Monday, 29 March 2010

Where Keynes Went Wrong, by Hunter Lewis.

I just read “Where Keynes Went Wrong” by Hunter Lewis (or parts of it). The chapter entitled “Markets Do Self-Correct” looked interesting, because Keyes’s main point was that they don’t.

The crucial passage reads:

During a slump, people buy less. This reduces business revenues. Because revenues fall first, before expenses, profits fall. Business owners then lay off employees to reduce costs and restore profitability. If, instead, wages fall, profitability can be restored without layoffs.

This is especially necessary if prices start falling throughout the economy. If people buy so much less that almost all prices start to fall, businesses revenues will be especially hard hit. Not only will fewer widgets be sold, but each individual widget will sell for less. Under these circumstances, if wages do not fall with prices, businesses will certainly face bankruptcy. On the other hand, if both prices and wages fall together workers should be no worse off. Although wages are lower, the consumer products workers buy will also cost less. It will be a wash.

Poor old Hunter Lewis just doesn’t get it: if prices, wages (and profits come to that) all fall by X%, everyone is back where they started! The only change is that the value of the monetary base in real terms has risen which would encourage spending (the Pigou effect). Hunter Lewis has evidently not heard of Pigou or the Pigou effect; at least he doesn’t mention them.

The latter effect would certainly work, but we might have to wait rather a long time. It’s far easier to have the central bank continuously create monetary base. That more or less condemns us to inflation, but as long as we’re talking say 2% year, that’s not so bad.


  1. Poor old Ralph Musgrave. Lewis got it right. If prices and wages both fall by X, profits will not fall, which is the point.

  2. Both Musgrave and Lewis got it wrong, because they don't take in the full impact of economic theory. At least Lewis got part of it right - that is, manipulation of interest rates and the money supply DO harm the economy by causing booms and busts. But pointing toward a third type of economic theory - nonprofit charitable redistribution - also has its consequences. Lewis is a liberal single-pie theorists and promotes a liberal theory for economics. That is, the rich get richer while the poor get poorer. So we need to force the rich to give more to the poor because they can never spend it all themselves. So why not have the government step in and offer a tax credit to the rich by giving more to charity. This is forced redistribution in a subtle manner.

    The problem with this is it's still force and leads to greater consumption and lesser productivity. This inevitably leads to more government intervention to prop up the economy with more money printing. This backfires on Lewis, because he fails to see repercussions of his thought processes.

    Beside, who is to tell the "rich" how much of their money they should be spending during their lifetime. Doesn't Lewis realize that the rich know they can't spend all their money during their lifetime? Of course they do. That's the reason they don't reduce their wealth by spending all their money during their lifetime. Reducing wealth is also reducing capital. They do what they do naturally - reinvest it for growing their wealth for their offspring. They have no intention of spending all their wealth.

    Additionally, when Lewis's plan goes into affect and productivity declines, a financial crisis hits. Nonprofits do not produce capital but rather consumption. Forced giving to charity will inevitably reduce capital. We all know that government is not inclined to reducing taxes or social programs. That's a dream of Platonists. Giving tax credits to the rich will only cause government to find other ways of revenue.

    When a crisis hits after capital and productivity decreases, then the government steps in and manipulates interest rates and the money supply. Booms and bust ensues.

    Musgrave is also wrong in that he fails to grasp the underlying reasons for booms and busts - the government's manipulation of interest rates and the money supply (credit).

  3. Hi Anon,

    I agree that adjusting interest rates is a poor way of regulating economies for reasons I set out here.

    But if booms and busts are attributable to interest rate manipulation, how come there were booms and busts in the 1800s – long before governments deliberately manipulated interest rates? Moreover, the booms and busts were if anything worse in the 1800s than in the post WWII period. See:


Post a comment.