<blockquote>"Crude, old-style Keynesianism has thus returned with a vengeance. In truth, it never really left. Despite all the talk by government policy makers and central bankers and their macroeconomic advisers that they have painstakingly developed and learned to deploy sophisticated new tools of "stabilization policy" in the last 25 years, their tool shed is, in actual practice, completely bare of all but the blunt and well-worn instruments of deficit spending and cheap money. For their part, the mandarins of academic macroeconomics have revealed the total intellectual bankruptcy of their discipline and the laughable irrelevance of their formal models by abandoning all scholarly reserve and decorum and stridently promoting and endorsing the long discredited policies of old-fashioned Keynesianism. The amazing, knee-jerk resort to simplistic Keynesian remedies by the macroeconomics establishment in the current crisis is tantamount to the admission that there has been absolutely no progress in the postwar era in understanding the causes and cures of business cycles. This reveals a deeper and more chilling truth: contemporary stabilization policy is implicitly based on one of the oldest and most naïve of all economic fallacies, one that has been repeatedly demolished by sound economic thinkers since the mid-18th century. This fallacy is that there exists a direct causal link between the total volume of money spending and the levels of total employment and real income.
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In brief, Hayek argues that all depressions involve a pattern of resource allocation, including and especially labor, that does not correspond to the pattern of demand, particularly among higher-order industries (roughly, capital goods) and lower-order industries (roughly, consumer goods). This mismatch of labor and demand occurs during the prior inflationary boom and is the result of entrepreneurial errors induced by a distortion of the interest rate caused by monetary and bank credit expansion. More importantly, any attempt to cure the depression via deficit spending and cheap money, while it may work temporarily, intensifies the misallocation of resources relative to the demands for them and only postpones and prolongs the inevitable adjustment.
The reason why this is not perceived by Keynesians is because of an implicit assumption that Hayek identified in Keynes's writings. Keynes wrongly assumed that unemployment typically involves the idleness of resources of all kinds in all stages of production. In this sense, Keynesian economics left out the vital element of the scarcity of real resources, the
pons asinorum of undergraduate economic-principles courses. In Keynes's illusory world of superabundance, an increase in total money expenditure will indeed increase employment and real income, because all the resources needed for any production process will be available in the correct proportions at current prices. However, in the real world of scarcity, as Hayek shows, unemployed resources will be of specific kinds and in specific industries, for example unionized labor in mining or steel fabrication.
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The prevailing macroeconomics paradigm has burst asunder along with the real-estate bubble. Modern macroeconomists failed to forewarn against the dangers of the recklessly inflationary monetary policy pursued by the Fed in the first half of this decade. They now are at a complete loss for a coherent explanation of its consequences in the deepening financial crisis and recession that afflicts the global economy..."
- Joseph T. Salerno,
Introducing A Tiger by the Tail, 4/20/2009</blockquote>