WEBVTT NOTE 11.17. Further Fallacies of the Keynesian System 1 00:00:00.000 --> 00:00:06.000 17. Further Fallacies of the Keynesian System 2 00:00:06.000 --> 00:00:17.000 We have seen that even if the Keynesian functions were correct and social expenditures fell below income above a certain point and vice versa, 3 00:00:17.000 --> 00:00:22.000 this would have no unfortunate consequences for the economy. 4 00:00:22.000 --> 00:00:29.000 The level of national money income and consequently of hoarding is an imaginary bogey. 5 00:00:29.000 --> 00:00:39.000 In this section we shall pursue our analysis of the Keynesian system and demonstrate further grave fallacies within the system itself. 6 00:00:39.000 --> 00:00:48.000 In other words, we shall see that the consumption function and investment are not ultimate determinants of social income, 7 00:00:48.000 --> 00:00:55.000 whereas previously we demonstrated that it makes no particular difference if they are or not. 8 00:00:55.000 --> 00:01:00.000 a. Interest and Investment 9 00:01:00.000 --> 00:01:08.000 Investment, though the dynamic and volatile factor in the Keynesian system, is also the Keynesian stepchild. 10 00:01:08.000 --> 00:01:13.000 Keynesians have differed on the causal determinants of investment. 11 00:01:13.000 --> 00:01:23.000 Originally, Keynes determined it by the interest rate, as compared with the marginal efficiency of capital, or prospect for net return. 12 00:01:23.000 --> 00:01:31.000 The interest rate is supposed to be determined by the money relation. We have seen that this idea is fallacious. 13 00:01:31.000 --> 00:01:41.000 Actually, the equilibrium net rate of return is the interest rate, the natural rate to which the bond rate conforms. 14 00:01:41.000 --> 00:01:46.000 Rather than changes in the interest rate causing changes in investment, 15 00:01:46.000 --> 00:01:53.000 In investment, changes in time preference are reflected in changes in consumption-investment 16 00:01:53.000 --> 00:02:00.400 decisions. Changes in the interest rate and in investment are two sides of a coin, both 17 00:02:00.400 --> 00:02:06.400 determined by individual valuations and time preferences. 18 00:02:06.400 --> 00:02:13.360 The error of calling the interest rate the cause of investment changes and itself determined 19 00:02:13.360 --> 00:02:19.440 and by the Money Relation is also adopted by such critics of the Keynesian position 20 00:02:19.440 --> 00:02:26.440 as Pigou, who asserts that falling prices will release enough cash to lower the interest 21 00:02:26.440 --> 00:02:33.440 rate, stimulate investment, and thus finally restore full employment. 22 00:02:33.440 --> 00:02:38.880 Modern Keynesians have tended to abandon the intricacies of the relation between interest 23 00:02:38.880 --> 00:02:46.380 Invest and Investment and simply declare themselves agnostic on the factors determining investment. 24 00:02:46.380 --> 00:02:51.820 They rest their case on an alleged determination of consumption. 25 00:02:51.820 --> 00:02:56.480 B. The Consumption Function 26 00:02:56.480 --> 00:03:02.220 If Keynesians are unsure about investment, they have, until very recently, been very 27 00:03:02.220 --> 00:03:05.760 emphatic about consumption. 28 00:03:05.760 --> 00:03:09.720 Investment is a volatile, uncertain expenditure. 29 00:03:09.720 --> 00:03:15.720 Aggregate consumption, on the other hand, is a passive, stable function of immediately 30 00:03:15.720 --> 00:03:18.640 previous social income. 31 00:03:18.640 --> 00:03:26.040 Total net expenditures determining and equaling total net income in a period, gross expenditures 32 00:03:26.040 --> 00:03:34.080 between stages of production are unfortunately removed from discussion, consist of investment 33 00:03:34.080 --> 00:03:42.320 and Consumption. Furthermore, consumption always behaves so that below a certain income level, 34 00:03:42.320 --> 00:03:48.640 consumption will be higher than income, and above that level, consumption will be lower. 35 00:03:50.000 --> 00:03:56.240 The stability of the passive consumption function, as contrasted with the volatility 36 00:03:56.240 --> 00:04:03.040 of active investment, is a keystone of the Keynesian system. This assumption is replete 37 00:04:03.040 --> 00:04:16.840 A. How do the Keynesians justify the assumption of a stable consumption function? 38 00:04:16.840 --> 00:04:24.200 One route was through budget studies, cross-sectional studies of the relation between family income 39 00:04:24.200 --> 00:04:29.320 and expenditure by income groups in a given year. 40 00:04:29.320 --> 00:04:36.000 Studies such as that of the National Resources Committee in the mid-1930s yielded similar 41 00:04:36.000 --> 00:04:43.080 consumption functions, with dis-hoardings increasing below a certain point, and hoardings 42 00:04:43.080 --> 00:04:51.160 above it, that is, income below expenditures below a certain point, and expenditures below 43 00:04:51.160 --> 00:04:53.720 income above it. 44 00:04:53.720 --> 00:05:00.640 This is supposed to intimate that those doing the dis-saving, that is, the dis-hoarding, 45 00:05:00.640 --> 00:05:06.960 are poor people below the subsistence level who incur deficits by borrowing. 46 00:05:06.960 --> 00:05:09.840 But how long is this supposed to go on? 47 00:05:09.840 --> 00:05:13.120 How can there be a continuous deficit? 48 00:05:13.120 --> 00:05:16.480 Who would continue to lend these people the money? 49 00:05:16.480 --> 00:05:22.620 It is more reasonable to suppose that the dis-hoarders are de-cumulating their previously 50 00:05:22.620 --> 00:05:29.440 Accumulated Capital, that is, that they are wealthy people whose businesses suffered losses 51 00:05:29.440 --> 00:05:31.860 during that year. 52 00:05:31.860 --> 00:05:38.620 B. Aside from the fact that budget studies are misinterpreted, there are graver fallacies 53 00:05:38.620 --> 00:05:39.740 involved. 54 00:05:39.740 --> 00:05:46.840 For the budget study at best gives a cross-section of the relation between classes of family 55 00:05:46.840 --> 00:05:50.940 expenditure and income for one year. 56 00:05:50.940 --> 00:06:07.940 The Keynesian Consumption Function attempts to establish a relation between total social income and total social consumption for any given year, holding true over a hypothetical range of social incomes. 57 00:06:07.940 --> 00:06:14.940 Budget studies, therefore, can in no way confirm the Keynesian assumptions. 58 00:06:14.940 --> 00:06:25.440 C. Another very popular device to confirm the consumption function reached the peak of its popularity during World War II. 59 00:06:25.440 --> 00:06:37.440 This was historical statistical correlation of national income and consumption for a definite period of time, usually the 1930s. 60 00:06:37.440 --> 00:06:44.440 This correlation equation was then assumed to be the stable consumption function. 61 00:06:44.440 --> 00:06:58.440 Errors in this procedure were numerous. In the first place, even assuming such a stable relation, it would only be an historical conclusion, not a theoretical law. 62 00:06:58.440 --> 00:07:07.440 In physics, an experimentally determined law may be assumed to be constant for other identical situations. 63 00:07:07.440 --> 00:07:11.360 Conditions In human action, historical situations are 64 00:07:11.360 --> 00:07:17.600 never the same, and therefore there are no quantitative constants. 65 00:07:17.600 --> 00:07:24.260 Conditions and valuations could change at any time, and the stable relationship altered. 66 00:07:24.260 --> 00:07:29.040 There is here no proof of a stable consumption function. 67 00:07:29.040 --> 00:07:36.000 The dismal record of forecasts such as those of post-war unemployment made on this assumption 68 00:07:36.000 --> 00:07:38.880 should not have been surprising. 69 00:07:38.880 --> 00:07:43.680 Moreover, a stable relation was not even established. 70 00:07:43.680 --> 00:07:48.160 Income was correlated with consumption and with investment, 71 00:07:48.160 --> 00:07:53.360 but consumption is a much larger magnitude than net investment. 72 00:07:53.360 --> 00:08:00.880 Furthermore, income is here being correlated with 80 to 90 percent of itself. 73 00:08:00.880 --> 00:08:04.240 Naturally, the stability is tremendous. 74 00:08:04.240 --> 00:08:11.360 If income were correlated with saving of similar magnitude as investment, there would be no 75 00:08:11.360 --> 00:08:18.680 greater stability in the income-saving function than in the income-investment function. 76 00:08:18.680 --> 00:08:25.400 Thirdly, the consumption function is necessarily an ex-ante relation. 77 00:08:25.400 --> 00:08:32.520 It is supposed to tell how much consumers will decide to spend given a certain total 78 00:08:32.520 --> 00:08:41.040 Historical statistics, on the other hand, record only ex-post data, which give a completely 79 00:08:41.040 --> 00:08:43.040 different story. 80 00:08:43.040 --> 00:08:50.520 For any given period of time, for example, hoarding and dis-hoarding cannot be recorded 81 00:08:50.520 --> 00:08:52.260 ex-post. 82 00:08:52.260 --> 00:09:00.800 In fact, ex-post on double-entry accounting records, total social income is always equal 83 00:09:00.800 --> 00:09:10.000 to Total Social Expenditures, yet in the dynamic ex ante sense it is precisely the divergence between 84 00:09:10.000 --> 00:09:18.320 total social income and total social expenditures, hoarding or dis-hoarding, that plays the crucial 85 00:09:18.320 --> 00:09:26.160 role in the Keynesian theory. But these divergences can never be revealed, as Keynesians believe, 86 00:09:26.160 --> 00:09:35.520 by Study of Ex-Post Data. Ex-post, in fact, saving always equals investment, and social 87 00:09:35.520 --> 00:09:43.240 expenditure always equals social income. Eric Lindahl shows the difficulties of mixing 88 00:09:43.240 --> 00:09:50.960 ex-post income with ex-ante consumption and spending as the Keynesians do. Lindahl also 89 00:09:50.960 --> 00:09:58.920 also shows that expenditure and income coincide if the divergence between expected and realized 90 00:09:58.920 --> 00:10:03.360 income affects income and not stocks. 91 00:10:03.360 --> 00:10:10.480 Yet it cannot affect stocks, for contrary to Keynesian assertion, there is no such thing 92 00:10:10.480 --> 00:10:19.520 as hoarding or any other unexpected event leading to unintended increase in inventories. 93 00:10:19.520 --> 00:10:26.680 An increase in inventories is never unintended, since the seller has the alternative of selling 94 00:10:26.680 --> 00:10:29.240 the good at the market price. 95 00:10:29.240 --> 00:10:36.440 The fact that his inventory increases means that he has voluntarily invested in larger 96 00:10:36.440 --> 00:10:41.760 inventory, hoping for a future price rise. 97 00:10:41.760 --> 00:10:42.760 D. 98 00:10:42.760 --> 00:10:50.000 Actually, the whole idea of stable consumption functions has now been discredited, although 99 00:10:50.000 --> 00:10:54.040 many Keynesians do not fully realize this fact. 100 00:10:54.040 --> 00:11:00.680 In fact, Keynesians themselves have admitted that, in the long run, the consumption function 101 00:11:00.680 --> 00:11:08.840 is not stable, since total consumption rises as income rises, and that, in the short run, 102 00:11:08.840 --> 00:11:14.600 It is not stable since it is affected by all sorts of changing factors. 103 00:11:14.600 --> 00:11:21.780 But if it is not stable in the short run and not stable in the long run, what kind of stability 104 00:11:21.780 --> 00:11:23.560 does it have? 105 00:11:23.560 --> 00:11:25.460 Of what use is it? 106 00:11:25.460 --> 00:11:32.120 We have seen that the only really important runs are the immediate and the long run, which 107 00:11:32.120 --> 00:11:36.520 shows the direction in which the immediate is tending. 108 00:11:36.520 --> 00:11:42.160 There is no use for some sort of separate, intermediate situation. 109 00:11:42.160 --> 00:11:50.960 E. It is instructive to turn now to the reasons that Keynes himself, in contrast to his followers, 110 00:11:50.960 --> 00:11:55.840 gave for assuming his stable consumption function. 111 00:11:55.840 --> 00:11:58.960 It is a confused exposition indeed. 112 00:11:58.960 --> 00:12:06.080 The propensity to consume out of given income according to Keynes is determined by two sets 113 00:12:06.080 --> 00:12:35.080 In classifying subjective factors, Keynes makes the mistake of subsuming hoarding and investing motivations under categories of separate causes, precaution, foresight, improvement, etc. 114 00:12:35.080 --> 00:12:36.080 Etc. 115 00:12:36.080 --> 00:12:43.000 Actually, as we have seen, the demand for money is ultimately determined by each individual 116 00:12:43.000 --> 00:12:49.000 for all sorts of reasons, but all tied up with uncertainty. 117 00:12:49.000 --> 00:12:54.940 Motives for investment are to maintain and increase future standards of living. 118 00:12:54.940 --> 00:13:01.840 By a sleight of hand completely unsupported by facts or argument, Keynes simply assumes 119 00:13:01.840 --> 00:13:07.640 He assumes all these subjective factors to be given in the short run, although he admits 120 00:13:07.640 --> 00:13:10.720 that they will change in the long run. 121 00:13:10.720 --> 00:13:16.840 If they change in the long run, how can his system yield an equilibrium position? 122 00:13:16.840 --> 00:13:24.280 He simply reduces the subjective motives to current economic organization, customs, standards 123 00:13:24.280 --> 00:13:28.960 of living, etc., and assumes them to be given. 124 00:13:28.960 --> 00:13:36.160 The objective factors, which in reality are subjective, such as time preference changes, 125 00:13:36.160 --> 00:13:43.480 expectations, etc., can admittedly cause short-run changes in the consumption function, such 126 00:13:43.480 --> 00:13:48.060 as windfall changes in capital values. 127 00:13:48.060 --> 00:13:53.920 Expectations of future changes in income can affect an individual's consumption, but Keynes 128 00:13:53.920 --> 00:13:59.760 Mises simply asserts without discussion that this factor is likely to average out for the 129 00:13:59.760 --> 00:14:02.240 community as a whole. 130 00:14:02.240 --> 00:14:08.580 Time preferences are discussed in a very confused way, with interest rate and time preference 131 00:14:08.580 --> 00:14:15.160 assumed to be apart from and influencing the propensity to consume. 132 00:14:15.160 --> 00:14:22.220 Here again, short-run fluctuations are assumed to have little effect, and Keynes simply leaps 133 00:14:22.220 --> 00:14:29.580 to the conclusion that the propensity to consume is, in the short run, a fairly stable function. 134 00:14:30.540 --> 00:14:39.020 What is fairly supposed to mean? How can a theoretical law be based on fair stability, 135 00:14:39.580 --> 00:14:44.860 more stable than other functions? What are the grounds for this assumption, 136 00:14:44.860 --> 00:14:47.500 particularly as a law of human action? 137 00:14:47.500 --> 00:14:55.220 F. The failure of the consumption function theory is not only the failure of a specific 138 00:14:55.220 --> 00:15:00.660 theory, it is a profound epistemological failure as well. 139 00:15:00.660 --> 00:15:06.900 For the concept of a consumption function has no place in economics at all. 140 00:15:06.900 --> 00:15:14.740 Economics is praxeological, that is, its propositions are absolutely true given the existence of 141 00:15:14.740 --> 00:15:21.980 of the Axioms, the basic axiom being the existence of human action itself. 142 00:15:21.980 --> 00:15:29.660 Economics therefore is not and cannot be empirical in the positivist sense, that is, it cannot 143 00:15:29.660 --> 00:15:37.660 establish some sort of empirical hypothesis which could or could not be true, and at best 144 00:15:37.660 --> 00:15:41.620 is only true approximately. 145 00:15:41.620 --> 00:15:49.700 with empirical historical laws are worthless in economics since they may only be coincidences 146 00:15:49.700 --> 00:15:57.740 of complex facts and not isolable repeatable laws which will hold true in the future. 147 00:15:57.740 --> 00:16:04.420 The idea of the consumption function is not only wrong on many counts, it is irrelevant 148 00:16:04.420 --> 00:16:06.020 to economics. 149 00:16:06.020 --> 00:16:13.780 Furthermore, the very term function is inappropriate in a study of human action. 150 00:16:13.780 --> 00:16:20.240 Function implies a quantitative determined relationship, whereas no such quantitative 151 00:16:20.240 --> 00:16:22.820 determinism exists. 152 00:16:22.820 --> 00:16:27.400 People act and can change their actions at any time. 153 00:16:27.400 --> 00:16:33.580 No causal constant external determinants of action can exist. 154 00:16:33.580 --> 00:16:40.820 The term function is appropriate only to the unmotivated, repeatable motion of inorganic 155 00:16:40.820 --> 00:16:42.720 matter. 156 00:16:42.720 --> 00:16:49.260 In conclusion, there is no reason whatever to assume that at some point expenditures 157 00:16:49.260 --> 00:16:56.580 will be below income, while at lower points it will be above income. 158 00:16:56.580 --> 00:17:06.380 X does not and cannot know what X anti-expenditure will ever be in relation to income. 159 00:17:06.380 --> 00:17:12.380 At any point it could be equal or there could be net hoarding or dis-hoarding. 160 00:17:12.380 --> 00:17:19.380 The ultimate decisions are made by the individuals and are not determinable by science. 161 00:17:19.380 --> 00:17:26.080 There is therefore no stable expenditure function, whatever. 162 00:17:26.080 --> 00:17:29.440 c. The Multiplier 163 00:17:29.440 --> 00:17:36.680 The once highly esteemed multiplier has now happily faded in popularity, as economists 164 00:17:36.680 --> 00:17:43.360 have begun to realize that it is simply the obverse of the stable consumption function. 165 00:17:43.360 --> 00:17:50.240 However, the complete absurdity of the multiplier has not yet been fully appreciated. 166 00:17:50.240 --> 00:17:55.960 The theory of the investment multiplier runs somewhat as follows. 167 00:17:55.960 --> 00:18:01.440 Stable income equals consumption plus investment. 168 00:18:01.440 --> 00:18:08.240 Consumption is a stable function of income, as revealed by statistical correlation, etc. 169 00:18:08.240 --> 00:18:15.720 Let us say, for the sake of simplicity, that the consumption will always be 0.8 income. 170 00:18:15.720 --> 00:18:21.280 Actually, the form of the Keynesian function is generally linear. 171 00:18:21.280 --> 00:18:27.080 For example, consumption equals 0.8 income plus 20. 172 00:18:27.080 --> 00:18:34.480 The form given in the text simplifies the exposition without however changing its essence. 173 00:18:34.480 --> 00:18:44.880 In that case, income equals 0.8 income plus investment, 0.2 income equals investment, 174 00:18:44.880 --> 00:18:49.960 or income equals 5 times investment. 175 00:18:49.960 --> 00:18:53.700 The five is the investment multiplier. 176 00:18:53.700 --> 00:19:00.720 It is then obvious that all we need to increase social money income by a desired amount is 177 00:19:00.720 --> 00:19:07.520 to increase investment by one-fifth of that amount, and the multiplier magic will do the 178 00:19:07.520 --> 00:19:08.520 rest. 179 00:19:08.520 --> 00:19:15.600 The early pump primers believed in approaching this goal through stimulating private investment. 180 00:19:15.600 --> 00:19:22.040 Inter Keynesians realized that if investment is an active, volatile factor, government 181 00:19:22.040 --> 00:19:28.360 spending is no less active and more certain, so that government spending must be relied 182 00:19:28.360 --> 00:19:32.880 upon to provide the needed multiplier effect. 183 00:19:32.880 --> 00:19:37.980 Creating new money would be most effective, since the government would then be sure not 184 00:19:37.980 --> 00:19:45.520 to reduce private funds, hence the basis for calling all government spending investment 185 00:19:45.520 --> 00:19:52.120 It is investment because it is not tied passively to income. 186 00:19:52.120 --> 00:19:58.580 The following is offered as a far more potent multiplier, on Keynesian grounds even more 187 00:19:58.580 --> 00:20:07.040 potent and effective than the investment multiplier, and on Keynesian grounds there can be no objection 188 00:20:07.040 --> 00:20:08.040 to it. 189 00:20:08.040 --> 00:20:15.420 It is a reductio ad absurdum, but it is not simply a parody, for it is in keeping with 190 00:20:15.420 --> 00:20:18.300 with the Keynesian Method. 191 00:20:18.300 --> 00:20:25.960 Social income equals income of, insert name of any person, say the reader, plus income 192 00:20:25.960 --> 00:20:28.260 of everyone else. 193 00:20:28.260 --> 00:20:30.480 Let us use symbols. 194 00:20:30.480 --> 00:20:40.220 Social income equals y, income of the reader equals r, income of everyone else equals v. 195 00:20:40.220 --> 00:20:45.880 We find that V is a completely stable function of Y. 196 00:20:45.880 --> 00:20:53.020 Plot the two on coordinates and we find historical one-to-one correspondence between them. 197 00:20:53.020 --> 00:20:59.700 It is a tremendously stable function, far more stable than the consumption function. 198 00:20:59.700 --> 00:21:03.180 On the other hand, plot R against Y. 199 00:21:03.180 --> 00:21:09.660 Here we find, instead of perfect correlation, only the remotest of connections between the 200 00:21:09.660 --> 00:21:16.820 The fluctuating income of the reader of these lines and the social income. Therefore, this 201 00:21:16.820 --> 00:21:24.020 reader's income is the active, volatile, uncertain element in the social income, while 202 00:21:24.020 --> 00:21:31.420 everyone else's income is passive, stable, determined by the social income. Let us say 203 00:21:31.420 --> 00:21:51.940 Say the equation arrived at is v equals 0.99999y, then y equals 0.99999y plus r, 0.00001y equals 204 00:21:51.940 --> 00:22:04.260 This is the reader's own personal multiplier, a far more powerful one than the investment 205 00:22:04.260 --> 00:22:05.540 multiplier. 206 00:22:05.540 --> 00:22:12.420 To increase social income and thereby cure depression and unemployment, it is only necessary 207 00:22:12.420 --> 00:22:17.700 for the government to print a certain number of dollars and give them to the reader of 208 00:22:17.700 --> 00:22:19.100 these lines. 209 00:22:19.100 --> 00:22:27.100 The Reader's Spending will prime the pump of a 100,000-fold increase in the national income.