John Aziz writes,
But Keynes’ theory has nothing whatever to do with the size of the government. It is really about the timing of government spending. Keynes thought that against-the-grain fiscal policy could mitigate the business cycle, which he viewed as a natural outgrowth of the wild animal spirits of the market. When the economy is booming — unemployment low and growth strong — Keynes advised that government should reduce spending and run a surplus, thereby dampening demand and lowering the chance of the economy overheating. And when the economy is in recession, he advised that government should increase spending and run a large deficit, to boost demand and push the economy back toward growth.
This reminds me of two things. First, while not specifically on fiscal stimulus (which I don’t support), Aziz’ article reminded me of a blog post (of my own) with a very similar message, “What is Limited Government.” While I don’t put in these terms, I think this summarizes my idea pretty well. Just like we can only talk about excess or a shortage of demand in the context of some equilibrium, we can only talk about too much or too little government in the context of an equilibrium, or the “right amount” of government — and the latter equilibrium, like all equilibria, are not fixed.
Second, it reminds me of a passage in Hayek’s “The Gold Problem” (1937; published in Good Money, Part I). In this article, Hayek discusses the problems of an over- and under-supply of gold, as experienced between ~1920–1937. He spends part of the article blaming problems with the gold standard on bad monetary policy,1 and later he discusses some proposed solutions to the problem of gold, the price level, and nominal shocks. One of these is by Lionel Robbins, who proposes that government hoard (save) surplus revenue during booms, and use these savings to fund counter-cyclical policy. Hayek gives an interesting response,
There remains a third option, however, which has a good deal in its favour at least theoretically and is likely to play an important role in the future discussions of this problem. We refer to Lionel Robbins’s recent ingenious proposal that excess gold be used to finance the government’s anti-cyclical and anti-recession policy. The traditional methods for financing such measures unfortunately have the built-in tendency to counteract their effectiveness. There is nothing wrong with the basic concept to set aside reserves to be used for unemployment compensation and public works in times of recession during the preceding period of prosperity. The trouble arises when these reserves are invested in the usual fashion and then must be withdrawn from the market as needed during the slump. The forced accumulation of additional capital in boom times further stimulates the overheated investment activities, while the liquidation of this fund during the slump, when it is needed, deprives the economy of funds at the very time that they should be supporting investment activity. A rational investment policy would require such funds, if they are raised by tax revenues, to be truly hoarded, so as to be available as a ‘war chest’ for deployment in times of recession. The relative reduction of the money supply during periods of economic expansion and its relative increase when the economy is in a decline would counteract the inverse changes in the velocity of money that regularly manifest themselves in these two phases.
— p. 183.
- This article ties Hayek’s business cycle theory together with the theory that a mismanagement of the gold standard caused the Great Depression, by forcing countries to tighten the money supply and exacerbate (or cause) a secondary deflation.
In the opening to a recent post, J.P. Koning gives a very good overview of Paul Krugman’s and Larry Summer’s secular stagnation theory,
According to Krugman, if the natural rate of interest has become persistently negative—i.e. new capital projects are expected to yield a negative return—then investors will look to existing durable assets like gold or land that yield no less than a 0% return. The prices of these goods will be bid upwards, bubble-like. Or, as Summers puts it, if the return on capital is below the economy’s growth rate, then intrinsically valueless ponzi assets may be recruited as stores of value to bridge the distance between an individual’s present and the future. (Krugman and Summers’s ideas are a bit hard to follow, but Nick Rowe has a bunch of helpful posts on these ideas).
This is how I interpret the above: a negative natural rate of interest makes investment in capital projects unattractive, leading investors to invest in commodities, rather than in productive capital goods.
In my experience, if you think you have a “gotcha” you probably don’t and you’re probably wrong. But, it seems to me that the pro-cyclical behavior of intermediate goods contradicts Krugman’s and Summer’s prediction,
I’m using “intermediate materials” and not “capital equipment” — and, admittedly, the PPICPE is more ambiguous —, but I think the intermediate materials index does a better job capturing the range of inputs firms use to make physical investments. Capital equipment tracks machinery, but intermediate materials is more inclusive,
Commodities that have been processed but require further processing before they are ready for sale to the final demand user. This includes goods such as flour, cotton yarn, steel mill products, and lumber. This also includes items that are physically complete but that are purchased by business firms as inputs for their operations, such as diesel fuels, paper boxes, and fertilizers.
The behavior of input prices seems to be better explained by a business cycle theory that predicts procyclical movements in inputs for physical investment projects, rather than theories that assume physical investment is comparatively unattractive.
Milton Friedman on the minimum wage,
[T]he effects have been concentrated on the groups that the do-gooders would most like to help. The people who have been hurt most by the minimum wage laws are the blacks. I have often said that the most anti-black law on the books of this land is the minimum wage law.
— quoted in Mark J. Perry, “Raising Minimum Wage Would Be Disastrous…“
Greece, since its independence in 1830, is in a state of bankruptcy almost 50% of the time. Does this tell you something?
— Carmen Reinhart, quoted in Panagiotis Petrakis, The Greek Economy and the Crisis: Challenges and Response (London: Springer Heidelberg, 2012), p. 330.
By the way, the link will take you the book’s Amazon page. Check out the suggested retail price (not Amazon’s price). It’s $189. These books are published specifically for an inclusive market that includes university libraries. The book has its qualities, but it’s not worth $189. I find that scandalous.
Bob Murphy tries to catch a DeLong contradiction. I’ve disagreed with DeLong that Murphy’s prediction errors should lead to dramatic changes in views (i.e. Austrian → Keynesian). But, being honest, I do think Murphy should have made some changes to his views. Of course, everyone thinks what they know is right, but I don’t think Murphy’s predictions of inflation were called for by the data. If we look at the minutiae (i.e. the work of [I'm in L.A. so I can't check my references], I believe, Jeffrey Hummel is a good example — I have in mind the evidence that the Fed is practicing specific allocation of credit, rather than neutral credit provision), the predictions that come to my mind are very different. Of course, the Fed could change policy and Murphy could turn out to be right.
Also, the ends that DeLong, Krugman, et cetera, seek are close to what Murphy was warning of (high inflation), so they’re two economists worth listening to in that area. If DeLong and Krugman, who want high inflation to induce hoarders to spend, predict low inflation, they probably have a pretty good case.
Finally, I agree with Daniel that these comparatively small changes are the kind that DeLong and Krugman made — the kinds that ought to be made. I definitely think this is a point in their favor (even if they expect far too much from people who disagree with them, who have as much right to hold on to the bulk of their ideas as DeLong does). It’s ironic, because their detractors tend to be the most dogmatic (and, just to be clear, I don’t have Murphy in mind at all here — I think Keen is a better example).
Two horrible posts on Austrian economics, one by Paul Krugman and the other by Brad DeLong. The only thing I’ll write with respect to Krugman’s post is that he’s, maybe unintentionally, insulting his peers in the profession with Austrian tendencies. This is understandable because Krugman’s knowledge of what the Austrian School stands for is virtually zero — he only knows two predictions that some Austrians made on the eve of the Great Recession. But, given that his knowledge on this subject is close to zero, his posts should say as much (explicitly or implicitly).
DeLong’s post is a footnote to Krugman’s, where he chastises Bob Murphy for not amending his priors given the failure of his prediction (of high inflation). The problem is that the only option for change, acording to DeLong, is to embrace a non-Austrian worldview. In reality, this isn’t the only option. Murphy’s prediction of high inflation is based on a heuristic that represents a set of “Austrian” theories (because it’s not as if Austrian and non-Austrian theories are always incompatible) as he interprets them. There were many Austrians, including myself, who were not convinced the prediction was right — there were some which predicted deflation. The point is, whatever Murphy’s heuristic is, it can represent different interpretations of “Austrian” theory. So, a revision of his priors could lead him to reviewing his understanding of the underlying theory. Another way to put it is: there are two options, replace or revise. DeLong pretends as if the former (replace) is the only choice.
I can change the case to make my point clearer and more agreeable. Consider a Bizarro world where the dominant school is the Austrian one, and that DeLong belongs to a loud minority known as the “Keynesian School.” Following an important financial crisis in 2007–09 a deep recession sets in. Based on his interpretation of Keynesian doctrine — I don’t mean “doctrine” disparagingly, although it fits with Krugman’s accusation of cultism —, DeLong predicts that a fiscal multiplier of two, such that the radically austerian program of negative fiscal expenditure implies a contraction in GDP by X by 2012. It turns out that the economy contracted by less than X. Bob Murphy, columnist and blogger for The New York Times, notes the failure of DeLong’s prediction and publishes: man, this guy was really wrong, if he weren’t part of the cult then he would have replaced his priors, by which I mean he’d adopt Austrianism. But, this statement is wrong, because to (our hypothetical) DeLong the failure induced him to revise his priors by fixing the perceived mistakes in his understanding of the Keynesian worldview.
To Krugman and DeLong remaining an Austrian after the failure of your prediction is fanatical because they mistake the prediction for the theory. They simply don’t know the actual theory well enough to concede the possibility of revision. This is understandable since they are great economists who are too busy with other topics that are more important to them. I’m only asking that they they accept the limits to their understanding. Don’t insult somebody by essentially accusing him of being part of a cult knowing that his behavior doesn’t reflect that at all.