Hayek on Keynes

This is from Hayek on Monday Conference in 1976 where he discusses the failures of Keynesian economics. But I must confess that if Hayek thinks of public spending as “a simple monetary device”, then he has characterised Keynesian economics in a way that no one will recognise, including me.

MOORE: In your Nobel Memorial lecture, why did you say, speaking of economists, ‘we have made a mess of things’. Now can I ask you this, why have economists made a mess of things? Why have they? Are they blind or are they …

HAYEK: No, it was the seduction of a very impressive and ingenious man, John Maynard Keynes, who persuaded economists that there was a simple way of permanent[ly] securing full employment. He was wrong but he was exceedingly persuasive, and he had gained the support of probably 95% of the current international economists. I have been arguing against the ever since.

I have been arguing with him when he was still alive, but there was no chance of getting a hearing so long as it seemed plausible that by a simple monetary device you could assure full employment. And that monetary device was in fact of such a nature that in the short run you could do it, that in fact at the same time you created distortions of the structure of the economy which in the long run was bound to bring about unemployment, a thing which a few of us had pointed out.

What seemed to be in contradiction was the actual experience — currently it worked beautifully — that we have been predicting you will have to pay for this in the future, people just wouldn’t listen to you. Well what we have predicted [h]as come to be very true. We found out that the Keynesian method of creating employment by accelerating inflation works only for a limited period and creates a condition for the following unemployment and that is the state of disillusionment in which we are now.

A great many economists feel that what they have — I mean the economists who have been trained between the middle 30s and the present, are now finding out that they have been taught a wrong doctrine.

It was 95% then and it’s 95% now, but if the other 5% thinks we are dealing with a small monetary device and not something larger and more insidious then there really is nowhere to begin the process of reversal.

As for the “simple monetary device”, it seems to me that he may have explained it later:

The basic problem is that with a new Keynesian economics they’ve given a charter to the trade unions to ask as much as they want and imposed the duty on monetary authorities to offset this by providing enough money.

There are many ways to buy off a majority of the population with higher money wages only one of them. His characterisation of the processes involved may have worked for the time and been suitable for a television audience but does not penetrate far enough to explain the nature of the problem.

[My thanks to Rafe for the link.]

There are climate sceptics everywhere, even at The Age

In The Age this morning and also The Sydney Morning Herald there’s an article on climate scepticism by their long-time cartoonist John Spooner. How sound, how sensible, how on the money. Such a pleasure to read. You should read the whole thing yourself. Here is a bit just to get you going:

I was once told by a friend that when it comes to scientific issues of major public concern, it is ‘not what you know but who you know’. I think he meant that my fledgling scepticism about dangerous anthropogenic global warming (DAGW) was pointless, for as a cartoonist I was as unqualified to assess the science as he was.

The implication was that all who are untrained in ‘climate science’ are required to accept the scientific and political authority of the Intergovernmental Panel on Climate Change (IPCC) and its local colleagues such as the CSIRO: the scientific establishment.

I found my friend’s advice baffling.

Anyone familiar with the judicial process knows the gravest issues of liberty and fortune are often determined by a jury selected from the public. Expert witnesses can give evidence in support of either side at a trial. The judge must rule on questions of admissibility, but in the end it is the jury that decides which scientific evidence is to be believed.

When it comes to climate change, we are the jury, not the IPCC. Dead on the money from end to end.

He believes it but does anyone else?

It’s not that he says it but that he believes it that makes this so pathetic:

WAYNE Swan has blamed the conservative Tea Party movement in the US for damaging the global economy and contributing to the “whack” to Australia’s budget position that has ruined Labor’s planned 2012-13 surplus.

The Acting Prime Minister and Treasurer used Twitter yesterday to warn that the looming fiscal cliff in the US, coupled with the European debt crisis, had directly affected Australia by reducing tax receipts, thus undermining next year’s budget surplus.

But Mr Swan saved his key criticism for the Tea Party, accusing it of holding the world to ransom and setting back the post-global financial crisis recovery for the past 18 months.

‘The impact of America’s fiscal cliff saga combined with Europe’s deep problems is having a real impact on the entire global economy,’ he tweeted.

‘Of course, we’re seeing that impact first hand in Australia with the huge whack we’ve copped to our revenue base.

‘The fact is, no matter what happens this week, huge damage has been done over the last 18 months thanks to the Tea Party’s influence. It is lamentable that so much of the world’s post-GFC economic recovery has been held hostage in such a reckless way by the Tea Party.’

Automatic cuts to social security and defence accompanied by scheduled tax increases are threatening to plunge the US back into recession, with President Barack Obama cutting short his Hawaii holiday to return to Washington yesterday to try to hammer out a solution to stop America sliding over the fiscal cliff.

Personal responsiblity for any of this is zero. Why he wants a surplus here but thinks the US can go on forever with its insane deficits he does not explain.

Elites, serfs and freeloaders

hopeful dems v rep

This is a survey whose results hardly need much explaining to me. The world is in the grip of the left and there seems no genuinely conceivable way to loosen that grip short of serious catastrophe. And even then, if they elect some right side party, it is for emergency purposes only. The middle of the road is so far to the left, and is kept there by a media that is even more to the left than the average, that there is little prospect of anything other than an elites-serfs-and-freeloaders kind of future. The elites will keep themselves in power by promising a guaranteed minimum income for the freeloader class.

Reading as I have been doing the socialist literature of the nineteenth century through the eyes of one of its great critics, Yves Guyot, the one constant is “those who do not work, do not eat”. This was an old staple then partly addressed to those who received income through interest payments and dividends but mostly to those who did not pull their weight in the workplace. Now we really do have a massive cohort of non-working income earners dependent on the State but they have become the very essence of left side politics and its most reliable base of support.

Just to take the American example, in the United States the distribution of “food stamps”, which can now be used to buy TVs and whatnot, reaches towards half the population. When Obama became president the proportion was one third.

If you have a vision of a world made up of independent, self-reliant individuals who will look after themselves, you are nostalgic for a world that is disappearing so rapidly and in a way that it is almost impossible to imagine a return to how things were. And this is before we even start thinking about foreign policy and international relations.

If you’re a Republican why wouldn’t you be depressed?

Understanding Say’s Law of Markets

I have been in quite some correspondence since the Macro Follies video arrived and from these conversations I can see that there are four bits I may be leaving out in my explanations, the first being the necessity of seeing these issues in aggregate terms, the second the role of consumption, the third that the delay between receiving one’s income and spending does not provide a theory of recession and the fourth the effect of living in a money economy. Nothing I say in adding these in is in any way contrary to the classical understanding of the law of markets or different from anything I have tried to explain before.

Aggregate Concept

Say’s Law is about the economic aggregates of an economy. There may not have been a set of national accounting figures published during the nineteenth century but they still had a grasp of the economy as a whole. Say’s Law never applies to any individual. No individual’s demand is necessarily comprised of that individual’s supply. We borrow each other’s savings, we pay taxes to the government, we give money gifts for others to spend. Say’s Law is a concept that applies to the economy at the aggregate level only. The total demand found in an economy in real terms consists of the total output of the economy in real terms.


Say’s Law does, of course, presuppose that as much output as can be produced will be bought but this will only happen if what is produced coincides with what buyers want to buy.

Production is valueless without consumption. If no one wished to buy then no one would produce. But since desires are insatiable there is no reason to worry that if producers can work out what buyers want to buy that that buyers will stop short of purchasing everything produced. Keynes however argued that people in aggregate would earn incomes for producing 100,000 units of output and then only decide to buy 90,000 units of what they had produced. This is the underlying dynamic in an economy that is experiencing a recession due to deficient demand.

And so far as policy is concerned, he seems to have then assumed that businesses would increase employment and production if what they had already produced could find a market. The reality is that businesses will only employ and produce if they believe they will earn a profit from what they produce next. Past sales have only a minor effect on employment going forward. Current sales are only one indicator amongst many in the production matrix of a typical firm. It is why Keynesians were so astonished by the Great Inflation of the 1970s since the combination of high unemployment and rapidly rising prices should have been theoretically impossible.

When looked at from above, if the amount being spent in aggregate is greater than the amount that was earned from producing output – let us suppose the government is running a deficit – then somewhere within the economy there are income earners being short changed since they do not receive in value the amount of value they produced. The spending may have taken place in Washington or Pennsylvania, the shortfalls may show up in Montana or Tennessee. But as invisible as the process is, the effect is quite clear. Some businesses will not earn the returns they expected. They will therefore scale down their level of production or even close down entirely. Ultimately the level of employment will be lower than it otherwise would have been as will the level of national output. A Keynesian will attribute this to too much saving and not enough demand.

The Time Gap between Receiving an Income and Spending

The existence of money adds some complication to the Say’s Law story but not much. There is always the intrinsic time delay between (A) outlaying money in some productive venture; (B) selling products one has produced or earning wages as someone’s employee; (C) receiving the money for what one has produced or earned as an employee which may be delayed through sales on credit or by being paid wages in arrears; and (D) spending the money one has received.

An increased time delay between C and D is not a theory of recession and unemployment.

This is what Mill in his essay “Of the Influence of Consumption on Production” is trying to get across. He was desperate to try to explain to the boneheads of his own time what the conclusions from the Law of Markets are. And it is extraordinary the number of people I have come across who read this essay and then argue that Mill is contradicting himself because he denies demand deficiency at the start of the essay and then talks about people hanging onto their money and delaying expenditure at the end. This is John Stuart Mill we are talking about, the man with the nineteenth century’s highest IQ and whose previous book was his Logic (1843) which was used throughout the nineteenth century and well into the twentieth. He is not likely to have contradicted himself in a way that any bumbling idiot could pick it up. Perhaps they should try to work out more closely what he meant.

And what Mill is trying to get people to understand is that a prior theory of recession is needed to explain why the delay between C and D has occurred. That is the explanation for recession not some blue sky decision not to spend. The increased delay has been caused by something. What is it? That is what needs to be known. And whatever it is has caused the rate of increase in A to diminish as well. But if you believe that the cause has been too much saving, then says Mill, you will never understand the first thing about how an economy works.

The Role of Money

To understand the money side of these things, it helps to go to Wicksell who followed Mill by about half a century (see Chapters 16 and 17 of the second edition of my Free Market Economics). What Wicksell discusses firstly is the natural rate of interest which is the supply and demand for productive resources (machines, bricks, tools, labour hours, everything that can be used in production). Of these, there is only a finite amount (it is a stock) and the potential rate of increase is very slow. Then there is the nominal rate of interest which regulates money and credit, the number of units of purchasing power in an economy. These can be increased at quite a rapid rate, much more rapidly than can the quantum of real resources.

Start with 100,000 units of productive resources and money and credit equal to 100,000 units of currency. Each unit of production thus costs one unit of currency. If the amount of money and credit goes up to 200,000 units of currency, eventually the price of productive resources will rise to two units of currency. But that is eventually. In the meantime, the people who first get their hands on the extra units of currency can buy more since the price level has not as yet risen to the full extent that it will.

But the producers of those 100,000 units of real output will eventually find that they have not been able to exchange what they produced for enough money to allow them to buy products equal in value to the value of the products they sold. If they are running a business, they find they are unable to replace their stock with the revenues they have earned. They have been cheated blind and yet the one place they don’t look for that theft is in the increased demand created by the government since that is what they have been taught to believe is what has been done to save them from the problem that very solution has caused.

And if you have made it this far and would like to see a further continuation of this discussion, see Misunderstanding Say’s Law of Markets which provides a different perspective but on the same issues.

Is the unemployment rate really 6.4%?

I’m about to do an interview on the Labour Force and unemployment. I guess with everyone away on holidays, it’s time for a few of us old stagers to be called upon to inform everyone about what’s going on while they’re at the beach.

So I’ve downloaded the Labour Force data which I almost never do any more and what a surprising set of data. Most interesting to me was that the participation rate has fallen from 65.8% as it was in November 2010 to 65.1% in November this year. This comes to a loss of 131,000 persons from the working world. Since these people have disappeared into the not-included-in-the-labour-force category, which usually means they have become discouraged workers, if we add them back in, the total number of unemployed is actually around 780,000. Much different again from the 650,000 officially recorded.

Had the participation rate stayed constant, the unemployment rate would now be something like 6.4%, very different from the published 5.3%. Feels more accurate as well, since that is why the RBA is bringing interest rates down. They know just as every business survey has been showing. The economy is into a downwards turn. 2013 will be a year of surprises, I feel, and after the Americans go over their fiscal cliff who knows what the New Year may bring.

Misunderstanding Say’s Law of Markets

If you would like to see what passes for a discussion of Say’s Law in the modern world, see below. My comments are in bold and found in square brackets. An utterly and thoroughly Keynesian description of the Law of Markets with almost no understanding of the classical theory that sits beneath it. And I even think this is supposed to be a defence. Why is it impossible for someone writing on Say’s Law to read my book. He even sources Horwitz in the book I edited but hasn’t even bothered to read my intro. Useless junk! No wonder no one understands Say’s Law. The question I always ask anyone who tries to defend Say’s Law is why classical economists thought it was so important. What major principle was involved? What instructions did it give to makers of policy or what did it tell them not to do? From what you see below, the writer could not possibly give a coherent answer to any of these questions. But at least he did give it the perfect title.

Misunderstanding Say’s Law of Markets

– By Garrett Watson, St. Lawrence University

Few ideas in the history of economic thought have achieved a level of perplexity and criticism than Say’s Law. Perhaps one of the most misunderstood and elusive concepts of the Classical economics, Say’s Law of Markets, first postulated by John Baptiste Say in 1803 [They only think this because it was given the name Say’s Law in the 1920s], underwent considerable support and eventual decline after its assault by John Maynard Keynes in The General Theory. Many of the fundamental disagreements we observe in historical debates surrounding macroeconomics can be traced to different conceptions of how Say’s Law operates in the market economy and the scope used in the analysis. By grasping a thicker idea of Say’s Law, one is able to pinpoint where disagreements in both macroeconomic theory lie and judge whether they necessarily must be dichotomized.

Say’s Law is best known in the form Keynes postulated it in The General Theory: “supply creates its own demand” (Horwitz 83) [He needs to footnote Horwitz! Why hasn’t he read The General Theory if he’s going to talk about Say’s Law?]. Despite the apparent eloquence and simplicity [!] contained in this definition, it obscures the genuine meaning of the concept. For example, one may interpret this maxim as meaning that whenever one supplies a good or service, it must be demanded – this is clearly untrue (83). Instead, Say’s Law can be interpreted as saying that the ability to produce generates their ability to purchase other products (84). One can only fully grasp Say’s Law when analyzing the nature of the division of labor in a market economy. Individuals specialize in producing a limited range of goods or services, and in return receive income that they use to buy goods and services from others. The income one receives from production is their source of demand. In other words, “all purchasers must first be producers, as only production can generate the power to purchase” (84) [Not right. The notion is being reduced to individual buyers when it is an aggregate concept where demand in aggregate is constituted by supply in aggregate. Purchasers are often borrowers who have produced nothing but intend to buy more than their incomes will allow. Lots of other possibilities right down to giving my children their allowance.]. This idea is intimately linked to the Smithian idea that the division of labor is limited by the extent of the market (89).

The result of this fascinating principle in the market economy is that (aggregate) supply will equal (aggregate) demand ex ante as demand is equally sourced by previous production (Sowell 40) [And having repeated exactly and with no modification the very conclusion reached by Keynes, we can dispense with any thought that our author has any idea whatsoever about the meaning of Say’s Law in pre-Keynesian times. ]. Another important point made by Say’s Law is that there exists a trade-off between investment and consumption (40). In contrast to the later Keynesian idea of falling investment leading to a fall in consumption and therefore aggregate demand, an increase in investment means falling consumption, and vice versa. This idea can be analogized to Robinson Crusoe [RC is a terrible example since in a discussion of Say’s Law we are of necessity talking about an exchange economy. This is a discussion explaining that saving is the feedstock for investment.] abstaining from consumption to build a fishing net, increasing his investment and his long-term consumption of fish (42). Therefore, a higher savings rate pushes up investment and capital accumulation, increasing growth and output (as Smith eloquently argues) (40). In another stark contrast to Keynesian analysis, there is only a transactions demand for money, not a speculative nor a precautionary demand (40). The implications of this are that money cannot affect real variables; it is a veil that facilitates transactions only – money is neutral (Blaug 148).[This is just Keynes repeated. Does he really think classical economists believed that no one ever held money as an asset and that the amount of money held was a constant. Thinking in terms of the quantity theory of money – MV=PQ – meant that V would fall during recession.] Finally, Say’s Law also shows that there cannot exist a “general glut”; an economy cannot generally overproduce [Why? Needs explanation. I don’t think he understands the reasoning so can’t provide one.](Sowell 41). While relative over and under-production can occur, there is no limit to economic growth [He seems to think Say’s Law is an argument against secular stagnation!](41).

While it was uncontroversial among the Classical economists that there wasn’t a limit on economic growth [Say’s Law is not a theorem about secular stagnation.], several economists took issue with the fundamental insights of Say’s Law (44). One of the most well-known criticisms was that of Thomas Malthus. Malthus was an early proponent of the “Paradox of Thrift” [What an anachronism!] – an excessive amount of savings could generate an economy with less than full employment (43). One could describe the view of Malthus as fundamentally “under-consumptionist” (Anderson 7). Unlike his contemporaries [Wrong, wrong, wrong!!!!! This is drenched in Keynesian idiocies.], Malthus did not view money as inherently neutral (Sowell 41). Other classical economists, such as Smith, argue that money “will not be allowed to lie idle”, effectively dismissing a precautionary motive for holding money and therefore monetary disturbances [He should at least read Becker and Baumol to cure him of at least some of his ignorance.] (38). This is where we see the inherent difference in perspective in the analyses of Smith and Malthus. Smith is focused on long-run conditions of money (its neutrality and importance of real fundamentals) versus the short-run disturbances money can generate in output (39).

Money is half of every exchange; a change in money can therefore spill over into the other half of every exchange, real goods and services [This is not a defence of Say’s Law, it is a criticism from someone who has no idea what the proposition means.] (Horwitz 92). In effect, “The Say’s Law transformation of production into demand is mediated by money” (92). This means that Say’s Law may not hold in conditions in which monetary disturbances occur.[Then Keynes is right!] John Stuart Mill recognized this possibility and affirmed Walras’ Law: an excess of money demand translates to an excess supply of goods [How wrong can you get.] (Sowell 49). An excess money demand manifests itself by individuals attempting to increase their money balances by abstaining from consumption. This therefore generates an excess supply of goods, which some would argue can be self-correcting, given downward adjustment of prices [More Keynes.] (Blaug 149). Malthus (and later on, Keynes [He is explicitly siding with Malthus and Keynes!!!!!!!!!!!]) argues that downward price and wage rigidities (which can be the result of game theoretic problems in firm competition, efficiency-wages, or fixed wage contracts [This is Malthus? Would have been news to him.]) can short circuit this process, yielding a systematic disequilibrium below full employment (Sowell 65). In terms of the equation of exchange, instead of a fall in V (and therefore a rise in money demand) being matched by a fall in P, the fall in V generates a fall in Y. This point was taken into further consideration by later monetary equilibrium theorists, including Friedman, Yeager, and Hutt. The same analysis can be used to understand the effects of drastic changes in the money supply on short term output, as Milton Friedman and Anna Schwartz would demonstrate in the contraction of the money supply during the formative years of the Great Depression [As if classical economists would be unaware that a fall in money supply would constrict economic growth. What does he think the quantity equation shows?].

When analyzing the large disagreements over Say’s Law, it becomes clear that they stem from a difference in scope: supporters of Say’s Law analyzed the macro economy in terms of long-run stability, while Malthus and others after him focused on short-run disequilibrium generated by monetary disturbances (Sowell 72)[Neither he nor Sowell understand Say’s Law. I never liked Sowell’s explanations as can be seen from my book.]. Smith and other classical economists, pushing back against mercantilist thought, emphasized that money was merely a ‘veil’ that does not affect economic fundamentals, and that quantities of money ultimately didn’t matter [Every sentence gives me pain.](72). The Malthusian grain of truth regarding disequilibrium caused by monetary disturbances in the short-run does not refute Say’s Law; it reveals the necessity of getting monetary fundamentals correct in order for Say’s Law to cohesively operate. [This is an Austrian version that is deeply mixed with Keynes. If you accept this, arguments against the stimulus are much weakened since there really is a shortfall of demand.] It becomes increasingly clear that once we look at the disagreements through the lens of scope, the two conceptions of the role of money in a market economy need not necessarily be incompatible.

And now that you’ve read this, you should read Understanding Say’s Law of Markets.


Anderson, William. “Say’s Law: Were (Are) the Critics Right?” Mises Institute1 (2001): 1-27. Mises Institute. Web. 19 Oct. 2012.

Blaug, Mark. “Say’s Law and Classical Monetary Theory.” Economic Theory in Retrospect. 4th ed. Cambridge: Cambridge University Press, 1985. 143-160. Print.

Horwitz, Steven. “Say’s Law of Markets: An Austrian Appreciation,” In Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle, Steven Kates, ed. Northampton, MA: Edward Elgar, 2003. 82-98. Print.

Sowell, Thomas. On Classical Economics. New Haven [Conn.]: Yale University Press, 2006. Print.