"Most people are in arrested development and cannot use logic." Jacob.
"Competition and capitalism are hated to-day because of their tendency to destroy poverty and privilege." William Hutt
"America is unique in that our economy is totally dependent on global charity." Peter Schiff

Thursday, June 23, 2011

Lord Keynes rises from the Grave

Well, dear readers, our humble blog has moved up in life. We were graced with a visit from Lord Keynes himself. Not of course the one who wrote a book in 1936, but a blogger whom we have been mistakenly calling Cynicus Economicus, when in actuality he styles himself Lord Keynes.

Following the precedent set by Pravda, we are going to edit all our earlier blogs, eliminating all mention of Cynicus, who was there by mistake, and replacing him with "LK".

Now we will reply to LK's trenchant comments on my defense of Say's Law.

1. He begins by pointing out that although fiat money might not have existed in Say's days, fractional reserve banking did.
Short answer: The rebuttal I wrote to fiat money, and showed that Say wrote it, too, applies to money created by fractional reserve banking as well. It is not money earned by the bankers in exchange for a good or service they provided.

2. I attributed to Keynes the cause of recessions as animal spirits, which I paraphrased as "darned if I know".
To which he stated, I think, do not be fooled by the whimsical phraseology. There is a deep insight behind the words animal spirits, mainly, that nobody can know what causes recessions. [Which contradicts posts he has on his blog saying recessions happen because of deflation]. He mentioned Lachmann, who apparently agreed with Keynes and yet is considered an Austrian.
Here's what he wrote:
Animal spirits is essentially an irrelevant term used by Keynes' describe why we act. You can dispense with it TOTALLY and still have his fundamental insight: that because of uncertainty (thatis non-calculable) we have subjective expectations. This idea is also held by the Austrian radical sujectivists who follow Ludwig Lachmann. That is why the investment is subject to instability and fluctuation, why investment will not necessasrily equal loanable funds supply.

Short answer: So we agree that Keynes animal spirits means "darned if I know". You are just adding that "darned if I know" is the right answer. I am sure you are familiar with Austrian writings that have a different answer.

3. I wrote that printing new money causes inflation. LK replied with two points. First that "(1) large deficits matched $for$ by bond issues are not creating new money."

Short answer. Depends on where the money came form to buy those bonds, and how those bonds are going to be repaid, right? Take QE2. It is a case of printing money to buy bonds to finance the US govts deficit spending. As for how the bonds are going to be repaid, we know the answer to that one, too. The govt wants to increase the debt ceiling lest we go into default. Translated, they want to borrow more money to repay the old bonds. Since for the last 6 months all US govt bond issues have been bought by newly printed digital money, that means the old bonds are going to be repaid with printed money.

In any case, there are plenty more ways of printing new money, be it paper or digital. You mentioned a few in your original post, which I quoted.

4. He also replied to my assertion that printing new money causes inflation with the following longish statement:
(2) in an economy in a recession or depression, it is PRECISELY when there are significant idle resources, unused capacity at plants and factories, idle labour and available resources.

Keynesian stimulus is about getting the private sector to create wealth by increasing capacity utilization and using idle resources (including labour), just as
private investment, private bank credit, and private payment of wages to workers by businesses would do the same thing if there was a recession.

You make the same mistake as Anderson:


I call this a non sequitor. What relevance does this have to the fact that printing money causes inflation?
The only thing I can think of is that LK means that the benefits of printing money, in the proper context, outweigh the inflation it causes, in his and Keynes' opinion.

As a student of Austrian Economics, I am sure LK knows that AE's reply to his comment is that Keynes did not understand nor correctly describe the problem, and that his proposed solution solves nothing, but rather makes things worse.

If you are reading this LK, I suggest we continue by your summarizing what AE has to say about Keynes [why his diagnosis as well as his prescription are totally wrong], to make sure we are all on the same page, and then rebut if you can.


  1. Responses

    Animal Spirits
    “here is a deep insight behind the words animal spirits, mainly, that nobody can know what causes recessions.”

    We know precisely what causes recessions: falls in consumption, investment, government spending or earnings from exports.

    What actually causes the falls in real world recessions is a matter for empirical investigation.

    “So we agree that Keynes animal spirits means "darned if I know".”

    False. The meaning of the term as used by Keynes is perfectly clear:

    “as a result of animal spirits – of a spontaneous urge to action rather than inaction (Keynes 2008 [1936]: 144).

    As I said, it is an expression and concept actually irrelevant to the theory of subjective expectations. Whether or not humans have “spontaneous urge to action rather than inaction” is a matter for modern psychology, neuroscience and cognitive psychology. All that Keynes needed to say here is that people act in the face of uncertainty, but they cannot know the future or give objective probabilities for possible events affecting their decisions: uncertainty simply cannot be quantified. Their expectations in the short or long urn are also influenced by what other people around them think.

    And I will point you to a comment by the quite well known Austrian economist Steve Horwitz made on my site:

    “Of course expectations are subjective. What Austrian thinks otherwise?”

    You blog title says you use or promote “Austrian economics” on this site. What kind of “Austrian” (assuming you claim to be one) is ignorant of basic Austrian concepts, like subjective expectations?

  2. "I wrote that printing new money causes inflation."

    The main effect of new money spent into an economy with excess capacity utilization and idle resources (including labour) is an increase in employment and real ouput. Yes, inflation is a secondary effect, just as it would be if the money had not been created by the government: e.g., if the money had been (1) created by a private fractional reserve banking system or (2) had flooded into a country by its capital account and been lent out.

    The effect of even this private money in an economy in recession is actually as above: mainly an increase in employment and real output and then inflation is a secondary effect.

    This is how real world capitalism functions in all forms in modern history. Show me one example of a pure 100% reserve banking system. There are none.

  3. Regarding the Austrian critique of Keynes, one of the more important ones was Hayek's trade cycle theory that was used in the 1930s. However, as any student of economics knows Hayek's theory was torn to shreds even back then, and not even by Keynesians, but also by other neoclassicals.

    Sraffa in particular published what was a devastating critique of Hayek in Piero Sraffa, 1932a. “Dr. Hayek on Money and Capital,” Economic Journal 42: 42–53.

    I have dealt with the Austrian trade cycle theory (ABCT) many times:




    To take just one exmaple, ABCT in its Hayekian form and early forms in Mises' work uses an invalid Wicksellian natural rate of interest concept. They assume a unique real natural rate that does not exist in a growing, money-using economy, as Sraffa showed. The natural rate is one that would obtain, as if loans were made in natura (that is, in real commodities). But even in a barter economy not in equilibrium, there could be as many natural rates as there as commodities.

  4. TY for the links to where you have dealt with Austrian trade cycle theory. Will have a look at them, time permitting.

    As for your other comments, they are mere assertions of statements that Austrians have refuted. Certainly they are far from self evident, so I do not see the point of making them as if they have any value by their mere appearance on paper, with no proof.

    I will grant one thing. It is not clear [to me at least] how much weight Keynes placed on animal spirits in the general scheme of things. Was he relying 99% on general economic principles, and the animal spirits were mere icing on the cake of the case he was making? Did Austrians detect a flaw in his tale, mainly that he fails to account for why there is a decrease in consumption, for how the [non existent according to Austrians] underused capacity came to be underused, and filled in the blanks with a sarcastic "must be the animal spirits", when the more precise statement would be that he just fails to give any explanation?

  5. The term "animal spirits" is used but 3 times in whole General Theory, and in a discussion of factors influencing investment decision making under uncertainty and long-run expectations.

    As I said above: it is irrelevant and can be dispensed with completely, leaving you with Keynes's main point: that business expectations are subjective under uncertanity. It is a total waste of time waving it around like you do: even Austrians agree with Keynes on subjective expectations (which you seem unaware of).

    Since business people cannot know what will happen in the future their decisions to invest are not based on objective probabilities. When subjective business expectations become pessimistic and shocked, no amount of money in loanable funds (even 100% commodity money) will induce them to invest all that money, even in fact when there ARE plenty of profitable opportunities for investment.

  6. Welcome back, LK.
    1. Sadly, I get the impression we are talking past each other.

    In your last comment you seem to be giving animal spirits a huge place in the scheme of things, saying that pessimism and shock are to blame for recessions. This right after saying it has a very minor role, because it is only mentioned three times in Keynes.

    2. I read the blogs you mentioned that you think refute Austrian economics. They all contain but one idea, that Sraffa's paper demolished all Austrian theories of interest, which you claim teeter back and forth between various misunderstandings of what an interest rate is.

    To sum it up, Austrians say that when central banks, say, cause interest rates to be too low, a boom and bust will happen. Sraffa supposedly proved that there is no such thing as "too low", because there is no such thing as what an interest rate "should be".

    Doesn't strike me as very convincing. We can leave the details of how to guess what the interest rate would be absent central bank intervention to the professionals. But it would be some number, call it X. And if the central bank sets interest rates at much less than X, there is where you will set up an Austrian business cycle.

  7. "In your last comment you seem to be giving animal spirits a huge place in the scheme of things, saying that pessimism and shock are to blame for recessions."

    I am doing no such thing: I made it clear to you that I dispensed with the entire concept of "animal spirits" defined by Keynes as "a spontaneous urge to action rather than inaction” (Keynes 2008 [1936]: 144). Whether we have any such "urge" is utterly irrelevant. All that needs to be said is:

    (1) that business makes decisions under conditions of uncertainty;

    (2) that they cannot give objective probabilities for future events that will affect the profitability of their investments;

    (3) that their expectations in the short run and longrun are subjective.

    As the Austrian Horwitz in comment above says: all Austrians would agree that expectations are subjective in this sense.

    They all contain but one idea, that Sraffa's paper demolished all Austrian theories of interest, which you claim teeter back and forth between various misunderstandings of what an interest rate is.

    You are wrong. Sraffa demonstrated that there is no unqiue natural rate of interest, as Hayek thought.

    The natural rate of interest is the fundamental Wicksellian concept underlying Hayek's business cycle theory in Prices and Production (1931). When it falls, so does Hayek's theory.

  8. 1. OK, now I understand. It's not animal spirits that cause recessions, it's "subjective uncertainty", something all Austrians agree exists.

    Am I to understand that all Austrians agree it exists,and also that it causes recession? That all Austrians no longer beleive what Mises and Hayek wrote?

    Or do all Austrians agree it exists, but not all Austrians think it can by its lonesome cause a recession? That in fact they consider it a pretty lame excuse to hang a recession on?

    2. Still don't see how Sraffa did anything. Given any loan taking place between Party A and Party B, there are two rates we can discuss: the rate actually agreed upon between A and B, and the rate that would have happened absent the existence of a central bank.

    I think we can both agree that a role the central bank has taken for itself is to influence interest rates. They certainly say so explicitly; I hope Sraffa agrees that they actually do.

    Once again, we can call the rate that would have happened, even though we do not know what it is, X(A,B). [Who said Austrians don't use Math?]. If the actual rate that happened [call it Y(A,B)] is much less than X [often written Y<<X], for many values of A and B, then Hayek's trade cycle will kick in.

  9. Hey mr. Smiling,

    "They all contain but one idea, that Sraffa's paper demolished all Austrian theories of interest, which you claim teeter back and forth between various misunderstandings of what an interest rate is."

    I just finished writing this :
    I hope this can be helpful.

    M.H. (alias rodolphe topffer from mises forum, you know, the french weird guy...)