This is a great statement by Karl Smith. The point really transcends Hayek, of course. After all, Hayek is often not the best source to go to if you want to give primacy to an evolutionary [dare I say yet again - pragmatist] understanding of the world over a logical foundationalist understanding of the world. His Austrian fellow-travelers are often far too caught up in deductionist conceits, and after all it was Hayek that Keynes was referring to with the "remorseless logician" line - and he had some cause for it. Hayek certainly matured into a more evolutionary understanding of our knowledge of the world and he left behind some of the most important applications of those ideas we have. Anyway - these are important insights where ever they come from. I picked up a lot of these ideas from Dewey and Rorty, and most importantly Keynes. But Smith is right to cite Hayek too - it's not a point that should be lost on libertarians (and before people go nuts in the comment section, it should go without saying that I know it's not lost on many libertarians and this is what attracts many libertarians to Hayek in particular - but you're not going to convince me for a second that the sort of thing Smith describes, this cult of reason, isn't out there - even among people who know Hayek and therefore should know better).
Anyway - I've talked long enough. Time to let Karl Smith talk:
"[C]ommon sense lies – as Hayek might have said – between instinct and reason. It has evolved over generations of folks dealing with each other.
And, importantly it does not depend on reason itself. People don’t have to have any understanding of why they believe what they believe for what they believe to be usefully true. That is, operating as if the world was this way informs you about the world.
A reasoned theory of the world should acknowledge this anchor. In some way our reasoning should accommodate common sense. Either as a special case, or as an approximation, or as a local maximum or something.
Otherwise, you have a hard time explaining why common sense has stood the test of time and cultural selection."
Often you'll hear the argument that whether Keynes was right or wrong, he opened the flood-gates to politicians who destroyed fiscal sanity in his name. Buchanan makes this argument in Democracy in Deficit, and recently it's been repeated by Peter Boettke and Don Boudreaux.
It's an absurdly weak line of reasoning, and I want to illustrate why by using the same logic with Hayek - not because I think it's a legitimate case against Hayek (unlike Boettke and Boudreaux with Keynes, I personally think Hayek is an extremely high-caliber economist) but to illustrate how ridiculous the argument sounds:
So let's start by simply assuming that Hayek's great - that paying attention to Hayek will not lead a government astray and will not pile up an unmanageable debt. Hayek, on his own, is fine. But that's not really important. What's important is what Hayek and Hayekian economics gives politicians the license to do. Many politicians over the years have said that they are inspired by Hayek. Thatcher and Reagan are obvious politicians that fit this - both are symbolic of their era and of course have many allied politicians who felt the same way about him. More recently Paul Ryan has listed Hayek as a major influence, and has quoted him (here and here), including at CPAC - a major Republican Party venue. The same goes for Senator Rand Paul, and obviously his father as well. When was the last time Keynes was listed as a top intellectual influence for a President or for a Prime Minister? When was the last time Keynes was promoted at a Democratic Party function? I'm not sure if it's ever happened. You also have Hayek trumpeted by Glenn Beck and promoted on his show. My assertion - which I don't think any honest person looking at the evidence can reject - is that if you think Keynes has set a tone for any set of politicians (whether they are faithful to him or not), then Hayek has obviously set an even more substantial tone for another major set of Republican politicians (whether they are faithful to him or not). Anyone who wants to claim that Keynes gave politicians a license to do what they do has to admit that Hayek, as a major inspiration for a large swath of conservative politicians, has given at least as much license and therefore ought to be judged by the same standards that Buchanan, Boudreaux, and Boettke judge Keynes by in this regard.
So what can we lay at Hayek's feet for the license he gave politicians? Massive military buildups. Large and growing deficits during recessions as well as boom years. A complete lack of will to deal with entitlements or propose a long-term budget solution.
No one who lays these things at Keynes's feet can neglect laying them at Hayek's feet as well. If anything the case is stronger. Ron Suskind's recent book on Obama reveals to us that the president was vehemently opposed to the major Keynesian voices on his economic team. This is Obama - the guy that actually did stomach a modest stimulus two and a half years ago. If this guy has been given license by Keynes, then certainly we can put the Reagan legacy and virtually all post-Reagan Republicans at Hayek's feet.
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I propose something different: we stop honoring this argument as legitimate or logical. I appreciate James Buchanan a great deal. I've said here before I was thoroughly impressed when I was first assigned to read him as an undergraduate. I still am. But James Buchanan did a very poor job thinking about the legacy of Keynes, and unfortunately his arguments have been reproduced widely.
Krugman has made a similar argument about Hayek to what I make above. The difference between Krugman and myself is that he thinks it's actually a legitimate argument against Hayek and I don't. Boettke and Boudreaux seem to understand the problems with this line of argument when it comes out of Krugman's mouth. But when it comes out of Buchanan's mouth about Keynes and when they repeat it themselves, they are completely oblivious to how illogical they sound. Foolishness gets passed off as wisdom. This argument really has to stop. I'm getting to the point where I am having a hard time taking people seriously who make this argument.
If you have a problem with politicians - criticize politicians. Don't bring the bone you have to pick with Keynes into it unless there's a much clearer connection than this one.
In a post on "the lies and misrepresentation spread yesterday by left wing journalists Yasha Levine of Nation and Kate Zernike of the hyper-partisan New York Times", Greg writes that "she’s [Kate Zernike] a demonstrable ignoramus — and a highly bigoted one at that" and "She’s incompetent, yet intentionally deceptive and dishonest to boot." It didn't get truly classy until the comments "Levine & his co-author are trash writers for a hard left yellow journalism Internet rag with roots in most pathological anti-social elements in Russia." And what was that gem in response to? A commenter simply asked for an example of when they had lied! Then more of this: "intellectually incompetent ravings of these reeking sewer rats from the bowels of Russia and the Internet".
And anyone that knows Greg knows this is not a fluke. I really have to steeply discount people that get flustered by DeLong's occasional "shrillness" but can somehow react politely to this.
The biggest problem (for Greg, not me), is that his post offers no reason whatsoever to question the claim that Charles Koch got Hayek to come work for IHS by trying to convince him that America's safety net was strong enough that Hayek didn't have to worry about leaving Austria, which he liked precisely because of the social safety net that they had that was serving him so well in his time of need. Digging in like this only makes the claim look more credible to me. Could they have fabricated it? Perhaps. But the fact that Greg Ransom - a veritable Hayek encyclopedia - simply sputters nasty non-sequitors at it suggests to me he's got nothing.
I like Hayek. I'm pretty much uninterested in the Koch brothers. I like a social safety net. This isn't an argument that Hayek is a bad person. It's a notation that Hayek and Koch both recognize the value of these sorts of things when they let down their guard and think no one is listening.
[A reminder - I do lightly moderate comments for trolls. If Greg or anyone else comes on here and starts bad mouthing my regulars, I don't care what kind of substance is in the comments too - you will be deleted]
Why are Hayekian triangles the shape of a triangle? Why not two axes with an irregular line between them?
Let's pretend the yield curve doesn't exist and there's actually a linear relationship between time and the interest rate. That still doesn't guarantee that it should be a triangle. Although in that case the marginal cost of capital is linear over time, the marginal cost of capital at the point that it is equal to the marginal product of capital need not have this linear relationship with time.
Another way of posing the question is, why can't higher order processes be very heavy in the addition of factors of production, lower order processes be very light in the addition of factors of production (but perhaps time intensive). Or vice versa to such an extreme extent that the capital structure is hyperbolic rather than triangular.
This seems to make a big difference when we get around to:
1. Empirically looking at changes in the capital structure, as Andrew Young does in his forthcoming RAE article, and
2. Thinking about how the capital structure rebalances during a downturn.
And yet I've never heard anyone really ask this question - why is the Hayekian triangle a triangle? I'm not sure if there is a good answer, and if the answer is "there's no reason for it to be", I'm still not quite sure what all the implications of that are.
I'm posting this against my better judgement... every time I touch on anything out of Papola the discussion seems to degenerate at a faster than average rate into pointlessness. But this introduces somewhat new material, so what the hell.
The issue at hand is a 1998 review by Brad DeLong of a book by James Scott about the problems with central planning particularly as they relate to the importance of local knowledge, which Papola mentions in this post. The local knowledge point is one that lots of people have made but of course one very famous person who made this point was Hayek, and DeLong recognizes this. Indeed in the review DeLong takes Scott to task for not mentioning Hayek more in the book. If you want a treatment of the role of very local information in social decision making and allocation, the best place to start is certainly Hayek. Papola follows this link with the statement "I think he [DeLong] was less Keynesian then than now."
I don't understand what makes people like Papola tick. I don't understand this tendency where people imagine that there has to be stark battle lines drawn in intellectual life. DeLong is Hayekian in this 1998 review so he clearly can't be Keynesian, according to Papola. What exactly does Papola think we all think? Does he think that Keynesians are generally opposed to a Hayekian outlook on the economy? I suppose he might actually think that, and I just don't understand it. Do I (and does DeLong) disagree with Hayek? Sure, on certain things. Certainly a few policy areas. Probably some methodological points. A world where there is no disagreement with Hayek is as bizarre as Papola's world where there is no agreement. And in order to generate a stark contrast between "Hayekian" ideas and "Keynesian" ideas Papola has to erect this version of Keynes that is purged of the price mechanism, purged of market efficiency, purged of free market orientation, purged of liberalism, and purged of any disaggregated conception of economics.
In other words, to get "Keynesian" and "Hayekian" to be concepts that repel in his mind, Papola reinvents Keynesianism.
I don't know - maybe life really is this stark and oppositional. I sure hope not. I don't think so. I'd like to keep my Hayek and my Keynes. The first video was pretty good (weak in expositing the point of Keynesianism, but good) because it focused on a very real point where saying you're both Hayekian and Keynesian is a lot harder: the macroeconomics of the business cycle and macroeconomic policy. The broader scope of the second video is precisely what revealed the true paucity of Papola's vision of this "fight" (what an utterly bizarre word to describe the relationship of the thought of these two tremendous thinkers). As I've said elsewhere - I'm positively disposed towards Hayek and positively disposed towards Keynes, but when you present a narrative where I'm turned off by the "Keynes" voice and find myself in agreement with the "Hayek" voice, something is very wrong.
Kumbaya, "can't we all just get along", yadda yadda yadda. I don't mean to be too pie in the sky, but I don't want to invent reasons to fight either.
Niklas Blanchard has a post up on the Keynes-Hayek rap. He also takes issue with the "central planning" line (the list is getting longer). Steve Horwitz thinks we can just chalk it up to poetic license. Now I've been very good about noting the scope for poetic license in most of my commentary on the video, but this is an awfully odd way for Russ and John to exercise it. Poetic license seems to me to be useful for bending truths to fit rhymes... not to fabricate stuff. Why not substitute "fiscal plan" for "central plan"? The proof is in the pudding - many take it literally (Gary Gunnels), and John Papola seems to have intended it literally. And that's... well there's no point in sugar coating it: that's dishonest. In a political climate where I regularly get called a socialist, a statist, and even occasionally a fascist I personally don't think you can just call it "poetic license". Then again, I doubt Steve is ever called those things, which may explain his ability to shrug it off.
Anyway - that's not what I wanted to discuss. I wanted to discuss an interesting contrast that Blanchard draws between what modern self-identified "Hayekians" proclaim and what Hayek actually thought. He quotes David Frum:
"it is precisely a policy response that our modern self-described Hayekians preclude. Monetary policy? No can’t do that – it only leads to inflation and more bubbles. Stimulative government spending then? No that’s out, it leads to inflation, bubbles, etc. Tax cuts for the ordinary working person such as the payroll tax holiday? No way – we must balance the budget. So that leaves only supply-side tax cuts aimed at the upper-income brackets. balanced by large immediate budget cuts in Medicaid, food stamps, unemployment insurance. Does anybody believe that such a policy mix will lead to rapid employment growth? The Heritage Foundation claimed so, for approximately 48 hours, but now even they have abandoned that assertion."
I don't think I necessarily agree on this point about the tax cuts. Usually they aren't opposed to tax cuts for working Americans (although some seem to prefer not supporting any tax cuts to supporting only tax cuts for working Americans). But I think the real point is on monetary and fiscal policy. People who claim Hayek today are adamantly opposed to both.
Blanchard then cites White's JMCB article on Hayek and the depression and points out that Hayek was actually a proto-Sumnerian! When I worked through this paper for my 1920-21 article I remember thinking White's case was a little weak - I'd have to dig up the exact concerns I have. But the point still remains - White argues (I think most think persuasively) that Hayek was open to monetary policy at least, and maybe fiscal policy? (I'd have to review the paper).
This all makes me wonder why nobody talks about "Hayekian economics and the economics of Hayek". Why is that? I have to justify and clarify this point on Keynes all the time. I personally think the distinction between "Keynes" and "Keynesians" is vastly overblown. Neoclassical synthesis was different in presentation from Keynes, but it didn't change any of the fundamental points. The New Keynesians had a Pigovian streak, and I always note that. But that's about all. I also have always argued that while Keynes added new details (the multiplier from Kahn, etc.) his fundamental outlook didn't even change all that radically in his own life. It matured, as everyone's thinking does. But there was no stark difference between a young Keynes and an old Keynes.
Hayek is different - certainly his later focus on spontaneous order and the knowledge problem is an entirely new focus (although not exactly inconsistent with what he had written earlier). And as Blanchard points out, modern Hayekians to a large extent make very different arguments than Hayek if we are to take Larry White at his word. White himself of course is more consistent with what he says Hayek said. Steve Horwitz, who I mentioned above, is also one of those guys that matches White's Hayek in the JMCB article pretty closely. But aside from them and a few others, why is it that the libertarians who are the most consistent with Hayek himself (or White's version of him) are also the libertarians who are least identified with the Austrian school (Sumner, Cowen, etc.). I think someone oughta write a book to match Leijonhufvud's book, and title it On Hayekian Economics and the Economics of Hayek.
UPDATE: And Steve - you can add Greg Ransom to the list of people who think that Keynes advocated what amounted to the same thing Lange and Lerner were saying to Hayek on "collectivist economic planning". Lange and Lerner do advocate "central planning", and Greg thinks Keynes is on par with them. He's not taking it as "poetic license".
John Papola and Russ Roberts' new Keynes v. Hayek video is up. It is very high quality and entertaining, like the last one. I have a few reservations about the content, though (also like the last one) - but it's still worth a watch.
First and foremost, is this really "the fight of the century"? The contrast between Keynes and Hayek just seems so artificial to me. I've always been a proponent of what's been called "Hayekian micro" and see no contradiction with Keynes on that front. In some ways, Hayekian micro is more consistent with Keynesianism than more traditional neoclassical micro. As for Hayekian macro, I've always thought there was something to that too (Keynes thought there was something to it as well), it just doesn't seem to provide a viable counter-argument to the liquidity preference theory of the interest rate, and therefore it doesn't displace Keynes. Keynes still provides the best view of the macroeconomy that we have, and I think Hayek provides a good treatment of a more specific process that probably also goes on. Of course, when we juxtapose Keynes and Hayek it's often a stand-in for the libertarian and non-libertarian strains of the classical liberal tradition. OK, fine. There is some conflict on that front. But they seem to be allies in the liberalism vs. fascism or liberalism vs. central planning fight. In economics itself their conflict doesn't really exist in any real way in micro (Keynes didn't weigh in there and there's nothing about Hayek's micro that contradicts Keynes), and their conflict in macro is fairly marginal compared to other macro fights (I know it doesn't seem this way from some corners of the blogosphere, but it really is).
Another issue with the video is that Keynes is referred to as "central planning", "top-down", "chessmen moved on a board at a whim", etc.. Oh please. If this is artistic license, then OK. As I said, I enjoyed the video and don't want readers here to get the impression that I'm disparaging it over what amounts to artistic license. The concern, though, is that people that are starting to get interested in these subjects and are relatively new to Keynes and Hayek are going to get a very skewed idea of Keynesianism.
A recurring problem in this video is that it distorts Keynesianism in much the same way that the first one did - namely, Keynesianism is reduced to "C+G+I=Y, so if we boost G we boost Y". This is exactly what you're supposed to learn that Keynes was not saying. John and Russ are confusing accounting identities with behavioral laws. They're confusing a static economy with a dynamic Keynesian economy. This is a very bad habit in economics. In the last video, we had the Austrian theory of the interest rate, but no Keynesian theory of the interest rate. In this video we have neither theory. So once again, John Papola gets hung up on this "you can spend on anything - it doesn't matter" issue. That sounds very strange if you think that Keynesianism is "if we boost G, we boost Y". It makes more sense when you realize it's about government note creation - Keynes's version of the helicopter drop.
Econometrics makes its way into this video as well, in some funny ways. First, I'm not sure why the Hayek character thinks that econometricians have a predisposition to Keynesianism. Any macroeconomic theory is going to have its cadre of econometricians and empirical evidence. Second, it's odd that Russ keeps making this claim about how unscientific this work is... we're still waiting for Russ's "Great Austerity Hoax" post about the Heritage analysis where two economists formerly affiliated with GMU use exactly the same models that stimulus advocates used!
Another thing that might be worth noting is that the Austrian inferiority complex comes out here, as in the last one. Hayek isn't recognized at the door again and gets a cavity search (the Hay-eksplosives line was great!), he loses in the end despite punching out Keynes, etc. This is all a little silly too. Hayek won a Nobel Prize. He's widely recognized as a towering figure in economics. He's not a marginal figure. Keynes is lionized too, of course - and for good reason. And he's not celebrated today despite being proven wrong. He's celebrated because most of what he predicted has been borne out by the data. We can note that you can squeeze Austrian theory into the data too if we are so inclined. Predictions about interest rates and inflation that Keynesians got right are a little embarassing for some Austrians, but you can make a case for them. But it's simply not true that Keynes has been knocked out here. John and Russ and many others want to ascribe Keynes's success to politicians - because apparently politicians love Keynes (you could have fooled me - I thought everyone's been trying to outdo each other on deficit reduction). Personally, I think it's more than a little condescending for John and Russ to keep repeating this sort of thing. Politicians get elected on promises to "rein in spending" - you don't see me going around saying that the only reason Hayek is having a revival is that politicians love him. I know that's condescending and I know that's simply not true, despite the apparent coincidence between what some politicians say and what Austrians say. That's not the reason why a large share of the profession is coming around to ideas they had rejected for decades in the case of Keynes or Hayek.
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So in summation, it's a great video. It's always tough to talk critically about this or the last one because I do think there's a degree of artistic license and I do thoroughly enjoy the videos. But you have to be careful with these as well. I think people could really enjoy this if they come at it knowing something about the economics of Keynes and the economics of Hayek. But for less informed viewers, a lot of these videos can be extremely misleading. And the "central planning" lines, etc. are very unfortunate - even from an artistic license perspective. It makes me less interested in taking part int he discussion if that's what "the other side" thinks of me, and I'm sure I'm not alone. If you want to fight with a central planner over the pretense of knowledge go find a central planner, and stop wasting your time with Keynesians.
- This is an old post on the prospect of a Keynesian-Austrian synthesis. Also here and here. I sketched out some of the math on this a couple weeks ago in response to a conversation at Coordination Problem where - again - commenters insisted on this false choice between Keynes and Hayek. I hope to finish that this fall. The posts above actually don't get into exactly what that entails - essentially I was working on an IS-LM models with a capital structure. Or, if you prefer, a capital structure model with a liquidity preference theory of the interest rate.
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What are people's thoughts on the video? I want to draw people's attention to my new comment policy - I'm not going to put up with drive-bys anymore.
UPDATE: One more point I meant to mention on the substantial WWII segment in the video. I think the episode is suggestive, and it's suggestive in clear favor of Keynes - but it's very hard to make much of it because as Hayek says in the video, it's just one datapoint. However, one of the things that bothers me about this talk about WWII is the idea that all wars are all waste. I am always stunned that people talking about WWII from a Bastiatian angle are so loathe to note that keeping fascists from dominating Europe was a very, very good thing. War is hell. It's not something to be excited about. It causes lower standard of living at home. It does all these things. But Nazis are more hellish, and I wish people would do less insinuating about how the draft tinkers with unemployment figures and be more explicit about the fact that those soldiers were fighting for a free world.
Commenter Prateek Sanjay makes a good criticism of central planning in the comment section to this post, and I don't disagree with him. The sorts of price controls and planning he describes are things that the market does very well and that the government does very poorly.
But I see this sort of planning as fundamentally different from the interventionism that Keynesians such as myself and Brad DeLong in his recent Project Syndicate article usually advocate. We need not be reminded about market efficiency. We are well aware of it. Most of us even like Hayek on the uses of knowledge in society. It's excellent stuff. You hear Keynesians complaining about Austrian Business Cycle Theory, but you rarely hear denunciations of his perspective on the uses of knowledge in society. It's because there's no great quarrel (maybe there were a few Hayekian turns of phrase that some Keynesians might have taken issue with - but no fundamental quarrel exists).
The difference between planning as Hayek critiqued it and intervention as Keynesians advocate (I'm not sure what a good word for this is - maybe "management"?) is precisely that Keynesians identify where the market functions Hayek describes aren't really relevant. Some people have taken to calling this "market failure", but I don't really like that phrase much. The market hasn't failed, it simply doesn't have the inputs required for market efficiency. It's silly to blame the market for that!
Several months ago I had a whole series of posts on this issue, which I characterized as "calculation problems vs. incentvie problems". This line of thinking is still what fundamentally informs when I sound like a Hayekian and when I sound like an interventionist, but I realized a lot of people like Prateek probably didn't read or comment here when I was thinking a lot of that through. So in case you're interested in how I approach these questions, my posts with the "calculation vs. incentive" tagline are here. Very closely related are my posts with the "externality" tagline, which are here. I think the concept of an externality is much firmer than the concept of a "market failure". I think my differences with the Austrian school come from two primary places: (1.) the difference in our theory of interest, which drives the difference in the way we think about money and general gluts, and thus the relative emphasis we place on different explanations of depressions, and (2.) our understanding of how the market process works when confronted with externalities - I think Mises, for example, butchers the question which is the source of a lot of subsequent confusion. I discuss Mises's problematic treatment of externalities here.
Anyway - just thought that background was important for people to understand my take on intervention. I'm working on some research right now comparing Calvin Hoover's (an American Keynesian) perspective on this question and one other to Hayek's perspective. Keynes died before he could engage these issues with Hayek, and I'm trying to think about Calvin Hoover as a useful lens through which we can understand how Keynes might have responded - where he would have agreed and disagreed with Hayek.
Tyler Cowen challenges Bob Murphy and ABCT on the grounds of what he considers to be an embarassing co-movement of investment, capital maintenance, and consumption during the boom. Murphy had originally claimed that investment and consumption can move together because capital maintenance is neglected.
A few obvious questions emerge from this explanation from Murphy. The first one that comes to my mind is also mentioned by Cowen - why would monetary expansion encourage investment but not capital maintenance? Wouldn't those same low interest rates that encouraged malinvestments also encourage capital maintenance? It seems to be an awfully convenient thing for Murphy to grab for.
But the whole discussion also reminded me of something that Hayek said in Prices and Production (lecture 2) that has bothered me since I first read it. It solves the co-movement problem without resorting to Murphy's capital maintenance explanation. The problem is, I'm not sure why we should believe this "solution". Hayek writes:
"The raison d'etre of this way of organizing production is, of course, that by lengthening the production process we are able to obtain a greater quantity of consumer' goods out of a given quantity of original means of production. It is not necessary for my present purpose to enter at any length into an explanation of this increase of productivity by roundabout methods of production."
So Hayek says that you don't even need to resort to the neglect of capital maintenance. Investment and consumption move together because the lengthening of the capital structure makes investment more productive.
I wish he had explained it more because I see absolutely no reason to think this is true. He's not talking about technological progress that happens to elongate the capital structure. He's simply talking about increased roundaboutness itself. Why does that - in and of itself - make things more efficient? Does anybody believe this?
This line always bothered me for precisely the reason that I think Murphy's explanation bothers Cowen - it seems like a very convenient solution to the problem that is also conveniently short on details, citations, or empirical support. Take this assumption away and (it seems to me) you still have a theory of the business cycle that makes some sense (unsustainable changes in the capital structure - malinvestments that might need to be liquidated later on), but one that seems less binding theoretically (why can't we just grow into these malinvestments - clearly some roundabout production is necessary, and regular growth rates should allow us to eventually make use of investments that, just a few years ago, where malinvestments) and less convincing empirically (Tyler's co-movement problem reemerges).
Robert Skidelsky and Bruce Caldwell on Hayek and Keynes in the Depression. These are lectures from Soros's new Institute for New Economic Thinking organization.
Skidelsky says something interesting - he says we should embrace theories that accept the possibility that depressions happen, and that it is the Austrian and Keynesian theories that do so and they need to be the "building blocks" for theory as we go forward.
From "A few remembrances of Friedrich von Hayek (1899–1992)," Journal of Economic Behavior & Organization 69, pp. 1–4. This selection on Prices and Production is quite harsh, but Samuelson has better things to say about other work that Hayek had done later in the article. Nevertheless, that other work is not the subject of our reading group!:
"Rise and Fall of 1931 Prices and Production
There were good historical reasons for fading memories of Hayek within the mainstream last half of the twentieth century economist fraternity. In 1931, Hayek’s Prices and Production had enjoyed an ultra-short Byronic success. In retrospect hindsight tells us that its mumbo-jumbo about the period of production grossly misdiagnosed the macroeconomics of the 1927–1931 (and the 1931–2007) historical scene.
When a centrist like me says this about an extremist like Hayek, readers have a right to reserve judgment. More weighty was the later opinion to the same effect of the conservative Lionel Robbins. It was Robbins who had brought Hayek out of Austria to the LSE. It was Robbins who wrote a 1934 Hayekian book entitled The Great Depression. Not so very long after 1934, Robbins repudiated his own early take, saying in effect, I must have been a bit loony at the time. Aside from the substance of Hayek’s (1931) text, part of his short-lived popularity came from the fact that many in England, annoyed by Maynard Keynes’s unorthodox testimonies before the 1930 Macmillan Committee, hoped that Hayek would be the White Knight to slay the Black Dragon.
Productivity and reputation of Keynes itself fluctuated in Kondratief waves. His 1930 two-volume Treatise on Money posterity judged to have been an anti-climatic flop. But the deeper the drop into the 1929–1935 Great Depression, the more rapidly came the recognition of Keynes as top dog in the twentieth century. (In 1932 as a 16-year-old freshman, I asked my Chicago tutor, Eugene Staley: “Who is the world’s greatest economist?” He answered, “John Maynard Keynes.” For once I never became tempted to question the authority of my many great teachers.)
Gentle Charles Darwin had Thomas Huxley to be his bulldog for evolution. Sraffa (1932) must have been editor Keynes’s bulldog to annihilate Prices and Production, and its author. I never much admired Sraffa’s methodological contentions in that debate but at least his item did have the merit of introducing for the first time Sraffa’s novel concept of “the own rate of interest” in terms of corn or rye or caviar.
For my money more to the point was Richard Kahn’s simple oral 1932 statement:
"If Hayek believes that the spending of newly printed currency on employment and consumption will worsen our current terrible depression, then Hayek is a nut."
Alas, one fatal error eclipses a few elementary true truths á la Mises and Hayek: Easy money now often does entail tighter money later which will come as a surprise to uncompleted projects and new contingent contemplated investment projects. Hayek himself, naively, diagnosed the fall of his 1931 opus as due to the fact that his period-of-production mutterings there did not do full justice to the not-yet-completed Austrian theory of capital (Menger, Böhm et al.). Therefore, heroically but hopelessly, he wasted years on a task that he was grossly under-equipped to handle. Hayek’s (1941) The Pure Theory of Capital was not stillborn. But it was a pebble thrown into the pool of economic science that seemingly left nary a ripple."
I share this to (1.) note the thoughts of a giant in modern economic thought on the subject of our studies, and (2.) to demonstrate that I'm not the harshest critic of Hayek out there!
Richard Kahn, by the way, is credited with shoving Keynes towards thinking more about employment than he had previously in the years between the Treatise on Money and the General Theory.
Hayek uses the first lecture in Prices and Production to lay out what he sees as the developmental trajectory of monetary theory, as well as an introduction to the advances he proposes to make in subsequent lectures. He identifies four stages of theory, the last of which is said to be in its infancy in 1931, when Hayek wrote the lectures.
The first stage is more or less what most people know of as the quantity theory of money. Hayek has two primary critiques of this approach: it is analytically problematic, and even if it weren't problematic it is practically useless. I think Hayek errs on both of these points (which is not to say that I disagree with him that monetary theory could be developed beyond the quantity theory). First, Hayek suggests that "none of these magnitudes as such ever exerts an influence on the decisions of individuals; yet it is on the assumption of a knowledge of the decisions of individuals that the main propositions of non-monetary theory are based". In this sense, Hayek sees a divorce between monetary theory and what we would know as microeconomics. He continues, "if, therefore, monetary theory still attempts to establish causal relations between aggregates or general averages, this means that monetary theory lags behind the development of economics in general. In fact, neither aggregates nor averages do act upon one another, and it will never be possible to establish necessary connections of cause and effect between them as we can between individual phenomena".
Towards the end of his discussion of the first stage, Hayek writes that "you are all sufficiently familiar with this type of theory to supply these [examples] for yourselves and to correct any exaggerations which I may have committed", and so I'll take him up on this and correct some exaggerations. What Hayek appears to miss here is that the quantity theory is useful not as a behavioral law or a statement of causal relations, but simply as a statement of accounting. If you take all the prices charged in an economy and add them up, and then take all the instances that a particular piece of money in the economy was spent and add all those up, the two sums have to be equal to each other. This is a definitional constraint on the system. Think of it as analogous to the "conservation of energy" in physics. On its own, the conservation of energy doesn't tell you anything about cause and effect, and it doesn't tell you about the dynamics of a particular system. Its power is in parameterizing the system so that when action does occur as the effect of some other cause, that action is forced to conform to the conservation of energy, and so the conservation of energy is a useful principle in understanding how cause and effect play out in physical systems. The same is true of the quantity theory of money. Hayek fundamentally misunderstands the very purpose of these theories if he thinks they imply some sort of causal relationship.
The second thing that Hayek critiques about this first stage is his claim that anything that the quantity theory can tell us is relatively useless. He writes "for none of these magnitudes as such ever exerts an influence on the decisions of individuals; yet it is on the assumption of the knowledge of individuals that the main proposition of non-monetary economic theory are based". This seems odd. The various problems associated with inflation and deflation are very well understood, and were most definitely understood when Hayek wrote these lectures. Fisher had not yet written his famous article on debt-deflation theory, but I don't think anyone has claimed that these ideas were especially original to Fisher. Keynes wrote extensively on the differential impact of inflation and deflation in 1923, and I know Hayek read that book. Debt-deflation, the differential impact of deflation on quits and layoffs, the differential impact on the distribution of wealth and the implications for demand, etc., can't be investigated by asking "what does the price do in this particular market - how do relative prices change?". These things can only be investigated by asking "what happens to the general price level?". So on both counts, I think Hayek is quite misguided in his critique of the "first stage" of monetary theory, although he's certainly right that there is more to be said.
The second stage Hayek identifies is the attempt by Locke, Montanari, Cantillon, and others to trace the path through which an increase in the money supply affects prices. The modern equivalent is something like the "monetary transmission mechanism", which has been so central to Ben Bernanke's own research (back when he did research!). He has a few other things on his plate right now, but even now this transmission mechanism problem has played a substantial role in how he has handled his tenure as Fed chairman relative to Greenspan. I was very interested in this section of Hayek's lecture to see some vague allusions to a long-run vs. short-run Phillip's Curve relationship: "Hume, however, makes it clear that, in his opinion, "it is only in this interval or intermediate situation, between the acquisition of money and the rise of prices, that the increasing quantity of gold and silver is favourable to industry".
The third stage of the development of monetary theory was the link between money and the interest rate. Hayek attributes this insight to many people, including Malthus, Mill, Bentham, etc. - but of course it is found in its most developed form in the hands of Knut Wicksell. Hayek muses that "by a curious irony of fate, Wicksell has become famous, not for his real improvements on the old doctrine, but for... his attempt to establish a rigid connection between the rate of interest and the changes in the general price level." This was interesting to read because I know Wicksell best for his "natural rate of interest" and loanable funds market theory of interest work, and not for whatever this other point is that Hayek is refering to. Clearly, the discipline has recognized in Wicksell as important exactly what Hayek recognized as important in 1931. That's encouraging! In 1931, Hayek felt that Wicksell was being acknowledged for the wrong thing, but now in 2010 we all acknowledge Wicksell for the work that Hayek thought was important.
I have another critique of Hayek here - I think he is far too hard on Wicksell when it comes to equilibrium and the price level. Hayek writes "according to Wicksell, the equilibrium rate of interest was a rate which simultaneously restricted the demand for real capital to the amount of savings available and secured stability of the price level" - taking issue with this position, Hayek counters that "the banks could either keep the demand for real capital within the limits set by the supply of savings, or keep the price level steady; but they cannot perform both functions at once. Except in a society in which there were no additions to the supply of savings, i.e., a stationary society, to keep the money rate of interest at the level of the equilibrium rate would mean that in times of expansion of production the price level would fall." Hayek's analysis here is right, of course, but I think his critique of Wicksell is misguided. Wicksell provides us with a loanable funds market equilibrium, right? The equilibrium position assumes a given demand for and supply of loanable funds. Of course if there is an "expansion of production the price level will fall", as Hayek says - but the whole point is if there is an expansion of production there will be a shift in the demand for loanable funds and there will be a new loanable funds market equilibrium. Imagine if you were describing a market for food and you noted that where supply and demand met you had an equilibrium price where the real price level would be stable. Hayek here is saying "well that doesn't make sense because if you make more bread the price level will fall!". Certainly it will, but that's because the supply curve has shifted. So, just as I would not take his critique of the quantity theory very seriously, I would not take his critique of Wicksell very seriously. There are ways to complicate and add to the loanable funds market, but there's nothing fundamentally wrong with it.
The fourth stage of the development of monetary theory is of course Hayek's turf: the impact of changes in the quantity of money on relative prices, particularly prices of the same good over time. I can't argue with the fact that this is one avenue to develop. I've never accused this version of ABCT of being illogical. Hayek is a little vague on why exactly this is such an important culmination of prior monetary theory. It appears to me to be an interesting side-issue to look into, not a conclusion towards which monetary work was naturally heading. But of course, my bias in this regard is probably obvious. If you asked a group of people reasonably well educated in the history of economic thought "which early twentieth century economist earned his fame for his work bringing monetary economics into mainstream economic theory", the answer would not be Hayek. The answer, in all likelihood, would be Keynes. This is not to say that Keynes invalidates Hayek's work. This was, at it's core, both of their projects. They both sought to make monetary theory relevant for the broader world of economic theory. My feeling is that Hayek took this project down a detour. It is an interesting detour and probably an accurate detour, but a much less significant path than the path that Keynes took. This seems to be the assessment of Hayek and Keynes's peers and descendants as well. Money is important because it is the medium through which demand is translated into effective demand, and the quantity of circulating medium substantially influences the efficacy of demand in stimulating production. I don't want to make this a post about Keynes, but the similarity between their missions was absolutely unmistakable in reading this first lecture.
I guess my lingering question is "why is this the fourth stage, other than because Hayek is writing about it and he wants to put it in the context of earlier stages?" Any answers? Why should I care more about relative prices than about the impact of money on effective demand?
*****
Other discussions of Hayek's first lecture tied into our reading group (graciously organized by Jonathan Catalan) can be found here, here, and here. Please let me know if I've missed one.
I'm going to try to finish the first lecture up tonight and maybe post tomorrow morning (if I'm awake... it was a full working weekend and I'm burned out on a Monday - not good), but Jonathan's first post on Hayek's Prices and Productionis already up. There is also a thread going on his forum here (it will be interesting to see how these multiple venues work together).
I've mostly been studying for the GRE this weekend, but I took a break from that last night to read some more of Lovecraft's letters. Still no reference to Keynes, although he cites an awful lot of British figures that were deeply influenced by Keynes. Lovecraft is nothing if not well-read and well-informed (even though he puts a fairly eccentric spin on a lot of things).
I thought readers of this blog would be interested in a brief reference to Hayek and Robbins:
"But the real joke of course is, that all this isn't a matter of choice anyhow! Capitalism is dying from internal as well as external causes, and its own leaders and beneficiaries are less and less able to kid themselves. I'm no economist, but from recent reading I've been able to form a rough picture of the dilemma - the need to restrict consumers' goods and to pile up a needless plethora of producing equipment in order to maintain the irrational surplus called profit - which has caused orthodox economists like Hayek and Robbins to admit that only starvation wages and artificial scarcity could stabilize the profit system in future and avert increasing cyclical depressions of utterly destructive scope. Laissez-faire capitalism is dead - make no mistake about that. The only avenue of survival for plutocracy is a military and emotional fascism whereby millions of persons will be withdrawn from the industrial arena and placed on a dole or in concentration camps with high sounding patriotic names. That or socialism - take your choice. In the long run it won't be the New Deal but the mere facts of existence which will be recognized as the real and inevitable slayer of Hooverism. Nobody is going to "destroy the system" - for it has been destroying itself ever since it evolved out of the old agrarian-handicraft economy a century and a half ago." [letter to Catherine L. Moore, Feb. 7, 1937]
"On the question whether to spend or whether to invest our position is different from the signatories of the letter which appeared in your column on Monday [by Pigou, Keynes, and various other Cambridge economists]. They appear to hold that it is a matter of indifference as regards the prospects of revival whether money is spent on consumption or on real investment. We, on the contrary, believe that one of the main difficulties of the world today is a deficiency of investment - a depression of the industries make for capital extensions etc, rather than of the industries making directly for consumption. Hence we regard a revival of investment as particularly desirable."
I extended the selection from the Lovecraft letter beyond the mention of Hayek to highlight Lovecraft's position on fascism. It's been very encouraging to read his later letters where he has unequivocally turned against fascism and the Nazis (and for that matter, he doesn't talk about racial inferiority as much either - although I'm guessing he still maintained those views). In the early thirties he treated the Nazis as fascinating curiosity. He never liked them per se. He always talked about how crude and ultimately dangerous Hitler was. But he would regularly allude to the fact that they were on to something because society could not undergo a Communist revolution but it had to be more forcefully commanded. By '35, '36, and '37 that seems to have faded away completely. In the early thirties he would use "Marxist" and "Communist" as an epithet for leftists who he thought dangerous. Now, in '36 and '37 he uses "fascist" and "Nazi" as an epithet for right-wingers. He makes references to "Wall Street Nazis", for example. The early romance with fascism has faded, and I have to say I'm relieved. Lovecraft has grown on me. I know he died eighty years ago, so even if he had a soft spot for Hitler until the end it's not like that should really affect me, and it's not like that would change how fascinating and brilliant he was. But it is nice to know the brief infatuation did seem to come to an end.
I went kayaking with my dad yesterday, just upriver from one of my favorite places: Mount Vernon, and he brought along a big box of my papers I had left at the house from undergrad. I threw away most of it, but kept a few things - including material from my honors thesis, a lot of readings from my history of economic thought class, and several readings from a week-long workshop in experimental economics at George Mason University. This was my first real exposure to George Mason economics and the Austrian school, which of course came up a lot that week. I thought I'd share a selection from a Vernon Smith lecture we got at the workshop. This was based on his Nobel Prize lecture, which can be found in the AER here. It looks like the text is largely similar, but I'll be using the lecture I have. By way of introduction, Smith starts by introducing the two types of rational orders that Hayek identified - constructivist and ecological rationality. Constructivist rationality is the "conscious deliberate use of reason to analyze and prescribe actions judged to be better than alternative feasible actions that might be chosen", and ecological rationality "refers to emergent order in the form of practices, norms and rules governing action by individuals and institutions that are part of our cultural and biological heritage, created by human interactions, but not by conscious design".
Smith says:
"Roughly, we associate the former with attempts to invent or design social systems, and the latter with processes of discovery in natural social systems. As we shall see, the two need not be mutually exclusive, opposed or incompatible: we sometimes apply reason to understand and model emergent order in human cultures and to evaluate the intelligence and function of such order. Again, individuals and groups invent products, ideas, policies, etc. but whether they endure or are copied is subject to forces of selection and filtering that are well beyond the control of the initiators. Ecological rationality, however, always has an empirical, evolutionary and/or historical basis; constructivist rationality need have none, and where its specific abstract propositions lead to some form of implementation must survive tests of acceptibility, fitness, and/or modification.
In our time it was Hayek who articulated forcefully the idea that there are two kinds of rationality. He did this with characteristic insight in several lectures and articles. I am not aware, however, that this important idea has had any significant influence on economic thinking, certainly nothing like the influence of his recognition that the market pricing system serves as an information and coordinating system. If my assessment is correct, why has the idea not been influential? I would conjecture that a critical element in understanding this proposition is to be found in human perception. We naturally recognize only one rational order because it is so firmly a part of the humanness of our reason. Emergent rational orders are not plainly visible to our perception, intellectual curiosity, and reason."
If anything I think Smith is being pessimistic here (and certainly unnecessarily pessimistic outlooks have played an important part in propelling research agendas). People may not use Hayek's words (and perhaps using Hayek's words and citing Hayek would bring more precision to the discussion), but I think the point here is intuitive and broadly recognized. Take as an example the last chapter of The General Theory of Employment, Interest, and Money.
Keynes writes of individualism and decentralization of decision making:
"It is also the best safeguard of the variety of life, which emerges precisely from this extended field of personal choice, and the loss of which is the greatest of all the losses of the homogeneous or totalitarian state. For this variety preserves the traditions which embody the most secure and successful choices of former generations; it colours the present with the diversification of its fancy; and, being the handmaid of experiment as well as of tradition and of fancy, it is the most powerful instrument to better the future."
Decentralized action, for Keynes, united all the most important guarantors of future betterment: (1.) traditions that (to quote Smith) emerge through "forces of selection and filtering that are well beyond the control of the initiators"; (2.) what Keynes calls "the diversification of its fancy" (i.e. - personal preferences of the current generation), and (3.) support for experimentation with new ideas.
And Keynes certainly proposes ideas for experimentation - derived from a constructivist approach to the economy and a cognizance of the emergent system on which he is commenting. Earlier he writes:
"At the same time we must recognise that only experience can show how far the common will, embodied in the policy of the State, ought to be directed to increasing and supplementing the inducement to invest; and how far it is safe to stimulate the average propensity to consume, without foregoing our aim of depriving capital of its scarcity-value within one or two generations. It may turn out that the propensity to consume will be so easily strengthened by the effects of a falling rate of interest, that full employment can be reached with a rate of accumulation little greater than at present. In this event a scheme for the higher taxation of large incomes and inheritances might be open to the objection that it would lead to full employment with a rate of accumulation which was reduced considerably below the current level. I must not be supposed to deny the possibility, or even the probability, of this outcome. For in such matters it is rash to predict how the average man will react to a changed environment. If, however, it should prove easy to secure an approximation to full employment with a rate of accumulation not much greater than at present, an outstanding problem will at least have been solved. And it would remain for separate decision on what scale and by what means it is right and reasonable to call on the living generation to restrict their consumption, so as to establish in course of time, a state of full investment for their successors."
Keynes has a long history of couching his ideas in the necessity of experimentation and the response and openness of society to change. In my 1920-21 paper, I cite instances in his earlier Tract on Monetary Reform where he does the same thing.
None of this is to say Keynes "beat Hayek to it", it's simply to say that Hayek's point, being right, is necessarily reflected in the way that a lot of people approach economic and social policy making. How broadly and how explicitly it is accepted is a different matter, of course. Vernon Smith thinks that most people, seeing a pattern, assume the existence of a designer. I suppose this might be true. Most people certainly don't analyze patterns in social life as emergent patterns with the erudition of a Vernon Smith, a Friedrich Hayek, or a John Maynard Keynes. Does that mean they think someone consciously designed it, or does that just mean that they don't really put much thought into the origins of patterned and structured social life when they see it? I don't really know, but I would tend to be somewhat suspicious of the assumption that they assume the existence of a designer. I think people generally adopt a viewpoint that in sociology is called "functionalism" - social institutions and patterns exist because they are functional and therefore persist. Ask someone about why we do things a certain way as a society - "because it works well" is likely to be the response. Functional institutions survive, dysfunctional institutions die off or get replaced.
Yesterday I remarked that Okun's Law seems to be broken. I think I should provide more background on this. Of course "Okun's Law" isn't a scientific law at all - it's just a rule of thumb. But it' a consistent rule of thumb that is worth remarking on when it breaks down. It states that for every two percent decrease of output from potential output, we can expect to see the unemployment rate rise by one percent. We're not seeing this now (and I should note - people have been remarking on this for a while now, it's just gotten new attention recently, even if not by name from all commenters) - unemployment is a lot higher than Okun's Law would predict. It's just a rule of thumb - there's nothing deeply existentially troubling for the economist to see that it's not working. But it is grounded in enough sensible economics that it's worth asking "why is this time so different?"
It is useful to note that this break-down is happening in a lot of places. Greg Mankiw suggests that the Phillip's Curve might be exhibiting unusual behavior too (this is not new misbehavior for the Phillip's Curve, a more regularly misbehaving rule of thumb).
Mark Thoma and David Altig note another misbehaving rule - the Beveridge Curve, which relates unemployment to job vacancies. Like the Phillip's Curve, it's not particularly surprising that the Beveridge Curve is misbehaving. It shifts up and down with the matching efficiency of the labor market. So this change is the least mysterious.
Russ Roberts remarks on the same disconnect between employment and output, and he seems to think that this is troubling for Keynesians. He circles around a couple (IMO) relatively unimportant issues for a while, and then he writes this:
"I’m not saying Keynes (or Obama or Larry Summers) is wrong because all spending does is bid up prices and wages. I’m not trying to prove that the stimulus failed. I’m challenging the standard macro textbook story that says aggregate demand leads to output that leads to employment."
So we have a situation where Russ is not trying to say that employment isn't going up because stimulus is channelled into wage and price changes (a little redundant, but nevertheless...). He makes it clear that he's not making that argument. The stimulus-to-output chain may be weak for him, but it's plausible. His problem is how "the standard macro textbook" explains the output-employment link. Okun's Law, in other words. Roberts goes on:
"The textbook aggregate demand story ignores how people view the future– the animal spirits–the confidence employers, investors, and consumers have about the future. If employers are anxious about the future (partly because the government is running up debt and because the regulatory environment is highly uncertain and partly because we’ve had a run of bad times), then spending doesn’t obviously create jobs."
I did a double-take when I read that, because it was easily the most Keynesian thing I've ever read on Cafe Hayek. Concern about the future means that money may not go to prices or employment - it may go to liquidity which ultimately has it's roots in fear of "the dark forces of time and ignorance that envelope our future". Of course Roberts doesn't seem to recognize that this is a very Keynesian insight. Perhaps he does, but there's no indication of it.
What does this have to do with all the other rule-breaking? The best explanation I've seen so far for why changes in the Beveridge Curve, the Phillip's Curve, and Okun's Law all relate to liquidity preference is Roger Farmer. I really, really, really need to get this man's new book.
So the obvious question in my mind is "did Keynes forsee this". Unfortunately, I can't say right now but I'm going to check up on it this weekend. Hicks clearly didn't. For Hicks, liquidity preference broke the link between money and output, not between output and employment. In other words, in the IS-LM model, Okun's Law should work fine because all the disruption of liquidity preference happens before output even comes into the picture. I know Hayek did critique Keynes for not presenting a detailed enough explanation of the relationship between employment and output (does anyone know where he said this... I'm very, very curious now). What I don't know is whether Hayek's critique was valid or not. Did Keynes have as simple of a view of the output-employment relationship as Hicks (in which case the critique is valid), or didn't he?
UPDATE: [Coordination Problem and Taking Hayek Seriously pick this up as well. The commentary on Taking Hayek Seriously is a little much (there are references to binging, spending on "any and every projects they might imagine", and similar characterizations I can't place or make sense of)... lot's of straw men without a single quote from the Cambridge letter. Coordination Problem is characteristically classier. I have my disagreements, but it is what it is.]
UPDATE 2: [It's really a shame Mario Rizzo isn't a Keynesian - he'd make a damn fine one. Oh well. In the comment section to his post he includes this source as well, highlighting how counter-cyclical spending and Keynesianism are related. Anyone who has read any economics from the 1920s knows that while there's a lot of common ground between advocates of counter-cyclical spending and Keynesianism, Keynesianism (i.e. - The General Theory and work that built on it) by no means originated it, nor was it defined by it. The paper Mario links to explains the different paths that the Chicago School and the Keynesians took from a common, initial support for counter-cyclical fiscal policy. The paper seems to focus on Keynes's thoughts on government budgeting - needless to say there are also additional theoretical departures from the early counter-cyclical spending literature that justify Keynes's practical advice on budgeting]
The Cambridge crew writes:
"when a man economizes in consumption, and lets the fruit of his economy pile up in bank balances or even in the purchase of existing securities, the released real resources to not find a new home waiting for them. In present conditions their entry into investment is blocked by lack of confidence. Moreover, private economy intensifies the block. For it further discourages all those forms of investment - factories, machinery, and so on -- whose ultimate purpose is to make consumption goods. Consequently, in present conditions, private economy dos not transfer from consumption to investment part of an unchanged national real income. On the contrary, it cuts down the national income by nearly as much as it cuts down consumption. Instead of enabling labour-power, machine-power and shipping-power to be turned to a different and more important use, it throws them into idleness."
Before this statement, they noted that frugality in World War I did not have these problems because resources were directed towards what they call "an insatiable war machine". They follow this point by highlighting that the same effective demand logic applies to government that applies to individuals.
Rizzo highlights two critiques from Hayek, Robbins et al.. The first is a critique of Keynes, Pigou et al. on their hesitation in the purchase of existing securities. The LSE crowd contends that purchase of these existing securities is necessary for the issuance of new security and investment and so is a good thing. I really agree with both Cambridge and LSE on this, and I think to a certain extent they're just talking past each other. I don't think the Cambridge letter is saying that there is anything inherently destructive about the investment in existing securities themselves. Their point is more that such investments in existing securities, as well as deposits, are symptomatic of the reduced demand for consumption and investment - and that reduced demand is problematic. I would agree with that. Robbins and Hayek seem to miss that and treat it like Keynes and Pigou are arguing that investment in existing securities is the problem in and of itself - and not a symptom of the problem. The Hayek/Robbins solution is essentially saying "let's satisfy this demand for liquidity so the economy can get back on its feet - let's buy those existing securities". To which I think the Keynesian response would be "fair enough - but there are better ways to do that than waiting for the demand for liquidity to be satisfied - particularly since we think that this liquidity preference is artificial in the first place". In other words, I think they're talking past each other on this point - which provides a marvelous precedent for the modern debate as well!
I think Rizzo fails to quote what I think is the most interesting part of the Hayek and Robbins letter. He references this point I mentioned above on existing securities, as well as an additional concern about public debt. So far that's just (1.) talking past Keynes and Pigou on securities, and (2.) a standard Reinhart-Rogoff position on being careful about public debt. Rizzo doesn't quote the part where Hayek and Robbins's Austrian bona fides really stand out. They write:
"They appear to hold that it is a matter of indifference as regards the prospects of revival whether money is spent on consumption or real investment. We, on the contrary, believe that one of the main difficulties of the world to-day is a deficiency of investment -- a depression of the industries making for capital extension, &c., rather than of the industries making directly for consumption. Hence we regard a revival of investment as peculiarly desirable."
I always find this to be an interesting point. A Keynesian generally says that the market works fine, but the level of demand is not always consistent with full employment. If we place value on full employment, we should boost demand for capital, goods, and services relative to demand for money. Keynesians value both consumption and investment, and aside from perhaps some social initiatives (i.e. - spending on the poor and/or unemployed because... well because they're poor and/or unemployed), they don't really want to dictate where it goes. More direct spending is more efficacious of course in terms of the multiplier - but they don't place a higher priority on consumption relative to investment generally. As Hayek and Robbins say "they [Keynes and Pigou] appear to hold that it is a matter of indifference... whether money is spent on consumption or real investment". Indeed they do. Here, the LSE writers are of the opinion that what you really need is more investment.
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Rizzo contends that the debate today is essentially the same, that everything ultimately boils down to a debate between Hayek and Keynes, and that everything else is a footnote. To a certain extent I agree with this - but I think he's discounting the extent to which these are differences of emphasis rather than opinion. He notes that Hayek comes out and says deflation is undesirable. I note here that they don't really disagree on the existing securities question - Hayek and Robbins confuse the fact that Keynes and Pigou are arguing that investment in existing securities is symptomatic of the problem rather than the problem itself. Hayek and Robbins also raise the Reinhart-Rogoff point about the debt - which essentially every economists agrees on, we just disagree on when it is really worrisome and when it isn't. So on all of these points, Hayek, Keynes, Robbins, and Pigou basically agree - they just place different emphases. I think the same is true today. There are lingering disagreements. They still don't see eye-to-eye on the unique importance of investments. They still don't see eye-to-eye on their theory of output. Those are very important issues. But they shouldn't obscure the fact that there is common ground. Indeed - the guy that coined that insight that all economic argument boil down to the disagreement between Keynes and Hayek (that would be J.R. Hicks) was a big fan of both Keynes and Hayek.
Russ Roberts's piece in the Wall Street Journal on Hayek today left a little to be desired, but I suppose there's only so much you can expect from an op-ed.
He asks: "Why the sudden interest in the ideas of a Vienna-born, Nobel Prize-winning economist largely forgotten by mainstream economists?"
Name me a single mainstream economist that has "largely forgotten" Hayek. Hayek is a major figure in 20th century economics. I think what Roberts means is that mainstream economists don't think of Hayek in the same way that he does. That's not quite the same as Hayek being "forgotten". Would it be accurate for me to say that Roberts has "forgotten" Keynes? Perhaps it would be, since he goes on to write:"First, he and fellow Austrian School economists such as Ludwig Von Mises argued that the economy is more complicated than the simple Keynesian story. Boosting aggregate demand by keeping school teachers employed will do little to help the construction workers and manufacturing workers who have borne the brunt of the current downturn."Keynes offers a simple view of the economy relative to Hayek and Mises? That's news to me! But then again, this sort of straw-man version of Keynes shouldn't be surprising to anyone who has seen Roberts's Hayek vs. Keynes rap.
It's also sad that Roberts writes something like this: "But now that the stimulus has barely dented the unemployment rate, and with government spending and deficits soaring, it's natural to turn to Hayek." No one who talks about Bastiat as much as Roberts does (not to mention anyone who teaches economics at the university level) should have to have the concept of a counterfactual explained to him. My guess is Roberts understands the concept perfectly, he just deliberately presents a disingenuous picture of the stimulus in this article because it furthers his own narrative. That's unfortunate. If you can't make a fair, honest case in an op-ed this short, that's understandable - but it doesn't give you license to distort the evidence to make a dishonest case.
Even David Henderson is a little hesitant on Roberts's claims about what Hayek means for Fed policy under Greenspan. But again, Roberts has his own narrative of how the crisis went down. For him it's a simple story, not a complicated one (which makes his earlier critique of Keynes espeically ironic) - and he's not going to let the evidence get in the way of that.
I'd dispute some reckless applications of this statement, but you can't really contest Roberts here: "Third, as Hayek contended in "The Road to Serfdom," political freedom and economic freedom are inextricably intertwined."
Also here: "The fourth timely idea of Hayek's is that order can emerge not just from the top down but from the bottom up. The American people are suffering from top-down fatigue." The point he's making in the first sentence is self-evident, but his application is shaky. I'd argue the election of Obama is just a culminating event in a bottom-up movement to retake American self-government in the wake of 1990s passivity and Bush-era top-down leadership. Even the opposition now (the Tea Party) is a grass-roots opposition to what is fundamentally a grass-roots governing majority (the Obama movement), in contrast to the Bush years where a top-down administration's only organized opposition for most of the first decade of the 21st century was a Democratic Party establishment that was largely complicit in the Iraq war and in most of Bush's domestic excesses as well. That started to change towards the end of Bush's presidency, and by the 2008 election we had a genuinely grass-roots movement behind Obama and a genuinely grass-roots movement on the Republican side that continues to this day.
I take issue with some of what the administration has done as being too centralized. The health reform package, for example, is not the package that I would have put together. But Roberts makes this bizarre case that anything emanating from the federal government is "top-down", no matter how "bottom-up" its origins are. Essentially, if you don't agree with Russ Roberts's libertarianism you're "top-down". If you do what he thinks should be done (namely, reducing federal spending and action), then it's bottom-up. This is patently absurd. It's another example of this weird phenomenon among libertarians where they can't comprehend their own propensity to ride roughshod over human liberty, despite the fact that it's blatantly obvious to the rest of us.
- Brad DeLong contrasts Knut Wicksell's Stockholm School view of general gluts with the views of Bagehot and Fisher. DeLong makes a point I heartily agree with and briefly referenced earlier today about the fact that many theories in economics don't conflict as much as people suggest they do. DeLong writes:
"Which of these three schools is correct? All of them--that is, any one of these three financial-market excess demand configurations can trigger a depression. In general, asset market prices and interest rates will react differently depending on which disequilibrium is active."
- Don Boudreaux points out a misreading of Hayek by Paul Samuelson. Samuelson counters Hayek's critique of socialism with the example of Sweden and other Scandinavian countries. Boudreaux explains the problem with this example:
"Hayek said that “the planning against which all our criticism is directed is solely the planning against competition – the planning which is to be substituted for competition.” So because Scandinavian countries emphatically do not plan in this way, Samuelson was mistaken to say that their socialism is of the sort that Hayek believed paved the road to serfdom. Those countries have reasonably free trade, only light regulation of capital markets and business, and strong private property rights. In short, all Scandinavia retains what for Hayek was the most significant protection against serfdom: competitive economies."
He goes on to point out the fact that the welfare state was not inherently problematic for Hayek's primary point on market competition. This is an extremely important point and it gets back to an earlier series of posts on calculation problems vs. incentive problems. Hayek's point was that the market is more efficient at using knowledge and calculating solutions than socialist planners. His concern was with planning that interfered with the calculation process specifically - not planning that achieved some other end such as a desired social justice outcome. That's not to say he loved other sorts of planning (i.e. - for social justice). It's simply to say that his primary academic objection to planning was grounded in it's interference with competition and the market process. And the Scandanavian countries do quite well on this front (as does, I should add, the ideal-type of Keynesian "planning"). Don't read past the initial post into the comments. This more nuanced point of Hayek's isn't really discussed in the comment section - it's mostly just mud-slinging at Samuelson.
- The Urban Institute library still isn't completely packed up yet (they're shutting the library down). As I was walking through it to get a cup of coffee I noticed a book by Erik Lundberg, also of the Stockholm School, called "Instability and Economic Growth". It appears to be an underconsumptionist presentation of macroeconomics as opposed to a business cycle theory. Obviously that was interesting to me, as it is the foundation of the Keynesian approach. Lundberg also developed the "sequence approach" to markets. I'm hoping to finish a lot of Garrison on the plane to Paris (a week and a half!). Perhaps I'll read Lundberg next.
Peter Boettke has a good point in an earlier comment section. He writes:
"Hicks once wrote that when the history of 20th century economic policy comes to be written, the pivotal debate will be the Hayek v. Keynes debate. When you scratch the surface of the various positions, it ultimately comes back to that. That is why I believe you see the rise of interest in these two positions again, and again. And ultimately, the earlier version of that debate is contained in the letters exchanged between Malthus and Say."
My initial response to him was that if that's the debate that stands out it's a very good debate to have, but that (especially when it comes to Hayek vs. Keynes), I really hope we don't feel like we have to choose between them. I certainly don't feel that way. They both do a good job highlighting each other's blindspots and the tradeoffs that each brings to the table. For that reason alone this debate is an important one. But in the end, Keynesian policy without a cognizance of what Hayek said is doomed to failure. Crude Hayekianism without an appreciation of Keynesian insights is doomed to bumping along at a sub-optimal level. I think it's very dangerous to choose between them rather than choose from among them.
Anyway, the Malthus vs. Say point is interesting I think. Say dominated over Malthus for a long time for a very good reason: Malthus could not provide stability conditions for a general glut. Economist have always recognized that shocks can disrupt the economy. Malthus described what a general glut looks like, but he didn't really adequately explain how an economy could produce them naturally. That is where Keynes makes his contribution. I'm wondering, though, has anyone really expanded on Say in the way that Keynes expanded on Malthus? Hayek adds good stuff about knowledge, etc., but that doesn't really speak to the macroeconomic issue of general gluts, which is the heart of the Malthus/Say debate. I can think of two things:
1. The whole real balances debate, and on policy 2. Ricardian equivalence
The first is good, but I think amounts to qualifying Keynes rather than disproving him. And that's good - qualifying and tempering is important. The second one amounts to assuming your own conclusions. It's not a development of Say - it's going back to one of Say's contemporaries and restating the argument with math. Not very impressive, and again - it's more of a qualifier anyway (ie - "to the extent that Ricardian equivalence is true stimulus will not work" - but you can't just assert absolute Ricardian equivalence and call it a day).
I don't know much of Hayek's macro, but a macroeconomics based on the capital structure again doesn't seem to refute Keynes so much as provide another model. A good model, I might add, but not one that has to conflict with Keynes (ie - there's no reason that I know of why even simple IS-LM logic fails if you were to incorporate the capital structure).
Has there been any real development in the counter-argument since Say?
I've been refered to Hazlitt on liquidity preference and was disappointed, nevertheless, perhaps some day I should read Hazlitt cover to cover because I know a lot of people like him.
Daniel Kuehn is a doctoral candidate and adjunct professor in the Economics Department at American University. He has a master's degree in public policy from George Washington University.
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