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The Paradox of Thrift

There seems to be some confusion about what this is. Wikipedia knows what’s up:

The paradox of thrift (or paradox of saving) is a paradox of economics, popularized by John Maynard Keynes, though it had been stated as early as 1714 in The Fable of the Bees,[1] and similar sentiments date to antiquity.[2][3] The paradox states that if everyone tries to save more money during times of economic recession, then aggregate demand will fall and will in turn lower total savings in the population because of the decrease in consumption and economic growth. The paradox is, narrowly speaking, that total savings may fall even when individual savings attempt to rise, and, broadly speaking, that increase in savings may be harmful to an economy.[4] Both the narrow and broad claims are paradoxical within the assumption underlying the fallacy of composition, namely that what is true of the parts must be true of the whole. The narrow claim transparently contradicts this assumption, and the broad one does so by implication, because while individual thrift is generally averred to be good for the economy, the paradox of thrift holds that collective thrift may be bad for the economy.

Exactly. Very straightforward. Whether or not you agree with it, that’s what the “paradox of thrift” is. It’s about saving–“thrift”–and it’s paradoxical, because when the community tries to save more, they end up saving less. Hence, “the paradox of thrift.” Very neat and tidy.

In contrast, if someone says “the paradox of thrift” is “really about” a mismatch of saving and investment, and that if the community suddenly decided to invest less, that this too would be “the paradox of thrift”…well no, that not only is wrong, but it would make no sense at all.

If you open any textbook that has the actual phrase “paradox of thrift” in it, I am quite sure it will define it along the above lines. If someone can show me a textbook saying that a community deciding to invest less–where that is the starting point of the analysis–is an example of the paradox of thrift, I will PayPal the first such person $25. And I will take it out of my investment spending.

Papola Has a Barrel of Ink

Uh oh, I think John took it personally when some people accused him of dishonesty and/or ignorance. (Words hurt, kids.) Remember, the issue here is that John in his latest Christmas video is taking on the “fallacy” (his term, which he attributes to Keynes and others) that consumption drives the economy, and that if everyone just consumed more, the economy would be fine. Some people said this is a total misreading of Keynes, and that Keynesianism says no such thing. So John defended his honor and struck back with this in the comments over at Daniel Kuehn’s blog (I’m not going to bother fixing the hyperlink formatting):

http://www.themoneyillusion.com/?p=17187

Here’s LAURA D’ANDREA TYSON and OWEN ZIDAR in the NY Times:

“These demand-side forces explain why consumption goes up much more after tax cuts for the bottom 95 percent than after equivalently sized cuts for the top 5 percent. An increase in consumption, which still accounts for about 70 percent of G.D.P., fuels increases in demand, and that leads companies to create more jobs.”

Here’s Paul Krugman in the NY Times:

http://www.nytimes.com/2008/10/31/opinion/31krugman.html
“No, what the economy needs now is something to take the place of retrenching consumers. That means a major fiscal stimulus. And this time the stimulus should take the form of actual government spending rather than rebate checks that consumers probably wouldn’t spend.”

Shouldn’t he be talking about retrenching business spending? Ehem. Yeah.

Here’s Henry Blodget:

http://www.businessinsider.com/companies-need-to-share-more-profits-with-employees-2012-12

“American consumers — the folks who account for ~70% of the spending in the economy.

Almost every dollar these folks earn in salaries gets spent — on food, clothing, houses, education, entertainment, cars, and other goods and services that big American companies produce. So, if, instead of hoarding their wealth by hiking their profit margins ever higher, companies invested more in employees and equipment, they would help the whole economy.”

Sure sounds EXACTLY like Thomas Malthus to me, there, Gene. The rich capitalists should pay their worker more since workers consume more as a share of their income. Why not just take a page from William Spence (before Malthus) and have the rich pay the poor to blow glass bubbles and then smash them?!?!?

I could go on and on and on right through Christmas day. I’ve produced a video aimed at confronting a very real fallacy being put forward by economists who should, as you note, know better and a broader media class who disseminates an even cruder version of it.

Keynes Hearts Saving?

John Papola, creator (with Russ Roberts) of the Hayek-Keynes rap videos and the latest Christmas video, is perplexed that he is getting push-back from people saying he’s setting up a strawman by implying that Keynesianism promotes the idea that consumption drives the economy.

John sent me an email with a quote from the General Theory itself, and said he had done research beforehand to be sure this wasn’t a right-wing invention. He doesn’t think it is. (And remember the Paul Krugman column I pointed to, before.)

Moreover the richer the community, the wider will tend to be the gap between its actual and its potential production; and therefore the more obvious and outrageous the defects of the economic system. For a poor community will be prone to consume by far the greater part of its output, so that a very modest measure of investment will be sufficient to provide full employment; whereas a wealthy community will have to discover much ampler opportunities for investment if the saving propensities of its wealthier members are to be compatible with the employment of its poorer members. If in a potentially wealthy community the inducement to invest is weak, then, in spite of its potential wealth, the working of the principle of effective demand will compel it to reduce its actual output, until, in spite of its potential wealth, it has become so poor that its surplus over its consumption is sufficiently diminished to correspond to the weakness of the inducement to invest.

But worse still. Not only is the marginal propensity to consume[6] weaker in a wealthy community, but, owing to its accumulation of capital being already larger, the opportunities for further investment are less attractive unless the rate of interest falls at a sufficiently rapid rate; which ‘brings us to the theory of the rate of interest and to the reasons why it does not automatically fall to the appropriate level, which will occupy Book IV.”

The General Theory – Page 28.

Two other quick points:

==> People tried to turn my Krugman column against me, by pointing to an earlier Krugman piece in which he explained that a boost in savings wasn’t a problem. Right, and in that very piece, Krugman is chiding other Keynesians for saying it would be. Thus, people are “proving” to me (and John) that Keynesians don’t actually think underconsumption is a problem, by pointing to Krugman lecturing his peers that they need to stop saying it is.

==> Daniel Kuehn and I think Gene Callahan (?) have tried to tell me that even something called “the paradox of thrift” was never a warning about the dangers of thrift, but instead was a story about a mismatch between investment and saving, and in fact would be just as applicable to a situation in which people didn’t save more, but decided to cut their investment spending. No, that would be “the paradox of investment” (or something). The “paradox of thrift” is about thrift. That’s why they called it that. If I complain that the National Institutes of Health is too focused on fighting cancer, you can’t say, “Oh, but cancer is a sickness, and so really any program program for cancer funding is really fighting all sickness.”

DeLong Smackdown on Landsburg (and Callahan)

Wow, if you thought we blogging economists were talking past each other in the Cantillon debate, DeLong’s response to Landsburg on this Thomas Nagel issue (about the ability of pure reason to give us knowledge about reality) will knock you on the ground. I don’t even know how to summarize it; it must be seen to be believed. (Here is Landsburg’s reply, in turn, though I think Steve should have said “neutron star” instead of “black hole.”)

Anyway, I was reading the comments at DeLong’s post and just had to share these with you. Remember, these are people flipping out over avowed atheist, Steve Landsburg:

Rich Puchalsky said…
Why are you getting in this argument with creationists in the first place? Would you patiently keep responding to flat-earthers in this way? Do you think that it’s up to the IPCC to keep telling Internet blowhards that anthropogenic global climate change really does exist, for as long as there are Internet blowhards?
…

bakho said…
Sign that man up for a comparative neurobiology class so he can learn what we know about how we think.

Does he meet the prereqs?

Dave said…
I have always found the most comical of people to be those who study philosophy at religious universities expecting to find a rational reason that Mary was a virgin.

I hate to see people waste their lives and brains that way.
…

Will said…
I cannot even stand to follow this debate. It boggles my mind that 250+ years after David Hume, and 150+ years after Charles Darwin, the referee has not called this match in favor of Team Materialism.

Jeff said…
The whole thing is bollocks, if you ask me. All these clowns need to take some biology classes. For Nagel, I have no idea what he is saying. This is the case with most philosophy, which is a pathetic failure of a discipline that sits around trying to jam all the progress of the past four centuries into archaic categories like “neutral monism” and “idealism” and “materialism” and ends up pure gibberish…

If you’re baffled at why DeLong’s fans think Steve (and atheist Nagel) are creationists, you’ll have to read the post.

One More on Cantillon for 2012

[UPDATE below.]

Last post this year from me on Cantillon, with the usual disclaimer that if Paul Krugman jumps in, all options are back on the table…

In another comment Bill Woolsey says:

In my view, Richmond’s short quotation and your short quotation about Wall Street restaurants were very much wrong and focus on from whom particular assets are purchased. In particular, the notion the somehow that whatever benefit primary security dealers get from trading with the Fed is similar to the benefits of counterfeiting is very much wrong.

Yes! This is a great controversy and it would make for a good analysis (which I don’t have time to do right now, and I think more and more people are tiring of this discussion). Believe it or not, I have always had trouble with the standard exposition of Cantillon effects, precisely for the expectations reasoning that JP Koning made explicit. (This was all in Scott’s first post, I’m just saying Koning fingered it as the central issue under dispute.)

But this isn’t a Rodney King moment, not yet. It’s not simply that Sheldon Richman pointed to a certain mechanism and placed more importance on it, than Scott or Nick Rowe or Bill Woolsey would have done. No, Scott’s repeated clarifications are much stronger than that.

For example, in his latest salvo Scott implicitly says I am wrong on this and a child (but he quotes someone else so the sting didn’t come from Scott’s own lips), and that Steve Horwitz in contrast is the only Austrian adult in the room. OK fair enough, I said Scott’s post title was “palpably false” so I should be ready for some pushback. Yet Scott also said this:

I notice that lots of commenters insist that bondholders gain when the Fed injects money by buying bonds. Even if this were true, it would have no bearing on my criticism of Richman….But there’s a much bigger problem with this fallacy. It’s unlikely that monetary injections would raise bond prices at all.

On a plain English reading (and perhaps that’s not the best lens through which to interpret Sumner posts), Scott is saying the Fed as a general rule can’t affect short-term interest rates. So, there goes Austrian business cycle theory. I don’t think Steve Horwitz was conceding that in his post, which (to repeat) Scott praised as being sensible, as opposed to the nonsense that Sheldon and I were spouting.

UPDATE:: OK, correcting for what I think was a typo on Scott’s part, it seems he is here clarifying that the Fed can make T-bills go up in price by buying them, but it can’t make T-bonds go up in price by buying them. How this proves that “any influence of the injection point is a matter of fiscal policy” is beyond me, but at least it seems Scott agrees that the Fed can cut short-term interest rates.

Bill Woolsey Replies on Cantillon Effects

Bill Woolsey opened a long comment in my last post by writing, “Suppose the government decides to increase tank production. It might fund this by printing currency, by borrowing money, or by raising taxes. The tank manufacturers benefit the same amount regarless of this choice.”

Hang on a second, fellas. You are changing the question.

When someone asks, “Does it matter where the government injects new money into the economy?” the natural interpretation is to say that we first inject $x billion into one place, then we hold everything else constant, and instead inject the $x billion somewhere else. If things change, then we say, “Yes, it matters where the government injects new money into the economy.”

In contrast, Bill (following in Sumner’s footsteps) is asking, “Does it matter to the recipient how the government finances a new expenditure?” (I actually think it does matter, but even if it didn’t, the question is still a different one from the one we were all supposed to be answering.)

More generally, my stance isn’t some arbitrary approach. It is exactly this kind of behavior by Scott and many other proponents of “Bernanke needs to do more!!” that has me so upset. When QE3 was announced, Sumner et al. were mildly pleased, they just wished the numbers had been bigger. That’s because Sumner cares about NGDP first, NGDP second, and NGDP third. Whether the Fed bought MBS, Treasuries, or Robert Murphy books, he didn’t care. The important thing was, pump more money into the economy and get the public to think future NGDP would be higher.

So that’s not at all a scenario of, “The government was going to buy a certain amount of MBS, and the question is, should it do it by raising taxes, or by….” If the Treasury had started buying $40 billion of MBS each month, and paid for it by raising income taxes, do you think Scott would have approved? Of course not.

So Woolsey’s question, though perhaps interesting in its own right, has no bearing on this argument over the Austrian usage of Cantillon effects.

Clarification on Cantillon Effects

Steve Horwitz’s thoughts reinforced my own inkling that I should spell out what I had always filed away as “the Austrian point about Cantillon effects.” So the following is what I would have said, had you asked me a month ago. Note that I speak for myself, and I’m not even saying this is what Cantillon himself would have stressed:

When we’re first getting students to think about money and prices, we might say, “Imagine the stock of money magically doubles overnight. Every single piece of currency creates a copy of itself. If you had $30 in your wallet went you went to bed, you wake up with $60. Now, after everything settles down into the new equilibrium, you see the community isn’t richer. All the prices doubled.”

But once the student gets that under his belt, you make it more realistic. You point out that all prices won’t just magically double. Commodity prices rise very quickly, whereas labor contracts are more rigid. If an old widow is on Social Security, she is clearly going to lose out, whereas a magician can just jack up the going rate for his performances pretty quickly. So we see that even though “on average” nobody is changed by doubling the money stock, in reality some people benefit and some people lose.

Yet another complication is that in the real world, new money doesn’t come in via a magical increase of currency, nor through a helicopter drop. Instead the government (or the owners of gold mines in a Rothbardian world) gets the money first, and then hands it out to its cronies. The new money then ripples out into the community. It’s best to be the government, it’s second-best to be the defense contractor or Wall Street banker who get sweetheart deals, it’s third-best to be the fancy restaurant that caters to the Wall Street bankers, etc. If you’re running a deli in Boise, you’re going to see your input prices rise before your customers are able to pay more for your sandwiches. So there will be a general redistribution of wealth to the people closest to the money spigot, every time there is a new injection of money that disturbs the price equilibrium.

Finally, to the extent that this new money comes into the economy via the credit market (as opposed to a helicopter drop or, say, running the printing press to pay the Army), then one of the prices that rise early on is the price of bonds. In other words, real interest rates are temporarily pushed down, until the new injection stops and then the price system re-equilibrates. This artificially low interest rate sets off the unsustainable boom.

==> Now in the above, especially given Nick Rowe’s concession to Gene’s brilliant point, I think the market monetarist objection is not over whether injection points matter–of course they matter! If the government buys bonds versus gold versus paying opera singers, this will clearly affect people and the allocation of resources. However, the market monetarists are objecting over how these disturbances manifest themselves. Once we allow for people to anticipate price changes, they don’t have to wait to receive the new money before reacting. The traditional Austrian exposition of Cantillon effects–looking at the new money as it ripples through the economy, with the poor saps at the end of the line looking at their watches impatiently so they can start jacking up their prices–is naive. This is what JP Koning was saying.

==> The problem is, the market monetarists overstepped. Scott Sumner could have said, “I agree with Sheldon Richman, the central bank certainly can make some connected players wealthy at everyone else’s expense, for example by buying up toxic assets or taking over AIG. Clearly it matters very much where the new money is injected into the economy. However, I don’t at all like the mechanism Richman cited. He said it has to do with people getting the money at an earlier date than other people. That’s totally wrong, and here’s why…”

But no, Scott didn’t say that. Instead he wrote a post with the palpably false title, “It makes very little difference how new money is injected.” On a plain English reading of that sentence, it is false; Scott doesn’t believe it for one second. If the new money is injected into the Tomahawk missile sector versus the MBS sector versus the Treasury sector, of course it will make a huge difference. That’s why some of us flipped out and were asking Scott questions that must have struck him as an absurd waste of time.

A similar thing happened with JP Koning. He made the great point about expectations–pointing out that the canonical Austrian exposition of Cantillon effects implicitly assumes adaptive expectations–but then he ended up saying this: “On the other hand, if rational expectations are assumed from the start, then the location of gold’s injection point is moot since everyone perfectly anticipates the repercussions and adjusts.” No, of course that is wrong. If I find 10,000 pounds of gold in my backyard, that will make the economy adjust one way, compared to the scenario in which a guy in France finds it.

An Example of Wishy-Washy Dualism versus Hardcore Scientific Materialism

In the comments of my post on materialism, Ken B. lives up to the stereotypical materialist better than anyone could have hoped. Among his other claims, he said that dualism offers not a single testable prediction, whereas materialism is falsifiable. (If I misread him, I will retract these statements, but I’m pretty sure that’s what he said.) So I first asked Ken to tell me what kind of evidence would convince him that materialism is wrong.

Think about that for a second. Right now, just about everybody agrees that the materialist approach doesn’t offer a satisfactory explanation for consciousness and free will, in the same way that reductive materialism has “explained” thunder and lightning in terms of more basic physical properties. Furthermore, as the Feser’s discussion of Nagel suggested, there is a very compelling reason to think that even in principle reductive materialism can’t be applied to conscious experience, since some of us at least think by its very nature, conscious experience isn’t a physical thing. For example, when you “explain” the color red by reference to photons, you’re not saying that the photons are red. Instead you’re replacing what we mean by “red” with something else. There is a definite sense in which this very approach might not work when it comes to conscious experience.

So, whether you find what I just said compelling or not, my point is this: If this current state of affairs–where materialists haven’t yet come up with a satisfactory theory of consciousness/mind, and there are philosophical arguments held by many brilliant thinkers that suggest in principle it can never be done–isn’t sufficient to make one abandon materialism, then what would? It would be ironic if the hardcore “scientific minds” out there, are adhering to a non-falsifiable worldview that they adopt because it just suits their prejudices more than dualism does.

As far as predictive power, I said this:

OK Ken, I predict that if the attorney general of New York moves his vocal chords to create sound waves that correspond to the frequencies that you would hear as “we will fine gas station retailers $10,000 if they charge above $2/gallon,” then within 24 hours there will be large masses of organic material in hulking objects that are powered by combustion engines queuing up near certain latitude/longitude coordinates that I will specify beforehand. These are genuine, falsifiable predictions I will make for you. I am thinking you can’t come up with the same thing by relying on neuroscience.
Oh wait, this is cheating. You don’t mean this kind of thing, because “we all know” about this stuff. You’re talking about seeing an electric signal telling my hand to twitch before I realize I am trying to give you the finger. That’s what “mind” is all about.