In Is your recession really necessary?, the Financial Times discusses the Misesian view of the business cycle–although they do this as a foil to show why Keynes proved this wrong, they clearly see the Misesian view as something that must be addressed.Full piece:
Is your recession really necessary?
Published: January 3 2009 02:00 | Last updated: January 3 2009 02:00
What a bleak midwinter. It is still hard to see where any green shoots of recovery will break through the permafrosted ground. The recession seems especially unnerving given the length and scale of the good times which preceded it – years in which the current malaise was brewed. It is, therefore, tempting to believe that the world deserves and needs recession to pay for those excesses and to rid ourselves of our unnecessary indulgences. This view, however, is wrong.
In the past few years, the world economy stumbled out of kilter. House prices were unsustainably bloated by cheap money. Deficit countries, such as the UK and the US, borrowed frantically to sustain their consumption. Surplus countries, such as China and Germany, grew rich by sating their bingeing.
These imbalances had been allowed to grow to enormous sizes, nourished by dangerous financial magic. Mortgage straw was not respun, but rather packed into bales and relabelled as triple-A gold. The financial services industry engorged itself, ran up large profits and paid its staff huge bonuses. But the pro-cess also contributed handsomely to government budgets and created enormous demand.
Having lived beyond our means, some economists, notably disciples of the Austrian School, would say that we need recession. The “malinvestment” of the past few years must be liquidated away. The inefficient, along with charlatans and fraudsters, must be exposed. In 1934, during the Great Depression, Ludwig von Mises wrote that policymakers should have been “raising the rate of interest and restricting credit and so giving free play to the purging process of the crisis”.
To von Mises, policy that aimed to “bolster up undertakings that would otherwise have succumbed to the crisis, and on the other hand to give an artificial stimulus to economic life by public works schemes . . . eliminated just those forces which in previous times of depression have . . . paved the way for recovery”.
Such liquidationism makes a fine morality tale: you reap what you sow. It should be little surprise that many prominent members of the Austrian School – and most of its key adherents – are and were socially conservative. But it took the genius of a man whose inhibitions were informed by life in the Bloomsbury Set to fully explain why this is so very wrong.
One of John Maynard Keynes’ great insights was to understand how, in a crisis, demand would not necessarily fall back to the desired sustainable level. If all market actors pull in their horns, the result is the paradox of thrift: demand will dry up, and economic activity will crack and crumble with it. Crisis will certainly arrive, and it may not leave. Once demand has evaporated, economies can slide into a lowemployment, low-growth equilibrium. Governments must respond by supporting demand with loosened monetary and fiscal policy.
These weapons are slow-acting blunderbusses; they do not allow for rapid responses or fine-tuning. But they are preferable to von Mises’ harsh prescription, which could deepen the recession. It is not possible to liquidate the malinvestment without risking allowing unemployment to spiral out of control and demand to fall with it. Such a plan would be less a healthy purgative, and more an acid bath.
Businesses can, and should, still fail. Politicians must not subsidise existing companies. Nor should they seek to prevent necessary adjustments which must take place. If this is what John Maples, the UK Conservative MP meant when he said the “recession has to take its course”, then he is right. But governments must work together, internationally, to sustain demand. They must not sit idly by.
The allure of the Austrian story lies in its devotion to the free market. The real threat to capitalism and democracy, however, is depression and unemployment. It is not countercyclical fiscal policy.
{ 22 comments }
Bah… FT is only marginally better than the atrocity known as BusinessWeek.
So the FT argument is that governments caused this recession with excessive spending and the solution is more government spending? Hey, FT, where does the money the governments spend come from?
As C. Evans has pointed out, all government spending comes at a cost to the taxpayer (or to the holder of currency) and will be much less productive on average than private spending. All Keynesian policy does is create malinvestments even worse than those which started the recession in the first place.
Nobody denies the presence of feedback loops in the economy with respect to spending and employment. However, spending and employment are irrelevant if they are directed improperly. The only way to have spending and employment that are productive is to take liquidate, and start fresh.
“One of John Maynard Keynes’ great insights was to understand how, in a crisis, demand would not necessarily fall back to the desired sustainable level. If all market actors pull in their horns, the result is the paradox of thrift: demand will dry up, and economic activity will crack and crumble with it. Crisis will certainly arrive, and it may not leave. Once demand has evaporated, economies can slide into a lowemployment, low-growth equilibrium.”
This was shot down by Pigou early on, when he pointed out that by only looking at flows this scenario had left out crucial stuff like the effect of stocks. It turns out that this Real Balance Effect sorts it all out nicely even according to classical economics, unless intervention gets in the way.
Does this hogwash pass as serious analysis? Hayek refuted Keynes’s garbage decades ago. Where are the Keynesian responses to it? Are they too embarassed to acknowledge it? Charlatans indeed.
“Such liquidationism makes a fine morality tale: you reap what you sow. It should be little surprise that many prominent members of the Austrian School – and most of its key adherents – are and were socially conservative.”
These idiots do not seem to comprehend the gravity of the problem. It is not a mere “morality” play, it is a serious imbalance in the economy. Of course these vultures care little for morals anyway, but this is nonsense. Thanks to PM Lawrence as well for that bit of information. It seems that the Keynesian system has been refuted so many times it has no leg left to stand on, except when it comes to financial mystics. I’m also at a loss as to why one must be a “social conservative” to be at one with common sense. I suppose this is tacit admission that left-”liberals” are frivolous.
It’s not particularly important, but I’m sure it will cheer up some people around here to learn that that wikipedia article mentions that an Austrian economist, Gottfried Haberler, spotted that particular gap in the reasoning even before Pigou did.
I disagree with modern received wisdom that the effect is a purely psychological “wealth effect”. People whose nominal holdings have risen in value may well spend more because of their feelings, but they have real balances that allow them to do so and mean that they can keep going until equilibrium is restored – unlike people who “feel” rich because they hold bubbled housing, for instance. Besides, you still get an effect from people who spend the same in nominal terms and only “feel” as wealthy as they did before, e.g. retirees on fixed nominal incomes.
The issue Haberler and Pigou discussed is really a part of the discussion of Say’s law.
I don’t particularly like Pigou’s idea because it relies too much on aggregation and looking backwards.
Dig out Ivan Johnson’s article in the Quarterly Journal of Austrian Economics, and Hutt’s piece “The Rehabilitation of Say’s Law”.
That’s oversimplifying. The Real Balance Effect operates (or not) regardless of Say’s Law operating (or not); they are “orthogonal”. It’s just that when both operate, they work together and can be handled together by making certain adjustments, basically changing the co-ordinate system that the analysis is using and then showing that one co-ordinate will be (or tend to) zero when everything is working properly without the effect of interventions and distortions, etc. But throw in an outside shock, say, and you will see that the two things are not the same.
Oh, and Pigou’s idea does not rely on aggregation, it just operates even in simplified models that use aggregates. It still operates even when you disaggregate, but for purposes of illustration you might as well not bother to do that.
“But governments must work together, internationally, to sustain demand. They must not sit idly by.”
And always the basic problem is collectivism.
The problem is that the editorial comment left out the assumptions needed for the paradox of thrift to be true (Never mind that in real life, it won’t hold true).
I thought of a very simple reason as to why the paradox of thrift won’t be true (Which I am sure has been stated before): stores will have more products than they would have had the consumption remained the same. And so, the stores would simply reduce their prices, even if wages were to remain the same (Although that depends on the other costs of production and more generally on the size of the profit). For example, the price at which one shoe would say could become the price for two shoes. Also, they forgot to mention that at the time Keynes came up with this paradox, price and wage controls were considered to be unquestionable rather than problematic. But of course would be mean.
What baffles me is that they still claim to support the free market. Unfortunately, this is forgetting that government intervention begets government intervention.
The featured FT article is like a discussion between two parties where each one just has one chance to provide their arguments. In these situations the one who moves first is at a disadvantage because it cannot react to the second mover’s arguments. And by providing to much arguments before the second mover in order to counter the supposedly to be providen arguments by the second mover, the first mover’s main points can become snowed under.
If in the FT article, Keynes would have been the first mover, an educated Austrian would surely have been so very kind to point out the fallacy of the paradox of thrift, perfectly explained by e.g. F.A> Hayek: http://mises.org/daily/2804
*sigh* Such nonsense. Somehow, governments are supposed to “sustain demand” without subsidizing anyone, and being sure that businesses fail at the same time. How can such an obvious contradiction be accepted?
The allure of wishful thinking should not be underestimated.
“One of John Maynard Keynes’ great insights was to understand how, in a crisis, demand would not necessarily fall back to the desired sustainable level. If all market actors pull in their horns, the result is the paradox of thrift: demand will dry up, and economic activity will crack and crumble with it.â€
The author makes two mistakes, one in each sentence. In the first sentence, he assumes that consumer demand drives the economy. If it did, then Keynes might have been right, but it doesn’t, as Austrians point out. In a way, the author is guilty of assuming his conclusion. The second mistake is the assumption that all market actors will quit buying anything. That’s not a realistic assumption; it’s a nightmare scenario intended to frighten people as much as possible, much like the hysteria of Paulson and Bernanke at the beginning of the current financial crisis.
Finally, the author creates a straw man, as do most opponents of Austrian econ, by casting it as a morality tail. Austrian econ does not say that recessions are punishment for bad behavior. It says they are inevitable because of economic laws. The choice is not between no pain, and severe pain, but between greater and lesser amount of economic pain in the recession. Austrian econ points the way to lesser pain. Keynesian econ claims to point the way to no pain recessions, but history has proven that it produces the greater pain. After all, both Hoover and Roosevelt tried Keynesian econ before Keynes published his general theory and the result was the deepest and longest depression in US history, and the deepest and longest depression in the world at the time.
To P.M.Lawrence…
Perhaps you could link to an article showing your argument in more detail. I think you could be right.
In 1929, Hayek published an essay “The Paradox of Savings” which refutes the Keynesian nonsense quoted by Fundamentalist above. The essay is contained in the Mises Institute’s recenty published Hayek collection.
http://mises.org/books/hayekcollection.pdf
“One of John Maynard Keynes’ great insights was to understand how, in a crisis, demand would not necessarily fall back to the desired sustainable level. If all market actors pull in their horns, the result is the paradox of thrift: demand will dry up, and economic activity will crack and crumble with it……”
Keynes had no great insights, at all, at all.He was a recycler of old mercantilist ideas.
Note Keynes never explained the cause of a crisis
ever. To him they were blowing around in the wind
and were unavoidable.
Only Austrian econ explains the business cycle from start to end.
Sometimes I suspect that writers of articles like this
are aware of and agree with ABCT.But they dare not say so.For if they did they would be forced to advocate the abolition of the central banks and the artificially cheap credit they create.
And that would be career suicide.
They probably don’t know about the ABCT, at least not on a deeper level (As opposed to less superficially than Krugman). And even if they did, they would simply dismiss it as not based on historical evidence or other empirical evidence. In fact, I suspect they don’t know very much about Keynes either. Granted, I don’t know much either, but I read somewhere that Keynes himself didn’t stress the importance of consumption as much as some of his followers are wont to do (Of course, the media being populated by economic illiterates are worse).
Who would expect the Financial Times to expose Lord Keynes as a quack? That would be nothing but unbecoming for an Anglophile.
Why even mention the Austrian School? Because it has the attention of every clear-headed thinker.
These masters of the half-truth are at it again in a vain attempt to salvage a decadent, morally bankrupt, and scientifically invalid ‘economic’ theory. Marxism can no longer pretend to be an economic theory and now Keynesianism is about to join Marxism in the slimy pigeonhole for systems of political exploitation.
N.B. The link to the article (“Is your recession really necessary?”) is currently broken.
they do not allow for rapid responses or fine-tuning. But they are preferable to von Mises’ harsh prescription, which could deepen the recession, end of quote.
Well, I have seen it many times on a chart. Yeah, it is deeper, but not prolonged. We call them spikes. So Keynes take your choice quick or prolonged disaster of misery, caused from intervention. Like the flu, does one want a good 12 hour dose or live days with the symptoms.
Qoute:”The real threat to capitalism and democracy, however, is depression and unemployment.”
This is so very true. So what caused it. Your intervention of allowing loose credit. Ludwig only suggested for you to tighten credit to reverse what you already started for lessor pain. When Keynes proponents ignore this with a continued binge, well we get more of what we got with an even deeper prolonged recession that you are now suggesting that must be address or loose our capitalism and democracy.
We lost our democracy of freedom when the interventionists took it to create this monster in the first place.
Current, I don’t know of an article about it, but the independence of Say’s Law and the Real Balance Effect follows from what I pointed out earlier about the latter dealing with the effects of levels, where Keynesianism leaves levels out and only deals with flows. As flows are the rates of change of levels with time, anything like that automatically leaves levels out as such (even though, in the long run, if markets can bring everything together, there is a correspondence between how flows and levels behave). Well, Say’s Law also looks at the consequences of flows, which means that any consequences of levels (rather than their rates of change) don’t show up under it. To bring them together, to unify them, you have to find the interest rate that balances the prices of flows and levels. An undistorted economy will go through some “higgling of the market” iterations to bring everything together like that, but you can’t look at the distorted economy we’ve actually got and just plug in the interest rates you find there. Once you’ve got distortions, you can’t assume proper equilibrium tendencies.
To someone like me with a mathematical background, this seems so nearly intuitive that it’s hard to see what other people might be missing, and even harder to find analogies that aren’t themselves too technical. I was thinking of trying to compare it with fluid flows or electrical engineering, but that would probably just be switching one technical area for another.
Don’t worry I’m an electronic engineer. I’ve read a bit more about it and I get it.
I’m not really so sure about the idea though. The real-balance effect seems to be fundamentally a backward looking idea. People’s ideas about wealth depend on their ideas about the future.
This gets into the problem of to what extent Lucas and Barro are right. If I had a spare few years I’d try to find out.
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