Keynes book would prove so controversial that in 2005 it would prove a strong contender for the title ‘most dangerous book of the 19th and 20th century.’
Like Freud’s work, Keynes book has shaped the views of people who haven’t heard of him or the book or think they disagree with it.
The message of Keynes:
Keynes’s book was in the context of the time a quite conservative book, despite this he was derided as a socialist and his ideas as ‘evil.’
Keynes book was written during the Great Depression, a time of huge unemployment, waste and suffering on an unprecedented scale.
Many scholars reached the conclusion that Capitalism had failed and turned instead to socialism, believing that perhaps nationalisation of production could restore the economic climate to stability.
However Keynes argued that because (in his view) these failures had narrow technical causes that the solution could also be narrow and technical. I.e. that whilst the machine was broken only one part needs to be fixed rather than replacing the entire machine. Especially when the new machine (socialism) wouldn’t be able to perfectly fit the place of the original.
The conclusions of The General Theory can be summarised as four points:
•Economies can and often do suffer from an overall lack of demand, which leads to involuntary unemployment
• The economy’s automatic tendency to correct shortfalls in demand, if it exists at all, operates slowly and painfully
• Government policies to increase demand, by contrast, can reduce unemployment quickly
• Sometimes increasing the money supply won’t be enough to persuade the private sector to spend more, and government spending must step into the breach’
Nowadays none of the above points would be startling or controversial except for perhaps the last one. However in Keyne’s time they were more than radical, unthinkable in fact. And as Krugman explains, it is Keynes’s greatest achievement to make the unthinkable, thinkable.
How Keynes did it:
Keynes was well versed in the economic theory of his time and thus believed he understood the power, merits and drawbacks of the theories he now challenged.
Because Keynes was developing a whole new way of thinking he had to clarify his thoughts in coherent explanation to others. So that his theory could not be faulted and would be accepted by the reasonable man. It is for this reason he devoted so much time to the specifics ‘the choice of units’ the definitions of income and savings etc. He knew that his new theory would hold no ground if he was not precise from the ground up.
The model that Keynes challenged was what we call today ‘the real classical model.’
This model was:
· The model of a barter economy, in which money and nominal prices don’t matter, with a monetary theory of the price level appended in a non-essential way, like a veneer on a tabletop.’
· A model in which Say’s Law applied: Supply automatically creates its own demand because income must be spent.
· One in which the interest rate was purely a matter of the supply and demand for funds, with no possible role for money or monetary policy.
As well as breaking free of the classical model, Keynes has to free himself from the times business cycle theory.
Mr Keynes and the moderns:
There is the impression that The General Theory failed to give monetary policy, largely purported by John Hicks in his essay ‘Mr Keynes and the classics.’
Krugman argues The General Theory neither dismisses nor ignores monetary policy, In fact Keynes discusses it at length and his theories are much similar to current theory of monetary policy.
However The General Theory is largely sceptic about adding to the money supply is enough to restore full employment. This scepticism was not born out of ignorance of the potential role of monetary policy but instead an empirical judgement on his part due to the fact The General Theory was written in an environment where interest rates were already so low that there was little an increase in the money supply could do to push them lower. In the economic climate of the time it is perfectly simple to see why Keynes’s scepticism was so prevalent in the chapter.
Alternate view:
There are those who argue we have lost the true Keynesian path and that modern macroeconomic theory is a betrayal of Keynesian thinking. This is because it reduces Keynes to a static equilibrium model and tries to based largely on rational choice.
On the issue of rational choice, it is true that compared with any modern exposition of macroeconomics, The General Theory contains very little discussion of maximization and a lot of behavioural hypothesizing.
Keynes had an emphasis on the non-rational roots of economic behaviour. It was only after Keynes that macroeconomics attempted to form models of consumption behaviour based on rational choice. Keynes meanwhile focused on psychological observation and felt that there is a strong non-rational element in economic behaviour. However his basis for discussion was not always correct whilst he argued on psychological grounds that the average savings rate would rise with per capita income it turned out not to be the case.
Whether or not modern macroeconomic theory is a betrayal of Keynesian thinking is a debateable one. However Krugman argues that it does not. That whilst Keynes was a keen observer of economic irrationality, the book was not primarily about this. Instead he chose to emphasise stability and ground that in rational choice.
The static equilibrium model Krugman argues is not a betrayal due to the fact much of Keynes work was indeed just that. That ‘employment is determined by the point at which the value of output is equal to the sum of investment and consumer spending.’
What Keynes missed:
The strongest ciriticism levelled at Keynes and The General Theory s that he mistook an episode for a trend. He believed that the monetary environment of the 1930s would continue as the norm from then on.
Why was Keynes wrong:
Part of his misjudgement was due in fact to him underestimating the ability of mature economies to stave off diminishing returns. Keynes’s “euthanasia of the rentier” was predicated on the presumption that as capital accumulates, profitable private investment projects become harder to find, so that the marginal efficiency of capital declines.
In the context of the time his view might have seemed reasonable, however after WW2 with a combination of technological growth and a population boom this opened up many investment opportunities that Keynes did not foresee in his theory.
Monetary policy has however remained effective due to persistent inflation which has resulted in higher interest rates than would be possible with stable prices. Whilst inflation is much lower than it was 20-30 years ago, it still maintains a vital role in keeping interest rates away from zero.
It is persistent inflation which makes The General Theory seem on the surface somewhat less directly relevant to our time than it would in the absence of that inflation. This can be attributed in part to Keynes’s influence, for better or worse.
For worse: The inflationary takeoff of the 1970s was partly caused by expansionary monetary and fiscal policy, adopted by Keynes-influenced governments with unrealistic employment goals.
For better: both the Bank of England, explicitly, and the Federal Reserve, implicitly, have a deliberate strategy of encouraging persistent low but positive inflation, precisely to avoid finding themselves in the trap Keynes diagnosed.
Keynes didn’t forsee a future of persistent inflation but no one else of the time did either. This tells us he was very pessimistic concerning the future prospects of monetary policy. It also meant he would never address the problems posed by persistent inflation, which instead preoccupied macroeconomists in the 70s and 80s.
Thus a failure to address problems that couldn’t be imagined at the time cannot be held against him. Now that inflation has subsided Keynes looks highly relevant again.
The economist as saviour:
The General Theory retains its importance and place in history due to its influence on the world. It made the idea that mass unemployment is the result of inadequate demand, an idea that had long been unthinkable become comprehensible and obvious.
The General Theory marked a period whereby economic policy was lead out of ignorance and into intellectual prevalence. This is the greatest strength of The General Theory, it combined intellectual achievement with immediate practical relevance in a time of global economic crisis. Keynes understood the prevailing economic ideas of the time and defied them completely with his radical critique of economic orthodoxy.
Keynes showed that: mass unemployment had a simple cause, inadequate demand, and an easy solution, expansionary fiscal policy. Whilst he was not always right, his influence continues to this day. As a radical and intellectual who only through intimate knowledge of a flawed system was able to fundamentally criticise and improve upon it.
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