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In fact, the Keynesians have to burn up (expend) pieces already organized in the puzzle in order to mobilize those pieces on the sidelines.

And while they are pushing all of the unused pieces willy-nilly onto the solved puzzle, it becomes costlier to re-organize already solved puzzle pieces that get bumbed out of their place -- you've got to spend time moving the dumped pieces out of the way, and it costs time to locate all of the pieces now bumped out of place.

One of Hayek's points again Keynesian demand pumping is that in the process of pumping, valuable resources must be diverted from more preferred/more valuable uses to less preferred/less valuable uses, bidding up prices for goods and processes that are more valuable/more preferred, and thereby actually reducing the general wealth.

This seems to be an argument against crude Keynesianism rather than a case against the idea that there's a wedge between the market interest rate and the marginal efficiency of capital. But maybe that's just me.

I hereby strongly concur that the way capital and other factors of production work together in specialized patterns matters a great deal.

Your analogy misses the idea that stimulus inevitably moves already established pieces in the puzzle to do things that would otherwise be meaningless.

Further, especially given obama's 'stimulus,' the act of stimulus forever changes the picture. For example, Obama gave permanent and significant increases to education and 'green' energy. Those are not temporary puzzle movements. They remain until someone actively takes them off the board again.

This analogy fails. "We" don't put puzzle together as one exercise. Billions of actors do their pieces. There are no beeps that'll satisfy some economist, imaginary or real. Daniel Kuehn, as always, is pissing in the wind when he suggests that Keynesians are capable of putting the puzzle together through economic stimulus.

No sandre - the argument is that when the pieces are turned upside down (price signals distorted by liquidity preference) we should turn them right side up again and let decentralized agents get back to specializing and exchanging.

What is it's not obvious if the pieces are upside down?
What if the stimulus actually inverts pieces that were OK?

Further, what if the market actors realize they can't proceed until the political actors are finished rearranging pieces?

The peices are capital, and the puzzle is put together by millions of people. The beep is a reward -- humans act based on reward. So the analogy is apt.

Of course, the problem is too that the number of pieces is also growing. And it matters which ones grow and which ones do not. This is of course a complicating factor, but it's one that matters.

Another analogy would be that of a growing organism. We want our organism to grow, but it has to grow in a healthy manner. One can grow by becoming overweight or by getting a tumor. Both are kinds of growth. Thus, when Krugman argued after the tech bubble burst that the U.S. government should create a housing bubble, he essentially argued that the solution for the weight loss of the organism from pneumonia was for it to get cancer. Yes, the organism grew in size, but it was not healthy growth, to say the least. The tumor must be removed, and the patient will be very thin and unhealthy as a result. So what should we do? Well, we know that a tumor made the organism gain wait in the past, so let's fill it full of carcinogens until it grows a tumor again.

That is what Keynesian stimulus is: carcinogens designed to make the organism gain weight by giving it cancer.

Seriously, where's the malpractice lawyers wehn you need them?

Keynesians are FOR....NEXT
while
Austrians are DO UNTIL...LOOP

Sam -
Not sure what you mean. If stimulus does its job, you narrow the gap between the marginal efficiency of capital and the interest rate. The market sorts out what is viable at certain interest rates, not the government. You're thinking of Keynesianism as "leaning against the wind". That's not how most Keynesians talk about stimulus. If you read DeLong, he never really talks about putting people to work with government projects - he talks about supplying the market with high quality assets (Treasuries). Everybody complains about ditch-digging as if it was promoted as a make-work project. What it was was Keynes's version of the helicopter drop.

You ask: "I'd be interested in hearing whether this analogy works and how it might be extended."

This is my extension: http://factsandotherstubbornthings.blogspot.com/2011/03/stimulus-and-jigsaw-puzzles.html

The analogy could be further extended by blending with Theory of Constraint principles. Due to relative scarcity differentials and the fact that most goods are only useful in certain quantitative combinations with others goods, it's virtually impossible to imagine a world where some few fundamental constraining goods did not result in a multitude of slack variables in the remaining goods. To create a meaningful "picture" that used all or even most of the "pieces of the puzzle" amounts to Utopian dreaming. But I guess intentions are more important than results for some minds. Great post..thank you.

@Daniel

So what would be the picture in real life? If there is indeed a picture showing how the patterns should fit, where is innovation in your analogy?

I understood this analogy to be about figuring out a pattern when there is no clear picture of the final image which I consider to be an apt analogy given the future is uncertain and that economic factors are constantly changing.

Working without a total picture as a metaphor for future uncertainty is probably another good extension, toxicafunk, but that was actually not what I was saying.

Contrary to what Steve may expect, I accept all he has to say about the complexity and interdependencies of capital and other means of production, and I don't think there's all that much controversy over that. Keynesians, to my knowledge, have not abandoned specialization, exchange, and the market process!! Innovation is similar to the way that Steve described it - figuring out new ways to combine puzzle pieces in a productive way. Of course the economy isn't static. Real innovation involves dreaming up whole new puzzle pieces and whole knew puzzles. But that's OK - I don't think a metaphor has to capture everything.

What I was suggesting was that Keynesians argue that an important price distortion - a distortion of the interest rate - cuts into investment during downturns. Interest rates become artificially high relative to the interest rate that would clear the loanable funds market. Information from prices is distorted in such a way that a lot of potential investment opportunities become unviable. In the puzzle analogy, one way to talk about this is to say that some puzzle pieces have been flipped over. People putting together the puzzle are receiving distorted information about where the pieces go, and what was recently a viable investment opportunity becomes unviable by virtue of the price distortion. When this happens in building puzzles, we flip the piece back over so we have the information we need to put the puzzle together again. That's all Keynesians propose - eliminating the price distortion.

Daniel:
"The market sorts out what is viable at certain interest rates, not the government."

But the government is setting that rate of interest, not the market. I guess in the end it still gets down to Austrians believing that the market will sort out the proper price for capital, and Keynesians believing that government, in its benevolent wisdom, knows better what that price should be - well, as long as government is listening to the Keynesians.

@Daniel

So how did price distortion occurs in the bust? AFAIK the busts occurs because of an initial distortion in loanable funds market, according to you, Keynesians argue that busts occur naturally and the job of economic planners is to lower them again, right?

While I got your attention, you also argue that the benefit from stimulus is to eliminate the price distortion in the interest rate, but to do that you'd first need a way to objectively determine the natural rate of interest, so how do you do that?

thx.

This analogy brings to mind Theory of Constraints: "Activating a resource is not synonymous with utilizing a resource." Which, until now, I haven't associated with macro economics. This puzzle analogy seems to make the case that theory of constraints has some application in the larger realm beyond business management.

Troy...The beep is a reward

What about false beeps? What about the rewards people/entrepreneurs received from distorted(puzzles that didn't really fit) parts of economy?

My two year-old would make a great Keynesian, but even my four year-old understands the basic concepts of design and intentionality.

Imagine that this puzzle is moving through time so that it takes on a 3-D look. Each puzzle piece you place consumes precious time, and before you know it, the clock strikes 12 and you fall asleep exhausted. You wake up in the morning only to discover that the software code has changed and you need to rebuild a part of your puzzle. This reminds me of Mark Twain's description of navigating the Mississippi River--it's changing all the time and maps become outdated.

This puzzle process also is analogous to the bio-chemical designs scientists create on the nano-technology scale.

The stimulus must distort the market.

Instead of satisfying consumers, businesses will want to satisfy requirements for getting simulated.

Steve, a quick question on a somewhat related topic.

Has there been any serious "Austrian" responses in the literature to New Keynesian versions of the New Neoclassical Synthesis?

@ Daniel

I'm sorry, but the last paragraph of your comment from 11:27 am today in defense of Keynesianism, serves only as evidence of Keynesianism as just so much elitist, arrogant tripe.

Keynesians suppose that they can somehow see what nobody else can see and that they know - at all times - the correct value of all assets. They suppose that profit seekers will not identify asset prices moving away from fair value and will not seek to capture this difference. That is an extraordinary thing to say.

Keuhn: Interest rates become artificially high relative to the interest rate that would clear the loanable funds market.

How do you know? If there are millions of market participants seeking to loan funds for profit and they are unwilling to lend at a lower rate, on what basis does a handful of Keynesians, with no stake in the outcome, claim that the asking price of money is too high? An increase in interest rates is virtually the definition of scarcity in loanable funds, not an indication of excess loanable funds. It is the hubris of the Keynesian position that if the funds are sitting somewhere, they must be loanable. Funds are only loanable when those who possess them are willing to lend them and lenders communicate their willingness to lend by adjusting the interest rate.

Keuhn: Information from prices is distorted in such a way that a lot of potential investment opportunities become unviable.

I don't understand what that means. Price is information. When the price of capital rises it reduces the return on investment. Some investments may become unviable. So? I don't know what the definition of "a lot" is and I don't know that it matters. How do you measure "information from prices"?

From the rest of your paragraph, I gather that you mean that the price itself is distorted. That the price of an asset has deviated from its fair value. If that is what you mean, fine.

A deviation of price from fair value is known as an "arbitrage opportunity". Specifically, it is called "statistical arbitrage" - it's statistical because the fair value is also a calculated guess. Billions if not Trillions of dollars are devoted to the capture of this "edge" (the deviation of the price from fair value). These price deviations happen all the time and the greater the deviation, the greater the the edge and the greater the willingness to devote more resources to compete with all other arbitrageurs to capture that edge, driving the price back to fair value.

In other words, there are millions of pairs of eyes looking for turned over puzzle pieces and seeking to profit from flipping them right side up.

You are in effect arguing that Keynesians are the most magnificent arbitrageurs in the world because they see what nobody else does. How? How do they gain this incredible insight that cannot be had by millions of others? Is it magic? Are they clairvoyant?

There's profit in flipping over the right puzzle pieces. If they're so smart, how come they aren't so rich?

Sandre,

The false beeps are created when we adopt Keynesian policies that create price distortions. Which gets us back to Steve's points. The machine is false-beeping. We have to get rid of the Keynesian distortions in the market in order to get true beeps. When we adopt Keynesian policies to drive down interest rates, below what the market has them -- which can be done by printing money, thus reducing the effective interest rate -- there is a price distortion that encourages people to take risks they would not have taken otherwise. That's a false beep.

Methinks -
re: "Keynesians suppose that they can somehow see what nobody else can see and that they know - at all times - the correct value of all assets. They suppose that profit seekers will not identify asset prices moving away from fair value and will not seek to capture this difference. That is an extraordinary thing to say."

Not sure where you got this, but let me just clarify in big bold neon letters that I don't think any of these things.

re: "Price is information. When the price of capital rises it reduces the return on investment. Some investments may become unviable. So?"

It's much the same reason Austrians get concerned about fluctuations in the interest rate - why they're not sanguine and calm about what happens to the interest rate in the boom. Austrians think there is essentially a price ceiling on the interest rate during the boom. Keynesians argue that there is essentially a price floor on the interest rate during the bust.

re: "A deviation of price from fair value is known as an "arbitrage opportunity"."

Hmmmm... would you refer to the minimum wage as an arbitrage opportunity? Of course not. Why do you do that here?

re: "You are in effect arguing that Keynesians are the most magnificent arbitrageurs in the world because they see what nobody else does. How? How do they gain this incredible insight that cannot be had by millions of others? Is it magic? Are they clairvoyant?"

You are seeing only a calculation problem, when the real problem is an incentive problem. Labor market surpluses as a result of a minimum wage don't occur because of calculation problems - if they did, as you say, arbitrageurs would solve it quickly. Loanable funds market surpluses as a result of liquidity preference don't occur because of calculation problems either, and arbitrageurs are in no more a position to solve that problem than they are to solve the labor surplus under a minimum wage.

Indeed, labor market surpluses as a result of a minimum wage don't occur because of caluculation problems -- they occur because people are priced out of the market. The calculation process is working just fine. This is true of all price distortions. People are reacting rationally to the prices as given. If there is a surplus of loanable funds, you can be sure that there is an interest rate distortion. When the government distorts the market -- which is pretty much all it does and can do -- you get shortages and/or surpluses. Which is, of course, the intention of such distortion. What is always at issue is whether there should be such distortions, and whether they have the effect intended. They almost never do.

re: " If there is a surplus of loanable funds, you can be sure that there is an interest rate distortion. When the government distorts the market -- which is pretty much all it does and can do -- you get shortages and/or surpluses."

Did Troy Camplin just agree that we have a surplus in loanable funds above what investors are willing to use because the interest rate is artificially too high???

I must be dreaming.

You're going to be booted off the Austrian island if you're not careful, Troy. Maybe you haven't crossed the line yet, but you're getting dangerously close.

@Daniel,

Where I "got this" is that it is implied in your refutation of Boudreaux's and Horowitz' claim that Keynesians don't care how resources are allocated as long as they're deployed (dig the ditch). You complain that they misunderstand Keynesians' wisdom and depth. They, in fact care (I buy that) and they only want to turn over the puzzle pieces that are wrong side up. To do this, a handful of people must be so incredible that they know that which the market does not. If you don't agree with my conclusion, then please tell me HOW they know that pieces are upside down when nobody else knows.

I'll just agree with Troy on the issue of minimum wage. Minimum wage is a distortion created and enforced by government. It is not naturally occurring phenomenon and you'll forgive me for not seeing the logic in correcting government created distortions with more government created distortions.

Kuehn: "You are seeing only a calculation problem, when the real problem is an incentive problem."

No, I'm not seeing a calculation problem at all. The market can calculate the price distortion as well as is humanly possible. I'm telling you that we are calculating a price distortion and we have every incentive to correct that price distortion.

You are pointing to a government created distortion (minimum wage) that the market is prevented from correcting and claiming that the market CAN'T correct it. Do you not see the silliness?

Keuhn: "Loanable funds market surpluses as a result of liquidity preference don't occur because of calculation problems either".

Why not?

re: "To do this, a handful of people must be so incredible that they know that which the market does not. If you don't agree with my conclusion, then please tell me HOW they know that pieces are upside down when nobody else knows."

This is getting to the point of stretching the metaphor to its limits. No Keynesian suggests that we pick out investments and say "OK - now this one, this one, and this one should be viable". What happens is that you know real interest rates are too high, you know some signs that indicate when they are no longer too high, and you lower the interest rate to allow the price mechanism to "flip over the pieces".

If you can figure out a good way of saying that with a jigsaw puzzle metaphor, please let me know. I did my best. Metaphors go only so far. As I've said a couple times at this point, the price mechanism "chooses" what investments are viable at what cost of capital. The Keynesian intervention is to reduce the distortion in the cost of capital, not to do the work of the price mechanism in making investment-specific economic calculations.

re: "No, I'm not seeing a calculation problem at all. The market can calculate the price distortion as well as is humanly possible."

Precisely. I'm not disagreeing with this. I said you see the calculation problem as the only problem to be solved. If that were the only problem to be solved, then I would agree the market is up to the task.

re: "You are pointing to a government created distortion (minimum wage) that the market is prevented from correcting and claiming that the market CAN'T correct it. Do you not see the silliness?"

WHAT? The market can't correct it. That's my point. The way to correct it is to end the distortion - to end the government policy. Markets can only use the information available. If you give them bad information (minimum wage price floor/interest rate price ceiling) you're going to get a bad result. The solution is to eliminate the distortion.

Scratch that - interest rates in a depression are a price floor as well - not a price ceiling.

Keuhn: "WHAT? The market can't correct it. That's my point. The way to correct it is to end the distortion - to end the government policy."

The market can and will correct it if the brick wall of government were not there. I'm saying the same thing differently. Your starting point is the natural existence of government policy. Mine is the lack of it. if I remember my reading of Keynes correctly (many millions of years ago, so cut me some slack), he started with these distortionary policies and built his prescription to accommodate them. I seem to remember labour unions very prominently factored into his General Theory.

Keuhn: "No Keynesian suggests that we pick out investments and say "OK - now this one, this one, and this one should be viable".

No. Keynesians don't care which one is viable and which one isn't. I'm not saying they wouldn't prefer positive NPV projects, but it doesn't matter. Dig ditches, fill them in again.

Keuhn: "What happens is that you know real interest rates are too high, you know some signs that indicate when they are no longer too high, and you lower the interest rate to allow the price mechanism to "flip over the pieces".

We can leave the pieces alone if you want. Refresh my memory, please: what determines the interest rates and how do you know they're TOO high (that they're high or low, we can observe)? What is the prescription?

Don't make too big a deal out of a sentence that begins with the word "if." I did not agree that such was the case -- I just said that if it were the case, it was caused by distortions. If there are excess lendible funds, it may also be the case that people are afraid to borrow because of all the idiocies they see the government engaged in. Faced with regime uncertainty, who in their right mind wants to borrow?

Let's suppose I opened a restaurant and offered bull sperm and cow eyeball soup. Now, if I'm not selling any at $5 a bowl, does that mean I am pricing it too high? Or might there be some other reason why nobody wants it?

The same with lendible funds. One interpretation is that if there is an excess, the interest rates are too high; another interpretation is that nobody in their right mind wants to take out a loan under current circumstances.

Troy,

Isn't the other reason that risk premiums have increased? That they were too low before? Another way to say it is there aren't as many viable projects as we thought there were before we realized they were never viable?

Indeed, there are a lot of factors at play making borrowing unattractive.And do not forget that the Fed is actively discouraging lending to try to keep the money they created from getting into the economy. That, of course, is failing as we speak.

So, has there been any "Austrian" engagement at the formal level of the post-RBC macro of the last 10-15 years, e.g. DSGE New Keynesian macro, what some call the New Neoclassical Synthesis?

It's not at the level I think you're looking for Greg, but my exchange with Gauti Eggertsson at Econ Journal Watch does get at a few of the issues. Here's my last of the exchange: http://econjwatch.org/articles/unfortunately-unfamiliar-with-robert-higgs-and-others-a-rejoinder-to-gauti-eggertsson-on-the-1930s

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