Saturday, February 14, 2009

Christmas Trees and Kandy Keynes

So, in the interest of "getting it" and not being labeled as some wild-eyed extremist, let's consider the theoretical, and perhaps empirical, case for government "stimulus." (Am I alone in wishing that Beavis and Butthead would make a brief reappearance to snicker idiotically at the phrase "stimulus package"?) Hopefully, I can get my economist friend to offer a critique, if I am missing something fundamental.

The true essence of Keynesian stimulus theory is psychological. The free market critique of Keynes seems so straightforward as to be unassailable, as long as pure rational market actors are assumed. That is, neither the government nor the private sector can magically create wealth. It is, as always, a marriage of capital and labor to produce something of value. And if the government is allocating capital, then it is inevitably displacing something else that could be done in the private sector, i.e. opportunity cost. A quick sanity check on this: the money must come from somewhere! So the government must either tax it, borrow it, or print it. Either taxing or borrowing removes the money from private hands, and printing it is the ultimate illusion (no new stuff, just more money to buy it with--inflation). So, in a classic, rational market, government stimulus could be compared to scooping water from the deep end of the pool and pouring it into the shallow end.

But the reason Keynes could be right would be that, in the midst of a severe downturn, a crisis of confidence can cause those with capital to basically withdraw from rational investing. That is, there are bound to be good opportunities somewhere (there always are, there have to be, it's just a matter of finding them) it's just that in this moment of crisis, investors have no faith in anything and want to sit on their cash. So, enter the government. Said fearful investors, unwilling to bet on anything else, are nonetheless willing to lend to the government, i.e. buy treasury bonds. By being the borrower and spender of last resort, government gets the money moving again.

Keynes in a nutshell: psychological! Unless you really do believe that government, on average, as a matter of principle, actually does a better job at allocating resources than the private sector. And if you do believe that, then I think maybe the "S" word does apply... though I won't utter it, seeing as how mercilessly McCain (for whom I did not vote) was mocked.

And so, further, it does not really matter, from this point of view, whether the money is particularly well-spent or not. Yes, other things being equal, it is better for government to spend wisely rather than unwisely, but if what you want is stimulus, and if Keynes is right, just show me the money! Enjoy the Christmas tree of a bill that we have! Let us hope our children don't regret having to pay for it...

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Anonymous Michael Lavender said...

The first part of your fallacy is the rational part. All economics is psychological. Why does a company fill a warehouse? Because they think they have a sellable product. In a rational agent run world, only products that are guaranteed to sell would be made and warehoused. Just look at the overstocking of the first Mac that nearly ended Apple in the '80s for example of blindly forcasting past sales. An emotional response.
Right now we have half-million layoffs every month. It's a dragon eating it's own tail. Less workers mean less goods bought. Means less to stock means less workers. Rinse and repeat. Some outside force needs to create those workers/buyers. And, the largest outside agent is the government. If you want to paint that as a psychological effect, I'm not going to dissuade you.

February 15, 2009 6:46 AM  
Blogger wRONgainey said...

Michael, it is not "my" fallacy, it is a fallacy of classical economics. The cartoon version of the belief in free markets is that everyone always behaves rationally and therefore nirvana is achieved. Admittedly, some people do hold something like that cartoon version. I, as ongoing believer, hold a subtler view that I might call the paraphrased Churchillian: "The free market is the worst possible economic system, except for all the other ones." It is not that free markets produce perfection, but that you (the generic broadly defined "you") cannot do better. A group of wise men and women, however brilliant, noble, and well informed, cannot "manage" the economy from some central location, cannot do better than the unwashed, irrational crowd. I remain convinced this is a broadly true principle, and have empirical reason to believe it.

And yet, in spite of all that, I am conceding the possibility that times exist when something Keynesian might help, and that if such times do exist, this would be one. Finally, there is no "outside" force, since the government is, and always will be, deeply enmeshed in the economy. The economy will eventually recover, one way or the other, the question is whether "stimulus" will help it recover faster, relative to leaving it alone. I am open to the idea, but not necessarily convinced.

February 15, 2009 9:25 AM  
Anonymous Heath said...

> So, in a classic, rational market,
> government stimulus could be compared
> to scooping water from the deep end of
> the pool and pouring it into the
> shallow end.

I enjoyed the paragraph that led to this statement. But your conclusion begs the question: Is stimulus intended to increase the volume of water, or is it intended to increase the rate of flow?

February 16, 2009 8:07 AM  
Blogger wRONgainey said...

Perceptive as always, Heath, and I would say that your question exposes a weakness in the metaphor, which I borrowed from someone I heard on the radio. I do think the metaphor still does capture an important point for much of the "lay" public, however. Many, many, people (and most of the media) simply ignore the question of where the money comes from, and act as though the government "stimulus" is free money, or free wealth, which is a bit of economic nonsense I am trying to battle.

But the flaw you point out is that if the water represents wealth (or economic value), then the metaphor breaks down because in the real economy, circulation can actually produce more water, at least some of the time! Which brings us back to the whole idea where Keynesian government spending could prime the pump, if the private sector pump is broken... So your question, I would say, is a very succinct way of getting at my whole thesis! Damn you, don't show up the author, bad form, man!

February 16, 2009 2:56 PM  
Anonymous markm said...

The problem with this psychological justification for government intervention in the economy is that it ignores the increased uncertainty resulting from any prospect of government action - you really never do know what Congress might do... So, the more they talk about stimulating the economy, the more businessmen - rational or irrational - are going to hold tight to their capital until they see just how it's going to work out.

March 01, 2009 7:31 PM  

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