Friday, 2 August 2013

The “Austerian” Response to Keynesian Pseudoscience

William Watson has an editorial in the Financial Post attacking “Austerian” economics. This is what he wrote:
“Austerian” is a melding of “Austrian” and “austerity.” The two go together because the Austrian school of economics, represented most famously by Ludwig von Mises and Friedrich Hayek, rejected the standard Keynesian prescription for getting out of recessions or depressions, which was for governments to increase their deficits and debts.
“Either they don’t understand the circular flow of income and expenditure — my spending creates your income which creates your spending which creates my income — or they can’t grasp simple Keynesian arithmetic such as Y = C + I + G + (X-M), which means that national income and output, Y, is made up of Consumption, Investment, Government spending and the trade balance, which is the difference between eXports and iMports.

I would like to address this ratiocination in two parts. First, Watson’s assumption that an economy is a “circular flow” where “my spending creates your income which creates your spending which creates my income.” This can be scrutinized by referencing the Broken Window Fallacy. If a vandal breaks a window of a butcher, is the community richer? The butcher must go out and repair the glass, enriching the window manufacturer. But the butcher was going to spend his money on a new suit, enriching the tailor. There is hidden wealth that’s been destroyed thanks to the vandal’s actions. In an economic downturn, actions once profitable are revealed to be disastrous. Prices signify scarcity but governments attempt to override this process by taxing, borrowing, spending and inflating. When people should be saving, governments encourage spending by force. They are the vandals writ large.

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