I suspect that John Cochran’e Wall Street Journal op-ed critiquing Keynesianism won’t go unanswered:
Keynesians told us that once interest rates got stuck at or near zero, economies would fall into a deflationary spiral. Deflation would lower demand, causing more deflation, and so on.
It never happened. Zero interest rates and low inflation turn out to be quite a stable state, even in Japan. Yes, Japan is growing more slowly than one might wish, but with 3.5% unemployment and no deflationary spiral, it’s hard to blame slow growth on lack of “demand.â€
Our first big stimulus fell flat, leaving Keynesians to argue that the recession would have been worse otherwise. George Washington’s doctors probably argued that if they hadn’t bled him, he would have died faster.
While I agree with Dr. Cochrane that Keynesian economists are too slow to acknowledge the failures of their preferred policy, particularly in Japan where it’s hard to see how they could have spent more, I think some of his criticisms are overblown.
As I’ve mentioned before I took my economics courses when Keynes was king. Keynesianism was not just the dominant strain of economic thought, it was very nearly the only strain of economic thought. I don’t think I heard the word “incentive” once in three years of economics courses. I think that Keynes was correct, even tautological, in theory. It’s obvious to us now that you can compensate for a shortfall in aggregate demand by filling up the hole with government spending spent in deficit. However, it has proven extremely difficult to implement Keynesian policies in practice for political reasons. The timing and structure can never be made exactly right.
My gripe is more against fine-tuning in general.
Let’s wait for the riposte as a prominent Keynesian or two weighs in in defense of Keynesianism (or at least a policy they’re calling “Keynesianism”).
The economy is expanded through credit creation, and asset inflation is required to keep the economy expanding. In order to roll-over existing credit, the collateral assets need to have inflated and to be inflating to make it equal to or greater than what it is replacing, and inflating asset prices ensure the new credit will also increase the credit supply.
Consumer prices are a weak indicator of the economy. Artificial money distorts the natural supply-demand feedback loop, and it becomes unreliable. Consumer price deflation should be good because it allows the consumer to purchase more assets, and this should cause asset inflation.
The problem with asset inflation in a fractional reserve lending system with fiat money is free money is never free. Assets are used as collateral for credit, and that credit is used to build more credit. Nobody will ever accept that bubbles exist until after, and then, they will only allow them to exist in the past.
The student loans are following the housing pattern except there are no greedy Wall Street Bankers. Here we have greedy GSE’s, Universities, professors, administrators, etc. selling bogus degrees. They use the same tactics that the real estate agents used. Actually, they were more like used car salesmen, but used car salesmen were more honest. (I saw it first hand a few years ago.)
They need to put asses into seats to get the student loan money, and the GSE’s need to lend as much money as possible to increase their profits. The students begin getting credit card applications about thirty seconds after they get to school, and as soon as they pay a few months on time, the limit is upped.
When they graduate, they cannot afford houses. The GSE’s are losing money, and they are whining to Congress. They want to lower the standards for the mortgages they can accept.
I might have gone off the rails a little. @Drew had made a comment about the GSE’s a while back, and I never got to add to it.
TB
Asset values do not need to inflate for loans to be made or rolled over. Not all loans are hard collateral based in their underwriting. A mortgage is a classic example of a hard collateral based loan, even if cash flow of the borrower is the primary source of expected repayment. However, a credit card is just the opposite, with zero collateral support. In the same vain, C&I loans of the working capital flavor are often hard collateral based but never with presumed receivables or inventory asset value inflation expected or part of the underwriting. The flavor of C&I loans that yours truly utilizes, known as leveraged or structured loans, are based almost solely on cash flow, and usually presumed escalation in cash flow from expanded operations, but almost never from collateral “inflation.”
I would suggest that the causality is the other way around, with general price inflation due to a quantity concept. Completely different is (financial) asset price escalation resulting from yield chase in turn caused by the mechanism of QE.
“However, it has proven extremely difficult to implement Keynesian policies in practice for political reasons. The timing and structure can never be made exactly right.”
That observation is every bit as much a tenant of counter theory as Keynes theory.
I suppose I should name it: Buchanan and Wagners principal-agent problem.
@Drew
I am at the macro level. The economy as a whole is using money borrowed from the future. This is how fiat money in a fractional reserve lending system is able to derive value. When the future becomes today, the assets that were used to create the fiat money will become due, and depending upon their value, the economy will increase, decrease, or stagnate.
Guess where we are at today.
This is not something you are doing. It is a function of the system. Also, I am not strictly limiting it to consumer debt. I include all the various credit instruments, private as well, and the assets would include anything used as collateral, private as well. I am not making a value judgement about the system.
Keynesians need it to create money, and they made a deal with the devil (to them). Free money is never free, and as the amount of free money increases, the value of it decreases. The people with first access to the free money get it before it is degraded, and they can make money from the difference. I suspect that you are still one of us poor slobs, and you still have to work for your money. But, I digress.
The people with first access would do a lot better with limited free money, but they have made a deal with the devil (to them). The financial industry would like to be the OPEC of Wall Street, and they would control the amount of free money flowing into the economy. Their partners have other ideas, and since their partners control the free money, the financial industry is in bed with government.
Liberals and Keynesians need free money to fund their government programs, but just throwing free money uncontrolled into the streets would cause a problem. They need the financial industry to give at least a veneer of respectability to the free money, and this is where you come in.
Like it or not, you facilitate the government programs you dislike, and this is vastly different than just paying taxes. The reason that the people making the big bucks do not complain about the same programs is because they understand the symbiotic relationship. The goose that is laying the golden eggs is the government, and they do not want to kill it.
@Drew
The Fed, academics, and the other eggheads have little to no understanding of how the economy works or the financial industry. Apparently, the Fed became aware of MBS’s in 2009 or somewhere there about, and they had been around for a decade or two.
I agree about QE, but that is the eggheads trying to use inflation to expand the economy. They have no idea how anything actually works, and therefore, they cannot fathom what you are saying.
In their minds, the solution to something not working is to do more of it – a lot more.
I think the intent of QE is rather simple. Depress the term structure of interest rates to chase money to supposed wealth effect inducing appreciating assets………….and keep metered money costs low.
It’s great for those of financial means, but horrible for those without the financial wherewithal to participate in those asset classes or who’s age makes it imprudent to overweight their portfolios.
I think it’s all but criminal. But I haven’t heard bip from Obama or his acolytes, same for Clinton. It will be a test of Republican political leadership to see what stance their candidate adopts. Il bet Mitt Romney is not amused.
As for MBS, they just didn’t believe housing values could fall sufficiently to trip all the loan to value assumptions. It was less stupidity and more succumbing to the ever present enticement that historical norms no longer hold. Can you say the stock market?
@Drew
I was arguing with somebody about the Bush tax cuts (I think), and we got into housing and the financial crisis. It wandered into MBS’s needing to be regulated, and I stated that they are regulated through the entity that purchases them. I was sent a link to a Fed paper from 2009, and it was about MBS’s and the shadow banking industry.
They just learned about MBS’s in relation to the shadow banking system, and they may have just learned that there is a private banking system. I did not read the whole paper. Frankly, I was astounded.
I got the impression that they thought private banking was some type of skullduggery. Hence, the name shadow banking, but to my knowledge, there is nothing illegal or unethical about it.
These folks do not have a clue how your industry works, but you will never convince them that you do. I understand what you are saying about QE, but that is well beyond their comprehension.