The central fallacy of Keynesian economics is that consumption is somehow superior and preferable to saving and investment.
That the free decisions of individuals to divide their income into consumption and saving could somehow be bad for the collective of society.
Keynesian economics views this antisocial decision to save too much as an invisible hand phenomenon,
but an insidious one where optimal decisions by individuals become socially suboptimal.
One thing Keynes fails to consider in the general theory is the implication of financial
intermediation for his multiply. Keynesian economics is called on to justify
bailout and stimulus spending and additional rounds of quantitative easing.
As Christina Romer, former chair of the Council of Economic Advisors, has argued, theorists
are getting in the way of the expansionary policy necessary for recovery because they
want to fight inflation. But unlike empiricists, they are not looking at the real economy where
CPI inflation is no higher than it was before the recession. So why worry? Empiricists who
who are not necessarily tied to outmoded dogma,
unless it's Keynesian dogma, can support continued expansionary
policies.
Anyone who's been buying groceries
knows that the CPI has already lagged behind actual price
increases.
It's also biased downward because it
uses a fixed pre-recession weighting for housing prices
which have fallen.
But that's not empirical proof.
It's only an anecdote.
Romer's own research shows that tax cuts have a multiplier of about three. Estimates of
the multiplier for government purchases are much lower, often less than one. Every dollar
of additional government stimulus makes the economy smaller, and empiricists apparently
want us to make up the difference on volume. Theorists unhelpfully raise these irrelevant
and objections grounded on that mysterious and arcane discipline of arithmetic.
Oh wait, I'm sorry, I'm going too fast.
Are Austrians theorists or empiricists?
Are we saltwater economists or freshwater economists?
Do we want to be grouped with anyone else?
Probably not.
These are not legitimate taxonomies but rhetorical devices intended to offer superficial explanatory
Power, really the appearance of explanatory power to build the writer's credibility.
It's akin to relating various disparate facts to a patently absurd conspiracy theory purporting
to explain everything.
Then the writer can sell the reader what they're going to sell them, at least for any reader
who's still buying.
The objective of economic policy is to restore the golden age of the great moderation.
In the 30s, it was to bring back the roaring 20s, though without prohibition, or Republicans.
To an Austrian, the Great Moderation was no justification for a multi-paradigm consensus
because we were not one of those paradigms that was included, but it was an unsustainable
period of inflationary expansion.
Yes, the inflation rates were always lower than they had been during the 70s or during
the 20s in Germany.
Keep in mind that Bernie Madoff was able to keep his Ponzi scheme going for decades because
his unrealistic returns were almost realistic enough to snow most observers, including all
of his investors and the SEC.
Charles Ponzi's scheme blew up in months because he promised a much higher return,
and obviously unrealistic one.
During the Great Moderation, the business cycle was obsolete.
Nobel Prize winners like Lucas and Krugman
were telling us so, just as Keynesian stabilization policy
had made the business cycle obsolete in the 1960s.
Here's the basic math of the Keynesian multiplier
in somewhat more detail than Keynes provides
in the general theory.
The key point is that any permanent change in total aggregate income is the sum of successive
changes in expenditure, which all result in income to somebody. Most of each increment
in expenditure slash income is spent in the next round, and each successive round is always
related to the preceding one by a fixed ratio, the marginal propensity to consume. And it's
It's debatable whether this ratio is really fixed or if it varies significantly over the
business cycle and with people's overall, Keynes would say animal spirits, but their
overall optimism or pessimism.
Assuming it's fixed, this enables us to derive a constant multiplier equal to one divided
by the MPS.
If we recognize, as Keynes failed to, that the portion of each round of expenditure that
is saved is deposited and then most of that is loaned out to finance investment expenditure.
We can see that each round of expenditure is actually related to the preceding one by
the MPC plus the MPS times one minus the reserve requirement and that one minus the reserve
requirement is not necessarily so much a regulatory feature but really just the bank intermediation
Rate. This multiplier can be, or I'm sorry, this ratio can be rewritten as one minus the MPS times
the reserve requirement and then the multiplier becomes one divided by the MPS times the reserve
requirement. Because the reserve requirement is typically small, about 10% for the United States
and as low as 3% in Europe and it appears in the denominator, this increases the multiplier far
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.
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.
It does explain some empirical findings that the multiplier was fairly low even when, for the United States, the MPC was apparently very high.
It had always been argued that the multiplier was, in reality, much higher than empirical examinations could confirm.
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.
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.
These models of the consumption function turn out to be unnecessary, or at least less necessary, in light of financial intermediation.
If we assume a full round of deposit expansion occurs between every round of additional aggregate expenditure,
the ratio between each increment of spending and the succeeding one is then much greater,
multiplying the second term in this ratio by the money multiplier.
This makes the multiplier approach infinity.
Income can be infinite, at least theoretically,
even with a finite money supply, though to reach
this upper limit, the velocity of money
must also be infinite.
Under 100% reserve banking, the multiplier
reduces to its familiar form given by Keynes.
This would probably not be too relevant in such a world,
because conventional deposits would probably
be partially superseded with innovative products,
which were riskier but higher returning.
Keynesian stimulus created the unsustainable boom
which caused the recession in 2008 to 2010,
and the one in 2001, and in 1992, and in 1982.
Only private purchases are welfare maximizing
because only free private decisions create
Pareto improvements, that is, the only kind which
Makes Somebody Better Off Without Making Anyone Else Worse Off.
We can increase short-term output and employment
through inflation and expansionary policy,
but this leads to speculative bubbles, recession,
higher unemployment, and longer-term unemployment.
None of these are welfare-enhancing policy
objectives.
The Keynesian resurgence is in no way
is merely a resurgence of Keynesian economics
as an intellectual force.
It is merely a resurgence of Keynesian economic policy.
This policy is doubly, even triply discredited
because it is precisely what has led to the financial crisis
and the most recent recession.
Thank you very much.