A few weeks ago, Students for Liberty proudly organised a conference by Professor Juan Ramón Rallo on the mistakes of keynesian theory. I would strongly recommend anyone to watch the video. Rallo is one of the youngest and most brilliant economists in Spain, and is sure to become an iconic figure in the fight for liberty and freedom.
The Link for the video is here: Los errores de la teoría Keynesiana
For those of you with a busy schedule, I will try to sum up the content of the 2 hour lecture as best as I can.
Keynesian theory, is the most prevalent and accepted theory in mainstream economics. Unmasking the basic flaws of this theory, as Rallo does so eloquently, is no easy task, but it is necessary, if general economic thinking is to shift course for the better. So let’s get straight to it.
The first mistake Keynes makes, is in his interpretation of Say’s Law, which has now sadly become the commonly known interpretation. What Say said, was that suppl generates its own demand. What he meant by this, was to say that demand is determined by supply, to the extent that we can only demand as many goods as we have created. Ultimately, we are exchanging good for goods. Keynes, from this, extrapolate the idea that suppl creates its own demand, and that, therefore, any form of production, any good produced in the market, will automatically find its own demand. This statement is absolutely false, and defies classical economic thinking, which rightly points that demand creates supply. First a need arises, demand, then that need is satisfied, supply, pretty simple.
With this in mind, Keynes goes on to elaborate his further theory on a mistaken premise. Keynes argues in his book The General Theory of Employment, Interest, and Money, that the economy is always subject to ups and downs caused by a lack of consumption due to a change in what Keynes labelled “animal spirits”, which basically says that consumers may feel optimistic or pessimistic and will consume accordingly. Therefore, economic cycles are caused by a lack of consumption, which then gets transmitted into a reduction of supply, fall of employment, less wages, less consumption, and we enter a vicious cycle. The way to break this cycle, according to Lord Keynes, is to simply boost consumption. What type of consumption? It doesn’t matter, apparently, since all consumption will create supply, and supply produces its own demand.
Keynesian theory marries perfectly with politics because it gives the government an excuse to get involved in the economy. If consumption is falling, simply get the Gov to spend more, and invest more. Does this really work? Keynes seemed to think so. But reality would prove him wrong. First of all, the ability of a government to spend occurs always at the expense of the private sector, consumers, whether it happens today, or in the future, the government used debt, doesn’t matter, unless you can keep accumulating debt forever, which we have reason to think Keynes believed, after he famously said “In the long-run, we’re all dead”. Or in other words, live today at the expense of the future. The only other reason you could justify government intervention, is if you thought they could invest in something that is actually productive and no one else has thought of. But do you really have faith in some enlightened politician doing this? Do you believe that there is someone in the government more intelligent than all the entrepreneurs around him? We know that government can’t, and shouldn’t try to replicate the market.
If government spending is the first pillar of keynesian theory, interest rates, would be the second. Through interest rates, Keynes claims that employment can be controlled. And therefore, calls for fixing the price of interest rates at the whim of some appointed political body. Must I even explain why price-fixing is bad? Now just imagine how bad it can get if you distort one of the most important prices there is. Keynes doesn’t take into account the kind of distorting effects this can have, which are so well explained in Austrian Business Cycle Theory, and are the key to understanding the crisis of 08. Furthermore, as I’ve said endlessly, the interest rate manipulation not only distorts interest rates, but also the value of money, which creates macroeconomic imbalances of great magnitude.
In conclusion, Keynesian theory at first glance, seems simple, intuitive, and comprehensive, and this is one of the key reasons for its success. However, a more in-depth look will reveal that the Keynesian theory is intrinsically wrong, since it’s based on flawed premises.