Central banking and Keynesian economics

This is Alan Kohler explaining why “Central Banks Are Destroying The World”. There’s no doubt they are doing everything they can, and there are not a lot of people around who will say this in public. But I also mention his comments since it is nice to see myself mentioned in despatches.

These days our “patrician overlords” are central bankers, benignly manipulating our behaviour (“aggregate demand” they call it) by adjusting the price and availability of the thing we all so crave – credit.

The question for this week is: what should they, and you, do instead? Bearing in mind the old joke that if you wanted to get to Dublin, you wouldn’t start from here.

Well, there’s no doubt in my mind that “they” – the Fed, ECB and Bank of Japan – need to start raising interest rates pronto, and stop worrying about inflation being too low. It’s caused by technology reducing costs and debt suppressing consumption and investment – not by a shortage of demand that can be reversed by monetary policy. Specifically they should allow the market to set interest rates, just as the market sets most other prices. But these are not, to say the least, mainstream opinions.

As an old friend of mine, Steve Kates of RMIT University, wrote in his book Free Market Economics:

“Today, there is no aspect of an economy’s structure that governments do not believe themselves capable of making a positive contribution towards. … Such actions are not undertaken with a sense of dread at the possible unintended consequences. They are undertaken with a confidence that is simply unwarranted…”

“To believe that some central agency can plan ahead for entire economy is one of the major fallacies often associated with economic cranks. No single person, no central body, no government agency can ever know anything remotely like what needs to be known if an economy is to produce the goods and services the community wants, never mind being able to innovate or adjust to new circumstances.”

In my view, those “goods and services” include credit. Our patrician overlords at the central banks believe themselves capable of determining how much of it we need and at what price.

The Keynesian economic central planners went into hiding after the Berlin Wall came down in 1989 and the failure and corruption of Soviet style Marxism became evident. After that, and after the recession of 1991, the world had 10 years of spectacular growth due, in part, to interest rates being left to find their own level. However after the tech crash of 2000, the real Fed funds rate was taken negative – what Keynes called “the euthanasia of the rentier” – on the basis that wealth creation through rising assets prices would lead to economic growth.

Charles Gave of GaveKal Research calls this “one of the stupidest ideas ever put forward in economics”. It led to an explosion in debt and speculation on housing, which led, in turn, to the 2008 credit crisis, and Great Recession.

Instead of learning from this mistake, the central bankers then went all the way – reducing nominal rates to zero and keeping them there for six years.

To a large extent the current thinking is based on the proposition that we face “secular stagnation” a phrase rediscovered by former US Treasury Secretary Larry Summers (it was originally coined by Alvin Hansen in 1938, in a book called “Full Recovery or Stagnation?”).

Those promoting this idea today don’t remember that it’s the same incorrect argument that was floated towards the end of the 1930s, and they don’t believe that if left to its own devices the economy would go back to normal. Instead they think the world’s entrepreneurs, business people and consumers would somehow remain comatose if central bankers et al didn’t poke at them to wake up. Central bankers have never run a business themselves but are totally confident in their ability to goad businesses and consumers into action and then distributing the proceeds.

These are the misguided vanities of what Lewis Lapham calls our patrician overlords. Economic growth is failing to recover because central bank actions have increased the stock of debt, which is weighing on the world’s economy like a heavy blanket. It needs to be cleared, through being priced correctly and borrowers and lenders recognising their losses. In other words, the free market must apply.

As Steve Kates wrote: “The problem lies in the belief that that the natural state for an economy is for it to be growing with unemployment low, when the reality is that the natural state for an economy is that it is adjusting to new circumstances during every moment of every day.”

Perhaps the greatest of all Keynesian disasters was to promote the idea that economists have any idea on what to do to make economies grow. As it happens, our growth over the past sixty years has been in spite of our economists, but the economists are now in such control that they are pushing our economies backwards at unprecedented rates.

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19 Responses to Central banking and Keynesian economics

  1. Clive 4 Evah says:

    the economists are now in such control that they are pushing our economies backwards at unprecedented rates

    You really do inhabit a very odd world, Professor.

  2. Rodney says:

    Everything that I was taught in economics, and everything I taught in economics was at best irrelevant.
    Neither monetary nor fiscal policies matter.
    What’s left?
    Perhaps govt regulation, for better or worse is the key in the era of innovation.

  3. closeapproximation says:

    Great post. I like Kohler more and more.

  4. m0nty says:

    Where was the Kohler piece posted? I don’t see it at Business Spectator or the Australian.

  5. m0nty says:

    Oh, I see, it’s in the Eureka Report newsletter.

  6. Bruce of Newcastle says:

    Perhaps the greatest of all Keynesian disasters was to promote the idea that economists have any idea on what to do to make economies grow.

    The greatest of all Keynesian disasters is it gave an excuse to politicians not to free up the economy by rolling back the bureaucratic state sucking on all our necks like vampires.

    As Jean-Claude Juncker said:

    We all know what to do, we just don’t know how to get re-elected after we’ve done it

    So instead of doing it they can look meaningfully at the central bank boss who obediently lowers rates or helicopters money. Unfortunately cheaper credit is a useless thing when no project investment can make hurdle returns. Why would you borrow to invest if you can’t make a return? To reinvigorate productive investment you have to remove the 4000 odd approvals that any project, shop or lemonade stand requires to start doing business and making profit. Then you have to not tax them into the stone age with stupid things like payroll tax, so they can actually survive.

    But you can’t be re-elected if you go after the vampires with stake and mallet, since the Left will scare the LIV’s witless.

  7. Eyrie says:

    Kohler sometimes pulls one out of his hat doesn’t he? The rest of the time must be an act.

  8. . says:

    Yeah I know Eyrie. Like ALP Treasurers or Opposition Leaders.

    Costa had a picture of Hayek in his office for pete’s sake!

    Anyway, a very well written argument by Kohler. He must secretly read Mises.

  9. H B Bear says:

    ALPBC talking head Kohler quoting Steve Kates. Talk about down the rabbit hole.

  10. Frank Brus says:

    Interest rates will have to remain low for foreseeable future so that the huge debts run up by all governments can be serviced. Given that just about every western country is running large deficits raising interest rates will be an impossible option for left wing governments who will never chose to reduce welfare spending.

  11. Sinclair Davidson says:

    You should unleash your inner Hayek more often.

  12. Chris says:

    You should unleash your inner Hayek more often.

    Starting to seem like the inner Hayek needs an outer Pinochet to make any difference.

  13. Lem says:

    Of course politicians (who never created wealth) will ask “professional” economists (who never created wealth) for their opinion on what to do, once they have won office. And of course they will listen to economists who tell them the way to prosperity is to borrow and spend, especially when the politicians live on short terms, and know that no matter the outcome they will be superannuated, and wealthy enough to skip town.

    The system demands complete over throw.

  14. thefrollickingmole says:

    Caught a chap on the ABC this morning, he was a japann expert and had lived there for 40 years.

    Japans economic problems??

    Still too much savings.

    30 odd years of massive government spending and this bloke still clings to the busted flush of “too much savings/punish the prudent”

  15. . says:

    Those damned savers! They’re ruining everything!

  16. thefrollickingmole says:

    Those damned savers! They’re ruining everything!

    I would have got away with it if it wasnt for those pesky kids economic realities.

    /channelling Scooby Doo off

  17. Jaftur says:

    Those who wrote this article and commented on it know little about macroeconomics or, at least, understand little about Modern Monetary Theory, (MMT).
    1. There is no such thing as a free market. The market needs the rules of a central authority, the currency issuing government, limited liability companies, the main productive enterprises in a modern country, could not exists.
    2. Gold proved to be massive failure as a means of exchange. Finding gold in South America destroyed the Spanish economy of the time. The Spanish thought that they had discovered wealth. They had found a metal that has no more claim to be a source of wealth as the Pacific Islands that valued shells.
    3. MMT is based on empirically supported facts. If you really wish to understand money and the economy of a fiat currency area read the article Mobilization and Money by J D Alt and published in August 2013 at neweconomicperspectives.com the Economics Department blog site of the University Of Missouri, Kansas City. That blog was which was under the control of Dr Stephanie Kelton before she took two years leave of absence to advise Senator Bernie Sanders as he strives to win the Democratic Party nomination for Potus. Alt’s article how money, taxation and loans were used to convert the USA, from the depression of the 30s,
    to the most powerful and properous society ever during WW2.
    As Alt writes we may have forgotten how to achieve such success.

  18. Jaftur says:

    I missed a word and probably a couple of qualifiers.
    In numbered section 1, it should read “…. otherwise limited liability companies ……….. could not exist”
    For clarity I should have pointed out that such limited liability companies made agglomeration of capital for major industries possible.
    The statement on Pacific Islands may be misleading. It was the shells that the residents valued as a means of exchange.

  19. . says:

    #1837848, posted on October 26, 2015 at 7:36 pm
    Those who wrote this article and commented on it know little about macroeconomics or, at least, understand little about Modern Monetary Theory, (MMT).

    MMT is a crank theory. Every time it has been used (US Continental Dollar, Weimar Papiermark, Argentine Peso) the currency has failed and left behind a destroyed banking system and international payments system, along with decadal depressions.

    Gold is money and free markets are merely a matter of political will.

    Anyone pushing MMT ought to hand back their degree.

    Sanders will not be the President of the USA and FDr’s economic policies prolonged the Great Depression by seven years – contrast with Australia which used classical economics and grew whilst America declined.

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