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  • Obama’s Keynesian Error

    Posted by Shannon Love on December 29th, 2008 (All posts by )

    Obama wants to spend tax money to “create” jobs in the sagging economy. [h/t Instapundit] He is clearly working from a Keynesian model in which government borrows saved money and hires unemployed people to do make-work. The employed people spend the saved money and the economy revives.

    Seems like a good idea except that Keynes was wrong.

    Entire libraries have been dedicated to Keynesian theory, but for our purposes we can boil it down to the core idea that the movement of money itself through the economy (as people traded) creates a good economy. In Keynes’ model, recessions and depressions occurred when people saved too much and spent too little. This caused the money to stop moving. Government could “prime the pump” of the economy by taking the saved (and thus static money) and spending it. He famously summed up his idea by saying that the government could stimulate the economy by simply burying large amounts of money in the ground and then letting people dig it up again. The money spent to dig up the money would drive the economy again. 

    However, the mere movement of money itself is not what drives the economy. We use money as an accounting tool in order to calculate the relative exchange quantities of goods and services. Money is information. The movement of money allows people to communicate to one another the value they place on different economic activities. Each individual exchange passes information from one human being to another. 

    Money communicates information not by its movement by rather by the differences in prices. It is analogous to the way in which analog phone wires carry information by fluctuations in voltage from moment to moment. Keynes was like a naive individual who discovered that phones lines carry information with electricity and then decided that if he pushed more electricity through the line he would convey more information. In reality, all he would get is a squeal. Likewise, arbitrarily moving money through the economy does nothing if that movement does not transmit information about the real value of different economic choices. 

    People who spend time digging up money the government buried in the ground do not stimulate the economy. Instead, they introduce information into the economy saying that digging holes in the ground has a higher priority than other things people could be doing. Likewise, Obama’s idea to “create” jobs by repairing infrastructure or building alternative-energy project will merely skew the information transmitted by the money spent to make other activities look less of a priority. Obama’s programs will produce a loud squeal of noise in transmission of economic information. 

    We are currently facing a major planetary recession because the government interfered in the economy’s prioritizing by making housing appear much more important that it should have been. Now Obama wants to dump yet more noise into the economy’s flow of information. 

    He will make the recession longer and all us collectively poorer in the long run. 

     

    9 Responses to “Obama’s Keynesian Error”

    1. Jonathan Says:

      Yes. The rationale for Keynsian pump-priming is a variant of the broken-windows fallacy. It also confuses cause and effect: it assumes that businesses aren’t spending and investing because money and credit are tight, rather than asking whether the investment slowdown results from reduced incentives as might be created by increased taxes and a politically-driven climate of uncertainty.

      Keynes shouldn’t get too much blame here. He was a shrewd and insightful man and might not have supported our current government’s grandiose spending plans. Unfortunately, some of his ideas are now routinely taken out of context and used as all-purpose rationalizations for increased government control of national spending.

    2. C. Smith Says:

      Can you also distinguish a Tenth Amendment fallacy at work?
      If the spending requirements originate from the Fed, but the tax details of funding them come from the states, I’d contend that there would be improved transparency and accountability, in stark contrast from the Cosmic Credit Card approach currently in use.
      Forced to have a sane input/output model for the cash flows, we could even avoid cavitation on ye olde financial pump.
      I know, it’s a fantasy.

    3. C. Smith Says:

      Can you also distinguish a Tenth Amendment fallacy at work?
      If the spending requirements originate from the Fed, but the tax details of funding them come from the states, I’d contend that there would be improved transparency and accountability, in stark contrast from the Cosmic Credit Card approach currently in use.
      Forced to have a sane input/output model for the cash flows, we could even avoid cavitation on ye olde financial pump.
      I know, it’s wishful thinking.

    4. david foster Says:

      “like a naive individual who discovered that phones lines carry information with electricity and then decided that if he pushed more electricity through the line he would convey more information”…something like this was actually tried during the early days of the Atlantic telegraph cable. Signals arriving at the other end were so weak that they couldn’t be read reliably…a consulting electrician was engaged and recommended raising the transmission voltage.

      They burned out the cable.

    5. sol vason Says:

      “The movement of money allows people to communicate to one another the value they place on different economic activities.”

      You have identified the invisible hand. Thank you. I never understood money until this moment. This means that a strong central government will always prevent a free economy from allocating resources so as to maximize each individual member’s utility. The stronger the government, the more deprivation the people must suffer, especially if the government is motivated solely by humanitarian goals.

    6. dre Says:

      “a consulting electrician was engaged and recommended raising the transmission voltage”

      Dr. Edward Whitehouse

    7. Shannon Love Says:

      My analogy with the analog telephone was meant to convey the confusion between the movement of electricity down the wire and the changes in voltage that actually pass the information along. By analogy, a Kenesian would believe that to push more information down the wire, one would increase the current flowing through it. In reality, one increases the rate at which the voltage changes up or down.

      People are exchanging information by exchanging money. You cannot move more information by creating the artificial movement of money. This is also why inflation and deflation do not work. They merely attempt to alter the transfer of money without attaching any particular information to it.

    8. Bill Stepp Says:

      Jonathan,

      IMO Keynes deserves plenty of blame. He advised Roosevelt II to “prime the pump” in 1937, and he is a major inspiration for the Krugmans and DeLongs of the world.

    9. OBloodyhell Says:

      > Government could “prime the pump” of the economy by taking the saved (and thus static money) and spending it.

      This might vaguely have had some value in the old days when paper money (or specie) was the dominant form of the money supply, you might actually have had some people who kept it — hoarded it — in reserve.

      Nowadays, no rational person keeps large amounts of cash/specie on-hand. They keep most of their money in the bank, which means, if *you* aren’t investing it, then someone else IS investing it.

      There’s no mattress people keep their money in, any more. So “priming the pump” makes little or no sense of any kind any more. The pump’s already there and running. It’s the valves which are stuck, if you want to retain the water analogy. How do you get the valve controllers to open them up?

      I still think that the flow of money is still highly relevant, but not that it’s the only relevant issue towards a stable, balanced, and growing economy.