The Keynesian Delusion
By: Lauren Reiff
Tags: John Maynard Keynes, Economics, Austrian Economics, Finance, Central Banking

In the 1930s a British economist by the name of John Maynard Keynes burst onto the frontlines of economic theory. Something of a revolutionary for his time, he diverged from his classical liberal predecessors (i.e. Hayek, Mises) that had previously dominated the scene. He approved of government interventionist policies and smiled favorably upon central bank monetary planning (something his Austrian counterparts would have surely frowned upon). It is telling that Keynes almost singlehandedly shifted the Western world’s economic persuasions. Was he especially brilliant? Were his theories just unquestionably correct, or so convincing so as to be so quickly latched onto?

It does seem probable that in part his glittering popularity had something to do with how appealing his theories were to the political classes, the academics, and the elites. These cadres were, after all, scrambling for a new economic philosophy in the tumultuous wake of the post-war and Great Depression period. The political landscape was changing, progressively giving way to more socialist-inclined notions. The libertarian-esque principles that emerged from Austria and had reigned in the past were no longer quite so in vogue. In America, the nation’s peoples were grappling with the aftermath of the market crash and were scrounging for an explanation. A new, more fashionable, and vaguely statist liberalism was underway.

Unimpressed with Hoover and embittered that he was partly culpable for the mess helped to lay the foundations for the nation’s election of a fairly left-wing president — FDR — who appeared to approve of, or otherwise lend from, Keynes’ ideas. (Of course, the commonly accepted narrative of the Great Depression was that Herbert Hoover caused it, or was at least unable to stem it off, and that FDR was the hero who courageously stepped in with interventionist politics, activism, and massive spending. To this day, this narrative is used to justify liberal policies and their apparent successes but this translation of events is far too quiet on the possibility that FDR’s Keynesian-esque policies actually extended the Great Depression.)

Keynes believed in the legitimacy of stimulus spending, favored the central bank manipulation of interest rates and money supply (as not only tolerable but necessary), and generally believed that inflation was a utilitarian tool in the government’s toolbox to generate what he called the “wealth effect”. The wealth effect was nothing more than the changing of people’s perceptions of how rich they were in an effort to stimulate demand, and thus consumption, and then more demand, and then more consumption, and so on. That demand could be artificially prodded into being, ferreted out from each individual’s conscience and encouraged was at the core of what Keynes considered made an economy successful. This changing of perceptions occurred mainly via the lowering of interest rates and/or the production of money.

It is my belief that this is false advertising. What is the good in making people believe they are wealthier than they actually are? What is the good in projecting a smooth, smiling image of a falsely wealthy economy? In time, if a spectrum of individual people can all be trained to believe in what Keynes appropriately titled “the wealth effect” then what’s to say that this effect will not unfurl to the entire nation? What do you do if everyone’s been taken in by false advertising? Why are theatrics so lauded and how was this view so academically corroborated? In the modern Western economy, image is everything. ‘Image’ as a concept valuable to economics is perhaps one of Keynes’ largest contributions. And I can’t say that it’s a good one.

The Keynesian notion that the economy can essentially be efficiently ordered by a table of government bureaucrats still reigns supreme. As nice as it would be to imagine there are people as competent and, well, omniscient as that, this is not the case. No one is smart enough or possesses a sufficient amount of information to the degree that would be necessary to plan an economy; it’s much too complicated. They simply don’t have the full grasp of our obscenely large and complex marketplace. Alan Greenspan, fumblingly and reluctantly admitted as much in his famous congressional address. We like to think that central bankers can forecast and plan and predict, but their actions end up as gross estimations at best and all too often turn out to painfully miss the mark. All of this is not very reassuring — that perhaps things are just too complex and large — it is a very psychologically overwhelming view for a great deal of people to contend with, which is probably why, to some degree, government interventionist economic leanings are not only appreciated by the people but are particularly appealing to those at the top. People inherently like control (even if it would destroy them in the end if they gave it up).

This human compulsion to control is part of the reason why governments and central banks historically favor inflation over deflation and why they’re prone to utilizing variations of Keynes’ wealth effect. Feelings of intimidation surround the possibility of deflation because deflation crunches the space with which to manipulate interest rates, putting a squeeze on the power of the elites. There is only so far down you can go before you start veering into that weird, alien territory of negative interest rates which would inconveniently produce a whole host of new problems. Inflation, on the other hand, can be handled one of two ways. 1) printing/creating money in an effort to erode the value of the dollar or 2) shock therapy much like Paul Volcker did in 1979–80 in the form of raising interest rates extraordinarily high. (The latter of which, if I had to guess, simply would not fly in today’s environment.)

As well, the more politicians and central bankers can create a false perception of wealth and in doing so, often cause inflation, the better chance they have of being able to siphon off some of that new money. For example, if business mood is optimistic and demand/consumption seem to be up, pay raises may be in order for employees. Conveniently, a pay raise is something that the government can tax. They cannot do the same if a deflationary environment is in effect. In a deflationary environment, prices decline and as a result, if you have extra money in your pocket, the government can’t touch that, much less tax it.

In any case, the popular Keynesian viewpoint is that inflation is good, expansionary policies are good, and “easy money” is the essential lubrication for an economy. Because such policies prompt people to spend more and to extend their cash out into the economy, the aforementioned “wealth effect” occurs. But usually, this wealth effect is false and isn’t backed by gains in productivity or actual increases in demand untampered by the meddling of central bankers and politicians. You can’t actually create wealth that way by faking that the economy looks rosy. It’s all illusory. It’s ridiculous to think that at some point, we will stumble out of this illusion and into “realist” territory. Any time fiddling with the elasticity of the money supply occurs, false economic signals are the result. Elastic currencies engender false economic signals. Perhaps it’s nothing but a myth that we even need elasticity to our money supply. I’m sure there’s a host of reasons to want it, but do we need it? I’m skeptical.

And so, here’s my final thought: Economics can be more powerful than politics. (Which is probably why Austrian-school proponents were so adamant that political freedom was impossible without economic freedom — an astute observation.) Classically, republicans and democrats differ in the ways in which they would go about spurring economic growth. Democrats suggest stimulus policies and modified government handouts while, on the other side of the aisle, republicans endorse the idea that cutting taxes does the job (because in doing so, the money goes into the pockets of the people and not the into the hands of the government). And both insist that they are diametrically opposed to each other. And yet, I cannot help but think that in today’s environment, both of these options essentially create the same effect.

This may be daring to say, but there is almost little use quarreling over the merits or virtue of either one when, if you look at the long-term, both will be complicit in structuring that illusory wealth effect and distorting economic signals. Why is this so? Cutting taxes in an effort to keep more money in the hands of the people rather than the government is noble and good in theory, but what’s the point when the government presently would need to borrow/create money to fund its bloated self anyways? There is no way in hell, at this point, that we would slash our government expenses to the degree that we would be able to be funded fully with taxes (because currently we borrow money that we would fundamentally never be able to pay back). In practice, therefore, these two approaches basically do the same thing and simply aren’t in touch with economic realism. Our problems are thus, far more structural than we’d like to admit.