Austrian VS Keynesian.

Thanks to PRO. I'm going to rebut PRO's arguments and offer my own contentions within them, as many of them fit within that context. PRO states, "Inflation, welfare programs, and the subsidies all do more harm than good." He makes this claim, but then goes on to only address inflation--he doesn't tell us how welfare and subsidies do more harm than good, so we can discredit this class outright. As for his example which follows regarding the roaring Twenties, it completely misses the mark. First, the link between inflation and asset bubbles is not nearly as profound as PRO would have us believe. Dr. Frankel of Harvard University remarks, "[W]hen the global financial crisis hit..it was neither preceded nor followed by an upsurge in inflation" (1). Asset bubbles which lead to busts are a function not of inflationary pressures as much as they underpricing of risk and financial excesses. There are several causes of that: one could be overly loose monetary policy, which is an indictment not on the institution of the Fed itself (for, without it, we would've have a mechanism by which to readily tighten policy should the need arise), but on bad policy, much of which, as Alesina and Summers point out, is a function of political pressure (2). Another point worth mentioning, as Larry Summers from Harvard has noted, the economy in 2002-2007 did not overheat in spite of the fact that a housing bubble was in the works (3), and there weren't any signs of an inflationary buildup at the time. It's critical, then, to separate out inflation from bubbles, as this association doesn't exist. Underpricing of risk is a real issue, but it can be solved not by laying waste to the institution which has the power to stop it--but rather through more extensive financial oversight and regulation, as measures like Dodd-Frank seek to do. For instance, the Glassed-Steagall Act, enacted in 1933, prevented financial crises for 50 years, but was repealed in 1999, allowing for banks to take on far too much leverage and become "too big to fail" (4). A return to sensible, "boring" banking, therefore, is the solution. As for the 1920s, the fast majority of the 1920s was actually *deflationary*--which is to say that prices were falling. The average inflation rate was actually zero, and the only year in which there was high inflation was 1920 (5)--and, had the Fed done its job and kept inflation low and stable at around 2 percent, this wouldn't have been an issue. The reason investors tend to underprice risk and take on too much leverage is low interest rates, but low interest rates are spawned not solely by expansionary Fed policy, but by deflationary expectations and low levels of consumption and income--so the fact that the Fed was not expansionary enough in fact contributed to these financial excesses. Further, this propels debt deflation, eroding the value of collateral and exacerbating the deleveraging process. Further, this data provides evidence of the Fed combatting high inflation in 1920 that followed WWI. The Fed quickly and aggressively tightened policy, induced a recession, and then loosened policy, in order to bring inflation down. This rivalled the 1980s when Paul Volcker aggressively brought down inflation from the 1970s after overly loose policy , structural changes, such as a decline in trend productivity growth and rise in the natural rate of unemployment, and a negative oil price shock brought it to inconceivable levels (7). But the key point worth emphasizing is that monetary policy has been far more tame since the 1980s, as the Fed has built credibility as an inflation fighter and has anchored inflation expectations at around its 2 percent target. This is important, because inflation expectations are embedded in nominal wage contracts as well as spending and investment decisions, and tend to be self-reinforcing--meaning that, provided that expectations are well-anchored, inflation shouldn't rise above the Fed's target. Research by J. Scott Davis finds evidence for this point, as he manages to show not only that expectations have become more anchored over time, but that they're less susceptible to shocks--meaning that, should an exogenous shock occur, the public trusts the Fed to bring down any inflationary pressures, and thus don't adjust their behavior as though said inflationary pressures will persist indefinitely (8). PRO goes on to address the New Deal, but he begins with a misconception. First, there isn't a school of thought I'm aware of that actually holds that the government ought not spend a penny, even on public goods like roads, bridges, and police forces. The difference between PRO and I--or at least between these two schools--is stabilization policy: how do we react to recessions, and how do we seek to prevent them? The Keynesian school, based on the historic success of the Glassed-Steagall Act and regulations like it, as well as the malaise that took place upon lifting those regulations, think we should not only have barriers in place to prevent these recessions from happening, but that after they take place, we ought to do something about it. The reasons the Austrian perspective of "do nothing and allow markets to clear and wages and prices to fall" in response to demand shocks--and both the Depression and the Great Depression were negative demand shocks--is because wages and pric are sticky in the short run. When demand falls, in order for markets to clear and for us to return to full employment, wages and prices must be able to fall. Because they're not able to, much of which is due to contractual obligations quoted in fixed nominal terms, people get laid out. In that phase of a prolonged downturn such as the Depression and the Great Recession which poses a significant impact on household net worth, incomes and livelihoods tend to fall, which drives interest rates close to zero--note that this is a function of market forces, not solely of Fed policy. When this takes place, because real interest rates are equal to nominal rates minus the rate of inflation, any fall in inflation induces a rise in real interest rates, which chokes off investment and consumption, reduces inflation again, and the cycle continues. Even if wages were to fall at zero nominal interest rates, the economy would in fact be worse off--a phenomenon Krugman notes is called the "Paradox of Flexibility" (9). Because markets are unable to solve these deep recessions on their own, and prolonged downturns deal permanent damage to potential output and future growth, as Martin et al., 2014, note (10), it's necessary for the government to intervene in order to mollify those downturns, lest we find ourselves in a debilitating, self-reinforcing deflationary spiral iike Japan in the 1990s, which makes further stabilization policy even harder, meaning that because wages are sticky, people get laid off, inflation falls again, and the cycle continues. With respect to the unemployment numbers PRO cites, there are several problems. First, he provides no sources for his numbers and he's cherrypicking numbers at whim. Second, estimates of the unemployment rates from those dates by Darby show unemployment at 15.3% in 1931 and 11.3% in 1939 (11), so his numbers are wrong. Third, the New Deal was not nearly as expansionary as we would have wanted, which is why Keynes himself wrote a letter to FDR condemning much of it (12). Fourth, even IF PRO's numbers were true, they lack context--you cannot say that X event followed Y event, and therefore Y caused X. In fact, there was a lot of contractionary policy--the opposite of Keynesian stimulus--during that period. From 1936-1937, the Fed doubled reserve requirements, shrinking the money multiplier (13). Further, in 1936 FDR both raised taxes and cut spending--more anti-Keynesian contractionary policy that, as I explained, will significantly depress output (14). And, of note is that PRO actually *concedes* that WWII ended the Great Depression, lending credence to Krugman's thesis that the New Deal was simple inadequate, and further spending was needed. He concedes that stimulus is effective at demand shocks--akin to conceding this debate. I haven't much space left, but I'll address the remainder of PRO's arguments as best I can.His argument on inflation is counter-factual. Inflation is a rise in the general price level, but not a rise in the cost of living. Most wages are indexe to various measures of inflation, so if prices rises by 2 percent, wages tend to rise by the same amount, meaning that real wages and the cost of living remain unchanged. Again, sticky prices and wages prevent rapid movements in inflation. Further, in the short run there's a negative relationship between inflation and unemployment, so the notion that people are "hurt" by inflation, on net, is ludicrous (15), as higher inflation is consistent with faster economic activity. Second, his argument on gold is unsourced, so you should disregard it anyway, but it actually demonstrates the volatility of the gold sandard: it's dependant on how much gold you manage to mine, whereas the Fed is actually able to control the supply of money and thus inflation so these types of shocks do not occur. Further, prices would be significantly more volatile under a gold standard, and deflatioanary episodes which dampen growth would be much more frequent. In fact, there was 23 percent less variances in the price level after the Fed launched QE than there was under a gold standard (16). SOURCES (1) http://tinyurl.com... (2) http://tinyurl.com... (3) http://tinyurl.com... (4) http://tinyurl.com... (5) http://tinyurl.com...; (6) http://tinyurl.com... (7) http://tinyurl.com... (8) http://tinyurl.com... (9) http://tinyurl.com... (10) http://tinyurl.com... (11) http://tinyurl.com... (12) http://tinyurl.com... (13) http://tinyurl.com... (14) http://tinyurl.com... (15) http://tinyurl.com... (16) http://tinyurl.com...