Thursday, December 23, 2010

Conversation with John Papola at EconLog

I've been involved in an extended conversation with John Papola, the creator of the "Keynes vs. Hayek" video, in a blog post by David Henderson.

The post starts off by talking about one of Papola's remarks on behavioral economics. My initial concern was that he's conflating questions of cognitive bias with questions of socialist calculation unnecessarily. We can "solve" cognitive bias problems in ways that governments are doomed to failure in addressing calculation problems (for example - on savings decisions its plausible to think we can start to over come "status quo bias" but still recognize we can't centrally plan individual savings levels). That, however, quickly turned into a discussion of Keynesianism. My comments were rushed during lunch breaks and early in the morning so I hope I've done it justice - he comes at me with a lot of questions, so I'm sure I dropped some of them. But I think its instructive because he's peddling a lot of the fallacies about Keynesianism that I talk about on here - that Keynesians actually want to plan economic decisions, concerns about heterogeneity in depression, confusion of the savings identity with a behavioral law (which is done by assuming we're at full employment), talking about Keynesianism as if investment doesn't matter and consumption is paramount, etc. etc. Anyway - I try to succinctly address all of that because it all crops up.

If you (1.) live under a rock, or (2.) just want to see it again, this is Papola's video:


  1. I'd be very interested in an elaboration/explanation of this point from your conversation if you ever have the time:

    "- Keynes thought that the interest rate coordinates the supply and demand for cash/liquidity (Hicks said both the Austrians and Keynes were right - it serves both functions... I personally prefer Hicks to Keynes on this)"

    Or else if you could recommend a good place to start on this subject, I'd appreciate it a lot.

  2. Sure thing anonymous - why don't you start by reading this:

    Where I discuss the issue.

    Are you familiar with the basic IS-LM model? Basically Hicks said we should think of a money market where inelastic (ie - vertical) money supply meets money demand. There interest rate is on the y axis there. There's also a classic loanable funds market with the usual supply and demand curves - supply thought of as savings and investment thought of as demand. The y axis also has the interest rate here.

    So Hicks presented two markets with the same price - the interest rate.

    Now, he said, demand for loanable funds, supply of savings, and demand for money all shift as income/output increases. So he said we should trace the equilibrium points of the interest rate in each of those two markets as we change income/output. That will give you a downward sloping series of equilibrium interest rates in the loanable funds market (this is called the IS curve), and an upward sloping series of equilibrium interest rates in the money market (this is called the LM curve).

    Now, there can only be one interest rate, and that is the intersection of the IS and the LM curve. You've pinned down the interest rate with these two markets for which the interest rate is the price, and it gives you the level of output that that's consistent with that interest rate. The point is, there's nothing that constrains that level of output to be a full employment level of output. Several others - Hansen, Modigliani, Klein, etc. - expanded on this basic Hicksian model.

    Keynes was familiar with Hicks's model, but rejected it (see the link above). He did not think the interest rate cleared the loanable funds market - he only thought it cleared the money market.

    Check out the New School's History of Economic thought website for more details - they have a good page on IS-LM, and they've got a strong post-Keynesian vein so I'm sure they've got a good discussion of non-Hicksian Keynesianism (which, as I alluded to, is not the form of Keynesianism I consider myself a part of).


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