Monday, February 21, 2011

If You Just Reverse Keynes, Do You Get a Theory of a Real Economy?

Keynes argued that recessions occured because people held money (for no apparent reason and, strangely, all together at once) rather than spent it. Of course, this gets things backwards:

He who believes that the prices of the good in which he takes an interest will rise, buys more of them than he would have bought in the absence of this belief; accordingly he restricts his cash holding. He who believes that prices will drop, restricts his purchases and thus enlarges his cash holding. As long as such speculative anticipations are limited to some commodities, they do not bring about a general tendency toward changes in cash holding. But it is different if people believe that they are on the eve of big cash-induced changes in purchasing power. When they expect that the money prices of all goods will rise or fall, they expand or restrict their purchases. These attitudes strengthen and accelerate the expected tendencies considerably. This goes on until the point is reached beyond which no further changes in the purchasing power of money are expected. Only then does this inclination to buy or sell stop and do people begin again to increase or to decrease their cash holdings. (Mises, Human Action, 426-7)
In other words, it is the general decrease in prices -- deflation -- which causes people to hold onto their money as they wait for ever-better deals rather than, as Keynes claimed, people holding onto their money en masse that results in deflation and, thus, recession. His approach blinds people to the fact that there is something else which triggered the price decrease. And no, it's not anything like "external shocks" like the oft-blamed "oil shock". In American recessions, at least, oil prices often drop toward the beginning of the officially-recognized recession -- but the pattern is not entirely clear. Further, we should not be surprised if oil prices dropped during a recession. Or that oil prices should go up during an economic bubble -- especially considering how much economic activity requires transportation. Again, the Keynesians reverse cause and effect.

The real causes of recessions are described by Austrian Business Cycle Theory. Keynesianism describes nothing. At best, it tries to treat the symptoms -- and often does so in such a way as to make the patient sicker.

So why do people fall for Keynes?

A retailer or innkeeper can easily fall prey to the illusion that all that is needed to make him and his colleagues more prosperous is more spending on the part of the public. In his yees the main thing is to impel people to spend more. But it is amazing that this belief could be presented to the world as a new social philosophy. Lord Keynes and his disciples make the lack of the propensity to consume responsible for what they deem unsatisfactory in economic conditions. What is needed, in their eyes, to make men more prosperous is not an increase in production, but an increase in spending. In order to make it possible for people to spend more, an "expansionist" policy is recommended.

This doctrine is as old as it is bad. (Mises, Human Action, 432)
More, it again gets things backwards. Further, inflationary policies end up driving the next round of bubble-misallocation-recession that is the real cause of economic downturns. So Keynes not only gets things backwards, but his recommended cure causes the disease. And that's really getting things backwards. I'm sure Mises would be horrifed to learn that such nonsense is still believed after all this time.
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