Classical economics and recession in many countries (wonkish)

Sharp tests of economic theories are rare and hard to find, particularly in macroeconomics. Any examination of particular episodes in economic history necessarily involves counterfactuals, and these provide room for endless dispute. As an obvious example, assessing the impact of the Obama Administration’s 2009 stimulus requires an estimate of how things would have gone without the stimulus, and that is obviously hard to do.

Similarly, arguments about unemployment in the US get bogged down in disputes over whether it is structural or demand-driven and the extent to which policies such as the extension of unemployment benefits to 99 weeks have contributed. 

There is, though, one way in which the current Great Recession/Lesser Depression provides a sharp test of a critical proposition in economics. All forms of classical economics involve, in one form or another, the claim that the causes of unemployment are to be found in labour markets, and not in  macroeconomic variables such as the level of aggregate demand. That’s equally true of the Say’s Law version of classical economics criticized by Keynes, the New Classical macroeconomics of Robert Lucas and the attempts by Real Business Cycle theorists like Kydland and Prescott to explain cyclical fluctuations in terms of labor market shocks.

The crucial problem for all these theories is that labor markets and the associated institutions operate mainly at the national level. Even within the EU, different countries have very different labor markets. So, it is essentially impossible for labor markets in many different countries to move together, except as the result of macroeconomic influences operating at an international level[1]. That means that the occurrence of a sharp and sustained increase in unemployment, taking place in many countries at once, is inconsistent with classical economics.

This point seems trivially obvious, but as far as I can tell hasn’t been made, or at least not clearly. Once it’s conceded, it seems impossible to avoid a view of the world that is basically Keynesian in its analysis of the macroeconomy.  It is possible to hold such a view and reject Keynesian policies on pragmatic grounds, as in Friedman’s critique of ‘fine-tuning’. But the longer and deeper the recession the harder it is to sustain this view.

This seems like a good time to plug the fact that a paperback edition of Zombie Economics will be out soon (May 6) with a brand-new chapter on Austerity, bits of which have been seen here. On 9 May, I’ll be launching an Australian edition, where the added material is a chapter on Economic Rationalism. And a week or two ago, I received some copies of the Italian edition










fn1. Of course, you can cheat and label these macro influences “technology shocks”, then assume them to be internationally correlated. But in the ordinary meaning of technology, there is no plausible way in which economies as disparate as, say, the US and Greece can experience a common technology shock.

Posted via email from John’s posterous

95 thoughts on “Classical economics and recession in many countries (wonkish)

  1. @Chris Warren

    I find your use of the words ‘capitalism’ and ‘capitalist’ unhelpful.

    Bankers aren’t capitalists – especially when they don’t wear the risk of their business decisions (this would include both those who are salaried, and those subject to government bailout).

    Academics are not capitalists, unless they’re moonlighting. They may or may not have sympathies for the capitalist system, but they are not capitalists themselves.

  2. @Dan
    I sorta half agree with you (re: Bankers), although does capitalism inherently require risk as a fundamental attribute of its definition? One could loosely define state sponsored bailouts as somewhat “post premium injected” insurance payouts? In no way am I attempting to justify them.
    Capitalism ultimately drives innovation – both good and bad innovation. In Banking, bad innovation would include much of what we refer to as “financial innovation” eg. derivatives ; also political innovation eg. lobbying legislators and regulators to loosen financial regulation with the *ultimate* goal of maximum returns or rewards for the *individuals* driving the action. Of course the goal of minimum risk to the *individuals* driving the innovation shouldn’t be discounted as a primary motivation for the action.
    You could argue such innovation is a product of capitalism, although there’s plenty of examples of corrupt activities under socialist systems that are quite innovative and far less transparent.

  3. @Dan

    I think you have to see today’s commercial banks as capitalists. There may be some argument otherwise, but it would need to rest on a boutique definition of capitalism.

    I do not have a problem describing Keen as a capitalist based on the published positions he takes which I included.

    However in general I agree – academics are not capitalists – only some, but they must self identify. Of course he can change, but this may be like waiting for Godot.

    I assume most people on this blog are capitalists as they presumably would support economics based on wages equaling marginal productivity of labour, and all the conceptions that flow from this. Such wage labour is the basis of capitalism.

    There may be an issue between those who “have sympathies” with capitalism vs those who are active capitalists (ie investors), but I have combined the two. This is common. Academics esposing apartheid or “White Power” are still racist even if they do not actively discriminate against other races in their day-to-day life.

  4. @Adit

    Fair bit to digest here with different emphases. Probably not possible to attend to it all on a Monday.

    In short….

    Yes – the Harbour Bridge is stimulus and a non-capitalist economy should have every opportunity to access such stimulus. This is not the aggravated compounding stimulus required by long-running capitalism.

  5. The grounds on which I say bankers aren’t capitalists is purely Marxian – I’m not trying to split hairs or be obscurantist here.

    They would better be described as ‘inflationists’ as their core business is to generate bubbles and skim some of the result off for themselves.

    Capitalism would work better, not worse if this sort of gambling did not exist, and it is up to regulators to prevent it (and a tremendous job they’ve been doing of late, of course; the case for narrow banking kind of makes itself).

    Whether capitalism can work at all in the long term is a different question.

  6. It is intriguing to note the following in the graph in the paper Ernestine links to above. Australia experienced its best employment performance (average uneemployment of 1.9%) in the “Keynesian Period” of 1940/41 to 1973/74. I am sure Keynesian economic policy was not the only factor in this good performance but it would appear to be one of the factors. As far as I can recall, inflation and interest were also low in this period. Demand was also stimulated by war, post-war reconstruction and more war in Korea and then Vietnam.

    War appears to be one of the few activities that governments of all stripes won’t leave to “market forces” or individual preference relying instead on state command, mandates, drafts and massive state expenditures. This expenditure creates demand and the economy responds to that demand. This is more evidence that the modern capitalist or mixed economy, in the absence of gross and obvious resource shortages and labour shortages, is clearly demand driven.

    What a pity the dirigist approach cannot be extended beyond that most vile of human endeavours, namely war, into positive state command to transition from a fossil fuel economy to a solar economy. The demand generated by a twenty or thirty year full transition program would easily shift unemployment back to the “frictional” 2%.

  7. @Ikonoclast

    Yes this is the period of managerial welfare state capitalism as Minsky calls it. It followed the disillusioned defense of capitalism by Keynes in his general theory. From it and work of public servants like Keyserling we got social security, universal healthcare, minimum wage, glass steagal, public ownership of natural monopolies etc etc etc. I agree this stemmed from Keynes’ demand side approach – it would’ve been great if we kept going instead of being ideologically jousted by neoclassicals in the 70s and the experience of the oil shocks and stagflation supposedly justified this. oh how wrong they were.

    @Chris Warren

    I’d also suggest that market socialism and capitalism are not mutually exclusive. Aspects of each can coexist. Indeed in the post war era after a more accurate understanding of how capitalism operates we started to see reforms (noted above) that would suggest the beginnings of a transition to more “market socialist” organisation. These effectively came to a halt and even reversed to an extent through the re-ascendency of neoclassical thought (maybe New Keynesian but NOT Keynesian). in fact I’d argue the Keynesian analysis of capitalism updated over the years by Minsky, Kalecki, etc.. naturally leads to a more market socialist (if that’s what you want to call it) conception of capitalism.

    Concluding, the demand side approach provides a serious alternative to the “kind” of capitalism that has reigned for the last few decades.

  8. @Adit

    Capitalist banks do not have to own MoP. They still use capital to accumulate surplus value. They do this privately as a private corporation. Within a capitalist framework capital must earn profit irrespective of where it is employed.

    Operationally interest and commercial profit are different, the activities they engage in, are different, but the capitalist relationship is identical, money is only invested where it receives maximised profit which is value that should have been paid to workers and should have funded final consumption expenditures. Both banking profits and MoP profits generate the same tendency to a GFC.

    Interest payments and profits themselves (without capitalism) are also different and have precisely the same nontrivial differences as under capitalism. A workers cooperative may well have savings that could be loaned to some other community that needs to build some asset (eg a bridge). Some negotiated interest can accompany this behaviour. Alternatively IOU’s can be created, given to the suppliers of bridge building, with promises to pay later with a bit extra for waiting funded by increased earnings from the new bridge. Properly regulated, this economic behaviour should not cause any economic crisis.

    Similarly profits (ie rewards for innovation) by themselves do not cause economic crisis. Innovation increases output, so more commodities exists to represent boosted incomes. Its not clear that you would need any extra money at this point. However a capitalist would demand more money.

    Those arguing

    bubbles from rising private debt – yes that is the source of financial instability. Every recession/depression can be traced back to private debt dynamics, not ‘capitalist profit’.

    are not looking past a rather glaring symptom.

    Rising private debt or ‘private debt dynamics’ (whatever this means) is not the source, because it is itself “caused”.

    Noone is trying to:

    calculate wages receiving the full value of their productivity?

    Wage-labour itself needs to be opposed. Any business receives the full value of its productivity in its sales revenue, so participants in that business can decide how this is distributed based on the amount of cash and their costs.

    All competitive market activity creates so-called “creative instability” and this is natural. Capitalism creates additional financial instability that builds up over time. Natural creative instability creates windfall gains for some and windfall losses for others. This does not immediately create capitalist profit unless the creative innovation is monopolised. Then the rot can start.

    There is no need to differentiate between financial capitalism and commercial capitalism. Capitalism only has strength if it exists in suitable political environments which provide for; accessing cheap overseas products to sell in home market, purchasing inputs when population is low but selling when population is high, increased concentration of commerce and associated monopoly rights and, most importantly, relatively fixed wages (by law or contract or violence if necessary) but free market prices. Additional corrupt practices can strengthen capitalism such as the sensational subsidies given to Kodak in the past and to car manufacturers over the years. These all have limits. As the amount of lustful capital increases these methods must work harder and harder which is impossible – so finally capitalists end up having to sell and invest with debt. At first this may not be too much of a problem, but in theory, it grows exponentially.

    It is not clear what you are referring to when you use the word “capitalist”. I only object to the aspects covered by Marx. This is capital as distinguished from wealth and means of production. As Marx said – wealth, finance and means of production are not capital – they need converting into capital. There are no crisis tendencies inherent to MoP, wealth, debt or finance. They only create crisis if wage labour exists.

  9. ‘Sharp tests of economic theories are rare and hard to find, particularly in macroeconomics.’ Very true and rarely do cases repeat themselves in isolated experimental contexts. So many variables are included that one can only study them after all has been said and done.

  10. @Adit

    There may be an argument that capitalism and market socialism can coexist.

    In general, as capitalism accumulates capital to then build itself, and socialism distributes capital to build society, huge tensions would be expected. Possibly rigorous conditions could be legislated.

    So far the ‘mixed economy’ theorists have not reached this point. However subsidising non-profit co-operatives from super-profits taxation may be considered. This means applying Keynesian stimulus to a sector of the economy, not to the economy as a whole.

  11. @Ernestine Gross

    There is no doubt that Australian unemployment dropped faster than US unemployment between 1931 and 1936.

    I’d venture the opinion that fiscal policy had little to do with it.

    Much more important to Australian employment was Empire Preference instituted by the Ottawa Conference. This benefit was amplified in early 1931 by the massive devaluation by 30% of the Australian Pound.

    Australia enjoyed an export-led recovery that stimulated the domestic economy and enabled Australian governments by virtue of increased tax revenue to return to fiscal surpluses.

  12. Katz, see by alex Millmow

    In 1934, Lyons proclaimed that the Australian economic recovery was ‘one of the most spectacular…the world has known’. He asserted that unemployment due to the Depression had been cut in half. By 1935–36, Australia regained the peak of pre-depression output achieved in 1927–28

  13. Jim

    Once again you point me to Ohanian papers however attempting to explain the depression via general equilibrium analysis once again leaves me cold.

    Private sector debt to GDP was 119% of GDP, rising to a peak of 148% of GDP in 1922 while private debt to GDP was 158% in 1929 rising to 196% of GDP in 1931. The two episodes are not comparable. The debt ratio in 1920 had been falling since 1916 as the economy entered a period of wartime inflation. The debt to GDP ratio was lower in 1922 than it was in 1916. In contrast the much higher level of debt in 1929 came after a decade of very low inflation. The rapid rise in debt during the 20s increased the economy’s and banking sector vulnerability to shocks.

    The early 20s depression was the result of deliberate Fed policy, it was started and ended by the Fed. In contrast, the economy failed to respond to sharp cuts in the Fed discount rate in the Fed discount rate should give a hint of the financial stress on the economy in the early 30s.

    Ohanian fails to explain the relatively robust recovery from 1933-37 despite rising real wages.

  14. thanks sdfc, must be quick because it is late.

    the slow recovery from the U.S. Depression has been known for decades, including in the Cole and Ohanian, Armen Alchian, Milton Friedman and Anna Schwartz, and Robert Lucas, all of whom point to New Deal policies that depressed competition in labor and product markets.

    The economic fundamentals that drive all expansions and recoveries were very favorable during the New Deal. Productivity grew very rapidly after 1933, the price level was stable, real interest rates were low, and liquidity was plentiful.

    Both Lucas and Rapping (1969) and Ohanian and Cole (2004) calculated on the basis of productivity growth and other factors, employment and investment should have been back to normal levels by 1936 in the USA.

    The recession in a depression in 1937-38 was not the result of a reversal of New Deal policies, but a deepening of New Deal polices that raised wages even further above their competitive levels, and which further prevented the normal forces of supply and demand from restoring full employment.

    the 1920-21 depression was understudied, but that is changing in part due to ohanian and Cole.

    Ernestine Gross, I used Interwar Unemployment in International Perspective
    Interwar Unemployment in International Perspective, Eichengreen, Barry J.; Hatton, T.J. (Eds) at google books, about page 30 or so. best I could find.

    did not know of your reference, will read tommorow.

  15. Jim,

    your proclamations about Australia are highly misleading.

    Like the UK The Australian economy was not strong before the Depression, unlike the USA for example, so it doesn’t mean much that it got back to pre-depression levels in 1936.

    You entirely miss out the massive devaluation ( in Bernanke the academic terms).

    This meant inflation returned to Australia and hence no liquidity trap. This is the major reason why Hawtrey disagreed with Keynes. He thought large devaluations would have a positive affect on price levels and then monetary policy could resume its prominence.

    Unfortunately the UK proved that incorrect.

    Australia only got unemployment back to 8% at best. It entered WW2 in double digits yet within a year it had fallen threefold!

    The other thing is that it is likely the structural surplus here,was like in the UK, very small and thus the change even smaller. This means fiscal policy at the federal level had little impact. It was still expansionary at the State level.

    On the US, you for some reason completely miss Keynes criticism of NIRA. Given he wrote an open letter to Roosevelt I find that strange.
    Even given his poor labour policies average growth from 32-36 was near double digits.

    If he didn’t have his appalling 1937 budget then recovery would been when expected. It would have been a hellva lot quicker if real wages were allowed to fall.

    There was no depression in 1920/21 just a recession. I think the three recessions in 7 years should be studied further.

    One result would be to see how poor classical econmics is in terms of macro-economics.

  16. JB Cairns, remembered this yearbook link

    “The unemployment rate has fluctuated throughout the century, with peaks and troughs closely reflecting movements in the economic cycle.

    In 1906, unemployment stood at 6.7%, and fluctuated at around this rate (though it rose briefly to a little over 9% in 1915, and just over 11% in 1921) until 1929 when unemployment stood at 11.1%.

    The unemployment rate then increased rapidly to 19.3% in 1930, before reaching a peak of 29.0% in 1932, in response to the economic conditions of the Great Depression.

    This unprecedented high rate of unemployment persisted for two years, before the unemployment rate fell rapidly to below 10% by 1937.”

    Hard to find interwar unemployment data

  17. well they relied on Trade union data.

    However even unemployment at 8% merely means recession to depression to recession.

    I should have mentioned the massive devaluation which brought on much needed inflation led to real wages falling and unemployment thus falling.

    cuts in nominal wages when there was deflation led to real wages rising!

  18. I thought the point of the discussion was a rapid recovery from the depths of a depression despite a massive fiscal contration.

    would a fiscal expansion have speed the already rapid recovery?

  19. Jim,

    There was no massive fiscal contraction.
    You are ignoring the effects of the massive devaluation and also that with inflation around there was no liquidity trap.

    Also if you have falling real wages then you have a recipe for unemployment to fall quickly.

  20. The premiers’ plan required the federal and state governments to cut spending by 20%, including cuts to wages and pensions and was to be accompanied by tax increases, reductions in interest on bank deposits and a 22.5% reduction in the interest the government paid on internal loans. the plan was complementary to the Arbitration Court’s 10 per cent wage cut of January 1931 and the devaluation of the Australian pound.

    While MacLaurin (1936) dated the economic recovery from the last months of 1932, it was to take another three years before unemployment rates fell below 10 per cent — the rate it had been during the 1920s.

    The Plan contrasted with the approach put forward by John Maynard Keynes, which held that governments needed to spend their way out of the Depression.

    Australia came out of the Depression earlier than most other countries because of the approach that was made under the Premiers’ Plan.

  21. There is a good RBA paper looking at the banking sector through both Depressions we have had.

    Fiscal policy was not expansionary before the Depression and hence not all that contractionary after it.

    Actually Keynes favoured devaluations before public spending just as he did here.

    Also the health of the banking sector was much better here than in the UK or USA and so monetary policy could affect the economy.
    Devaluation helped both Manufacturing domestically and primary in terms of exports.

    The early recovery was muted. It gained strength after the devaluation.

  22. thanks John, you might know that Cass Sunstein defines a conspiracy theory as “an effort to explain some event or practice by reference to the machinations of powerful people, who have also managed to conceal their role.”

    Many millions of people hold conspiracy theories – that powerful people have worked together to withhold the truth about some important practice or some terrible event. Most conspiracy theories typically stem from a sharply limited number of relevant information sources.

    Conspiracy theories generally attribute extraordinary powers to certain agents – to plan, to control others, to maintain secrets, and so forth.

    Conspiracy theories overestimate the competence and discretion of officials and bureaucracies, who are assumed to be able to make and carry out sophisticated secret plans, despite abundant evidence that in open societies that government action does not usually remain secret for very long.

    Conspiracy theories also assume that these nefarious secret plans are easily detected by ordinary members of the public such as themselves without the need for special access to non-public information nor any investigative resources.

    A distinctive feature of conspiracy theories is their self-sealing quality. Conspiracy theorists are not likely to be persuaded by an attempt to dispel their theories; they may even characterise that very attempt as further proof of the conspiracy

    Karl Popper argued that conspiracy theories overlook the pervasive unintended consequences of political and social action; conspiracy theories assume that all consequences must have been intended by someone

    Most people lack direct or personal information about the explanations for terrible events, and they are tempted to attribute such events to some nefarious actor.

  23. Johnathan Portes is very perceptive.

    Karl Popper said, cruelly but accurately, of Marxism:
    [it] is no longer a science; for it broke the methodological rule that we must accept falsification, and it immunized itself against the most blatant refutations of its predictions. Ever since then, it can be described only as nonscience—as a metaphysical dream, if you like, married to a cruel reality.
    He then likens this to Austerity types at present. Steve Kates comes to mind when one reads the line.

    Keynes approved of Austerity but at the right time like Australia now not Europe, UK or the US . Austerity at the wrong time merely increases the budget deficit and public debt.

  24. JB Cairns, Thomas Humphrey wrote an excellent 250 year long literature survey of the rules versus discretion debate in the 1998 Richmond Fed Quarterly.

    He wanted to know if macroeconomics was a progressive science in the sense that superior new ideas relentlessly supplanted inferior old ones.

    Humphrey found that:
    • Keynesian ideas and their many antecedents gain currency when unemployment was the main concern.
    • Monetarist ideas tended to reign when price stability was the main problem.

    The policy debate keeps recycling because
    1. people forget the lessons of the past and
    2. For better or worse, politicians and the public tend to believe that central banks, the focus of his studies, have the power to boost output, employment, and growth permanently.

    Humphrey showed that stable policy rules are popular in good times to contain inflation, and when unemployment was rising, discretionary policies returned to policy vogue.

    Humphrey concluded that doctrinal historian knows that much of what passes for novelty and originality in monetary theory and policy is ancient teachings dressed up in modern guises.

    Haberler, Jacob Viner and frank knight also all pointed out in their reviews of the General Theory that it lacked originality, and presented old ideas, often incorrectly, in confusing new vocabularies that made the book difficult to read.

  25. @Jim Rose

    The summary you give from Sunstein is pretty good. Being a conspiracy theorist and believing that conspiracies occur are not inevitably the same thing. It’s the use of conspiracy as a theory of society or its major political faultlines that is decisive in marking something out as a conspiracy theory.

    Sunstein is right in noting the overestimation conspiracy theories make of the competence and discretion of officials, bureaucracies and others. More broadly, conspiracy theories locate events within metanarratives — commonly metaphysical ones — that stretch across decades and even centuries, imposing themselves onto the conduct of people who have never met and did not even live at the same time. Most ingeniously, all events have a “Morton’s Fork” quality about them, since apparently anomalous behaviopur by parties to the conspiracy are seen as mere instants of some even more overarching narrative — the game within the game. This makes them unfalsifiable. All of human history is reduced to one coherent narrative, rather than the product of human conflict.

    The problem is of course that if everyone is on the same page — wittingly or otherwise, one might wonder why apparent conflict would be needed at all. The whole point of actual conspiracies is to gain an advantage againts some rival — which means there must be rivals — i.e. people who are not parties to the conspiracy.

  26. Jim,

    Keynes had it right. Most of the time you let monetary policy be the main lever in economic policy. It is only when it doesn’t work ( I would add impaired) that you use active fiscal policy.

    Type in Hard Keynesianism on this blog and get a better understanding.

    As Farrell and Quiggin show when you move away from from that you get problems.

    Classical economics has a problem in that there are no successful examples to observe.

    This is not surprising as Classical economics is pro-cyclical.

    By attempting to keep the budget in balance no matter where in the cycle a country is you will exacerbate the business cycle.

    If a country has a slowdown and attempts to keep its budget in balance then it mist mean it is tightening policy because it cuts structurally. After-all in cyclical terms there is an easing.

    So a slowdown becomes a recession.

    On the other hand as the economy is strong any attempt to keep the budget in balance will mean a structural loosening.

    Booms and busts!!

  27. when the classical policy rules applied prior to 1929, most governments were little more that a post office and a military. government spending would have struggled to get into the mid-teen double digits of GDP.

    the threat of inflation to implicitly repudiate debt was more real.

    during the period from 1870 to 1914 adherence to the gold standard was a signal of financial rectitude, a good housekeeping seal of approval, that facilitated access by peripheral countries to capital from the core countries of western Europe.

    countries with poor records of adherence were charged considerablym ore than those with good records

  28. @JB Cairns

    However, statements like “let monetary policy be the main lever” are more poetic concepts than say – adjusting interest rates, selling bonds and currencies etc.

    But the real problem is not Keynesian responses to ‘boom and bust’, but the fact that this is a temporary fix that is incomplete and passes the problem onto the next generation. While this would be obvious in a closed economy, not even open economies are immune. Over decades the general instability expands and expands. See:

    We now inhabit a world dominated by looming unemployment, at least 100 trillion dollars of excess ‘money’ and population and climate pressures – the result of excessive lusts for growth.

    All this reality in the 21st century – when those like Nicholas Kaldor claimed in the 1930’s they were developing policy that could “mitigate economic instability” and Samuelson claimed we could escape boom and bust. Anyone can paper over instability if you hand out dollars to capitalists and increase the population. This is a temporary fix that necessarily ratchets.

    I know our Keynesians are feeling a bit smug at the moment as the predicted inflation has not stormed across Western economies. They still think they can:

    redevelop Keynesian economics in a way that overcomes these failings

    presumably by a ‘mixed economy’ where you mix public and private, or so the story goes.

    This just ain’t so. This is mixing non-profits with capitalist enterprises – lambs with dingos.

  29. @JB Cairns

    However, statements like “let monetary policy be the main lever” are more poetic concepts than say – adjusting interest rates, selling bonds and currencies etc.

    But the real problem is not Keynesian responses to ‘boom and bust’, but the fact that this is a temporary fix that is incomplete and passes the problem onto the next generation. While this would be obvious in a closed economy, not even open economies are immune. Over decades the general instability expands and expands. See:

    We now inhabit a world dominated by looming unemployment, at least 100 trillion dollars of excess ‘money’ and population and climate pressures – the result of excessive lusts for growth.

    All this reality in the 21st century – when those like Nicholas Kaldor claimed in the 1930’s they were developing policy that could “mitigate economic instability” and Samuelson claimed we could escape boom and bust. Anyone can paper over instability if you hand out dollars to capitalists and increase the population. This is a temporary fix that necessarily ratchets.

    I know our Keynesians are feeling a bit smug at the moment as the predicted inflation has not stormed across Western economies. They still think they can:

    redevelop Keynesian economics in a way that overcomes these failings

    presumably by a ‘mixed economy’ where you mix public and private, or so the story goes.

    This just ain’t so. This is mixing non-profits with capitalist enterprises – lambs with dingos.

  30. @Jim Rose

    Where precisely did Frank Knight point out in his review of:

    the General Theory that it lacked originality, and presented old ideas, often incorrectly, in confusing new vocabularies that made the book difficult to read.


  31. Knight reviewed the general theory in the canadian journal of economic sin 1937.

    classical macroeconomics was very familiar with business cycles and deflation. most obviously, from postwar resumptions of convertability such as in the UK in 1821, 1879 and 1925.

    see Classical deflation theory by Thomas M. Humphrey at and
    Getting pegged: comparing the 1879 and 1925 gold resumptions by Tamim Bayoumi and Michael D. Bordo

  32. “In this chapter and throughout the book, his references under this phrase are, in general, the sort of caricatures which are typically set up as straw men for purposes of attack in controversial writing.

    I mean, of course, that that is the way in which they impress me. In the great majority of cases the doctrines so labelled seem to be quite at variance with, and often contradictory
    to, anything I was ever taught as classical doctrine in any modern sense—and I went through the academic “mill”; and they are certainly alien to anything I have ever taught as
    such, and I have been rated, and have supposed myself, an adherent of the general type of position referred to by the term.

    many of Mr. Keynes’s own doctrines are, as he would proudly admit, among the notorious fallacies to combat which has been considered a main function of the teaching of economics. ”

    Frank Knight 1937.

  33. Jim

    Just what sort of growth rate would satisfy Lucas and co? RGDP grew 11% in 1934, 9% in 35, 13% in 36 and 5.1% in the recession year of 37 before hitting the wall in late 37. The continuing high unemployment was a product of the 45% drop in income between 29 and 33. Rising productivity during a recovery should not be a surprise.

    The rise in real wages during the recovery was nowhere near as damaging as the drop in nominal income during the slump. Falling income reduces the private sector’s ability to service pre-existing debt. The higher the debt level the bigger the problem.

    Sorry Jim Lucas, Ohanian and co are off the mark. Quite staggeringly so.

  34. @sdfc

    “Falling income reduces the private sector’s ability to service pre-existing debt. The higher the debt level the bigger the problem.”

    Exactly. And non-service of debt – default – results in discontinuities somewhere in the system. (This is not obvious in models which do not have a financial sector or models which exclude, by design, the possibility of default.)

  35. @Jim Rose

    Your sources do not substantiate your statements w.r.t. Knight. However Keynes ‘vocabularies’ is an issue. However the GT was original.

    It is not clear what your project is – Are you engaging in an Austrian criticism of Keynes?

  36. thanks Fran, yes, conspiracy theorist’s attribution of great competence and discretion to politicians, bureaucracies and others is amazing.

    Their ability to uncover the secret plot without investigative resources is more amazing.

    The police, crime and anticorruption commissions take years of careful detective work.

    Watergate was uncovered because of rather indiscreet conspirators doing brazenly clumsy things. Even then, the investigation was several years long. the current UK phone tapping scandal is another example.

    The air of corruption can be thick before any evidence is found worthy of going to trial.

    Hong Kong had to invent the crime of having unexplained earnings in the 1960s to break the back of police corruption, as I recall. Article 20 of a UN Convention defines the offence of “a significant increase in the assets of a public official that he or she cannot reasonably explain in relation to his or her lawful income”

  37. Chris, the Knight quote was a cut and paste.

    as for Harbeler, consider his 1938 letter to Keynes:

    “As regards the quotation from your article in the first sentence of my note to which you object I should like to say this: I understood you to have promised not to use the term classical economist any more, because it covers a multitude of different views; the admission, in other words, that what you called the `classical theory’ covers a number of heterogeneous propositions–erroneous ones in your opinion–carries with it, I thought, the promise not to call all these different views indiscriminately `classical’.

    In this assumption I am evidently mistaken, and I have accordingly changed the first paragraph of my note as indicated on the enclosed paper.”

    the links also notes that

    “In a recent contribution to this Journal, Mr Keynes admitted the validity of Mr Robertson’s complaint that his condemnation of classical economics is tantamount to “shying at a composite Aunt Sally of uncertain age”


  38. chris, another nice quote from a Haberler letter to Keynes:

    “I am glad that you interpret `classical economist’ now in such a broad sense. If Hawtrey, Robertson, Ohlin are not classical economists, then Wicksell isn’t one either, nor Pigou in his Industrial Fluctuations, and not even Marshall in many passages.

    Everybody is then classical and non-classical at the same time.

    In business cycle theory Say’s Law is quite out of place and there is no doubt that cycle theory has more and more encroached upon general economic theory, relegating full-employment equilibrium to a special case.

    On your definition I do not regard myself as an adherent of the classical school.

    It seems to me that the difference between your theory and of writers which you call classical, is still smaller, if a number [of] purely verbal misunderstandings are removed–of which an almost complete collection is contained in Mr Kahn’s paper on my book.

    There is one further point: Would you agree that an equilibrium with involuntary unemployment is incompatible with perfect competition in the labor market?

    If namely competition there were perfect, money wages would fall all the time so long as unemployment existed and any conceivably desired level of liquidity could be reached.

    If that could be agreed upon–and I think you say it yourself in a later part of your book–most classical economists would agree with you, because nobody denies that unemployment can persist, if money wages are rigid.”


  39. @Ernestine Gross

    Ernestine says; “Exactly. And non-service of debt – default – results in discontinuities somewhere in the system. (This is not obvious in models which do not have a financial sector or models which exclude, by design, the possibility of default.)”

    By implication, Ernestine is saying that valid models of the economy must include the financial sector and financial sector operations including defaults. Again, I agree. By further implication, heterodox economists like Steve Keen, who are trying to model the economy with financial system elements in it, would appear to be on the right track. Now, Steve Keen claims that orthodox equilibrium models ignore the money system and financial system. I do not know if Steve Keen is correct in this assertion. Keen goes further and claims he is modelling dynamic disequilibria whereas the orthodox “neoclassical” models (attempt to) model only a static equilibrium. Again, I am not widely read enough to know if Keen is setting up the mainstream “orthodox neoclassical” position as a simplistic homogenous (mono-culture?) straw man or not.

    Others more widely read and educated in economics may be able to enlighten me on these points.

    More broadly, I would say this. Four Australian academic economists whose views I have some awareness of and some understanding of (however slight) are John Quiggin, Ernestine Gross, Steve Keen and Bill Mitchell. However, strongly these economists might disagree on certain points empirical, practical and theoretical (and the disagreement would be very strong on some issues), I suspect they would be unanimous on the issue that pro-cyclical budget policy of the kind now proposed by Wayne Swan (seeking a surplus when the economy is slowing, employment growth is weak to non-existent and inflation is tamed) is anathema to good economic policy and real economic outcomes. I think they would also agree that at a point of private debt overload and net deleveraging (taking spending out of the economy) then public spending (deficits) is necessary to ameliorate and reverse the recessionary pressure.

    Why are Wayne Swan and the Gillard government too obtuse to see this or admit it when all the more credible economists can see it? What is driving this pro-cyclical “austerity” stupidity? Professional economists (academic or business) can you answer these questions?

    It is terribly frustrating even as a non-qualified, non-entity “lay economist” to see this rank stupidity holding sway in public policy. It must be much more frustrating for well credentialled professional economists to see all their well-funded prescriptions ignored.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s