Keynes v. Mises: Why Should You Choose Keynes

 Keynes v. Mises: Why Should You Choose Keynes
A Review of the Mises Wire Article: For Keynesians and Austrians, "Uncertainty" Means Two Different Things

https://mises.org/wire/keynesians-and-austrians-uncertainty-means-two-different-things

    Recently, having been in multiple arguments with incredibly dogmatic Austrians, I have been confronted with a Mises Wire article that claims that the Austrians are also subjectivists compared to Keynes but are not nihilistic, my words, in the sense that the price system conveys all of the necessary information to prevent the phenomena of multiple entrepreneurs facing radical swings in investment behavior, “Animal Spirits”. Putting aside the fact this article is from a Neo-Confederate institute founded by isolationists, and that they frequently use the pejorative “Animal Spirits”; I found the article interesting enough to consider writing a post on for the sake of my own boredom. The article’s main argument is essentially that due to the price system existing, entrepreneurs cannot be mass-mislead and cause a business cycle in the form of massive “mood swings”. To begin with: 

“One such explanation inspired by the General Theory emphasizes the endemic uncertainty of the future and its implications for market stability. Championed by Paul Davidson and popularized by Robert Skidelsky, this line of thought blames the crisis and recession on the fickle expectations and “animal spirits” that guide investment in a market economy.”

    The use of animal spirits, to begin with, is problematic in the sense it was barely used by Keynes at all, a term borrowed from Descartes. Only 3 times had the term been used by Keynes, the use of animal spirits is largely a pejorative used by dogmatic Austrians to ridicule the “Keynesians”. Animal spirits, then, are not the sole reason for the radical swings in investment behavior as a hormonal teen would act, rather the problems that arise from operating in a complex economy in which immense amounts of capital are being moved around, increasing the psychological burden placed upon entrepreneurs and consequently turning investment behavior into almost gambling like mentalities. 

“Per this thesis, in an uncertain world, entrepreneurs and investors suffer from mood swings. Optimism regarding the future abruptly gives way to pessimism. Fluctuations in economic activity are the result of these variations in outlook.” 

    As I’ve stated above, these “mood swings” are much more than mood swings. These swings in investment behavior are a consequence of all investments being irrational and consequently subject to mass error due to the impossibility of knowing the future and determining what the subjective valuations of consumers will be. This phenomenon makes itself incredibly apparent in financial markets, in which the sole purpose of the markets is to bet on a future that does not exist yet. No matter the amount of studies done before making investment decisions, there is simply no way of telling us exactly what the future will be when factoring in billions of decisions on the daily changing the open ended future, the problem of finding the necessary data in a world of crucial decisions and incredibly innovation to forecast the future reliably simply is impossible, it is not a matter of complexity nor is it a phenomenon that is possible for a deus ex machina to solve, no amount of computational power can ever compute and probabilistically determine the future exactly. Fluctuations in economic activity, then, are a result of the massive amount of instability behind millions of decisions like the aforementioned being taken on the daily in financial markets, it makes perfect logical sense. 

“With its focus on uncertainty, this line of thought bears a striking resemblance to Austrian ideas. Moreover, its rejection of mathematical probability as a foundation for expectations is echoed by several prominent Austrian economists.” 

    Not necessarily incorrect, just something worth noting that Hans Hermann Hoppe, the leader of the contemporary Austrian School, accepts this probabilistic view of the future in his criticism of Lachmann. The section on Keynes’ theory of probability and uncertainty is somewhat correct, with occasional mistakes. 

“Lurking behind her animal spirits are expectations formed as the result of an attempt on her part to “conform with the behavior of the majority or the average.” A similar striving on the part of everyone else gives rise to a “conventional judgment” regarding the future, shared by the overwhelming majority of entrepreneurs and investors.” 

    In this situation, the authors seem to be claiming that “animal spirits” are formed collectively and individual expectations mold around that in Keynes’ theory. This, however, is definitely not true to any Post-Keynesian who understands uncertainty theory. The reason for the chain reaction of a decline in the financial sector and consequent collapse is due to the fact watching multiple bank failures occur shakes investing expectations in a major manner, leading to flight from the country and consequent certain attempts to hedge against an increasingly uncertain future, e.g., liquid assets, which prevents the standard Austrian story of individuals simply saving to rebuild the capital stock from being true, it fails to consider the existence of liquidity preference in their analysis involving a false theory of loanable funds. 

“Based on the flimsy foundations of the psychology of opinion and with no moorings in experience, this conventional judgment is subject to sudden and violent change. Like a school of fish, investors and entrepreneurs swim this way and that, always taking their cues on what to do from others, without recourse to any solid foundations in which to ground their expectations.”

    Again, the Austrians fail to consider the core of the Keynes-Post Keynesian theory of business cycles and investment, that is, the market is volatile and subject to massive swings due to the immense amount of decisions being taken in the financial sector in which the goal is being to accurately forecast the future, something that is impossible, regardless of the existence of a deus ex machina that the Austrians seem to find in the market system, particularly prices. This theory of a machine that can mitigate all uncertainty through spontaneous order, however, is flawed when considering that this is simply a case of epistemic uncertainty rather than Ontological Uncertainty, which is fundamentally what the market process is about. 

“Buoyed by an optimistic conventional judgment, investors, with positive animal spirits pumping through their veins, rush to produce more capital goods, lifting the fortunes of workers with them. Soon the judgment turns and pessimism sets in. Investors no longer have the urge to act. They become quiescent, and unemployment increases.” 

    This statement above misses out the majority of what Post-Keynesians use for considerations of the business cycle, i.e., the paradox of tranquility. Times of economic growth breed instability due to creating investment decisions which are based on the belief that the growth of the current will continue forever, without regard for future supply side shocks and radical changes in subjective preferences, leading to over-leveraging and consequently unsustainable investment decisions which must be liquidated eventually when real resources and financial capital do not exist in the abundance presupposed by the mislead entrepreneurs. The judgment does not occur simply because of unknown psychological forces, it is caused due to the phenomena which occur in the boom of over-leveraging, to claim otherwise is a clear strawman of Minsky, Keynes, and other Post-Keynesian boom-business cycle theorists. 

“The path to greater market stability requires heavy government intervention. It is the job of the state to counter the waxing and waning of animal spirits and help stabilize the level of investment, output and employment.” 

    This passage above isn’t necessarily what is being claimed by Post-Keynesians, a great deal recognize that certain policies can induce greater uncertainty into the market through “Regime Uncertainty”; however to mitigate the investment decisions which are unsustainable Post-Keynesians do propose certain methods such as 100% reserve banking, or at least higher bank reserves, and other regulatory mechanisms to prevent hedge finance units from becoming Ponzi finance units which dominate markets in laissez-faire markets during times of stability. 

Starting with the section on Austrian “subjectivity”: 

“Prominent Austrian economists such as Mises,5 Lachmann,6​ and Rothbard7​ agree with Keynes’s rejection of a mechanistic relationship between past and future prices.” 

    Something I find amusing, is the adoption of Ludwig M. Lachmann of all people as an appeal against the Keynesians. The same Lachmann who was ostracized by the Austrian School for being too Keynesian, the same Lachmann who was deemed an epistemological nihilist by the dogmatist Murray N. Rothbard, the same Ludwig M. Lachmann whose followers are still rejected by a majority of Austrians. The appeal to Lachmann of all people for the situation at hand is incredibly ironic. 

“This has implications for the formation of expectations. Entrepreneurs cannot study past prices, calculate the numerical probability associated with them and then simply extrapolate these numbers into the future. As a result, mathematical probability is not a suitable foundation on which to base expectations. However, this does not imply that we know nothing about the future. The past can still serve as a guide to action.”

    The final claim, that the Austrians believe that due to the past acting as a guide for action, is ignorant of the fact Post-Keynesians do also comprehend the past as an indicator for future investment decisions, however putting less emphasis due to the existence of Shackle’s crucial decisions. Crucial decisions are decisions which cannot be reverted and fundamentally change the direction of the market process, making the existence of past information before this a great deal irrelevant through the phenomena of Schumpeterian “Creative Destruction”. This appeal to past information ignores the existence of crucial decisions and Schumpeterian “Creative Destruction”. 

“Entrepreneurs can still estimate the likelihood of future events. They do so by trying to understand the motivations underlying the valuations of market participants in specific situations in the past. They must peer beneath the veil of past prices and must analyze why market participants acted the way they did under the given conditions.” 

    The attempt to understand the motivations of market participants in the past, however, is a fool’s endeavor a majority of times. It requires analysis of subjective value scales and almost omniscient knowledge of the market at that time, it simply cannot occur for a simple entrepreneur wishing to enter the market. Another thing is that this analysis of the past does not change the Post-Keynesian analysis, it still leads to decisions being made that are essentially betting on a non-existent future with limited past knowledge that cannot be fully correct due to the existence of crucial decisions. Crucial decisions essentially, through the process of creative destruction, makes a great deal of information irrelevant due to the irrelevance of the firms who produced this product in the current because of creative destruction. 

“This, as in the case of Keynes, lends them a subjective flavor. Nevertheless, the subjective expectations of entrepreneurs do not coalesce into a homogenous and ever-shifting conventional judgment regarding the future. Instead, these expectations are heterogeneous. Two entrepreneurs may come to different conclusions regarding why individuals behaved the way they did in the past. Moreover, their grounding in the past gives them a basis in reality. Thus, they are not whimsical and subject to random fluctuations.”

    Almost painfully ignorant of Keynes and the Radical Subjectivists, the authors then proceed to claim that expectations are somehow homogenous in Keynes’ theory unlike the Austrian theory which accounts for it. This is completely false, the reason for the collapse of the financial system is due to heterogeneous expectations being influenced by a collapse in major institutions, these send shockwaves throughout the market and cause investment expectations and investment demand to fall. It is not a matter of “heterogeneous” or “homogeneous ”, it’s a matter of what occurs when market institutions decline and cause economic panic. This statement is both unfounded and proves nothing.   

“This process of entrepreneurial selection allows for the coordination of the decisions of producers and consumers. It ensures that, at any given moment in time, the best appraisers of the future are in control of making the key production decisions in the economy. Thus, in the Austrian framework, uncertainty and subjective expectations are compatible with market order and stability.” 

    This view, however, is not true when considering Schumpeterian and other Post-Keynesian elements, the market is not naturally equilibrating. On this, more in depth, see my other post on Hayekian plan coordination equilibrium, but I will give a brief summary here. The concept that somehow the market tends towards increased coordination, i.e., Hayekian equilibrium, is completely false when considering heterogeneous subjective expectations which can react in any way to new information in the market, leading to discoordination on the production side due to competition and creative destruction, necessary disequilibrating processes due to the fact competition is essentially purposeful plan discoordination to control more resources and clientele than the other firm, a conquest that is disequilibrating for power. 

“The key to ensuring this is a price system that results from the voluntary decisions of market participants to engage in mutually beneficial exchange. The prices that emerge on the various factor markets must reflect the appraisements of the participating entrepreneurs. Any interference with such a system of prices can interfere with this process of coordination and the order generated by the market.” 

    The concept of spontaneous order does not hold true for a dynamic market in which Creative Destruction prevails, which is a necessary condition for all dynamic market economies. No such “order” is created in the market, it is always destroyed and overthrown without any time for readjustment due to innovation and creative destruction, causing some sort of ability to retaliate against the paradox of tranquility to simply not exist. The core is not about homogeneous expectations, it is about the way collapses of major institutions have effects on market participants and consequently abandonment of production processes, unemployment, and a fall of aggregate demand! This appeal to the price system simply does not make sense in a world that is dynamic and without an ordering axiom, it is fallacious! 

The rest of the article happens to be about the false Austrian Theory of the Trade Cycle: 

“Profits no longer reward those entrepreneurs who allocate scarce resources to the highest ranked ends of the consumers. Instead, they reward those who, misled by the artificially low interest rate, embark on production projects that are unsustainable. Those entrepreneurs who correctly perceive the underlying unsustainability now lose control of the capital at their disposal and gradually lose the ability to influence the course of affairs.” 

    This theory rests on the adoption of a more capital intensive technique that is profitable at this lower rate of interest but not at the higher rate which happens to be more natural. However due to capital reswitching, it has been demonstrated that this monotonic relationship does not exist, nor is it necessary for entrepreneurs to adopt a more profitable higher capital intensity project. Reswitching is essentially a production technique that is profitable at a high rate of interest, unprofitable at a medium rate, and profitable again at a low rate of interest. This technique which is profitable at both technique extremes, higher and lower, is less capital intensive but cost minimizing, which means the necessity of adopting a more capital intensive unsustainable project does not need to occur. For further information on this, check out Robert Vienneau’s blog, in which he demonstrates under a wide array of conditions that reswitching can occur.

    Finally, to answer the question posed at the title of the blog, why should you choose Keynes over Mises? The reason for this is quite simple, Keynes provides a full analysis of uncertainty and consequently derives truthful axioms about the economy, that it is fundamentally unstable due to a radically uncertain future! The Austrians simply pick and choose what they enjoy about uncertainty, and forget it the next! It is nonsensical then, to claim that Mises is superior to Keynes.