Art Carden  

Keynes v. Hayek: A Dialogue With Two of My Children

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Shall Europeans elect their Pr... I Don't Have To...

The long-promised but slow-in-coming dialogue promised here.

PERSONS OF THE DIALOGUE

Jacob Carden, Age 4

Taylor Grace Carden, Age 2

Dad: Art Carden, an Economist, Age 34

Scene: Chuck E. Cheese's in Vestavia Hills, Alabama.

Dad: Children, I notice you aren't eating your pizza. Eat your pizza.

Jacob: Why should we? We're not hungry at the moment, we would rather play, and besides, we can save the pizza and have it for lunch tomorrow.

Dad: Lay aside for the moment questions of authority. I'll ignore your disobedience for now. What we have here is a question of macroeconomics.

Taylor Grace: Macroeconomics?

Dad: Yes, macroeconomics. We're interested in why we have business cycles. Know that if you don't eat your pizza, aggregate demand will surely collapse.

Taylor Grace: How do you know?

Dad: It's obvious, isn't it? By saving the pizza, you lower our planned expenditures. By lowering our planned expenditures, you create a vicious spiral leading to unemployment, at least in the short run.

Jacob: Do explain.

Dad: Here's what happens. You don't eat your pizza, so we save it for tomorrow. Since you'll eat the pizza tomorrow instead of (say) peanut-butter-and-jelly sandwiches, which means we will need to spend less on groceries. Our local grocer will observe an increase in inventories. Observing this increase in inventories, he will then cut back on his orders of new goods.

Taylor Grace: Such as?

Dad: Peanut butter, jelly, and bread, in our example. Producers of peanut butter, jelly, and bread will, in turn, cut back on their orders of peanuts, grapes, sugar, salt, wheat, and so on. The cycle continues until planned expenditure is again equal to actual expenditure. We end up with output below the economy's potential. So eat your pizza: American macroeconomic stability depends on it.

Jacob: You might be right in a sense, Dad, but you should remember your Hayek: "Mr. Keynes's aggregates conceal the most fundamental mechanisms of change." What do you do with your savings from lower grocery purchases, what signals do your rising savings send, and how will entrepreneurs respond?

Dad: Do continue. What do you mean?

Jacob: Presumably, your additional saving winds up in the bank, shifting the supply curve for loanable funds rightward. Taylor Grace is illustrating by drawing a helpful diagram on a napkin. This lowers the interest rate. In response, firms increase the quantity of loanable funds they demand. And furthermore...

Taylor Grace: ...the lower interest rate suggests to investors that consumers are willing to sacrifice present consumption to get future consumption. "Temporally remote" projects, meaning things like asteroid-harvesting ventures initiated by firms like Planetary Resources, will now be profitable because of the lower interest rate.

Jacob: So what we would actually observe is a reduction in employment opportunities in industries that produce goods for immediate consumption. That much is true. However, this reduction in current consumption frees up resources (like labor and capital) that can be used by firms like Planetary Resources--firms engaged in production processes that won't yield consumable output for a very, very long time.

Dad: So what is the mechanism?

Taylor Grace: Like we said, the interest rate sends the signal. Roger Garrison explains it in this lecture and this essay (Taylor Grace is fiddling with Dad's iPhone now). In late-stage industries--those producing for current consumption--the "derived demand" effect dominates the interest rate effect. In the short run, these industries contract. However, in early-stage industries--which produce goods that go into far-future consumption--the interest rate effect dominates the derived-demand effect. As Garrison puts it, following Hayek, we have here "an economy working right" in which an increase in saving leads not to a recession, but to a capital restructuring. And one that, I might add, leads to greater economic well-being in the long run.

Jacob: So don't try to guilt us into eating pizza we'd rather save until tomorrow. If you want to discuss it further, we'll be playing Skee-Ball.


Comments and Sharing





COMMENTS (17 to date)
Daniel Lemire writes:

Except, of course, when the interest rate is already zero, the Hayek mechanism is broken. Firms can already get dirt cheap loans. Saving does not help in any way.

In such a case, you are much better off eating your pizza. No?

egd writes:

Skeeball - where the expected return is significantly less than the cost to play. Even if the expected return were greater than the cost to play, you're still converting fungible cash into unfungible tickets that have limited opportunities to redeem and are non-negotiable.

Clay writes:

This can't be real, can it? I can't believe that a four year old can intelligently quote Hayek. If your four year old does anything even close to that, I am intensely jealous.

Mordecai writes:

Although it may be parental malpractice, could you please encourage your children to go into politics anyway?

BZ writes:

@egd: Skeeball is fun, therefore the expected return, usually, is greater than the cost to play.

@Daniel: Interesting reply -- you made me think through all kinds of stuff, like the incentive to save at -1% when expected inflation is 3%, or the effects of triage in a negative borrowing rate environment. In the end, I can't imagine this happening without some sort of distortionary actor, like a central bank.

Imagine if someone came along and promised the kids free pizza for the rest of their lives. In the short run, they eat more and save less (why save cold pizza when hot pizza arrives tomorrow?!). However, in a world of scarcity, we can't imagine such a thing going on forever, by which point the PB&J industry truly is dead, and pizza is hard to come by.


Art Carden writes:

@Clay: I wish!

@Daniel: good point, but Garrison and Hayek start from an equilibrium in which the interest rate is positive. I doubt the nominal interest rate would be so low without Fed action. Even still, Murray Rothbard argued somewhere that the additional saving might rationalize some of the newly-undertaken investment that otherwise wouldn't pan out.

@egd and @BZ: Given the right deal, each Skee-Ball game costs about twenty cents (you can usually get a "100 tokens for $20" coupon online or somewhere else). I'm trying to use Chuck E. Cheese's tickets to teach the kids about saving and delayed gratification: they can either get a trinket now, or they can get something a little more substantial later. Granted, that "something a little more substantial" will probably end up costing four or five times what we'd pay at retail, but the thrill is in the hunt, so to speak.

Philo writes:

“So what we would actually observe is a reduction in employment opportunities in industries that produce goods for immediate consumption.” Not necessarily a reduction from prior levels of employment; rather, a reduction from how much employment there would have been if you had eaten more and saved less. “In the short run, these industries [late-stage industries] contract.” They become smaller than they would have been with less saving and more consumption, not necessarily smaller than they were before. Perhaps the late-stage sector of the economy continues to expand, only not as fast as it would have done.

(How much credit does Hayek deserve for these ideas? Surely they were commonplace in the 19th century, perhaps even earlier.)

egd writes:
I'm trying to use Chuck E. Cheese's tickets to teach the kids about saving and delayed gratification

While I'm sure it's a great teaching tool for your 4-year-old, I can't imagine it being very effective with the 2-year-old (especially knowing my 2-year-old).

I was being flippant about Skeeball, but if you're educating your kids about economics, they should know why Skeeball is not a good investment.

Nobody ever says "it doesn't matter that you lost money in the stock market, at least you had fun."

Jon Murphy writes:

You have two very articulate children. You must be one proud papa!

Ted Levy writes:

Clearly your first mistake was to not go with the fact people are starving in Africa...

gwern writes:

Surprised no one in the dialogue noted that cold pizza tastes worse than hot pizza, especially at Chuck's. That makes the analogy a little more difficult...

Ken P writes:

Roger Garrison's YouTube video (an older one) is what got me interested in economics. That and reading pretense of knowledge by Hayek. The way be links stages of production, loanable funds and production possibilities frontier really grabbed me. I still have a lot to learn about basic economic concepts.

@Ted. I definitely remember that argument as a kid. I remember the first time I heard it there was no logic to it. I knew whether I ate or not had no bearing on starving children in Africa. I started questioning the intelligence of parents.

Ken P writes:

Roger Garrison's YouTube video (an older one) is what got me interested in economics. That and reading pretense of knowledge by Hayek. The way be links stages of production, loanable funds and production possibilities frontier really grabbed me. I still have a lot to learn about basic economic concepts.

@Ted. I definitely remember that argument as a kid. I remember the first time I heard it there was no logic to it. I knew whether I ate or not had no bearing on starving children in Africa. I started questioning the intelligence of parents.

Chris Koresko writes:

Here's an idea that needs a critique: The Keynesians are right that demand drives the economy, but they go wrong when they define demand in terms of money. Demand is actually tradeable wealth.

Look at it this way: At least according to my admittedly "pop" understanding of Keynesianism, government can create demand by printing money and mailing it out to private citizens to spend, and that sort of thing is supposed to "stimulate" the economy.

But in my way of thinking, that can't work. Money is just information about the amount of wealth its owner can claim from society at large, about the relative cost and value of various things, and about the relative value of consumption today versus tomorrow. The key here is that money is nothing more than information. It's numbers in a database. Creating it out of nothing is just a way of telling lies, and those lies are going to cause confusion unless the liar is much wiser and more knowledgeable than those he lies to.

If you fix the error by redefining demand to be tradeable wealth, then the famous claim of pop Keynesianism reduces to the observation that a recession occurs because people are too poor.

Cdiddy writes:

@ Chris Koresko,
Good analogy but you missed one thing. The printing of additional money must be taken from some where. You can not print money out of thin air. Yes money is trade-able wealth.

The government has a couple of choices for their stimulus (and "stimulus" is often spent directly by the government no need to mail it) 1. They can borrow it by removing money from investors or foreign governments and using it as stimulus. This results in loss of future consumption due to a future increase in tax payments (and possibly a crowding out effect). 2. Print the money and inject it into the system. This of course will result in inflation and a general increase in prices.

Yes demand is a result of creating wealth or utility. Even though a service such as a skeeball game leaves the user with no additional wealth (or only tickets) the user has increased his enjoyment or utility. An example of the creation of wealth: Oil in the ground has no value, but add labor to remove, distribution etc... you have created value or wealth.

So the observed reduction in demand and employment is correct, but only in the short run since demand is always adjusting to changes in how people value a good or service.

The Kaynesian would say that the increase in savings has stopped the market from functioning properly since people have incorrectly valued goods and services, therefore the government must take action to increase demand since they believe that demand drives the creation of wealth.

Kitty_T writes:

edg: 'Nobody ever says "it doesn't matter that you lost money in the stock market, at least you had fun."'

Oh, I don't know. That was basically my attitude towards having underwater dotcom options in 2000.

That being said, we use actual allowances for this purpose - the weekly amount is set to be a bit less than the cost of a desirable toy, so the kids are forced to save.

And I don't have to endure Chuck E Cheese.

Matt Bramanti writes:

Kids that great shouldn"t be subjected to pizza that lousy.

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