Keynes and his contemporary followers don't understand the economy

From Mark Thornton of the Mises Institute on "the upside-down world of John Maynard Keynes"... (A free, audio version of this is available by clicking here.)

John Maynard Keynes often employed flowery language like "animal spirits" and "liquidity trap" to describe things he did not understand. He was, after all, more of a bureaucrat than an economist. In fact, he would best be described as an anti-economist because he eschewed things like supply and demand and held the opinion that government could run the economy.

So, for example, he could not understand why people would invest resources in risky adventures that helped keep the economy growing at full employment. He therefore substituted "animal spirits" for the profit motive. These spirits allow entrepreneurs to proceed with a naïve confidence and to set aside concerns over losses. Similarly, the failure to invest was also a psychological problem that he dubbed the "liquidity trap." This trap occurs when investors seek liquidity in cash and when monetary policy — in terms of cutting interest rates — no longer produces an increase in investment.

The problem with Keynes is that he thought that if entrepreneurs lose their collective nerve, the government should socialize investment, prop up demand and employment, and provide assurances to drive the economy back to full employment. He did not understand how the economy works so he could not understand how the economy corrects itself once a contraction occurs.

The problem for us is that Bush, Obama, Geithner, and Summers are all following the Keynesian playbook, with Nobel laureate Paul Krugman serving as head cheerleader. If instead we just allowed the free-market process to work, the economy would likely have already bottomed; companies like AIG would be emerging from bankruptcy and the unemployment rate would be dropping instead of continuing to rise.

The market process was curtailed just a few months into this contraction and — over the last 15 months — has been almost wholly replaced with government intervention....

This slew of interventions has been disorderly....Ironically, by adopting the Keynesian position that we have lost our "animal spirits" and are suffering from a psychological problem of fear, the government has undertaken extreme policy changes that greatly undermine the profit motive. Entrepreneurs are no longer looking for new profit opportunities in the economy. Instead, they are more likely either trying to preserve their capital or lining up for a government bailout....

Because they do not understand how the market works, Keynesians think [the self-correctingof the market] is a fantasy. But if you follow the Austrian recipe of allowing liquidation of bankrupt firms and debt, allowing prices to fall without monetary inflation, not propping up employment or subsidizing unemployment, and not discouraging hoarding, you will end up with the quickest possible recovery and minimize the magnitude of economic pain.