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August 2002; Volume 20, Number 8 

Nonsense from a Nobel

Frank Shostak

The June 3, 2002, issue of The Nation heralds the 2001 Nobel Laureate Joseph Stiglitz as a "rebel with a cause." That characterization is certainly a stretch for an economist, who is former senior vice president of the World Bank and who adheres to orthodox Keynesian doctrine, the dominant economic paradigm of mainstream political and economic theory for the past 50 years.

Stiglitz's Keynesianism isn't just a matter of habit, as it is with so many economists, but instead amounts to a strict doctrinal adherence. In his recent article "IMF should take a lesson on Keynesian economics" in the Straits Times, Stiglitz went so far as to resurrect the New Deal-era bromide that market economies are to blame for the boom-bust economic cycles.

According to Stiglitz, "since capitalism's beginnings, the market economy has been subject to fluctuations—to booms and busts. Capitalist economies are not self-adjusting: Market forces might restore eventually an economy of full employment, as economist John Maynard Keynes said, but in the long run, we are all dead."

Boom-bust cycles, however, are not caused by the market economy. They are the outcome of central authorities' interventionary monetary policies. The monetary theory of boost-bust cycles as developed by Ludwig von Mises provides an accurate explanation of the boom-bust-cycle phenomenon. It is about activities that sprang up on the back of loose monetary policies of the central bank.

Thus, whenever the central bank loosens its monetary stance, it sets in motion an economic boom by means of diverting real funding from wealth generators to various false activities that a free unhampered market would not facilitate. 

Whenever the central bank reverses its monetary stance, this slows down or puts to an end the diversion of funding toward false activities, and that in turn undermines their existence. In short, the trigger to boom-bust cycles is central bank monetary policies, not capitalism. Furthermore, in an unhampered market, human errors are self-correcting. The corrections tend to be rather quick.

Following in the footsteps of Keynes, Stiglitz holds that expansionary monetary and fiscal policies must be used in hard economic times. Also, again following Keynes, Stiglitz believes that fiscal policies are more effective than monetary policies. Regardless of the state of an economy, however, every economic activity has to be funded. Neither printing money nor expansionary fiscal policies generate wealth. 

What loose monetary and fiscal policies do is to divert real funding from wealth generators to wealth consumers. Consequently, neither loose monetary nor loose fiscal policy can lift an economy if the wealth, capital, and savings are not there to support it. It is a myth that fiscal policy can be more effective than monetary policy in growing an economy. None of these policies can. Only an expanding capital base, based on savings and profitable investment, "grows" an economy.

Stiglitz is of the view that, in advanced economies, Keynesian economics is the bread and butter of economic forecasting and policymaking. He also suggests that, because of Keynesian policies, expansions are longer and downturns shallower and shorter in advanced economies.

It is a great tragedy that Keynesian economics provides the foundation of thinking of most economists and policymakers. In advanced economies, expansions are longer and recessions are shorter due to accumulated capital and the power of free enterprise, not because Keynesian prescriptions work. There are, however, indications that this may not last. For instance, the flow of savings is barely visible, and individuals' indebtedness is now at a record high.

As a proof that Keynesian policies are valid, Stiglitz insists that, "we learn from economic policy failures as well as successes. When the International Monetary Fund (IMF) forced large expenditure cuts in East Asia, output in those countries fell just as Keynesian theory predicted."

But the output in these economies fell, not because of the cut in government expenditure, but because the previous loose monetary and fiscal policies had severely diminished the quantity of investable resources. A cut in government expenditure has revealed the fact of reality—that there is not much left to invest.

If lifting government expenditure drives an economy, then why do we still experience many economic problems? According to the Keynesian magic formula, all that is needed is to increase government spending and the rest should follow suit. If this view were correct, then poverty in the world would have been eliminated a long time ago.

Not so, maintains Stiglitz. "In early 1998, when I was chief economist of the World Bank, I debated the United States Treasury and the IMF concerning Russia. They said that any stimulation of the Russian economy would incite inflation. 

"This was a remarkable admission: Through their transition policies, they had managed, in just a few years, to decrease the productive capacity of the world's No. 2 superpower by more than 40 percent, a devastating outcome greater than that of any war. 

"In August 1998, with the ruble's devaluation, we tested the alternative, Keynesian hypotheses: Production soared, and relatively quickly, showing that policies emphasizing excessive austerity had caused unnecessary idleness of human and physical resources, and unnecessary suffering."

In fact, the productive capacity collapsed, not because of austerity, but because of previous loose policies. For instance, between January 1993 and April 1996, the yearly rate of growth in money M1 fluctuated between 120 percent and 500 percent. Austerity measures have only revealed the extent of the damage caused by loose monetary policy. The recovery emerged because there was still something left in the "kitty" and because austerity helped strengthen the basis for future sustainable growth. 

On Argentina's crisis, Stiglitz writes, "remarkably, the IMF was slow to learn the lesson. While it recognized belatedly its fiscal-policy mistake in East Asia, it repeated it in Argentina, forcing expenditure cuts that deepened recession and boosted unemployment to the point where things fell apart finally. 

"Even now, the IMF has not acknowledged the lesson: It still insists on further cutbacks as a condition for assistance. It continues to insist on an alternative economic theory—one which Keynes fought against over 60 years ago. In a nutshell, he struggled against the notion that if only countries would cut their deficits, confidence would be restored, investment would return, and their economies would again attain full employment."

But cuts in government expenditure did not cause Argentina's present economic crisis. There are several factors responsible for the crisis. Prior to the introduction of the currency board and the currency peg, money supply was growing in excess of 100 percent annually. So, the IMF is to be blamed for endorsing a peg to the dollar while the peso was extremely overvalued. This destroyed the export sector.

Furthermore, the high money rate of growth severely distorted the structure of production and depleted the capital base. The IMF is wrong in focusing on the reduction of the budget deficit. The focus must be on the reduction of government expenditure that Stiglitz opposes. 

A cut in government expenditure is a blessing for wealth generators and frees up property for productive use, so why should it be seen as bad news? Obviously, the cut in government outlays is bad for various activities that only consume real wealth without making any contribution to productive capacity. If the percentage of these activities exceeds the percentage of wealth generators, the economy will suffer. Aggressive government spending will only further deplete investable resources and prolong the depression. A good example of this is Japan. Aggressive Keynesian policies have been employed for over 10 years, yet the economy has continued to fall. Surely by now Keynesians should concede that these policies are a recipe for disaster.

In conclusion, Stiglitz says, "Economics is difficult because we cannot conduct controlled experiments. But we do have a wealth of experience from which to draw inferences. This wealth of experience all points in one direction: Professor Keynes's teachings are very much alive, and Argentina today would be in far better shape if his lessons had been taken to heart."

Indeed, we do have a wealth of experience—which clearly indicates that Keynesian policies based on the view that something can be created out of nothing are responsible for economic misery in the world. Professor Keynes's teachings may still be alive, but they are killing economies all over the world.


Frank Shostak is an adjunct scholar of the Mises Institute and a frequent contributor to ( The author expresses gratitude to Michael Ryan for helpful comments during the writing of this article.


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