Zingales on Keynes

This is Luigi Zingales’ opening statement in The Economist‘s 2009 debate. It is Say’s Law in all its ramifications without the actual name applied. It is my bolding in the article below:

What does “being Keynesian” mean? Simply believing in the role of demand-side factors in the determination of aggregate output is an insufficient characterisation. A true Keynesian differs, in so much as he also believes that: 1) monetary policy is not the most effective tool for stabilising the economy and it may be completely ineffective in some circumstances (liquidity trap); 2) fiscal policy is effective and government spending is the preferred tool; 3) government intervention works and short-run consequences are more important than long-run ones.

With this definition in mind, there could be four ways in which the statement “we are all Keynesians now” can be interpreted. I propose that the statement is false in three out of four of these interpretations.

The first interpretation is that the economic profession has reached a consensus on Keynesian positions. This statement is definitely false. If you browse through the articles published in the leading journal of the American Economic Association in 2008, you would find that only one of the 12 articles that deal with macroeconomic issues (JEL Code E) supports (albeit very indirectly) the idea of a fiscal policy expansion as a policy tool. An even stronger imbalance is present at the pinnacle of our profession. Among the 37 Economics Nobel prize winners in the last 20 years, four received the prize for their contributions to macroeconomics. None of these could be considered Keynesian. In fact, it is hard to find academic papers supporting the idea of a fiscal stimulus.

The second possible interpretation is that there exists a consensus among economists that the causes of the current crisis are Keynesian. Even under this interpretation the statement is patently false. I do not think that any economist would dare to say that the current US economic crisis has been caused by underconsumption. With zero personal saving and a large budget deficit the Bush administration has run one of the most aggressive Keynesian policies in history. Not only has adherence to Keynes’s principles not averted the current economic disaster, it has greatly contributed to causing it. The Keynesian desire to manage aggregate demand, ignoring the long-run costs, pushed Alan Greenspan and Ben Bernanke to keep interest rates extremely low in 2002, fuelling excessive consumption by the household sector and excessive risk-taking by the financial sector. Most importantly, it has been the Keynesian training of our policy-makers that has led them to ignore the role that incentives play in economic decisions. The main difference between Keynes and modern economics is the focus on incentives. Keynes studied the relation between macroeconomic aggregates, without any consideration for the underlying incentives that lead to the formation of these aggregates. By contrast, modern economics base all their analysis on incentives. In 1998, when the Fed co-ordinated the bail-out of Long Term Capital Management, it did not care about the impact this decision would have on the incentives to take risk and price liquidity appropriately. When Mr Bernanke engineered the bail-out of Bear Stearns, he did not care about the impact this decision would have on the other investment banks’ incentives to raise equity capital at rock-bottom prices. When he changed his position twice in the space of two days, letting Lehman fail, but bailing out AIG, he did not care about the impact it would have on investors’ confidence and incentives to invest. It is this erratic behaviour that has spooked the market and created the current economic crisis: in a recent survey 80% of Americans declare that they are less confident of investing in the market as a result of the way the government has intervened.

If Keynesian principles and education are the cause of the current depression, it is hard to imagine they can be the solution. Thus, even the third interpretation of the house statement—that we should follow Keynesian prescriptions to combat the current economic crisis—is false. I am not disputing the idea that some government intervention can alleviate the current economic conditions, I am disputing that a Keynesian economic policy can do it. With a current-account deficit that in 2008 was $614 billion, a budget deficit that was $455 billion and military expenditures of $731 billion, it is hard to argue that the government is not stimulating demand sufficiently. The current crisis is not a demand crisis, it is a trust crisis. Bad corporate governance coupled with bad government policies has destroyed the financial sector, scaring investors and freezing lending. It is as if a nuclear bomb had destroyed all roads in America and we claimed that to alleviate the economic impact of such an event we should invest in banks. It is possible that eventually the effect will trickle down. But if the problem is the roads, you want to rebuild roads, not subsidise the financial sector. And if the problem is the financial sector, you want to fix this and not build roads.

The only interpretation under which the house statement is true is that “we”—the English/American people and their elective representatives—are all Keynesians now. Keynesianism has conquered the hearts and minds of politicians and ordinary people alike because it provides a theoretical justification for irresponsible behaviour. Medical science has established that one or two glasses of wine per day are good for your long-term health, but no doctor would recommend a recovering alcoholic to follow this prescription. Unfortunately, Keynesian economists do exactly this. They tell politicians, who are addicted to spending our money, that government expenditures are good. And they tell consumers, who are affected by severe spending problems, that consuming is good, while saving is bad. In medicine, such behaviour would get you expelled from the medical profession; in economics, it gives you a job in Washington.

I just don’t think the major dividing line is over incentives. It is, in my view, about the need for value adding activity which public spending never provides.

Recalling that 2009 debate on Keynes at The Economist

At the very start of the GFC and the stimulus there was a debate at The Economist Online about what should or should not be done, revolving around Keynesian theory and policy. We now, of course, know who won the debate so far as policy is concerned but I still wonder whether it was not also won so far as theory goes as well. The arguments against were from John Cochrane of the University of Chicago who wrote:

Nobody is Keynesian now, really. Keynes distrusted investment and did not think about growth. Now, we all understand that growth, fuelled by higher productivity, is the key to prosperity. Keynes and his followers famously did not understand inflation, leading to the stagflation of the 1970s. We now understand the links between money and inflation, and the natural rate of unemployment below which inflation will rise. A few months before his death in 1946 Keynes declared:1 “I find myself more and more relying for a solution of our problems on the invisible hand [of the market] which I tried to eject from economics twenty years ago.” His ejection attempt failed. We all now understand the inescapable need for markets and price signals, and the sclerosis induced by high marginal tax rates, especially on investment. Keynes recommended that Britain pay for the second world war with taxes. We now understand that it is best to finance wars by borrowing, so as to spread the disincentive effects of taxes more broadly over time.

Really, the only remaining Keynesian question is a resurrection of fiscal stimulus, the idea that governments should borrow trillions of dollars and spend them quickly to address our current economic problems. We professional economists are certainly not all in favour. For example, several hundred economists quickly signed the CATO Institute’s letter2 opposing fiscal stimulus.

Why not? Most of all, modern economics gives very little reason to believe that fiscal stimulus will do much to raise output or lower unemployment. How can borrowing money from A and giving it to B do anything? Every dollar that B spends is a dollar that A does not spend.3 The basic Keynesian analysis of this question is simply wrong. Professional economists abandoned it 30 years ago when Bob Lucas, Tom Sargent and Ed Prescott pointed out its logical inconsistencies. It has not appeared in graduate programmes or professional journals since. Policy simulations from Keynesian models disappeared as well, and even authors who call themselves Keynesian authors do not believe explicit models enough to use them. New Keynesian economics produces an interesting analysis of monetary policy focused on interest rate rules, not a resurrection of fiscal stimulus.

Our situation is remarkable. Imagine that an august group of Nobel-prize-winning scientists and government advisers on climate change were to say: “Yes, global warming has been all the rage for 30 years, but all these whippersnappers with their fancy computer models, satellite measurements and stacks of publications in unintelligible academic journals have lost touch with the real world. We still believe the world is headed for an ice age, just as we were taught as undergraduates back in the 1960s.” Who would seem out of touch in that debate? Yet this is exactly where we stand with fiscal stimulus.

Robert Barro’s Ricardian equivalence theorem was one nail in the coffin. This theorem says that stimulus cannot work because people know their taxes must rise in the future. Now, one can argue with that result. Perhaps more people ignore the fact that taxes will go up than overestimate those tax increases. But once enlightened, we cannot ignore this central question. We cannot return to mechanically adding up today’s consumption, investment and export demands, and prescribe the government demand necessary to attain some desired level of output. Every economist now knows that to get stimulus to work, at a minimum, government must fool people into forgetting about future taxes, an issue Keynes and Keynesians never thought of. It also raises the fascinating question of why our Keynesian government is so loudly announcing large and distortionary tax increases if it wants stimulus to work.

There is little empirical evidence to suggest that stimulus will work either. Empirical work without a plausible mechanism is always suspect, and work here suffers desperately from the correlation problem. Quack medicine seems to work, because people take it when they are sick. We do know three things. First, countries that borrow a lot and spend a lot do not grow quickly. Second, we have had credit crunches periodically for centuries, and most have passed quickly without stimulus. Whether the long duration of the great depression was caused or helped by stimulus is still hotly debated. Third, many crises have been precipitated by too much government borrowing.

Neither fiscal stimulus nor conventional monetary policy (exchanging government debt for more cash) diagnoses or addresses the central problem: frozen credit markets. Policy needs first of all to focus on the credit crunch. Rebuilding credit markets does not lend itself to quick fixes that sound sexy in a short op-ed or a speech, but that is the problem, so that is what we should focus on fixing.

The government can also help by not causing more harm. The credit markets are partly paralysed by the fear of what great plan will come next. Why buy bank stock knowing that the next rescue plan will surely wipe you out, and all the legal rights that defend the value of your investment could easily be trampled on? And the government needs to keep its fiscal powder dry. When the crisis passes, our governments will have to try to soak up vast quantities of debt without causing inflation. The more debt there is, the harder that will be.

Of course we are not all Keynesians now. Economics is, or at least tries to be, a science, not a religion. Economic understanding does not lie in a return to eternal verities written down in long , convoluted old books, or in the wisdom of fondly remembered sages, whether Keynes, Friedman or even Smith himself. Economics is a live and active discipline, and it is no disrespect to Keynes to say that we have learned a lot in 70 years. Let us stop talking about labels and appealing to long dead authorities. Let us instead apply the best of modern economics to talk about what has a chance of working in the present situation and why.

Here is some Keynesian wisdom I think we should accept.

“The difficulty lies, not in the new ideas, but in escaping the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.”

“How can I accept the doctrine, which sets up as its bible, above and beyond criticism, an obsolete textbook which I know not only to be scientifically erroneous but without interest or application to the modern world?”

“Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”

Not much of an argument. It merely did the usual macro trick of saying that the spending will shift from the private sector to the public. What doesn’t get said is why that might be a problem for both growth or employment. Leaving out value added leaves out everything that matters. But since it is a measure that cannot be captured in statistical series – how do you tell if an expenditure will repay all of its costs which can only be known at some future date – there is no means to measure. And if Barro is the height of the anti-Keynesian theoretical argument, there really is no argument worth the name at all. Without Say’s Law the anti-Keynesian case is all nonsense.

Dismal science indeed

It is somewhat of a mystery that economists remain devoted to demand as an actual mover of economies. There is, in fact, nothing less likely to cause anything to happen, either in production or employment, than raw desire for a product unbacked by an ability to offer something else in exchange. Money used to be received almost always in exchange for products sold so it was a near perfect proxy. Now money is often received in exchange for nothing of commercial value so is regularly diluted. Either prices rise, quality falls or, invisibly, the productive capital of the economy continues to crumble.

Debt and deficits are a problem that continues to bring ruin. Virtually none of this can be shown in the national accounts because it adds in public spending as if it were really value adding and the crumbling of the capital stock doesn’t show up for a period of years since the “G” in GDP stands for gross. There is therefore almost no means using official statistics to show the deterioration. Statistics using the national accounts are therefore poorly designed for capturing underlying movements in the economy. Which brings us to Reinhart and Rogoff.

The issue is summarised in this paper, It Just Gets More and More Dismal by Andrew Ferguson:

Consider the fate suffered in recent weeks by a pair of well-known economists, poor Carmen Reinhart and Kenneth Rogoff, both of Harvard. They are the authors of several scholarly papers, slightly fewer newspaper op-eds, and one big-selling book, This Time Is Different, which aim to prove scientifically that too much debt is bad for you. More precisely—and how could they be scientists if they weren’t precise?—they claim to have discovered that when a government’s debt rises to 90 percent of its country’s gross domestic product, the country’s economy contracts by (on average) one-tenth of one percent per year.

And so the counter attack from those who love that debt and those deficits:

Few challenged RR on methodological grounds until this April, when three economists—informally called HAP, an acronym of their last names—released a paper debunking the idea of a threshold. Fondling the same sets of figures that RR had used, HAP found that RR had neglected to include some important historical data in their calculations. When those figures were factored in, the threshold vanished. On the graphs, GDP no longer dropped like a plumb after the debt-to-GDP ratio reached 90 percent.

But as even HAP had shown:

The HAP graph shows a long slow decline in GDP under heavier and heavier debt loads. RR shows a dramatic drop at the threshold. The HAP graph is inherently more plausible precisely because RR’s is so dramatic. Cataclysms are rare in life; it’s why they’re so cataclysmic. Predictable cataclysms that happen on a regular schedule are even rarer. RR’s graph shows countries meandering along until .  .  . WHOMP! The HAP graph shows countries meandering along until .  .  . they keep meandering along, en route to more meandering along.

But at least he makes one brief mention of the problem with the approach of both RR and HAP:

RR made no distinctions between kinds of debt or their varying effects on growth. Not all debt works the same way. Money borrowed to build roads and bridges has enduring benefits that help an economy grow; money borrowed to invest in Solyndra .  .  . doesn’t. RR can’t tell us which countries had which kind of debt during which periods.

Yes, spending has to be value adding. Something of a throwaway line in the midst of the article. Hopefully one day it will come to be seen as the crucial issue that it is.

A bottomless chasm, a deep, mysterious, emotional, profound man

A story about class:

Shortly after Barack Obama was elected in 2008, a fellow reporter who’d covered President George W. Bush all eight years told me she’d had enough of the travel and stress and strain of the White House beat, that she was moving on…

I asked her if she’d miss covering President Obama.

“Not at all. He’s an inch deep. Bush is a bottomless chasm, a deep, mysterious, emotional, profound man. Obama is all surface — shallow, obvious, robotic, and, frankly, not nearly as smart as he thinks. Bush was the one.”

…By the way, she’s a hardcore Democrat.

But she was right. And that contrast was apparent to all who watched Thursday’s ceremonial event to open W’s new presidential library in Dallas….

Jimmy Carter … was first to speak. But he was, as always, befuddled.

…he opened with, “In 2000, as some of you may remember, there was a disputed election for several weeks.” Nice way to start. He then took credit for giving W the idea to intercede in Sudan… He never mentioned 9-11 and the war on terror, or the commander in chief’s leadership during America’s most trying hour. Which is why his comments lasted just 3¼ minutes.

Bill Clinton followed. He, of course, spoke twice as long, filling his speech with jokes and faux humility. He was his usual affable self… But… Mr. Clinton, for all his prodigious gifts, will always be the class clown…

George H.W. Bush, turning 90 in June, was a welcome respite. Somewhat frail now, he spoke only briefly from his wheelchair, but garnered two standing ovations — and the biggest laugh of the day from his oldest son. After his remarks, just 24 seconds, he shook his boy’s hand and said, deadpan, “Too long?”

President Obama took the podium next. Every bit as cunning as Slick Willy, his speech too was filled with fake self-effacing insights, including one on “the world’s most exclusive club,” which he said “is more like a support group.”… Then, on a day that was intended to be without politics, he hawked his push for amnesty…

Mr. Obama skipped the praise he had laid on W the night before. “Whatever our political differences, President Bush loves this country and loves its people and shares that same concern and was concerned about all people in America, not just those who voted Republican. I think that’s true about him, and I think that’s true about most of us.”

Except it’s not. Especially not this president. He has made his presidency about dividing America — along lines of class, sex, race, sexuality, you name it…

Then, finally, W took the podium…. He gave a profound lesson to his successor and his predecessor: “In democracy, the purpose of public office is not to fulfill personal ambition. Elected officials must serve a cause greater than themselves…

“As president, I tried to act on these principles every day. It wasn’t always easy and it certainly wasn’t always popular … And when our freedom came under attack, we made the tough decisions required to keep the American people safe,” he said to loud applause.

But it was the end that gave us the truest glimpse of the man… With tears in his eyes, his voice breaking, he said: “It’s the honor of a lifetime to lead a country as brave and as noble as the United States….” By the end he was in tears, barely able to creak out: “God bless.”..

But there was one last classy move not many saw. The program nearly over, Sgt. 1st Class Alvy R. Powell Jr. came to the side of the stage to perform the “Star Spangled Banner.” A big, powerful black man, Mr. Powell belted out the anthem. With the crowd applauding, the sergeant moved along the line of people, shaking hands with all. After greeting W, he turned to go. But the 43rd president put his hand on the sergeant’s arm and said, “Stay,” just as a chaplain stepped forward to give a benediction.

[From Andrew Bolt.]

I think we’ll stay home instead

We thought we might go off to the movies but the only two not directed towards the teenagers market we haven’t seen were this

which was a definte No or this

which made me think we should keep our own company instead.

The politicisation of the film industry is nothing new, of course, but if Chileans believe they would have been better off with their own version of Fidel Castro they have no idea which side their butter is breaded on. And as for making heros of the Weathermen (and women), murderous psychopaths every one, I only wish we could isolate the kinds of people who go in for this sort of stuff and have them live their lives in the kinds of places that Bill Ayres or Salvador Allende would have made for them while leaving the rest of us alone. For our own self preservation we save their worthless hides from their own stupidity, or at least we have up until now. I just fear that the rush of leftist ideas has now so overwhelmed us that there may be no going back but we shall see.

Popper, Keynes and that nonentity Nassim N. Taleb

Here Gary North goes after not one, not two but three amongst the many whose beliefs I find profoundly wrong. Here we are dealing with Popper, Keynes and that nonentity Nassim N. Taleb, author of The Black Swan and Fooled by Randomness. On Popper:

To Popper, the sophomore’s retort is appropriate, despite its sophomoric standing. ‘In what way is Popper’s hypothesis subject to falsification?’ He should have written a lot of pages presenting criteria for how his theory of falsification could be falsified. I guess I missed that article. It surely is not in any of his books that I have read.

I read the main one, The Open Society and Its Enemies, in 1963. In that book, which Hayek helped to get published, is an assumption: The truly free society is a society without permanent truths (other than the truth of falsification, of course). Taleb summarizes the book’s thesis: ‘An open society is one in which no permanent truth is held to exist; this would allow counter-ideas to emerge.’ Again, it’s time for the sophomore’s retort: ‘How about ideas that deny Popper’s theory?’

On Keynes:

Keynes’ final book, The General Theory of Employment, Interest and Money (1936), is one of the most garbled, incoherent, and poorly argued books that has ever reached the level of universally acclaimed masterpiece. It remains as unread today as it was in 1936. It justified the growth of state power over the economy — just what the politicians wanted to hear in the Great Depression.

The best evidence that the book is a political tract is its incoherence. Keynes wrote compelling prose throughout his life — just not when he wrote to promote British economic policy. The very incoherence of The General Theory is the tip-off that the author was self-deluded in arguing for nonsense, namely, denying that sellers will lower their prices when they find that nobody will buy at a higher price. Keynes’ arguments rest on this bedrock presupposition: ‘Sellers really do believe that no income is preferable to some income.’ He believed in permanent gluts.

And on Taleb:

Taleb describes himself as a fool. This is the most accurate assessment in his book. He is a fool for the reason that he repeatedly says he is a fool. He is fooled by randomness.

He is fooled by a few statistically unpredictable oddities found in nature, including the human mind, into believing that there is no ethical cause and effect in the universe. He is exactly what he claims to be: a consistent Darwinist. ‘One must be either blind or foolish to reject the theories of Darwinian self-selection’ (p. 94). As such, he hates moralists above all, as he says. Why? Because he hates the idea that morality, not evolution through impersonal natural selection, governs the universe.

The fact that his book is a best-seller indicates just how far gone morally the intelligent public is. Yes, the book is clever. True, it has a useful bibliography. No question about it, it has some great one-liners. But at bottom, it is the work of a suicide bomber. His targets are people who still believe that there is a predictable relationship between honesty and success, between hard work and success, between thrift and riches. In short, it is a hand grenade against people who think that Warren Buffett got rich through decades of entrepreneurial service to consumers, not by statistically improbable luck.

Death of a revolutionary

On the plane back from Hawaii, I read Susan Faludi’s “Death of a Revolutionary” about how Shulamith Firestone helped to create a new society, the one we are actually living in. The Dialectics of Sex had a big influence on my life having been of the new left just as it was published. Gory personal details unnecessary here, but if you would like to see gory details, read the article. The personal is the political seems to be almost perfectly replicated in Firestone’s extremely sad life. Listening to Germaine Greer forty years after her glory days makes you appreciate just what a stupid bill of goods these people had for sale. When you remember that it was Richard Nixon who approved equal pay for women you can see how non-radical the sensible part of the feminist agenda was and is.