Category Archives: Economic theory and policy

The economics equivalent of Godwin’s Law

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This is a correspondence that began on the Societies for the History of Economics (SHOE) website that originally dealt with wages and productivity. But as the thread developed, the issues drifted over towards Keynesian economics, and not I emphasise because of anything I had contributed. So on November 15, there was the following contribution which began with a quote from something that had been written by James Ahiakpor:

It was with much amusement that I read Michael Ambrosi’s comments. Amusement because I remain puzzled as to why some historians of economic thought can’t seem to shed their Keynesian beliefs in the face of analysis clearly contradicting them … I’m getting to the point of accepting that some people just can’t be helped with arguments or clarifications. It’s just a waste of time. Would that I did not encounter them in the academic refereeing process …

Following which the following question was asked:

There are ex-Marxists and ex-Keynesians: where are the ex-Austrians?

So on the very same day, I wrote the following response:

Rob asks an interesting question which I think is worth a thread of its own:

‘There are ex-Marxists and ex-Keynesians: where are the ex-Austrians?’

Austrian economics was one strand of pre-Keynesian classical economic theory but an important strand today since it is the only strand that survived the Keynesian Revolution. I don’t classify myself as an Austrian but as a classical economist which gives me an overlap of around 75% with the Austrian School and about 10% with modern neoclassical macro. And there is almost nothing in Mises and Hayek I ever find myself in serious disagreement with.

There are, no doubt, ex-Austrians but I suspect none of them end up in any of the modern strands of economic theory. I often mention Mill but a more modern and accessible version of the classical school can be found in almost any text pre-1930. My favourite for a variety of reasons is Henry Clay’s 1916 Economics: an Introduction for the General Reader but there are many to choose from. Haberler’s Prosperity and Depression published in 1937 moves you closer to the depth and breadth of the classical theory of the cycle.

I have for many years found Keynesian demand side analysis utterly wrong but where was the evidence? Now we have had a radical experiment in economic policy across the world and if it is not obvious beyond argument that a Keynesian stimulus will not work then I don’t know what conceivable evidence there could ever be that would convince anyone just how poorly structured the underlying Keynesian theory is. Y=C+I+G in my view and the view of many others provides no insights into either the causes of recession nor what to do when they happen.

There are therefore no ‘ex-Austrians’ in the same sense as ex-Marxists or ex-Keynesians because the world continues to behave more or less as we classical/Austrian economists expect it to. Classical theory does explain and it does provide policy answers which we are seeing put in place under the name of austerity as an attempt to restore balance after the Keynesian excesses of the past five and more years. Those who are taking this road are guided by intuition without textbook answers but are doing pretty well what a classical economist would have recommended. That is, they are doing exactly what the UK, Australia and others did to take our economies out of the Great Depression.

A series of responses followed this, some reply to Rob and others to me. But the largest complaint about what I had written was not about Keynesian theory but whether I had gone to far in stating that the failures of the Keynesian stimulus had been “obvious”. That the stimulus has made things worse in every economy it has been tried seems so self evident that I still don’t know how the obviousness of the mess the stimulus has caused can be question. Nevertheless, this is what I wrote in reply on 16 November:

I should not have said ‘if it is not obvious beyond argument that a Keynesian stimulus will not work etc etc’ since it is not obvious. But even here in Australia, where for a variety of reasons we probably experienced the least damaging downturn following the GFC, the general assessment is that the stimulus has left us with massive problems that will require a repair job going over many years. No one goes around talking about how well the stimulus turned out and even as unemployment has now returned to its post-GFC high and still heading north, our new government is attempting to cut spending and bring the budget into balance just as the previous government attempted to do. And on this we are not alone.

So it is not obvious what went wrong, merely a conundrum: this is what it says in the textbooks and this is what we feel we need to do. Why are they different?

Every economist seems to be in some ways eclectic. They put their own worldviews together built around one of the existing frameworks that for individual reasons appeal to themselves. And over time they shift and change as they learn more and observe. But with macro just about everyone starts from AS-AD which has now become a major dividing line. Keynesians versus Austrians is the way it is often portrayed but this is a short form which leaves out much of what is relevant.

But however you would like to describe the nature of this divide, we as economists should in my view be having some kind of in-house review on the relevance of AS-AD to the formation of policy. It’s true that AS-AD is a very seductive concept, not obviously wrong. But still, starting from casual empiricism and then working through the econometric work of Alesina, say, but also others, and with theoretical considerations also then brought into this discussion, alternatives to AS-AD might eventually emerge in our textbooks. In the meantime, ever fewer policy makers are willing go near AS-AD to work out what ought to be done in the real world. That much anyway is obvious. Given that our economic texts ought to be a guide to economic policy, all this should be seen as something of concern to the profession.

The only reply since then has been to say this:

If I may offer just one more quote from some people who care about the evidence. Jordà, Òscar and Alan M. Taylor, 2013:

The Time for Austerity: Estimating the Average Treatment Effect of Fiscal Policy

[W]e have a measure of the multiplier that explicitly accounts for failures of identification due to observable controls. Our estimates … suggest even larger impacts than the IMF study when the state of the economy worsens. … It appears that Keynes was right after all.

As Steve now allows, it is *not* obvious that the fiscal responses to the Great Recession invalidate Keynesian claims about the role of aggregate demand. Not in the least.

To prove using a Keynesian model that Keynesian theory delivers the goods in the face of the massive disasters that ought to be the unarguable evidence that the US economy is sinking, only proves there are some people who cannot see because they will not see.

There really needs to be an equivalent to Godwin’s Law in economic discussion. Whoever is the first to bring empirical results into an argument about economic theory automatically loses.

Spending does not make an economy grow

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A note by Karen Maley in the AFR today brings enlightenment following my post on True Confessions yesterday. There she wrote:

Dalio and his team at Bridgewater, the world’s largest and most successful hedge fund, which manages about $150 billion in global investments, argue in a note to clients this week that in the old days, central banks used to cut interest rates to stimulate the economy. But that all changed when interest rates fell to zero per cent. At that point, central banks instead adopted quantitative easing (QE), or printing money and buying financial assets such as bonds. This pushed up the price of financial assets, and central banks hoped those who owned these assets would feel wealthier and would spend more, and this would, in turn, trickle down to stimulate economic activity. [My bolding]

I do not know what to make of this Keynesian dreck any more. If this is the actual dinkum basis for the quantitative easing we have been having, then this is worse than insane, assuming financial suicide is a form of peak insanity.

Spending does not make an economy grow. I’ll say it again. Spending does not make an economy grow. Putting in place real productive assets makes an economy grow. Can you see the difference? Apparently there are folks in powerful positions in every major central bank in the world, and probably in every Treasury as well, that can’t see the difference. But the difference is in having low growth economies that never seem to budge and high growth economies where the largest problem is a shortage of labour.

The Keynesian walking dead

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keynesian walking dead

Megan McArdle has an article on Bloomberg they’ve titled, Why It’s So Hard to Kill Keynesianism. And in spite of the arguments you find in the article which are from a rather diverse crew of supposedly anti-Keynesian economists, it’s straightforward why Keynesian theory continues to lurch forward.

  • It is taught in virtually every introductory economics textbook in the world.
  • No economist would even consider giving up on aggregate demand as the driver of economic activity.

So we have John Cochrane quoted as saying:

Since about 1980, if you send a paper with this model to any half respectable journal, they will reject it instantly.

I don’t know what “this model” consists of but if he is saying that employing aggregate demand is instant death for any article, I would have my doubts. But it’s not the articles supporting Keynes that interest me. Where are the ones that point out that Keynesian theory and policy are nonsense? Articles along those lines would be a radical departure but where are they? And let me add, as a personal experience, that it is not all that easy to get them published if you write them.

But then, what would be the exact point of these articles so far as policy is concerned? As McArdle says herself:

New Keynesian models do predict stimulative effects from government spending. But they do so through a completely different channel from the old Keynesian models that are still popular with most of the public intellectuals who support stimulus.

No one at the political level, trying to work out what to do as recession comes crashing through the wall, is going to be interested in the channels that cause a stimulus to work. They just want an answer, and if the answer is a stimulus then off they go. And off they did go. They have now spent in haste and are repenting in leisure but it was some variant version of Keynesian theory that drove them to take the actions that they took. But where are the post mortems on what went wrong? Plenty on what caused the Global Financial Crisis. Almost nothing on why the stimulus that followed has been such a disaster.

And for McArdle to say that Keynesian theory represents “an economic model with zero percent mindshare among professional macroeconomists” just cannot be true. The reality is that economists know virtually nothing else. I have scoured the article for the alternative theory the people she spoke to have in mind and can find nothing. The most you hear is that we should abandon macro and leave everything to micro which is as nonsensical an idea as the Keynesian theory it would replace. I would merely point out that The Wealth of Nations was entirely macro, classical macro. That is where the action is and the answers begin. Economic theory around 1916 say, would be something like the high point and a good place to start over from.

McArdle does, however, go into “supply side economics” but restricts it to the notion of tax cuts. She unfortunately goes nowhere near the underlying theory or discusses any of the wider implications. And there is nothing on the absolute necessity found within supply-side theory which explicitly requires starting over from classical presuppositions and a return to Say’s Law.

And while the efficient market hypothesis is fine as far as it goes, what it does not do and cannot do is rule out recessions. In my view, there is nothing in the EMH that is not fully discussed in classical business cycle theory (and who amongst the entire history-deprived economics profession could tell me whether I am right or wrong on this). Just because you believe that information gets fully used as soon as it is available is no reason to think recessions cannot happen. There are the known unknowns and the unknown unknowns that will get you every time. Even the known knowns can sometimes put an economy into recession. No one can prepare for everything.

The Keynesian walking dead are anyone who uses aggregate demand to explain how an economy works. If that’s not 100% of the profession, it’s near enough.

[My thanks to I.D. for bringing this article to my attention.]

True confessions

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This is the wildest story yet about American economic management that if you understand it will terrify you. It is from the Wall Street Journal and is titled, “Confessions of a Quantitative Easer”:

Having been at the Fed for seven years, until early 2008, I was working on Wall Street in spring 2009 when I got an unexpected phone call. Would I come back to work on the Fed’s trading floor? The job: managing what was at the heart of QE’s bond-buying spree—a wild attempt to buy $1.25 trillion in mortgage bonds in 12 months. Incredibly, the Fed was calling to ask if I wanted to quarterback the largest economic stimulus in U.S. history.

You and I have, of course, never heard of this guy till now but he has quite a story to tell. If you are interested in knowing how the economic world you live in is “managed” this is one port of call you might make. This is just included as a teaser:

Where are we today? The Fed keeps buying roughly $85 billion in bonds a month, chronically delaying so much as a minor QE taper. Over five years, its bond purchases have come to more than $4 trillion. Amazingly, in a supposedly free-market nation, QE has become the largest financial-markets intervention by any government in world history.

As he says:

We were working feverishly to preserve the impression that the Fed knew what it was doing.

What they are doing is riding on the back of a tiger. Those idiots who voted for Obama to help the poor and the disadvantaged, what a bad joke that is. If Goldman Sachs is your favourite charity then maybe you’re onto something. Otherwise, if you are dumb enough to work you can help repay this debt while they drive off to the Hamptons.

[Picked up from Powerline.]

Explaining Hayek’s logic

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This was posted today on the Societies for the History of Economics (SHOE) website:

Can someone explain Hayek’s (1978) logic:

“I have just published an article in the London Times on the effect of trade unions generally. It contains a short paragraph just pointing out that one of the effects of high wages leading to unemployment is that it forces capitalists to use their capital in a form where they will employ little labor. I now see from the reaction that it’s still a completely new argument to most of the people. [laughter]”

In further explanation of his puzzlement, he pointed out that this makes no sense using marginal productivity theory since everything else will re-adjust to create full employment so what was Hayek trying to say. I therefore gave my explanation which followed behind another explanation given by James Ahiakpor, the only other modern day relentlessly anti-Keynesian economist I know of, but this is from me:

In Australia where I was involved in our National Wage Cases on behalf of employers, there was an argument we continually had to deal with which came from the bench and not the unions. It was that raising wages would be good for the economy since it would force businesses to become more capital intensive. The assumption here was that the higher productivity forced on employers would lead to increases in the economy’s ability to finance the higher real wage being imposed.

Marginal productivity theory is part of micro and will tell you what an individual firm will do in the face of higher real labour costs. It does not, however, tell you what will happen across the economy. Forcing real wages higher than the underlying productivity of the economy will support will drive some people out of work. This seems to me so obvious that both then and now it leaves me nonplussed to see it even mentioned, but then I, like James, think about these questions using classical forms of analysis. Unfortunately, like Hayek said, it still seems to be a completely new argument to most people.

The only difference between myself and James is that I would send you to Mill rather than Ricardo.

Classical economists – there are still a few of us around

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A quite instructive article by Peter Boettke on The Great Disruption in Economic Thought. Addressed in particular towards Janet Yellen but more generally to anyone capable of listening, you are encouraged to read it all but let me provide the first para so that you can decide if you would like to continue after that:

Roughly speaking classical political economy, or economic orthodoxy, taught the following: private property, freedom of contract and trade, sound money, and fiscal responsibility. For our purposes we refer to this set of policies as the laissez-faire principle. Of course throughout the history of economic ideas there were always subtle differences of opinion within orthodoxy, and fine points of disagreement in method and methodology. But these paled in comparison with the broad consensus on matters concerning the nature and signficance of economics and political economy. Yes, John Stuart Mill had exceptions to the laissez-faire principle that one could drive an intellectual truck through, but re-read how he sents up that discussion and the importance he places on the laissez-faire presumption.

I will only add that anyone who thinks they can drive an intellectual truck through the ideas of John Stuart Mill has their work cut out for them. But since for most people, someone’s views on John Stuart Mill are not apt to be an obstacle, let me encourage you to read the rest.

And if you do, let me mention that I specifically classify myself as a classical economist a label which Peter is also willing to use. Indeed, I go further. I think of my own book on economic theory as a twenty-first century version of Mill’s 1848 Principles. We have learned a lot since then it is true, but we have forgotten even more.

Fear of spiders

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The Government seems to be filled with a desire for a few changes around here. This is first and foremost from the office of the Attorney-General, George Brandis:

THE repeal of the ‘Andrew Bolt’ provisions of the Racial Discrimination Act that make it unlawful to offend and insult people because of their race will be the subject of the first legislation Attorney-General George Brandis will introduce to parliament.

The repeal, which will honour an election promise, will change the definition of racial vilification to eliminate at least two of the grounds that were used against the conservative columnist over articles about light-skinned Aboriginal people.

And then there’s this, again from the Attorney-General:

LITIGATION funders and plaintiff law firms are facing the prospect of regulatory change after Attorney-General George Brandis strongly criticised the involvement of law firms in the companies that finance class actions.

He said the litigation funding industry was under ‘active consideration right now’.

He believed the involvement of law firms with these companies gave rise to unavoidable moral hazards and conflicts of interest.

‘I am by no means satisfied about the way this is dealt with at the moment by rules of court or by self-adopted protocols by those practitioners,’ he said.

‘In the near future it is my intention to give some indications about the way I think those conflicts of interest and moral hazards should be addressed.’

And finally there’s this:

TONY Abbott will take an axe to 20 government committees and councils today in the first stage of a campaign to cut costs and slash redundant agencies.

The move comes as the government warns of a mounting bill to top up funds at major commonwealth authorities, as regulators plunge into the red in a struggle to meet growing demands.

The Prime Minister’s changes, to be unveiled today, risk a backlash from groups ranging from sporting shooters to adoptive parents as he scraps advisory councils and hands their functions back to government departments.

And let me say about these advisory councils, that my experience on them was that we were hardly ever responsible for the slightest change in anything although I would put in a good word for the Australian Statistics Advisory Council (ASAC).

But I liked this in particular from Joe Hockey:

Every cupboard I am opening has spiders in it — as illustrated by the fact that, in a meeting with the ACCC, they tell me that they are running out of money in April this year and that they are underfunded for the next four years by over $100m.

If you have this kind of arachnophobia you should avoid becoming Treasurer in a Coalition government immediately following a Labor Government, but I am sure that Joe will be on top of it.

An Austrian course on Keynesian economics

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I have been hassling my Austrian friends for quite some time that it is not enough to be pro-Hayek and pro-Mises but they also have to be anti-Keynes. Unless they specifically present their own pre-Keynesian classical views as a direct counterweight to the Keynesian wreckage, they have no hope of seeing Keynesian economics finally removed from our texts. It still remains a mystery that the events of the past five years have not even commenced a massive overhaul of mainstream economics. It does seem as if the mainstream continues to believe they are on top of it all. But if mainstream economists still think that Y=C+I+G can explain what caused the recession in the first place or what is needed to create recovery, not only is their economic understanding now worthless but so too is their credibility.

But this morning I have received a notice from the Mises Institute that it is about to run a six-week online course on Keynesian economics:

Beginning Monday, November 11, William Anderson will be teaching ‘The Ghost of Keynes’ at Mises Academy. This six-week online course will examine how and why many economists and governments continue to ignore the numerous fallacies that accompany Keynesian thinking even as the Keynesian-influenced economies around the world continue to flounder in high unemployment and low growth.

Whether this will include a discussion of Say’s Law I do not know but it absolutely needs to. You can watch my presentation to the Mises Institute above on Keynesian economics and Say’s Law. But even though there is an appreciation amongst Austrian economists that the two are related, the importance of Say’s Law is not yet completely embodied in the way Austrians discuss economics. They, of course, do not reject Say’s Law but they also do not fully embrace it.

Nevertheless, I encourage you to sign up for this six-week course. You can enroll here.

Never too old to learn

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There was an article on Alan Greenspan the other day in The Business Australian about his new book The Map and the Territory in which he made an interesting set of observations, both political and economic. First the political:

ALAN Greenspan, the former chairman of the US Federal Reserve, goes to a lot of parties. He and his wife, the TV journalist Andrea Mitchell, ‘sort of get invited everywhere’, he says, sitting in front of the long bay window in his office in Washington.

Lately, though, cocktails and dinners seem to have guest lists drawn almost exclusively from one political party or the other. ‘It used to be a ritualistic 50-50 at parties – the doyennes of culture and partying were very strict about bipartisanship,’ he adds. ‘That doesn’t exist any more.’

Talking to each other is what much of politics is about. Although there’s not a lot to say for Canberra, it is small enough that you are always bumping into people and the informal side of making contacts helps. Now we find the former more collegial atmosphere in Washington has been superseded by a poisonous rancour to such an extent that people don’t even meet each other any more.

Even here, the kind of viciousness that seems to have invaded Gillard’s speech on misogyny was personal and would have made it much more difficult for Abbott to even pretend to have a friendly relationship with the then-Prime Minister. As I learned in industrial relations, you can only settle a dispute by sitting down with the other side. Turning opponents into visceral enemies cannot be good for getting on with the business of getting things done. “Electricity Bill” Shorten travelling to Afghanistan with Tony Abbott is how these things ought to be.

But it was what Greenspan says about economics that I found perhaps even more interesting.

‘I’ve always considered myself more of a mathematician than a psychologist,’says Greenspan. But after the Fed’s model failed to predict the financial crisis, he realised that there was more to forecasting than numbers. ‘It all fell apart, in the sense that not a single major forecaster of note or institution caught it,’ he says. ‘The Federal Reserve has got the most elaborate econometric model, which incorporates all the newfangled models of how the world works – and it missed it completely.’

Econometric models are based on the past so that they can really only forecast the kinds of events that have happened before. But even after the event, I would have to think that the linkages from the housing market to the world’s financial system would have made forecasting what did happen all but impossible, which is why no one did. Many claim they did but no one did. So the story goes on:

‘A few days (after the crisis hit), I run into an article, and it is titled, “Do we economists know anything?”‘ he says.

Greenspan set out to find his blind spot step by step. First he drew the conclusion that [A] the non-financial sector of the economy had been healthy. The problem lay in finance, [B] because of its vulnerability to spells of euphoria and irrational fear. Studying the results of herd behaviour provided him with some surprises. ‘I was actually flabbergasted,’ he says. ‘It upended my view of how the world works.’

He concluded that fear has at least three times the effect of euphoria in producing market gyrations. [My letters and bolding.]

A bit of economic history and a study of the history of economics would not go amiss. The man who invented the term “irrational exuberance” now says he’s just discovered that “irrational fears” drive markets. Middle stages of dementia, obviously.So please let me point out that so far as [A] was concerned, the problem was the housing market which had over-produced and found a sub-prime market amongst those who could never repay their debts. This was a real problem, not financial and not psychological. The underlying structure of the American economy was fantastically distorted and has become even more so with the coming of the stimulus. He needs to read a bit of pre-Keynesian business cycle theory, or if he would like a short cut, he could read my Free Market Economics.

And so far as [B] goes, if he thinks that fears that mounted at the end of 2008 were mere shadows with no substance then he is even more off centre than he thinks he is. If this is the new wisdom in Washington, I can only think it would be better if both sides stop inviting him to parties if that is what he now has to say.

Philistines and ignoramuses

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The Australian Business Deans Council has in its preliminary report indicated that it would lower the journal ranking of History of Political Economy to a B which if it did would merely display, for all to see, what a Philistine bunch of ignoramuses they are. They are for nuts and bolts, debits and credits, tangibles and assets, not this academically philosophical, highly abstract historical economics kind of stuff, which is actually what a proper education consists of, including a business education.

For those as far from economics as a council made up of the deans of schools of business, this may seem a remote and unimportant area of study. The reality is that it is an area of study at the very forefront of economic theory. As just one example, one of the great monetary theorists in the world today, David Laidler, has just written an article on “Three Revolutions in Macroeconomics: Their Nature and Influence” going back over the historical development of three different revolutionary episodes in macroeconomics and in which he ends the abstract with these words: “some implications of this story for today’s macroeconomics are briefly discussed.” Nor is he the only major economist who has done important work in the History of Economics. Nobel Prize winners, including Paul Samuelson and George Stigler, have done extensive research in this area, not as a way to pass the time but as real and genuine contributions to our understanding of how economies work.

I have even written a book just this year on the crucial importance of this area titled, Defending the History of Economic Thought (Elgar 2013). This may be an area that is under-appreciated even amongst economists but when the moment of truth came in 2007 to remove the History of Economic Thought from within the economics classification, there was an uprising amongst economists in general, not only across the academic world but encompassing economists at every level reaching right through to the secretaries of every economics-related department in the Federal public service. It should therefore not be left to the tender mercies of the deans of schools of business to make such negative determinations about the value of journals in one of the most important areas of economics.