Deficits, Dollar, Federal Reserve, Game Theory, Taxes, Treasury, Trust

Austrian Economics vs. Keynesian Economics: Debate

There aren’t a lot of debates between Austrian and Keynesian economists out there unfortunately, but I was able to dig one up. Here Lord Robert Skidelsky, author of Keynes: The Return of the Master and Russ Roberts, the host of Econtalk and the guy behind the Keynes/Hayek rap video. Here they debate the roots of the current financial crisis. For the entire debate, see here.

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10 thoughts on “Austrian Economics vs. Keynesian Economics: Debate

    • A few thoughts:

      Human beings are flawed, whether individuals in markets acting in their own self-interests, or government bureaucrats central planning monetary and fiscal policy. Skidelsky fails to apply that notion to a Keynesian government intervention world view. In debates like this, the comparison is usually government intervention vs. laissez-faire or free market capitalism. It’s almost always assumed the United States got itself into this financial crisis as free market capitalists. What we’ve had in the US is far from free market capitalism and it’s important to remember that. However, that doesn’t mean that timely, common sense regulation wasn’t missing on the government’s part.

      The feds repealed the Glass–Steagall act in 1999. Here are four reasons they shouldn’t have:

      1. Conflicts of interest characterize the granting of credit — lending — and the use of credit — investing — by the same entity, which led to abuses that originally produced the Act.

      2. Depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.

      3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.

      4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).

      The Fed provided artificially low interest rates for an extended period which expanded the monetary base. Fractional reserve banking provided the credit boom. Government poured gasoline on the fire by supporting loose lending and home ownership through Fannie and Freddie, as well as in stump speeches. And the government sat on the sidelines and watched banks roll out sub-prime mortgage products, bundle toxic mortgages and pass the risk on to others as mortgage-backed securities. They also watched the derivatives and credit-default swap game get out of hand and did nothing.

      Skidelsky points out that investment bankers felt they could rule the world with their financial models, but obviously could not. That is the understatement of the year. However, Austrian economics as I know it doesn’t rely on individuals having complete information about how the world works. Quite the opposite. Said F.A. Hayek:

      Liberty is essential in order to leave room for the unforeseeable and unpredictable … It is because every individual knows so little and, in particular, because we rarely know which of us knows best that we trust the independent and competitive efforts of many to induce the emergence of what we shall want when we see it. Humiliating to human pride as it may be, we must recognize that the advance and even the preservation of civilization are dependent on a maximum of opportunity for accidents to happen.

      The capitalist system has provided more wealth to more people than any other in the history of the world. We have lacked anything close to resembling free market capitalism in this country for some time; as well as sound, concise, common sense government regulation. As Roberts says, we have a profit and loss system without the loss portion which helps people guide their risk-taking. As Skidelsky says, some of these investment bankers did not accurately assess their exposure to risk. But as Roberts points out, a belief that the government would bail them out was present. Why? Because the government has intervened in the past (S&L crisis just to name one). Skidelsky tries to make a distinction between traditional banks and investment banks, where the latter would not have such a precedent of government help to rely on. Unfortunately, since the Glass-Steagall act was repealed, the lines between financial institutions have blurred. Institutions have become huge financial services malls that do everything from open a checking account to trade credit default swaps. Goldman Sachs does more than just institutional investment banking. For example, they have a commercial banking division. So the distinction Skidelsky reaches for doesn’t really work in the current world. Even if it did, an investment bank going under could still cause a general banking panic, which is fueled by psychological fear of a domino effect (whether factually likely or not).

      Both men had interesting things to say, which made me think. Anything that gets people to think a little more about these issues is a good thing in my book.

      If you don’t want constant asset bubbles, don’t have artificially low interest rates and a fractional reserve banking system as it currently operates. The government should have been there to stop the sub-prime/securitization/derivatives party. But nothing has changed about our banking system to prevent this from happening again. Same old Federal Reserve, same old fractional reserve banking, same old crony capitalism without fear of bankruptcy for the largest financial institutions. Don’t be surprised if a similar crisis happens again.

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  1. lief erickson says:

    Bernanke AER June 1893. I hate this article but at least he understand where the money supply comes from, people taking out loans, also he notes several times how the great depression was the first time that the monetary collapse lead to a collapse in real output. Hi Friedman stuff is crap though. I like how skidelsky calls him out a couple of times for making up history, he still calls people out using rentier language. Classic.

    M-C-M’ rules the roost, if capitalists cannot make M’ from their C they will not invest in M, and invest it in bonds, breaking Say’s law. Because people can hoard money, they defer employing workers and make profits off paper, without employing any workers which causes a drop in Aggregate Demand.

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  2. lief erickson says:

    Oh an i believe we should be able to come up with a better model than human beings are flawed. What did he say that 4 times in a row? Terrible

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  3. lief erickson says:

    i like how you point to skidelsky for not following the real world but have yet to look at your personal model. Your hayek quote only better proves the point. you model is perfect assuming we are all robots the competition is equal and there are no classes in society, and your reply address little of what i have said. in money manager capitalism, our current economic stage, the goal is to be liquid, precisely because of uncertainty. It not to let the best rise to the top. It is because capital investments are uncertain that banks would rather remain liquid, than loan and hold the loans, the financial instability hypothesis, read minsky. like i said above if you dont want financial asset bubbles make production more profitable than trading financial instruments.

    now as to your backward economic theory . you are right interest rates are set by the government, solid observation. but austrian theory that crisis comes from the natural rate being different than the real rate is crazy. what is it the the triangle of capital development or something like that. so when the two rates differ, the focus goes to either primary goods or final goods in disproportionate amounts. wrong. like i said so long ago, it all depends on if the capitalist believes that a profit can be made from the production of a good. it is a question of how the capitalist wants to store wealth, financial assets or capital assets. more to the point your theory believes that one, capital is malleable and an even more egregious mistake is believing that their is a natural market. humans make everything and we only make what we need are more specifically what is profitable.

    like i pointed out on your facebook page read veblen the nature of capital. capital is a social creation. it takes time to build. costs a lot to produce and takes time to pay off. even more so, its production today for sell tomorrow. it is a planned economy, not by the government but by corporations. you have to cover your cost with sales. this is why prices are sticky ( i dont want to explain all this to you right now).

    to the next point interest rates dont matter. it is just a question if the capitalist things he can make a profit given the interest rate. a good example is now, they are zero and there is no investment, and even better example is the late 70’s interest rates were through the roof and yet the money supply was still growing. it is because the money supply is equal to money demand. that is because all you have to do to get money is get the bank to give you a loan. see forth coming on the role of the fed and banks. it is all about financing and banks do not lend based on savings, rather on the hope of also making a profit. they are NOT intermediaries rather they too are business. interest rates are a reward for holding a less liquid positions not a reward for postponing consumption. money is endogenous to the system, not exogenous as your theories assume.

    finally you are forgetting that skidelsky and keynes themselves were capitalist, trying to save the capitalist system, which has made both of them lots of money. the goal is provide stability not end the system. I give the austrians credit for at least believing in historical time, however money is more than a medium of exchange, it is a unit of account and of most importance a store of wealth. this is why says law is wrong. demand does not equal supply because capitalist will not invest to employ the capital they own or even worse remain liquid and hoard cash, and that is why you need the government to fill the gap and stabilize effective demand. see keynes

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    • This is an interesting comment. Thanks for that.

      Just because a Hayek quote is used doesn’t mean that I worship at the altar of Austrian economics. You keep referring to my “personal model” and talking about Austrian economics or The Road to Serfdom as the end all for me. You did a similar thing to Andrew referring to him as a “supply sider”. All the quote was meant to illustrate is that I believe better outcomes arise from individual freedom then they do from central planning. I’m well aware that Keynes was a capitalist and abhorred long-term structural debt. Many of the actions taken today, which have been bestowed as “Keynesian”, he wouldn’t necessarily sign off on. I think one of the biggest problems in economic discussions today, is the willingness to make sweeping generalizations about people’s ideas. People have to be free marketeers, or leftist statists, Austrians or Keynesians, libertarians or socialists. You keep discussing perfect models. I wasn’t aware there was such a thing. People are flawed, therefore large groups of people operating in any economic framework will not be perfect. Perfection is not the issue. The best possible system is. I measure the best possible system as the system which creates the greatest amount of wealth for the most people. History has shown that freedom and capitalism is that.

      So I would suggest that you stop taking 20th century intellectuals’ philosophies and acting as if people subscribe to there entirety. It’s a poor assumption.

      How can interest rates not matter, yet they are key in a capitalist determining whether they can make a profit or not? Of course they matter. What loan underwriting process doesn’t take into account a borrower’s ability to repay a loan i.e. income, debt-to-income, savings, net worth? A bank wants to be paid for their risk premium on whatever the loan endeavor is deemed to be, and also wants sound borrowers and collateral if the loan defaults. Yes, the financial industry is a business. But the business does still mostly rely on real people and real assets, or securities backed by real assets. Once you float into the derivatives world, that is dangerous territory and there should be some regulation and limits to a bank’s exposure. Banks are hoarding cash currently, you are right. That’s because their balance sheets are a minefield. It’s a rational move.

      I did search around for Veblen’s The Nature of Capital, and was unable to find a copy. I do intend to read it.

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  4. Kristy says:

    I just want to thank both of you for your dialogue. I’ve never studied economics, and it’s enlightening to me to read your differing points of view.
    Cheers,
    Kristy

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  5. kenezen says:

    Privatizing Government debt Is a great and viable concept. It does not however change the economic pressures of majority government continuously expanding causing ever smaller as opposed to larger civil population.
    Privatizing the Government debt would perhaps enable continuous pressure by Central Government of ever faster absorption of the population. Currently workers, paid from taxes, exceed slightly the Private Industry work force. That’s already a bad sign for Capitalism. Perhaps we could include a long term Government hiring freezes at both State and Federal levels that would prevent this unwelcome escalation of debt additions. Government has grown in far larger proportion to net income collected. Since 1910 it has grown in size and cost a net 6300% over population growth.

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  6. kenezen says:

    Both of you guys Ryan and lief define and defend Keynesian and Heterodox philosophies well. Tell me, what you think about the two largest Financial markets on Earth, Derivatives and credit default swaps markets(CDS)? We know Keynesian models come into play and specific logic to practice is there. What do you think of derivative tranching and re-tranching? What do you think of the two party CDS a relatively private market almost unencumbered. It hedges, speculates and flat gambles on most issues concerning money. What are your views since they had a great deal to do with this last economic situation ongoing in the world?

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