Chicago economics — a dangerous pseudo-scientific zombie

29 May, 2017 at 14:58 | Posted in Economics | 5 Comments

Savings-and-InvestmentsEvery dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both. This form of “crowding out” is just accounting, and doesn’t rest on any perceptions or behavioral assumptions.

John Cochrane

What Cochrane is reiterating here is nothing but Say’s law, basically saying that savings are equal to investments, and that if the state increases investments, then private investments have to come down (‘crowding out’). As an accounting identity there is of course nothing to say about the law, but as such it is also totally uninteresting from an economic point of view. As some of my Swedish forerunners — Gunnar Myrdal and Erik Lindahl — stressed more than 80 years ago, it’s really a question of ex ante and ex post adjustments. And as further stressed by a famous English economist about the same time, what happens when ex ante savings and investments differ, is that we basically get output adjustments. GDP changes and so makes saving and investments equal ex ost. And this, nota bene, says nothing at all about the success or failure of fiscal policies!

Government borrowing is supposed to “crowd out” private investment.

william-vickrey-1914-1996The current reality is that on the contrary, the expenditure of the borrowed funds (unlike the expenditure of tax revenues) will generate added disposable income, enhance the demand for the products of private industry, and make private investment more profitable. As long as there are plenty of idle resources lying around, and monetary authorities behave sensibly, (instead of trying to counter the supposedly inflationary effect of the deficit) those with a prospect for profitable investment can be enabled to obtain financing. Under these circumstances, each additional dollar of deficit will in the medium long run induce two or more additional dollars of private investment. The capital created is an increment to someone’s wealth and ipso facto someone’s saving. “Supply creates its own demand” fails as soon as some of the income generated by the supply is saved, but investment does create its own saving, and more. Any crowding out that may occur is the result, not of underlying economic reality, but of inappropriate restrictive reactions on the part of a monetary authority in response to the deficit.

William Vickrey Fifteen Fatal Fallacies of Financial Fundamentalism

A couple of years ago, in a lecture on the US recession, Robert Lucas gave an outline of what the new classical school of macroeconomics today thinks on the latest downturns in the US economy and its future prospects.

lucasLucas starts by showing that real US GDP has grown at an average yearly rate of 3 per cent since 1870, with one big dip during the Depression of the 1930s and a big – but smaller – dip in the recent recession.

After stating his view that the US recession that started in 2008 was basically caused by a run for liquidity, Lucas then goes on to discuss the prospect of recovery from where the US economy is today, maintaining that past experience would suggest an “automatic” recovery, if the free market system is left to repair itself to equilibrium unimpeded by social welfare activities of the government.

As could be expected there is no room for any Keynesian type considerations on eventual shortages of aggregate demand discouraging the recovery of the economy. No, as usual in the new classical macroeconomic school’s explanations and prescriptions, the blame game points to the government and its lack of supply side policies.

Lucas is convinced that what might arrest the recovery are higher taxes on the rich, greater government involvement in the medical sector and tougher regulations of the financial sector. But – if left to run its course unimpeded by European type welfare state activities -the free market will fix it all.

In a rather cavalier manner – without a hint of argument or presentation of empirical facts — Lucas dismisses even the possibility of a shortfall of demand. For someone who already 30 years ago proclaimed Keynesianism dead — “people don’t take Keynesian theorizing seriously anymore; the audience starts to whisper and giggle to one another” – this is of course only what could be expected. Demand considerations are simply ruled out on whimsical theoretical-ideological grounds, much like we have seen other neo-liberal economists do over and over again in their attempts to explain away the fact that the latest economic crises shows how the markets have failed to deliver. If there is a problem with the economy, the true cause has to be government.

Chicago economics is a dangerous pseudo-scientific zombie ideology that ultimately relies on the poor having to pay for the mistakes of the rich. Trying to explain business cycles in terms of rational expectations has failed blatantly. Maybe it would be asking too much of freshwater economists like Lucas and Cochrane to concede that, but it’s still a fact that ought to be embarrassing. My rational expectation is that 30 years from now, no one will know who Robert Lucas or John Cochrane was. John Maynard Keynes, on the other hand, will still be known as one of the masters of economics.

shackleIf at some time my skeleton should come to be used by a teacher of osteology to illustrate his lectures, will his students seek to infer my capacities for thinking, feeling, and deciding from a study of my bones? If they do, and any report of their proceedings should reach the Elysian Fields, I shall be much distressed, for they will be using a model which entirely ignores the greater number of relevant variables, and all of the important ones. Yet this is what ‘rational expectations’ does to economics.

G. L. S. Shackle


  1. 1. Starta med en lögn.
    2. Applicera den numera populära metoden “ständiga kvantitativa förbättringar” tills du fått en bättre lögn.
    3. Hoppas att ingen märker skillnaden.
    4. Förbered ditt tal inför den 10:de december.

  2. I must say, I am shocked by this non-sequitur by Cochrane. I know that it is obvious to most, if not all reader here, but let me take it line by line.

    “Every dollar of increased government spending must correspond to one less dollar of private spending.”

    True, on the assumption that spending is constant. If the total spending is given, then, as he says, this is just accounting.

    “Jobs created by stimulus spending are offset by jobs lost from the decline in private spending.”

    That is not just accounting. It says that the number of jobs remains constant over time. Aside from being falsified over and over.

    “We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both.”

    Again, neither accounting nor empirically justified.

    “This form of “crowding out” is just accounting, and doesn’t rest on any perceptions or behavioral assumptions.”

    An amazing claim, which flies in the face of both logic and science.

  3. “My son , you should know , by how little Wisdom this, world is runned ” Axel Oxenstierna , Swedish Rikskansler, “Primeminister” long way back round 1650 .

  4. “Myrdalian ex ante language would have saved the General Theory from describing the flow of investment and the flow of saving as identically, tautologically equal, and within the same discourse, treating their equality as a condition which may or not, be fulfilled.” (George L. S .Shackle (1989) in “What did the General Theory do?”, in J. Pheby New Directions in Post-keynesian Economics, Aldershot: Edward Elgar.)

  5. “11 Criticisms Against the Say’s Law of Market

    1. Possibilities of Deficiency of Effective Demand:

    It is assumed in Say’s Law that whatever is earned is spent either on consumption goods or on investment goods, thus, income is automatically spent at a rate which will keep all the resources employed.

    All this, however, is not supported by actual facts, as the income is not automatically spent on consumption and investment. Keynes pointed out that there can be a deficiency in aggregate demand as all income earned in producing an output would not necessarily be used to purchase it.

    Keynes argued that money is an important form of storing wealth. That part of the current income, which is not spent, saved and may go to increase individual’s holdings. Therefore, whatever is saved out of current income does not constitute investment, because the opportunities for investment are not unlimited. We cannot say definitely that whatever is saved is spent on investment goods rather it may go to swell the liquid assets of the individuals. In this way, there can be a shortage of aggregate demand and the claim of Say’s Law that aggregate demand cannot be deficient at full employment is entirely defeated.

    The fallacy of Say’s Law is revealed by Keynes’s division of aggregate demand into investment and consumption for purposes of income analysis (Y = C + I). Keynes points out that the factors which determine consumption are quite different from the factors determining investment but together they constitute the aggregate demand and determine the level of income. Consumption is a function of current income, but it does not increase as much as the increase in income.

    Investment, on the other hand, depends upon technological developments and the marginal efficiency of capital. It is, therefore, clear that the determinants of consumption and the determinants of investments are not interconnected in such a way as to ensure adequate aggregate demand.

    Hence, total demand would not always be such as would guarantee adequate market for the output. The stability of the aggregate demand would be attained only when the gap between current income and current consumption is made up completely by the necessary amount of investment. Keynes, thus, found in the failure to spend current income on consumption and investment goods the cause of unemployment.

    2. Prolonged Depressions—a Reality:

    It is not uncommon to experience a ‘glut’ in the economy such as between 1929—32. If supply creates its own demand, there is absolutely no reason of stocks piling up in factories and a general slump setting in. It was during this depression that employers faced with lack of adequate effective demand, turned out large numbers of people and put up ‘no vacancy’ signboards being afraid of a further fall in prices. Say’s Law stood practically discredited. This gave a rude shock to Keynes’ faith in Say’s Law and led to the discovery of General Theory of Income and Employment.

    3. Fallacy of Aggregation:

    Keynes pointed out that the main fallacy in Say’s Law was that the principles which apply to an individual firm or industry could also apply to the economy as a whole. Keynes stressed that it was too much for Say’s Law to assume that microeconomic analysis could profitably be applied in macroeconomic considerations.

    4. Misplaced Confidence in the Effectiveness of Wage Cuts:

    Pigou’s formulation of Say’s Law also came under heavy fire. Keynes pointed out that a general fall in wages will not increase employment in the economy as a whole, because wages are income to a large section of the population. With the purchasing power reduced, their demand for goods and services will also fall. Employment in the economy depends on aggregate spending (effective demand) and not on wage level.

    5. Wrong Assumption of Interest Elasticity of Investment:

    The assumption of interest elasticity of saving and investment has also been challenged. Say’s Law presumes that all savings are automatically invested and the rate of interest brings about the necessary adjustment between savings and investment. Keynes, however, denied it on the ground that income and not the rate of interest is the equilibrating mechanism between savings and investment. Savings and investments depend upon income and are not sensitive to the changes in the rate of interest.

    6. Presence of Monopoly Elements in Product and Factor Markets:

    Besides, there is a conventional objection to Say’s Law as it presumed free and perfect competition in the economy. In actual practice, we see that imperfect competition in the market is the rule and perfect competition only an exception, because in modern capitalist economies there is a strong tendency towards monopoly.

    7. Importance of Short-run Economics:

    Say’s Law has been defended at limes, in terms of long-run equilibrium on the ground that the long-run aggregate demand tends to be sufficient to purchase all that the economy is supplying. This long-run equilibrium is brought about by the free forces of market alone. But Keynes remarked “that in the long-run we are all dead.”

    8. Unrealistic Assumptions:

    It would not be wrong to say that the entire thesis of Say’s Law is built upon unrealistic assumptions like flexibility of prices, wages, interest, rates, perfect competition, wide extent of the market, consumer’s sovereignty, etc. These assumptions are very difficult to realize in actual practice. Hence the difficulty and criticism of Say’s Law.

    9. Money Illusion:

    Say’s Law is based on ‘money illusion’ and treated money as a veil or medium of exchange. But money is a store of value and effects all economic activities like consumptions, production, exchange, distribution, saving, investment, etc. Money is not neutral as assumed by him.

    10. State Intervention:

    Say’s Law is based on non-intervention by State in economic activities. But Keynes recognised the regulatory role of the State. Private enterprise is guided by profit motive and may, therefore, not invest. Keynes favoured State intervention at such a time to control and regulate effective demand. He favoured mixed economy.

    11. Underemployment Equilibrium:

    Underemployment equilibrium is the chief contribution of Keynes. Say denied it. According to him there is equilibrium at full employment in the economy but Keynes showed that economy can be in equilibrium at less than full employment called underemployment equilibrium.” by M. Agarwal

Sorry, the comment form is closed at this time.

Blog at
Entries and comments feeds.