Economic theory reaching the bottom of the barrel

Excerpts from a comment on Keynesian economics. Everything about this annoys me and is demonstrably wrong. The full comment is found at the end of this post

1) “Keynes’ mistake was not in his solution to a savings glut, since there is nothing wrong with the notion of using public works to absorb a savings glut

2) “the distortions created by excessive government intervention are likely to do far more damage than they solve over time

3) “neither Keynesian nor neoclassical synthesis are used by mainstream economists today

4) “both were well and truly discredited by the new classical revolution sparked by the Lucas critique, Friedman, Schwartz and others”

5) “unfortunately, new classical economics failed to explain the real world which enabled new Keynesian economics to emerge.”

6) “there are also a few very dopey economists who go the other way and persist with discredited ideas from the right, such as the Austrian school.”

So my comment on this comment.

1) A “savings glut” is a misinterpretation of the effect on business confidence after a financial crisis. That everyone goes into a shell for a few months is hardly surprising, whose effects are compounded by a reluctance of those with money to lend to others since no one really knows who is and is not solvent.

2) I absolutely do go along with the concern about governments misdirecting resources but the qualifier at the end, “over time”, makes me very suspicious. The damage caused by the distortions are immediate although it may take a while before the effects of misdirected production begin to show up, and here we are talking about even 3-4 years.

3) If I was told that the phrase “aggregate demand” had been purged from economic theory I might just be willing to go along with the idea that Keynes is dead and gone. But once you recognise that the Keynesian innovation was “aggregate demand”, the notion that Keynesian economics is dead is absolute nonsense. Until that goes, macro will only cause harm and almost never do a single thing right, other than by chance.

4) “New classical” economics is so absurd that it never fails to astonish me that it ever gathered a following, other than it pretended to be the refutation of Keynesian theory. This is what it really is. Keynes set up a strawman version of classical theory in The General Theory which he said was based on the supposedly classical assumption that there could never be involuntary unemployment. No actual pre-Keynesian classical economist believed any such thing, but New Classicals actually do. They have attempted to refute Keynesian theory by actually promoting Keynes’s strawman as the real thing!

5) New Classical theory gave up all pretence of being able to understand an actual recession after the GFC. Since it said no such things could occur – that all unemployment was voluntary! – they had nothing in their kit bag to explain the situation or to devise policies to deal with a set of circumstances they argued could never actually occur.

6) Not an Austrian myself – “JSM Classical” – but you can get a lot more sense in Mises than from just about anyone since he actually incorporates the role of entrepreneurs in how economies work, as do all other Austrians. They discuss markets and relative price adjustments. They see an active role for competition. I have my differences, but most of Austrian theory is as sound as you can find in the modern world.

Economic theory is at such a low level of insight that it fills me with a kind of despair, since as it is currently structured, it is part of the process helping to push the freest and most prosperous civilisation in history over the cliff.

As for the comment in full, here it is in all its irrelevance.

Keynes believed there was a diminishing return to capital and so there was a risk of a savings glut and hence lower consumption. His prescription was for public works spending to absorb this savings glut and and so maintain production. Keynes never suggested redistribution of either wealth or income which is what your anecdote implies. Indeed, Keynes was very much opposed to governments running cyclical deficits on recurrent expenditure, which is why he suggested that any temporary increase in spending to address a savings glut should be managed through public works.

The common misunderstanding of Keynesian economics stems largely from the fact that John Hicks wrote a book to interpret the General Theory in terms of neoclassical economics. As a result, the view of Keynesian economics shared by most people today is of Hicks’ neoclassical synthesis rather than Keynesian.

Keynes’ mistake was not in his solution to a savings glut, since there is nothing wrong with the notion of using public works to absorb a savings glut. The problem is that such savings gluts are exceedingly rare and transient at best which means that they will almost inevitably be over before any government can respond. In fact, the distortions created by excessive government intervention are likely to do far more damage than they solve over time.

Of course, neither Keynesian nor neoclassical synthesis are used by mainstream economists today. Both were well and truly discredited by the new classical revolution sparked by the Lucas critique, Friedman, Schwartz and others.

Unfortunately, new classical economics failed to explain the real world which enabled new Keynesian economics to emerge. This new Keynesian economics had little foundation in economic theory and so the two branches merged to give us the new neoclassical synthesis which is the mainstream of modern economics.

Whilst there may be much in the new neoclassical synthesis that is wrong, there is nothing in the theory which supports the redistribution of ether wealth or income. What this means, is that many economists may believe in redistribution but the economics itself does not support this, at least as far as the mainstream is concerned.

Naturally there remain a number of heterodox economists out there who support outlandish ideologies, such as a few Marxists, Sraffians and New Keynsians etc. There are also a few very dopey economists who go the other way and persist with discredited ideas from the right, such as the Austrian school. However, orthodox economics, and this includes Keynes, new classical and the latest new neoclassical synthesis does not support redistribution.

Thus we may chuckle at such amusing anecdotes, but this does not represent the problem and never did.

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