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Of Puzzles, Keynes, and the Austrians

by on March 17, 2011

I left a comment over at Facts and Other Stubborn Things, which I think is long enough to post here. I think I should have turned the comment into a full on blog post, but that’s okay; it gets the point across pretty well on its own. I recommend going to the original blog post (here) and reading it before you read my comment. If you’re looking for even more background, here‘s the original post that Daniel is responding to.

Anyway, here it is:

I think your analogy makes quite a bit of sense, but it has one problem that I can see. In the Austrian story, prices play a coordinating role within the economy, signaling consumer demands and preferences to entrepreneurs. Government officials, however, don’t have the same information, signals, or incentives that private businesses do, so they don’t know how the puzzle is supposed to be put together. They’re like a blindfolded person attempting to make the pieces fit. It’s a shot in the dark, so to speak.

The Keynesian story is that during the bust, prices (specifically the interest rate) are distorted, so that investors are kind of like the blindfolded government officials. The interest rate isn’t coordinating investment like it should be. As you say, the puzzle pieces have been turned upside down and something needs to be done to right them.

Correcting the distorted puzzle pieces typically takes the form of one kind of government stimulus or another in the Keynesian story. If we stick with the puzzle analogy, the problem is that now everyone is essentially blindfolded. Prices aren’t conveying correct information to anyone. Investors may be lost, but the original information problems that faced the government in the Austrian story still exist. They’re flipping the pieces around hither and thither, but they still don’t know where the pieces should go or how to make a meaningful picture. In other words, the original problems facing government’s ability to coordinate resources haven’t disappeared, they’ve just been compounded with the addition of a new problem- the market’s inability to coordinate resources.

I may simply be reading too much into the puzzle analogy, but it seems like even if you are correct about the inability of interest rates to coordinate investment, your solution suffers from the same problem.

I may come back later today and expound on that line of thought, but for now I have to get myself off this computer and get some errands done.

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