Wednesday, 24 December 2008

Are our leaders misrepresenting Keynes?


Central Banks appear to be citing Keynesian monetary policy as a reason for pushing down interest rates to dangerously low levels.

Yet it is far from clear that the dead economist would himself have approved of low or no interest rates.

According to his General Theory of Employment, Interest and Money, when the "rate of interest has fallen to a certain level… almost everyone prefers holding cash to holding debt which yields so low a rate of interest," as a result of which central banks can "lose effective control over the interest rate" (p. 207).

The problem, as I have noted repeatedly, is that if interest rates are low, there is no incentive to lend money, thus furthering the very “liquidity trap” that the Central Banks believe they have to resolve. As Keynes understood, people have no incentive to hold bonds (or deposits) rather than cash. In fact, the rational investor would shift their money abroad.

Rather than resolving the problem, today’s low interest rate policy is sowing the seeds of the next economic crisis by encouraging further credit expansion which, in turn, will lead to further misallocations of resources and requiring future punitive interest rate rises.

4 comments:

Kit said...

Keynes' "General Theory" was nothing of the sort and dealt only with Great Britain's post WW1 Gold Standard (it was set too high). It is worth listening to Hayek:

http://blog.mises.org/archives/009112.asp

Adam Smith said...

Why Don't You Hedge Your Economic Future?


The Economy? They Paint It Black.
Let's Paint it Green, Will You?


What Are They Offering Except to Wait, Suffer and Be Patient Till, On the Long Run, The Crisis is Over?

A milder avatar of the present crisis started in Japan in 1993. Its consequence was called "Japan Lost Decade". It is 15 years old now.

Believe us they tried everything available: Keynesian Fiscal Policy, Zero Interest Rate Policy (ZIRP), Quantitative Easing... You Name It!


DIE ZEIT: Can the right monetary and fiscal policy keep the US out of a recession?

Master Conductor Alan Greenspan:

"Probably not. Global forces can now override most anything that monetary and fiscal policy can do. Long-term real interest rates have significantly more impact on the core of economic activity than the individual actions of nations.
Central banks have increasingly lost their capacity to influence the longer end of the market.

Two to three decades, ago central banks were dominant throughout the maturity schedule.
Thus, the more important question is the direction of long-term real interest rates."


Sir Alan 'El Maestro' Greenspan

The Great Irony of Success
© ZEIT online, 30.1.2008


"The long run is a misleading guide to current affairs. In the long run we are all dead.

Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again."

Sir John Maynard 'Invisible Hand' Keynes
A Tract on Monetary Reform (1923) Ch. 3

We Can't Afford to Wait That Long. Or Can You?

"The decadent international but individualistic capitalism, in the hands of which we found ourselves after the war, is not a success. It is not intelligent, it is not beautiful, it is not just, it is not virtuous—and it doesn’t deliver the goods.

In short we dislike it and are beginning to despise it. But when we wonder what to put in its place, we are perplexed.”

John Maynard 'Invisible Hand' Keynes


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"The composition of this book has been for the author a long struggle of escape, and so must the reading of it be for most readers if the author's assault upon them is to be successful, a struggle of escape from habitual modes of thought and expression.

The ideas which are here expressed so laboriously are extremely simple and should be obvious.

The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds."

Sir John Maynard 'Invisible Hand' Keynes
The General Theory of Employment, Interest and Money,
December 13, 1935 Preface



"At the present moment people are unusually expectant of a more fundamental diagnosis; more particularly ready to receive it; eager to try it out, if it should be even plausible.

But apart from this contemporary mood, the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood.

Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.

Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. Emperors and armies come and go; but unless they leave new ideas in their wake, they are of passing historic consequence.

I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval;

for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest.

But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil."

John Maynard 'Invisible Hand' Keynes,
The General Theory of Employment, Interest, and Money,
13 December 1935, p. 383.

Quoted by Master Conductor Sir Alan 'El Maestro' Greenspan.
Adam 'Defunct Economist' Smith
At the Adam Smith Memorial Lecture, Kirkcaldy, Scotland
February 6, 2005


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✔ A Specific Application of Employment, Interest and Money:
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not an economist said...

Can someone tell me why people are favouring the Japanese Yen over sterling? I only ask 'cos as I understand it the Japanese economy has been in recession for over ten years. What makes it anymore attractive than the British economy at the moment?

Tom Papworth said...

An interesting question, non-economist.

I guess the former exchange rate was based on Japan's economy being weak and ours strong. Even if Japan's remains weak, if ours also becomes weak then the relative value of the Pound to the Yen must fall.

Does that make sense?