Although Keynes’ conceptual framework for macroeconomics was original, the economic ideas broadly known as Keynesianism — the possibility of unclearing markets, and countercyclical spending — are much older than John Maynard Keynes, and their continued predominating association with him is rather puzzling to me. Indeed, looking at Keynes’ ideas through the lens of his predecessors is illuminating.
According to Genesis in the Old Testament, in ancient Egypt, Joseph son of Jacob warned the Pharaoh that his dreams foretold seven years of abundant harvest to be followed by seven years of poor harvests. Farming in the Nile delta depended on good rainfall in the highlands of central Africa to flood the delta area with water and fertile topsoil. Without good rainfall, Egypt was susceptible to famine.
Joseph told the Pharaoh to store a surplus of grain during the first seven years so that the country would have grain during the drought. During the time of plenty, Joseph ordered the storage of 20 percent of farmers’ output in the Pharaoh’s granaries.
This was a countercyclical fiscal policy millennia before Keynes. If we are to be historically correct, Keynesianism might be better known as Josephianism. And although Joseph’s coat-of-many-colours might arouse the suspicions of certain homophobic critics of Keynes, it is noted that Joseph’s wife bore him two sons.
Keynes’ notion of disequilibrium was a reaction against an idea that only grew wings roughly 130 before Keynes with the industrial revolution — Say’s Law, the notion that “products are paid for with products”, that “a glut can take place only when there are too many means of production applied to one kind of product and not enough to another” and that subsequently “a rational businessman will never hoard money; he will promptly spend any money he gets “for the value of money is also perishable.”
Say’s Law is empirically false. Under certain conditions — including the present condition — savings levels can soar uncontrollably even while interest rates languish at zero, and while unemployment is elevated. In fact, Say himself foresaw the possibility of massive involuntary unemployment and like Keynes and Bastiat, advocated public works programs to decrease unemployment. Indeed perhaps Say’s Law — at least in its post-Keynes incarnation — is more reflective of the ideas of Nassau Senior or David Ricardo than Jean-Baptiste Say.
Although the human sphere has always been driven to disequilibrium by the divergency of human plans and imaginations, prior to the industrial revolution — like in the time of Joseph and the Pharaoh — the possibility of involuntary unemployment (and starvation, etc) arising out of flood, robbery, famine, plague, drought, barbarian raids or some other externality was everywhere. The difference between the modern breakdowns in the Great Depression and the Post-2008 Depression and pre-industrial breakdowns of production is that the cause of the former is psychological (investors become grossly fearful of markets, etc, allowing resources to sit idle rather than being reallocated to productive uses) while the cause of the latter is actual material scarcity. But in the worst case the result is the same — needs and wants go unsatisfied and skills and trades stagnate. The outcomes of pre-industrial scarcity can seep into the post-industrial world through the channel of human psychology.
Keynes’ and Joseph’s recommendations on saving in the fat years to spend in the lean ones are ultimately apolitical in nature and apply just as much to the private sector as to the public sector. There is a widely-held conception that spending in the slump and saving in the boom is statist and favours central economic planning. This is not necessarily true. If a stateless society — let’s say, a future moon colony led by radical libertarians — becomes depressed, unemployment rises and resources lie idle, one solution to lift economic activity would be voluntary private infrastructure and capital spending. While Keynes himself rather unfortunately noted that “the theory of aggregated production… can be much easier adapted to the conditions of a totalitarian state”, infrastructure spending of private origin would be just as helpful in a depression in a stateless economy.
Yet Keynes sometimes pushed his arguments too far. Keynes suggested that “digging ditches is preferable to doing nothing” and proclaimed that the dawn of the Second World War meant that “the end of abnormal unemployment is in sight”. But wasting idle resources on unwanted projects like ditches or giant space lasers to repel a nonexistent alien invasion, or actively harmful projects like wars even though it may raise aggregate demand is still wasting resources. If the point of countercyclical policy is to avoid excessive levels of stagnation, it seems self-defeating to take idle resources and spend them on something entirely unwanted and unwarranted. Spending labour and capital on a destructive life-ending and infrastructure-destroying war rather than on useful infrastructural and scientific projects is akin to Pharaoh spending grain in a famine to support a war where just as many Egyptians die fighting as would have died in the averted famine.
So for successful countercyclical policy, I think it is important to emphasise quality projects that people actually want rather than simply emphasising aggregate levels of spending. In Pharaoh’s Egypt, that was a store of grain…
Very nice post. It’s Douglas that we need to study.
Good post. Now, I’ve just been reading some figures that the world spent $1735b on war in 2012. I can’t even begin to comprehend that amount of money but apparently it would take approximately $135b to totally eradicate poverty and perhaps a few other things like child labour, dirty water or lack of it and toilets etc, etc etc.
How nuts is this: “Say’s Law is empirically false. Under certain conditions — including the present condition — savings levels can soar uncontrollably even while interest rates languish at zero, and while unemployment is elevated…”?
Interest rates are not “languishing” at zero — the monopolist central bank is forcing them to zero. And what is meant by uncontrollable saving rates? Uncontrollable by whom? For what reason and for whose benefit?
How sad it is that those who choose to save for a (non)rainy day have to confront some central planner who thinks of them as some pawn in his macro plan.
You look at this graph and tell me interest rates are artificially low. Savings as a percentage of GDP vs interest rates:
Compared to the historical average relative to demand for savings, interest rates are comparatively high. And if we add in checkings, the figures look worse…
Having an abnormally high number of people wanting to save money is going to force interest rates ridiculously low.
The savings glut is real. The liquidity trap is real. Low interest rates are a result of a huge desire for savings by huge numbers of people.
A few questions:
1. Assuming you are correct and there are more people wishing to save money in the USA than is usual, what do you think is the main reason?
2. Do you think that low interest rates only arise as a result of a desire for savings, or do you think there are other factors? If so, what are these other factors and can you quantify the importance of each?
Fear about the economy, fear about stocks, fear that the world is going to hell.
I think the desire for money is a complex phenomenon, and the value of money is of course in the eye of the beholder. Yet like with all other commodities, the supply and demand for something (in this case, savings) does have a pretty significant output on price (in this case, the interest rate).
Specifically, I don’t think these low rates would be possible in an environment where national savings relative to national income were at pre-2008 levels
1. Record high corporate profits and historically high income inequality have led to the excess of savings, IMO. These are also the same reasons we have unusually low consumer demand.
2. I also think low interest rates are caused by excess savings. But the abnormally low long-term rates are caused by the Fed. Bernanke and others are trying to “fix” the economy be re-inflating the asset bubbles.
Re: 1. So, people are saving more because they are fearful of what the future holds. I understand this. I’m not sure I understand how this necessarily leads to interest rates decreasing. Do I have this right: increasing demand for saving money leads to an increase in the cost associated with saving money, which is met via a lower rate of interest?
Re: 2. Michael, if people are piling money into banks then does that mean the Fed are doing a pretty shoddy job of inflating those asset bubbles?
Increased demand for saving means that all else being equal banks do not have to offer competitive rates, yes. If there was little demand for savings deposits, banks who want to attract deposits would have to offer a higher rate to attract savers.
It’s not just the wealth effect stuff. The Fed should in theory be trying to get money to productive uses so people with ideas and visions can create products and companies and jobs and growth! The fact that savings are still soaring suggests that the Fed is failing at this, yes.
Moscow, considering the weak economy and high unemployment you wouldn’t expect the stock market to be at record highs. You also wouldn’t expect real estate in many American cities to be up double-digits each of the past few years. The fact these things are happening in spite of the weak economy tells me the Fed is doing a very good job of re-inflating asset bubbles.
“The savings glut is real. The liquidity trap is real. Low interest rates are a result of a huge desire for savings by huge numbers of people”
Agreed. And with global productivity skyrocketing (Everything is so Kaizen now) and every nation is trying to deflate its currency and export) we’ll see deflation and more hoarding.
Hear me out Aziz.
If we remember back in 2008/2009 — the fed forced down rates to near zero, and they pledged to keep them there. As a result, many people who had retirement goals (based future conjectured dividends/asset prices/ interest payments) had to begin saving more money to reach these previously valued goals. The prices of their assets also suffered a devastating collapse. People were not as rich as prices had led them to believe. By forcing down the fed funds rate (and thereby having a great impact on all yields) the fed blocked the last available route which savers had to recover(in real terms): interest payments. It is true that a higher rate would have been detrimental to other groups, e.g., college students, speculators, banks, but everything has a cost.
I believe that these events are so close in correlation that they appear to have a causal link, but having a very activist central bank can distort many of the causal relationships on the market.
The federal reserve’s forcing down the rate of interest set in a motion a chain of events that makes people save more; precisely because they cannot live off of the paltry interest payments which they had previously planned. We must also factor in what rising commodity prices will do to people in the face of such low rates. This also explains why people are so reluctant to retire, and that they are taking opportunities to work until their more twilight years.
Essentially my main point is that the interest rate — at the present moment — is more driven by the Fed’s desire to ease, and not by individual’s desires to save. The more the fed eases, then the more individuals must save to counterpoise higher prices and lower (real) rates.
All the best regards,
Except before rates hit zero there was precisely the opposite relationship. Why should I assume that would change when rates hit zero? Why should lowering rates be a disincentive to save all the way down to zero, but suddenly when you hit zero everyone wants to save massive amounts? Even while bonds both Treasuries and corporate bonds and junk bonds are falling to the lowest rates ever? Even while alternative assets like gold and silver are rallying (or they were at least ’til 2011), and while stocks are rallying as they have been since 2009 around the world, people are going to want to save more because rates are zero? There are lots of things people can invest in that isn’t cash sitting in the bank and is giving them a better rate. Yet people are still desperate to have cash in the bank.
Doesn’t make any sense to me. If the correlation was that lower rates made people want to save less above the zero bound, there is no reason at all to believe that it would go the other way all of a sudden. The Fed could once upon a time lean on the market’s desire to save through lowering the Federal Funds Rate, but at this level of demand for savings the Fed has no chance even when lowering it to zero. Monetary policy is powerless, and unless someone (businesses? individuals? government?) starts eating into and using up the excess savings at a much faster rate, rates will stay very low. This is a liquidity trap. People are afraid of investments, and are happy to sit in cash.
“Except before rates hit zero there was precisely the opposite relationship. Why should I assume that would change when rates hit zero?”
That relationship did not vanish, but there are other forces at work. Particularly, massive capital consumption during the boom — this depleted many individuals’/institution’s savings.
“Why should lowering rates be a disincentive to save all the way down to zero, but suddenly when you hit zero everyone wants to save massive amounts?”
These changes in data do not happen ceteris paribus. All relationships are preserved, and they still exert an effect, but it can be offset by a more pressing desire to rebuild savings. Artificially cheap credit during the boom led to a draw down of savings — partially due to the relative abundance of credit, and partially because the market had not collapsed (risk was underestimated). After the crash [of 2008/2009] I’m certain that many individuals/institutions are leery about jumping in again.
“Monetary policy is powerless, and unless someone (businesses? individuals? government?) starts eating into and using up the excess savings at a much faster rate, rates will stay very low.”
Many businesses are reluctant to invest when factor prices are artificially propped up by Fed easing and government make work schemes(or just unemployment). Falling factor prices would raise effective real demand for those complementary factors which are crucial to cash laden businesses/investors.
All the best regards,
A powerful factor over the last 20 years has been the use of Debit Cards, then Credit Cards. People used to have to go to the bank and withdrawal enough to get them through. With Debit cards, people had ready access and spent a lot more. When they were tapped out, they accessed credit.
Now the economy is not on steroids, everything is slowing and we are seeing deflation. People are more fearful of unemployment now. Globalisation and especially “Made in China” has made everybody acutely aware of their own job security. The Boomers are very careful now, since the market collapse has reminded them that their investments are just vapour. Many who did not sell in the 2008 collapse are just breaking even again.
A few thoughts:
– Keynes gets the glory because he wrote academic books/papers on the topic at the start of the modern growth of economic depts in universities.
– The Say’s law thing is a depressing reminder that what is special about Keynes is that unlike so many other giants of economics (and contra their claims, esp. the Austrians) he didn’t believe in a self-correcting, self-healing economy.
– You misread Keynes at the end there, he meant that digging ditches was preferable to people starving for the lack of employment. There’s little reason to believe he would have preferred makework to real work or even (in a modern context) a citizen’s basic income. The problem is of course (as even Bryan Caplan has noted) far too many economists are far too blase about the evil of unemployment.
Well, he did believe in that in the long run! But obviously, he thought that “the long run” was a useless timeframe for economists…
No, I don’t think I’m misreading. He injures himself by stringing himself up on a hypothetical (just as Krugman does with giant space lasers) in which it is impossible to find some useful employment for the unemployed. But I don’t think there’s ever been a period in history where there has been no possible gainful employment. Here in the UK I can think of lots of useful projects that people actually want, e.g. distributed solar grid, 1Gbps broadband, improved road and rail network, brownfield housing developments, etc. It’s better to focus on arguments for those kinds of quality projects that people actually want than some hypothetical that has never actually been relevant. With arguments about ditch digging you’re just inviting accusations of misallocating labour and capital.
Your mistake is to think that the opponents of spending are reasonable and can be persuaded by mentioning useful projects. The reality is that they are philosophically opposed – it’s a morality play for them.
I think this is actually a really fair point. In many cases, austerianism is more about morality — enforcing poverty as a punishment for “past sins” than any economic case.
Of course, I think in many cases with the right economic argument you can still win even against those morally motivated toward austerity.
The opponents of further spending in these poor economic times are quite reasonable and don’t object for moral reasons, but rather pragmatic ones. I’m sure they could be persuaded if there is a logical case. There isn’t one.
What the hell are you talking about? What pragmatic reasons? The fact that interest rates are the lowest they have ever been? The fact that there is massive unemployment of people and resources?
You really need to read and grasp the following —
It’s pragmatic to doubt the value of getting into yet more debt for some pie in the sky idea that doing so will kick start the economy. You can disagree with me, but it doesn’t change the fact that my objection to further debt is not based on morality but rather for pragmatic reasons i.e. I don’t think it works.
Why do you think further debt is bad?
I think that with the UK and US governments already being large, their state debts being large and with increases in unfunded commitments already built into their future finances, every unit increase in government spending will cause their GDP’s to rise by less than that unit.
Now, perhaps I’m wrong and maybe you can cite actual historical examples, backed up by data, to show that extra spending in such circumstances works far more often than it fails. But nevertheless – my objection to extra spending is not based on morality. As I said previously, I simply don’t think it works.
I think it is possible to make the argument that judging by levels of interest rates for government borrowing, debt is currently small. Relative to GDP, UK government debt is small compared to the historical average (even when we were on the gold standard!), but judging by interest rates the levels of borrowing are extremely low. UK and US governments can hardly be said to be pursuing full employment policies. If rates were 6%, and unemployment was 2%, we could talk seriously about austerity.
That said, you’ve convinced me your position is not motivated by morality.
I agree that current levels of interest rates do suggest that debt is currently small. That, of course, presupposes that interest rates are being set at purely market levels and that they aren’t being manipulated for political reasons – e.g. to reinflate bubbles as some say, and/or to keep the costs associated with servicing the debt low.
Relative to the levels of savings in the economy, I am pretty sure that interest rates are, if anything, higher than they have been historically. This is hard to believe, because they are currently at zero, but the level of savings right now is historically unprecedented:
Levels of savings were pretty much correlated with interest rates until interest rates hit a lower bound that couldn’t fall further (zero), and savings continued to soar uncontrollably.
Are you sure about that? Some sources seem to suggest that savings are not that high: http://www.tradingeconomics.com/united-states/gross-national-savings-in-percent-of-gdp-imf-data.html
About as certain as I can be.
The figures I am using are total savings deposits and checking deposits. That’s the rawest data there is of the actual levels of savings in the system. Other data like rates of saving look somewhat different, but they don’t have the pre-existing correlation with interest rates that my data has, and they are not measures of absolute levels of savings but of various derivatives.
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Keynes didn’t SERIOUSLY suggest pointless ditch digging. He was simply illustrating the multiplier. That is, if government prints money and spends it having people dig pointless ditches, those people will spend their newly acquired income on something a bit more sensible, which means that on balance, a country can gain – even from a form of spending which is totally pointless.
As I said to another commenter, Keynes strung himself up on a hypothetical question about a situation that has never arisen (what to do if there are no good projects to undertake). I don’t understand why Keynes and Krugman have been so keen to make these kinds of massively debatable comments when all they really need is the argument I have made about levels of capital and labour slack in my post When is the Time for Austerity at the Treasury
Do you by any chance have the exact source of that “strung up” point you attribute to Keynes?
I believe that you have to split out individual vs herd behavior, both on an institutional and an non-institutional level.
Because of the unprecedented set of monetary circumstances we witness today, the forces that mold individual and institutional behavior are predictable in one sense, but highly unpredictable in another, in that individuals are being forced into adopting self-defeating strategies, especially those older folks who countered on receiving a reasonable return from conservative bond/interest bearing instruments.
Add into the mix the capital stolen in the form of inflation, taxes, sovereign debt, usury-ous interest rates, bubbles exacting absurd prices on nearly every necessity [housing, education, health care, food, fuel, etc.], and you end up with a scenario where even a zillion super computers running 24/7 could not possible figure out the implications of an economy so completely fucked-up.
So, sit back and have a beer and don’t worry so much about the why, instead, understand that it is what it is, regardless.
Keynes suggests saving money in good times to tide you over in the bad times, and people actually think this is a novel idea? Isn’t this just common sense? Some academic writes common sense on paper and all of a sudden the world listens? No wonder we’re in such big trouble.
I’ve recently read some very good articles stating that people are NOT saving money, that they are unable to as their other costs keep escalating. Several bloggers have pointed out that the writing down of bad debt and mortgages is counted as “savings” in the States, and that THIS is where a lot of the so-called “savings” is coming from.
The elite might be saving, but the lower and middle income groups are struggling, not saving.
Yes, and that has more to do with the maldistribution of wealth, which increases steadily linearly, as with any cycles.
In nature, when things come out of balance, the solution is re-balancing. Since human being still seem to be part of nature, it would follow that we need to re-balance an economy that has come out of balance.
Less debt, less taxes, more savings, more equitable distribution of income, less regulation, etc.
Although EVERYBODY knows these things, the top tier is still profiting handsomely from the dysfunction, so until this comes to an end [one way or another], it is what it is.
Policy-wise, it matter not what you wish to call it if it achieves [some of] the above goals. Having said that, most policy is designed to do quite the opposite.
In the long run, I’d like to see less debt and less taxes and less barriers to entry and a more equitable distribution of income. On the other hand, I think savings right now are pretty excessive. Levels of savings (not the savings rate, but the actual level of existent savings and checking deposit) are higher relative to GDP than at any time in recent economic history.
“In the long run, I’d like to see less debt and less taxes and less barriers to entry and a more equitable distribution of income.”
Pipe dream. The Politicians and their backers are selfish criminals. Until we get rid of Party Politics and bring back Statesmen who vote as individuals, who only pass laws that they actually READ and ponder the ramifications before they VOTE, then we’ll just have more spanners thrown in the machine cogs.
The amount of Government spending, budget announcements, policy back flips etc, who in their right mind would preempt those IDIOTS!
When you wed the irresistible force of advanced technological capability to the immovable object of profit making systems you can analyze it every which way, but the only solution to keeping profit making systems…..is the citizen’s dividend and compensated retail discount. They are like two protons in a particle accelerator on a collision course and something has to give. The result of that wedding/collision is something more fundamental like a “god”
particle….or should we say a Grace particle. Some would say, “Oh don’t get God involved in any of this.” I’m not. I’m about as agnostic as you can get. I’m talking about the physics of human awareness. Humans have evolved the ability to experience confidence, hope, love and grace for probably 50-60,000 years. It’s time our systems….caught up. Funny how symmetry (reflection) is so fundamental and important in nature and the cosmos. Maybe the financial and monetary systems require a truly social symmetry…in order for profit making systems to evolve, survive and thrive.
Is your site a parody? You start of by comparing the ancient Egyptian barter economy to modern capitalism?
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