Keynes the monetarist
Posted by Nicholas Gruen on Thursday, March 8, 2007
Brad De long republishes a great piece of his arguing that Keynes Tract on Monetary Reform was a great monetarist document. As he concludes:
[F]rom our perspective today–in which the Great Depression is seen as a unique disaster brought on by an unprecedented collapse in financial intermediation and in world trade, rather than as the largest species of the genus of business cycles–it is far from clear that Keynes of 1936 is to be preferred to Keynes of 1924.
Besides, Keynes of 1924 writes better: his prose is clearer, less academic, less formal; his argument is more straightforward, linear, easier to follow; his style is as witty.
If you’ve not read it, go check it out. Friedman was a big admirer of Keynes.
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it is some twenty years since I read most of Keynes so on an uncertain memory I will agree with both Brad & Nicholas but I did think his piece on the Versailles treaty and effects there of was pretty good too.
Funny enough although the General Theory is his most influential I found it the hardest going
Posted on 09-Mar-07 at 7:29 am | PermalinkKeynes’ diagnosis of the importance of “a stable measuring rod†was right, though hardly new. As for his solution, however, I’m not so sure, Nicholas. I think the evidence is against him. Monetarism, while useful as a description, has in practice proven to be far less so as a prescription.
For example, I don’t think it’s coincidence that the price level was broadly stable in the United States from its inception until the early 1900s and yet since the introduction of the Federal Reserve in 1913 and the gradual slide into fiat money, it has risen by a factor of twenty. During that previous 250 years, the occasional inflationary surge — triggered in each case by war – gradually receded again once peace broke out. This very long term price stability, quite unimaginable to us today, was a side effect of the discipline inherent in the use of specie money. Through much of that time, there wasn’t anything even resembling a central bank.
The inflationary periods were generally characterised by the introduction of some form of fiat money. During the civil war, for example, as the Union struggled to finance its efforts without having to unduly resort to taxation, large amounts of unbacked United States Notes were issued. Ditto with the “Continentals†created during the revolutionary war from whence originated the phrase “not worth a Continentalâ€.
To suppose, as Keynes did, that government functionaries would be able to “manage†the money supply so as to maintain price stability over the long term was a quite remarkable leap of faith. I can only presume that he saw himself as the model for such future mandarins. Dispassionate, well informed, free of any political or personal pressures and with an Olympian ability to remain entirely unaffected by the prevailing passions. Nay, more, to lean against them. As if this supposition were not large enough, they would still be confronted with the perennial problems of centralised price fixing; inadequacy of information and unintended consequences.
While there no doubt have been, and are, many fine examples of central bank governors and board members, the net result has been exactly as many predicted; relentless inflationary pressure with occasional blowouts like the 1970s. Even the much admired introduction of central bank independence here and there hasn’t altered the built-in bias. It is, quite simply, inherently asymmetrical. Rates tend to be raised late and lowered early and any hint of a severe downturn is met with concerted efforts to reinflate. In the short term, these efforts, and their results, generally appear benign and are met with close to unanimous approval. (There’s not much of a constituency for bear markets). The cumulative long term results are, unfortunately, not so attractive: discouragement of saving; encouragement of speculation; increasing absolute and relative debt levels; misallocation of capital and an increasingly pervasive and dominant financial sector.
With debt ratios at all time highs — by pretty much whatever measure one cares to consider — no central bank or government can even think about allowing a decent sized downcycle to take its course. (It’s quite another matter whether they’ll always be able to stave them off). Instead, the excesses and investment misallocation progressively accumulate so that deflation has indeed become the greatest fear. In the centuries leading up to the introduction of central banks and fiat money, on the other hand, mild deflation was a fairly common state of affairs as growing productivity set loose more goods and services into a world of relatively fixed money supply. Beneficial deflation certainly isn’t a word combination that readily trips off the tongue today.
Quite how this monetary adventure will play out is anyone’s guess. That it’s unsustainable is a matter of commonsense since debt ratios can’t grow to the sky. The price for having sidestepped occasional bouts of short term – and in the view of many, necessary — pain may, I fear, turn out to be heavy indeed.
Posted on 09-Mar-07 at 11:28 am | PermalinkNicholas, I’ve read this piece before, and I still don’t understand why Keynes’s ‘monetarism’ is being emphasised. De Long doesn’t in fact define monetarism – he just quotes a passage from Keynes and invites us to infer that it means worrying about price stability. But this is a very dubious criterion. Yes, Keynes was worried about price stability. He didn’t like inflation - in 1924, or ever., But he also feared deflation, and most of his thinking in the 1920s was a quest for enlightened policies to avoid deflation. In particular, he opposed the gold standard, and advocated managed exchange rates, all in the interests of price stability. This put him in complete opposition to sound money men (the monetarists of his day) who favoured the gold standard – from reasoning dating back to Ricardo – as a means to keep the supply of money in check, and who were prepared to suffer bouts of deflation as the price of adhering. If monetarism means anything, it means the propositions (1) that the money supply determines nominal GDP in the short run, which Keynes rejects with every breath of the Tract, and (2) that it determines the price level in the long run, which inspired his most famous statement (‘In the long run…’).
There may be some truth in De Long’s idea that the policy regime Keynes advocates in the Tract is in line with current thinking, and that aggregate demand is more robust than the General Theory would have it. But current thinking isn’t monetarist. Central bankers are not interested in the quantity of money any more, and thank goodness for that.
As for Friedman being a big admirer, could I have a reference, please?
And Ingolf, I endorse your critique of monetarism, but where did you get the idea that Keynes wanted to manage the money supply? The interest rate, yes, but not the money supply.
Posted on 09-Mar-07 at 1:19 pm | PermalinkJames, I see the two as inseparable. In managing interest rates, central banks do so for the most part through changes to the monetary base. Put another way, they can manage either short term interest rates or the monetary base, but not both at once. Determining flow on effects to the wider money supply and credit markets is of course another matter entirely.
Having said that, my comment about leaning against the prevailing passions is perhaps more apt when used to describe his views on countercyclical fiscal policy.
Posted on 09-Mar-07 at 1:38 pm | PermalinkThanks Ingolf,
I think you put the issues very well - and also in a way that highlight’s one of Keynes’ great instincts summed up in the phrase “in the long run we’re all dead”.
We live now in an age of monetarism - not the exact kind required by Milton Friedman but of the kind prescribed by Keynes - that is great efforts are given over by an independent and skilled mandarinate to preserve price stability - interpreted as low steady inflation of 2-3% in this country and slightly lower elsewhere.
Now you regard this as ‘relentless inflation’ in the long run. Well, it sure is pretty relentless. But like a lot of economic distortions a reasonable approximation is to say that the cost of the distortion is proportional to the square of its measurement. (this is a rule of thumb from micro - for tariffs for instance.) With inflation perhaps the curve is more exponential as once you get above a certain level of inflation - 30-40% perhaps the costs skyrocket and the economy ends up pretty much imploding.
But small deviations from the right level have much lower costs for obvious reasons. Now there are some reasons for choosing a positive inflation. Most particularly people are hard wired to really dislike wage reductions, though if a company is in trouble they can come much more easily at wage freezes. If you want to have a look at the literature on this google ["akerlof" wages "low levels of inflation"]
There’s the further point that we can’t measure inflation all that accurately - and product quality improvement may account for a seizable fraction of a percent per annum. So averaging 1.5% inflation (a little lower than us but other countries do this) might be averaging less than 1% with product quality taken into account.
So I’m not sure why this age we are living in has so much worse monetary policy than the gold standard era. And in the gold standard era downturns were much more severe with bank runs and all the rest of it.
What’s happening now is a big experiment as you say. Markets are reacting pretty rationally to the apparent taming of the cycle. They’re borrowing more and gearing up. That is exactly what you’d expect with a debt equity premium as large as it is. In effect the debt is bidding down the debt equity premium and it will be bid down further if and when interest rates rise. Will this end in tears. I don’t know.
But assuming that it does end in a nasty downturn, the question must still be asked whether a long downturn - say of the magnitude of the Japanese stagnation might nevertheless be better than the alternative of several sharper recessions in the period before then. Here Keynes would say ‘well you may be right, but you’re not that smart. No-one is. So we do what we can to keep growth going, we don’t do anything that’s clearly silly, but we don’t refuse to head off a recession (with monetary expansion) on the grounds of some theory that says that they’re really the best we can do. Perhaps we’ll get to that point, but everything in life is an experiment - theory doesn’t give us anything like 20:20 foresight, so trying to avoid recessions is an experiment worth trying and we should do it and keep our eyes out for traps and try to avoid them.”
Further I think there are really two things rolled into one in your comment. The first is inflation - and the worth or otherwise of zero inflation and/or a specie based monetary base and the tradeoffs between the long and the short term.
The second is the idea of leaning against the wind of the cycle which all modern monetary authorities do to some extent. If we are successful in doing this then we remove a major source of risk for investors - short-term systemic risk. This would occur whether we aimed for 2.5% inflation in the long term as we do in Australia or if we aimed for zero inflation. That would create pretty much the same kind of pressure on the equity premium it seems to me - entrepreneurs would borrow to invest. Debt would rise relative to equity and the equity premium would likewise start to diminish. And that might end in the same tears too. But it hasn’t been low levels of inflation that has caused it, it has been the central bank being able and prepared to lower systemic short-term risk.
As a conservative in these things I’d feel more comfortable taking this bet than the radicalism of going back to the gold standard - with all its arbitrariness and short term risks to the stability of the money supply. But of course I might be wrong . . .
Posted on 09-Mar-07 at 1:47 pm | PermalinkJames, I missed your exchange with Ingolf while drafting my comment above. I hope I’ve made myself clear that I regard Monetarism broadly as the emphasis on monetary stability seen as a policy in which “great efforts are given over by an independent and skilled mandarinate to preserve price stability”. I realise this is not how it was preached by Friedman (though his emphasis at the time was in minimising the cost of getting inflation down something we’ve not proven to be much good at), but his basic message has triumphed it seems to me even if the means he proposed did not. But if you want to preserve the word Monetarism for Friedman’s proposed approach then well and good - Keynes wasn’t ever a Monetarist.
Regarding Friedman’s views on Keynes, here are some quotes - all by Friedman and extracted and quoted by Friedman in his essay on Keynes in the Economic Quarterly, Vol 83, No. 2 Spring 1997.
This in an essay which is in fundamental disagreement with Keynes’ policy conclusions and predilections.
Posted on 09-Mar-07 at 2:16 pm | PermalinkIf that’s the definition of a monetarist, I wonder who isn’t one. Robert Mugabe?
As for Friedman’s praise quoted above, well, it doesn’t sound that sincere to me. I think he’s buying insurance againts charges of prejudice, which he knows is expensive in his case. But I’ll have a look at the whole article.
Posted on 09-Mar-07 at 3:07 pm | PermalinkJames, I presume that’s what Brad means by monetarist - together with the downplaying of fiscal policy in leaning against the economic cycle. Do you think Brad means anything more by it?
Posted on 09-Mar-07 at 3:12 pm | PermalinkNicholas, price stability as a policy aim certainly beats the hell out of the growth oriented approach of the 1960s and 70s. Nevertheless, its very amiability and seemingly irreproachable reasonableness can at times obscure serious problems.
In its 1998 annual report, the Federal Reserve Bank of Cleveland devoted a lengthy essay to the topic “Beyond Price Stability: A Reconsideration of Monetary Policy in a Period of Low Inflationâ€. The central question it addressed is summed up in a quote from Fisher in 1935:
The 1920s were characterised by high productivity growth, stable goods prices, soaring asset prices, a declining labour share of national income and an expanding business share. Much like the last decade or so, in fact. Had monetary policy been neutral, there’s no doubt prices would have steadily fallen in response to rapid productivity growth. They didn’t because policy was actually quite expansive and no small part of this monetary and credit excess ended up in an asset boom whose bursting was the proximate trigger for the depression that followed.
In our times, the productivity driven downwards pressure on prices has been further exacerbated by the supply side tsunami out of China et al. That price inflation has sailed on in the face of these heavy headwinds is an indication of how expansionary monetary conditions have actually been. In the last decade, M3 growth averaged about 8.5% in the US. In Australia, the figure is 9.5% (and household debt an average 13%). Is it any wonder asset prices have put on such a spectacular show and much investment been so terribly misallocated? As a result of all this we have, unfortunately, made ourselves terribly vulnerable.
I obviously accept these increases in money and credit have been driven in no small part by factors outside conventional central bank stimulus, particularly in the US. Deregulation, after all, brought with it a whole new zoo of players, instruments and techniques and the central banks sometimes look like bit players in their own game. Particularly when stacked up against the 800 lb gorillas of the BOJ and People’s Bank of China.
No, I suspect price stability as a bit of a chimerical beast. In hunting it to the exclusion of other considerations, there’s a fair chance we’ll fall foul of even more critical factors. So far, we’ve enjoyed the spring and summer of this radically new approach to monetary affairs. Autumn will, I suspect, be brief and winter awaits.
Posted on 09-Mar-07 at 5:46 pm | PermalinkThanks Ingolf.
You may indeed be right. I’m not sure that there are any failsafe ways through the various perils we are trying to navigate however. (In the meantime I’ve been selling assets!)
Posted on 09-Mar-07 at 5:56 pm | PermalinkAmen to that, Nicholas. If ever anything fitted Churchill’s description of Russia, it’s the current international financial architecture.
Posted on 09-Mar-07 at 8:54 pm | PermalinkBrad De long also has a very interesting article (pdf) he wrote a while back sketching a reasonable ‘liquidationist’ position on depressions - not that he concedes that liquidationism made any sense in the great depression. The arguments against it are very strong in that case.
Also this post outlines in a lot more detail his argument not just that “modern Keynesians are (in many respects) monetarists” but also that “modern monetarists are really Keynesians–even though they like to admit it even less.”
Posted on 09-Mar-07 at 10:14 pm | PermalinkInteresting article, Nicholas (the first one that is), but not one that I find particularly convincing.
De Long contends that “The Federal Reserve did not push reserves into the banking system during the 1929–33 decline. It passively stood by while the nominal money stock fell by a third.” This seems too simple a characterisation by far. While there was a substantial body of opinion that could fairly be characterised as “liquidationist”, the policies actually followed both by the Fed and the government more generally (particularly in its continual attempts to maintain wage and price levels) were confusing and to a considerable degree degree self-contradictory.
Bank reserves, the monetary category most realistically under the Fed’s control (unlike the money stock), remained relatively constant from 1929-1933. They ended 1929 at US$2.395 billion and at the depths of the downturn in June 1933 were US$2.211 billion. This apparently tranquil surface, however, hid a great deal of underlying volatility, in no small part because a number of crucial factors affecting reserves were not within the Fed’s control. Namely the level of the monetary gold stock, bank repayment of borrowings from the Fed and the level of cash holdings desired by the public. Its only real tool was the purchase or sale of securities and, allied to that, the level of short term interest rates.
It actually responded with considerable alacrity to the initial crash. In the final week of October 1929, it added almost US$300 million to the banks’ reserves (an increase of 12.5%) through a combination of discounting and outright purchases of government securities as well as lowering the discount rate from 6% to 4.5% by mid-November. (It was subsequently lowered to 1.5% by mid-1931 before being hiked again in response to severe gold outflows in late 1931 after Britain abandoned the gold standard and international opinion began to wonder whether the US might be next.)
Its attempts to reinflate, or at least stem deflation, were often stymied by those factors not under its control. By way of illustration, in just a few months in early 1932, the Fed purchased US$1.1 billion of securities in an attempt to boost reserves (a very large amount at a time when their equivalent of M3 was about US$45 billion) while at the same time there were outflows from reserves of US$788 million through increased demand for cash holdings by the public (US$122 million), a net repayment of bank borrowings from the Fed of US$290 million and a fall in the gold stock of US$380 million.
It’s also interesting that the level of excess reserves was higher pretty much throughout the downturn than it had been in 1929 and grew to about 20% of total bank reserves by late 1932. In other words, the problem wasn’t so much that the banks were starved of liquidity; they just didn’t want to invest or lend because they viewed the risks as far to high. This is the “pushing on a string†problem, one experienced more recently by Japan for much of the last 15 years.
His modelling exercise also seemed a bit shallow. He notes the following qualifications:
In excluding these from consideration, he disposes of two of the more critical components of the liquidationist view. The former I can sort of understand in the interests of simplicity – although it surely undermines whatever usefulness the model might have — but the latter I find surprising. In recent years, there’s been growing interest by economists in general, and central banks in particular, in the field of behavioural finance. Considerable effort is being devoted to precisely the question of whether speculative booms can be indentified ex ante and, if so, whether it is properly the job of central banks to act preemptively.
Anyway, as we agreed, this whole business is exceptionally complex and I’m not sure De Long really helps us much in gaining a better understanding. Not in this article at least.
Posted on 12-Mar-07 at 8:53 pm | PermalinkIngolf,
Whatever you think of De Long’s argument, are you endorsing ‘liquidationist’ recipes for dealing with the Great Depression? I’ve not studied this, but it certainly seems far fetched. Where was all this over-investment in the 1920s that needed to be liquidated by a prolonged depression?
Come to think of it, you argue that there’s been a lot of misallocation of investment lately. Well there has been in dwellings due in substantial part to tax lurks, some excess animal spirits and to some extent the ‘leaning against the wind’ of the central bank. That’s been unwinding here somewhat and unwinding more in the states. So where else is there massive misallocation of investment illustrating the kind of misallocation of capital goods investment that the liquidationist view requires to make sense?
In many ways I would have thought the trend was in the opposite direction - towards consumption whereas the theory I take it you are appealing to is one in which there is an investment in excessively long chains of production implying over-investment in capital goods.
Posted on 12-Mar-07 at 10:49 pm | PermalinkIt’s not so much that I favour a liquidationist approach per se as I do the withdrawal of government from activity that distorts price signals and risk/reward parameters. Their effect is a bit like western foreign policy in the Middle East in the last century or so. Each action created unexpected outcomes which in turn “required†fresh actions ad nauseum. (By the way, I’m not for a moment suggesting government shouldn’t set guidelines — on pollution levels, for example – or assist those who are in need of help, or try to ensure some equality of opportunity and so on, so long as these policies are transparent).
In a financial system without a central bank and without any bank guarantees, credit growth will to some degree be restrained by fear. Not only on the part of depositers but the banks and other financial institutions themselves. Operating without a safety net tends to concentrate the mind of most. The occasional flurry of animal spirits – as seems to happen every generation or so — will run its course, result in a panic or two, some liquidation of malinvestments and the transfer of others to stronger hands and things will go on.
Not so in a system which is either supercharged by central bank policies and/or underpinned by deposit insurance, whether implicit or explicit. There, excesses can persist and grow to a much greater extent. The excesses will tend to take different forms depending on the state of development of the economy concerned. In one still heavily engaged in industrial development, they’re likely to be concentrated in some combination of over or malinvestment. China now would be a perfect example and the US in the early 20th century was also still to a fair degree in this category. Usually, speculative excess will be a fellow traveller. When the excesses reach some difficult to define trigger point, the prevailing gung ho attitude will turn to fear. Those who have overextended will then be faced with the consequences of their folly.
My guess is that in 1929, the US – and many other countries – were hit by something approaching a perfect storm. In addition to the normal unhappy consequences of a pretty impressive boom – which probably could have been dealt with in relatively short order — many other factors were at work: a very disturbed geopolitical environment; great economic distortions and indebtedness left over after WWI; a haphazardly constructed international monetary system where some nations, like Britain, had gone back onto the gold standard at a singularly inappropriate exchange rate; government attempts to prevent prices and wages from adjusting to the real underlying supply and demand; an overextended debt structure resulting from central bank activity unsupported by bank guarantess and at the same time forced to operate within the restrictions of the gold standard; and finally, the rapid descent into “beggar your neighbour†trade policies. It was a period, in brief, where the worst aspects of two systems collided.
Disentangling this mess is probably an impossible task. Certainly, I’ve seen no explanation which entirely satisfies. What did happen, though, was a debt liquidation which of course fed on itself and was greatly prolonged by Hoover’s and Roosevelt’s policies. It would have been bad regardless but the combination of the above factors and subsequent government actions ensured a catastrophe.
Today, I see a somewhat different picture, albeit with some common elements. The underlying cause of all of them is the relentless growth in debt, premised in turn on a combination of central bank activity, a near total confidence that they and governments will prevent serious downturns, and the radical deregulation of the financial sector which has now metastisized to the point where it dominates many western economies. The primary difference from earlier booms like the 1920s, I think, is that the excess in the west this time around has more been one of overconsumption (in which I include a good deal of the explosion of housing investment). Much of this has been funded by debt and it has a number of consequences, none of them good. In effect, future consumption has been brought forward and hence producers have built, or are building, productive capacity to match a level of demand which in many cases can’t in the long term be sustained. Debt has also increasingly been concentrated in weak hands, often secured by assets which don’t produce sufficient income to service that debt. Much of the monetary excess – as discussed in the earlier post – has induced a speculative boom such that many asset prices bear little relationship to underlying fundamentals. And, of course, we’re left with unprecedented imbalances internationally as the Anglo-Saxon countries in particular have become heavy net consumers while China, the other east Asian nations and the oil producers are heavy net producers.
All of this, in my view, also has the potential to produce a perfect storm. Different, no doubt, from the last one but potentially no less destructive. And it’s almost all the indirect consequence of decades of unwillingness to accept the normal and needed corrective periods. In a free economy, without central banks or implicit and explicit guarantess, the excesses could never have even approached current levels and the corrections would be relatively minor and well distributed between sectors and areas. Now, it’s close to global and almost too large to contemplate.
One final comment. In my view, if a financial system is to be underpinned by a central bank and systemic guarantess, then it must also be quite heavily regulated. Otherwise the freed financial sector is in effect unconstrained by normal risk/reward considerations. If it is to be unregulated, which I certainly believe is the better solution, all guarantees must also be removed so that fear of loss can play its part in restraining credit growth and speculative activity.
Anyway, sorry it became such a long piece, Nicholas. Unfortunately, if I was to try to so any kind of justice to your excellent questions, I couldn’t really see a shorter way.
Posted on 13-Mar-07 at 12:50 am | PermalinkIngolf,
For me anyway, I think we’ve ended up where we started - in a productive rather than a repetitive way. I think you’re building far too much on some arguments which are perfectly reasonable but which could be quite wrong. Like Keynes I’m a (Burkean) conservative in this.
We know the economy is full of positive (destabilising) feedback in this area. That’s essentially the justification for governments leaning against the wind. Now if this is justified then leaning against the wind does diminish the magnitude of the business cycle and this generates large efficiency gains which grow over time. It is possible I grant you that it may end in something nasty, but we’ve got an aweful lot of growth out of the current system.
Your arguments would be stronger if we were protecting people from ‘real’ or ‘natural’ risks that we can’t mitigate socially - like the risk of fire to their houses or the risk that a technology won’t work. But the systemic risk that macro-economic management protects against is something that is not necessarily ‘natural’ or at least can be minimised. It can be minimised by social action - by the policies we pursue now. I see leaning against the wind as a trade in risk between parties poorly placed to bear it (individuals and corporations) and a party that is well placed to bear it - (the same parties acting collectively as the government).
When things are going well the state withdraws from risk sharing and when they threaten to get worse it extends it - into territory which we know no-one else will. (Better to batten down the hatches and wait till the expenditure of others gets things back to normal).
So far so good. Fundamentally I never really understand this penchant for thinking that recessions are natural and healthy. It’s not as if there isn’t a healthy evolutionary process in the economy sorting our the good and bad investments - it’s called competition. Even when we (successfully) protect people from recessions good investments generally continue to return more profits to their investors than bad ones. So the bad ones just go broke or get smaller slower. So what’s the problem - why do recessions improve on this mechanism? Why would removing them make things worse?
Now you argue that in the long run there’ll be some reckoning for all this. Perhaps, but I doubt it will outweigh all the benefits we’ve accrued so far and there could be some awfully big reckoning with what you’re suggesting and I think you agree that even without that there would almost certainly be quite substantial costs in moving to the new regime (recessions). I doubt the reckoning is likely to be on a scale that could outweigh the gains that the new approach has given us.
And in the long run we’ll all be dead.
Posted on 13-Mar-07 at 11:09 am | PermalinkMost interesting, Nicholas. I think I see a bit more clearly now why we differ. We’ll probably end up agreeing to disagree, but for what they’re worth, just a few comments on your post:
1) I don’t see the economy as full of destabilising feedback. Quite the opposite. Left to its own devices, it’s a self correcting, inherently stable system. This is born out by the experience prior to the early part of last century, as I noted in my first post.
2) Recessions are the natural consequence of some level of excess. If rationality always triumphed over animal spirits, we’d never need one. As you say, the normal process of competition would continually and almost invisibly correct errors. Such is not the nature of man, however.
3) Governments really only lean against the wind one way. Indeed their far more activist role in the last 80-100 years came about precisely to avoid recessions and their associated pain. In attempting to flatten volatility at all times (at least to the downside!), they instead unintentionally help to bring about the conditions that will eventually require a massive, and potentially disastrous, adjustment.
4) You assume we’ve had a net benefit as a result of central bank and government intervention to prevent recessions and promote growth. I don’t see how it’s possible to reach that conclusion. We don’t know where we would have been had the alternative path been followed. Certainly, classical liberals would expect the opposite.
5) I know you’re just being humorous, but that “long run†comment is really one of Keynes’ most fatuous. It either says nothing, or nothing. In all likelihood, he too just meant it as an amusing aside, a little bon mot.
All these and earlier comments about the costs and dangers of intervention refer only to governments’ activities in the financial sphere, not to questions of social equity or governance otherwise. As I see it, that’s an entirely separate discussion.
Posted on 13-Mar-07 at 1:55 pm | PermalinkIn the long run we’re all dead is not a fatuous comment. It’s an aphorism true enough. So it has to be read as a pithy (and to that extent improperly qualified) statement of a truism about a particular perspective - that of Burkean conservatism. It is full of import about the way Keynes thought. I don’t know if you’ve read Skidelski’s marvellous biography but he brings out Keynes’ Burkean conservatism particularly around this point. He sought amelioration, not revolution and what you’re suggesting is a (monetary) revolution. It’s hubristic about the powers of rationality to engineer some revolution.
Of course you can say that you’re arguing for the status quo ex ante circa WWI. But was that such a great system? What were growth rates then? And every decade or so you had a depression. As you know we had one in the 1890s which was very savage - up there but not as bad as the Big One of the thirties. Once you get bank runs it seems to me you’re stuffed - a bit like hyperinflation (though admittedly not so bad) you lose your monetary system - and the massive public good that comes with public confidence in the payments system.
We’ve not had bank runs or a depression since governments either through monetary or fiscal policy ‘lent against the wind’. EVER. Perhaps we will one day. It’s hard to imagine it being much worse than the Japanese experience which seems to have been a decade of near zero growth. That’s a lot better that a massive contraction wiping out a whole lot of perfectly good businesses and keeping all the entrepreneurs scared of ever investing in case the big one comes and wipes them out.
If what you’re suggesting is an improvement, can you point to one high growth country that has anything like it? Perhaps you could argue that countries that peg their currency to another are a bit like it, but where do we have high growth economies with banks that can fail?
And I’m mystified as to your comment about ‘classical liberals’ regarding the economy as a self-adjusting mechanism. Of course they regard individual markets as very close to this - as do it (unless there’s something wrong with the markets). But the monetary system itself is full of potential feedback all identified by Keynes and others. Expectations of future profit are a function of others’ expectations of future profit. Now you can argue that we’re destined to stuff up any centralised attempt to do better than the imperfect mechanism that would exist if we didn’t intervene centrally, but I can’t see how you can argue that issues of liquidity don’t involve collective action issues. This is commonsensical and confirmed both empirically and theoretically by the baby sitting co-operative used by Krugman to such good effect.
I’d also be interested in your reaction, if you’ve not read it to Krugman’s introduction to a re-issued Keynes’ General Theory. I thought it was very lucid. Brad De Long has a long excerpt here.
Posted on 13-Mar-07 at 2:26 pm | PermalinkYou’re right, Nicholas. “Fatuous†was a definite case of rhetorical carelessness. I haven’t read Skidelski but as I see it, Keynes’ comment can be read in two ways: one as I did in making that comment; the other as a plea not to sacrifice the possible on the alter of the perfect. It’s a sentiment with which I’m entirely in accord, providing of course the proposed possible doesn’t bring an even larger train of woe in its wake.
Oddly enough, in many ways I regard myself as Burkean. Certainly not as a revolutionary since both instinct and experience argue strongly that existing institutions should be respected and change only promoted with the greatest care. Clearly, I’ve not explained myself well.
One thing’s for sure; the whole topic of money and credit is fraught with complications. So much so that I have the impression even the experts are in a more or less continual quarrel, not only with different schools but also within their own. It’s classic “angels on a pinhead†territory and I no doubt can fall into the scholastic style of argument as much as the next man. To the extent that I’ve strayed into tedious dogmatism, apologies.
I’ve read through the posts and I don’t think I can put my case much better, Nicholas. I’d mostly just be repeating myself. Tedious, tedious. Whatever validity my view has rests on the belief that the longer term distortions I see flowing from the current system are sufficiently damaging, and dangerous, to outweigh the occasionally messy reality of a system free of support or interference. To a considerable degree, I accept this is a question of belief since no catastrophe has yet occurred under the current regime and what I’d like to see has never properly been trialed.
Just one final small puzzle that you can help me with. I was probably as mystified at your comment on “classical liberalism†as you clearly were at mine. Which must mean, I guess, we’re somehow talking past each other on this point. Isn’t it a cornerstone of this school that, as Wikipedia puts it:
“The “normative core” of classical liberalism is the idea that in an environment of laissez-faire, a spontaneous order or invisible hand market emerges that benefits the society.â€
It was at any rate for me merely a passing comment, one I’d thought entirely unremarkable.
Posted on 13-Mar-07 at 9:20 pm | PermalinkWell, the frustration was not really with you. I guess there are plenty of classical liberals that might argue against a role for leaning against the wind. But whereas their case is a strong one when it comes to micro markets, I think it’s absurd when it comes to macro-markets IF the argument is seriously put that there’s no market failure.
I guess there’s a perfectly good way to make it respectable which is to argue that govt failure is worse - that central banks mess things up and that therefore leaving it be is the best you can do. But the idea that there is a natural equilibrium rather than disturbance by positive feedback. Well I regard that as absurd - as demonstrated by the baby-sitting co-op. I have more time for classical liberals than that.
But I’m trying to get you to engage on those points. Surely you’d agree that there is strong positive feedback in an economy - through the monetary system.
Btw, I agree that money and credit is fraught. And it’s also a fertile field for nutters. I’ve always regarded it as somewhat magical. It’s certainly mercurial. I guess that’s partly my point. I don’t claim a deep knowledge, but I do believe that the idea of positive feedback is a big and simple idea that implies that leaning against the wind is a sensible policy. Anyway, I guess I’m repeating myself now. Again
Posted on 14-Mar-07 at 12:45 am | PermalinkNicholas, it’s becoming clear to me that I may not properly understand how you’re using various terms and concepts. For example, what do you really mean by saying it’s absurd to argue there’s no market failure when it comes to macro-markets? Or that the idea that there’s a natural equilibrium in a free monetary system is equally absurd? Nor am I sure I understand how you’re using the term positive feedback. Or, come to think of it, what you really intend to convey with your usage of “lean against the wind”.
These matters seem to be important to you, for reasons that aren’t at all clear to me. As I guess was obvious, I was trying to tiptoe out of the conversation with my last post because it had started to feel a bit too much like a stoush rather than an amusing discussion on a fascinating subject. So, maybe if I better understand your argument — and in particular your use of terminology — we might be able to clarify things and either reach some agreement or happily agree to disagree.
Posted on 14-Mar-07 at 10:25 am | PermalinkNicholas, going back to your #12, De Long’s characterisation of a specific school of ‘Keynesian’ thinking is accurate and helful. But he errs in equating this with ‘modern Keynesianism’ in general. ‘New Keynesianism’ is in fact essentially monetarist, by virtue of embracing the third plank in De Long’s menaifesto, namely:
But if you interpret ‘modern Keynesian’ neutrally as meaning contemporary Keynesians, they certainly don’t all subcribe to that, and needless to say Keynes wouldn’t either.
In any case, the cross fertilization of the last three decades doesn’t have much to do with your original post. What I objected to about that was the suggestion that the Tract on Monetary Reform contains some profound and original insights that Keynes subsequently lost sight of in the GT. It might have been more lucid, but it’s a much less ambitious book, and its adherence to the Quantity Theory framework, while completely understandable (everyone else did it), is a limitation rather than a virtue. I can’t see how anyone could agree with Krugman’s assessment and think otherwise.
As for the discussion with Ingolf, I suggest that one or other of you start a new thread, with as explicit as a statement as possible. This topic does lend itself to arguing at cross purposes.
Posted on 14-Mar-07 at 12:57 pm | PermalinkYes, fair enough James. I thought of your comments and this exchange with Ingolf when I read this exchange with Krugman on Krugman’s essay on Friedman.
Krugman agrees with you.
You pretty much word for word - though I think Krugman could have made his point more lively with a reference to Robert Mugabe.
Posted on 14-Mar-07 at 6:10 pm | PermalinkIngolf,
Apologies if you thought I was in for a stoush - not really my style. I was just hopping into the argument I thought on its merits. If you want to tip toe away please feel free, but I won’t bore others by following James’ suggestion and starting another post.
To answer your questions
1. what do you really mean by saying it’s absurd to argue there’s no market failure when it comes to macro-markets?
2. the idea that there’s a natural equilibrium in a free monetary system is equally absurd?
3. what you really intend to convey with your usage of “lean against the windâ€
Posted on 14-Mar-07 at 10:15 pm | PermalinkNicholas, absolutely no need for an apology. Anyway, we could always just do a swap for mine from #19!
Thanks for the answers. I’ll try to tackle them one by one as well:
1. I can’t say I see any of the examples you cite as evidence of market failure. They seem to me part of its normal workings; judging risks and opportunities; making decisions accordingly; reviewing the consequences and so on ad infinitum. Co-ordination is what the market does best, I would have thought.
2. I had a look at the Krugman article and also, out of curiosity, looked for the original article from the Journal of Money, Credit and Banking on which he based his story. (Only the front page – out of four — is available without shelling out US$44 so I contented myself with that!). Interestingly, it seemed to confirm what had seemed to me the most obvious fallacy with Krugman’s analogy. Let me quote the relevant excerpt from that first page:
Exactly. To solve the imbalance, they simply had to allow the price of the scrip to fluctuate according to the demand for and supply of baby-sitting services. But then it would really just be an ersatz form of money, something which I don’t think has ever worked out terribly well. There’s a deeper flaw with using this little scheme as a monetary analogy, though, since the scrip could primarily only be used for one service. To the extent that natural, chronic imbalances – whether seasonal or otherwise – occur in baby-sitting, they would always have problems using one-purpose scrip. In real life, on the other hand, money can be used for any purpose so come summertime, you’re either willing to pay up to get your sitter or you stay home with the kids. No insoluble problem there. Winter, you could get it for next to nothing.
In my experience of trying to get to understand these sorts of issues, apparent problems usually, as in this case, turn out to be a direct or indirect consequence of interference with market processes.
3. Right, that’s what I understood it to mean as well. Sorry to have troubled you for an explanation.
Posted on 15-Mar-07 at 1:16 am | Permalink