Why I don’t believe in Macroeconomics
Macroeconomics is a branch of Economics that deals with the aggregates of all agents in a country. The Idol of macroeconomics is John Maynard Keynes. Actual champion of Keynesianism is Nobel-Prize laureate Paul Krugman.
The foundations of Macroeconomics is this simple formula:
Y= C(Y-T) + I(r) + G → Y = C + I + G
Y = aggregated Income (well-being)
C = Consume.
C(Y-T) = What people consume after their income (Y) is taxed (T)
I = Investments
I ( r) = Investments dependent on interest rates
G = Government spending.
Of course, this formula gets more complicated when for example you use the Mundell-Fleming-Model which also deals with exchange rates, Imports and Exports. But for simplicity matters, we’ll just use the basic one. The flaws of the theory which I point extend to the more complex versions of the same.
Why Don’t I agree with macroeconomics, and (most) policies which are made based upon it?
1. I regard this formula as kind of a thermometer, which is used to analyse the economic health of a nation. The curious thing about this thermometer is that it is triggered by more than a variable. In metaphor: The country is the patient. The thermometer registers the temperature. The factors that influence the thermometer are the patients body temperature and the room temperature. The problem when you use policies aimed at increasing the aggregate income is that you may change other factors just so that the thermometer tells there has been improvement. This means that you may lower the room temperature and the thermometer will say that the patient has improved. In reality he is just as sick as he was before, the only difference is what the thermometer is telling.
Quoting Keynes vs Hayek (Round 2) video: “Real growth means production of what people demand, that’s entrepreneurship, not your central plan.” http://goo.gl/aNhLe
2. Too much aggregation. It combines things that cannot be properly added together.
It does not take into account the diversity of people. "models in which buyers and sellers are supposed identical is not a simplification of the real world, but a complete renunciation of it." (Austrian Economics, A primer)
3. It supposes that economics should behave in the same way as natural sciences (Chemistry, Physics). Whereas economics is much more complex because it deals with unpredictable individuals who have a mind of their own and react differently in different situations. All aspects of economics (currency, trade, etc) arose because of human action, not by human design (Hayek). The economy is not a machine which by pressing some buttons behaves the way you want it to. The economy is organic, it’s molecules are all individuals. In economics you can not make predictions the same way you would in natural science. I think it was Ludwig von Mises the one who said "If you throw a rock in a river, it will sink. If you throw a human into a river, he must decide if to swim or sink."
4. The Problem of Knowledge (The Use of Knowledge in Society, Hayek) http://goo.gl/McnAM
Because knowledge is so dispersed, it would be very hard if not impossible for any individual or group of individuals to gather this knowledge. This hinders the ability for governments and/or central banks to make decisions that deliver the intended consequences.
5. Unintended consequences. Policies based on the macroeconomic foundations may have unintended consequences that may have devastating effects.
Examples:
Fiscal policy (Change on Taxes or Government expenditure):
We are told that when government increases expenditure the total income arises ( G↑→I↓→ →Y↑ (G↑>I↓)
BUT: first of all, let us remember that government doesn’t actually earn any money. The money that government uses must come from taxes or investors that buy public debt. Any $/€/bs that government spends is a $ that is not used in the private sector. It is money that is not consumed by people (Who could have increased their individual utility by spending it) or is not invested in production of what people demand. This does not increase the income of people. This may be best understood with Bastiat’s Broken Window Fallacy (What Is Seen and not Seen) http://goo.gl/RRy8 Mainstream economists recognize that there is some crowding-out, however, they claim that this is less than the effect of the “multiplier”. Again, let us remember that economic well-being comes when goods are more plentiful, there is more variety, cheaper prices and more accessibility. Even if the aggregate Income actually increased, this would only be artificial, not real growth, because no value was actually created.
BUT: It also depends on what governments spend it in. If they build streets, highways, schools, etc where there was demand for it then it may not be that terrible. This depends if you believe that the public sector does a good job doing this or if you think these would be better taken care of by individuals. I personally believe that individuals could manage it better, but this is only a matter of which could do it best. There is little doubt that by building infrastructure that allows people to exchange easier there will be more trade and therefor more real creation of value. Someone once said that if you build a street between two towns you needed to do little else, because they would find ways to trade between one another in a spontaneous manner. However, most Keynesians don’t really care in what the government spends it in, as long as they spend it. For example Paul Krugman recently claimed that the best that could happen to the U.S was an alien invasion because it would increase government spending. Another famous claim was by Keynes himself who said that in times of crisis government should pay people to dig holes in the day and cover them up by night. If you are not convinced by my argument and even if you were convinced I strongly encourage you to read Bastiat’s essay (It’s not long, I promise.)
Tax Cuts : I have no problem with tax-cuts. As Milton Friedman, I would support them for any reason, at any time, to anyone. They let individuals have more money to spend it or invest it, this in turn, does increase the income of individuals and companies who in turn actually end up paying more taxes (10% of 100 is more than 15% of 50). This also helps lower the level of unemployment because it is now cheaper to pay for labor (Keynesians love to talk about unemployment). But employment is not an end in itself, it is just the means to create value, by letting the private sector do the hiring, people would be employed in the most efficient ways. Job programs are very well described by Milton Friedman in this story:
Milton Friedman was shown the construction on a massive new canal in Asia. When he noted that it was odd that the workers were moving huge amounts of earth and rock with small shovels, rather than earth moving equipment, he was told “You don’t understand; this is a jobs program.” His response: “Oh, I thought you were trying to build a canal. If you’re seeking to create jobs, why didn’t you issue them spoons, rather than shovels?”
Monetary Policy: Change in the money supply or interest rates.
Money supply: When governments print money there is inflation. Inflation hurts the wallets of all individuals without discrimination who can now buy less with the money they have. This does not increase total income for an obvious reason, money is now worth less.
Interest rates: This is one of the most interesting. According to mainstream economists, when you lower interest rates you increase investments, thus raising the aggregate income. But that does not foresee the unintended consequences. Interest rates represent the time preference of people (von Böhm-Bawerk) and their risks preference. When Central Banks artificially lower interest rates (without a change in the time preference of people) they make some investments (for example Housing) seem more attractive than they actually are. This is because there was a distortion of the price mechanism (Hayek). These are malinvestments that lead to a temporary Boom. When banks curb their lendings the Boom turns to Bust and you find yourself in a (avoidable) recession. The important thing is not how much capital we have, but how it is structured. This is explained by Hayek and von Mises in the Austrian Business cycle.
Trade Policy: An easy example of how misleading macroeconomic simplification is, is trade policy. Under the Mundel-Fleming-Modell with fixed exchange rates. They claim that by reducing trade barriers, the “Aggregate Income” falls.
NEX↓ → IS nach links → Y ↓ → r ↓ Impuls → e (↓), Abwertungstendenz → ZB verkleinert Geldmenge um eF zu halten, LM nach links → Y↓ (Sorry that it’s in german, I took it from my Macro class)
But, it goes beyond that. If there are no trade barriers, and a foreign producer can supply a good cheaper or better, that may hurt the local producers, true, but it helps everyone else (including themselves as consumers) The people can now buy goods cheaper than before. This allows them to use the extra money they have now available to consume in another good or invest it. Anyway, even in these model either C or I would go up, INCREASING the “Aggregate Income”. Another argument against trade barriers is Bastiat’s “Candlemakers petition”.
@CorderRosas
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