The Errors of Keynesian Thinking, or, Consumers Don't Cause Recessions

Doesn't anyone know why inflation's bad?

If you have something to say, say it.

Wild stab in the dark: Because it reduces the value (and therefore purchasing power) of the currency held by everyone that holds currency? It's analogous to stealing cash from my bank account.

Well, no. If your wages are going up at less than the rate of inflation that's a problem, and if your investments are earning less than the rate of inflation that's a problem, but that's why real economists do pretty much all their calculations in constant dollars.

Inflation, per se, is not bad. Wage/price spiraling, in which expectations of future inflation drive wage increases built into long term contracts, necessitating price increases to cover those wage increases, thereby resulting in the mere expectation of inflation increasing inflation is bad; overconsumption in the present due to fear of currency devaluation in the future is bad; government policies that result in the payment of negative real interest rates on bonds and a consequent loss of confidence that makes future government borrowing impossible are bad; etc.; but none of these kinds of things necessarily accompany modest inflation. In a productive, stable, and efficient economy, demand will be constantly increasing and supply will be constantly having to catch up, resulting in mild inflation. That's much better than the alternative of having supply lead demand, which involves an awful lot of inefficient guesswork on the supply side and which results in boom-and-bust economies as warehouses fill up and are emptied.

Constant dollars presume prices naturally hold stable over time given a fixed money supply. Does that seem at all plausible? If not, wouldn't that imply that inflation is being underreported, and so wages are not increasing with inflation?

You have no idea how hard it is for me to refrain from tearing this apart point by point, especially the end, which is not even wrong, but rather completely nonsensical even by Keynesian standards. It betrays a complete lack of understanding of even the most basic economic truths, namely that the price system is a feedback mechanism.

But I will exercise as much self-discipline as I can muster and refrain from tearing the argument apart, and will continue with the questions.

At this point, I reach a dilemma. Do I go back to the question of why the Fed didn't then leave interest rates at 1%? Nah, I suppose that one has been answered, or at least implied - if they were left that low, there would have been expectations of inflation.

So I suppose the question is: why is the economy no longer stable, productive, and efficient?

bump.

bump?

Interesting, educational thread I do not pretend to know anything about economics, but seeing we are at the point we are in this discussion, and you're asking why inflation is bad - the standard answer would be: because inflation means people have less money in their pockets, spend less and thus cause economic slowdown. So in this case, the fear of economic slowdown, caused raising of interest rates, which caused interest on mortgages to go up, causing a drop in demand for houses, a drop in house prices, which popped the mortgage-bubble / credit bubble etc.
Right?

Wrong. Inflation problematic enough to reduce people's buying power causes people to spend more, because if they spend now they get more for their dollar than if they spend later.

There are lots of different cases of inflation you can have. Nonexclusively:

1) Zero inflation or deflation, accompanied by unemployment wages generally declining as fast or faster than prices. This is where people start hiding money under the mattresses and stop investing. It's a situation that works out well for those with a lot of savings in very safe investments and for those with the right kind of very secure jobs--government workers, bankruptcy lawyers, etc.--but that royally sucks for everyone else. This is where people stop buying things.

2) Modest inflation, perhaps 2-3%, and wages and investments generally growing faster than inflation, perhaps 4-6%. The modest inflation itself isn't good but it's a sign that the economy is working well. Without it we'd almost certainly be in situation 1. In a modern economy you simply don't ever get consistent and widespread wage and investment growth without at least modest inflation.

3) Demand driven high inflation. This is generally part of a standard boom/bust cycle. You generally see higher inflation than in situation 2. Think of it as a bubble that's economy wide rather than limited to housing or internet stocks. The bubble, being economy wide, can't inflate as much as the housing bubble did and is exceedingly unlikely to do as much damage as the housing bubble did when it burst, but the basic idea is the same. People buy more and more, stretching their budgets thinner and thinner, driving up prices. The economy booms as manufacturers gear up to meet the increase in demand, but if the manufacturers overshoot, leading to warehousing and unemployment, or if the increase in demand is so high and artificial as to be unsustainable, that's where you get the boom/bust of situation 3 rather than situation 2.

4) Supply side high inflation. Prices on goods go up because prices on inputs for manufacturers broadly go up. Think a spike in energy prices leading to all goods costing more. This kind of inflation is a sign of underlying stress on the economy. It's not inflation per se that's the problem here; even if you could reduce the money supply so as to halt inflation, you'd still have the same fundamental problem of an economy that produces less because the relative expense of some critical input has gone up.

5) Inflation driven by increases in the monetary base. Contrary to popular belief, increases in the monetary base of currency plus deposits don't necessarily lead to inflation. Think, for example, of the Great Depression:



The monetary base increased dramatically during the Great Depression--essentially the U.S. government printed money like mad from 1931 and 1933--but that didn't lead to quick recovery, much less inflation, because money simply wasn't circulating.

Governments legitimately tinker with the monetary base to prevent slipping into the depression economics of situation 1, where deflation makes hiding money under the mattress a safe and reasonable alternative, on an individual basis, to investing or spending that money. Governments also legitimately tinker with the monetary base to prevent situation 3 from turning into the far more problematic situation 4 as expectations of future demand driven inflation get built into employment contracts, causing labor costs to broadly go up and leading to price/wage spiral inflation. It's when governments start printing money in an economy that is rapidly circulating all that additional money, leading to hyperinflation and a collapse in confidence in paper money, that you get real problems. Fortunately this doesn't really happen these days outside of corrupt countries where the economy is already a disaster.

I can't believe that you don't see the big gaping flaw in this line of reasoning.

Consider that most people have relatively static income, and that most people live paycheck to paycheck.

How the fuck is someone like that supposed to increase their spending even under the BEST of circumstances, let alone when their money suddenly becomes worth less that it ever was?

Exactly. And with inflation, and people having less to spend, more people will not be able to pay their mortgages and other depts. As for the fiddling with the monetary basis:

Except that the US is now printing extra money.. won't that lead to problems further on, when the cash starts rolling again?

But he has a graph!

Oh, rats.

The one question Pardot won't answer, of course, is why demand starts to collapse. The reason he won't answer, of course, is because by the time I got to that question, ON HIS OWN TERMS, I'd already asked it, and about a dozen intervening questions. That I come back to it demonstrates that Keynesian reasoning is circular logic, or alternatively, demand collapses "just because," which is inconsistent with even the Keynesian textbooks conceptions in microeconomics, which state that demand drops when a) prices increase, b) income falls, or c) tastes and preferences change. And yet we are told that according to Keynesian macroeconomics, a) doesn't matter, and b) and c) aren't happening. Keynesianism is based on false premises and/or circular logic (depending on which adherents you're talking to, and is thus wrong. Q.E.D.

What philosophy do you subscribe to?

Does it matter? This is a test of logic, not philosophy. Keynesianism, at the very least as presented by Pardot, fails it.

Alright, soi I'm s realist. I don't fmuch aq fuck about what shit says ineastead fo what whit works.


So if a failed logic system gives us 40 years of growth n stabiltiy and a better system gives us year os stagnation, why should I go with the better system (on paper0and stagnation over the failed one (on paper) and growth?!?!?

Keynesianism has given us:

Booms and their inevitable associated busts.
Stagflation, despite the fact that the theory says stagflation is impossible.
The Great Depression.
The unprecedented length of the Panic of 2008.
The loss of 95% of the value of the dollar.

Nor is the alternative stagnation. It is moderate growth, year after year, combined with moderate decreases in prices year after year where technology improves efficiency.

wHERE AHD this been seen?!

The rather short era concurrent with both free banking and the independent treasury, before bimetallism, at least when the government prosecuted fraud.

Crackers cause economic mess like aways do going to take a black ma n to cleen up the mess.

All this shit in the housing industry didn't start happening until they overturned New Deal era laws regarding banking regulations. The mortgage industry went on a binge after that. Even if you don't subscribe to a particular philosophy, I know one that I sure as hell don't subscribe to, and that is laissez-faire.

Errrr, no, that is SO not what happened.

If the bubble wasn't in housing, it would have been elsewhere (say, in stocks). That's the job of the Feds, to determine where the Fed bubble manifests itself.

Without going into the rest which is no doubt dubious, The Great Depression was way before Keynesianism.

No, it's not. Keynes rose to prominence in 1930. Most of the industrialized nations' governments were listening to him by 1933, if not sooner, and a great deal of what he said should be done was being done even before he rose to prominence.

"Listening to Keynes" does not equate to "having Keynesian policies". Those were first formualted by him in 1936.

Distinction without a difference, in this case. Was he telling governments to spend their way out of the Depression? Yes. Did his so-called General Theory contain that same advice? Yes.