David R. Henderson  

John Papola on Behavioral Economics

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Here is the most succinct criticism I have heard of many of the public-policy views of those who embrace behavioral economics:

Why in the world do behavioral economists who study our flaws and irrational quirks advocate centralized power in the hands of a small group of flawed overlords? If people are irrational, so are government regulators, only they have corrupting monopoly power.

It's from John Papola on Facebook. (Yes, he gave me permission to use it.)

We need to separate behavioral economics into two components: (1) their analysis of humans and the limits of rationality, much of which I agree with, and (2) their conclusion, on the basis of (1), that because humans aren't totally rational, other not-totally-rational humans who will not bear the consequences of their mistakes should be given power over people's lives. It's this second part that's so absurd and that John Papola puts his finger on. What it shows is the utter failure of the behavioral economists to grapple with public choice, or even to be consistent in the way they model the behavior of humans.


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COMMENTS (52 to date)
Daniel Kuehn writes:

Could you (or John?) clarify who advocates centralizing power in the hands of overlords and how this is advocated on the basis of behavioral economics?

I always thought behavioral economists advocated default enrollment in 401k plans (not enforced by the government as far as I know, I should add). They've said that Medicare Part D should have a smarter default enrollment and have information on benefits mailed out regularly to recipients. They've said that you should have to state whether you want to be an organ donor or not when you have your license renewed.

Is this really centralizing control in the hands of overlords?

John Papola has a habit of this - he's accused me of wanting similar attrocities.

He would do better to specifically identify what cognitive bias behavioral economists recognize in all people that would hamper the "nudge" type of policies they suggest. Of course this is not what John offers us.

Daniel Kuehn writes:

For example, behavioral economists argue that we suffer from a status quo/procrastination bias that makes us less likely to save for retirement. So they say maybe firms should have some sort of default 401K enrollment. How does this identified flaw in human cognition threaten the smooth operation of such a policy, exactly??? Is John suggesting that employers/policy-makers also suffer from status quo/procrastination bias and will therefore... what?... therefore forget to implement default enrollment? Procrastinate on default enrollment?

The fact is, John's avoidance of specifics obscures how empty the argument is. There's nothing I'm aware of that behavioral economists point to that they don't also recognize as operating in policymakers. There's no policy they advocate that I know of that is doomed to failure because of some behavioral bias that they identify in their work. Does John disagree? Does he have examples? Or would he rather just keep on insinuating that the yawningly banal and minor "nudge" policies of behavioral economists are tantamount to "centralized power" in the hands of "overlords".

John Papola's sentiments here are much like Daniel Klein's sentiments at the Cato forum recently. If he really thinks we want "overlords" to control us or that we think "overlords" have an implicit right to control us, then they clearly haven't spent much time actually discussing things with us.

JC writes:

Yes, that's the precise disconnect that's always bothered many of us. Just because A is true (and I do believe A is true), that doesn't mean B necessarily follows.

I've often wondered if a part of the reason for this is that some behavioral economists are actually psychologists first and economists second. (Whether it's a representative sample or not, my psychologist friends do tend to lean left and say 'the govt should do more' quite often.)

Fwiw, here's an apt quote from David Brooks a couple years back:

If you start thinking about our faulty perceptions, the first thing you realize is that markets are not perfectly efficient, people are not always good guardians of their own self-interest and there might be limited circumstances when government could usefully slant the decision-making architecture (see “Nudge” by Thaler and Cass Sunstein for proposals). But the second thing you realize is that government officials are probably going to be even worse perceivers of reality than private business types. Their information feedback mechanism is more limited, and, being deeply politicized, they’re even more likely to filter inconvenient facts.
http://www.nytimes.com/2008/10/28/opinion/28brooks.html

(Sorry for not making the link clickable; for whatever reason, the associated html code wasn't working.)

[made it clickable; not sure why the link button didn't work for you. Sorry about that. It seems fine now.--Econlib Ed.]

Megapolisomancy writes:

This is an interesting perspective. See:

http://www.againstpolitics.com/2009/06/14/animal-spirits-in-public-policy

What we need is something called "behavioral public choice."

Ron writes:

My favorite economists are those in the public choice school, Austrian school and the neoclassical school but I feel that behavioral economics has expanded our knowledge of the field. Unlike Keynesian theories which are self-contradictory nonsense, I feel like behavioral economics does offer a legitimate critique of much of what has been used to defend the free market for the past five decades. Year after year they put out more research that is challenging the rational-actor paradigm in every single social science field. Eventually, the rational-actor model is going to have to concede that it cannot defend itself against all criticism and somehow adopt parts of the behavioral economics model.

I agree with David, while their critiques I agree with, their conclusions are typical government regulation of market failure and soft paternalism or often times welfare statism. They aren't new. I think the challenge is however taking their arguments seriously and trying to prove the free market points. We should dump the rational actor model which the Austrians always had a problem with anyway. It's only good if its very nuanced.

David R. Henderson writes:

@Daniel Kuehn,
Good points. I also made some of them in a previous post. See this. I get nervous, though, when the "behavioralists" get around government officials who think they know so much better than the average person. I assume that John heard them advocate government policies that are in the direction of paternalist rather than in the direction of libertarian.

Daniel Kuehn writes:

Ron -
What does Keynesianism have to do with these points? Keynesianism speaks to entirely different questions. You can have and we have had a rational choice oriented Keynesianism, and you can have and we have had a behavioral oriented Keynesianism. I fail to see what Keynesianism (or by the same token, Austrianism) has to do with these concerns. One can productively do either (Keynesianism or Austrianism) both with and without behavioralist assumptions and it's widely remarked that both Austrianism and Keynesianism share a solid critique of rational-choice type oversimplifications.

fundamentalist writes:

I strongly disagree with the idea that people are irrational. Ignorant, yes; weak-willed, yes; but not irrational. Of course, that depends upon your definition of rationality. It appears to be different for every field. For behavioral economics rational seems to mean that people act like the behavioral economists think they should.

But if people are truly irrational, then economics is impossible, even behavioral economics, because we can never distill any general principles from human behavior.

The best definition or rationality I have seen comes from the econ text by Roger Miller: People will not knowingly make themselves worse off. That allows for people to be ignorant, or have different values, and still be rational.

Peter G. Klein writes:

I think John's question is the right one, and I too have accused the New Paternalists of neglecting comparative institutional analysis:

http://organizationsandmarkets.com/2010/02/19/comparative-institutional-analysis-and-the-new-paternalism/

Thaler strongly denies this see http://truthonthemarket.com/2010/12/13/richard-thalers-rejoinder-to-the-totm-free-to-choose-symposium/, particularly points 5 and 6), but I think his response is weak, e.g., "we don't advocate bigger government, just smarter government."

JC writes:

Correct me if I'm wrong, but doesn't the behavior-based literature posit two basic decision making mechanisms, one that's logical, calculative, rational, and one that's more instinctive?

And doesn't it then have something to say about when the former decision making system is likely to call the shots, and also when the latter system is likely to assert primacy (w/ rational logic then being used to justify the instinctive decision)?

(Or are contextual boundaries not very well defined yet? My guess, btw, is that this question is actually tied into the assumption of a positive role for government. Iirc, while attributes such as IQ and sometimes 'skin in the game' are orthogonal, knowledge that cognitive bias exists and might be influencing you actually does help; thus, one might claim that trained 'nudgers' will be less prone to bias than ignorant members of the public. Not saying I do or don't buy this line of thought, btw; just predicting what it might be.)

Also, yes, the definition of rationality matters. And sometimes what is deemed irrational may, actually, be rational. For example, impartially examining the expected net present value of money spent on lottery tickets makes it seem like that's an irrational choice. But when one considers the utility gained via how much people enjoy daydreaming about riches, well, $1 for that increased level of happiness seems like a bargain.

Another example might be televangelists selling ethereal snake oil. Yes, my donation may do nothing more than support his lavish lifestyle. But perhaps I gain an awful lot of utility in exchange for this donation, e.g., increased self-worth (as I compare myself favorably to heathen), daydreams of heaven, the intrinsic satisfaction that accompanies judgments that I have 'done the right thing' and am a 'good person', etc.

For me, an interesting tie in would be Bryan's voter biases. It would be interesting to read a paper integrating these ideas.

John Papola writes:

@Daniel,

Here is something I posted on facebook that speaks to your question:

I an exchange I had with Robert Schiller at the economist's buttonwood gathering event. He was celebrating the need for a single person to over see "systemic risk" because it required "intuition". He proclaimed that we would be better off if only a guy like Paul Volker was regulating the financial system (himself, just about). He then went off on the Alan Greenspan is a libertarian/ efficient market hypothesis and it's culture are to blame routine.

I raised my hand, got the mic and said the following (roughly):

"there's a credible argument that the manipulation of interest rates by the fed are what fueled this housing bubble and created the conditions for all the frenzy. That's not a market phenomenon, so it's a little odd to blame Greenspan's alleged libertarianism for the crisis. Moreover, the Fed, despite having failed on every front, has emerged from this crisis with dramatically more power, just as it has in last crises. What does that say about this discretionary system you want? Simply put: who regulates the regulators?"

I thought he was going to say "we regulate them, through democracy". But his response was far scarier. He quoted Thomas Hobbs saying that Hobbs posited a benevolent dictator whose interest would lie in passing on his kingdom to his heirs may be the best regulatory force. He then punted, saying that "who regulates the regulator" is the age-old question and there is no answer.

Schiller seems to be a very nice man. But holy cow.

fundamentalist writes:

John, that is scary. There are some scary people out there masquerading as intellectuals.

Daniel Kuehn writes:

John -
Ultimately it would depend on what that regulator was given authority to do, I suppose. This is a much bigger deal, and I think it's different from what most people think of when they think of the policy recommendations of behavioral economists.

I don't want to make assumptions about what Schiller was proposing, but even in his case, though, you don't have the problem of cognitive biases. I don't think you can just assume that an authority tasked with identifying the operation of cognitive biases in the economy is going to be hampered by those same cognitive biases. If your own money is on the line, then yes - hyperbolic discounting is in play. If your own time and effort is on the line, then yes - procrastination bias is in play. But Henderson's quote seemed to suggest that you thought these same biases would be in play for, say, a regulator. I don't see how that can be the case.

Now - depending on the authorities granted to the regulator, other wholly new issues could of course come into play. Most obviously, the concerns of the socialist calculation debate and economic calculation might come into play. But that's only if the regulator is even tasked with anything as substantial as economic calclation. I'm not sure if that's what Schiller is proposing.

As for what caused the crisis, etc. etc. I think you can adequately critique Schiller for citing Greenspan's libertarianism, but I don't think that terminological critique amounts to the further claim. The Fed's imperfection was never in doubt and is hardly proof that things would have gone better without the Fed.

John Papola writes:

@Daniel,

One more thing to consider in my commentary overall. I am not an academic economist. I’m an intensely, passionately interested amateur with an unorthodox mix of understanding in economics. Some of it is embarrassingly shallow (what is consumer surplus really and why does anyone take such an idea seriously?), some of it passable and some of it might even be right (maybe).

Frankly, I don’t value the impact of academic economists for their “science” and academic output nearly as much as I value the cultural narratives which the most effective popularizers put into the world. For all the narrow, nuanced nudges your are talking about, my facebook post was reacting to the PBS Nova special “Mind over Money” which set up a “free markets vs. regulation” battle between Fama/Cochrane/EHM and Schiller/Behaviorists.

The narrative was clear. Free markets require rationality, therefore irrationality justifies so-called “regulation”. I find this framing ludicrous and non-sequitor, hence my comment. I find the use of the term “regulation” instead of “intervention” to be incorrect and intentionally misleading/positive (just like the use of “reform” instead of “change” with legislation).

So that’s the narrative. Irrationality = justification for the corporatist mixed economy I see as an naive, corrupt scam. I’ve seen this repeated by Krugman and DeLong and Schiller and Stiglitz and countless others. That narrative, in my opinion, is nonsense.

Behavioral economics is interesting. Understanding people’s quirks represent an opportunity for peaceful, competitive firms to improve delivery of products (as well as manipulate them for their own gain). Watch any background piece on the design of a casino floor or the layout of a retailer and the use of human behavior to achieve some ends becomes clear as an obvious embedded part of economic decision making and normal free market arbitrage.

The world is imperfect. People are imperfect. That’s why we need the market process of entrepreneurial discovery! The answers aren’t available ex ante!

In reality, unlike the lab, we do keep repeating most of these games. We do have repeated interaction with companies, brands, products and people. If someone scams us by playing our quirks against our better judgment, we catch on, let other people know and learn. I see no such institutional intelligence in government, which is why the tax bill includes yet another 5+ billion in corn ethanol subsidies even though ever single knowledgable person on earth knows that it’s a child-starving evil fraud. And yet, there it is.

Libertarian paternalism appears to be a scam too. I read/heard that Sunstein thought websites should be “nudged” to include links to opposing points of view, but that if they didn’t comply, he felt fine with congress coercing compliance through legislation. Some “nudge”.

I don’t want the state to “nudge” me. The state doesn’t “nudge” anything. I pushes hard with the handle of rifle.

Noah Yetter writes:

Y'all need to read your Mises. All deliberate human action is rational.

As for Daniel Kuehn's question at the top of the comments:
"How does this identified flaw in human cognition threaten the smooth operation of such a policy, exactly???"
By leading the overlords to design a policy that does not actually solve the problem, or indeed makes it worse. This may seem silly, since the solutions to your favored examples seem so obvious, but just look at the world of actual policy. How many allegedly intelligent policy makers think price controls are a viable solution to some market problem? The mistake you're making is in insisting that the challenge to the nudgers must show that Cognitive Imperfection A, would fail to be solved by Nudge Policy X, *because of* Cognitive Imperfection A being shared by policy makers. What we are actually saying is that Nudge Policy X may be poorly designed because of Cognitive Imperfections B, C, ..., Z. In other words, you have to look at the big picture.

Ben writes:

To me the possibility that the regulators will be as irrational as their "children" is the weakest criticism of behavioral-economics based paternalism. In fact, I think it's weak on absolute terms as well. Suppose, for example, that regulators are indeed as susceptible to framing as the common man--how does that prevent them from generally doing a good job of ensuring that the questions everyone else face are "properly" framed? Questioning the rationality of the regulators is an important point to make, but I don't think it holds up as a significant criticism.

If you want to criticize the behavior of regulators, public choice arguments seem much stronger. Or you could just go to the heart of the matter and dispute that behavioral economics has unearthed evidence of irrational behavior, making everything else moot.

Ben writes:

Or point out how behavioral economics can also imply that there is too much government, or that voters demand irrational policies and politicians, needing votes, are likely to supply them.

Eric Hosemann writes:

@Daniel:

"Ultimately it would depend on what that regulator was given authority to do, I suppose. This is a much bigger deal, and I think it's different from what most people think of when they think of the policy recommendations of behavioral economists."

See John's Schiller quote. Stop punting, man. This is a serious question. Don't throw around terms like "the regulator" and pretend you're not rhetorically arming them because you're using the passive voice! Man up! Who gives them the authority? And why are you so comfortable expressing yourself in this way? You're the one who needs a paradigm reassessment, not John, not any other libertarian who takes these ideas seriously!

"I don't think you can just assume that an authority tasked with identifying the operation of cognitive biases in the economy is going to be hampered by those same cognitive biases."

Why not? Because the authority "tasked"--by whom? Clarify! CLARIFY!--is an alien intelligence, or because you imagine yourself "tasking" such an authority with nudging the rest of us into an indolent hell?

John Papola writes:

Noah,

I think it's too strong a case to claim that all deliberate human action is rational, unless your definition of "rational" is a tautological statement. People do self-destructive things. They commit suicide. They kill their family. They kill other people. Any definition of "rational" must allow me to deem such acts as "irrational" even if they are deliberate.

Ben, I agree that public choice is the best framework for debunking these technocratic lab coat paternalists and their "nudging". But that gets to the heart of my thinking if not my comment. To focus on human flaws but then model government as some perfect public goods-producing utopia is to apply totally different standards of scrutiny and thought. The idea that this leviathan can be trust to tweak and nudge all of these "policy" dials just appears manifestly wrong.

But let's look closer at the real example that matters: counter-cyclical regulatory policy. Where is the evidence that state interventionists have the knowledge or incentives to effectively lean against boom-time "irrational exhuberance", with properly calibrated higher capital ratios or more stringent lending standards? The evidence seems to suggest that when times are booming, the political apparatus will do everything to keep from taking the punch bowl away. And that ignores that the state interventionists are the ones who spiked the punch and got the whole party started in the first place.

Schiller responds to this with the need for "independence", aka, freedom from democracy. This is no solution at all. It's just tyranny by people he likes.

I see in this stuff an empathetic error. Behavioral economists who favor paternalism believe that the paternalists can be just their vision of themselves: wise, scientific, objective arbiters. "If I can recognize these flaws in my lab, so can Paul Volker!"

I call that hubris. It's the same old progressive reformer technocracy wrapped up in more jazzy pseudo-science.

[broken url fixed--Econlib Ed.]

Doc Merlin writes:

"Why in the world do behavioral economists who study our flaws and irrational quirks advocate centralized power in the hands of a small group of flawed overlords? If people are irrational, so are government regulators, only they have corrupting monopoly power"

I have been saying this for years!

John Fast writes:

@Megapolisomancy and @Doc Merlin

George Mason University is, ironically, probably the best school in the country for both public choice *and* behavioral/experimental economics.

I getting a Ph.D. in economics here and those are two of my fields. (In fact, my dissertation is on framing and involves both public choice and behavioral economics, and I'm convinced those are going to be the Next Big Things in economics.)

I'm also a hard-core libertarian.

Maybe we can start the Journal of Behavioral Public Choice!

Mr. Gehring writes:

It is not true that all behavioral economists are pro more government intervention. Check this most interesting paper that argues against more regulation. It list all the psychological arguments why more centralization and government are so wrong, even and especially from a behavioral point of view. And it incorporates public choice views.
Try it:

David Hirshleifer: Psychological Bias as a Driver of Financial Regulation

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1018820

Regards

Daniel Kuehn writes:

I am not an academic economist.

I'm not either, although I think consumer surplus is a pretty valuable concept :)

Daniel Kuehn writes:

John, re:
For all the narrow, nuanced nudges your are talking about, my facebook post was reacting to the PBS Nova special “Mind over Money” which set up a “free markets vs. regulation” battle between Fama/Cochrane/EHM and Schiller/Behaviorists.

OK, my apologies. I had no idea we were discussing a PBS special.

Noah -
First Mises, contrary to popular belief, does not have a monopoly on the determination of economic terminology. Second, I'm not sure why you think I'm not "looking at the big picture". If the question is politicians who think price control is viable, I can assure you that you and I are on precisely the same page. I think there are actually fewer of these politicians than you fear, but then again I've never polled them.

Eric -
Man up? What are you talking about? Regulators do lots of things. I have no idea what Schiller was refering to. Confident presumptions in the face of sparse information doesn't constitute "manning up". You need to man up and just say "I don't know what the hell he's ultimately talking about so I'm not going to pass judgement, but I will make a few contingent claims (ie - if he's claiming X then I think Y, but if he's claiming A then I think B)."

John -
re: "The evidence seems to suggest that when times are booming, the political apparatus will do everything to keep from taking the punch bowl away" Ummmm... exactly... this is precisely why Keynesians are so critical of the way the state currently operates. You make the mistake of assuming that because there is any role for the state in Keynesianism, it's a tacit approval of the way the state is currently operating. That makes no more sense than people who criticize libertarians for crony capitalism. It's one thing to take something the state can't do like plan the economy and say "if it could plan the economy, that would be great". That's clearly wrong. It's another thing to take something the state can do, like moderate counter-cyclical policy, but doesn't do, and say "the state should do this". It's the same with libertarians and the market. They recognize what the market can be, but isn't. That's legitimate. It would be illegitimate to make claims for the market about things that it can't do.

re: "I call that hubris. It's the same old progressive reformer technocracy wrapped up in more jazzy pseudo-science." - and libertarians wonder why nobody in the mainstream ever wants to talk to them.

Steve Roth writes:

There's at least one simple reason why we don't want to be governed by the first 100 people in the New York phone book.

The average IQ, by definition, is 100. And:

Smarter people act more rationally and reasonably.

1. They’re more patient when patience will yield superior outcomes.

2. They’re much better at choosing among different risky options–they’re more risk-averse when it makes sense to be, but they’re also more likely to take risks when the calculated outlook is good.

3. They’re better at choosing among short-term vs. long-term benefits–-factoring time into the considerations of pro and con to achieve the best results.

4. They’re more consistent in their decisions–they don’t jump all over the place when the conditions are largely the same, or choose “no” when conditions are even more favorable than for a previous “yes.”

5. They’re more likely to persevere in a job when quitting has a big penalty.

6. They have “higher social awareness and a greater tendency to be cooperative in a strategic setting.”

7. They “more accurately forecast others’ behavior and differentiate their behavior as a second mover more strongly depending on the first-mover’s choice.” IOW, they’re superior Machiavels in zero-sum games, and (see #6) they also win more of the win-win games–along with the people they’re playing “against.”

http://www.cemmap.ac.uk/resources/files/rustichini.pdf

[link fixed--Econlib Ed.]

John Papola writes:

Daniel,

I believe you’re making my point for me even as you attempt to refute it, my friend. Let’s lay this out so we can find where it is we really are disagreeing.

#1. people are imperfect. We make mistakes. We act in ways that are counter-productive to our own stated long-term interests.


#2. “the market” is simply the term for the process through which these flawed people come together in an effort to discover beneficial trades with one another. It is not a thing. It is not really a place. It is a process of bidding and arbitrage.

#3. what appears likely to make us better off ex ante is not guaranteed to do so when reviewed ex post. This is the nature of uncertainty. I may buy a car expecting to like it and realize that I didn’t consider something that makes it less satisfying after the fact.

#4. There are larger forces which can lead ex ante decisions in a market to appear beneficial (or “rational”) yet ex post be revealed as mistakes.

Austrians call these seemingly ex ante rational mistakes, “malinvestments” and see the larger forces that drive and synchronize them as being rooted in the credit cycle (since money is half of all transactions across the economy).

Keynesians/behaviorists see these forces as rooted in mass psychology unhinged from causal events. The mechanism of contagion here is much more dubious especially in decades past. So the housing boom turns to bust because people “suddenly” decided they don’t want as many houses. That’s Schiller. But that’s wrong. There were real events that preceded the attitude change, namely profits getting squeezed as interest rates rose and input price inflation accelerated. Those are rational events, they were simply unanticipated.

This is the nexus of macroeconomic study and the business cycle.

Now, Keynesians/Behavioralists rightly see psychology as being important. It is important. They DO identify irrational decisions ex post. Everyone can see them ex post. They do identify market flaws that are real. Fine.

The problem is that they misunderstand the real causes and then construct a set of solutions which require perfect government action and technocratic management to apply a solution which only appears correct in their aggregate view. Keynesianism is about aggregate spending, which isn’t so much a behavioral thing. In fact, that is the problem. It’s blind to human action. It’s flaws are rooted in over-aggregation and a misunderstanding of the role of savings and investment relative to consumption. That’s just bad econ, not behavioralism.

You claim to recognize that central planning can’t work. Is that because you agree with the Hayek/Mises side in the socialist calculation debate? If so, you are already half-way to debunking keynesianism. Keynesian spending is socialist spending all the same. He called for the “socialization of investment” after all. So given a world of scarcity, why should socialist spending deliver real productivity gains during a recession when we both agree it can’t work in normal times? I can’t. So the non-behavioral economics are wrong. Keynesianism can’t calculate.

Keynesians respond that they don’t need to calculate because of the spending multiplier. I reject this idea because scarcity isn’t banished in a recession. Stimulus spending in healthcare and education during 2009 and 2010 was inflationary. The “slack” is sectoral. There is no such thing as a “general glut”. When Brad DeLong says that “anything that increased the deficit will help”, he can be debunked on purely socialist calculation grounds.

Now, back to the behavioralism. Public choice reveals that government agents, given monopoly power to nudge us, face incentives that will drive them to nudge us in ways that are beneficial to THEM not to US. This is clearly true. See ethanol. But beyond public choice, there is the problem that governments have never been able to spend at the levels Keynesians want them to spend, accept in times of war. That keynesians point to wars as proof that their theory works reveals the sheer horror of their misunderstanding. But the behavioral fact remains, the technocrats cannot achieve the theoretical ends.

Again, though, even if they could, socialist calculation explains why it would still fail and leave us worse off due to wasteful consumption. So Keynesianism fails on both practical and theoretical ground while behavorialism as a subset fails on public choice/practical grounds.

Coming back to my core point. It’s bad theory to compare imperfect people with perfect theoretical government action. If you are going to play in realm of people’s real behavioral quirks, you MUST take into account the real institutional behavior of the government you hope to be a good parent. What we have seen is that the government CAN’T do “moderate counter-cyclical policy” any more than it can plan the economy, and for the very same reasons.

Steve Roth writes:

> government CAN’T do “moderate counter-cyclical policy”

Except via automatic programs like food stamps, unemployment insurance, EITC, etc. Rational decision-making, encoded as laws and formulas that are hard to change in the heat of the moment.

Daniel Kuehn writes:

John - all your enumerated points I completely agree with. Your interpretation of Keynesians, though, is completely foreign to me. People "suddenly" don't want houses? Who claims this, John? You are confusing bubble psychology (ie - placing a higher value on assets whose prices are growing, or having demand as a function of the change in prices), and some sort of exogenous swing in demand. Again, I can't be expected to defend PBS's version of behavioralism - and I'm not going to defend your version of Keynesianism either.

re: The problem is that they misunderstand the real causes

Could you clarify?

re: then construct a set of solutions which require perfect government action and technocratic management

Nothing I have ever recommended requires "perfect government". I guess it depends on what you mean by "technocratic" on whether it requires that. If you simply mean a treasury and a central bank, then I suppose I'm "technocratic". But you certainly don't need perfection to do Keynesianism. That's absurd. Who would back a policy that would require men to be perfect?

re: It’s flaws are rooted in over-aggregation and a misunderstanding of the role of savings and investment relative to consumption. That’s just bad econ.

If you want to direct me anywhere where you discuss this in more detail, that would be great. This is simply a claim that strikes me as being vague, undefended, and wrong. I can't do much with this except to register my view that it doesn't have these problems at all that I'm aware of.

re: "You claim to recognize that central planning can’t work. Is that because you agree with the Hayek/Mises side in the socialist calculation debate?"

Yes, and I actually prefer Mises's position to Hayek's on that side of the SCD (which is not a preference I usually have between the two of them). I wrote a little bit about why here: http://factsandotherstubbornthings.blogspot.com/2010/05/hans-hermann-hoppe-and-calculation-vs.html

re: "Keynesian spending is socialist spending all the same. He called for the “socialization of investment” after all."

You need to reread that chapter of the GT. This is absurd, John.

re: So given a world of scarcity, why should socialist spending deliver real productivity gains during a recession when we both agree it can’t work in normal times?

This gets into questions of liquidity preference and whether the economy is operating at full employment. But this is besides the point - nobody is advocating socialism.

re: "The “slack” is sectoral. There is no such thing as a “general glut”."

Of course the slack is sectoral. Have I ever claimed it wasn't? The point is, while there are sectoral variations there is sufficient general slack to justify it. Why do you think there is no general glut? You keep making these claims that I have no clue how to respond to because you never justify them.

re: "Public choice reveals that government agents, given monopoly power to nudge us, face incentives that will drive them to nudge us in ways that are beneficial to THEM not to US."

You're exactly right - see my 3:54 pm post where I discuss this. I'm not sure why you continue to act as if I haven't already made these points myself.

Daniel Kuehn writes:

re: "But beyond public choice, there is the problem that governments have never been able to spend at the levels Keynesians want them to spend, accept in times of war."

OK, but what would you expect us to say? No, the response has not been sufficient to this recession. But because we've made a clear and convincing case that has convinced a large number of economists and policymakers, we got better than we would have gotten 100 years ago. I consider that a victory. So what do you expect me to do? Say "OK - a third of the way is good enough". No - of course I'll keep pushing to do more. But its not a failure of the theory to recognize that political realities make fully filling the output gap unlikely. The same could be said of you. There is no chance that what you want - short of a war that wipes out the current government - would ever happen completely. Does that mean your ideas are bankrupt? Does that mean you crave a devastating war? Does that mean you don't celebrate the small victories? Of course not. Be serious John. How do you expect me to react to the political realities? I plan on reacting realistically to them.

re: "That keynesians point to wars as proof that their theory works reveals the sheer horror of their misunderstanding."

Now you're just being a drama queen. Do I need to cite libertarians praising cell phone networks in Somalia?

re: "Coming back to my core point. It’s bad theory to compare imperfect people with perfect theoretical government action."

And to come back to the point that I've made several times now - I could not agree more. No matter how many times you try to inform me what my position is, it still does not make it my position.

re: "What we have seen is that the government CAN’T do “moderate counter-cyclical policy” any more than it can plan the economy, and for the very same reasons."

What? What do you call ARRA and the Fed response? Look, there are things I'd do differently and I might jack up the juice in these policies if I were able, but this is moderate counter-cyclical policy. This is not central planning. Governments can't do central planning. They can do counter-cyclical policy. They do it imperfectly. There's no reason we can't improve how they do it.

But these conversations always go from "yes we do policy imperfectly" to "any imperfection means you can't do it at all" or even worse, to "the imperfect implementation is because its socialism". I simply don't know how you make those leaps, John.

Daniel Kuehn writes:

This is not central planning. Governments can't do central planning. They can do counter-cyclical policy.

To restate this somewhat more stylistically, economic calculation is calculation under conditions of scarcity. The whole point of a Keynesian depression is that scarcity is not binding. Governments cannot do economic calculation, but when scarcity isn't binding they can do something. How binding scarcity is of course varies on a sectoral/regional/etc. basis. Those are things to watch out for. But the Keynesian argument is not one of economic calculation in the socialist sense.

John Papola writes:

Daniel,

Departing from the behavioral discussion for a bit, let me pose some questions for a keynesian central planner that will clarify my thinking and comments above.

#1. Where is the slack capacity? How did you determine where that slack is?

You must know where it is before you can target spending at re-deploying it. As a washington DC planner, or a state capital planner, your ability to collect the knowledge of slack capacity is every bit as problematic as plain old socialist central planners. So how can this work out exactly?

#2. Why do you believe the "slack" is due to temporary liquidity constraints vs. real preference changes?

If tomorrow our government stopped its shockingly ignorant and immoral corn ethanol subsidy/mandate scam, there would like be a wave of bankruptcies in the ethanol production industry. Let's imagine that the capital flight goes into "cash hoards" instead of other enterprises. Would it make any economic sense at all to "stimulate" this "slack capacity" with some keynesian spending? No. People don't want ethanol. It's nonsense. So the "slack" isn't capacity to make anything of economic value.

At least some of what keynesians see as "slack" in a bust may in fact be what Hayek called "non-economic goods", aka, stuff that nobody wants anymore except at fire-sale prices (if that). Figuring out what capacity is valuable for serving real voluntary demands is plain old entrepreneurial calculation. Nothing special. Nothing "new economics" about that. So, again, how does the Keynesian central planner decipher temporary "slack" from insolvent slack that should be sold at a firesale? Same old knowledge problems abound.

#2a. Why doesn't the reduced demand of certain goods as part of increased liquidity preference matter?

If people cut back on spending to hoard cash, the things they are cutting back on first are the things they value least. Isn't this useful, real information about people's relative preferences and priorities and don’t the relative price effects transmit this information? Why should Keynesian central planners expect that their choices can override these free dispersed choices? Socialist calculation problems abound.

#3. Money is a specific good. If demand for money increases, why should I believe it isn't sufficient to increase the supply to match? Why should increased demand for other goods equilibrate specific people’s increased demand for money?

Holding more cash is not the same thing as holding fewer "general goods". There is no such thing as a "general good". So, given #2/2a, where in reality people cut back on specific spending on specific goods, why should we use this crude and information-free concept of a "general good" when discussing increased demand for money? If people want more cash, that is specific demand for a specific commodity: money. Money can be produced to meet that specific demand without the need to conjure up some brand new idea of so-called "macro" economics based on aggregates. Institutional problems like a central bank lacking the knowledge of who demands to hold money or an unwillingness to use other tools beside short term rates doesn't suddenly mean that government buying politically motivated goods from other people will somehow magically resolve the monetary disequilibrium. The "liquidity trap" is an institutional failure, not a theoretical one. There is no such thing as an "infinite" demand for money.

Lastly on this subject, people don't demand money, really. What they want is real purchasing power. They want to be able to weather a storm by having more potential future consumption in reserves. They want to, say, increase their savings from 3 months of living expenses to 6 months or a year. While I recognize that money-demand deflation can be problematic depending on the flexibility of certain wages and prices, I must say that it seems like a deflation could indeed help address the specific people's desire to hold more real purchasing power. This is the "real cash balance effect" and it seems to be a legitimate possibility.

Price level aggregates are, after all, among the most crude and problematic we've got. If housing prices are falling and people are holding more cash, that may impact the so-called "price level" but it doesn't impact the purchasing power of anyone who isn't in the market for a house.

#4. How can you seriously state that there is "general slack" when there are almost always areas with rising prices?

Healthcare, energy and education represent a non-trivial percentage of our economy. All have seen rising prices through this recession. The first two in particular saw no decline in employment and, in fact, face shortages. How can one talk of "general slack" and expect to be taken seriously given these facts?

#5. Public choice makes #1 - #2 a non-starter for keynesianism, does it not?

The stimulus spend big on supply-constrained areas like and health and education where scarcity already a problem. It spent based on political allocation of resources, NOT slack capacity, and that's given the problem of determining what slack has value. Worst of all, which the theory of stimulus is that it should be timed, targeted and temporary, it clearly sets up constituencies that become permanent taxpayer parasites that put even more drains on the future economic growth.

#6. All spending is not the same. Kindly explain why Paul Krugman hates savings by the rich. In other words, why don't Keynesians understand that consumption destroys wealth while investments in productivity-improvement create wealth?

In criticizing the tax rate extensions for top tax brackets, Krugman claimed that they wouldn't help the economy because the "rich" would likely save more of their income instead of spending it. This and countless other statements by him and delong and others make it appear that they see no difference between consumption and investment in real terms. This is clearly false. Giving $1000 to a bunch of people so that they will buy and consume pizza does not produce economic growth the way giving that $1000 to the owner of the pizza shop so that he can buy a faster baking oven.

Consumption doesn't create wealth, productivity-enhancing investments do. There is no "paradox of thrift" or except as a symptom of a broken banking system.

#7. Lastly, when all of the above is swept aside, there remains one last Keynesian point which is behavioral: the importance of confidence and animal spirits. What causes animal spirits to change?

I believe the animal spirits are actually Keynes' most important contribution, but his remedy is actually rendered faulty by this very insight. There's pretty good evidence to suggest that massive amounts of government debt don't improve confidence but can actually hurt it, especially when a sovereign debt crisis occurs.


This is the most I can write in this format at this point. Just know this, while my own moral beliefs render government coercion bad as a normative question and I am prone to treat politicians as if they were scoundrels, I do care about getting the ideas right. So I will listen to criticisms that are fair. One can be open to ideas and an ideologue.

Troy Camplin writes:

Mises says action is rational. Whether the goal is rational or not is another thing. But that is a value judgment of others' value judgments, and therefore falls into the category of ethics, not praxeological science.

Daniel Kuehn writes:

John -
I feel like we're going over the same poitns over and over again. Can you just read my earlier posts? What do you mean by "Keynesian central planner"? That sounds like an oxymoron to me.

I'm also not sure why you're talking about slack as goods. There's slack in the use of the means of production. As for these questions about the specificity of the slack it's a question of the general level of prices. If we're at full employment (allowing for some friction), and there is a decline in the demand for ethanol there will be an increase in demand for other things. Who cares? I'm not sure why you're highlighting these shifts in demand. Who cares about those? Those are fine - those are changes in preferences. But a general fall in the price level and a general failure to utilize resources is inefficient. You and I agree on socialist calculation problems - thats a market calculation problem. You can address that with monetary policy (to lower the cost of investment) or you can address that by fiscal policy (to counterbalance liquidity preference and make use of idle capital), but you can't address that by saying "gee - ethanol is slack, construction is slack, and autos are slack so I'm going to hand them $X, $Y, and $Z dollars respectively". This is why I've said several times now - you cannot expect me to defend your version of Keynesianism or PBS's version of Keynesianism.

The only thing that Keynesians may be said to want to "plan" is money. I can accept that claim. But that's all. All your critiques of planning demand in these specific industries I fully accept - I'm not sure why you're not understanding that.

Now, of course government has to spend on something, and there may be some uneveness and some distortions to that. I'd refer you back to everything Skidelsky said in your Boom and Bust videos. Of course there will be waste when the appropriations actually come, but it pales in comparison to the waste of a modern industrial market that unemploys millions. You ask me how Keynes and I can live with the distortions of Keynesian policy? How can you and Hayek live with the distortions of a "full employment by accident" market? However, there are more than enough "public goods" (I don't generally like that term, but you take my meaning) to invest in and more than enough humanitarian endeavors to spend on that I don't worry too much about the composition of the stimulus package. When we run out of those I'll worry more.

How can one talk of "general slack" and expect to be taken seriously given these facts?

See my response above to why its bizarre for you to think that any Keynesian would assume that all things are equally depressed. On this question specifically - how can one see tens of millions of skilled workers un- or underemployed, not talk of "general slack" and expect to be taken seriously? We both believe that the degree of slack is uneven. I never claimed otherwise. Are you under the impression that we are at full employment (accounting for frictions, of course). In other words, are you under the impression that the tens of millions of workers un- or under-employed are simply in their current condition for frictional reasons?

Public choice makes #1 - #2 a non-starter for keynesianism, does it not?

If it does then you must be smarter than me because I hold both Public Choice Theory and Keynesianism to be true and insightful.

Moving further down - if you're going to call people "parasites" they'd probably appreciate it if you were more specific. In my experience, they'd appreciate not being called parasites at all, but at the very least you could refrain from being so vague when you make accusations like that.

On Krugman, your guess is as good as mine on why he doesn't support the tax cut extension. I always have. I'm not aware of any real substantial Keynesian logic behind it. I can think of Keynesian logic for why the cut wouldn't be the most stimulative thing in the world - but I still don't see why he'd prefer letting the cut subside to keeping it. These tax cuts do pose medium to long term budget problems, to be sure, but those aren't the problems we face now.

That having been said, you completely misunderstand the issue of savings and its relationship with investment. If all savings were for investment, you would be right. Its not. You're accusing Krugman of not valuing saving because you confuse the accounting identity of S=I with an economic law that if you increase your savings rate you increase investment. This is not true - savings can remain idle, which lowers output, saving, and investment. You are projecting your own conclusions about the full employment of savings onto Krugman and then claiming he doesn't care about investment. Look, maybe you don't buy into liquidity preference/paradox of thrift logic but don't go around accusing people who do of not caring about investment. Investment is central to the Keynesian story. Consumption is tangential. I have more on that here if you're interested:

http://factsandotherstubbornthings.blogspot.com/2010/12/keynesianism-and-consumption-keynesian.html

Daniel Kuehn writes:

Giving $1000 to a bunch of people so that they will buy and consume pizza does not produce economic growth the way giving that $1000 to the owner of the pizza shop so that he can buy a faster baking oven.

Right. You, Krugman, and I are agreed on this I think its safe to say. You are projecting your own confusion about savings and investment onto him.

Consumption doesn't create wealth, productivity-enhancing investments do. There is no "paradox of thrift" or except as a symptom of a broken banking system.

Of course investments create wealth. What Keynesian has said otherwise? This is why its so frustrating to argue with you about this stuff and why your music video was so misleading (well done, entertaining, enthusiasm generating, and fine from a poetic-license standpoint, of course). If you think investment is downplayed and consumption is emphasized in Keynesianism you have turned the idea completely on its head. As I've said at several points now, I can't be expect to defend your version of Keynesianism.

One can be open to ideas and an ideologue.

I have serious doubts about this.

John Papola writes:

Daniel,

You are arguing past my points and ignoring the central issues. Worse, though, you continue to imply that I'm unconcerned about understanding the real Keynesian point of view. You do realize that I personally spend weeks editing those Skidelsky interviews in order to be fair and construct them in a coherent (as much as possible) way, right? I've spent hours read and listening and watching Krugman, DeLong, Schiller, Stiglitz and other public Keynesians. Their approach is what shapes the debate and informs the political process. I have no interest in strawmen. Zero. So stop wasting your time attacking my approach and start debunking my questions.

I have laid out questions about how the administrator of a keynesian spending program will be able to target the "slack" and determine if it is "slack" because of temporary liquidity constraints vs permanent preference changes. So... HOW?!? This the very heart of the entire matter. If the people charged with allocating deficit-financed spending face the same information and incentive problems as any other central planner, how can they address these vital issues. Falling prices on certain items are a signal that people don't want them at the current price. Why should I believe that a Keynesian administrator has the knowledge to override that market signal? Where are they getting that knowledge. I gave important examples of large sectors that have no "slack" as evidenced by rising prices and shortages, which invalidates any talk of "general slack"... yet you ignore this too.

Come on, man. Show me the source of Keynesian knowledge. Please address this or I will assume you're not really interested in helping me understand your point of view or trying to understand mine.

I don't see that being the case. I think you are misrepresenting the keynesian perspective and providing more micro-economic and relative price sensitivity than it actually has.

DeLong has said "At this point, anything that boosts the government’s deficit over the next two years passes the benefit-cost test–anything at all."

Stiglitz stood before congress and proclaimed that paying people to dig ditches would be good for the economy now.

Here's the funny thing. My criticism of Keynesian information problems stem from the assumption that where you spend the money matters. But Keynesians repeatedly assert that it DOESN'T MATTER where the money is spent, so long as it's spent and not saved. That was Krugman's tax point and he's made it countless times. That is the line of reasoning made by Pelosi and Krugman when they tout the stimulative power of unemployment benefits. it's all about spending on anything at all. That's why Krugman believed that the Iraq war was a major stimulus to the economy. Keynes repeatedly referenced the wealth-creation that came from pyramid building. His predecessor, William Spence made the same insane make-work claim about paying people to blow glass bubbles and then smash them.

None of this indicates any concern for sectoral/relative price factors or the relative scarcity of real resources. Zero. It's exactly the same blindly over-aggregated stuff which Hayek criticized Keynes about from the get go. So I need YOU to show me why my understanding is a strawman when it is based on DeLong, Krugman, Stiglitz and Keynes himself. You assert that relative prices and scarcity matter for keynesianism. I see no evidence for it in the actual execution of stimulus programs or the rhetoric from keynesians I've listed above.

The treatment of tax cuts as being indistinguishable from spending increases is yet another way that Keynesian rhetoric reveals total ignorance of incentives. Giving money to a relatives small set of specific people clearly has very different incentive effects from changing the return on work and investment for everyone.

As for the Savings vs Investment analysis and the so-called "paradox of thrift"... Mr. Kuehn, have you not heard of the interest rate? If I put my savings in a bank, it is not "idle". The bank will seek people to lend it at interest. The more people save, the more banks will have a supply of loanable funds and lower their interest rates to compete for borrowers. This "idle savings" stuff is a total fallacy, especially as enumerated by Krugman. Savings when held as a bank liability, a stock or bond are not "idle". Now, if you hold your savings as physical currency, they are not put into the supply of loanable funds and so they don't drive down interest rates. The falling prices that result if that demand is unmet does, in fact, transfer purchasing power to other cash holders who may not have increased their demand, and so they can purchase more goods in other areas and drive up demand for labor in other areas anyway.

But lets for the moment that money-demand deflation due to institutional wage-price stickiness will lead to unemployment in the sectors which see demand collapse, why should I expect that increased government spending on some other sector will be a sustainable solution that reflects real consumer preferences (versus a boondoggle like ethanol)? There are specific people demanding more cash balances and they are cutting back on consumption of specific goods. Maybe they'd buy more of those same goods if the money supply increased to meet their demands... but maybe not. How does the keynesian planner know? They don't.

The notion of "fiscal policy" as being a compliment to monetary policy only holds if you abstract away all of the relative price and scarcity considerations above. The loanable funds model of interest rate formation makes sense. At the heart of keynes is the rejection of this model in favor of a liquidity preference model which doesn't make any sense. Yes, liquidity preferences impact interest rates, but they do so through the supply of loanable funds. Krugman's writings on S=I, and I have read most of the posts on the matter for the past 3 years, simply don't make any sense.

I absolutely do understand that Keynesians view investment as an unstable component of total spending and consumption as the stable one. This is obviously true and born out by facts. But recognizing that says nothing about the reasons, and trying replace a fall in private investment with an increase in government consumption is a non-sequitor which only makes sense based on the tautological ex-post circular flow story that follows from Y = C+I+G. That tautology flows through all of what I've ready in the keynesians above. That their models go deeper than the accounting identity hasn't shown me that their causal understanding does as well.

As for the "parasites", I will define that simply as anyone whose business model is contingent on taxpayer-financed government subsidies. Don't like the judgement tone? Oh well. I don't like being ripped off at gunpoint so that Monsanto can make more profit or GM getting the same or some "green" energy scam getting the same or, for that matter, watching my wife and son needlessly radiated or hand-raped at the airport so that Rapiscan and Michael Chertoff can make bank. These people are parasites. It's a scam.

Doubt my openness as someone that adheres to first principles at the moral level. That's fine. But don't pretend that "pragmatism" and discretion has performed any better in the political sphere. I am a private pragmatist that weighs costs and benefits in my personal choices and interactions with others. But even there I keep my morality in play. Stealing is off the table. Fraud is off the table. In politics, pragmatism is just more excuses for stealing and fraud. Most of the founders were ideologues who saw government as an evil beast to be tied down. Thank god for that. That was a virtue.

Lee Kelly writes:

John,

May I suggest "The Significance of Monetary Disequilibrium" by Leland Yeager? Better yet, check out Yeager's book, The Fluttering Veil.

In any case, it is worth reflecting that when people hold currency or banks hold reserves they are de facto lending to the central bank. Since central banks are divorced from the feedback that would coordinate saving and investment at commercial banks, it is quite possible for them to render idle some of the resources being lent to them, i.e. for money to be too tight.

The fact is that an Austrian business cycle is both caused by and the cause of inflation. This second point is usually overlooked. Austrians sometimes recognise a difference between good and bad deflation and, though less commonly discussed, good and bad inflation. Good inflation occurs because of some unfortunate decline in overall productivity, like when a significant portion of total savings is malinvested. Since prices have already adjusted to the higher level, instigating the bust, additional inflation driven by a fall in output is surely the natural response.

Daniel Kuehn writes:

OK, I don't have time to respond to all this or even read it right now - but I will at least read it tomorrow. However, regarding this:

You are arguing past my points and ignoring the central issues. Worse, though, you continue to imply that I'm unconcerned about understanding the real Keynesian point of view.

I'm not arguing past your points, I'm answering them I just think you aren't convinced by my answer. And to be honest I wasn't convinced by your initial point.

As for my implications, if I implied that I didn't mean to and I'm sorry. I'm sure you're concerned about understanding the Keynesian point of view. I feel like you expect me to provide you with an argument for why central planning works, and that is the argument you want to understand. I can't present such an argument. I don't think there is one, and I don't think its Keynesianism if it is. I'm sure you are genuinely interested in getting a grip on Keynesianism - what I'm trying to suggest is that you seem to have a firm grip on a Keynesianism that is not one that I understand to be Keynesianism.

The heart of Keynesianism is the natural operation of the economy below full employment. I've tried to cover those points - feel free to look at my blog where I talk a lot about it too. But if you really want to grasp the core of Keynesian think through:

1. What could lead an economy to stably operate below its full capacity.

2. What assumptions you are making (about savings, about investment, about efficiency, about crowding out) would change below full capacity and how they would change.

Daniel Kuehn writes:

For the record - I agree with both DeLong and Stiglitz on those things they said.

I think you could think up something better to do than what Stiglitz suggested, but I don't disagree with the sentiment that it is better than not doing anything. He is right on that.

Do you think I'm trying to whitewash these views? I don't think I am.

You're focusing on the "what gets done with the appropriations" side of things. I'm saying the Keynesian approach focuses on the "making use of idle resources, and attendant multiplier effects" side of things.

Daniel Kuehn writes:

As for the Savings vs Investment analysis and the so-called "paradox of thrift"... Mr. Kuehn, have you not heard of the interest rate? If I put my savings in a bank, it is not "idle".

Ha - I need to work and I know I said I wouldn't respond, but I have to take this one up...

- Austrians and various other economists think the interest rate coordinates the supply and demand for loanable funds.

- Keynes thought that the interest rate coordinates the supply and demand for cash/liquidity (Hicks said both the Austrians and Keynes were right - it serves both functions... I personally prefer Hicks to Keynes on this)

This is the stumbling blog of the Austrians on this question.

Yes, you're right. If the interest rate only served the purpose of getting my savings to an investor to use, then Keynesianism wouldn't make much sense. My whole point is that's a misunderstanding of the interest rate.

The savings in the bank are more idle than they might be elsewhere. Don't think of this so dichotomously.

Daniel Kuehn writes:

I'm genuinely sorry if I made it seem like I think you're being disingenuous - you're clearly interested in getting to the bottom of this (and my response to your comment on ideologues was a reflection of my view on ideologues, not on you... maybe that's the source of the confusion).

But I feel like I keep getting the same points brought up that I've already answered. Something isn't being communicated or interpreted correctly if you still think this has anything to do with central planning (aside from the interest rate, which is the one real true, genuine element of "central planning" the Keynesians engage in). It's probably my fault, not yours - but I can't quite understand what's not getting through.

It's one thing not to buy certain Keynesian arguments. I'm troubled that it still sounds like central planning or consumptionism to you.

John Papola writes:

Daniel,

Do me a favor. Dig into my specific points/questions about aggregation in my last long post. You haven’t yet. You’ve just waved your hands by saying “keynesians recognize that slack is unevenly distributed”. That’s not an answer. I’m asking what I believe are reasonable and reasonably precise questions. That you agree with DeLong and Stiglitz suggest to me that my understanding of keynesianism is correct and that my criticism holds. Posting your blog that I’m spewing fallacies doesn’t do anything to point them out. You haven’t. I’m listening. Nothing would make me happier in life than to have keynesianism proven true. After all, both political parties are keynesian.

Daniel Kuehn writes:

John - I said "peddling" not "spewing" fallacies... that sounds a little nicer to me. Isn't it? I was referencing the "Keynesianism as consumptionism" fallacy and the assumption that we're operating at full employment (ie - no liquidity preference so no paradox of thrift). I feel pretty solid calling those "fallacies" and I have pointed to them explicitly a couple times now, so don't suggest I haven't pointed them out - I have.

OK - on aggregation - let me try and think of another way of phrasing my point.

We always experience uneven levels of depression, growth, market tightness, market looseness, inflation, and deflation. That is always with us - they are simply temporary disequilibria and price signals to direct scarce resources to their best use. They're a good thing in a market economy because the market uses the price signals from those imbalances to make economic activity more efficient. This is intertemporal as well - people save and borrow because the market allocates goods and services over time as well. What I'm saying is that in some situations, there is a general depression. There are still these heterogeneous differences as there always are, but everything is more depressed than it would have been under normal circumstances. This occurs when there is a reduction in effective demand - when people and firms don't want to save to set something aside for the future - they want to save to have a liquid asset. This isn't time preference this is liquidity preference, and it's something Austrians regularly ignore. You say your money is in the bank and isn't idle. It isn't absolutely idle, you're right - but savings can be kept in more liquid and less liquid forms. More liquid assets are by definition kept less productive than less liquid assets.

So, the point of Keynesianism is that while liquidity preference may be rational in the sense that its understandable why people have it, it isn't socially functional. It's unnecessarily wasteful and it means that the market does not always efficiently use all factors of production. The task at hand is to turn that liquidity preference shock into actual income.

Restoring full employment in that sense has absolutely nothing to do with your concern about unevenly depressed sectors. The task isn't to say "what's especially low out there? - let's fill up that hole because its not doing so well". No. That defeats the whole purpose. We like those relative differences because those provide price signals that efficiently allocate means of production. That's not the way to think about fiscal policy. Think about fiscal policy as being much like monetary policy. People are demanding liquid assets, so they hold money or some other highly liquid asset, and it just sits there - depressing everything, not just specific sectors. Fiscal policy is the government saying "here, why don't you hold on to this bond - its very liquid, there's always a market for it, it'll satisfy your mattress-stuffing impulses, and I'm going to go credit worker and contractor accounts to do this "stimulus" stuff. People want to turn income into liquid assets and take it out of circulation. So the government says "I'll take that trade", and then puts it back into circulation. It's no different from monetary policy, which you were damn close to embracing on Cafe Hayek recently.

So that's why I say you're thinking about this from completely the wrong angle. You are thinking of it from the goods and services side of things, which is why it seems like a calculation problem to you. You need to be thinking about what's going on in the money and loanable funds markets - why your savings are in fact idle, and what fiscal policy does about it.

Daniel Kuehn writes:

So see - the case I've made so far has nothing to do with these relative imbalances. Because I don't see the relative imbalances as a problem - I only care about general gluts. Market specific gluts are going to be worked out by the market. The task is to fix the problem that lead to the general glut.

Now, I did agree with you that these relative imbalances in different sectors are important because clearly fiscal policy is going to have an impact in various markets in ways that monetary policy simply isn't going to. You want to be smart about how you spend the money in that sense. If you spend $800 billion on Sponge-Bob Square Pants DVDs, macaroons, and snow-globes you're going to introduce some pretty bizarre price distortions. You'll still put idle cash back into circulation, which is why Brad DeLong says anything passes the cost-benefit test and why Keynes talked about burying bank notes and digging them up again. You will, in essence, solve the general glut problem but exascerbate the industry-specific gluts. I am not aware of a Keynesian that doesn't recognize this, John. Are you? The argument is that the general glut is by far and away the bigger problem at a time like this - period. If we solve the general glut and cause a few issues with relative price distortions, the argument is that the cost of those relative distortions is much, much lower than the benefit of solving the general glut. You can't accept this because from what I gather you don't even think general gluts are real.

So this is why I say anything works as long as you put money back into circulation, but relative prices still matter because of course you can introduce distortions. The thing is, there are a lot of public goods that we could be investing in. They are sub-optimally underinvested in right now so we can dump money on them and they would indeed change relative prices but they would improve the situation. We can dump money on research and education and it would adjust relative prices for the better because these are underpriced by the market. We could dump money on clean energy technology and it would indeed adjust relative prices, but for the better because this is underpriced by the market. We could increase NASA's budget five-fold and it would adjust relative prices for the better because space colonization is currently underpriced by the market. We could also just put a roof over people's head, food in their mouth's, and clothes on their back as a purely humanitarian act because people are deserving of the basic dignity of having their needs met. At full employment you have to weigh that against what you're taking money away from. Below full employment, I say "it solves the general glut and it serves a humanitarian motive outside economic calculation - win-win to me".

You have to be careful of course, because these can have bad distortionary effects too. You mentioned health care in an earlier post. Policies that drive demand for health care - mandates, tax breaks on health plans, etc. are not the way to spend stimulus money. Things that will lower costs like health care IT and grants for nurse training wouldn't be as bad.

But the point isn't to distribute money to every weak market. It's not "C, I, G, altogether adds to Y - keep that total growing and watch the economy fly". That's crude Keynesianism. That completely misses the point. The point is get money back into circulation, recognize that as your number one priority, but also recognize the distortionary effects your policy might have and try to avoid them the best you can.

Robert Skidelsky says it very well on your website - there is government waste and there is market waste. Governments absolutely waste when they try to allocate resources. Governments cannot do economic calculation, period. But in a general glut, markets are far more wasteful than governments. You have to just live with some government waste to solve the market's waste problem - and ideally you spend on positive externalities and public goods to minimize the level of government waste in the first place.

Keynes wrote: "To put the point concretely, I see no reason to suppose that the existing system seriously misemploys the factors of production which are in use. There are, of course, errors of foresight; but these would not be avoided by centralising decisions. When 9,000,000 men are employed out of 10,000,000 willing and able to work, there is no evidence that the labour of these 9,000,000 men is misdirected. The complaint against the present system is not that these 9,000,000 men ought to be employed on different tasks, but that tasks should be available for the remaining 1,000,000 men. It is in determining the volume, not the direction, of actual employment that the existing system has broken down."

I could not agree more.

If you still don't feel like I'm speaking to your point, you may want to look for answers elsewhere because I'm clearly not communicating this well. I feel like this has been asked and answered countless times by lots of Austrians before you, and maybe I'm just not addressing it right. Needless to say, if you still think I'm violating some assumption about economic calculation I'm miscommunicating something because I am fully on board with Hayek on economic calculation.

Daniel Kuehn writes:

Oh - I meant to note one other thing.

Note that Keynes never submitted a report to the Chancellor of the Exchequer saying "My dear chap, I strongly feel that we should bury banknotes and pay the unemployed to dig them up". Notice Stiglitz never castigated Congress for not including more ditch digging in the stimulus package.

Doesn't that say something to you? The whole reason for pointing out these completely crazy options is to try to highlight this fact that its not about "boosting consumption" or even "boosting investment" directly. A lot of people think of fiscal policy as the government spending when the market won't - as if the government is stepping in to do the economic calculation.

That completely misses the point, which is precisely why Keynes came up with such goofy examples. But he never seriously proposed such examples because even though the point wasn't to bolster certain goods and service markets, it clearly could have the effect of distorting those markets.

John Papola writes:

Daniel,

Proclaiming that I'm wrong because "I'm assuming full employment" is not an answer because I'm not assuming that all.
Did you actually read my 10:25am post? I'm fully aware of the liquidity preference view. I don't need it repeated back to me and it doesn't address my aggregation problems at all.

You say your money is in the bank and isn't idle. It isn't absolutely idle, you're right - but savings can be kept in more liquid and less liquid forms. More liquid assets are by definition kept less productive than less liquid assets.

This looks like a backpedal to me. There's a big difference between saying "savings are idle" and "more or less liquid forms". If I put my money in a savings account, it is available on demand. It's more liquid than a treasury. And yet a functioning bank can turn around, leverage its local knowledge and lend 90% of it out to any manner of project. It can be a long-term project or a short term bridge loan. So the "idle cash" idea is a fallacy unless the cash is in your mattress.

You need to be thinking about what's going on in the money and loanable funds markets - why your savings are in fact idle, and what fiscal policy does about it.

I don't see how spending money on political boondoggles addresses insolvency or debt overhang in the banking system. What I see is a set of policies which calcified the problems and produced politically managed zombies. "Fiscal Policy" is just another word for government allocation of resources.

If you spend $800 billion on Sponge-Bob Square Pants DVDs, macaroons, and snow-globes you're going to introduce some pretty bizarre price distortions. You'll still put idle cash back into circulation, which is why Brad DeLong says anything passes the cost-benefit test and why Keynes talked about burying bank notes and digging them up again.

How does this spending re-employ construction workers? Moreover, since it doesn't reflect consumer preferences, why should we expect it to sustain itself when the stimulus spending is cut off? Saying "it puts idle cash bank into circulation" both rests on the assumption of "idle cash" but also on this hydraulic circular flow nonsense. It's tautological. Explain what "putting cash back into circulation" means. Why should I believe that the forces which encouraged some people to hoard cash aren't still in play? Meanwhile real resources are being wasted on boondoggles concocted by political fraudsters.

"but everything is more depressed than it would have"

This is wrong. It's manifestly untrue. "Everything" is not more depressed man. HOW MANY TIMES MUST I MAKE THIS POINT. Healthcare and education are NOT DEPRESSED AT ALL. There is no "general glut" except as an ex-post accounting. You are making an assertion that is false and repeating it over and over. We have supply constraints in full effects in Energy, Healthcare, Food, Education. How do I know? BECAUSE PRICES ARE RISING THERE. So no "everything" is absolutely NOT depressed. Until you contend with this point head on, we will never get any deeper in this discussion.

People want to turn income into liquid assets and take it out of circulation. So the government says "I'll take that trade", and then puts it back into circulation. It's no different from monetary policy

This is silly. Monetary policy does not produce debt, for starters. If the Fed buys assets, it's not a loan that needs to be repaid at a later date. That matters. Debt increases fragility (see Ireland). Monetary policy also does not squander real resources on boondoggles either. I don't have any faith in Central Banking as anything but a crude second best solution, but if we have a central bank, it's efforts to target NGDP need not pave roads to nowhere in districts that didn't have a housing bust. Money is a specific good. Conflating it with your fictional notion of fiscal policy increasing demand for "goods in general" is wrong.


They are sub-optimally underinvested in right now so we can dump money on them and they would indeed change relative prices but they would improve the situation. We can dump money on research and education and it would adjust relative prices for the better because these are underpriced by the market. We could dump money on clean energy technology and it would indeed adjust relative prices, but for the better because this is underpriced by the market. We could increase NASA's budget five-fold and it would adjust relative prices for the better because space colonization is currently underpriced by the market. We could also just put a roof over people's head, food in their mouth's, and clothes on their back as a purely humanitarian act because people are deserving of the basic dignity of having their needs met.

And my point is made. This is Political allocation of resources which deny the information signal of prices. This is just socialism via central planning. It's certainly not economics. Are you seriously telling me that EDUCATION is "underpriced"?!?!?!? Ha. The point here is that you are coming to these judgements based on political beliefs, not economics or market signals. You personally think it would be wise for us to spend more on space colonization, therefore the fact that we aren't as much as you think we "ought" to means it's "underpriced". You've gone off the rails, Daniel. This is just more proof to me that Keynesianism is just scam to invoke socialism (and mercantilism, of course) during a recession. And yes, it would be lovely to provide for those in need, but this claim was made by Mao, Stalin and Chavez. It’s just pandering populism. In the real world, the government spends on its buddies.

How do you know these things need more investment? The market of free people interacting isn't telling you that. Political ideology is. I thought you agreed that the market is better at allocating resources? It looks like that's not really what you believe. You believe that the market is good at allocating resources... except when it doesn't suit your own priors.

And how does ANY of this re-employ construction workers in a sustainable production process based on real consumer preferences? All of it appears to be stuff where a permanent new parasitic constituency will fight to keep the borrowed money flowing into their pockets.

I think we've hit a wall. You don't seem to understand my points about aggregation and continue to make falsifiable generalizations like "everything is depressed" prove that misunderstanding. And, in the end, you prove that

Have a Merry Christmas. If you want more moon base research, make a donation. Don't rip off the public by issuing bonds to dump into your science fiction fantasies.

Daniel Kuehn writes:

You say this: "Did you actually read my 10:25am post? I'm fully aware of the liquidity preference view. I don't need it repeated back to me and it doesn't address my aggregation problems at all."

And then you say things like this: "As for the Savings vs Investment analysis and the so-called "paradox of thrift"... Mr. Kuehn, have you not heard of the interest rate? If I put my savings in a bank, it is not "idle"." or "Saying "it puts idle cash bank into circulation" both rests on the assumption of "idle cash" but also on this hydraulic circular flow nonsense. It's tautological." or "There is no "general glut" except as an ex-post accounting.".

What do you expect me to conclude, John??? You claim that you buy liquidity preference problems, and then you argue as if you don't buy it.

re: This looks like a backpedal to me.

Then I must have miscommunicated my point. I never intended to suggest that assets are always 100% productive or 100% idle. I'm not sure how you picked that implication up, but it's not what I intended.

re: This is wrong. It's manifestly untrue. "Everything" is not more depressed man. HOW MANY TIMES MUST I MAKE THIS POINT. Healthcare and education are NOT DEPRESSED AT ALL.

I suppose you'll keep making the point until you get it right. Health care and education are more depressed than they otherwise would be. That is not to say that they are crashing - as I outlined for you, these relative differences are maintained even in the midst of a general glut.


I don't even know where to start with your discussion of my points on externalities and public goods. If you think the market can price these things there are deeper issues to address and I don't really have time now.

I've answered these questions several times now, John. You act as if these points are somehow lost on me, or that basic economics escapes me. I'm trying not to be insulted by the insinuation, but its getting hard. I don't know how many times we have to walk through this before you recognize that I am not ignoring what you're accusing me of ignoring and I'm not failing to recognize what you're accusing me of failing to recognize.

I have to do a few things - merry Christmas.

Daniel Kuehn writes:

And I should note, John, I put a hell of a lot of thought and effort into these issues and into my communications on these issues. If you're not convinced, fine. Offer me a counter-argument. Some of this stuff is just hard to empirically verify too, so if you disagree maybe chalk up the disagreement to empirical fuzziness. But don't accuse me of dodging questions, socialism, or say I've "come off the rails".

Don't ask me to have a discussion with you on these points and then just dismiss my very detailed, very carefully thought through responses. Notice in this whole conversation I lead with one question for you, but I haven't been showering you with questions. You've been asking me to speak to things and I have at length. I don't appreciate being lectured to for the effort.

John Papola writes:

Daniel,

The truth of the matter is that this stuff is clearly ideological between you and I and it will not be resolved. It’s very frustrating. I don’t think that it’s legitimate to claim "Health care and education are more depressed than they otherwise would be.” That is not science or economics. I have no idea what it is. It appears to be concocting imaginary alternative realities against which to compare so that your point can hold. I simply don’t accept that as legitimate. It’s not a rebuttal.

You have yet to explain the mechanism through which spending on maxed-out industries like Healthcare leads to re-employment of slack resources. You haven’t explained how it is that a Keynesian administrator is able to discern between slack due to liquidity shocks vs. slack due to preference changes. This all started because you questioned my used of socialist calculation as a problem for keynesianism. You’ve rebutted none of that. I don’t understand why you feel that you have. It’s very confusing to me. I am hungry to hear the real rebuttal, but what I’m getting seems like hand-waving and broad assertions. You probably think that’s how I sound.

Everything you’ve written seems to amount to the following paraphrase:

Yes, John, all of your sectoral and structural concerns are understood by Keynesians and don’t matter. Digging ditches can still help. Anything that increases the deficit will still be good during a recession. There’s still a general glut because and areas where there is supply shortages like healthcare and education and energy and food are still in “glut” because, well, they would have faced even greater shortages in my alternate “full employment” counter-factual (more like fictional).

We are at an impasse. If real shortages and scarcity are actually “slack” compared to some fantasy counter-fiction, there’s not much progress left to be made in our discussion. If you can honestly claim that education is “underpriced”, I see no reason to believe your claims about the value of market pricing to allocate resources, never mind any rational study of the cost/benefit performance in US K-12 education in the real world.

As far as I can tell, Keynesianism is just a convenient way for you to justify more government in order to achieve political ends that have nothing to do with macroeconomic stability or full employment (whatever “full employment” is supposed to mean).

In a world where our government spends a trillion a year enriching contractors and murdering kids in Pakistan with robots… where they starve children in Africa so that the Iowa caucus swings their way… where they reject the will of the people to bail out the richest people on earth… I see no reason to believe this institution deserves a reasonable doubt. I take public choice seriously. I look at government as it is, not this textbook public-goods service.

I don’t think you’re a bad person or have bad intentions. But I do think you’re advocating the empowerment of terrible people who do terrible things.

Maybe I’m muddying the waters with too many unrelated examples of government evil. For all my scattershot attacks on government, they pale in comparison to the scattershot contents of what gets called a “stimulus” bill. If politicians and keynesian economists are going to call “anything that increases the deficit” (especially war) a “stimulus”, I feel in bounds pointing to just about anything evil the government does as a reason NOT to trust these murderous state crooks. Krugman agrees with Bush that the Iraq war was a “stimulus”. I call that evil on top of a fallacy.

Maybe you don’t deserve to be treated like a “useful idiot” for these political hacks. But I honestly, sadly, believe that that is the truth. That’s not meant to be a personal attack on you, but it is an attack on your ideas. Does that end our ability to debate? I don’t think so. You may disagree.

In the spirit of disentangling this stuff so that we can at least try to understand where we disagree, maybe we should try a different venue and approach. Maybe we could dual-host on our respective blogs a series of narrow questions that walk through the above with some mutually agreed rules of engagement. That could be fun.

In the meantime, have a great holiday weekend.

Daniel Kuehn writes:

John, I am not an ideologue, I take this stuff seriously, and if you think this just go and discuss it with someone else. I don't have time for people that feign interest in discussing issues like this and then accuse others of being caught up in ideology when they hear something they don't like.

Daniel Kuehn writes:

In the spirit of disentangling this stuff so that we can at least try to understand where we disagree, maybe we should try a different venue and approach. Maybe we could dual-host on our respective blogs a series of narrow questions that walk through the above with some mutually agreed rules of engagement.


No, I don't think this is something that I'd be interested in.

With how you've reacted here - continually insisting I haven't answered questions I put a lot of time into responding to you on, saying I'm wrapped up in ideology, saying the only reason why I hold my views is to justify and expansion of political power, etc. - what could I possibly gain from such an interaction with a person like that, that clearly doesn't respect me?

I blog on Keynesianism all the time and I interact with Austrians that don't accuse me of these sorts of things, and who are actually interested in dialogue over this. And I certainly don't need a discussion with you to satisfy my own desire for more knowledge about the Austrian School.

The thing is, John, when I blog (and I've blogged jointly with people - for example a Hayek reading group I've participated in) we've found that we don't need these "rules of engagement" you suggest, because we've always been perfectly capable of respecting each other.

John Papola writes:

Daniel,

Fine by me. I don't think you're being honest with yourself about the role that ideology plays in your analysis. Saying that education is underpriced in America, or that healthcare is slack relative to a fictional alternative "full employment" state appear to be ideologically driven assertions to me, not economic science.

Maybe Ive been too shrill, here. I'm sorry if thats the case. It's the result of frustration over getting what I see as dodges despite very narrow questions.

I don't understand precisely how to rephrase my questions another way. At least I'm honest about my biases, rather than attempting assert some mantra of objective analysis. I don't think objectivity is possible in these debates. At someone point, it just boils down to a belief that markets work vs a belief that they don't. DeLong, Krugman, Schiller and Stiglitz all engage in this ideological root position. Keynes clearly did. Am I do believe that you don't? Come on, man.

John Papola writes:

Daniel,

I'd like to apologize for my tone in some of the posts above. After having a conversation with David and reviewin our conversation, I agree that there are a number of places where I needlessly and unproductively pushed your buttons. That no way to treat someone who is concerned enough with alternative points of view to frequent this site given your views.

I do respect your efforts and intelligence even if I strongly disagree with some of your ideas.

Here's to a new year.

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