Krugman's Intro to Keynes's General Theory

Paul Krugman has written a very good introduction to Keynes's General Theory of Employment, Interest and Money:

In the spring of 2005 a panel of “conservative scholars and policy leaders” was asked to identify the most dangerous books of the 19th and 20th centuries.... Charles Darwin and Betty Friedan ranked high on the list. But The General Theory of Employment, Interest, and Money did very well, too. In fact, John Maynard Keynes beat out V.I. Lenin and Frantz Fanon. Keynes, who declared in the book’s oft-quoted conclusion that “soon or late, it is ideas, not vested interests, which are dangerous for good or evil,” [384] would probably have been pleased.

Over the past 70 years The General Theory has shaped the views even of those who haven’t heard of it, or who believe they disagree with it. A businessman who warns that falling confidence poses risks for the economy is a Keynesian, whether he knows it or not. A politician who promises that his tax cuts will create jobs by putting spending money in peoples’ pockets is a Keynesian, even if he claims to abhor the doctrine. Even self-proclaimed supply-side economists, who claim to have refuted Keynes, fall back on unmistakably Keynesian stories to explain why the economy turned down in a given year....

It’s probably safe to assume that the “conservative scholars and policy leaders” who pronounced The General Theory one of the most dangerous books of the past two centuries haven’t read it. But they’re sure it’s a leftist tract, a call for big government and high taxes.... [T]he arrival of Keynesian economics in American classrooms was delayed by a nasty case of academic McCarthyism. The first introductory textbook to present Keynesian thinking, written by the Canadian economist Lorie Tarshis, was targeted by a right-wing pressure campaign aimed at university trustees. As a result of this campaign, many universities that had planned to adopt the book for their courses cancelled their orders, and sales of the book, which was initially very successful, collapsed. Professors at Yale University, to their credit, continued to assign the book; their reward was to be attacked by the young William F. Buckley for propounding “evil ideas.”

But Keynes was no socialist - he came to save capitalism, not to bury it. And there’s a sense in which The General Theory was... a conservative book.... Keynes wrote during a time of mass unemployment, of waste and suffering on an incredible scale. A reasonable man might well have concluded that capitalism had failed, and that only... the nationalization of the means of production - could restore economic sanity.... Keynes argued that these failures had surprisingly narrow, technical causes... because Keynes saw the causes of mass unemployment as narrow and technical, he argued that the problem’s solution could also be narrow and technical: the system needed a new alternator, but there was no need to replace the whole car. In particular, “no obvious case is made out for a system of State Socialism which would embrace most of the economic life of the community.”... Keynes argued that much less intrusive government policies could ensure adequate effective demand, allowing the market economy to go on as before.

Still, there is a sense in which free-market fundamentalists are right to hate Keynes. If your doctrine says that free markets, left to their own devices, produce the best of all possible worlds, and that government intervention in the economy always makes things worse, Keynes is your enemy. And he is an especially dangerous enemy because his ideas have been vindicated so thoroughly by experience.

Stripped down, the conclusions of The General Theory might be expressed as four bullet points:

1. Economies can and often do suffer from an overall lack of demand, which leads to involuntary unemployment
2. The economy’s automatic tendency to correct shortfalls in demand, if it exists at all, operates slowly and painfully
3. Government policies to increase demand, by contrast, can reduce unemployment quickly
4. 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

To a modern practitioner of economic policy, none of this - except, possibly, the last point - sounds startling or even especially controversial. But these ideas weren’t just radical when Keynes proposed them; they were very nearly unthinkable. And the great achievement of The General Theory was precisely to make them thinkable....

So now let’s talk about the core of the book, and what it took for Keynes to write it.... In Book I, as Keynes gives us a first taste of what he’s going to do, he writes of Malthus, whose intuition told him that general failures of demand were possible, but had no model to back that intuition: “[S]ince Malthus was unable to explain clearly (apart from an appeal to the facts of common observation) how and why effective demand could be deficient or excessive, he failed to provide an alternative construction; and Ricardo conquered England as completely as the Holy Inquisition conquered Spain.”... That need to “provide an alternative construction” explains many of the passages in The General Theory that, 70 years later, can seem plodding or even turgid.... When you’re challenging a long-established orthodoxy, the vision thing doesn’t work unless you’re very precise about the details....

Keynes’s struggle with classical economics was much more difficult than we can easily imagine today. Modern introductory economics textbooks - the new book by Krugman and Wells included - usually contain a discussion of something we call the “classical model” of the price level. But that model offers far too flattering a picture of the classical economics Keynes had to escape from. What we call the classical model today is really a post-Keynesian attempt to rationalize pre-Keynesian views.... The real classical model... was, essentially, a 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. It was a model in which Say’s Law applied.... One measure of how hard it was for Keynes to divest himself of Say’s Law is that to this day some people deny what Keynes realized - that the “law” is, at best, a useless tautology when individuals have the option of accumulating money rather than purchasing real goods and services....

There’s a widespread impression among modern macroeconomists that we’ve left Keynes behind, for better or for worse. But that impression, I’d argue, is based either on a misreading or a nonreading.... If you don’t read Keynes himself, but only read his work as refracted through various interpreters, it’s easy to imagine that The General Theory is much cruder than it is.... Let me address one issue in particular: did Paul Samuelson, whose 1948 textbook introduced the famous 45-degree diagram to explain the multiplier, misrepresent what Keynes was all about? There are commentators who insist passionately that Samuelson defiled the master’s thought. Yet I can’t see any significant difference between Samuelson’s formulation and Keynes’s own equation for equilibrium employment, right there in Chapter 3: [29]. Represented graphically, Keynes’s version looks a lot like Samuelson’s diagram; quantities are measured in wage units rather than constant dollars, and the nifty 45-degree feature is absent, but the logic is exactly the same.

The bottom line, then, is that we really are all Keynesians now. A very large part of what modern macroeconomists do derives directly from The General Theory; the framework Keynes introduced holds up very well to this day.

Yet there were, of course, important things that Keynes missed or failed to anticipate. The strongest criticism one can make of The General Theory is that Keynes mistook an episode for a trend. He wrote in a decade when even a near-zero interest rate wasn’t low enough to restore full employment, and brilliantly explained the implications of that fact - in particular, the trap in which the Bank of England and the Federal Reserve found themselves, unable to create employment no matter how much they tried to increase the money supply. He knew that matters had not always been thus. But he believed, wrongly, that the monetary environment of the 1930s would be the norm from then on.... In the United States the era of ultra-low interest rates ended in the 1950s... Yet the United States has, in general, succeeded in achieving adequate levels of effective demand. The British experience has been similar. And although there is large-scale unemployment in continental Europe, that unemployment seems to have more to do with supply-side issues than with sheer lack of demand.... [Keynes] underestimated 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.... [T]he euthanasia of the rentier does not seem imminent. But there’s an even more important factor that has kept interest rates relatively high, and monetary policy effective: persistent inflation, which has become embedded in expectations.... [E]ven now, when inflation is considered low, most of the 20-year rate reflects expected inflation rather than expected real returns.

The irony is that persistent inflation, which makes The General Theory seem on the surface somewhat less directly relevant... 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....

What makes The General Theory truly unique... is that it combined towering intellectual achievement with immediate practical relevance to a global economic crisis.... There has been nothing like Keynes’s achievement in the annals of social science. Perhaps there can’t be. Keynes was right about the problem of his day: the world economy had magneto trouble, and all it took to get the economy going again was a surprisingly narrow, technical fix. But most economic problems probably do have complex causes and don’t have easy solutions....

Comments

[ken melvin]

Given time, all things and persons come to be known as conservative. If that screaming liberal Smith made it, so too shall Keynes.

[Sebastian Holsclaw]

Isn't the problem with Keynes' theory really a political artifact? In the real world, yes governments can stimulate the economy through spending. But they almost cannot cut back that spending dramatically when the economy is running well. This creates an unhealthy ratchet effect.

[Kevin Donoghue]

I'd like to read Krugman's entire piece. Was there a link there somewhere that I missed?

Sebastian, if the "ratchet effect" was a real problem wouldn't government spending consume an ever-greater share of GNP? I grant you that Keynes gave spendthrift politicians an excuse which they were only too glad to take. It's a bit like medical researchers saying that a daily glass of wine is good for you. But if that's what they find, that's what they should say.

[Anderson]

Sebastian, I'm not sure how "dramatically" fits in. Does Keynes require that adverb?

It would be nice btw to know what edition of the Keynes book this introduction is appearing in, if that's the kind of "introduction" it is.

[pgl]

Paul gets it exactly right. Now why didn't I write these excellent passages. Then again - something tells me that Donald Luskin will mischaracterize what Paul (and Lord Keynes) wrote - again. Which means that you get to write another Stupidest Man Alive post. After all - you did trademark this one!

[pgl]

Sebastian - governments can spend up or slow down government investments as a countercyclical tool. I need to check my notes, but haven't the Swedes tried this? Of course, I'm not sure what the track record is from this experiment. But as far as the U.S. is concerned, the only substantive variance in Federal purchases comes from defense spending - which DID fall in the 1990's.

[michael vassar]

Pierre: I generally hate to hear that x, y, or z " got us out of the great depression". How silly. Such statements seem to presuppose that the default would be for depressions to last forever.

[anne]

Of course, there was a budget surplus just 5 years ago thanks to Bill Clinton and the Democratic majority in Congress. There was a budget surplus and a sparkling economy. So Keynesian theory is indeed workable given political responsibility, which is just what we have not had since 2001.

[anne]

The supposed worry in 2000 was that federal debt would be gone this decade in the wake of a surplus hungry enough to devour Minnesota :)

[Bruce Moomaw]

To Pierre: Krugman has written frequently on how the contractionary force in Japan -- due to a radical collapse of the people's faith in their government's economic competence -- has reached such a point that even the most radical Keynesian polices can't retrieve the situation. (I presume this is an example of the Keynesian "pushing on a string".) He's also written that therefore the only solution is for the Bank of Japan to follow expansionist monetary policies, which (the last I heard) it was stubbornly refusing to do. Recognizing (as Keynes did) that the applicability of Keynesianism does have some limits is hardly the same thing as calling it invalid.

But, to Michael Vassar: the whole point of Keynesianism is that -- without some radical governmental action of some sort -- depressions CAN become stable and last forever (or at least for an extremely long time) contrary to what economists had believed previously. (According to Michael Stewart in "Keynes and After", the main flaw of monetarism is that it ends up mostly returning to the old discredited idea of such a self-righting economy where unemployment levels are concerned -- which is why Milton Friedman confidently predicted at the start of Thatcher's reign that her purely monetarist policies would quickly reduce Britain's inflation WITHOUT producing any serious rise in unemployment.)

[Colin Danby]

"Keynesian" is a floating signifier. Krugman gives a conventional hydraulic-Keynesian, IS-LM sort of reading which has certainly been influential within economics but which is a rather partial reading of the GT. Chapter 12 does not fit well into his bullet points, nor does JMK's QJE article in response to critics the following year.

JMK occupied an ideological niche that no longer exists (partly for good reasons), so efforts to peg him with current labels are silly. The best places to start are the horse's mouth: "Am I a Liberal" and other political essays in _Essays in Persuasion_. Robert Skidelsky, both in the short bio _Keynes_ (OUP, 1996) and the more recent 3-volume version, presents a thoughtful and informed view of Keynes' politics which emphasizes its Burkean affinities. Toye's _Keynes on Population_ (OUP, 2000) is also instructive.

Both supporters and detractors have passed up the chance to learn things by reading Keynes in the light of the postwar planning debates.

[pgl]

Pierre made a couple of points at the end that deserve further review. It is true that politicians abuse aggregate demand policies. The current Administration comes to mind. But how can one blame Lord Keynes for the fact that George W. Bush failed to listen to Glenn Hubbard and Greg Mankiw? As far as Ricardian Equivalence (RE) proving the General Theory wrong - the only aspect of Brad's four points that RE addressed was #4 - fiscal policy. RE would hold that changing tax obligations without changing the future course of government spending will not induce more consumption. Tell that to George Bush and Lawrence Lindsey. But changing the timing of government investment programs will change aggregate demand especially if there is Robert Rubin like commitment not to change the present value of government spending over the long-run EVEN IN A RE WORLD. So Pierre's point does not undermine the General Theory even if it does undermine the nonsense from this White House.

[robert waldmann]

I would consider the new alternator that the car needed to be the FDIC (or equivalent). Keynes was just talking about a jump start. Krugman's choice of metaphor is clearly deliberately odd, reflecting, I think, a fear that lord Keynes was a bit optimistic about capitalism.

Like many critics of Keynes, Holsclaw has remarkable resistance to facts. First, Keynesians can cut taxes as well as raise spending, and it is hard to raise taxes. The logic of the ratchet analogy implies that spending should go up and up and taxes down and down.

Clearly this has not happened in most countries, nor did it happen in the USA in the 20th century. This is a Bush administration phenonomenon and not Keynes' fault.

The cause of the upward trend of (G+TR)/Y is clearly something else, since much of it has been accomplished during periods of very low unemployment, when, according to Holsclaw, the political ratchet should be straining against pressure to cut spending.

[anne]

About Japan; there was a lack of understanding of the need for decisive monetary policy as early as 1992. Remember, the Japanese did not understand the growth limitations of the dramatic increase in the relative value of the Yen from the time of the Plaza Accord. However, Japan did use deficit spending effectively from 1994. Fiscal policy softened the effects of the slowing of growth on the middle class, and allowed for the slow structural changes needed for an economic revival. Paul Krugman has noted that government spending, which was regretted by Wall Street economists was an important cushion for Japan. As far as I can tell, Japan is recovered.

[Winslow R.]

Pierre wrote:

"(theres a vast literature in public choice economics / political economy showing that politicians are not the best people (to say the least) to have in charge of expenditure). "

Yes, I'm sure the author of this quoted literature or those funding their research would do a much better job spending 'the peoples' money. The problem with a representative democracy - it is for the politicians to decide. In China it's different. I'd prefer to live here.

In regards to Japan, deficit spending reached sufficient levels in 2002 and as long as they do not turn off the fiscal tap with Koizumi exiting in September (approx min -7%) , they will stay on the path to recovery.

fiscal balance
http://www.esri.cao.go.jp/en/stat/data/p027en.pdf

compare to

gdp growth
http://www.esri.cao.go.jp/en/stat/data/p001en.pdf

[Lawrence]

One can't help but note how Pierre lapses into truthiness(as oppossed to truthfullness). To repeat:
"In a letter Keynes wrote to Friedrich Hayek, he said “moderate planning will be safe if those carrying it out are rightly orientated in their own minds and hearts to the moral issue”. I really cant see how one can read this and assert that “Keynes was no socialist”. Krugman should recall that socialism is based on the concept of, well, central planning."

Notice how "moderate planning" becomes "central planning," a concept Keynes was thoroughly familiar with and detested. Furthermore Pierre equates central planning based on the expropriation or nationalization of lots of private property to moderate planning using public finance and monetary measures based on a market economy. The moral imperitive was to eliminate involuntary unemployment, and yes, horrible living conditions. Socialism sees no need for markets and thus you can centrally plan an economy. Not all what Keyne's had in mind. (Try reading his letters to George Bernard Shaw, who was a for real socialist, to see the difference).

Finally, why a letter to Hayak? Had Hayak had the courage to publish his thesis against Keynes while Keynes was alive then we could have had the opportunity to have a real response by Keynes.

[Lawrence]

One can't help but note how Pierre lapses into truthiness(as oppossed to truthfullness). To repeat:
"In a letter Keynes wrote to Friedrich Hayek, he said “moderate planning will be safe if those carrying it out are rightly orientated in their own minds and hearts to the moral issue”. I really cant see how one can read this and assert that “Keynes was no socialist”. Krugman should recall that socialism is based on the concept of, well, central planning."

Notice how "moderate planning" becomes "central planning," a concept Keynes was thoroughly familiar with and detested. Furthermore Pierre equates central planning based on the expropriation or nationalization of lots of private property to moderate planning using public finance and monetary measures based on a market economy. The moral imperitive was to eliminate involuntary unemployment, and yes, horrible living conditions. Socialism sees no need for markets and thus you can centrally plan an economy. Not all what Keyne's had in mind. (Try reading his letters to George Bernard Shaw, who was a for real socialist, to see the difference).

Finally, why a letter to Hayak? Had Hayak had the courage to publish his thesis against Keynes while Keynes was alive then we could have had the opportunity to have a real response by Keynes.

[Lawrence]

One can't help but note how Pierre lapses into truthiness(as oppossed to truthfullness). To repeat:
"In a letter Keynes wrote to Friedrich Hayek, he said “moderate planning will be safe if those carrying it out are rightly orientated in their own minds and hearts to the moral issue”. I really cant see how one can read this and assert that “Keynes was no socialist”. Krugman should recall that socialism is based on the concept of, well, central planning."

Notice how "moderate planning" becomes "central planning," a concept Keynes was thoroughly familiar with and detested. Furthermore Pierre equates central planning based on the expropriation or nationalization of lots of private property to moderate planning using public finance and monetary measures based on a market economy. The moral imperitive was to eliminate involuntary unemployment, and yes, horrible living conditions. Socialism sees no need for markets and thus you can centrally plan an economy. Not all what Keyne's had in mind. (Try reading his letters to George Bernard Shaw, who was a for real socialist, to see the difference).

Finally, why a letter to Hayak? Had Hayak had the courage to publish his thesis against Keynes while Keynes was alive then we could have had the opportunity to have a real response by Keynes.

[Lawrence]

One can't help but note how Pierre lapses into truthiness(as oppossed to truthfullness). To repeat:
"In a letter Keynes wrote to Friedrich Hayek, he said “moderate planning will be safe if those carrying it out are rightly orientated in their own minds and hearts to the moral issue”. I really cant see how one can read this and assert that “Keynes was no socialist”. Krugman should recall that socialism is based on the concept of, well, central planning."

Notice how "moderate planning" becomes "central planning," a concept Keynes was thoroughly familiar with and detested. Furthermore Pierre equates central planning based on the expropriation or nationalization of lots of private property to moderate planning using public finance and monetary measures based on a market economy. The moral imperitive was to eliminate involuntary unemployment, and yes, horrible living conditions. Socialism sees no need for markets and thus you can centrally plan an economy. Not all what Keyne's had in mind. (Try reading his letters to George Bernard Shaw, who was a for real socialist, to see the difference).

Finally, why a letter to Hayak? Had Hayak had the courage to publish his thesis against Keynes while Keynes was alive then we could have had the opportunity to have a real response by Keynes.

[anne]

Winslow is clever:

"there's a vast literature in public choice economics / political economy showing that politicians are not the best people (to say the least) to have in charge of expenditure)."

Ah, I understand, we must find non-politicians to be in charge of expenditure. Wherever though would we find such curious creatures :)

[Bruce Wilder]

We live in an era, when an alliance of the stupid with the greedy, prevails in politics. The Presidency of George W. Bush has been simultaneously an object lesson in why it is not a good idea to elect a moron to high office, and a boon to the corrupt and greedy.

In such an era, it must seem almost subversive to people like Pierre and Sebastian, to suggest smart, honest and decent might be better. Keynes's achievements are a monument to the advantages to the world of having some really smart, honest people prevail, from time to time.

The business cycle and the difficulties of developing and managing a system of financial institutions, money and monetary debt, had been wrecking periodic havoc and hardship at least since the 17th century. Oddly enough, just having an effective way of thinking about the macroeconomy has been a major obstacle to creating necessary institutions and policies. Truly moronic concepts have stuck in economics better, sometimes, than clear formulations.

On even the liberal blogs as well as in the daily newspapers, "the unfavorable balance of trade" is the subject of confident analysis and comment, with little apparent awareness of the irony that the current trade balance favors the United States rather strongly. But, the idea of what constitutes a "favorable" balance of trade, or a trade "deficit", was set in stone, by know-very-little mercantilists in the 17th century, and is better accepted by the man in the street than Ricardo's comparative advantage argument. Given that precedent in the history of economic ideas, that Keynes should be remembered at all is an achievement in and of itself.

But, Keynes achieved a great deal more. That central bankers, mostly, realize that the the best-of-all-possible-worlds involves their deliberate creation of a low, steady rate of inflation has saved the world since 1940 a great deal of suffering. Any plot of business cycles since the 18th century reveals the remarkable change, wrought by the abandonment of deflation and the gold standard as desiderata of national policy.

[Lawrence]

Arggh! Sorry about the multiple posts. I have no idea what I did.

[Knut Wicksell]

Nice. I taught the whole General Theory (students had to read every page of it and write an asigned essay on it) in an honours history of economic thought a couple of years ago (we do a whole year of it, so there's time). The students couldn't believe how sophisticated it was. The stuff on the stock market still has a bit of juice to squeeze (not much, but some).

I was lucky. Jim Tobin taught me. Once you'bve been through that mill, you really understand what Keynes was all about. Glad that Paul is giving him some more advertisement. As a general point, you are never a worse economist for having read the classics -- Smith, Ricardo, Marx, Walras, Marshall, Wicksell, Keynes, J.B. Clark and (even Menger),

[anne]

http://www.calvorn.com/gallery/photo.php?photo=6097&exhibition=7&u=99|3|...

Hooded Merganser
New York City--Central Park, Turtle Pond.

Bruce Wilder, nice :)

[Jim Dandy]

Apart from its practical implications (emphasized by Krugman), Keynes’ contribution in the General Theory had a profound significance in two areas that deserve equal emphasis:

(1) He broke through the prevailing fallacy of composition in understanding economic behavior (still prevailing in some quarters of orthodox economics today) by exposing what he called “the vital difference between the theory of the economic behaviour of the aggregate and the theory of the behaviour of the individual unit” (GT, Ch. 7, p.85 in my edition). This analytical breakthrough was crucial in making investment demand the decisive driver of the macroeconomic engine and relegating the saving decision to a more ambiguous and subordinate role (Ch. 16).

(2) The discussion of the marginal efficiency of capital (Ch. 11) and state of long term expectations (Ch. 12), taken together, still constitutes a uniquely fresh and creative understanding of the complex institutional and behavioral factors underlying investment dynamics in modern capitalist economies. One can see here (and elsewhere in GT) some of the nuggets that are currently being exploited in work on path dependence, hysteresis, and the like.

Any teacher of macroeconomics (as distinct from history of economic thought)who fails to recommend the GT as required reading for intermediate and advanced classes is doing a great disservice to today's students.

[Robert]

It is completely wrong to cite political problems in putting Keynesian policy into practice or 1970s stagflation as a refutation of Keynesian theory. Kalecki independently developed lots of the ideas, and experience with these issues just comfirms his 1945 essay "Political Aspects of Full Employment".

[Winslow R.]

Pierre wrote:

"Clintons' policies were decidedly anti-Keynesian and givesfurther credence to the concept of "expansionary fiscal contraction" (the very antithesis of Keynesianism)."

Marginal propensities to consume?

Spending can be matched with taxation resulting in a balanced budget and still achieve a Keynesian goverment increase in aggregate demand. How? By balancing increases in government expenditures with increases in taxes on those with high propensities to save and low propensities to spend.

We may agree the power of deficits can be 'misused' with the 'wrong' guys in office, but that is for 'the people' to decide. Vote in the last election?

[dsquared]

In general a good piece (and surprisingly congenial to the Post-Keynesian interpretation, whose relationship of mutual hatred and distrust with PK used to be quite startling in its ferocity). Just one quibble; it seems a bit odd to give Yale the credit for bringing Keynes to America, as the usual history of these things has it centred on Harvard and the group which included JK Galbraith.

[Lax]

Pierre wrote:
"The most charitable thing to say about Keynesianism is that its naive."

Hmmmm... I am waiting for the likes of George Loewenstein and Colin Camerer to come up with a piece titled "JM Keynes: THE Behavioral Economist". That should take care of the naivete allegation.

Agree with Robert and Kevin Donoghue, 1990s politics cannot be used to discredit 1930s scholarship. You cannot blame Keynes if your politicos are crooks.

[Jim]

Any economist who says he favors "the euthanasia of the rentier, and consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the
scarcity-value of capital" is ok in my book. You econommists sometimes seem to forget that "the economy" is a system of power relationships, and one which grossly benefits those with extreme wealth / power.

That Keynes is experiencing a revival is a hopeful sign.

[Ronald Brakels]

I lived in Japan for six and a half years and in that time we had constant deflation. Now I'm not a very clear thinker, but I think Keynes pointed out that deflation was ye olde spanner in the works of the economy. If the Japanese government never did what was necessary to lick deflation, I don't see how you can say Keynesianism doesn't work in this example. The best you can say that is inadequate Keynesianism doesn't work as well as you might like.

[larry birnbaum]

Speaking as a complete ignoramus, I always understood this as saying that economic systems (like lots of other complicated systems) can get stuck in local maxima that aren't actually very good, and such that the local hill-climbing mechanisms that constitute normal economic activity can't get them out of, and that the only way around this (like in lots of othe complicated systems) is to shake things up by adding lots of energy ( = , mostly, money).

Is this a ridiculous misinterpretation?

[Colin Danby]

Lawrence is right about about Pierre's conflation around "planning," and it's clear from his more recent posting that Pierre's notion of "Keynesianism" is not derived from reading Keynes.

But I do have to protest Lawrence's jab at Hayek. Hayek published plenty while Keynes was alive (see the list of major works here http://cepa.newschool.edu/het/profiles/hayek.htm)
and really can't be accused of a lack of fortitude.

[a different chris]

>Is this a ridiculous misinterpretation?

Not qualified to comment overall, but you meant local "minima". ;>

>It defies credulity that he, on the one hand, attacks the government and then goes on to ask for *more* government.

So I take it you're with me on the absolute disgust at the standard right-wing stance, the basic Republican platform, which is "government" is bad but "the military" is just the greatest thing ever?

[tedm]

I agree with Lax that the GT includes some components that would fit well in Behavioral Economics - especially the behavior of investors. JMK notes that some investors will base their behavior not on the fundamentals but on the expected behavior of other investors. Price declines could beget delay rather than increase quantity demanded, which could extend the period of price declines. The length of the time lag mattered to Keynes. Irving Fisher, who believed in a relatively quick macro rebalance, lost a fortune when he continued buying as the stock market declined.

Unfortunately for Keynes' theory, and for Krugman's belief in simple narrow technical fixes, people don't just anticipate other traders' behavior. They also try to anticipate the behavior of government policy-makers. The evidence seems to show that this is a devastating ommission by Keynes. If the anticipation is rational (Lucas Critique), the 'fix' will be merely ineffective. But, if Keynes and/or the Behavioralists are correct, the 'fix' could actually make things far worse.

I think the GT is a great read and an amazing contribution. Just keep in mind that government suffers from that physics principle that the observer affects the observed.

[Barkley Rosser]

Pierre,

Well, it is far from obvious that Keynes would have disapproved of Clinton's budget policy. It is sheer ignorance that lies behind the widely held view that Keynes was some big fan of big deficit spending to stimulate economies, especially ones not deep in Great Depressions. The traditional fiscal policy of the UK was to run budget surpluses, so what for Keynes was a stimulative fiscal policy was to run a smaller surplus during an economic downturn.

One can criticize Keynes for believing in what is now derisively labeled "fine tuning Keynesianim." OTOH, while he downplayed the ability of monetary policy to stimulate an economy in a deep depression, he did support focusing on interest rates in monetary policy and in keeping them generally low. To the extent the opposing view is Friedmaniac monetarism, Keynes is the overwhelming victor here. All central banks now target interest rates, not money supply, even if they are inflation targeting.

BTW, Keynes invented what is now the garden variety Principles text AS-AD analysis in Chap. 24 of the GT. He describes verbally the three zones of what is now called the SRAS, the horizontal "Keynesian" zone, the "intermediate" upward-sloping zone when bottlenecks start to appear in certain sectors, and the vertical "classical" zone when full employment is achieved, although in other places he seemed to see this as not such a limit.

The most currently prophetic chapter of the GT is Chap. 12 on long run expectations, with its brilliant and current remarks about financial markets. Some of this is very high powered. Thus, we have n-level game theory being done by Stahl and Camerer and others. The base is the beauty contest of Keynes, and they know it. That grad students currently do not know or read Keynes is meaningless. They do not study history of thought.

Regarding your supposedly wonderful theories, this sounds like you went to grad school in the 80s or maybe early 90s and did not learn anything since. Both Ricardian equivalence and "the death of Keynesian Economics" (Lucas) depend on rational expectations. This is now a joke assumption that nobody doing anything serious pays too much serious attention to, although it is still in some models. RE said the savings rate would rise when deficits went up, but it went down during the Reagan ones and now the Bush ones. Duh.

The current macro synthesis is dynamic stochastic general equilibrium (DSGE) models that supposedly combine "new Keynesian" and "new classical" elements, including some ratex stuff. Woodford and Svenson and some others will probably get Nobels for this curious construction. Menzie Chinn over on econbrowser has reported on how both the Fed and the World Bank have their own competing DSGE models, but they give very different results in forecasts due to different assumptions (duh). So, the WB model is much more pessimistic about the impact of US budget deficits on the US BOP than is the Fed's. Goody.

In fact, while it is true that grad schools no longer teach ISLM, most policy makers in fact fall back on it for analysis, for better or for worse. Of course, that construction was due to Hicks and Hansen, not Keynes, although he appears to have not disapproved of it too much.

Pierre, I think you need to do some reading and get up on the current lit. Ratex is dying as we read and write here.

[Urinated State of America]

'"Clintons' policies were decidedly anti-Keynesian and givesfurther credence to the concept of "expansionary fiscal contraction" (the very antithesis of Keynesianism)."'

This is a bizarre assertion. Clinton's economic team, including Tyson, Bentsen & Rubin, struck a deal with the Fed that if the Administration increased tax receipts to narrow the deficit the Fed would respond by lowering the target Fed funds rate. How is this not Keynesian?

[Sebastian Holsclaw]

"First, Keynesians can cut taxes as well as raise spending, and it is hard to raise taxes. The logic of the ratchet analogy implies that spending should go up and up and taxes down and down."

I'm sorry are you disagreeing with me? Keynesians CAN cut taxes, but in the modern era they don't. The only substantial Clinton-era spending cuts were in military spending with respect to the "peace dividend". The social spending expanded without a blink--ratchet effect. The military spending cuts were not sustainable after 9/11. The tax hikes of the time were very moderate--nothing for instance like what would be required to fund Clinton's more expansive policy wishes like his medical care ideas.

You are of course free to argue that Democrats aren't Keynesians--that they use whatever excuse available to permanently raise social spending. So during recession they pretend to be Keynesian and forget about it during economic expansion. Heaven knows Republicans don't live up to their alleged economic ideals.

The problem with economic theory in the political world is that it tends to get used by both sides only when expedient. Americans really want more social services. Democrats pander to that and make noises about economic sanity by nodding to tax hikes that don't even approach covering their spending ambitions. Americans really want lower taxes. Republicans pander to that and make noises about economic sanity by nodding to spending cuts that won't even approach covering their tax cutting ambitions. Neither party is willing to say that you can't have it all. Both parties will appeal to sound economic practices only when it fits in with their other agenda.

That is why I said: "Isn't the problem with Keynes' theory really a political artifact? In the real world, yes governments can stimulate the economy through spending. But they almost cannot cut back that spending dramatically when the economy is running well."

His theory could perhaps be helpful to a rational government that would increase spending only to prime the pump, and would decrease it after the economy was running well again. That isn't in fact our government--not under Democrats and not under Republicans. Until we deal with why that is so, his theory ends up being used in damaging ways because it is half-used as a convenient fig leaf for the policies each side already wants, but the balanced part of the policy prescription which does not conform to what each side already wants gets ignored.

[anne]

Duh; there was really really really a budget surplus during Bill Clinton's presidency. Not a deficit but a surplus, that has been frittered away with startling quickness since. There is no need to slash social benefit spending when the economy is strong, only a need to slow the growth now and again to keep the deficit growth in line with general economic growth. The only problem Republicans have with Keynes however is with social benefit spending for any reason not to mention social insurance such as Social Security and Medicare. As for war, however, spending hundreds of billions of dollars on Iraq is evidently of no account to Republicans.

[Walt]

Sebastian: Keynesianism (as practiced by both parties) saved American capitalism. The US used to have violent business cycles, much more violent than we have now -- the reason is Keynes. Those violent cycles were gigantic advertisements for socialism. The choice is not intervention or not; it's intervention or communism.

[anne]

These Republican squabbles have nothing to do with fiscal policy or deficits as such, only with the purpose of fiscal policy. War in Iraq, no matter the material cost is fine for these folks, Medicaid or HeadStart or Food Stamps gives them the shivers.

[andres]

Barkley Rosser did a good job of debunking Pierre's right-wing mythology about Keynes, so I'll not repeat him and instead I'll talk about an important half-truth about graduate schools made by Pierre:

"Regarding Krugmans claims that Keynesian economics is very much alive, Krugman would do well to remind himself of his own experience at MIT, widely regarded as the top econ dept. In an article (Theres something about Macro”) he tells us how the dept couldn’t get anyone willing to teach Keynes (except for him). He says:

You see, younger macroeconomists - say, those under 40 or so - by and large don't know this stuff. Their teachers regarded such constructs as the IS-LM model as too ad hoc, too simplistic, even to be worth teaching - after all, they could not serve as the basis for a dissertation.

He goes on to say that Keynesian economics is “regarded with contempt”. In this article he says “we really are all Keynesians now”. Well, how things change."

As pointed out, this may have been true in the 1980's and even the early 1990's. Krugman, by the way, was criticizing most economics graduate departments including MIT--in addition to salary and professional considerations, I'm guessing that a side reason that he left MIT was because in the area of policy recommendations as opposed to research the MIT department had become Chicago-Lite. Too many of MIT's most famous developing country graduates ended up crashing and burning in the real world of developing country political economy as a result of following neo-monetarist policies--Carlos Salinas and Domingo Cavallo being only the most famous examples.

Nowadays it is New Classical economics, created almost entirely as a reaction to Keynes, which has pretty much become passe in economics. I can't think of one major New Classical theoretical contribution--policy irrelevance, real business cycles, Ricardian equivalence--which has stood the test of time and is taken seriously by the majority of the economics profession. Even Rational Expectations is viewed as a rather shaky foundation given that the "real world" model is too often a shifting quicksand that is dependent on expectations themselves--anyone who takes RE seriously (either one) has not carefully read ch. 12 of the General Theory.

The mainstream of the economics profession still has a lot of _serious_ problems. As Colin Danby pointed out, too much of the modern understanding of Keynes is based on a mechanistic, hydraulic model of aggregate spending which is at best a subset and at worst a distortion of what the General Theory actually contains. And too much of microeconomics is still founded on Walrasian utopianism which presumes that perfect competition is the undistorted "original state of nature" whereas it is actually not simply utopian, but a logical fallacy as well, and therefore not fit to be used as a theoretical yardstick to judge on the effects of government policy.

Nevertheless, I would venture to say that in spite of its manifest shortcomings, the economics profession is in much better shape today than it was a decade and a half ago when monetarism and New Classical economics were still being taken seriously as policy agendas as well as research agendas. In the sad world of economics, half a loaf (e.g. a profession of Krugmans and DeLongs), is better than crumbs (a profession of Lucases and Barros).

andres

P.S. At the risk of going on a rant, I should mention that it is rather pointless to use Nobel-prize winning economists, even sympathetic ones, as authority figures when judging on the merits of Keynes and other classics, for the Nobel Prize is highly overrated. In my mind, the greatness of an economist is measured by the influence he exerts _outside_ of the economics profession's narrow research agenda, and by this standard, only four or five of the profession's 55 Nobels have really had much influence: Kuznets, Hayek, Samuelson, and Friedman. Scholes (and Black) have influence outside the profession, but it is almost entirely limited to the denizens of the financial derivatives markets. Two other Prize winners, Sen and Stiglitz, are still in the running and only time can tell. The rest, I would venture to declare, are either the unremarkable products of an intellectually inbred tradition, or have been forgotten outside the profession in spite of the importance of some of the things they wrote (e.g., Myrdal and Lewis). Enough said.

[anne]

http://www.calvorn.com/gallery/photo.php?photo=5895&u=4|2|...

Hooded Merganser (female) Drying Wings
New York City--Central Park, Harlem Meer.

Barkley and Andres, nice :)

[Esq.]

As a non-academic, non-economist, I find Pierre's comments on Keynes lack historical context.

Please recall that the NRA was one of the competing experiments put in place to combat the depression. As I understand it, the NRA was "moderate planning" in the form of government organized and abetted oligarchy, not central planning.

I also note that the CCC and WPA, as well as the draft, were examples of government spending with immediate effect on employment (spending which was later cut back too!) that have been left unmentioned.

[Jim Dandy]

“That grad students currently do not know or read Keynes is meaningless.” (Barkley Rosser).

BR, this seems to me a bizarre conclusion in an otherwise agreeable argument, and seemingly inconsistent with your argument.

Is there nothing, then, for current grad students to learn from actually reading Keynes?

[Tracy]

"Had Hayak had the courage to publish his thesis against Keynes while Keynes was alive then we could have had the opportunity to have a real response by Keynes."

Yeah, right. As if anyone would have had the courage to cross swords in a public arena with Keynes on any question involving economic theory. I mean Marx might have tried, if he had been around ...

Btw, Andres, you missed Leontief and Kantorovich in your list.

[Thorsten Veblen]

Tom,
While choosing to go to original data is a wonderful idea, please exercise care with the interpretation of that data.
(1) Read the definitions. The numbers you posted are total debt securities. In the venacular, most people think that an increase in debt is an increase in "overspending." What you have defined with these numbers is the equivalent of someone taking out a home loan and putting all the cash in the bank. While that is technically an "increase in debt", it is not how most people are interpreting the phrase - as excess spending over revenues. I realize there is a large desire to conflate this, but yes, there was a surplus in the last three years.
(2) Yes, Republicans had charge of Congress starting in 1994. Now go back and examine the prior Clinton Era budgets - subtracting the interest cost of that additional debt accumulated under the Reagan and Bush I administrations. While I would not argue that Gingrich and Clinton kept the Democrats and Republicans at a stalemate, it was not 1994 that brought fiscal responsibility.
(3) Do check who is "REALLY in charge of sending (sic)." As far back as I can remember, the Executive has now presented Congress with the budget. Does Congress modify the budget? It certainly can and does. For the most, however, the reality of the situation is that Executive can and does drive government spending.

[Barkley Rosser]

Jim Dandy,

I did not say that I approve of the fact that history of thought is not taught in grad schools. I simply recognize that it is a fact outside of some heterodox programs. The students are too busy taking math and getting ready to pass prelims to indulge in such things. Nothing any of us can do about it. They have to learn about the old farts like Keynes after they graduate and grow up.

[Robert]

"A riddle remains: why did Hayek fail to write a review of _The General Theory_?... He returned to the question often, probably because, as he put it, 'I have to the present day not quite over a feeling that I had then shirked what should have been a plain duty.'" (Bruce Caldwell, 1995. "Introduction" in _The Collected Works of F. A. Hayek, Volume 9: Contra Keynes and Cambridge: Essays, Correspondence_.

[Esq.]

I find it fascinating that econ grad students don't read Keynes, but I had to read large chunks of the General Theory as an undergrad, as part of a history of economic thought course. I still have my copy.

[liberal]

Sebastian Holsclaw wrote, "The military spending cuts were not sustainable after 9/11."

Yes they were. The _conventional_ military threat to the US did not increase after 9/11, which was committed, after all, by terrorist groups.

Only exception to this is that it was appropriate to remove the Taliban from power after 9/11, and that would indeed cost money. But most military spending goes towards military threats posed by other states' militaries.

[liberal]

andres wrote, "I can't think of one major New Classical theoretical contribution--policy irrelevance, real business cycles, Ricardian equivalence--which has stood the test of time and is taken seriously by the majority of the economics profession."

Since when is empirical validity a major concern of modern economics?

;-)

[liberal]

Thorsten Veblen wrote, "The numbers you posted are total debt securities. In the venacular, most people think that an increase in debt is an increase in 'overspending.' What you have defined with these numbers is the equivalent of someone taking out a home loan and putting all the cash in the bank. While that is technically an 'increase in debt', it is not how most people are interpreting the phrase - as excess spending over revenues."

But isn't the change in the debt going to equal excess spending over revenues?

Note that one difference is that total debt numbers will reflect debt owed by the general fund to the Social Security trust fund, whereas the most commonly reported deficit/surplus measures ("unified budget" numbers) don't. And IIRC if you take the SS surplus out of Clinton's surpluses, they shrink (thought in fact they disappeared except for one year).

"While I would not argue that Gingrich and Clinton kept the Democrats and Republicans at a stalemate, it was not 1994 that brought fiscal responsibility."

One very large factor was the 1990 Budget Enforcement Act, and its subsequent revisions. Which the Republicans didn't renew in (2002?) when it lapsed.

"For the most, however, the reality of the situation is that Executive can and does drive government spending."

True.

[PJGoober]

Here is a gem:

[There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of desttruction, and does it in a manner which not one man in a million is able to diagnose.]
-John Maynard Keynes
source:Mankiw, Macroeconomics 5th ed, pg 75

but Mankiw adds: "The hidden forces of economic law" that lead to inflation are not as mysterious as Keynes claims in the quotation that opens this chapter."

[PJGoober]

Here is Mankiw on the Great Depression:

[According to that [Classical] theory, national income depends on factor supplies and the available technology, neither of which changed substantially from 1929 to 1933. After the onset of the Depression, many economists believed that a new model was needed....

Keynes proposed that low aggregate demand is responsible for the low income and high unemployment that characterize economic downturns. He criticized classical theory for assuming that aggregate supply alone, capital, labor and technology-determines national income. Economists today reconcile these two views with the model of aggregate demand and aggregate supply introduced in Ch.9. In the long run, prices are flexible, and aggregate supply determines income. but in the short run, prices are sticky, so changes in aggregate demand influence income.]
-Mankiw, Macroeconomics 5th ed. pgs 257-258

[Bobby]

Hi,

I've got Paul Krugman's introduction in its entirety at the link below:

http://www.pkarchive.org/economy/GeneralTheoryKeynesIntro.html

[Mike D]

Keynes and the Great Depression showed the inadequacy of Classical Economics.

Pendulums of thought being what they are, things were taken too far.

Friedman-Phelps and stagflation of the late 60s and 70s showed the inadequacy of Keynesianism.

Pendulums of thought being what they are, things were taken too far.

IMHO, the current mainstream consensus has more or less equal roots in neo-classical and neo-keynesian analysis.

More Keynesian in the SR, more neo-classical in the LR.

[Damien]

[In the real world, yes governments can stimulate the economy through spending. But they almost cannot cut back that spending dramatically when the economy is running well.]

Either Krugman or Galbraith pointed out how progressive taxation and unemployment insurance can be a Keynesian auto-regulator. Economy dips, people lose their jobs, unemployment payments increase. Economy does well, people get more money, rise into higher tax brackets, and pay more taxes. No legislative action needed...

[Michael Emmett Brady]

It appears that all of the commentators above have overlooked the generalization that Keynes made in chapters 20 and 21 of the General Theory of the existing neoclassical theory,which was that the full employment condition in the aggregated labor market is given by the optimality condition that w/p=mpl,where w is the money wage,p is the price level and mpl is the marginal product of labor derived from an aggregated neoclassical production function.Keynes's generalization is that the condition needs to be rewritten as follows-w/p=mpl/(mpc+mpi),where the mpc is the marginal propensity to spend on consumption goods and mpi is the marginal propensity to spend on investment goods.Only in the special case where mpc+mpi =1 will the neoclassical case hold.Keynes's result can be obtained by anyone who knows how to simplify elasticities and integrate the derivatives to obtain Keynes's basic functions-D=pO being the expected aggregate demand function and Z=wN+P being the expected aggregate supply function,where P is expected economic profit(p.283,GT,1936).Set D=Z,solve and then combine with the actual,realized aggregate demand function Y =C+I from chapter 10.

[a]

The real classical model... was, essentially, a 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.

On the other hand it is still usefully employed to "demonstrate benefits" of outsourcing.