Daniel Kuehn Falls Into My Gnome Trap Headfirst
I actually have to get a bunch of “real work” done before flying to Vienna this weekend, and I’ve yet to earn the luxury of blogging a full response to Karl Smith on this gnome business. But for now, let me just point out that Daniel Kuehn tried to jump in on the action, and broke a battle over Maynard’s head without realizing it.
Remember, the whole point of my post–if you don’t believe me, look at where I summarized its lesson here right after it ran–was that I thought I had come up with a clear-cut “supply side” scenario that the Keynesians would mistakenly diagnose in the same way that they are treating our current recession.
So in that light, look at what Daniel Kuehn ironically had to say, after mulling over Karl and my exchange:
So the gnome attack thought experiment has to do with the capital heterogeneity issue.
I’m not sure I entirely get Bob’s point here. If gnomes attack like this, how would Keynesians talk about it? They’d say it’s a sharp fall in the marginal efficiency of capital, wouldn’t they? Bob acts like Keynesians have no way of talking about specific capital that doesn’t work well, so they try to fit the square aggregate demand peg into the round hole in the observed data. That seems wrong to me.
Now – as I’ve pointed out previously – Keynesianism relies on heterogeneous capital…
Keynesians wave their hands at specific distortions of the capital structure, but they at least have a way of incorporating it into their models – namely the marginal efficiency of capital. There are lots of ways that the capital structure could be distorted. Gnome attacks. Zombie attacks (not as effective as gnomes). Ninja attacks (this would probably be even more effective than gnomes). Pirate attacks, etc. Of course if you really stretch your imagination you could also consider technological advance and obsolescence, political instability, interest rate distortion of the time structure, changes in regulations, wars, bottlenecks in energy supplies, and other problems messing up a heterogeneous capital structure too. It’s not clear to me why we would want to stake a business cycle theory on any single problem with the capital structure, particularly when we typically think entrepreneurs are more or less rational and profit maximizing. I prefer the more general Keynesian approach which explains how – given a particular marginal efficiency of capital – the economy can sit at an equilibrium below full employment.
Yet Daniel is leaving out a biggie in terms of what Keynesians think can push down the marginal efficiency of capital: a drop in expected future demand for a business’ products. That’s the mechanism through which “animal spirits” can lead to a slump, after all.
In any event, how does a Keynesian propose to fix a drop in the marginal efficiency of capital? It would depend on why the marginal efficiency dropped, wouldn’t it? If the Keynesians knew it had fallen because of a supply shock, then (hopefully) they’d sit back and let nature take its course. In contrast, if it fell because of a drop in demand, then they would recommend monetary or fiscal stimulus.
Incidentally, I hope Daniel’s point isn’t that the Keynesians could look at video footage of the gnomes moving stuff around, and then declare, “Whoa, supply shock! Nobody touch the fed funds rate!” Obviously it’s cheating to know what the actual cause is.
Rather, my point is that the standard Keynesian diagnostics would react to a gnome attack the same way they’d react to a balance-sheet driven drop in AD. Daniel Kuehn’s post confirms my claim.
Please report back as to whether those Wieners have Strauss Waltz karaoke.
http://www.youtube.com/watch?v=U8Q3X5Gw5I4&feature=related
Will do. I know David Hasselhoff is big in Germany; I may try “Hooked on a Feeling” in Vienna.
You’ll probably need to pick up a toupee and a light-up jacket if you want to pull that one off.
As well as being drunk eating hamburgers on the floor of a bathroom in his gitch.
Keynesians don’t need to react to a gnome attack. They will prevent it with an appropriate fiscal stimulus to finance an efficient anti-gnome SWAT team that will dwarf any attack before they could think of it.
Don’t belittle yourself with this strawgnome argumente, Bob.
Keynesians don’t need to react to a gnome attack. They will prevent it with an appropriate fiscal stimulus to finance an efficient anti-gnome SWAT team that will dwarf any attack before they could think of it.
What if the government are the ones financing the gnomes?
Don’t belittle yourself with this strawgnome argumente, Bob.
He wasn’t attributing to Keynesians any argument they do not have, so it’s not a straw man.
Run through why it would be cheating to refrain during gnome attacks? You stopped quoting me right before I wrote this:
“This hasn’t prevented Keynesians from identifying specific problems when they’re relevant. When the oil embargo happened, didn’t everybody agree there was an oil embargo? When the dustbowl happened, didn’t we all agree about the role of the dustbowl? Haven’t we all agreed about the role that mortgage backed securities played in distorting the capital structure more recently? I don’t see why Bob thinks this would be such a mystery. If gnomes struck I think we’d all agree about the gnomes too.”
We usually have a pretty decent sense of what our troubles are, right? If you want to imagine a world where we don’t know what our troubles are, I suppose that’s fine. One could conceive of a world where we are totally clueless. But historically we’ve done an OK job at sorting out supply and demand. To the extent that cows in factories and drill presses in fields become a problem in the future, I would think we would be able to recognize that problem for what it is (even if we didn’t know the gnomes did it). But even if we don’t – if you really want to create this fantasy world where everyone is in complete ignorance – what is the Austrian solution? To work out the malinvestments? Just keep the drill press in the field and the cow in the factory until the firms go out of business? Or what I don’t even know what.
The point is, if your motivating assumption is that the capital structure magically becomes incomprehensibly unproductive and nobody has insights as to why that might be I agree there is little hope for a coherent recovery from that situation. Why you are theorizing such a situation confuses me.
Your problem is that you are trying to criticize “standard Keynesian diagnostics” by putting a whole suite of “standard Keynesian diagnostics” (really just intelligent person diagnostics) out of reach as “cheating”. Karl Smith pointed this out to you too, Bob.
The drill press really isn’t in the field and cow isn’t really in the factory.
Instead, these item and all others, including interest rates, have all been mis-priced thanks to the thievery and money dilution practices of the central bank. Bob Murphy’s gnome example was necessary because the actual Austrian analysis (apparently) cannot be comprehended (which has always astonished me).
[W]hat is the Austrian solution? To work out the malinvestments? Just keep the drill press in the field and the cow in the factory until the firms go out of business? Or what I don’t even know what.
DK, we know you don’t even know what.
Hayek:
“The primary cause of the appearance of extensive unemployment, however, is a deviation of the actual structure of prices and wages from its equilibrium structure. Remember, please: that is the crucial concept. The point I want to make is that this equilibrium structure of prices is something which we cannot know beforehand because the only way to discover it is to give the market free play; by definition, therefore, the divergence of actual prices from the equilibrium structure is something that can never be statistically measured.
Your problem is that you don’t know how to admit you got caught. You seem to be unable to take such things gracefully.
Bob was specifically talking about recessions and depressions, aggregate economic calamities, not sector or industry specific problems like oil embargoes or dustbowls or mortgages. That is all just esoteric hand waving on your part.
Keynesians can’t explain why these sector specific problems would accompany economy wide problems without falling back on the old falling monetary demand story. That was Bob’s point, and he is right on.
And what’s with this “the capital structure magically becomes incomprehensibly unproductive and nobody has insights as to why that might be” nonsense? The Austrian theory specifically addresses WHY the capital structure would become unproductive and they DO have insights as to why that is the case.
Bob is criticizing the Keynesian theory by showing an example where the problem really is “supply-side”, but Keynesians would have no other option than to fall back on “it’s demand stupid!” because they don’t have an adequate capital theory.
You claim that Keynesian economics relies on heterogeneous capital. Oh really? So why the one-dimensional “K” to sum it all up? Why the focus on “investment” rather than “investment in different productive stages or orders”? Why “THE marginal efficiency of capital” instead of “marginal efficiency of capitals in particular stages”? The only Keynesians who are even utilizing heterogeneous capital in their models are those who have moved AWAY from Keynes and adopted a more Austrian capital approach.
Keynes even writes:
“It is my belief that much unnecessary perplexity can be avoided if we limit ourselves strictly to the two units, money and labour, when we are dealing with the behaviour of the economic system as a whole…and the use of vague concepts, such as the quantity of output as a whole, the quantity of capital equipment as a whole and the general level of prices, to the occasions when we are attempting some historical comparison which is within certain (perhaps fairly wide) limits avowedly unprecise and approximate.”
“It follows that we shall measure changes in current output by reference to the number of hours of labour paid for (whether to satisfy consumers or to produce fresh capital equipment) on the existing capital equipment, hours of skilled labour being weighted in proportion to their remuneration. We have no need of a quantitative comparison between this output and the output which would result from associating a different set of workers with a different capital equipment. To predict how entrepreneurs possessing a given equipment will respond to a shift in the aggregate demand function it is not necessary to know how the quantity of the resulting output, the standard of life and the general level of prices would compare with what they were at a different date or in another country.”
You even admitted that Keynesians must fall back on demand in order to explain actual supply-side problems. Your attempt was to invoke “the marginal efficiency of capital” doctrine. Maybe you don’t understand Keynesian economics but the marginal efficiency of capital doctrine is fully and totally DEPENDENT on “the square aggregate demand peg.” It is a money-based, i.e. demand-based, doctrine!
Keynes advanced three reasons why the marginal efficiency of capital would fall in a depression:
1. As more net investment takes place to offset the additional saving accompanying the additional employment, the prices of capital assets would rise, in response to the increase in demand for capital assets constituted by the additional net investment. (This by the way is false, because capital asset prices would fall when wage rates and prices fall as they would in a depression that is left to run its course without government interference).
2. As more net investment takes place, it means more capacity in place, which means lower selling prices of products, which, other things being equal, means a fall in profitability. (This is false, because not everything else is equal. Wages and prices are falling!).
3. Diminishing returns would accompany more net investment that was required to offset the additional saving taking place as employment, output, and real income expanded. (This is false, because not only are diminishing returns not connected to profitability, but coming out of a depression, as more formerly unemployed people are employed again, the ratio of labor to capital rises, which increases returns, it doesn’t decrease returns).
With these three reasons, it is clear that “more aggregate demand” is the implied solution. The first reason depends on prices and hence demand. The second reason depends on prices and hence demand. The third reason appears to be supply-side driven, but is not related to a distorted capital structure scenario that Bob is speaking of, but rather to a non-distorted “savings glutted” economy that allegedly cannot profitably invest all the savings because of the law of diminishing returns.
In other words, Bob’s gnomes succeeded in tricking you and that is probably making you mad.
re: “Bob was specifically talking about recessions and depressions, aggregate economic calamities, not sector or industry specific problems like oil embargoes or dustbowls or mortgages. That is all just esoteric hand waving on your part.”
Wait a minute – let me get this straight. Bob is talking about gnomes and I am talking about things that actually happen – and I’m doing the esoteric hand waving?!?!?!?
Bob wants to say “if you just look at aggregates you won’t know what the underlying causes are”.
That’s why Karl Smith and I have both responded “this is precisely why nobody ever suggested we should just look at aggregates.
For some reason that’s “cheating”. I have no idea why.
Usually Bob doesn’t fall into this, but he’s doing exactly what is so frustrating for people about a lot of Austrians on the internet. They insist that you defend what they want you to defend even if it’s completely insane.
That’s why Karl Smith and I have both responded “this is precisely why nobody ever suggested we should just look at aggregates.
Really? Then why are all Keynesian policy recommendations currently grounded solely on inferences from aggregates? i.e., “AD/NGDP fell, so we need to jack up spending (on what, it doesn’t matter, just spend, on something, anything).”
I don’t see anything in there about, “Well, AD fell, AND we checked out that all capital was being used productively (even though all the structures built around perpetual home value increases turned out to be useless), so it looks like we gotta goose AD “
“We should not just look at aggregates” does not mean “we should not look at aggregates”.
I’m not wasting any more time with you today than that clarification. If you think there are people that only think about, talk about, and look at aggregates than you are reading people I personally haven’t stumbled across yet.
I’m not wasting any more time with you today than that clarification. If you think there are people that only think about, talk about, and look at aggregates than you are reading people I personally haven’t stumbled across yet.
That’s not what Silas is saying. He is not saying that Keynesians never look out their window and see single factories, single laborers, single industrial sectors, etc. He is saying that the Keynesian policy prescriptions are almost universally aggregate focused. Aggregate demand, aggregate employment, etc.
Way to not address a single SUBSTANTIVE argument in my last post. Sounds like either you’re intellectually unable to do it, or you are, but you prefer to debate back and forth over lower level mockings and flinging insults.
Wait a minute – let me get this straight. Bob is talking about gnomes and I am talking about things that actually happen – and I’m doing the esoteric hand waving?!?!?!?
MORE hand waving. Oh you’re good.
No, Bob is providing a thought experiment concerning the aggregate economy that in principle can be explained using an economic theory, and you are doing esoteric hand waving by denying the context of the thought experiment and going off onto irrelevant tangents of sector specific issues that do not relate to it. They are desperate defenses of someone clearly backed into a corner.
Bob wants to say “if you just look at aggregates you won’t know what the underlying causes are”.
That’s why Karl Smith and I have both responded “this is precisely why nobody ever suggested we should just look at aggregates.
Nice diversion. Bob isn’t suggesting that all Keynesians everywhere ONLY look at aggregates. He is saying that the Keynesian theory has no other explanation for the collapse in production and employment than to fall back on aggregate demand.
At any rate, Keynesians DO suggest all the time to look at aggregates, especially aggregate demand, and not only that, but they explain recessions and depressions as caused by aggregate demand shortfalls, period.
For some reason that’s “cheating”. I have no idea why.
No, that was not what was “cheating.” The cheating Bob was referring to is breaking the 4th wall of thought experiments and deny the point he is making by saying “Of course it was the gnomes, Bob!” It should have been blatantly obvious that he wants not on Keynesians, but Austrians as well, to explain why the economy should collapse assuming we don’t know it was gnomes that caused the rearranging of capital and labor.
He wants Keynesians to use a purely economic explanation for why production and employment collapsed. He correctly anticipated that he would “catch” some Keynesian fish, and you are “Exhibit Tuna.”
Usually Bob doesn’t fall into this, but he’s doing exactly what is so frustrating for people about a lot of Austrians on the internet. They insist that you defend what they want you to defend even if it’s completely insane.
How is it “completely insane”? It’s a thought experiment for crying out loud. You know, like DeLong’s asteroid wiping out the human race thought experiment to challenge libertarian political philosophers. I don’t recall Bob or any other libertarian saying “That example is insane!” No, they all answered it.
The purpose of Bob’s example, since it needs to be spelled out to you slowly, is to isolate the core economic issues that Bob wants to address.
You’re “frustrated” by a lot of “Austrians on the internet”? Sounds like a personal problem.
It’s funny, because it is precisely YOU that “fell” for something, which was to explain away the economic problems in the thought experiment by indirectly referring to demand, which is exactly the point Bob was trying to make. He caught you into claiming that the economic collapse in the thought experiment is one that is explained by the “square demand peg” story.
Are you going to address any of the substantive arguments I made in my past post, or are you going to again relegate yourself to base antagonism?
re: “He is saying that the Keynesian theory has no other explanation for the collapse in production and employment than to fall back on aggregate demand.”
And we’ve explained several times at this point why that’s wrong. If you want to pretend we’re not speaking to your substantive points, then go off into your echo chamber and keep believing that.
re: “How is it “completely insane”? It’s a thought experiment for crying out loud. You know, like DeLong’s asteroid wiping out the human race thought experiment to challenge libertarian political philosophers. I don’t recall Bob or any other libertarian saying “That example is insane!” No, they all answered it.”
No you’re missing my point. Bob tells us what version of Keynesianism he wants Keynesians to defend, and when we say “that’s a dumb version of Keynesianism”, we’re allegedly “cheating”. If I recall DeLong was responding to the asteroid point and there were lots of libertarians (not Bob) who said it would be fine to have a government response. And DeLong accepted that they thought that, to my knowledge.
With tihs gnome example we’re being told what position Bob wants us to defend. Have you ever played a board game with a six year old (I imagine Bob has). It feels like that – they tell you what rules you have to follow and what plays you have to make.
re: “Bob is criticizing the Keynesian theory by showing an example where the problem really is “supply-side”, but Keynesians would have no other option than to fall back on “it’s demand stupid!” because they don’t have an adequate capital theory.”
Why do you think Keynesians “would have no other option”? This is the critique that both Smith and I made but Bob hasn’t spoken to. We have had both supply shocks and demand shocks and Keynesians and everyone else seems to be pretty capable of telling the two apart.
So explain to me why Keynesians would have no other option than to fall back on “it’s demand”. Enlighten me why you think that’s the only option.
Why do you think Keynesians “would have no other option”?
Because their theory is lacking.
Ask yourself why you explained the collapse in production by falling back (indirectly through marginal efficiency of capital) on “It’s demand!”
This is the critique that both Smith and I made but Bob hasn’t spoken to. We have had both supply shocks and demand shocks and Keynesians and everyone else seems to be pretty capable of telling the two apart.
More diversions. Is this your specialty? To continually deny the context of the arguments you are addressing and to change them so that you can argue against them instead?
I didn’t say that Keynesians don’t know what a supply shock is or what a demand shock is. The context is economy wide depressions. The context is explaining why economy wide depressions occur. Keynesians reject supply side explanations. They hold depressions to be demand caused.
So explain to me why Keynesians would have no other option than to fall back on “it’s demand”. Enlighten me why you think that’s the only option.
I look at what Keynesians are saying. I look at them vehemently deny supply side explanations for recessions and depressions.
Why did you fall back on demand in the obviously supply side thought experiment?
re: “Keynesians reject supply side explanations. They hold depressions to be demand caused.”
OK, it’s clear you have no idea what the hell you’re talking about. This is pointless.
re: “Oh really? So why the one-dimensional “K” to sum it all up?”
The exact same reason that Garrison uses K to explain ABCT and why Hayek uses an undifferentiated “factors of production” to explain ABCT:
1. Because aggregation along a single dimension is not the same as homogenization along all dimensions
2. Ease of expositions/pedagogical reasons
3. Insensitivity of the result to disaggregation (ie – replace “K” with “sigma Ki” and let i go from 1 to inifinity, and you’ll get the same insight)
So unless you’re going to criticize Garrison and Hayek for this too, don’t bring it up with Keynesians. My advice to you, though, is not to criticize Garrison or Hayek for it. They use it for a good reason and they don’t follow your suggestion here because your logic is bad.
To bring Garrison and Hayek into this, both of who adhere to the “Hayekian triangle” capital structure of production, who do in fact differentiate capital to explain ABCT, is intellectually bankrupt. Garrison does NOT use “K” to explain ABCT. He uses Hayek’s triangle which delineates capital into different stages.
Garrison and Hayek do not BASE their theory on homogeneous capital. Keynesians do. To the extent that Garrison utilizes “capital” as such, it is to explain aggregate production levels. It is not to explain production as such.
So unless you’re going to criticize Garrison and Hayek for this too, don’t bring it up with Keynesians. My advice to you, though, is not to criticize Garrison or Hayek for it.
Sorry, I can and I will bring it up with Keynesians, because unlike Garrison and Hayek, they do base their theory on homogeneous capital and it’s not just for pedagogical purposes, it’s because they don’t understand capital. They lack an adequate theory of capital. There is no heterogeneous capital structure theory in the Keynesian worldview.
They use it for a good reason and they don’t follow your suggestion here because your logic is bad.
My logic is bad? Your logic is absent.
As Krugman likes to say, you don’t need to refill a flat tire through the hole.
I agree with Daniel. I think what you’ve done is presuppose an world in which there is an extreme ABC recession and asked Keynesians how they would use Keynesian solutions. Of course, in a world where ABC is true Keynesians wouldn’t have any solutions.
It’s sort of like saying ‘what if every first born had a heart attack?’ Well, yes, the economy would be f**ked beyond belief, as would everything else. But ultimately it’s an empirical question whether our current problems are demand side or structural, and the gnome thought experiment doesn’t answer that.
I agree with Daniel. I think what you’ve done is presuppose an world in which there is an extreme ABC recession and asked Keynesians how they would use Keynesian solutions.
Nope. Bob just changes the locations of capital and labor and then asked how would the Keynesians “deal” with it.
It wouldn’t be unfair to the Austrians if Keynesians imagined an “extreme demand problem” where say 99% of the money supply disappears, and then asked the Austrians: “OK Austrians, what does your theory say the problem is and what does your theory hold as the solution?”
The Austrian theory would be fully capable of explaining it if they were not advised it would happen, but that it just did. Austrians would see aggregate demand collapse, and the solution would be for prices for everything to fall through the market process.
It’s sort of like saying ‘what if every first born had a heart attack?’ Well, yes, the economy would be f**ked beyond belief, as would everything else. But ultimately it’s an empirical question whether our current problems are demand side or structural, and the gnome thought experiment doesn’t answer that.
No, it’s not an empirical question whether our problems are demand side or structural. It’s a theoretical question of correctly interpreting the data. If you try to interpret the data using a demand side theory, then you can ALWAYS explain away every depression as “demand is wrong.” If you try to interpret the data using a supply-side theory, then you can ALWAYS explain away every depression as “supply is wrong.”
What you need to do is compare theories against each other using another method that is based on understanding, not past data.
‘Nope. Bob just changes the locations of capital and labor and then asked how would the Keynesians “deal” with it.’
Well there’d be little you could do from a policy perspective, because it’s a ridiculously dire situation. The question is whether or not this is what’s happening.
‘The Austrian theory would be fully capable of explaining it if they were not advised it would happen, but that it just did. Austrians would see aggregate demand collapse, and the solution would be for prices for everything to fall through the market process.’
What would be wrong with expanding the money supply?
‘No, it’s not an empirical question whether our problems are demand side or structural. It’s a theoretical question of correctly interpreting the data.’
It’s not an empirical question, it’s a question of interpreting the data ?? Those two sentences mean the same thing.
‘If you try to interpret the data using a demand side theory, then you can ALWAYS explain away every depression as “demand is wrong.” If you try to interpret the data using a supply-side theory, then you can ALWAYS explain away every depression as “supply is wrong.”’
Let me get this straight – you are arguing that you can interpret anything from data? That seems obviously untrue.
For example, if there were a similar amount of job vacancies as unemployed people the problem would clearly not be demand side.
I have to be quick. Like I said, Daniel, I intend to do a really exhaustive response to you and Karl. But for right now, let’s go through the other examples you list, when Keynesians know full well there are supply shocks going on:
(1) Dustbowl. So Keynesians were against demand pumping in the 1930s?
(2) Oil embargo. Right–this coincided with stagflation. Too bad the Keynesians at the time didn’t recognize it and demand they stop inflating.
(3) MBS today. Yay, we agree! Karl seems to think there’s not a supply shock going on. That’s what started the whole gnome thing in the first place. We Austrians are saying the capital structure is all screwed up, and Karl is saying, “No, we’ve got idle factories and workers sitting on their couches.” So Daniel please tell him it’s a supply shock, not a problem of inadequate demand.
===
NOTE: I’m being facetious in the above. I recognize that you and Karl think there is a dinky little supply shock that might explain a dinky little slowdown in GDP growth because of a slowdown in housing construction for X quarters, but that can’t explain the huge mess we’re in. And I’m saying, I think you are not properly gauging how screwed up and unsustainable the world capital structure was in mid 2006. If today’s prominent Keynesians had any idea how screwed up and unsustainable it was, they wouldn’t naively look at GDP, and plot a dotted line upward from 2006 on, calling that “potential output.”
In his later post Bob then highlights that he believes that the situation we are now in is not dissimilar to the aftermath of the gnome-attack because of “how screwed up and unsustainable the world capital structure was in mid 2006”.
Undoubtedly the housing boom caused a distortion (as explained by the ABCT) and the various stimulus packages we have had since have hardly helped the market to fix those distortions. That said: Can that be the whole story ? What about the huge amounts of leveraging (aka increase ion the demand for money) that have taken place since that has undoubtedly reduced AD by way more than can be explained by the housing bust ?
I’m not saying that this means we need AD stimulus but I am trying to highlight that seeing everything as down to the distortions in the structure of production due to the bubble, and ignoring secondary factors (which may in fact have a larger net effect) is to misdiagnose the current situation.
“de-leveraging” not leveraging.(typo in last post)