Lets be clear about something. We did not just live through a 30 year period of laissez faire that has come to an end. Government got neither smaller in scale or scope. At best the growth of government slowed, but it was never reversed.
Fiscal policy has been irresponsible for at least two generations, monetary policy has been loose in an effort to minimize the short term pain of adjustment. WE ARE CURRENTLY SUFFERING THE CONSEQUENCES OF THE VERY SAME POLICIES WE ARE NOW ADVOCATING TO FIX OUR PROBLEMS. We didn't have an era of complete deregulation and free trade, we had partial deregulations (and attenuated property rights) and managed trade agreements. We have international agencies that promote administrative command/managed capitalism overseas and call it "free market", we have politicians at home that engage in discretionary spending unheard of before who claim to be "fiscal conservatives".
It is also the case that this is not a new argument by me or anyone else. Lawrence Kontlikoff has been sounding a warning bell on the fiscal side for my entire professional life. And thinkers such as Axel Leijonhufvud have been discussing the dire costs of inflation in terms of coordination failures since the 1960s. And it is not like the names Buchanan and Hayek are unknown to those in the economics profession since both won the Nobel Prize, and Buchanan explained in detail the consequences of the breakdown in the old time fiscal religion and the Legacy of Lord Keynes, and Hayek explained clearly the consequences of engaging in the Keynesian dance of holding the "tiger by its tail" with respect to inflationary monetary policy.
So how can it be that we get articles such as these --- Jeffrey Sachs making the case for Big Government in Time, and Yves Smith arguing that current crisis undermines the idea of economics as a science. The "analysis" of Sachs and Smith needs to be read, but also understood to be full of conceptual confusion and historical inaccuracy.
The sad reality is that since the 1940s, economic policy world-wide has been dominated by Keynesian ideas. Research in economics has been dominated by Keynesianism even when it supposedly had thrown off those intellectual ideas. Keynesian ideas led to Keynesian models, which in turn led to the development of Keynesian data that was then used to test Keynesian models with the purpose of exploring the efficacy of Keynesian policies. All that oscilated was whether we should be "liberal" or "conservative", but everyone in power was fundamentally Keynesian. After the 1987 crash, for example, Reagan was asked whether this meant the rehabilitation of Keynesian economics, he responded by telling the audience that Mr. Keynes didn't even have a degree in economics. That was his rhetoric, but the diagnosis of why the 1987 crash was one of aggregate demand failure, and the policy response was attempts to stimulate consumption. "Buy, Buy, Buy" Reagan told his audience within in 2 minutes after telling us that Keynes didn't have a degree in economics.
The very same economic framework that was unable to see the looming problems of fiscal irresponsibility and loose monetary policy, also couldn't see the difficulties of state socialism in the former Soviet Bloc and the problems of 3rd world poverty. But each of these economic policy failures are at root problems with statism, not problems with the market economy. Keynesianism is the prefered economic policy of statism (as Keynes himself pointed out when he argued that the policy experiments in Germany and Russia might be the more natural home for his ideas).
The "Washington Consensus" and the so-called era of laissez faire following the Reagan revolution are in fact, lets face it, much closer in reality to the policy prescription of John Kenneth Galbraith than Milton Friedman. Friedman's rhetoric was employed to pursue Galbraithian policies. Galbraith argued for Keynesian activism via a weird mix of Marx, Veblen and Keynes --- but the basic prespection was on of government involvement both as referee and active player in the economic game. This is what we have had since the 1940s. Friedman argued against these positions via the logic of economic theory and the empirical examination of the consequences of government activism. Friedman won the intellectual debate among his peers, but lost the war of policy implementation in Washington and throughout the world. He pointed this out himself --- classical liberal he said have won the battle of rhetoric, but lost the battle of implementation. But Friedman's argument hasn't impacted the conceptual confusion and historical inaccuracy that blames our current crisis on the era of small government and laissez faire policy. So now we read about how Friedmanesque ideas (let alone Hayekian) are refuted by the current situation. Even President-elec Obama referred the other day to the "failed ideology" of the past, and the need for a new era of regulation of the economy fit for the 21st century.
Ironcially, one of the major sources for the confusion is found in Friedman's framework himself. When it came to macroeconomics, Friedman was fundamentally a Keynesian. What was needed was a complete rejection of the entire methodological and analytical framework of Keynesianism. Friedman was the first "conservative" Keyensian arguing against the "liberal" Keynesianism of the time. So his intellectual victory did not translate into a fundamental change in the structure of public policy either in the US or abroad.
Free market public policy had absolutely NOTHING to do with our current financial crisis, just as the current policy response has absoultely NOTHING to do with free market public policy. In fact, we are responding with public policies that are exactly what caused the problems in the first place. Give me Hayek and Buchanan, and perhaps if we followed their methodological, analytical, and policy prescription the perhaps economics could be revitalized as a scientific discipline and our economy could recover from the current malaise which statism has entrapped us.
I just got off the phone with a reporter and said almost precisely this to him:
"WE ARE CURRENTLY SUFFERING THE CONSEQUENCES OF THE VERY SAME POLICIES WE ARE NOW ADVOCATING TO FIX OUR PROBLEMS."
(Although I didn't shout it.)
It can't be said enough Pete.
Posted by: Steve Horwitz | January 12, 2009 at 09:53 AM
Great Post, Pete. I agree with all.
Two things:
(1) Minsky says we've had a period of Big Government for decades (his capitals and his applauding), while at the same time bemoaning our laissez-faire ideology.
(2)Marxists: they've said we've been in State Capitalism, or Late Capitalism, for decades. Well, that ain't no laissez-faire, free market system.
(3) Bernstein's Evolutionary Socialism. Don't they applaud exactly that -- that's what we have.
Where are any of these people now? Why do they throw all *their* claims and appraisals away and damn our so-called -- by them!!! -- free market excesses?
Pete, you don't want the hermeneutics of suspicion.
But I do.
Posted by: Dave Prychitko | January 12, 2009 at 09:59 AM
As an Austrian, I can't add.
Posted by: Dave Prychitko | January 12, 2009 at 09:59 AM
Who are people going to believe, you or Barack Obama?
You or the New York Times?
You or everyone's favorite Hollywood TV show or celebrity?
You or CBS News, NBC News, ABC News, and CNN?
You or 95% of the other professors in academia?
It's not a very freedom -- or truth -- friendly environment out there right now, and we've all got to be very aware of it.
Posted by: Greg Ransom | January 12, 2009 at 10:02 AM
Wanna see a guy try to argue we have "laissez-faire" and then blame Bush for running up the deficit and not see the contradiction?
https://www.blogger.com/comment.g?blogID=6867343265106830137&postID=5169526378210747335&page=1&pli=1
Posted by: Steve Horwitz | January 12, 2009 at 10:03 AM
The current economic crisis of confidence is also a scientific crisis for financial modeling, in the way that 1987 was not. Portfolio insurance was abandoned after it proved unworkable.
There is no similar solution today, and the consequence is that we see banks hoarding the capital given to them because they no longer trust even themselves.
What is the Austrian response to this problem of confidence?
Posted by: michael webster | January 12, 2009 at 10:45 AM
Let me try that earlier link again:
http://ryviewpoint.blogspot.com/2009/01/republican-cynical-hypocrisy.html
Posted by: Steve Horwitz | January 12, 2009 at 10:54 AM
Friedman was a "conservative Keynesian?"
There is a division among Austrian economists who pay attention to macroeconomics. Some are with Rothbard, with his "in praise of deflation." Others agree with Friedman in the broadest sense, that it is important that aggretate expenditure be maintained.
This same division has existed with the free market wing of the neoclassicals. New classical economics more or less assumes that any necessary deflation has already occured. I guess everyone else, including Friedman, are being classified as "conservative Keynesians" because they recognize that adjuting the real supply of money to the demand is disrputive.
Of course, I think Yeager is the person to read on this. But then, what else would I say?
Mainstream macroecnomics (conservative and liberal Keynesians?) recognize that there can be sectoral shifts that impact the unemployment rate. What else is structural unemployment supposed to mean? That physical capital as well as human capital might be lost is hardly a stretch. That these sectoral shifts have implications for total production seems obvious.
But such shifts happen all the time. And it is hard to see how they can be avoided. Or that they should be avoided.
Anyway, I find it very frustrating to read free market economists who only speak of structural shifts and won't explicitly discuss the role of deflation. Are you calling for a general deflation of prices and incomes to return to equilibrium? Is deflation disruptive at all?
By the way, during the last 30 years there was a large decrease in marginal tax rates. There was substantial banking deregulation--nationwide branch banking is permitted. Price floors in transportation and finance are gone. And monetary policy is better than the "long run phillips curve" era.
All that said, it is obvious that we didn't have anything like laissez-faire. I believe there was a speculative bubble in housing. Did the Fed, FDIC, HUD, SEC all say, we should stop this, but we don't have the legistlative authority? Or, did they have that authority but just forebear stopping it because they felt that it would interfere with private property rights? Were all of these statist economists advocating some new regulations to stop it? Or, is the truth that the regulators and the left-liberal economists where promoting the bubble?
Let's see.. Rubin, the hero of the Clinton administration was working for Citibank! I guess they are just promising that they will do better next time.
Posted by: Bill Woolsey | January 12, 2009 at 11:34 AM
Having read Sach's now..
He is advocating having higher taxes to fund more social spending. This is supposed to improve our health, environment, and education.
I think he is quite clear in explaning that this will reduce the amount of private consumer goods and services people obtain.
The noton that the U.S. should be more like Sweden is hardly new or a critique of the market economic system.
One must grant that if one's goal has been to substantially higher taxes to fund a substantial increase in the welfare state, something has stood in the way over the last 30 years.
I think that there is some sense in which a pro-market approach was in opposition to that goal. Some kind of notion that people should be able to buy the things they want with the money they earn, rather than have the government take that money and produce the things that politicians think they should have.
And, of course, Sachs is also proposing transfers to the poor.
Posted by: Bill Woolsey | January 12, 2009 at 12:04 PM
Just read Smith.
Perhaps to outsiders, there is an assumption that all economists do macroeconomic policy.
I suppose that is what society at large thinks we are "good for." When you say, "I am an economist," don't you generally get a request for what is going to happen to the stock market?
In reality...
How many microeconomists do you know who dismiss macroecomics altogether? (Perhaps that comes from knowing too many free market types.) And which Nobel winner's response regarding policy recommendations was more public money to support pure mathematical research?
I know that I followed discussion about whether there was or was not a speculative bubble in housing prices. I never felt like I had to take a position on the matter. It was just interesting research by other economists.
Anyway, I certainly recognize a need to revamp what I teach about money and banking. Not the theory so much, as the institutions. Everything I have said about what the Fed basically does became wrong over the last year. Buying bonds? Targetting the Federal Funds rate? Lender of last resort to the market?
However, for those of us from the free banking perspective, I think there are some elements that deserve new thought. How does a free banking system deal with massive insolvency. If there is a nationwide branch banking system, the possibility that nearly all of them would do something stupid, a bit like AIG, seems more plausible. What happens?
My view has been that public capital ratios is how depositors protect themselves in a free banking system. How did the shadow banking system, money market mutual funds, overnight commercial paper, and the like, attract so many deposits with so little capital?
On a related note, if a free banking system uses capital to assure depositors, and there are heavy losses, does the system have the same problem as created by capital requirements? The losses are assorbed by capital, but new investor must be attracted to make new loans.
Posted by: Bill Woolsey | January 12, 2009 at 12:29 PM
As always Bill adds insight and raises great questions. Unfortunately, earlier today I had edited my original post thoroughly and cleaned up typos and some of the ambiguities in my presenations, but my internet server went down and I don't have time to fix it now.
But my point on Friedman is different than a Yeager point because while Yeager adopts an old Chicago view, he never embraced the full scale Keynesian apparatus. He is a monetary disequilibrium thinker and in that I agree with him about the coordination failures that can result from both bouts of inflation and deflation. What I was disagreeing with Friedman about is that for the sake of argument he adopted the Keynesian analytics and argued at the aggregate level. This ensured the victory of the Keynesian framework, and reinforced the Keynesian inspired data collection, and Keynesian public policy.
But perhaps I could state this much more clearly. And while we have had "minor" victories, the essential framework was left in tact. This is a basic Buchanan point about the constitution of economic policy. We have not adopted the "generality norm" in politics and thus moved from politics by interests to politics by principle.
If we want fundamental change, Buchanan's proposals have to be taken much more seriously.
Pete
Posted by: Peter Boettke | January 12, 2009 at 01:14 PM
Bill Woolsey wrote:
"How many microeconomists do you know who dismiss macroecomics altogether? "
Franklin Fisher kept on repeating "There is no such thing as macroeconomics." He is not particularly pro-freemarket, he seems to have the usual middle of the road politics.
But why do you frame your question as if it was a matter of democratic voting whether macroeconomics --as done today, aggregatively-- is well founded or not? If one economist gives solid arguments as to why most macroeconomic models are misleading, then the matter is settled, regardless of vote counting.
Structural unemployment is recognized -- but when the models you have to work with are aggregated, there is nowhere to put such phenomena except under the rug ("insignificant", etc. )
Posted by: Alex | January 12, 2009 at 04:41 PM
Michael Webster
"The current economic crisis of confidence is also a scientific crisis for financial modeling, in the way that 1987 was not."
[...]
"What is the Austrian response to this problem of confidence?"
About ten years ago Taleb wrote about the danger of replacing the hard won experience of traders with a matrix or correlation coefficients, as in the VAR methods. He was proved right in spades.
So there is no particular response needed --Austrian or not-- for the dismissal of most of quantitative finance, anymore than there is a need for a replacement for blood-letting. People can put more money in value investing, they can have a deeper distrust of high leverage, they can diversify much broadly than portfolio theory suggests etc.
Quantitative finance theories were teaching birds how to fly and it turns out that, in fact, it was teaching them how to crash.
There is no particular replacement needed for quack pseudo-science.
Here is Taleb, who is more entertaining --but also serious-- on the subject than I can be:
"So when you see a quantitative “expert”, shout for help, call for his disgrace, make him accountable. Do not let him hide behind the diffusion of responsibility. Ask for the drastic overhaul of business schools (and stop giving funding). Ask for the Nobel prize in economics to be withdrawn from the authors of these theories, as the Nobel’s credibility can be extremely harmful. Boycott professional
associations that give certificates in financial analysis that promoted these methods. Remove
Value-at-Risk books from the shelves – quickly. Do not be afraid for your reputation. Please
act now. Do not just walk by. Remember the scriptures: “Thou shalt not follow a multitude to
do evil.”"
The whole piece is worth reading:
http://www.fooledbyrandomness.com/Ft-Bystanders.pdf
Posted by: Alex | January 12, 2009 at 05:32 PM
What is the precise definition of "Keynesian"? Reading the General Theory, my impression was that Keynes primarily set out to show that investment doesn't follow savings. Is this the viewpoint all Keynesians share?
Posted by: Grant | January 12, 2009 at 05:40 PM
http://delong.typepad.com/sdj/2009/01/delong-what-has-happened-to-milton-friedmans-chicago-school-draft.html
I'm no economist but this, by DeLong, seems horribly, horribly wrong.
Posted by: John V | January 12, 2009 at 06:19 PM
Most likely I misunderstood Bill Woolsey's point about microeconomists' dismissals of macroeconomics -- he was agreeing that there is a lot of such dismissal going on. So on this point we seem to be in agreement.
But this doesn't seem to stop macroeconomists from making policy recommendations based on aggregated models -- regardless of whether microeconomists dismiss them or not.
Posted by: Alex | January 12, 2009 at 08:02 PM
Incredible, the argument is that the Capitalistic economies were not perfect enough for the Free-Market to work properly. The Utopian liberal economic ideals were not strictly adhered to.
How about this very quick and accurate summation: The markets do not work according to your simple and ridiculous templates. The real world has no clue about your economic rules and equations of certitude.
Take a look at a long term chart, any chart, stocks, commodities. I will not bother you with an explanation other than to point out the chaos and periodic long tails.
I swear, you are using the wrong economic models, so wrong that it is scary to think how wrong headed you are.
I use math for investing, but it is so wildly different and non-traditional that it is beyond most economists Utopian world abilities.
I can say that it is rather simple at times and elegant. And accurate down to a few tics on a chart, sometimes over decades. There is even a time element to the real world that makes me shake my head at times in wonder.
I dare not try to rationally explain why price and time react in logical mathematical relationships. It does not matter. But you theoretical economists always think you have it figured out, exactly how people think and make decisions. That is why the field of economics has always been a joke, like the weatherman predicting the weather before satellites, you are not advanced enough to see any weather patterns.
If you want, I can send charts to anyone interested, but you will have to expose your email to me. Curious?
Posted by: Arnold T | January 12, 2009 at 08:30 PM
Arnold,
You seem to be attacking the neo-classicals. Are you aware of Austrians work on uncertainty, knowledge etc?
Nick
Posted by: Nick | January 13, 2009 at 05:48 AM
Grant,
1. "Keynesian" = aggregate economics, where aggregate variable interact with one another unmorred to human choice.
2. "Keynesian policy tools" = monetary and fiscal policy tools, with the main focus being on achieving some sort of balancing of the aggregate variables.
3. "Keynesian" = a fundamental judgment that government must be the critical actor to achieve the corrective because the situation is such that entrepreneurs and the market economy in general is not in a position to make the critical steps.
These are broad brush statements, but should give you a basis by which to understand what I am saying.
Pete
Posted by: Peter Boettke | January 13, 2009 at 10:40 AM
My point about microeconomists dismissing macroeconomics was about why the AEA
meetings might not be devoted to a purported
falure of macroeconomics to predict the recent
financial problems. Smith seemed to think that the AEA meetings should have been devoted to a reassessment of macroeconomics (including such important points as how the weakening of labor unions has lead to a crisis.) For many economists, what exactly does the this have to do with their research program? My point was really about specialization within the economics.
I don't agree with fundamentalist critiques of macroeconomics. But I didn't mean to criticize microeconomists who see no value in it.
Posted by: Bill Woolsey | January 13, 2009 at 02:31 PM