Robin Hood and broken window facts and fallacies

Note: This is an update of two previous posts.

The broken window ‘fallacy’ is an enduring parable invented by Frédéric Bastiat in 1850, and popularized in English by Henry Hazlitt (chapter 2) in his attempt to combat the dominance of Keynesian macroeconomics after the Great Depression. The parable is primarily misused by austerians* in an effort to discredit Keynesian economics by associating it with a story about stupid policy: breaking windows. Austerians who misuse Bastiat’s parable of the broken window to refute Keynesianism are committing a Petitio Princpii fallacy. They assume what they purport to prove. They assume that breaking windows cannot help mitigate because there is already full employment which means they are assuming there is no recession to begin with.

In Bastiat’s parable, breaking a window would simply redirect workers from doing other work they had been planning to do. In Bastiat’s original example, the person whose window had been broken was planning to spend the time creating new shoes and ended up repairing the broken window instead so there is no change in employment because he is already working as much as he wants to work. Because the parable assumes no resources are unemployed, obviously a broken window cannot reduce unemployment and reduce the problems of a recession. But this is a straw-man argument because nobody argues for Keynesian stimulus when unemployment is low. Bastiat parable essentially assumes that unemployment is zero and then says breaking a window cannot reduce it which is true because unemployment cannot go below zero. This reasoning agrees with Keynesian theory because Keynesians support austerity when unemployment is zero, but when a recession creates high unemployment, a fiscal stimulus can do some good.

This Keynesian theory can be illustrated using a parable about Robin Hood breaking windows. Suppose the Sheriff of Nottingham decides to hoard as much money and other resources as possible. Rather than spending, he doesn’t buy services from the villagers. And the Sheriff wants to hoard the game animals in Sherwood Forest, so he does not let villagers hunt. This creates unemployment. In the Robin Hood legend, Robin creates work for his band of merry unemployed men by illegally hunting the Sheriff’s game animals in Sherwood Forest to feed the villagers.

This is tantamount to breaking windows, but they are destroying wild animals instead of destroying glass. Robin Hood is famous for stealing from the rich and giving to the poor. In this case he is not only redistributing resources, he is also increasing GDP by putting unemployed people back to work (hunting) and using underutilized capital (Sherwood Forest). It would be even more productive to farm the forest land, but the Sheriff’s men can easily control farmland and Robin Hood doesn’t have the military might to secure land for farming. The best Robin Hood can do is steal illegal game in the lightly-guarded forest. Robin Hood would prefer to steal the Sheriff’s gold, but that is impossible to steal because it is locked inside the heavily-guarded castle and Robin Hood cannot create jobs by employing the villagers to steal anything else.

If Robin Hood cannot steal the Sheriff’s unproductive gold hoard inside the castle, another way for Robin to create jobs for the villagers is to get the sheriff to spend some of his hoard by destroying something the Sheriff will want to rebuild. A simple way is for Robin Hood to use his arrows to break some castle windows. That gets the greedy Sheriff to spend some of his hoard to hire unemployed villagers to rebuild the windows (and perhaps hire more villagers to guard against Robin Hood). This grows GDP by making unemployed resources become more productive. Unemployed workers can produce windows and earn a living to feed their families. And some of the unemployed gold that the greedy Sheriff had hoarded becomes productive once again by circulating in the economy rather than just sitting idle in his treasury. Money is only productive when it is circulating and facilitating economic exchanges, so getting the money out of the Sheriff’s vault also acts as a monetary stimulus too.

Monetary and fiscal stimuluses work the same way. Both get money from hoarders and use it to increase spending. A fiscal stimulus is an increase in government borrowing that takes money from hoarders and tends to increase the interest rate that they earn. A monetary stimulus reduces the interest rate (and/or increases the inflation rate) which encourages hoarders to lend more money because it makes it harder to earn interest in safe investments. A monetary stimulus redistributes resources and ends recessions by punishing hoarders and encouraging spenders. Monetary stimulus is painful for savers. Although a fiscal stimulus would seem like it would be less politically painful because nobody pays any price in the short run ironically, the opposite is true. Fiscal stimuluses are almost never deliberately used whereas monetary stimuluses are routine. The Fed announces changes in monetary stimulus eight times per year, every single year. For example, as you can see in the graph below, the Fed sometimes changes the Federal Funds Rate eight times per year, and this is only one of several monetary policy tools at the Fed’s disposal.

So breaking windows can be a useful stimulus if there is a recession caused by a shortfall in demand (hoarding) which has been the main problem in almost all recessions in the past century (with the possible exception of the oil-shock recessions of the 1970s which also had notable supply problems). A recession caused by hoarding is a kind of market failure that wastes resources (unemployed labor and capital) sort of like breaking windows is usually a waste of resources. Ironically, when there is a market failure (hoarding), adding another market failure (breaking windows) can potentially make things better instead of worse! This is known as the theory of the second best and it is true in the Robin Hood example where Robin’s vandalism redistributes under-productive resources from hoarders to consumers which stimulates the economy and makes everyone better off except the Sheriff, and even he doesn’t suffer because he wasn’t using his hoarded resources anyway.

But breaking windows would be a ridiculously wasteful kind of stimulus that nobody would advocate except if all other options are impossible. Robin Hood would much rather simply steal resources from the Sheriff and redistribute them to the poor because that would be a much more efficient stimulus. Robin Hood doesn’t want to break window just to be spiteful. His purpose is not make the Sheriff suffer. His goal is to help the poor and although breaking windows is a stupid way to do it, it may be the best choice in this unfortunate scenario where the Sheriff’s stupid hoarding is keeping everyone else desperate and unemployed.

Similarly, Keynesians don’t promote spending money on wasteful projects like breaking windows because there are so many actual needs that new projects could try to serve. Keynesians are often quoted out of context in an attempt to discredit their ideas. For example Keynes is often ridiculed for writing that we could stimulate the economy by burying money in the ground and then letting others dig it up. He actually wrote that simple parable to ridicule the defenders of the gold standard who implicitly argue that we should pay miners to dig holes in order to create a monetary stimulus. He pointed out the absurdity of this idea because it would be cheaper and more efficient to print money and then use the money to pay some people to bury money and let people to dig it up again. He was not suggesting this as his preferred stimulus plan. He was merely pointing out that it is no more absurd than the gold standard. If you read the context of the quote Keynes was ridiculing the wastefulness of digging holes looking for money (gold). Later in chapter 16, Keynes repeats his criticism of the wastefulness of digging holes looking for money and wasteful government projects like building Egyptian pyramids. He reiterates that although it would work as a stimulus, it is ridiculous to think that such wasteful spending could be the optimal choice when there are many more useful things to do.

The Robin Hood parable illustrates why Keynesian economics is so politically polarizing. Keynesian economics only works by redistributing money from savers to consumers and that means redistributing from people who are richer than the median to people who are less-rich than the average. That is one reason why many rich elites are so passionate about opposing Keynesianism. Economists rarely acknowledge this fundamental reason for political tension because economists shy away from talking about redistribution, but it is baked into the Keynesian cake. The Robin Hood parable makes it memorable. The burden of government spending disproportionately falls on wealthy people in democracies. Wealthy people prefer to promote tax-cut Keynesianism as an alternative to Keynesian spending, but both forms of Keynesianism work in the same way.

In the Disney version of Robin Hood, the Sheriff taxes the villagers too much and Robin Hood steals from the Sheriff and gives money back to the poor like a tax rebate. This is another form of Keynesian stimulus. Tax cuts only work to stimulate the economy if they increase the incomes of consumers who will spend the money. Tax cuts do not work if they increase the incomes of hoarders who simply lock more money away. Giving a tax cut to the Sheriff would do nothing except encourage even more hoarding. Because the poor and middle class are better consumers than rich elites, a tax cut for the poor works much better to stimulate the economy than a tax cut for the wealthy people that pay the highest tax rates. Unfortunately, some of the tax-cut Keynesians are elites who just want an excuse to reduce their own taxes. Tax cuts for elites who hoard the money are ineffective stimulus compared with tax cuts for the median and below who have more needs to spend money on.

The tax-cut ‘Keynesians’ who want to cut taxes for corporations and the wealthy have it backwards. Tax cuts for the middle and bottom of the income distribution are much more stimulative than tax cuts for the rich because non-rich people tend to spend money whereas the rich just tend to add it to their hoard. That is exactly what happened to much of the tax rebate checks that George W. Bush sent out in 2008. High-income households pay the most income taxes and so a disproportionate amount of the tax rebate went to them and they tended to hoard it rather than spend it. Only the part of the tax cuts that went to the median household (and below) was spent and stimulated the economy. Research found little stimulative effect because of this and because even many of the low-income people used the rebate to pay back debt and thereby returned their money to the hoarders rather than directly spending it.

A reverse example is the payroll tax hike of 2013 which reduced take-home pay by 2 percentage points, but only on wages under $113,000. That means that almost all American workers had a tax increase this in 2013, but billionaires were scarcely affected. Whereas there was a tremendous fight in Congress at the same time about whether to raise taxes on the top 2% richest Americans, all workers saw our taxes rise without any complaint in Washington because Congress only cared about preventing tax hikes for elites rather than tax the tax hike that hit all ordinary workers.

Keynesian economics is favored by mainstream economists on mmutilitarian grounds–because it increases GDP–and Bastiat’s is smart to ridicule mmutilitarianism. Bastiat’s parable shows one way mmutilitarianism could go astray. Breaking windows (or a war, natural disaster, or pollution) never decreases GDP, so it is never bad according to naïve mmutilitarianism. Professional economists are rarely this naïve, but defenders of military spending sometimes come close. For example, Paul Ryan and Mitt Romney were criticized by libertarians for using this sort of mmutilitarian economic reasoning to support increased defense spending. Unfortunately Ryan and Romney had often used austerian logic against government spending that they opposed. So Ryan and Romney agreed with Keynesian logic for defense spending and tax cuts, but opposed Keynesian logic for many social programs. I supports Keynsianism because it tends to help the median of the income distribution (and below) AND it tends to increase GDP, and I have no problem with increasing the size of the economic pie (GDP) when the benefits are broadly shared.

Bastiat attacked the mmutilitarian logic that defense spending is always good for GDP. This is often derided by calling it military Keynesianism, but that is a misnomer because most of those people are just in favor of higher military expenditures regardless of the business cycle. Keynesians are often mischaracterized as always supporting increased government spending, but they support cutting government spending (to cut deficits) when unemployment is low. Military spending, like all government spending, is only good if it is more productive than its opportunity cost and the opportunity cost rises during economic expansions when businesses need more workers. In 2012, Ryan and Romney’s military spending priorities agreed with Keynesian logic because there happened to be high unemployment at the time and so there was a Keynesian justification for military spending. But Keynesians should support decreasing government spending when unemployment is low and Bush’s chief economic adviser, Michael Boskin always opposes defense cuts. For example, he opposed defense cuts in the mid 1990s when unemployment was extremely low and he made the nonsensical argument that it would increase unemployment at a time when unemployment was arguably too low. That is not Keynesianism, it is a true example of the broken window fallacy. Keynesianism recommend cutting government spending because unemployment was so low. When resources are fully employed, Keynesians agree with the broken window fallacy.

When hoarding (wasteful saving) causes a recession, the opportunity cost of government spending is extremely low when spending redistributes resources from unproductive hoarders who have too much money to the unemployed who have too little. During economic expansions when unemployment is low, savings (mostly of older, richer people) is productively channeled by financial institutions to borrowers who need the money more than the savers. Like an invisible hand, finance channels the impulse to save and hoard into productive activity by lending savings to people with a greater need of the resources. When a recession happens, the invisible hand of finance stops channeling savings to put people to work. Instead, the invisible hand of finance puts savings into unproductive hoards. The money leaves the economy which makes the economy poorer. Workers lose their jobs due to the lack of spending and factory owners go bankrupt because their factories sit idle. Keynes’ genius was in realizing how monetary and fiscal policy can be used to make the clenched hand of finance relax and release the hoards to get people (and our capital equipment) working productively again.

Robin Hood In Glassland

In the middle ages when Robin Hood lived (according to legend), glass windows were incredibly valuable and only the elites could afford them. The rareness of glass made stained-glass cathedral windows appear miraculously heavenly. Glass was still so rare in the early 1700s, that wealthy Americans could rarely afford much in the way of glass windows. At the time, stained glass exemplified the state of the art of glass technology although it evolved out of the technological limitations of the era. Glass panes were impossible to make smooth, clear and large anyhow, so glaziers might as well dope their off-color glass with extra color and fit the little pieces together into big stained-glass windows. Glass was still so valuable in the 1800s that it was still being used as money in some parts of the world.

Medieval Europe was bestowed with a relatively generous endowment of gold and silver, but it those metals had been as scarce as diamonds in Robin Hood’s England, ordinary people might have used glass as money like they did elsewhere in the world. If glass had been used as money, the parable of Robin Hood Breaking Windows would explain Keynesian economics even more clearly. Suppose the Sheriff was hoarding panes of glass rather than gold and silver, then even if Robin Hood could not directly steal the glass from the castle, he could indirectly ‘steal’ some of the Sheriff’s glass and give it to the poor by breaking the Sheriff’s windows. The Sheriff would have to pay peasants some glass to put them to work replacing his windows.

In a commodity money economy like this, Keynesian hoarding theory is even more obvious than in a paper-money economy like today. For example, imagine a society using iron as money. A recession happens when people start hoarding money (and rich elites have the most to hoard). Because they are hoarding a commodity money, it is clear that money hoarders are hurting the economy because they are hoarding iron which is useful. Hoarded iron is unproductive and people cannot work if they don’t have enough iron to make things. Hoarding is wasteful just like breaking things is wasteful. In an economic expansion, the invisible hand of finance would direct the iron hoarders to loan some of their unemployed iron to unemployed workers so that they can make more plows and pots and make everyone richer. In capitalism, flows of money are required to facilitate productive exchanges and induce people to be productive making plows and pots and other goods. It does not matter if the money is iron, paper or electronic. In a recession, the invisible hand of finance has a spasm and clamps too much of money in unproductive hoards.

Keynesian fiscal and monetary policies are all about loosening the cramped hand of finance to get the hoarded money–and the productive resources that the money commands–back out in the economy to can get people working again. Economics needs to expand its vocabulary to be able to explain recessions better. We need to be able to distinguish between savings and hoardings. When economists talk about ‘savings’ they usually mean lendings. A dollar saved is usually really a dollar lent to someone else because when you put it into the bank (or another financial institution), you have lent the dollar to the bank which promises to pay it back, often with interest. Saving is great for the economy when it increases capital investment and productivity and that is normally what happens. One person has more money than they currently have productive use for can help other people with a money shortage become more productive.

Hoarding is when money is taken out of the economy and hoarded for oneself without being lent out to someone who can use it. Hoarding is taking money, and the production that it represents, out of the economy for a time. During the Great Depression, many Americans hoarded their money by hiding it in mattresses or in buried jars because they understandably did not trust the banks to pay back their savings. In the modern economy, hoarding sequesters money in different kinds of places, but the effect is the same. For example, the Great Recession of 2008 was partly caused by banks hoarding money as excess reserves that sat unproductively at the Fed, but it had the same effect as if people were hoarding their money in their mattresses. It was also partly caused by banks hoarding money in complex securities like CDOs that got stuck because of defaulting homeowners and banks until the time-consuming legal process could sort out the complex contracts and decide how to divide the assets and liabilities that remained.

Another place Americans hoarded their money during the Great Recession was in government bonds. A government bond is normally a form of savings because it is a way to lend money to the government. But it is impossible to call it ‘lending’ to the government when government bonds pay a negative real interest rate. Real lending involves taking a risk and thereby earning a positive real interest rate. If a business in a competitive market could borrow money for a negative real interest rate, it would do anything it could to expand. That is because loans are free and if you don’t use free money to expand, your competitor will expand at your expense. The government doesn’t work that way. It does not spend and invest more money simply because private individuals are willing to pay the government to store hoards of money. The government was borrowing money at zero percent nominal interest and negative nominal interest rates became more widespread than ever before in history. That is just hoarding.

Any money that is kept as a store of value rather than as a medium of exchange is being hoarded rather than saved. Principles of economics teaches that money is useful for three purposes: 1) a medium of exchange, 2) a store of value, and 3) a unit of account. There is an inherent tension between the first two purposes because whenever money gets used as a store of value, it stops being used as a medium of exchange and that is what causes a recession. Money used as a store of value is hoarding. When money stops being used as a medium of exchange, goods and services stop being exchanged. Savings are different than money because savings pay positive interest and money does not. Savings should be used as a store of value, not money. Durable consumption goods like housing and clothes are another common store of value that earn a return because of use even if we never exchange (sell) them. Money is different from all other stores of value because money would be worthless if it could not be exchanged for something that is directly useful to have. Money is only valuable because it is easier to exchange than anything else. A positive real return on holding money is called deflation and deflation is particularly harmful because it encourages people to hoard more money. Good monetary policy should strive to prevent deflation and reduce the tendency to use money as a store of value. One of the reasons that recessions were so frequent under the gold standard was the fact that deflation was a regular recurrence whenever the price of gold (and therefore the value of money) increased.

If money gets used more as a store of value than as a medium of exchange, that is hoarding and that is what causes a recession, but for some reason, economists have ignored the central problem of hoarding and rarely use the word, so there is no agreed-up definition of what counts as hoarding, but I’ll give it a try. Interest rates should help distinguish between savings and hoardings because only money can be hoarded. Savings that are lent out at a positive interest rate means that the money is merely being transferred to a borrower who has an incentive to spend the money on something productive because the borrower is paying a real interest rate that prevents hoarding. That is why savings continue to circulate in the economy and hoardings don’t. Savings are lendings that are used to buy durable goods the yield a real stream of benefits and hoardings are where demand is simply sucked out of the economy altogether. Any financial asset that is being lent at a zero nominal interest rate (like T-bills during the Great Recession) is clearly being hoarded because a zero nominal interest rate is the same interest rate as money. Similarly, money that is saved at a negative real interest rate (when the nominal interest rate that is less than the expected inflation rate) is probably being hoarded because a negative real interest rate signals that the savings are achieving zero productivity.** Because risk is proportional to return, a negative expected return signals the low risk tolerance of a hoarder. Similarly, any for-profit business that keeps persistent balances at zero real interest or less (above the amount of cash needed to manage cash flow) is hoarding. Unfortunately, during the Great Recession, many private business like
Apple were run by executives with so little imagination and so little competition that hoarded billions of dollars at negative real interest rates rather than spending it on something productive. So big, profitable corporations were also guilty of hoarding.

It is harder to use interest rates to determine when the median individual is hoarding because average people are often liquidity constrained, have higher transactions costs, and have little knowledge of how to invest at a positive real interest rate, but the same kind of logic would apply if we could actually measure the money stocks that each individual holds, but we cannot, so the true quantity of money that is being hoarded will always be unmeasurable.

 

* ‘Austerians’ are people who want the opposite of Keynesian policies. In many cases it is because they actually believe the broken window fallacy is a fallacy. Unfortunately, there has been little support for Keynesian policies in government after the beginning of the 2008 recession. Obama was Keynesian only for his first year in office and then he abandoned Keynesianism and became an austerian. I supports Keynesians against austerians like the latter-day Obama, Michael Kinsley, and the BIS.

**During deflationary periods (negative inflation), the interest-rate definition of hoarding is a bit different because hoarders get a positive real return by simply hoarding cash. There is always a positive real return on hoardings during deflation which is why hoarding gets so bad during deflation. During deflation, hoardings are balances that are expected to earn zero nominal interest. If inflation is positive, hoardings are balances that expect to earn zero real return (or less) for at least six months. Savings are balances that earn an income greater than hoardings without any turnover for at least six months. Some balances that do not earn a real return are used for short-run transactions. This is a transactional balance that turns over with cash flow. That is neither part of savings nor hoardings because it is not intended to be used as a store of value, but as a medium of exchange.

 

Postscript

For further reading describing a more formal model, see how the textbook macroeconomic model of recessions should be written.

 

 

 

Hoardings cease to be used as money for facilitating transactions. Even when the government borrows at a negative interest rate, corporate bonds usually pay a positive real interest rate.

 

 

Savings is a hybrid between money and durable consumption goods because savings are lent to people who use the money to buy things that earn them a value in use and then they pay the saver part of the use value in use in the form of an interest payment. The only way to keep deflation from increasing hoarding is if the real return on investment for lending is high enough to keep the nominal interest rate from reaching zero.

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Posted in Macro
2 comments on “Robin Hood and broken window facts and fallacies
  1. […] Updated at Robin Hood and broken window facts and fallacies […]

  2. […] Updated at Robin Hood and broken window facts and fallacies […]

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