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Source link: http://archive.mises.org/10648/mini-review-where-keynes-went-wrong/

Mini-Review: Where Keynes Went Wrong

September 12, 2009 by

I’ve just finished Hunter Lewis’ new book Where Keynes Went Wrong: And Why World Governments Keep Creating Inflation, Bubbles and Busts link here (scroll down to bottom).

The biggest surprise of the book is that it is thoroughly Austrian. The author draws upon Mises, Hayek, Rothbard, Resiman, Hutt, Rueff, and other thinkers in this tradition who have been most critical of Keynes. Lewis says that he set out to write the book that Hazlitt had planned to write, which resulted in The Failure of the New Economics. While Hazlitt had intended to produce a popular book, as he delved more deeply into his task he produced something closer to an academic treatise. Lewis’ book is accessible to anyone who has had a macro course or even to the general reader of business media.

The first section, What Keynes Really Said, consists of short excerpts from Keynes’ own writing, mostly The General Theory. Lewis tries to provide the reader with a fair and unbiased understanding of Keynes’ views. Going back to the source is a worthwhile endeavor because most people know what they know through a macro textbook using a second or third-generation graphical synthesis of Keynes’ idea, or through media buzzwords such as “stimulus” and “consumer confidence”.

The second section, Why Keynes Was Wrong, mirrors the structure of the first section. In the table of contents, the two sections are lined up side-by-side in columns. For example, a section in the first part called Spend More, Save Less, and Grow Wealthy is lined up against a section in the second part called Spend More, Save Less, and Grow Poorer.

There are several main themes in book. One is that most of Keynes key doctrines are paradoxical. The most well-known example is the paradox of thrift: saving is good for the individual but if everyone tries to save, then it drives the economy downwards into a bust. Another example of paradox is “unemployment equilibrium”. In each case, Lewis provides simple, logical arguments against Keynes’s paradoxes. The book could be characterized as a defense of common sense against obscurantism and muddle-headedness.

Keynes’ reliance on paradox brings to mind what philosopher Michael Levin calls “the skim milk fallacy”:

According to this paradigm, science always shows that things are the reverse of how they seem. Deep scrutiny of virtually any phenomenon will reveal that everyday convictions about it are wrong. In fact, taking things at face value betrays naiveté, while readiness to debunk is the mark of the sophisticate, what David Riesman called an “inside dopester.”

Another theme is Keynes’ reliance on his own opinion without any supporting facts. Lewis gives many examples of how Keynes moves through a point in his reasoning that cannot be decided on purely theoretical grounds by recourse to pure opinion without any empirical support. Lewis has located empirical studies from the subsequent years suggesting the opposite of Keynes’ opinions (and in other cases, Lewis provides a common sense argument against Keynes’ opinion). Where some empirical work existed at the time, Keynes would dismiss with no supporting evidence if he needed things to go in the opposite direction in order to arrive at the result he wanted.

This book fills a missing niche in the literature: a debunking of Keynes for the general reader. I believe that this book would also be useful as a supplement in a macro course. But its most important contribution in my view is that it demystifies Keynes. The ideas in The General Theory form the foundation of modern macro-economics, which is the basis for the modern practice of central banking and pretty much all monetary policy around the world. What I mean by the mystification of Keynes is that, because his theories are so long-established and deeply embedded in academic economics, government, and the public consciousness, it is difficult not to think that there must be something really deep and profound there. Upon reading Lewis’ book, it is somewhat shocking to see how weak his arguments are and how poorly they stand up to any kind of logical examination.

{ 29 comments }

Ohhh Henry September 12, 2009 at 4:55 pm

Spend More, Save Less, and Grow Wealthy

I think this demonstrates why Keynes is a perennial favorite among politicians and the lumpen – the promise of something for nothing. As for the wrapping of Keynes’s arguments in new buzzwords, it is an absolute requirement that new disguises be invented, once every generation or so, to save the old fallacies from exposure and ridicule.

Andrew_M_Garland September 12, 2009 at 5:32 pm

Keynes, Digger of Holes

No one should trust a theory that predicts greater prosperity from digging holes. Yet, this is the theory by Keynes (that Obama is following), and many past presidents have followed, to forcibly change our society. We will supposedly create even more wealth in the future by wasting our current wealth today.

I know. I must be wrong. No one could believe such a thing. Certainly no President of a great country would listen to a dead crank who spouted such nonsense. But, there it is.

There is a story at the link about Keynes dirtying some towels in a washroom and claiming that he had just helped the economy.

How many obviously false statements must a person make before the quality of his entire thought is in question? The limit has not yet been set for economists and politicians.

Matt_T December 10, 2011 at 6:12 am

Keynes was right on one thing. “Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” It just so happens that the defunct economist ended up being Keynes himself.

Everyone seems to forget that Keynes was not a capitalist. He didn’t like capitalism very much at all. “Capitalism is the astounding belief that the most wickedest of men will do the most wickedest of things for the greatest good of everyone.” His goal was to find something to replace capitalism, which he viewed as broken, and he eventually settled on “managing” it because socialism wasn’t much better. “The decadent international but individualistic capitalism in the hands of which we found ourselves after the war is not a success. It is not intelligent. It is not beautiful. It is not just. It is not virtuous. And it doesn’t deliver the goods. In short we dislike it, and we are beginning to despise it. But when we wonder what to put in its place, we are extremely perplexed.”

newson September 12, 2009 at 8:29 pm

thanks for the washroom anecdote. bad economics and bad manners to boot.

Walt D. September 12, 2009 at 10:17 pm

The real problem is not with Keynes, who died in 1946, but with the boneheads who are are still alive who believe his economic philosophy.

mpolzkill September 12, 2009 at 10:37 pm

Andrew and Walt,

“I know that most men, including those at ease with problems of the greatest complexity, can seldom accept even the simplest and most obvious truth if it be such as would oblige them to admit the falsity of conclusions which they have delighted in explaining to colleagues, which they have proudly taught to others, and which they have woven, thread by thread, into the fabric [$ and power, in the case you speak of], of their lives.”

– Leo Tolstoy

Ohhh Henry September 12, 2009 at 10:58 pm

There has to be a way to politely talk to people and tell them, look, I can’t stop you from believing in these stupid nonsensical fairy tales that your government and media and academia are feeding you, but I wish you wouldn’t. It’s not that I care whether you ruin your life and end up with no job, no pension and no medical care in old age … I’m actually being completely selfish … I want you to stop believing this bullcrap because I know that when you lose everything just like someone who builds their house on sand, you’re going to use your idiotic voting system to punish and steal from all the people who DIDN’T buy into the B.S. and who spoke the truth and lived the truth … because it won’t do you any good in the long term, and it certainly won’t do me any good in the long term.

Edward September 13, 2009 at 3:37 am

I cannot believe how economists have not yet seemed to have reached an agreement on what should be the basics of the field.
It makes the field as a whole appear more like an advanced philosophy class than an actual science.

Incredible.

Lucas M. Engelhardt September 13, 2009 at 6:34 am

Ohhh Henry,

Actually, Robert Kiyosaki and Donald Trump wrote a book to that effect (“Why We Want You To Be Rich”). It basically said “Look, guys, the political system is biased against the middle class, so it’s going to disappear. As rich guys, we want most of the middle class to become rich so the poor guys can’t use the political system to take all of our hard-earned money.”

Luke M September 13, 2009 at 12:38 pm

Thanks for bringing this book to my attention, Robert, it sounds really good. I’ll be adding this to my next Amazon order!

Frank V. September 13, 2009 at 7:20 pm

The main reason Keynes is famous is because he actually knew why The Great Depression was caused. Iriving Fisher was doomed into obscurity when he claimed that the stock market crash was nothing to be worried about. Meanwhile, Keynes saw the flaws in classical economics and built a theory that has stood the test of time.

To Hayek markets are rational. Keynes, and the vast majority of modern economists, know better.

Robert Brager September 13, 2009 at 8:47 pm

Frank V.

Yes, sir, I’m sure you’re right.

Which is to say, that must be why today we find ourselves staring out over an economic abyss that the “modern economists” led us to. Turning away, we find the doctrines and policy implementations of the modern economists approaching, as a phalanx, shields high, spears drawn.

As to the fallacious quip about Hayek, this oft-contended bit of nonsense seems to get debunked about 500 times a day on this site and yet its use persists among those whom I can only assume are casual (or blind) visitors here.

Robert Blumen September 13, 2009 at 11:26 pm

Frank V, your characterization of Hayek is a bit unfair. Hayek did not argue that prices in the real worlds always reflected the highest and best allocation of resources. Hayek’s work on business cycles was based on the premise that the prices of capital goods could, for a significant period of time, deviate from their equilibrium values due to monetary injections. Hayek also devoted a lot of effort to putting forth arguments about how much we do not know.

Tobbog September 14, 2009 at 2:38 am

“Another theme is Keynes’ reliance on his own opinion without any supporting facts. Lewis gives many examples of how Keynes moves through a point in his reasoning that cannot be decided on purely theoretical grounds by recourse to pure opinion without any empirical support. Lewis has located empirical studies from the subsequent years suggesting the opposite of Keynes’ opinions (and in other cases, Lewis provides a common sense argument against Keynes’ opinion). Where some empirical work existed at the time, Keynes would dismiss with no supporting evidence if he needed things to go in the opposite direction in order to arrive at the result he wanted.”

I thought that most Austrians rejected empirical analysis.

Tobbog September 14, 2009 at 8:12 am

Tobbog,
Austrians don’t reject empirical analysis, they just reject economic models used to justify various theories but with poor arguments and assumptions that greatly weaken the predictive value of these models e.g. the notions of perfect markets carried by neo-classicals or the notion of boosting aggregate demand which disregards the importance of the quality of investing (read malinvestment).
My favorite lesson from Austrianism is the three ways in which government finances its expenditure- taxes, borrowing and inflation. You’ve gotta hand it to these guys, they have shown how government, especially socialists, steal from you and me… because I consider savings my hard earned cash and should someone devalue my assets without my consent by simply printing more funds… I consider that stealing!!!

mikey September 14, 2009 at 10:33 am

” Keynes is famous is because he actually knew why The Great Depression was caused…”

Keynes believed that the business cycle was a result
of “animal spirits”.
Taken literally, this means that the ghosts of dead animals are influencing human behavior in such a way
as to cause economic booms and busts.
Now, it is unlikely that Keynes, even distracted as he doubtless was by constant homo-erotic fantasizing,
thought this was true.This is not what he meant.
But what did he mean? Keynes never did say.
(Greenspan, his intellectual heir, once mumbled something about irrational exuberance.)
It seems better to say anything at all, now matter how
nonsensical, than to make any mention of credit expansion by central banks, as the cause of economic recessions and depressions.
Keynes’ convoluted writing style could be a clue to his convoluted thinking.His inability to express his ideas in clear, concise words could mean that he was unable to think clearly. He had a history of changing his mind about what he thought was true.
There is anecdotal evidence that he recanted all of his main points shortly before he died, over lunch with an aquaintance.

Mushindo September 15, 2009 at 8:36 am

Mikey wrote:

Keynes’ convoluted writing style could be a clue to his convoluted thinking.His inability to express his ideas in clear, concise words could mean that he was unable to think clearly. He had a history of changing his mind about what he thought was true.

Heheh. This recalls a comment made by one of my professors during my first postgrad course. I had submitted an assignment covering (what I now know as the Tired Old False)…. dichotomy between Keynes and Monetarism.
Next to a paragraph I was particularly pleased with at the time (but which I can’t even remember now), he had scrawled in pencil some words I have never forgotten: ‘Most of the macroeconomic debate is about WHAT KEYNES REALLY MEANT (emphasis mine).

Len Hart September 19, 2009 at 8:51 am

Re: “I think this demonstrates why Keynes is a perennial favorite among politicians and the lumpen – the promise of something for nothing.”

Keynes didn’t propose ‘something’ for ‘nothing’ Keynes was rather traditionally committed to the ‘labor’ theory of value even in his famous remark about burying pound notes in landfills and digging them up. Certainly, if the value added to an economy by the value of all labor expended in production, moneys not ‘trickling’ down will ‘trickle up’ thus ‘contracting’ the economy. The other word for this is: depression. Certainly, Keynes was right if not merely satirical. More monies in the hands of those who might spend those moneys in ways that stimulate increased production is to be preferred over ‘tax cuts’ which benefit ONLY that class which invests the windfalls offshore or in other ways which do not increase production. If increased production is ‘good’ for the economy it is only because the ‘labor theory of value’ is true. That is hardly ‘something for nothing’, rather ‘value’ derived for something, as a result of ‘something’ –that something being labor.

Lubo October 13, 2009 at 4:29 am

@Let Hart: Just because Keynes proposed mechanisms to boost employment doesn’t mean he was committed to labor theory of value. But i agree with you that he certainly didn’t promise something for nothing.

Many articles about his policies here make two mistaken assumptions:
1. That keynesian policies are simply about government spending and inflating money.
But this is only half of the story. The other half is that he advocated inhibiting demand in times of expansion precisely to prevent bubbles and to motivate people to save. Just because government didn’t adhere to this part of his theory and consequently caused bubble doesn’t mean Keynes was wrong …

2. That keynesian policy is an attempt to provide a miracle cure that will always help.
I view his theory more as a specific cure to two specific problems: first – oversaving, underconsumption and the resulting recession, and second – small otherwise harmless recession degenerating by the sudden decrease of aggregate demand and by deflationary spiral into depression.

These problems have the same cause as bubbles – mass speculative “investment”. In case of both recession and oversaving, money itself can become bubble commodity, especially in times of uncertainty.

And one last thing – most supporters of austrian school call keynesian “pyramid building” or equivalents nonsensical, and claim to use “common sense” to show that he was wrong. But think about it, isn’t this just a different form of redistribution? And when you compare it to normal welfare, you’ll find it is even less harmful to economy – because instead of supporting laziness it provides work. This off course doesn’t mean this work can’t be used to do something productive, and even Keynes supported it. But the essence is that this is not about creating value, indeed any redistribution destroys value, but if it helps correct systematic problem, it is worth it.

Lord Buzungulus, Bringer of the Purple Light October 13, 2009 at 7:39 am

David Gordon offers some of his typically brilliant insights on a modern Keynesian, who believes his mainstream compatriots aren’t Keynesian enough (scary thought, I know):

http://mises.org/misesreview_detail.aspx?control=365

Lubo October 14, 2009 at 10:33 am

Pity i can’t comment on that article directly, so i will do so here.

The author claims: “If people want more of these units to increase their liquidity, fewer units are available to purchase goods and services. The result is an economic collapse. Had he taken account of purchasing power, he would have realized that if people increase their demand to hold money, the purchasing power of money will rise. So long as prices are flexible, there need be no fall in demand for goods and services.
In other words deflation. By letting “prices be flexible” in recession the only thing we will achieve is to provide additional incentive for holding cache (this time as an “investment”), increasing the demand for liquidity, and consequently causing the purchasing power of money to raise even higher, completing the deflationary cycle.

Sounds familiar? It should, because it is very similiar to what happened in recent reality bubble, only this time money would be the bubble commodity.

The second criticism concerns the role of uncertainty. He says that austrian school acknowledges that future is uncertain too, but he mistakenly assumes that the level of this uncertainty is always the same and we cannot draw any conclusions from it. Keynes correctly observed that in times of greater uncertainty people prefer liquidity, because long term investments are becoming more risky. The author then asks this question:
Evidently, the future is uncertain, but somehow this state of affairs alters when government enters the scene. Why should we believe this?…
It’s simple. If there is a guarantee that government will inflate currency if consumers suddenly decrease demand, then there is one certainty : holding liquidity is no longer so advantageous during recession. Thus, consumers are motivated to spend, and this decreases demand for liquidity, preventing financial bubble.

Next, the author seems to draw mistaken conclusions based on Keynes’ article “National Self-Sufficiency” – that Keynes was against foreign trade. I read this article, and view it more as an early precursor observing the dangers of globalization and consumerism more than anything else.

Author then follows with a citation, which talks about the need for balance in foreign trade (which Keynes advocated for example when he proposed bancor and International Clearing Union) and seems to draw from it a contradiction against the previous mistaken conclusion that keynesians should have “little use for free trade”.

Robert Blumen October 14, 2009 at 3:35 pm

Lubo Ferianec,

By letting “prices be flexible” in recession the only thing we will achieve is to provide additional incentive for holding cache (this time as an “investment”), increasing the demand for liquidity, and consequently causing the purchasing power of money to raise even higher, completing the deflationary cycle.

Most of the articles on the site are informed by the Austrian theory, which holds that credit expansion results in an unsustainable boom, and that the recession is the process by which the price system functions to correct the mal-adjustments of the boom.

The point that the author is making is that if prices, wages, and other costs fall, the demand for goods in real terms is not affected by changes in the purchasing power of money. We (Austrians) do not believe that changes the demand for cash has any macro-economic consequences per se. As long as prices and costs can move in the same direction, there is no reason to think that an increase in money demand results in a change in the real demand for goods.

It is the case the the demand for cash does increase during the correction phase for several reasons. One is the default of the poor quality credits that were created during the preceding boom. Another is that demand for cash may have become artificially low during the boom as people chased the inflating assets. A third reason is that people may anticipate further falls in prices of goods and plan to buy later. All of these factors speed the adjustment process as the price system wrings out the distortions created during the preceding boom.

Another point for your consideration is that the increase in demand for cash is a result of the implosion of the unsustainable boom. In practice there is no such thing as a sudden unmotivated increase in the demand for cash. People hold cash as they need it. The increase in demand for cash is the result of the onset of the bust, not the cause.

If there is a guarantee that government will inflate currency if consumers suddenly decrease demand, then there is one certainty : holding liquidity is no longer so advantageous during recession. Thus, consumers are motivated to spend, and this decreases demand for liquidity, preventing financial bubble.

We (Austrians) do not believe that a withdrawal of consumer spending is the cause of a recession, or that a restoration of spending is the cure for a recession. Recessions are caused by credit expansion, which results in over-consumption, and under-saving/forced saving plus malinvestment.

As noted above, an increase in the demand for cash need not result in a fall in the real demand for goods. The same transactions can occur at lower prices.

In any case, capital spending, which amounts to about 4-5x consumer spending, is far more significant as a component of the total spending in the economy. If consumers spend less on consumption goods and save-invest more, this helps the adjustment process of the bust by retroactively justifying some of the forced saving that occurred during the boom.

As for your statement that an increase in the “demand for liqudiity” prevents a financial bubble, that makes no sense at all. Financial bubbles occur when there is a lot of spending on particular financial assets, whatever the bubble asset class is. As the asset inflates, as long as credit continues to expand, there is a knock-on “wealth effect” as people spend some of the unrealized gains of the inflating asset. It is the illusion (temporary) of being able to spend more on assets and more on consumption at the same time which is brought about by credit expansion.

Lubo October 20, 2009 at 2:07 am

Robert,

i am commenting here precisely because i view the Austrian theory as lacking it this case.

First, i agree that continued credit expansion, even during boom indeed causes bubbles and recession. My point was that this is not Keynesian policy as many authors here seem to mistakenly assume. He advocated credit expansion only during recession, and measures preventing high inflation during boom.

Second, the mechanism you described, while accurate, is not the only cause for recession. You said: “The point that the author is making is that if prices, wages, and other costs fall, the demand for goods in real terms is not affected by changes in the purchasing power of money. We (Austrians) do not believe that changes the demand for cash has any macro-economic consequences per se. As long as prices and costs can move in the same direction, there is no reason to think that an increase in money demand results in a change in the real demand for goods.”
and “As noted above, an increase in the demand for cash need not result in a fall in the real demand for goods. The same transactions can occur at lower prices.”
The (lack of)change in real prices is not the cause for change in demand. The change in nominal prices is. When prices are falling, consumers can (and will) postpone consumption in the expectation of even lower prices in the future. Think of it as a form of investment, only almost risk-free. But this form of investment is speculative – there is no production caused by it (in other words, it doesn’t contribute to demand for capital). And during recession, this decrease is fueled further by growing uncertainty.

And this is true even from the viewpoint of investors – why invest in potentially risky business, especially in times of decreasing demand, when just keeping money at home will provide greater real gain with almost no risk? This is especially true for time intensive production – at the time product is finished, prices decreased significantly with respect to prices of factors of production. It is only logical to postpone production also. So, again no capital spending, but speculation. The result is that investments which were slightly profitable are now discarded in favor of holding cache. In economy with near perfect competition (which Austrians assume would be the result of free market) this would be the case of many investments. What follows is unemployment, even less consumption, even less investment, … and the cycle becomes self-perpetuating. In other words deep recession.

And finally, in your last paragraph, i assume you meant decrease in demand for liquidity, not increase, since i said decrease prevents financial bubble. Now, to clarify it, i am not talking about just any financial assets, i am talking about money itself. Money is the bubble asset in this case, because its price increases faster relative to other investment options. This, and very low perceived risk of losing value motivates people to decrease both consumption and investment in production in favor of holding cache.

Can you describe any mechanism which will solve this problem in a free market? None of Austrians i talked with before could provide satisfactory answer to this question. That is why i am asking it here, because this is a central point of Keynesian theory.

P.M.Lawrence October 20, 2009 at 9:02 am

Lubo wrote “And this is true even from the viewpoint of investors – why invest in potentially risky business, especially in times of decreasing demand, when just keeping money at home will provide greater real gain with almost no risk? … Money is the bubble asset in this case, because its price increases faster relative to other investment options. This, and very low perceived risk of losing value motivates people to decrease both consumption and investment in production in favor of holding cache [sic]. Can you describe any mechanism which will solve this problem in a free market? None of Austrians i talked with before could provide satisfactory answer to this question. That is why i am asking it here, because this is a central point of Keynesian theory.”

Try Pigou’s Real Balance Effect. There is an automatic stabiliser that does what Keynes thought was missing from free markets, stabilising which he thought needed government intervention to provide because his analysis only looked at flows – and only considering the flows leaves out any of the cumulative effects. Because governments intervene, this automatic stabiliser isn’t given a chance to operate properly – there is too much and too quick dislocation for it to head off trouble, and once big trouble hits, governments do something else before things can sort themselves out. (Also, state-big business symbiosis keeps many people from building up their own independent bases of wealth as individuals, so the pool of actors is kept artificially small.) This was one of the earliest and most profound counters to Keynes’s theory, and instead of dealing with it he put a lot of effort into sidelining Pigou’s influence and coming up with a limited special case of his own that he named after himself, the Keynes Effect.

Anyhow, essentially what happens is that the more people build up cash balances, the more they gain from the increasing value of their holdings – ultimately, far more than linearly, so it eventually outpaces people’s desire to gain by hoarding appreciating cash. It works as though helicopters had dropped money on them, and encourages more spending. Eventually, even in recessionary conditions, things reach equilibrium again. More usually, in an undistorted market (if there ever were one), it would head off recessionary conditions if any drift that way happened by chance.

There are other problems around as well – caused by past as well as present state actions, over generations, so simply stopping those actions would not clear the problems up on a shorter time scale – which mean that even this leads to higher unemployment than optimal unless governments overstimulate, which is unsustainable. I recently addressed these here and here.

Robert Blumen October 20, 2009 at 12:18 pm

Concerning: “None of Austrians i talked with before could provide satisfactory answer to this question.” and “i am commenting here precisely because i view the Austrian theory as lacking it this case. ” you should read Hazlitt’s “The Failure of the New Economics” and the collection by Skousen on critics of Keynes. All of these points have been addressed in the literature. Perhaps the people that you talk to have not read those books.

There is no such macro-economic problem as a deflationary spiral that you describe.

For the moment, consider consumer goods. Even if a consumer expected the price to fall in the future there is the tradeoff against the service provided by the good in the present against the possible greater services provided by an increased purchasing power of money in the future. We all consume goods all the time, and in many cases if the good were cheaper in the future it would not affect our decision to buy in the present. Everyone knows that if you wait a year to buy a computer you can get one for less money that will be faster and have more features. Yet why do people buy computers? Because you need a computer now and for the next year more than the worth of waiting for a better one. The idea seems a bit backwards to me in any case because simple supply-and-demand theory tells us that the quantity demanded should be greater at a lower price. The volume of computers sold now is far higher than it was some years ago when they used to be priced much higher.

Also the depiction of this price adjustment process taking years and years as people continually abstain from spending is not realistic. Retailers cut prices until they clear out inventories. Those who understand that they need to reduce costs will do so by bidding down their buying prices of labor and producer goods. If you are referring to consumption goods, retailers will cut prices to the level necessary that they can clear out their inventories. As I stated above, this need not threaten the profits of retailers because, as long as costs and prices fall, there is still the same real amount of demand and profitability.

The process of price adjustment to clear markets need not take a long time. In the stock market, prices adjust to balance supply and demand on a monent-by-moment basis. As buyers who expect lower prices in the future (which may be minutes, days, or months from now) withdraw their bids or drop their limit prices, the price must move down to balance supply and demand.

Concerning producer goods, the difference is that the cost-benefit of buying or waiting can be more quantitatively expressed. If you are referring to producer goods, if their price falls, then entrepreneurs who have cash find their purchasing power increased. Entrepreneurs do not care about the “price level” as such, they care about profits. Contrary to your statement “why invest in a time of falling demand”, demand as a whole is not necessarily falling. Anyway entrepreneurs do not care about “Demand” as such but demand for specific goods relative to the cost of necessary factors. This entire process is a price adjustment process. The entire economy has not gone on a starvation-abstention diet.

As money demand increases, not all prices will change at the same time or rate. Price movements depend no who withdraws their demand from which purchases. As the structure of relative prices change, spreads between business costs (producers goods and wages) relative to consumer goods, or between different stages of producer costs and producer revenues in some cases narrow and in other cases widen, creating profit opportunities for entrepreneurs with cash. It is not necessarily the case that it pays to wait as even if the “price level” were to fall more, the opportunities for profit afforded by arbitrage beween producer goods and producer revenues may prove temporary.

Those businesses that relied excessively on debt or are not able to speculatively reduce their costs as quickly as their revenues may go into bankruptcy but again there is no need for this to have systemic macro-economic consequences. Only this means that the ownership of equity changes hands in bankruptcy workout, but the new owners may choose to continue operating the business if — having written down the debt — cash flow is now positive; or the assets can be redeployed elsewhere in the economy as astute entrepreneurs find an opportunity to aquire assets cheaply.

So in reality there is no “deflationary death spiral” that simply has no bottom and goes lower and lower, extinguishing all production and consumption until we stop producing altogether.

Alan King November 4, 2009 at 3:29 pm

Robert Blumen leaves out the capital markets, so in this sense he is arguing about a barter system. “Deflationary spiral” occurs when overvalued assets on bank balance sheets need to be sold. The selling of these assets further erodes bank capital, and so forth.

Keynes was a solid thinker who was trying to understand why 25% unemployment coincided with so many unmet needs. His concept was that unmet needs and employment can be matched by entrepreneurs who calculate probablilities of making profits at given rates of interest.

But if the entrepreneur cannot obtain a loan (as is the case now) then there economic activity slows down. As activity slows down then the entrepreneurs calculate ever lower probabilities of profit. Keynes argued that in such a situation the government must step in to restore the capabilities for banks to make loans. This is Keyne’s message in a nutshell.

That this is controversial is merely an indication of the politically charged nature of the postwar period, and the spineless behavior of economists seeking to make political careers.

Empirical problems with bubbles and inflation did not emerge until the late 1960′s. The Phillips curve was an important discovery in the case of inflation — that economic actors might anticipate the provision of government liquidity and reset their inflationary expectations was an important addition to economic thought.

The most satisfactory explanation of bubbles and is given by Minsky and his followers. Many in Wall Street believe that we are in a “Minsky moment” — the collapse of a Ponzi scheme based on the massive creation of securities whose interest was paid by refinancing old versions of the same securities.

Robert Blumen November 7, 2009 at 3:49 pm

Alan King (kingaj@us.ibm.com):

Robert Blumen leaves out the capital markets, so in this sense he is arguing about a barter system.

Not so. Go back and re-read my post, above, focusing on the passages starting with “in the stock market” and “concerning producer goods”. Financial assets are claims on capital goods. They provide an alternate means to purchasing producer goods directly. And any statement I made concerning “goods” can apply equally well to producer and consumer goods.

“Deflationary spiral” occurs when overvalued assets on bank balance sheets need to be sold. The selling of these assets further erodes bank capital, and so forth.

Yes, this is true, if you have a fractional reserve banking system. But the process is finite. Once the banks are bankrupt, their new owners take over the assets and continue. And I must emphasize again, this process does not imperil the productive activities in the economy as such. As a result of this process, the phony credit created by the fractional reserve system is wiped off the books and the prices of bank assets are brought more in line with the amount of volunary savings.

Keynes was a solid thinker who was trying to understand why 25% unemployment coincided with so many unmet needs.

There have been a number of Austrian writers who have addressed this – Thomas Woods, Bob Murphy and Robert Higgs come to mind. The unemployment came about because of rigidities in the labor markets. Hoover’s policy of encouraging above-market wages and above-market prices prevented markets from clearing.

Sam Grove January 22, 2010 at 2:52 pm

When prices are falling, consumers can (and will) postpone consumption in the expectation of even lower prices in the future.

This is known HOW!

Falling prices is equivalent to increasing income. When income increases, people spend more.
Computer industry has demonstrated this amply.

In my own case, I do sometimes wait for prices to drop, yet at the same time, I buy stuff that has already dropped and that I know will drop even further in price. The question is about the utility of waiting versus having what you want or need now.

Clare Krishan January 22, 2011 at 11:42 pm

Ettore Gotti Tedeschi formerly head of Banco Santander and since 2009 head of the Vatican’s bank liked the book too apparently:

http://www.catholicnewsagency.com/news/vatican-bank-chief-issues-warning-about-us-european-economic-policies/

“Tedeschi cited a 2009 book, “Where Keynes Went Wrong: And Why World Governments keep creating Inflation, Bubbles and Busts,” by the American economist and philosopher Hunter Lewis.
He said Lewis had spelled out the “doctrinal errors and practical disasters” of Keynes’ theories.”

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