More conversation with Papola

I thought this was worth reproducing - someone let me know if I could have said it better. Lee? You're always good at verbalizing the general glut point, although I know you cringe to do it in a fiscal policy context. Anyway, here it is:

John: "Do me a favor. Dig into my specific points/questions about aggregation in my last long post. You haven’t yet. You’ve just waved your hands by saying “keynesians recognize that slack is unevenly distributed”. That’s not an answer. I’m asking what I believe are reasonable and reasonably precise questions. That you agree with DeLong and Stiglitz suggest to me that my understanding of keynesianism is correct and that my criticism holds. Posting your blog that I’m spewing fallacies doesn’t do anything to point them out. You haven’t. I’m listening. Nothing would make me happier in life than to have keynesianism proven true. After all, both political parties are keynesian."

Me: I said "peddling" not "spewing" fallacies... that sounds a little nicer to me. Isn't it? I was referencing the "Keynesianism as consumptionism" fallacy and the assumption that we're operating at full employment (ie - no liquidity preference so no paradox of thrift). I feel pretty solid calling those "fallacies" and I have pointed to them explicitly a couple times now, so don't suggest I haven't pointed them out - I have.

OK - on aggregation - let me try and think of another way of phrasing my point.

We always experience uneven levels of depression, growth, market tightness, market looseness, inflation, and deflation. That is always with us - they are simply temporary disequilibria and price signals to direct scarce resources to their best use. They're a good thing in a market economy because the market uses the price signals from those imbalances to make economic activity more efficient. This is intertemporal as well - people save and borrow because the market allocates goods and services over time as well. What I'm saying is that in some situations, there is a general depression. There are still these heterogeneous differences as there always are, but everything is more depressed than it would have been under normal circumstances. This occurs when there is a reduction in effective demand - when people and firms don't want to save to set something aside for the future - they want to save to have a liquid asset. This isn't time preference this is liquidity preference, and it's something Austrians regularly ignore. You say your money is in the bank and isn't idle simply by virtue of the fact that it is paid interest. It isn't absolutely idle, you're right - but savings can be kept in more liquid and less liquid forms. More liquid assets are by definition kept less productive than less liquid assets.

So, the point of Keynesianism is that while liquidity preference may be rational in the sense that its understandable why people have it, it isn't socially functional. It's unnecessarily wasteful and it means that the market does not always efficiently use all factors of production. The task at hand is to turn that liquidity preference shock into actual income.

Restoring full employment in that sense has absolutely nothing to do with your concern about unevenly depressed sectors. The task isn't to say "what's especially low out there? - let's fill up that hole because its not doing so well". No. That defeats the whole purpose. We like those relative differences because those provide price signals that efficiently allocate means of production. That's not the way to think about fiscal policy. Think about fiscal policy as being much like monetary policy. People are demanding liquid assets, so they hold money or some other highly liquid asset, and it just sits there - depressing everything, not just specific sectors. Fiscal policy is the government saying "here, why don't you hold on to this bond - its very liquid, there's always a market for it, it'll satisfy your mattress-stuffing impulses, and I'm going to go credit worker and contractor accounts to do this "stimulus" stuff. People want to turn income into liquid assets and take it out of circulation. So the government says "I'll take that trade", and then puts it back into circulation. It's no different from monetary policy, which you were damn close to embracing on Cafe Hayek recently.

So that's why I say you're thinking about this from completely the wrong angle. You are thinking of it from the goods and services side of things, which is why it seems like a calculation problem to you. You need to be thinking about what's going on in the money and loanable funds markets - why your savings are in fact idle, and what fiscal policy does about it.

So see - the case I've made so far has nothing to do with these relative imbalances. Because I don't see the relative imbalances as a problem - I only care about general gluts. Market specific gluts are going to be worked out by the market. The task is to fix the problem that lead to the general glut.

Now, I did agree with you that these relative imbalances in different sectors are important because clearly fiscal policy is going to have an impact in various markets in ways that monetary policy simply isn't going to. You want to be smart about how you spend the money in that sense. If you spend $800 billion on Sponge-Bob Square Pants DVDs, macaroons, and snow-globes you're going to introduce some pretty bizarre price distortions. You'll still put idle cash back into circulation, which is why Brad DeLong says anything passes the cost-benefit test and why Keynes talked about burying bank notes and digging them up again. You will, in essence, solve the general glut problem but exascerbate the industry-specific gluts. I am not aware of a Keynesian that doesn't recognize this, John. Are you? The argument is that the general glut is by far and away the bigger problem at a time like this - period. If we solve the general glut and cause a few issues with relative price distortions, the argument is that the cost of those relative distortions is much, much lower than the benefit of solving the general glut. You can't accept this because from what I gather you don't even think general gluts are real.

So this is why I say anything works as long as you put money back into circulation, but relative prices still matter because of course you can introduce distortions. The thing is, there are a lot of public goods that we could be investing in. They are sub-optimally underinvested in right now so we can dump money on them and they would indeed change relative prices but they would improve the situation. We can dump money on research and education and it would adjust relative prices for the better because these are underpriced by the market. We could dump money on clean energy technology and it would indeed adjust relative prices, but for the better because this is underpriced by the market. We could increase NASA's budget five-fold and it would adjust relative prices for the better because space colonization is currently underpriced by the market. We could also just put a roof over people's head, food in their mouth's, and clothes on their back as a purely humanitarian act because people are deserving of the basic dignity of having their needs met. At full employment you have to weigh that against what you're taking money away from. Below full employment, I say "it solves the general glut and it serves a humanitarian motive outside economic calculation - win-win to me".

You have to be careful of course, because these can have bad distortionary effects too. You mentioned health care in an earlier post. Policies that drive demand for health care - mandates, tax breaks on health plans, etc. are not the way to spend stimulus money. Things that will lower costs like health care IT and grants for nurse training wouldn't be as bad.

But the point isn't to distribute money to every weak market. It's not "C, I, G, altogether adds to Y - keep that total growing and watch the economy fly". That's crude Keynesianism. That completely misses the point. The point is get money back into circulation, recognize that as your number one priority, but also recognize the distortionary effects your policy might have and try to avoid them the best you can.

Robert Skidelsky says it very well on your website [see his discussion starting at 12:53] - there is government waste and there is market waste. Governments absolutely waste when they try to allocate resources. Governments cannot do economic calculation, period. But in a general glut, markets are far more wasteful than governments. You have to just live with some government waste to solve the market's waste problem - and ideally you spend on positive externalities and public goods to minimize the level of government waste in the first place.

Keynes wrote: "To put the point concretely, I see no reason to suppose that the existing system seriously misemploys the factors of production which are in use. There are, of course, errors of foresight; but these would not be avoided by centralising decisions. When 9,000,000 men are employed out of 10,000,000 willing and able to work, there is no evidence that the labour of these 9,000,000 men is misdirected. The complaint against the present system is not that these 9,000,000 men ought to be employed on different tasks, but that tasks should be available for the remaining 1,000,000 men. It is in determining the volume, not the direction, of actual employment that the existing system has broken down."

I could not agree more.

If you still don't feel like I'm speaking to your point, you may want to look for answers elsewhere because I'm clearly not communicating this well. I feel like this has been asked and answered countless times by lots of Austrians before you, and maybe I'm just not addressing it right. Needless to say, if you still think I'm violating some assumption about economic calculation I'm miscommunicating something because I am fully on board with Hayek on economic calculation.

Note that Keynes never submitted a report to the Chancellor of the Exchequer saying "My dear chap, I strongly feel that we should bury banknotes and pay the unemployed to dig them up". Notice Stiglitz never castigated Congress for not including more ditch digging in the stimulus package.

Doesn't that say something to you? The whole reason for pointing out these completely crazy options is to try to highlight this fact that its not about "boosting consumption" or even "boosting investment" directly. A lot of people think of fiscal policy as the government spending when the market won't - as if the government is stepping in to do the economic calculation.

That completely misses the point, which is precisely why Keynes came up with such goofy examples. But he never seriously proposed such examples because even though the point wasn't to bolster certain goods and service markets, it clearly could have the effect of distorting those markets."