WEBVTT NOTE The Central Fallacy of Keynesian Economics 1 00:00:00.000 --> 00:00:08.000 The central fallacy of Keynesian economics is that consumption is somehow superior and preferable to saving and investment. 2 00:00:08.000 --> 00:00:17.000 That the free decisions of individuals to divide their income into consumption and saving could somehow be bad for the collective of society. 3 00:00:17.000 --> 00:00:26.000 Keynesian economics views this antisocial decision to save too much as an invisible hand phenomenon, 4 00:00:26.000 --> 00:00:33.000 but an insidious one where optimal decisions by individuals become socially suboptimal. 5 00:00:33.860 --> 00:00:39.640 One thing Keynes fails to consider in the general theory is the implication of financial 6 00:00:39.640 --> 00:00:45.600 intermediation for his multiply. Keynesian economics is called on to justify 7 00:00:45.600 --> 00:00:51.400 bailout and stimulus spending and additional rounds of quantitative easing. 8 00:00:51.400 --> 00:00:57.480 As Christina Romer, former chair of the Council of Economic Advisors, has argued, theorists 9 00:00:57.480 --> 00:01:02.320 are getting in the way of the expansionary policy necessary for recovery because they 10 00:01:02.320 --> 00:01:08.600 want to fight inflation. But unlike empiricists, they are not looking at the real economy where 11 00:01:08.600 --> 00:01:16.040 CPI inflation is no higher than it was before the recession. So why worry? Empiricists who 12 00:01:16.040 --> 00:01:18.880 who are not necessarily tied to outmoded dogma, 13 00:01:18.880 --> 00:01:23.000 unless it's Keynesian dogma, can support continued expansionary 14 00:01:23.000 --> 00:01:24.800 policies. 15 00:01:24.800 --> 00:01:26.440 Anyone who's been buying groceries 16 00:01:26.440 --> 00:01:30.020 knows that the CPI has already lagged behind actual price 17 00:01:30.020 --> 00:01:31.680 increases. 18 00:01:31.680 --> 00:01:33.660 It's also biased downward because it 19 00:01:33.660 --> 00:01:37.360 uses a fixed pre-recession weighting for housing prices 20 00:01:37.360 --> 00:01:39.040 which have fallen. 21 00:01:39.040 --> 00:01:40.880 But that's not empirical proof. 22 00:01:40.880 --> 00:01:41.960 It's only an anecdote. 23 00:01:41.960 --> 00:01:51.200 Romer's own research shows that tax cuts have a multiplier of about three. Estimates of 24 00:01:51.200 --> 00:01:57.580 the multiplier for government purchases are much lower, often less than one. Every dollar 25 00:01:57.580 --> 00:02:03.400 of additional government stimulus makes the economy smaller, and empiricists apparently 26 00:02:03.400 --> 00:02:10.960 want us to make up the difference on volume. Theorists unhelpfully raise these irrelevant 27 00:02:10.960 --> 00:02:16.280 and objections grounded on that mysterious and arcane discipline of arithmetic. 28 00:02:16.280 --> 00:02:20.480 Oh wait, I'm sorry, I'm going too fast. 29 00:02:20.480 --> 00:02:24.200 Are Austrians theorists or empiricists? 30 00:02:24.200 --> 00:02:28.440 Are we saltwater economists or freshwater economists? 31 00:02:28.440 --> 00:02:31.680 Do we want to be grouped with anyone else? 32 00:02:31.680 --> 00:02:33.300 Probably not. 33 00:02:33.300 --> 00:02:39.880 These are not legitimate taxonomies but rhetorical devices intended to offer superficial explanatory 34 00:02:39.880 --> 00:02:46.480 Power, really the appearance of explanatory power to build the writer's credibility. 35 00:02:46.480 --> 00:02:53.000 It's akin to relating various disparate facts to a patently absurd conspiracy theory purporting 36 00:02:53.000 --> 00:02:55.440 to explain everything. 37 00:02:55.440 --> 00:03:00.040 Then the writer can sell the reader what they're going to sell them, at least for any reader 38 00:03:00.040 --> 00:03:03.280 who's still buying. 39 00:03:03.280 --> 00:03:09.680 The objective of economic policy is to restore the golden age of the great moderation. 40 00:03:09.680 --> 00:03:18.700 In the 30s, it was to bring back the roaring 20s, though without prohibition, or Republicans. 41 00:03:18.700 --> 00:03:25.320 To an Austrian, the Great Moderation was no justification for a multi-paradigm consensus 42 00:03:25.320 --> 00:03:30.700 because we were not one of those paradigms that was included, but it was an unsustainable 43 00:03:30.700 --> 00:03:33.960 period of inflationary expansion. 44 00:03:33.960 --> 00:03:39.640 Yes, the inflation rates were always lower than they had been during the 70s or during 45 00:03:39.640 --> 00:03:41.960 the 20s in Germany. 46 00:03:41.960 --> 00:03:47.640 Keep in mind that Bernie Madoff was able to keep his Ponzi scheme going for decades because 47 00:03:47.640 --> 00:03:53.880 his unrealistic returns were almost realistic enough to snow most observers, including all 48 00:03:53.880 --> 00:03:57.320 of his investors and the SEC. 49 00:03:57.320 --> 00:04:02.200 Charles Ponzi's scheme blew up in months because he promised a much higher return, 50 00:04:02.200 --> 00:04:05.320 and obviously unrealistic one. 51 00:04:05.320 --> 00:04:09.480 During the Great Moderation, the business cycle was obsolete. 52 00:04:09.480 --> 00:04:11.880 Nobel Prize winners like Lucas and Krugman 53 00:04:11.880 --> 00:04:16.360 were telling us so, just as Keynesian stabilization policy 54 00:04:16.360 --> 00:04:19.920 had made the business cycle obsolete in the 1960s. 55 00:04:24.000 --> 00:04:26.680 Here's the basic math of the Keynesian multiplier 56 00:04:26.680 --> 00:04:29.680 in somewhat more detail than Keynes provides 57 00:04:29.680 --> 00:04:31.400 in the general theory. 58 00:04:31.400 --> 00:04:36.960 The key point is that any permanent change in total aggregate income is the sum of successive 59 00:04:36.960 --> 00:04:43.680 changes in expenditure, which all result in income to somebody. Most of each increment 60 00:04:43.680 --> 00:04:50.120 in expenditure slash income is spent in the next round, and each successive round is always 61 00:04:50.120 --> 00:04:56.480 related to the preceding one by a fixed ratio, the marginal propensity to consume. And it's 62 00:04:56.480 --> 00:05:01.680 It's debatable whether this ratio is really fixed or if it varies significantly over the 63 00:05:01.680 --> 00:05:07.040 business cycle and with people's overall, Keynes would say animal spirits, but their 64 00:05:07.040 --> 00:05:10.240 overall optimism or pessimism. 65 00:05:10.240 --> 00:05:16.160 Assuming it's fixed, this enables us to derive a constant multiplier equal to one divided 66 00:05:16.160 --> 00:05:20.480 by the MPS. 67 00:05:20.480 --> 00:05:25.920 If we recognize, as Keynes failed to, that the portion of each round of expenditure that 68 00:05:25.920 --> 00:05:33.640 is saved is deposited and then most of that is loaned out to finance investment expenditure. 69 00:05:33.640 --> 00:05:38.440 We can see that each round of expenditure is actually related to the preceding one by 70 00:05:38.440 --> 00:05:47.360 the MPC plus the MPS times one minus the reserve requirement and that one minus the reserve 71 00:05:47.360 --> 00:05:55.000 requirement is not necessarily so much a regulatory feature but really just the bank intermediation 72 00:05:55.000 --> 00:06:02.520 Rate. This multiplier can be, or I'm sorry, this ratio can be rewritten as one minus the MPS times 73 00:06:03.080 --> 00:06:10.120 the reserve requirement and then the multiplier becomes one divided by the MPS times the reserve 74 00:06:10.120 --> 00:06:18.200 requirement. Because the reserve requirement is typically small, about 10% for the United States 75 00:06:18.200 --> 00:06:24.920 and as low as 3% in Europe and it appears in the denominator, this increases the multiplier far 76 00:06:24.920 --> 00:06:31.920 Contrast this with the conventional Keynesian view, which is that a high MPC means a high multiplier, and a high MPS is bad because then increasing government spending would be relatively ineffective. Horrors. 77 00:06:54.920 --> 00:07:06.920 This result should not be taken too literally because, like the money multiplier, it's an oversimplification and only gives an upper limit aggregate income and expenditure can approach. 78 00:07:06.920 --> 00:07:16.920 It does explain some empirical findings that the multiplier was fairly low even when, for the United States, the MPC was apparently very high. 79 00:07:16.920 --> 00:07:23.920 It had always been argued that the multiplier was, in reality, much higher than empirical examinations could confirm. 80 00:07:23.920 --> 00:07:33.920 Apparently, you know, it was okay to be a theorist in that context, but the multiplier operated with too much of a lag to be picked up in empirical studies. 81 00:07:33.920 --> 00:07:46.920 In particular, the permanent income hypothesis and the life cycle hypothesis were formulated to reconcile low observed values of the multiplier with high estimates of the MPC. 82 00:07:46.920 --> 00:07:55.920 These models of the consumption function turn out to be unnecessary, or at least less necessary, in light of financial intermediation. 83 00:07:55.920 --> 00:08:02.920 If we assume a full round of deposit expansion occurs between every round of additional aggregate expenditure, 84 00:08:02.920 --> 00:08:08.920 the ratio between each increment of spending and the succeeding one is then much greater, 85 00:08:08.920 --> 00:08:12.920 multiplying the second term in this ratio by the money multiplier. 86 00:08:12.920 --> 00:08:15.920 This makes the multiplier approach infinity. 87 00:08:15.920 --> 00:08:18.680 Income can be infinite, at least theoretically, 88 00:08:18.680 --> 00:08:21.040 even with a finite money supply, though to reach 89 00:08:21.040 --> 00:08:23.160 this upper limit, the velocity of money 90 00:08:23.160 --> 00:08:24.440 must also be infinite. 91 00:08:28.040 --> 00:08:32.280 Under 100% reserve banking, the multiplier 92 00:08:32.280 --> 00:08:36.360 reduces to its familiar form given by Keynes. 93 00:08:36.360 --> 00:08:39.300 This would probably not be too relevant in such a world, 94 00:08:39.300 --> 00:08:41.520 because conventional deposits would probably 95 00:08:41.520 --> 00:08:45.840 be partially superseded with innovative products, 96 00:08:45.840 --> 00:08:50.540 which were riskier but higher returning. 97 00:08:50.540 --> 00:08:53.560 Keynesian stimulus created the unsustainable boom 98 00:08:53.560 --> 00:08:57.400 which caused the recession in 2008 to 2010, 99 00:08:57.400 --> 00:09:04.080 and the one in 2001, and in 1992, and in 1982. 100 00:09:04.080 --> 00:09:07.280 Only private purchases are welfare maximizing 101 00:09:07.280 --> 00:09:10.160 because only free private decisions create 102 00:09:10.160 --> 00:09:12.840 Pareto improvements, that is, the only kind which 103 00:09:12.840 --> 00:09:17.280 Makes Somebody Better Off Without Making Anyone Else Worse Off. 104 00:09:20.120 --> 00:09:22.880 We can increase short-term output and employment 105 00:09:22.880 --> 00:09:25.680 through inflation and expansionary policy, 106 00:09:25.680 --> 00:09:28.980 but this leads to speculative bubbles, recession, 107 00:09:28.980 --> 00:09:33.200 higher unemployment, and longer-term unemployment. 108 00:09:33.200 --> 00:09:35.360 None of these are welfare-enhancing policy 109 00:09:35.360 --> 00:09:36.800 objectives. 110 00:09:36.800 --> 00:09:38.840 The Keynesian resurgence is in no way 111 00:09:38.840 --> 00:09:40.960 is merely a resurgence of Keynesian economics 112 00:09:40.960 --> 00:09:43.040 as an intellectual force. 113 00:09:43.040 --> 00:09:47.360 It is merely a resurgence of Keynesian economic policy. 114 00:09:47.360 --> 00:09:50.240 This policy is doubly, even triply discredited 115 00:09:50.240 --> 00:09:53.760 because it is precisely what has led to the financial crisis 116 00:09:53.760 --> 00:09:55.120 and the most recent recession. 117 00:09:55.120 --> 00:09:57.120 Thank you very much.