The great battle since 2008 has pitted the ghosts of F.A. Hayek against John Maynard Keynes.
Team Keynes dictated the policies we know too well: more government spending, flood the economy with money, prevent liquidation. This team predicted a recovery that still hasn’t come.
Meanwhile, Team Hayek has had a different set of predictions. This would not boost recovery. It will forestall it, even make everything worse. We’ll pay an even higher price later on.
As the failure of Team Keynes has become clearer, the battle has become brutal, a real war of words, some of which have been flung at our very own Robert Murphy, who serves on the Advisory Board of the Spy Briefing Club.
Naturally, we’re coming to his defense.
Hayek and Keynes — the great opponents in the struggle over how government should manage recessions — were social acquaintances. They disagreed profoundly on nearly everything. Still, they had respect for each other’s professional accomplishments.
For this reason, in 1946 Hayek asked Keynes the burning question. Did Keynes worry about whether his followers would use his theories and invoke his name on terrible policies? Keynes said “no” because he would simply step up and correct them, distancing himself from whatever contradicted his core values.
A few weeks later, Keynes died.
He left hundreds and thousands of economists — many generations now — to claim to speak for him. And what they have said and done is really quite terrible. And most of these terrible policies have been an extension of what Keynes himself suggested in the 1930s and 1940s.
Would Keynes have repudiated them? Maybe or maybe not. Keynes had a long record of randomly changing his mind depending on the political need at the time.
So it is with his followers. The two most prominent and politically engaged Keynesians today are Berkeley’s Brad DeLong and Paul Krugman of MIT and the New York Times. Since 2008, they have been the leading voices in in defense of endless rounds of stimulus. However much money Congress spends, it’s never enough. However much money the Fed creates, it should create more. No matter how low interest rates are, they should be lower.
For five years, they’ve engaged in an unrelenting rhetorical ploy. When there’s good economic news, they say: look how government intervention worked! When there’s bad economic news, they say: we told you that there needed to be more government intervention!
It’s pretty clear that no existing reality will ever shake their faith in the power of government to cure all ills through regulations, inflation, spending, and taxation. It’s an infallible doctrine.
It’s been fascinating to watch mainly for one reason. Those of us with a non-Keynesian understanding of economic processes knew all along that the post-2008 stimulus would not fix the problem and would actually end up doing more damage. The proponents like DeLong and Krugman — two among multitudes — said repeatedly that only government measures would cure the problem.
Team Hayek knew better. We knew that artificially low interest rates would only break the system, that more spending would only divert resources, that more regulation would only gum up the works of enterprise, and that more debt would only crowd out private investment.
You might think that DeLong and Krugman should be held to account. Well, one of the most effective interlocutors has been our own Robert Murphy. He has tracked their predictions carefully for five years and shown repeatedly that they have been consistently wrong. More substantially, he has shown why they have been wrong. Their simple mechanical models are too aggregated to capture the complex pricing signals of the market.
Murphy has repeatedly challenged Krugman to a debate, and even raised $81,000 to go to a charitable cause if Krugman agrees. But neither DeLong nor Krugman have shown any willingness to engage Murphy in a debate or closely discuss Murphy’s “Austrian” views on the great economic problems of our time.
Then at year’s end, both blew a gasket.
DeLong went first. He called out Murphy on his prediction that we would see 10% price increases by 2013, and further drew attention to a $500 bet that Murphy made with economist David Henderson on this point. Then Krugman jumped in too, further flogging Murphy. Both said that Murphy needs to apologize to his readers and rethink his entire worldview.
Talk about chutzpah, huh? The Keynesians are the ones who have been “completely, comprehensively, unmistakably, fundamentally, fatally, totally wrong” (to use DeLong’s words) about the stimulus. After all, if stimulus #1 worked, there would not have been a need for #2, #3, #4, and #5 unto infinity. It’s never enough. Even the little progress they can point to, such as a slightly lower unemployment rate, is compromised by the dramatic fall in the workforce itself. It’s hardly progress that millions have simply decided to give up on ever finding suitable employment.
It was Murphy that has been 100% right about the big picture: Keynesian policy has not done what it is supposed to have done, and this is for all the reasons that the Austrian-Hayekian model would predict.
But what about Murphy’s own inflation prediction? After all, wasn’t Murphy wrong here and didn’t he lose? Yes, he was wrong. But note: he obviously believed in it enough to put his own money on the line, which is saying something in a world of punditry without accountability.
Moreover, being wrong on this one empirical matter says nothing about the Austrian model itself, which is a not a model designed to predict inflation but a model to account for the business cycle itself and how not to try to cure it.
The mitigating factors that Murphy overlooked make a fascinating study in themselves. The European meltdown dramatically increased the market for dollars overseas, blunting inflationary effects at home. Money velocity has also taken a dramatic fall, reducing upward price pressure all around.
Above all else, Bernanke’s zero interest rate policy has broken the banking system and made it less effective in creating the credit that it might have in the past. In other words, Murphy had assumed that prevailing institutions would keep working as they had. But they stopped working and therefore didn’t react as one might expect.
(I’m also among those who had expected dramatic increases in prices, and admit that I too was wrong. My attempt to account for why appeared in Spy Briefing Today under the title “The Great Disconnect“).
There is nothing unusual about this. Recessions often signal troubled bank balance sheets and a broken system of credit expansion. In fact, he years 2008-2013 closely parallel the years 1930 to 1932, when the Fed was busy trying to create new money through the banking system but the banking system would not cooperate. Reserves ballooned (just like today) but money on the street did not.
Murray Rothbard tells the story in America’s Great Depression, the definitive Austrian account of the onset of the crisis. He shows how the Fed kept trying to expand money and credit through low rates and bond purchases, but they were unable to achieve their goals.
Following the stock market crash, “in 1930, the government instituted a massive easy money program. Rediscount rates of the New York Fed fell from 42 percent in February to 2 percent by the end of the year…. Despite this increase in reserves, the total money supply (including all money-substitutes) remained almost constant during the year,” while “production and employment kept falling steadily.”
Then in 1931: “The Federal Government had tried hard to inflate, raising controlled reserves by $195 million — largely in bills bought and bills discounted, but uncontrolled reserves declined by $302 million, largely due to a huge $356 million increase of money in circulation…. The inflationary attempts of the government from January to October were thus offset by the people’s attempts to convert their bank deposits into legal tender.”
Again: “The Federal Reserve tried its best to continue its favorite nostrum of inflation — pumping $268 million of new controlled reserves into the banking system (the main item: an increase of $305 million in bills discounted). But the public, at home and abroad, was now calling the turn at last…. the will of the public caused bank reserves to decline by $400 million in the latter half of 1931, and the money supply, as a consequence, fell by over four billion dollars in the same period.”
And then 1932: “Despite this great inflationary push, it was during this half year that the nation’s bank deposits fell by $3.1 billion; from then on, they remained almost constant until the end of the year. Why this fall in money supply just when one would have expected it to rise? The answer is the emergence of the phenomenon of ‘excess reserves.’ … Naturally, the banks, deeply worried by the bank failures that had been and were still taking place, were reluctant to expand their deposits further, and failed to do so.”
Rothbard summarizes the paradox with a general principle: “In a time of depression and financial crisis, banks will be reluctant to lend or invest, (a) to avoid endangering the confidence of their customers; and (b) to avoid the risk of lending to or investing in ventures that might default. The artificial cheap money policy in 1932 greatly lowered interest rates all-around, and therefore further discouraged the banks from making loans or investments. just when risk was increasing.”
As a result, money supply was flat or fell just as the Fed was inflating.
Sound familiar? Absolutely. It’s just like today. But get this: Rothbard is a thorough practitioner of the Austrian theory, a man from whom Murphy’s learned economics. His book is the main Austrian account of the Great Depression.
In other words, it is the Austrians who have best accounted for our current plight, and that includes the phenomenon that Murphy himself had mispredicted only because he underestimated how much the downturn plus Bernanke’s policies would wreck the credit system. Other than this point, Murphy has been more accurate in his forecasts than any economist of the non-Austrian variety.
It is very much to Murphy’s credit that he was chosen by the two leading spokesmen for Keynes today as the great enemy that they have to slay. He is indeed. He is young, smart, and he knows his stuff. He has argued consistently that the Fed’s policies will create new forms of distortions. We might yet see price inflation but even in its absence, the distortions in the bond market and capital structure are real and highly dangerous for the future of economic growth.
They attacked him on a small point on which he was vulnerable in order to distract from the bigger point on which he has been completely correct and they have been completely wrong.
I’m also very happy to announce that Murphy will be first up in an exciting new series of seminars run by the Spy Briefing Club. In the course of three lectures with questions and answers, he will discuss the current economic stagnation and the correct theory that accounts for it. He will present to readers the ideas that have granted him such prescience in a time when the Keynesians have been so consistently wrong.
Sincerely,
Jeffrey Tucker
