Archive for the ‘Austrian Economics’ Category

Keynesian economics is a failure.

It didn’t work for Hoover and Roosevelt in the 1930s. It didn’t work for Japan in the 1990s. And it didn’t work for Bush or Obama in recent years.

No matter where’s it’s been tried, it’s been a flop.

So why, whenever there’s a downturn, do politicians resuscitate the idea that bigger government will “stimulate” the economy?

I’ve tried to answer that question.

Keynesian economics is the perpetual motion machine of the left. You build a model that assumes government spending is good for the economy and you assume that there are zero costs when the government diverts money from the private sector. …politicians love Keynesian theory because it tells them that their vice is a virtue. They’re not buying votes with other people’s money, they’re “stimulating” the economy!

I think there’s a lot of truth in that excerpt, but Sheldon Richman, writing for Reason, offers a more complete analysis. He starts by identifying the quandary.

You can’t watch a news program without hearing pundits analyze economic conditions in orthodox Keynesian terms, even if they don’t realize that’s what they’re doing. …What accounts for this staying power?

He then gives his answer, which is the same as mine.

I’d have said it’s because Keynesianism gives intellectual cover for what politicians would want to do anyway: borrow, spend, and create money. They did these things before Lord Keynes published his The General Theory of Employment, Interest, and Money in 1936, and they wanted to continue doing those things even when trouble came of it.

Makes sense, right?

But then Sheldon digs deeper, citing the work of Professor Larry White of George Mason University, and suggests that Keynesianism is popular because it provides hope for an easy answer.

Lawrence H. White of George Mason University, offers a different reason for this staying power in his instructive 2012 book The Clash of Economic Ideas: The Great Policy Debates and Experiments of the Last Hundred Years: namely, that Keynes’s alleged solution to the Great Depression offered hope, apparently unlike its alternatives. …White also notes that “Milton Friedman, looking back in a 1996 interview, essentially agreed [that the alternatives to Keynesianism promised only a better distant future]. Academic economists had flocked to Keynes because he offered a faster way out of the depression, as contrasted to the ‘gloomy’ prescription of [F.A.] Hayek and [Lionel] Robbins that we must wait for the economy to self-correct.” …Note that the concern was not with what would put the economy on a long-term sustainable path, but rather with what would give the short-term appearance of improvement.

In other words, Keynesian economics is like a magical weight-loss pill. Some people simply want to believe it works.

Which is understandably more attractive than the gloomy notion the economy has to go through a painful adjustment process.

But perhaps the best insight in Sheldon’s article is that painful adjustment processes wouldn’t be necessary if politicians didn’t make mistakes in the first place!

A related aspect of the Keynesian response to the Great Depression—this also carries on to the current day—is the stunning lack of interest in what causes hard times. Modern Keynesians such as Paul Krugman praise Keynes for not concerning himself with why the economy fell into depression in the first place. All that mattered was ending it. …White quotes Krugman, who faulted economists who “believed that the crucial thing was to explain the economy’s dynamics, to explain why booms are followed by busts.” …why would you want to get bogged down trying to understand what actually caused the mass unemployment? It’s not as though the cause could be expected to shed light on the remedy.

This is why it’s important to avoid unsustainable booms, such as the government-caused housing bubble and easy-money policy from last decade.

Hayek, Robbins, and Mises, in contrast to Keynes, could explain the initial downturn in terms of the malinvestment induced by the central bank’s creation of money and its low-interest-rate policies during the 1920s. …you’d want to see the mistaken investments liquidated so that ever-scarce resources could be realigned according to consumer demand… And you’d want the harmful government policies that set the boom-bust cycle in motion to end.

Gee, what a radical notion. Instead of putting your hope in a gimmicky weight-loss pill, simply avoid getting too heavy in the first place.

For further information, here’s my video on Keynesian economics.

P.S. Here’s some clever humor about Keynesian economics.

P.P.S. If you like humor, but also want some substance, here’s the famous video showing the Keynes v. Hayek rap contest, followed by the equally entertaining sequel, which features a boxing match between Keynes and Hayek. And even though it’s not the right time of year, this satirical commercial for Keynesian Christmas carols is right on the mark.

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I’m understandably partial to my video debunking Keynesian economics, and I think this Econ 101 video from the Center for Freedom and Prosperity does a great job of showing why consumer spending is a consequence of growth, not the driver.

But for entertainment value, this very funny video from EconStories.tv puts them to shame while also making important points about what causes economic growth.

The video was produced by John Papola, who was one of the creators of the famous Hayek v Keynes rap video, as well as its equally clever sequel.

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I’ve written several times about Hoover and Roosevelt causing/deepening/lengthening the Great Depression with their tax-and-spend, interventionist policies (see here, here, here, here, here, here, and here). But I’ve only once waded into the deeper economic issues. But a new column by Robert Higgs (h/t, Don Boudreaux) has motivated me to give some well-deserved attention to Austrian economic theory.

As you can see in the excerpt below, Higgs succinctly explains that understanding the works of scholars such as Hayek and Mises is necessary if we want people to truly understand why Keynesianism doesn’t work. Higgs also cites two excellent articles (here and here) by my former grad school colleague, Steve Horwitz, for those who want a head start on grasping these issues.

Misunderstanding the Great Depression has caused much mischief in modern macroeconomics and, more important, in government fiscal and monetary policies based on or influenced by this faulty understanding. If we are ever to arrive at a sound understanding of the Depression, we will have to persuade the economics profession to take Austrian economics seriously, as most economists did before the publication of Keynes’s magnum opus in 1936. Keynesianism in particular has proven itself to be a fundamentally flawed mode of analysis, yet one that has survived, evolved, and—like the zombies in the film “Night of the Living Dead”—keeps coming back, no matter how many times anti-Keynesians credit themselves with having dealt it a fatal blow. Monetarist, New Classical, and other recent critiques have themselves been inadequate or indefensible in various ways, as well.

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This doesn’t have the production quality of the Hayek-Keynes rap video, and it presumably won’t get as many views, but this young lady has a very clever love song for Friedrich Hayek.

(h/t Instapundit)

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In his Washington Post column discussing a crisis of confidence among economists, Robert Samuelson correctly notes that Keynesians don’t seem to have the right answers. But he concludes that other schools of thought are similarly befuddled by current events. What he writes is not terribly objectionable, but it’s almost as if he thinks the fiscal debate in the economics profession is limited to the spend-now-and-forever Keynesians and the all-that-matters-is-the-budget-deficit proponents of “austerity” (which often is just an excuse to raise taxes, as I explain here). I gather Samuelson’s not familiar with the Austrian theory developed by scholars such as Mises and Hayek. Unlike the Keynesians and the crowd at the IMF, the Austrian school is not baffled by world events. The Austrians are not so foolish as to think they can predict the economy’s short-term fluctuations, but they were the ones who correctly warned against the intervention and spending that created the current mess and they can take a certain grim satisfaction about being proven correct. And they have the only intelligent prescription for what should be done now – namely, that politicians should get out of the way. After all, the crowd in Washington created the mess by doing too much and doing more of the same bad policies will – at best – further reduce the economy’s long-term prosperity.
Economics has become the shaky science; its intellectual chaos provides context for today’s policy disputes at home and abroad. Consider the matter of budgets. Would bigger deficits stimulate the economy and create jobs, as standard Keynesianism suggests? Or do exploding government debts threaten another financial crisis? The Keynesian logic seems airtight. If consumer and business spending is weak, government raises demand through tax cuts or spending increases. But in practice, governments’ high debts impose financial and psychological limits. …There’s a tug of war between the stimulus of bigger deficits and the fears inspired by bigger deficits. …The disconnect between theory and reality seems ominous. The response to the initial crisis was to throw money at it — to lower interest rates and expand budget deficits. But with interest rates now low and deficits high, what happens if there’s another crisis?

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