Thursday, March 17, 2011

Stimulus and jigsaw puzzles

Steve Horwitz has a post arguing that the metaphor of a jigsaw puzzle illustrates the difference between the Keynesian and the Austrian perspective. It's long, but this portion gets the essential points out:

"In a series of newspaper columns last year, Don Boudreaux compared the economy to a giant jigsaw puzzle with billions of pieces that can fit together in numerous combinations only a small number of which produce a meaningful pattern or picture. We learn which combos work because they “beep” every time we get one “right” and those beeps give us pleasure. I like that metaphor and I want to make use of it to talk about Austrians, Keynesians and stimulus spending.

Imagine that we do what Don describes and start constructing this jigsaw puzzle, but rather than the beeps reflecting combinations that create meaningful patterns, imagine that the beep mechanism is suffering from a computer virus that leads it to commit both Type I and Type II errors. The result is that we end up creating a puzzle that sees no meaningful image emerge (whether one characterizes the pattern as “out there” or emergent isn’t essential to my point). Suppose further that we eventually use up all of the pieces and discover we have wasted our time because there is no meaningful picture to be found.

What happens next? For one thing, we have to spend some time pulling the puzzle apart as what we’ve created produced no meaningful picture. Then we’d want to fix the bug in the beeping mechanism. And then we’d want to get back to the task of building a puzzle that did create a meaningful pattern. Of course this extension of Boudreaux’s metaphor is designed to mimic the Austrian theory of the business cycle, though somewhat imperfectly.

Now suppose we are in the process of dismantling the old puzzle. Suppose further that as we pull pieces apart, we have to wait for a beep to inform us that doing so was a good “pulling apart.” Once we know we have correctly dismantled, we can try to “re-fit” those pieces into the puzzle. As we engage in this process, there will be a bunch of pieces that are sitting around waiting to be “re-fit” into the puzzle, ideally generating a true beep and helping create a meaningful picture when re-fit correctly. Of course if we’ve really fixed the beep mechanism, these “pieces in waiting” will grow at first as we do more dismantling than reconstructing, then shrink as those reverse.

So while the Austrian puzzle observers nod approvingly as the dismantling and reconstruction continues slowly but effective onward as puzzle makers learn from the beeps, along comes their friend the Keynesian. The Keynesian bemoans the fact that there are so many puzzle pieces sitting “in waiting.” He says “wouldn’t things be better if we just starting putting those pieces into the puzzle in any old way? Even if we don’t get a meaningful pattern, at least we’d use up all the pieces. After all, isn’t that how you know you’ve reached the goal of a finished puzzle?”

The Austrians respond by saying “No, the point isn’t to just use all the pieces. That’s easy to do, but it’s not the challenge of this kind of jigsaw puzzle. The challenge here is to produce a meaningful pattern without having a picture on the box, and which might not require all of the pieces to be used, because the meaningfulness of that pattern derives from the way in which the organization of the pieces matches what puzzle demanders want in a picture even though they cannot articulate it ahead of time.”

Now it’s true that puzzle pieces are not human beings, but the underlying contrast of visions here seems to me to capture the debate. The argument for stimulus spending by Keynesians amounts to saying we need to activate idle resources either without thinking about whether the puzzle pieces actually fit together or, more subtly, not thinking about, or not caring about, whether they produce a meaningful pattern. The point is just to make sure they are being “used.”"

It's always interesting to hear what people think you think - for example, that Keynesians don't care or worry or realize that market activity is characterized by complex, extended specialized exchange relationships. I don't think this analogy quite works because it only really seems to address the crude Keynesian "lean against the wind" sort of argument that says "I and C are low so we have to increase G to make up the difference". "Lean against the wind" as a simple decision rule isn't the worst thing in the world, so it usually gets by without too much criticism. Better that people think in those terms than that they embrace austerity. But it really misses the primary point.

Keynesians argue that the price distortion occurs in the bust, not the boom. Interest rates are too high, and the Austrians are embracing this distortion of the price mechanism as normal. When you hear Keynesians talk about stimulus, they don't usually talk about how it gives people jobs directly (although if you can do that on worthwhile projects like building roads and schools of course that's nice). When Brad DeLong talks about stimulus, for example, he always refers to its benefit as being the provision of high quality assets for which there is an excess demand. The point is to eliminate the price distortion in the interest rate, so that investors can once again engage in specialization and exchange.

A better analogy for Keynesianism (if we stick to the jigsaw puzzle), is that some shock occurs - someone bumps into the table where you're working on the puzzle - turning a bunch of your pieces upside down. The information that investors were using to make decisions is distorted because you no longer have the picture on the front of the puzzle piece to use to make decisions about the use of that puzzle piece. Whereas previously all puzzle pieces were available for utilization, the shock distorted information such that many of the puzzle pieces aren't viable for use. What does one normally do in this situation? Well, you start to correct the distortion! You start turning over puzzle pieces so that the people working on the puzzle can now viably use all of the puzzle pieces that are available. To Keynesians, the Austrians look like they are embracing a price distortion and insisting that the people working on the puzzle continue to use the pieces that have been turned upside down. The Austrians insist that those working on the puzzle will figure out what goes where, even if they no longer have the picture on the front of the piece to look at (information from undistorted prices). Keynesians are simply responding "why don't we turn the piece over and then keep working on the puzzle?", and find it incredible that this idea seems so foreign to people.


  1. I think your analogy makes quite a bit of sense, but it has one problem that I can see. In the Austrian story, prices play a coordinating role within the economy, signaling consumer demands and preferences to entrepreneurs. Government officials, however, don't have the same information, signals, or incentives that private businesses do, so they don't know how the puzzle is supposed to be put together. They're like a blindfolded person attempting to make the pieces fit. It's a shot in the dark, so to speak.

    The Keynesian story is that during the bust, prices (specifically the interest rate) are distorted, so that investors are kind of like the blindfolded government officials. The interest rate isn't coordinating investment like it should be. As you say, the puzzle pieces have been turned upside down and something needs to be done to right them.

    Correcting the distorted puzzle pieces typically takes the form of one kind of government stimulus or another in the Keynesian story. If we stick with the puzzle analogy, the problem is that now everyone is essentially blindfolded. Prices aren't conveying correct information to anyone. Investors may be lost, but the original information problems that faced the government in the Austrian story still exist. They're flipping the pieces around hither and thither, but they still don't know where the pieces should go or how to make a meaningful picture. In other words, the original problems facing government's ability to coordinate resources haven't disappeared, they've just been compounded with the addition of a new problem- the market's inability to coordinate resources.

    I may simply be reading too much into the puzzle analogy, but it seems like even if you are correct about the inability of interest rates to coordinate investment, your solution suffers from the same problem.

  2. Samuel -
    First, yes this is the role of prices in the Austrian school. It is also the role of prices for everyone else, it's worth noting.

    And you're right - government officials don't have this information directly. It is more hazy. But there are going to be clues that crowding out is kicking in and governments should ease off - inflation and rising interest rates being the primary clues. Prices in the market economy are efficient. They are precise. When the government tries to set prices like interest rates, it's rough - even if they have some clues. Still, with 9 percent unemployment and skyrocketing long-term unemployment I'd rather be roughly right than precisely wrong.

    "They're like a blindfolded person attempting to make the pieces fit"

    This I do not agree with. Government is not (or should not be - there may be select cases where they are) telling you how much food to buy, what furniture to buy, where to direct corporate research, etc. Demand management is not central planning - Keynes and others have been emphatic about this. If you start trying to fit the pieces together - if you start planning the economy - you are indeed in for trouble. That's why I was not keen cash for clunkers; that's why I was much more wary of the auto bailout than the finance bailout; that's why I don't like agricultural subsidies; that's why I've been skeptical of the health insurance mandate; that's why I don't like the mortgage interest deduction, etc. There are legitimate markets where the government has a legitimate case to act - either for equity, externalities, or what have you. Fine. But that's not macroeconomic management, and Keynesian macroeconomics does not call for any economic planning - with the exception of the money and credit markets. A fiscal stimulus will involve the purchase of goods and services, but that's just public demand - nobody is telling the economy how to specialize and produce, how much to make, or what to charge. Such planning has nothing to do with Keynesianism.

    re: "They're flipping the pieces around hither and thither, but they still don't know where the pieces should go or how to make a meaningful picture."

    You think? I don't think it's absurd to suggest that governments know the direction to push interest rates. Entrepreneurs are the ones that know what projects are viable or not viable at a given interest rate - they don't lose that knowledge, and the government doesn't gain that knowledge. But the government does have quite substantial indicators of when to hit the gas and when to hit the brakes.

  3. re: "your solution suffers from the same problem"

    We have two real problems that we deal with in economics - information/calculation problems and incentive problems:

    Firms have the information to decide whether to make a specific investment or not. Government does not have this information. Therefore, governments should not be going around making investments when firms are best informed to make those investments.

    Firms do not have an incentive to produce output at a rate that is consistent with full employment. Governments have whatever incentives we the people charge them with. Normal economic planning is usually just a Hayekian calculation problem. Hayek explained quite clearly what the solution to that problem is: the market. Macroeconomic problems don't really pose that substantial information/calculation problems. We know what to look at to determine whether there's a problem or not. We have all the information we need. Hayek's insights are irrelevant on this question. The problem is an incentive problem.

    In other words, fitting the puzzle pieces together and flipping over the puzzle pieces so that there is no distortion are two very different sorts of problems.


All anonymous comments will be deleted. Consistent pseudonyms are fine.