Home > Economics - General > The Treasury View: Swimming pool version

The Treasury View: Swimming pool version

March 6th, 2009

A reader sent me, for comment, one of those letters that circulate through the Intertubes. This one is sent as “an explanation of the stimulus bill”. I wouldn’t call it that, but it is quite a good exposition of what’s known as the “Treasury View”[1]. If you believe that the economy is like a swimming pool, and that no matter how big a splash some shock (such as the collapse of the financial system) might make, the water in it will rapidly find its own level, then you will agree that there is no need for, or possible benefit from, the stimulus package. And conversely, if you think the economy is not like this, you are entitled to wonder about the kind of economist (regrettably not imaginary) who would employ such an argument.

fn1. The reference is to the British Treasury, circa 1931

Stimulus Bill Explanation

Shortly after class, an economics student approaches his economics professor and says, “I don’t understand this stimulus bill. Can you explain it to me?”

The professor replied, “I don’t have any time to explain it at my office, but if you come over to my house on Saturday and help me with my weekend project, I’ll be glad to explain it to you.”

The student agreed.

At the agreed-upon time, the student showed up at the professor’s house. The professor stated that the weekend project involved his backyard pool.

They both went out back to the pool, and the professor handed the student a bucket. Demonstrating with his own bucket, the professor said, “First, go over to the deep end, and fill your bucket with as much water as you can.”

The student did as he was instructed.

The professor then continued, “Follow me over to the shallow end, and then dump all the water from your bucket into it.”The student was naturally confused, but did as he was told.

The professor then explained they were going to do this many more times, and began walking back to the deep end of the pool.

The confused student asked, “Excuse me, but why are we doing this? The professor matter-of-factly stated that he was trying to make the shallow end much deeper.

The student didn’t think the economics professor was serious, but figured that he would find out the real story soon enough. However, after the 6th trip between the shallow end and the deep end, the student began to become worried that his economics professor had gone mad.

The student finally replied, “All we’re doing is wasting valuable time and effort on unproductive pursuits. Even worse, when this process is all over, everything will be at the same level it was before, so all you’ll really have accomplished is the destruction of what could have been truly productive action!”

The professor put down his bucket and replied with a smile, “Congratulations. You now understand the stimulus bill.”From Hell

Categories: Economics - General Tags:
  1. xyz
    March 6th, 2009 at 18:15 | #1

    OT: see Blooomberg’s “Bonds Beat Stocks in ‘Earth-Shattering’ Reversal”.

    Where’s the equity risk premium now?

  2. Bruce Littleboy
    March 6th, 2009 at 18:41 | #2

    John, I think you were astute to realise that this was about the Treasury View.
    But the point of the analogy is this, I think:
    When the government borrows a bucket of money from the private sector and then tips it in as government spending at the other end of the pool, nothing in total has happened.

    Of course the error in the Treasury view given above (as identified in the Keynesian counter-argument) is that the government is borrowing “idle money” from the wealth holders at one end who have buckets full beside the pool and who are not spending it. The government spends these funds and tips them into the pool. The water level therefore rises. (Total spending or MV rises; even though the money supply is unaffected, its velocity rises. If resources are idle, P changes little and Y, real output, duly rises.) As a result, extra government spending does not crowd out private-sector spending one-to-one.
    This is one way how Keynes disposed of the Treasury View. But it is a vampie that refuses to die no matter how often the stake impales it.
    The perplexed should consult Krugman: http://krugman.blogs.nytimes.com/2009/01/27/a-dark-age-of-macroeconomics-wonkish/

  3. Bruce Littleboy
    March 6th, 2009 at 18:45 | #3

    Correction: a vampie is killed by a steak.

  4. Alice
    March 6th, 2009 at 19:15 | #4

    Correction. The students Professor couldnt solve the problem as he had gone mad. The water leaked or evaporated for quite some time, over the side and into the grass so big was the splash, and so hot the sun. The filter was noisily sucking air due to lower water levels, disturbing the neighbours peace. All he had to do was turn on the tap and fill the pool, rather than engage the student in an idle and pointless activity.

  5. Bruce Littleboy
    March 6th, 2009 at 19:41 | #5

    You are right to mock these parables that purport to pass as analysis. But the spread of these viruses is evidence of their potency. One needs counter-illustrations to fight them where they break out. Major thinkers have trotted out tales like these as though they meant something powerful.
    I like the bit about simply turning on the tap: just fund government spending by increasing the money supply.

  6. SeanG
    March 6th, 2009 at 20:11 | #6

    Bruce @ 6.41pm – “Of course the error in the Treasury view given above (as identified in the Keynesian counter-argument) is that the government is borrowing “idle money” from the wealth holders at one end who have buckets full beside the pool and who are not spending it. The government spends these funds and tips them into the pool. The water level therefore rises. (Total spending or MV rises; even though the money supply is unaffected, its velocity rises. If resources are idle, P changes little and Y, real output, duly rises.) As a result, extra government spending does not crowd out private-sector spending one-to-one.”

    Bruce, this is not accurate in the slightest. Firstly, wealth is hardly ever “idle” as the Keynesian analysis would suppose it to be. Where the money is located – deposits for instance – is usually used by the holders to make investments either through loans or through other type of investments.

    Secondly, if the Government takes this money by borrowing then what happens is that it reduces the available capital to be lent to the private sector. Now we have upwards of $4 trillion that will be borrowed by governments across the globe. What will the impact of this be on the private sector? Already bond auctions in the UK and Germany have failed. The Obama Administration is planning a $60 billion bond auction. To entice lenders, the interest rates increase and this impacts on private borrowing.

    This is the reason why in the 1990s the Clinton Administration reduced deficits and moved to a balanced budget position. There is greater upside from reduced long-term interest rates than from higher government spending.

  7. Alice
    March 6th, 2009 at 20:14 | #7


    My idea was for government to fund government spending however the government likes (except printing money), I really dont care too much on that. When it kicks in they will get it back in taxes we hope and pray. No one can be really sure. Whats the alternative? Drop interest rates to the U.K.’s half a percent and watch nothing happen? Interest rates are a puny instrument and take too long at times like this.
    If ever there was a time for fiscal experiments, it just happens to be now. The only experiment not worth trying is the “do nothing” experiment, that is, the student shouldnt lie on his back with a noisy pool filter, and an empty pool, disturbing the neighbours and say oh the rain will fix it!


  8. Salient Green
    March 6th, 2009 at 20:28 | #8

    How about this? The banks are allocated a share of the pool which they can lend out 11 times over while there is a continuous, cascading flow of repayments from the lendees.

    Out away from the pool there is power being generated which is needed for the lendees to keep pumping a flow back to the banks over the pool.

    Suddenly the cost of this power skyrockets and the lendees spending too much on energy for themselves, can’t maintain the flow back to the banks.

    This would happen if the cost of any essential commodity skyrocketed while the banks were multiplying their profits in such a way.

    This is our future, skipping from one commodity shortage to the next, marked each time by a financial disaster.

  9. Alice
    March 6th, 2009 at 20:35 | #9

    And correct me if I’m wrong, but isnt demand for government bonds through the ceiling? (safe haven – no shortage of lenders to government backed bonds right now, while banks sit on their uneasy balance sheets and hands). As someone from Tyndalls said
    “Given what equities have done in the past few months, a positive return of 3 per cent looks good compared to a minus 20 per cent return.” Go with the nearest flow I would say.

  10. SeanG
    March 6th, 2009 at 20:39 | #10

    Bonds are loved but you are looking at the secondary market and you have to take into account different demands between US-denomiated bonds, Euro, Pound and between the various countries who issue Euro-denominated bonds.

    The bond auctions are having issues because there is only so much that people are prepared to buy. When the risk premium goes up people flood into that secondary market but those who would normally buy bonds at auction are now trying to pump prime their own markets are now thinking twice.

    I believe that the most interesting statistic is the CDS spreads on the government bonds. This is the credit risk of respective governments and the UK and German CDS spread has shot up indicating concern as to their financial viability.

  11. Alice
    March 6th, 2009 at 20:44 | #11

    8#Too true Salient,

    Or have we become slowly accepting of the idea that beyond a certain population level, governments lose control and there isnt much we can really can do about it? (well if its Australia, this is pretty damn pathetic. Look how small we are as a nation relatively!)

    Economic mismanagement here would be (is?) nothing short of shameful.

  12. Bruce Littleboy
    March 6th, 2009 at 20:53 | #12

    Re Sean G #6

    The term “idle” has probably misled you. Money held as wealth in the financial sector may be whizzing around from one financial market to the next. (It may not be in a bucket: try a blender!) The asset velocity of money may be extremely high, but it’s income velocity may be low. This means that, aside from the commissions earned by traders, money put into asset/finance markets and churned furiously does not lead to the generation of currently produced goods and services. Asset prices (house prices, share prices) rise, but the production of new houses and new factories lag, or never eventuate. That’s why asset bubbles occur: there is a potentially serious disconnect between financial markets and the real economy. Bubbles lack real substance.

    Note the vital distinction between a new financial investment (paper shuffling, the exchange of ownership of existing real assets, buying and selling bonds, spinning off new deritives etc.) and real investment in productive capacity(machines, buildings, inventories).

    If markets eventually do their job, money that is saved and flows into the financial sector sooner or later reaches someone who borrows it to fund productive investment. Keynesians believe that this circuit is slow, weak and unreliable. If you have studied first-year economics, this is why investment is autonomous (not connected to saving, for example), at least in the short run.

    If you think that a rise in saving quickly and reliably leads to a rise in productive investment, then you are a Classical economist. And if you a right, old-style Keynesian economics largely collapses.

    (Sorry to be didactic in tone, but I am a lecturer!)

  13. SeanG
    March 6th, 2009 at 21:00 | #13

    Bruce – I was taught Keynesian economics at university! I admit that my ideological leanings were initially heavily towards the Chicago School but my lecturers and professors were very good in explaining Keynesian, new Keynesian etc economics and I am not hostile to Keynesian economics at all!

    However, I disagree with the view that it is a workable strategy. The reason is that it presupposes that the accumulation of wealth can be better spent in a different area by the government. Yet it does not distinguish whether or not Government expenditure leads to higher economic growth than private investment. Further, it presupposes that all financial products are worthless – they are certainly not!

    Fund managers invest in numerous businesses from the highly risky such as venture capital, to alternative investments and the bond markets. But in the capital market where they invest it achieves a purpose. A large corporate entering the debt market to raise capital to expand can lead to what you are writing about: the purchasing of machines and the hiring of labour.

    Where I disagree with you is the assumption that pump-priming will lead to higher economic growth. The lessons learnt from Japan indicate that this is not the case. I believe that the government should engage in deficit spending and focus on long-neglected areas – transport, communication, energy and education infrastructure which provide the framework for a more efficent and productive private sector which will lead to higher economic growth over the medium and long term, rather than any ad hoc government spending program would do.

  14. Salient Green
    March 6th, 2009 at 21:32 | #14

    #11 Alice, I think govts have lost control in many ways to big business who are now too big for our own good and too big for our leaders to say “get stuffed”.

    I think the economy is being managed ‘big business centric’ and I think that constitutes mismanagement.

  15. Bruce Littleboy
    March 6th, 2009 at 21:48 | #15

    Sean G #13

    What you have said is sensible enough, though each point is debateable by me and others, of course. We may agree on what the facts are but disagree about their interpretation.

    Please remember the starting point. The Treasury View (TV) is that Keynesian policy cannot work as a matter of logic. The point of the Swimming Pool Parable (SWP) is that only a gibbering idiot would believe that fiscal policy could work even in principle.

    Important though it is, talking about whether fiscal policy always works in practice is a difficult and different question. But talking about whether it could work in theory is, I believe, as intellectually challenging and even more provocative.

    Do you accept that the SWP is unhelpful and misleading? The person who espouses it and spreads it either does not know (or pretends not to know) what the Keynesian chain of reasioning is. Analysing the parable makes each of us confront and identify what they believe about how a macroeconomy works in its most basic essence.

    Keynes’s point was that the stock of saving is very large, and some of the money now churned in the financial sector can be borrowed and spent on G without significantly reducing the ability of private investors to obtain funds for real investment. You can agree or disagree.

    Indeed, (brace yourself) if the old-style leakages and injections approach has any validity, an increase in global G will raise global S+T by the same amount, if I is fully autonomous. (Planet Earth is a closed economy, so net exports are zero). If there are idle resources that would otherwise not have been soon drawn into production, then the higher income resulting from G automatically generates the funds required to pay for it!

    The Keynesian model generates surprising results, and students these days are not aware of them; some people would accept its broad validity and others would reject it. But let’s be clear about what we disagree over.

    So let’s identify in a toy model what assumptions we are making and exactly how we see the causal processes that are at work. Whether you agree with the relevance of the Keynesian counter-parable I’ve related is not the issue; if you understand it, then you are in the position to judge its merit either way. Ideological persuasion should not be a barrier to understanding the causal logic of those with different beliefs.

    I think that many anti-Keynesians do not grasp what old-style Keynesianism is about. And these parables may be the only way that meaningful communication can occur.

    And probably none of this exploration of the underlying intuition ever makes the textbooks or the lectures. It’s all hidden behind equations, and the quality of university education is the worse for it.

  16. SeanG
    March 6th, 2009 at 22:06 | #16

    I think that the parable, like all parables, is meant to try to simplify what pump priming is about. I disagree with it because it is simplistic – rather than being a simplified explanation.

    What would be a better parable? Maybe the best way to explain the Fed’s policy making is that there is a pool in the professors backyard and a mad pilot has hijacked a helicopter and is trying to pour a bottle of water into a pool but keeps on missing and hitting the tiles instead.

  17. Bruce Littleboy
    March 6th, 2009 at 22:09 | #17

    Re #16 SeanG

    Your metaphor is better than you appear to think!

    I’m off home before Security appears. Good night all.

  18. paul walter
    March 6th, 2009 at 23:14 | #18

    Thanks to Alice, #4, for an explanation of “trickle-down”.

  19. observa
    March 7th, 2009 at 08:23 | #19

    Personally at the end of the MDB, it’s hard for me to be concerned about filling swimming pools and you might like to google ‘World worries as Obama team struggle’ for my perspective on that. Volcker has every right to be worried that so few economic generals want to join Geithner as the Obama administration hunts desperately for its Petraeus now.

    “We’ve got to isolate the bad assets,” says Gordon Brown somewhat pathetically now. Well Gordon there’s only one way to do that and that’s to let the market discover their true price in fiat money before the market finally goes looking for their true value in gold bullion. Citigroup shares plunging more than 96% to under a dollar in 10 months should be telling you that.

    It is of course the banks that hold the key to the value of all things denominated in fiat money and it’s clear that so much is overvalued or simply worthless now. The trillions dollar question is by how much and it’s quite clear no public servant wants to be the one to work it out. That leaves the free market after setting it a sensible parameter. In the long run bad assets on average could demolish 20-30% of collective savings although it could be more. Since public servants and politicians can’t choose a bottom line let me choose 60% of savings for them. That’s the global central bank bottom line for all, or at least for our Reserve, if the ROW can’t see sense. Our banks trade on that ironclad guarantee with the Reserve calling a halt to any institution facing a run. Credit totals are shown as a 60% guaranteed amount and a 40% non guaranteed amount. Temporary closure sees all depositors and lenders accounts reduced by 40%, the existing shareholders’ equity wiped out and the depositors immediately become new shareholders at a dollar a share, according to their respective 40% loss. The bank reopens with each depositor’s credit total now fully guaranteed and transferrable to any bank should they so wish. The guarantee amount holds so they can only be hit once, no matter where they subsequently choose to hold their funds (assuming the same entity). The new bank is free to raise capital on a $1/share basis as the shareholders newly elected board see fit. Their ultimate return of lost savings will now be riding on ‘their bank’.

  20. Ikonoclast
    March 7th, 2009 at 08:24 | #20

    The point of counter-cyclical spending is that a government can build surpluses in boom years (thus damping the economy) and then spend those surpluses in slump years by running deficits (thus stimulating the economy).

    This means, in this simplified model, there is no net financial borrowing over the cycle to compete with the private sector. However, there is a “taxation borrowing” followed by an “outlays return” at another part of the cycle.

    So the professor’s analogy was wrong. A better analogy requires a pool, a rainwater tank and a roof to collect rainwater. The pool can be replenished by rain on its own surface and by roof-collected rainwater. In times of strong rainfall the pool would overflow excessively if the tank was not intervening and collecting the excess water. In times of poor rainfall the pool would get too low if the surplus from the tank was not allowed into the pool.

  21. observa
    March 7th, 2009 at 08:32 | #21

    I forgot to add that naturally it’s compulsory for new shareholders in ‘their bank’ to approve all board and CEO remuneration.

  22. Michael of Summer Hill
    March 7th, 2009 at 10:12 | #22

    John, I am more optimistic than others that the stimilus package can work. In my opinion companies such as GM who are in dire straits would be in a better off if they offloaded their entire fleet, have one big firesale and start afresh. Businesses need to do more than just beg for money.

  23. Bruce Littleboy
    March 7th, 2009 at 11:18 | #23

    Re #19

    The Rudd Administration could also use a General Petraeus. Already (AFR, March 6, p. 1), plans are afoot to rein in the evil deficit, and presumably weaken the moderate stimulus recently applied.

    The press is full of anti-Keynesian commentary. To be charitable, it is to counterbalance the government line. But the government is incapable or unwilling to respond to these critics hand-to-hand in journalistic terms. Instead the government is starting to fold.

  24. Bruce Littleboy
    March 7th, 2009 at 11:41 | #24

    The rainwater tank is a good and simple explanation of a respectable Keynesian view. It may be better nowadays than the rustic / biblical stories about storing away good harvests to run down in bad times.

    I still think we need these stories: “A rising tide raises all boats” is a good one, but a colleague remarked that currently the leaky boats may sink anyway.

  25. Alice
    March 7th, 2009 at 12:01 | #25

    I thought of an even better parable. A runaway elephant from a local zoo stumbled into the professor’s backyard pool, proceeded to drink all the water, spouted it all over himself and onto the tiles and grass where it seeped away, and then made a huge mess in the pool so that no one else could swim safely in it. First you remove the elephant (no easy task), clean up the mess, fill it up with clean water and start again.
    Large global financial firms? The elephant in the pool.

    As for that “rising tide lifts all boats” fairy story – I hate that one. Its just too cute. What about the small boats that get crashed on the rocks because of the rising tide? Tides dont just nicely rise, they come with waves too.

  26. Lord Sir Alexander “Dolly” Downer
    March 7th, 2009 at 12:17 | #26

    The corollary I suppose of the pre-Keynesian UK treasury line is that you can tax the cr*p out of everyone (say a flat 90% income rate) and it would make no difference to economic activity.

  27. Alice
    March 7th, 2009 at 12:29 | #27

    “And probably none of this exploration of the underlying intuition ever makes the textbooks or the lectures. It’s all hidden behind equations, and the quality of university education is the worse for it.”

    Agree. The era of the disconcertingly vague chatty thin mildly mannered economics textbook is upon us. Largely chatter and barely economics and hardly an equation in sight. Hang on to your older texts lest we forget. What is the problem here? Some students too cool for school? Or some publishers too eager for sales?

  28. Alice
    March 7th, 2009 at 13:20 | #28

    Since Rupe achieved almost complete dominance in the Australian media, with Faifax and Consolidated press fading away, the dialogue has been distinctly anti keynesian, anti labor, anti intervention and pro deregulation, pro war, pro freed trade and pro liberal (How many years of it now?). We dont have a range of opinions here like they do in Europe or North America. Its very apparent. Did anyone notice how the story on the Calabrian mafia linked donations to Liberal party ministers and Vanstone’s immigration approval of someone who was later caught moving large amounts of ecstasy into the country just quietly disappeared without follow up and without ongoing media forensics, to be replaced by two weeks worth of articles on the labor minister Virginia Judge who approved a police station in shopping mall?

  29. charles
    March 7th, 2009 at 13:45 | #29

    So the good professor grasped that the system is dynamic. If the shallow end is spending and the deep end savings, the issue is how viscous should the liquid be, to represent the flow of spending to saving as the government buckets the savings back to the spending end.

  30. Jim Birch
    March 7th, 2009 at 14:21 | #30

    I don’t know if I’m the only crazy person around here, but I find this post and the comments both weird and interesting.

    It seems perfectly clear to me that anyone who thinks that something as complex as an economic system can be equated with a swimming pool and that an economic stimulus package is equivalent to a bucket is a more of loony than an economist. A stimulus package may or may not be a good idea, but surely it shouldn’t be chosen or rejected on the basis of a facile swimming pool analogy. A clinching economic argument, not.

    A more interesting question is this: Why are we sucked in to thinking that swimming pool economics is actually worth talking about at all? There may be some odd views floating around in these comments threads, but I think that the JQ commentariat would generally have mental capabilities that exceed a smart nine year old, so, what’s the attraction?

  31. Bruce Littleboy
    March 7th, 2009 at 15:46 | #31

    #30 Jim
    The reality is stranger than you may think. The basic Keynesian model is a circular flow of income with leakages (saving, imports and taxes) and injections (government spending, investment and exports). There is a Phillips Machine through which water passes according to the policy settings (turn a dial or tap) and basic data about the width of the tubing in various sectors. It reflects what Alan Coddington later called the hydraulic approach to Keynesian economics. It’s a rather literal model of the basic maths of the Keynesian system. The engineer (the expert/hubristic macroeconomist) could tweak the flows and stabilise income at any chosen level. This conception of an economy, once dominant, was always challenged by anti-Keynesians as well as by some Keynesians in other factions.
    Model building (not necessaraily in physical form!) is nowadays recognised as integral to science, and economists led the way in this regard.


  32. March 7th, 2009 at 15:48 | #32

    Jim, see Alice #28

  33. Alice
    March 7th, 2009 at 16:02 | #33

    A particularly nice piece of didacticism there…worthy of Gittins! So the swimming pool stays.

    Oh and no rising tide ever improved the seaworthiness of boats.

  34. Bruce Littleboy
    March 7th, 2009 at 16:12 | #34

    Perceptive and amusing, Dolly (if I may be so intimate).

  35. sdfc
    March 8th, 2009 at 13:05 | #35

    Why do critics always seem to miss the role expectations played in Keynes’ work? It’s this omission that leads to such rubbish analysis.

  36. Bruce Littleboy
    March 8th, 2009 at 17:55 | #36

    sdfc #35

    A few ideas:

    Keynes said greed and markets were potentially bad. The is ideologically incorrect. Authors of textbooks moved right, and so did their students. Ergo delete JMK on expectations.

    Keynes referred to irrationality and centred his economics on it. This conflicts with basic economics. Good economics is internally consistent. Ergo delete.

    Keynes was writing about the Great Depression and this extreme case warped his views about how financial markets work. Chapter 12 is purple prose, not analysis. Ergo delete.

    Keynes did not know that it was the Fed that caused the Great Depression, so he’s outmoded. Ergo delete.

    Keynes was long dead before rational expectations were conceived/discovered. Ergo delete.

    Keynes wrote in 1936, which makes him way out of date. Why read dead people? The latest working paper from the best university contains the best thinking.

    Besides, Keynes’s policies ceased to work in the 70s, so we can reject the theories behind them.

    Of course each of these claims by those who reject JMK on expectations is somewhere between debateable and outright false.

  37. Alice
    March 8th, 2009 at 18:47 | #37

    Sadly, too true # 36 Bruce. In doing so they deleted the sharpest economics mind of the century – and for what?. A whole pandora’s box of inadequate or flawed theories in their own right (but perhaps inherently more dangerous than those of Keynes). Even had they not “deleted”, even had they revised, even had they accommodated or developed, but no – Keynes was certainly loudly deleted and antithesis (for antithesis, or egos sake) has yet to work its way through.

  38. Ernestine Gross
    March 8th, 2009 at 19:19 | #38

    I don’t understand why many of the comments are in defence of Keynes rather than critical of Eugene Fama and John Cochrane.

    While it may be the case that Keynes has been ‘deleted’ in the applied policy area, in the math-econ area he is acknowledged to have inspired new theoretical work (non-Walrasian general equilibrium models).

  39. Bruce Littleboy
    March 8th, 2009 at 19:46 | #39

    Ernestine, some the models you may have in mind may relate to non-W analysis with trade at non-clearing prices. Expectations aren’t central there.
    But I imagine there’s a pile of stuff by now on self-fulfilling expectations equilibria. If so, do you have a favorite that has relatively ‘accessible’ prose?

    I think Krugman has done a good hatchet job on Fama and on Cochrane, by the way.

  40. Alice
    March 8th, 2009 at 20:20 | #40

    True, but overhwelmingly in academia only. As well, in the math econ area he hasnt just inspired new theoretical work in the non Walrasian general equilibrium model. There is also research that has made small adjustments to the standard Keynesian ISLM model to include money transfers and Walrus law is found to hold.
    The point I am making is that there is a disconnect between academia and applied policy areas, such that Keynesian theory has been out of fashion in any practical sense for some decades. I think, without being too particular about it, it can be said generally, Keynes was “deleted.”

  41. Alice
    March 8th, 2009 at 20:31 | #41

    I would also suggest here, there was never any insurmountable problem with Keynes’s theory. It was sound. The problem was more with rejection of Keynesian remedies and it has always been thus, even before Keynes.

  42. Ernestine Gross
    March 8th, 2009 at 20:36 | #42

    Bruce @ 39 (assuming the number doesn’t change), the following books contain relatively ‘accessible’ prose:

    Jean-Michel Grandmont, Money and Value, Econometric Society Monograph, 1983

    Douglas Gale, Money:in disequilibrium, Cambridge Economic Handbooks, 1983

    Frank Hahn, Equilibrium and Macroeconomics, 1984 (I like this book because of Hahn’s ability to verbally convey complex ideas. However it assumes a thorough grounding in post 1950 G.E. methodology)

    These books were published at a time when the great leap forward to the 19th century* was in full swing in the USA and the UK and progressing in Australia – the famous period of micro-economic reform.

    There is also a literature in Walrasian equilibrium theory, starting with Arrow in the 1950s and Radner in the 1970s which, IMO, made the leap forward to the 19th century* by the Chicago School very obvious. In this sense, Keynes is not critical in picking the regress of the Chicago School to the “Treasury View” (“dark ages” in Krugman’s article).

    *or earlier, eg Says Law.

  43. Alice
    March 8th, 2009 at 21:24 | #43

    An example of the “anti Keynesian remedy” style can be found at this link (Fama),


    For all our models and laws, whether on markets, demand / supply, equilibrium or disequilibrium, expectations, the role of money etc do we examine sufficiently power and influence in markets and what intellectual ideas can be purchased or rewarded to restrict effective policy, if those of influence gain by it, at the expense of the majority?

  44. Alice
    March 8th, 2009 at 21:27 | #44

    Sir Otto Niemeyer is alive and well and living in 2008.

  45. Stephen L
    March 8th, 2009 at 22:32 | #45

    This may be a good point to raise a question I have been looking to ask economists for some time.

    We are all being urged to spend rather than save, but I also understand that investing is also to be encouraged – if we go out and buy shares with our $900 the stockmarket will rise and this will both make it easier for companies to raise capital and boost confidence.

    But isn’t saving and investing pretty much the same thing? Doesn’t the bank I save with go and invest some of that money, when they are not lending it to other people? Surely they don’t just sit on it – how then could they pay interest?

    What am I missing here. And to be ethical what is the best thing for me to do for the economy at the moment, not only with the $900 but with a larger, much delayed, payment?

  46. sdfc
    March 8th, 2009 at 22:40 | #46

    Yeah that’s right Bruce, what relevance do the 1930s have to now?

    As for defending Keynes Ernestine, not really defending just pointing out a flaw in the argument that fiscal policy is ineffective regardless of economic circumstance.

    As for Fama well we’ve had a taste of how efficiently financial markets price assets during financial market dislocations.

    John Cochrane I think is the guy who said banks should be allowed to fail in an orderly fashion. If he is, then he is in cloud cuckoo land if he thinks letting Bank of America or Citigroup fail is a viable strategy. The new capital he discussed as coming in to pick up the pieces has packed up and gone home after having its fingers burned earlier in the piece.

  47. sdfc
    March 8th, 2009 at 23:10 | #47

    Yeah that’s right Bruce, what relevance do the 1930s have to now?

    As for defending Keynes Ernestine, not really defending just pointing out a flaw in the argument that fiscal policy is ineffective regardless of economic circumstance.

    As for Fama well we’ve had a taste of how efficiently financial markets price assets during financial market dislocations.

    John Cochrane I think is the guy who said banks should be allowed to fail in an orderly fashion. If he is, then he is in cloud cuckoo land if he thinks letting Bank of America or Citigroup fail is a viable strategy. The new capital he seems to think will come in and pick up the pieces has packed up and gone home after having its fingers burned earlier in the piece.

    Sorry Alice but I find the IS/LM summary of Keynes work as pretty uninspiring, having no room as it does for, you guessed it, expectations.

  48. sdfc
    March 8th, 2009 at 23:12 | #48

    Sorry I didn’t realise I’d pressed go the first time around.

  49. Alice
    March 9th, 2009 at 06:19 | #49

    Easily done sdfc

  50. Alice
    March 9th, 2009 at 06:50 | #50

    Sdfc – so we move on to the New Keynesians but what difference will it make, entire schools devoted to grooming CEOs (Chicago Booth – received a 300 mill bequest last year from a fund manager),when there are huge resources devoted to the aims of teaching people how to “maximise shareholder value” (share price), complete with their own theorists who may only have the most paltry of models by way of one dimensional accounting equations (see Fama link posted above) but who, will argue every time against fiscal expenditure of any description and for tax reductions every time.
    Keynes v.1, v.2, v.3 – may be superior at every step of the way over past decades, ambushed in practice. Is there a model for hijacks and diversions of practical policy?

  51. Bruce Littleboy
    March 9th, 2009 at 09:44 | #51

    #47 et al

    I am writing a paper about the contemporary relevance of Keynes.
    The answer depends on the extent to which the problem is caused by, or reflected in, a deficiency of total spending relative to our potential to supply. Clearly, overindebtedmess was causing some overspending (and over-production). We cannot strive to pump AD up to quite the level it was before.

    We may reasonably regard the banking crisis as a negative technology shock that has resulted, or is likely to result, in a necessary contraction or slowdown. But markets (financial and real) overshoot. There is the likelihood of an overcontraction of total spending and production. Pre-emptive fiscal stimulus may be a good idea: a hasty stitch in time may save an elegant nine later. The form, size and timing of this stimulus are separate issues.

    In the 1930s, the Fed allowed banks to fail and even initially tightened monetary policy to deal with the asset bubble. (I wonder if those who recently advocated high interest to break the asset bubble “before it got too big” realise how tricky this is to do.) Many thousands of US banks failed and millions lost their life savings. The effects on confidence and on spending were catastrophic. At least this blunder has not been repeated.

    The central bankers with Treasury support (resulting in a fiscal deficit) are the greater part of the current answer, and this has nothing much to do with the traditional methods of raising G or cutting taxes.

    Although there also was a financial crisis in the 1930s, I doubt that standard Keynesian remedies are as fully applicable today. In the 1930s, one could replace the private demand for steel with government demand (Hoover dam, battleships). And one could rely on liquidity-constrained people spending extra income on necessities. If people were hungry, you know that producing more soup can’t be far wrong.
    Now much consumption is discretionary and devoted to deferrable durables. In Australia, the government cannot simply enter the market to buy iron ore and coal to replace overseas buyers.

    But the idea of governments being employer of last resort is not dead. What these people do with their income (save or consume) is their business, I feel. I think exhortations to spend (and to buy locally) are tacky and ineffective.

    But I have no problem with significant fiscal stimulus. And there is no risk whatever in Australia that the deficits involved would constitute sovereign risk of defaulting on government bonds, even over accumulated deficits in a period of a few years. The US and UK may be in greater danger of a lack of public (actually, I probably just mean “market”!) trust and lack of credibility, it is worth remembering that these countries ended WW2 with national debts of about double their GDPs. And prosperity reigned. Furthermore I think there are degrees of trust and credibility, So there may be a corresponding degree of fiscal success even in those countries.

    Aggregate demand shocks are seldom spread remotely evenly across the affected sectors. There is always a structural impact. Some of these are “temporary’ (the investment sector is hit), but some may be more permanent. Markets do a better job of sorting resource out long-term structural change on a microeconomic scale. Macrostructural shocks may require fiscal stimulus so that the resources rendered idle will more smoothly find a new use elsewhere. But I am not a fan of propping up industries that merely have srong political lobbying power.

  52. sdfc
    March 9th, 2009 at 23:32 | #52


    I regard the current financial crisis as overwhelmingly the result of an extended period of loose monetary policy. While reigning in asset bubbles does present some problems for policymakers, the longer the bubble is allowed to run the greater the cost of reigning them in.

    The parallels with the 1930s are there for all to see, then as now the Fed conducted what was loose policy before tightening in the hope of putting a break on what had become a runaway train.

    Once the bubble popped, the Fed initially cut rates hard pushing the discount rate to a low of 1.5% by mid-1931. Unfortunately when your banking system is broken monetary policy doesn’t work.

    Sure the Fed later raised rates in an effort to stem gold outflows, and though this was a policy disaster, by this time, excessive debt, deflation and the banking collapse were major drags on the economy.

    In short the problems in my opinion were overwhelmingly caused by loose money which fed a excessive debt accumulation and the Fed’s failure to render assistance to the banking system once it had become apparent the system was in collapse. Not in my opinion tight monetary policy in the traditional sense.

    Back in the present, the Fed is no orphan among central banks in keeping monetary policy too loose for too long.

    Fom a domestic point of view, the RBA itself also kept rates too low for too long. While the RBA could be excused for underestimating the extent of the terms of trade boom early in the piece, by
    mid-2006 it had become apparent the commodities boom was a huge shock to the Australian economy yet they sat on their hands, raising the cash rate at a snails pace while household debt continued to build to astronomical levels.

    And now we get to 2009 and the turn in the terms of trade is set to hit us like a freight train.

    While I and others may quibble about the exact composition, in my opinion the government is doing what it should be doing in getting in early with a stimulus package to try and limit the damage.

  53. Bruce Littleboy
    March 10th, 2009 at 11:38 | #53

    In so far as monetary policy is directed primarily towards fighting goods-and-services inflation, asset prices are only of indirect relevance to central bankers. Given their blinkered view, interest rates were pretty much right.
    Old-fashioned Keynesian and Austrian critics of Orthodoxy could see there was a problem of easy money in the financial sector. Everybody saw it except orthodox New Keynesian adherents of so-called Taylor rules. (But Taylor has recently complained that his rule was not followed properly.)
    Mainstreamers rejected bubbles as old-fashioned Keynesian nonsense. Austrians and old-style Keynesians disagree about whether crises can be market failures or are essentially monetary-policy failures, but that’s a separate bunfight.

  54. swingtotheleft
    March 14th, 2009 at 00:03 | #54

    Explaining the Stimulus Bill Part 2

    Upon closer observation, the student spots a leak in the swimming pool and sees the President trying to refill the pool and plug the leak at the same time. Unfortunately, there are many cracks that started 30 years ago, and it has become even worse over the last 8 years. We could let rainwater refill the pool over time (free market), but the pool is leaking and evaporating too fast (deflationary spiral.) The remaining water will freeze next winter because the pool pump is broken (liquidity trap, banks not making loans) and the pool cracks will further breach causing the even more water to leak out in the spring. A real economist knows there is never a constant volume of water in the pool. After all, the government just added half a trillion gallons. It should have been lots more, except someone was standing on the water hose screaming MORE TAX CUTS! Last year, the Fed added 2 trillion gallons in the deep end where all the wealthy bankers hang out and where the largest cracks are leaking the most water. The President wants to help the professor RENOVATE his pool by making the shallow end deeper and the deep end deeper. That way he lifts ALL boats. But the professor only believes in the free market, not government, thus clouding his judgment. He would call his insurance company and file a homeowners’ policy claim, except they are backed by AIG who are now owned by the government. Too bad, I guess the pool will drain leaving the shallow end high and dry while the deep end has just enough water for the privileged few. The student realizes the professor is a hack and drops his class. The student was last seen reading a book on Keynesian economics.

Comments are closed.