Arnold Kling  

What Would Keynes Do?

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I write,


If you follow the news media, you may think that the economics profession is divided into two camps: the majority, who favor the stimulus bill; and a minority, who are against any stimulus. In fact, there are many of us who support the idea of a stimulus but who question the Pelosi bill.

Along similar lines, Mario Rizzo writes,

if we are going to attempt to solve the problems of today by drawing inspiration from Keynes, then we should pay attention to his mature ideas rather than to the textbook versions of what he said, some of which reflect Keynes's earlier thinking. When we do this we shall find that some of his policy proposals were quite different from today's "Keynesian" wisdom. Other proposals were extraordinarily radical and far from what is being proposed by lawmakers on the political left or right today.

Both essays offer some lessons in the history of economic thought.


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COMMENTS (4 to date)
Greg Ransom writes:

The idea of "sticky wages" goes back to MARSHALL, pre-dating Keynes by 60 years -- an idea widely appreciated by all the Cambridge economist. This isn't an argument that "comes from Keynes".

See David Laidler, _Fabricating the Keynesian Revolution_.

Keynes' bogus notion of "classical economics" was an invention set up as a straw man for young economists who didn't know much economics -- one reason Keynes was so reviled by so many of the senior economists, e.g. Frank Knight, who said what was true in Keynes wasn't new, and what what new in Keynes wasn't true.

The "sticky wages" stuff wasn't new ...

You write:

"Keynes made two arguments against the classicals. First, he suggested that wages are not as flexible as needed to eliminate unemployment."

You write: "There are many of us [economists] who support the idea of a stimulus but who question the Pelosi bill."

So, there is a good type of stimulus which works, but is mostly absent from the Pelosi bill. Do you have an example where it worked? What was this good stimulus, and what was the measure? If the stimulus was taken out of future earnings by borrowing, was that later negative effect figured into the measurement of the stimulus?

Does "stimulus" mean a greater effect than just the temporary increase in purchases? Is there an increase in wealth that exceeds what is spent (the stimulus multiplier)? How was that measured?

If there is a stimulus multiplier, what is the mechanism of the multiplier? Is that deemed to be a result of the Keynesian spending and re-spending equation?

It seems to me that sub-prime loans produced a large stimulus to the economy, supporting building and increased consumption. Why wasn't that a good stimulus?

If the failure to repay those loans cancelled the stimulus effect, should we risk the faiure to repay current borrowings, cancelling any stimulus effect and leaving us poorer in the future? Is that a risk we should take?

fundmentalist writes:

Gosh, Arnold, couldn't you have thrown Austrians even a small bone? We don't deserve even a cameo appearance?

The Austrian perspective is not the classical one described by Keynes, even though the classical perspective wasn't what Keynes said it was. Keynes was very dishonest in that respect.

For Austrians, unemployment happens because of misallocation of resources. As Dr. Kling has repeatedly written, resources were misallocated in housing, cars and banking. Those industries must shrink and many of their employees become unemployed until they can find work in other industries. There is no way around it.

Unemployment is always greatest in the producer goods industries, those companies that make labor-saving equipment, and those who provide services to them, such as banks. Cantillon noticed that fact back in 1720 and many economists have recognized it ever since, even today. The highest unemployment today is not in retailing or production of consumer goods. Please pay attention to how well Nestle's and Proctor and Gamble are doing, and how poorly Caterpillar is doing.

In Hayek's theory of the business cycle, consumer goods industries stop buying labor-saving equipment because the price of labor relative to income has fallen as profits soared, so they used more labor and less capital. Unemployment will reverse when profits fall in consumers good industries. Lower profits, even if wages don't change at all, will mean a higher cost of labor relative to income. With lower profits and higher relative wages, consumer goods makers will begin to order labor-saving equipment again, thereby sparking demand for workers in the producer goods industries where unemployment is the highest. As workers return to producer goods industries, greater employment will ignite consumer spending and help the consumer goods industries. Hayek called this process the Ricardo Effect. It's taught in intro to micro economics as the optimization of capital and labor expenses.

Any effort by the state to spur consumer spending will only reverse the Ricardo Effect. I'm afraid even reducing payroll taxes will be harmful.

Dezakin writes:

It seems to me that sub-prime loans produced a large stimulus to the economy, supporting building and increased consumption. Why wasn't that a good stimulus?

Because it wasn't backed by a central bank that can just print more money with quantitative easing to prevent issues of systemic risk. Of course that causes distortions in the market because of moral hazard. Which is worse? It seems to me none of these economists actually knows.

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