The Keynesian Fraud

Keynesian economics is a fraud.  It has neither theoretical coherence nor empirical support.  It was adopted out of desperation in the 1930s.

Many contemporary economists of the time protested that the fundamentals of the theory were incorrect.  Economists had rejected some of its premises more than a century before John Maynard Keynes was born.  For a sampling of some of the reactions, see The Critics of Keynesian Economics.

This article will explore the following topics:

  • How Keynesianism Was Accepted
  • The Case Against Keynesianism
  • How Politics Complicates Economics
  • Why There Will Be No Political Solution

Why Did Keynesian Economics Dominate?

Keynesian economics represented a major shift in economic thinking.  To understand how it dominated, some commentary on paradigm shifts is useful.

Thomas Kuhn described how knowledge advances in the physical sciences.  His work popularized the term "paradigm shift."  He asserted that more than just a crisis and "proof" was needed for a new paradigm to be accepted:

[C]risis alone is not enough. There must also be a basis, though it need be neither rational nor ultimately correct, for faith in the particular candidate chosen. Something must make at least a few scientists feel that the new proposal is on the right track, and sometimes it is only personal and inarticulate aesthetic considerations that can do that[.]

Kuhn's understanding of progress did not claim monotonically increasing knowledge.  According to the Stanford Encyclopedia of Philosophy, Kuhn anticipated occasional loss with the adoption of a new paradigm:

[A] later period of science may find itself without an explanation for a phenomenon that in an earlier period was held to be successfully explained. This feature of scientific revolutions has become known as 'Kuhn-loss' (1962/1970a, 99-100).

The social sciences are more complex, but presumably paradigms shift in a similar fashion.  The degree of uncertainty regarding the interpretation of data in the social sciences complicates the problem.  Some epistemologists argue that behavioral data cannot prove or disprove anything.  Friedrich Hayek's "scientism" was coined to describe the misuse of physical science methodologies to behavioral fields.

More variables, sometimes exceeding thousands, are related to an outcome.  Most of these variables are not knowable or measurable.  Many exist only in the mind of the actor(s).  Controlled replication of experiments is virtually impossible.

"Proof" is a difficult hurdle.  It is in this context that the paradigm shift to Keynesian economics should be viewed.  Politicians wanting to expand the role of government delighted in the new theory.  This attractiveness, plus the desperation associated with the Great Depression, enabled hundreds of years of prior economic knowledge to be discarded without normal due diligence.

Economists were also beneficiaries.  Economists gained higher income and prestige as well as more power.  Government-funded research ensured the continued academic support for economic activism.

President Eisenhower warned about the corrupting influence of such funding in his farewell address:

The prospect of domination of the nation's scholars by Federal employment, project allocations, and the power of money is ever present - and is gravely to be regarded.

Economists who acted on principle did so at their own personal expense.  Few opposed the switch to activist economics and government, especially when better incomes were made available.  Big government won and historians fell right in line and created the myth that government spending got us out of the Great Depression.  The truth is that the economy did not recover until the government cut spending dramatically at the end of WWII, precisely the opposite of what Keynesians would predict.

The Case Against Keynesian Economics

Keynesian economics lost much of its luster during the 1970s when the economy was burdened by both slow growth and high inflation.  Slowly, however, it climbed back to its position of prominence as a result of its usefulness to a government committed to expansion.

The current economic crisis is more severe than any since the Great Depression, causing the Keynesian paradigm to again be questioned.

Kevin Hassett claims that the net effect of Keynesian stimulus must be negative:

Every stimulus effort has not two but three stages. When the stimulus is imposed, there is some positive short-run increase in GDP. When the stimulus is removed, there is an approximately equal and opposite reduction in GDP. But after that, the stimulus must be paid for with higher taxes or ongoing borrowing -- causing a further reduction in GDP. Thus the total impact of the Keynesian policy is negative over its life. This fact is visible even in the fine print of Congressional Budget Office analyses so often cited by stimulus apologists, such as its 2009 finding that the Obama stimulus would reduce output in the long run.

In a sense, Mr. Hassett cedes the value of stimulus to Keynesians and still shows it is not net beneficial.  Some Keynesians now question the value of stimulus itself -- an unpardonable sin in the eyes of big-government economists.

According to the Austrian School of Economics, governmental intervention (government spending/credit creation) disrupts market prices, necessarily creating distortions in relative prices.  These "incorrect" prices serve as false signals to economic actors, resulting in decisions which may be both unwise and unsustainable.  An imbalance between consumption and investment is one result, as are distortions within these categories.

Imbalances are not immediately apparent but they do lower the efficiency of what an unhampered economy would produce.  Additional stimulus, generally in increased dosages, is necessary lest the distortions surface.  These additional stimuli further distort until a point is reached where additional stimulus is insufficient to cover up the problems.

The current housing crisis is an example of a major distortion that can no longer be hidden.  It was created by a credit-induced misallocation of resources.  Housing prices are now painfully correcting.  Governmental interventions to prevent these adjustments have failed.

The continued unresponsiveness of employment and economic growth at this stage of the so-called recovery indicates serious underlying structural problems.  Additional stimulus is unlikely to prevent the inevitable, as described by Ludwig von Mises:

There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion.  The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved.

An interesting discussion of Austrian economists' reactions to the stimulus program(s) is available in The Austrians Were Right, Yet Again.

Politics and Economics

The relationship between economics and politics is tenuous.  Politicians are notoriously short-term-focused while economics is properly long-term-focused.  Mr. Keynes was an influential politician sans office.  His economics reflected this.  He famously defended his economic policy against criticism by retorting that "in the long run, we are all dead."

Mr. Keynes died within his "short-run," but the rest of us are left to deal with the "long-run" distortions of continuous short-run economic fixes.  To be fair to Keynes, it is not clear he would have approved what his epigones have done in his name.

Mr. Hassett described the relationship between politics and intervention economics as a "Keynesian death spiral":

[A]ggressive stimulus sets off a kind of Keynesian death spiral in which nervous politicians adopt repeated stimulus packages in order to avert near-term distress, the cumulative effect of which can be ruinous.

The economy is now well into this death spiral.  The continuing shadow of Keynes on current policy and our feckless and cowardly political class was demonstrated in the debt-ceiling charade.  This deal was pure snake oil.  It accomplished nothing regarding spending or deficit reduction.

It provided politicians with a new credit card which they promptly used by increasing debt $239 billion on Thursday of last week.  To put this in perspective, prior to Obama, the largest annual deficit in history was $455 billion.

Government debt is clearly unsustainable.  Adding more is akin to pouring gasoline on a raging fire.  That Washington pretends otherwise is disgraceful.  Either politicians are the most ignorant fools in the world, or they believe their constituents are.  Neither hypothesis is flattering; either suggests that these clowns should be removed from office at the earliest opportunity.

Political irresponsibility is so blatant that S&P has downgraded the US government's debt rating, now rating our debt less safe than France's.

Mr. Hassett concludes that the case against Keynesian economics is so definitive that other motives might be suspected:

The arguments against recent stimulus actions are so strong that one wonders whether big-government ideology is the true source of the Democrats' Keynesian enthusiasm.  President Obama's plan all along may have been to expand government spending massively in the name of temporary stimulus, and then fight to never let it decline.

The political motives that drive Keynesian enthusiasm today are the same ones that powered it past the objections of sound economists in the 1930s.  Keynesianism is the vehicle for the expansion of government.  Many naïve politicians believe government should continue to expand.

Hassett ends his piece with the rather forlorn hope that a lesson may finally have been learned:

Perhaps now that the Keynesian approach has so visibly failed, policy makers can finally see clearly enough to do the right thing.

That is unlikely to be the case for reasons discussed below.

The Myth of Government

Aided by Keynesian economics, the political class cultivated and promoted the myth that government was responsible for economic success, especially the notion that more government means more success.

Government is like the rooster who believed his crowing caused the sun to rise.  More accurately, the propaganda-conditioned voters see government as this rooster.

Government cannot cause the economic sun to rise.  It can, however, prevent it from rising.  That is the point this country has reached.  Government has crippled the economy with an unbearable burden of poor policies, unnecessary regulations, and overspending.

Now the rooster crows but the sun does not rise.  The economic crisis persists and worsens, despite unprecedented government crowing (spending).

The economic solution is simple: pare back government and its burden on the economy.  Get government out of the way and the economy will recover.  The economic sun then will again rise.

The political solution is not simple.  Government is bound by its own Gordian knot.  It has convinced voters that more crowing is always better.  Less crowing would be political suicide for whoever proposed it.  The carefully crafted myth of government is a barrier to any political solution.  To admit that the myth is a lie requires an admission that government has been a fraud for the last seventy-five years.

That is why no political solution to the economic problem will be forthcoming.  The rooster will crow until markets behead it.  Spending and deficits will not decrease until the economic system collapses and we rebuild from the ashes that remain.  Ludwig von Mises described both Keynesian economics and our current situation:

Keynes did not teach us how to perform the miracle ... of turning a stone into bread, but the not at all miraculous procedure of eating the seed corn.

Make sure you preserve your seed corn.  Hard times are ahead!

Monty Pelerin blogs at at www.economicnoise.com.

Keynesian economics is a fraud.  It has neither theoretical coherence nor empirical support.  It was adopted out of desperation in the 1930s.

Many contemporary economists of the time protested that the fundamentals of the theory were incorrect.  Economists had rejected some of its premises more than a century before John Maynard Keynes was born.  For a sampling of some of the reactions, see The Critics of Keynesian Economics.

This article will explore the following topics:

  • How Keynesianism Was Accepted
  • The Case Against Keynesianism
  • How Politics Complicates Economics
  • Why There Will Be No Political Solution

Why Did Keynesian Economics Dominate?

Keynesian economics represented a major shift in economic thinking.  To understand how it dominated, some commentary on paradigm shifts is useful.

Thomas Kuhn described how knowledge advances in the physical sciences.  His work popularized the term "paradigm shift."  He asserted that more than just a crisis and "proof" was needed for a new paradigm to be accepted:

[C]risis alone is not enough. There must also be a basis, though it need be neither rational nor ultimately correct, for faith in the particular candidate chosen. Something must make at least a few scientists feel that the new proposal is on the right track, and sometimes it is only personal and inarticulate aesthetic considerations that can do that[.]

Kuhn's understanding of progress did not claim monotonically increasing knowledge.  According to the Stanford Encyclopedia of Philosophy, Kuhn anticipated occasional loss with the adoption of a new paradigm:

[A] later period of science may find itself without an explanation for a phenomenon that in an earlier period was held to be successfully explained. This feature of scientific revolutions has become known as 'Kuhn-loss' (1962/1970a, 99-100).

The social sciences are more complex, but presumably paradigms shift in a similar fashion.  The degree of uncertainty regarding the interpretation of data in the social sciences complicates the problem.  Some epistemologists argue that behavioral data cannot prove or disprove anything.  Friedrich Hayek's "scientism" was coined to describe the misuse of physical science methodologies to behavioral fields.

More variables, sometimes exceeding thousands, are related to an outcome.  Most of these variables are not knowable or measurable.  Many exist only in the mind of the actor(s).  Controlled replication of experiments is virtually impossible.

"Proof" is a difficult hurdle.  It is in this context that the paradigm shift to Keynesian economics should be viewed.  Politicians wanting to expand the role of government delighted in the new theory.  This attractiveness, plus the desperation associated with the Great Depression, enabled hundreds of years of prior economic knowledge to be discarded without normal due diligence.

Economists were also beneficiaries.  Economists gained higher income and prestige as well as more power.  Government-funded research ensured the continued academic support for economic activism.

President Eisenhower warned about the corrupting influence of such funding in his farewell address:

The prospect of domination of the nation's scholars by Federal employment, project allocations, and the power of money is ever present - and is gravely to be regarded.

Economists who acted on principle did so at their own personal expense.  Few opposed the switch to activist economics and government, especially when better incomes were made available.  Big government won and historians fell right in line and created the myth that government spending got us out of the Great Depression.  The truth is that the economy did not recover until the government cut spending dramatically at the end of WWII, precisely the opposite of what Keynesians would predict.

The Case Against Keynesian Economics

Keynesian economics lost much of its luster during the 1970s when the economy was burdened by both slow growth and high inflation.  Slowly, however, it climbed back to its position of prominence as a result of its usefulness to a government committed to expansion.

The current economic crisis is more severe than any since the Great Depression, causing the Keynesian paradigm to again be questioned.

Kevin Hassett claims that the net effect of Keynesian stimulus must be negative:

Every stimulus effort has not two but three stages. When the stimulus is imposed, there is some positive short-run increase in GDP. When the stimulus is removed, there is an approximately equal and opposite reduction in GDP. But after that, the stimulus must be paid for with higher taxes or ongoing borrowing -- causing a further reduction in GDP. Thus the total impact of the Keynesian policy is negative over its life. This fact is visible even in the fine print of Congressional Budget Office analyses so often cited by stimulus apologists, such as its 2009 finding that the Obama stimulus would reduce output in the long run.

In a sense, Mr. Hassett cedes the value of stimulus to Keynesians and still shows it is not net beneficial.  Some Keynesians now question the value of stimulus itself -- an unpardonable sin in the eyes of big-government economists.

According to the Austrian School of Economics, governmental intervention (government spending/credit creation) disrupts market prices, necessarily creating distortions in relative prices.  These "incorrect" prices serve as false signals to economic actors, resulting in decisions which may be both unwise and unsustainable.  An imbalance between consumption and investment is one result, as are distortions within these categories.

Imbalances are not immediately apparent but they do lower the efficiency of what an unhampered economy would produce.  Additional stimulus, generally in increased dosages, is necessary lest the distortions surface.  These additional stimuli further distort until a point is reached where additional stimulus is insufficient to cover up the problems.

The current housing crisis is an example of a major distortion that can no longer be hidden.  It was created by a credit-induced misallocation of resources.  Housing prices are now painfully correcting.  Governmental interventions to prevent these adjustments have failed.

The continued unresponsiveness of employment and economic growth at this stage of the so-called recovery indicates serious underlying structural problems.  Additional stimulus is unlikely to prevent the inevitable, as described by Ludwig von Mises:

There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion.  The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved.

An interesting discussion of Austrian economists' reactions to the stimulus program(s) is available in The Austrians Were Right, Yet Again.

Politics and Economics

The relationship between economics and politics is tenuous.  Politicians are notoriously short-term-focused while economics is properly long-term-focused.  Mr. Keynes was an influential politician sans office.  His economics reflected this.  He famously defended his economic policy against criticism by retorting that "in the long run, we are all dead."

Mr. Keynes died within his "short-run," but the rest of us are left to deal with the "long-run" distortions of continuous short-run economic fixes.  To be fair to Keynes, it is not clear he would have approved what his epigones have done in his name.

Mr. Hassett described the relationship between politics and intervention economics as a "Keynesian death spiral":

[A]ggressive stimulus sets off a kind of Keynesian death spiral in which nervous politicians adopt repeated stimulus packages in order to avert near-term distress, the cumulative effect of which can be ruinous.

The economy is now well into this death spiral.  The continuing shadow of Keynes on current policy and our feckless and cowardly political class was demonstrated in the debt-ceiling charade.  This deal was pure snake oil.  It accomplished nothing regarding spending or deficit reduction.

It provided politicians with a new credit card which they promptly used by increasing debt $239 billion on Thursday of last week.  To put this in perspective, prior to Obama, the largest annual deficit in history was $455 billion.

Government debt is clearly unsustainable.  Adding more is akin to pouring gasoline on a raging fire.  That Washington pretends otherwise is disgraceful.  Either politicians are the most ignorant fools in the world, or they believe their constituents are.  Neither hypothesis is flattering; either suggests that these clowns should be removed from office at the earliest opportunity.

Political irresponsibility is so blatant that S&P has downgraded the US government's debt rating, now rating our debt less safe than France's.

Mr. Hassett concludes that the case against Keynesian economics is so definitive that other motives might be suspected:

The arguments against recent stimulus actions are so strong that one wonders whether big-government ideology is the true source of the Democrats' Keynesian enthusiasm.  President Obama's plan all along may have been to expand government spending massively in the name of temporary stimulus, and then fight to never let it decline.

The political motives that drive Keynesian enthusiasm today are the same ones that powered it past the objections of sound economists in the 1930s.  Keynesianism is the vehicle for the expansion of government.  Many naïve politicians believe government should continue to expand.

Hassett ends his piece with the rather forlorn hope that a lesson may finally have been learned:

Perhaps now that the Keynesian approach has so visibly failed, policy makers can finally see clearly enough to do the right thing.

That is unlikely to be the case for reasons discussed below.

The Myth of Government

Aided by Keynesian economics, the political class cultivated and promoted the myth that government was responsible for economic success, especially the notion that more government means more success.

Government is like the rooster who believed his crowing caused the sun to rise.  More accurately, the propaganda-conditioned voters see government as this rooster.

Government cannot cause the economic sun to rise.  It can, however, prevent it from rising.  That is the point this country has reached.  Government has crippled the economy with an unbearable burden of poor policies, unnecessary regulations, and overspending.

Now the rooster crows but the sun does not rise.  The economic crisis persists and worsens, despite unprecedented government crowing (spending).

The economic solution is simple: pare back government and its burden on the economy.  Get government out of the way and the economy will recover.  The economic sun then will again rise.

The political solution is not simple.  Government is bound by its own Gordian knot.  It has convinced voters that more crowing is always better.  Less crowing would be political suicide for whoever proposed it.  The carefully crafted myth of government is a barrier to any political solution.  To admit that the myth is a lie requires an admission that government has been a fraud for the last seventy-five years.

That is why no political solution to the economic problem will be forthcoming.  The rooster will crow until markets behead it.  Spending and deficits will not decrease until the economic system collapses and we rebuild from the ashes that remain.  Ludwig von Mises described both Keynesian economics and our current situation:

Keynes did not teach us how to perform the miracle ... of turning a stone into bread, but the not at all miraculous procedure of eating the seed corn.

Make sure you preserve your seed corn.  Hard times are ahead!

Monty Pelerin blogs at at www.economicnoise.com.