17. Further Fallacies of the Keynesian System
We have seen that even if the Keynesian functions were correct and social expenditures fell below income above a certain point and vice versa,
this would have no unfortunate consequences for the economy.
The level of national money income and consequently of hoarding is an imaginary bogey.
In this section we shall pursue our analysis of the Keynesian system and demonstrate further grave fallacies within the system itself.
In other words, we shall see that the consumption function and investment are not ultimate determinants of social income,
whereas previously we demonstrated that it makes no particular difference if they are or not.
a. Interest and Investment
Investment, though the dynamic and volatile factor in the Keynesian system, is also the Keynesian stepchild.
Keynesians have differed on the causal determinants of investment.
Originally, Keynes determined it by the interest rate, as compared with the marginal efficiency of capital, or prospect for net return.
The interest rate is supposed to be determined by the money relation. We have seen that this idea is fallacious.
Actually, the equilibrium net rate of return is the interest rate, the natural rate to which the bond rate conforms.
Rather than changes in the interest rate causing changes in investment,
In investment, changes in time preference are reflected in changes in consumption-investment
decisions. Changes in the interest rate and in investment are two sides of a coin, both
determined by individual valuations and time preferences.
The error of calling the interest rate the cause of investment changes and itself determined
and by the Money Relation is also adopted by such critics of the Keynesian position
as Pigou, who asserts that falling prices will release enough cash to lower the interest
rate, stimulate investment, and thus finally restore full employment.
Modern Keynesians have tended to abandon the intricacies of the relation between interest
Invest and Investment and simply declare themselves agnostic on the factors determining investment.
They rest their case on an alleged determination of consumption.
B. The Consumption Function
If Keynesians are unsure about investment, they have, until very recently, been very
emphatic about consumption.
Investment is a volatile, uncertain expenditure.
Aggregate consumption, on the other hand, is a passive, stable function of immediately
previous social income.
Total net expenditures determining and equaling total net income in a period, gross expenditures
between stages of production are unfortunately removed from discussion, consist of investment
and Consumption. Furthermore, consumption always behaves so that below a certain income level,
consumption will be higher than income, and above that level, consumption will be lower.
The stability of the passive consumption function, as contrasted with the volatility
of active investment, is a keystone of the Keynesian system. This assumption is replete
A. How do the Keynesians justify the assumption of a stable consumption function?
One route was through budget studies, cross-sectional studies of the relation between family income
and expenditure by income groups in a given year.
Studies such as that of the National Resources Committee in the mid-1930s yielded similar
consumption functions, with dis-hoardings increasing below a certain point, and hoardings
above it, that is, income below expenditures below a certain point, and expenditures below
income above it.
This is supposed to intimate that those doing the dis-saving, that is, the dis-hoarding,
are poor people below the subsistence level who incur deficits by borrowing.
But how long is this supposed to go on?
How can there be a continuous deficit?
Who would continue to lend these people the money?
It is more reasonable to suppose that the dis-hoarders are de-cumulating their previously
Accumulated Capital, that is, that they are wealthy people whose businesses suffered losses
during that year.
B. Aside from the fact that budget studies are misinterpreted, there are graver fallacies
involved.
For the budget study at best gives a cross-section of the relation between classes of family
expenditure and income for one year.
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.
Budget studies, therefore, can in no way confirm the Keynesian assumptions.
C. Another very popular device to confirm the consumption function reached the peak of its popularity during World War II.
This was historical statistical correlation of national income and consumption for a definite period of time, usually the 1930s.
This correlation equation was then assumed to be the stable consumption function.
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.
In physics, an experimentally determined law may be assumed to be constant for other identical situations.
Conditions In human action, historical situations are
never the same, and therefore there are no quantitative constants.
Conditions and valuations could change at any time, and the stable relationship altered.
There is here no proof of a stable consumption function.
The dismal record of forecasts such as those of post-war unemployment made on this assumption
should not have been surprising.
Moreover, a stable relation was not even established.
Income was correlated with consumption and with investment,
but consumption is a much larger magnitude than net investment.
Furthermore, income is here being correlated with 80 to 90 percent of itself.
Naturally, the stability is tremendous.
If income were correlated with saving of similar magnitude as investment, there would be no
greater stability in the income-saving function than in the income-investment function.
Thirdly, the consumption function is necessarily an ex-ante relation.
It is supposed to tell how much consumers will decide to spend given a certain total
Historical statistics, on the other hand, record only ex-post data, which give a completely
different story.
For any given period of time, for example, hoarding and dis-hoarding cannot be recorded
ex-post.
In fact, ex-post on double-entry accounting records, total social income is always equal
to Total Social Expenditures, yet in the dynamic ex ante sense it is precisely the divergence between
total social income and total social expenditures, hoarding or dis-hoarding, that plays the crucial
role in the Keynesian theory. But these divergences can never be revealed, as Keynesians believe,
by Study of Ex-Post Data. Ex-post, in fact, saving always equals investment, and social
expenditure always equals social income. Eric Lindahl shows the difficulties of mixing
ex-post income with ex-ante consumption and spending as the Keynesians do. Lindahl also
also shows that expenditure and income coincide if the divergence between expected and realized
income affects income and not stocks.
Yet it cannot affect stocks, for contrary to Keynesian assertion, there is no such thing
as hoarding or any other unexpected event leading to unintended increase in inventories.
An increase in inventories is never unintended, since the seller has the alternative of selling
the good at the market price.
The fact that his inventory increases means that he has voluntarily invested in larger
inventory, hoping for a future price rise.
D.
Actually, the whole idea of stable consumption functions has now been discredited, although
many Keynesians do not fully realize this fact.
In fact, Keynesians themselves have admitted that, in the long run, the consumption function
is not stable, since total consumption rises as income rises, and that, in the short run,
It is not stable since it is affected by all sorts of changing factors.
But if it is not stable in the short run and not stable in the long run, what kind of stability
does it have?
Of what use is it?
We have seen that the only really important runs are the immediate and the long run, which
shows the direction in which the immediate is tending.
There is no use for some sort of separate, intermediate situation.
E. It is instructive to turn now to the reasons that Keynes himself, in contrast to his followers,
gave for assuming his stable consumption function.
It is a confused exposition indeed.
The propensity to consume out of given income according to Keynes is determined by two sets
In classifying subjective factors, Keynes makes the mistake of subsuming hoarding and investing motivations under categories of separate causes, precaution, foresight, improvement, etc.
Etc.
Actually, as we have seen, the demand for money is ultimately determined by each individual
for all sorts of reasons, but all tied up with uncertainty.
Motives for investment are to maintain and increase future standards of living.
By a sleight of hand completely unsupported by facts or argument, Keynes simply assumes
He assumes all these subjective factors to be given in the short run, although he admits
that they will change in the long run.
If they change in the long run, how can his system yield an equilibrium position?
He simply reduces the subjective motives to current economic organization, customs, standards
of living, etc., and assumes them to be given.
The objective factors, which in reality are subjective, such as time preference changes,
expectations, etc., can admittedly cause short-run changes in the consumption function, such
as windfall changes in capital values.
Expectations of future changes in income can affect an individual's consumption, but Keynes
Mises simply asserts without discussion that this factor is likely to average out for the
community as a whole.
Time preferences are discussed in a very confused way, with interest rate and time preference
assumed to be apart from and influencing the propensity to consume.
Here again, short-run fluctuations are assumed to have little effect, and Keynes simply leaps
to the conclusion that the propensity to consume is, in the short run, a fairly stable function.
What is fairly supposed to mean? How can a theoretical law be based on fair stability,
more stable than other functions? What are the grounds for this assumption,
particularly as a law of human action?
F. The failure of the consumption function theory is not only the failure of a specific
theory, it is a profound epistemological failure as well.
For the concept of a consumption function has no place in economics at all.
Economics is praxeological, that is, its propositions are absolutely true given the existence of
of the Axioms, the basic axiom being the existence of human action itself.
Economics therefore is not and cannot be empirical in the positivist sense, that is, it cannot
establish some sort of empirical hypothesis which could or could not be true, and at best
is only true approximately.
with empirical historical laws are worthless in economics since they may only be coincidences
of complex facts and not isolable repeatable laws which will hold true in the future.
The idea of the consumption function is not only wrong on many counts, it is irrelevant
to economics.
Furthermore, the very term function is inappropriate in a study of human action.
Function implies a quantitative determined relationship, whereas no such quantitative
determinism exists.
People act and can change their actions at any time.
No causal constant external determinants of action can exist.
The term function is appropriate only to the unmotivated, repeatable motion of inorganic
matter.
In conclusion, there is no reason whatever to assume that at some point expenditures
will be below income, while at lower points it will be above income.
X does not and cannot know what X anti-expenditure will ever be in relation to income.
At any point it could be equal or there could be net hoarding or dis-hoarding.
The ultimate decisions are made by the individuals and are not determinable by science.
There is therefore no stable expenditure function, whatever.
c. The Multiplier
The once highly esteemed multiplier has now happily faded in popularity, as economists
have begun to realize that it is simply the obverse of the stable consumption function.
However, the complete absurdity of the multiplier has not yet been fully appreciated.
The theory of the investment multiplier runs somewhat as follows.
Stable income equals consumption plus investment.
Consumption is a stable function of income, as revealed by statistical correlation, etc.
Let us say, for the sake of simplicity, that the consumption will always be 0.8 income.
Actually, the form of the Keynesian function is generally linear.
For example, consumption equals 0.8 income plus 20.
The form given in the text simplifies the exposition without however changing its essence.
In that case, income equals 0.8 income plus investment, 0.2 income equals investment,
or income equals 5 times investment.
The five is the investment multiplier.
It is then obvious that all we need to increase social money income by a desired amount is
to increase investment by one-fifth of that amount, and the multiplier magic will do the
rest.
The early pump primers believed in approaching this goal through stimulating private investment.
Inter Keynesians realized that if investment is an active, volatile factor, government
spending is no less active and more certain, so that government spending must be relied
upon to provide the needed multiplier effect.
Creating new money would be most effective, since the government would then be sure not
to reduce private funds, hence the basis for calling all government spending investment
It is investment because it is not tied passively to income.
The following is offered as a far more potent multiplier, on Keynesian grounds even more
potent and effective than the investment multiplier, and on Keynesian grounds there can be no objection
to it.
It is a reductio ad absurdum, but it is not simply a parody, for it is in keeping with
with the Keynesian Method.
Social income equals income of, insert name of any person, say the reader, plus income
of everyone else.
Let us use symbols.
Social income equals y, income of the reader equals r, income of everyone else equals v.
We find that V is a completely stable function of Y.
Plot the two on coordinates and we find historical one-to-one correspondence between them.
It is a tremendously stable function, far more stable than the consumption function.
On the other hand, plot R against Y.
Here we find, instead of perfect correlation, only the remotest of connections between the
The fluctuating income of the reader of these lines and the social income. Therefore, this
reader's income is the active, volatile, uncertain element in the social income, while
everyone else's income is passive, stable, determined by the social income. Let us say
Say the equation arrived at is v equals 0.99999y, then y equals 0.99999y plus r, 0.00001y equals
This is the reader's own personal multiplier, a far more powerful one than the investment
multiplier.
To increase social income and thereby cure depression and unemployment, it is only necessary
for the government to print a certain number of dollars and give them to the reader of
these lines.
The Reader's Spending will prime the pump of a 100,000-fold increase in the national income.