes, the more I think his motivation for the General Theory was his desire to overturn the establishment way of thinking. He appeared to have a contemptuous attitude to British society. I don’t know that he was motivated by a desire to find the truth.
    During my undergraduate degree, I always found myself asking questions like: is it really valid to aggregate all spending? Does a single ‘stock of capital’ make sense? Do different types of capital matter? These issues were always glossed over or neglected. It wasn’t until I read work from the Austrians and other classical economists did I even see these questions tackled. That is when I started to question the received wisdom…

  2. Pedro

    You’ll like this comment from Papola

    “The language of AS/AD may work well among economists who have a careful understanding of the distinction between monetary effects and real effects, but I believe strongly that it is difficult, even destructive, for non-economist readers precisely because nominal vs. real distinction becomes entangled. This is made worse by the fact that Keynesians explicitly discuss “demand” in terms of targeting real variables.

    . . .

    You said recently that macro students should only be taught two concepts: Say’s Law, and NGDPLT. I generally agree (even if I have concerns about NGDP being a sufficiently broad proxy for the flow of nominal spending). AS/AD doesn’t aid this understanding without it being HEAVILY caveated.

    When the public hears about “demand”, they think about “consumers” buying stuff. They think about wrong-headed ideas like the often-repeated notion that consumers “drive” economic growth, rather than production and investment. They think about the Keynesian approach, which is all they hear. And the Keynesian approach rolls in with it the conflation between saving and hoarding that has plagued macro since Malthus.”

  3. Jim Rose

    Economic historian Robert Higgs’ pioneering work on the Great Depression suggests that increased uncertainty can depress job growth even in the face of booming consumption

    In 1928, British economist Arthur Pigou stressed the importance of changes in expectations as a determinant of business cycles. when people are confident about the future, they may consume, invest, and work more today. Now called the news theory of the business cycle.

    Beaudry and Portier (2006) looked into the economic impact of news affecting future productivity growth. Found that expectations of higher future productivity have large effects on current consumption, investment, real GDP, and stock prices. news accounts for 40% of changes in consumption, investment, and hours worked.

    News is different from the animal spirits because the shifts in consumption, investment and labour supply are reflect rational changes in expectations that vary as the result of changing information on technology shocks and public policy.

    favourable news about future productivity can set of a boom today while a realization of productivity which is worse than was expected can induce a recession without any actual reduction in productivity ever occurring.

    booms and busts can happen absent large changes in fundamentals and no technological regress is required to generate recessions.


  4. Jim Rose

    see Robert J. Barro, 1994. “The Aggregate-Supply/Aggregate-Demand Model,” Eastern Economic Journal 20(1), pages 1-6, Winter. free download

    The aggregate-supply/ aggregate-demand (AS-AD) model is popular in textbooks, but has problems with logical consistency.

    In one interpretation, the Keynesian underpinnings of the AD curve-derived from the IS/LM model with downward price stickiness-conflict with the determination of the price level at the intersection of the AS and AD curves.

    In another view, the model corresponds to rational-expectations theories in which Keynesian properties are absent.

    In a third interpretation, the model is equivalent to the “complete Keynesian model,” which has counterfactual implications for real wages and other variables.

    The main conclusion is that the AS/AD model should be abandoned.

  5. WhaleHunt Fun

    Speaking of aggregates, Is there an estimate for the sum of all the wealth forgone, which would have been created if the work of Keynes had not misguided so many government decisions. It must certainly be in the billions if not tens of billions for Australia alone. An aggregate for the world must then rival the expenditures on global warming which seem yo be reaching a trillion or so. The confidence in Keynes must be one of the greater disasters to befall humankind, short of the world wars and a handful of great plagues.

  6. WhaleHuntFun, without even blinking, I would say the cost of Keynesian Theory would be in the Trillions of dollars. The opportunity cost of Keynes and his “theory” would be about 25% of last centuries Gross World Product.
    Now if this seems an extravagant claim, think of where the Human Race would be without the distortion his “Theory” had not provided a bottomless rat hole to pour the wealth of the Western world down, let alone the distortion of the African economy and the destruction of the social fabric of that miserable continent.

  7. WhaleHunt Fun

    Thank you Winston Smith. Africa had not crossed my mind.

  8. JohnB

    I am writing as someone who has not studied economics but I am firmly on the supply side of this equation. (Not much of an endorsement)

    When I look at demand stimulation I can see how an uptick in demand can lead to an uptick in production for existing goods. However it retards the production of wealth in providing an incentive for the customer not to produce (his needs and wants have been supplied by government forces rather than his productivity), retards productivity also through the costs of debt uncertainty and taxation. Also it is quite possible that increased demand can lead to an increase in global production as opposed to local production, too.

    When I look at supply side action, I find it improves demand by leaving more money in the hands of the producers. Even when people get rich beyond their needs or wants, the money is still useful as it will be spent or invested if good enough options for spending or investment are available- this encourages more production and innovation to these needs. This is very possible in an environment that is friendly to suppliers.

    So I see demand side as a system that provides diminished returns. But I see supply side providing amplified returns. Am I wrong?

  9. Mother Hubbard's Dog

    In Australia’s case, it is completely obvious that boosting consumption cannot drive the economy, because most discretionary consumer spending is spent on imports.

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  13. MattR

    Macrobusiness is a great example of what happens when you turn a really good concept into a festering pit of left wing group think. A couple of the contributers are excellent, the rest are nothing but left wing ignoramuses that have absolutely no idea how the economy really works.

    Rumplestateskin is the perfect example of how decrepit that blog has become over the last year or so. It’s nothing but discredited Keynesian nonsense and pro-ALP (pro-AGW scare) garbage that belongs more on the ABC or Fairfax.
    It’s such a shame because I used to love reading some of their blogs, they had some great insights into the property market and investment strategies. Now you can’t go there without some attack on Classical Economics, the economics of investment, production and growth (in other words actual economics), some attack on Tony Abbott, some defense of the ALP, some pro-Carbon Tax baloney and more.

    Such a shame.

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