The greatness of John Maynard Keynes, our only guide in this crisis

Judging from the comments on the FM site, most readers should carefully review these articles.  I believe this crisis results from a paradigm crisis in Keynesian economics, as we reach the boundaries of his vision — specifically, the point at which aggregate private sector debt becomes a limiting factor for the economy’s growth.  But however inadequate, Keynesian theory is all we have until another such genius comes along.

It does not matter how inadequate Keynesian theory might be, it is all we have today.  Thomas Kuhn explained in his great work, The Structure of Scientific Revolutions (chapter 8) that paradigms can only be replaced, not disproven:

The decision to reject one paradigm is always simultaneously the decision to accept another, and the judgment leading to that decision involves the comparison of both paradigms with nature and with each other. (p. 79)

A scientist, and even more strongly a public official, can no more make economic decisions without a paradigm than a computer work without software.  Unfortunately, today Keynesian theory is all we have.  Competitors, such as Austrian and Marxist economics, provide neither the precision or scope of vision necessary to manipulate fiscal and monetary policy.  Hence I recommend reading this brief essays on the application of Keynes’ work (developed by his successors) to our crisis.

  1. What Would Keynes Have Done?“, Greg Mankiw, New York Times, 28 November 2008
  2. The Keynesian moment“, Paul Krugman, op-ed in the New York Times, 29 November 2008
  3. The greatness of Keynes“, Paul Krugman, op-ed in the New York Times, 30 November 2008

Excerpts

What Would Keynes Have Done?“, Greg Mankiw, New York Times, 28 November 2008 — Excerpt:

IF you were going to turn to only one economist to understand the problems facing the economy, there is little doubt that the economist would be John Maynard Keynes. Although Keynes died more than a half-century ago, his diagnosis of recessions and depressions remains the foundation of modern macroeconomics. His insights go a long way toward explaining the challenges we now confront.

According to Keynes, the root cause of economic downturns is insufficient aggregate demand. When the total demand for goods and services declines, businesses throughout the economy see their sales fall off. Lower sales induce firms to cut back production and to lay off workers. Rising unemployment and declining profits further depress demand, leading to a feedback loop with a very unhappy ending.

The situation reverses, Keynesian theory says, only when some event or policy increases aggregate demand. The problem right now is that it is hard to see where that demand might come from.

The Keynesian moment“, Paul Krugman, op-ed in the New York Times, 29 November 2008 — Excerpt:

I think it’s worth saying a bit more about why, exactly, we’re in such a Keynesian moment.

If Keynes receded in our consciousness over the past few decades, it wasn’t mainly because of uninformed criticisms from the right; it was because central bankers seemed to have everything under control. Uncle Alan and his counterparts, by controlling the money supply, could do the job of stabilizing the economy, and Keynesian fiscal policy seemed irrelevant.

Now, Keynes understood the role of monetary policy quite well, and believed that it had been effective in the past. What he argued, however, was that there were situations in which monetary policy could do no more — and that the world economy he lived in was facing such a situation

The greatness of Keynes“, Paul Krugman, op-ed in the New York Times, 30 November 2008 — Keynes understood things that remain a mystery to non-economist policy gurus even today.  This brief essay is well worth reading in full.  Excerpt:

The greatness of Keynes is illustrated by the trouble people who consider themselves well informed have, to this day, in understanding the basic principles of how a depressed economy works.

Afterword

If you are new to this site, please glance at the archives below.  You may find answers to your questions in these.

Please share your comments by posting below.  Per the FM site’s Comment Policy, please make them brief (250 words max), civil, and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

For more information from the FM site

To read other articles about these things, see the FM reference page on the right side menu bar.  Of esp relevance to this topic:

Forecasts on the FM site about causes of the crisis:

  1. The post-WWII geopolitical regime is dying. Chapter One, 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
  2. Diagnosing the eagle, chapter I — the housing bust, 6 December 2007
  3. Death of the post-WWII geopolitical regime, III – death by debt, 8 January 2008 – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
  4. Let us light a candle while we walk, lest we fear what lies ahead, 10 February 2008 – Putting the end of the post-WWII regime in a larger historical context.
  5. A vital but widely misunderstood aspect of our financial crisis, 18 September 2008 — Too many homes.
  6. A picture of the post-WWII debt supercycle, 26 September 2008
  7. Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008
  8. Causes of the financial crisis (no, its not the usual list), 29 October 2008
  9. Government policy errors and the Great Depession, 1 November 2008

51 thoughts on “The greatness of John Maynard Keynes, our only guide in this crisis

  1. (1) One of the weaknesses of Keynes’ theories in the current downturn is that Keynes assumes that the aggregate demand in the period prior to the downturn was sustainable in the long run.

    (2) What happens if we are unable to return to the original level of consumption for next 10-25 years? Does the government continue to expand the national debt by $2 trillion per year for the entire period?

    I’m not advocating any particular course, I’m just looking for an answer to my question.
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    Fabius Maximus replies (1) This is another way of stating that Keynesian theory does not well handle the question of debt. The reason we cannot maintain our level of spending is that it was in excess of our income.

    (2) That would be a bad thing; the ending might not be pretty. To see the answer, watch Japan in the next few years. 20 years after the crash they continue with a weak economy, sustained by massive government borrowing — which has run up a debt equivalent to (aprox, frommemory) 125% of GDP (bizarrely high). Of course, their high savings rates allows this to continue for a far longer period than the US could manage.

    Which is why this series of articles is called “end of the post-WWII regime.” As I said in on eof the first posts on this site, “The post-WWII geopolitical regime is dying“…

    How will this play out? The end of the post-WWII geopolitical regime is like a singularity in astrophysics. We cannot see beyond it, because we do not understand the choices that will determine our fate — or how we will choose. It also resembles a singularity in that what lies on the other side is unimportant until one survives the passage through it.

  2. Of course! Krugman is a genius! How stupid of me not to recognize it immediately.

    Let’s see, the people who got us into this mess borrowed and spent beyond their (our) means, and the way to get out of it (as every household bookkeeper knows), is to borrow more and spend more, and get us the people to spend more as well – wait, let’s refinance their loans (er, recapitalize their failing businesses) and lend them more money so they can spend even more!

    Of course, the bills won’t be due for quite some time – after we’re dead, if we’re especially lucky. Next year, if not. Brilliant!

    Somehow the logic of this escapes me, but then I’m not a Nobel-certified intellectual giant like Paul “conscience of a guy who thinks he knows how to spend my money better than me” Krugman.

    Perhaps an alternative viewpoint is in order. Here’s just one: “The Krugman Recipe for Depression: Massive Government Spending is No Solution to Unemployment.“, AMITY SHLAES, op-ed Wall Street Journal, 29 November 2008.

    How arrogant the think that a handful of academics and beltway insiders can outperform the aggregate multitude of individual decisions and complex interactions that must take place for an economy to generate wealth and grow. Alas, the cure is worse than the disease.
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    Fabius Maximus replies: This is an understandable and natural reaction. I will take a shot at explaining it.

    (1) This is not just Krugman’s recommendation, but that of almost every mainstream economist — except for those who still believe we face a mild or typical recession.

    (2) Shales, like most opposing Keynesian solutions, has no alternative recommendations. Here she says:

    It {Obama’s team} can try to figure out a way to do that without hurting the private sector. Or it can just spend, Krugman-wise, and risk repeating the very depression we seek to avoid.

    (3) “and the way to get out of it, is to borrow more and spend more,”

    No. The point is to have the private sector reduce leverage, while the public sector borrows to maintain aggregate demand. The alternative is a depression. Hoover tried this, and nobody will repeat his experiment.

    (4) Most of the rest of her analysis misses the point. The New Deal lifted the economy off its 1932 lows and kept the economy functioning. Her sneers at those employed at “make work” would have gotten her lynched in the 1930’s by men for whom these programs meant work and food for their families.

    (5) The simple fact, which ideologs like Shales ignore, is that during the 1930’s nations did well to the extent they employed aggressive Keynesian solutions. Nations that stuck with the gold standard too long and used miminal stimulus — like the UK and US — suffered the most.

    All of this is explained in “Government policy errors as a cause of the Great Depession“, 1 November 2008.

  3. Another great post FM! The answer I think lays in the future operating environment. Main governing factor for KE for US to overcome the debt cycle before the depression that dictates demand positive glide slope is GROWTH, mainly population growth and SPACE, i.e. room for growth and specifically LAND RIGHTS/ACCESS. This is why we moved west from old EUROPE (GLOBALIZATION I-1492) and endured as endenchered servant TO BE possible land owners. This is why we “volunteered” to stay on for the Contential Army for Land Rights West the Blue Ridges; this is why some fought for a cause and after moved West; this is why OKIES left the Dust Bowl this is why Civil Conservation Corp brought us out and prepped us for our third industrial war; this is why our Vietnam fell (i.e. too late land policy for people); this is why we will recover: FREE PEOPLE with ACCESS to LAND and able to govern themselves unlike any other place in the world in a big melting pot called America. We have left Irish Colonies, Dutch East Indies, China, India, Africa and all parts fo the globe to come to a place were working class can “level skip”. Slow downs and depression will only reset the “Hamiltonians”[globalists/free traders]. The “Jeffersonian” [People/Land First] will ultimately weather the storm of down turn. Our POPULATION GROWTH with SPACE for expansion will either create greater demand for US to be strong again or led to others wanting to conquer resources for their national interests. Want to see government spending on INFRASTRUCTURE that puts our locals to work with money to spend. Build it and other will come. E.G. EISONHOWERS FEDERAL HIGHWAY BILL like the Missouri Compromise principally of were a LOC railway chock-point was located (CHICAGO vice ST.LOUIS) won a great war “preemptively” the highway project changed US economically and socially. With correct US infrastructure investments we will be able to pullout of this downward spiral and be ready for transition through the turbulent “information age” to our next sustainable US economy just as trains and highways and electricity infrastructure (not to mention some vertical and horizontal monopoly busts in the early part of last century) all the while creating our first national parks and protecting endangered species (through the BIRD ACT of TDR ;-) give us the wonderful Country We OWE today.

    Recommend read “The Earth, when Adam and first Matron Eve Had ended now thir Orisons, and found, Strength added from above, new hope to spring Out of despaire, joy, but with fear yet linkt; Which thus to Eve his welcome words renewd. [ 140 ]” or listen to the “The Last Resort” and realize we are stuck in Hotel California and everyone really wants what we have. BL: Keep Smiling and like my granddaddy told me “ I only asked for one thing in life: A JOB”. BTW he has TWO BRONZE STARS from initial invasion of LEYTE and a child of the great Depression. ‘So in the name of destiny and G. Keep Chargin. we will git better:-) KDOG SENDS

  4. I think one simple element of Japan’s situation is so obvious that it is generally overlooked: it’s size. It is by far the most densely populated nation in the world. This, coupled with a cyclical demographic problem (high percentage of senior citizens for a while) makes a perpetual growth model (which is what the modern economy depends upon and which is its deepest flaw especially since it is funded by debt issuance) makes it very hard, if not indeed impossible, for Japan to do much more than just maintain itself at more or less current level – which is very high in terms of sophistication, urbanisation, productivity and so forth.

    I shall take time to go through the articles linked above, for which again thanks. Still, I wonder if there is any modern economic system not based on perpetual expansion which is clearly a very dangerous foundation on which to build anything sane or stable.

  5. FM note: At almost 1400 words, this comment not only grossly exceeds the 250 word max of the comment policy (clearly stated at the end of every article) but the post itself (637 words). I previously gave a warning (here).

    Hence per the policy it has been edited. I left the opening and closing paragraphs (273 words). You can see the full comment here.

    Also: Mclaren has still not posted a retraction or apology for this gross mistake.
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    It’s remarkable to listen to the folks who ridicule Keynsian solutions to the current financial crisis. These people make exactly the same arguments as Herbert Hoover’s treasury secretary Andrew Mellon: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.”

    Been there. Tried that. Didn’t work.

    What Mellon’s recommendation boils down to, in plain words, is: shut down all the factories, fire all the workers, close all the banks, shut down Wall Street, and let everyone lose their homes and go live in caves in the hills and bang rocks and eat dirt. You don’t have to be a rocket scientist to figure out that this is a bad idea.

    It’s a testament to the fanaticism of the crackpot American far right, and the pathologies and dysfunctions afflicting America’s financial system, that otherwise sensible people could think that such a prescription makes sense.

    Just as numerous pages have now been set up to debunk anti-evolution creationist myths, someone ought to set up a page to dehunk the most common anti-Keynsian myths. One obvious candidate is the myth parroted above: namely, that you can’t fix a financial crisis caused by debt overhang by creating more debt. Like most crackpot delusions, this one sounds superficially sensible, but reveals a profound ignorance of basic economics and a fundamental lack of common sense.

    … For those of you who adore sound-bite bumper sticker-type slogans, here are two for you:

    YOU CAN’T PUT AMERICA BACK TO WORK BY SHUTTING DOWN ALL THE BUSINESSES AND FIRING ALL THE WORKERS.

    And: IRAQ — WE CAN LEAVE NOW WHEN IT’S CHEAP, OR WE CAN LEAVE LATER WHEN WE’RE BROKE.

  6. Keynes advice was not fallowed. Public debt was to used to increase aggregate demand during economic downturns. The debt was to be paid back during good times. The US, both at a private and public level, ran up debt with no intent to pay it off.

    Robert Mundell is an option as well. Wikipedia bio. His website. His homepage at Columbia University.
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    Fabius Maximus replies: Keynes advice was not followed during the 1930’s, as seen in this letter from Keynes to FDR dated 1 February 1938. Nor, (as you note) was it followed in sensible fashion afterwards. However I believe this weakness of his theory was noted at the time and often afterwards: his theory encouraged reckless accumulation of debt, and did not show the resulting terrible consequences.

  7. Very easy.

    1) dreaming with the posibility of a “perpetual growth” is like wishing dolly parton to have more…silly. She explodes and you cannot …you know what.
    2) that is one of the reasons growth betrayals happen in cycles…and debt saves and slashes.
    3) keynes is for americans…japan is another mind, that is why you silly boys will still count more than those 20 years.

    “In the long run we are all dead” (Beloved Keynes).

    Mankiw is just part of the game of cosmetics of the background quarterbacks playing (there is a big family that you don’t know?)….zionist neo-cons serve the first dish. While americans are just worried if mc’donlads is up or down?

    you are going down.

  8. Mclaren, I think you are barking up the wrong tree, tyin’ KE theory with “anti-creationism”(e.g. religion and/vs politics; religion and/vs economics) as all politics are local and religion is local, so in order to create majority solutions, follow the “Jefferson Letters” and keep them separate (i.e. religion and political arguments/religon and economics) as modern “creationist-theory” can supports economics and good governance. Is there is a sustainable example of a country or great power sustaining economically over multiple centuries without having some base in “creationist theory”? I think the closest example is modern China but China still holds to their rituals and this down-turn economically could see a “roll-back” of sorts for their anti-religion, based central government that is being seen more and more as not able to respond to the will of its people. BL: do not bash religion in this as that will drive you to a majority status; compromise for the critical requirement: IT’S THE ECONOMY…not religon

  9. I believe this crisis results from a paradigm crisis in Keynesian economics, as we reach the boundaries of his vision — specifically, the point at which aggregate private sector debt becomes a limiting factor for the economy’s growth.

    This seems very self-evident. Keynesian economics, in practice if not in theory, is predicated on ever-increasing levels of debt. The fact that his theory doesn’t account for the upper limit isn’t a “limitation”, it invalidates his theory outright. It’s no different than the “limitation” that communism doesn’t account for natural reaction of humans in the absence of profit motive.

    Competitors, such as Austrian…economics, provide neither the precision or scope of vision necessary to manipulate fiscal and monetary policy.

    Umm, that’s the point. Austrians believe it’s a fool’s errand (and ultimately counterproductive) to play God with the economy.

    This is not just Krugman’s recommendation, but that of almost every mainstream economist

    An irrelevant fact if the core problem lies within the theory embraced by all of those mainstream economists.
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    Fabius Maximus replies: Two comments.

    (1) “This seems very self-evident.”

    Do you have any citations of other people saying it?

    (2) “Austrians believe it’s a fool’s errand (and ultimately counterproductive) to play God with the economy.”

    Confidence in a laissez faire economics was burnt out in the early years of Hoover’s administration. I suspect that nobody with responsibility will try the experiment again for many generations. Which is why (from Wikipedia):

    {Austrian economics} remains a distinctly minority position, even in such areas as capital value. Currently, the only major US university with a significant Austrian presence is George Mason University. Austrian economic ideas are promoted mainly by bodies such as the Mises Institute and the Foundation for Economic Education.

  10. I agree with the importance of Keynes’s insights to understanding how we work our way out of our current predicament. Keyne shimself would, I am sure, have stressed the need for international economic action. This aspect isn’t being given enough attention at the moment.

    To understand Keynes as he really was, there is no substitute for reading one or more of the key biographies of him, such as by Donald Moggridge or Robert Skidelsky, and historically contextualised studies like Donald Markwell’s book — John Maynard Keynes and International Relations: Economic Paths to War and Peace (Oxford & New York: Oxford University Press, 2006).
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    Fabius Maximus replies: I agree with both points. We see the importance of the latter as China cuts the value of its currency (the RMB) — a “begger thy neighbor” policy that did great damage during the 1930’s.

    Several posts on the FM site discuss the attempts at international coordination, why they will fail, and what is necessary for success.

    * Results from the IMF meeting – just thin gruel, 12 October 2008
    * The G-7 meeting was the last chance for action before the global recession, 12 October 2008
    * Expect little or nothing from meetings like the G20 – or the Obama Administration, 18 November 2008

  11. Great new article: “Denial as the storm gathered“, Henry C K Liu, Asia Times, 5 December 2008. Conclusion:

    Still, under this market ideology, government assistance is not allowed to be applied directly to distressed individuals who are innocent victims of a dysfunctional debt regime to help them increase their income to transition to a new viable financial regime in a new economic system. It can only be applied to distressed institutions deemed too big to fail. Yet nationalization of insolvent private institutions facing weak demand so that they can continue to survive massive losses in a market economy will only bankrupt the entire nation, bringing down all citizens with it.

    What the US economy needs in this crisis is not inflation targeting but income targeting. Let’s hope the new Obama administration has the sense to implement immediately a massive income policy when it hits the ground running on January 20, 2009.

    Note on one comment above about 1930’s. Although it was not ‘purely’ applied, one regime that did well in the 30’s was National Socialism in Germany which applied the philosophy of tying national currency/finance to productivity versus debt via fiat or gold-backed currency. During this initial period the economic advances were the wonder of the world, albeit now largely ignored and still not thoroughly analysed because of what happened later. Thus there is a successful non-debt-based model in recent history contrary to what so many believe.
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    Fabius Maximus replies: I believe your description of Hitler’s economic policy is too complex. Germany had the 3rd largest collapse in GDP among the major western nations (26%) during 1928-32, and the greatest recovery. This resulted from Hitler’s exteem fiscal stimulus (there were no suicidal economists to tell Hitler that he could not do this, as FDR’s advisors limited the New Deal).

    For more on this see the IMF’s 2002 World Economic Outlook, Chapter 3, box 3.2 on The Great Depression.

  12. FM note: At almost 800 words, this comment not only grossly exceeds the 250 word max of the comment policy (clearly stated at the end of every article) but the post itself (637 words). I previously gave a warning (here).

    Hence, per the policy it has been edited. I left the opening and closing paragraphs, totalling 468 words. You can see the full comment here.

    Also: Mclaren has still not posted a retraction or apology for this gross mistake.
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    Erasmus makes a good point. In the 30s Germany lifted themselves out of the Depression with massive infrastructure projects (like the Autobahn) and a huge military buildup. The infrastructure spending worked well and outlived the Third Reich; the military spending didn’t turn out so well.

    … So one big issue is that America needs to change from our post-WW II economic regime in which we fund our science as a footnote to wasting huge sums on Buck Rogers superweapons that don’t work. If we scaled back our military and simply funded scientific blue-sky long-term R&D directly, we could eliminate a lot of economic inefficiencies in our current system.

    But two more worrisome problems remain, and I think FM is exactly right about these. First, we’re much worse off than during the Great Depression because back then America had vast amounts of unused industrial capacity — today we have very little unused industrial capacity. Today, our industrial capacity has gone away due to outsourcing. We would have to build it up again just to start from zero.

    Second, and potentially even more worrisome, during the Great Depression America’s high-wage jobs weren’t getting siphoned away by globalized outsourcing and our low-wage jobs weren’t under attack from illegal immigration. Today, it’s uneconomic to hire an American PhD when you can pay 1/5 the cost to hire a Chinese PhD to do the same work over the internet. This is cutting holes in our entire high-wage economy, from programming to chip design to consumer electronics to medical research to materials science to robotics to computer hardware like hard drives and motherboards. At the same time, illegal Mexican immigrants flood into the U.S., make it uneconomic to hire the lower-educated 20% of Americans. They’re also bringing a toxic patron-client social system into our country which further worsens income inequality and reduces social mobility, as FM has pointed out.

    It’s not obvious what to do about these two problems. Together, these trends cut out 40% of our working population from the economy. Shutting down our border with Mexico isn’t an option since it would make Mexico implode in a revolution: the single largest component of the Mexican economy is now the remittances sent back to their relatives in Mexico by Mexican citizens working in the U.S. (Since the drop in oil prices, remittances now exceed Mexico’s annual oil revenues. Remittances are what keeps the Mexican middle class going.) So American workers are becoming unemployable on the high end due to outsourcing to 3rd world Phds who’ll work for 1/5 the cost of a U.S. PhD, and on the low end by Mexican immigrants who’ll work below minimum wage just so they can give birth to a kid in America. We’re significantly worse off than during the Great Depression in that sense, and I don’t know what to do about those issues. No one does, AFAICT.

  13. Erasmus @4) ” Still, I wonder if there is any modern economic system not based on perpetual expansion which is clearly a very dangerous foundation on which to build anything sane or stable?”

    Ideally, socialism or communism, if not distorted by some innate human drive toward power and privilege, could do that. Instead of individual profit, social profit would be the dynamic of growth, and when the entire society had achieved a basic material security and prosperity, would turn to the production of immaterial or leisure goods.

  14. Do you have any citations of other people saying it?

    Any Austrian in any discussion. Here’s one such example: Hayek on Meet the Press (22 June 1975)

    Confidence in a laissez faire economics was burnt out in the early years of Hoover’s administration.

    The presence or absence of the political will to pursue a particular solution has no bearing on the correctness of that solution.
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    Fabius Maximus replies: (1) Do you have something other than a video? I mean a real citation; life is too short to watch TV (except Miami Vice, for the fashion tips).

    (2) “Any Austrian in any discussion.”

    All I asked for was one specific citation, not bizarro wild assertion. I have read much literature by Austrian economists and not seen any reference to a Kuhn-type paradigm crisis over Keynes handling of debt — as you stated in comment #9.

    (3) It is not a matter of political will, but unwillingness to repeat a massive policy failure. As has been shown many many times: nations that followed Keynesian solutions in the 1930’s did well, the stronger the program, the better they did. It’s a clear test with clear results.

  15. One aspect of Keynes, personally, was that he was a member of the Bloomsbury Group.

    The Bloomsbury’s were Bohemian, see, eg. After Cambridge, Keynes joined the snobbishly bohemian Bloomsbury Group, whose rejection of Victorian values and pursuit of cultural and sexual radicalism suited him well.

    Therefore, you should consider that one’s pursuit of bohemianism, on the individual, micro-level, is not necessarily at odds with this neoKeynesian macro architecture you are attempting to build.
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    Fabius Maximus replies: Please explain this a bit more. I don’t see these two aspects of Keynes as in conflict. And what neoKeynesian architecture am “I attempting to build”? It exists, and will be implmented. I am just reporting what the great and wise are doing, and why.

  16. We need more cash to increase aggregate demand. Bernake should really just print it — not tax, not borrow, just print legal ‘counterfeit’.

    The bailout elites will want to bail out elite millionaires first. Better would be the actual helicopter drop / deliver 5 000 to every filer of an income tax form.

    Probably even better (new idea!) would be offer a 1% ARM (max 7%, max 1% increase per quarter) IRS credit card to allow taxpayers to borrow that 5 000 from the IRS — but that they would have to pay it back in the future.

    This ARM rate would become a new tool in the Fed arsenel for it’s never ending quest to fine tune the economy, as well as the maximum credit limit, but for the short term it should mean more buying, more saving, less non-IRS consumer debt to current (in trouble?) banks.

    After house prices stabilize, and prices stabilize, the ARM could increase and the credit limit be reduced.
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    Fabuis Maximus replies: The Fed has already announced that they will be buying mortgage-backed securities with newly-printed money. The December 16th Fed meeting will probably ratify this and announce other “unconventional” monetary stimulus. Quantitative easing, a long period of near-zero interest rates, and pegging treasury bond rates — all the but the latter used by the Bank of Japan in their two decade-long war against deflation.

  17. I have read much literature by Austrian economists and not seen any reference to a Kuhn-type paradigm crisis over Keynes handling of debt

    It’s always stated in terms of the money supply. “Why Money Supply Matters“, Thorsten Polleit, 18 November 2005. (no moving pictures, I promise)

    Since our money supply is based on debt, any significant paying down of debt results in a monetary contraction, which rightly scares the pants off any Keynesian.

    It is not a matter of political will, but unwillingness to repeat a massive policy failure.

    You can repeat this as often as you’d like, but you’ll never find an Austrian that would point to Hoover and say, “Yes! That’s how I would have done it!”

    nations that followed Keynesian solutions in the 1930’s did well, the stronger the program, the better they did. It’s a clear test with clear results.

    No duh. If I drink enough coffee, I can stay awake for several days. It’s not sustainable, though. You dismiss crises such as this one and the depression as if they are anomalies that can be avoided once you perfect your theories. Austrians assert that they are the inevitable result of your policies.
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    Fabius Maximus replies: Your first reference suggests that you are not clear on the meaning of a Thomas Kuhn-type paradigm crisis. I suggest Wikipedia (perhaps starting here, then here), or better yet reading the Structure of Scientific Revolutions. From a quick glance, nothing in that article suggests any such thing.

    (2) One of the fascinating things about believers in off-beat economic theories (e.g., communism, gold bugs, laissez faire) is that their beliefs are irrefutable, since any real-world examples are not “true” forms of their belief. That is, they say “that’s not how I would have done it.” How true.

    This makes any debate impossible. Since these are enduring forms of belief, they reoccur throughout history. In a few generations and some bold theoreticians will convince folks to give each of these another try.

    Since none of these have any possibility of being tried today, we can leave the debate to those interested in obscure theories.

  18. And what neoKeynesian architecture am “I attempting to build”? It exists, and will be implmented. I am just reporting what the great and wise are doing, and why.

    Sloppy phrasing on my part.

    There is a distinction, if not necessarily a conflict, between the subjective micro response an individual might choose to current events and the objective macro response society might choose. Since we are discussing Keynes’ policies on the macro level, it might also be interesting to consider Keynes’ biography on the micro level.
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    Fabius Maximus replies: What a great question! The contradictions between the private life of philosophers and their writings is a fascinating subject. I strongly recommend reading “Intellectuals: From Marx and Tolstoy to Sartre and Chomsky” by Paul Johnson — the definitive treatment of this. From one of the Amazon reviews:

    Johnson’s thesis is quite simple: the revolutionary thinkers whose ideas have shaped intellectual history over the past 250 years were, for the most part, lousy human beings. These were not not common or garden variety jerks but personalities whose flaws were so manifest that they must call into question the value of the theories they generated.

    Johnson proves his theory ten-fold. The significance, the deeper meaning of this, remains a mystery.

  19. shortsighted post…just private sector debt? why would anyone avoid pointing to greenspan on this one. he is NO god for sure.

    we all know he contributed in immensity to the downcycle! or do you believe we are in guantanamo to fear our fingers pointing?
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    Fabuis Maximus replies: I find it odd that people post such bold comments after reading only one brief post, without checking the site for discussion of their question. As if 600 words could provide the master explanation of this vast and complex history.

    As a father I found “why” to be the most difficult of questions asked by my children. Why are we in this mess? I take second to none in my disgust at Alan Greenspan’s policies. As I said on 8 January 2008 in “Death of the post-WWII geopolitical regime – death by debt“:

    The Fed was an evasion of responsibility by our elected officials. In the words of Fed Chairman William McChesney Martin Jr., the Fed is like “the chaperone who has ordered the punch bowl removed just when the party was really warming up.” Its Chairman was to take the burden of making unpopular decisions off our elected officials. Then in 1987 Alan Greenspan became Chairman, and discovered that Chairman too could be famous and popular. Casting aside all considerations of prudence, he oversaw a massive increase in the debt of government, household, and corporate debt. every crisis or slowdown was met with more debt. This worked well for a long time. There were those warning that this would end badly, but they were discredited by the lack of immediate ill effects (heroin works in a similar fashion).

    But Greenspan did not force us to take on debt, so the responsibilty cannot be his alone. This is a free market economy in a democratic republican regime — so we as a collective whole must bear the ultimate responsibility.

  20. This is admittedly a sidebar but:

    I wrote: “National Socialism … applied the philosophy of tying national currency/finance to productivity versus debt via fiat or gold-backed currency. .
    .
    Fabius Maximus replies:

    I believe your description of Hitler’s economic policy is too complex. Germany had the 3rd largest collapse in GDP among the major western nations (26%) during 1928-32, and the greatest recovery. This resulted from Hitler’s extreme fiscal stimulus (there were no suicidal economists to tell Hitler that he could not do this, as FDR’s advisors limited the New Deal).

    My reply: actually, I think my description was far too simple albeit identifying a key paradigmatic difference (a major theme in original thread topic here), whereas yours treats the entire affair as just ‘more of the same’ essentially. Furthermore, there is much anecdotal evidence of significant debate about economic policy which was something that had been extensively worked on long before political power was achieved. Again, though, this period is very hard to study for many reasons so not worth discussing overmuch except to raise the possibility that a successful, modern, alternative paradigm does exist along with the skeptical suggestion that perhaps the reason it has not been properly studied is precisely because its stated intent was to undermine the credit-based bankster system that has been successfully driving increasing income disparity and general cultural degradation for decades now.

  21. I have read the source articles (and more elsewhere) but remain confused since economics is not my field despite having got a (thoroughly worthless) A-level in it back in the 70’s!

    Because I am unable to do so even after reading quite a bit the past few months, would someone here (please) care to take a stab at summarizing in a short,pithy sentence or paragraph what the Keynesian view is in terms of

    a) diagnosis of the current situation for which
    b) cure.

    Thanks in advance.
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    Fabius Maximus replies: Both of these things are discussed on this site in what I hope are clear and simple terms. I suggest looking at the FM reference page on Financial crisis – what’s happening? how will this end?.

  22. a)Consumers, companies, and governments overextended themselves and are now drowning in debt
    b)All of the above must borrow yet more money and spend it on digging holes in the ground if need be

    This is widely pronounced as genius by those in the hole digging and loan-making industries. I remain skeptical of the wonderous benefits for my own person. This skepticism is apparently deranged, to judge from the general reaction of bankers and hole-diggers to Austrian theory.
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    Fabius Maximus replies: Agreed, it is considered absurd by those familar with the history of the 1930’s. I suggest reading about the 1930’s. This is an easy place to start: “Government policy errors as a cause of the Great Depession” (1 November 2008).

  23. Keynes, like Adam Smith, David Ricardo, and Karl Marx before him, made a fundamental contribution to the THEORETICAL interpretation and analysis of economic phenomena. Like his predecessors, his predictive power for concrete real-time outcomes was basically crap. This was not because his analyses were necessarily flawed, but because macro theory is always general but the policy recommendations and outcome predictions of his time were necessarily extremely specific. As a result the generally-desired and eagerly-predicted economic activity outcomes could have occured without his theory being valid, and any failure to occur did not disprove his theory. The arguments continue to this day as to whether “recovery” occurred at all prior to WWII and if so whether they did so because of or in spite of specific policy recommendations associated with Keynes’ theory.

    Much like Charles Darwin, who also had original insights and presented a theory with vast, revolutionary implications, there is no way to prove or disprove the validity of Keynes’ theories themselves because that would require repeated controlled laboratory experiments on a national economy scale which – in spite of claims about the 1930s – has never actually happened. Just as modern biology uses Darwinian evolution as an fundamental explanation and starting place for modern theory, combining it with all the useful subsequent theories and discoveries, modern macroeconomics uses Keynesian cyclical analysis as a fundamental explanation and starting place – synthesizing it (in best practice) with the theories of Irving Fisher, Milton Friedman, Hyman Minsky, and many others.

    We are now in another major cyclical event whose course, with or without drastic interventions, no economic theory can safely be assumed to be able to accurately predict the outcome of. Of predictions themselves we have no shortage – as always. Drastic interventions are already underway, of course, and the monetarists, fiscalists (usually called Keynesians), and libertarians (also called Austrians) are already battling over the theoretical correctness of the actions taken so far and are spewing forth endless recomendations and predictions. Since – just as in the Great Depression – we are seeing both monetary and fiscal intervention at the same time and lots of maneuvering and change, by the time this is over every theoretical school will be either taking credit (if it looks like we escaped Total Meltdown) or blaming the others for having made it as bad as it was (if we don’t escape). Keynesian theory will always be with us, like Darwinian theory, but it will always remain only a theory with plenty of disbelievers.

  24. Re FM’s reply to #21.

    With respect, going through 40+ articles does not give a simple 1-3 sentence answer clarifying the root Keynesian paradigm/vision as applied to the current context!

    Also: there are many other paradigms, but not being ‘kosher’ they are ignored totally it seems. Most of them involve monetary reform which is seemingly the main thing ‘out of the question’ even though it is probably the only thing that can possibly work.

    Meanwhile we will all navigate through the Scylla of Deflation and the Charybdis of Hyper-Inflation, two sides of the same coin of extreme imbalance leading to exhaustion/collapse.

  25. After speed-reading through all 60+ essays, it became clear that first I had to verify the scientific bona fides of the numinous discipline known as ‘economics’. Although still not able to come up with a definitive formula clarifying the degree to which it is a ‘science’ versus an ‘art’, I have at least come up with identifiable quanta with which to conduct further research. I believe all here on the forum will benefit from this most valuable input:

    “GREAT JOKE, SAD TO BE SO TRUE

    Lawrence Livermore Laboratories has discovered the heaviest element yet known to science. The new element, Governmentium (symbol=Gv), has one neutron , 25 assistant neutrons, 88 deputy neutrons, and 198 assistant deputy neutrons, giving it an atomic mass of 312. These 312 particles are held together by forces called morons , which are surrounded by vast quantities of lepton-like particles called peons . Since Governmentium has no electrons, it is inert. However, it can be detected, because it impedes every reaction with which it comes into contact. A tiny amount of Governmentium can cause a reaction that would normally take less than a second, to take from 4 days to 4 years to complete. Governmentium has a normal half-life of 2 to 6 years. It does not decay, but instead undergoes a reorganization in which a portion of the assistant neutrons and deputy neutrons exchange places. In fact, Governmentium’s mass will actually increase over time, since each reorganization will cause more morons to become neutrons, forming isodopes . This characteristic of moron promotion leads some scientists to believe that Governmentium is formed whenever morons reach a critical concentration. This hypothetical quantity is referred to as critical morass . When catalyzed with money, Governmentium becomes Administratium (symbol=Ad), an element that radiates just as much energy as Governmentium, since it has half as many peons but twice as many morons.

    The above is not my original creation, the rest is my addendum. If the above does not make you laugh as much as cry inside, you aint human. The missing portion of the substance is known as corruptium , which leads to radiated energy into channels almost entirely into the power source, once damaged heavily by exposure to light, but now covered by czar tissue.”

    from: http://www.marketoracle.co.uk/Article7619.html

  26. It’s hard to believe WWII got us out of the depression simply because FDR sank a huge bunch of steel to the bottom of the oceans and we burned the cities of Europe and had a huge mobilization for war. I believe we recovered because of the kick ass list of cool projects we came out of the war with. Antibiotics, jet engines, electronic computing, synthetic polymers, telecommunications, microwaves, precision optics, nuclear power, and so on. It will be hard to get out of this cycle with no comparable list created. To secure the list from WWII took governments around the globe getting serious as a heart attack about innovation as the secret to winning the war. Vested interests who opposed such “industrial policy” were viewed and treated as traitors by an uber strong central govt. both here and abroad.
    .
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    Fabius Maximus replies: You might find it difficult “to believe” but its just a simple matter of fact. GDP recovered with the war-time increase in spending, both because of foriegn orders and US government spending.

    The projects you mention hardly had any real-time increase in productivity or economic activity, other than as government spending financed them. Technology developed during WWII may have resulted in a longer-term increase in productivity (I am not familar with the research on this).

  27. From #19: I believe you pointed clearly:

    I believe this crisis results from a paradigm crisis in Keynesian economics, as we reach the boundaries of his vision — specifically, the point at which aggregate private sector debt becomes a limiting factor for the economy’s growth”

    You are “selling” greenspan “cheap” to your readers…a total fraud from you responsibility as a “Fabius Maximus”.

    Given the implications to welth of americans, your proceeding are unaceptable. You owed clarity and research but with the integrity of puting up in every statement and in every post of the “I believe this crisis results…” the total universe of guilt. If not you are in the risk of becoming another common journalist.

    This is the real odd behaviour you showed in this post. Are you into the propaganda media? this omissions are the typical strategy to curb awareness from the public out of the core of the matter.

    Where does the responsibility of the causes and incentives of mass private indebtedness lyes on?

    From here to death, you become a childish commentator -and not a father- if you point ONLY to the so called aggregated “debt responsibility” of us all, in any literate piece.
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    Fabius Maximus replies: I have no idea what you are saying in this rant. Do attribute all this to Greenspan, some sort of Hollywood willian seducing the simple virtuous yeomen of America into debt?

    * What about the other Fed governors (he was Chairman, not Emperior of the Fed)?
    * What about the Fed staff, the legendary 500 PhD economists?
    * What about the Secretary of the Treasury and the department’s staff?
    * What about the independent agencies such the SEC?
    * What about our Senators and Representatives, and their vast network of staff (many are experts in these matters)?
    * What about the 50 teams of State regulators responsible for brokers and insurance companies?
    * What about the management and Directors of the many banks, brokers, and insurance companies whose imprudent actions are no so clearly revealed?
    * What about the rating agencies, without whose support much of this could not have happened?
    * What about the accountants, who allow the financial statements of banks and brokers to become so disconnected from reality?
    * What about the investors who bought the securities that financed this mess (either for themselves, or as directors of institutions), and their lack of simple due dilligence that has led to such massive losses?
    * What about the shareholders, who have ultimate control of most of America’s financial institutions (on paper, at least)?

    And last but not least…

    * What about the American people who reduced their savings rate to zero while borrowing so imprudently? Are they peons, unworthy of or unable to be citizens?

  28. Your first reference suggests that you are not clear on the meaning of a Thomas Kuhn-type paradigm crisis.

    From the opening paragraph of my source:

    For governments in general and the US government in particular, Ludwig von Mises had a policy recommendation: do not increase the stock of money any further.

    That’s clearly a different paradigm. Why would one formulate a different paradigm if it were not for some flaw in the prior paradigm? It’s not presented in the language of Kuhn, but it’s no less real. You acknowledge the crisis yourself at the opening of this post; the only difference is that you believe the answer lies deeper within the rabbit hole.

    One of the fascinating things about believers in off-beat economic theories… [blah blah accusation of No True Scotsman fallacy]

    NTS is not a fallacy when the subject in question is not a Scotsman. I let this slide in the context of Hoover being “laissez-faire”, but in the context of Hoover being Austrian, you are demonstrably wrong. Hoover presided over a monetary system that is fundamentally at odds with the basic tenets of the Austrian school of economics.
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    Fabius Maximus replies: Just read the book or even the Wikipedia pages. It is clear you do not understand the concept of a paradigm crisis, how (and why) Kuhn says that paradigms cannot be disproven but only replaced.

  29. FM: I referenced the Shlaes op-ed because one of the Krugman articles that you referenced blasted her.

    Professor Milton Friedman isn’t around to tell us what he thinks of it all, but here’s the next best thing: “What Would Milton Friedman Say?”, Peter Robinson, 17 October 2008 — “The late economist would have seen the market meltdown coming.”

    This is the fundamental problem with market (as opposed to money-supply) intervention. Central planners can’t help rewarding the stupid, malevolent, and inefficient, and screwing the prudent.

    Moreover, unrelieved debt is slavery (I owe my soul to the Company Store). With commodity prices dropping and providing demand stimulus, how much more in debt do we need to go? ‘Till we’re total slaves to the government? Baa Baa.
    .
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    Fabius Maximus replies: I did not mean to imply that there was anything wrong with citing Shales. She is an expert and appropriate to cite.

    Also, Friedman might have seen it coming. In “We have been warned. Death of the post-WWII geopolitical regime, Chapter II” (28 November 2007) I cited a long list of the warnings we have ignored, from individual experts and major financial institutions (links included). Lots of folks saw it coming, and warned about it many years beforehand — in time to take gentle and adequate corrective action.

    Here we are, with no good cards to play. We are in a situation familar to anyone who plays chess: a zugzwang. It means that you believe that all moves weaken your position. In the middle of a game, zugzwang typically occurs only in a player’s mind. It results from a lack of imagination, an inability to break free from his or her patterns of perception and analysis. But it is real for all that.

    I agree with excess debt is bad in many ways, perhaps terminal. But that insight comes too late for us. The relevant question is how to get out of the situation with the least suffering and the minimal possible damage to our nation.

  30. So we can build pyramids out of Italian marble, and Europe can build pyramids out of New England granite. Twenty miles on a side should just about do it fiscal stimulus wise. Even if this works, how do we transition from pyramid building to something more productive of wealth. I don’t question WWII’s Keynsian stimulus per se turning around GDP, but I think the serendipity of WWII was the way technical advances made the transition from a war economy to the modern era viable. Without the spin off list of technologies, it’s not clear what would have happened when the war ended. Conceivably we would have slid back into the depression. I don’t see how stimulus, even massive stimulus leads to guaranteed economic expansion even after the stimulus is removed.
    .
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    Fabius Maximus replies: When you find the answer, polish a spot for your Nobel prize. There have been hundreds, perhaps thousands of articles about that — with no answers yet. But its not a game we can pass on just because we have no firm answers.

    Japan tried most of the standard remedies over their 20 year battle with deflation. They fought it to a draw, and a new round begins. We have the benefit of their experience, and a different set of strengths and weaknesses. It will be interesting to see how well we do. Anyone who thinks there are easy answers is delusional IMO.

    I strongly recommend reading Koo’s presentation, an optimistic summary of the current art: “A certain casualty of the recession: the US Government’s solvency” (25 November 2008).

  31. FM: Just read {Kuhn’s} book or even the Wikipedia pages. It is clear you do not understand the concept of a paradigm crisis, how (and why) Kuhn says that paradigms cannot be disproven but only replaced.

    Molby: I read the wiki page and I didn’t see anything that changed my understanding

    Then perhaps what I’m describing isn’t a “paradigm crisis”. You were the one that labeled it as such, so I went along with it.

    I’m not challenging Keynes’ models, formulas, etc. Others might, but I’m not versed in them, so I’ll give him and his proteges the benefit of the doubt.

    What I’m saying is that you’ll never be able to apply those models well enough to achieve his goal of deliberately guiding the economy to high growth and perpetual stability.

    Instead, you’ll be a driver going quickly on an icy road: constantly overcorrecting in alternating directions. With enough study and training, you may eventually be able to keep the car on the road for long stretches of time, but eventually you will crash hard. To make matters worse, you’ve used government force to commit countless injustices along the way. Austrians are willing to forego your hare-like speed in exchange for tortoise-like stability and limited government.
    .
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    Fabius Maximus replies: As the opening makes clear, this post says that we are in a paradigm crisis of economic science — which has substantial real-world effects. I don’t ask that you agree with that (although I would like to see more sycophants in the comments (where does Tom Barnett get them?) — just that you don’t write rebuttals if you don’t know the concept. For example, see your comment #9:

    FM: “I believe this crisis results from a paradigm crisis in Keynesian economics, as we reach the boundaries of his vision — specifically, the point at which aggregate private sector debt becomes a limiting factor for the economy’s growth.”

    Molby: This seems very self-evident.

    Four comments later (#14, 17, 28, and this) it is painfully obvious you wrote that without understanding the meaning of “paradigm crisis.” If life was like a cyberpunk sci-fi novel (e.g., William Gibson’s “Neuromancer”), I would smite you with an electronic thunderbolt. Please do not do that again, as in real life my only response is elevated blood pressure.

  32. This “google books” link is on point: “Out of Work” by Richard K. Vedder (1997). It challenges the “Keynes saved us in WWII” argument by noting that govt. spending as a percent of GDP didn’t grow that much especially during the smooth and dramatically successful transition from a war economy.
    .
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    Fabius Maximus replies: I do not understand his point about government spending as a % GDP, which matches the standard textbook account. New Deal spending kept the economy running at a low level, WWII restarted the engine, then spending declined.

    * It was aprox 9% in 1929 – 1933,
    * roughly 16% from 1933-1940, peaked at 48% in 1944,
    * declined to 15% in 1947 – 1948,
    * then began the post-WWII rise to the roughly stable 19-20% range.

    See Carried Away for the graphs and data.

  33. What is this ?….typicall propaganda totally out of -the the critical functioning structure that defines how the private world of debt works in relation to FED policy??

    * What about the other Fed governors (he was Chairman, not Emperior of the Fed)?
    Exactly how decision are taken was a fault in bringing this analysis forth.

    * What about the Fed staff, the legendary 500 PhD economists?
    You can make them chew bubblegum and spin an agenda forward. Are you playing innocence here?

    * What about the Secretary of the Treasury and the department’s staff?
    Wrong question, its like asking what about Bush and Cheney.

    * What about the independent agencies such the SEC?
    Wrong question, its like saying Risk Agencies and CDO’s

    * What about our Senators and Representatives, and their vast network of staff (many are experts in these matters)?
    What do you mean here…are you trying to expand an argument into absurd ramifications? Do they work day and night (daytime congress, nightime FED)?

    * What about the 50 teams of State regulators responsible for brokers and insurance companies?
    Is there any Fed’s ability to control the dollar’s value with its interest-rate mechanism?

    * What about the management and Directors of the many banks, brokers, and insurance companies whose imprudent actions are not so clearly revealed?
    What does this have to do with the relation of decade IR policy and bubbles? You answer this one by yourself. Intuitive…

    * What about the rating agencies, without whose support much of this could not have happened?
    * What about the accountants, who allow the financial statements of banks and brokers to become so disconnected from reality?

    * What about the investors who bought the securities that financed this mess (either for themselves, or as directors of institutions), and their lack of simple due dilligence that has led to such massive losses?

    For this three. Are you suggesting there was no uncertainty-risks to profits association for key actors? Have you calculated the net profits of banks financial statements from securities, cap. markets, and on-demand assets such as households for the period in question?

    * What about the shareholders, who have ultimate control of most of America’s financial institutions (on paper, at least)?
    To believe in the concept of excessive saving is to assume a place in time where all human wants are satisfied such that capital would have to find another home; in the present case, property-debt…you click the Greenspan buttons some years and voila. Bubbles.

    Can you give a record of potential gains for private sector, for the period in question of each greenspan Fed cuts? What about dollar debasement that led capital “into assets that are invulnerable” to that same debasement? Do you have a quantitative approach under this situation that sends Greenspan to the second line while we remain in front? Can you give “the evidence that monetary policy did not added to the bubble “fragility” as a dominant factor?
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    Fabius Maximus replies: Well, that is a definitive reply to my questions. I guess Greenspan was the master bad guy, single-handedly running the US, all-powerful. I forget the details — was he a member of SPECTRE or COBRA?

  34. Exactly the same weak answer of a mainstream media CBS’ 6.oo pm news….
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    Fabius Maximus replies: Your comment was just a rant. There was no content requiring a reply.

  35. Fabius Maximus replies: Agreed, it is considered absurd by those familar with the history of the 1930’s. I suggest reading about the 1930’s. This is an easy place to start: “Government policy errors as a cause of the Great Depession”

    Leaving aside Rothbard as you seem to insist on doing without refuting his arguments, should I perhaps read the fine gentlemen from UCLA, that bastion of libertarian thought? / sarcasm

    New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis“, Harold L. Cole and Lee E. Ohanian, Journal of Political Economy (Vol. 112, No. 4, 2004, pp. 779-816) — Abstract:

    There are two striking aspects of the recovery from the Great Depression in the United States: the recovery was very weak and real wages in several sectors rose significantly above trend. These data contrast sharply with neoclassical theory, which predicts a strong recovery with low real wages.

    We evaluate the contribution of New Deal cartelization policies designed to limit competition and increase labor bargaining power to the persistence of the Depression. We develop a model of the bargaining process between labor and firms that occurred with these policies, and embed that model within a multi-sector dynamic general equilibrium model. We find that New Deal cartelization policies are an important factor in accounting for the post-1933 Depression. We also find that the key depressing element of New Deal policies was not collusion per se, but rather the link between paying high wages and collusion.

    .
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    Fabius Maximus replies: You are conflating two seperate issues. In comment #9 you said:

    All of the above must borrow yet more money and spend it on digging holes in the ground if need be This is widely pronounced as genius by those in the hole digging and loan-making industries. I remain skeptical of the wonderous benefits for my own person.

    I assume that was a rebuttal to the Keynesian fiscal stimulus discussed in this post.

    Ohanian is a major economist and expert about the Great Depression, writing about other aspects of FDR’s policies. Since they were beyond the bourdaries of current economic theory (just like us), FDR tried a grab-bag of measures — many of which were essential (fiscal stimuls, going off the gold standard), some useless, many counter-productive (e.g., tax increases, price fixing, and cartels). Economists are still sorting through the mix, determing the effect of each.

    I am slightly familiar with Ohanian’s work (see this archive), and have seen nothing in it about the ineffectiveness of a massive fiscal stimulus. The abstract clearly shows that.

  36. Great blogging, as always. Now I’ll get to the part where I respectfully disagree. Often, the validity of a theory can be tested by how it behaves under some extreme logical contingency. (What mathematicians sometimes call end behavior in numerical analysis).

    Often, these conditions never seem to happen in the real world. One exception could be about to occur with the premises of Keynesian economics. In particular, with respect to the theory that lowering intrests rates will increase liquidity.

    The blog Financial Armageddon argues that the current implementation of quantative easing in an environment of already low intrest rates presents a challenging test case. FA opines below…

    The greatest failed experiment of this theory is the practical implementation Keynesian and Neo-Keynesian economic policy. Today, right now you are witnessing the implementation of Keynesian theory to its absolute maximum limits with a policy of ZIRP and quantitative easing.

    What are your thoughts on ZIRP as an aymptotic case of Keynesian Theory regarding intrest rates. Does it indicate a situation that suggests Keynes fundamentally misunderstood how credit markets work? I tend to believe that it does.
    .
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    Fabius Maximus replies: Lots of interesting material here.

    (1) Let’s not ask too little or too much of economic theory. Prof Brad Delong (Economics, Berkeley) said (source):

    The problem is that economic theory is not rocket science. It is not like theoretical physics–conducting a relatively few crucial experiments to decide on basic theories and then working out the consequences of those theories from first principles. Economic theory is, instead, crystalized history. We take a bunch of historical episodes that seem relevant to the problems of interest of today. We boil down what seem to be their salient features. And then from the resulting soup and bones we construct simple stylized models that we think help us understand present and future episodes that fall into the same class.

    (2) “Does it indicate a situation that suggests Keynes fundamentally misunderstood how credit markets work?”

    Unlikely, as Keynes was not only the greatest economist of the 20th century, but also a great investment manager.

    (3) “The greatest failed experiment of this theory”

    Economic theory has worked quite well during the post-WWII era, esp by comparison with the 19th century post-Civil War American history — with its frequent depressions. So declaring failure is premature.

    I think it will fail, but not because the theory is false. We have just reached the limits of its operating envelope, esp with regard to aggregate debt. Just a Newtonian theory no longer works at relativistic speeds.

  37. The consequence of government intervention in economic affairs is the tying of the public sector into the trials and tribulations of the nation’s economy. There is no real difference between dollars spent in tax, and dollars spent in consumption, save for the fact that they go to different places. ‘Work Projects’ are simply the infusion of a percentage of income which otherwise would not be mobilized, into the market.

    Tax dollars and slave labor for the state are two things which need to be kept out of the market whenever possible.
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    Fabius Maximus replies: In a recession, investment and spending slow — while savings increase. This decreases aggreate income (your spending is my income). Left unchecked, this positive feedback (I stop spending, you stop spending, he stops spending) can create a depression. The government can spend money to sustain the economy while it heals. This was proven beyond doubt by comparison of different nations during the 1930’s, and more so during WWII.

    I find it astonishing that after decades in which economics was one of the most popular undergraduate majors, so many people do not understand the basics.

  38. Agreed. There has to be some content somewhere addressing the importance of whether fiscal stimulus takes the form of digging holes and filling them up again, building roads and bridges, or inventing plastics and microwaves. If not, IMO there’s a big opportunity to create some. Current policy wonks seem to think quick to trigger trumps return on investment. “Ready to fund” is the buzz phrase. That may give us the kick start we need, but in a perfect world, economists would sit down with scientists and engineers to identify some daringly expensive but do-able projects to fund. Hey, I’m a scientist and engineer, all we need now is an economist.
    .
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    Fabius Maximus replies: I have a post discussing this in the pipeline. Briefly, how much bang do we get from a new construction program? Will it employ idle real estate agents and brokers? Fifty-year old boomers? Or just relatively few specialized craftsmen and millions of illegals from Mexcio?

  39. Perhaps the problem with Keynes theory today is that at the time he developed it we were creditor nation not a debtor nation! That’s why he did not perceive debt as a problem. If you mentioned this before I probably missed it.

    The thing I’m pondering now is what if there is not enough money in the world to stop the bleeding and that we are so far beyond what Keynes thought that perhaps his theory no longer applies! I am just trying to determine the direction we are heading which at this point does not look good.
    .
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    Fabius Maximus replies: I agree on all points. (1) Keynes wrote the most comprehensive theory possible for him at that time; we have reached its boundaries and gone beyond. (2) With every major government applying large-scale fiscal and monetary stimulus, the world savings pool might be insufficient. That’s not a binding constraint, as everybody can print money. But the hangover afterwards might be unpleasant.

  40. On misquoting Mellon: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate”

    The only source I have ever seen for that is from Hoover’s memoirs written in the 1950s, not from any writing of Mellon. That may have been the foreseeable outcome of his policies but I doubt Mellon ever said or wrote that. Mellon was an orthodox economist of his day. Hoover was writing with hindsight.
    .
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    Fabius Maximus replies: I do not understand your point. As you note, Mellon’s was an orthodox view of his day, and indeed through the Depression. “Purging the system” and “balance budgets first” were common sentiments then, and are (in different form) visible today.

    In the 1930’s they led to FDR’s concern to balance the budget, and the tax increases and spending cuts (8%) — which led to the 1937-38 downturn. Note Keynes gentle criticism of FDR’s economic othodoxy in this 1 February 1938 letter.

    BTW, the full quote from Hoover’s Memoirs’ is …

    {Mellon, as Secretary of the Treasury, had} … only one formula: liquidate labor, liquidate stocks, liquidate the farmers, and liquidate real estate…. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.

    That accurately describes the nature of Hoover’s policies then, and neo-Hooverites now. Let the downturn run and burn itself out. Don’t reward imprudence. As in “{Norm} Coleman urges caution on new stimulus package”, Bemidji Pioneer, 22 October 2008:

    I would be very cautious if a stimulus plan becomes another excuse to simply spending more dollars,” the Republican senator said in an interview after a campaign rally Tuesday in Bemidji. … Coleman’s recovery plan includes enforcing spending caps, freezing congressional pay, enforcing pay-go where new spending must be accompanied by like spending cuts, require the president to submit spending cuts to Congress, giving the president line-item veto authority, closing the tax gap of unpaid taxes, closing tax loopholes, making sure Social Security and Medicare are solvent in the future.

    Senator Saxby Chambliss {R-GA}, interview on NBC, 21 October 2008:

    Should we attach more debt to the current deficit for our children and grandchildren to pay, without knowing its going to help?,” Chambliss responded. “I think if I had to say today, I don’t think that’s a package I could support.

    Supposedly Fred Thompson spoke about the “virtues of economic retrenchment” in a 4 December interview with Neil Cavuto on Fox (source, video). I’m waiting for the transcript. Has anyone watched the interview.

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