Why the “Stimulus” Will Only Make the Recession Worse, & Why Government Should Not Attempt to Prevent Bankruptcy

1.

The “stimulus” package is based on the Keynesian premise that spending creates wealth. In reality, however, only production creates wealth; spending merely transfers it. Goods are created when matter is physically altered, and wealth–as opposed to goods no one wants or needs–requires that what is produced by those alterations is actually valued by consumers. Keynesian economics holds that government spending can create wealth when factors of production are idle–that is, when people are out of work and factories have unused capacity. The Keynesian reasoning is that if unemployed people were working and factories’ idle machinery was put to use, more goods would be created. While this is certainly true, the Keynesians completely overlook the fact that there is a reason why those factors of production are idle, and it isn’t that everyone except government officials following Keynesian economics have lost their minds. Increasing the material output of goods is only productive in terms of the creation of genuine wealth if consumers are willing to pay a price for those goods that is higher than the manufacturer’s cost of producing them. The idea of the “stimulus” gimmick is to trick both sides of transactions into thinking that this is the case when it isn’t: first, trick consumers into thinking they can afford to buy more than they really can; then, trick producers into thinking they are making a profit from their sales (to people who can’t afford the goods in the first place) without realizing they are actually producing at a loss. The result of this is that the material output of goods will, in fact, increase, while the creation of wealth–what actually matters–suffers.

On the demand side: Right now I am trying to spend less because I can’t afford as much as I could (or rather, as much as I was fooled by inflation into thinking I could) before the crisis. The Keynesian response to this is to cause yet more inflation–to give me paper money printed out of thin air in order to fool me into thinking once again that I can afford to purchase more than I actually can. On the supply side: car manufacturers have left their machinery idle, because they have judged that they can’t make a profit by using them to produce more cars. The Keynesian response to this is once again yet more inflation; give them paper money printed out of thin air in order to fool them into thinking they are making a profit when they really aren’t, thus tricking them into producing more cars.

This double-fakery does not produce any new wealth. It does not make anyone more prosperous, although it does temporarily create the illusion of doing so by causing a nominal increase in everyone’s revenues. Once the inflation caused by the process sets in, however, this illusion of prosperity disappears–and it becomes obvious that the scheme has accomplished nothing but to squander everyone’s real wealth. Consumers can’t really afford to buy new cars, even though the scheme fools them into thinking they can because their incomes have risen in nominal terms; and likewise, car manufacturers aren’t making higher profits in real terms than they were before, even though the scheme fools into thinking so because their profits have risen in nominal terms. Consumers are deceived into making purchases that they can’t actually afford, and producers are deceived into producing at a loss. As the newly printed dollars circulate through the economy, the cost of living and the costs of production begin to rise: and once this effect inevitably sets in, the fact that no one has actually been made more prosperous by the Keynesian scheme becomes obvious.

It is important to recognize that wealth is a subjective term–that is, it is relative to the scale of values of the individual concerned. Suppose for example that my scale of values is such that even though I would like to stay in my current apartment and purchase both a new computer and a new TV, after I pay my rent I can only afford one or the other. AndI would consider myself more prosperous living in my current apartment with only a new computer than I would moving into a smaller apartment so that I could afford both a new computer and a new TV.

Thus, my scale of values looks as follows:

1. Current apartment; new computer; new TV.

2. Current apartment; new computer.

3. Smaller apartment; new computer; new TV.

After the “stimulus” puts inflated currency into my pockets, I am fooled into thinking that I can actually afford to stay in my current apartment and buy both a new computer and a new TV. So I do so, thinking that the Keynesian scheme has made me more prosperous, because I think I can now afford to stay at position 1 on my scale of values instead of position 2. But eventually, inflation sets in; prices begin to rise, and I find that I can no longer afford to pay my rent–so I have to pack up my new TV and computer and move into a smaller apartment. I am now on position 3 of my scale of values instead of position 2. Had the “stimulus” not hoodwinked me into thinking that I could afford both a new computer and a new TV when I really couldn’t, I would’ve purchased only the new computer, and I would have remained able to afford the rent on my old apartment–thereby remaining as prosperous on my own personal scale of values as I possibly could given my real income. I would have remained on position 2, which is all that my real wealth allows me to sustain. But because I was tricked by the Keynesian scheme into buying both the TV and the computer, I am now positioned lower on my own scale of values than I would have been otherwise–I am now at position 3. I am less prosperous. Thus the scheme temporarily fooled me into thinking that I was at position 1, and then dropped me down to position 3, when in the absence of the scheme I could have simply remained at position 2. Of course, in reality the effects of the scheme are not so simple and clear cut. On the basis of a given nominal salary, an individual typically sustains a higher level of consumption–more eating out, golfing, going out to movies, and so on–than he would have had inflation not made him think he had more money than he really did; and in the end the individual is made less prosperous by this process without even retaining anything tangible in the end, in the way that I at least retained my new TV and computer at the end of this example. So, I use this particular example even though it is slightly unrealistic to show that even if individuals retain wealth after the effects of this scheme have run their course, they are still left worse off in the end than they otherwise would have been. These same principles apply to businesses, as well. If they are deceived by the “stimulus” into putting their idle machinery to use, they end up worse off in the end than they would have been otherwise. Just as my rent payment rose due to inflation, so too do business’ costs of production begin rising, as well as the interest payments on their loans. In the end, even if the scheme does accomplish its goal of increasing the material output of goods, wealth has merely been squandered, leaving everyone less prosperous than they otherwise would have been.

Another important point which Keynesians completely ignore by advocating this double-fakery scheme as a response to consumers saving their incomes instead of spending it is that savings actually do eventually get spent. The critical question is of the nature of the spending that is done–is money being spent on production, or consumption? As far as the creation of new wealth is concerned, money that is spent on consumption is a dead end; it represents no net benefit to society. You buy bread; you eat it. The bread is gone, and there is nothing left to show for it. But if you invest the money, it is spent on production–say, to pay wages to the bakery’s employees, who use it to buy bread for themselves. Money is spent to buy bread that is ultimately eaten in both cases; the question is whether it goes towards feeding a worker who is making more bread than he eats (he is being hired at a profit, and spending less than his income), therefore representing a net gain to society–or whether it goes towards bread that is simply consumed, therefore representing no net gain to society. To be clear, there is nothing wrong with consumption–we produce things, after all, because we want to consume them. But Keynesian policies are premised on the absurd notion that savings are simply “stuffed under a mattress” without being spent, when in reality most savings are invested in future production and therefore represent a beneficial and desirable contribution to the economy. Thus the “stimulus” does not only squander wealth and leave everyone off less prosperous than before, it does so at the expense of savings and investment that would have benefitted the economy had the “stimulus” scheme not squandered that wealth.

This crisis was created by too much consumption, too much debt, and malinvestment. What is needed for recovery is not for the delusion created by a “stimulus” to fake consumers into thinking that their incomes are higher than they really are while faking producers into thinking that they are producing at a profit when they aren’t–but for the economy to be allowed to readjust to external reality. Most crucially, this means allowing the liquidation of malinvestments businesses were fooled by prior inflation into thinking they could afford. Encouraging more inflation in order to retain the illusion that those investments still represent a profitable allocation of capital is the exact opposite of recovery; in fact, it is an expansion of the very thing that created the problem to begin with–and it will accomplish nothing except to make the corrections and readjustments to reality that inevitably must occur in some form another more painful than they would otherwise have to be. Liquidation, the single most important ingredient in the recovery and readjustment to reality of an economy hampered by inflation, is the very thing that a “stimulus” package prevents.

2.

Although the purpose of a bankruptcy proceeding is to allow creditors to collect as much of the money they are owed by a bankrupt company as possible, debtors benefit from bankruptcy proceedings as well, because after they pay off the part of their debt they are able to, what is left over is extinguished and they are allowed to go on with their lives. In a bankrupcty proceeding, creditors decide in collaboration with a bankruptcy court whether it is better to shut the bankrupt business down and liquidate its investments, or continue its operation under new and more efficient management. Creditors have greater financial incentives than anyone else to insure that the decision they make will maximize the long-term prosperity of everyone involved. Thus, if they judge that the business can still make a profit under better management (indicating that it is a productive allocation of society’s scare capital and labor), they will decide to have the business taken over by more efficient management. Only if they judge that the business can not continue to make a profit (and therefore is not a productive allocation of society’s scare capital and labor) will they decide that it is better for the bankrupt business to shut down and liquidate its investments. This process removes capital and labor from businesses which are managing them poorly and redirects them to businesses which are efficiently using them to satisfy consumers. This allows the labor and capital structures of society to be redrawn in alignment with the wants and needs of consumers–that is, in alignment with external reality. The only thing that interference in this process can accomplish is to allocate capital and labor less efficiently than otherwise, in a way that is not best suited to fulfilling the desires of consumers–thereby making the economy’s inevitable and necessary readjustment to external reality that much more prolonged and painful.

An economy in which rapid bankrupcty proceedings are practiced is one which is predominated by growing businesses, since incompetent businesses are stamped out, their labor and capital reallocated to businesses that are satisfying more consumers and can therefore make better use of them. Hence, even if particular workers are occasionally displaced by a bankrupcty, workers as a whole benefit greatly from the existence of an economy in which bankrupcty proceedings are practiced. Everyone else benefits because the process removes capital and labor from those who are mismanaging them, and puts them in the hands of those judged by creditors as most capable of putting them to productive use satisfying consumers.

It is counter-productive, wasteful, and immoral for any government to ever try to prevent bankrupcties. Bailouts deny the legitimate right of the creditors to collect what they are owed by the bankrupt company. To force innocent third parties to pay for a bankruptcy company’s failure represents a vile form of corporatism; it allows companies poorly managing capital and labor to stay in control of society’s scarce resources, and lowers the prosperity of the entire society as a whole. The institution of bankruptcy is an essential feature of a just and prosperous society, and it is most needed as a readjustment to the capital structure of society after the government has created misallocations of capital by increasing the money supply. Bailouts and “stimulus” packages are thus not only unjust and immoral, they represent a continuation of the very practices that caused the problem to begin with.

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13 Responses to Why the “Stimulus” Will Only Make the Recession Worse, & Why Government Should Not Attempt to Prevent Bankruptcy

  1. RJ says:

    Sorry, but I cannot ignore the utter stupidity of this blog.

    1. Spending does create wealth, this is what Keynes defined as the ‘multiplier effect’ on the economy. The basic formula is 1/(1-MPC), in which the amount of government stimulus needed is G= Change in RGDP/(1/(1-MPC)). Spending money sends a shockwave throughout the economy. The amount spend by the governemnt becomes income for someone, a portion is saved while a portion is spend. This additional spending becomes income for someone else…and the cycle repeats. When an economy is in a recessionary gap, consumer spending, investment spending, and net exports drop significantly. Ultimately, deficit spending by the government on infrastructure is what is needed to pull us out of the recession. Also, there is a crowding in effect of firms because the government is seeking to buy certain goods/services.

    2. The government always (in the short run) has to choose between either less inflation and less jobs or more jobs and less inflation. This is the nature of the ‘Phillip’s Curve’ in economics. When the government monetizes the deficit, it not only buys its own bonds but seeks outside sources to buy its bonds and thus retains the value of our fiat currency. It’s uncertain that you will see a significant drop in real income or real wealth as the economy gradually begins to recover. Refer to the ‘AS and AD’ graph, if government demands more money and spends it the net effect is both the AS and AD curves shift to the right. While you see an increase in the PL, you also see an increase in RGDP. Monetizing excessively is not a good thing, but it is great for the short term.

    3. Having the population save their income during a recession is NOT GOOD! You WANT to give incentive for consumer spending. If the consumer see’s that his income/wealth increased, even though it may not have increased in real terms, he/she will still spend and thus contribute toward the shift in the AD curve. Your bread analogy is a terrible and completely fallacious analogy. If you buy and eat bread (ignoring the already existing multiplier effect), your going to get hungry again and need to buy more. This will occur with an array of consumers, who will want to buy more bread and therefore increase the demand of bread. The end result is, with greater demand for bread via consumer spending, there is a greater demand for labour (aka jobs) to produce and sell bread.

    • 1. Spending does not create wealth. The government has no money, it only has the capacity to re-arrange scarce resources into new patterns. No country other than America has ever attempted to spend so much to maintain a bubble economy and survived, America is now collapsing because no one wants to hold it’s worthless money anymore and the problem will only get worse as the last nails are hammered into Keynesian mumbo jumbo.

      Infrastructure spending is a waste of money for America. It is just more wasteful public works handouts for the unions at a time when the private market (where real wealth is created) is starving for capital and resources to engage in production.

      Before anyone spouts off on Keynes, they should know a thing or two about the difference between public and private production.

      2. The jobs/inflation balance is complete nonsense. Joblessness is created during busts as labour resources have to reallocate from projects with too long time horizons that now find the resources do not exist for completion. The other major cause of joblessness if price controls, specifically minimum wage laws, and disincentivization through progressive taxation.

      Inflation is only caused by all of the deficit spending prescribed by you in #1. The aggregate price level cannot rise with a stable monetary supply. Keynes policies were disastrous in the 70s, as there was rising inflation and unemployment simultaneously. This was the second post war debunking of Keynesian economics. The first came when the troops returned from WWII and the Keynesians predicted massive unemployment. And yet government spending was cut by 2/3rds, and the economy boomed with all of the labour resources coming home from the war.

      3. Savings are necessary during a recession, as recessions are brought on when capital is depleted. Real savings are capital, that is to say, saved resources that can be allocated to future production. Printing money to finance government deficit spending is not a substitute for real capital. You cannot print bricks and mortar, you cannot print lumber and plastics. The only way out of a recession, is to see all of the malinvestments purged. Those are the wasteful projects for which there is no capital to complete.

      And of course, individuals must increase production over consumption, if that means spending less, then so be it. Since America has destroyed it’s productive capacity through Keynesian capital consumption (what I like to call Sunshine Capitalism) most Americans cannot produce more, particularly as their government seeks to tax entrepreneurship. And thus, people will stop buying 3rd cars, 2nd homes and taking Caribbean cruises.

      Keynesianism seeks to dodge these basic economic facts with econometrics and macro theory. It’s a lot of bunk, and has been disproved enough times that it is shameful to see it posted here as some sort of revealed economic knowledge.

      • RJ says:

        Oooh fun…a moron.

        1. Spending does not create wealth. The government has no money, it only has the capacity to re-arrange scarce resources into new patterns. No country other than America has ever attempted to spend so much to maintain a bubble economy and survived, America is now collapsing because no one wants to hold it’s worthless money anymore and the problem will only get worse as the last nails are hammered into Keynesian mumbo jumbo

        Ever heard of bonds? You know, the kind of things that foreign banks and states purchase with their capital as a garuntee with interest. There’s your wealth that debunks the stupid-ass assertion that the government mearly rearranges scarce resources into new patterns (lol!) Monetizing the deficit is example of the Treasury printing more money and the Fed rearranging it, granted, but necessary when demand for more capital hits the given economy.

        Your rant sounds similar to an IMF cronie who frequently asserted that Asian markets contain a balanced budget when they’re going into a recession. Does No respectable economist since Herbert Hoover has ever followed this rational.

        Infrastructure spending is a waste of money for America. It is just more wasteful public works handouts for the unions at a time when the private market (where real wealth is created) is starving for capital and resources to engage in production.

        Really, because laureate Gary Becker and Mankiw disagree with your claim, along with Susan Woodward and Robert Hall. Again, infrastructure spending contains a multiplier effect on the economy by creating jobs and public goods not provided by the private sector during a recessionary gap. Private industries will actually cut investment spending significantly, refuse to raise wages for workers and slash hours (causing consumer spending to drop). Not to mention private banks are hesitant to make loans. This all prolonges a recession when the market acts in it’s self-interest. You can argue the ‘auto self-correction mechanism,’ however it’s doubtful that it would occur and if it does it would take quite a bit of time.

        The jobs/inflation balance is complete nonsense. Joblessness is created during busts as labour resources have to reallocate from projects with too long time horizons that now find the resources do not exist for completion. The other major cause of joblessness if price controls, specifically minimum wage laws, and disincentivization through progressive taxation.

        Joblessness is created when aggregate demand decreases or aggregate supply decrease when aggregate supply is static. Lack of demand for output creates cutbacks and layoffs. Your first claim of joblessness is sketchy, and you’ve yet to provide any evidence for your claims other than theoretical backing, which is a load of garbage when it comes to actual practice. Your assertion of price controls is correct to a degree. As for progressive taxation, well than maybe you can explain to me why exactly during the Clinton administration’s tax increase unemployment continued to fall below the natural rate of unemployment?

        Inflation is only caused by all of the deficit spending prescribed by you in #1.

        I’ve already mentioned that this is a fucking short-term solution for a recessionary gap and that continual deficit spending can cause inflation, but you don’t seem mentally competant enough to acknowledge or absorb what I’m saying. Instead you’re wasting my time with your ideologically based bullshit knowledge of economics, which can even hardely be considered amateur. Again, you guys seem to be believe that monetizing the deficit automatically causes the price level to rise. It doesn’t, this only happens when the money supply exceeds the amount of goods/services. Now, if spent to boost production (like infrastructure) and private production/investment (crowding-in effect), the amount of goods catches up and the result reaches equilibrium.

        Keynes policies were disastrous in the 70s, as there was rising inflation and unemployment simultaneously. This was the second post war debunking of Keynesian economics.

        Wrong, the 70’s (and the 60’s) had a better track record with Keynesianism than under Reagan’s supply-side years or both Bush’s conservative economic policies in terms of unemployment and both nominal and real GDP.

        Savings are necessary during a recession, as recessions are brought on when capital is depleted. Real savings are capital, that is to say, saved resources that can be allocated to future production. Printing money to finance government deficit spending is not a substitute for real capital.

        Saving will decrease consumption and investment spending during a recession, which isn’t what the economy needs. Having a contractionary fiscal policy during a recessionary gap prolonges the recession. Boosting consumer confidence and their ability to purchase goods/services is a strategy to get us to potential GDP and thus ending the recession.

        You cannot print bricks and mortar, you cannot print lumber and plastics. The only way out of a recession, is to see all of the malinvestments purged. Those are the wasteful projects for which there is no capital to complete.

        Again, you make the common fallacy that printing or monetizing the deficit necessarily leads to inflation. It can, but not by instant default as I’ve debunked above.

        And of course, individuals must increase production over consumption, if that means spending less, then so be it.

        That doesn’t even make the slightest bit of logical sense. If production exceeds consumption when aggregate demand is decreasing you won’t have anything to show for it. You’re assuming AD will remain static while AS must increase dramatically. That’d be nice, albeit very unpractical considering when overall spending decreases output will decrease as well.

        Keynesianism seeks to dodge these basic economic facts with econometrics and macro theory. It’s a lot of bunk, and has been disproved enough times that it is shameful to see it posted here as some sort of revealed economic knowledge.

        I’ll admit, it’s done a poor job at revealing itself…considering those seeking to debunk it carry little knowledge, and even less real world data, of it’s application and real-world economics. Is it a wonder why no reputable economist takes things such as Austrian or anarcho-capitalist theory seriously?

    • Die says:

      And now to deal with more moronic assertions from this aggressive little fool:

      “1. Spending does create wealth,”

      No, it consumes wealth. Sorry.

      ” this is what Keynes defined as the ‘multiplier effect’ on the economy. The basic formula is 1/(1-MPC), in which the amount of government stimulus needed is G= Change in RGDP/(1/(1-MPC)). Spending money sends a shockwave throughout the economy.”

      Spending money consumes existing resources. That all it does.

      “The amount spend by the governemnt becomes income for someone,”

      No, it becomes income stolen from someone else (drained from the economy and then given to another individual.

      ” a portion is saved while a portion is spend. This additional spending becomes income for someone else…and the cycle repeats.”

      So paper is moved from hand to hand and this creates “wealth”? Backed by what, one may ask? More paper?

      “When an economy is in a recessionary gap, consumer spending, investment spending, and net exports drop significantly.”

      Why? Perhaps because it’s the prudent thing to do, unlike what is advocated by Keynesian econostrologists.

      ” Ultimately, deficit spending by the government on infrastructure is what is needed to pull us out of the recession. Also, there is a crowding in effect of firms because the government is seeking to buy certain goods/services.””

      Assertion. What is needed is for the market to reprice and restructure itself after being coercively interfered with.

      “2. The government always (in the short run) has to choose between either less inflation and less jobs or more jobs and less inflation. This is the nature of the ‘Phillip’s Curve’ in economics.”

      Rubbish. The government can choose between creating an illusion of wealth and not doing so, in the former case robbing the population unwittingly of its wealth. All the worse when there is both inflation and high unemployment, so much for a “choice” between the two, as if the economy is some machine just to be tweaked…

      “When the government monetizes the deficit, it not only buys its own bonds but seeks outside sources to buy its bonds and thus retains the value of our fiat currency. ”

      So it buys up more debt.

      “Refer to the ‘AS and AD’ graph, if government demands more money and spends it the net effect is both the AS and AD curves shift to the right. While you see an increase in the PL, you also see an increase in RGDP. Monetizing excessively is not a good thing, but it is great for the short term.”

      Who cares about meaningless aggregates?

      “3. Having the population save their income during a recession is NOT GOOD! ”

      Asseertion/garbage.

      “You WANT to give incentive for consumer spending.”

      Assertion/garbage.

      “If the consumer see’s that his income/wealth increased, even though it may not have increased in real terms, he/she will still spend and thus contribute toward the shift in the AD curve.”

      So one must perpetuate the illusion and consume even more wealth (esp. in the form of capital.) Right.

      “Your bread analogy is a terrible and completely fallacious analogy. If you buy and eat bread (ignoring the already existing multiplier effect), your going to get hungry again and need to buy more. This will occur with an array of consumers, who will want to buy more bread and therefore increase the demand of bread. The end result is, with greater demand for bread via consumer spending, there is a greater demand for labour (aka jobs) to produce and sell bread.”

      Except the resources to bake bread are rapidly diminishing and fostering an illusion to tell consumers everything is “OK” will just worsen it. So please, stick to voodoo, it has more explanatory power than the nonsense you trotted out above.

  2. RJ says:

    Woops, the first sentence on the second paragraph should read less inflation and less jobs or *more* inflation and more jobs

  3. adambolton says:

    I want to emphasize that even if I am incorrect, the points you have brought up are not ones I am ignorant about—they are points I have rejected for what I firmly believe to be valid reasons. So I hope this discussion can remain civil, despite your presumptuous opening remark about “utter stupidity.”

    “1. Spending does create wealth, this is what Keynes defined as the ‘multiplier effect’ on the economy.”

    First off, I’d like to point out that mathematical “proofs” can demonstrate that -1=1 and 2=0. Unless one had an indepth understanding of mathematics, one wouldn’t be able to identify the fault in those “proofs” if presented with them. And yet, an inability to identify the precise fault does not mean that one should immediately accept the conclusion—common sense should lead us to label such a conclusion as suspect, even if we can’t immediately identify the fault in the logic that leads to it. To put it another way: math is a form of logic, and logic cannnot contradict itself. Therefore, if math contradicts common reasoning, we shouldn’t just throw common reasoning out the window—we should try to find out whether the logical fault is with our reasoning, or with our mathematics. Given the complexity of mathematics, we are more likely to leave a mathematical fault unrecognized than we are a fault in basic reasoning. Thus, if mathematics and basic reasoning contradict, it makes sense to be predisposed towards what basic reasoning tells us, and to be skeptical towards the contradictory mathematics.

    On the issue of production, this is what basic logic tells us: production always and necessarily must happen before there can be any consumption. If a good has not been produced, then it does not exist to be consumed. Likewise, consuming a good does not cause more goods to magically appear out of thin air. Thus, production is the crucial factor of economic development—not consumption, which can only come afterwards. This is what basic logic tells us.

    Here’s how economist Bob Murphy put it:

    “With all the talk of consumer spending and national income, we often forget that actual production must occur before people can consume anything. It doesn’t matter how many green pieces of paper are in your wallet; you can’t “demand” a TV set unless the store has an actual unit on the shelf. Pushing it back one step, no matter how many customers are lining up outside his store, the manager of Best Buy can’t stockpile his shelves with TVs unless the manufacturer has previously assembled them. And of course, the manufacturer can’t do so—regardless of how much money he is offered by the Best Buy manager—unless he can find enough workers, and enough of the relevant parts, to actually make the TVs.

    We now see why the circular-flow diagram above is a very misleading model of the economy.”

    Now, if you skip to Chapter 4, “The Myths of the Multiplier and the Accelerator,” of this pdf file: Dissent on Keynes, you will see an excellent critique of the “multiplier” idea.

    Here is the article’s point summarized:

    Using a mathematical construct which comes about as a result of human activity cannot be used to explain human activity—this is a circular explanation that gives us no new information. Since Keynes’ definitions of consumption, savings, investment, and income are accounting categories which come about after the fact of human activity, attempting to use them to explain human activity (which is what Keynes tried to do) merely provides us with a circular explanation that gives us no new information. Keynes used these definitions of consumption, savings, investment, and income, to write his famous identities: income equals consumption plus investment, and savings equal income minus consumption; thus, savings equal income. (p. 63 of the General Theory) However, Keynes is also guilty of shifting these definitions, since (p. 210-211 of the General Theory) he also claimed that savings do not equal income (where he defined saving as “hoarding” and continued to villify it).

    Then the article goes on to describe a simple Robinson Crusoe-type situation and show why, since the bases of Keynes’ Theory are accounting categories which come about only after the fact of human activity, they can not be used to explain it—even a single man, on a single island, producing and consuming his own produce. This Crusoe-situation is built into a modern economy with the addition of money and multiple actors, and it is shown that none of these factors change the basic facts of human action—thereby showing that precisely because Keynes’ theory is unable to explain a basic Crusoe situation, it is also unable to explain a modern economy. Applying these principles to a simple Crusoe situation simply allows us to see the flaw in them more clearly. I’ll leave the rest of the chapter for you to read and respond to on your own.

    Given the multiplier effect’s total lack of substance, I find it plausible that the theory is advocated in large part simply because it provides politicians with a rationale for spending money (and thus for existing parasitically in the first place upon the wealth we all produce).

    “2. The government always (in the short run) has to choose between either less inflation and less jobs or more jobs and less inflation. This is the nature of the ‘Phillip’s Curve’ in economics.”

    One of Milton Friedman’s major accomplishments was to demonstrate precisely why this is not so—strictly speaking, unemployment is caused by excessive wage rates. (See: a supply and demand graph.) Friedman’s demonstration was that increasing aggregate demand only effects employment if the real wage falls relative to prices due to nominal wage rigidity. Thus, the Phillips’ curve does not describe a set of long-run equilibrium positions—it only works as long as the market is unable to anticipate what is happening. The extreme variations of inflation-unemployment combinations both between different countries and within individual ones during varying historical periods testifies to the truth of this observation.

    “3. Having the population save their income during a recession is NOT GOOD! You WANT to give incentive for consumer spending.”

    You completely missed the point of my bread analogy, which was this: all spending is not equal. The basic problem here is our different diagnoses of what actually causes recessions in the first place. Your diagnosis, I can only assume, is that the public’s “animal spirits” drop, so they stop making so many purchases. Yes, a “recession” would, by definition, occur if general spending lessened. But this completely misses the point: is the recession a good thing, or a bad one? This depends on what specifically caused it. And in case you missed the whole point of this essay, what I’m proposing is that the real cause of recession is credit expansion. If I’m correct, then the processes set in motion by the recession (the liquidity of unsustainable investments, the transfer of capital from poor managers to its more efficient allocators) are precisely what need to be done for the harm to be corrected—and so-called “anti-recessionary” policies can only impede this process and make it even more harmful. Given the pervasiveness of credit-expansion in our economy, and the burst of the housing bubble in precise accordance with what this theory would predict, I find it a thousand more convincing than pseudo-psychological explanations revolving around “animal spirits.” If you’re interested, here is a collection of prolific essays explaining the theory. Here is a summary, excerpted from one of those essays, that wraps it up fairly well:

    The currently fashionable attitude toward the business cycle stems, actually, from Karl Marx. Marx saw that, before the Industrial Revolution in approximately the late eighteenth century, there were no regularly recurring booms and depressions. There would be a sudden economic crisis whenever some king made war or confiscated the property of his subject; but there was no sign of the peculiarly modern phenomena of general and fairly regular swings in business fortunes, of expansions and contractions. Since these cycles also appeared on the scene at about the same time as modern industry, Marx concluded that business cycles were an inherent feature of the capitalist market economy. All the various current schools of economic thought, regardless of their other differences and the different causes that they attribute to the cycle, agree on this vital point: That these business cycles originate somewhere deep within the free-market economy. The market economy is to blame. Karl Marx believed that the periodic depressions would get worse and worse, until the masses would be moved to revolt and destroy the system, while the modern economists believe that the government can successfully stabilize depressions and the cycle. But all parties agree that the fault lies deep within the market economy and that if anything can save the day, it must be some form of massive government intervention.

    There are, however, some critical problems in the assumption that the market economy is the culprit. For “general economic theory” teaches us that supply and demand always tend to be in equilibrium in the market and that therefore prices of products as well as of the factors that contribute to production are always tending toward some equilibrium point. Even though changes of data, which are always taking place, prevent equilibrium from ever being reached, there is nothing in the general theory of the market system that would account for regular and recurring boom-and-bust phases of the business cycle. Modern economists “solve” this problem by simply keeping their general price and market theory and their business cycle theory in separate, tightly-sealed compartments, with never the twain meeting, much less integrated with each other. Economists, unfortunately, have forgotten that there is only one economy and therefore only one integrated economic theory. Neither economic life nor the structure of theory can or should be in watertight compartments; our knowledge of the economy is either one integrated whole or it is nothing. Yet most economists are content to apply totally separate and, indeed, mutually exclusive, theories for general price analysis and for business cycles. They cannot be genuine economic scientists so long as they are content to keep operating in this primitive way.

    But there are still graver problems with the currently fashionable approach. Economists also do not see one particularly critical problem because they do not bother to square their business cycle and general price theories: the peculiar breakdown of the entrepreneurial function at times of economic crisis and depression. In the market economy, one of the most vital functions of the businessman is to be an “entrepreneur,” a man who invests in productive methods, who buys equipment and hires labor to produce something which he is not sure will reap him any return. In short, the entrepreneurial function is the function of forecasting the uncertain future. Before embarking on any investment or line of production, the entrepreneur, or “enterpriser,” must estimate present and future costs and future revenues and therefore estimate whether and how much profits he will earn from the investment. If he forecasts well and significantly better than his business competitors, he will reap profits from his investment. The better his forecasting, the higher the profits he will earn. If, on the other hand, he is a poor forecaster and overestimates the demand for his product, he will suffer losses and pretty soon be forced out of the business.

    The market economy, then, is a profit-and-loss economy, in which the acumen and ability of business entrepreneurs is gauged by the profits and losses they reap. The market economy, moreover, contains a built-in mechanism, a kind of natural selection, that ensures the survival and the flourishing of the superior forecaster and the weeding-out of the inferior ones. For the more profits reaped by the better forecasters, the greater become their business responsibilities, and the more they will have available to invest in the productive system. On the other hand, a few years of making losses will drive the poorer forecasters and entrepreneurs out of business altogether and push them into the ranks of salaried employees.

    If, then, the market economy has a built-in natural selection mechanism for good entrepreneurs, this means that, generally, we would expect not many business firms to be making losses. And, in fact, if we look around at the economy on an average day or year, we will find that losses are not very widespread. But, in that case, the odd fact that needs explaining is this: How is it that, periodically, in times of the onset of recessions and especially in steep depressions, the business world suddenly experiences a massive cluster of severe losses? A moment arrives when business firms, previously highly astute entrepreneurs in their ability to make profits and avoid losses, suddenly and dismayingly find themselves, almost all of them, suffering severe and unaccountable losses?How come? Here is a momentous fact that any theory of depressions must explain. An explanation such as “underconsumption”–a drop in total consumer spending–is not sufficient, for one thing, because what needs to be explained is why businessmen, able to forecast all manner of previous economic changes and developments, proved themselves totally and catastrophically unable to forecast this alleged drop in consumer demand. Why this sudden failure in forecasting ability?

    An adequate theory of depressions, then, must account for the tendency of the economy to move through successive booms and busts, showing no sign of settling into any sort of smoothly moving, or quietly progressive, approximation of an equilibrium situation. In particular, a theory of depression must account for the mammoth cluster of errors which appears swiftly and suddenly at a moment of economic crisis, and lingers through the depression period until recovery. And there is a third universal fact that a theory of the cycle must account for. Invariably, the booms and busts are much more intense and severe in the “capital goods industries”?the industries making machines and equipment, the ones producing industrial raw materials or constructing industrial plants?than in the industries making consumers’ goods. Here is another fact of business cycle life that must be explained–and obviously can’t be explained by such theories of depression as the popular underconsumption doctrine: That consumers aren’t spending enough on consumer goods. For if insufficient spending is the culprit, then how is it that retail sales are the last and the least to fall in any depression, and that depression really hits such industries as machine tools, capital equipment, construction, and raw materials? Conversely, it is these industries that really take off in the inflationary boom phases of the business cycle, and not those businesses serving the consumer. An adequate theory of the business cycle, then, must also explain the far greater intensity of booms and busts in the non-consumer goods, or “producers’ goods,” industries.

    Fortunately, a correct theory of depression and of the business cycle does exist, even though it is universally neglected in present-day economics. It, too, has a long tradition in economic thought. This theory began with the eighteenth century Scottish philosopher and economist David Hume, and with the eminent early nineteenth century English classical economist David Ricardo. Essentially, these theorists saw that another crucial institution had developed in the mid-eighteenth century, alongside the industrial system. This was the institution of banking, with its capacity to expand credit and the money supply (first, in the form of paper money, or bank notes, and later in the form of demand deposits, or checking accounts, that are instantly redeemable in cash at the banks). It was the operations of these commercial banks which, these economists saw, held the key to the mysterious recurrent cycles of expansion and contraction, of boom and bust, that had puzzled observers since the mid-eighteenth century.

    The Ricardian analysis of the business cycle went something as follows: The natural moneys emerging as such on the world free market are useful commodities, generally gold and silver. If money were confined simply to these commodities, then the economy would work in the aggregate as it does in particular markets: A smooth adjustment of supply and demand, and therefore no cycles of boom and bust. But the injection of bank credit adds another crucial and disruptive element. For the banks expand credit and therefore bank money in the form of notes or deposits which are theoretically redeemable on demand in gold, but in practice clearly are not. For example, if a bank has 1000 ounces of gold in its vaults, and it issues instantly redeemable warehouse receipts for 2500 ounces of gold, then it clearly has issued 1500 ounces more than it can possibly redeem. But so long as there is no concerted “run” on the bank to cash in these receipts, its warehouse-receipts function on the market as equivalent to gold, and therefore the bank has been able to expand the money supply of the country by 1500 gold ounces.

    The banks, then, happily begin to expand credit, for the more they expand credit the greater will be their profits. This results in the expansion of the money supply within a country, say England. As the supply of paper and bank money in England increases, the money incomes and expenditures of Englishmen rise, and the increased money bids up prices of English goods. The result is inflation and a boom within the country. But this inflationary boom, while it proceeds on its merry way, sows the seeds of its own demise. For as English money supply and incomes increase, Englishmen proceed to purchase more goods from abroad. Furthermore, as English prices go up, English goods begin to lose their competitiveness with the products of other countries which have not inflated, or have been inflating to a lesser degree. Englishmen begin to buy less at home and more abroad, while foreigners buy less in England and more at home; the result is a deficit in the English balance of payments, with English exports falling sharply behind imports. But if imports exceed exports, this means that money must flow out of England to foreign countries. And what money will this be? Surely not English bank notes or deposits, for Frenchmen or Germans or Italians have little or no interest in keeping their funds locked up in English banks. These foreigners will therefore take their bank notes and deposits and present them to the English banks for redemption in gold–and gold will be the type of money that will tend to flow persistently out of the country as the English inflation proceeds on its way. But this means that English bank credit money will be, more and more, pyramiding on top of a dwindling gold base in the English bank vaults. As the boom proceeds, our hypothetical bank will expand its warehouse receipts issued from, say 2500 ounces to 4000 ounces, while its gold base dwindles to, say, 800. As this process intensifies, the banks will eventually become frightened. For the banks, after all, are obligated to redeem their liabilities in cash, and their cash is flowing out rapidly as their liabilities pile up. Hence, the banks will eventually lose their nerve, stop their credit expansion, and in order to save themselves, contract their bank loans outstanding. Often, this retreat is precipitated by bankrupting runs on the banks touched off by the public, who had also been getting increasingly nervous about the ever more shaky condition of the nation’s banks.

    The bank contraction reverses the economic picture; contraction and bust follow boom. The banks pull in their horns, and businesses suffer as the pressure mounts for debt repayment and contraction. The fall in the supply of bank money, in turn, leads to a general fall in English prices. As money supply and incomes fall, and English prices collapse, English goods become relatively more attractive in terms of foreign products, and the balance of payments reverses itself, with exports exceeding imports. As gold flows into the country, and as bank money contracts on top of an expanding gold base, the condition of the banks becomes much sounder.

    This, then, is the meaning of the depression phase of the business cycle. Note that it is a phase that comes out of, and inevitably comes out of, the preceding expansionary boom. It is the preceding inflation that makes the depression phase necessary. We can see, for example, that the depression is the process by which the market economy adjusts, throws off the excesses and distortions of the previous inflationary boom, and reestablishes a sound economic condition. The depression is the unpleasant but necessary reaction to the distortions and excesses of the previous boom.

  4. RJ says:

    I read your Mises link, and I’m not impressed. Both you and the author do not seem to understand the multiplier effect. Furthermore, your response is just an inflation of biased articles that lack actual economic data which tells me your actual knowledge of economics is amateur at best due to the fact that it’s ideologically based. Similar to learning about politics solely from a Democrat, Republican, etc.

    But now I’m going to address the mises.org article.

    C,S,I, and Y are ex post facto accounting categories. Such constructs cannot explain human actions because they are formed by the monetary outcomes of human actions…These accounting categories do not guide his [Robinson Crusoe] actions; they have meaning in only tracing the effects of such action.

    So what? Is that an actual objection to mathematical constructs of human economic activity? The purpose of Keynes ‘Consumption Function’ was to measure the effect of human action, not the cause. Does one need to measure the ’cause’ of the excessive amount of CO2 in the atmosphere to understand its effect on global warming? No, they don’t! This argument is completely dismissable, and is a terrible opening to the ‘excellent’ pdf article critiquing Keynes.

    Even more ludicrous is the following claim…

    [In regards to Keynes claim that ‘S’ and ‘I’ cannot be performed by division of labor]If such coordination were impossible, Keyne’s criticism would apply to any form of market activity.

    LOL!!! You can’t divide the labor if S = I because if one individual were to undertake either task he’d be accomplishing the other in correspondence. This very argument is a false analogy from the very beginning.

    In regards to MPC:

    The author claims ‘C’ and ‘I’ could equate $C (dollar value of consumption goods within a given stock) and $I (dollar value of investment goods within a given stock) and therefore $Y (entire value of the given stock of goods) would equal $Y = $C + $I. He then goes on to make claims that make me doubt his ability to do basic arithmetic.

    $C > $Y, even for the entire economy, by consuming part of the existing stock.

    No, that’s mathematically impossible if $Y is the sum of $C + $ I.

    Also, if $C = $Y, $I would be negative because of depreciation.

    Jesus! $I would equal 0 if $C = $Y, not a negative value.

    Now onto the multiplier, and this is where it just gets sad.

    k = 1/1-MPC and 0 < MPC < 1

    One absurdity exists when MPC = 1…Even more damaging is the case where MPC exceeds 1.

    That’s why the formula follows the rule of 0 < MPC 1 or MPC = 1, but < 1. Why is this so…?

    There is no accounting principle that the MPC be bound this way.

    Yes there is. MPC is the % of additional income that a person spends, expressed in decimal form. If it’s 0 then the person is not spending, if it’s 1 then he spends all his income and it’s not additional.

    Why the formula 1/1-MPC ?

    Simple, it’s a reflection of the Geometric Series in mathematics.

    S = 1 + R + R^2 + R^3…etc

    RS = 1 + R + R^2 + R^3…etc

    Therefore, S – RS = 1
    Furthermore, S(1 – R) = 1
    Finally, S = 1/1 – R

    Except in the multiplier, S = k and R = MPC. Spending money on the economy develops a successive ratio between terms.

    The multiplier exists, and you’ve yet to (legitimately) demostrate the privilege of allowing yourself to claim that the multiplier has a lack of substance. I’m still confused on how exactly you’re applying the circular flow diagraham to my initial response to your blog, it has no place (yet) in this debate.

    One of Milton Friedman’s major accomplishments was to demonstrate precisely why this is not so—strictly speaking, unemployment is caused by excessive wage rates. (See: a supply and demand graph.) Friedman’s demonstration was that increasing aggregate demand only effects employment if the real wage falls relative to prices due to nominal wage rigidity. Thus, the Phillips’ curve does not describe a set of long-run equilibrium positions—it only works as long as the market is unable to anticipate what is happening. The extreme variations of inflation-unemployment combinations both between different countries and within individual ones during varying historical periods testifies to the truth of this observation.

    This is wrong overall. Friedman demostrated that in the long run (but I specifically emphasized the short run), the Phillip’s Curve collapses due to the Auto-self correction mechanism. This results in a verticle Phillip’s Curve at the natural rate of unemployment, but he acknowledged the short run effect. This is where you are correct. Again, however, we’re talking about the short run because we can’t make it to the long run if we suffer in the short run. For the issue facing the long run, we have NAIRU and Rational Expectations theory to apply to the Phillip’s Curve. Also, it is noteworthy to mention that the natural rate of unemployment does change and thus the Phillip’s Curve trade-off still remains. Humans are not super economic calculators, and it’s unlikely that they will keep up with the costant change in the PL.

    Anyway, I’ll get to the rest of your response later.

    • Die says:

      “I read your Mises link, and I’m not impressed. Both you and the author do not seem to understand the multiplier effect. Furthermore, your response is just an inflation of biased articles that lack actual economic data which tells me your actual knowledge of economics is amateur at best due to the fact that it’s ideologically based. Similar to learning about politics solely from a Democrat, Republican, etc.”

      I get that impression from your posts.

      “So what? Is that an actual objection to mathematical constructs of human economic activity? The purpose of Keynes ‘Consumption Function’ was to measure the effect of human action,”

      Why? What does this illumine?

      “No, they don’t! ”

      Yeah, they do. See how easy that is?

      “LOL!!! You can’t divide the labor if S = I because if one individual were to undertake either task he’d be accomplishing the other in correspondence. This very argument is a false analogy from the very beginning.”

      That’s an assertion. Saving is not investment, it is deferred consumption.

  5. RJ says:

    Oh, and here is actual economic data about the positive effect the stimulus will have…not some bs Austrian essay.

  6. Die says:

    The “data” proves nothing, sadly for you. In fact all it “proves” is that the “stimulus” might not have had as adverse an impact as it might have had. So funny when people try to misuse statistics in their favour. So far the only “bs essay” I see are your posts. Please prove, without resorting to mathematics, that the multiplier exists and that it can somehow result in the production of more wealth than an economy is physically capable of producing via savings. 🙂

    • RJ says:

      Awww, does the logic behind the mathematics of the multiplier hurt your tiny inbreed brain? It’s a waste of time responding to you considering the jist of your arguments consist of “Assertion, Assertion” and one or two superficial sentences. I don’t have time for child’s play or someone who denies the geometric series of mathematics, established through rigorous proof, or data from the non-partisan CBO (which also displays within the graph how our economy would have been without the stimulus, which is displayed to be worse.)

  7. Cake says:

    This is the reason why economics is the dismal science. Austrians are fundamentalists but at least they don’t force anyone to follow their plans. The Neoclassical economists are screaming, “we’re scientists, too!” You should have took an engineers class if you want to show you can do geometry.

  8. TheOrlonater says:

    “1.Ever heard of bonds? You know, the kind of things that foreign banks and states purchase with their capital as a garuntee with interest. There’s your wealth that debunks the stupid-ass assertion that the government mearly rearranges scarce resources into new patterns (lol!) Monetizing the deficit is example of the Treasury printing more money and the Fed rearranging it, granted, but necessary when demand for more capital hits the given economy.”

    Government bonds do not create wealth, but it increases the amount of money in circulation. Where does the government get the money to pay back bonds with interest? The private sector or its printing press. No new magical wealth has been created.

    “Really, because laureate Gary Becker and Mankiw disagree with your claim, along with Susan Woodward and Robert Hall. Again, infrastructure spending contains a multiplier effect on the economy by creating jobs and public goods not provided by the private sector during a recessionary gap. Private industries will actually cut investment spending significantly, refuse to raise wages for workers and slash hours (causing consumer spending to drop). Not to mention private banks are hesitant to make loans. This all prolonges a recession when the market acts in it’s self-interest. You can argue the ‘auto self-correction mechanism,’ however it’s doubtful that it would occur and if it does it would take quite a bit of time.”

    You’re destroying a private sector job for each unproductive public(most likely overpaid)sector job. The industries that are cutting their spending. The industries have to cut spending as save money for a bigger capital stock. The recession will only be on for about a year or two like almost every single panic in the 19th century, or more importantly the Great Depression of 1921. I agree with you that working hours should not be cut(one of Hoover’s biggest mistakes was cutting the work day in many industries, especially the Steel). I disagree with your whole wage rates must be buoyant. Wage rates should be lowered to the point in which firms can afford to operate with. Artificially propping up wages will result in less investment and more unemployment. This was Hoover’s greatest flaw in policy regarding the Depression, keeping up wage rates. Private banks will lend again once the capital stock accrues.

    “Joblessness is created when aggregate demand decreases or aggregate supply decrease when aggregate supply is static. Lack of demand for output creates cutbacks and layoffs. Your first claim of joblessness is sketchy, and you’ve yet to provide any evidence for your claims other than theoretical backing, which is a load of garbage when it comes to actual practice. Your assertion of price controls is correct to a degree. As for progressive taxation, well than maybe you can explain to me why exactly during the Clinton administration’s tax increase unemployment continued to fall below the natural rate of unemployment?”

    The Keynesian explanation regarding the fall in aggregates is partially correct. What it fails to explain is why this consumer irrationality comes about? The Austrian approach explains that there was overconsumption and malinvestment during the speculative boom phase. The visual prosperity was unsustainable and naturally transient. The recession or recovery period is a a path to sustainable economic growth.

    I’ve already mentioned that this is a fucking short-term solution for a recessionary gap and that continual deficit spending can cause inflation, but you don’t seem mentally competant enough to acknowledge or absorb what I’m saying. Instead you’re wasting my time with your ideologically based bullshit knowledge of economics, which can even hardely be considered amateur. Again, you guys seem to be believe that monetizing the deficit automatically causes the price level to rise. It doesn’t, this only happens when the money supply exceeds the amount of goods/services. Now, if spent to boost production (like infrastructure) and private production/investment (crowding-in effect), the amount of goods catches up and the result reaches equilibrium.

    When the economy’s problems are pushed off and when the new money is being loaned out there is a possibility of inflation. You are correct that it depends on the amount of goods/services. Debasing the purchasing power of money is not necessary. Stop focusing on the short term, we won’t be dead in two years. 😛

    Wrong, the 70’s (and the 60’s) had a better track record with Keynesianism than under Reagan’s supply-side years or both Bush’s conservative economic policies in terms of unemployment and both nominal and real GDP.

    And then it went bust in 82′.
    Regarding GDP, please read this article.
    http://mises.org/story/770

    Saving will decrease consumption and investment spending during a recession, which isn’t what the economy needs. Having a contractionary fiscal policy during a recessionary gap prolonges the recession. Boosting consumer confidence and their ability to purchase goods/services is a strategy to get us to potential GDP and thus ending the recession.

    No. When we save a portion of our income, the capital stock grows and that can be used for firms to expand production. Prices will have to fall when a certain amount of money is deferred for future consumption. When firms will expand output, prices will fall and purchasing power will rise. Production is the paradigm of wealth, not more spending and eroding of the capital stock.

    That doesn’t even make the slightest bit of logical sense. If production exceeds consumption when aggregate demand is decreasing you won’t have anything to show for it. You’re assuming AD will remain static while AS must increase dramatically. That’d be nice, albeit very unpractical considering when overall spending decreases output will decrease as well.

    Demand(increase in consumption) does not necessarily mean that they will increase in production. This means that savings are lower and interest rates are higher. Firms will not enjoy these higher interest rates when it comes to obtaining capital goods.

    I’ll admit, it’s done a poor job at revealing itself…considering those seeking to debunk it carry little knowledge, and even less real world data, of it’s application and real-world economics. Is it a wonder why no reputable economist takes things such as Austrian or anarcho-capitalist theory seriously

    Stop hiding behind your aggregates. They do not represent wealth and do not show whether investments are mistakes or not. We’re not taken seriously because we’re an anti-statist school. In our society, the state rules. It’s quite obvious. Also please don’t resort to your ad hominems and gratuitous posting of the acronym “lol.” It shows your immaturity and bad manners. I would think your parents and relatives would have taught you better.

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