Happy Keynesian New Year

29 December 2009 at 2:22 pm 6 comments

| Craig Pirrong |

Keynes and Hayek were major adversaries in the 1930s, but it is interesting to note that they shared some important ideas in common, but drew diametrically opposed conclusions from them.

In particular, Hayek, and the Austrians generally, believed in radical uncertainty, in the sense that individual economic agents had too little information about the world to assess probabilities of states of the world, or even to identify the possible states. Keynes similarly believed in the inability of individuals to evaluate investments in a rigorous quantitative way. Keynes concluded that this made investors subject to radical shifts in sentiment and “animal spirits” that could cause an autonomous collapse in investment.

But then, Keynesians (to a far greater extent than Keynes himself, probably) concluded that the response to such a collapse was massive government spending. That is, whereas collectively, the minds of investors were unable to make rational investment decisions, a single mind in government could correct that failing. It’s worse than that, actually, because the “single mind” is properly a political mind, the public choice mind.

In other words, for Keynesians, a theory based on the implications of the radical ignorance of individuals was used to justify a policy recommendation predicated on the belief that some were not so ignorant, and could guide the economy to choose the “right” outputs and inputs.

It is hard to imagine a greater, and less justified, logical leap, not to say contradiction. It also begs many questions, most notably: how do those making these decisions know how they will affect the decisions of those subject to the whims of animal spirits? The amount of knowledge and understanding required here has to be immense: if you believe Keynes’s diagnosis, to make policy it is necessary to know not just the technical capabilities of the economy and the preferences of individuals, it is also necessary to understand the psychology of those assumed by the theory to be insufficiently informed to be effectively irrational. That is, it is necessary to understand the mapping between government action X and the “animal spirits” driving agents {A1,A2, . , . , An}, and the mapping between these animal spirits and the actions of these individuals, and the mapping between these individual actions and the “aggregate” outcomes that go into the policymaker’s objective function.

Yeah, right.

Quite a miraculous process, really. By going into government or politics, the radically ignorant become nearly omniscient. Just how does that work? Or should we mere mortals not question the miracles of the Keynesian Church?

Hayek (and the Austrians) were, on the other hand, much more intellectually consistent and plausible. Radical ignorance and uncertainty don’t disappear when one crosses into government. If anything, the ignorance at such “higher” levels is in fact worse. So, if the real world of radical ignorance is undesirable, relative to the unreachable Nirvana alternative, it is still far superior to a world in which those even more ignorant of the specific knowledge of time and place are given vast coercive powers to reorder the world according to their (ignorant) visions.

But we live in a new Keynesian, and constructivist, era, in which sorcerer’s apprentices whose power vastly outstrips their knowledge are running amok. Which means, as I told my better half on election day last year, we are so screwed.

Oh, Happy New Year!

Entry filed under: Austrian Economics, Bailout / Financial Crisis, Former Guest Bloggers, Public Policy / Political Economy.

Can We Tackle the Big Problems? Call for a Slow-Word Movement

6 Comments Add your own

  • 1. srp  |  29 December 2009 at 9:56 pm

    I think the modern Keynesians actually believe that everyone can see the problem of “inadequate” aggregate demand and idle resources, but that there is a collective action problem that is most easily solved by the government. The idea is that I’ll hire people if I think everybody else will hire, but if nobody else hires then I don’t want to either. It’s a big coordination problem with multiple equilibria and the government is just doing the “obvious” thing of pushing everybody to the high-output equilibrium, no omniscience necessary.

    A mechanism like that may kick in as part of any given downturn, but I think the Keynesians overrate its importance, especially in circumstances like our current one. There are other mechanisms that are implicated in downturns as well.

  • 2. Peter Klein  |  30 December 2009 at 12:39 am

    Great point, Craig. I think Keynes himself didn’t believe that entry into government service magically transformed the ordinary ignorant person into a super-knowledgeable genius, but that certain people already were super-knowledgeable geniuses — primarily, himself and his Bloomsbury buddies — and that this elite cadre should run the economy. Obviously mundane public-choice concerns wouldn’t apply to these Nietzschean supermen.

    One small correction: As I understand the GT, Keynes applied the term “animal spirits” not to an irrational pessimism that caused investment to collapse in the face of negative demand shocks, but to the irrational optimism that brought about long-term investment in the first place. Because investors cannot predict other investors’ expectations (the “Keynesian beauty contest” problem), no one will invest in long-term projects, unless overcome by animal spirits or “spontaneous optimism.” The solution, for Keynes, was the socialization of investment (the “euthanasia of the rentier”). (BTW Keynes never considered that private investors can overcome the beauty-contest problem, and other capital-market inefficiencies, by establishing large, diversified firms with internal capital markets.)

  • 3. Jason  |  30 December 2009 at 1:20 am

    What then you you call the world before 2008? You know, the years when people looked to the actions of a single person sitting in a single central bank with utmost trepidation?

    By that charge, every year for the past 30 years has been a Keynesian new year. Why harp on this particular one?

    The world before Keynes, presumably Hayekian, now was that such a wonderful place?

  • 4. Recomendaciones « intelib  |  30 December 2009 at 12:15 pm

    […] Happy Keynesian New Year, by Craig Pirrong […]

  • 5. srp  |  2 January 2010 at 4:03 am


    Please don’t call me Craig. Shirley you’re not serious.

  • 6. Peter Klein  |  2 January 2010 at 3:07 pm

    Steve, as for your comments, well, I’m not sure. I haven’t seen anything like this since the Anita Bryant concert.

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