 All right, ladies and gentlemen. It's time to begin the big battle, Austrian economics versus Keynesian macroeconomics and modern monetary theory. I think this is going to be the new installment in the new Revive Marvel Comics series. And I don't know who's being cast for what yet, but we'll see. No, this lecture as timely as today's headlines. And so it's a big topic and a lot of things to discuss, so we'll get right to it. I found it interesting. Not recently, I found the Oxford Economic Dictionary indicated that the term macroeconomics was actually coined as recently as 1945 by Jacob Marschak. Not by who you might think it was, but he had an article called the Cross Section of Business Cycle Discussion, the American Economic Review. And the quote is, across the distinction between statics and dynamics cuts another one, that between aggregative or macroeconomics and the microeconomics of a single firm or household. And in that very statement, there's a germ of, or shall we say, a good indicator of the modern macro view of things. There are two types of economics. There's microeconomics and macroeconomics. Now, in macroeconomics, we can say that we can at least identify certain topics that economists are interested in. One is the purchasing power of money, the purchasing power of money, or price inflation and price deflation, the purchasing power of money being the inverse of the level of overall prices. Another topic would be recession or business cycles. What causes recession? And then third, the opposite of recession, what causes economic expansion development? Those are the three main topics that are discussed in macroeconomics. And any good macroeconomic framework should be able to speak truth to these topics. Note, unemployment is not on this list. I don't consider unemployment. A lot of macroeconomic textbooks put employment in. I do not, because unemployment is basically a micro phenomena. It happens when the wage rate is held above the market rate for some reason. And so that's more of a micro topic. I mean, we know that when a recession occurs and liquidation happens, people are thrown out of work. So unemployment does occur in a recession, but it's still a micro issue, not so much a macro issue. Now, I argue that these three issues can only be understood if we understand how each individual market is integrated with each other into the broad social economy. So to understand what determines the preaching power of money, what causes recessions, what contributes to economic expansion development, we need to know how the entire social economy is integrated together, how the different markets come together and are integrated with one another into the broad social economy. Keeping that in mind, that helps us see the fundamental distinction between Austrian economics and what we call modern macro. Modern macroeconomics is dominated by modeling. In fact, Roger Backhaus, when he was here many years ago and gave perhaps the Mises lecture, he noted that in his mind, the key characteristics of modern mainstream economics was modeling, and that set it apart from Austrian economics. Model building, of course, is the attempt to construct or create a construct of the economy using only a few of the many relationships in an economy or society. It's trying to simplify things and then abstract from reality to create some type of artificial model that we then hopefully can use to make some sense of what's actually going on. Model building is limiting, right? Model building is limiting, and we'll see how limiting it is when we talk about some of the common characteristics of Keynesian macroeconomic modeling. One of the characteristics is that time generally is ignored. The issue of time is ignored. As such, most of the modern macro models neglect the relationship between time preferences and capital structure. There is no capital structure, frankly, in most macro models. Rather, there's a notion of a one-dimensional horizontal production structure or productive circle, if you will, that's an equilibrium. Think of the circular flow of income, where money flows from households through goods markets to producers, and then the money flows from producers into factor markets to households. And it all happens just out of time. It flows instantaneously, and there's no sense that production is a time-intensive process, and the production of a consumer good is the result of a time-intensive multi-stage production process. Another characteristic of modern macro models is that money tends to affect the general level of prices, but changes in relative prices are not considered. Changes in relative prices only happen in the micro world. They don't happen in the entire economy, it turns out. And as that last point implies, what macro economic models tend to focus on are macro economic aggregates, GDP, for instance. And the way the models focus on aggregates prevent the analysis of underlying micro economic factors that can have significant effects for the entire social economy, such as malinvestment. And so most modern macro modeling separates the micro and the macro theories into two hermetically sealed worlds. When we have full employment, then micro principles are very relevant. And micro rules today, and quantities of fighting is quite demanded. And all of the factors are earning prices that are equal to their marginal revenue product or discounted marginal revenue product if the modern neoclassical people want to get real sophisticated. But when we do not have full employment, when we have unemployment, then we enter what Paul Samuelson called a topsy-turvy wonderland. A topsy-turvy wonderland where right seems left and left is right, where up seems down and black white. He could have said what we call evil good and good evil, but that's a lecture for another day. Now we can contrast, and that, by the way, is just sort of a general broad brush overview. And this whole lecture, by the way, is going to be fairly broad brush, because we're talking about three different frameworks in 45 minutes. That sort of general view of Keynesian macro modeling and another macro modeling helps us see how Austrian economics is different. Austrian economics does not separate micro and macro into two sort of separate sets of theories. Now, Austrian economics proceeds from human action, the principles of human action, to derive principles that allow us to ultimately analyze topics that are relevant for the entire economic order. We have seen, for instance, that actions of individuals as they engage in production result in an extensive market division of labor. We have seen yesterday that this division of labor incorporates an intertemporal capital structure. And we have seen that this entire capital structure, the entire market division of labor, is coordinated by entrepreneurs using economic calculation or through economic calculation, using market prices and interest rates. So all of what you have heard so far in terms of building up various aspects of Austrian economic theory from human action then allows us to turn our attention to how do we analyze these topics that are typically considered macroeconomic? Well, sound macroeconomics must incorporate what incorporates the entire social economy. Think about macroeconomics as something that deals with the entire social economy. What is it that sort of applies or that is of relevance for the entire social economy? Whether basically two things or at least two things. One is money, right? Money is traded for all goods, all consumer goods and all higher order goods. So money is something that should be included in any good macroeconomic framework. The second, as I already mentioned, is that the vast market division of labor is held together, is integrated in a capital structure. And so the capital structure is another factor or is another element of sound macroeconomics. And so if we're gonna do good macroeconomics, we need a macroeconomic framework that includes both of these, money and the capital structure. And that is the Austrian framework. Now, if we understand the nature of the capital structure, we understand what is necessary to accumulate capital, we see then that economic progress is the result of increases in voluntary saving. This here is a chart that's taken from a Hazel's Order to Soto's Book, Money, Bank, Credit and Economic Cycles. It's chart V-4 if anyone wants to take notes. Note in this chart, we have several stages of production from the first stage up to the seventh stage. At the bottom is the first stage, that's the stage at which consumer goods are produced. And then as I noted, money then gets spent and income flows up through the successive stages of various stages of capital, of production. Now, let us suppose, this by the way, this chart shows two things. It shows the old structure production and then a new structure production after saving, an increase in voluntary saving. The old structure production is represented by the rectangles that are outlined in black, outlined in black. Then they run from the first stage up to the fifth stage. The new structure production, the structure production that is left after there has been an increase in savings that has worked out throughout the entire social economic order is the gray lines, the solid gray lines. That the solid gray lines represent the structure production after significant, or after an increase in voluntary savings. And so when we have an increase in voluntary savings, one thing that happens, that we know happens based on our discussions last yesterday, is that when there's an increase in savings, there's a decrease in the interest rate. When there's a decrease in time preference, that moves people to consume less and save more, so there's a drop in the interest rate. So the interest rates will be lower. Also, when there's an increase in savings, the capital structure is transformed. There's a deepening of the capital structure, which means it's vertically longer. There are more stages. There are new stages of production added which did not exist before. They did not exist before because they were not considered profitable. That the social time preferences were such that interest rates were such at a certain level that these new stages were not profitable. The rate of return on these new stages were not high enough to warrant their activity at those stages. But if people increase their savings so that the market rate of interest falls, and they become more willing to put out present consumption, suddenly there are stages, there are productive activities that now appear profitable and entrepreneurs are happy to participate in. And so there are stages that are higher stages that began to be undertaken stages six and seven. Now, where do the resources come from to participate in these higher stages? Well, they come from resources that were utilized in the lower stages of production. When there's a decrease in consumption, the prices of the consumer goods fall, rates of return in the consumer goods industries become lower and they become lower relative to those rates of return at the higher stages. And so resources are freed up and are utilized at the higher stages. And so the capital structure deepens. The capital structure also widens at the previous highest stages. Notice that stage four and stage five, those stages are wider than they were before. There's more production at those stages as there were before. And the capital structure has already mentioned narrows the stages one, two and three because of the decreased demand for consumer goods and the drive demand at those stages. Also, we should note that the introduction of newer capital goods tend to implement the most advanced technology. And so not only does there tend to be an increase in the quantity of capital goods or tends to be an increase in the level of technology, embodied in those capital goods. And so the upshot is we end up with more voluntary saving, we end up with a more capital intensive structure of production. And with more capital intensive processes, the structure production, entrepreneurs firms become more productive. The produce over time, the production of consumer goods will increase while their prices fall. Real wages and national income then will rise permanently. And in the long run, people are able to buy more goods at lower prices. This is an increase in prosperity. Huerta de Soto refers to this as the healthiest, most sustained process of economic growth and development imaginable. It involves the fewest economic and social maladjustments, tensions and conflicts. So that's just, as I said, I'm painting with a very broad brush and skipping over some nuances we could talk about. But that gives a picture of an Austrian approach that builds from human action up through the entire capital structure. Now, the Keynesian macroeconomics is a little bit different. It represents national income and there are many varieties of Keynes, but this Keynesian economics, but this comes pretty much right out of Keynesian general theory. And national income is represented as a sum of spending in various sectors of the economy. And here we have Y, national income, is a sum of C plus I plus G. C, consumer spending, spending by consuming households. I is business investment and it's investment in physical production. It's not investment in financial instruments. That was sort of seen as an unhappy leakage. And then G, of course, is spending by the people who are here to help the government. Now Keynes also believe that the economy is inherently unstable and easily tends to recession. The social economy is not a social economic order. It's, I don't know, we could say it suffers from economic fragility all the time. And it's because of volatile business investment, the I in the equation. And the I goes up and down and when recession hits, because I collapses due to a collapse of what he calls the marginal efficiency of capital. And the marginal efficiency of capital is essentially a prospective rate of return on investment in the marginal unit of capital. And so when the when the marginal efficiency of capital collapses or falls, it's because of changes in what Keynes calls the animal spirits, right? It's a psychological theory of recession. For whatever reason, the investors decide that things are bad and then a handful of them start to get timid and they start to reduce their investment. And that becomes conventional wisdom. And then investors all pull their money out of production and investment collapses. Now, when this happens, well, I should move back up the truck, the important relationship for Keynes, in essence, is a relationship between the marginal efficiency of capital, the rate of return on an increment of capital investment and the interest rate. The interest rate, as Keynes says, is obviously measures, obviously, the premium which has to be offered to induce people to hold their wealth in some form other than hoarded money. That is what the interest rate is, right? Somehow Dr. Herbner missed the obvious definition of the interest rate. I don't know how that's possible. No, but for Keynes, that's what it was. It is a, the interest rate is a monetary phenomenon. It's determined by the supply of the demand for money. The theory is called the liquidity preference theory of money. It's the rate of interest paid and received in the loanable funds market, right? And only in the loanable funds market. Hence, the interest, in essence, it's like interest foregone by holding money is seen as the price necessary to induce people to not hold money. It's the opportunity, it's the cost of holding money. It's the price of money. It's the price of hoarding money, the way Keynes would put it. As such, the quantity of money demanded varies inversely with the interest rate. If the interest rate is high, the cost of holding money is very high. It would be better for me to buy some bonds, right? And so the quantity of money demanded would be very low. If the interest rate is very low, then I'm not gonna make money very much in the bond market. So I'm gonna hold more money, right? So the quantity of money demanded is inversely related to the interest rate. Now, if the interest rate, according to the Keynesian theory, if the interest rate is, well, if the marginal efficiency of capital falls because of animal spirits below the interest rate, this makes spending on unproductive financial instruments, according to Keynes, increase. Because the cost of borrowing is not low enough to make investment in physical production attractive. And so investment in production falls. And decreases in investment, which is the decrease in I, that results in decreased aggregate demand, right? If investment falls, C plus I plus G together fall. So aggregate demand falls. And that results in an excess quantity of goods in the market. Malthus would call it a general glut of goods. And businesses would cut back on their production. Output would fall. The demand for labor would fall. And because wages and prices are quote unquote sticky downward, this results in a general glut of goods and unemployment and depression ensues. That's the explanation. Now, there are or Keynes saw at least sort of two primary potential solutions to this problem. One is state managed interest rates. We can manipulate interest rates to continually to ensure quote the appropriate volume of investment. We can solve this problem by increasing the money supply. If we increase the money supply, the quantity of money supplied will exceed the quantity of money demanded. So there'd be an excess supply of money. And then people would spend money on interest bearing instruments. People would spend money on bonds. They would go out and buy more bonds, financial bonds. Do, do, do, do, do, do, do, do, do, do, do, do. This increased demand for bonds will drive up the price of bonds and then decrease the interest rate. And so the interest rate then would fall to a point where suddenly now it's below the marginal efficiency of capital and investment in productive physical production then becomes attractive again. I goes back up. Agri-demand goes back up. Equilibrium output goes back up. Equilibrium income goes back up. The demand for labor goes back up and we're closer to full employment. So that's great. The problem for Keynes is that there are limitations on the effectiveness of this policy of increasing the money supply to lower interest rates, to stimulate investment, to stimulate agri-demand, to stimulate output and income. And one is the so-called liquidity trap. The idea that Keynes puts forward about the liquidity trap is he says, quote, after the interest rate has fallen to a certain level, liquidity preference may become absolute in the sense that almost everyone prefers cash to holding a debt which yields so low a rate of interest. So the interest rate could fall so low at some point it's just not worth it. People aren't eager at all to buy any more financial assets. And at that point, we reached that point of the low interest rate. Every extra dollar created, people will continue to hold it. The interest rate will no longer go down anymore, which means it no longer will provide an incentive for borrowing and physical investment. And so the effectiveness is neutralized. Now, Keynes actually thought that this was very unlikely to happen. It was not the main explanation for the limitation on the effectiveness of monetary policy. What he thought was more likely is the more likely a reason why the interest rate will not fall low enough is because essentially of transaction costs and risks. He says, quote, the intermediate costs of bringing the borrower and ultimate lender together and the allowance for risk, especially for moral risk, which the lender requires over and above the pure interest rate, will keep the market interest rate above, or well, it'll put it this way, it limits how low the interest rate can go. And once we get to that low point, of course, any further increase in the money supply is ineffective. Well, so what do we do? Well, then we come to his second solution, or the second enumerated, it's really plan A for Keynes if he could get what he wants, what he really, really wants. It's Keynes' zig-a-zig-ah, so to speak. And that is socializing investment, right? Socializing investment. It seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine the optimum rate of interest, of investment rather. I can see therefore that a somewhat comprehensive socialization of investment will prove the only means of securing an approximation to full employment. And so the point is, we're gonna have to have the state basically to just sort of come in and dictate and force enough investment to take place to prop up aggregate demand enough to keep us closer to full employment. Now, beginning with Samuelson, of course, there was also a third policy suggested, and it is a policy that you can sort of find inklings of in Keynes' general theory, and that is increasing government spending, right? We engage in increasing government spending to make up what we could call the investment gap, right? If investment falls by a certain amount of money, we increase government spending by the same amount of money, and that will prop up aggregate demand and we'll be back to where we want to be. So that's sort of the Keynesian story. There are a lot of things I wanna talk, I can say about this, I'm gonna talk about this, but we're gonna hold off, because I wanna go to the next framework, right? So we talked about auction economics, and then we talked about Keynesian macro, and by the way, I think it was Roger Garrison said, the reason we call it macro so often and not macroeconomics is there's so little economics in it, so as best as to call it macro. Anyway, modern monetary theory. Modern monetary theory is a, well, what should we call this? It's a newly titled, it's a newly titled, what should one even say? A newly titled policy suggestion, I'm gonna call it that, all right? If you're interested in this, by the way, there's important work that has been done on this, Robert Murphy, Bob Murphy's work on modern monetary theory at mesis.org, I recommend highly. Patrick Newman, an article recently published in the Atlantic Economic Journal called Modern Monetary Theory and Austrian Interpretation of Recru Descent Keynesianism. The article's good just for its title, and the rest of the article's pretty good too. I highly recommend both Patrick Newman's work and Bob Murphy's work on this. The key premises of modern monetary theory is that money is a creation of the state. Money is whatever the government wants it to be, and the government creates a demand for it by requiring it in payment for taxes. So that the whatever, the government can just decide something wants to be money and how they're gonna get people to hold it and use it while we're gonna force people to pay taxes with it and so it'll be written, so it'll be done. Another important premise is that the government cannot become insolvent. The government can never go bankrupt if it holds a monopoly on, if it issues its own money, it can never go bankrupt because it can always print more money to pay its debts and finance new spending. So as long as you have a government that has a, some people call it a central bank, but it's really a central money creating machine, as long as you have that, then you'll never have to worry about going insolvent because you can always just, it's like the old Frito, the old Frito Lake commercial. I know the old Doritos commercial, like eat all you want, we'll make more, right? You know, spend all you want, we'll print more, right? Another important premise is then that unemployment is due to insufficient government spending or we can put it this way. Again, so that the free market is incapable of having labor markets that clear and so there's always gonna be, what shall we say? Unemployment and we can fix that simply through increases in government spending. So it's really insufficient government spending, right? Some sense it's insufficient added demand, but it's the G that matters, right? Now, modern monetary theory arrives at its conclusions by manipulating the Keynesian income equation. So national income as you've already seen is Y and it's equal to C plus I plus G. We could also see it, national income is equal to consumption spending plus savings and taxes. So C plus S plus T are sort of the way people allocate their monetary incomes. They can spend it on consumption, they can save it, spend it on savings or they can spend it on taxes, right? So all income is spent on consumption, savings or taxation or spent on taxes. Now in equilibrium, of course, since Y is equal to C plus I plus G and Y is equal to C plus S plus T, in equilibrium C plus S plus T equals Y equals C plus I plus G. See how easy this goes. We can drop the C out of the equation because it's on both sides and then we're left with S plus T, saving plus taxes equal to investment plus government spending or we can rearrange the variables. So we have G plus T or G minus T, government spending minus taxes is equal to savings minus investment. And that's the big theoretical payoff, right? The government budget deficit is equal to net private saving. And so if we want to increase saving that will then work its way into increase our demand through investment. We increase government spending. We run government deficits. And so the policy conclusions is that the government can and should monetize government deficit spending, right? It's not that far removed from when I was at Paul Krugman in 2009 in the throes of the meltdown said, look, somebody has to spend beyond its means and right now it has to be government. And so it's basically taking the Krugman policy and making it sort of general policy. Government can and should monetize the government deficit spending. An increased definite spending will result in an increased net saving and hence an increase in output and employment. And the only thing that's holding us back it turns out is our political will. It's not economic reality. Now one might say, well, wait a minute, right? I mean, if we just increase the money supply and just print the extra, I don't know, four trillion dollars we're gonna spend this year, surely somewhere, somehow, sometime prices are going to go up and we're gonna get inflation. And they recognize this that price inflation can occur. There can be high price inflation. And if that does occur, well, we can simply fix that problem by increasing taxes. Because if we increase taxes, people will have to spend less on consumer goods and producer goods and that money will be sent to the government and the government sort of takes it off the table and the money supply comes back down and prices come back down. Well, so what are we to make of this? Well, there are a number of things I wanna say about the whole, the general Keynesian and modern monetary theory practice together. I do first want to mention a couple of things about modern monetary theory to begin with. And the first is that it's not exactly new. It's not exactly modern. And this is one of the things that really truly fascinates me about this. In the Wall Street Journal, in the Wall Street Journal not too long ago, Stephanie Kelton describes her what she called, she called it her Copernican moment. It was a moment that revolutionized her way of thinking. And she said it was in a conversation, she by the way is the author of this book called The Deficit Myth. And she's one of the, Stephanie Kelton is a proponent of modern monetary theory. And she describes in this op-ed piece that was derived from her book it said, a conversation with the Wall Street investor, Warren Mosler. And she says this quote, since the U.S. government is the sole issuer of the currency, he said, it was silly to think of Uncle Sam as needing to get dollars from the rest of us. My head spun. Like it was shocking, the idea, the wait a minute, wait a minute, wait a minute. You mean, if I want to spend money, I don't have to raise taxes and I don't have to borrow other people's, I can just create money, the government can create money. That, that makes my head spin. I did not know that that was possible, right? Well, the state theory of money, the idea that money is a creation of the state and so the state needs more money just makes more, that goes actually all the way back to Plato and Aristotle. Plato and Aristotle talked about that theory. Arrest me. Arrest me in the mid-1350s, wrote an entire treatise, essentially opposed to the state theory of money and talked about the economic problems of the state creating, that the king creating more money and then eating away people's purchasing power through spending it. So this theory is not exactly modern. It's also not exactly monetary. It is true that they talk about monetizing the debt. That is true, but really it is more of a fiscal policy than a monetary theory. It's simply talking about a different way we can fund fiscal policy, increases in government spending. So I would say it's not exactly monetary, it's more a fiscal policy than a monetary theory. And also we could say that it's not exactly a theory either, right? It could be called the modern monetary alleged accounting identity, right? It's sort of what we could call it. It ignores, for instance, that savings can increase without an increase in government spending. You don't see that in the equation because they conveniently drop C out of both sides. But the idea that, well, wait a minute, time preferences could drop so we could reduce consumption and then increase savings, that is possible. Well, it is possible if we include time and time preference into our analysis, but if we keep it out of our analysis, well, and of course we can't do that, right? And so consumption can fall, which can allow for, and does allow for, increases in saving and investment without any increases in government spending and without any need for increasing the money supply. And that's a good thing because when we increase the money supply, however we do it, to fund government spending, there are certain consequences. So I wanna talk about the general consequences of monetizing government debt. What are the general consequences of monetizing government spending? One is massive inflation. I mean, if we spend four or five trillion dollars above what we bring in in taxes and we fund that excess simply by printing four to five trillion dollars and given it to the government and the government spends it all, that's going into the economy right now. And all that does is increase G. Increase G is only an increase in dollars spent. More monetary units does not magically create more factors of production. We don't automatically get more land, labor and capital goods with more dollars. It does not therefore monetary inflation, more monetary units does not magically create more consumer goods. If there's no more land, labor and capital goods, there's not gonna be more consumer goods. So it increases demand, monetary inflation increases the demand for the same quantity of goods. So overall prices must increase. So that's one thing that's gonna happen. But additionally, it will also cause capital consumption. It'll cause capital consumption. What if Treasury issues new bonds which are resold to the Fed in the bond market? In other words, let's suppose that the Fed monetizes the debt sort of using normal, normal hyperactive, but nevertheless normal open market operations. New money will be injected into commercial bank reserves. Banks then will expand credit and artificially lower interest rates and that generates the inflationary boom bus cycle that Dr. Newman told us about. So it would create an inflationary boom and it would cause malinvestment. That malinvestment in the malinvestment capital is actually consumed and will be relatively impoverished. What on the other hand if the newly created money goes directly into the Treasury the way the modern monetary theorists would like it to happen? Well this forcibly increases the consumption saving ratio and hence overall time preferences. Because when the government spends money it's essentially government consumption. It's the consumption desired by the bureaucrat. And so consumption will increase relative to savings and that would be economically that's the same as an increase in overall time preferences. This reduces genuine savings and hence reduces capital accumulation. How so? Because it immediately increases government spending on welfare programs, guaranteed job programs, other pet projects, there may be sort of pet green subsidies that are doled out. But as I said this is consumption spending not investment and this type of spending will direct labor and resources away from their productive uses into uses that are relatively less productive and we know they're relatively less productive because if they were more productive they'd be undertaken by the entrepreneurs that are trying to satisfy people's actual preferences. So as consumption increases and saving decreases as consumption increases and saving decreases capital is consumed. And as capital is consumed that essentially is shrinking that capital structure. The capital structure will become less deep. There'll be fewer stages. The stages that exist will be narrower and the economy will be less capital intensive as people in general will be then less productive and bad times will be ahead. Now, as the rate of price inflation becomes the increase, their solution of course monetary, modern monetary theory will be taxes will be increased to reduce the money supply. Well, increased taxes we know reduces the incentive and ability to save and invest which further leads to and further encourages capital consumption. So the private economic order will progressively shrink relative to the size of the state. More and more economic decisions will be undertaken by the state less and less there are fewer and fewer economic decisions undertaken by private entrepreneurs because they'll have fewer resources with which to work. And it's very likely that the recurring increases in taxes will not actually arrest the inflation because the government does not like to receive money that just sits on and the money comes in they have a thousand points at which they can spend it. So the government will continue to run fiscal deficits by financing it's ever increasing spending with the money supply. And this would be the worst of all possible worlds, right? Massive inflation proceeding hand in hand with chronic depression. That 70s show all over again. And with that, I'll call it a day.