A Response to Paul Krugman

by Christopher Carr

Nobel Prize winning economist Paul Krugman’s existence in the popular consciousness largely rests on ideological antagonism.  Krugman’s infamous September 2009 New York Times Magazine editorial, “How Did Economists Get It So Wrong?“, attacking University of Chicago’s John Cochrane and others, was the “Hit Em Up” of economic policy debate.

“How Did Economists Get It So Wrong?” is noted for, among other things, resurrecting the terms “saltwater economics” and “freshwater economics”, and thereby grossly oversimplifying the way economics is discussed in the public sphere and in government.  The two terms originate from 1970s discussions of economic modeling methodology vis-à-vis the rational expectations assumption.

The “saltwater” school was based largely at Harvard, MIT, Princeton, Berkeley, and other coastal schools, and supported the Keynesian-Neoclassical synthesis belief that both monetary and fiscal policy can be used effectively as economic stimulus.  The “freshwater” school consisted largely of economists from the University of Chicago, Carnegie Mellon, the University of Minnesota, and the University of Rochester who rejected the prevailing Keynesian-Neoclassical synthesis and aspired to show quantitatively that monetary stimulus is preferable to fiscal stimulus measures such as jobs creation.  Both groups generally support monetary stimulus, and have found commonality there.

Nevertheless, Krugman’s renovation of the terms for popular consumption on his blog, The Conscience of a Liberal, suggests two irreconcilable and antagonistic schools corresponding to two irreconcilable and antagonistic political parties: one urbane and sophisticated, one backwoods and boorish.  In Krugman’s world, neither heterodox economists nor heterodox politicians can work together to solve problems honestly.  This is hackery.  In reality, the economics discipline is a nuanced conglomeration of disparate ideas.  The unholy marriage of economics and partisan politics which Krugman represents only threatens to undermine the credibility of economics as rational discourse on human behavior.

Krugman recently wrote a blog post, Antipathy to Low Rates, in which he stereotyped his opponents, associated the stereotype with something unpleasant, and then quoted people he doesn’t like as representative of his odious caricature to discredit them.  This is an unacceptable rhetorical device called a straw man which charlatans (and Nobel Prize winners apparently) use when their premises cannot be built on any logical foundation.  Krugman quotes (the dead) F.A. Hayek (way) out of context to characterize today’s opponents of further stimulus as ideologues:

(Krugman:) And Hayek found it

(Hayek:)…still more difficult to see what lasting good effects can come from credit expansion. The thing which is most needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production.  If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand resources [are] again led into a wrong direction and a definite and lasting adjustment is again postponed.  The only way permanently to ‘mobilise’ all available resources is, therefore to leave it to time to effect a permanent cure by the slow process of adapting the structure of production.

(Krugman:) These days, relatively few economists are willing to say straight out that they regard persistent high unemployment as a good thing. But they find reasons to oppose any and all suggestions to use government policy — including monetary policy — to alleviate the slump. Same as it ever was.

Krugman knows that Hayek was not supporting “persistent high unemployment”, yet here he suggests that Hayek’s opposition to the New Deal was born out of certain disregard for the struggles of the poor.  On the contrary, Hayek’s opposition to stimulus lay in the understanding that the negative externalities of using policy to redirect such a large portion of the economy towards unproductive pursuits would ultimately snowball, and the economy would rot from the inside.

Krugman also conflates the very different oppositions to fiscal stimulus of the Austrian (Hayek) and Monetarist (Friedman) schools respectively.  Austrian economists generally oppose both fiscal and monetary stimulus on the grounds that prices convey information about the relative scarcity of goods.  To interfere with the price mechanism results in consumers making irrational decisions, widespread malinvestments, and bubble economies.  Monetarist opposition to fiscal stimulus is grounded in the idea that both fiscal and monetary policy can be used to the same effect, monetary policy is more efficient and therefore is preferable to fiscal policy as mechanism of stimulus.  In short, Keynesians and Monetarists want to steer markets.  Austrian economists want them set free.

Before this takes on the characteristics of a Krauthammer editorial: economic theories must have demonstrated predictive power to be considered legitimate.  It is often said that World War II, and not the economic growth of the late 1930s, vindicated Keynes.  However, it is more appropriate to say that the war interrupted and contaminated the Keynesian experiment.  Hayek believed that too aggressive policy had progressively distorted consumer preferences throughout the 1920s, only to be met with expansions of credit to further fuel ten years worth of central planner tinkering and malinvestments.  The economy was suddenly and viscerally refocused on reality in 1941 in the form of an economically overwhelming war effort.  Were it not for the war, perhaps only one of the two theories would be standing today.

Keynes believed that, if the war had never happened, the economy would have continued growing steadily, government planners would have compensated for New Deal stimulus during subsequent boom periods, and the economy would ultimately return to equilibrium with the number of people negatively affected by the natural trough of the natural business cycle minimized.  Perhaps he was correct.

Hayek believed that, if the war had never happened, New Deal stimulus would have continued to imperfectly direct production towards probably value-less pursuits, government planners would grow complacent and forgetful during subsequent boom periods or that there would be a change in policy as the result of electoral replacement, and America would suddenly discover that, instead of using the bust to clean house and purge unproductive entities, it had merely prolonged a disaster made worse by the further concentration of economic power in either corporate or government hands.  Perhaps he was correct.

Whatever shape the economy was in when the United States entered World War II, whether steady recovery as Keynes hypothesized, or deceptive crash course as Hayek hypothesized, this all changed when the nation’s resources were redirected towards the (very real) war effort.

World War II was effectively a reset button, and for this reason, economists still remain divided on the efficacy of intervention.  Paul Krugman at least knows this, and despite the need to pander to his audience, should not assume malicious intent, indifference to the struggles of the poor, or stupidity in those with whom he disagrees on the efficacy of interventionism.  Paul Krugman should stop being a ringmaster and go back to being an economist.

Today, as we in the United States debate the merits of additional stimulus measures and watch asEurope vascillates, intellectual honesty takes on a new importance (as if it wasn’t important before).  One doesn’t have to agree with Hayek to value his insight.  One doesn’t have to agree with Krugman to know he’s one of the brightest minds in economics.  But there is room for economists and non-economists alike to disagree amicably, recognize the absurdity of orthodox opinions on stimulus, realize there is a trade-off, and work together to effectively solve problems in pragmatic and dispassionate ways.

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58 thoughts on “A Response to Paul Krugman

  1. The unholy marriage of economics and partisan politics which Krugman represents only threatens to undermine the credibility of economics as rational discourse on human behavior.

    Which is all for the better, because despite its pretensions, it’s still more like a disparate grouping of discourses on ideologically-determined representational models on human behavior than an actual rational discourse. I think it is telling that both models failed to account for the war, but continued to use it as evidence for their position.

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  2. OK, I’m old. So tell why the fuck link to Tupac? I’m sure it’s cool and the smart kids get it. But, I’m old.

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  3. In theory, would it be possible to say whether Keynes was right after 2011 winds down?

    Or will we be in yet another situation where we don’t know because the stimulus wasn’t big enough and the wreckers got in the way?

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    • I doubt it. I don’t think we’ll be able to draw a line under the intellectual or economic underpinnings of the current economic crisis for at least decade, and probably more.

      And let’s also note, contrary to some on the Right, that Keynes and the associated Keynesian or neo-Keynesian economic methodologies are not necessarily ridiculous in toto.

      What is disgraceful is the current stimulus package and other welfare state agglomerations whose accountable rationale is either thin or nonexistent.

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      • @Koz, the base question is, of course, “Is It Falsifiable?”

        If it ain’t, this needs to be made explicit.
        If it is, we could use some ground rules of “well, if X happens, we’ll know that our hypothesis was wrong and it’s time to embrace a new one”.

        What’s X? Can we be Austrian next time?

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        • “the base question is, of course, “Is It Falsifiable?””

          That’s the optimal situation but often times in social science you can’t get there and have to rely on a weaker heuristic instead.

          My beef isn’t necessarily that the liberals are Keynesians or vice versa (or that their advocacy falls short of the scientific method), but that in the particular circumstance of the stimulus package and other policies of the Obama Administration, neither one has has offered anything but Fisher-Price level argumentation for what they’re trying to do.

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            • The one that comes to mind immediately is a back and forth between (I think) Brad DeLong and Tyler Cowen about the health care debate.

              Leaving aside all the smoke and mirrors about cost estimates and all rest of it, DeLong et al want to argue that the Obama health care bill is at least deficit neutral wrt current policy.

              Cowen et al point out that even if that were so, that current policy is unsustainable and widely acknowledged as such by informed people. Furthermore, the expands health care entitlement commitments and raises various taxes to finance it. Tax revenue, which if not already dedicated to the illusion of deficit neutrality for HCR, could be used to restore fiscal balance.

              At this point, we hear crickets from the DeLong and other HCR/Administration supporters.

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      • @Koz, But if the neo-Keynesians are right, or at least possibly right, that provides a rational for stimulus if you’re in a deep recession, especially a liquidity-related recession like this one, so what more argumentation in favour of the stimulus do you need?

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  4. Paul Krugman is Exhibit A for the proposition that liberalism is a mechanism for turning otherwise intelligent people into drooling idiots.

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  5. Well that devolved fast.

    , It seems you’re more offended by Krugman’s lack of technical book keeping (e.g. simplifying economic philosophies, disagreements) then his actual arguments, correct?

    While rightly criticizing any straw men fallacies, you seem to be offering Krugman’s simplification of jargon/characterization of schools of thought, as a “response” to the actual merits of his argument.

    It seems unfair to berate him by taking a small slice of a much larger argument about government’s role in economic turnaround, and attacking the details rather than the argument. The details are very important, but at least in this instance, seem tangential, especially for the majority of the public who is uninterested in distinguishing schools of economics based on the salt content of their nearby water.

    “Krugman knows that Hayek was not supporting “persistent high unemployment”, yet here he suggests that Hayek’s opposition to the New Deal was born out of certain disregard for the struggles of the poor”…if by “persistent high unemployment” it is meant, unemployment for 6 months or more, isn’t that true?

    Hayek’s point seems to be that sometimes the economy needs to work itself out, and will give short term pain to those workers in industries that are reorganizing/evolving/going extinct.

    Krugman’s implied point seems only to be that economists of that stripe from than and now don’t fully appreciate the costs he believes are associated with extended unemployment.

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    • @E.C.Gach,

      Krugman’s implied point seems only to be that economists of that stripe from than and now don’t fully appreciate the costs he believes are associated with extended unemployment.

      Having read economists like Paul Krugman and Brad DeLong throw childish temper tantrums towards those they disagree with (remember DeLong referring to economist opponents of the stimulus as “ethics-free partisan hacks”?), I am extremely skeptical that Krugman is attempting a good faith disagreement, especially given his complete disdain for the Austrian School.

      The way I tend to read Krugman when he discusses subjects like fiscal stimulus is not that there is a debate between competing schools of thought, but that the debate was settled in the 1930s and he wonders why we’re having it again (DeLong is much worse about this).

      As far as disregard for the poor, I remember when Krugman criticized people who had the audacity to suggest that unemployment benefits may actually contribute to unemployment because the incentive to find work immediately may not be as strong for someone that is receiving unemployment benefits compared to someone that isn’t. What was funny about this was that people responded to Krugman by quoting him out of a macroeconomics textbook that he had written.

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      • @Dave, whether his argument is in good faith or not, speaks only to his character, not to the merits of his argument, which in that context, would be that the losses associated with the growing pains of recession unemployment are greater than the short term deficits that a believer in fiscal policy would run to address the problem.

        Whether or not his infamy casts a shadow on the assertions of labor economics/fiscal policy, the point remains that “no pain no gain”/”tighten our belts” metaphors don’t really apply in this situation.

        It fundamentally comes down to this: there are people who needs things, and people who need work. Right now, a lot of people who need things, can’t afford to buy them cause they can’t get the work they need. People who want to sell things can’t higher more people cause they can’t sell there things/services. Nothing in capacity has changed.

        Clearly this is a situation that can be fixed. So is the disagreement about how to fix it, or whether in fact, it actually can be fixed (by people/policy)?

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    • @E.C.Gach,
      I think the differences between the Monetarists and Keynesians are fairly trifling, and I think Krugman’s playing them up – while not necessarily an underhanded strategic move – has the effect of moving the debate beyond efficacy of stimulus and straight towards mechanism of stimulus, i.e. do we save people from themselves by stealing from suckers or do we just give them jobs with no real benefit to society?

      I wanted to stay away from normative economics here, but the grand, unresolved Hayek-Keynes debate ultimately centers around normative economics: very few Austrians doubt fiscal stimulus creates jobs; they just think it creates “the wrong kind of jobs” when those people suddenly finding themselves unemployed after a recession (willingly or unwillingly) ride the coattails of government spending instead of patiently looking around and making themselves of use, sometimes after six months or even years.

      I think the ultimate reason why Krugman specifically needs to be called out and shamed is because, despite their philosophical differences, economists of all ideological leanings can operate with more humility. Krugman makes this difficult with straw-man and ad hominem attacks and titles like “Reality has a Keynesian Bias” dehumanizing his opponents. The readership of a Paul Krugman column is huge, but not as many people read John Cochrane’s journal articles or know that Jim Rogers predicted the collapse of the real-estate bubble in 2004.

      Want to give people jobs making cars that nobody wants? Fine, but realize that Hayek’s idea that doing so directly diverts resources away from future growth is the anti-hubris.

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      • @Christopher Carr, I also think it’s pretty common to overload one’s rhetoric when rival arguments get a pass on basic scrutiny. If the opposing side frames the debate outside the realm of empirical evidence (e.g. arguments about human behavior, human nature, skepticism), it’s unfortunate but understandable, if not condonable, that your arguments descend to the level of the competition.

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        • @E.C.Gach, I think that’s largely the point of Austrian economics. It’s not quite economic nihilism, but it is more or less macroeconomic nihilism and definitely stimulus nihilism. Here’s a quote from Hayek to put it in perspective:

          “An experiment can tell us only whether any innovation does or does not fit into a given framework. But to hope that we can build a coherent order by random experimentation with particular solutions of individual problems and without following guiding principles is an illusion. Experience tells us much about the effectiveness of different social and economic systems as a whole. But an order of the complexity of modern society can be designed neither as a whole, nor by shaping each part separately without regard to the rest, but only by consistently adhering to certain principles throughout a process of evolution.”

          Just some food for thought. Keynesians are often inclined to respond to Austrian critiques with, “So what’s your model then?” but you see here that that is inappropriate.

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          • @Christopher Carr, Thanks for the response, though I’m not well read on Hayek. In that paragraph he doesn’t explain necessarily why principles and not policy are the fix. Rather it seems (please correct me) that he’s supporting the conclusion with the assumption:

            “But to hope that we can build a coherent order by random experimentation with particular solutions of individual problems and without following guiding principles is an illusion…but only by consistently adhering to certain principles throughout a process of evolution.”

            Could you expand the argument for me?

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            • @E.C.Gach, Hayek is essentially saying that any models we might posit to explain what we call the macroeconomy severely understate its natural complexity, and as such, the law of unintended consequences must prevail.

              His specific criticism of Keynes was that, while his model was elegant and complex, it was not enough to justify stimulus action in any spirit of certainty. Specifically, Keynesianism threatened widespread malinvestments, whereby distortion of prices results in individual actors making poor decisions that ultimately hurt the economy in the long run.

              It is better to devise economic policy based on adhering to certain principles, such as maximizing individual economic freedoms, than to imagine some greater good that can be met by general stimulus. We should therefore design economic policy to allow the economy to evolve in conjunction with such fixed principles.

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            • @Christopher, This is where I start to have a problem with the Austrians. They insist on using verbal reasoning from “self evident truths about human nature” (what the rest of us call assumptions), but then smuggle quantitative assumptions and reasoning in by the back door. At the level of the completely trivial and probably unimportant, Mises goes on and on about the invalidity of continuous, quantitative reasoning in economics but then turns around and uses continuous supply and demand curves just like everyone else (having admittedly derived them via a different mechanism).

              More importantly, the Austrian business cycle theory does in fact involve assumptions that would be better elucidated with some maths. For example, that monetary (or fiscal) stimulus necessarily shifts investment towards high-order capital goods, or that the investment thus diverted necessarily always becomes mal-investments and generates no return. To the extent that mainstream economists have properly formulated and tested these ideas they don’t appear to be true. And yet Austrians by rejecting the use of mathematics also manage to reject the evidence that this particular theory is wrong.

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  6. “The details are very important, but at least in this instance, seem tangential, especially for the majority of the public who is uninterested in distinguishing schools of economics based on the salt content of their nearby water.”

    I don’t know how closely you follow the economics blogs, but the actual argumentation for fiscal stimulus has been horrifically weak. Proponents of stimulus almost inevitably appeal to the results of some model without any credible explanation of what the model is supposed to encapsulate or why we should believe it.

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    • @Koz,

      Proponents of stimulus almost inevitably appeal to the results of some model without any credible explanation of what the model is supposed to encapsulate or why we should believe it.

      The opponents do the same thing. I read the economics blogs, and I don’t see much of a difference. Sure, I’ve read Robert Barro discuss multipliers that he believes are much lower than what the CEA believes, but they’re numbers until people go through the underlying models and convince themselves that he’s right (which 99.9% of us won’t do). It’s not like he’s making any more an effort than anyone else to tell you WHY you should believe it.

      You’re doing the exact same thing you accuse proponents of the stimulus of doing only your criticizing their faith in their models without any credible explanation as to why you are criticizing the model and what models and/or variables we should be focusing on in its place.

      You are holding your opponents to a standard that you yourself are not willing to embrace.

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      • No, this fits in a very particular context.

        That is, that as Keynesians assert, that national finance is in very important ways much different than the extrapolation of personal or household finance. This is largely because nations have wider access to credit at much lower interest rates and also the ability to create fiat money (and the right to compel the payment of taxes, etc).

        That gives nations the ability to try things that individuals cannot (and bigger, more prosperous nations the ability to try things that other nations cannot).

        It is in this context that Krugman et al want to argue that we can use some cute engineering tricks to get us out of our trouble. To the extent that the neo-Keynesians and critics of whatever stripe want to argue about multipliers, I find the pessimists to be much more persuasive. But that’s not even the real issue for me.

        The real problem is that the Krugman et al stimulus/aggregate demand maneuvers implicit depend on baseline assumptions about the state of the macroeconomy at a time when those assumptions are in state of greater uncertainty than at any time since the Great Depression.

        Therefore, let’s emphasize, it’s not a matter of “If you don’t like it, what’s your model?”

        If you want to go to the next town five miles over, you can take a bicycle or a glider to get there. If you choose the glider you are depending on advanced engineering and advanced knowledge of aerodynamics, etc. But even if you get those right, the glider probably won’t work in a thunderstorm or tornado.

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        • @Koz, Precisely what baseline assumptions about the state of the economy do you think that stimulus advocates are dependent on?

          I’m not much of an advocate of fiscal stimulus. I’m more of the view that the fed should stop worrying about non-existent inflationary pressures, believe what the bond market is telling it, and get with the money creation already.

          However the logic behind fiscal stimulus is not really different from that behind monetary stimulus. When the government issues new debt it creates (broad) money, and when it spends it increases the velocity of (narrow) money. In this its essentially the same as any other entity, but its actions have a much greater effect on the economy because of its sheer size and the trust put in its debt. The fact its spending comes back to it in taxes also also allows the state to sustain debt created in this way where a private entity could not.

          That’s really all there is to it, and I don’t see where the delicate glider-like balancing act comes it. Provided we’re in a recession with basically monetary causes, stimulus spending works, just as a trying to get nominal GDP back to its mid-2008 level by monetary means would work. Regardless of the details, I don’t think anyone can reasonably deny that this recession has basically monetary causes.

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          • “Precisely what baseline assumptions about the state of the economy do you think that stimulus advocates are dependent on?”

            Many assumptions, in this context the main one is that GDP or growth “should” be at such-and-such a level and simply requires some cute macro maneuvers (fiscal or monetary) to get there. See your comment below.

            “That’s really all there is to it, and I don’t see where the delicate glider-like balancing act comes it. Provided we’re in a recession with basically monetary causes, stimulus spending works, just as a trying to get nominal GDP back to its mid-2008 level by monetary means would work. Regardless of the details, I don’t think anyone can reasonably deny that this recession has basically monetary causes.”

            I do. We have a lot of economic problems at the moment, but the two biggest are 1. the fundamental uncertainty for many many sectors of the labor market and 2. the sovereign debt/welfare state drag.

            It’s very important to understand that in cyclical terms we’re not in a recession at all, we’re in an expansion. In particular corporate profits are good and based on those profits and historical multiples valuations if anything are conservative.

            The problem is that, because of the folk Marxist commitment of liberals and Democrats to the ever-expanding welfare state, we are in the middle of rebalancing to a New (slow-growth) Normal. And nobody has, intellectually or emotionally got dialled into what the New Normal will look like.

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  7. “The real problem is that the Krugman et al stimulus/aggregate demand maneuvers implicit depend on baseline assumptions about the state of the macroeconomy at a time when those assumptions are in state of greater uncertainty than at any time since the Great Depression.”

    Your argument seems to be one of skepticism. You don’t see a basis for the underlying assumptions of keynesian macro, so you disagree with policy positions based one it. Fine. Your at the same standstill Dave notes.

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    • Close but not quite. I actually have more sympathy for Keynesian macro than you might suppose.

      The underlying assumptions of Keynesian macro are reasonably complicated but comprehensible. The current economic situation is reasonably complicated but still comprehensible.

      Anyone who wishes to apply Keynesian macro to the current crisis has to be able to grapple with the nuances of the theory and the nuances of the current situation and give a coherent argument between them.

      The Administration and its defenders simply aren’t doing this. “Aggregate demand is low, therefore I spend money.” That’s it. That’s what the Administration is gambling your future on. To the extent you support them, you’re making the same gamble.

      On the other hand, we can cut the entitlement state, elect Republicans and punish liberals. We can rely on what we fundamentally believe about supply and demand, debt and credit, risk and reward. We don’t have to trust manipulative arguments about multipliers and aggregate demand. In no way are we required to remain in Dave’s standstill if we don’t want to be there.

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      • @Koz,

        If you understand the nuances of the arguments, you’d know that the smarter Keynsians are not going to represent their arguments that way. They are also going to discuss the effects of deflation, one of the key causes of The Great Depression as well as the problems when monetary policymakers exhaust their available tools and it is still not enough to steer the ship back on course.

        You may disagree with their assessments, but I think they understand the situation quite well.

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          • @Koz,

            If the most ardent Keynsians believe that the stimulus package was too small and the situation we are in is because the federal government has been weak in its response to this crisis, why would they show accountability between their policy advocacy and the state of the economy? They would say the policies that went into effect were not the policies they advocated for.

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            • Ok, then they (Krugman, DeLong, et al) shouldn’t be doing anything at all then.

              That is, if you’re right then the “fiscal solution” to the recession is not politically feasible at the time when its proponents are at their maximum political strength, then the such a plan is not feasible in general.

              If we didn’t have the stimulus package and the health care bill, we could make some progress on the sovereign debt problem instead of exacerbating it.

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            • @Dave, I think the at least one but possibly two unnecessary wars and the profligate spending during the good times might also be a contributor Koz me lad. I’d add that honest Keynesians (which most politicians ain’t) call for reduced spending and reining in or debt during said good times.

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            • “I think the at least one but possibly two unnecessary wars and the profligate spending during the good times might also be a contributor Koz me lad.”

              Ok, so what? In that case Krugman et al are still just as wrong.

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  8. It seems to be an impasse of Conservatism vs. Progressivism.

    Systems are too complex and ultimately both humans and their knowledge is more incomplete than complete and more fallible than accurate.

    Or our knowledge grows and builds on past learning and experience, allowing us to progress to better understanding of systems and more accurate predictions.

    And so we adhere just to principles, or to some stockpile of knowledge and growing access to information to “progress” to more accurate fixes, economic policy or otherwise.

    At the very least it seems that a melding of the two, both a cautious perspective as well as the acknowledgment of improved ability to engineer better outcomes overtime through increased knowledge. Maybe we would disagree on the ability to engineer “better” outcomes over time, but we would probably agree on the fact that knowledge and experience increases over time, and so where would that leave us as to the “Progressive” potential of society and public policy?

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  9. I don’t think its quite right to attribute the idea that stimulus diverts resources towards unproductive uses to Hayek – lots of Austrians do believe that, but Hayek was a good deal more careful, and said different things at different times. Hayek did believe that stimulus leads to “mal-investment”, but its really not the same thing – mal-investments may very well be productive. For example, if the government borrows extra money and spends it on filling in potholes and resurfacing roads, thats a stimulus and its also productive, but it may also constitute a mal-investment in that the supppliers of asphalt, rollers, etc will perceive increased demand and invest to fulfill that demand, taking labor and resources away from other projects where they might otherwise have been employed.

    Austrians, as you say above, also believe that monetary stimulus leads to mal-investment and the internet pop-Austrian tendency is to again claim that this means that the growth experienced during monetary booms is somehow “fake” even if its not actually inflationary. Again this is not only obviously not true – people do in fact manage to fill needs during booms that they can’t fill during busts – but a mis-representation of the Austrian theory. The problem with mal-investments isn’t that what they produce is worthless, but that they undermine price signals and thereby cause resources to be mis-allocated.

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  10. Pingback: Hayek links 7/10/10 | Taking Hayek Seriously

  11. Krugman is nothing more than an intelligent charlatan who has been “wrong” in his predictions more often than he has been “right.”
    As Vedran Vuk said in a recent commentary, and in a far more eloquent way that I ever could:
    “propagandists may have an outer circle of hell waiting for them, but I’m sure that the darkest corners of Dante’s imagination are reserved for folks like Krugman who spread deceit while being fully aware of the truth.”

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    • I disagree. Once upon a time Krugman was a legitimate scholar. It’s even possible that he could be one again someday but for now his emotional commitment to liberalism has turned him into a drooling hack.

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  12. Hayek believed that, if the war had never happened, New Deal stimulus would have continued to imperfectly direct production towards probably value-less pursuits,

    WWII from an economic POV was a ‘value-less pursuit’. You can debate whether the Hoover Dam was not as useful an investment if the gov’t had simply let the private market choose how to invest the funds used to build it, but even today its there generating power and income.

    A battleship, though, is yielding no income today. It yielded fantastic returns in protecting our freedom but in economic terms it was the ultimate dead end of stimulus that Hayek feared was coming….the equilivant to paying one group to dig a ditch and another to fill the same ditch.

    Keynes, though, argued for stimulus regardless of whether it was valuable. Yes the Hoover Dam is a better way to use stimulus than paying people to dig and fill ditches, but when facing a Depression either will do the most important job of returning the economy to full employment.

    On the contrary, World War II was not a reset button but pushing Keynes’s theory into overdrive. It was also pushing Hayek’s theory into overdrive. The US put a huge amount of investment in war production. When the war was over a lot of that investment was useless. Yet the economy did not require a crash and depression to ‘clean out’ that useless investmet and retool for a consumer economy, it transformed itself with hardly a disruption.

    If the economy could have transformed itself so seemlessly after the massive ‘malinvestment’ caused by huge gov’t spending as well as direct planning of the economy then what of his explanation that the Great Depression was a needed correction to misinvestment in the 20’s? Whatever foolish decisions were made in the 20’s by individuals buying stocks or Florida swampland couldn’t light a candle to the economics of WWII.

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    • @Boonton, I sympathize with your interpretation, but, however you want to look at the mechanics of the war, speaking in positive terms, the result indicated that U.S. participation had been a superior investment. Europe and Japan were both completely destroyed, and the U.S could invest in (and did invest in) their certain post-war regrowth. The U.S., with the notable exception of Pearl Harbor, remained intact. From a strictly economic perspective, the U.S. gained considerably by financing the economic growth of the rest of the world. So, your contention that WWII was a value-less pursuit is flawed. Similarly, the post-war economy didn’t seamlessly adjust back to pre-war conditions. It, and America, became an entirely different animal.

      I don’t think Austrians argue that all government investments are necessarily malinvestments. The very concept is theoretical and indeterminate by its very nature, like an error rate for stimulus measures that is never taken into account. There are of course certain federal investments that see real returns, specifically those which correct for market failures, which by definition cannot be solved by the free market. One example is the national highway system, which was actually built in emulation of Hitler’s networks of blitzkrieg highways and in anticipation of Soviet Invasion. Another example is Richard Nixon’s “War on Cancer”, which funded the research that discovered cancer as mutation of genes coding for tyrosine kinase growth factor receptors.

      I think you’ve nailed the difference between Keynes and Hayek here: “Keynes, though, argued for stimulus regardless of whether it was valuable. Yes the Hoover Dam is a better way to use stimulus than paying people to dig and fill ditches, but when facing a Depression either will do the most important job of returning the economy to full employment.”

      Keynesians may (and many of them do seemingly to defy Hayek) believe that keeping full-employment is the ultimate goal of economic policy, and there is no normative difference between digging holes and building the Hoover Dam, but Austrians see full-employment as subservient to technological and infrastructure-driven “real” growth as directed through the unpredictable spontaneous order of the free macroeconomy.

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      • @Christopher Carr,

        Your evaluation of the economic benefits of WWII suffers, I believe, from the broken window fallacy. Let’s just say Germany and Japan were never hostile. Your analysis seems to indicate that if the US had invaded them anyway and left them with massive destruction the US would benefit from their regrowth.

        Additionally while there was some profits made by the US in Europe’s rebuilding it competed for capital in the US’s own dramatic post war expansion. Yes if you destroy a lot of capital the marginal return on new investment goes up but as you said the US didn’t loose a lot of capital in WWII destruction. If your model was correct the US would have seen slack investment while most capital went to rebuilding efforts in Europe.

        IMO if we didn’t have WWII but if we did push the economy to full employment in the early 40’s we could have achieved 1970 in 1960 or 1950.

        The distinction between digging holes and ‘real’ growth is a bit spurious here. Full employment generates real growth. Full employment puts all the current infrastructure to work. Therefore since capacity is being utilized the prospect of private investment expanding capital does not appear as risky. As Krugman points out, with something like 30% office space vacancy why would anyone start building office buildings? What happens if you follow the Hayekian theory? You don’t push full employment, the 30% of office capacity is unused and no one has much incentive to either build or innovate (why invent a replacement for offices? If you need an office the market has plenty of empty ones) until the 30% starts to disappear by rotting away and only then is the incentive to make ‘real investment’ there again.

        Likewise full employment makes existing debt more secure and generates savings for spontaneous order free market innovation and investment. Consider Europe. Just suppose they had full employment. Would Greece still have debt trouble? Quite probably but not as bad as it is now and the rest of Europe wouldn’t have to worry as much about its debt. Full employment isn’t a cure all, those who act intelligently reap more from full employment than those who don’t but going below full employment doesn’t spur more intelligent decisions. Pain for the sake of pain doesn’t earn the economy more in the long run.

        Now if instead of the Hoover Dam, FDR had just used useless ditch digging he might have still generated full employment. But every year since full employment in the US has been richer because that dam has been there generating power, adding to income year in year out. Clearly a wise use of spending, not letting the ‘crises go to waste’ so to speak, is better than a foolish spend. But the economy needs spending now.

        Now Hayek’s argument was bad investment needed to be purged by a slump. The 30% of office buildings really need to rot and if we need five years at 10% unemployment so be it. But this doesn’t square with US experience. A lot of the ‘wasteful investments’ of WWII didn’t have to rot under 20% unemployment before a consumer economy could roar back. Businesses quickly used full demand to convert the tank factories back into car factories, to start building factories making new things that were invented in WWII.

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  13. I was just musing that broken windows are good for the glass-maker, and a broken world is good for the world-maker. I’m with you on the war, and all wars, ultimately being wasteful, or course, for the global economy. I was just pointing out that in terms of GDP, there is nowhere to go but up after a devastating destruction of capital, by definition.

    I guess I would counter Krugman’s office space example with the existence of computers. The reason those hypothetical offices are going unused is because technological change has made them obsolete. Naturally as fewer individuals want to rent office space, there is a shift in demand, and some entrepreneur comes along and converts them into something which serves a real, market-driven need.

    Your contention that the office buildings would just rot away until they become a nuisance for everybody seems highly unlikely. Can you come up with any real-world examples where development was not constrained by bureaucratic meddling, government takeovers, and politicking, a la Ground Zero?

    What happens if we follow the Hayekian theory? Perhaps an entrepreneur comes and converts the empty office buildings into a department store, but that isn’t very popular and it is then allowed to go through bankruptcy and liquidation procedures. Then, a hotel is built, but as that section of town is no longer populated by businesspeople, it too fails. Then, an entrepreneur comes along and converts them into townhouses, which are very popular with young couples, and the neighborhood becomes wealthy, safe, and firmly residential.

    But, in short, I don’t really know what happens to those empty office buildings if we follow the Hayekian theory, and that’s the point. The true solution is several orders of magnitude more complex than the entire litany of my sense-data. Neither I, nor Paul Krugman, nor Lawrence Summers can predict an ideal future for those empty structures, and we should therefore allow them to evolve in conjunction with our technological progress and a priori determined legal standards.

    Let me also reiterate that I’m not arguing against government spending, just abstract “fiscal stimulus” measures, which are usually poorly thought out and the goals of which are secondary to achieving full-employment. As I mentioned above, I think the Hoover Dam and the National Highway System, and Boston Common as well were wonderful uses of public money, but in those cases, people basically just said, “Wouldn’t it be nice if we had some grass on which to congregate. Let’s section off a park.” They did not turn to abstract mathematical models which essentially do no more than justify their initial ideological assumptions.

    Of course, I say these projects were wonderful uses of public money, but in some alternate universe without those public projects, one of the Hoover Dam laborers invented the time machine, and a lack of a national highway system spurred on the implementation of magnetic high-speed trains which go from New York to Los Angeles in three and a half hours.

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    • @Christopher Carr,

      I was just pointing out that in terms of GDP, there is nowhere to go but up after a devastating destruction of capital, by definition.

      That explains the GDP of Europe post WWII but not the US. And, while I don’t have figures on me, I don’t think the US’s post WWII growth can largely be attributed to internal growth rather than exporting to Europe and Japan.

      I guess I would counter Krugman’s office space example with the existence of computers. The reason those hypothetical offices are going unused is because technological change has made them obsolete.

      This makes sense in a full employment world where unused office space is pared with shortages in the home office and mobile office market. While there are some industries that are expanding (such as health care), the lack of demand everywhere else can’t be found there.

      Here’s where WWII and Hayek’s failure are well illustrated. Hayek would say that having too many office buildings causes the whole economy to go through pain. The market needs the unemployment and depression to clear out this wasted capital so room is made for the new, more useful capital. As I said WWII put both theories into overdrive. At the end of WWII we had a lot more ‘useless capital’ than 30% too many office buildings. We had nearly the whole economy restructured towards military production that was no longer needed. This should have been Hayek’s worse case Keynesian fiasco. Not only was full employment achieved by ditch digging and filling, but the whole economy was shifted towards ditchdigging/filling. Families raised their sons to be ditch digger/fillers. Companies made digging/filling machines, universities were putting R&D into making better diggers/fillers. Now all in the sudden everyone realizes there’s no more reason to dig and fill ditches! The counter reaction should have made the Great Depression look like a little summer rainstorm. Hayek’s theory would say that we should have experienced the economic equilivant to nuclear winter. Instead we got nothing of the sort. Yes there was a brief unemployment spike as hundreds of thousands of GIs returned home and started looking for civilian work but the economy quickly began its push towards civilian production.

      Your contention that the office buildings would just rot away until they become a nuisance for everybody seems highly unlikely. Can you come up with any real-world examples where development was not constrained by bureaucratic meddling, government takeovers, and politicking, a la Ground Zero?

      In general that is what happens. There are homes and buildings that stay vacant for long periods of time. they do often end up rotting away so that if demand ever does come back, developers who take over the property end up having to tear down the structure and build from stratch. Yes gov’t does have various regulations that try to push property owners from letting that happen but that doesn’t change the dynamic. Look at the ghost towns in Nevada and Florida where swimming pools breed mosquittos. Look at Brooklyn in the 70’s where vandals set empty buildings on fire for fun.

      What happens if we follow the Hayekian theory? Perhaps an entrepreneur comes and converts the empty office buildings into a department store, but that isn’t very popular and it is then allowed to go through bankruptcy and liquidation procedures.

      Actually I think you’re misreading Keynes and Krugman. The point Krugman was making was that the lack of new investment right now is not due to business ‘uncertainity’ over cap-n-trade or healthcare or future tax increases. Its over the simple fact there’s no need. If an entrepreneur needs an office building he has a slew of empty ones to pick before he considers building a new one from scratch.

      The point is to bring the economy to full employment or full demand. Then the lack of demand in one market (30% empty office buildings) is mathematically offset by excess demand in other markets (work from home set ups). Hayek talks about spontaneous order but ideally Keynesian stimulus incorporates a lot of spontaneous order. Total demand is increased but not specific demand. The goal isn’t to push up office building rentals but to simply push up total demand. It very well might be that there will still be underutilized office buildings that will end up rotting away. That’s ok provided the economy is at full employment.

      The $8K homebuyers credit therefore is not ideal Keynesian stimulus. Extended unemployment is better as it increases demand in a diverse manner accross multiple markets. I personally would consider adding a bit of ‘supply side Keynesianism’ with, say, a $5K ‘relocation grant’ for long term unemployed individuals who live in areas with greater than average unemployment.

      Even so, though, the $8K is not nothing. It doesn’t seek to reverse the rampant overdevelopment in the foreclosure cities of Florida and Nevada but it does increase demand all over to one degree or another.

      Let me also reiterate that I’m not arguing against government spending, just abstract “fiscal stimulus” measures, which are usually poorly thought out and the goals of which are secondary to achieving full-employment.

      Actually I think the ‘abstract’ measures are better. Look at the stimulus package. The ‘shovel in the ground’ stuff was a minority of it. Most of it was payroll tax cuts, unemployment extension and food stamp boosts and helping the states with a bit more Medicaid matching. Where this stimulus ended up is very hard to track as its mostly ‘spontanaous order’ stuff. Hence the difficulty in linking stimulus to specific job creation. I would say the stuff that was more thought out (cash for clunkers, homebuyers credit) wasn’t as good (although cash for caulkers seems to offer a lot more bang for the buck) but I’d rather have it in a deep recession than not.

      An analogy I like to use is a big swimming pool and a huge swim party you are hosting. The role of Keynesianism is basically to add water to the pool if its really low and the partiers don’t have enough room to play their games. Where the water you add ends up is really unanswerable since it mixes with all the other water and where the partiers end up partying (north side of the pool, south side, deep end, low end etc) is really spontaneous order stuff.

      Now if you are into tinkering with the dynamics of the party you may decide there are too few partiers at the southwest corner of the pool in addition to the water being too low. So you set up some type of hose-fountain thing there to both add water to the pool and attract people to that corner. This idea may or may not be well thought out but the fact remains the pool needs more water and if the choice is between letting it stay empty or the silly fountain thing better to opt with the later.

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  14. On a simple level, 30% office buildings being empty can mean three things:

    a. The market is changing, we don’t need office buildings as much so they go empty as rents come down.

    b. The entire economy is in recession.

    c. Some combination of both.

    Keynes and Hayek had no debate about a. Yes the market might change leaving too many buildings. In that case rents fall quickly. Maybe the buildings get filled up or maybe they just start to fall apart. Elsewhere, though, there is excess demand and as the market works to clear the office building market by decreasing it other markets expand.

    Long before Keynes and Hayek, though, government has always tried to interfere in a. Building owners become a loud and noisy lobby. They seek special rules to ‘cushion’ the market turning against them. The expanding markets are often diverse and have no direct incentive to counter lobby. That’s an old fight but its important not to pretend its an argument against Keynes. If so you’re just arguing a straw man.

    b and c are more problematic. Let’s just say that 15% of the vacancy is due to recession and 15% is due to changing market. Half the vacancy is healthy market corrective action, despite the pain to landlords. The other half has two problems:

    1. It is producing more pain that is needed to correct the market, hence it is inefficient.

    2. 15% of office buildings are not really surplus. When the whole economy recovers they will be filled. By not being filled now the buildings begin to rot. If the recession lasts years when the economy finally recovers that 15% of buildings will be unusable. Instead of expanding capital into new and useful things it will have to go towards rebuilding what had already been built at great cost.

    People follow a similar pattern. Long term unemployment causes human capital to rot. People loose their work ethic, find ways to survive on welfare or other family members. Let it go on too long and when you finally get recovery you’ll have to waste a lot of capital just getting people back into the groove of full time work.

    I agree with you that gov’t planners don’t know how much of that 30% is due to recession versus market change. We know the figure is almost certainly greater than 0%, though. We do know that demand is deficient by the across the board glut of under utilized people and capital. Stimulus can be simple and broad based. It doesn’t have to know how much of the 30% is due to recession since it seeks to simply cure the recession, to fill the pool with water, and let the market figure out how much of the 30% to start using again and how much to let rot away.

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  15. Speaking of taking Hayek seriously, I was in B&N on Sunday and spent an hour perusing the new paperback edition of The Road to Serfdom. Very interesting because of what I did not find.

    There is absolutely no reference to Keynesian economics in the entire book. There is a citation of Keynes reporting on Germany in 1915 but that’s it. In one of the three or four introductions there’s a reference to critics of the book that included Keynes, however his letter to Hayek praised the book as “grand” and only offered a very mild criticism that he made a case for drawing a line but didn’t articulate where the line should be very well.

    What you will find is a huge number of references not about even the USSSR but Nazi Germany and an attempt to point out that Nazism was socialism minus its liberal aspects. It would seem to me that in retrospect this book has been recast as a counter-argument to Keynes but it really isn’t. It’s a counter argument to the idea that socialism and the ‘planned economy’ was the wave of the future. In many respect Keynes and Hayek were on the same team.

    Advocates of planning at the time were coming from two angles. On one side were communists and socialists who felt Nazi Germany was the endpoint of capitalism. Hayek found this view totally wrong. From what I know of Keynes, he felt that Germany’s moral implosion was caused by the unreasonable demands of WWI’s peace. Not that Germany had reached some type of ultimate level of the capitalism video game.

    On the other side were advocates of ‘planning’. While vague on theory, this group had a sense that the economy should be ‘managed’ just as urban development was managed by urban planners, schools were managed by educational associations, and so on. This group was probably inspired by numerous forces including the rise of scientific management in the late 19th century, the rise of the professional urban class, the soft-paternalism of the Victorian upper class (“we refined educated gentlemen have a duty to direct and care for the less well off”) as well the fact that WWII was demanding that countries engage in national economic planning to secure enough capital for the war effort while managing demand at home for civilian goods.

    This groups policies were not aggregate demand management (Keynes’s more or less ‘hands off’ approach of making sure the pool has enough water in it) but more direct management of the economy. In the Depression this meant various price controls, trying to move industry into large cartels, various schemes to inflate prices by creating artificial labor shortages and so on. While FDR has been retconned into a pure Keynesian, the reality was that he was all over the map on economics. His NRA, for example, was the epitome of economic planning. Later he advocated for free enterprise (Hayek even quoted him approvingly at the beginning of the book, praising free enterprise as the idea that hasn’t yet been tried!, the quote was from 1938!)

    No doubt other forces were pushing in favor of planning. The urban environment in the first half of the 20th Century seemed to argue that planning was needed to avoid choas. The heavy industrialization with huge numbers of workers being employed by giant factories also seemed to hint that aside from some minor small businesses, the wave of the future was not the small shop but industrial giant. The labor movement and last but not least the fact that the USSR fought as an ally with the US and UK against Nazi Germany set off a brief period where criticizing the USSR was unfashionable.

    The argument is great and the history is fascinating but its also a dead argument IMO. The ‘planned economy’ is no longer advocated by anyone, esp. in this age of the wiki. (Not that planners ever really did get off the ground and present a coherent theory that explained how you actually manage a planned economy).

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    • @Boonton,
      I wanted to take the time to respond thoughtfully to this, and then I was sick, so please forgive the time lag.

      (1) No matter to what U.S. post-war growth can be attributed, shifting from an economy geared to war to an economy geared towards other stuff, such as massive expansion of suburbs for returning vets and others, is a massive undertaking that necessitates growth. I think we’re arguing two sides of the same coin here.

      (2) I personally admire the theories of Keynes, and think, if properly applied, they might go a long way to resolving some short-term problems, but, that being said, they are not, nor have they ever been intended to be anything more than short term fixes. The problem with the Keynesian model, is that often times Keynesian short-run solutions directly contradict long-run goals. Hayek calls this mal-investment.

      (3) People who appreciate Hayek are not saying that full-employment cannot be achieved through Keynesian means. What they are saying is that the unintended consequences of those Keynesian means make the economy worse in the long-term.

      (4) The recent crisis occurred not because there wasn’t enough credit, but because there was too much credit. It was far too easy for even incompetent people to engage in privileged activities. One could harp on people without steady incomes buying houses well above their price ranges, or on banks lending to people and then collecting defaults. It doesn’t matter. What does matter is that, for example, a malinvestment: a too-large proportion of the economy has an absence of worthwhile skill; we are exceptionally talented at filling out TPS reports, and an inordinate percentage of graduating college seniors became bankers in the run up to the crisis. Meanwhile, we have a 35% shortage in primary medical care. Those same math-and-science-inclined individuals could be responding to that shortage, and I say with a fairly large degree of confidence that they would if we “let the markets rip” to use a recent Will Wilkinson coinage.

      (5) Ghost towns are awesome. Somebody will come along in twenty years and make those Nevada ones tourist attractions; if not, then those states will have to reap what they hath sown, and pay some manual laborers, hopefully illegal immigrants, because it’s the humanitarian thing to do, to demolish them. Remember that those ghost towns are ultimately shrines to the religion of boosting aggregate demand.

      (6) I don’t think I’m misreading Keynes. I think Keynes’s solution is brilliant for short-term problems. What I deeply resent about Krugman’s interpretation, however, is this tendency to silence and discredit critics of Keynesian solutions to our current economic predicament. Essentially, Keynes suggests boosting aggregate demand either through monetary or fiscal policy in times of trouble. The only problem is that our trouble this time is too much aggregate demand. So, how do we save the economy without making the economy worse?

      One thing I am pretty sure of however is that we already injected massive amounts of liquidity into the economy, and those injections seemed to help out Goldman Sachs and Chrysler (the posterchild for malinvestment), but unemployment is still at 10%. Krugman argues for fiscal stimulus, such as jobs creation, to directly remedy the problem, and I might consider providing extended unemployment benefits a halfway decent policy, but would prefer the same money were used instead to subsidize technical education.

      (7) Road to Serfdom is not an economics book. I would recommend this (http://www.sjsu.edu/faculty/watkins/hayek.htm) for starters and this (http://books.google.com/books?hl=en&lr=&id=BR0tmZtNK4EC&oi=fnd&pg=PR9&dq=Hayek&ots=YM4UzSOc4Y&sig=J6_bTo1gZCqR5WvCytRcxYOq7go#v=onepage&q&f=false) if you want a challenge. Keynes and Hayek were generally politically aligned in an early twentieth century context.

      (8) I’m not arguing against Keynes except that his model (admittedly) ignores the long-run. I’m arguing here against Krugman’s intellectual dishonesty and sophism.

      (9) If you want to discuss The Road to Serfdom, I think what Hayek was arguing – although I read the book years ago and can’t remember exactly – is that there will never be a moment where we “choose” a planned economy. It will just sort of come upon us. Maybe I’m wrong. The early twentieth century was crazy.

      Anyways, I’ll offer you the last word on this one. I look forward to your response. Cheers.

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  16. There are discontinuities in this discussion that muddy the waters.

    Nearly every discussion of Keynes comes from people who have read about him, not read him in actuality. Half of Keynsian economics is debt and deficit elimination and banking of surplus during good times, and using that surplus for stimulus spending. There has been only one economic intervention in a full-blown depression that has ever worked, and it just so happens that that was the only genuine Keynsian intervention on the scale he prescribed as essential to success.

    Hjalmar Schacht was placed in charge of a destitute Germany by the NSDAP in 1933, and had that nation out of it’s depression in 18 months. The infrastructure spending was staggering, but it put the nation back to work (not welfare – work) and got people buying again. That stimulated business. Once Schact had accomplished that, the Nazis bypassed him and began spending on armaments.

    As for Hayek vs Keynes, check this out.

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