Mises on Keynes

Abandoned Factory

But, in practice, general over-production, as popularly imagined, has never, so far as I can discover, been a chief cause of great disequilibrium. The reason, or a reason, for the common notion of over-production is mistaking too little money for too much goods.

— Irving Fisher, “The Debt–Deflation Theory of Great Depressions,” Econometrica 1, 4 (1933), p. 340.

I’m taking professor Joseph Salerno’s “Austrian Macroeconomics” course on Mises University (which I’m genuinely excited for), and one of the reading materials for this Wednesday’s lecture is Ludwig von Mises’ “Lord Keynes and Say’s Law.” The original purpose of this post was to ask for a citation, so I’ll do that first before moving on to what this post has developed into. The third paragraph reads as follows,

Whenever business turned bad, the average merchant had two explanations at hand: the evil was caused by a scarcity of money and by general overproduction. Adam Smith, in a famous passage in “The Wealth of Nations,” exploded the first of these myths. Say devoted himself predominately to a thorough refutation of the second.

I haven’t read The Wealth of Nations, and I’ve asked this question before, but I don’t ever remembering receiving a specific answer. Can anybody cite the “famous passage” (since we may have different editions, chapter and subtitle would be nice)?

The title, and much of the content, suggests that Mises is defending Say from Keynes. He makes it clear that Smith is associated with “exploding” the scarcity of money thesis, and Say with the general overproduction thesis. I’m not sure what Mises means when he characterizes one argument as being about the “scarcity of money,” because for many economists the “general overproduction” argument really boils down to a shortage of money. It may be that Mises has in mind theorists like John Law when he discusses Smith.

Apart from the above, there’s three aspects of Mises’ paper that people may disagree with,

  1. His criticism of the notion of a general glut induced by a shortage of money;
  2. His treatment of Keynes;
  3. His narrative on the debate between Malthus, Sismondi, and Say.

The third is not something I know enough about (but, recently it has become more accepted that Say eventually conceded Malthus’ point). Regarding the first I won’t say much, because my own position is somewhat flaky (although I’ve criticized monetary equilibrium theory elsewhere). I will say that I think he missed the point. Wrote Mises,

Commodities, says Say, are ultimately paid for not by money, but by other commodities. Money is merely the commonly used medium of exchange; it plays only an intermediate role. What the seller wants ultimately to receive in exchange for the commodities sold is other commodities.

I think this far most economists will agree with Mises. But, the fact of the matter is that first a commodity has to be purchased with the medium of exchange. The monetary general glut theory holds that a shortage of money will impede this process from taking place. I think it’s clearest if we illustrate this conceptually. Suppose that there is a money stock of quantity ‘x’ and as soon as someone receives a dollar for her good, she turns around and spends it. Now, let’s say that the demand for money rises to ‘y,AD-AS AD Collapse‘ implying that a shortage of ‘y – x.’ If prices don’t immediately adjust to the clearing, or equilibrium, values what happens is that those who would have otherwise received an aggregate of ‘y – x’ dollars no longer do (and the quantity of money in circulation falls to ‘x – [y – x]’). If prices don’t adjust this implies a contraction in output.

The AD–AS graph to the left is rudimentary, but it helps get a visual understanding of what a “shortage of money” entails. My criticism of monetary equilibrium theory is that the firms adversely affected by the increase in cash balances will lose out either way, because monetary injections won’t necessarily target them. But, if we think about it a bit more I think my error becomes obvious. If we assume that prices are not flexible enough to maintain the original quantity of output, then as I stated above output will fall. However, if aggregate demand recovers through an increase in the stock of money to make up for the increase in cash balances, denoted as ‘y,’ then output will also recover. Now, my criticism is right in that this doesn’t mean the composition of output will remain the same. But, that can be seen as a benefit to maintaining monetary equilibrium: output is restored, but the composition of output is still guided by profit and loss.

I’ve written more than I wanted to on the concept of a monetary general glut. The purpose behind this post, other than that original question, is to comment briefly on Mises’ critique of Keynes. Throughout this short piece, there’s not one instance where Mises actually engages things Keynes wrote. Instead, he falls back on an appeal to authority — that all economists have agreed with him (I suppose that those which agreed with Malthus, Sismondi, and later Keynes, aren’t really economists) —, and the claim that Keynes’ theories are popular because they legitimize economic policies that have been used for decades, or even centuries, before the arrival of Keynes. It’s ironic, because he characterizes The General Theory as an “emotional” rejection, positing that “he did not advance a single tenable argument to invalidate its rationale” — nevermind that a theory being wrong doesn’t mean it’s “emotional.”

I’m no defender of Keynes, but this strikes me as one of Mises’ worst pieces of writing — maybe because it’s meant as a popular article, originally published in The Freeman, and popular articles aren’t usually rigorous. But, Mises was a brilliant economist and one really does expect more of him. It may be that his poor rendition of the “general glut” argument is a product of his unwillingness to more honestly engage Keynes, because Keynes’ theory is ultimately a variation of monetary disequilibrium. Keynes’ version is not about increases in cash balances, rather his business cycle theory relies on a breakdown in financial intermediation. As a result, much of “Lord Keynes and Say’s Law” is spent discussing physical general overproduction, and monetary disequilibrium gets inadequate treatment.

P.S. George Machen, in the comments, links me to an online version of The Wealth of Nations. This must be the passage Mises is referring to,

No complaint, however, is more common than that of a scarcity of money. Money, like wine, must always be scarce with those who have neither wherewithal to buy it, nor credit to borrow it. Those who have either, will seldom be in want either of the money, or of the wine which they have occasion for. This complaint, however, of the scarcity of money, is not always confined to improvident spendthrifts. It is sometimes general through a whole mercantile town and the country in its neighbourhood. Over-trading is the common cause of it. Sober men, whose projects have been disproportioned to their capitals, are as likely to have neither wherewithal to buy money, nor credit to borrow it, as prodigals, whose expense has been disproportioned to their revenue. Before their projects can be brought to bear, their stock is gone, and their credit with it. They run about everywhere to borrow money, and everybody tells them that they have none to lend. Even such general complaints of the scarcity of money do not always prove that the usual number of gold and silver pieces are not circulating in the country, but that many people want those pieces who have nothing to give for them. When the profits of trade happen to be greater than ordinary over-trading becomes a general error, both among great and small dealers. They do not always send more money abroad than usual, but they buy upon credit, both at home and abroad, an unusual quantity of goods, which they send to some distant market, in hopes that the returns will come in before the demand for payment. The demand comes before the returns, and they have nothing at hand with which they can either purchase money or give solid security for borrowing. It is not any scarcity of gold and silver, but the difficulty which such people find in borrowing, and which their creditor find in getting payment, that occasions the general complaint of the scarcity of money.

— Book IV, chapter I, p. 281 in the 2009 [2007] Harriman House edition.

27 thoughts on “Mises on Keynes

  1. Raoul

    I think also that Mises’ article doesn’t include any valuable argument against Keynes, but I would say we can easily salvage this piece of writing by saying it was not its goal. It’s a sociological or historical, and not an economic, paper. Now, I’m wondering why Salerno quotes it.

  2. JCatalan

    Raoul: That may be true. I don’t discuss it (although I hint at it), but even his characterization of the debate between Say, Malthus, and Sismondi is considered to be flawed (Say conceded to Malthus & Sismondi on the possibility of a monetary general glut). Also, he neglects to admit that a large percentage of the profession agreed with Keynes (although less at first). So, even as a work in the history of thought, I don’t think it’s all that good. Regarding its use in Salerno’s class, it’s probably because it’s an easy introduction to the idea that ultimately commodities are traded for other commodities.

    UE: How close, though? I admit I don’t know the history very well. But, reading this post by Gavin Kennedy suggests that Smith only supported anti-usury laws when interest rates are above the “market rate.” Keynes thought that the market rate can be fundamentally wrong. Also, it seems that Smith’s views on usury were mostly a criticism of those who charged “too much,” while Keynes’ views on interest have more to do with the volume of investment.

    1. Unlearning Economics

      The legal maximum of 5%, and government bonds of 3% is not far away from Keynes, who wanted the monetary authorities to keep it at 2-2.5%

      And the views are similar: Keynes viewed speculation as the primary destabilising force in an economy, which was partially caused by investors seeking excessively high yields because they borrowed at a high rate. You can easily see this in Smith’s views.

      1. JCatalan

        I’d keep in mind that that was close to what Keynes thought was the “lower bound” to the interest on loanable funds, since otherwise banks might just seek to invest in alternative financial assets with higher rates of return.

        1. JCatalan

          But, Keynes’ views on interest aren’t only related to speculation, they’re also related to the rate of investment. Keynes supported lowering the rate of interest to induce investment (which, ironically, is tantamount to promoting speculation).

          1. Unlearning Economics

            It’s not at all. Keynes and Smith’s view is the polar opposite to the Austrian view: high rates both discourage worthwhile investment and make the investment that remains more speculative. Lower rates don’t only encourage investment, they make it more productive in nature.

          2. JCatalan

            All action, by its very nature, is speculative. That last sentence is interesting, because Sraffa might disagree with you (and it shows the difference between the more modern Austrian view on capital and, maybe, Böhm-Bawerk’s, where the latter’s might relate to technique while the former’s has more to do with the ratio of capital goods to consumer goods in the market).

      2. Blue Aurora

        Thanks for the help, Unlearningecon. However Jonathan, Keynes DOES distinguish between speculation, investment, and enterprise. To take a commonly invoked example, Keynes states in Chapter 12 of The General Theory that speculation (I’m paraphrasing here) “may do no harm as a bubble on a stream of enterprise”, but when enterprise “becomes a bubble on a whirpool of speculation, then the job is likely to be ill-done”.

        Dr. Michael Emmett Brady’s paper on Smith, Bentham, and Keynes, which I linked to earlier, seems to have been well-received by Gavin Kennedy.


        Furthermore, Dr. Michael Emmett Brady does refer to the passages in The Wealth of Nations in which Adam Smith is supposed to hace railed against the “prodigals and projectors”, which are 18th Century English terms that roughly correspond to speculators and rent-seekers. He also does refer to parts of The General Theory in which you can use to compare and contrast with Adam Smith.


  3. George Machen

    >> Whenever business turned bad, the
    >> average merchant had two explanations at
    >> hand: the evil was caused by a scarcity
    >> of money and by general overproduction.
    >> Adam Smith, in a famous passage in “The
    >> Wealth of Nations,” exploded the first
    >> of these myths….

    > I haven’t read The Wealth of Nations,
    > and I’ve asked this question before, but
    > I don’t ever remembering receiving a
    > specific answer. Can anybody cite the
    > “famous passage”…

    Search on “scarcity of money”

  4. Raoul

    I was not aware that Say conceded on the possibility of a general glut but I did think he was wrong to hold it. Nevertheless, I don’t believe it makes Say’s law erroneous, because the gist of it is not the impossibility of a general glut, but that a general glut isn’t caused by an overproduction.

    Edit : I mean that overproduction is not the cause, but the result, of the crisis. The cause may lie (within a free market framework) in some great uncertainty.

    1. JCatalan

      That’s a good point about the causes of the crisis — I agree with it (if we’re talking about monetary gluts). Hayek considered a heightened demand for money as a secondary consequence of a malinvestment boom (although he advocated stabilizing MV). On Say and Malthus, check out this post on Gene Callahan’s blog (he also links to DeLong, who says much of the same): “Macroeconomic History.” Like I said, though, I have no personal experience with the topic, other than those blog posts.

  5. Roman P.

    The impossibility of the general gluts created by the shortage of money must depend on the money neutrality, no? Because if we accept that in the monetary economy money is never neutral, we have to admit that the changes in its flows/stocks create real effects too.

    I personally feel that Say and other classicals popularized a lot of novel economic ideas that later turned out to be bogus. Alas, we still live in the shadows of their treatises. I think that much underappreciated William Petty had a better grasp on the mechanics of the macroeconomics than famed Adam Smith…

    Your defense of Keynes is fine in the sense that it works – but you are actually repeating not-quite-Keynesian neoclassical ideas. A ‘bastard Keynesianism’, if you want. Essentially, the core of your argument are price rigidities that obstruct the reaching of the Walrasian equilibrium. Maybe it’s better to point at the income flows disruption? As Bruce Wilder from Crooked Timber has recently put it:

    “There is a theory of unemployment in the General Theory, whether you consent to acknowledge it or not. It is implicit in the notion of twin circular flows, as measured by the double-entry system of national accounts: a flow of money in one direction, and goods in the other. Unemployment is high because nominal prices and nominal wages are high relative to the volume of (money) flow, but the money flow of income is drawn directly from nominal wages and prices, as they are. Reducing wages and prices simply reduces the aggregate flow of income. Our intuition, drawn from disaggregate experience, is that reducing relative prices or wages, can increase demand, but there is no easy way to reduce prices and wages in the aggregate relative to the aggregate income, since one is a composite of the others; prices and wages, are, in the circular flow, the source of income — reduce one and you reduce the other.”

    Also, concerning the money as only the medium of exchange, ‘most economists will agree with Mises’?! Even harcore neoclassicals like Arrow & Hahn produced some fundamental research why it is not so; in fact, reducing the money to the medium of exchange means reducing the economy to the barter one. Mises is just very, very wrong here.

    1. JCatalan

      I don’t think it relies on monetary neutrality. Mises, and other free market economists, will agree that an increase in the demand for money may erode the profitability of certain businesses. Mises says as much in the linked article, where he argues that the real problem is entrepreneurs who failed to predict changes in the demand for their product. Since the price of inputs is imputed, their price will largely be based on expectations. If entrepreneurs pay more for the aggregate of their inputs than the aggregate value of their outputs (in nominal terms) their business will fail. Falling prices can’t affect costs already incurred (the past purchase of inputs).

      And yea, price rigidity isn’t Keynesian, in the purist sense. Neither is monetary disequilibrium theory. But, Keynes’ argument is that a nominal fall in wages will also lead to a nominal fall in the value of output, meaning that real wages stay the same. I don’t think there very many economists who still agree with this (or did when the book first came out), because he basis this on the classical theory of value (rather than the subjective theory of value and the theory of marginal product that follows).

      Btw, the “agree with Mises” part is only in reference to the fact that money acts as a medium of exchange, and that ultimately the real goal is to exchange commodities for commodities. Money just helps accomplish this when there isn’t a double coincidence of wants. Mises didn’t believe in the neutrality of money (either short-run or long-run), and in fact his theory of the business cycle relies on the non-neutrality of money.

      Edit: I should also mention that most theories of nominal frictions are based on the idea of money being a medium of exchange — i.e. reducing transaction costs. The basic, simplified premise is that a breakdown in this system will also cause a breakdown in the economy.

  6. Dan(DD5)

    Changes in societal time preference also forces changes in prices across the board. In fact, this seems to be far more complex of a change then just demand for money because prices are going down on one end of the structure, while going up on the other end at the same time – Price differentials must equally shrink across the entire time domain between each sequential stage of the structure for the economy to actually become more roundabout as accurately predicted by the theory of the Structure of production (and time preference). The Keynesians are at least more consistent when talking about the paradox of thrift as well as diminishing aggregate demand.

    “If prices don’t adjust this implies a contraction in output.”

    There is no predictable contraction in output because:

    1. Only changes in time preference affect the structure of production (So a rise in time preference would cause it to be less roundabout)

    2. Demand for money is time neutral – all things being equal, has no affect on time preference, thus, no affect on structure of production.

    Now, for some reason, incorporating price theory into the equation confuses everybody and immediately they forget #1 and.or #2. I’m not talking about the people who are not familiar with #1 or #2. Really, any theory of how prices are changing or not, whether correct or not, in no way refutes either #1 or #2. They are both praxeologically derived and they do not rely on the use of money to be true. They precede money! Your approach basically tackles the problem in reverse – somehow everything starts with money prices, but it doesn’t! Money prices exist precisely because they constantly do change to reflect the constantly changing economy. Prices would be useless (and so money with them) in your clearing equilibrium world. So any theory of prices that makes assertions about “prices not clearing fast enough” is contradictory and is simply wrong.

    1. Dan(DD5)

      Also, since this debate over “shortage of money” goes back a few years already, I still speculate that your sympathy towards this alleged problem is that you accept it to some degree. In other words, you still maintain that there can really be a shortage of money in the same sense that there can be a shortage of shoes.

    2. JCatalan

      When monetary disequilibrium theorists talk about price adjustments, at the root, I don’t think the purpose is to make some firms profitable at the expense of others. That is, I don’t think the purpose is to inflate the price of inputs that are suffering due to the rise in the demand for money. Rather, when they talk about a shortage of money they talk about those who’d like to transact but can’t because circulating media is in too little supply to correspond with relatively high prices. More than the sale of goods, I think it refers to the inability to purchase goods (although, ultimately the two are of course related, per Say’s Law; and some monetary disequilibrium theorists, like Yeager, do talk about fluctuations in output due to falling out prices). So, in a sophisticated theory of monetary disequilibrium the firms that see a fall in the demand for their products still fail, but by maintaining a certain level of circulating media it allows the structure of production to shift in favor of profitable firms. In the case that the volume of circulating media is not maintained then you not only see a contraction in the output of unprofitable firms, but you also don’t see the reallocation of capital to conceivably profitable companies. So output as a whole contracts, whereas otherwise output would just be rearranged.

      I think an increase in demand for money can be time neutral, but it also can represent a fall in time preference. For example, an individual that would have purchased consumers’ goods might instead decide to hold that proportion of her income, suggesting a postponement of consumption to some future period in time. You’re right, though, that it can also be a case of an individual who was going to invest in some physical processes of production. But, changes in the money supply would respect the status of time preference. For example, suppose we’re talking about the consumer who increases her demand for money, thus decreasing time preference. An increase in the supply of fiduciary media distributed to entrepreneurs will increase or widen the structure of production. Now, let’s assume it’s the entrepreneur who’s increasing her demand for money. But, if investment is funded out of savings, then an increase in fiduciary media will only maintain the nominal value of savings stable. Let’s say that ‘x’ is the original amount of savings, and ‘y’ represents the money that’s taken out of circulation. So, nominal savings being used to purchase capital goods falls to ‘x – y;’ therefore, an increase in fiduciary media by amount ‘y’ would result in ‘x – y + y,’ which is time neutral.

      Regarding the last paragraph of your first response, while monetary disequilibrium theory starts from a position of equilibrium, the real problem isn’t necessarily of maintaining equilibrium, but it’s a problem that’s associated with the use of money as a means of lowering transaction costs. That is, if there is a “shortage of money” then the problem is a reduction in the volume of exchange, which in turn results in a reduction in the volume of output. If equilibrium is used I’d suggest interpreting this as a methodology similar to early Hayek’s, where he thought that starting from equilibrium was pertinent as to emphasize certain qualities, and then study those abstracted from. Related, this is a similar technique employed by Ronald Coase when writing pieces like “The Problem of Social Cost.”

      I do suspect that I sympathize with monetary disequilibrium theory. At the very least it’s an idea that I see merit in studying, and it’s an idea that I come across a lot, since most theories of the business cycle rely to some degree or another on the concept of monetary disequilibrium. I’ve also done a bit of research on spontaneous order, institutional development, and transaction costs, all of which have something to do with the role of money in society. This being said, like I wrote in the post, my position is fickle.

      1. Dan(DD5)

        “That is, if there is a “shortage of money” then the problem is a reduction in the volume of exchange, which in turn results in a reduction in the volume of output.”

        To show why there is a reduction in the volume of output, you have to somehow relate your “shortage of money” to loss of capital. Why is real capital disappearing suddenly due to an increase in demand for money?

        anyway, why do you describe the shortage as “shortage” in quotes? Either there is a shortage or there isn’t. yes your position is fickle.

        “I think an increase in demand for money can be time neutral, but it also can represent a fall in time preference.”

        This isn’t a valid statement. It can’t be two things at the same time. That’s not to say that two different things can’t happen at the same time

        EX: A rise in demand for money, all things being equal…… Stop! what are the “all things being equal”? Time preference is one of them. IF it’s not, then it’s not ALL things being equal, but almost all things being equal. Your confusion stems from not separating two demand for TWO different types of goods, that indeed can change (and often do on the market) at the same time. You can have a rise in demand for gasoline coincide with a rise in demand for cane food. Are they then the same thing? maybe sometimes? So sure, you can have a rise in demand for money and a rise or fall in demand for future goods (or present goods) at the same time. But the point is that demand for money by itself is neither

        Also, a rise in demand for money can also represent a rise in time preference. Greater uncertain future due to some crisis or natural disaster can lower demand for future goods and increase demand for present goods. And money itself originates because there is uncertainty in human action. No uncertainty, no money.

        1. JCatalan

          To show why there is a reduction in the volume of output, you have to
          somehow relate your “shortage of money” to loss of capital.

          This has been outlined pretty explicitly by monetary disequilibrium theorists. The value of capital is related to the rate of profit associated with the alternative means of use, so if monetary disequilibrium leads to a decline in the purchase of the outputs related to these capital goods, then the latter will lose value.

          This isn’t a valid statement. It can’t be two things at the same time.

          Nobody said it can be two things at the same time. Obviously referring to two different instances of a rise in the demand for money implies two different “things.”

          You don’t engage my point about how changes in the supply of money being able to respect how changes in the demand for money affect (or don’t affect) time preference.

          1. Dan(DD5)

            “This has been outlined pretty explicitly by monetary disequilibrium theorists. The value of capital is related to the rate of profit associated with the alternative means of use, so if monetary disequilibrium leads to a decline in the purchase of the outputs related to these capital goods, then the latter will lose value.”

            Oh so suddenly prices do change? (lose value?)

            and they should lose value on account that prices are expected to fall (if not already).

            The fact is that there is nothing special going on here. Every change in demand for anything requires costly adjustments. So changes in demand for money also requires constant costly adjustments, but the adjustments for market actors are same. There’s nothing special going on here even if we can [correctly] stipulate that changes in demand for money are more costly then if demand had been constant. This doesn’t demonstrate a special problem.

            The Monetary disequilibrium (and equilibrium) theorists are of course saying much more then this. They are claiming that there are shortages of money.

          2. JCatalan

            Out of curiosity, how much of the MET literature have you read? The price of outputs don’t have to fall for the value of inputs to fall. Firms can simply choose not to lower prices and face a fall in demand for their products. This isn’t anything new; it’s common to read people arguing that in the long-run prices change, but in the short-run output fluctuates.

            But, you still haven’t challenged the bulk of what I wrote above.

  7. JosephFetz

    I just enrolled yesterday and I haven’t gotten to the reading yet. I’ll definitely be reading that article through a different lens. I am curious as to how Salerno is going to fit this into his lecture, but you could always bring it up in discussion.

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