Undergraduate Economics For Keynes & Krugman

John Maynard Keynes never had anything like what we would call a graduate education in economics.  He was a brilliant amateur with massive gaping blind spots in his economic education — Friedrich Hayek’s well considered judgment was that Keynes had an incompetent economic education in most all economics outside of Marshall.  Unfortunately, American mathematical economists turned Keynes’ economic incompetence into rigid math blueprints and graduate school dogma.   Not by accident, loud echos of this incompetence are still heard today in the pronouncements of Paul Krugman and many other leading economic figures.  Mr. Keynes incompetence as an economist is nowhere seen more glaringly than in his incompetent botching of Say’s Law, an incompetent misunderstanding which has become dogma for many contemporary economists, who themselves have an incompetent education when it comes to almost any economic idea produced prior to, say, 1985 (about the time history of economic thought was removed from graduate education).  Incompetence in the area of Say’s Law stands at the center of current economic policies and debate.  Time for some remedial summer school education courtesy of Hayekian macroeconomist Gerald O’Driscoll:

Say’s Law of Markets answered the fears of under-consumption as the spreading industrial revolution brought forth an ever more bountiful supply of goods. The law’s logic is that production creates the income that is the source of the demand for goods.

In the General Theory, J. M. Keynes recast Say’s Law as the proposition that “the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output.” That formulation would be foreign, if not incomprehensible, to any economist who had ever subscribed to Say’s Law ..

The classical economists typically articulated propositions in terms of long-run comparative statics (Ricardo being the prime example). But all (even Ricardo) also analyzed short-run dynamic processes.  In modern parlance, excess demand in some markets and excess supply in other markets were entirely consistent with Say’s Law. And that included inter-temporal demand and supply.

Even in situations of disequilibrium (to use modern phraseology), long-run propositions are a discipline on analysis.  They point in the direction toward which markets are moving.  By contrast, propositions about transitional effects, like the Paradox of Thrift, cannot be generalized. They are not true in the long run.  When some economists enunciate them as permanent truths, they become dangerous nonsense that misleads policy makers and confuses the public.

Consider the current economic situation.  A financial crisis has been brought on by, first positive, and then negative monetary shocks.  In the short run, individuals are increasing their demand for money (velocity is declining), and are simultaneously increasing their long-run, desired savings to a more normal rate.  These effects combine to place downward pressure on nominal demand in many markets.

But the decline in nominal demand is not evenly spread across all markets.  If demand is to be stimulated consistent with the new consumption/savings equilibrium, it would need to be supplied in the precise proportions that correspond to the new pattern of demand across markets (including inter-temporal markets) ..

If nominal demand is falling at uneven rates, then relative prices are changing.  The same self-regulating forces are at work as described in microeconomics. Resources are being re-allocated across markets even as this is being written.  A macroeconomic model with one good (output), one price, one interest rate, one wage rate, etc. is incapable of capturing those forces. The rationale for stimulus makes sense only in terms of such models and not in terms of how market economies actually work.

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5 Responses to Undergraduate Economics For Keynes & Krugman

  1. JIHa says:

    Keynes theory about aggregate demand deciding production in natural in in the short run when there are a lot of spare capacity, like in the US today.
    Keynes wisdom moved many countries out of the depression i the ’30.

    Still increased spending is the right dedisin for the US now, when you get around 500 000 new enemployed every months.
    And, I wonder why Krugman have a PhD, are proffesor at a top University and got the Nobel price, and not any of the neo-hayekianomists.


  2. Rafael Guthmann says:

    While Keynes didn’t have a very good knowledge of economic theory he was smart enough to notice one problem that the exclusive preoccupation with equilibrium analysis by the economists of that day: The assumption that the market was always at a full coordinated state.

    Using the limited set of analytical tools that he had learned he at least perceived the problem and tried to understand it. In the end he failed, but what he achieved even with his limited education, proved that he was brilliant. A brilliant amateur, like Greg said.

  3. Greg Ransom says:

    This is a myth invented by Keynes for rhetorical purposes. It’s sad how many naive undergraduates and now Ph.D’ed economists it has persuaded over the years.

    Rafael writes:

    “While Keynes didn’t have a very good knowledge of economic theory he was smart enough to notice one problem that the exclusive preoccupation with equilibrium analysis by the economists of that day: The assumption that the market was always at a full coordinated state.”

  4. Al says:

    If Keynes was so brilliant, why did it take the US 12 years to dig itself out of the depression? Also, other countries, such as Australia, started recovering within three years. There was an article by two UCLA economists, written in July of 2007, I believe, in which they reported that their research showed Roosevelt’s policies actually *prolonged* the depression in the US by 7 years.

    I’m no economist, I’m an engineer, so someone will have to explain to me how government make work jobs, which add exactly ZERO the the GDP, can be a substitute for actual productivity.

    As I understand it, the idea is that you can kick-start a floundering economy with government spending. Well, if the problem is consumer confidence and capital markets frozen with fear, I don’t see how outlandish government spending will fix the problem. The average citizen is afraid of all this new government debt, which I believe is the reason consumer confidence and capital markets are still fearful.

  5. Steve Van Loon says:

    I’m trying to wrap my head around the Ricardo Effect. I can see part of it I think. I’m assuming a period when the public has increased their time preference, and start saving less, and consuming more.
    Assume a company’s cost of production is evenly split between capital goods and labour. Assume now that consumer prices increase, but nominal wages remain unchanged. All of a sudden now, that company is getting more return for the amount they invest in labour.
    If the nominal prices of capital goods also remain unchanged, it seems the company enjoys the same increased return for the amount they invest in capital goods also. There would be no reason to shift more of their investments away from capital goods, and into labour. But according to the theory of the Ricardo Effect, businesses will become more labour intensive in a time such as I have described. This causes me to suspect that the nominal prices of capital goods has not remained unchanged, but have increased. Quite simply,……Is this the case? YES or NO will go far here.

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